The Weaknesses of the Gold Standard

Jerry Bowyer has an outstanding column today on the meaning behind the rising price of gold, combined with still-low inflation. He argues against over-reliance on gold prices as an economic prediction model. For those who don't understand the basis for the gold standard and the arguments for and against it (hint, hint, Mr. Neiwert), this article is a terrific place to start, even though it is not specifically about the gold standard.

Bowyer's argument is excellent because it points out the truly great flaw in the gold standard- the gold standard is terrific, but only insofar as gains in overall human production move at roughly the same pace as gains in the production of gold. When human production significantly outpaces the production of gold, as has been the case for the last 25 years or so, an absolute gold standard will result in massive deflation, which is not much better for smoothing the economic cycle than inflation.

I suspect that eventually humans will be able to discover a form of currency that automatically self-adjusts with increases and decreases in production. But until that time, we will have to rely on human best-guesses to manage inflation and deflation, which, unfortunately, makes the Fed a necessary evil. As long as the Fed maintains a goal of staying within a very narrow band of inflation/deflation, it is probably the best currently-known way of smoothing the economic cycle. Unfortunately, the Fed can do little about government deficit spending. As for the things the Fed actually can control, it unfortunately must overcome immense political pressure at times to pursue inflationary policies. This political pressure, as I understand it, is a major concern Greenspan addresses in his new book, which I really need to read.