Gold: Not Just for Gold Bugs Anymore

Leave the fire ashes; what survives is gold
       -- Robert Browning, Rabbi Ben Ezra

It’s the “g”-word. It’s the word that everyone almost says, and then doesn’t, because saying it can make you sound like a little like a loon, or maybe more like a combination of a train spotter and a conspiracy theorist, with an Austrian economics overlay for luck. It’s “gold”, of course.

Of late, however, gold has actually provoked some thoughtful discussion, at least insofar as imagining what might be different in the current crisis if modern currencies, especially the dollar, were tied to gold (or something like it) in a fixed ratio. For a thoughtful example, check the following sent to me today by the folks at QB Partners. Agree or disagree, at least the case will have been made.

…the notion of multiple subjective global monetary policies managed by unitary policy makers seems anachronistic. Fiat currencies allow sovereign governments and their central banks to issue as much paper currency as they wish, as long as merchants, consumers and trading partners are willing to accept that paper in return for goods, services and assets. Because various nations have different growth rates, as well as differing social, economic and political agendas, it follows that subjective domestic monetary policies and the absolute and relative purchasing powers of their attendant currencies are highly unstable and, in many instances, inordinately unfair.

Maybe the US dollar – or whatever form of money the world chooses to have as its reserve currency in the twenty-first century – should revert back to the gold standard? A gold standard is a quaint idea inasmuch as the theory of relativity is a quaint idea. Nothing has changed in the current global economic environment that argues against the legitimacy, flexibility and practicality of re-adopting a currency anchor – not the size, divergent interests or sophistication of global economies, banking systems and capital markets.

The common fear that banking systems could extend only limited credit under a gold regime is fallacious. There is plenty of gold – at the right gold price – to peg paper money to it. As long as fractional reserve banking systems exist, money and credit growth would be limited only by natural economic forces – not by rigid formulae. Neither is re-anchoring currencies to gold a partisan issue, as is so often thought. The healthy tension surrounding free market control and the distribution of wealth would remain in the political sphere, to be argued by liberals and conservatives.

Within all nations, it is the peoples’ collective wealth - earned from innovation, natural resources, labor and productivity - that their central banks attempt to optimize. Central banks throughout history have spotty records of doing this. Politicians across the political spectrum are equally critical of the limitations of a subjective central banking system capable of promoting violent economic booms and busts, which may threaten the very viability of their nation. The question of fairness within an economy – the manner in which collective wealth is concentrated, distributed or re-distributed - is a separate matter with a different pathology from employing a gold peg.

Gold-backed currencies require fiscal and trade discipline among all constituent economies – not necessarily rigid mandated controls. A nation that runs a persistent trade deficit, for example, would find gold leaving its vaults for those of net-exporting nations. This would prompt one of two responses by the indulgent nation: 1) tighten domestic monetary policy which, all else equal, would lessen demand for imports and lead to a rebalancing of accounts or, 2) adjust its fixed exchange rate downward, which would hinder its relative terms of trade with other nations (the overly indulgent nation’s exports would become relatively cheaper while goods it had been importing would become more expensive). These disciplinary dynamics work naturally to rebalance trade and capital flows and to encourage domestic economic sustainability and fairness among trading partners. This is timeless theory (straight from Adam Smith) and would be very practical today.

Read the whole thing here.

Of course, nothing is truly new under the economic sun, as this piece from Time back in 1979 makes clear. Read it for more context on gold’s fashionability in crises.

Comments

[Michael Fit...:]

hello paul - nice article. also enjoy your commentary on CNBC but they usually don't go back to you if the pundits there don't like what you are saying. but wrt this article, and as far as the using the gold standard for the US dollar as a world reserve currency, i have an excersize for you which may be enlightening:

1) calculate the amount of gold the US government owns
2) calculate the amount of US debt and dollars in circulation
3) what price would an oz of gold have to fetch in order to back all the Us paper?

please get back to me when you figure this out @
fitzsimmons_mike@hotma...
meantime, if you have time, please read my strategic, long-term, comprehensive energy policy and give me some feedback:
thefitzman.blogspot.co...

reason i say this is because if the US doesn't adopt something like this pretty damn soon, gold and oil will be the world's reserve currency and the US dollar will be a footnote in history just like the weimar republic.

2008 Nov 16 12:58 AM

[lewy14:]

"Politicians across the political spectrum are equally critical of the limitations of a subjective central banking system capable of promoting violent economic booms and busts, which may threaten the very viability of their nation."

Um... didn't we get into this current crisis because of the "Great Moderation" - the taming of the business cycle and volatility in the Greenspan era? A good chunk of the criticism of Greenspan was that he didn't let the "busts" happen naturally.

