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Gold, Money, and Price Volatility

January 3, 2008
Murphy's latest response to Frum is excellent. There is one point that he did not meet that merits special attention. Frum says:
Gold is a commodity. Like all commodities, its price is highly volatile. A money fixed to gold must be highly volatile too. Signing up for a true gold currency would be signing up for an unending monetary roller-coaster ride.
However, it is not true that the volatility in the purchasing power of gold-as-it-is-now would be the same as gold-as-money. As Rothbard and Mises have noted, the total demand to hold the money commodity is the sum of the demand for use as a commodity and demand for use as a money. With a return to the gold standard, the demand to hold gold-as-money would increase (right now, this demand is negligible), causing its price in US dollars to increase. The volatility of the use-value component of gold will be swamped by the exchange-value component. No roller coaster there. With regard to the demand to hold money, Mises pointed out:
Every economic agent is obliged to hold a stock of the common medium of exchange sufficient to cover his probable business and personal requirements. The amount that will be required depends upon individual circumstances. It is influenced both by the custom and habits of the individual and by the organization of the whole social apparatus of production and exchange.
This demand to hold is the dog of the monetary system, and the purchasing power of money is the tail it wags. During a recession, the demand to hold money broadly increases because many people forebear from unnecessary expenses. Against a relatively fixed supply of money, this will increase the purchasing power of money, which has the socially desirable effect of increasing the effectiveness of the money held by people in the recession. This is hardly a roller-coaster ride, either. A roller-coaster ride is this: during a recession, the demand to hold money broadly increases because many people forebear from unnecessary expenses. The government greatly increases the supply of money to "heat up the economy", which decreases the purchasing power of money, thwarting the intentions of people attempting to survive the recession. More on this here, of course.

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