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Currencies: Re-evaluating the ghost of gold

Monday, September 10, 2012
By Kevin Voigt, CNN


Imagine if, over time, as our solar system swings around the Sun, the planet Jupiter suddenly put on a tremendous amount of weight. Over time the gravitational pull of the planets — and the Sun — would begin spinning around Jupiter, causing great celestial upheavals in the process.

Nobel laureate Robert Mundell likens that scenario to what has happened with currencies in the modern economic era. For most of human existence, the sunny center of our buying and selling solar system was gold and other precious metals. In the 20th century, however, economies in Europe began going off the gold standard during the Great Depression, a conversion completed when the U.S. went fully off the gold standard in 1971.

One platform of the recent U.S. Republican National Convention that, ultimately, could reverberate around the world is a plan to study a possible return of the U.S. to the gold standard. While it was perceived as a move to appease the party's extreme right wing, economists like Mundell think the world needs a limited return to the gold standard.

“Currencies are the ghost of gold,” Mundell said in a speech to the Asia Society in Hong Kong last year. And while few believe the U.S. will move back to the gold standard, Mundell noted that 40 years is a relatively short period of time to judge the experimental success of a global currency system that circles the U.S. dollar versus gold.

You can see this U.S. dollar universe at play in the way global investors awaited word last month whether the Fed would introduce QE3, printing cash to help bring down the value of the dollar and make U.S. goods more competitive in the global markets. But central banks in Asia and elsewhere cringe at these moves — the extra U.S. cash sloshes around the global economy, seeking the best places for return, which these days are developing markets like Indonesia, Mongolia and Brazil.

But that influx of U.S. dollars — as we saw in the early rounds of “currency wars” in 2010 and 2011 — both can spur inflation and raise the value of local currencies, hurting their competitiveness abroad.

Erratic currency value slides in 2008 were an under-reported catalyst of the recent financial crisis, Mundell said.

“The worst period in (economic) world history, I think, was the third quarter of 2008. The price of oil went from US$70 to US$148 and then down to US$33 and very quickly back up,” Mundell said. “What kind of global system is creating such crazy instability? We've got to do better.”

Judging from bullion prices, investors are increasingly turning to “in gold we trust.” In the past 10 years, an ounce of gold has gone from US$310 an ounce to about US$1,660, after peaking near US$1,900 last year. Most of those gains have come since the 2008-2009 financial crisis, ballooning from about US$900 an ounce in January 2008.

That would be nothing if the U.S. returns to a gold standard. According to one calculation, the U.S. monetary base — which includes notes, coins and some deposits at the U.S. Federal Reserve — is currently around US$2.6 trillion. The U.S. Treasury and the Federal Reserve hold about 260 million ounces of gold. That means if the U.S. made every single dollar convertible into gold an ounce of the metal would in theory be worth US$10,000 — six times its current price.

“Nobody's thinking about going back to gold coins or anything like that, but you could go back to the idea that gold is an anchor in some sense as a reserve for currencies ... as an antidote to unstable exchange rates and unstable raw material prices,” Mundell said.

An immediate return to the gold standard “would cause total chaos throughout the world,” Stephen Leeb, founder and president of Leeb Capital Management in New York, told CNN. “But where I think gold could be helpful as part of a currency system — not the only part of the currency system — is a way of allocating and developing scarce resources.”

Like Mundell, he thinks it will add much-needed stability, especially in the commodities markets. He points to the recent decision by BHP Billiton, the Australia-based mining giant, to cottonball US$52 billion in planned new projects, ostensibly because of the drop in commodity prices due to sagging demand from China and other developing economies. But Leeb said that isn't the whole story.

“Oil has gone from a low of US$10 to a current price of US$115 despite no major growth in major economic blocs during the last five years,” he said. “If you're BHP and you have a US$100 marginal price for oil, how in the world are you going to develop iron ore five or six years from now? If BHP wants to be able to cost out what it's going to cost them, they can't do it in dollars.”

Mundell advocates a system that uses the value of gold to keep the U.S. dollar and the euro — the world's two largest foreign reserve currencies — within a stable exchange range. Perhaps 20 years down the line, when the Chinese yuan is fully convertible, it could join the system. Regardless, “it's very difficult to devise a (global currency) system that would be credible and would work without using gold,” Mundell said.

Kevin Voigt is an Asia business producer at CNN.com, based in HongKong. For more business coverage, go to www.cnn.com/business.

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