The Death of Money (31 page)

In 2003 Kaspar Villiger, then the Swiss minister of finance, when asked in parliament
about the location of Swiss gold, infamously replied, “
I don’t know . . . don’t have to know, and don’t want to know.” Such arrogance, typical
of global financial elites, is increasingly unacceptable to citizens, who see their
gold reserves being dissipated by bureaucrats operating behind closed doors in central
banks and enclaves like the IMF and BIS. The actions of Swiss officials cost their
citizens over $35 billion in lost wealth, compared to the value of their reserves
had Switzerland kept its gold.

The Venezuelans, Germans, and Swiss may be the most prominent exemplars of the gold-repatriation
movement, but they are not alone in raising the issue. In 2013 the sovereign wealth
fund of Azerbaijan, a major energy exporter, ordered its gold reserves moved from
JPMorgan Chase in London to the Central Bank of Azerbaijan in Baku. The gold-repatriation
issue was also raised publicly in 2013 in Mexico. In the Netherlands, members of the
center-right Christian Democratic Appeal Party and the leftist Socialist Party have
petitioned De Nederlandsche Bank, the Dutch central bank, to repatriate its 612 tonnes
of gold. Only 11 percent of the Dutch gold, or 67 tonnes, is actually in the Netherlands.
The remainder is divided with about 312 tonnes in New York, 122 tonnes in Canada,
and 110 tonnes in London. When asked in 2012 about the possibility of Dutch gold stored
in New York being confiscated by the United States, Klaas Knot, then president of
De Nederlandsche Bank, replied, “We are regularly confronted with the extra-territorial
functioning of laws from the United States and usually these are not cheerfully received
in Europe.” A small movement in Poland under the name “Give Our Gold Back,” launched
in August 2013, focused on the repatriation of Poland’s 100 tonnes of gold held by
the Bank of England. Of course, many countries, such as Russia, China, and Iran, already
store their gold at home and are free of confiscation risk.

The issues of gold acquisition and gold repatriation by central banks are closely
related. They are two facets of the larger picture of gold resuming its former role
as the crux of the international monetary system. Major gold holders do not want to
acknowledge it because they prefer the paper money system as it is. Smaller gold holders
do not want to acknowledge it because they want to obtain gold at attractive prices
and avoid the price spike that will result when the scramble for gold becomes disorderly.
There is a convergence of interests, between those who disparage gold and those who
embrace it, to keep the issue of gold as money off the table for the time being. This
will not last, because the world is witnessing the inexorable remonetization of gold.

■
Gold Redux

There are few more tendentious comments on gold than the a priori statement that a
gold standard cannot work today. In fact, a well-designed gold standard could work
smoothly if the political will existed to enact it and to adhere to its noninflationary
disciplines. A gold standard is the ideal monetary system for those who create wealth
through ingenuity, entrepreneurship, and hard work. Gold standards are disfavored
by those who do not create wealth but instead seek to extract wealth from others through
inflation, inside information, and market manipulation. The debate over gold versus
fiat money is really a debate between entrepreneurs and rentiers.

A new gold standard has many possible designs and would be effective, depending on
the design chosen and the conditions under which it was launched. The classical gold
standard, from 1870 to 1914, was hugely successful and was associated with a period
of price stability, high real growth, and great invention. In contrast, the gold exchange
standard, from 1922 to 1939, was a failure and a contributing factor in the Great
Depression. The dollar gold standard, from 1944 to 1971, was a middling success for
two decades before it came undone due to a lack of commitment by its principal sponsor,
the United States. These three episodes from the past 150 years make the point that
gold standards come in many
forms and that their success or failure is determined not by gold per se but by the
system design and the willingness of participants to abide by the rules of the game.

