Gold Standard

The value of money

What is the value of your money? Doesn't your money always have value? Well no. Your money is only worth as much as it buy! This is why 1 American dollar is worth more than 1 Mexican Peso. So does it occur that 1 American dollar is worth more than 1 Mexican Peso?

Well for this, we have to go back to the old days. What is money is basically trade. It represents value. So let's go throuhg the time line.

1. People exchange good directly. I trade you 1 cow for 10 chickens.
2. This becomes tedious, so people trade via rare objects than represent wealth. I trade you 1 cow for 10 pieces of Gold. This requires everyone to accept that a piece of Gold has value and can later be redeemed for goods. Gold is good because it is rare, doesn't rust or deteriote, easily maleable…
3. People eventually find it easier to represent Gold with Paper (more complicated reason, but for simplicity). So now, I trade you 1 cow for a 10 dollar bill that represents 10 prices of Gold.
4. Government eventually decide they don't like to be limited by the supply of Gold, so they invent fiat money. Basically they control the amount of paper money in circulation. So now, I trade you 1 cow for a 10 dollar bill that represents the trust you have in the government.

All the way before step 4, the trade invovles real value or a representation thereof. Only in step 4, does the government/centrla banks able to decide how much the value of money is. Consider this.

Suppose a country has 4 people and a central bank. Each person has the amount of money stated.
Person 1 farmer $5000
Person 2 blacksmith $10000
Person 3 makes bread $3000
Person 4 entertainer. $2000

All the money in the country is $20000
Now imagine a central bank decides to print money to fund a war or some other government program. If it just prints $100, not much changes in our 4 person country. What if the government prints $1 000 000. Suddenly, all the wealth earned by the farmer and the rest of the workers becomes worthless as the government has just thrown in so much more money.

This by the way is exactly what happened in Zimbabwe (circa 2006). President Mugabe was spending too much money and jsut started printing more and more money. That makes Zimbabwe's money worth less and less to the point that it now requires over 1 billion zimbabwe dollars to buy cup of coffee.

Gold Standard

So what about the Gold standard. The gold standard is a way to protect the individual from this kind of printing of money.
What it means is that each printed dollar is backed by real physical gold. For example, 1 dollar is backed by 1 ounce of gold. This was true in the US before 1971. Is there anything special about Gold? Not really, it is just rare enough and doesn't deteriote.

Does Gold protect you from inflation?

Kind of. You can mine new gold and suddenly introduce new gold into the system just as you can print money. However, finding gold is rare and requires work. you have to spend money and investment to mine it and even then, the amount you find is limited. Wheras, in a purely fiat system, the government can just print money with the flick of a switch. So even with Gold, it is possible to lose the wealth you have as people mine new gold, but that is limited by the time and effort to mine new gold as well as the limited amount of gold in the world. You can't just mine 1 000 000 000 worth of gold in a day :P

So Gold protects you from bad government fiscal policy.

It is not a cure all. The gold market can be cornered and perhaps a basket of precious metals or others is better. In any case, the gold standard really acts as a balance to government. However, any society that steers away from liberty will eventually turn to a fiat currency to finance itself (unless its a resource rich country). So the real problem is not the currency, but the size of government and liberty.

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