No fiat currency has been stable long term... but then, no gold standard has been, either! People seem to forget that. Look at the history of the Progressive movement (the 19th century one, not the 21st century version) to see what kind of narrative you'd start hearing a dozen years after Gold Standard 2.0 is introduced.

Finally think about the dislocation that will be caused by gold suddenly being worth, what, some hundred thousand dollars an ounce or some such. The very idea will cause a scramble and panic the likes of which may be unrecoverable.

Think you'll profit by holding gold prior to a re-standardization? I doubt that's the way it would work.

In fact, if I were a world leader taking my country onto a gold standard, I'd first freeze the price of gold, and then seize it (with compensation at the frozen price), so as not to reward speculation, etc. Ample precedent.

2008 Nov 16 03:13 AM

[Rhunzzz:]

Dear Sir,

I have often wondered exactly how a country could actually go back on to the gold standard. Because it seems more like a very theoretical solution that would have horrific consequences if actually tried.

The current spot price of gold is $743.35 per troy ounce.
1 metric ton is 32150.746 troy oz.
Therefore, currently, 1 metric ton of gold is worth $23,899,257.04.
At last count, the US economy is approximately $18 trillion. Hence, for every dollar to be backed by gold would require... 753,161.49 metric tonnes of gold.

For reference, the entire world's gold reserves are reported at 29,822.6 tonnes. In 2001, it was estimated that all the gold ever mined totaled 145,000 tonnes. (Figures from the World Gold Council).

So perhaps we should reset the theoretical reserve price of gold to be lower? Let's take the last reserve price backed by the US Fed in 1971, which was $35. For the present size of the US economy, backing a reserve price of $35 per troy ounce would require 15,996,074.07 tonnes of gold.

So clearly, to go back to the gold standard would require one, or some combination of the following:

1. The US buys up a lot of gold in order to back up its targeted reserve price, in fact much more than the current global reserves, and much more than all the gold ever mined as of 2001, therefore driving up the spot price of gold in the process, diverting a lot of investment into gold-mining and gold processing rather than other activities like, oh, agriculture or technology.

2. The US economy shrinks to a fraction of its size.

So it does look like going back to the gold standard MIGHT be quite a horrific idea actually. Of course, this is just simple arithmetic.

2008 Nov 16 03:35 AM

[AndrewLib:]

The "gold standard" of the 19th century as someone described was just there to ensure the busts. What does this mean, it means we still let people print "money" on top of their gold assets, then when they redeem and find they run out of gold and people panic we get a the bust after the boom. This system only regulates the credit expansion, but we are still faced with a group of people who have a monopoly of the printing of money. So yes, we would have booms and busts, however, the busts would be smaller and more often. This at least would be a step in the right direction. Until a "favoured" bank is due for bankrupcy or a certain voting group is due to lose its money, then governments need to intervene to keep their own jobs. So eventually we move down the road to full FIAT paper again.

However, a more radicle but unlikely solution would be to get rid of fractional reserve banking and move to a 100% reserve banking with every note redeemable in gold. Mises and Rothbard have both demonstrated that the money supply does not need to increase. This of course would change the nature of banking into warehouses for demand desposits and investment houses for interest bearing deposits (money you cannot withdraw without notice because it has been lent out). This is the perfect solution (read Murry Rothbard the case for a 100% gold dollar and "what has government done to our money"). However, this is NOT likely to happen. Why?

Because just like any monopoly the right for some to print money will not be given up lightly and we all know the history of the federal reserve and the fight against central banks that President Jackson had before that. No, what we will get is a new currency that will be back by some silly small amount of gold (or some other invented paper reserve asset), then they will break the gold backing (or inflate the reserve asset). We will be on a single global fiat and nothing will have changed. Individual countries will be utterly controlled by un-elected bankers (even more so than now) from a new world bank etc. Read Keynes he openly wanted this and considering Keynes is now the "economics" in unversities we cannot expect anything other than this from the current architects (after all they want socialism for the world).

Blogs and newspaper opinions about the new role of gold etc are really saying we will be putting the power of money back in the hands of the public. Will that happen? We have since world war I been moving progressivly to the left with the socialisation of everything, will these people and interest groups give up those rights and benefits at the expense of the prosperity of the public? I doubt it, if they were so inclined there would be no lobby groups and bail outs. The fact the intervention exists, is justified by thousands of payed academics and think tanks proves that this would not happen. The USA had the chance with Ron Paul and they blew it. The rest of G7 or G20 doesnt not have anyone in sight that has the wisdom and knowledge to perform such a feat. I think giving credit to the current financal talks as something that will move power away from banks, governments and guns a butter programs is rubbish or at best wishful thinking.

