Inflation, Gold standard and government borrowing

John Humphreys has posted an excellent article on inflation and what can be done to prevent it. Here's an extract:

However, in contrast with the private sector (which needs to expand production to pay back the loans) the government has no market dicipline to ensure that their spending increases national production. Indeed, government spending often decreases national production though distorted incentives, deadweight loss, administrative and compliance costs, waste and corruption. This means that there will be more money chasing the same (or fewer) goods… leading to inflation.

Greenspan suggests that only a gold standard can prevent this. But he is wrong. All of these problems still exist with a gold standard. If the government is still allowed to borrow and tax, then even under a gold standard banks will have an incentive to create credit for the government without ensuring an equivalent increase in production.

The only way to ensure a stable monetary system is either to (1) remove the government’s power to tax; or (2) remove the government’s right to borrow; or (3) allow them only to borrow when the future repayments on the loan do not come from tax revenue.

Very much worth reading in full and even clear enough that even I can understand it.