Media Dump - 9/25/16

Here's some interesting links for your Sunday

Podcast---

I've been listening to a podcast called Philosophize This by Stephen West for a long time. He walks his listeners through the history of philosophy in a very comprehensible. He's got a few great episodes on economic philosophies and politics. Here's a few:

• Ep. 81 - Capitalism vs. Communism
• Ep. 50 - Are You Left or Right?
• Ep. 49 - Adam Smith - The Tip of the Iceberg of Wealth
• Ep. 48 - Adam Smith - Specialization

The entire podcast is a great resource to dive in to. At the end of the day, economic beliefs are a strong reflection of views of morality and philosophy (what one believes to be right and wrong in society, and how to best achieve those goals).

Books---

• Moss's A Concise Guide to Macroeconomics - A fantastic introduction to how money works, how the world economy works and why we have certain institutions like fiat money and central banks

• Cohen & DeLong's The End of Influence - I wasn't a huge fan of this book as it bounced around too much. But it is a thought experiment of what happens after the US runs trade deficits and public spending deficits for long enough.

• Piven & Cloward's Regulating the Poor - A history of welfare and the theories behind it. Dry and academic, but really interesting history.

Blogs---

• Tyler Cowen & Alex Tabbarok's Marginal Revolution

• David Beckworth's Macro and other Market Musings

Market Inefficiencies (Part 3): The Free-Rider Problem & Public Goods

This is part 3 of a series on various market inefficiencies.

Why isn't the military privately funded?

It seems pretty obvious. Pretty much everyone in any country would agree that if you have aggressive neighbors, having a military is a smart investment. And if everyone agrees on something being a good investment, and the free market loves good investments, why doesn't the free market yield defensive military services?

Economics has an explanation for this: The Free Rider problem. It's a simple concept that can affect a lot of public goods.

Here's Fred. He's a free market capitalist.

Fred is a pretty smart guy and he follows his market tendencies to maximize his benefit. Free market capitalism has been pretty good to Fred. He studied hard, made a good living, sent his kids to private universities, and bought that vacation home in Lake Tahoe for market price.

Fred's really grateful that he doesn't have to worry about Canada invading. His country has a strong army. But this army is a little different than most armies. Fred's country's army is all funded by private citizens. They all voluntarily pay a fee of $50/year to fund the army.

But Free-market Fred had a realization one day. Fred benefits from the military because his home and his livelihood are protected. But Fred also realizes that if he doesn't pay the military to protect him... what's going to happen?

Pretty much nothing. The military has PLENTY of money. They get $50 from every person in the country. How is Fred's $50 going to make any difference? It's such a small amount and he could use that money to take Mrs. Fred out to a nice anniversary dinner. And so Fred stops paying. He still gets all the benefit of a functioning military but doesn't have to pay anything because this is a free market and if Fred doesn't want to pay for something he doesn't have to.

The reason people in this example are funding a military is because the existence of the military creates a public good. A public good is something that everyone in a society benefits from no matter how much they pay for it (sometimes nothing). In this case, the public good is peace and security.

Public goods are defined by two main characteristics. They are

(a) Non-excludable: I cannot stop you from enjoying the benefits of a public good, even if you haven't paid for them.
(b) Non-rival: My enjoyment of the benefits of a public good do not stop you from enjoying them as well.

So Fred just became a free-rider because he is enjoying a public good and not paying for it. Ideally the free market would then transfer the risks and downside of not paying for the military to Fred, but it can't because peace and stability are non-excludable. We can't stop Fred from enjoying the peace that the rest of us are all paying for, and we can't let Canada invade only Fred's home but no one else's.

As soon as Fred's neighbors see that Fred is benefiting from peace and not paying for it, they realize that they're all being played for fools. So they stop paying too. And then the whole system falls apart and the military has no money to defend the population. The public good goes away, Canada invades, and suddenly the roads are running brown with maple syrup.

