Gold has often been considered to be the best form of money. The free market has been correctly and justly lauded as the best form of organization for an economy. It comes as no surprise, therefore, that one of the most popular proposed solutions for economic problems of almost any sort is the proposal to use metal based money in a perfectly free market, or at least a market free of governmental interference.
There has never been a free market for any significant time period in written history. Those free markets which have been observed in the world have been those of very primitive technology, (hunting and gathering) societies which have only dogs as domestic animals. But we will ignore that and, as a mental exercise, consider what would happen if there were to be a true free market with a fixed (or nearly so) supply of gold serving as its only form of money.
Let us assume that the gold is evenly distributed and the level of technology is that of the mid twentieth century. We further assume that there is a true free market and that the free market is maintained throughout. We will even assume that there are no taxes at all and, to keep the system "pure" we will assume no foreign trade. Finally, we assume that all parties are law abiding and that business organizations never form trusts or other means of restraining trade or generating monopolies so that "pure competition" is maintained. These assumptions are wildly unrealistic but will permit us to exclude possible disruptive influences.
The economy functions in this way for a few years. At the end of that year some people will have acquired more of the gold than others. But since the supply of gold is fixed (or changes very slowly) the gains by some must be matched by loses by others. So let us consider the persons who have the most gold. Starting with the top gold owner and working our way down the list we add their gold until we reach a gold total that represents 10% of the gold in the economy. Let us assume that this requires only two percent of the population so we observe that two percent of the population owns 10% of the gold. (I believe this to be a very conservative estimate given the distribution of knowledge, talent, determination, effort, skill, luck, and opportunity.) It seems to me that this top two percent will continue to gain on the rest of the population in the proportion of the economy's gold. The personal consumption of each of these "rich" people will be greater than that of each of the poorest 20% of the population but will probably not be 10 times as much. Therefore, the proportion of the gold owned that is freed for investment for the rich will be much greater than that available to the bottom 20%.
So let us assume that this top 2% place their gold in bank accounts at 3% interest. In 25 years the amount of gold they own will have doubled to 20% of the total gold. In 25 more years it will have doubled again to 40%. In a further 25 years they will own 80% of the gold. So within 100 years, the economy will grind to a halt since all the gold will be owned by that two percent. That will not work.
Let's assume that the top 2% invest their 10% in various businesses. Since they achieved their status in the top 2% on the basis of being superior at gaining money, one must assume that whatever advantages they had to get into the top 2% they retain. If this assumption is correct then it is only reasonable expect that over the next few years, they will be able to use their superiority and the power, influence, and opportunities that having more money provides to gain a still greater proportion of the existing gold. Is there any reason to believe that these advantages will be reduced as they control a greater and greater proportion of the gold? I think not. I think experience tells us that those who are good at getting money will continue to be so.
Of course as the top two percent gain more and more of that limited supply of gold there is less and less gold available for others. Now just as experience has shown that some are better than others at getting money, so some are considerably worst than others at this skill. In fact, there are many foolish, disabled, irresponsible, and just plain unlucky people. As these people lose money they will have very few ways to gain money. They lack skills to produce goods and services. They lack capital goods. They lack knowledge. They become increasingly poor until they have no gold at all. For despite being poor they still have to spend gold to live.
This generation of poverty will always happen with a free market because everyone who is better able to get money will do so. The poor will always be weaker and less able to defend their money. Even when the market is free and fair the poor will be unable to generate income because everyone else is better at getting and keeping money.
As the poorer part of the population grows, they have less and less to spend. Therefore, prices must fall or production must be reduced for there can not be as much demand. Since the poor will slowly stop buying, production of consumer goods will also slow. This will result in the loss of jobs by many in the middle group. Since they also must continue to spend or die, they also come to have less and less gold. Many of them become poor. This process accelerates as the rich gain a higher and higher proportion of the gold until the system fails.
No matter how we arrange things, the gold tends to accumulate in fewer and fewer hands until the economy fails.
Note that this is because the supply of money is fixed. In our imaginary economy there is no banking system that expands the money supply by loans. But even if there were such a banking system, the proportion of the money in the economy in the hands of the rich would still increase. But we have already shown that if there are banks paying interest the system cannot succeed.
Of course this is all just a fantasy. There is no free market. There are all sorts of ways business can conspire and prevent the functioning of a free market. The government both influences and is influenced by business. We know that money gives all sorts of power and influence and opportunities to cheat. We know that there are all sorts of force and fraud in the real business world. We know that in the real world, money also concentrates in the hands of a few.
In the real world, just as in our fantasy free market world above, the money becomes more and more concentrated until the system fails. This is the nature of any physical object money regardless of whether it is coins, paper, or just computer accounts. This is the experience of every nation and every economy around the world for which we have information.