Alasdair Macleod – 11 November 2010
Supporters of sound money were heartened on Monday by an FT article written by Robert Zoellick, who is President of the World Bank, in which he recommended that a new “co-operative monetary system”, a “Bretton Woods III” should be planned and it “should also consider employing gold as an international reference point about inflation, deflation and future currency values.” Following the buzz this statement created, he clarified it, denying that he was calling for a return to a gold standard, rather that there is a problem to be fixed. The markets appeared to give the original FT article some credibility: if Zoellick was recommending a monetary role for gold, presumably there is a chance it will happen.
Zoellick’s article and subsequent clarification leave us asking the question: what is the difference between fixing a price, and a reference price? Presumably a reference price is one that does not have to be defended by a central bank, in which case, why bother? If gold is to have any role, it must be credible. But this is extremely unlikely to be even considered for two basic reasons.
First, it is impossible to fix even a reference price for gold in paper money terms at anything like current prices, at a time of rapid monetary expansion. By definition, a reference price would have to be set which must apply for longer than the foreseeable future. A sustainable price would also be different for each currency, making agreement on a Bretton Woods III almost impossible. It would be a return to fixed parities, or at least dirty floats, which have been already discarded in the past. Furthermore, setting a dollar gold price at higher levels would probably cause the bankruptcy of the bullion banks, which operate a fractional system to back their customers’ unallocated accounts.
The second reason for ruling out any gold discipline is that central banks need maximum flexibility to deal with some very serious problems. Taking the Fed as an example, it is managing an imploding shadow-banking system, collapsing residential property prices, growing storm-clouds over the commercial banks and several states on the verge of bankruptcy. Whatever we may think about printing money and back-stopping the system to resolve these issues, we have to recognise that the Fed’s primary function today is to buy off a systemic collapse by all the means at its disposal.
And it is not just the Fed. Both the Japanese and the British have their own serious problems that can only be addressed the way central banks know how: by having the ability to write open-ended cheques to buy off systemic insolvency. The ECB does not publicly admit to having this responsibility, but in reality it has and likewise, will not wish to be boxed in.
The idea that the recent rise in the gold price is based on even a faint possibility that gold will be incorporated in a new currency order is misplaced. Zoellick’s article is a huge embarrassment to central bankers, who must be wishing he had kept quiet.