How Central Banks Destroy Money’s Purchasing Power
The comments below are an edited and abridged synopsis of an article by Frank Shostack
A growing economy requires a growing stock of money, because growth gives rise to a greater demand for money that must be accommodated. The alternative is declining prices of goods and services, which will destabilize the economy and lead to an economic recession or depression.
Since growth in the money supply is important, economists are always searching for the optimum growth rate. For instance, Milton Friedman’s followers want the Fed to target the money supply at a fixed percentage. They say that if this percentage is maintained over a prolonged period, it will usher in an era of economic stability.
The idea that money must grow in order to sustain economic growth gives the impression that money somehow sustains economic activity. If this were so, most third-world economies would have eliminated poverty by printing money.
Money’s main job is to be a medium of exchange. Money doesn’t sustain or fund real economic activity. The means of funding is provided by saved real goods. By fulfilling its role as the medium of exchange, money just facilitates the flow of goods and services.
In the past, people used gold and silver as the general mediums of exchange. Most economists, while accepting this historical evolution, cast doubt on the idea that gold can fulfill the role of money in the modern world. Relative to the growing demand for money as a result of growing economies, they say the gold supply is inadequate.
If you take into account that a large portion of gold is used for jewelry, this leaves the stock of money almost unchanged over time. It is held that the free market, by failing to provide enough gold, will cause money supply shortages. This runs the risk of destabilizing the economy. Most economists believe that the money supply must be controlled by the government.
Up for discussion: people want purchasing power, not just money; there is no correct rate of money supply growth; and how paper displaced gold as money.