Home > Government & Politics > Paper Money and the Gold Standard (The Value of Money – Part III)

Paper Money and the Gold Standard (The Value of Money – Part III)

If you’re unfamiliar with the principles of a gold standard currency vs. fiat money, About.com:Economics has a great article you can read.  As Mike Moffatt, stated in this article, it’s unlikely that the U.S. will return to a gold standard for currency any time in the near future. 

One of the primary benefits of a gold standard is that it tends to keep inflation in check, but it can also restrict government monetary policy because the government can’t print money that is not backed by value of the gold it controls.  This may be one of the reasons that President Franklin D. Roosevelt  pushed to remove the gold standard in 1933, which was part of his economic plan to move the country out of the Great Depression.

For most of us, it doesn’t matter too much whether our money is backed by gold, so long as we can buy what we want.  Since inflation has been relatively low for the past 30 years, we have yet to experience the loss of purchasing power resulting from government monetary policy gone awry.

I recall being in Romania in 2001 and 2002. The exchange rate was about 32,000 Romanian Lei to $1 U.S. in 2001.  A year later, the exchange rate was nearly $36,000 Romanian Lei to $1 U.S.  The inflation rate was about 10% per year.  Not the worst in the world, but definitely not great either.   In 2001, the Romanian government had just begun printing the 500,000 Romanian Lei bill (the equivalent of about $13.89), because of the large amounts of cash people were required to carry.  Those 500,000 bills came in handy when paying the dinner tab for our group, which could easily exceed 10,000,000 Romanian Lei, and trust me, we weren’t eating in posh places.  On July 1, 2005, the Romanian government revalued their currency for the fourth time.  It was revalued at 10,000:1.

If you don’t live in Romania, you may wonder what this has to do with you.  The point… any government (including the U.S.) can print as much fiat money as it wants. The question is… what’s it worth?

The Federal Reserve System of the United States (the Fed) controls the monetary policy of the U.S.  In order to help stimulate the economy and prevent the financial markets from collapsing in 2008, the Fed increased money supply by approximately $1 trillion.  How did they do that?  Since it is fiat money, all they needed to do was crank up the printing presses.  The money then entered the financial system through the discount window and by the Fed’s purchase of bonds.  With a federal deficit of $1.42 trillion for the year ended September 30, 2009, who do you think bought some of those U.S. Treasury Bonds?

Still seem like it doesn’t matter to you.  Maybe it won’t, but maybe it will.  The challenge now facing the Fed is the how to reduce the money supply.  That could result an increase in the interest rate at the discount window, which will likely cause a tightening of credit and higher interest rates for borrowers.  It could also slow down the economic recovery.  Alternatively, leaving the money in the system for too long could cause a significant rise in inflation.  The Fed may find that it’s a lot easier to print $1 trillion, than it is to get back $1 trillion.

The Fed controls the U.S. monetary policy, and there is little you can do about it.  However, by paying attention to the Fed, you can keep tabs on the value of your money.  Under a fiat money system, your dollar literally may not be worth what it used to be.

Your Money vs. Other People’s money will be the topic of The Value of Money – Part IV.

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