My question is about gold standard. But not the version I always see mentioned (trading bills for gold at a set price). I mean having gold coins in circulation.

For example, new currency consists entirely of gold coins (various sizes/purity diluted with worthless metal). The ratio is 1¢/mg with coins ranging from 1 cent to 100 dollars (worth roughly 5x that in current money). The 100 dollar coin maybe being pure gold (quarter-sized, used mostly for saving).

This system seems to have a few good advantages. Simple to understand, minimal inflation (I think), people owning real value instead of worthless paper/plastic being trusted etc. How well would this system function and what possible problems are there with it?


Here are three types of money:

  • Commodity money: goods of value are used as money (e.g. gold in your example, or cigarettes in a prison),
  • Representitive money: money is still based on a commodity but, instead of actually using that commodity in exchange, they use pieces of paper that can be exchanged for the commodity (e.g. the gold standard),
  • Fiat money: money with no intrinsic value, which is trusted by people because they government tells them it will be the official medium of exchange into the indefinite future (e.g. the modern US dollar, British pound, Euro, etc.).

A fourth type that is emerging (e.g., in the form of Bitcoin) has no intrinsic value and no official backing from government. It is accepted in exchange solely because people believe that will be able to spend it again in the future.

The physical burden of physical money

Firstly, there is a serious practical problem associated with commodity money in its purest form, namely that transporting and storing the money is difficult and expensive. If I want to buy a house, am I supposed to work around with half a million dollars worth of "stuff" in a briefcase and hope nobody steals it? What if I want to buy a book from Amazon? Do I have to send them some gold coins in the mail?

At the very least, these considerations are going to compel people to use representative rather than commodity money.

The problem of debasement

Where commodity money has been used historically, it has been exposed to the problem of "shaving". Since the currency is intrinsically valuable, there is an incentive to shave a tiny amount off of each coin (such that the difference is indistinguishable from normal coin wear) and melt those shavings together into a piece of precious metal that can be sold. You can read more about this here.

Takes away some valuable policy tools

Imposing a commodity money would take from the government some valuable tools to deal with economic shocks. In particular, it reduces the ability of the government to use monetary policy to reduce the real effect of economic downturns. For example, during the most recent recession, major governments engaged in "quantitiative easing", which saw them creating new money to stimulate the economy. This would be much more difficult if creating new money meant having to dig a significant quantity of gold out of the ground of another country.

Additionally, it is not obvious how big/genuine the advantages you describe are. For example, here is a plot of US inflation:

enter image description here

Note that inflation tended to have higher peaks and be much more volatile during the first half of the C20 than in recent years. But that was exactly when the gold standard was in effect and the value of currency was directly tied to a physical commodity. Also, deflation was more common then, which is problematic because deflation has a number of damaging effects on an economy. Modern policy makers are better able to regulate the money supply to control inflation and keep it around the low and stable levels thought to be optimal.

People might be more willing to trust commodity money. But they would have to overcome concerns about counterfeiting and debasement. Recent experience from the last half century has been that people in stable democracies are, in fact, quite willing to trust fiat money.

Edit in response to comment:

  1. It's true that precious metals are sufficiently valuable that large quantities are not needed to make most payments. But the problem remains that (a) if I am carrying them around to make payments then I am subject to a new source of theft/loss that is less acute with electronic financial balances; (b) insisting on a physical commodity money makes it hard to transact remotely (e.g. buying goods online or remitting money to pay for bills or an invoice); (c) businesses regularly need to spend, store, and move money on the order of millions or sometimes billions; often across borders or oceans. Moving from a world in which money can be stored and moved at essentially zero real cost, with essentially zero delay, to one where we are burning real resources to move physical stuff around would be a huge technological step backwards.

  2. I don't understand what you mean about debit cards. Your whole question started out with "...not the version I always see mentioned (trading bills for gold at a set price). I mean having gold coins in circulation..." i.e. we are talking about commodity money, not representative money. Yes, debit cards fix the problem of physics, but they also mean we aren't talking about commodity money any more. Having a debit card you can hand to your bank in exchange for gold is really equivalent to having a US dollar banknote that you can hand in to exchange for gold.

