Return to the gold standard?

Mr Market remembers mid-August as the time when, on 15 August 1971, US President Richard Nixon interrupted the hit TV series Bonanza on a Sunday night to announce that Washington had decided to unilaterally withdraw from the post-WW2 international monetary system by abandoning the Bretton Woods agreement and the gold standard, which pegged all currencies to the dollar and the dollar to gold at $35 an ounce.

Arthur Burns, then Fed chairman, warned him that Pravda would run front-page leads about the “collapse of capitalism” and the flight from gold would hurt America’s reputation, earned so painfully after the great war, as the custodian of the global economy.

But Nixon would have none of it. Long years of the Korea and Vietnam wars, coupled with generous government spending to build the Great Society at home, ruled out any chance of balanced budgets that administrations in the 50s and 60s had at least paid lip service to.

Deficit spending was the new Washington mantra – “I am now a Keynesian”, the president boasted in January 1971 – even if it meant radically altering the course of human monetary history. This was, after all, the first time in 2,500 years that gold was “effectively demonetised” in all of what is popularly known as the western world.

Previously, the US government had only rarely, and temporarily, abandoned the gold link, that too in times of extraordinary stress like the civil war, world wars, great depression, etc.

But by the early 70s the prospect of long-term deficits was causing concern about devaluation of dollar assets held by foreign governments; even warnings of a run on US gold holdings with countries lining up to exchange their greenback for the precious metal.

And unable, rather unwilling, to balance its budget and improve its fiscal health, Washington decided to rubbish the gold standard to the dustbin of history instead, paving the way for the era of free-floating fiat currencies.

Modern markets, with wildly swinging currencies and volatile interest rate regimes, have little memory of the gold standard, but let’s not forget that this particular brand of freely floating markets is only half a century old (52 years to be exact).

And though this gamble paid off in that global GDP skyrocketed on the back of free currencies and freer credit — from $3.8 trillion in 1971 (according to IMF estimates) to $105 trillion today; also up $5 trillion from 2022 – there are already signs that it might have peaked and the dollar’s days as the reserve currency, tough still plenty, are limited.

It’s ironic that the BRICS – Brazil, Russia, India, China, South Africa – summit later this month in South Africa is rumoured to have a gold-backed common currency on the agenda just when the Ukraine war has triggered a shift in political and financial alliances and encouraged non-dollar trade, including oil, on a scale not seen in the last half-century.

Interestingly, a number of countries – 20 by the latest count – have also formally asked to join the bloc, including Saudi Arabia, Argentina, Iran and the UAE (United Arab Emirates).

A possible Saudi entry could be the real game-changer, especially if it begins to phase out the petrodollar. With so many oil exporters and importers in the alliance, a move to a common currency would prompt them to reduce central bank dollar holdings, which are necessary to finance commodity, especially oil, imports right now, in favour of gold or a gold-linked currency.

None of this is yet a done deal, of course, but there is a clear common desire to find ways of sidestepping the SWIFT system since the US-EU combine sanctioned Russia so harshly after the Ukraine war.

So if there is talk of a new currency, which has been doing the rounds for a while, and Riyadh does take the lead in the swing towards what is already being called de-dollarisation, then the lack of settlement in US dollars will eventually have a substantial effect.

“The glue that will make all of this work is indeed having a currency backed by commodities, presumably gold, using distributed ledger technology or blockchain,” according to Andy Schectman, president and owner of Miles Franklin, Precious Metals and a very prominent figure in the financial services industry for more than 25 years.

It’s still early days, but another 20 countries joining BRICS would imply about two-thirds of the world’s population represented in that group. That’s a scenario where, in the extreme case, a big part of the global population and their central banks could simply dump the dollar.

Yet those dollars will continue to exist even if or when they are not used to buy oil. And once they find their way out of central bank vaults and back to the US, the textbook says that they would trigger new rounds of inflation, interest rate hikes and eventually, devaluation.

There’s a good chance that nothing of the sort happens and the BRICS summit passes without much noise. Some participants, including India, have already ruled out the new currency conspiracy theory.

But that doesn’t mean there aren’t enough pieces on the board for the puzzle to start taking shape. Either way, the summit will tell whether or not it’s time for king dollar to take the long ride downhill.

Copyright Business Recorder, 2023