Monday, November 28, 2011

gold standard and inflation

In reality, few governments follow the gold standard, but it's instructive to consider what if they do.

Annual gold mining output is steady and presumably quite low.

If there's an authority controlling the total number of HK dollars in circulation [1] and that authority ensures every dollar "created" is backed by a fixed quantity of gold in its reserve, and if every country adopts a similar gold standard, then any time we would be able to mathematically convert all the dollars to gold and all the yens to gold.... and the total gold reserve is still less than total physical gold ever "dug up". This would be a truly effective control on inflation.

Central banks could print currency easily (inflation) when there's no gold standard, but no CB can suddenly get 10 times more gold. To obtain more gold, the country must export and receive payment in foreign currency...

[1] But how does that authority control banks lending huge amounts in dollars therefore creating dollars? I think answer is the regulation. An unregulated private lender (e.g. loan shark, venture capital, pure-play investment banks) can lend $10b and charge an exorbitant interest amount of $1t, but how does the debtor get the $1t to repay? It has to sell goods/services then collect real USD, which is controlled by the authority. When inflation rises to (for eg) 50% a year, that can only be a central bank action, not a market action.

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