The cross of gold

I notice that the nutcases advocating a return to the gold standard as the solution to all our problems are still rattling their antiquated 19th century chains. But that doesn't change reality. The biggest problem with gold-backed money is that it does not address the root cause of the inflationary/deflationary pressures inherent in the business cycle: fractional reserve lending. During the era of gold-backed money in the United States, we saw repeated inflation-deflation cycles that served to strip wealth from average Americans and transfer it to a group of oligarchs as debts taken out in cheaper inflated dollars could not be repaid in more expensive deflated dollars and thus the oligarchs took ownership of the real assets which secured the debts. The inflation-deflation cycles are inherent in the business cycle as banks expand lending during up times (thereby reducing their fractional reserves and thus inflating the money supply via the fractional reserve multiplier effect) and step back on lending in order to build up their reserves to cover losses during down times (therefore increasing their fractional reserves and thus deflating the money supply via the fractional reserve money multiplier). In short, a gold-based money supply in any economy that has fractional reserve lending is a recipe for transferring the wealth of the masses to a few oligarchs. Only a fiat money supply where money is printed during down cycles to prevent deflation, and where money is taken out of the money supply during up cycles, can prevent this inflation-deflation boomerang cycle if you wish to preserve fractional reserve lending as a part of your economy.

So fractional reserve lending is a fraud, you say? Uhm, no. Fractional reserve lending is where you loan your money to a bank for them to loan onwards. Still, it should be banned because of its inflationary/deflationary effects, you say? The problem then is that businesses no longer are able to leverage current economic activity in order to produce future economic activity, because you are greatly reducing the amount of money available to lend in an economy if you ban fractional reserve lending. Capitalism simply works better, responds to consumer demand more nimbly, if you can pay for the assets needed to satisfy consumer demands using the future income created by those assets, rather than requiring current cash sufficient to buy those assets. Any economy without fractional reserve lending is uncompetitive in the world marketplace and swiftly devolves to third world status. Just look at most of the Islamic world, where fractional reserve lending was largely banned as ursury for many, many centuries.

The end result is that for you to have a modern economy, a fiat money which can be inflated and deflated in inverse to the business cycle is necessary. The gold standard was a primary reason for why the Great Depression resulted in such a collapse of business activity between 1930-1933 -- the gold standard prevented the Federal Reserve from simply printing the fiat money needed in order to fill in the hole of all the money that disappeared due to the stock market crash and resulting contraction of the money supply, causing deflation, which caused people to default on their debts, which caused banks to collapse, which caused deflation, wash, rinse, repeat until most of the country devolved to a barter economy, which is incredibly inefficient at fostering business activity. A modern economy simply has too many intermediaries for barter to be an adequate method for handling the incredible series of trades needed in order to produce even the simple computer you're reading this tome on, that's the whole reason the Communist system collapsed, because it turns out that training an economy with tokens (currency) via the mechanism of the market simply works better. But this only works if the tokens have a reasonably constant value, slightly declining in value every year in order to keep them available for use rather than hiding under a mattress (where they foster no economic activity but, rather, simply serve as lumpy bed stuffing). Gold simply doesn't serve that purpose well if you have fractional reserve lending, thus why it's not used as the primary token of trade in any modern economy today -- NOT because of some secret conspiracy by Jewish bankers yada yada yada, but, rather, simply because it DOESN'T WORK.

- Badtux the Economics Penguin