Gold may glitter, but being tied to it would be ruinous

Last week, France’s far-right leader Marine Le Pen, who will run in next year’s presidential election, proclaimed that the euro was doomed and that the world should return to a gold standard in order to anchor the global economy that’s now in turmoil.

Such a monetary move, which would see the abolition of paper currencies whose value isn’t underwritten by gold, has long been the wet dream of one school of economists and businessmen and moneybags who argue that central banks cannot be trusted to run fiat-currency monetary policy without stoking hyperinflation.

Earlier this year, businessman Steve Forbes said he could foresee a time - within five years - when the US would return to the gold standard, and that such a move would solve America’s fiscal and monetary ailments. Such a move, he added, would help stabilise the dollar’s value, restore foreign investors’ confidence in US government bonds and discourage reckless federal spending.

The recent bout of inflation swirling in India and around the world, a consequence of the abnomally low interest rate regime and endless rounds of “money printing” in an economically enfeebled US and in Europe, has amplified sentiments supportive of a return to the gold standard.

Commentaries ranting against the “debasement of paper currencies” and the perfidious politicians and central bankers who oversee such a debasement are legion (including, evidently, among some Firstpost readers). Investors like Marc Faber and Jim Rogers frequently criticise Ben Bernanke for debasing the dollar, and talk up gold. The fact that gold prices have more than doubled in the three years since the 2008 financial crisis, and have today surged to a new high, adds resonance to those voices.

In the popular narrative, it is gold that retains its purity as a store of value, and its status as a safe haven in a period of excessive turmoil in currency markets. Gold is even seen to act like a currency in its own right. That perception has been reinforced by the establishment of “gold ATMs” in London , Abu Dhabi and Las Vegas .

More strikingly, in recent weeks, months and years, even central banks (including India’s) have been steadily buying up tonnes of gold, manifestly to diversify their foreign exchange reserve portfolio away from the US dollar - which has lost substantial value (particularly since 2008) - and the euro , whose very future as a currency remains in doubt.

Does this mean the world is edging towards a return to the gold standard?

There are compelling reasons to argue that for all the nervousness about the diminishing value of the US dollar and other paper currencies, and the gradual diversification that we are indeed witnessing away from the US dollar, we’re unlikely to ever see a return to the gold standard.

And that’s probably a good thing.

Gold bugs and those who pitch for a return to the gold standard argue that by promising and delivering price stability, and by limiting the fiscal elbow room that governments would have, the gold standard will ensure tranquillity and the promise that thrift will be rewarded.

One of the most compelling cases for the gold standard’s merit as an instrument of price stability has been advanced by US Congressman Ron Paul, a libertarian economist and a US presidential candidate whose ideological influence runs through the Tea Party movement that has changed the political discourse in the US in the past two years.

Paul points out that for most of the 19th century, the US had an (imperfect) gold standard.

“In the 67 years prior to the beginning of the Federal Reserve system in 1913, the consumer price index in the US increased by just 10 percent.”

He contrasts that with the 67 years since 1913, during which period CPI increased 625 percent.

In other words, the abandonment of the gold standard unleashed runaway inflation, and a return to that tether will tame inflation and provide the enabling environment for stable economic growth.

But in fact, that represents an overly rosy characterisation of the effect of abiding by the gold standard. As economist BarryEichengreen notes in his book Golden Fetters , the gold standard of the 1920s, which tied the hands of policymakers in the face of economic slowdown and a banking system under strain, in fact set the stage for the Depression of the 1930s.

“The gold standard,” he writes, “was the mechanism transmitting the destabilising impulse from the US to the rest of the world.” And it prevented policymakers from averting the failure of banks and containing the spread of financial panic. And for those reasons, the international gold standard was a central factor in the worldwide Depression, from which recover proved possible only after abandoning the gold standard.

It is easy to fault Ben Bernanke, another scholar of the Great Depression, for his readiness to resort to “helicopter” imageries as part of his policy response to avert a Depression. And although the hyperinflation scenario that scaremongers have been warning of for three years hasn’t come true, the demerits of an excessively easy money policy are manifestly evident.

Yet, even the gold standard that critics of the central banking system point to as the solution isn’t without risks. And as we saw during the recent debt ceiling debate, when the far-right Tea Party movement held hostage America’s reputation as an economy worthy of trust, ideological rigidity of the sorts that the gold standard implies can have even graver consequences.

The critical difference between the US and, say, Greece is that since the US is a sovereign currency issuer, it literally has a limitless capacity to repay, and the risk of its default arose only from an readiness of the Tea Party to sabotage a debt ceiling deal. And it is that ideological rigidity that led to a sovereign rating downgrade, not any perception that the US did not have the capacity to repay its debt obligations.

The return to a gold standard would effectively burden each and every central bank in the world with the millstone of a rabid Tea Party around its neck. It would in every way be a cure worse than the disease.