Gold standard debate reignited

At the end of the day, not much is expected out of the Seoul summit. Our own PM, Mr. Harper stated that he does not have any certainty over whether or not an agreement will be cobbled together by the evening conclusion of the meeting. Interesting quiz question: Who is the US’s largest trading partner? If you hurried to reply that it is China, think again. Hint: Ask Mr. Harper.

As for China, well, the heat is on. The heat of higher-than-desirable inflation, that is. All of this means, that “fire-fighting” strategies will also soon be on display, courtesy of the PBOC. Yesterday, the central bank hiked its reserve requirements and forced the country’s banks to put more money aside as opposed to handing it out in the form of loans (with which speculators have run property and other prices amok). Lost in the news (but not in translation) is the fact that China is showing a decline (!) in imports for certain commodities. Imports of copper, iron ore, and oil caved in during the month of October.

Perhaps this was the result of a larger-than-normal level of inflows in September, perhaps it was not. Some analysts expect the resumption of such stronger patterns and ‘good times’ to last until sometime in 2011; mainly on the heels of the Fed’s accommodation. We would say that it would be highly advisable to keep that magnifying glass squarely over the import spreadsheets of China. In the interim, headline would have us believe that – at least this morning – gold is rising because of Chinese inflation. Yes, perhaps, but the PBOC is not the Fed, is not the ECB. And even those two are looking at 2011 as the turning point in policy.

Much ado followed World Bank President Zoellick’s so-called ‘proposal’ to perhaps include gold into a revamped form of global monetary peg, given current turmoil and uncertainty. Camps are forming, battle lines are being drawn, forum chatter is ablaze with flamers (on both sides), and…economists, well, they bring logic to the table with “on the other hand” types of analyses. One such academic is Nouriel Roubini. According to whom, the re-adoption of a gold standard is unworkable.

Speaking on CNBC the other day, Professor Roubini flat-out stated that "A fixed exchange regime, even if it is not a gold standard… that world just doesn't work, because in that world, monetary policy by definition instead of being countercyclical becomes pro-cyclical. Suppose you have a fixed exchange rate just exacerbates the business cycle."

NetNet reporter Ash Bennington details that “although he is best known as an economist who challenges conventional views, Roubini pretty well lines-up the consensus view of mainstream economics on the gold standard or fixed exchange rate regimes: ‘You have the opposite of what any optimal rule about monetary policy will tell you.’ Basically, fixed rate regimes inhibit the ability of banks to provide their ‘lender of last resort’ support role to an economy when most needed. In so many words, the ‘good old days’ were anything but ‘good.’”

This is borne out by the more than 22 recessions (some harsher than what took place in 1929-1941) the US experienced before WWII. See, for example, the “original” Great Depression (aka “The Long Depression”) that plagued the European and US economies from 1873 to 1896. The gold standard is generally thought to have its origins in the early 1700’s.

UC Berkeley Prof. Barry Eichengreen has blamed the “dragging out” of the Great Depression 2.0 on the fact that the gold standard was then in force. Economic theorists would concur that – under such a rigid standard – monetary policy would essentially be determined by the rate of gold production. Variations in the amount of gold that can be mined at any particular time (where are the ‘peak gold’ adherents when you need them?) could cause inflation if there is an output increase, or deflation if there is a decrease in same.

"When you had a traditional gold standard, boom and bust with severe swings in economic activity were the norm—really big ones. It was only once we moved to fiat money that central banks were able to smooth the business cycle, and make it less volatile, as we did during the financial economic crisis," Prof. Roubini said.

We say, hold that personal “gold standard” of your own, and remain on it. Let central banks do what they might (while not forgetting that they, too, have their own ‘reserve’ stash of the stuff) – chances are they will steer a course away from rocky shores. Hoping for a crash upon said rocks is not in anyone’s best interest. Never has been.

Jon Nadler is a Senior Analyst at Kitco Metals Inc. North America

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About the Author
Jon Nadler Jon Nadler is a Senior Analyst at Kitco Metals Inc. North America
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