August 21, 2011
Is There a New Gold Rush? ...
President Richard Nixon gathered his top White House staff and Treasury officials with characteristic secrecy in his lodge at Camp David on the afternoon of Friday, August 13, 1971.
The goal was to thrash out a comprehensive package of measures to tackle the US’s myriad economic troubles.
By the Sunday afternoon and without either consulting or warning the international community, the president was ready to address the nation on television.
“In the past seven years there’s been an average of one international monetary crisis every year,” he growled. “Now who gains from these crises? Not the working man, not the investor, not the real producers of wealth. The gainers are the international money speculators … In recent weeks the speculators have been waging an all-out war on the American dollar.
“Accordingly … I have directed Secretary Connally to suspend temporarily the convertibility of the dollar into gold.”
With these words the 1944 Bretton Woods agreement, which guaranteed an ounce of gold for $35, was at an end. Nixon might have said “temporarily”, but the current era of floating currencies had arrived.
The Nixon Shock, as the address came to be known, was designed to help the US cope with the costs of the Vietnam war, an inflation rate of 6% against a growth rate of less than 1%, and a ballooning trade deficit. By coming off the gold standard, America effectively defaulted on its debt.
“The dollar is our currency, but it’s your problem,” said an unapologetic Secretary John Connally later that year at a meeting of G10 leaders.
The subsequent near-20% depreciation of the dollar as a means of boosting exports was rapidly followed by the other major powers, desperate to keep their economies competitive.
Oil was, and still is, priced in dollars. Oil producers suddenly found that their dollar revenues bought fewer goods and services on global markets. Opec duly quadrupled the price of oil in 1973, valuing it to make good on the fall in the rate of the dollar, a move which contributed to the oil crisis and stagflation of the mid-seventies. In the 20 years from 1947 to 1967, oil prices had remained relatively stable. The Nixon Shock changed that and ushered in an era of volatile oil prices.
Departing from the discipline of the gold standard allowed banks to massively increase the money supply by printing money. They were soon pressing for financial deregulation to take full advantage of these new powers, leading to the likes of the Big Bang deregulation of the City of London in October 1986 and the repeal of the Glass-Steagall Act in the US in November 1999.
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These led to massive credit expansion in the US, UK and Europe, spawning the age of opaque and bewildering financial entities such as mortgage-backed securities and collateralised debt obligations – later dubbed “weapons of mass financial destruction” by celebrity investor, Warren Buffett. And not least, departing the gold standard led to the metal’s long climb to its current levels, closing last week at well over $1800 per troy ounce.
Predatory speculators, debt and international financial crises are of course the backdrop to the world we live in today. The fear is that with monstrous debt, an anaemic growth rate and growing unemployment and inflation, the US will once again shock the world and default on its debt, thereby plunging the global economy into chaos. A growing chorus demands action. Ironically, many call for a return to the gold standard.
Traditionally seen as a safe haven for wealth during uncertain economic times, gold might not offer the dividends of equities. But its ability to store purchasing value has investors in a fever to take possession as inflation, volatile markets and low interest rates eat away at capital.
The key feature of a gold standard is that it imposes monetary discipline on central banks and governments. Proponents argue that it provides long-term price stability, since it prevents the printing of money, which is one of the main causes of inflation.
Backers of a gold standard are no longer maverick voices but include the likes of Nobel laureate Professor Robert Mundell, known as the father of the euro, and Steve Forbes, the owner and editor-in-chief of establishment business magazine Forbes, who recently predicted that the US will be back on a gold standard within five years.
Russia has advocated a return to a gold standard and Switzerland is due to debate a gold currency in its parliament. Even the president of the World Bank, Robert Zoellick, is said to back a return to the days when gold was used to impose discipline on global finance.
Professor Ronald MacDonald, Adam Smith Professor at Glasgow University and a specialist in international finance, says: “The gold standard was a well-designed, international monetary system.
“It provided both credibility and flexibility by allowing member countries to depart temporarily during times of economic crisis.”
However, MacDonald does not advocate a return. “The problem is that supply of the commodity [gold, or whatever else might be used instead] is restricted by the availability of the resource. The supply of gold is controlled by countries with gold mines.”
