INDEPENDENT VIEWPOINT

How realistic are the chances of a return to a gold standard?

While economists broadly do not favour a return to such a system, the general population in the US seems to be increasingly warming to the idea

Author: Ross Norman
Posted: Friday , 20 Jan 2012

LONDON (Sharps Pixley) - 

There was a time when politicians kissed babies to show they had the common touch and a real connection with ordinary folk. With the outcome of the US elections finely poised, gold and a return to a gold standard is seen as a potential vote-winner - today they are embracing gold, not babies.

In South Carolina 33% of voters are gold standard supporters, with 18% warm to the idea while only 11% are against and 6% cool on the proposal. Gold is a clear 3-1 vote winner.

To be fair, Republican presidential candidates Newt Gingrich and Ron Paul have both consistently been strong supporters of 'hard money' but their advocating a "gold commission" to consider a return to a gold standard is interesting at two levels - firstly in what it tells us about the mood in the USA - and secondly by its potential impact on the gold market itself.

President Nixon moved the US out of the gold standard in 1971 and brought to an end the Bretton Woods system of monetary management introduced in 1946 where currencies were pegged to each other and the dollar was pegged to gold at a price of $35/ounce. The proposal is to back US dollars with gold (and possibly silver).

The main benefit of the gold standard was that, by linking a country's currency to a fixed asset like gold, it prevented policy makers from over-expanding the economy - it was a forced discipline or straight-jacket which effectively has a self-regulating and stabilizing effect on the economy. As such, the government can only print money depending upon the levels of gold reserves it has. This discourages inflation, budget deficits and debt. Furthermore, the more productive nations benefit - as they should - because the more they export, the more gold they can purchase and therefore money they can print to grow their economy further.

In the current political climate there is a strong desire to achieve economic stability through fiscal discipline, a balancing of the budget and by reducing government interference in the economy. Many would be prepared to forgo potential economic growth that a fixed money supply would engender and even tightness in credit markets that would stifle company growth through lack of funding. Such is the anger at the mis-management of the economy and the short-comings of the fractional reserve banking system.

But can gold fulfill its extended role ? Certainly gold prices have behaved in an exemplary manner during the crisis as a wealth preserver and its role in maintaining purchasing power parity in the long run has been well proven. Prescient gold investors have been well rewarded with over 20% compound growth year-on-year - for over a decade.

But with a large and highly globalised economy, can gold sensibly underpin the world's senior reserve currency in a complex financial world ?

Representing, as it does less, than 1% of global financial assets, gold is very clearly limited without a massive upward revision in its price from $1650/ounce to about $45,000/ounce. There are also fundamental problems in fixing exchange rates between currencies that we had  under Bretton Woods - it is not unlike the artificial and flawed arrangement that underpins the Eurozone. The short answer as to whether or not gold can fulfill this role is in the detail and what sort of system you want. For a review of some recent proposals see 'The Gold Standard: An Analysis of Some Recent Proposals' at : http://www.cato.org/pubs/pas/pa016.html

Economists broadly do not favour a return to a gold standard. The University of Chicago conducted a poll of 40 leading economists none of whom supported the move.  But it is also clear that something needs to change. So long as policy makers make over-extended promises on the one hand (to ensure re-election) and overextend the printing presses with the other then we will continue to see inflation and currency declines as those shown below. Since 1971 the US dollar has lost over 85% of its value by official (CPI) measures. Truly the thief in the night and that's just not right. To use the words of President Hoover in 1933 - "We have gold because we cannot trust governments".

 

Ross Norman is the CEO of Sharps Pixley