RC asks: While I like the idea of money being tied to specie, I fail to grasp a few things. First, if money were tied to silver and/or gold, then it would seem that the only way to “make money” would be in the mining business and all other businesses don’t make money but merely push it around. Second, if people create things that are worth more, such as Adam Smith’s classic example of creating pins from steel, but no gold is involved, how is the additional worth measured and factored in to the money supply? It would seem that if you have more and more worth/value being created, but a constant amount of dollars/pesos/yen, it would seem you would go ever downwards in a deflationary spiral. Help my unbelief!
You are confusing worth with price. The primary advantage of a metal-based monetary system, such as the gold standard, is that the money supply will only increase at approximately the rate of normal economic growth, around 3-4 percent. This is a real limit on money creation, since it is a lot of work to mine metal. As the economy grows, (in your terms, additional worth is created), the money supply grows with it.
Deflation, in a normal economy, is not a real problem for anyone except banks. In fact, it is only a much-feared problem in a paper-based economy where the moral hazard of constant inflation has created a vast overhang of debt. In that case, (the situation we’re in), deflation makes it impossible to continue the game since borrowers will not be able to repay debts in less valuable future dollars.
For example, the deflationary period between 1839-1843 saw a supposedly catastrophic drop in the money supply of 34 percent, causing almost a quarter of American banks to fail. However, during those four years, there was an increase in consumption of 21 percent and real GDP of 16 percent – 4 percent annual growth.
The 1879-1889 period of deflation is generally considered to be a period of hard economic times by clueless economists who only look at the 30 percent drop in the money supply and ignore the fact that real wages rose 23 percent and GDP almost doubled – an explosive rate of growth. So, when you hear that deflation is a horrific evil, it’s important to keep in mind that what is bad for the banks is not necessarily bad for the average worker, and vice-versa.
I strongly recommend A HISTORY OF MONEY AND BANKING IN THE UNITED STATES: the Colonial era to World War II, by Murray Rothbard, to anyone interested in these matters. It is available at the Mises Institute.