Money: Pegging/backing to Commodities

[Capitalism Forever]

If we had a gold based economy, whereby the amount of gold remained more or less at the same level -- i.e. the money supply would be stable -- then it would not be a period of deflation. Deflation could only occur if the money supply decreased

How do you define "deflation" ?

[Steve D'Ippolito]

Obviously there are two uses of the word "inflation" that are being conflated here, at least by some people. One is "a general increase in prices" (and the word "deflation" got used in the corresponding sense by at least one poster). The other is "an increase in the quantity of money." The latter is technically the correct definition, but almost nobody sticks to it.

For convenience I'll refer to "price inflation" and "monetary inflation" here.

Certainly it is true that price inflation is a symptom of monetary inflation.

In a growing economy, in fact, even *stability* in price levels would indicate that there is monetary inflation, at such a rate as to match the growth. (Some central banks attempt to do this, believing that stable prices are good.) A *fixed* money supply would result in a decrease in prices (price deflation) in a growing economy as the same amount of money chases more and more goods.

Gold is not immune to monetary inflation, but at least it would not be at the arbitrary whim of a government. Historically, when the Spaniards conquered the Inca empire, the vast quantities of gold they brought back to Spain created tremendous inflation, and I understand that the Spanish economy was actually hurt by this.

-------------------------------------

Another point--at some time in this thread somebody advocated either naming the unit of money after a weight measurement, or simply using the unit of weight *as* the monetary unit. This would make it harder to inflate any token currency based on it. It occured to me that this will not actually succeed, as good an idea as it sounds, and again history is my guide. The British Pound was originally one troy pound (12 troy ounces, 5760 grains, as opposed to the avoirdupois or "regular" grocery and body tonnage pound of 7000 grains, 16 "regular" ounces) of sterling (.925) silver; you will even hear it referred to as the "pound sterling" sometimes. Also the Mark was once a weight measure (the Cologne mark consisted of 24 Karats--which gives you an idea where karat for purity came from--the number of karats of pure gold in a mark of alloy, pure gold is 24 karat). The Lire was once a unit of weight from which the pound derives (and is why the symbol for "pound sterling" was a script L).

IIRC the English first debased the pound clear back in the 13th century or perhaps earlier; it became a half pound of sterling silver. (That's based on a vague recollection of a print article I read many years ago, so until I figure out how to verify it, please take it with a small grain of NaCl.)

So using a unit of weight is NOT foolproof.

[agrippa1]

By the same token, interest-bearing deposits and investments in the stock market are also a bad thing, aren't they, since they make people slow down their buying and wait until they have more money? This idea that saving is bad for the economy is based on the primacy of consumption and you've probably got it (indirectly) from Keynes.

I was unclear here. I meant that comment strictly in the sense of holding on to cash, waiting to buy products. With inflation, people tend to spend sooner because they see their cash value slowly declining. (Thus inflation effectively burns a hole in your pocket.) With deflation, people will tend to wait as long as they can to buy, hoping for prices to go down. "Saving" in the normal economic sense, does not include cash withheld from the economy by individuals.

[agrippa1]

The prices of products at the cutting edge of technology keep coming down all the time (think computers, cell phones, GPS devices), and yet their producers still manage to make a profit.

Backwards: the cost of production of cutting edge technologies keeps coming down all the time, thus producers are able to compete profitably at lower prices.

If the prices of bread rolls and sewing kits were falling too, their producers would survive as well--because the price of everything else would also be falling.

So, would that be a net wash for the bakers, a gain, or a loss? If the (real) per capita production of a society falls, individual (real) incomes also fall.

[agrippa1]

Let me put it this way. Had you bought gold back in 1970 and saved it, that gold would now be worth ten times what it was worth back then in terms of dollars. This discrepancy was brought about due to inflating the fiat money supply by over ten times in the past thirty years. If you did not save gold for all of that time, then your greenbacks are now worth 1/10th what they were worth back then.

