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Thursday, November 11, 2010

Mahathir Urges Return To Gold Standard Why American Scholars Against It

gold standard
A new monetary system must be devised based on something of real value such as gold ,former  Malaysia prime minister Tun Dr Mahathir Mohamad said today. He said that despite everyone knowing that the abuses of the banking system which had caused the present economic crisis, no one was seriously thinking of changing the system. “The US dollar has no backing whatsoever. Other currencies including the Malaysian ringgit are backed by gold or other so-called hard currencies held in reserve ”, he said at the World Congress of Accountants 2010 during his session on “Transitioning to a Sustainable Global Financial System Lessons from Global Financial and Economic Crisis”.

Robert Zoellick, the president of the World Bank, wrote an article in The Financial Times this week, arguing that it might be time for a new international system of adjustable exchange rates that would use gold as a reference point for inflation and currency values. "Although textbooks may view gold as the old money," Mr. Zoellick wrote, "markets are using gold as an alternative monetary asset today." Gold prices moved past $1,400 per troy ounce on Monday. (On Wednesday, Mr. Zoellick in clarifying his comment, said he was not advocating a gold standard, but described gold prices as "the elephant in the room" that policymakers needed to acknowledge.)

As The Financial Times noted, "Although there are occasional calls for a return to using gold as an anchor for currency values, most policymakers and economists regard the idea as liable to lead to overly tight monetary policy with growth and unemployment taking the brunt of economic shocks."

Would moving to a modified gold standard make sense in this global economic climate? Or would it make recovery more difficult? How might this work?

Hindering Recovery, Fostering Protectionism-Douglas Irwin is professor of economics at Dartmouth College and author of "Free Trade under Fire" and "Peddling Protectionism: Smoot-Hawley and the Great Depression."

The Federal Reserve's plan for additional "quantitative easing" has sparked international controversy because other countries do not want to see their currencies appreciate against the dollar. This had led to fears of a "currency war." Should the G-20 head off such a prospect by linking their currencies to gold in order to provide greater exchange rate stability? Absolutely not.

The gold standard intensified protectionist pressures in the 1930s, helping to destroy world trade during that decade.

The United States should avoid anything that remotely resembles a gold standard. Fixing the exchange rate against gold diverts the focus of monetary policy away from ensuring domestic economic stability to maintaining an arbitrary exchange-rate target. That is the wrong approach when the economy is still suffering from the aftermath of the recent financial crisis.

The Federal Reserve should be free to take whatever actions it feels necessary to promote economic growth and ensure stable prices without having to worry about the exchange rate. If the dollar depreciates against other currencies and other countries do not like it, so be it. As Treasury Secretary John Connally once said when other countries were complaining about exchange rates in the early 1970s, "the dollar is our currency, but your problem."

Any proposal to resurrect the gold standard today overlooks the stark lessons of economic history. The malfunctioning gold standard was intimately related to the Great Depression of the 1930s. Countries that were not on the gold standard managed to avoid the Depression, while countries on the gold standard did not recover from the Depression until they left it (as the United States did in early 1933).

Furthermore, the gold standard intensified protectionist pressures in the 1930s. By making exchange rate adjustments more difficult, the gold standard hampered a monetary policy response to the slump. This forced countries to resort to protectionist measures, including higher tariffs, import quotas, and exchange controls. Such measures helped destroy world trade during that horrible decade.

The United States should remain committed to a flexible, market-determined exchange rate regime to ensure its monetary independence and prevent the outbreak of damaging and counter-productive protectionism.

The Dollar's New and Old Rivals-Jeffrey Frankel is a professor at Harvard University’s Kennedy School of Government and a member of the National Bureau of Economic Research Business Cycle Dating Committee, which officially declares recessions. He is the author of "On Exchange Rates."

I doubt very much if Mr. Zoellick has in mind a return to the gold standard, though goldbugs and critics alike are talking as if he does.

The world is moving away from a monetary system in which the dollar is the overwhelmingly dominant international reserve asset.

Even if one placed overwhelming weight on the objective of price stability — enough weight to contemplate a rigid straightjacket for monetary policy — gold would not be a suitable anchor. The economy would be hostage to the vagaries of the world gold market, as it was in the 19th century: suffering inflation during periods of gold discoveries and deflation during periods of gold drought. This is well-known, and I am confident Bob Zoellick understands it. (He and I were in the same macroeconomics seminar at Swarthmore College in the 1970s.)