2008 Nov 16 08:06 AM

[goldis4ever:]

>>>>divert... a lot of investment into gold-mining and gold processing rather than other activities like, oh, agriculture or technology<<<...

Oh, yeah, as if Wall Street really cared about a sweeter pea. Perhaps u weren't around for the last several years?

2008 Nov 16 09:27 AM

[Rhunzzz:]

Dear Sir,

The point is not what Wall Street cares about. We all know they will aim to maximize profit, that is the whole point of the market system, after all.

The point is that to return to a "total" gold standard, where every single dollar in circulation is backed by physical gold, would result in a huge distortion of the market. You think the ethanol subsidies diverting food production into biofuels was bad? If the Fed were to seriously set about drastically increasing its gold reserves to back up the dollar, even at the current spot price, the resultant distortion of the market would greatly dwarf this!

Think about it, current global gold reserves are only 29,822.6 tonnes. To back up every dollar at current spot price would require 753,161.49 tonnes!

Am I totally wrong in this? If so, please enlighten me. How else would the US return to a gold standard without either driving up the price of gold so high that it would greatly distort the market, or causing deflation so severe that we would be reverting to barter trade?

A fractional gold-reserve monetary system perhaps? If so, then I don't see how it would be much of an improvement over the current system.

2008 Nov 16 10:15 AM

[Alex Stanczyk:]

If a person bothers to study history it will become clear this isnt some new idea.

Currency systems have gone from disciplined money (aka fixed to gold or silver in some way) to undisciplined (ie print as much as you like) for thousands of years.

It is no more cataclysmic to go from pure paper to gold backed as it is to go from gold backed to pure paper.

How many people even noticed we went from gold backed to pure paper in 1971?

The average person has no clue it even occurred.

2008 Nov 16 10:42 AM

[Paul Brodsky:]

As a co-author of the piece, I find the mere discussion of re-adopting a new monetary regime - that we all seem to agree is necessary - to be heartening. I encourage all interested parties to follow the link and read the entire piece, "A Not-So Modest Proposal." My partner, Lee Quaintance, and I go through a methodology for re-pricing gold to a practical level and the likely consequences of doing so. In it we outline the mechanics behind re-instituting a gold-peg.

We realize US and European policy makers do not currently have the political cover to start discussing a gold standard - even if they felt it were necessary. However, it is becoming increasingly clear to us - and maybe to you - that the G7's global authority is being diminished as those of emerging economies are rising. There will have to be a new, more equitable global monetary regime in the coming years. Our hope is that the US policy makers do get in front of this inevitability so they can outline terms of trade that all the US a leading role.

2008 Nov 16 11:30 AM

[tequiladoboy:]

How does the new "Amero" ( North American Union) backed by silver play into this? This new common currency for Canada, US and Mexico is supposedly coming into play in February. Last night , Bloomberg had a news clip that Russia, China and Korea are also considering a common currency between the three countries. Anyone have any further info??

2008 Nov 16 11:42 AM

[Paul Brodsky:]

I believe the Amero would include only North American economies, which would likely exclude (and enrage?) most of global trade. Conceivably it could be used should a new global regime be rolled out.

There are two issues of immense practicality that need to be considered before a classical gold standard can be adopted globally however:

1) political forces have for years embraced the power to control a nation's money supply - we very much doubt that the enablers and beneficiaries of the current fiat money system will yield to such a seemingly rational solution without a fight.

2) given the massive growth in global paper "reserves" of the last 40 or so years, the equilibrium price of a gold peg today is simply shocking in terms of its magnitude (in all major currencies - not just the US dollar).

Regarding point # 2, simple back-of-the-envelope calculations imply that for existing US dollar bank reserves to be made exchangeable into gold, the current exchange ratio (or price) would be approximately $8700 per ounce - and growing every time the Fed increases its balance sheet. (The figures for the large Asian economies are multiples of this by the way.)

We come to this figure in a rather straightforward manner and readily acknowledge that more precise calculations can be made (regardless, the qualitative nature of this point will remain valid we suspect):

a) the US reports official gold holdings of approximately 8100 tonnes, or, about 286 million ounces
b) the liabilities of the US Federal Reserve's balance sheet equal, today, approximately $2.5 trillion
c) simply dividing "b" by "a" yield an equilibrium gold price of ~ $8700 per ounce

These cold hard facts will make a classical gold standard politically difficult to propose and adopt no doubt. Nonetheless, the logic and rationale of such a proposal are indeed fundamentally sound and, at a minimum, provide the basis for a constructive debate going forward.

2008 Nov 16 12:04 PM

[Dean Plassaras:]

Maybe is not an all or nothing proposition after all. Perhaps gold needs to play a small but significant part in the rebuilding of the global economic/finance system. Perhaps a hybrid between the gold standard and the arbitrary system we have at present.