No. The gold would be worth 30 times what it was worth back then.

The money supply (M1) has only risen 6.3 times.

The discrepancy, I believe, is that inflation is not due primarily to expansion of currency, but to deficit spending by the government. That is, overall debt of the federal government, of which M1 is only a small fraction, and which backs the larger money supply, M3. The point here is that fiat currency is not the evil, it is only the facilitator of the true evil of deficit spending. A fiat currency not tainted by the government's (natural tendency for) deficit spending would hold its value, which value would be based on the natural value provided by a market currency (over barter systems).

True enough, this could be provided by private institutions, and yes, the primary motivating reason governments mandate gov't currency is to allow for deficit spending. I'm probably being too theoretical here, because the reality is that bureaucrats will naturally discover the benefit (to themselves) of deficit spending, as well as the "theoretical" justifications of Keyensianism.

The problem with private currency sources is that fraud would be inevitable (I know, stop chuckling) and I could imagine scenarios in which the economy would be fragmented by factional currency sources, reducing the efficiency of the overall market. I guess the question here is: what is the optimal coverage - geographically, economically, politically - of a single currency? There may be a good argument that a national single currency is stabilizing and efficient, which would argue for a government role - restricted, of course - in currency supply.

[Miles White]

The problem with private currency sources is that fraud would be inevitable

One of the things I love most about the gold standard. Anybody can print counterfiet paper that looks like dollars, but it's allot more difficult to try and replicate gold coins.

[Thomas M. Miovas Jr.]

Yes, to clarify, by inflation I meant an increase in the money supply and by deflation a decrease in the money supply. Everything else being equal, inflation leads to higher prices and deflation leads to lower prices; the value of the money decreases due to higher supply in inflation, and the value of money increases due to lower supply in deflation. If gold were money, leaving aside large mining of gold deposits or large losses of gold money, the supply of gold that is used as money would remain relatively fixed through time -- that's what I meant when I said the money supply would be stable; not stable relative to production, but stable relative to the total quantity of gold available on the entire earth.

Then reason it is not a good idea to measure inflation strictly by price changes, is that there are many factors that go into price; so it is possible for there to be either increases in prices or decreases in prices not immediately relatable to inflation or deflation, but rather coming about due to production increases or decreases. Overall, however, inflation generally means higher and higher prices and deflation means lower and lower prices. But, one cannot say that simply because the price goes down that we are in a deflationary time period, because with the advent of, say, the computer production methods, prices will come down due to increased production, which is good.

I don't think deficit spending on the part of the government causes inflation, at least not directly; the government going into debt does not create more greenbacks, but rather the government prints more greenbacks in order to pay for the deficit spending. The cause of inflation is an increase in the money supply and the cause of deflation is a decrease in the money supply. In essence, we wind up paying for the debt that is covered by more printed money by the overall money we have in our pockets decreasing in value a certain percent every year due to inflation. In a way, it is like the government shorting money; they borrow it at full value, then print up some extra bills and pay it back in dollars that are worth less than the money they borrowed; but in doing this they decrease the value of money in the economy, so not only are the dollars they are paying themselves back worth less, so are yours. If we have a 5% inflation rate, then you are in essence paying a 5% premium on everything you buy, even if that is not directly shown in the price (maybe the prices would have come down 5%, but due to inflation, you get no extra savings on that purchase).

In general, inflating the money supply or deflating the money supply makes it very difficult to plan long-range, because one never knows what the value of the money itself will be over a given future period of time. If I could try to make this clear, let's say that today one dollar is 1 trillionth of the amount of all dollars out there. If the money supply doubles, then that same one dollar is only worth 1/2 trillionth of the amount of all the dollars out there; if the money supply halves, then that dollar is now worth 2 trillionths of all the money that is out there. When business and other long-range planners look to the future in terms of 30 or 50 year contracts (or even longer), they would like to know that the money is worth the same then in the future as it is now. For example, if someone had a 30 year contract starting in the 70's, due to fiat money they could not accurately plan for the fact that the money supply has increased at least 10 times what it was back then, effectively making the dollars they get today no where near as valuable as what they contracted for back in 1970. However, had they made the deal in quantities of gold, 20 pounds of gold back in 1970 would still be 20 pounds of gold today; but in terms of dollars, the dollars paid now is only worth 1/10th of the amount of gold that was expected at the time of the transaction.

