Wednesday, September 22, 2010

The down side of "sound money"

I have a soft spot for goldbugs: they're at willing to consider how our economic system could be different with very different foundations, and relitigate century-old monetary disputes. It's like a steampunk monetary policy. Although I always wonder why they never talk about silver, the international standard for thousands of years, instead of gold, a colonial-era fad. Or why something like the terra wouldn't be more plausible going forward.

But the gold standard is a bad idea. Gold is deflationary, because it can't be mined at a pace that keeps up with global economic growth. Deflation discourages investments in future production rather than savings, and it's difficult to get people to accept nominal pay cuts during a recession. Modest, controlled inflation is more conducive to long-term growth, but everybody really, really hates inflation.

But this chart from Doug Short lays out the effects pretty clearly.

The gold standard offered great price stability in its day. Because it more frequently interrupted inflation and economic growth with deflation and protracted recessions.

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