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Wednesday, November 04, 2009

Gold backed currency is not viable

There is a big debate about going back to gold-based currency system. It has some obvious limitations. Ellen Hodgson details a simple argument against gold-backed currency in the Web of Debt - Chapter 37 - The Money Question: Goldbugs and Greenbackers Debate.

Constant volume asset-backed currency is deflationary
Broadly, any asset backed currency - asset availability will determine the amount of money in the system. So money supply will be limited to the extent we can find the asset - here - gold. Now,this is by no means a stable solution.

Store of value v/s transmitter of value
The real problem, I believe, is due to design of money. Money was designed as carrier of value not as a store of value. It was designed as a river not as a dam reservoir. The arguments for gold-backed currency stem from "store of value" side and arguments against it originate from "transmission of value" side. Inflation helps transmission but can potentially hinder "store of value" concept. Deflation helps "store of value" but can potentially hinder" transmission" concept.

In sum...
I believe these two functions are separate and must not be confused. We need a new design for money - one that can fit in both roles. Will someone open the financial innovation tool-box please? Anyone? Pandora?