So, using something as money, the total supply of which neither increases or decreases much over long periods of time, leads to a much more valuable economy in that producers can plan long-range. Both inflation and deflation lead to much shorter time scales of production projections; which is bad for the economy overall.

To put this more on a time scale most people are used to in every day life, would you loan someone a dollar if you knew you would only be getting back 50 cents for it tomorrow? Well, just think of the hesitancy of making 30 year transactions in which one might wind up getting back only 10 cents on the dollar. That is what inflation has done to our money over the past thirty years.

[agrippa1]

I don't think deficit spending on the part of the government causes inflation, at least not directly; the government going into debt does not create more greenbacks, but rather the government prints more greenbacks in order to pay for the deficit spending.

I didn't get this until I listened to "inflation and egalitarianism" in Philosophy, who needs it. I had to listen a couple of times and also refer to Greenspan's Gold Standard piece, but I eventually made the connection that printing money is a sort of government debt. If the dollars are backed by gold, then there is no real "debt" because the dollars and gold are interchangeable. But if the dollars are only partially backed or not backed, then they represent actual debt. Except: The dollars have a certain amount of value which is the additional efficiency that currency provides to the aggregate transactions of an economy. If the amount of currency expands and contracts based on the value of currency to the economic exchanges taking place, then the price indices will be stable. If it expands more, so that the value of each dollar to the exchangers decreases, then you will see price inflation. This excess can be counted as debt against the federal government. Now, if the federal government starts spending more than it takes in, and issues government securities to cover the additional spending, then those government securities are counted as additional debt against the government. The additional debt becomes a liability against the total amount of currency in the economy, and devalues that currency proportionately. (Once people catch on) Our current debt is about 65% of the GDP, which is far more than currency, and is a pretty good correlator to current gold price. Interestingly M3, the total amount of "money" including loans, accounts, securities, etc., roughly equals federal debt, which seems to indicate that M3 is backed ultimately by federal debt instruments (including currency).

Greenspan's comment on the amount of public debt balancing out with the amount of money taken from the economy via price inflation gives the clue to the true nature of price inflation.

Edited February 13, 2008 by agrippa1

[Capitalism Forever]

Obviously there are two uses of the word "inflation" that are being conflated here, at least by some people. One is "a general increase in prices" (and the word "deflation" got used in the corresponding sense by at least one poster). The other is "an increase in the quantity of money." The latter is technically the correct definition, but almost nobody sticks to it.

I agree that the two should not be conflated, but let me make it clear that whenever I say "inflation" or "deflation," I refer to changes in the purchasing power of money, i.e. the price level. Under a gold standard, this is equivalent to the purchasing power of gold, or in other words the extent to which people value gold relative to other goods.

[Capitalism Forever]

I was unclear here. I meant that comment strictly in the sense of holding on to cash, waiting to buy products. With inflation, people tend to spend sooner because they see their cash value slowly declining. (Thus inflation effectively burns a hole in your pocket.) With deflation, people will tend to wait as long as they can to buy, hoping for prices to go down. "Saving" in the normal economic sense, does not include cash withheld from the economy by individuals.

I see, so you're basically arguing that inflation tends to increase the velocity of money while deflation decreases it. I disagree; I think the decision between holding on to cash versus investing it into low-risk interest-bearing instruments is only affected by the nominal rate of interest offered. After all, if you have $100 now and supposing you want to keep it for a year, the choice is between having $100 next year and having $105 next year. In this decision, it does not matter how much more (or less) a dollar will buy you in a year than now, since both choices you are weighing have their maturity in a year's time.