The way society has historically fixed this is through coercion. A government can coerce its citizens to pay for something by levying taxes and using the threat of force or imprisonment in the case of nonpayment (two forces which are non-existent in a completely free market system). The military is the most obvious and well-cited example of a necessary public good and the free rider-problem potentially occurring, but there are others. Before you look below, which ones can you think of?



Some public goods:

• peace
• clean air
• clean water
• low crime rates 
• a predictable, stable currency
• a well-educated population
• sunshine

Free-rider opportunities:

• not contributing to a police force, 
• refusing to cut carbon emissions and pollution despite others doing so 
• people taking advantage of herd immunity when they can be vaccinated
• any donation based entertainment (museum admission, album purchase, live band, public radio, etc) in which an audience member does not contribute.
• that time you pretended to be lifting a heavy couch, but the other three people were carrying all of the weight.

Market Inefficiencies (Part 2): Tragedy of the Commons

This is part 2 of a series on what can make free markets break sometimes. Here's a second form of free market inefficiency.

This is a common one (ehhhhh.... ok, no more jokes). But it's very important for understanding basic economic theory. So let's do a short post on the Tragedy of the Commons.

Sounds like a bad space movie from the 80's. So let's go with that theme.

In this movie we travel to a far off world, Alpha Ruminant. Alpha Ruminant is inhabited by space-ranchers who herd space-cattle.

Space cow

There's only one thing for space cows to eat on Alpha Ruminant and that's space grass.

Space grass

Space grass is a great resource, and it grows back every year so the cows can keep on eating, keep on growing, and keep on living the dream. As longs as the cows are happy, the ranchers get their space cow burgers and are happy too.

Now, the reason that space ranchers space ranch at all is because space cow's milk is VERY valuable. People on the nearby planet of CookieTron drink the stuff like it's water and are willing to pay big bucks for it. 

And because it's so valuable, it is in a space rancher's interest to own as many cows as he can to produce as much space milk as he can. All the ranchers invest and grow their herds over time. 

The production of space grass on Alpha Ruminant is about 1,000 kilograms per year, and each space cow eats 1 kilogram per year. The ranchers have an incentive to grow their herd as much as possible and grab as much of the grass as they can, but there is a limited production of grass. Eventually, if the 10 ranchers on Alpha Ruminant each own 100 space cattle, then the cows are eating the space grass as fast as Alpha Ruminant can grow it (1,000 kilograms of production and consumption). 

First reaction: hmmm... ok, I guess that sucks but the lack of grass will regulate the market and just limit the number of cows. 

Here's the problem: time. If the ranchers invest to grow the heard to make more money, and then grow the collective number of space cows beyond 1,000 in the beginning of the year, all the cows might eat all the space grass in (for example) 11 months. And then there's no more grass for a month. And I don't know a lot of space cows that can go for a month without food. 

And then all the space cows die. And everyone's life sucks. 

If the ranchers had all just come to an agreement beforehand that no individual could own more than 100 cows (or that the number of cows was somehow capped at 1,000), then everyone would still have cows and be making crazy money off those suckers in CookieTron. Instead, they all just have a bunch of dead cows.

The most disappointing version of this scenario is when the individual ranchers can foresee the problem and KNOW that it is in everyone's best interest to limit their consumption. But they don't trust everyone else to scale back. So they decide to get what they can while they can, even though in the end the costs far outweigh the profits. And everyone does the same thing. (This happens in the real world)

The grass in this example is known as a commons (this example actually comes from real cows eating real grass on real commons in the centers of real towns, I just added the space). A commons is a resource that is either directly owned by nobody, or owned collectively by society. In this example -and many real life examples- free market behavior can lead to the destruction of common resources that benefit all business and individuals. And the destruction of those resources can make everyone in the system ultimately worse off. 

