Gold Standard – Part II

Last week we talked about the Gold Standard, which was when the United States government guaranteed each gold-backed American dollar in circulation.

With the current economic contraction that is underway, some people are positing the notion that returning to the gold standard would help.  But the reality is that the gold standard contributed to the Great Depression.

A currency is only as good as the government’s credibility that backs it up.  Sticking with the gold standard?   If a government goes on, then off, then on again,well, you can see that credibility is quickly lost.  And historically, that is what countries have done.

In the years after World War I, many countries had suspended convertibility of gold during the war, and then stayed of gold.  They experienced fiscal chaos as speculators moved in and wildly fluctuating monetary policies robbed citizens of stability needed to rebuild.

But counting on a gold standard, in a fiscally unstable market, when investors, speculators and citizenry doubt governments’ ability to keep to that standard was edging too close to the cliff.

International capital flows became more erratic, not less, as doubts were raised about whether first the pound, then the dollar.

Britain lost ground under these speculative attacks and released its gold standard in 1931.  The U.S. toughed it deliberately raising interest rates in the same year, when the economy was already in near free fall.  The resulting damage to the economy is well known.

The longer a country stuck to the gold standard, the more overall deflation it experienced. Many experts are persuaded that this deflation greatly added to the economic difficulties of those countries that insisted on sticking with a fixed value of their currency in terms of gold.  It got worse, not better.

The bottom line is if buying gold is your standard for maintaining economic stability, then let it continue to be your standard.  As for a return to the gold standard, that is unlikely and probably ill advised.

Gold Up; How About a Gold Standard?

The price of gold vaults upward, surpassing predictions and hits $1000 per ounce this week.  Not surprising, given consumers and investors concerns about the stability of the American dollar.  The value of gold always flies in the opposite direction of the dollar’s value.  That is, if investors think the dollar is going up, the value of gold drops in proportion.  If investors are worried about the dollar holding value, the price of gold goes up.

And every so often, we hear some naysayer suggest that what is truly needed is a return to the “gold standard” of yesteryear.  What is a gold standard?

A gold standard is a monetary system in which the regions common media of exchange (we’ll use the dollar as our example today) is a paper note that is freely, normally convertible to pre-set, fixed quantities of gold.  The gold standard is not in use by any government currently, having been replaced by currency.  (Although there are occasional, rare private currencies backed by gold.)

Every once in awhile, when financial concerns are weighing heavily, someone suggests that “all would be right if we would just return to the gold standard.”   We suggest that is probably not a likely scenario.

Why?  Let me offer you a few of the disadvantages of a gold standard system.

* The total amount of gold ever mined is believed to be in the amount of 142,000 tonnes.  Assuming a gold price of $1000 per ounce (which is sorta handy, at the moment!) that would bring a value of about $4.5 Trillion.  There is more American currency circulating than that, currently, so using a gold standard might be a little embarrassing.

* Most mainstream economists believe that adding currency to troubled economies helps.  If we relied on the gold standard, that would be impossible.

* Monetary policy and politics would be determined by gold production.  Do you really want mining companies running world politics?

The advantage: we might all feel more confident in the government, which is good at times of economic uncertainly like what we are facing, but in fact our government needs more freedom to operate in the face of such difficulties than a gold standard would induce.

Gold standard: the name sounds good, but the prospects aren’t likely or likeable in the long-term.

Gold Surpasses $1,000 on Fears of Inflation

Fears fomented by long-term inflationary concerns over President Obama’s huge stimulus package drove investors to gold as a hedge against likely devaluation of the U.S. dollar.

Historically, the price of gold has been intimately wed to the value of the U.S. dollar. This was not difficult to predict. As the dollar loses value, gold gains it. It’s a time-honored maxim, set into motion when about a century ago, on March 14, 1900, the U.S. government passed the Gold Standard Act.

The Gold Standard Act Stated:

“…the dollar consisting of twenty-five and eight-tenths grains (1.67 g) of gold nine-tenths fine, as established by section thirty-five hundred and eleven of the Revised Statutes of the United States, shall be the standard unit of value, and all forms of money issued or coined by the United States shall be maintained at a parity of value with this standard…”

Back then, the price of gold was set at only $20.67 per ounce (48.38 times less than $1,000)!

This week’s stock market free fall has not helped matters either, with the Dow Jones shedding another $152 of muscle today, bringing the value, as I write this, to $7,313.74.

“There really is no other place to go,” says Leonard Kaplan, president of Prospector Asset Management. “People are scared.”

When falling house prices, stock market crashes, unemployment rates, recession, high deficits, fear of inflation, and the fact that the near future is unknown, tangible assets (not abstract investments) flourish.

Gold should continue to be a safe, hedge investment for the forseeable future. But if the recently passed stimulus package and the upcoming bail out impregnates our economy with Obama’s campaign-trail promise of “new hope”, be prepared to re-evaluate your gold holdings: life and the economy with it, can again experience a vast paradigm shift.