I think he is making another point — that the world is moving away from a monetary system in which the dollar is the overwhelmingly dominant international reserve asset.The dollar’s share of international reserves has been declining ever since Richard Nixon unilaterally ended the Bretton Woods system in 1971.

The dollar’s unique role is not an eternal god-given constant of the universe, any more than it was for pound sterling. (The dollar of course replaced the pound in the first half of the 20th century, with a lag of 25 years or more after the U.S. surpassed the U.K. economically.)

Will some asset replace the dollar, then? No, not a single asset. But we are probably moving to a system where there will be as many as a half dozen international reserve assets.

First, there is the euro. Despite the serious troubles facing it this year, the euro has been a competitor for the dollar since it came into being 11 years ago. Both the yen and the Swiss franc have to some extent played safe haven roles during the last three years of global financial turmoil. The pound is not out completely. Some day the renminbi will be added to the roster of major international currencies, when China’s financial markets are sufficiently developed and open. Even the S.D.R. (special drawing right) came back from the dead in 2009.

And, yes, gold too has re-joined the world monetary system. Gold was seen as an anachronism as recently as a couple of years ago. The world’s central banks had been gradually selling off their stocks. But all that changed in 2009. The People’s Bank of China, the Reserve Bank of India and other central banks in Asia have bought gold. Understandably, they want to diversify their reserves. It appears that central banks have stopped selling gold even among advanced countries and that aggregate gold reserves have risen over the last year. This is a multiple reserve asset system.

A Distraction From Real Problems-Simon Johnson, a professor at the M.I.T. Sloan School of Management and a senior fellow at the Peterson Institute for International Economics, is the co-author of "13 Bankers: The Wall Street Takeover and The Next Financial Meltdown."

In a world with so many instabilities, there is an understandable search for something that offers a stable value – preferably something that cannot be affected by the whim of government or the latest scheme of a central bank. Unfortunately, this search proves just as illusory as the pursuits of alchemists in pre-modern times; there is no magic to gold.

The main issues in the U.S. are high unemployment, an unstable financial system and longer-term budget problems. How would a gold standard help?

For international economic transactions, proposing any kind of return to the gold standard is equivalent to wanting more fixed exchange rates, i.e., moving away from market-determined rates and returning to the system, at least in part, to how it operated before 1971.

But it is hard to imagine how this would help with regard to the major currencies, which are again the subject of controversy today. The main issues in the U.S. are high unemployment, an unstable financial system, and longer-term issues around the budget. How exactly would gold help on any dimension?

Advocates of a modified gold standard argue that this would serve as a form of anchor to the system – but in the 1930s it proved to be an anchor tied around the neck of some countries, including the United States. Nobody needs the kind of “stability” associated with the Great Depression.

And China’s exchange rate today is controversial precisely because it is essentially fixed in nominal terms against the dollar. Adding gold as a reference point for China’s exchange rate would do nothing to affect the problem – China keeps its currency undervalued in real terms, aiming for a large current account surplus. This is unfair and violates both the rules of the exchange rate system and the reasonable expectations of its trading partners.

The world – and the G20 -- needs to confront its main problems: global banks have become far too powerful, financial reform has failed, and we are setting ourselves for another dangerous credit cycle – which will again devastate jobs. The G20, incredibly, has refused to take up the issue of how to handle the failure of megabanks when these operate across borders. The failure of leadership and responsibility at the Seoul summit is profound.

Proposing a modified gold standard is at best a distraction. At worst, it may be latched onto by people who wish to further divert us from the real problems.

A Disaster for Wages-James D. Hamilton is a professor of economics at the University of California, San Diego.

The total number of dollars earned as wages and salary by American workers today is about what it was a year and a half ago. The dollar price of an ounce of gold has gone up about 40 percent over that the same period. If we had been under a gold standard that required us to maintain a fixed dollar price of gold, that relative price change would have required a 40 percent cut in the dollar wages of a typical American worker, which would be associated with some very traumatic dislocations.

Recovery from the Great Depression typically began only after the country abandoned the gold standard, which led to wage and price deflation.

