If gold is at the center of discussions relating to the dollar dilemma, the reason is purely physical, not mystical or magical. Gold is, in 2007, as it always has been, and that is the fundamental point. By its nature, gold has physical properties that do not change with time, and thus neither does its value change. That is the key to its unique appeal and utility in the management of currencies.

The most important virtue of a currency is its capability to maintain value without change over time. This characteristic makes a currency attractive and acceptable to any producer of goods and services, and to any owner of assets interested in exchanging them for a fungible store of value. Owners and producers will exchange what they have for currency if they can be confident it will retain the value attributed to it until the holder is ready to exchange the currency for something else of equal value. Currency that deteriorates in value will be avoided altogether or exchanged for another asset as quickly as possible, thus interfering with preferred plans of its users.

This need for constant value in currency is the essence of gold’s relevance to the responsibilities of central bankers in 2007. As ever has been the case, people who use dollars the world over want to rely on its value constancy over extended periods. Yet, the dollar is at or near its lowest value in U. S. history relative to gold, and trust in the dollar’s stability appears to be waning rather than building as 2007 nears its end. This was not always the case, as for most of U. S. history the dollar was termed “honest” and “good as gold,” because dollars could, in fact, be exchanged for gold at a guaranteed price if the holder preferred to have gold rather than dollars.

For today’s users of dollars, which include people and governments globally, the absence of a link between the dollar’s value and gold is clearly apparent. The Federal Reserve and the U. S. Treasury regularly declare that the dollar’s value “floats” and is to be determined from day to day “by the markets.” In this environment, a rational person expects prices of goods and services to change inversely to the change in currency value. Still, Fed officials act surprised that their floating dollar causes changes in prices and wages, and they insist they are “fighting inflation” while managing the dollar so it loses value almost daily.

The Fed certainly does not use the unchanging nature of gold to provide stable value for the dollar. Banks, governments and central banks have done so throughout history, but the Fed has not since 1971. Instead, the Fed prefers to manage domestic interest rates. Doing so stifles competition among banks and costs borrowers more for credit, and it causes the prices of assets to rise and fall inversely as interest rates are manipulated. Worse, as the Fed moves interest rates artificially, it separately adds dollars to the economy without a reliable guide to the number needed for real growth. The result has been a volatile, rocky road to a devalued dollar, which has lost about 96% of its purchasing power relative to gold since 1971. In certain intervals, the Fed has added too few dollars, causing severe deflation and collapse of business and financial markets, as occurred in 1996-2002.

Some observers insist gold is an “ancient relic” unusable by contemporary central banks for any beneficial purpose. If that is true, then why does every major government and central bank hold so much gold? Surely gold must have some relevance to financial stability, because the U. S. Treasury holds about 8,000 metric tons in its vaults and declines to exchange it for dollars. With Treasury taking that stance, producers of crude oil and manufactured products in other countries could hardly be criticized for doing the same.

Others complain that gold is useful in monetary management only if gold mining produces precisely the same amount of new gold annually as all others produce in goods and services. Otherwise, they claim, the “gold standard” can only cause inflation (if too much new gold is mined) or deflation (if mining production falls behind), because gold-backed currency must be issued only in strict proportion to gold held by the central bank. These ideas are, in truth, the “ancient relics” of monetary theory. Like manipulation of domestic interest rates and other mercantilist theories, they are tied to the constricted thinking of the Middle Ages with much less excuse for being so.

Exchanging gold for currency through bank teller windows is not the one and only means by which gold might serve the interests of central banks seeking to achieve stable currency value. Gold may be used, for example, as the “measuring stick” of currency value rather than as the substitute for it. Gold can be looked to for its constant nature, and its value may be assigned by all market participants rather than by central authority. Since the markets presently determine that something more than $800 are equal in value to an ounce of gold, the Federal Reserve or the U. S. Treasury as a matter of policy can decide that the dollar ought to be worth $500/oz in perpetuity, and liquidity will be managed to achieve that end.

Under this policy, the markets would continue to determine the dollar’s value on a daily basis, and no stresses or dislocations will build. As events change the need for liquidity, the Fed can be confident in every injection or draining of liquidity that the policy objective will be met – the dollar will remain at $500/oz – meaning that all users of dollars can trust in that fair outcome. The currency grows in exact proportion with economic expansion and the demand for dollars, showing perfect elasticity without inflation or deflation.

In this mode, the Federal Reserve would provide every dollar demanded by the global economy at a uniformly stable value. Nothing more and nothing less should be asked of any central bank or currency.

With the return of the “honest” dollar would come elimination of “moral hazards” in the nature of expectations that large enterprises will be bailed out by the Fed if its financial undertakings prove unsuccessful. At the same time, however, such enterprises will no longer be caught in crises brought on by currency with unpredictable future value. That is a trade-off that every enterprise and worker ought to be eager to make.