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Posted: 4/30/2011 8:05:51 AM EDT
The following post is meant to educate arfcom on the very basic rules of currency and labor economics.

1) Currency: fiat vs. gold.

The Gold Standard: Gold has long been used as a currency. It is rare, easily melted, and easily shaped into coins. In the days when swords were the main armament of knights, gold was an excellent currency.

Advantages of the gold standard: If every nation on the planet used the gold standard, then it follows that each nation has fixed exchange rates. This takes the analysis of future exchange rates out of international business decision. Fixed exchange rates in general make a lot of sense for small countries that rely exclusively on international business, such as Hong Kong.

Disadvantages to the gold standard: Acquiring more currency requires mining and conquest. If you cannot acquire enough gold to correspond with GDP growth, then you will have deflation. Prices will fall. Wages will fall. This creates a dynamic of excessive saving, as goods will always be cheaper in the future than they are today. This also means that debt becomes harder to pay off, because money borrowed today is worth more than money earned tomorrow.

Fiat currency: Since 1932, the supply of US dollars is not backed by gold or silver. You can't walk into the bank and get gold in return for your dollar bill.

Advantages: Increasing the money supply is as simple as printing more money. If the US GDP increases by 2%, you can increase the money supply by 2% in order to keep prices constant. Typically a modest amount of inflation is included for reasons I'll get to further down. Fiat currency also allows the central bank to make loans to commercial banks to reduce liquidity problems if there is a run on the bank. This is considered to be the main reason the great depression was so bad, and is the reasoning behind the first bailout bill.

Disadvantages: Unless the monetary authority wishes to have fixed exchange rates, fiat currency typically is sold on the market, with the exchange rate being the market price. This means exchange rates are variable, and add an extra dimension of decision making in international capital markets. Also, if the central bank is directly controlled by the government, then typically more money will be printed come election time to cause a temporary boom, with high inflation being the main result. This is why the Federal Reserve is not directly controlled by congress.

When the central bank is independent of the federal government, fiat currency is far better than the gold standard. Our recessions have been much less severe under fiat currency.  Our inflation has been quite modest. Obviously, it will not remain so if the government covers our debt by printing money, but that's not really the topic I'm discussing.

2) Unemployment

Unemployment is best analyzed as a surplus of labor. If you are familiar with basic supply and demand, if the supply curve shifts out (increase in supply), then prices must come down to reach equilibrium. Otherwise, there will be a surplus. The graph for employment is identical, except that the vertical axis represents wages, which is the "price of labor."

Right now, unemployment is high. That means real wages must come down so that employment will go up. However, as we have seen, unions riot and people bitch a lot if they get pay cuts. The backdoor method of reducing wages, which is built into standard US monetary policy, is inflation. If there is modest inflation, then prices slowly but steadily increase over time. If wages remain the same as prices increase, then you achieve the exact same goal lowering nominal wages with a fixed dollar value, except you have less cities burned down and less national guard troops deployed.


In short, the gold standard sucks (as does Ron Paul for wanting to reinstate it), the federal reserve is actually a pretty good institution, and labor unions make life difficult.

I will now get back to studying for my finals.

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