The money supply, the gold standard and impending doom

Scroll through the comments of any financial article published on Yahoo Finance and you will read predictions of impending economic catastrophe. These comments can be downright chilling for anyone who reads them, no matter how deep their economic knowledge. I have to admit, after a session of reading reviews on Yahoo Finance, I’m willing to sell every stock I own to invest my money in canned goods and ammunition. Not really! but…it makes 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 regarding the economy is the ever-increasing money supply. Economists like Ron Paul and Peter Schiff argue that by increasing the money supply, we the people are indirectly taxed by the government. This argument makes a lot of sense. The first lesson taught in any economics course is that when the supply of something increases, the value decreases. This is one of the reasons the value of the US dollar has declined so much over the past decade. I remember in 2002, when I was stationed in Okinawa, I could buy 120 yen for $1.00. Today, $1 will only buy 74 yen. Now, there are other factors such as inflation that need to be considered in order to find the real exchange rate, but right now I’m sitting in a beach bar in Destin, Florida. so I’m not about to pull out my calculator and start drawing graphs.

The purpose of this article is not to make a definitive decision, but to introduce the questions I have about the 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? Should they also go to the gold standard? As the economy becomes more global every day, would going to the gold standard really be beneficial? What about the money supply? According to many pessimistic economists, printing money is bad. My question 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 population rate, then wouldn’t we experience deflation? Of course we would!

Suppose there are 10 people in an economy and there are 10 dollars, that would equal one dollar per person. Now suppose these 10 people had babies who grew up and had babies of their own. Now there would be, say, 25 people in the economy but only $10. In this new economy without an increase in the money supply, there would only be 40 cents per person. These people would still need basic necessities to survive, but they would have less money to meet their basic needs. What would happen? What would happen is that the dollar would strengthen and prices would fall. It’s deflation. Isn’t deflation bad? If prices fall, consumers are less willing to spend because their dollar appreciates day by 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? Moreover, with deflationary pressures, employers should lower wages. People, who are the most important component of an economy, would not react well to a drop in wages; so why the economy? Is this what would happen in the real economy if we stopped increasing the money supply and backed it up with gold? Alright, so we can just back the dollar with gold and increase the money supply at the rate of population growth. Is this the answer? One thing I am sure of is that there would be thousands of new jobs in the gold mining industry.

For every dollar printed, an equal amount of gold would have to be mined. Now as I write this, I’m starting to wonder… What is the real value of gold anyway? I can’t eat it. It does not serve well for clothing. Maybe we should just support the dollar with water. So everyone would live on the coast, right?

As I said, the purpose of this article was not to offer a conclusive position, but simply to present the questions that come to mind when I am in the mood to reflect. 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’m just going to try to make as much money as I can in the economy I’m exposed to and hope the economy finds a fair balance no matter what decisions are made.

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