The Quantity of Gold

2009-03-14T18:29:00Z

This is a reply to a question that was forwarded to me regarding how to respond to the criticism that there is not enough gold to use it as money. Any feedback would be appreciated.

The first thing that should pop out at us is that to state that there is not enough gold begs the question "enough gold for what?" I would probably ask this question first, just to see what they say. Generally, the theory is that there is not enough gold to represent all the goods and services in the economy. There may have been enough at one time, but as the economy has grown, we need the supply of money to grow in order to maintain consumer demand. Let's consider this.

Imagine you're a baker, and the price of a loaf of bread is 1/100 oz of gold. The population and the economy grow, and there are now many more loaves of bread (and more of every other good and service, plus new goods and services). If the price of bread is 1/100 oz gold, but now there are many more loaves of bread, we would need more gold in order for people to be able to buy you're bread. So you have all this extra bread, but since there isn't any extra gold in the economy, it just sits on the shelf because people don't have the gold to pay for it. What do you, the baker, do? Do you keep charging 1/100 oz, leaving the excess bread to mold? Or do you lower the price, maybe to 1/150 oz, or 1/200 oz, in order to sell off your remaining stock? You would find, as all producers do, that 1/150 oz, while less than 1/100 oz, is still better than 0 oz, and you would do the latter, that is, to let the price adjust until you can find a buyer for all of your goods. Fortunately for you, the miller is in the same position, needing to drop prices in order to find buyers for all of his flour.

Or, imagine if we all wake up tomorrow morning to find that all of our money - checking accounts, savings, cash on hand, etc. - have all been cut in half. I had $20 in my pocket last night, now I only have ten. I come to you, the baker, in a panic. I explain that I need to buy my daily bread, but I have lost half my money. You, of course, have been hearing the same thing from all of your other customers, indeed, saw the same happen to yourself, and have discovered the miller in the same situation. There would be disruptions with such a sudden shift, as prices get sorted out, but in (probably short) time, we would see prices adjust to roughly half of what they were before.

Don't get to wrapped up in the details of this - they are abstractions to illustrate a point - but they show how the supply of money doesn't matter in the way that someone who objects that we wouldn't have enough gold thinks it does. Money conforms to the law of supply and demand just like any other good. So long as no one (read: the state) is preventing prices from dropping, the particular supply of money doesn't really matter. The general price level is a function of the quantity of goods and services in relation to the quantity of money. For a given quantity of goods and services, more money = higher prices, less money = lower prices. Conversely, for a given amount of money, more G&S = lower prices, fewer G&S = higher prices.

Now, it is technically true that the quantity of gold available doesn't really matter in the way we have been considering it. Yes, if gold were money, and there were only an ounce of it, and we could divide it to sufficiently small amounts, prices would still adjust downward to reflect that. However, for the size of our economy and population, that would suffer for practical reasons. No one person on earth would have more than a tiny sliver of that ounce, and when we left with pocket change to buy a loaf of bread, it would probably get lost in the fabric of our clothes (it would probably save on transportation costs, though). While it is it's scarcity that gives gold value, it is also it's relative abundance (relative to, say, the specific quart of milk sitting in my refrigerator) that makes it actually practical to use. If, for some reason, all the gold began to disintegrate, we would shift to some other commodity for the medium of exchange. Metals work well for a variety of reasons, so we would probably see the introduction of metals like platinum and palladium as currency.

Testing the Waters

The Quantity of Gold