Huh?
I'm a little confused. First you explain that the gold standard was dropped as a response to a situation that was rapidly depleting gold reserves and thus, since we were using a gold standard, depleting the country's money supply. You then go on to explain that dropping the gold standard was the trigger event that caused everything to go to shit. You are armchair quarterbacking a decision that was made in the face of impending disaster.
The supply of gold grows at a very slow rate compared to world population growth. This means that given a gold standard, the actual amount of money to go around shrinks on a per person basis. Assuming that the average standard of living stays constant, and that the speed by which money flows through the economy stays constant, approximately the same amount of goods per person must be purchased. A single dollar can only be in one person's hands at a time, so in order to buy the same goods, they must now be cheaper. That's deflation.
That may sound good, but in reality, while inflation is a royal pain in the ass, deflation is absolutely devastating. What would you do if the price of everything was constantly dropping? Probably the same thing I would do. Your reluctance to purchase non-essential goods would increase at a rate that is a function of the rate that prices drop. The aggregate effect of this is that fewer goods get sold, so businesses must lower their prices. So the rate of price drop increases, and your reluctance to buy now increases. At some point, it becomes necessary for businesses to switch to a barter system, since they can no longer sustain themselves on monetary income. At this point, the economy has collapsed.
On the other hand, what do you do if prices are constantly increasing? Probably the same thing I would do. Put my savings into investments of some kind in order to preserve their value. If you are risk averse, then there is always the money market, which is very safe and generally keeps an even pace with economic growth. I would also not put off buying things that I intend to purchase so long as I have the means. This gives businesses an incentive to meet market demand, create new markets, cheat investors, and do all the other wonderful things a good little capitalist does.
Obviously, there are market segments that are exceptions, like computers, but in those segments, there is incentive to buy as well due to the increase in capabilities. When new capabilities no longer offer any compelling value to buyers, the good news ends. This has already happened to hard disks and RAM, and manufacturers of both have been damaged considerably. Similarly, very few people need more than the 2Ghz that is standard in even the cheapest desktop now, and both Intel and AMD are looking a little green around the gills. The deflationary spiral described above occurred on a smaller scale as soon as capabilities got good enough that the incentive to buy the latest and greatest was weakened or eliminated for most buyers. If you hadn't noticed, the manufacturers have switched to building game consoles, small electronics, and other areas where consumers are interested in features they can provide.
Now, inflation is a result of dropping the gold standard, but not having the money supply constrained as a fixed resource gives the powers that be a measure of control (for good or evil) over the economy.
Essentially, a dollar is borrowed from the government by a bank and loaned to other people. The bank gets interest and principal payments back from borrowers and uses that to lend out more money, etc. When the supply of borrowers gets lower, the bank pays the extra back. (Why pay interest if you don't have to?) When there are more borrowers, the bank borrows more.
So, if virtually every dollar in the economy is really a loan from the government, that means that there is always interest to be paid. The government can therefore use that interest rate to control the rate of growth in the money supply so that it tracks the rate of growth in the economy.
To put it another way, the value of money is the size of the economy/its scarcity. The scarcity of gold is relatively fixed, causing its value to increase as a function of economic growth and causing prices to fall. The scarcity of money in our current system is tweakable, so it can be used to tune the value of a dollar.
The value always has to drop (inflation) because it can never be allowed to rise (deflation). So the trick is to try to hold inflation to a manageable rate while maintaining enough of a buffer to prevent a shift in the other direction.
The major fluctuations in the economy have all been caused by major fluctuations that changed the other variable in the above equation but were completely unrelelated to the structure of our monetary system:
OPEC price control on oil (70's)
The widespread use of automatic trading software(late 80's)
Too many people with too much money creating worthless companies to exploit the internet. (late 90's early 00's
Excessive cronyism among banks and other businesses in Japan causing the banks to hold massive amounts of bad loans which they cannot write off because doing so would devastate both the banks and the companies that borrowed the money. Unfortunately the situation is such that it is too late to just pop the bubble and hold things together until everything settles. (That's what happened here at earlier stages of a similar situation, and while it was tough, we recovered. And Neil Bush stayed out of prison.)
The same problems occur with a gold standard, its just that with no throttle to control them, they get even worse:
The great depression was caused by widespread corruption in stock and trading. (far, far worse than today)
The tulip bulb crash of 1637 which I've always found to be very similar.
There are others, but maintaining the standard of living for the nobility while subjecting everyone else to grinding poverty and devastating taxes is also a good way to buffer the economy. (If you're into that sort of thing.)
(So is having half your population die of Plague.)
