Classic Liberal Blog

In a series of posts, I'd like to answer a number of questions posed by Jenn (that deserve answers), and hopefully put a few economic myths to rest.

One of the main arguments against a gold standard is that there simply isn't enough gold:

I also know that there is not enough gold in existence to account for all the world’s economic activity unless you are going to artificially set prices. If you do that then the holders of gold will be wiped out.

Let's look at a simple illustration:

Imagine you're a baker, and the price of a loaf of bread is 1/100 oz of gold. The population and the economy grow, and there are now many more loaves of bread (and more of every other good and service, plus new goods and services). If the price of bread is 1/100 oz gold, but now there are many more loaves of bread, we would need more gold in order for people to be able to buy you're bread. So you have all this extra bread, but since there isn't any extra gold in the economy, it just sits on the shelf because people don't have the gold to pay for it. What do you, the baker, do? Do you keep charging 1/100 oz, leaving the excess bread to mold? Or do you lower the price, maybe to 1/150 oz, or 1/200 oz, in order to sell off your remaining stock? You would find, as all producers do, that 1/150 oz, while less than 1/100 oz, is still better than 0 oz, and you would do the latter, that is, to let the price adjust until you can find a buyer for all of your goods. Fortunately for you, the miller is in the same position, needing to drop prices in order to find buyers for all of his flour.

Or, imagine if we all wake up tomorrow morning to find that all of our money - checking accounts, savings, cash on hand, etc. - have all been cut in half. I had $20 in my pocket last night, now I only have ten. I come to you, the baker, in a panic. I explain that I need to buy my daily bread, but I have lost half my money. You, of course, have been hearing the same thing from all of your other customers, indeed, saw the same happen to yourself, and have discovered the miller in the same situation. There would be disruptions with such a sudden shift, as prices get sorted out, but in (probably short) time, we would see prices adjust to roughly half of what they were before.

Don't get to wrapped up in the details of this - they are abstractions to illustrate a point - but they show how the supply of money doesn't matter in the way that someone who objects that we wouldn't have enough gold thinks it does. Money conforms to the law of supply and demand just like any other good. So long as no one (read: the state) is preventing prices from dropping, the particular supply of money doesn't really matter. The general price level is a function of the quantity of goods and services in relation to the quantity of money. For a given quantity of goods and services, more money = higher prices, less money = lower prices. Conversely, for a given amount of money, more G&S = lower prices, fewer G&S = higher prices.

As you can see, the quantity of gold argument is a myth.