Commentary by Michael R. Sesit
March 3 (Bloomberg) -- Gold can be worn as jewelry, used as an investment and deployed as a hedge against economic and political risk. It can also serve as the anchor of a country’s monetary and exchange-rate policy.
The first is a matter of personal taste. Investments and hedges are often related; their success boils down to the price initially paid for the metal. History shows that as a hedge and investment, bullion over the years has performed both spectacularly and miserably, depending on the time frame.
A return to the gold standard, where countries peg their currencies to a given quantity of the metal and thus to one another, is a bad idea. Gold-based monetary systems are overly rigid and restrictive, possess a deflationary bias and can be volatile. They make long-term inflation dependent on the pace of mining output in places such as China, South Africa and Russia. Bullion-based policies are also as prone to political manipulation as those not anchored in the metal -- something few gold bugs are willing to acknowledge.
Gold has been on a tear. Futures soared 35 percent from $705 an ounce on Nov. 13 through March 2. Before retreating, the metal traded as high as $1,007 on Feb. 20, its first move above the $1,000 plateau in almost a year.
Extended Recession
The high price reflects investors’ concerns that massive deficit spending and ultra-loose monetary policies will reignite inflation. Paradoxically, worries about an extended recession and that policy makers won’t succeed in rescuing the global banking system also haunt investors.
Gold is now regarded as a hedge against both inflation and deflation, says Alan Ruskin, the chief international strategist at Greenwich, Connecticut-based RBS Greenwich Capital Markets Inc. The first is reflected in the high dollar price of bullion, the second by the surge in gold’s price in euros.
When gold last traded at more than $1,000 on March 18, 2008, the metal’s price was 643 euros an ounce. Yesterday, it was 743 euros in late European trading. Some folks interpret gold’s rally against the dollar at a time the greenback is strengthening against many currencies as a sign of investor disenchantment with fiat, or paper, money -- legal tender with no tangible backing except the good faith of the government that issued it. The risk is that hyperinflation may render it worthless.
‘No Safe Store’
“In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value,” former Federal Reserve Chairman Alan Greenspan wrote in 1966, when he was running consulting firm Townsend-Greenspan & Co. in New York. “This is the shabby secret of the welfare statists’ tirades against gold. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process.”
Not so fast, Mr. Greenspan.
A gold standard tends to have a recessionary bias. When speculators and others attack a country’s currency, the burden usually falls on that nation to adjust by contracting its economy and increasing unemployment. The system places no matching requirement on countries with “strong” currencies to adjust.
The inflexibility of the gold standard makes it difficult for governments to adopt policies best suited to their domestic economic needs.
Take South Korea. Its currency, the won, has fallen 29 percent against the dollar in the past six months. Such a depreciation wouldn’t have been permitted under a gold standard. Korea would have been required to support its currency by raising interest rates to maintain the won’s parity with bullion, exacerbating an already virulent recession.
Gold and Depression
In a parable with relevance to today’s economic environment, “attachment to the gold standard played a major part in keeping governments from fighting the Great Depression, and was a major factor turning the recession of 1929-1931 into the Great Depression of 1931-1941,” Bradford DeLong, an economist at the University of California, Berkeley, wrote several years ago.
Commitment to the gold standard prevented the Fed from expanding the money supply in 1930 and 1931, forcing President Herbert Hoover “into destructive attempts at budget-balancing in order to avoid a gold-standard generated run on the dollar,” DeLong said.
China, the U.S., South Africa, Australia, Russia and Peru make up the six biggest gold producers. If their mining operations were interrupted by, say, political upheaval, it could lead to deflation and rising unemployment. In contrast, major improvements in mining technology could ignite inflation.
Population’s Willingness
What’s more, a gold standard isn’t the panacea its advocates claim. A central bank’s ability to adhere to it is only as strong as the population’s willingness to endure the pain associated with enforcing the system.
Countries periodically abandoned the gold standard during times of war -- Britain during World War I, for example -- and free-spending Latin American countries were repeatedly forced to exit the system in the late 19th century. The Bretton Woods System collapsed in 1971 when the costs associated with fighting the Vietnam War forced President Richard Nixon to suspend the convertibility of dollars into gold.
If you don’t have faith in central bankers or politicians to ride herd over inflation, why would you trust them to keep a country on a gold standard for more than a short period of time?
(Michael R. Sesit is a Bloomberg News columnist. The opinions expressed are his own.)
To contact the writer of this column: Michael R. Sesit in Paris at at msesit@bloomberg.net
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