Paper money is inherently risky. So is electronic money. Authorities (politicians and bureaucrats) can create it out of nothing. Monetary economists call it "fiat money". It is created by fiat of the authorities. Every newly created item of currency, which adds to the stock of currency on issue, marginally devalues the existing stock. The abiding risk of paper and electronic currency is not just inflation--the gradual erosion of value of the currency--but hyper-inflation. The price of goods and services rises because the value of money is falling by the day.
We have all heard the horror stories of hyper-inflation. Germany in the 1930's. Zimbabwe several years ago. Venezuela now. Money being trucked into a shop in a wheelbarrow to buy a loaf of bread. That sort of thing. It evidences and portends horrendous economic collapse and an inevitable looming depression.
The government more often than not has a vested interest in devaluing the currency and inflating the money supply. That interest lies in the public debt. As public debt grows through reckless governments spending more than they can raise in taxation, the temptation to inflate the currency (that is, print more money or create it electronically) rises.
Politicians and their bureaucrats are under constant temptation to inflate the currency to pay back the national debt with cheap money--a rort known as "monetising debt". The lender, naturally, takes a hiding because he/she/it is being repaid in money worth less than what it extended in a loan in the first place. It represents theft on a grand scale.
It is these realities which underlie the case for gold as the basis of a nation's monetary system. Gold meets the four attributes necessary to serve as a currency: it is rare; it is durable; it is transportable; and it is divisible. Its rarity means that it is less subject to political manipulation. It just cannot be created by the roll of the printing press, or the strokes of a computer keyboard. And that is a huge plus. It skirts the moral risk of venal politicians. Peter Bernstein provides an anecdote which aptly sums up the issue:
In 1928, George Bernard Shaw, no conservative, summed up this attitude perfectly in The Intelligent Woman's Guide to Capitalism and Socialism: "You have to choose between trusting to the natural stability of gold and the honesty and intelligence of members of the government. And, with due respect for these gentlemen, I advise you, as long as the capitalist system lasts, to vote for gold." [Peter L. Bernstein, The Power of Gold: The History of an Obsession (New York: John Wiley and Sons, Inc, 2000), p. 369.]The great benefit of a gold standard as the basis of a nation's money is that it helps keep corruptible politicians and officials honest. It represents a standard they cannot manipulate to their own advantage through devaluation--or at least it represents a monetary standard less easy to manipulate.
Herein, however, lies the reason why gold, or any other "objective" monetary standard fails to deliver at the end of the day. Gold is like any other good or commodity. It has no "natural" price. The price of gold on any given day is simply an objectified corporate abstraction representing the price transactions of millions upon millions of gold traders--people buying and selling gold--on a market "floor", whether virtual or real.
But when governments run a monetary system based on gold (or silver, or platinum, for that matter) historically the government has fixed the price. A gram of gold represented (by fiat declaration) so many units of paper currency as set by government authorities. But there is no science behind such a price control declaration--any more than there is behind the government declaring that the price of a house will be "x". If it reflected market value yesterday, it certainly won't tomorrow. Value is always subjective: one man's bargain will be another's "rip-off".
Bernstein documents the distortions, imbalances, and economic crises that occurred through the years when gold standards were applied. He cites with approbation Benjamin Disraeli's assertion to a group of Glasgow merchants in 1895:
It is the greatest delusion in the world to attribute the commercial preponderance and prosperity of England to our having the gold standard. Our gold standard is not the cause, but the consequence of our commercial prosperity. [Bernstein, ibid., p. 258.]To which Bernstein adds,
The notion that gold would make everything come out all right was a notion that was upside down: gold would make everything come out all right only when everything was all right in the first place. That was the real meaning behind Disraeli's assertion in 1895 that Britain's gold stand was the consequence, rather than the cause, of her commercial prosperity. [Ibid., p. 326f. Emphasis, author's.]
How, then, can the venality and corruptibility of politicians and monetary authorities be controlled? Gold cannot do it. When made the basis of a monetary system, it merely represents yet another politicised corruption of price and value. It turns out the best defence against fiat money and currency corruption is to subject money itself to free market pricing--which is what substantially exists today. Every day, millions upon millions of currency traders on global markets express their perception of the value of a particular currency and the relative economic strength of the nation represented by that currency.
Simplistically speaking, if the "market" perceives over time that a currency's value is eroding through excessive fiat money creation, the price of that currency will decline on global markets. Over time, monetary authorities and venal politicians will be exposed and punished for their monetary duplicity. Over time, hard money will drive out soft money.
In summary, the market of free floating currencies provides a far more exacting daily discipline upon monetary corruption and fiat currencies than a gold standard was ever able to provide.
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