SPEAKING
FREELY Back to the gold
standard By Peter Morici
Speaking Freely is an Asia Times
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Gold is selling for
more than US$700 an ounce, up from $258 in 2001 -
and this is but one of the many signs of a flight
to gold, which has become a worldwide phenomenon.
We could yet see a return to the gold standard by
the world's central banks. The main cause? The
economic policies of the Bush White House - but
this requires a bit of explanation.
Jewelry and industrial applications absorb
85% of new gold supplies. Although production has
fallen a bit and industrial demand has increased,
this alone cannot explain surging prices, because
bringing new deposits on line would cost less than
$700
an
ounce. The big new players in the gold market are
exchange-traded funds. These store bullion for
investors who have lost confidence in the US
dollar, and may be a precursor to a new gold
standard.
In 1944, the International
Monetary Fund established a system of fixed
currency-exchange rates. The US dollar was fixed
to gold and other currencies set to the dollar.
This system ultimately failed because rising
production costs pushed the industrial price of
gold above its monetary value, and fixed exchange
rates proved unsustainable. Productivity and
competitiveness advanced more rapidly in Japan and
Germany than in the United Kingdom, France and the
United States, and trade imbalances caused crises
for the pound, franc and dollar.
When the
pound and franc became overvalued, those were
devalued against the dollar, yen and mark. When
the dollar became overvalued, US president Richard
Nixon ended its convertibility into gold in 1972,
and the system of fixed exchange rates was
abandoned by the end of 1973. Subsequently, the
price of gold rose from $100 an ounce to a peak of
$700 in October 1980.
Over the next two
decades, central banks demonetarized gold. They
increasingly backed their currencies with US
dollars, and to a lesser extent German marks (then
euros) and Japanese yen. Many sold off significant
portions of their gold. The price of gold
fluctuated but trended to lows of $255 in July
1999 and $258 an ounce in April 2001.
Two
things made this possible. In the United States,
Federal Reserve chairman Paul Volcker whipped
inflation and presidents Jimmy Carter and Ronald
Reagan put the US economy on the path of
deregulation. These steps unleashed mighty waves
of productivity and innovation, created the US
prosperity of the past 15 years, and made the
dollar a better and more stable store of value
than gold.
In recent years, though, record
budget deficits, dysfunctional energy and
environmental policies, and a dollar overvalued
against the Chinese yuan and other Asian
currencies have created huge US trade deficits.
Dollars and dollar-denominated securities have
flooded into international capital markets. These
now total $5 trillion, increase $700 billion each
year, and erode confidence in the dollar.
To keep the yuan from rising against the
dollar, China purchases more than $200 billion in
foreign securities every year. A few central banks
are buying gold again, and some economists are
counseling the People's Bank of China, the
country's central bank, to diversify its reserves
from dollars into gold.
A significant
revaluation of the dollar against the yuan seems
inevitable, and it will cause a wholesale
adjustment for the dollar against other Asian
currencies. With so much of what the world
consumes now coming from China and other Asian
economies, the dollar will be worth a lot less to
gold miners in South Africa or Russia, and Asian
currencies would be worth more. The Chinese yuan
or South Korean won price of gold would not rise,
and might fall, but the US dollar price of gold
would increase, a lot.
International
investors with wealth to park are foolish to put
it in dollars; however, the currencies with the
best prospects are backed by governments with poor
track records for controlling inflation or
honoring commitments to foreign investors. Could
you tell your mother her money would be safe in
Korean or Chinese bonds?
If private
investors continue to doubt the dollar and bet on
gold, central banks will be forced into gold.
Investors won't trust currencies back by dollars,
and central banks would be just as foolish as
private investors to trust won- or
yuan-denominated bonds.
What brought the
US to this pass? The root causes, as mentioned,
are high government deficits and bad policies on
energy and the environment, which have added to
the country's trade deficit by exacerbating its
dependence on foreign oil. And on all these
matters, the buck stops (to put it ironically)
with the administration of President George W
Bush. The decision last week not to cite China as
a currency violator, which again showed the US
president's refusal to address the root causes of
the trade deficit, will not improve matters.
Unless the United States gets its economic
house in order, gold will become money again, and
national currencies will only be money if backed
by gold.
Peter Morici is a
professor at the University of Maryland's Robert H
Smith School of Business, former chief economist
at the US International Trade Commission, and a
commentator on economic and political issues.
(Copyright 2006 Peter Morici. Used with
permission.)
Speaking Freely is an
Asia Times Online feature that allows guest
writers to have their say. Please click hereif you are interested in
contributing.