Examples of real world commons and ways they can be destroyed by over-competition:

• Air 
• Pollution 
• Fish populations
• Over-fishing
• Water resources for farmers (wells, rivers)
• Over-irrigation
• Oil supplies
• Over production
• Low orbit outer space 
• Space debris rendering certain orbits too dangerous for satellite use.

Market Inefficiencies (Part 1): Externalities

"The free market can fix any problem".

This is a powerful saying. It's beautiful, elegant, and -best of all- requires no government intervention. If you wait long enough, the market should be able to fix any problem that young, hungry entrepreneurs set their eyes on.

There is a issue, though. Economists have known about the issue for many years. But the explanation is longer than the sentence "the free market can fix any problem", so it's easy to ignore. But if you have a few minutes and want to know hear one reason (among a few still to come), continue reading.

This is an externality. He's a pain in the ass. He shows up to parties uninvited.

Here's my definition of externalities: stuff not included in the price of a product.

Stuff is a pretty general term, so we'll get 5% more specific.

An externality is a "cost or benefit that affects a party that did not choose to incur that cost of benefit" (that's from wikipedia).

Let's think of some common examples.

• People who drive their cars up snowy mountain passes without tire chains
• Smog

Let's start something simple and common. The last one seems like a good place. Smog.

Let's imagine a world where a gallon of gas costs $2.00 (clearly not California). That's the market price. It includes all the efforts it took to drill the well, pump the oil up, refine it into gasoline and deliver it through an elaborate supply chain to your local gas station, plus a little profit for the companies involved.



As a consumer, I look at the price of a gallon of gas and ask myself "Am I getting at least $2.00 in benefit from this gallon of gas?". If the answer is yes, I go ahead and buy it. If the answer is no, I don't. And the market works efficiently because of millions of these decisions.

In this imaginary example I choose to live in a city like LA (but not in California, for consistency), where various meteorological forces cause the exhaust from my car to linger in the air around the city. Most people would agree that smog and air pollution cause lots of diseases. Let's assume the smog gets so bad that my friend Larry eventually gets unlucky and is diagnosed with lung cancer as a result of breathing in terrible air for 30 years. That sucks, hardcore.

And now Larry - or Larry's health insurance company - has to shell out $100,000 in treatments.

If the smog didn't exist, Larry might never have gotten lung cancer. So there was an EXTERNAL COST (not included in the original price of gas) to other people that I never paid when I bought my gallon of gas.

If you totaled up all the cases of lung cancer that were a result of smog in the city and then divided it by the total gallons of gas that were burned to create the smog, you might end up with a total healthcare cost per gallon of $0.02 (completely fake number, just to illustrate the idea). So if I were to pay for the benefit I got AND set aside money for Larry's future medical bills (the cost I imposed by benefitting from the gasoline),  I should have paid $2.02 for that gallon of gas.

But I didn't. Someone else ended up paying the $0.02. It doesn't sound like a lot of money. But when you see that 384,000,000 gallons of gasoline are used in the United States per day, and that the environmental costs could be much higher than $0.02 per gallon, it adds up real quick.

----

Ok, so this can be hard to imagine because there's a lot of INDIRECT externalities that are hard to track. So what if we take a really short, really tangible example?

Tire chains can be bought for $10 per pair. They are required in snowy passes in the mountains to maintain traction. In a free market, the owner of a two-wheel drive Honda Civic should have the right to either buy the tire chains ($10) or suffer the consequences of getting stuck: it's up to him if he wants to take that risk.

If you've ever gotten stuck behind a Honda Civic that can't get up a snowy mountain pass, you know that the owner of the Civic's stupid decision to not buy tire chains affects more than just him. It affects you and the long line of cars behind you.



There are very tangible costs to everyone waiting for this Civic to get unstuck. Lost wages, missed meetings, lost free time, gas wasted idling, lost hours skiing, immense frustration. That person's "free market" decision to take the risk affected a huge group of people and cost the collective group much more than $10 in mental serenity. The $0 he paid was not the actual social cost of his decision (i.e. his decision wasn't cost-free just because he chose the $0 option).

