Following Zoellick down the rabbit hole

November 9, 2010

We’ve all gone down the rabbit hole.

World Bank President Robert Zoellick has lent a certain Alice in Wonderland quality to the financial landscape by saying that the world should consider a return to a modified gold standard of international exchange.

If you’d asked me in 2007 how likely it was that a consummate insider like Zoellick would propose such a thing I’d have said it was only slightly more credible then the head of the National Cattlemen’s Beef Association coming out in favor of giving cows the vote.

The idea that we would move away from or curb a fiat money system — in which the value of money is tied only to faith in a government, buttressed by its policies — was, and probably is, unsupportable, not so much impossible to implement as impossible to agree.

The takeaway from this is not that we will go back to currencies tied to gold but rather that the existing order is dying. When old religions die — and that pretty much is what any monetary system is — fantastic new ones spring up to contend to fill the void.

Zoellick is acknowledging what investors have already figured out — real assets are the place to be when the solvency of the banking system is threatened and the authorities refuse to deal directly with this.

With trillions in bank collateral worth less than where it is marked and with an economy mired in a balance sheet recession, the temptation to magic away issues by creating more backed-by-nothing money is too great. This is exactly what the Federal Reserve is doing in its latest $600 billion round of quantitative easing.

This in turn is an invitation to the rest of the world to print right back. There is no brake on this system other than the ability of nations to cooperate, and right now cooperation is not in everyone’s individual interest.

Gold then can serve as a sort of adult in the global kindergarten dispute because it is finite, sort of. You simply cannot go and print your way out of trouble because we have adopted an arbitrary limit. No gold, no new dollars, or yen, or yuan.

You could argue that where we are now was a likely outcome of the current system. A global reserve currency in a fiat system creates tremendous incentives to take on too much debt. China helped the U.S. along by feeding it capital and keeping its own currency low, but there were many other ways in which this could have happened.


So, the strange thing is not that a fiat system tends towards debasement of the currency — that is always the risk, but rather that someone from inside the system is grappling with that possibility openly.

Of course, you have to understand that Zoellick, who was writing in the Financial Times, made his call for debate over the role of gold at the end of a very long list of proposals, few of which are likely to ever come to fruition: here#axzz14iI6H1gW

That is the job of the head of the World Bank during a currency war that may morph into a trade war — advocate the unlikely until your head disappears beneath the waves.

Zoellick argues first that China and the U.S. should agree on a course of yuan appreciation, as well as committing not to engage in trade retaliations. This happy fantasy having been broached, he goes on to propose that the rest of the major economies join in by agreeing not to intervene in currency markets except when approved by others.

This isn’t going to happen and neither is a new monetary system that uses gold as an “international reference point of market expectations about inflation, deflation and future currency values,” as Zoellick wrote.

There are, of course, huge problems with this. Matching current supply of gold to current supply of money implies a huge appreciation in the metal or huge deflationary pressure. The gold is also not now in the hands it would need to be in to make such a system possible. Further, world trade can only grow as fast as money in supply to make possible the exchanges, so tying to a currency regime to gold means putting what could turn out to be an arbitrary brake on trade growth.

So, the lesson here is not a return to the ancient store of value, but instead that things are so volatile and risky that people in authority might even suggest it.

Runaway inflation is not inevitable, but avoiding it is not a sure thing either. Investors will continue to look for ways to hedge that risk, and that will drive not just gold but the prices of things that can be eaten, combusted, or manufactured with higher.

(Editing by James Dalgleish)

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund)


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The fact that a human sytem can run by fiat is a sure sign of moral well being, and possibly this shortlived era will be regarded as the true golden time of the Western civilization.

Now that the fiat system has degenerated into chaos, we should wonder: who is it that has entered the arena of our civilized emisphere? Who has taken adavantage of a system that needed a degree of trust and respect to function? Which party to the system is morally inferior?

Posted by Neander | Report as abusive

The idea of some kind of basket-of-assets-based monetary standard is actually a very good approach and at least an approach that is not in the main stream. Gold, silver. copper, oil, commodities of all kinds, etc. could all be used.

Unfortunately, it will happen when pigs fly. It would mean all those countries and central bankers would no longer be able to make up their own financial rules or print money any time they felt like it.

Can you see the Fed or China giving up that kind of power? I don’t think so.

Posted by stanrich | Report as abusive

The gold standard is archaic. The emerging market countries are likely sources of its rise. Wealthy East Indians, Asians and Africans keep a lot of gold jewelry by tradition. Some wear it as dowry money or part of the marriage ceremony.

In a way – the rush for gold is a dumbing down of the financial system. Many emerging market countries simply don’t trust the stability of their own currencies and the mistrust is spreading.

A comment to Mr. Saft’s column (In Reuters India and I don’t know how my comment got there) tried to claim that Gold is a “more peaceful” currency. But how can anyone claim that one currency is a “more peaceful” form of money than another. Both WWI and WWII were fought while Gold was the standard. The nineteenth century stock market was a very volatile exchange. I think there was a “black” day for every day of the week during the 19th century – especially after the Civil War – but not all in the same week or the same year. Gold didn’t provide any greater stability to the stock market nor did it halt inflation.

If gold, at it’s present value, was used as the par value of the dollar, the true value of all that underwater real estate – and the stuff still treading water, would plunge overnight, if incomes were not also immediately increased. And how likely is it they would be?

The value of Gold was about $800/oz a few years ago (Sorry, but I haven’t looked this up) when so many homes were valued at about 1/4 million dollars. The price of those homes hasn’t risen. But with a gold standard set at its present value, that means they would really only be worth slightly more than half what they are even now.

I think all a gold standard could provide would be to substitute one false sense of security for another. And wouldn’t it also eliminate the Forex markets?

Posted by paintcan | Report as abusive

Oh, highly unlikely we’ll jettison the fiat system, after all, why does gold and other metals have value? Because it is perceived to be worth something. Despite the recent mess, the fiat currencies are still a medium for trade, nothing more.
Hell, we could be using shells and have the same problem that we have now-those people from the north shore with the green ones found a bunch on a sand bar, and the chief gave them all 5 a household. I want two of those instead of the 1 to buy this coconut yesterday. It’s not fair, after all.

Mr. Saft is correct, the confidence is really low. That does not mean that the end is nigh.

Posted by dzoo35 | Report as abusive