Monday, November 15, 2010

A Basket of Gold

Reuters: World Bank Chief Surprises with Gold Standard Idea
The National: Obama Defensive in Face of World Bank
Financial Times: The G20 Must Look Beyond Bretton Woods II
Financial Times: Zoellick Seeks Gold Standard Debate

The President of the World Bank, Robert Zoellick, has called for reform of international exchange rate policy. His most striking comment was the suggestion that the world use gold as a reference point for inflation, deflation, and determining future currency values. Many financiers, and even textbook writers, view gold as “old money” with no place in modern, computer-driven finance. Zoellick’s rationale is that many countries, especially in the West, still hold massive amounts of gold in reserve as secure assets; it should be formally put to use. Gold is viewed as a safe asset, so its value goes up when the economy is in recession, or when people think the economy is slowing. Thus, its use as an indicator is that its value is inversely related to general economic trends.

Although Zoellick’s recommendation that gold regain some of its lost importance was surprising to many, it was part of a more important statement. Zoellick outlined a system bringing together a basket of currencies, plus gold, into a fixed relationship with each other to create greater stability to the global monetary system. The system would not leave currencies totally fixed in value with one another, rather the currencies would be adjusted to allow for changes in economic conditions.

The primary reason for Zoellick’s recommendation is the current instability in currency markets. Although initial signs indicate the United States’ second quantitative easing is having positive effects, many nations have voiced their discontent or condemnation of American monetary policy. The Federal Reserve bought $600 billion in various bonds to increase the money supply in an effort to strengthen the American economy. Buying bonds, and thus increasing their price, causes the interest rate to fall. When the interest rate falls, holding dollars is less profitable, and investors move their money elsewhere. China, Germany, Russia, India, and many emerging nations worry the excess money will gather in their economies where the interest rates are higher, creating fears of inflation and asset price bubbles.

The German Finance Minister also noted that it is inconsistent for the U.S. to criticize China for currency manipulation and then use the Federal Reserve to lower the value of the dollar. The G-20 Summit, occurring November 11th-12th, will focus mostly on currency disputes. Zoellick’s proposal is certain to add to the discussion.

1. Other developed nations have not greeted the recent expansion of the American money supply with the same harshness as the developing world. Why is Germany the exception?
2. How would American interests be damaged by the world shifting away from using the U.S. dollar as the main reserve currency?
3. Given the tension among the G-20 members on various issues regarding the world economy, how will this latest dispute affect the talks?

No comments: