Recently I published an article on Seeking Alpha ("When will the economic slowdown end: an experienced economist's view." - October 28) explaining why the economy would not turn around until the Federal Reserve acted more creatively in the way it added money to the economy.
One of the comments (atrios28) suggested the Federal Reserve was a profit seeking business owned by the banks and that our money supply ought be based on gold instead of Federal Reserve decisions. The tone of the comment suggested he was seriously considering investing in gold.
It's true the Federal Reserve was initially funded by commercial banks - so it could be independent from the Congress and White house. But it is not a for-profit business in that it pays a 100% tax on its income. It's also totally transparent in that it fully reveals its assets, liabilities, and costs. It's also true that its decision makers have been (and still are) unqualified political appointees with a poor track record of dealing with inflation and recessions.
Despite the shortcomings of the Fed, macro-economists have not called for a return to gold to "back" our dollars or as the basis for the quantity of money in our economy because gold's record has been even worse - the gold standard has absolutely and disastrously failed and been abandoned every single time it has been tried.
The problem with the gold standard and "backing" the dollar with gold is quite simple: a complex market economy such as ours at all times needs "enough" money in circulation so that mega-billions of individual transactions can occur every day - never too little money so there is not enough spending such that a recession results nor too much money so there is an inflation caused by too much spending.
In other words, the amount of gold in our economy might result in too much or too little money in circulation to keep our economy prosperous.
Under the gold standard gold flows in and out of an economy for reasons unrelated to the needs of the economy's businesses and consumers for money. For example, another country might change its exchange rate to attract dollars, and thus gold, away from the United States - then we instantly would have less money in circulation than we need to handle normal transactions. Or a gold mining company may dig up more gold so that there is more money in the economy when we already have enough. Or a country in a war that's not going well might send its gold to the US for safety as the UK did in WWII - then we could have too much money in the hands of consumers and businesses so that spending rises and inflation results.
How much money an economy needs in circulation depends on the size of the economy and how fast it is growing. If we tie our money supply to gold then we risk repeating what has happened over and over again - a major recession or depression because we don't have enough money in circulation because we don't have enough gold. Or gold comes in for some reason so the money supply increases and we have an inflation as prices are bid up as a result of too much spending because we have too much gold.
Inflation and recessions discourage and destroy savings and are very debilitating to businesses and people. So every country in the world whether free or socialist or autocratic has come to the conclusion that it needs a central bank to make sure it at all times has enough money to have prosperity - not too much to cause inflation due to excessive spending nor too little to cause inadequate spending and recession.
For better or worse, long ago when markets and money replaced barter and the world adopted checking accounts, electronic transfers, credit cards and other complex financial transactions, gold became just another metal useful for filling teeth, wedding rings, and jewelry. In essence, the world's economies are now too complex for a currency backed by a commodity whether it be gold or pork bellies or beads or land. In the real world the gold standard long ago outlived its usefulness and was proven to be a total failure too many times - so it has gone the way of Indian wampum and the great auks and dinosaurs.
Since the gold standard won't be back, investors should be wary of buying gold or gold-related properties and assets because someone claims it will be returning and the price of gold will soar when the US starts buying gold to back its money. It won’t return - anyone who suggests it might return is trying to mislead you into buying gold.
On the other hand, gold is commodity and like any other commodity knowledgeable traders can make profits by buying and selling it. And it might even have bright prospects for long term appreciation as prosperity and a desire for gold jewelry and teeth comes to China and India's gold-loving population continues to grow. On the other hand, these positive elements may be already excessively factored into today's market price. Bets will be made either way and some traders will lose and others will profit - that's what markets are all about.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
