According to some commentators on the gold standard, an increase in the supply of gold generates similar distortions that money out of “thin air” does.
Let us start with a barter economy. John the miner produces ten ounces of gold. The reason why he mines gold because he believes there is a market for it. Gold contributes to the wellbeing of individuals.
He exchanges his ten ounces of gold for various goods such as potatoes and tomatoes.
Now people have discovered that gold apart from being useful in making jewellery is also useful for some other applications.
They now assign a much greater exchange value to gold than before. As a result, John the miner could exchange his ten ounces of gold for more potatoes and tomatoes.
Should we condemn this as bad news because John is now diverting more resources to himself? This however, is just what is happening all the time in the market.
As time goes by people, assign greater importance to some goods and diminish the importance of some other goods. Some goods now considered as more important than other goods in supporting people’s life and wellbeing.
Now people have discovered that gold is useful for another use such as to serve as the medium of the exchange. Consequently, they lift further the price of gold in terms of tomatoes and potatoes. Gold now predominantly demanded as a medium of exchange – the demand for the other services of gold such as ornaments is now much lower than before.
Let us see what is going to happen if John were to increase the production of gold. The benefit that gold now supplies people is by providing the services of the medium of the exchange. In this sense, it is a part of the pool of real wealth and promotes people’s life and wellbeing.
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