The Money Supply, The Gold Standard and the Impending Doom

The Money Supply, The Gold Standard and the Impending Doom

Scroll down the comments of any financial article published on Yahoo Finance and you will read predictions of impending economic disaster. These comments can be downright scary for anyone reading them no matter what their depth of economic knowledge is. I have to admit, after a comment reading session on Yahoo Finance I’m ready to sell every stock I own to invest my money in canned goods and ammunition. Not really! but… It does make me think! So instead of just taking a stand based on what I’ve heard or read, I decided to do just that… I decided to think!

One of the most discussed issues relating to the economy is the ever increasing money supply. Economist like Ron Paul and Peter Schiff make the argument that by increasing the money supply we the people are being indirectly taxed by the government. This argument makes a lot of sense. The first lesson taught in any economics class is that as the supply of something increases, the value decreases. This is one of the reasons why the value of the US dollar has decreased so much over the past decade. I remember back in 2002 when I was stationed in Okinawa, I could purchase 120 yen for $1.00. Today $1 will only purchase 74 yen. Now, there are other factors such as inflation that need to be taken into consideration in order to find the real exchange rate, but right now I’m sitting at a bar on the beach in Destin, FL. so I’m not about to break out my calculator and start drawing up charts.

The point of this article is not to come up with a conclusive decision, but to introduce the questions that I have about money supply; so here they are. If we were to go back to the gold standard how much gold should the dollar be backed by? How would foreign currencies be affected? Would they have to switch to the gold standard too? Since the economy is becoming more global everyday, would switching to the gold standard really even be beneficial? What about the money supply? According to many doom and gloom economist, printing money is bad. The question I have is about population growth? Shouldn’t the money supply grow at the same rate as the population? If we don’t increase the money supply at or above the rate of the population then wouldn’t we experience deflation? Of course we would!

Suppose there are 10 people in an economy and there are 10 dollars, then this would equal a dollar per person. Now suppose these 10 people made some babies that grew up and had some babies of their own. Now there would be say, 25 people in the economy but only 10 dollars. In this new economy with no increase in money supply, there would only be 40 cents per person. These people would still need the basic necessities to survive but they would have less money to purchase their basic needs. What would happen? What would happen is the dollar would get stronger and prices would drop. This is deflation. Isn’t deflation bad? If prices are decreasing then consumers are less willing to spend because their dollar is getting stronger by the day. Why spend a dollar today if you could buy more with the same dollar tomorrow?

Consumers would also be less willing to borrow. Why would they want to borrow just to pay the bank back with a stronger dollar later? Also, with deflationary pressure employers would have to decrease wages. People, which are the most important component of an economy would not react well to cut wages; so why would the economy? Is this what would happen in the real economy if we stopped increasing the money supply and backed it by gold? Okay, so we can just back the dollar by gold and increase the money supply at the rate of the population growth. Is this the answer? One thing I know for sure is that there would be thousands of new jobs in the gold mining industry.

For every dollar printed there would have to be an equal amount of gold mined. Now that I’m writing this I’m starting to wonder… What is the real value of gold anyway? I can’t eat it. It doesn’t serve well for clothing. Maybe we should just back the dollar with water. Then everyone would be living on the coast wouldn’t they?

Like I said, the point of this article was not to come up with a conclusive stand but to just introduce the questions that come to my mind when I’m in the thinking mood. I agree with a lot of what Peter Schiff and Ron Paul have to say, but I also agree with their counterparts like Paul Krugman and dare I say Ben Bernanke. I guess I’ll just try to make the most money I can in the economy that I am exposed to and hope that the economy will find a fair equilibrium no matter what decisions are made.