Consideration of a new gold standard begins with the understanding that the old gold
standard was never completely left behind. When the Bretton Woods system broke down
in August 1971, with President Nixon’s abandonment of gold convertibility by foreign
central banks, the gold standard was not immediately deserted. Instead, in December
1971 the dollar was devalued 7.89 percent so that gold’s official price increased
from $35 per ounce to $38 per ounce. The dollar was devalued again on February 12,
1973, by an additional 10 percent so that gold’s new official price was $42.22 per
ounce; this is still gold’s official price today for certain central banks, for the
U.S. Treasury, and for IMF accounting purposes, although it bears no relationship
to the much higher market price. During this period, 1971–73, the international monetary
system moved haltingly toward a floating-exchange-rate regime, which still prevails
today.

In 1972 the IMF convened the Committee of Twenty, C-20, consisting of the twenty member
countries represented on its executive board, to consider the reform of the international
monetary system. The C-20 issued a report in June 1974, the “
Outline of Reform,
that provided guidelines for the new floating-rate system and recommended that the
SDR be converted from a gold-backed reserve asset to one referencing a basket of paper
currencies. The C-20 recommendations were hotly debated inside the IMF during 1975
but were not adopted at the time. At a meeting in Jamaica in January 1976, the IMF
did initiate substantial reforms along the lines of the C-20 report, which were incorporated
in the Second Amendment to the IMF Articles of Agreement. They became effective on
April 1, 1978.

The international monetary debate, from the C-20 project in 1972 to the Second Amendment
in 1978, was dominated by the disposition of IMF gold. The United States wanted to
abandon any role for gold in international finance. The U.S. Treasury dumped 300 tonnes
of gold on the market during the Carter administration to depress the price and demonstrate
U.S. lack of interest. Meanwhile, France and South Africa were insisting on a continued
role for gold as an international reserve asset. The Jamaica compromise was a muddle,
in which 710 tonnes of IMF gold
was returned to members, another 710 tonnes was sold on the market, and the remainder
of approximately 2,800 tonnes was retained by the IMF. The IMF changed its unit of
account to the SDR, and the pricing of SDRs was changed from gold to a basket of paper
currencies. The United States was satisfied that gold’s role had been demoted; France
was satisfied that gold remained a reserve asset; and the IMF continued to own a substantial
amount of gold. The essence of this U.S.-Franco compromise remains to this day.

With the coming of the Reagan administration in 1981, the United States went through
a profound shift in its attitude toward gold. It sold less than 1 percent of its remaining
gold from 1981 to 2006, and it has sold no gold at all since 2006. The retention of
gold by the United States and the IMF since 1981, as well as the continuation of large
gold hoards by Germany, Italy, France, Switzerland, and others, have left the world
with a shadow gold standard.

Gold’s continued role as a global monetary asset was brought home in a stunningly
candid address given by Mario Draghi, head of the European Central Bank, at the Kennedy
School of Government on October 9, 2013. In reply to a question from a reporter, Tekoa
Da Silva, about central bank attitudes toward gold, Draghi remarked:

You are . . . asking this to someone who has been Governor of the Bank of Italy. Bank
of Italy is [the] fourth largest owner of gold reserves in the world. . . .

I never thought it wise to sell [gold] because for central banks this is a reserve
of safety. It’s viewed by the country as such. In the case of non-dollar countries,
it gives you a fairly good protection against fluctuations of the dollar, so there
are several reasons, risk diversification and so on. So, that’s why central banks,
which had started a program for selling gold a few years ago, substantially . . .
stopped. By and large they are not selling it any longer. Also the experience of some
central banks that liquidated the whole stock of gold about ten years ago was not
considered to be terribly successful.

France’s insistence at Jamaica in 1976 that gold continue as a reserve asset has returned
to the IMF’s monetary banquet like Banquo’s ghost.
Just as Banquo was promised in
Macbeth
that he would beget a line of kings, so gold may persevere as the once and future
money.

■
A New Gold Standard

How would a twenty-first-century gold standard be structured? It would certainly have
to be global, involving at least the United States, the Eurozone, Japan, China, the
U.K., and other leading economies. The United States is capable of launching a gold-backed
dollar on its own, given its massive gold reserves, but if it were to do so, other
currencies in the world would be unattractive to investors relative to a new gold-backed
dollar. The result would be deflationary, with a diminution of transactions in those
other currencies and reduced liquidity. Only a global gold standard could avoid the
deflation that would accompany an effort by the United States to go it alone.

