Asymmetrical Information

The way the gold standard worked from 1793 to 1971 didn't depend on the gold reserves. If the government printed one dollar more than was needed in the banking system, at the end of the day, the holder of that dollar could come to the gold window and demand gold. This was a signal to the government that it was printing too much money.

If the economy demanded dollars and the government failed to provide them, then at the end of the day, the banks would come to the government with gold and demand dollars. This way the government was signalled to print more money.

Using these signals provided the government with a way to automatically inject the desired amount of dollars into the economy. That's the real value of the gold standard. If the government obeys the signals, then there is no need for people to come to the Fed and get gold, because they can't really use it to buy anything. The fixed gold price acts as a measure, a unit of account, not a store of value.

Butwhat if the supply or demand for gold changes radically? Won't that cause a change in the price level? What if Russia decides to mine a lot more gold? Those are good questions for another time.

The CPI: Gold predicted the Japanese deflation eight years ahead of Japan's CPI. Eight years of people sitting there scratching their heads, what's wrong with Japan?

The reason for gold as money is very simple. Money of many kinds has been used at one time or another. But, over the long run, gold is the money that the market has chosen. Given freedom, people will likely choose gold again.

Of course, that is not proven. The only way to find out what money a free people really would pick, is to free them and let the market work. Perhaps our modern economies would create some money other than gold. I tend to doubt that, myself.

Andreas: I will address some of your points in a future post - I like your 'dicipline' point. But I had for myself a side question: "Of what use is the 9000 metric tons of gold bullion bars sitting in the vault of the FRBNY?"

I'm surprised that no one has mentioned this yet, but it's the fact that others also hold the commodity that imposes the discipline. And the discipline is imposed on the government, not the actors in the economy. If there were a gold standard, they would be free to choose the bullion or the currency. Given the weight of the bullion, if the government adheres to the discipline, the actors will choose the currency just as they now are choosing electronic transfer and eliminating currency from most transactions.

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