One key disadvantage is that the value of gold is around a 1/60th of the amount of money in current circulation, according to the McKinsey Global Institute. This would leave the system vulnerable to runs in times of crisis because there would be insufficient gold to satisfy all the demands on it. So any return to a gold standard would require revaluing gold sharply upwards. With an estimated 80% to 90% of above-ground gold held privately, revaluing gold would deliver private owners a massive windfall.
A reintroduction of the gold standard would also impose severe economic depression in many parts of the world where gold is relatively scarce, because their currencies would devalue accordingly. Ireland’s central bank, for example, has a paltry six tonnes of gold. Italy’s central bank, by contrast, has the fourth-largest central bank holding of gold with around 2500 tonnes, according to figures from the World Gold Council.
Nixon laid the blame for ending the gold standard agreement at the door of international speculators. In a similar way French and Italian governments have hit out at speculators targeting Continental banks for the ongoing crisis in the eurozone and recently imposed a ban on short-selling. MacDonald might not support a return to the gold standard, but he points to an important advantage over the euro that should be incorporated into any new system.
‘Speculative attacks didn’t happen with the gold standard. It had flexibility built into it. If countries were experiencing difficulties they could exit for an agreed period of time. That’s what’s wrong with the eurozone. Countries cannot break the link with the euro to fix their economies and so speculators are attacking,” he says. “The eurozone lacks the institutional structures necessary to make it work.”
An alternative to a gold standard was recently put forward by the new economic superpower on the block, China, which favours the creation of a new international reserve currency. Central bank governor Zhou Xiaochuan recommended that the new currency be issued and administrated by the International Monetary Fund and would therefore belong to no individual country.
The proposal is to use a synthetic currency already used by the IMF for its transactions with member nations. Known as special drawing rights (SDRs), this synthetic currency has been in use since the 1960s and its value is set by a basket of major currencies.
The idea is backed by a host of leading economists known as the Beijing Group, led by Nobel winner Joseph Stiglitz, who in an article in the Financial Times called for “an immediate expansion of the current system of special drawing rights” as a means of stabilising the global economy.
In reality, calls for a re-imposition of a gold standard can be seen as a desire for a return to sanity and justice in global finance. Whatever way the debate moves from here, however, there is one major glitch. No new currency will do anything to settle the outstanding debts owed by the US, the UK and Europe, built up in the decades following the Nixon Shock. Whatever the pros and cons of the alternatives to floating currencies, none will be workable until this conundrum is resolved.
SILVER shares gold’s long history as a trading currency, but it has yet to infect private global investors with the same fever. In 1890s America there was a lot of political debate over whether the country should use gold, silver or both as currency (since tying currencies to precious metals goes back much further than Bretton Woods). Silver’s appeal was that it was more accessible to the common man and political movements such as the Silverite movement brought the issue centre stage during election campaigns.
The Wizard Of Oz has been said to be an allegory of the struggle to establish silver as a currency. In the original story by Frank L Baum, Dorothy was depicted wearing silver rather than ruby slippers. In this reading, the yellow brick road serves as the gold standard. The Scarecrow is the put-upon farmer, the Tin Man is the working man prey to the whims of industrialists and the Cowardly Lion is cast as the politician. The group travels to Oz, the political centre, only to find that the Emperor has no answers to Dorothy’s plight, her solution having been on her feet the whole time.
The Silverites’ motto was “16 to 1”, referring to the historic ratio of the price of gold to silver. That gold and silver should settle around this 16:1 ratio has fuelled claims that today’s silver market is being manipulated, although the trading ratio has lurched from 15 to as high as 100 over the last century. Silver is currently hovering around $40 an ounce. Were it to correct towards this 16:1 ratio, its value would rise sharply to around $110 an ounce.
The US Commodity Futures Trading Commission (CFTC) is currently conducting investigations into whether the price of silver is being kept artificially low, amid speculation that major US banks might be involved. This has fuelled a raft of colourful campaigns, such as the Silver Liberation Army, advocating investment in silver.
Manipulation of the silver market would not be new. Most recently, oil tycoons the Hunt brothers’ seven-year attempt to corner the silver market came to a spectacular end with the one-time billionaires losing their fortune. Back then the silver price hit a high of $50 an ounce in January 1980 and fell to below $11 an ounce two months later. Nelson Bunker Hunt was later fined $10 million and banned from trading in the commodity markets.
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