Is a Return to a Gold Standard the Answer?

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There have been a lot of strongly expressed views about the merits and desirability of returning to some form of gold standard, some for, some against, but all recognizing that the fiat currency system we have had in place since Richard Nixon severed the US dollar’s relationship to gold in 1971 has not proved sufficiently robust to prevent politicians and markets from causing havoc with the global economy on many occasions in the intervening decades.

Multiple supporters of, and believers in, the virtues of tying our currencies to the value of gold argue for a return to the gold standard.   Jordan Roy-Byrne recently wrote a strongly worded and passionately argued piece comparing the relative stability of the world economy from 1800 to 1971, a period in which he says the world’s average per capita income increased over 10 fold, while the world’s population increased over sixfold. Apart from brief periods during that time, inflation remained benign and living standards for those in industrializing countries increased unimaginably. We would take issue with the writer’s suggestion that all this is due to the rigors of fixing currencies in a gold standard and that simply by returning to such a system all our problems would be solved. Yet the fact is we have a system of huge trade imbalances and almost unmanageable levels of debt in many western countries: the US, parts of Europe and Japan in particular. The genie is out of the bottle and simply returning to a gold standard isn’t going to solve that.

Nevertheless, the reality of the current system, with swings from inflation to recession and back again, are forcing many with even small savings, investments and pensions to seek out, if not gold hedges, then commodity hedges as a way of securing their personal fortunes. Sales of ETFs and commodity related equities are example enough of a universal loss of faith in our politicians to control our economic future.

On the other side of the argument stand many (although not all) economists — like Roger Bootle, managing director of Capital Economics and economic adviser to Deloitte, writing in the Telegraph newspaper this week. He gives four reasons why a return to a gold standard would not work.

The first is that while acknowledging that the gold standard may have helped sustain long-term price stability, it did not achieve that in the short run, citing the experience of the UK (In 1822, it experienced 14% deflation, but by 1825 it was suffering 17% inflation). Such volatility was not an isolated incident and both the UK and the US went through periods of inflation and deflation during the time frame in question.

Bootle’s second reason why a gold standard would not work toady is based on what he feels is the mistaken idea that gold offers a guarantee of money values in the long run and therefore supports confidence and decision making. The fact that the world has lived with fiat currencies for forty years means there is no guarantee future governments would stick with or honor a gold standard if it suited them to do otherwise. Long-term faith in any rigid system is a thing of the past, especially based on faith in a largely non-industrial metal with variable intrinsic value. Uncertainty, whether we like it or not, is now the norm and it’s no good pretending otherwise.

The third reason is that, even in itself, a return to a gold standard may not end financial instability, pointing to the 1920s asset boom and crash of 1929 as examples of profound instability even while the world was on a gold standard.

Lastly, the world’s supply of gold tends to rise at a slower rate of growth than the real and financial activity, which would govern the demand for it, meaning the system would display a marked deflationary bias, depressing the ability of such a regime to raise living standards.

To his credit, Bootle doesn’t suggest he has all the answers, pointing out the merits of Keynes’s proposal for a new international currency to replace the dollar as one option, and of the much more recently suggested regime requiring countries to operate within symmetric surplus and deficit obligations as another. That idea we felt had considerable merit but then we would, living in a deficit country; those in surplus, such as Germany and China, instantly poured cold water on the idea prior to the recent G20 summit. Still, it has the benefits of being readily measurable, of mutual accountability and of being easily understood by the electorate as fair so if sacrifices are required, the reasons are readily explained.

Which, if any, of these ideas will prevail may take some years to become clear, but in the meanwhile there is at least a growing acceptance that the turmoil of the last 40 years has been a high price to pay compared to the relative stability of the preceding 170 years, and that more of the same isn’t the answer.

–Stuart Burns

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