Gold Standard Redux: All That Glitters...

LFT“I recently returned from Istanbul,” Jim Rickards writes in the latest Currency Wars Alert,“the largest city in Turkey, and one of the most beautiful anywhere.

“It is not too much to say that Istanbul is the crossroads of the world. It blends the ancient and new. It bridges Europe and Asia. It combines a 1,700 year old Christian heritage with a modern Muslim state.

“The spices, carpets and hookahs give it an exotic air, while its telecommunications, electronic exchanges, and port facilities are as advanced as those in Europe or the U.S.”

“Turkey is strategically located astride the Bosporus and Dardanelles, two straits that control access from Russia’s warm water ports in Crimea to the Mediterranean Sea. Despite these advantages, Turkey now finds itself in difficult economic straits.”

Alongside other emerging markets like Brazil, Malaysia, Russia, Venezuela and South Africa, Turkey is trapped in the currency war curtain of fire.

“The fundamental problem,” Jim writes, “is the strong dollar. The dollar has been bolstered by threats from the Federal Reserve to raise interest rates this year.”

But you probably already knew that…

The lesser-told story is this: In response to this crisis, Turkey’s love for the yellow stuff is growing stronger by the day. And being the world’s fourth largest gold consumer, the country has an affection for gold that goes way back…

LFTLittle known fact: In 6th century BC — when its people called it Lydia — Turkey minted the first gold coins used as money.

Even long before that, though, for the far better part of the past 4,000 years, gold was considered money. From the Bible to the Founding Fathers to the banks: “Gold is money,” JP Morgan announced in 1912 while testifying in front of Congress, “everything else is credit.”

But, as you may know, the global ‘golden age’ was put to a stop (“officially”) by the IMF in 1974, three years after Nixon slammed the gold window.

And now we’re here.

In Episode Four of Currency Wars Week, we’ll dive into why the gold standard, despite what the critics say, is still relevant — and we’ll ponder the possibility of a potential return to the Midas metal. We’ve learned enough about the nature of currency wars this week to know that the system is fundamentally broken. Our current monetary order is on life support. And Currency War III is only a chaotic delay of the inevitable.

But, we ask…

What happens when it all falls down? What’s the solution? What will bring order out of chaos? Is the Phoenix that rises out of the ashes slathered in gold?

LFTThe true international gold standard, contrary to popular thought, only lasted between the years of 1870-1914.

“It was a period of almost no inflation,” Jim says, “in fact, a benign deflation prevailed in the more advanced economies as a result of technological innovation that increased productivity and raised living standards without increasing unemployment.”

What’s more, the system was entirely voluntary. No coercion necessary. Join if you’d like, or sit on the sidelines. No skin off no backs.

“Not every major nation joined,” Jim writes, “but many did, and among those who joined, capital accounts were open, free market forces prevailed, government interventions were minimal and currency exchange rates were stable against one another. Some nations had been on a gold standard since well before 1870, including England in 1717 and the Netherlands in 1818, but it was in the period after 1870 that a flood of nations rushed to join them and the gold club took on its distinctive character.”

The U.S. was one of the last major nations to join the club with the signing of the Gold Standard Act in 1900. And despite certain pundits barking that only “paranoid, fear-based, far-right fringe and fanatics” would want to bring back the gold standard, consider this: “Economists are nearly unanimous in pointing out the beneficial economic results of this period. Giulio M. Gallarotti, the leading theorist and economic historian of the classical gold standard period, summarizes this neatly in The Anatomy of an International Monetary Regime:

“Among that group of nations that eventually gravitated to gold standards in the latter third of the 19th century (i.e., the gold club), abnormal capital movements (i.e., hot money flows) were uncommon, competitive manipulation of exchange rates was rare, international trade showed record growth rates, balance-of-payments problems were few, capital mobility was high (as was mobility of factors and people), few nations that ever adopted gold standards ever suspended convertibility (and of those that did, the most important returned), exchange rates stayed within their respective gold points (i.e., were extremely stable), there were few policy conflicts among nations, speculation was stabilizing (i.e., investment behavior tended to bring currencies back to equilibrium after being displaced), adjustment was quick, liquidity was abundant, public and private confidence in the international monetary system remained high, nations experienced long-term price stability (predictability) at low levels of inflation, long-term trends in industrial production and income growth were favorable and unemployment remained fairly low.”

LFTThe classical gold standard’s beauty was in its simplicity.

And the benefits, as outlined by Jim below, were vast:

