“When the monetary history of the year coming to an end is written decades from now, the headlines of European debt crisis and Federal Reserve’s adoption of QE2 may turn out to be mere footnotes to the bigger story: 2010 could be a watershed marking the beginning of the end of the dollar-based, Western-centric monetary system.” – Randall Forsyth, Barron’s
“We wish to highlight not all but some of the ‘fears’ that keep us awake at night, and illustrate why right now is not the final act for gold. 2011 could be an explosive year for this most illustrious of metals. . .We believe withstanding a lack of gold standardisation, gold has a firm place in modern portfolio management and in accounting procedures.” – Hinde Capital, None Shall Sleep 2011 – by Michael J. Kosares
It all started very quietly with a little-known speech in May of 2008 by Benn Steil, a highly respected policy insider at the Council on Foreign Relations. The CFR is generally considered the font of establisment thinking on foreign and international economic policy. Steil’s speech had to do with gold – an unusual subject for someone so prominent in the CFR. His proposal? That gold should be restored to a central role in the international monetary system.
Steil’s proposal had an immediate impact. Reports began to filter into the markets that certain central banks were beginning to accumulate gold bullion as part of their reserves. Some went about their acquisitions quietly. Others pursued their interest in the open. India, for example, made a highly publicized 200-tonne purchase from the International Monetary Fund. Simultaneously, traditional gold sellers, like many of the European central banks, shelved selling plans. Sales under the Central Bank Gold Agreement came to a standstill. It was about this time, too, that reports began to surface of a very strong developing interest in gold bullion among major hedge fund operators.
By 2010, policy notables like Robert Zoellick, president of the World Bank, Thomas Hoenig, president of the Kansas City Federal Reserve, Randall Forsyth of Barron’s magazine and Indiana Congressman Michael Pence, an oft-mentioned contender for the 2012 presidential sweepstakes, had come public with their own support of a new role for gold in the world’s monetary system. Hoenig stated that the gold standard is a “very legitimate monetary system.” Pence suggested that “the time has come to have a debate over gold, and the proper role it should play in our nation’s monetary affairs. A pro-growth agenda begins with sound monetary policy.” Zoellick wrote in Financial Times that gold should be looked upon as a means to stabilizing the global monetary system. In January, 2011, former Fed chairman Alan Greenspan noted in a Fox Business interview that “There are numbers of us, myself included,who strongly believe that we did very well in the 1870 to 1914 period with an international gold standard.” Suddenly, and to some inexplicably, gold had gone from hopelessly out-of-style in policy circles to highly fahionable. Gold, in fact, suddenly had become politically correct.
The new role for gold narrows down to two options covered below. The first is to return to a fixed-price gold standard similar to the post World War II Bretton Woods arrangement. The second is for gold to take on a role similar to the one it now plays in the European Union. In either instance, the best-positioned investors, for reasons outlined below, will likely be the owners of the physical metal itself, although those who own the right gold-mining companies could also gain significantly over the longer run, as the need for sizable new production becomes increasingly apparent.
Option #1 – Bretton Woods II, the traditional gold standard
Recently Alan Greenspan surfaced as probably the most prominent advocate of the gold standard. “We have at this particular stage a fiat money,” he said, “which is essentially money printed by a government, and it’s usually a central bank which is authorized to do so. Some mechanism has got to be in place that restricts the amount of money which is produced, either a gold standard, a currency board, or something of that nature.” Without it, he warned, “all of history suggests that inflation will take hold with very deleterious effects on economic activity.”
Much of the discussion on a return to the gold standard has centered around resurrecting Bretton Woods, which was the operating monetary system from just after World War II to the early 1970s. Under Bretton Woods, the price of gold was fixed at $35 per ounce and all the currencies, in turn, traded at fixed exchange rates relative to the dollar. This arrangement broke down in 1971 when president Richard Nixon closed the gold window. Continued redemptions at the $35 benchmark eventually would have depleted the U.S. gold reserve. Nixon declared that “we are all Keynsians now” and the world went on the fiat money system that is still in operation today.
To make a gold standard work today, the metal would have to be valued at a very high dollar price to address the imbalances already existing in the world’s reserve system, and to make it possible for the new system to function smoothly and equitably. If, for example, one were to value the U.S. gold reserve high enough to cover the U.S. national debt of over $14 trillion, gold would have to be benchmarked at over $50,000 per ounce. To cover the external U.S. debt of $4.3 trillion, it would need to be valued at $16,500 per ounce.
Though $50,000 an ounce, or even $16,500 an ounce, may be significantly more than would be required to restore order in the monetary system, too low a price would recreate the same problems which caused the abandonment of Bretton Woods in the first place. To make a gold standard work, policy-makers will be called upon to choose a price that would bring balance between the roughly 8000 tonne U.S. gold reserve and the massive dollar reserves that have built-up all over the globe. To be sure, it is unlikely such balance would occur in the current price range.
Beyond the pricing problem, a return to a fixed gold standard presents additional challenges. The essential reason for a gold standard is to restrict governments’ ability to run deficits and print money. When politicians consider the problems faced by countries like Greece, Ireland, Portugal and Spain during the recent European sovereign debt crisis, they will not fail to note that in each instance those nation-states had relinquished their monetary sovereignty to the larger European Union. The options to run deficits, print money and debase the currency as a means to an end were off the table. Those who read their history texts carefully will be quick to point out that the gold standard offers major benefits, like a low inflation rate, balanced trade accounts and a strong currency. However, for all its benefits, it also conjures up images of deflationary depressions and financial panics, which would imply the kind of economic chaos that plagued the world economy intermittently under the gold standard before World War II.