Rebirth of the Gold Standard

I’m pleasantly thrilled to discover that the president of the World Bank, Robert Zoellick, also shares my ignorance. He announced today that he felt a gold standard was just the thing to be incorporated into a “co-operative monetary system that reflects emerging economic conditions.”

Writing in the Financial Times Monday, Zoellick pointed out that, “Although textbooks may view gold as the old money, markets are using gold as an alternative monetary asset today.”

Zoellick’s remarks were met with equal parts contempt and bewilderment by various economic groups.

Fred Bergsten, director of the Peterson Institute for International Economics in Washington, said that Mr Zoellick’s overall approach was “very sensible” but that the idea of using gold was “minor and really irrelevant”.

“I happen to think that gold is a very poor reference point because it fluctuates so widely,” he said.

The idea of the gold standard has been fluttering around the fringes of mainstream economic discourse in varying degrees of ubiquity since the end of the Bretton Woods agreement in 1971.

The chief features of the Bretton Woods system were an obligation for each country to adopt a monetary policy that maintained the exchange rate of its currency within a fixed value-plus or minus one percent-in terms of gold and the ability of the IMF to bridge temporary imbalances of payments.

That policy made it technically impossible for signatory nations to manipulate their currency exchange rates, either through direct suppression or through massive dilution via the printing press – a condition that came to be in direct opposition to the interests of the United States Treasury Department and the U.S. Federal Reserve.

The U.S., at that time, was witnessing a phenomenon where the more money they printed, the less willing institutions were to hold dollars, preferring gold, even at the artificially fixed price of 1/32nd of an ounce of gold for each U.S. dollar. The price for an ounce of gold was fixed at US$35 an ounce.

The Nixon administration was characterized by Nixon’s proclamation that “Now I am a Keynesian”, even though he admitted that would entail having to burn up a lot of old speeches denouncing deficit spending. He introduced a Keynesian “full employment” budget, which provided for deficit spending to reduce unemployment.

This triggered a weak dollar, which saw foreign central banks converting their dollars to gold and taking it out of the United States. And that is what spurred Nixon to end the convertibility of the dollar to gold. How could he print with abandon if that would empty the United States’ vaults of gold?

And so by ending the convertibility of the dollar to gold, use and demand for gold began to dry up, and, as the dominant emerging economic power, and global leader in energy production and sales, the U.S. dollar replace gold as the standard for trade.

So when people dismiss the gold standard as unworkable, in most cases, they envision the gold standard as defined by the Bretton Woods Agreement of 1944.

What Robert Zoellick is proposing, while not specific, suggests that he envisions “employing gold as an international reference point of market expectations about inflation, deflation and future currency values.”

Policy makers seem to be out of touch with the realities of the marketplace.

The idea of unregulated markets for whom an infinite supply of money and credit is made available is failing before our very eyes, yet the U.S.

administration can conceive of no better remedy than to continue flooding the market with a product for which there is no further demand.

More money and credit, in the face of infinite free money and credit, can neither spur economic growth nor create employment. And that is because the continued deluge of dollars has reached a bulkhead beyond which it cannot pass – namely, the banks.

In the absence of employment and economic productivity, banks cannot extend the dollars and credit to small businesses or individuals because their ability to repay is catastrophically doubtful due to general economic conditions. So we end up with this glut of money churning around in the top layer of the economy – in the financial services industry – generating fantastic paper profits while the man on main street starves and goes homeless.

The one outcome that a currency that was forced to abide the discipline inflicted by the limited amount of money in circulation a properly configured gold standard would enforce is that there wouldn’t be these huge excesses of capital sloshing around on the top of the economy like useless foam on a mug of good beer.

But that is precisely the source of the opposition to the idea. Since it’s the financial services industry, who relies on an ever increasing volume of capital in the system to support a perpetual earnings growth model in times of economic stagnation or contraction, the resistance to anything that would thwart monetary growth is fierce and intransigent.

In May this year, Sean Fieler and Jeffrey Bell of the American Principles Project submitted an essay entitled: “The Gold Standard: The Case for Another Look”.

They stipulate that, “The U.S. could return to a gold standard, a system that would not only prevent the government from running chronic budget deficits but would also curb attempts to manipulate the value of the dollar for political reasons.”

The go on to say that the value of a gold standard was “proven” in the 19th century.

“The value of a gold standard was proven in the 19th century. Following the English parliament’s passage of the Coinage Act in 1816, which created a gold standard in England in collaboration with the semi-private Bank of England, gold gradually displaced copper and silver to become the world’s sole final currency. In doing so, gold established ground rules for international trade and integrated the world’s economy. Countries that adopted the international gold standard prospered. This remarkably successful monetary system only blew apart with the outbreak of World War I in 1914.”

Fortunately, the idea of incorporating gold into the next generation of global trade unit seems to be percolating upward to where it counts. Which shouldn’t really come as a surprise. As demonstrated  yet again by gold’s insistent price rise in direct opposition to the dilution of the U.S. dollar monetary base, it has, for 5,000 years, always been the standard by which all other fiat currencies are valued.

James West is the publisher of the highly influential and widely respected Midas Letter at midasletter.com. MidasLetter specializes in identifying emerging companies in gold and silver exploration at the beginning of their share price appreciation curves, and regularly delivers 10 baggers (stocks that increase in value by at least a factor of 10) to his premium subscribers. Subscribe at http://www.midasletter.com/subscribe.php.