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What would happen to an economy if physical precious metals were legal tender currency?

Imagine money that had intrinsic value. How would this affect banking, government spending, saving, and consumer spending?

Better or worse than fiat money?

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    Mar 18 2013: the effects are many.

    first, if paired with 100% reserve banking, it immediately stops inflation, and the economy returns to a slow deflation, its natural state.

    second, since the government (or its sock puppet, the central bank) can not create new money to pay its debt, interest rates will rise to some 5-10%, which is the true rate following from the time preference of people.

    third, since there is no inflation, bank deposits fall, as some people now will consider keeping money in some vault.

    fourth, due to the rising interest rates, borrowing hugely slows down. only investments able to churn out more than 10% return will be undertaken.

    fifth, a whole bunch of businesses will go bankrupt, because they were counting on cheap loans. with the rise of interest rates, these businesses will be revealed to be not profitable, and will be liquidated. entire sectors are expected to collapse, like mortgage derivatives, and their dependent fields like the construction industry.

    sixth, since governments can not maintain their level of spending, political crisis will follow. those that live on benefits or otherwise dependent on the state will march on the streets, cars will be set on fire, stones will be cast, and the unions will cry doom. the current political system built on lies and deception will collapse like a house of cards.

    seventh, the truth will be revealed, profitable businesses will take the place of the wasteful old and corrupt ones, honest politics will take place of the dishonest old one, wars will be ended, end the economy will grow in an unprecedented rate.
    • Mar 18 2013: I think this was a great analysis right up to the Seventh effect where I begin to diverge a little:

      "..... the truth will be revealed, profitable businesses will take the place of the wasteful old and corrupt ones, honest politics will take place of the dishonest old one, wars will be ended, end the economy will grow in an unprecedented rate."

      I think we need to take a good look at he externalities. A UN study, GAEZ calculates that we can feed 10 billion people - in the current phase we can assume that we are or will be pretty well maxed out on the ecological credit card over the next couple of decades if we get that far.

      .What that means is that the New Dawn optimistically forseen by Krisztian has to take place "on the lean" - a healthy sustainable population of 10 billion without war is entirely possible within ecological limits but it would require a deeply materialist understanding and a very high discipline in the way we use material resources and accessible birth control may be a help too. I'm sure that any economy growing quickly during this time will have to be working on a zero sum basis and the role of profit itself will have to re-examined. In another post I've described the resulting state as "The new Mercantilism".
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        Mar 18 2013: i have to words for that: "UN study". enough said.
        • Mar 19 2013: I don't think anywhere near enough is said!

          There is far to little attention paid to the human condition as experienced by the human species as opposed to the individual. the literature on Population all seems to point in the same direction - although the human carrying capacity of the planet is variously estimated at between 0.25 and 500 billion many of the more realistic ones estimate agree with that 10 billion area. If you're going to treat all those other people too with the same (hope fully humorous) disdain , well, well, I'm running out of words. OK, I agree, Enough said.
    • Mar 27 2013: With 100 percent reserve banking wouldnt banks be desperate for cash and need to offer high interest rates on savings accouts, cd's, etc thus attracting peoples savings to the banks vault?

      Secondly, in your opinion would this change be good or for whom would it be good for?
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        Mar 27 2013: interest rates are set by supply and demand. interest rate plays the same role as prices for products. if the interest rate is higher, less people want to borrow and more people want to lend. if the interest rate is lower, more people want to borrow and less people want to lend. at some point, lent and borrowed amount is equal, and the equilibrium is set.

        banks has no way to change that. interest rates will rise, as they are below market level now. banks has to offer higher interest rates, but also will charge higher interest rate on their borrowers. this will lead to a shrink in total lending, which will indeed make banks desperate, until some of them go bankrupt, and we reach a new balance.

        in the long run, it will be good for everyone. it will be good for entrepreneurs, as they will be able to calculate more reliably. proper market interest rate is central to the calculation of ROI and other measures. market interest rates are also good for savers. as the investment market stabilizes, one can more easily estimate future yields, and find safe investments. and it will be good for the economy, thus benefiting everyone.

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