Debunking The Gold Standard: The Myth of Inflation

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Brooch - First gold smelting in Johannesburg, South Africa

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The popular children's television network Nickelodeon derives its name
from the early movie theaters that appeared across the United States
near the turn of the 20th
Century. For the price of a shiny nickel, patrons could take in news
reels and catch the latest film entertainment on the silver screen. By
the time the Baby Boomers were flocking to theaters the price of
admission had gone up nearly five times and the Atomic Horror films of
the early Cold War brought a quarter for every seat sold. Today, nation
wide, movie tickets sell for about $6.55, 131 times what audiences
payed to see Charlie Chaplin in Modern Times and 26 times the cost of
admission for The Bells of St. Mary's in 1945. The notion that prices
go up over time is fairly foundational to economic theory yet one of
the most persistent critiques of a fiat based monetary system is the
loss of purchasing power over time.

Since Uncle Tom's Cabin debuted in 1914, the American Dollar has
lost the overwhelming majority of its purchasing power. Alongside 5
cent movie tickets, the America of 1914 saw milk at eight cents a quart
and flour at 3 cents a pound. This represents an inflation rate
approaching 2,000% for the intervening 93 year period -- meaning that
were one to find a dollar bill from 1914, its buying power today would
be just 0.0005% of its real value when it was printed. By all accounts,
this is a staggering drop in value and Gold Standard advocates point to
it as a ready and obvious example of the dangers of a fiat currency.

But then again, who keeps 93 year old money around anyway?

The key assumption is all of this debate is that inflation is a bad
thing. It is not. Inflationary pressures spur economic growth,
encourage investment, and allow for the massive development,
infrastructure, and expansion that the United States has enjoyed since
1914. Alongside inflation comes growth, and without this companion, the
scales seem unbalanced indeed.

Inflation creates, in a word, risk. The sequestration of capital is
a risk-free enterprise in a world with no inflation. Inflation deters
hording and encourages the rapid deployment of that capital. As
inflationary pressures increase, so also does the velocity of money
which itself relates directly to the propensity of an economy to both
consume and invest. The converse is also true, as inflationary
pressures approach zero individuals are more likely to horde capital
than they are to invest it. This results in deflationary pressures
which themselves reinforce the impetus to horde.

Inflation and deflation are both natural aspects of market
economics, and though inflation is exacerbated somewhat by the
dominance of a fiat currency, it is not eliminated in its absence. The
Federal Reserve, created in the early 20th
century, serves and served to regulate and to some degree mitigate the
fluctuations of international monetary markets. Though the Fed was
created to help defend the US Dollar on the international stage, it
proved unequal to the task after the collapse of the stock market in
1929.

In the aftermath of the 1929 collapse, a banking crisis struck the
United States. With a run on the banks came a halt to lending. The
money supply, tied firmly to the price of gold, dried up and massive
deflation set in. Prices dropped and profits and wages drooped with
them. As Jeffry Frieden explains in Global Capitalism, the Federal
Reserve's hands were tied:

Governments searching for alternatives to deflationary
paralysis and financial ruin ran into an apparently immovable
international object, gold. Attempts to halt deflation and raise prices
were blocked by government commitments to the gold values of their
currencies. As two economic historians put it, the gold standard's
"rhetoric was deflation and its mentality was one of inaction."

While gold standard economies experience constant oscillation between
inflation and deflation, resulting in long term stability but short
term immobility, fiat based systems experience deflation only under
very unusual circumstances but retain extensive flexibility as a
consequence. As a result fiat based systems, though subject to the
hypothetical malice and incompetence of government, are better prepared
to to maximize growth and innovation, spur investment, and generate
wealth. Moreover, it is through the ebb and flow of this constant
inflation that fiat currencies are regulated and through this constant
inflationary pressure that their economies grow. As Berry Eichengreen,
economist and historian, wrote in Golden Fetters:

The gold standard is the key to understanding the
Depression. The gold standard of the 1920s set the stage of the
Depression of the 1930s by heightening the fragility of the
international financial system. The gold standard was the mechanism
transmitting the destabilizing impulse from the United States to the
rest of the world. The gold standard magnified that initial
destabilizing shock. It was the principal obstacle to offsetting
action. It was the binding constraint preventing policymakers from
averting the failure of banks and containing the spread of financial
panic. For all these reasons, the international gold standard was a
central factor in the worldwide Depression. Recovery proved possible,
for these same reasons, only after abandoning the gold standard