Navigating an uncertain path

The idea of the gold standard seems to be gaining some traction.  Earlier in the week the President of the World Bank suggested a new basket of currencies, including gold, be used as a new "standard" by which individual currencies could be weighed.  He quickly clarified, however, that he did not intend to suggest a return to the classical gold standard but something quite different.

But Zoellick said that was not a call to return to the gold standard.
Speaking in Singapore Wednesday, Zoellick clarified that he was referring to the need for gold to play a role in a new international monetary system, which would need to balance the values of the the dollar, the euro, the yen, the pound and eventually the Chinese yuan.
"Gold is now being used, being viewed, as an alternative monetary asset. This is not the same as a gold standard," he said in prepared remarks.

But there are plenty of voices, increasingly less marginal, calling just for such a return, even in the pages of the New York Times. 

 Let the economists gasp: The classical gold standard, the one that was in place from 1880 to 1914, is what the world needs now. In its utility, economy and elegance, there has never been a monetary system like it. 

Of course the opinion is far from uniform.  There are still many voices rising against any return to gold but circumstances are forcing them to make explicit rather than just depending that the idea would be discarded out of hand.

The subsequent 40 years have seen wild swings in currency values, prolonged periods of high inflation and several acute financial crises. So you can readily see why some people support resurrecting gold's monetary role.
But there are four powerful arguments against. First, while the Gold Standard helped to sustain long-term price stability, it did not achieve anything like price stability in the short run. In 1822, the UK experienced deflation of 14pc. Yet by 1825 this had given way to inflation of 17pc.

Second, the idea that gold offers a guarantee of stable money values in the long run, and therefore supports confidence and long-term decision-making, is a delusion. In the past, countries were committed to the Gold Standard, which was widely expected to last forever. But we now know that gold can easily be replaced by a paper-based system. Once the genie is out of the bottle, it cannot be put back in. This means that there is no reassurance from relying on gold in the first place.

 My own view that we may very well, before it is all said and done, end up with a retreat into some form of gold or silver standard for our financial system.  The systemic problems are that bad.  The distance between here and there, however, could be a long walk and the terrain is unknown.

A return to a fixed standard could only be accomplished with a devaluation of the dollar either leading up to or at the moment of conversion.  If the danger of a fiat currency is in the direction of inflation, a standardized currency is always at risk of deflation.  If we entered it at the current cost of gold with our current level of household debt, the results would be disastrous.  If, however, through a period of high inflation or the setting of the worth of the dollar at 1/3, 1/4, 1/5 or much more of the current value our nation's and household debt would be reduced by roughly the same percentage.  The change would still be traumatic and would require a vast retooling of the economy.

Allowing the dollar to inflate before a return makes more sense the a sudden change anytime in the near future for numerous reasons.  First among them is the fear we have of change.  The gold standard was abandoned in stages.  It remained in some degree of distress from 1917 until it was finally completely abandoned in 1971, 54 years. 

Rather than a sudden change it seems more likely that we would return to a standardized currency in fits and starts, being dragged kicking and screaming all the way.  If that is the case we should expect to remain in a degree of economic uncertainty until the nation is frustrated enough to under go so great a change, and the disruption the change would cause will appear preferable to the status quo.  The market can stay irrational longer than anyone reading these words can stay solvent.  I think we will return to a gold standard.  I believe it will be in my lifetime.  I am not buying gold and only own what is on my left ring finger.

While it might be a good idea to invest in gold with your disposable income for the long run,  such a stategy is beset with risks.  For forty years it was illegal to own or sell gold bullion in the United States, are you willing to risk being locked in for that long?  The price of gold could very well go down before it goes up, if you are stuck with debt or a need to purchase goods prior to the new stability are you willing to be forced to buying low and selling lower, if not in absolute terms but in the value of the dollars you are able to retain.

In my view, a better investment would address a period of ongoing financial crisis prior to the ultimate re-organization.  Little or no debt and the ability to live cheaply are worth more than there equivalent in any precious metal.  As we roll through the uncertainty necessary to change a nation's habits away from the borrow and spend which has typified two generations, a strong community of support is more valuable to a family or individual than a roll of Krugerrands.