2008 Nov 16 12:56 PM

[jerrybutler...:]

Great comment but seeing as the present crises is a lack of confidence how do you prepose to regain confidence among the world banking community without bringing in some sort of price rule or standard of value???


On Nov 16 08:06 AM AndrewLib wrote:

> The "gold standard" of the 19th century as someone described was
> just there to ensure the busts. What does this mean, it means we
> still let people print "money" on top of their gold assets, then
> when they redeem and find they run out of gold and people panic we
> get a the bust after the boom. This system only regulates the credit
> expansion, but we are still faced with a group of people who have
> a monopoly of the printing of money. So yes, we would have booms
> and busts, however, the busts would be smaller and more often. This
> at least would be a step in the right direction. Until a "favoured"
> bank is due for bankrupcy or a certain voting group is due to lose
> its money, then governments need to intervene to keep their own jobs.
> So eventually we move down the road to full FIAT paper again. <br/>
>
> However, a more radicle but unlikely solution would be to get rid
> of fractional reserve banking and move to a 100% reserve banking
> with every note redeemable in gold. Mises and Rothbard have both
> demonstrated that the money supply does not need to increase. This
> of course would change the nature of banking into warehouses for
> demand desposits and investment houses for interest bearing deposits
> (money you cannot withdraw without notice because it has been lent
> out). This is the perfect solution (read Murry Rothbard the case
> for a 100% gold dollar and "what has government done to our money").
> However, this is NOT likely to happen. Why?
>
> Because just like any monopoly the right for some to print money
> will not be given up lightly and we all know the history of the federal
> reserve and the fight against central banks that President Jackson
> had before that. No, what we will get is a new currency that will
> be back by some silly small amount of gold (or some other invented
> paper reserve asset), then they will break the gold backing (or inflate
> the reserve asset). We will be on a single global fiat and nothing
> will have changed. Individual countries will be utterly controlled
> by un-elected bankers (even more so than now) from a new world bank
> etc. Read Keynes he openly wanted this and considering Keynes is
> now the "economics" in unversities we cannot expect anything other
> than this from the current architects (after all they want socialism
> for the world).
>
> Blogs and newspaper opinions about the new role of gold etc are really
> saying we will be putting the power of money back in the hands of
> the public. Will that happen? We have since world war I been moving
> progressivly to the left with the socialisation of everything, will
> these people and interest groups give up those rights and benefits
> at the expense of the prosperity of the public? I doubt it, if they
> were so inclined there would be no lobby groups and bail outs. The
> fact the intervention exists, is justified by thousands of payed
> academics and think tanks proves that this would not happen. The
> USA had the chance with Ron Paul and they blew it. The rest of G7
> or G20 doesnt not have anyone in sight that has the wisdom and knowledge
> to perform such a feat. I think giving credit to the current financal
> talks as something that will move power away from banks, governments
> and guns a butter programs is rubbish or at best wishful thinking.

2008 Nov 16 07:11 PM

[nova:]

From the article above:

1. Within all nations, it is the peoples’ collective wealth - earned from innovation, natural resources, labor and productivity.

[First, Wealth Creation. And only then, one can talk about wealth redistribution Mr. Obama is so eager to move forward with.]

2.Gold-backed currencies require fiscal and trade discipline among all constituent economies – not necessarily rigid mandated controls.

[Without sound fiscal and trade discipline, an economy can sustain itself]

These are the bases and foundation of a sound economic.

2008 Nov 16 07:21 PM

[Dean Plassaras:]

In response to the Fitzman comment above, it looks like $14K/ounce:

www.financialsense.com...

2008 Nov 16 10:41 PM

[Rhunzzz:]

Dear Sir,

I am reading the article you linked. I have some points to raise.

1. The article states that the Fed's balance sheet liabilities would have to be backed by its current gold reserves. In other words, not every single dollar would need to be backed by gold. So why would this be any different from a fractional reserve system? It would just be a fractional gold reserve system - only partially backed by something of value (debt in the current system, gold in this putative system).

2. Current spot price of gold is $743.35 per troy ounce, last I checked. For the dollar to be pegged at the reserve price $7,000 per oz. would mean a 950% devaluation of the dollar in gold terms. This would appear to me to have catastrophic inflationary and redistributive effects upon the economy. All of a sudden those who had accumulated gold would suddenly see a sharp increase in their purchasing power, relative to everyone else. I don't see how this could be good for the US economy.

I don't see anywhere in the article suggesting how to deal with such a huge drop in the purchasing power of the dollar in gold terms. If I have missed it, please point it out.

2008 Nov 17 07:02 AM