The History of the Federal Reserve
There is only ONE THING that you left out of this equation. GREED. If someone found a new big gold mine and it produced that well, they would buy enormous amounts of bling, waste it on women, fast cars, servants, etc.
Let's replace gold with NBA contract. Someone got an NBA contract and it produced so well, they bought enormous amounts of bling, wasted it on women, fast cars, servants, big houses, etc. Every time someone gets a bigger NBA (or whatever sport) contract, they waste it, and it affects the world economy zero on the downswing as you indicate.
Greed will override deflation EVERY SINGLE TIME. When was the last time you saw a corporation rake in the bucks and then use it to lower prices? Let's see - the biggest corporate gains in WORLD HISTORY - the recent profits of Exxon/Mobil - have you noticed gasoline prices going down since they made so much money? Did they return to $1 a gallon gasoline, or did gasoline simply continue going higher?
Point made - greed trumps gold every single time.
Let's address "interest rates would be insanely volatile." Countrywide, anyone? Have you even LOOKED at adjustable rate mortgages (ARMs)? The interest rates on them are INSANELY VOLATILE. People refinance a small home from $1400 a month and then get into a fixed mortgage for 50% more - $2100 a month - for a SMALL HOME. For 99% of the markets, $2100 a month is a LOT of money.
Add greed in - "points" which is a nice way of saying "you pay us for the privilege of borrowing, PLUS interest," attorney fees; closing costs, fees, fees, fees EVERYWHERE.
When money is backed by gold, it only means that inflation goes up very slowly, until you throw in greed. If money IS gold, then guess what? Inflation can STILL happen - 1849 gold rush for instance - things were priced at TODAY'S prices in dollars there, but elsewhere, fairly stable. Inflation happens regardless of gold backing or not, but gold backing will for the most part keep things more stable. Without it, you end up with hyper-inflation like at the end of WWII in Germany - a wheelbarrow of money for a loaf of bread. That was WITHOUT gold backing for the money. WITH gold backing - gas at 19 per gallon in 1970. WITHOUT gold backing in 1973 gasoline had doubled, then quadrupled. In 1979 gasoline hit $1 per gallon. In less than a decade, oil moved up 5x, where it had been relatively stable with gold backing the money. Gold backed money makes a society more stable, plain and simple, without it (like now), you end up with volatility.