"A good deal of the harm ascribed to the gold standard will by a future generation of economists be recognised as a result of the different attempts to make it inoperative." 

F.A. Hayek: Prices & Production (1932)

A hard currency must be redeemable in base money to prevent system participants to create excessive currency supply. Governments often suspended gold redeemability to engage in inflationary currency creation to fund warfare or wasteful policies, price stability returned quickly when gold redeemability was reinstated.

There are many explanations of mixed merit for why the gold standard failed and why it was abandoned, why governments could replace it with their inferior fiat money. Many economists observed towards the end of the gold standard that gold supply was too inelastic to satisfy money demand. These sources however offer no further explanation of the mechanism of this insufficiency. Here is our theory and how Bitcredit Protocol solves it.

No stable purchasing power when the base money asset doubles as a reserve asset

Before the invention of gold-redeemable credit money people knew redeemable gold certificates. When banks started to create credit money in the form of banknotes or bank deposits, people perceived these banknotes as equivalent to gold certificates, as claims to base money. And normally, they were. However, the mismatch between present gold and future claims to gold created a timing problem when too many depositors wanted to redeem their banknotes, namely bank runs. With fractional reserve banking ,this liquidity risk is unsurmountable.  

This practice caused a second, hidden systemic problem. As the population grew and technological progress elongated the production process and supply chains, the demand for credit money rose. When banks creates it, they also needed more gold reserves. Over time, this reduced the gold stock held by the non-financial sector and created increasing scarcity which by economic law causes a rise in the value of gold. The objective consequence is a general decline in prices, deflation.

Moreover, this rise of the value of gold accelerates over time when a rising reserve requirement meets an ever dwindling stock of gold reserves held by outside the monetary system. The elasticity of gold credit money supply progressively declines, the banking system loses the leeway to adjust the money supply to the needs of the real economy. The frustration of the entrepreneurs, the reins on economic growth through the unavailability of credit money sparks the idea to abandon the gold standard and switch to a fiat system. Obviously, there is no scarcity of “reserves” when a government's central bank can create it at will. This fits with politicians’ self-interest, as new money printing in a fiat system greatly increases the capacity for government deficits and indebtdness.

The Bitcedit solution

In a Bitcoin monetary system, the value of Bitcoin must be stable. Money supply must match money demand, so Bitcoin can be adopted by the real economy in first place. To avoid the inelasticity problem of a Bitcoin reserve, Bitcredit Protocol secures the system with a dedicated digital asset: the eIOU reserve token. When mints need more reserves, the demand for eIOU will not influence Bitcoin, all that happens is that the price of eIOU rises. This results in a virtuous circle: when the price of eIOU rises due to one mint's purchase, all other eIOU holders benefit because their reserves rise in value. As adoption rises, this positive feedback loop will keep the total Bitcoin credit money system elastic, ever more stable and secure, where the gold standard became more inelastic and fragile.

Read on: Proofs  (Don't trust.)