A return to the Bretton Woods international gold standard created in 1944 is inevitable
Thirty-seven years ago the world’s economies started on the circular
track back to Bretton Woods. We will sooner or later be back where we
started, with international transactions guided by a fixed gold price.
The official output of the November 2008 G-20 Summit is 3,366 words, including 61
instances of the word “should” as in “Financial institutions must also
bear their responsibility for the turmoil and should
do their part to overcome it including by recognizing losses” and “Incentives should
be aligned to avoid excessive risk-taking” and “Regulators should
enhance their coordination and cooperation across all segments of
financial markets” to cite only the first three. The entire rambling
tract says in sum, “We met. We talked. We agreed that serious
challenges to the world economy and financial markets exist but are not
so serious as to compel us to do anything about them. There is so
little urgency that we decided not to meet again until the spring of
2009 to talk about the crisis more.”
The only intriguing output that passel of pattering public servants
managed to produce is a rumor that the topic of gold came up in the
meeting. Judy Sheldon, writing for the Wall Street Journal on Friday,
in her article Stable Money Is the Key to Recovery: How the G-20 can rebuild the 'capitalism of the future said:
can an exchange rate really mean," he wrote in "Changing Fortunes"
(1992), "in terms of everything a textbook teaches about rational
economic decision making, when it changes by 30% or more in the space
of 12 months only to reverse itself? What kind of signals does that
send about where a businessman should intelligently invest his capital
for long-term profitability? In the grand scheme of economic life first
described by Adam Smith, in which nations like individuals should
concentrate on the things they do best, how can anyone decide which
country produces what most efficiently when the prices change so fast?
The answer, to me, must be that such large swings are a symptom of a
system in disarray."
If we are to "build together the capitalism of the future," as Mr.
Sarkozy puts it, the world needs sound money. Does that mean going back
to a gold standard, or gold-based international monetary system?
Perhaps so; it's hard to imagine a more universally accepted standard
Gold has occupied a primary place in the world's monetary history and
continues to be widely held as a reserve asset. The central banks of
the G-20 nations hold two-thirds of official world gold reserves;
include the gold reserves of the International Monetary Fund, the
European Central Bank and the Bank for International Settlements, and
the figure goes to nearly 80%, representing about 15% of all the gold
Ironically, it was French President Charles de Gaulle who best made the
case in the 1960s. Worried that the U.S. would be tempted to abuse its
role as key currency issuer by exporting domestic inflation, he called
for the return to a classical international gold standard. "Gold," he
observed, "has no nationality."
Alan Greenspan a year ago recommended the same, as we noted at the time
We’re glad a WSJ writer said this before we did. We’d get labeled
goldbugs for asserting that not only is a return to an international
gold standard necessary to restore the global financial system, it is
an eventuality. Greenspan and the WJS get away with it because they are
the WSJ and Alan Greenspan. Who are we but a bunch of fruitcakes who
backed up the truck and bought gold at $270 in 2001? What do we know?
Note: An international gold standard does not require a
return to national gold standards by participating nations. In an
international gold standard gold is only relevant for international
transactions between nations. Fiat currencies, such as the dollar,
euro, and yen, remain in use for domestic transactions within countries.
Still Questioning Fashionable Financial Advice
In our original August 2001 article Questioning Fashionable Financial Advice
we made the case to readers to buy gold when it was trading at $270, we
offered the following argument that was as offensive to goldbugs as to
the gold phobic.
Do you know
of any commodity that the world's central banks hold in such large
amounts? The world's central banks have had over 30 years since gold
was disconnected from currencies to sell their gold. But they haven't.
According to the International Monetary Fund, "Total official holdings
have been reduced by 3,000 tons, or less than 10%, over the past 30
years." (Source -- World Gold Council) The question is, if they don't
think they need it, why haven't they sold it? The standard answer is
that they have too much of it to sell without negatively impacting the
price of the remaining gold they possess and hurting economically
allied nations that produce gold. The problem with this argument is
that the world's central banks have had 30 years since the demise of
the Breton Woods system to sell their gold. Methods for selling gold
without significantly impacting price or hurting gold producing
countries are well documented (see "Can Government Gold Be Put to Better Use? Qualitative and Quantitative Effects of Alternative Policies").