The first step would be a global monetary conference, similar to Bretton Woods, where
participants would agree to establish a new global monetary unit. Since the SDR already
exists, it is a perfectly suitable candidate for the new global money. But this new
SDR would be gold backed and freely convertible into gold or the local currency of
any participant in the system. It would not be the paper SDR that exists today.

The system would also have to be two-tiered. The top tier would be the SDR, which
would be defined as equal to a specified weight in gold. The second tier would consist
of the individual currencies of the participating nations, such as the dollar, euro,
yen, or pound sterling. Each local currency unit would be defined as a specified quantity
of SDRs. Since local currency is defined in SDRs, and SDRs are defined in gold, by
extension every local currency would be worth a specified weight in gold. Finally,
since every local currency is in a fixed relationship to SDRs and gold, each currency
would also be in a fixed relationship to one another. As an example, if SDR1.00 =
€1.00, and SDR1.00 = $1.50, then €1.00 = $1.50, and so on.

In order to participate in the new gold SDR system, a member nation would have to
have an open capital account, meaning that its currency
would have to be freely convertible into SDRs, gold, or currencies of the other participating
members. This should not be a burden for the United States, Japan, the Eurozone, or
others who already maintain open capital accounts, but it could be an impediment for
China, which does not. However, China may find the attractions of a nondollar, gold-backed
currency such as the new SDR sufficiently enticing that it would open its capital
account in order to join and allow the new system to succeed.

Participants would be encouraged to adopt the new gold SDR as a unit of account as
broadly as possible. Global markets in oil and other natural resources would now be
priced in SDRs rather than dollars. The financial records of the largest global corporations,
such as IBM and Exxon, would be maintained in SDRs, and various economic metrics,
such as global output and balance-of-payments accounts, would be computed and reported
in SDRs. Finally, an SDR bond market would develop, with issuance by sovereign nations,
global corporations, and regional development banks, and with purchases by sovereign
wealth funds and large pension funds. It might be intermediated by the largest global
banks, such as Goldman Sachs, under IMF supervision.

One of the more daunting technical issues in this potential global gold SDR system
is the determination of the proper fixed rates at which currencies can convert to
one another. For example, should €1.00 be equivalent to $1.30, $1.40, $1.50, or another
amount? This is essentially the same issue that the founders of the euro faced after
the Maastricht Treaty was signed in 1992, which committed the parties to create a
single currency from diverse currencies such as the Italian lira, the German mark,
and the French franc. In the euro’s case, years of technical study and economic theory
developed by specialized institutions were applied to the task. Technical consideration
is warranted today, too, but the best approach would be to use market signals to solve
the problem. The parties in the new system could announce that the fixed rate would
be determined in four years based on the weighted average of bank foreign currency
transactions during the last twelve months prior to the fixing date. The four-year
period would give markets sufficient time to adjust and consider the implications
of the new system, and the twelve-month averaging period would smooth out short-term
anomalies or market manipulation.

The most challenging issue involves the SDR’s value measured in a weight of gold,
and the fractional gold reserve required to make the system viable. The problem can
be reduced to a single issue: the implied, nondeflationary price of gold in a global
gold-backed monetary system. Once that issue was resolved with respect to one
numeraire,
conversion to other units of account using fixed exchange rates would be trivial.

Initially, the new system would operate without an expansion of the global money supply.
Any nation that wanted SDRs could buy them from banks or dealers, earn them in trade,
or acquire them from the IMF in exchange for its own currency. Local currency delivered
to the IMF in exchange for SDRs would be sterilized so the global money supply did
not expand. Discretionary monetary policy would be reserved to national central banks
such as the Fed and ECB, subject to the need to maintain fixed rates to gold, SDRs,
and other currencies. The IMF would resort to discretionary monetary policy through
the unsterilized creation of new SDRs only in extraordinary circumstances and with
approval of a supermajority of IMF members participating in the new system.