Roger Lowenstein discusses the problem with the ‘goldbugs’, those who want to return to the gold standard (boldface mine):
Let us interject that in any monetary system, some authority must fix either the price of money or the supply. McDonald’s can either set the price of a hamburger and let the market consume the quantity it will — or, it can insist on selling a specified quantity, in which case consumer demand will determine the price.
The Fed has a similar choice with money. The Bernanke Fed, which is trying to stimulate the economy, regulates the price of money — the interest rate — presently 0.0 percent. Paul Volcker, who assumed command of the Fed in 1979, when inflation was rampant, chose the opposite tactic. Mr. Volcker provided a specific (and, dare I say, miserly) quantity of liquidity, letting interest rates go where the market directed — ultimately 20 percent. There is an element of arbitrary choice either way.
The gold standard, in effect, replaces the Fed chief with the collective wisdom (or luck) of the mining industry. Rather than entrust the money supply to a guru or a professor, money is limited by the quantity of bullion. The law in the early 20th century stipulated that dollars be backed 40 percent in gold. This fixed the dollar in relation to metal but not in relation to things, like shoes or yarn, that dollars could buy. This was because the quantity of bullion that banks had in reserve, relative to the size of the economy, fluctuated. As a historian noted, it was as if “the yardstick of value was 36 inches long in 1879 … 46 inches in 1896, 13 and a half inches in 1920.”
The gold standard — which John Maynard Keynes termed a “barbarous relic” — led to ruinous deflations. When gold reserves contracted, so did the money supply. David Moss, a Harvard Business School professor, asserts that the United States experienced more banking panics in the years without a central bank than any other industrial nation, often when people feared for the quality of paper; specifically, it experienced them in 1837, 1839, 1857, 1873 and 1907.
But Lowenstein misses something very important.
The advantage of a fiat currency is that the economy is never currency-limited. We can still be resource-limited (either goods or people). We can be capacity-limited (e.g., not having enough factories to make stuff we need). But we don’t have to be currency limited, and sit around waiting for gold to be dug out of the ground.
If we have idle workers, idle capacity, and enough resources, but we are money-limited, which is where we are today, there’s a simple answer: alleviate the money shortage and print more money. We do that by deficit spending. The government electronically ‘prints money’ and moves it to the bank accounts of people who are doing stuff. And as long as we don’t bump up against the real limits of the economy, this is not inflationary.
That’s why fiat currency is an improvement over the “barbarous relic” of the gold standard.
Sadly, our political discourse still thinks we are on the gold standard. So millions will be out of work needlessly, and our infrastructure will continue to decay