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The Pros And Cons Of The Gold Standard


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The 500 per cent rise in the gold price since April 2001 prompted gold bugs to speculate about a new age of gold

Return Of The Barbarous Relic

Despite Gold’s Rising Popularity, Central Reserves To Continue Using Paper Money

John Milton wrote, “Time will run back and fetch the age of gold.” In the 19th and early 20th centuries, gold played a key role in international monetary transactions. The gold standard was used to back currencies, values were determined by its fixed relationship to gold and the precious metal was used to settle international accounts. Imbalances ininternational trade were settled by physical transfers of gold bullion.

A country with a deficit would deplete its gold reserves and would, thus, reduce its money supply, reducing demand for imports and boosting exports through lower prices. It is through this mechanism that the trade deficit adjusted. A country with high inflation lost gold as holders converted paper into gold, reducing the amount of money available, reducing inflationary pressure.

In Goldfinger, Colonel Smithers explained the monetary role of gold to James Bond succinctly, “Gold and currencies backed by gold are the foundation of international credit… We can only tell what the true strength of the pound is…by knowing the amount of [gold] we have behind our currency.” The system operated more or less continuously until the early 1970s, when the world moved to the era of floating currencies with no link to gold. Since the replacement of the gold standard with the dollar standard, gold prices have fluctuated widely. In January 1980, the gold price reached a high of $850 an ounce, reflecting high rates of inflation and economic uncertainty.

Subsequently, global recovery saw gold fall for nearly 20 years, reaching a low of $253 an ounce in June 1999. From 2001, the gold price began to rise due to a mixture of increased demand, especially from emerging nations such as India and China. In 2007/2008, gold received an additional boost from the onset of the global financial crisis. Concern about a banking collapse drove gold prices higher with gold prices finally passing the 1980 high, reaching $865 an ounce in January 2008, peaking at $1,913 in August 2011.

The 500 per cent rise in the gold price since April 2001 prompted gold bugs to speculate about a new age of gold. Having earlier sold off their holding, some central banks are now rebuilding gold reserves. A weak US dollar and the questionable prospects of other major currencies, like the euro and yen, have driven central bank demand for gold as de facto currency. With a large portion of reserves invested in currencies of developed nations that were losing value, central banks sought to switch to gold and other real assets.

The revival of interest in gold is also underpinned by debate of a return to the gold standard. Advocates as varied as Libertarian US Presidential candidate Ron Paul and the Islamic Liberation Party (Hizb ut-Tahrir) have argued that the gold standard is a solution to the problems of the global economy. The gold standard, they say, would foster economic stability and prosperity, primarily by creating price stability, fixed exchange rates and limiting deficit spending and trade imbalances. It will also limit credit-driven boom-bust cycles through constraints on the supply of money.

The gold standard, opponents argue, would limit the flexibility of governments and central banks in managing economies, restricting the ability to adjust money supply, government budgets and exchange rates. Opponents also point to the inflexibility of the gold standard that may have contributed to the severity and length of the Great Depression. A return to the gold standard would also confer a financial advantage to countries that produce gold, such as the US, China, Russia, Australia and South Africa.

Geopolitical considerations and global competition make this unlikely. There are also limits to supply. In all human history, only 1,40,000-1,70,000 metric tonnes of gold has been extracted. Annual production is around 2,400 tonnes of gold. The world’s existing stock of gold is equivalent to about two Olympic-standard swimming pools. The value of this amount of gold is over $6 trillion, roughly 10 per cent of everything the world produces in a year and a tiny fraction of global wealth and assets. Limited central bank holdings of gold constrain a return to the gold standard.

The US, German and French central banks have gold stockpiles valued at 250-300 per cent of their reserves of foreign currencies. China, India, Russia, Brazil and South Korea hold between 0.5 per cent and 10 per cent of their reserves in gold. If the central banks of China, India, Russia, Brazil and South Korea sought to raise their gold holdings to 15 per cent of reserves, they would need to purchase more than 10,000 tonnes of gold. The US, the world’s largest gold holder, holds a little over 8,000 tonnes.

Max Weber defined the state as the agency that successfully monopolises the legitimate use of force. The state, through its monopoly over the printing presses, has almost total control of money and the economy. Money is now a matter of pure trust. American dollar still bears the words, ‘In God We Trust’. But God is not responsible for control of money, it is governments and central banks. Policymakers are unlikely to willingly cede the power that a paper money system provides.

As the metal’s price rose, a Tuscan spa offered wealthy clients a treatment that entails the entire body being covered in 24-carat gold. Costing 420, the treatment, proponents claim, provides unverified benefits such as delaying the visible effects of age, skin hydration and skin elasticity. Having switched from traditional financialinvestments to gold to preserve their wealth, investors will be hoping for the health benefits of the gold treatment rather than another possible ending. In the film Goldfinger, the character Jill Masterson, played by Jill Eaton, is murdered by being painted head-to-toe in gold paint – one of movie history’s iconic scenes.

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About Keerthika Singaravel
Engineer,Investor,Businessperson

2 Responses to The Pros And Cons Of The Gold Standard

  1. Alex Jones says:

    As longs as a piece of paper called currency has tangible assets like gold backing it then there is no problem, it is when nothing supports the paper that there is a problem. Another good action would be to take the control of money away from banks and return it to the governments.

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