12 June 2007

Get gold asap, clearly

In a recent article as important for its source as its content, the Director of International Economics at the Council on Foreign Relations adapted a metaphor first employed by Jacques Rueff to describe the "absurdity" of the Bretton Woods post-war international monetary monetary system a few years before its collapse. B. Steil, "The End of National Currency," Foreign Affairs (Vol. 86, No. 3, May/June 2007), pp. 83-96. Rueff had compared the chronic balance-of-payments deficit then being run by the United States to buying from a tailor who, whatever you paid him for a suit, would loan the money back to you the very next day. Bringing the metaphor current, Mr. Steil writes (at p. 93):

With the U.S. current account deficit running at an enormous 6.6 percent of GDP ... , the United States is in the fortunate position of the suit buyer with a Chinese tailor who instantaneously returns his payments in the form of loans -- generally, in the U.S. case, as purchases of U.S. Treasury bonds. The current account deficit is partially fueled by the budget deficit ... , which will soar in the next decade in the absence of reforms to curtail federal "entitlement" spending on medical care and retirement benefits for a longer-living population. The United States -- and, indeed, its Chinese tailor -- must therefore be concerned with the sustainability of what Rueff called an "absurdity." In the absence of long-term fiscal prudence, the United States risks undermining the faith foreigners have placed in its management of the dollar -- that is, their belief that the U.S government can continue to sustain low inflation without having to resort to growth-crushing interest-rate hikes as a means of ensuring continued high capital inflows.

The rising nervousness of America's Chinese tailor is reflected in its recent efforts to redeploy a portion of its mammoth foreign exchange reserves, mostly held in U.S. dollars, into other investments. See, e.g., F. Gimbel, Trickle of money could become investment flood, FT.com (May 21, 2007) (alternate link).

Mr. Steil's preference (at p. 95) is for a world in which governments "replace national currencies with the dollar, the euro or, in the case of Asia, collaborate to produce a new multinational currency over a comparably large and economically diversified area." Of course, as he freely admits, this solution requires the United States to get its fiscal house in order and the European Union to deal effectively with similar fiscal concerns. "It is," he concludes (at p. 96), "the market that made the dollar into global money -- and what the market giveth, the market can taketh away. If the tailors balk and the dollar fails, the market may privatize money on its own (emphasis supplied)."

When Mr. Steil talks about privatizing money, he pulls no punches. He asks (at p. 94): "So what about gold?" And he answers:

A revived gold standard is out of the question. In the nineteenth century, governments spent less than ten percent of national income in a given year. Today, they routinely spend half or more, and so they would never subordinate spending to the stringent requirements of sustaining a commodity-based monetary system. But private gold banks already exist, allowing account holders to make international payments in the form of shares in actual gold bars. Although clearly a niche business at present, gold banking has grown dramatically in recent years, in tandem with the dollar's decline. A new gold-based international monetary system surely sounds farfetched. But so, in 1900, did a monetary system without gold. Modern technology makes a revival of gold money, through private gold banks, possible even without government support.

So there it is, straight from the Council on Foreign Relations: James Turk's GoldMoney and other digital gold payments systems could supplant the dollar and the euro in international trade if the United States and the members of the European Union cannot bring their structural budget deficits under control. What is more, a nudge or misstep from America's Chinese tailor could accelerate the dollar's fall and rapidly plunge the international payments system into crisis.


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