Hehe...I used to be hung up on this too, so I'll spend some time explaining the conclusions I came to. Like any other commodity, the value of gold is determined
exclusively by supply and demand. Since we're not using gold as a currency today, there's only a moderate demand for it. In an economy based on fiat money, hunks of gold are useful for only a few things - jewelry, USB connectors, looking pretty, a relatively stable investment to protect against inflation, etc. Since gold in today's economy has no special status and it's treated like any other commodity, supply and demand therefore dictates that all the gold in the world is worth only $3.4 trillion right now.
However...
If we were exclusively on a gold standard and we actually used it as our currency, the reserve currency status of gold would drive demand for it wayyyyy up, making it much more valuable than it is now (some other poster once gave a figure in the ballpark of $111,000 an ounce in today's terms - I have no idea how valid that is, but it wouldn't surprise me). Similarly, under our Federal Reserve fiat currency system, our $1 bills are worth $1 (in today's terms, that is - they may be worth 4 cents in yesterday's terms
), but under a gold standard, the demand for those notes would drop to nearly zero, making them worth less than the paper they're printed on (unless we decided to use the same notes, except backed by gold...). In other words, no matter what you're using as your single reserve currency, and no matter how much or little of it you have*, the invisible hand of the market will force prices for goods and services to seek an equilibrium with the total volume of currency in circulation.
Now, what Ron Paul really advocates is not a single reserve currency but freely competing currencies (which probably requires the IRS to be abolished as a prerequisite, since it'd be hard to track
). In such a system, people can essentially use whatever they want as money, but the market will tend towards commodities that have the following two-and-a-half important qualities (there are probably others, too):
- It must be physically/chemically stable. Nobody wants their money spontaneously disintegrating, whether it be in their pockets or in a vault somewhere.
- It must be rare, and it must have a relatively constant or slow-growing finite supply. You don't want your currency to be common dirt, because inflation would go through the roof as people "discover" new money in their backyard. Also, the sheer amount would make it not only impossible to carry around but even impossible to store in a vault!
- Here's the halfway important quality: It's probably a good idea if the commodity is not really all that useful in the industrial sense: The high demand for the currency would make it impractical to use for most industrial purposes, and that would be a loss to the economy if suitable industrial replacements aren't found (or worse, if the currency was still used widely for such an industrial application, there would be a lot of deflationary pressure). If we were solely on a strict gold standard for instance, gold jewelry, dental fillings, conductors, etc. would all go through the friggin roof in price due to the demand for gold being about two orders of magnitude higher than it is today. This wouldn't be a huge deal...people would have to use other substances for conductors and dental fillings, and people would probably have to give up their sentimental attachment for gold jewelry and buy other types (unless they're obscenely rich), but in the grand scheme of things, these are small sacrifices to make for sound money.
Precious metals exhibit these qualities to a much greater degree than any other commodities (i.e. bags of grain). This is why precious metals such as gold and sterling silver have historically been chosen for currencies: They're simply the most practical and stable.
As I mentioned before, under a single, state-sponsored reserve currency like a gold standard, the prices of goods in services will seek equilibrium with the value of the total amount of currency in circulation. Under competing currencies (whether the currencies are state-sponsored or privately-issued), the prices of goods and services will also seek equilibrium with the total amount of currency in circulation, but they'll be balanced between the currencies depending on factors such as the market's confidence in each particular currency (supply and demand for each individual currency). The advantage of competing currencies is that the market gets to choose which currency it wants: That way, if inflation goes to hell like it is with our dollar (i.e. massive gold deposits are found in China), people can jump ship and use something more stable.
While I'm sure you already know this, I just wanted to make it explicit: Regardless of whether commodity-backed currencies are privately-issued or state-issued, nobody's actually talking about walking around with hunks of metal in their pockets - we'd still be using paper currency, credit-based transactions, etc.
There are some disadvantages and advantages of commodity currency under and over fiat currency.
Disadvantages:
- As I mentioned before, even precious metals have some industrial or cultural uses, so we'd have to make some small sacrifices (i.e. if went on a gold standard, we'd have to accept that gold jewelry will become quite rare and obscenely expensive).
- Technically speaking, whenever you're dealing in money based on real, physical commodities with a nontrivial intrinsic value, there's always a risk that they could be physically destroyed. Let's say someone nukes the vault your sterling is held in: Unless it's insured (or government-run and the government electronically redistributes all of the wealth to give people the same proportion of currency that they had before the attack), you just lost tons of money. As a side note, unless the event disrupts the entire economy, prices will probably go down to accomodate the new supply of sterling - unless that currency is issued only by the company or government owning the vault and the attack causes people to lose faith in that company's (or government's) security measures - then, demand will go way down, prices will go way up, and people will opt for a different competing currency.