Now, the decision between putting your money into a dollar-denominated instrument (which low-risk interest bearing instruments are) or using it to buy something else (be it stocks, real estate, or strawberries and cream to eat right now) does of course depend on the expected future purchasing value of the dollar. Assuming that the dollar is under the gold standard, you can express this in an almost tautological way: the choice between gold and non-gold is affected by whether you expect the purchasing power of gold to increase or decline. If you expect it to increase ("deflation"), you will be more motivated to keep your money in gold--that is, in a dollar-denominated form--and vice versa. But once you have made this decision, you next have to decide between "barren" forms that do not earn you interest (such as gold coins, gold bullions, or gold-standard dollar bills) on the one hand versus interest-bearing forms like bonds or CODs on the other. And this decision, as I showed above, is influenced by the nominal interest rate, not the inflation rate.

Backwards: the cost of production of cutting edge technologies keeps coming down all the time, thus producers are able to compete profitably at lower prices.

[...]

So, would that be a net wash for the bakers, a gain, or a loss? If the (real) per capita production of a society falls, individual (real) incomes also fall.

I'm not sure I follow you here. We were talking about real production growing with the money supply not keeping up.

[softwareNerd]

Does anyone worry about the limitations that gold reserve would have on the economy?

A multi-commodity reserve is also quite feasible. Dual-commodity based systems used to have a huge problem: the fixed inter-commodity price. However, a multi-commodity reserve can be implemented that has no such fixing, simply by having the monetary unit be the equivalent of a certain basket of two (or more) commodities. The prices of the commodities therefore do not get fixed relative to each other. Such a system can be more complex, but it will also be more robust. Edited February 13, 2008 by softwareNerd

[Capitalism Forever]

by having the monetary unit be the equivalent of a certain basket of two (or more) commodities

You realize, though, that this would mean that the growth of the money supply would be limited by the rate of growth of both commodities? Say, a dollar is convertible to a basket of 1/16 ounce of gold plus 3/16 ounce of silver, and suppose that the stock of above-ground gold grows at 2% while silver grows at 1%. This would mean that the money supply can only grow at 1%, rather than 2% as it could under a pure gold standard.

This "conjunctive bimetallism" (if I may coin a phrase) would make the currency stronger (more prone to deflation or less prone to inflation); it is actually the traditional "disjunctive bimetallism" that makes it weaker (less prone to deflation or more prone to inflation). But, as I said, deflation is not a big problem.

[Thomas M. Miovas Jr.]

This would mean that the money supply can only grow at 1%, rather than 2% as it could under a pure gold standard.

You seem to be operating from a premise or a theory that an increase in the money supply is a good thing for the economy. Could you explain why?

[Capitalism Forever]

You seem to be operating from a premise or a theory that an increase in the money supply is a good thing for the economy. Could you explain why?

Not my premise, agrippa1's.

Does anyone worry about the limitations that gold reserve would have on the economy?

It seems to me that a gold-backed currency would be limited by the amount of gold available to back the currency. [...] If the economy grew faster than the gold supply, the only way to keep from throttling the growth would be to lower the cost of goods to make the same amount of money cover more economy.

It is this worry that my last few responses here have been addressed at. And to summarize, my response is that the solution is NOT to want to increase the money supply but to simply stop worrying.

[agrippa1]

I see, so you're basically arguing that inflation tends to increase the velocity of money while deflation decreases it. I disagree; I think the decision between holding on to cash versus investing it into low-risk interest-bearing instruments is only affected by the nominal rate of interest offered.

I disagree. Real rate of interest, I'll agree with, but not "nominal." Investment decisions are based on relative real rates of return. Clearly in an inflationary period, people will spend more and invest less (assuming similar nominal rate) because real rate of return is lowered by price inflation.

