Gold: Money and Partial Gold Standard Essay

Submitted By nickboroda
Words: 884
Pages: 4

1. The fiat system allows a government to control the flow of money into the economy. When prices are dropping too fast, the government can "print" more money, slightly inflating the currency and steadying prices. However, when prices are rising too rapidly, the government can decrease the flow of money, making the currency slightly more valuable and steadying prices again.

In the U.S., the Federal Reserve controls this by regulating banks, adjusting the flow of money into the economy, and lending capital to banks when necessary. To prevent massive financial panics the Fed has three specific tasks -- maximizing employment, stabilizing prices, and moderating long-term interest rates. Pretty much it wants to create a stable economy.

2. Pros and Cons
Our paper money is a "fiat" currency that can be printed without limit and has no real value – its value is only maintained by the "full faith and credit" of the government. Gold has real value due to its beauty, usefulness, and scarcity.
With a fiat currency the government can essentially manufacture money virtually out of nowhere. Since leaving the gold standard in 1971 US currency in circulation increased from $48.6 billion to over $1 trillion dollars in 2012. Between 1971 and 2003 the entire supply of money in the United States has increased by 1,100%. Under a gold standard, new money could only be printed if a corresponding amount of gold were available to back the currency.
Since leaving the gold standard in 1971, inflation has reduced the value of the dollar, and inflated the price of oil about 32 fold. In 1973, Saudi Arabia agreed to trade oil only in dollars. This created a new international demand for the fiat dollars the Fed was now printing and as more dollars flooded the world, general inflation in oil prices followed. When on a partial gold standard in the 1950s and 1960s the nominal price of oil was stable, averaging $2.90 a barrel. By June 2008 the nominal price of oil hit $126.33 per barrel
Since gold is a finite natural material, and must be mined and processed at a significant cost, it tends to be produced at levels consistent with demand. Under a gold standard, creating more currency requires obtaining more gold, which raises golds market price and stimulates increased mining. More gold is then used to back more money until a point when currency levels are adequate, the price of gold levels out, and mining gets scaled back.
Over the 179 years the United States was on some form of a gold or metallic standard (1792-1971), the economy grew an average of 3.9% each year.

Between 1879 and 1933, when the United States was on a full gold standard, the inflation adjusted market price of gold fluctuated from the $700 range (1890s) to the $200 range (1920s). From 1934-1970, when the US was on a partial gold standard, the inflation adjusted price of gold went from $563 to $201. In 1980, the inflation adjusted price of gold was $2,337, much higher than today's price of $1,672 per ounce
Under a gold standard, economic growth can outpace growth in the money supply since more money cannot be created and circulated until more gold is first obtained to back it. When this happens deflation and economic contraction occurs.
Under the current fiat money system the Federal Reserve can use