Private sector should lead gold standard adoption

November 8, 2010

A proposal from the president of the World Bank, Robert Zoellick, to use gold as a reference point could prove destabilizing. Like the Bretton Woods system, such a government-run peg would break under stress. A better approach would flip the monetary order and use gold as a private means of global exchange.

Zoellick suggests using the yellow metal as an “international reference point of market expectations about inflation, deflation and future currency values.” In its weakest form, this would simply use the gold price as one indicator of the health of the global monetary system, something many central bankers already do. In a stronger form, it would mean fixing a peg for currencies in terms of gold, in a similar manner to the Bretton Woods monetary system in force from 1944 to 1971, and in vestigial form until 1973.

The model worked well only while the United States was the dominant global economy and in control of foreign exchange markets. Once other economies revived and global FX markets were liberalized after 1958, the system proved unable to handle growing monetary imbalances. Today, America is economically much less dominant and FX markets are more powerful than in the 1960s, so the life expectancy of a state-administered fixed peg system would be correspondingly shorter.

An alternative route for dealing with global distrust of currencies inflated by excessive monetary easing would be for the private sector to start using gold in ordinary transactions. Exporters from Germany or China, for example, distrusting the dollar and not wishing to use the possibly fissiparous euro or the state-controlled yuan, could invoice customers in gold, thus creating gold-denominated trade paper. Banks wishing to serve such customers could offer gold-denominated accounts, either hedging themselves in the futures market or maintaining a gold fractional reserve against such accounts.

This wouldn’t necessarily up-end the banking system, though if widely adopted it would require bigger changes. But if the world’s monetary authorities maintained control of their currency issuance, the private gold transactions market would remain modest, expanding only if global inflation took off. It would nevertheless provide the private sector with a useful protection against some of the misguided enthusiasms of central bankers.

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