  • No Central Bank Necessary: “While a central bank might perform certain functions, no central bank was required; indeed the United States did not have a central bank during the entire period of the classical gold standard.”
  • The Great Economic Anchor: “… when two currencies become anchored to a standard weight of gold, they also became anchored to each other. This type of anchoring does not require facilitation by institutions such as the IMF or the G20. In the classical gold standard period, the world had all the benefits of currency stability and price stability without the costs of multilateral overseers and central bank planning.”
  • Price Equilibration: “If gold supply increased more quickly than productivity, which happened on occasions such as the spectacular discoveries in South Africa, Australia and the Yukon between 1886 and 1896, then the price level for goods would go up temporarily. However, this would lead to increased costs for gold producers that would eventually lower production and reestablish the long-term trend of price stability. Conversely, if economic productivity increased due to technology, the price level would fall temporarily, which meant the purchasing power of money would go up. This would cause holders of gold jewelry to sell and would increase gold mining efforts, leading eventually to increased gold supply and a restoration of price stability. In both cases, the temporary supply and demand shocks in gold led to changes in behavior that restored long-term price stability.”
  • Nation Rebalancer: “In international trade, these supply and demand factors equilibrated in the same way. A nation with improving terms of trade — an increasing ratio of export prices versus import prices — would begin to run a trade surplus. This surplus in one country would be mirrored by deficits in others whose terms of trade were not as favorable. The deficit nation would settle with the surplus nation in gold. This aused money supply in the deficit nation to shrink and money supply in the surplus nation to expand. The surplus nation with the expanding money supply experienced inflation while the deficit nation with the decreasing money supply experienced deflation. This inflation and deflation in the trading partners would soon reverse the initial terms of trade. Exports from the original surplus nation would begin to get more expensive, while exports from the original deficit nation would begin to get less expensive. Eventually the surplus nation would go to a trade deficit and the deficit nation would go to a surplus. Now gold would start to flow back to the nation that had originally lost it. Economists called this the price-specie-flow mechanism (also the price-gold-flow mechanism).”

LFTEven so, the arguments against the gold standard seem, to most, convincing enough to keep it distasteful…

Here are the top three, along with Jim’s response rebuttals.

ONE: There’s not enough gold to support the requirements of the global economic system.

JIM: The problem in this scenario is not the amount of gold but the price. There is ample gold at the right price. If gold were $17,500 per ounce, the official gold supply would roughly equal the M1 money supply of the Eurozone, Japan, China, and the United States combined.

TWO: Gold dissers will tell you that a gold standard can’t possibly come back because… duh… gold is what caused the Great Depression.

JIM: The sequence of events from 1922 to 1933 shows that the Great Depression was caused not by gold but rather by central bank discretionary policies. The gold exchange standard was fatally flawed because it did not take gold’s free-market price into account. The gold exchange standard did contribute to the Great Depression because it was not a true gold standard. It was a poorly designed hybrid, manipulated and mismanaged by discretionary monetary policy conducted by central banks, particularly in the U.K. and the United States. The Great Depression is not an argument against gold; it is a cautionary tale of central bank incompetence and the dangers of ignoring markets.

THREE: Modern economies are more stable when gold is avoided and central banks are left to their own devices. Gold causes panics.

JIM: Panics are neither prevented nor caused by gold. Panics are caused by credit overexpansion and overconfidence, followed by a sudden loss of confidence and a mad scramble for liquidity. Panics are characterized by rapid declines in asset values, margin calls by creditors, dumping of assets to obtain cash, and a positive feedback loop in which more asset sales cause further valuation declines, which are followed by more and more margin calls and asset sales. The point is that panics have little or nothing to do with gold.

We’ll wrap up in just one moment. Before we do, Rickards has one more thing to say about the gold standard. The most profound thing…

LFT“Most profoundly,” Jim writes, “a new gold standard would address the three most important economic problems in the world today: the dollar’s decline, the debt overhang, and the scramble for gold.

“The U.S. Treasury and Federal Reserve have decided that a weak-dollar policy is the remedy for the lack of world growth. Their plan is to generate inflation, increase nominal aggregate demand, and rely on the United States to pull the global economy out of the ditch like a John Deere tractor hitched to a harvester up to its axles in mud.

“The problem is that the U.S. solution is designed for cyclical problems, not for the structural problems that the world currently faces. The solution to structural problems involves new structures, starting with the international monetary system.”

What, then, is the solution? According to Rickards, one has already been chosen for us. And it’s slowly being introduced behind our backs through Soros-style social engineering. Moreover, they’ve been priming our pump for decades.

With this in mind, the dollar’s demise, Jim predicts, will take one of three paths.

But we’ll get to that in tomorrow’s episode.

LFTFor now, the madness continues.

And it’s creating some interesting investment opportunities for you.

You probably know: Many of the biggest fortunes in the world were created in times of crisis. To understand why is simple. The average Joe either has his head in the sand or is too overwhelmed, confused, befuddled and exhausted to act when the time is right. Because of this, he’s certain to act at exactly the wrong time.

How many do you think have resigned to “sit this one out”? Of course, many of them say so, but they won’t. They’ll wait for the “right time.” Meaning, they’ll probably strike right when the iron has started to cool. I’m guilty of it, and I’m sure you are too.

When the opportunity presents itself, only the clear-headed can see it coming. And when the stakes seem at their peak, the rewards are always at their highest. The time, as you’ve seen this week, is now.

And that’s what IMPACT is all about: giving you the “edge” to not only pass through the current financial crisis unscathed — but to come out the other end, a wiser and if Jim has his way, wealthier, person. No matter what comes next.

Click here to learn how IMPACT works and see if it’s right for you.

Until tomorrow,

Chris Campbell

Chris Campbell

Written By Chris Campbell

Chris Campbell is the Managing editor of Laissez Faire Today. Before joining Agora Financial, he was a researcher and contributor to SilverDoctors.com.