The gold standard is money which can be exchanged for gold at a fixed rate. For example, the central bank might print paper money, and anyone can bring paper money to the central bank and exchange the paper money for gold. The central banks's promise to exchange paper money for gold makes paper money equivalent to gold, as long as people believe the central bank will keep its promise. The gold standard is money which is equivalent to gold.
With the gold standard, gold is money and money is gold. This can confuse someone who thinks gold and money are different. For example, I once saw some statistics from the 1920s about the amount of money held by american banks, and it took me a while to realize that this was actually the amount of gold stored in american banks.
The silver standard is the same as the gold standard, except using silver instead of gold. The silver standard is bad for the same reason that the gold standard is bad.
Prices are based on supply and demand. With the gold standard, the price of gold must be constant. However, the supply and demand of gold are not constant. Gold production decreases as old mines run out of gold ore. Gold production increases when new gold mines open. Demand for gold varies with fashion and fear. New technology could reduce the cost of producing gold, or could create new uses for gold. Supply and demand of gold usually change slowly, but could change rapidly.
If there is a gold shortage, then the price of gold should rise. But with the gold standard, the price of gold cannot rise, so the price of everything else must fall instead. And a surplus of gold causes the price of everything else to rise. So a gold shortage causes deflation and a gold surplus causes inflation.
The gold standard has been successful for short periods of time when there were no gold shortages or surpluses. But over a long period of time, there is more likely to be a major gold surplus or shortage.
Surpluses and shortages of gold cause fluctuations in the prices of everything else, which disrupts all economic activities because all prices must be renogiated.
If the monetary authorities are manipulating money and trying the maintain stable prices, then the price of gold can be allowed to rise or fall if there is a gold shortage or surplus, and the prices of everything else can remain stable. A gold shortage or surplus will only disrupt economic activities which are directly related to gold.
There are no historical examples of a gold standard economy successfully coping with a major gold surplus or shortage.
Another reason why the gold standard is bad is that gold is underutilized. The monetary authorities must keep some gold in storage as a reserve, and this gold must remain unused. This gold cannot be used to make jewelry or computer circuits.
In other words, some of the resources of the economy must be used to mine the gold which is used as money. These resources must be reallocated from producing food, clothes, houses, medicines, toys, and other things which are more useful to people.
The cost of producing the gold which is used as money reduces the standard of living.
Tax backed paper or electronic money (see fiat money should be called tax backed money) is better than gold money because the cost of printing paper money is less than the cost of mining gold, and because the monetary authorities can easily manipulate the money and maintain stable prices.
The usual argument in favor of the gold standard is that the government cannot manipulate money, because the amount of gold which exists cannot be controlled by the government. The government can neither create nor destroy gold.
This is incorrect. The government can manipulate the amount of gold in circulation. The government can create deflation by reducing the amount of gold in circulation by buying and storing gold. The government can create inflation by taking gold from storage and selling the gold.
Historically it was uncommon for governments to manipulate money directly by buying and selling gold. It was more common for governments to manipulate money indirectly by changing bank regulations about how much gold reserves banks were required to have, or by changing the terms by which the central bank would borrow from or lend to banks. These changes in bank rules would change the amount of gold in circulation, so the changes in bank rules had effects which were similar to the effects of the government buying and selling gold.
Suppose the government requires banks to keep gold in reserve. The amount of gold which banks are required to keep in reserve depends on how much money has been deposited in the bank. Now suppose the government increases the reserve requirements. The banks must increase the amount of gold they hold, or decrease the amount of deposits. So most banks would increase the interest rate on loans and decrease the interest rate on deposits. This would increase the banks' income and reduce the banks' costs, and the banks would spend the extra money buying gold and adding the gold to reserves. Meanwhile the increased interest rate on loans would result in fewer loan and the reduced interest rate on deposits would result in fewer deposits. So the banks would increase gold reserves and reduce deposits until the banks were in compliance with the new government reserve requirements. The amount of gold in storage has increased, and the costs of acquiring and storing the gold have been passed on to the banks' customers. The effect on the economy is exactly the same as if the government had taxed banks and used the money to buy and store gold. The government can create inflation by reducing the reserve requirements. The government can create deflation by increasing the reserve requirements.
I think governments should manipulate money directly or not at all. Governments should not manipulate money indirectly. The effects of direct manipulation of money should occur more quickly than the effects of indirect manipulation of money. Therefore direct manipulation of money should be able to resolve problems more quickly, and make it easier to determine whether or not economic policy is working. The indirect manipulation of money creates confusion about what the central bank is doing. This encourages people to believe that cental banking and manipulation of money is black magic instead of science. The confusion makes it more difficult for wise economists to convince people to support good economic policy, and makes it easier for stupid economists to convince people to support bad economic policy. Also, direct manipulation of money is more efficient. Bigger effects can be achieved at lower costs.
From 1922 to 1928 the Federal Reserve Bank of New York's Open Market Investment Committee bought and sold bank and government loans and bonds in such a way as to maintain stable prices. Bank laws and customs at that time required that gold reserves be related to loans, so by manipulating loans, the OMIC was manipulating gold reserves. The OMIC was indirectly managing the amount of gold in circulation in order to prevent inflation or deflation.
Many european nations sent gold to America to pay for supplies in World War I, and to pay for postwar reconstruction supplies. This increased the amount of gold in America. If the government of America had not manipulated money, there would have been inflation. The government reduced the amount of gold in circulation by increasing the amount of gold in storage. The government of America manipulated the gold standard in a mostly successful attempt to achieve stable prices.
The gold standard does not prevent the government from manipulating money, but the gold standard does limit how much the government can manipulate money.
There is theoretically no limit on how much deflation the government the government can create with the gold standard. If the government purchased and stored all gold which exists, there would theoretically be infinite deflation, and the price of everything except gold would become zero. But the government would have to collect a lot of taxes to buy that much gold. As the goverment buys gold, deflation would occur, and wages and prices would fall, and taxes receipts would also fall. The government would have to keep raising taxes in order to keep buying gold. The high taxes would be unpopular, and there would probably be a revolution before the government succeeding in buying all gold. Also, governments usually do not want deflation. So there is little danger of a government creating excessive deflation.
The government can create inflation by manipulating the gold standard, but there is a limit to how much inflation the government can create. The government can create inflation by taking gold from storage and selling the gold to the free market. But once the government has taken and sold all gold from storage, then the government cannot create any further inflation.
If there is a gold standard, there should not be a central bank, the government should not issue paper money, and the government should not regulate banks. If there is a central bank, the central bank will inevitably try to manipulate the money by changing the amount of gold in storage. If banks are regulated, the government will inevitably try to manipulate money by manipulating banks.