It’s vital in economics to understand what money is and how it works,or should work, to do this we must look back at history, and analyze how money came into existence, what it represents and how mismanaged it is today.
Money dates back to…well quite early on I would say, people were using anything from salt,spices and more recently gold to make exchanges. This is the natural evolution from barter. At a given point, it becomes more efficient to use a common good, such as gols, as a measure of valu, as a point of reference, to facilitate market interactions. But why gold?
Gold, and other forms of precious metals, were commonly accepted as a form of payment. This wasn’t something imposed by the law, rather it emerged from he free market, since gold was a good store of value. Eventually, to make things easier, governments, or even private banks, like in America, would print out their own paper money. Why did people accept this money? It was backed by gold, or better phrased, it’s value was managed to be kept at a stable parity (price) with gold. In effect, people could actually go to the bank and change their paper notes for actual gold.
From the usage of gold coins, to the use of fiat currencies linked to gold, these are forms of a Gold Standard. There are many myths today about the gold standard. I find that most economists have no real idea how it worked. I will dedicate the gold standard a full post, if not more, for now, suffice to say that it worked. During the gold standard era, the dollar and sterling pound, and also many other currencies, maintained their link to gold and indirectly to each other. So for about 200 years the exchange rate between the pound and the dollar didn’t change, something that international investors could greatly appreciate.
Of course, there are many cases throughout history of countries abandoning the gold standard. Britain did so during the Napoleonic wars and the U.S. during their secession war. It’s really no mystery why, they were doing so to finance the war. Kind of what like they are doing now to finance “getting out of the recession”, more so in the U.S. than in Europe but still. You might even say we are precisely using war time economics, but there is no war!
This was not the norm, for the most part the countries had a tie to gold, and it was precisely during these periods when countries such as the U.S. experienced some of the largest growth rates in history. Remember the magic formula?
This all changed, however, not that long ago, people talk about the gold standard as if it were a relic, but the U.S. operated one till 1971.
It was after the second world war, when things started to collapse. The Bretton woods act was put into place. And the U.S. was to become the world reserve currency, the dollar still being linked to gold, the rest of the currencies indirectly pegged to it via the dollar.
Sadly, however, the U.S. caved to what you might read were “internal pressures” and abandoned the gold standard in 1971. By internal pressures I mean of course that Richard Nixon, embarked on a campaign to achieve economic short-term success by greatly expanding the money supply, printing money (nominal GDP targeting they called it), and of course, when there is an over-supply the price must drop. And the gold standard was no more.
Since 1971 we have had a system of floating exchange rates, freely moving from day to day. Allowing the governments of the world to freely debase/devalue our currencies, in effect making us poorer in the process. It is a hidden tax, really, that comes in the form of inflation. It isn’t rocket science. If the money you have is worth half of what it was worth you’re gonna have to need twice as much to buy the stuff you want.
The argument in macroeconomic textbooks goes as follows. They would claim that fixed exchange rates are not feasible, let alone a gold standard, because the Central Bank is giving up its “macroeconomic tools”.
For me the argument is the opposite. Firstly, their macroeconomic tools are worthless, real problems can’t be solved by printing money, however much of a nice little theoretical model you build around it. Secondly, their use are preventing us from having our most important economic tool. Sound money.
I just wanted to give you an idea of historically how money has been thought and managed. Often people get too caught up in what’s going on now, looking for new solutions. The solutions have been there for centuries. Even the Bible talks about the soundness of money, and the immorality of unsound money.
It’s just a matter of knowing.