Will a New Gold Standard Make Our Future Brighter?

In the latest Buttonwood post at the Economist entitled "Paper promises, golden hordes," the writer notes that gold is coming back into vogue. The price has tripled over the last six years, says another researcher, David Ranson of Wainwright Economics.

It looks like the public has decided that paper money isn't so attractive at this conjuncture, and even some central banks are thinking along those lines, to wit Russia, China, and India.

All this makes perfect sense. Gold is not only a store of value; it's a barometer for currencies.



This flies in the face of a recent paper by Barry Eichengreen and Douglas Irwin, cited in the Buttonwood post. These two economists have come to the conclusion that "[d]ropping gold did work" i.e. that abandoning the gold standard has somehow shortened recessions and reduced the inclination to raise as many tariffs.

Other economists would disagree. They hold that, in fact, dropping the gold standard and instituting a process of monetary expansion through a central bank is what caused the distortions in the economy in the first place, which in turn led to the recessions and even the Great Depression itself.

I particularly love this statement: "When countries on the gold standard suffered a shock [my italics] they had to let the real economy, rather than their currencies, take the strain." Countries don't just "suffer a shock." Distortions in the economy cause shocks. And according to some economists, central bank responsibility is involved in every recession and depression since the Fed's creation. Like SUVs, economies don't just drive off the road.

We may never find ourselves back on a gold standard as that institution was understood in 1900; however, I believe the world is on a de facto gold standard, by the very nature of this unique metal. Push will come to shove soon, as the Buttonwood post explains:

"[F]oreign creditors have a right to be more suspicious of debtor countries. Even if they do not resort to outright default, they can always achieve partial default through currency depreciation.

"Indeed, the law of volatility can be invoked again. Developed-country governments have attempted to control bond yields through quantitative easing and to support stock markets through ultra-low interest rates. But they cannot support their currencies as well without risking problems in the bond and equity markets. Gold's surge may indicate that investors fear the next stage of the crisis will occur in the foreign-exchange markets."

You can bet your bottom dollar on that one. And with jawboning for China to reevaluate its currency (watch out what you wish for), Australia hiking its interest rates (twice already), and the dollar reaching new lows (how low can it go?), gold will start to look better than ever.

Comments

[Carlos Lam]

"[F]oreign creditors have a right to be more suspicious of debtor countries. Even if they do not resort to outright default, they can always achieve partial default through currency depreciation."

This is the crux of the matter. With $12 TRILLION in debt plus $100 TRILLION in unfunded liabilities, the feds have a great incentive to print. In the Federal Reserve, they have a great ally as well, who has been willing to go along.

You are absolutely correct that gold is a barometer, and it's displaying a marked lack of confidence in fiat currencies.

2009 Nov 16 05:12 AM

[Gedankonomist]

"These two economists have come to the conclusion that "[d]ropping gold did work" i.e. that abandoning the gold standard has somehow shortened recessions and reduced the inclination to raise as many tariffs."

In a way, these two charlatans are correct. The system has been "very very good to them;" they get nice fat salaries at some over-rated academic institution, they get this and that award, they get to sometimes go on CNBC, etc., and all they have to do is spew establishment propaganda.

So how do you expect them to say otherwise?

2009 Nov 16 10:49 AM

[constab]

The idea behind the Golden Standard was to create Balance between the Economies of the World. When one of the dominant participants in a Standard is out of Balance the Standard fails. It happened with England and now it is happening with the US. All the time the main reason was a costly War.

2009 Nov 16 11:23 AM

[Mad Hedge Fund Trader]

vhu Paul Tudor Jones nicely summed up the fundamental argument in favor of gold. The yellow metal is accumulated, and not consumed, and is the ultimate store of value. Gold does particularly well during times of excessive monetization, inflation, and instability of the banking system, as we are seeing now. Central banks, which have been consistent sellers for the last 20 years, are about to flip to net buyers. If non G7 central banks, like China, want to increase their gold holdings from the current 20% of reserves to the 35% weighting now owned by the G7, it will require 1.3 billion ounces of new purchases, or 20% of the total world supply. Certainly they are getting fed up with their ever depreciating dollar holdings. Witness last week’s Bank of India purchase of 200 metric tonnes. ETF’s now own $50 billion worth of the barbaric relic, about 3% of the world total, making them the sixth largest holder in the world, and retail demand for these gold proxies is expected to explode in coming years. Private investors, mutual funds, and pension funds are all underweight gold. This is all happening in the face of declining production from traditional gold suppliers like South Africa. It all adds up to a whole lot of new gold buyers and a shrinking body of sellers. Paul didn’t give any specific price targets other than “up.” Long time readers of this letter know I have been banging the table about gold all year. Time to salt away more American eagles for those college funds and grandkids.

2009 Nov 16 11:59 AM

[kennypowers09]

Yes lets re-introduce the gold standard, and cut the world GDP in half and introduce double digit inflation. The time for the gold standard is long past. Tying the global economy to a finite rock that has litte relevance to modern society, would be like begging to go back to the 1930's. There is a statistically proven correlation between the countries that that finally decided to abandon the gold standard, were the first countries to enter out of the great depression. While the dollar is certainly weakening, its far from "weak" as the sheep continue to cry about. Most economists and analysts will argue the dollar has been overly strong over the last several decades, given the significant changes in inflation and trades balances, due to the de facto usage of the dollar as a reserve status for emerging economies. Those who believe in "free markets" will support the weakening of the dollar and embrace a potential correction in trade balances. There is no need for a gold standard.

2009 Nov 16 01:52 PM

[bob adamson]

While some part of the surge in the price of gold represents a yearning for a return to some version of the gold standard one should be cautious in drawing the conclusion that this yearning is as wide spread or influential as some might suppose. Clearly gold along with oil and other commodities has a current attractiveness for many as a place to park one’s money in anticipation of inflation and exchange rate fluctuation at some point in the near future. Further, momentum in the price increase in these commodities itself makes parking money there attractive in the near term.

In short, one should be cautious in interpreting increasing prices for gold in isolation currently as a positive desire to establish some version of the gold standard rather than as part of a broader increase in attractiveness for a range of reasons of commodities generally.

2009 Nov 16 04:33 PM

[Old Trader]

Upon reflection, after reading this article, I could certainly see gold being included into the "basket of currencies" of say, an IMF SDR. I seem to recall the Chinese suggesting that. I'd consider this much more likely than any attempt to turn the clock back, and return to the "gold standard" of old.

2009 Nov 16 09:47 PM