  3. Yes, the US dollar has lost a lot of its purchasing power. But that's a good thing! There are numerous economic benefits to a low (but positive) stable rate of inflation. Inflation per se is not bad, it only becomes problematic when we have either very high levels of inflation, or when the rate of inflation is not stable (both were true under the gold standard).

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  • $\begingroup$ Thanks for the detailed answer. Although I'm not sure some of the things you mentioned are issues with gold. 1 kg of gold is worth about 40,000 current dollars so surely you can easily carry enough to buy almost anything in cash. Secondly using debit/credit cards, can you not just make the purchase and have the bank make periodic physical exchanges with business?(could even be monthly). For inflation/deflation, maybe gold has bigger short term changes, but hasn't the dollar lost like 98% of its purchasing power the last 100 years, while gold has remained relatively unchanged? $\endgroup$ – Guest Oct 27 '16 at 13:53

This question rises from confusion about basics. I'm going to cite some answers I've placed elsewhere, hopefully this gives a sufficient base such that you can answer this question on your own.

Having all these out of the way, what's left of your advantages?

  1. Simple to understand
  2. people owning real value instead of worthless paper/plastic being trusted etc

I don't think that 1. is important. People are holding money, none of my non-economists friends is telling me that they want to hold less money/cash because they don't know how the value is determined.

In fact, as long as the government enforces some payments through cash, the value of money is determinate and strictly positive (Oberg and Malmberg, 2016). From the abstract:

This shows that in the basic setup,tax requirements provide a simple mechanism for price level determination.

In fact, quite oppositely, bitcoin is a new thing - despite values of bitcoins being determined is much more complicated than that of cash. It is exogenous, I grant you that, but the algorithms behind are much more difficult to understand than "Some guys in a central bank decided to set this lower bound onto the interest rate".

Your 2. is actually a bad thing, in my opinion. First, as in the links above, fixed currency, fixed exchange rates etc. are all extremely worrisome. Not without reason did almost all of the currency regimes fail, and countries that left fixed exchanges rates did better later on.

Also, you're wasting a lot of gold! Value of gold (and silver) is already increasing, partly because of increased use in technologies, also because a rising middle class in Asia. Now imagine reducing Gold even more because people start holding it to use it as cash - horrible.

Summa summarum, I don't see any of the advantages that you propose holding up. (Fixed) low inflation, if true, actually is really dangerous and disadvantage.

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You wrote something like if money were at least partially made of precious metals, then people would "own real value instead of worthless paper"

Whatever value money made of precious metals is worth, or not worth, I guarantee you that paper money is even more valuable.

I am going to offer you a highly unrealistic, contrived, hypothetical scenario.

Despite being an unrealistic thought experiment, there is a powerful lesson that you can learn from it. I think you will like it the thought experiment, if you are willing to give it a try.

I want you to imagine yourself as the ruler of an ancient people. Maybe, your society looks something like Ancient Egypt. In your little world, your citizens do many different things:

  • your citizens grow food: perhaps chickpeas, lentils, lettuce, onions, garlic, sesame seeds, corn, barley, flax, etc…
  • some of your citizens – not necessarily everyone -- makes pots out of clay.
  • some your citizens make woven grass baskets. The baskets are so well made, that they are often water tight
  • your citizens build homes (e.g. Mesa Verde cliff dwellings)
  • some people make clothing.

Not only are you supreme dictator of your little world of villagers, but you are somewhat removed from “the system.” I want you to pretend (or maybe not pretend) that you have no desire to sit on a thrown of gold. You have no desire to wear fancy clothes, and eat food all day. In this hypothetical scenario, imagine for a moment: “what if the well-being of other people is my only concern?”

Assume for the moment that the government you run controls the only mint. Assume that you are in charge of making money. Regardless of whether it is silver coins, or paper bills, you make it.