In an ideal market, all of those individuals would then have a claim on the owner of the Civic for the costs imposed on them. But it is neither practical or efficient for everyone in their cars to sue him for (for example) $15 each. The government, recognizing these costs and the failure of the market to compensate, steps in and regulates the road: Use tire chains or face a $100 fine. That $100 fine, in some ways captures a portion of the external (negative) value imposed on society by the inefficiency (or non-existence) of the market for snowy hill lawsuits and tire chains.

The list of activities that include externalities is essentially endless. Here's a few more:

• Not wearing your seatbelt in a car (added healthcare costs in the event of an accident)
• Playing loud music at night (annoys your neighbors)
• CO2 emissions (effects of global warming)
• Nuclear plant being built in your neighborhood (decreases the value of your home)
• City building a park in your neighborhood (increases the value of your home)
• Littering (costs associated with city beautification)
• Smoking (second-hand smoke, among others)
• Microbeads

David Moss on Insurance

I'm reading a great (if not a little bit dry) book by David Moss called "When All Else Fails: Government as the Ultimate Risk Manager". In the book, Moss has a really amazing and elegant explanation of how insurance works that I wanted to repeat here. The following example is Moss's work summarized by me.

Here's a very simple statistics refresher for you (it will be necessary). If you already understand expected value, you can skip ahead to the break:

---[definition: expected value]---

Let's say there's a raffle. This raffle has a payout of $100. There are 1,000 tickets given away for free for this raffle and they are all thrown in a hat.

We know that someone is guaranteed to win, because a ticket is going to be chosen. By getting 1 lottery ticket, you have a 1 in 1,000 chance (.001%) of winning the $100. Obviously, if you get your hands on 5 tickets, you have a 5 in 1,000 chance (0.005%) of winning the $100.

To be clear: If each ticket has a 1 in 1,000 chance of winning, and you participated in this raffle on 1,000 separate instances, you're expected to win once.

In statistics, we use a term called expected value. All that means is that, if you played this game over and over and over again forever, there is a certain amount that each play would be worth (or how much money you expect to make on average from each play). We calculate this by multiplying your odds of winning, by how much money you expect in winning. In this instance, the expected value is:

You can also include the calculation for what happens if you lose. But the payout if you lose is $0, so it just cancels out that whole part of the equation and doesn't change anything.

This means that if you end up with a raffle ticket, the expect payout per ticket is $0.10.

---[break]---


Ok, on to Moss's insurance explanation.

Imagine that there is a boat captain and he ferries shipments from Boston to London. If he makes a successful journey, he will be paid $10,000 for his cargo.




In this world, hundreds of boats attempt this journey every month. And because so many boats attempt the journey, we know that on average about 80% of the boats are successful. The other 20% never make it because of storms or attacks by the sea monster. Every boat that makes it gets $10,000 for its cargo.

Given the odds of making it, and the payout of being successful, we can calculate the expected value of a single journey to be the following:

This means that if the sailor makes the journey thousands of times over his lifetime (and doesn't die in one of the wrecks), his average income per journey will end up being $8,000.

Now the problem with this is that while his expected income is $8,000 per journey, the variation between the amounts he can make is huge. It is either $10,000 or $0. And sometimes people can't deal with such a large variation in their expected income (imagine planning your personal finances around a paycheck like that). One of the terms we use for this variability in statistics is standard deviation. 

There's lots of statistical theory behind this, but we can ignore that. The basic idea is that as a sample size gets larger and larger (more and more boats making the trip), the average real earnings gets closer to the expected value.

Maybe our ship captain can't afford to miss a profitable trip because he has bills to pay. Missing a bill (employee salaries, mortgage payments, etc.) would cause him financial distress. In an extreme case it could trigger bankruptcy putting his business at risk. He'd like to be guarded against this risk, so he decides to buy insurance.

