CQCA Business Research

Supporters of a fiat currency system believe a gold standard is too rigid, but always seem to point to some other indicator, such as productivity or population growth, as a metric for expanding the money supply.

The supply of gold in the world is limited. It does not change much in quantity from year to year. One ounce of gold will always be worth one ounce of gold. The only way to increase the money supply in a gold standard is to extract more from the earth or find alternatives to what is already consumed.

Increases or decreases in productivity cannot be objectively measured. It can be observed, such as the fact that it now takes hours to travel around the world, instead of years. But, there is no way to objectively measure it. Whether the money supply should be increased by 4.3% or 4.4% after the development of the iPad 2 would be up to the opinions of the central planners. The productivity argument also overlooks the fact that increased productivity in any industry would most likely find its way into the mining and metal processing sectors, which would increase the quantity of money in a gold standard. So in essence, a gold standard would accomplish the same goal, but without a central bank.

Population growth is more objective, considering population is much more easy to measure. The question, though, is how much money we should allocate per person. I used data from the top 20 economies by GDP and divided their most recent M2 money supply data by their total population. The results were then converted into U.S. Dollars using December 31, 2010 exchange rates.

Each country has a vastly different amount. If there were some objective, natural amount of money that should circulate per person, there would probably be more consistency in the numbers.

The other problem for both systems is distributing the money. Under a gold standard, mined gold would be used to buy other goods required for mining (such as food, water, clothing, housing, etc.) This would allow wealth to flow directly to the wealth creators (be they directly involved with mining or not). If a central bank increases the money supply to reflect their opinion of productivity, that money would be unevenly distributed to whomever borrowed the money first. If population were used as a metric, the only logical way would be to give inflated dollars to newborns and confiscate money from dead people and destroy it. This would create a society I do not want to live in.

Most central bankers claim to rely on some form of productivity to increase the money supply. This has never succeeded. All fiat currencies have ended in hyper inflation, all the way back to the first real fiat currency, issued by the Mongolian empire. Population measures, to my knowledge, have never been used. Gold has been currency for thousands of years. It still is.

Since the start of the 2007 financial crisis, the Federal Reserve has reacted by printing money on a scale that has never been seen before. Most of that, though, has been digital inflation. The bailouts, TARP, the deficits, and quantitative easing have all just been numbers on a screen, mostly flowing into bank reserves held at the Federal Reserve, which are not calculated in the money supply. That is a sign of our digital age, but it seems like the Federal Reserve is also taking us back to the kind of inflation in a horse and buggy era.

M2, the broadest money supply indicator that the Federal Reserve publishes, increased 27% between January, 2007 and April, 2011. The monetary base, which represents digital inflation, has increased 213.8% over the same period. M0, which represents bills and coins in circulation and is an indicator of printing-press inflation, increased 26.5% over the same period. (It is a coincidence that they expanded at about the same rate, and an increase in M0 does not directly lead to a proportional increase in M2. M0 is only 10% of M2, so a 26.5% increase in M0 should have been a 2.65% increase in M2, all other things being equal.)

A quick look at the U.S. Bureau of Engraving and Printing’s annual production figures shows that more $100 bills were produced in 2010 than ever before.

In 2002, Ben Bernanke gave a speech titled “Deflation – Making Sure ‘It’ Doesn’t Happen Here.” He stated: “Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.”

It looks like the Federal Reserve has been using both its printing press and its electronic equivalent.