For thousands of years, societies modeled their economic systems on a physical commodity. The purpose of tying one’s economic value to a physical commodity was to determine the value of money. In other words, tying money to a physical commodity made it possible to determine the amount of money needed to stimulate the economy. Having a commodity backing an economy was a very effective financial instrument for maintaining monetary and financial stability.
The effectiveness of having an economy backed by gold or silver is that such a commodity limits the amount of money in circulation. The amount of money in circulation is limited by the amount of available commodities. Thus, a commodity-backed economy is effective at controlling inflation.
A society whose economic system is backed by a commodity is less prone to inflation. Because the value of money is linked to the value of a physical commodity, it is less susceptible to inflation. This is because the government cannot simply print more money to stimulate the economy, as this would lead to a decrease in the value of the commodity and, therefore, the value of the currency.
To control inflation is to control price stability. Commodity-backed currencies tend to be more stable than fiat currencies, which are not backed by any physical commodity. This is because the value of a commodity-backed currency is more predictable, as it is based on the value of the underlying commodity.
More importantly, commodity-backed currencies can be a good investment for savers, as they tend to appreciate in value over time. This is because the value of the commodity is likely to increase as the demand for it grows.
Modern governments will surely not like having a commodity-backed economy because it will constrain their spending powers. Those favoring a credit-based economy reject the idea of going back to the gold standard on the premise that commodity-backed economies are less flexible than fiat-based economies, as the government cannot easily adjust the money supply to respond to economic changes. But it is not the role of government to address economic changes by interfering in markets. Markets are organic social institutions that regulate themselves according to the fluctuations they experience.
Modern governments economically survive by operating on deficits. A commodity-backed economy wouldn’t allow governments to run their economies on deficits because this would require excessive money printing, which in turn, would lead to inflationary pressures because the money supply would be outpacing total economic output. Hence, commodity-based economies would produce more surpluses than deficits.
Commodity-backed systems aren’t flawless, however. One challenge that commodity-backed economies experience is the vulnerability to commodity price shocks. The value of a commodity-backed currency can be volatile, as it is affected by the price of the underlying commodity. This can make it difficult for businesses to plan for the future, as they cannot be sure how much their products will cost to produce or sell.
Now the question is ask is whether a commodity-based system would be better than a credit-based system. Any person who understands economics and has some knowledge of economic history would know that a commodity-based system is a much better system in terms of preserving monetary and financial stability. Government’s spending power is constrained by the amount of commodities available; thus, it can’t foolishly spend money whenever it wants.
The credit-based system only enables an economy to sustain itself in the short-term but not in the long-term. And this is because running an economy on budget deficits increases public debt. It is unsustainable in the long-term because it uses the value of future resources to maintain the value of current resources. This then reduces the value of future resources. Consequently, the credit-based system can only survive if government runs its economy on deficits.
The higher is inflation, the lower is the purchasing power of the consumer. In a commodity-based system, the consumer will naturally have a higher purchasing power since inflation will be relatively low. But in a credit-based system, the consumer’s purchasing power will be lower since the high level of the money supply erodes the purchasing power of the consumer.
No system is, of course, perfect. But if one is better than the other, the commodity-based system presents many more upsides than downsides compared to the credit-based system.