Currency Not Tied To Gold Or Other Standard Becomes Worthless
November 25, 2011
The Washington Times
By Richard W. Rahn
The major world governments are in the process of destroying the value of the money their citizens hold. On Nov. 16, the Cato Institute held its annual monetary conference. Speakers included high-ranking officials from the Federal Reserve and monetary experts from the academy, think thanks and financial institutions. There was unanimous agreement that the world monetary system is in deep trouble, which is obvious to anyone who keeps up with the news. It is easier to observe the problem than to come up with a solution.
Economists define money as having the following characteristics:
A unit of account, meaning that we can define the value of goods and services in it.
A medium of exchange, meaning that others will accept your “money” (e.g., the U.S. dollar) for goods and services.
A store of value, meaning that it keeps its intrinsic worth.
Since the beginning of the Federal Reserve System in 1914, the U.S. dollar has been a lousy store of value. It is now worth just one-twenty-second of what it was worth in 1913 and only less than one-quarter what it was worth as recently as in 1971, when the United States officially cut the last tie of the dollar to gold. Even so, many people around the world prefer to keep U.S. dollars because dollars have been less subject to inflation than most other major currencies. At the moment, the U.S. dollar is losing value at a rate of about 4 percent per year.
Inflation occurs when the central bank – the Fed in the United States or the European Central Bank in Europe – creates money at a faster rate than the supply of goods and services increases. Changes in the rate with which people spend money (referred to by economists as changes in the velocity of money) also affect inflation in the short run. If people hold on to money rather than spend it, inflation will fall and vice versa. Central banks can control the supply of money but not changes in velocity. In the United States, velocity has fallen because regulators have been increasing lending standards, so, in many cases, banks cannot even make what they think will be good loans. Also, regulators have been increasing the amount of reserves banks must hold. The result is that even though the Fed has been rapidly increasing the money supply, much of it is sitting in banks rather than being used for additional investment or consumption. Even so, the growth in the money supply has been greater than the growth in new goods and services; hence the current inflation.
Democracies have an inherent flaw in that many seek to use the political process to transfer wealth from some to others. This leads to counterproductive levels of government spending. People also dislike paying taxes. Therefore, the politicians tend to spend more than the tax revenue provides, and this excess spending is funded by the sale of government bonds. Under a classic gold standard, the sale of bonds by government was limited to the amount of gold the government held, plus the amount of gold that the bond buyers could reasonably expect the government would be able to buy from projected tax revenues if it became necessary.