For a long time, the United States government did not issue currency, or was not the only entity to issue currency. However, I view it like this: We are eating at a restaurant many food options. Our goal at the moment is to decide which of menu item#1 or menu item#2, we would prefer relatively speaking. The menu items are ounces of silver by government decree or pure fiat paper backed by nothing. Maybe you really want menu item #5, but for the moment, I want you to decide which you like better (relatively speaking) between (1) government issued (paper money NOT redeemable for silver) or (2) coins made of precious metal. As supreme dictator, you must make the decision:

  • Make paper bills completely unassociated with precious metals.
  • Make money from silver/gold coins. If not that, issue paper certificates redeemable for silver or gold. Okay. That was some of the ground-work.

Next, I want you to consider. next year, your citizens will spend their time doing something. Suppose we had a nice pie-chart.

pie chart

For example, maybe 20% of the citizens spend 8 hours a day, 5 days per week, growing chickpeas. That is not a particularly realistic percentage, but the exact numbers are beside the point.

Back in the present-day (not ancient Egypt) next week, next month, and next year, the citizens of United States will all spend their time doing something. Maybe next year, somebody named “Joe” will spend an average of 1 hour and 58 minutes per day watching internet-streamed videos on computer. Not only is this true for the United States, but people South Africa, Pakistan, India, China, Brazil, Germany, etc… all spend their time doing something, even if that it laying in bed "doing nothing."

A single working age people who manages to stay alive for a whole year (more than 50%), we have 8,760 hours to work with. That includes sleep, and I recommend that you spend at least 2,920 hours per year sleeping to maintain your own sanity.

If you are supreme dictator of a imaginary country of 1,000 citizens then you have 8,760,000 hours at your disposal for the next year. Will you have people spend 5,000 hours growing lentils? or 10,000 hours? As supreme dictator, that will be up to you to decide.

So we have a pie chart:

  • x% of people’s waking hours are spent watching TV.
  • y% of citizen’s waking hours are spent planting, tending, and harvesting corn. The great plains of the United States are said to be one of the two great "bread baskets" of the world. There are no other regions of arable land quite so large.
  • z% of citizens of society’s hours go to making clay pots
  • A% is allocated to making money (making silver coins or paper bills)
  • etc...

Here's a shocking idea: if making your citizens happy is one of your chief goals, then maybe try to reduce the amount of labor required to make stuff.

  • There are different ways to grow chickpeas.
  • There are different ways to make money (you can make paper bills instead of silver coins).
  • There are different ways to make most things.

What if somebody came up with a better way to make books? In fake-world-otopia whenever we wanted a copy of a book, we find some poor slub, and gave them some blank papyrus and ink. The shlub then spent many days handwriting each and every letter of "Shakespeare's Collected Works." (Ancient Egypt pre-dates Shakespeare, but that's fine). Today, one of your man peasants has invented something they call “the printing press.” the infernal contraption takes time time and effort to build than an ink-pot and quill. However, in the long-run it seems to take the peasants fewer hours per book, to make books?

As supreme dictator of made-up Unicorn and rainbow land, you can decide:

  • you can pay some dude, or dudette, to spend all year handwriting 100 paper and ink copies of Douglas Adams “The hitchhiker’s guide to the galaxy”
  • use a printing press

Likewise, as supreme dictator of made-up Unicorn and rainbow land, you can decide:

  • copper and silver coins
  • paper money.

Which society would you rather live in (relatively speaking)?

|          Society A          |          Society B          |
| work 8 hour days            | work 6 hour days            |
| eat 5 units of corn per day | eat 5 units of corn per day |

As supreme dictator, if you can make the same number of ears of corn for less labor, THEN DO IT. Your citizens will be happier.

As supreme dictator, if you can make the same number books for less labor (printing press versus handwriting), THEN DO IT. Your citizens will be happier.

As supreme dictator, if you can make money for less labor (pure-paper & ink money versus silver bullion), THEN DO IT. Your citizens will be happier.