One last thing. The actual price of gold today is not much more than the cost of digging it out of the ground. The only reason the price is that high is that the supply is kept artificially low by governments maintaining large gold reserves and controlling the price with careful buying and selling. A shift to the gold standard would be very good for anyone who invests in gold, but very bad for everyone else, and if everyone invested in gold it would be verybad for everyone.
Nice proposal
It's actually based on the Real Bills Doctrine. You never hear about that any more with modern monetary theory, but if you look at the structure of fractional reserve banking and how the Fed mostly holds government securities as backing for its notes and deposits, it's obvious we still live by this doctrine, otherwise why would we bother to have a central bank holding these securities at all. It's interesting then that we do an about face and talk about the "money supply" measures M1, M2, and M3 as though our monetary system were based on the Quantity Theory. It's not even possible to measure a "money supply" directly and that's why we have three aggregate measures in the first place. A dollar in the bank is not the same as a dollar in your www.jasminlive.mobi wallet. The dollar in the bank is backed mostly by loans owed to the bank. Same with your mutual fund accounts. They will both say you have x number of dollars, but they aren't real U.S. dollars. The banks and mutual fund companies must be in the constant process of buying and selling notes and securities to maintain the value of these accounts.
Anyway, if are monetary system is still based on the Real Bills Doctrine, that would mean correct monetary theory should be to maintain the price of gold (relatively speaking) which would presumablely be the basis for the value of the dollar. I'm currently in an email discussion with an econ professor at California State University on the topic of the Real Bills Doctrine. His paper "Backed Money, Fiat Money, and the Real Bills Doctrine" turns up as the first link in a Google search for "real bills doctrine". The latest paper he sent me, "No Such Thing as Fiat Money", which unfortunately isn't on his webpage yet, talks about the value of the dollar in demand vs. supply, and liquidity-demand vs. investment-demand terms. One of the interesting things he states in that paper is that the Central Bank could maintain the value of gold, and hence the dollar by buying IOUs when the price of gold dropped, and selling them when it rose... basically exactly what you say in your last section. I then hypothecized, (and he hasn't gotten back to me yet), that perhaps our persistent inflation over the last several years, is due to the fact that the Fed has been ignoring this basic indicator and grossly oversupplying our demand for liquidity. This is happening because the market is not in control of the assets the Fed holds. The board of governors is. This leaves the board to guess and debate what correct monetary theory should be, and predictably their stance has changed a number of times over the years.
Now the only thing I am uncertain about here is how stable the financial system would be under the "Golden Ruler" system. True there has been constant inflation since we left the Gold Standard, but there were many banking crises before the establishment of the Federal Reserve and even up to and including the Great Depression. And since then... well we've had inflation. Is this an intentional tradeoff on the part of our monetary authorities? I'm not sure but I would like to do some actual research on the Great Depression era and also read the book Secrets of the Temple. (I have it on good authority this book has qualitative discussion on monetary theory and not just more conspiracy theory mumbo jumbo.) At that point I should understand a lot more, but I still like the idea of the "Golden Ruler".
Will gold really help?
According to a chap I know in HSBC Canada, he's increasingly seeing countries around the world dropping the USD as a reserve currency, favouring instead to denominate in the currency of their main trading partners. It seems this allows them to control their currency fluctations as it is more directly linked to what they trade. This is putting increasing downward pressure on the USD. IMHO, linking the USD to gold in this situation is going to cause problems as the value of USD won't reflect its desirability.
Also of note is the increasing use of the Euro as a reserve currency. I suppose this is to be expected due to its economic size and the amount of global trade with the Euro-zone. It's been a long time since the world had two major reserve currencies: think early part of the 20th century when the USD was growing in popularity and the GBP sterling was going the other way. It was hardly a stable period. I'm not convinced that having multiple very strong reserve currencies will lead to better global stability - it certainly doesn't bode well for Americans and their strong USD.
People have already mentioned some very recent problems caused by artificially pegging a currency, including Thailand and Argentina. Lets not forget the European Exchange Rate Mechanism (ERM) fiasco a decade or so ago. Several currencies of some of the largest economies in the world came under intense pressure as they were deemed to be over-valued. A lot of money was spent trying to maintain the artificial levels - a futile and very expensive effort. The result was currencies like the GPB being ejected from the ERM and immediate free fall. How can pegging the USD to gold be of benefit, especially considering that in time it will be faced against other strong currencies globally?
If every currency were pegged to gold, we wouldn't need separate currencies, right? Roll on the Republic Credits! As it is, exchange rate fluctations are useful tool to some goverments, and seem to indicate a country's general economic health. Pegging the currency to anything seems to me like a fruitless way of fighting normal market forces.
