Probably after his stance on the Iraq war, the issue that most prominently sets Ron Paul apart from the rest of the field of the US presidential candidates is his view of currency: particularly, his belief that the government should reinstitute the gold standard to avoid the so-called ‘inflation tax’ caused by seigniorage.  Perhaps due to the importance placed on the issue of sound money by Paul and other prominent libertarians, one of the most active threads [registration required] at the UK Libertarian Party’s forum is in the same vein.

However, I’ve avoided the discussion for reason of disagreement(perhaps counter-productive, but the day’s only so long, and I don’t have as much time to argue the toss on internet fora as I once did!). The rallying cry of ‘Safety in Gold!’ is a common one amongst libertarians, but it simply doesn’t add up. As Milton Friedman was eager to point out to those that thought gold a suitable refuge (as, indeed, the world’s governments did when he wrote Capitalism and Freedom), to link the value of money to a single commodity is insanity.

The most obvious economic argument against the gold standard is that value of gold, and indeed of any commodity, is it has no inherent or eternal value. Production technologies change in different industries at different rates, and, should mining benefit from a great investment or miraculous technological progress, the price of gold would slump, leading to inflation in a country stuck to the gold standard. The same problem applies if silver, oil, electricity, or other commodities are used as benchmarks.

To solve this problem, one would have to find a commodity that increases at exactly (or close above, if the target is small positive inflation, as can be easily justified) the rate of economic growth. As Friedman argued, the Great Depression, by and large, occurred because the money supply grew more slowly than the rate of economic growth during the 1920s: due to the gold standard. Since no commodity will increase in circulation at the same rate as economic growth, a commodity-backed currency can’t work as flawlessly as its proponents claim.

The truly libertarian solution would be to scrap the legal tender, remove any obligation on individuals interacting with the government (mostly paying taxes, etc) in sterling, and let them trade in whatever currency they see fit. A similar system existed in the 19th century; in the absence of legal tender, Spanish and Mexican silver dollars emerged as the currency of choice in east Asia, whilst the local currencies - debased by their rulers to raise currency through seigniorage - were rarely used except where dollars weren’t available.

Currency competition puts an incentive on the government of a given country to protect the value of its currency, lest people cease to use it as a means of exchange. If a government does guard the value of its money better than its competitors, it can use a limited degree of seigniorage to cover some of its operations (the ‘profit’ of being more efficient in the market of issuing currency, if you will). This would be a tax that affects only those that choose to use the currency out of their own self-interest: another way the state can raise money without coercing anyone.

I think competition is the true free-market response, and the one that libertarians ought to follow, rather than foolishly backing a government monopoly tied to the value of a lump of shiny metal.