In an inflationary environment, holding on to cash is not an option, because you are incurring a cost due to inflation. During deflation, your cash is gaining in value, so you are realizing a benefit while holding on to it. I would assert that the motivation for decisions is stronger towards avoidance of costs, than it is towards increasing benefit, for most people. If my assertion is true, then inflation increases velocity and deflation decreases velocity. I don't have anything to back that up, except the binary evaluation most people use, of "losing money" v. "making money," as the first measure of success.

But assuming that the "held cash" effect is negligible, due to the relatively small amount of cash held statically in an economy, it would seem that the rate of price inflation/deflation affects the mixture of purchases v. investments, with inflation pushing folks towards purchases, and deflation pushing them towards investments. The question then becomes: Does the velocity of money stay the same, whether it is put into purchases or investments? I don't know how to approach this one, except very simply: investment is essentially the transfer of purchasing decisions to another. It seems that the financial process of pushing money around from investor to ultimate borrower amounts to a delay in the (proxy) purchase of real goods by the investor, and thus a decrease in velocity v. direct purchase.

Edited February 13, 2008 by agrippa1

[Capitalism Forever]

I disagree. Real rate of interest, I'll agree with, but not "nominal." Investment decisions are based on relative real rates of return. Clearly in an inflationary period, people will spend more and invest less (assuming similar nominal rate) because real rate of return is lowered by price inflation.

I am talking about holding on to cash vs. investing into interest-bearing instruments. The difference between the future value of the two is the nominal interest.

Perhaps it will be a bit clearer if I present it as a single decision with the following three options:

1. Strawberries and cream for immediate consumption.

2. Keep the cash, for purchasing strawberries and cream a year from now.

3. Interest-bearing COD, for purchasing strawberries and cream a year from now.

First, let us consider how the three options compare in an inflationary environment. Let's say your $10 buys 10 oz of strawberries and cream now and you expect $10 to buy 9 oz a year from now.

1. Immediate purchase and consumption: you get 10 oz right now.

2. Hold in cash for a year: you get 9 oz in one year's time.

3. Interest at 5%: you'll get 10 * 1.05 * .9 = 9.45 oz in a year's time.

Which one will you choose? The answer is clearly #1, unless for some reason you've really got to save that money (say, you expect to be unemployed and hungry in a year's time). In that latter, rare case, you will definitely prefer #3 over #2, because you will have 1.05 times as many strawberries with #3 as with #2.

Now let's look at what happens in a stable-price environment.

1. Immediate purchase and consumption: you get 10 oz right now.

2. Hold in cash for a year: you get 10 oz in one year's time.

3. Interest at 5%: you'll get 10.5 oz in a year's time.

Here, you might choose #1 if you're hungry, or #3 if you prefer to eat half an ounce more in a year. You will still definitely prefer #3 over #2, just like in the previous scenario, because you will have 1.05 times as many strawberries with #3 as with #2.

In a deflationary environment:

1. Immediate purchase and consumption: you get 10 oz right now.

2. Hold in cash for a year: you get 11 oz in one year's time.

3. Interest at 5%: you'll get 10 * 1.05 * 1.1 = 11.55 oz in a year's time.

Again, you might choose #1 if you're hungry, or #3 if you're willing to wait for more--the difference is that here you have a greater incentive to choose #3. You will still definitely prefer #3 over #2, just like in both previous cases, because you will have 1.05 times as many strawberries with #3 as with #2.

So, with a 5% nominal interest rate, you will always prefer #3 over #2, regardless of whether you prefer #3 over #1--and it is precisely choosing #2 that would decrease the velocity of money. It would take a very low nominal interest rate to make you choose #2: so low that the difference would not be worth the bother of visiting your bank's website. This is unlikely to happen on a one-year planning horizon, but it can easily affect the choice of whether or not you buy a one-week COD.

[agrippa1]

I think I meandered my way over to agreeing with you on this.