This is the reason that the gold standard played an important role in making the Great Depression of the 1930s as severe as it was. Recovery for each country from the Depression typically began only after the country abandoned gold and could thereby free itself from the wage and price deflation that remaining on the gold standard required.

The same problems that made the gold standard such a disaster in the 1930s are very much with us today. Committing to a gold standard does not make a country's fiscal policies any more sustainable, does not prevent the relative price of gold from changing drastically, and does not make it any easier for workers to absorb significant nominal salary cuts.

Limiting What Central Banks Do-Russell Roberts is a research fellow at Stanford University’s Hoover Institution and professor of economics at George Mason University. He is the host of EconTalk, a weekly podcast.

A recent column by Robert Zoellick suggested that he might favor a return to the gold standard. He has since clarified his remarks, backing away from a gold standard per se, but still suggesting a possible role for gold in a future revamp of the world’s monetary system.

The gold standard was terribly flawed. But a move toward a more constrained Fed is a move in the right direction.

Zoellick’s remarks raise the important question of how central banks should be constrained. It is easy to dismiss a return to the gold standard. Critics of the gold standard correctly point out that in the Great Depression, the constraints of the gold standard imposed unexpected deflation on many of the world’s economies, bankrupting both creditors and the institutions they owed money to. This either caused or at least exacerbated the downturn. The gold standard shackled central bankers to a sinking ship. When countries left the gold standard, they began to recover. Countries that were never on the gold standard had very mild recessions during the Great Depression. Why would we ever want to return to such a flawed way of organizing monetary policy?

But the current way of organizing monetary policy around the world suggests that some kind of shackles, gold or otherwise, might be in order. Here in the United States we have seen an unprecedented expansion of Federal Reserve assets with more to follow. We have also seen an unprecedented expansion of Federal Reserve regulatory intervention beginning with the bailout of the creditors of Bear Stearns which signaled to other creditors of large financial institutions that the government would insulate creditors from their mistakes, contributing to further bad bets being made with other people’s money. The winners from this policy are the wealthiest Americans. And by reducing prudence, we squander the productive use of our capital. The lack of oversight and constraints on Fed behavior is bad for capitalism and democracy.

Whether the Fed should be unconstrained to do what it thinks best or if it should be constrained in ways that a gold standard or other mechanisms would require is part of a long debate in economics over rules vs. discretion. Those of us who are skeptical of the wisdom of experts and the incentives they face prefer rules despite the limits they impose. Such limits are often a feature, not a bug, of any economic system.

So yes, the gold standard was terribly flawed. But so is the current system. A move toward a more constrained Fed is a move in the right direction.

Gold During the Depression-Mark Thoma is an economics professor at the University of Oregon and blogs atEconomist's View.

The ability of countries to use monetary policy to address domestic problems depends upon whether they have a fixed or floating exchange rate.

A gold standard would mean that monetary policy could no longer be used to stabilize the economy.

Under floating exchange rate systems, each country has the ability to set domestic monetary policy independently. However, in fixed exchange rate regimes -- as when the value of the domestic currency is fixed to the value of gold -- countries lose the ability to pursue domestic monetary policy. This is because any attempt to change the money supply to ease domestic economic problems would cause the value of the currency to change relative to gold.

Since the money supply cannot be manipulated at will, an advantage of a gold standard is that it insulates countries from inflation due to excessive money growth – a helpful constraint for countries with a history of inflation problems. The disadvantage is that monetary policy would no longer be available as a stabilization tool. Countries are forced to increase their reliance on fiscal policy, which can create its own problems.

The experience of the Great Depression shows that the loss of the use of monetary policy as a stabilization tool can be quite costly. In the 1930s, the countries that abandoned their commitment to the gold standard had much better outcomes than countries that kept the value of their currency fixed in terms of gold. In addition, historical experience with the gold standard shows that both inflation and deflation will still occur because variations in the supply and demand for gold will alter the price of gold relative to other commodities.

So the cost of giving up monetary policy is high while the benefits from price stability are not very large. So why does Robert Zoellick suggest “employing gold as an international reference point of market expectations about inflation, deflation and future currency values”? Since the gold standard is a proven bad idea, I am going to give him the benefit of doubt and assume he has something else in mind – perhaps Jeffrey Frankel’s interpretation is correct. But whatever he is suggesting, returning to the gold standard is not a policy we should pursue.

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