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Monday, June 30, 2008


What gold is telling us about global economy

Look at these numbers: 21, 35 and 1,000. What kind of vital statistics would you say these were? The amount of calories you need to deny yourself to get back into shape? The number needed on your point card to earn the cash back you covet at your local supermarket?

Neither is, of course, the answer. All three figures represent the same thing, in fact. They are the price of an ounce of gold as calculated in U.S. dollars. The difference is in the timing. In the 1920s, $21 would buy you an ounce of gold. That was the official rate at which the U.S. Federal Reserve would trade gold with anyone who wished to make the transaction. From the mid 1930s to 1971, that official dollar-for-gold conversion rate was fixed at $35 per ounce.

Those fixed conversion rates were called the dollar's gold parity. Now the dollar no longer has a gold parity. The price of gold, just like any other commodity, is determined by the markets. And earlier this year, there was a point at which the market price for gold soared to $1,000 per ounce.

Up until the mid 1930s, most major currencies had gold parities. They were convertible to gold at that rate whenever anyone went along to the relevant central bank to request the exchange. This was the time of the international gold standard. It was a time of great currency stability, because by definition, foreign-exchange rates could not deviate very far from the fixed gold parities. Whenever that was liable to happen, gold would flow out of a country that had a depreciating currency, causing its economy to shrink. This was because the amount of money the country could create was linked directly to the amount of gold in its possession.

No gold, no money. No money, no growth. And where there is no growth, there are no imports. No imports means no trade deficit. No trade deficit means no currency depreciation. Thus, the exchange rate would slide back up toward the currency's gold parity, and everything would quiet down again. Stability would be restored.

Life was simple then, but at the same time very static. Since countries could not run trade deficits for very long, they were effectively prevented from living beyond their means. That made it very difficult for them to grow. This constraint on growth was the basic reason why the gold standard broke down. With Britain taking the lead, major nations began to go off the gold standard in the 1930s, triggering of an exchange-rate war, the severity of which was well documented in many an academic study.

Some seventy years on from those currency warfare days, and thirty-odd years from August 1971, when the United States finally went off the gold standard, suggestions are now being made that maybe it's time to revive the international gold standard so that the extreme currency instability of these recent months and weeks can be put to rest. The very fact that gold is being so highly priced by the markets, proponents claim, is a sign that the world is ready for the revival of gold parities among nations.

The suggestion has its merits. Perhaps the global economy could do with a dose of the extreme discipline the gold standard imposes. For the prime feature of the global economy is that it has absolutely no discipline whatsoever.

Yet discipline will come at a price. The global economy would suffer a severe shrinkage. But then again, such a shrinkage might come anyway if the economics of greed maintains its current pace, gold standard or no. We live in dangerous times.

Noriko Hama is an economist and a professor at Doshisha University Graduate School of Business.

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