And you clearly show that inflation biases us towards purchasing, while deflation biases us towards investment, which agrees with my final paragraph. Whether a shift from purchasing to investing affects the velocity of money is still an open question, though it seems that the banking process would tend to slow it down, and that the interest skim by the bank would tend to deter borrowers somewhat. But I'm not 100% sure of the answer.

I think, though, that if you apply a similar analysis to borrowers, rather than investors, you will see a clear difference between inflation and deflation. Assume a constant rate of change for capital, raw materials, labor, and prices, and see if you don't see a problem for borrowers in times of deflation.

[agrippa1]

This "conjunctive bimetallism" (if I may coin a phrase)

You may not... Symmetallism is the correct term.

[adrock3215]

I recently picked up a textbook for a college course entitled "The Economic History of the United States" by Fite & Reese. There are a few very interesting sections about the history of banking in America from the colonial era until the 1970's. I found a particular part I wanted to share, as it pertains to this issue, and it is very nearly identical to what Steve D'Ippolito was saying somewhere in this thread (I think page 2):

The Spanish dollar had been adopted as the basic monetary unit under the Articles of Confederaton, and in 1792 Congress modified the system by providing for a bimetallic currency based on gold and silver. The gold dollar was fixed at 24.7 grains of gold and the silver dollar contained 371.21 grains of silver. This was a ratio of approximately 15 to 1 and corresponded to the market value of the two metals at the time of adoption. By 1800, however, the value of silver had declined relative to gold and the market rate was almost 16 to 1. The difference between the market ratio and the mint ratio made the sale of gold as a metal more profitable than coinage, and as a result gold coins practically disappeared from circulation.

It was also difficult to keep silver in circulation. The brand new American dollars could be circulated in Latin America at full value despite the fact that the American dollar contained less silver than the Spanish dollar. Under these circumstances, American traders found it advantageous to export America dollars in exchange for Spanish dollars. The Spanish dollars were then taken to the mint for conversion into American money at a profit. This trade in American dollars had the effect of reducing the supply of specie in the country. Since the mint was operated at government expense, the increased volume of business also increased the expenses of the government. In 1806, President Jefferson tried to stop the trade by ordering the mint to discontinue the coinage of silver dollars...

In 1834 the gold-silver ratio was changed to 16 to 1 in an effort to bring gold back into circulation. Unfortunately, this ratio undervalued silver and overvalued gold. By 1851 the metal in a silver dollar was worth $1.04 in gold, and silver coins had almost completely disappeared.

It is historically clear that this type of "mint ratio" established by government declaration is a failure.

[softwareNerd]

It is historically clear that this type of "mint ratio" established by government declaration is a failure.

Yes (with 20/20 hindsight) what they should have done is to have said:

2 dollars = 24.7 grains of gold plus 371.21 g of silver

in other words -- you could never directly exchange a dollar for only gold or only silver. For each dollar, you could get exactly 12.35 grains of gold and 185.605 grains of silver. Of course, at the time of exchange, one might get all gold or all silver, if one wished to do a second transaction of exchanging one for the other; and, that exchange could also be incorporated into the exchange so that it was one transaction.

[adrock3215]

Yes (with 20/20 hindsight) what they should have done is to have said:

2 dollars = 24.7 grains of gold plus 371.21 g of silver

in other words -- you could never directly exchange a dollar for only gold or only silver. For each dollar, you could get exactly 12.35 grains of gold and 185.605 grains of silver. Of course, at the time of exchange, one might get all gold or all silver, if one wished to do a second transaction of exchanging one for the other; and, that exchange could also be incorporated into the exchange so that it was one transaction.

We would have to prove that what you are saying is: 1.) a function of government, in principle, and 2.) advantageous to a system of each bank printing its own banknote and establishing its own conversion ratio.

[Steve D'Ippolito]

...and it would also solve nothing because you must still make coins out of actual metal. What are you going to call the coin made out 371.21 grains of silver and the other coin made of out 24.7 grains of gold? "This coin is some unspecified portion of two dollars"?