Since everyone in the industry is in the same boat (pun intended), they all get together and decide to start an insurance plan. They all put money into a fund that will be paid out to those captains who have failed expeditions. In order for the insurance plan to function properly though, enough money must be paid in to cover the average losses (otherwise the plan would quickly run out of money).

The reason an insurance plan works in this case is because instead of having the potential for a $10,000 or $0 payout, the boat owner pays $2,000 per trip in insurance premiums and GUARANTEES an $8,000 profit per trip ($10,000 payout minus $2,000 premium). He knows that he will lose every fifth boat on average, but he will get paid $8,000 from everyone else's premiums.

(It's kind of like he set aside and saved $2,000 from each successful trip for the failures. You might be thinkings: "Why doesn't he just do that?" The reason is that everyone in the system is spreading the risk across the entire population to avoid strings of failures. So if our boat captain runs into a time where he has 4 failures in a row, the greater population will still statistically make up for it by using the premiums from higher-than-average successes by other captains. And if statistics holds true, the boat captain - if he operates long enough - will eventually diminish the effects of that string of losses on his average earnings.)



His expected value did not change, it stayed the same. But his variation, or standard deviation was reduced... essentially for free, because he coordinated with his fellow boat captains. Of course, if our boat captain loves risk and wants to play the odds at making $10,000 in a trip (and can afford the risk), he won't buy the insurance. But over the long run, he'll end up with the same average profit, just with greater variation.

The beauty of this is that an efficient insurance program where everyone shares the same average risk will keep the insured very close to his or her expected value in a system. It just reduces the likelihood that a participant will run into financial distress if they have a string of bad luck (e.g. if the ship has 4 failures in a row).

Where it gets complicated is in something like health insurance. Perhaps I am very healthy, I have good genes and good eating habits. My expected medical costs over the course of my life might be $20,000. But there is also someone who is very unhealthy with poor genes and poor eating habits who has an expected medical cost of $200,000 over the course of her life.

The example above would state that my premiums should bring me close to my expected costs over time, but that only works in a system where everyone has the same level of risk (like the boat captains). In a system where individuals have varying levels of risk (like health), the insurance plan brings you close to the average expected cost of the entire group (the two numbers are the same in the ship example).

In the imaginary healthcare example with only two people, the average of $20,000 and $200,000 is $110,000. So both I and the other person must pay a guaranteed $110,000 over the course of our lifetime if the system is to function properly. That's a tough bargain for me*, but while healthcare risks are statistically predictable for an entire population, they are hard to predict for individuals. And when an individual encounters a major health problem, the costs can be astronomical and place that person into financial distress. The insurance program doesn't exist to reduce the cost of healthcare; it exists to eliminate the huge standard deviation that causes financial problems beyond what a person can deal with if they get sick.



*This "tough bargain" leads to the problem of adverse selection which I will write about in a future post.

Here's why you should stop wanting a gold standard (Part 3)

Part 3: Trade & Exchange rates

Trade. It makes the world go round. Canada has maple syrup, America has Hollywood movies. America exports one movie and imports a couple gallons of syrup and everyone is a little bit happier.

However, international trade isn't based on a barter system. When I create a product, and someone in another country wants to buy it, they need to give me cold, hard cash or they don't get my product. In fact, they need to give me cold, hard, green, 25% linen 75% cotton American cash if they want my stuff. I'm not accepting any of those monopoly money Canadian dollars; I can't use them at the corner store to buy my bread.

So what does the gold standard have anything to do with this? Let's head back to Bananastan to find out.

• Bananastan isn't the only country in our imaginary world. Right next store are two other nations called Yoyopia and Duckstein.

• Yoyopia and Duckstein are both industrialized nations who have factories that output products.
• Yoyopia produces yoyo's
• Duckstein produces rubber duckies
• There's lots of trade between all three countries. Bananastan imports yoyos and duckies from each respective country, and exports bananas to both countries. 

