Standard
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Humans have acknowledged the importance of a standardized medium of exchange for thousands of years worldwide. As the economies became increasingly complex and larger, and more people became involved in trades and exchanges, the need for a standardized medium of exchange grew stronger and stronger. Although gods introduced money and Gold coins in the earliest known civilization, Sumeria, the role of the government was limited to none in the money affairs. Exchanging parties and their mediators, like Goldsmiths, determined and standardized the value of the medium of exchange. Standardization of coins and the issue of money by governments came much later. The value of all commodities, including Gold and services, was purely determined by markets.
Determination of value by free markets is the only flawless method of value determination. It is free from all the drawbacks of artificial value determinations done by governments and central banks. It is because the value fluctuates a lot in markets, and a centrally determined value cannot keep up with it. Governments and central planners are typically way slower than the dynamic markets. So, the official values end up under- or overvaluing the commodities and services, causing severe imbalances. The Coinage Act of 1792 established the value of coins in terms of Gold and Silver. The government determined a fifteen-to-one ratio between Gold and Silver in accordance with the market prices of these metals at the time.
Silver prices went up later on, hence discouraging the minting of silver because it would immediately devalue the silver. Later, near the end of the eighteenth century, when more silver deposits were discovered and many countries switched from silver to the Gold standard, the demand and hence the prices of silver fell. It would have made sense now to get silver minted at the official value because it would immediately raise the value of coined silver. But silver minting was already stopped in 1873 due to the lack of demand for silver. If markets were determining the value of the minted coins, then none of these problems would have ever happened. Market prices, supply, and demand would have automatically adjusted the value of the minted coins.
When people deposited Gold with goldsmiths, they came up with a solution that made people’s lives much easier. Instead of carrying Gold coins all the time, they would carry IOUs issued by a goldsmith that would be used for selling and purchasing. These IOUs were redeemable for Gold by the issuing goldsmith on demand. Later governments used this tradition to issue currencies backed by Gold and silver. All currency notes were redeemable into Gold and silver on demand. IOUs also gave rise to fractional reserves. There is nothing wrong with fractional reserves as long as all involved parties consent to it. The problem was that many goldsmiths issued IOUs worth more than their reserves.
Fractional reserves were also established by private banks when they came into existence. Ultimately, the secret would be out, causing a run on the goldsmith or other banks, which would likely bankrupt the bank. But when the government adopted the fractional reserves, there could not be runs on the government, and the only effect it would have is inflation because the government is issuing larger quantities of money compared to the net productivity and real wealth in the society. Extra money would create higher demand, which would raise the prices. Under Gold and silver standards, in free markets, the prices would generally fall, as the money supply would grow with a set ratio, and the supply of goods and services would increase faster.
Governments kept decreasing the Gold reserves ratio to fund warfare and welfare, and finally completely ditched the Gold standard in 1971. Since the inception of fractional reserves and fiat money, inflation has become a continuous phenomenon. Due to the ever-increasing supply of fiat money, the currency devalues continuously, resulting in price inflation. In many cases, it may even result in hyperinflation when currency virtually becomes worthless. Zimbabwe, the Weimar Republic, Argentina, France, Peru, and Venezuela, along with others, have gone through hyperinflation in the past. Inflation is not just higher prices. It causes the devaluation of work, productivity, wealth, savings, and business and investment unpredictability.
Hence, business cycles have become increasingly shorter, and booms and busts as part of these cycles are happening more frequently with higher intensity at increasingly shorter intervals. Busts are also getting longer. The inflated supply of money produces a boom with tons of unsustainable malinvestments and inflation. At some point, the inflation starts getting out of hand, and the central banks then have to press the brakes with higher interest rates. The malinvestments could not be sustained at higher interest rates and fall apart, causing massive unemployment and recession. Recessions happen in the absence of central banks as well, but in this case, those are much less intensive and short-lived.
The reasons why the modern recessions are deeper and longer lived are that the bubbles created by artificially low interest rates are far bigger, and the central banks do not allow the markets to correct themselves. In free markets, the correction would happen much earlier when the bubble is still relatively minor. Instead, the central banks under the influence of faulty Keynesian theories would pump more money into the markets. This would not allow natural correction to happen and would increase the size of the bubble by involving other sectors of the economy. By the time it becomes necessary to raise the interest rates to prevent hyperinflation, the bubble has already grown too big, hence the crash is far more serious.
In accordance with Keynesian theories, price inflation and unemployment are two opposite phenomena, and they always claimed that it was impossible to have both at the same time. This claim got debunked by the new phenomenon called stagflation in the 1970s, when price inflation and rising unemployment were happening simultaneously. This essentially debunked Keynesianism because its foundational principle that Inflationary monetary policies are the cure for unemployment was proven wrong. Governments and central banks are still clinging to Keynesianism, though.