- Under a true, disciplined gold (or platinum, or whatever) standard or under freely competing currencies, no unelected (or elected) body of elites can arbitrarily manipulate the supply of the currency. This is only a disadvantage if you're beholden to the Keynesian or monetarist schools of economics, which believe that disciplined, well-informed manipulations can prevent recessions for all eternity without any negative consequences
rolleyes.
Advantage:
- Under a true, disciplined gold (or platinum, or whatever) standard or under freely competing currencies, no unelected (or elected) body of elites can arbitrarily manipulate the supply of the currency. This would prevent our crazy boom/bust cycle, and it would also prevent runaway inflation and the inflation tax that destroys everyone not in bed with the government.
In my opinion, the advantage of commodity-based currency greatly outweighs the disadvantages, and here's why:
Although I haven't really studied Austrian economics, my gut instinct (and the failures of Keynesian economics) tells me Ron Paul picked the right school.
More importantly,
even if I'm wrong and the Keynesian or monetarist schools are theoretically correct, the Fed's behavior over the last century has shown us that human weakness will prevent Keynesian and monetarist economics from
ever being judiciously implemented in practice. Instead of only creating bubbles and printing money when new Keynesian economics says to (and also
restricting it when new Keynesian economics says to), the Fed has shown us that it will also print money simply to subsidize Congress's rampant spending problem, and Congress uses that as a blank check to spend even more! The resulting inflation absolutely destroys the savings of anyone who isn't a banker or on the receiving end of Congress's spending (either now or later - regardless of how much issued credit or printed money is not currently in domestic circulation, it
all will come back to bite us eventually). While "properly managed" fiat money may theoretically be the perfect currency, and it's the most compatible with interventionist and noninterventionist economic schools alike, history has shown us that we cannot ever trust it to be properly managed in practice. In my opinion, the seemingly inevitable inflation and wealth transfer under fiat money is
far worse than the vague threat of physical currency destruction (which can be insured against) under specie money.
*as long as the total volume of currency is divided into a sane number of pieces - you wouldn't want to use a single "magical rainbow piece of paper" as currency, where everyone in the world has to wait their turn to use it, and where people have to offer literally anything to get it back
EDIT: Hehe...Zippyjuan's quote about Friedman is actually quite funny to me:
Why wouldn't a market-based gold standard be feasible or desirable under present circumstances? Friedman explained his reasoning in an April 1976 lecture entitled "Has Gold Lost Its Monetary Role?" that was delivered in Johannesburg, South Africa. Simply put, governments are no longer willing to be restrained by a gold standard. They want control over money for various macroeconomic manipulative purposes. However, Friedman said that
"if you could re-establish a world in which government's budget accounted for 10 percent of the national income, in which laissez-faire reigned, in which governments did not interfere with economic activities and in which full employment policies had been relegated to the dustbin, in such a world you might be able to restore a real gold standardŠ. A real honest-to-God gold standard is not feasible because there is essentially no government in the world that is willing to surrender control over its domestic monetary policy."
The irony of this is that the reluctance of governments to give up their manipulative abilities (which they abuse the hell out of) is
precisely why commodity money is not only feasible but necessary!
Friedman was definitely a smart guy, but I think he sometimes forgot that we the people do not give a flying shit about what powers our governments wish to keep for themselves.
Our government is not meant to be our master, nor should it act like a spoiled child needing to be appeased. Our government is meant to be a servant to the people, and it is supposed to bow to the people's will without any selfish ambitions of its own. It's an outrage that we've let our government get so out of control that we actually have to listen to what IT wants...
BTW, more in response to the original post: From what I've gathered, the gold standard itself was
not the cause for the Great Depression. Rather, the Federal Reserve's
abuse of the gold standard was the cause: Every note was supposed to be redeemable for its face value's worth in gold, so the dollar was therefore tied to gold, but the Fed's fractional reserve banking system created loads of unbacked credit. This greatly contributed to the booming economy of the roaring 20's, but it came back to bite us in the ass when the resulting credit crunch hit. I saw a thread on these forums just a few days ago with a really telling graph...I can't find it now, but it showed that the value of gold (inflation and deflation) gently fluctuated throughout the 19th century (except for a spike during the Civil War), then as soon as the Fed was created, it started making much more wild swings.
