Free Markets, Free People
It has become an article of faith in modern economics that the gold standard just isn’t suitable for modern economies. Since the Great Depression started the movement away from the gold standard, we have moved towards a system of freely convertible fiat currencies whose values are, in the main determined by the ability of central banks to maintain control of inflation. Any talk of returning to the gold standard, therefore, is derided as some sort of fanatical return to a failed past.
Now, to be sure, there are problems with gold as money. Some of them are perceived problems, others are real.
Ultimately, gold, as a currency, tends to be deflationary. A country’s money supply is limited by the amount of gold on hand. Absent an increase in the amount of gold, any increase in real output must cause prices to decline.
Also, any balance of payments deficit reduces the country’s gold supply. For instance, during the Depression, England had a horrific balance of payments problem. The country was paying out so much money in foreign payments, that it was literally draining all the gold out of Britain. The only real remedy to this was to massively deflate British prices…in the midst of an already deflationary recession.
Monetary shocks are easily transmitted from one country to another via gold. Since countries who participate in the gold standard have fixed links, inflation or depression in one country can be quickly transmitted to another. For instance, the discovery of a large gold mine increases the supply of gold, without affecting real output. That inflationary effect is quickly felt throughout all the countries who share the standard.
But–and this is a big “but”–the change from a gold standard to freely convertible fiat currencies has solved those old problems by introducing entirely new ones. Governments and central banks have embarked on massive programs of public indebtedness, the inflationary–and sometimes hyperinflationary–printing of fiat currencies, and the wholesale selling of sovereign debt to foreign countries who may not have, as their primary interest, recouping the money on their investments, but rather the manipulation of an enemy’s economy, should it become necessary.
These problems bring us to Robert Zoellick, the head of the World Bank. In an Op/Ed in the Financial Times addressing our current economic woes, he suggests something that will no doubt be much discussed. In a discussion of how to create a monetary regime to succeed the clearly dying Bretton Woods II paradigm in which we’ve operated since 1971, he suggests, among other things:
This new system is likely to need to involve the dollar, the euro, the yen, the pound and a renminbi that moves towards internationalisation and then an open capital account.
The system should also consider employing gold as an international reference point of market expectations about inflation, deflation and future currency values. Although textbooks may view gold as the old money, markets are using gold as an alternative monetary asset today.
If I’m not mistaken, the head of the World bank just called for the creation of a new gold standard for international trade.
This should be interesting.