The gold standard: Neither free-market nor nutty

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I was on the Diane Rehm Show last week, talking about my book, and Jacob from Ypsilanti, Michigan called in to say:

I wanted to ask your guest why we so often … demonize the free market without discussing the Federal Reserve’s policy of regulating the value of currency through interest rates and how that subverts that same market.

Ah, a gold bug, I thought. So I said that linking the value of the dollar to gold wasn’t any more of a free-market option than letting the Fed “regulate” the value of the dollar. The free-market solution is to let every bank create its own currency and let them all fight it out amongst each other. But even advocates of thisĀ  “free banking” say it requires a gold (or some other commodity) standard to really work. Which leaves your money supply, interest rates, price level, etc. at the mercy of the gold-mining business. If they find lots of new gold, you get inflation. If gold discoveries fail to keep up with economic growth, you get deflation.

Then Jacob from Ypsilanti said something interesting:

I guess I have more faith in the gold market being a little less arbitrary than the interest rates set by the Federal Reserve Board.

That is the question, really (and it relates to my last post on the Fed and financial crises). In theory we ought to be able to come up with a mechanism for regulating the money supply that’s better than just defaulting to gold. But have we come up with such a mechanism in practice?