Interesting question. Did I say that? Nope, I don’t recall ever saying that paper is more connected to value than gold, although that is probably the case.
Ideally, you want a currency that facilitates rapid response to change in the amount of valuable stuff, as well the value of that stuff today compared to other days in the past.
What money does is to help us establish an arbitrary, but standard way of valuing everything humans do and make. If you hold the money supply constant, then, when we make more stuff, there are fewer dollars chasing more stuff. This is deflation, and it is bad because once it starts, people stop buying stuff, because if they wait a little bit more, their dollars will be worth more. So if you freeze the money supply, you create deflation which stops the economy in its tracks.
It is the job of the Fed to keep an eye on how the economy is going, and to add currency in order to keep the value of the dollar almost constant. They need to put in a little more money—enough to create an inflation rate of around 3%. This is enough to encourage people to spend money now, before their dollars decline too much, but not to freak out because inflations is too high, and they can’t afford to buy anything or borrow or whatever.
When there is too much stuff per dollar, deflation starts. The antidote to deflation is to pump more dollars into circulation in order to get people to buy more stuff. This is what they have been doing in order to get the economy moving out of this recession. But conservatives are uneasy because they think too much money is going into the economy, which will result in too much inflation, once people catch on there’s money to spend.
The Fed’s job, as I said, is to balance these things, and to keep inflation at 2–3%. Right now it’s at 1%, and thus the Fed is still pumping more money into the system. So inflation hawks are freaking out. There’s another reason why they freak, and that is because of the deficit. The deficit is another way of pumping money into the system. So the Fed has to keep a close eye on deficit spending, so they don’t overdo it with the money supply.
Now here’s the problem when you use a finite substance as a symbol of value. Since there is a finite amount, it stays constant, while we make more stuff. As I said before, this causes deflation, which stops the economy in its track, because people won’t spend, when they know their gold will be worth 10% more tomorrow. And there’s no way around this problem, because we can’t be alchemists and make gold out of sulfur and tin—or whatever.
That’s why we have ended up with paper, and really, it’s hardly paper any more. It’s mostly electrons crossing the internet. I think paper money represents only a very tiny portion of the value of all stuff. Soon, we’ll dispense with paper entirely, and the only thing we will see is numbers on our cell phones that symbolize what we are worth. There won’t even be credit cards any more. Just phones with retina recognition, possibly doubled with fingerprints.
Because the most important thing in the economy is confidence. We have to believe that every “dollar” or value unit is honestly earned. It hasn’t been faked or hacked or made through fraud (such as telling people a house is worth more than it really is). If people have confidence, they will use the dollar and trust it.
This is why people all over the world prefer the dollar to their own currencies. It is a trustworthy value metaphor. If your hypothetical South Carolina created its own currency, it would go nowhere because no one would trust it, and everyone would use dollars.
During this last recession, there was some increase in distrust for the dollar, and people started trying to use the Euro as a standard currency. But, of course, it turns out that Europe has even more credit challenged nations that the problems in the US reflect, and so it turned out that the dollar still is the strongest currency in the world. I.e., people place more trust in it than any other currency.
If we go to the gold standard, we’ll kill our economy. Stop it dead in its tracks. Our only sensible choice is to move forward to the world of digital currency.
Of course, for currency to work, you also have to trust the bank whose job it is to pump in money, as necessary, in order to keep the relationship between currency and value in the right balance. The problem with this is that it means the Fed has an awful lot of power. Many people are quite uneasy with this—both because they think the fed will make the wrong decisions, but also because they think the Fed is somehow stealing from the people, and funneling money to the oligarchs.
They ask, where are the checks and balances for the Fed? Why can’t there be competition for the Fed to keep it honest? Or why do we even need the Fed at all? We don’t. Let’s go to the gold standard which is something we understand.
I think there are very few people in the world who understand the role of the Fed. All of them have come from the banking industry or from the field of academic economics. Everyone else (including me) thinks they understand, and I probably understand more than most, but there is still a lot of things I don’t understand.
Congress and the POTUS are supposed to keep an eye on the Fed. The POTUS can change the Chairman of the Fed if he or she wants. I think Congress can approve or not the President’s appointments to the Fed board. There are probably a bunch of eggheads and people on Wall Street who keep a close eye on the Fed, too.
So there probably are reasonable checks and balances, but Joe the plumber won’t see that. It’s way to arcane and it is a world filled with the high and mighty, and the Joe’s of the world don’t trust them even as far as they can throw them. So people want gold. Something tangible. Something they think they understand. And who can blame them? It’s awfully complicated.
Most people don’t know what money is. It’s a metaphor, and people don’t get metaphors. They think money is something real. It’s not. It’s just an idea. It’s just virtual reality. That makes people really nervous, ‘cause no one knows what is going on in the virtual world. Probably half the people think a computer virus could transfer into a human being.