Silver and gold supported currency requires a lot of labour. There are silver mines. After mining the silver, somebody drives a giant truck full of ore to an ore "mill." At the mill, the rocks are thrown into giant metal barrels. Some steel ball bearings are throw in inside as well. The barrels rotate round and round for several days. The steel ball bearing grind the gold ore into fine powder. The powdered rock then goes into chemical baths. Special chemicals stick to the gold, and that stuff float to the top. Paddle-wheels then skim the gold-rick ore off the top of the liquid vat of nastiness. And the process goes on, and on, and on...

Linen, ultra-violet ink, infra-red ink, paper, etc... all take time to make. However, it requires fewer hours, relatively speaking, than finding and mining gold.

What is the purpose of a fork and knife? To cut food. If your kitchen cutlery is made of stainless steel instead of silver, guess what? It accomplishes the same purpose for fewer labour hours. Soceity gets to consume the same number of forks for fewer labour hours. Alternatively, for the same number of labour hours, you get more forks.

Remember the pie chart of hours? Suppose the printing press is invented and 20% of hours making books becomes 10% of hours making books. Well, the extra 10% is great. People can either spend more time in leisure (watching youtube videos) or they can work, but make something else. Basically, all the villagers get to eat the same amount of corn that they used to, but now they have more other goodies.

What is the purpose of money?

Well, unfortunately (or fortunately) money has many purposes. Money is like a Swiss army knife.

Imagine you are a tribal chieftain again. Most of your citizens want to eat food, but a few of them do not want to grow corn. Specifically, there is one asshole named “Bob,” who is worse than anybody else.

  • Bob never helps plant the corn (or chickpeas... depending on whether your kingdom is in Egypt or meso-America)
  • Bob never goes down to the river to fetch water
  • Bob never goes hunting with bow and arrow

Bob mostly sits walks around talking to his friends all day. Despite the fact that Bob likes not starving to death, Bob does not contribute very much to the tribe.

what is the purpose of money?

Although there are many different solutions to the "Bob-problem," consider this one: Everyday that your people work in the field tending the corn, or every-time some finishes making woven grass basket, you give them some “tokens” (money) Your citizens give you all of the dried corn, woven baskets, etc… and you put all of the goodies inside a cave which you control the entrance to.

Inside of the cave, is a giant pile of stuff.

  • People put stuff onto society's pile (they put dried corn, or maybe a clay pot, on the pile)

  • People also take stuff off the table (they take a nice leather jacket off of the pile to wear in winter)

  • Bob wants to take from societies pile, but not contribute.

Anytime one of your citizens wants eat corn, you require that they give you tokens before taking food out of the cave. Thus, most citizens put stuff on the pile (corn, pottery, etc…). Your citizens receive tokens for contributing to society. Then, when they later want to take something off the pile, they use their tokens to buy things.

If we fast-forward thousands of years, maybe the blacksmith puts lots of horseshoes on top of the big pile of stuff. Later, the baker takes a horseshoes and and blacksmith takes a loaf of bread.

People all give-to and take-from society's massive pile of stuff. This hypothetical scenario ignores a lot of reality, but please bear with me.

For example, most of the stuff on the pile are actually services, not physical items. You can imagine little slips of paper on the pile which say things like “On Wednesday May 27th, Sarah contributed 6.5 hours of washing hotel bed-sheets and scrubbing toilets.” Sarah would rather be at home watching movies. Instead she spent 6.5 hours of her time doing something she did not enjoy, in order to receive tokens for buying spiral-bound notebooks and glue-sticks for her school child.

Imagine what if Bob was a free-loader, and continued to not work, and then received no tokens from the tribal chief. When Bob comes to take food from the pile in the cave, Bob won’t be able to buy food from the tribe. The really hard workers will receive many tokens, and they will be able to buy many leather jackets, clay pots, and other stuff from you and your cave.

Basically, I have described a unrealistic meritocratic society, where if you sit on your bum all day, you’re not allowed to eat corn. If you work a lot, you are paid wages, and you can buy lots of corn, and cool stuff to put inside your yurt.

