Return of the Gold Standard?
By Adrian Ash
July 23, 2007
Tinkering with interest rates
is failing to control the bubble in world money supplies...
YOU ONLY have yourself to blame. Consumers in
the West, rich in credit ratings if not cash, shouldn't have
borrowed and spent so much money when interest rates hit a
half-a-century low in 2003.
Nor should consumers have continued to borrow and
spend when the rate of interest slipped below the inflation rate
making debt pay as cash savings lost real value over the
next two years.
And we really should haven't have accepted all
those super-low teaser mortgages...0% charge cards...and
money-back deals on shiny new SUVs...when the global money
supply began to balloon between 2005 and 2007.
Should the cost of living now shoot higher, then
our monetary masters at the West's central banks will stand
ready to say: "Told you so!" Because they themselves,
of course, have got nothing to do with the problem.
"The sooner households begin to acknowledge the
consequences of higher interest rates," warned Bank of
England member Tim Besley in a speech this month, "the
greater is the chance of a smooth adjustment towards a level of
consumption consistent with maintaining the inflation target in
the medium term."
In other words, "Stop or your monthly
mortgage fee gets it!"
Besley's logic, like his task as a central banker,
is simple enough. The more people spend, the more they risk
pushing up prices. The mechanism is made plain enough by a quick
glance at the residential housing market and Besley might as
well have been wagging his finger at consumers across the
Atlantic as well as in the United Kingdom, along with households
in Australia, New Zealand, South Africa, Spain, Ireland...
Wherever household debt has exploded, funding an
explosion in house prices and consumption, the solution looks
clear: Make money dearer, and inflation will recede. Indeed,
"it is a widely accepted proposition in the economic
profession," as the European Central Bank noted in its most
recent policy statement, "that a change in the quantity of
money in the economy will be reflected in a change in the
general level of prices."
The task of central banking, in short, is to
maintain the quality of money thus preserving its purchasing
power by limiting the quantity that's sloshing around.
Right?
Trouble is, the Western world's central bankers seem to have
lost control over the very mechanism they claim turns higher
interest rates into lower inflation. The supply of money the
actual quantity of cash and near-cash financial instruments now
flooding the globe has shot higher even as the Fed, Bank of
England and ECB in Europe have begun making debt more expensive.
European money supply is now growing at a near-two
decade record. The United Kingdom is witnessing the fastest
growth in money supply since the late '80s. In the US, where the
Fed stopped reported broad "M3" money supply at the
start of last year, the quantity of money is reckoned by several
respected analysts to be growing by 10% per annum or more.
Classically defined, inflation means exactly this
kind of growth in the quantity of money. Capping it with higher
borrowing costs makes sense in theory. That was how central
bankers led by Paul Volcker at the Federal Reserve finally got
round to killing the Great Inflation of the late 1970s. It took
them more than one attempt, too.
"Many government officials throughout the free world became
monetarists in the 1970s," writes David Hackett Fischer in
his grand history of price inflations, The Great Wave.
"Major efforts were made by the Federal Reserve Board in
the United States and the Bank of England in the United Kingdom
to stabilize their disordered economies by regulating the money
supply. These efforts were not successful and actually increased
instabilities."
"Economist Milton Friedman raged against the
errors of his own disciples," notes Hackett Fischer,
"repeatedly accusing the governors of the Federal Reserve
System and the Bank of England of grievous incompetence."
But as John Kenneth Galbraith replied, "An
economic policy needs to be within the competence, however
limited, of those available to administer it." In other
words, a solution proposed is no solution at all if it proves
impossible in practice and perhaps a return to some kind of
Gold Standard would prove just such a non-solution today.
"The global derivatives market grew nearly 40%
in 2006," as Robert Rodriguez of First Pacific Advisors, an
$11-billion investment fund, noted in a speech to the CFA
Society of Chicago late last month. "The amount of
contracts based on bonds more than doubled to $29 trillion. The
actual money at risk through credit derivatives increased 93% to
$470 billion, while that amount for the entire derivatives
market was $9.7 trillion.
"The International Monetary Fund, in its April
2006 Global Financial Stability Report, estimated that
credit-oriented hedge fund assets grew to more than $300 billion
in 2005," Rodriguez went on, "a six-fold increase in
five years. When levered at five to six times, this represents
$1.5 to $1.8 trillion deployed into the credit markets."
Tinkering with interest rates has done nothing to
cool this bubble in money and near-money substitutes so far. A
classical Gold Standard would mean restricting future growth to
the 1.3% growth in above-ground gold stocks each year. But would
it be possible?
Squashing the global supply of what now passes for
money into the even broadest measure of world gold holdings
the outstanding stock of 153,000 tonnes now reckoned to sit
above ground would most likely mean destroying the economy
first. That's why, like the tame monetarism practiced by central
bankers in the late '70s, it's unlikely to work.
Just try getting a Gold Standard past Congress...no
matter how bad inflation becomes! Asking politicians to defend
the value of money would be like getting David Beckham to
concentrate on his game, not his pay-check. It sounds like a key
part of the job spec', perhaps even the most essential part of
the job as far as L.A. Galaxy are concerned. But elections
aren't won by politicians who admit that defending the value of
money most particularly after an unprecedented bubble in
credit and debt would almost certainly guarantee a
recession.
"As the restraint took hold," said Paul
Volcker, former head of the US Fed, in a speech 10 years after
he raised US interest rates to 19%, "one country after
another was caught up in recession or an extended period of
stagnation." Even central bankers need to make their own
mortgage repayments each month, of course, and raising interest
rates to slow inflation will never be popular. Raising them so
far that your neighbors lose their lose jobs is a tough call to
'fess up to at your local barbecue.
What's more, the mere idea of a Gold Standard has
suffered a bad rap ever since Winston Churchill took Great
Britain back to a fixed value for the Pound Sterling against
gold in 1925...and doomed the country to depression by applying
the pre-World War I exchange rate. The British government's
debt, meantime, had ballooned more than 11 times over since 1914
to pay for the blood spilt in Flanders, and the cost of living
had doubled. Pretending that One Pound in 1925 could be equal to
One Pound in 1914 meant that soon "Englands government
coffers [were] full," as one French observer put it,
"but the economic situation is poor...and its industry is
operating at half-speed. From every side, you hear complaints
that British producers cant possibly compete with foreign
suppliers..."
Dismissing the return of a Gold Standard today,
however, isn't to say that gold doesn't hold any monetary value.
Indeed, the only real question for investors and savers: Why
wait for the rest of the world to catch on?
If the bubble in credit and money hadn't grown so
large in the first place, we wouldn't need to defend ourselves
with a lump of shiny yellow metal. Now gold continues to gain in
value whilst all official world currencies sink to reflect the
deluge of money created so far this decade.
Perhaps that's just where we've got to in the
long-term history of credit and money, bubbles and busts
awaiting the whirlwind now due after sowing so much bad debt.