Advantages of Commodity Backed Monetary System

In the monetary systems of most countries, commodities play a significant role. For a long period, precious metals like gold and silver were the medium of exchange and have even served as legal tender, though for their intrinsic value. The advantage with having gold and silver as commodity money was that it is very difficult, and near impossible to replicate them as they are prohibitively expensive to counterfeit. Moreover gold and silver coins were easily portable. It was over a period of time that a commodity based monetary system evolved.

Technological advances and the need for convenience in day-to-day transactions led to the creation of paper currencies. This form of money was guaranteed by the government and was backed by commodities. The paper currency could always be converted to the commodity it was backed by, like gold or silver, at a fixed price. However, the price of gold for consumption purposes would depend on the demand and supply position and would have nothing to do with its being a commodity backing the paper currency.

The advantage with such a commodity backed system is that currency can be mass produced hence keeping the cost of production low. The banks will also be able to control inflation during fluctuations. We need to keep in mind that the rules under which the banks operate are laid by the people who are responsible for the monetary policy and its implementation. Though the rule says that a country has to be able to produce an equal quantity of gold on demand, the fact is no one really knows if there is sufficient quantity of gold as a commodity backing the monetary system.

Due to global recovery, the international commodity prices are on the rise. However, this does not affect the U.S. monetary policy. The U.S. is a large player in world commodity markets; however it is not able to control the prices of commodities in world markets. This is due to other large players like India and China who have entered the fray relatively later. The economies of these two countries have been growing at a rapid rate. However, this is to do with relative prices of commodities on world markets. The world prices of commodities in US dollars still have a lot to do with US monetary policy.