Note that one of purposes of money is to serve as a record keeping tool. It records many things (Swiss army knife) one of which, is how hard people work. The various purposes of money are sometimes in conflict, and there are also other reasons why the hard-workers in this world are not the most financially wealthy. That is not actually how the world works, but it is certainly ONE theoretical society

Note that being made of gold is not necessary to record how many hours people spend making things for others.

A hammer made of steel and a hammer made of gold will both put in nails. Actually steel is better since gold is a fairly soft metal, but let's not go down that rabbit hole.

Paper fiat currency is still able to record how hard people work even if it is not made of gold.

The primary necessity for money to be potentially used as a tool to record how hard people work, it that it be difficult to counterfeit.

If tribal-tokens are easy to make, free-loader Bob will make fake money, and cash it in.

Gold coins can be counterfeit. IF you take two metals, one denser than gold, and one lighter, you can mix them in the right ratio to make a coin having the same density as gold. Also, you can electro-plate the outside. I once watched a TV news story about a man who drilled holes in gold bars he had purchased, to find them filled with lead inside.

As long as paper money is sufficiently difficult to counterfiet (difficult... not impossible), then paper money is useful.

Paper money has more value to society than silver or gold bullion, because it accomplishes the same purposes as gold-money for fewer labor hours. The extra hours saved can be spent making new stuff or in leisure. If some people had not spent the last 2,000 years finding ways to produce more in less time, you would be a farmer right now. Cellphones exists because the printing press enabled the people who used to copy books by hand, to go make something else instead.

Every hour spent making X is an hour not spent making Y. That is a special case of the idea of "opportunity cost"

I wanted to show that there exists a theoretical society in which money has a purpose un-related to being made of metal. It has value because you stopped Bob from being so much of a free-loader. Counterfeiting money is analogous to saying "oh yeah, I worked really hard in the corn fields last year. Look at all of the hours in my ledger." As long as more than 99% of people cannot change the number of zeros on their bank account balance with the stroke of a pen, lying about doing no work last year more is difficult, than if money were easy to fake.

Today, in the United States, United Kingdom, and elsewhere, paper money is difficult (not impossible, but difficult) to counterfeit.

Note that Planet Saturn does not think that gold coins have value. The laws of physics do not think that gold coins have value. There is no "inherent value" to gold. Gold coins are tool. Paper bills are a tool.

Paper money is a more useful tool than gold-money.

Hammers, chisels, screwdrivers are all man-made tools. Although maybe someday there will be screwdrivers on planet Saturn, there aren't any yet. Hammers are real, but man-made.

The definitions of words in the English language are not written on the fabric of the universe. It is not wrong to say, "I ate a chicken moderock for lunch" when you really ate a "roast beef sandwich." The laws of physics don't care. Other humans beings, no better than you nor I, made-up the words "roast," "beef," and "sandwich." The reason to use words the same way other people to has nothing to do with notions truth, or factual correctness. If you are goal is to communicate that you ate roast beef, then saying "chicken moderock" is less likely to accomplish your goal (relatively speaking) than saying "roast beef".

My point is that money is not the only useful tool around. Even English words are, in some sense, "fake." They are all useful tools. I encourage you to choose the tools you find most useful.

The “stop bob from being a free-loader” value of money is actually pretty pitiful. Money is a swiss army knife, it it does serve other roles.

Money is a useful tool optimization. Money has extreme value in it’s ability to quantify how much time and effort to make things. If there are two different ways to build a house, how do you know which is better? In a society without money, it's difficult. Money quantifies things. It allows mathematics to be brought to bear. Sum up the wages you paid to employees, all of the things you bought, etc... and you can see which of the following is cheaper:

  • using one large size cardboard box for all shipments
  • using three different size boxes

Maybe with three difference size boxes, employees have to spend more time picking out the right size box, and occasionally they choose a box which is too small, and end-up re-packing everything.

