Saturday, November 14, 2009

You can take gold out of the standard, but you can't take the standard out of gold

In the latest Buttonwood post at the Economist entitled "Paper promises, golden hordes," the writer notes that gold is coming back into vogue. The price has tripled over the last six years, says another researcher, David Ranson of Wainwright Economics.

It looks like the public has decided that paper money isn't so attractive at this conjuncture, and even some central banks are thinking along those lines, to wit Russia, China, and India.

All this makes perfect sense. Gold is not only a store of value; it's a barometer for currencies.


This flies in the face of a recent paper by Barry Eichengreen and Douglas Irwin, cited in the Buttonwood post. These two economists have come to the conclusion that "[d]ropping gold did work" i.e. that abandoning the gold standard has somehow shortened recessions and reduced the inclination to raise as many tariffs.

Other economists would disagree. They hold that, in fact, dropping the gold standard and instituting a process of monetary expansion through a central bank is what caused the distortions in the economy in the first place, which in turn led to the recessions and even the Great Depression itself.

I particularly love this statement: "When countries on the gold standard suffered a shock [my italics] they had to let the real economy, rather than their currencies, take the strain." Countries don't just "suffer a shock." Distortions in the economy cause shocks. And according to some economists, central bank responsibility is involved in every recession and depression since the Fed's creation. Like SUVs, economies don't just drive off the road.

We may never find ourselves back on a gold standard as that institution was understood in 1900; however, I believe the world is on a de facto gold standard, by the very nature of this unique metal. Push will come to shove soon, as the Buttonwood post explains:

"[F]oreign creditors have a right to be more suspicious of debtor countries. Even if they do not resort to outright default, they can always achieve partial default through currency depreciation.

"Indeed, the law of volatility can be invoked again. Developed-country governments have attempted to control bond yields through quantitative easing and to support stock markets through ultra-low interest rates. But they cannot support their currencies as well without risking problems in the bond and equity markets. Gold's surge may indicate that investors fear the next stage of the crisis will occur in the foreign-exchange markets."

You can bet your bottom dollar on that one. And with jawboning for China to reevaluate its currency (watch out what you wish for), Australia hiking its interest rates (twice already), and the dollar reaching new lows (how low can it go?), gold will start to look better than ever.

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