What would a return to the gold standard mean?

Gold Standard

 

This is an edited version of an article originally published at TraderPlanet

The debt clock keeps on ticking. The U.S. federal debt recently surpassed $16 trillion and is still rising. Republicans ushered the idea of a return to the gold standard to the center stage at their Tampa convention in August. Some see a return to the gold standard as a panacea to instill fiscal responsibility by our elected officials. While there are no easy answers or simple solutions to the massive debt crisis America faces, could a return to the gold standard be the answer?

The U.S. went off the gold standard under President Nixon in 1971. What may not be widely known is that the classic gold standard that the U.S. was utilizing (and that Britain and France had followed before) included a 40 percent cover ratio.

What does that mean? “The government will only print money if it has gold in its Treasury equivalent to 40% of the currency in circulation,” says Jeffrey Christian, managing director at the CPM Group. “That means if you have $10 billion of money in circulation, you have to have $4 billion of gold in the Treasury. A lot of gold bulls don’t realize it was a 40 percent cover.” Christian noted.

How Much Gold Is In Fort Knox?

Given that the current U.S. federal debt stands at $16 trillion, it begs the question, how much gold does the United States own? Currently, the U.S. does have the largest gold reserves in the world at 8,133.5 tons, according to the World Gold Council. Just for comparison, Germany is a distant second with 3,395.5 tons and the IMF is in third place at 2,814 tons.

So, the U.S. has a lot of gold, but is it enough to back all our debt? Not even close.

David Beahm, vice president at Blanchard & Co., a New Orleans based precious metals investment firm, did some quick back-of-the-envelope math. “One ton equals 2000 pounds. One pound equals 16 ounces. 2000 times sixteen equals 32,000 ounces. With spot gold about $1,760, one ton equals about $56 million,” he says. That equals about $456 billion at current market value, or roughly half a trillion in gold, he said.

“Even if we liquidated our gold we could only bring our debt down to $15.5 trillion,” Beam notes. “That’s a lot of shortfall. The next step [for the gold standard] is for them to revalue gold. It would make it go up by 400-500 percent.”

David Hargreaves, a widely watched mining consultant, has actually calculated a figure at $40,000 per ounce, based on world GDP figures (roughly 100 trillion).

Others have estimated a $10,000 per ounce. But, again even that could be high, as CPM Group’s Christian notes that most gold bulls are assuming a 100 percent cover rate, while historic gold standards have only boasted a 40 percent cover.

While gold bulls are frothing at the mouth at the thought of cashing in the gold coins buried in their backyard for a government-mandated standard, let’s take a look at both sides of the coin. What are the positives of a gold standard for the economy, and what are the negatives?

Pros

Simply put, the big positive of a return to the gold standard “would give us fiscal discipline for governments, businesses and individuals,” says Ken Goldstein, economist at the New York-based Conference Board.  “It would force all of us to be more fiscally responsible.”

While that may sound enticing given the $16 trillion price tag Washington D.C. has currently placed on our future, the gold standard comes with some costs too.

Cons

On the negative side of the coin, Goldstein explains “our jobs, incomes and the overall economy would grow at a much slower pace.” Why?

The answer comes down to money supply. That simply means the total money in circulation. and it is a dynamic and growing figure.

“Modern finance has growing money. Money supply grows in reaction to the growth of the real economy,” says CPM Group’s Christian. “As an economy grows, more wealth is generated. Post industrial growth for the last 160 years has averaged 2-3 percent and the gold supply hasn’t risen at the same pace.”

Put another way, today’s global economy stands at roughly $100 trillion GDP, and has been growing at 3-4 percent per year. “Finding that much more gold per year is just not going to happen,” says Goldstein. That’s why going back to the gold standard is a pipe dream.”

Choke Off Growth

Bottom line? A gold standard would result in a relatively fixed money supply. Money supply couldn’t grow faster than the supply in gold, which would ultimately choke off growth. “It would force lending to slow down and the economy to slow down,” says Goldstein. Explaining the connection and impact on lending, Goldstein elaborates. “For every dollar a bank has, it can loan maybe $10-15 out. But, if those dollars are convertible to gold, that all collapses.”

“If you can’t borrow, it would choke off the jobs growth, businesses can’t raise prices, and consumers can’t buy at higher prices because they can’t borrow. Basically, you put a chokehold on the economy.”

Additionally, for anyone who has current debt now, including a mortgage, “our ability to pay it back would take us longer and would cause us to do without other things to pay it back,” says Goldstein. The gold standard would result in a devaluing of the dollar and it would buy less. That would include bonds issued by cities and towns, and corporate debt as well as consumer debt. “The lenders would benefit, but the people who suffer are people who have to pay back debt.”

CPM Group’s Christian echoed those thoughts. “If we are going to manage our money supply, the economy cannot grow as rapidly as it wants to grow with periods of deflation, starvation and depravation that simply don’t have to occur,” he says, noting that repeated periods of starvation were seen in the U.S. through the 1870’s-1890’s “because the money supply could not grow fast enough to grow the economy.”

Longer Recessions

While many gold bugs are known Fed bashers, Christian points to the Bank Panic of 1907, which occurred while the U.S. was on the gold standard and prior to the creation of the U.S. Federal Reserve. “That bank panic threw almost the whole world into depression,” he says. “The U.S. was in recession in 60 of the 90 following months.”

Goldstein agrees that a gold standard would make “the climb out of recession longer because you can’t create as much debt with a gold standard.”

What’s Ahead?

So, what are the odds that we will see a gold standard? “Pretty slim,” says Pete Grant, chief market analyst at USAGOLD.

Adrian Day, president of Adrian Day Asset Management, highlights the November U.S. presidential elections as key. “If the Republicans win, I suspect a commission could well be set up,” Day notes.  “But, just because you get a commission doesn’t mean they will do it.” In fact, there was a Gold Commission set up to study the matter in 1981, under President Reagan. At that time, “the majority said that gold had no role,” Day says.

Looking around at academia and the Washington bureaucracy, Day adds “I don’t think there is broad pressure for a return to the gold standard. But, a new commission could have a suggestion that gold could play a role.”

Looking ahead, however, Day sees potential for the tides to shift. “As time goes on and the financial mess continues to not be solved, and the currency continues to lose its purchasing power, the sentiment that we should have a gold standard will grow stronger and stronger,” Day says. Perhaps “we could have a dollar standard backed by a basket of hard assets including gold,” he adds.

Christian concedes that “it’s possible we could see a gold standard briefly if you had a major world war. But, once you got out of the cataclysmic crisis, we would quickly go off.”

Is It Practical?

Another stumbling block would be the difficulty in actually organizing a shift back to the gold standard. Some say it would only work if all countries agreed to work off the gold standard. “Suppose we did it and the rest of the world didn’t drink the Kool Aid, we’ve got an economy moving at a snail’s pace and we’ve got the rest of the world growing at a 3.5-4% pace,” says Goldstein.

Besides, he adds, “it would be unwieldy just to get an [global] agreement. Look at the degree of difficulty just getting 17 member of the European Union to agree.”

Does the Conference Board’s Goldstein think we’ll see a gold standard anytime soon? “You will hit the lottery before we go back on the gold standard,” he concludes.

Others are more optimistic. “The odds are remarkably high that we will see gold play an increasing role in the monetary system over the next ten years,” says Day. “But, I don’t think we will see a return to a pure gold standard.”

 

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About the Author

Kira McCaffrey Brecht is managing editor at www.TraderPlanet.com. She has been writing about and analyzing the financial markets for 20 years. Brecht previously worked as managing editor at SFO magazine and technical analyst at MMS International and Bridge News.