It's hard to imagine that sales of an average of 3.3% of holdings per
year over 30 years, an amount that represents a small percentage of
annual gold mining output, will have had a significant impact on the
Part of our investment theses since then is that monetary
gold, rather than natural or honest money, is an artifact of ancient
government money protocol. Most histories of gold coinage begin with
the factoid of King Croesus of Lydia introducing gold coins around
643-630 B.C. but without explaining why; to enable the collection of
taxes not in pigs and grain but in coin that the servants of the king
and state could not manufacture on their own. Kingdoms and governments
liked this arrangement so much that from then until the last century
gold coin grew to become the most widely accepted form of tax payment
collection globally, and so became the coin of many realms for domestic
and international commerce as well.
As economies and commerce grew more complex, fractional reserve banking
based on gold reserves, the true risk-free reserve asset, evolved. The
30,000 tons of gold that central banks still hoard in their vaults 37
years after the end of the gold standard is an artifact of that ancient
evolution. In our usual habit of asking the most obvious question, when
we did our analysis in 2001 we pondered: Why do central banks own
30,000 tones of gold when the stuff has had no monetary purpose for
decades? Why not sell it over that time and hold "risk-free" government
bonds instead that earn interest? How many hundreds of billions of
dollars in interest income have central banks lost by not holding “risk
free” government bonds instead of gold all this time? How can central
banks justify this apparent fiduciary delinquency and waste?
The answer is obvious once you have asked the question. A central bank
without gold reserves today is like a stunt pilot without a parachute.
The stunt since 1971 is maintaining stable international currency
values in a system of fiat money and floating exchange rates, difficult
but possible when the global economy and money supply are expanding but
impossible when debt, the hangover from a 27 year long credit bubble,
is deflating worldwide.
We’ve been here before
In the 1930s, nations abandoned the gold standard one by one, then
formed into three currency blocks that commenced a global monetary
circular firing squad. The three groups engaging in competitive
currency devaluation in turns in desperate attempts to export deflation
to each other by means of depreciating the value of their respective
currencies. The Smoot-Hawley Tariff Act was America’s unimaginative
defense. It famously made matters worse; in 1933, after the US money
supply collapsed 40% and bank credit 50% since 1929, by devaluing the
dollar 69% against gold FDR, a unilateral deflation of the dollar
against gold that created a near instantaneous 40% monetary inflation.
There can be little argument that WWII was rooted in the political
fallout of the global depression. Populations made angry and destitute
by the depression electing various flavors of dictator to bang heads
together to set things right. After the war, the international monetary
regime developed at Bretton Woods was designed to avoid a repeat
scenario that follows the folly of credit inflation, should such a
dangerous error be allowed by the ignorant and greedy to develop again:
financial crash, economic contraction, debt deflation, economic
depression, political instability, dictatorship, war.
The development of America’s first ever current account deficit under
the Bretton Woods system appeared at $400 million in Q1 1971 and grew
to $1.17 billion by Q4, a tenth of one percent of GDP. That was enough
to send US trade partners scrambling for payment in US Treasury gold
rather than soon-to-be devalued dollars. In response, Richard M. Nixon
first "temporarily suspended" gold convertibility, then devalued the
dollar twice two years later in 1973. Gold convertibility was never
restored. In the intervening years, the US current account deficit has
ballooned to $183 billion, by a factor of 158 while US GDP grew by a
factor of only 12.
Central banks have not had to use their gold reserve parachutes, but
the circumstances we face today are precisely what they are there for:
to permit the simultaneous reflation of all currencies in the event
that another 1930s style global deflation recurs.