If there were no money, it would be very difficult to judge whether one way to make a car required fewer labor hours than another. Even if you buy steel, the price of steel partially (only partially, but still, partially) represents the cost of labor for making the steel. If no-one in the world ever spent an hour working pulling iron out of the ground, there would be no iron.

If not a single soul grew potatoes, grocery stores would have fewer potatoes than if people farm them.

The price of a potato is partially a record-keeping tool for tracking how much labor was used to grow a potato.

Money, like kitchen cutlery is a tool. If you can eat your soup at least as easily with a stainless steel spoon as a spoon made of sterling silver, go with the least expensive option ("expense" being quantified as "the number of labor hours required to make the damn spoon")

In summary, Money is more useful when made from paper, than made from gold.

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This r/explainlikeimfive comment by BitOBear answers your question. I edited punctuation and grammar.

Both Gold and Sliver have some common qualities. They physically exist. They can be verified to be what they are, so they are virtually impossible to counterfeit. (The original "touch stone" as a means of determining gold's validity is a huge piece of technology in its day.) Neither will "go bad" or be eaten by vermin so its shelf-life never ends. Up until recently either metal had little real use, so nobody was going to raid the coinage to make it into food.

So gold and silver were great for being money. Imagine if money were made out of actual food, like rice cakes were coins. Someone could easily eat the currency and then the money would go missing! So money as money must fulfill a bunch of particular traits, and yet we don't like those traits.

It's a pain in the arse to haul a million gold coins somewhere. So we moved to the checkbook. But hauling some paper that says "give this guy a million gold coins" is way easier. So as the amounts of money grew, paper money, or bonds, or writs, or bank drafts became needed.

So now in the big depositories, they'd shift coins or bars or whatever in response to drafts. None of the actual "coined gold" needed to ever leave the vault. It's just moved from pile A to pile B as directed.

Out in the real world, first the gold rush, then the silver boom, lowered the confidence in one of gold's (and then sliver's) traits — that being rarity! When you've got what may be a seemingly inexhaustible supply of gold showing up and potentially making gold as common as tin, well you don't want your money to be based on gold. So you switch to the second best — silver! Then an increase in supply happens again, the sliver mines are spewing out the stuff, so you decide to just stop using either one directly.

But then the gold rush and the silver boom each end before the price is really wrecked. So you go back to trading either metal for the same reasons it was good to make it into money in the first place. But the price of gold and sliver are no longer tied to a currency.

So the "pound note" in England was a note for "one pound of sterling silver". Then one day you stopped being able to ask for your pound of sliver, because it stayed "a pound" but it became a pound of nothing in particular. It became a promise of uncertain value.

So most currency now days is paper money, or base coins (random alloys of metal that look good but are worth less than the amount pressed into their face). When you get a dollar, it's worth a dollar, but what's a dollar worth?

So nowadays gold and silver have real industrial uses, and its value beyond those industrial uses is illusory. But were society to collapse, the advantages that made gold good at being money still apply. A gold coin weighing a quarter ounce will be worth a quarter ounce of gold wherever you take it, even if the "money number" on the front doesn't apply. For example a \$20 gold coin "Krugerrand" currently sells for a lot more than \$20.

So gold and silver have become the default measuring sticks for certain things, and that utility is its value.

Honestly, though, the deeper you look into economy and finance, the more you realize it's just a giant reputation lottery. All money is a promise that someone will want it from you as much or more than you wanted it from me.

The corner cases get really odd. Like "Tally Sticks": split chunks of wood that was used for taxes. The taxed lords would buy the sticks, then ship the sticks. If brigands tried to steal the sticks, the only place they had any value was to turn in as taxes for landed gentry. So the value of that currency was hugely specific.

Look deep enough and the answer to most questions about economy and money come back to the answer — "because we said so". Why are there stock options? "because we said so". Why is gold valuable? "because we said so". As long as the people from whom you wish to receive a good or service are one of the "we", then the transaction will work.

It's surprisingly arbitrary nowadays, but in the old times it was vital for long distance trade in an age without fast or reliable communication.

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