Is a new gold standard a realistic option?

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 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 countries currency to a fixed asset like gold. it prevented policy makers from over-expanding the economy — it was a forced discipline or straitjacket that 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 the more 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 of 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?

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