Sunday, 31 July 2011

Gold Standard vs Credit Economy

The US debt problem that has caused gold to rise sharply, combined with the debt crises in the EU periphery nations, has fueled discussion about a gold standard. Not only is it necessary for the US to raise its borrowing requirements, especially given the low GDP growth rate in 2011, but the EU may need as much as $5 trillion to save the eurozone. This means that both the dollar and the euro as reserve currencies are in essence worth a great deal less than their nominal value which rests on the fact that they are reserve currencies with the faith of the holder that the economies of the US and EU would perform better in the future than they do now.

On 8 November 2010, World Bank president Robert Zoellick proposed “employing gold as an international reference point of market expectations about inflation, deflation and future currency values.” Less concerned about China’s undervalued currency than the IMF that has sided with the Fed, the World Bank, which enjoys a cordial relationship with China, made the ”gold standard proposal” ahead of this week’s G-20 meeting.
Given the sensitivity of the monetary policy question and the war of words that has erupted between various countries, Zoellick is proposing something that countries with reserve currencies can agree in order to engender greater international financial and trade cooperation. Zoellick added that: “This new system is likely to need to involve the dollar, the euro, the yen, the pound and a renminbi that moves towards internationalization and then an open capital account.” 
The World Bank proposal is attractive to monetarists, to the IMF and to creditor countries like Germany pushing tight monetary policy because it is to their benefit. In recent interviews, Wolfgang Schäuble, Germany’s finance minister, castigated Fed policy for pursuing a “stimulative monetary policy” while at the same time criticizing China for doing the exact same thing. “It is not consistent when the Americans accuse the Chinese of exchange rate manipulation and then steer the dollar exchange rate artificially lower with the help of their [central bank's] printing press,” Schauble told the press.
Who gains and who loses under a gold regime based on a basket of currencies is the key question before the G-20. In 1971 Nixon, under pressure from Japan and Europe and with the advice of the IMF that had secretly warned Washington about its current account deficit and weak dollar since 1957, ended the link between dollar and gold established during Bretton Woods in 1944. “Bretton Woods II” began in 1971 and it seemed to serve the US and countries with strong currencies that held dollars as reserve currency. China, Russia, India and Brazil were not part of the equation in launching “Bretton Woods II,” the EU did not have a common currency, and there was no economic crisis to the degree the world is confronting today.

There are a number of reasons that the World Bank proposal will not be adopted. First, creditor nations trying to develop their economies amid global economic contraction would suffer disproportionately under the World Bank’s proposal. Second, the Organization for Economic Cooperation and Development (OECD) has recently trimmed growth forecasts for 2011 and cautioned central banks about raising interest rates that would further choke off growth. In 2011 US and EU will perform by 40-50% under what the OECD estimated six months ago, and they will not reach 3% growth as was expected for 2011 until 2012. 
“OECD warned that the economic crisis of the last two years had ‘pushed public deficits and debt to unsustainable levels.’ OECD Secretary General Angel Gurria said: ‘Simply stabilizing debt relative to gross domestic product in most countries will require a historical consolidation effort of anywhere from 6.0 to 9.0 percent of GDP.” 
Third, if the World Bank proposal is adopted, growth will suffer and unemployment will rise, as will the sharp gap between the rich creditor nations and the poor debtor countries. Fourth, trade will increase between rich nations, but it will slow in many parts of the underdeveloped world to the degree that there will be a return to bartering at the local level. The gold standard proposal raises the political question of how society ought to measure the “wealth of the nation,” a question that Adam Smith tried to answer during the nascent stage of industrial capitalism. Should we return to a regime of neo-Bullionism? 
Adopting the World Bank’s “gold standard” proposal will entail lower inflation, stable reserve currencies, absence of currency wars, fewer cases of “out-of control budgetary deficits,” and very strong banking/finance capital sector. The clear winners in this scenario would be the banks and financial institutions in general. It would also mean that politicians would be surrendering power of monetary policy to the banks. Given that the public sector accounts for a very large percentage of the economy’s GDP–larger in China than in the US–and given that monetary policy impacts economic and social policy, should the elected representatives of the people have the power over monetary policy, or should it be the banks, insurance companies, and investment firms? 
If the World Bank gold proposal was in effect, could the FED buy $600 billion of long-term bonds, the day after the election, in order to stimulate the stock markets and indirectly the real economy? Taking the long view, if countries stuck to the gold standard when the Great Depression erupted, how much greater would be the cost for people? There are economists who argue that the gold standard was a factor that caused the Great Depression, and those who believe that gold standard regime severely restricts economic growth. Right-wing ideologues, and of course financial elites in general, though they are by no means of one mind on monetarism, want government to have as little influence in money supply policy as possible. 
Finally, the monetary policy debate that the World Bank is proposing as “food for thought” more than a plausible alternative implies that tight monetary policy best serves society because it engenders “monetary stability.” Putting aside the OECD warning about a tight monetary policy, the more significant question is that the culture of capitalist economics has convince people around the world that inflationary policies are detrimental, while deflationary policies are beneficial. And there is no doubt that hyper-inflation is detrimental as is inflation accompanied by IMF monetarist policies that severely curtail wages and benefits in order to curb consumer spending.
Examining the periods of inflationary vs. monetarist policies, in almost every case what we see is that the financial elites do not fare as well under inflationary climate as they do under a tight monetarist regime, but upward mobility definitely takes place during inflationary cycles and downward mobility during deflationary cycles as the world is currently experiencing. Truth and wisdom on monetary policy are not the domain of one ideological school of thought or the other. Rather the issue before us is about social interests; it is an issue of what social groups benefit and what social groups are harmed if tight monetary policy and/or the gold standard is followed as the large banks, conservative ideologues and the IMF and World Bank wish. 
While the timing for gold standard debate seems appropriate against the background of massive public debt problems in many countries, including the US, the question is how long before another cyclical economic downturn precipitate serious damage to reserve currencies to the degree that creditor nations demand a new reserve currency that would be treated like gold, a prospect that has been on the table for some time and has the support of countries like China as one of the world's largest creditors. How long before finance capitalism completely destroys the credit system as capital remains super concentrated?

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