re: #480 subsailor68

Sigh, where’s 3wood when I need him? I don’t really understand all the issues around tying a currency to a commodity (like gold or silver). I read an article recently (maybe Thomas Sowell - can’t remember or I’d try to find a link). It was a response to Ron Paul supporters who support a return to the gold standard. The point of the article was (and my numbers are probably off a little, but the point’s the same) that the GDP of the U.S. last year was around 12 trillion, and the total value of all the gold EVER mined is around 7 trillion, so a return to the gold standard would force an instantaneous contraction of the economy by about 60 percent - if we already owned all the gold in the world (which we don’t).

So, in my really lacking understanding, my question to the smart lizards here is - wouldn’t the same concept apply to any commodity of finite supply?

To “back” a currency with a hard asset (like gold) simply means that, at any time of the currency holder’s choosing, a unit of that currency can be exchanged for a comparable unit of the asset.

Does that mean that you have to have as much of that asset as you have units of that currency issued? No. The fundamentalists will tell you “yes” but they are wrong. And there is no avoiding it.

Here is why.

Banks are supposed to be able to provide depositors their funds on demand. But banks are in the business of lending out those deposited funds and making money on the difference in interest paid versus charged. The only way to do this is to hold a percentage of those deposits - to more than cover what one would expect in the way of withdrawals in a given period of time. When the economy is stable and the bank is perceived as solvent this works out fine. In fact, it works out so well that it actually makes the economy larger - with money available to borrow, people start businesses and employ people. Or they build houses and live in them, which also employs the people who build houses and provide goods and services to home owners.

Now if a bank could only lend excess funds (accumulated profits) then you would see far less economic capacity. In general, Money Supply metrics measure this economic capacity.

Getting back to the “hard asset” backed currency, theoretically the government would have to hold as much of the asset as there is of the currency. But it can’t. With credit cards and other forms of lending there are dollars out there that the treasury has never printed. If you have $500 in a savings account and the bank has lent out $400 of it there are $900 out there. And if you are a public employee, then the $500 you were paid and saved was probably borrowed from someone else. So unless you eliminate lending of borrowed funds from the economy you will never have this fundamentalist nirvana of a fully solvent economy.

Economies that prosper are based on trust. Trust in the person you are doing business with. Trust in law enforcement. Trust in your employer. Trust in the courts. And when people feel good about society they spend more and take more risks which creates prosperity.

Pegging the dollar to a hard asset won’t do anything to change that although it will prevent the government from acting like a bank. But we need the government to act like a bank and show trust in the economy when no one else has it. That is what the last 12 months have been about. Fundamentalists freak out about it, but letting all bonds of trust disintegrate in the economy so as to start with a clean slate is akin to amputating a hand to treat a hang nail.