Paul Krugman presents a graph that I think is pretty relevant to the state of America:

During 1947-73 (for all but two of those years America had a gold standard where the unit of exchange was tied to gold at a fixed rate) average family income increased at a greater rate than that of the top 1%. From 1979-2007 (years without a gold standard) the top 1% did much, much better than the average family.

As we have seen with the quantitative easing program, the newly-printed money is directed to the rich. The Keynesian response to that might be that income growth inequality can be solved (or at least remedied) by making sure that helicopter drops of new money are done over the entire economy rather than directed solely to Wall Street megabanks.

But I think there is a deeper problem here. My hypothesis is that leaving the gold standard was a free lunch: GDP growth could be achieved without any real gains in productivity, or efficiency, or in infrastructure, but instead by pumping money into the system and assuming that this would have a positive effect on the economy as a whole. After all — say the Keynesians — “aggregate demand” (i.e. money circulation) “is the state of the economy”.

But in reality “higher GDP” and “higher aggregate demand” just mean more money circulating. It’s perfectly possible for more money to circulate while the real economy (productivity, labour, technology, infrastructure, etc) deteriorates. In fact, in many respects this is exactly what happened during the Bush administration, where trillions of dollars of productive capital was burnt up on military adventurism.

So — in effect — I hypothesise that fixed money acted as a check on irrational exuberance. GDP growth could not be conjured up via money printing (and resulting credit expansion) but instead had to be earned slowly and laboriously through real development. It also made investors and financial institutions significantly more cautious — they could not lose it all playing at the derivatives casino, and then enjoy a recapitalisation from newly printed money.

Most importantly, governments could not run up and monetise absurd deficits on spending in the name of military adventurism and maintaining the petrodollar standard. Government spending had to be of real, palpable benefit to the nation — infrastructure, medicine, education, technology, defence (clue for George W. Bush & Barack Obama: “defence” does not mean “attack”) etc. The bare necessities.

The trick here is that the only difference between gold and paper is that gold is naturally limited, and governments can’t just conjure large quantities of it out of thin air at will in the name of largesse, or saving the world from non-existent weapons of mass destruction, or whatever takes the central planners’ fancy.

In theory a fiat system could work so long as in the long run (when we are all dead) governments are willing to practise the discipline to save in the fat years, and spend in the lean ones.

The problem is that such self-discipline has never been maintained in the long run. In fact, governments (in Britain, the Eurozone, and America) seem to misunderstand that concept altogether, running huge deficits in the fat years, and then trying to undertake austerity programs in the lean years — exactly the opposite of what Keynes intended.

Which suggests to me that as a society we are not yet mature enough to leave the haven of fixed money, for when we do, we wreck everything.

A Keynesian or Krugmanite perspective would be welcome, of course.