After a discussion on Facebook as to why I am not a proponent of the gold standard, I thought it was necessary to explain how I feel here.
What is gold? Gold is a metal, a commodity, a material used in various things. It’s been sought after by man since their creation. Many advocate using gold as a means of backing a currency. Their thought is that, among other things, if there is something backing the currency, the currency holds value relative to other world currencies.
Before currency was extensively used, economies worked on a barter system. If Tom has apples, he can trade them with Harry for oranges. In today’s society, we can equate this to Richard fixing a fence in exchange for me to mow the lawn. This system could not stay efficient in that what one person’s needs and/or outputs are not always the same from day to day. Tom doesn’t always need oranges, and I can’t always mow lawns. (“They let any Tom, Dick, and Harry be President… no offense Jefferson, Nixon, and Truman”)
Currency is a means of exchange that replaced the barter system. Tom may have apples to give away, and Harry may only have oranges to give in exchange, but Tom doesn’t need oranges. Instead, the two assign a value to the goods. They use some sort of base to assign value, whether they call it dollars, yen, or euros. Or, maybe they assigned a number of apples and oranges to fractional ounces of gold.
However, using fractional ounces of gold is quite inefficient. First, the value of gold is currently set around $1400/oz, so one needs 1/1400th of an ounce for $1. It’s impractical to carry around gold wherever you go. It would need to be weighed, and purity isn’t easily assessable. The amount of time needed to weigh and purity test makes the use of gold an inefficient use as a currency. (HEY! You gave me 1/1500 of an oz instead of 1/1400 of an oz!)
Next, gold standard proponents fix the amount of paper currency to the amount of gold on hand. We will assume $1 million of gold (1000 ounces at $1000 an ounce) is on hand at the Bank of Estay for simplicity purposes. Generally, gold standards fix the amount of money associated with an ounce of gold, so we will assume $1000 per ounce. We will also assume for this example that gold and money are readily interchangeable at the Bank of Estay. On the world market, if the value of gold goes down on the world market, citizens of Estayland can purchase gold (100 oz) then subsequently sell the gold to the Bank of Estay in exchange for dollars ($100,000). This would increase the amount of money in Estayland is increased and causes inflation of 10% ($1 million to $1.1 million).

Date Oz Gold in Bank Money in System
1 1,000 $1,000,000
2 1,100 $1,100,000

Same facts as above, except if the value of gold goes up, the citizens of Estayland could exchange their paper money for gold, then sell their gold on the world market. The amount of money in Estayland is reduced. In this scenario, 10% currency deflation would occur in Estayland ($1 million to $0.9 million; we assume that, all else equal, if more money in the system causes inflation, we must also assume less money in the system causes deflation. We also assume that after the transactions, the world value of gold returns to $1000/oz due to supply/demand rebalancing due to changes in supply).

Date Oz Gold in Bank Money in System
1 1,000 $1,000,000
2 900 $900,000

If you look at the Great Depression, countries that were on a gold standard stayed in the Great Depression for much longer than countries that were not. England abandoned the gold standard in 1931, and soon after its economy was on the path of recovery. The US, however, stayed on through 1933, which started recovery in 1934. (China supposedly had a silver standard and felt no effects)
Chart
Looking at this chart, it seems to suggest that personal incomes generally rose after a country abandoned the gold standard. Of course, it doesn’t necessarily prove my point since it doesn’t consider any other policies that each country could have put in place to also help personal incomes rise.
My argument is that even without a gold standard, the US$ is backed by not only the good faith and credit of the US government, but also the goods and services produced by Americans. Currency can be anything… paper, gold, diamonds, apples, water, or a lawn mowing. The value of a currency depends on what value others put on that currency medium. If you have a limited amount of paper dollars, then the value of those dollars are high. Same is true with gold, apples, water, etc. If you’re out in the middle of the Gulf of Mexico on a stranded cruise boat, a bottle of potable water has high value. If you’re in jail, a cigarette has a lot of value. If you’re an ice salesman, you’re not going to get a lot of value selling your ice to an Eskimo. And your gold isn’t going to be worth much when you’re in the middle of a desert (or post-Katrina New Orleans) when you’re thirsty and hungry for clean water and edible food.


Let me also make sure you understand that I am not a proponent of free-printing of money. The printing of money is, all else equal, a force that causes inflation. The money supply must be kept in check to ensure that prices of goods and services are orderly. Monetizing debt is not a solution to today’s problems.

Units Currency Currency per Unit
1000 $1100 $1.10
1000 $1000 $1.00
1000 $900 $0.90

As you can see in this table, increasing the amount of currency (or personal income) in the system causes inflation, while decreasing the amount of currency causes deflation. Since units (or we can also call it GDP) stayed the same, an increased supply of dollars made the value of the dollar worth less, requiring more dollars to buy a unit.

Units Currency Currency per Unit
900 $1000 $1.11
1000 $1000 $1.00
1100 $1000 $0.91

Here, the GDP is fluctuating while the supply of currency (income) remains the same. What this table is designed to show is that if GDP falls with the amount of currency staying the same, inflation will occur since not enough units are there to fulfill demand, and deflation will occur if demand (GDP) increases since there’s too many units chasing too few dollars.
So I guess what I’m trying to say is… a dollar, an ounce of gold, or whatever you choose to use as your currency is only worth what you say it’s worth. Currency is merely a medium of exchanging an asset for an asset, and using a paper dollar is most efficient way of effecting trade. A gold standard is nothing more than a shackle that can hinder trade. Yet, the amount of money in the system must be responsibly managed. In essence, we’re probably still screwed either way.