Unless of course you are willing to *alloy* the two metals and create a coin slightly larger than a half dollar made out of electrum, and call *that* a dollar. But such a specification would be written quite differently ("The dollar shall be an alloy of 185.605 grains of silver and 12.35 grains of gold" [assuming I did the math in my head properly]). And it would still tend to go "out of whack" relative to the money of every other country in the world, which was either silver or gold, whenever the gold/silver value ratio shifted.

The two viable options are: Make both coins, but make sure one is seriously underweight and make it freely redeemable in the other. This is known as subsidiary coinage. This is what was acutally done, in two stages: Silver coins smaller than a dollar (half, quarter, dime, half-dime, yes we made a silver coin half the weight of a dime once) were actually reduced in weight relative to the dollar sometime in the 1800s--so two half dollars weighed less than a silver dollar (I think it was 1837; don't hold me to that). Also, once we decided to be on a gold standard, and noted that the price of silver was dropping relative to gold, we simply let the silver dollar itself become a subsidiary coin. By the 1930s I believe it only had thirty (gold) cents worth of silver in it, and when the trade dollars of the early 1870s were demonetized their collector value initially dropped down to that range. (Today, I will happily buy all of the US trade dollars you are willing to sell me at bullion value--hell, I'll gladly pay $30 apiece for them (and if you take me up on that you are a sucker).) Also the cent and nickel 5 cent piece were subsidiary too once the cent was reduced to its current physical size back in 1857. Ironically (and pathetically) the cent and nickel cost more to make than they are worth now, even though the cent isn't even made out of solid bronze any more.

The other option, not very practical back then, but somewhat more so today, would be to mint silver coins of a certain weight, and call them dollars (and fractions thereof), and gold coins of some other weight, and call them something else, like for instance "ducats" (note that dollars were traditionally big silver coins and ducats were somewhat smaller gold coins), and let the two units of currency float against each other on the open market. (You might even run into merchants willing to give you a break if you pay in gold instead of silver (or vice versa) because they think their preferred method of payment will go up in value soon, or they just like the way it loooks.) Obviously this imposes a computational burden on transactions--if I as a merchant am willing to accept one ducat in place of 4.8 dollars, I'd better be prepared to do some math. This is what God made calculators and abacuses for.

[softwareNerd]

We would have to prove that what you are saying is: 1.) a function of government, in principle, and 2.) advantageous to a system of each bank printing its own banknote and establishing its own conversion ratio.

True, but I wasn't trying to make a case for the standard being government-imposed. I did assume that, because that's the historical context; but, my focus was on the nature of the standard, not on who sets it. You're right that standards could be set private parties.

...and it would also solve nothing because you must still make coins out of actual metal.

Why would coins need to be different from notes, in the sense that they are symbolic currency?

I think if one is establishing a 100% convertible currency, using two or three metals as the underlying standard (rather than one) would ensure more stability of the standard.

Edited August 11, 2008 by softwareNerd

[Steve D'Ippolito]

Why would coins need to be different from notes, in the sense that they are symbolic currency?

I think if one is establishing a 100% convertible currency, using two or three metals as the underlying standard (rather than one) would ensure more stability of the standard.

I was responding specifically to the suggestion that defining two dollars as X amount of gold plus Y amount of silver would somehow fix the problem of the relative values of gold and silver fluctuating. Even if you use paper money, it must be redeemable; and that means you will at some point need coins. The only way a multi-metal standard would work here is if the coins were made out of an alloy of that proportion.

There IS something to be said for multi-metal standards; I watch bullion prices and it is amazing how one metal will sometimes go up more than the others. Gold and silver tend to rise or fall in unison, but platinum and palladium can sometimes fall (and sometimes a LOT) while gold and silver rise or remain fairly steady.

[Steve D'Ippolito]

...whoops, didn't finish that last thought.

With metals moving against each other a mixed-metal standard would "damp out" any sudden spike in the value of a particular metal due to sudden problems with production facilities (say that there is a mine cave in, for example).