Now, remember how I wanted American dollars when someone from outside the US wants to buy my stuff? The citizens of these three countries are the same way. If someone in Bananastan wants to purchase a duckie, he or she needs to find some Ducky Dollars to pay the local producer with. The best way to do this is the same way we do it in the real world: take some Banana Bills (BB) to the bank and exchange them for Ducky Dollars (DD). Same goes for Yoyo Yen (YY).

Let's assume that our new world starts with everyone trading happily and equally. One banana is sold, one duckie is sold and one yoyo is sold every day. And because of the equality, it just so happens (in our imaginary world) that 1 Banana Bill = 1 Ducky Dollar = 1 Yoyo Yen, and I can go and trade these at the bank any time I want.

But what happens when demand changes? Let's say that there was a mass environmental movement in Bananastan to conserve water and everyone started taking short showers instead of long relaxing, candle-lit bubble baths. And since they aren't taking baths, they don't really need rubber duckies anymore. Well, demand just plummeted for duckies. 

And since the people of Bananastan no longer need duckies - and that's the only thing they buy from Duckstein - then they don't really need Ducky Dollars anymore. So demand for Ducky Dollars just plummeted too. But bananas are still in demand all over the world, so demand for Banana Bills is as high as ever. 

In both our imaginary world and the real world, this situation leads to a change in the exchange rate. Because less people want Ducky Dollars, the value of a Ducky Dollar might decrease to 0.50 Banana Bills per Ducky Dollar (or 2 Ducky Dollars per Banana Bill).

This is actually a really awesome mechanism. When the value of a local currency goes down, it makes their exports more attractive assuming wages don't adjust perfectly with the exchange rate (they never do). People in Bananastan used to pay 1 Banana Bill for a duckie, but now they can get it for 50 Banana Cents, and that might look like a pretty good deal. And the people in Yoyopia never adopted water conservation and they definitely want more duckies at the reduced price (why have one ducky when you can afford two?).

On the other side, people in Duckstein used to pay 1 Ducky Dollar for a banana, but now that price has risen to 2 DD because the bank only gives them 0.50 BB for their Ducky Dollar (1/0.5=2). This means that people in Duckstein will buy less bananas because they are too expensive... reducing demand for bananas... reducing demand for Banana Bills... lowering the value of banana bills... etc. until it all equilibrates at the "optimal" market price.

"AHHHHHH... So much going on!". OK, moving on. 

If you grasped that overcomplicated explanation, maybe you can see where I'm headed with this. If a gold standard existed in this imaginary world, it would break the dynamic exchange rate system. If all three countries pegged to gold and 1BB = 1DD = 1YY = 1 Ounce of Gold, then the exchange rate would never change because they all MUST equal one ounce of gold at any given point. If, for whatever reason, demand for a country's exports fell, the currency would not be able to adjust and the currency would be overvalued.

Overvalued currencies lead to countries importing more stuff than they can reliably sustain over a long period of time. If my country isn't productive, but I keep importing stuff, that is called running a current account deficit. China is doing the opposite of this, keeping their currency artificially low so that their exports look more attractive to the outside world (while keeping imports are abnormally expensive for the in the local market).

If I am buying stuff and not producing stuff, I must be paying for my new imports somehow. Well the US has been running a current account deficit for 40 years. How do they do it? Debt! The longer a currency is overvalued, the more debt will build in the country until something gives.

So the exchange rate system allows the natural mechanisms of markets to work efficiently. Countries that mismanage their production get a hit to the value of their currency and countries that do a good job of growing production are "rewarded" with a higher value currency with which they can buy more things. Gold standards break the system.

Here's why you should stop wanting a gold standard (Part 2)

Part 2: Banks & Lending

Banks play a crucial role in any economy. They not only provide a safe place for you to store your money, they also use that money to give loans to small business and families taking out mortgages to buy homes.

