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How a Gold Standard Could Come Back

Four scenarios that could see the re-emergence of gold-backed currency...

IN THE YEARS ahead we will witness the death of paper money and the reemergence of a global gold standard, reckons

Here's why. In the coming months and years governments around the world will do everything in their power to prevent a global depression. They will do this by printing massive amounts of new money and pushing it out into the global economy – something which will result in a collapse in the value of paper money. 

Eventually, as their actions fail to produce lasting economic growth, people will lose faith in governments' ability to resolve the crisis. Crucially they will also begin to lose faith in the paper money these governments issue, and ultimately it is this loss of faith in what is essentially worthless money that will necessitate our return to a gold standard. 

This is the first time in history that no currency on the planet is backed by anything tangible. They are all fiat. History teaches us that fiat (paper) currencies do not stand the test of time. In fact, there have been 34 instances of hyperinflation in the last 100 years alone, the majority of which took place in the 20th century with fiat currencies.

In his excellent new book, 'The Golden Revolution: How to Prepare for the Coming Global Gold Standard', John Butler states that a, "currency can only function as such if there is a general consensus that it provides a stable store of value. Without this trust, money, no matter what form it takes, will be abandoned – either suddenly in a crisis, or gradually over time – in favor of something else."

Mr Butler also makes the case that, "the world is rapidly moving toward some form of global metallic standard, in which money, at least in official, international transactions, is linked directly to gold, silver, or both". 

In his book, Mr Butler, who was a managing director at Lehman Brothers, Deutsche Bank and Dresdner Bank, lays out four scenarios for returning to a gold standard.

In the first scenario Russia suddenly announces its intention to return to a gold-back currency. This was a scenario which was originally put forward by Jim Rickards, author of Currency Wars: The Making of the Next Global Crisis, during a war-game exercise at the US Department of Defense. 

In this scenario Russia's return to a gold standard is motivated by the desire to improve its global economic position, as well as the desire to inflict economic harm on the United States due to a disagreement over its foreign policy.

A gold-backed Ruble would become a threat to the US Dollar, since for the first time in over 40 years investors around the world would have the choice between holding unbacked US Dollars issued by a country with almost $16 trillion in public debt, a $1.3 trillion annual budget deficit, and a massive looming entitlement problem, or holding a currency backed by gold.

Even if investors were only to diversify a small percentage of their capital out of US Dollars it would cause serious problems for the United States, which brings us to the next scenario.

In the second scenario the United States pre-empts such a move by Russia, or some other country, and takes steps to return to a gold-backed Dollar. This move would require a massive change in fiscal and monetary policy, as well as a considerable adjustment in the political process. It would also require a program of education so that American citizens understood why it was necessary.

In the third scenario the BRIC countries club together and form a new currency block that is backed by gold. This scenario is similar to the first one, except this time Russia gets together with Brazil, India and China to form a new currency block which is backed by gold from all four countries. 

Again this scenario might not be as far-fetched as it seems since all four countries have recently expressed their concern about US foreign policy, and their combined gold reserves would be the fourth largest in the world behind the US, Germany and the IMF.

In the fourth scenario the financial markets, in particular the gold vigilantes, force one or more governments to back their currencies with gold. In this scenario investors continue to do what they have been doing for the past 12 years, only on a much larger scale. Rather than holding rapidly devaluing paper currencies, they instead opt to hold (and transact in) gold. 

The behavior of these investors is not dissimilar to that of the bond investors during the 1970s. These so-called bond vigilantes forced the US government to reign in its profligate spending (and hence inflation) by demanding higher returns for holding US debt. 

The gold vigilantes may eventually force the US, or some other country, to return to a currency backed by gold. This would mean that the currency could not be issued without limit – something which would help restore faith in it.

No one should underestimate the impact of a return to a gold standard. As Mr Butler puts it, "The practical reality of the transition to the coming global gold (or bimetallic) standard is going to be substantially different from the global fiat monetary and financial regime of today. It is not just money that is going to change. The nature and business of banking will also be affected, as will finance in general."

Those that stand to lose the most from the coming paper money collapse are those that don't see it coming and therefore remain holding paper currencies even as rising inflation eats into their value. Anecdotal evidence from inflationary episodes in countries such as Argentina and Brazil suggest that most people don't take steps to protect their wealth from inflation until it reaches as high as 50%.

The big winners in this transition from faith-based money to gold-backed money will be the early adopters, those that make the transition before a large part of their wealth has been eroded by inflation.

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