It is movement, not absolute price of gold
Where's Electric Angst, expert on exactly nothing, when we need him? He would, you know, tell you that studies prove you wrong. Studies by very important people. Of course, he has never read the studies, and has no idea what they say, why they say it, or whether they prove anything at all besides the mass of a certain number of chaturbate pages of a certain sort of paper, but every time anyone on k5 ever brought up gold in an economic discussion back in the good old days, he was there to repeat himself over and over again, eliminating all arguments based in fact or reasoning in favor of a singular and surprisingly successful(in terms of crowd reaction) appeal to authority.
Anyway, the only real argument against you is the so-called deflationary spiral. I'm not convinced it is a necessary feature of the scheme you propose, but that's for reasons none of us could really get into here. (Basically though, I suspect that gold standard currencies were manipulated by the wealthy just as our modern currency is, and that this was the source of the extreme deflation problems. Having a reputable control on the overall price and a very large economy to start with would reduce or eliminate this problem. If you want to know how you can manipulate a gold standard currency, imagine that you are Bill Gates. Imagine that you suddenly convert all your dollar holdings into gold, or vice versa. Think about the effects on everyone else, versus the effects on yourself. Now imagine the days when you and all the other Bill Gates of the world were all good friends, and could collude openly, and controlled most of the world's wealth.)
All that talk about gold is just distracting from the main point. You can get inflation with gold - if more gold is produced it gets worth less. I believe the Spanish had something like that a few hundred years ago - got all that gold from the Americas but the same amount of goods to buy. e.g. same amount of oranges but more ducats around means the price of oranges goes up.
There's nothing really special about gold. It isn't really a solution to inflation.
Money is a more convenient way to barter with things. You exchange money for something else.
Money gets worth less when there is more money around than goods to exchange for.
If you fixed the amount of money circulating then there wouldn't be inflation unless the amount of goods reduces.
If the amount of money circulating were fixed and if the population grows, and the amount of goods and stuff increases, there would be deflation - money gets worth relatively more, and you'd need to pay less for stuff.
There are many reasons why this is not desirable - a lot of it to do with psychology.
Examples:
How many of you would prefer to be paid less year by year for doing the same thing? Population and goods grows by 5% but same money going around.
People may be less inclined to buy stuff- if they wait till next year they might be able to buy more with the same amount of money. This is not always bad or good, but something to consider.
In theory a few jasminelive people could end up hoarding all the money, not spending it and becoming very very rich. Right now the various Governments work with banks to control the money supply. If banks just took depositors money and kept it instead of lending it out, things can get screwy. Same if they overlend.
Inflation is usually just a (sometimes nasty) symptom of something more important that's happening.
The other difference between Gold and Currency is that with the latter, the Gov controls the "Currency Mine" - they control how much to produce/print. With the former, the ones who own the Gold mines control them, which may not be acceptable to many governments.
Think through the strategic consequences
The Fed would sell bonds, drawing dollars out of the world, and extinguish the dollars it received.
And later pay back those bonds at greater than the original purchase price, using new money printed by fiat. Congratulations, you have just exported the inflation to the future. Quietly, in a back room, without general public recognition. Policy mistakes would take several times the bond maturity life to settle out.
While silver and copper are pulled from the Earth with relative ease and sometimes in erratic quantities, gold has a slow, constant trickle from the Earth's veins, the above ground stock growing about 1.5% each year.
The above-ground stock of gold is vast: it is dissolved in the oceans. The metallic gold in vaults is a few paltry flakes in comparison.
If you hitch the economy to gold, you give assured destruction capability to whoever can figure out how to extract gold from the oceans. Biochemists are getting very, very good at making designer binding molecules with ultra-high specificity, so this hazard is not at all farfetched, and would likely be much cheaper than putting 15,000 plutonium warheads on missiles.
If the goal is to keep the dollar stable, a gold price could be set at the level where most long-term economic decisions has been decided.
Narrowly-focused optimization is the root of all evil. The U.S. has much bigger problems, like running our factories into the ground today so the corrupt Chinese ruling class will be able to buy our land and politicians tomorrow (but not our goods because we no longer make them). Or building a policy structure based on absolute equality when half our people are below the 50th percentile. Or FUBARing our health care system with highly regressive income tax deductions. Or letting our schools be captured by career bureaucrats. Or Air Force brass who have neglected our heavy transport, heavy bomber, and close air support capabilities in favor of stealth crapola and fighters. Or the War on Drugs* Etc, etc, etc. Monetary policy doesn't top my list of problems that need fixing.
I recently read a claim that no "War On" anything had ever been won. I haven't found any counterexamples.