The theory of the gold standard revolves around its ability to cap the supply of money to avoid inflation. However, government isn't the only entity that "creates" money in a system, as we'll see in the example below.

Let's go back to Bananastan:

• Mr. and Mrs. Peel (two banana farming residents of Bananastan) have been model citizens. They have worked hard, lived frugally and saved some money from selling their bananas at the local market in their hometown, San Manzano. 
• They decide that the best place to put this money is downtown at the Bank of San Manzano.
• The manager at the Bank of San Manzano is delighted to take their deposit of $50 BB and place it into their savings account, assuring the family that their money will be safe and available whenever they need it.
• One entrepreneurial resident of Bananastan, Mrs. Split, wants to open up a chocolate banana stand in town, but needs a small business loan.  So she goes down to the Bank of San Manzano where she passes a credit check and the manager gives her a loan of $50 BB. The source of the loan is all the deposits that the citizens of Bananastan have placed in the bank (including those of Mr. and Mrs. Peel).
• Mrs. Split takes the money and buys timber, nails, a 55 gallon drum of chocolate and 100 bananas from the Peel banana farm. Then she opens the chocolate banana stand and pays a local teenager a week's salary (5 BB) to run the place.  Mrs. Split has spent all the money.
• The teenager, at the guidance of her parents, then places her 5 BB in the Bank of San Manzano to start saving for college.

This is great. Times are good. Business is booming. But wait. Something is weird here.

• By all accounts, Mr. and Mrs. Peel are correct to believe that they have $50 BB. Every time they log into their account on the bank's website, it's right there. 
• Mrs. Split may have spent the loan by building the stand, but she has $45 BB worth of stuff (wood, nails, etc.) that she didn't have before she got the loan.
• All the vendors who sold Mrs. Split her supplies are now holding that same $45 BB in cash that Mrs. Split had a short while ago.
• As far as the teenager is concerned, she has 5 BB sitting in the bank that she worked hard for at the stand and responsibly put into the bank.

This bank just created money out of thin air. If Mrs. and Mrs. Peel are the only people with deposits at the bank, and if they want to withdraw their money today it is not there. "Money" was created without any government printing or intervention. There was $50 BB in the system, now there is at least $100 BB. 

This is what is called the money multiplier effect, and it can certainly cause inflation even in the presence of a gold standard. When the government (central bank) creates a dollar, its very likely that that dollar will multiply in the economy. Image how complicated it gets once the Bank of San Manzano lends out the teenager's $5 BB deposit - that's a double lending of the Peels' original 5 BB. And in reality a single dollar can be re-lent many many times*.

So, it should be obvious given the example above that the gold standard does not make inflation impossible. There are other forces that can cause inflation in an economy beyond printing money.

In fact, inflation during a gold standard has happened lots of times in the real world. Take a look at this chart below (source):

The US dollar was pegged to a gold standard until 1933, and inflation from 1919 until 1922 ranged from -16% to +24% in a short period after WWI, and wobbled around thereafter. Numbers that extreme today would be incredible and would have very detrimental effects on expectations in the economy (For example, "We can't plan that vacation until we know what my salary is going to be next year.")

Another extreme example in history is when Musa Keita of Mali went on his pilgrimage to Mecca in 1324. He rolled through Egypt and thought he would do the poor a favor and give them all gold (literally tonnes of gold). This sudden influx caused the value (price) of gold to plummet and inflation to skyrocket, devastating the economy of Egypt for a decade. Holding gold in that time was no hedge against inflation.


*Bonus material:

In an environment where banks are allowed to just keep lending all the money they take in, crises can develop when people want to collect their deposits - and bank runs happen. Governments reduce the likelihood of this happening through a few mechanisms, one of them being reserve requirements. The government says "If you are going to give out $1000 (USD) in loans, then you need to have at least $200 cold hard (or digital) cash reserved in your vault". This creates a 1:5 deposit to loan ratio. The higher that reserve number, the fewer loans a bank is able to give out.