To us, the question of a global reflation of currencies and deflation
of debt against gold is a matter of when and how not if. The cost will
be born unequally, with debtors like the US gaining more benefit and
creditors like Japan and China less. In a world where trillions in
currencies swim the global currency markets sea daily, the
re-institution of an international gold standard with some formula of
fixed exchange rates, even if temporary, will be wildly disruptive and
costly to the global economy, and more to some nations than others.
This is why we don’t see this happening until global economic
conditions resulting from debt deflation grow much more dire; the
economic and political costs of the ongoing debt deflation must
outweigh the costs of implementing a new international gold standard.
More daunting, as the costs and benefits of that solution are unequal,
who will provide the necessary leadership? Imposing a new world
monetary order in 1944 was a simple matter in the wake of WWII when
only one nation, the US, stood economically and militarily strong
enough to drive all nations to consensus. In a multi-polar world, how
will consensus be gained, especially if economic hardship is once again
motivating populations to demand expedient solutions, and autocratic
government makes a comeback, never mind that one major party at the
table, China, is autocratic now?
Will gold re-monetization make me rich if I own gold?
Is gold re-monetization good for gold owners? We’ve seen calculations
of potential future post re-monetization prices such as those suggested
by Larry Edelson over at Money and Markets
ranging from $5,300 to $53,000 per ounce. We have since 2001 forecast a
$5,000 peak gold price, but that estimate is based on a set of metrics,
such as the ratio of gold to the DOW that we anticipate at the top of a
global currency crisis, not post re-monetization gold reserve ratios.
Less important than the gold price to gold owners, however, is the ugly
political and legal environment, not to mention the social atmosphere,
that is likely to exist at the time that economic conditions drive
international parties to the table to hammer out a new international
The range of future popular opinion of private gold holders under those
drastic circumstances ranges from villain or hero and everything in
between. If gold owners are vilified, you can count on a less than
friendly government policies on gold taxation and possession. The 1933
confiscation was strictly old school; the modern approach is more
likely to take the form of a 90% capital gains tax on private gold
sales with high penalties to encourage sales to the government at a
fixed price and slow a popular rush to the metal, and of course create
an enormous black market in the bargain. If that sounds paranoid, you
haven’t been watching the news lately.
To time a new international gold standard you have to think in terms of
the G-20 time-line. A year into the debt deflation, global leaders have
yet to acknowledge it is the root problem, let alone do anything but
issue vague “should do this” and “should do that” official statements,
let alone propose a radical solution like gold re-monetization to bring
the devastating effects of debt deflation under control. Our forecast
two years ago of a severe post housing bubble recession was strictly
tin foil hat at the time, as was our call of a bottom in the price of
gold 2001, as this latest forecast will appear to many.
Rounding the bend, back to Bretton Woods
Another year or two must pass before the collapse of global economies
motivates bold policy moves to address the root of the problem, how to
deflate all of the excessive debt. Even then the question remains:
without dominant economic and political leadership, who can herd the
cats–the US, the EU, Japan, China–who may be fighting like cats in a
sack, to a mutually beneficial accommodation when the costs and
benefits are unequal? Yet the alternatives are either a new circular
firing squad of competitive currency devaluation or ongoing destruction
of economies around the world by debt deflation.
We cannot say, of course, how the impending crash of the world’s
national and regional economies on the track back to the Bretton Woods
international gold standard will turn out, but only a diehard optimist
can imagine we all escape without a scratch.
Our position has not changed since 2001. Central banks own gold for
good reason: the global monetary system is fatally flawed. They don’t
trust each other, and so why should we trust them? The only new issue
we’ve raised here, now that events are developing more or less as
expected, is this: when the time comes, will owning gold do us any
good? Is there some other asset we should own either in addition or
To receive the iTulip Newsletter or iTulip Alerts, Join our FREE Email Mailing List
When the gold prices rises in all major currencies that means all currencies are depreciating against gold and we are seeing global inflation. Daily gold charts below since Jan. 2000.
(Source: World Gold Counsel)
Gold in US dollars daily
Gold in EU euros daily
Gold in Japanese yen daily
Gold in British pound sterling daily