by Peter Schiff, Schiff Gold:

Some people claim gold isn’t “sound” money any more than dollars or euros. They argue that the gold supply can be inflated just like a fiat currency. After all, gold is constantly being pulled out of the ground, right? They say a gold standard actually makes the boom-bust cycle worse. But commentators who make this claim miss a number of important points.

In the first place, gold is produced at a relatively constant rate and it’s impossible to ramp up production on a whim. It’s not like a gold mine operator can go fire up the printing press and produce more gold just because he wants to. Gold is, by its very nature, scarce. On the other hand, dollars are not. A government can create as much new currency as it wants, whenever it wants. Although the gold supply does inflate, it’s nothing like the intentional inflation we see with fiat currency.

In the second place, many analysts think gold production will wane in the coming years. Some of the top people in the gold mining industry believe we may be at or near peak gold – the point at which gold production begins to decline at a steady rate, instead of increasing as it has since the 1970s. So it doesn’t appear gold inflation is actually going to be an issue.

Third, gold has utility beyond its role as money. People also demand gold for jewelry and it is increasingly used in technology and industry. This makes it fundamentally different from fiat currency. You can’t use a dollar bill for much other than as a medium of exchange. I suppose you could use it as a napkin, but that’s about it.

But let’s take the argument at face value? Can the gold standard make boom-bust cycles worse? Economist Dr. Frank Shostak doesn’t believe it can, and he laid out the case in an article originally published at the Mises Wire.

The following was written by Frank Shostak. Any views expressed are his own and do not necessarily reflect the views of Peter Schiff or SchiffGold. 

According to some commentators on the gold standard, an increase in the supply of gold generates similar distortions as money out of “thin air” does.

Let us start with a barter economy. John the miner produces ten ounces of gold. The reason why he mines gold is that he believes there is a market for it. Gold contributes to the well-being of individuals.

He exchanges his ten ounces of gold for various goods such as potatoes and tomatoes.

Now people have discovered that gold apart from being useful in making jewelry is also useful for some other applications.

They now assign a much greater exchange value to gold than before. As a result, John the miner could exchange his ten ounces of gold for more potatoes and tomatoes.

Should we condemn this as bad news because John is now diverting more resources to himself? This, however, is just what is happening all the time in the market.

As time goes by people assign greater importance to some goods and diminish the importance of some other goods. Some goods now then considered more important than other goods in supporting people’s life and well-being.

Now people have discovered that gold is useful for another use, such as the medium of the exchange. Consequently, they lift further the price of gold in terms of tomatoes and potatoes. Gold is now predominantly demanded as a medium of exchange — the demand for the other uses of gold, such as for ornaments is now much lower than before.

Let us see what is going to happen if John were to increase the production of gold. The benefit that gold now supplies people is by providing the services of the medium of the exchange. In this sense, it is a part of the pool of real wealth and promotes people’s life and well-being.

One of the attributes for selecting gold as the medium of exchange is that it is relatively scarce. This means that a producer of a good who has exchanged this good for gold expects the purchasing power of his effort to be preserved over time by holding gold.

If for some reason there is a large increase in the production of gold and this trend were to persist, the exchange value of the gold would be subject to a persistent decline versus other goods, all other things being equal. Within such conditions, people are likely to abandon gold as the medium of the exchange and look for another commodity to fulfill this role.

As the supply of gold starts to increase its role as the medium of exchange diminishes while the demand for it for some other usages is likely to be retained or increase.

Therefore, in this sense, the increase in the production of gold is not a waste and adds to the pool of real wealth. When John the miner exchanges gold for goods, he is engaged in an exchange of something for something. He is exchanging wealth for wealth.

Contrast all this with the printing of gold receipts, i.e., receipts that are not backed 100% by gold. This is an act of fraud, which is what inflation is all about, it sets a platform for consumption without contributing to the pool of real wealth. Empty certificates set in motion an exchange of nothing for something, which in turn leads to boom-bust cycles.

The printing of unbacked gold certificates diverts real savings from wealth-generating activities to the holders of unbacked certificates. This leads to the so-called economic boom.

The diversion of real savings is done by means of unbacked certificates, i.e., unbacked money. Once the printing of unbacked money slows down or stops all together this stops the flow of real savings to various activities that emerged on the back of unbacked money.

As a result, these activities fall apart — an economic bust emerges. (Note that these activities do not produce real wealth, they only consume. Obviously then without the unbacked money, which diverts real savings to them, they are in trouble. These activities did not produce any wealth hence without money given to them they cannot secure the goods they want.)

In the case of the increase in the supply of gold, no fraud is committed here. The supplier of gold — the gold mine — has increased the production of a useful commodity. Therefore, in this sense we do not have here an exchange of nothing for something. Consequently, we also do not have an emergence of bubble activities. Again, the wealth producer, because of the fact that he has produced something useful, can exchange it for other goods. He does not require empty money to divert real wealth to him.

Note that a major factor for the emergence of a boom is the injections into the economy of money out of “thin air.” The disappearance of money out of “thin air” is the major cause of an economic bust. The injection of money out of “thin air” generates bubble activities while the disappearance of money out of “thin air” destroys these bubble activities.

Read More @ SchiffGold.com