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Return of the gold standard

How much longer before the Islamic world gains the Gold Dinar...?

WE ARE SLOWLY drifting towards a period of monetary turmoil. Turmoil always leads to change, and the ideal result this time will be the establishment of a new gold standard.

   It may seem unlikely right now, but there are already several indications that it could be achieved by the end of this year. A necessary condition will be that at least a small group of people understand what a gold standard really is. So let's start with that.

   Humans have used gold as money – along with its adjunct, silver – since prehistory. It is the one item best suited for such a role, the main reason being that gold's monetary value is stable, or at least more stable, than the alternatives.

   It follows that anything which has its value linked to gold must, by definition, be as stable in value as gold. Link the value of paper currency to gold, for instance, is no stretch. The world's first gold-linked money was in fact made of clay, during Sumerian times, around 3500 BC. Clay tablets were used as warehouse receipts for gold, and traded among third parties.

   Nor is it hard to link the value of a paper currency to gold, even if the issuers of currency own no gold whatsoever. It can be accomplished by adjusting the supply of currency, much like a currency board operates. Currency boards, such as those used in Hong Kong or Estonia today, can just as easily and reliably link to gold instead of another currency.

   One of the most straightforward ways to link the value of a currency to gold is, quite simply, to make the currency itself out of gold. In the past, when economies and thus paper currencies collapsed, people sometimes began doing their business in gold and silver coins. In a similar fashion, most of the Dollar bills in the world today are actually being used outside the United States in under-the-table or even illegal activities of one sort or another. Where the local currency won't do, the Dollar – or gold – can help.

   But the popularity of the US Dollar outside the United States has been in steep decline in recent years. Many people that formerly used the Dollar for their business have been switching to Euros or other currencies. Apparently, some of these underworld elements have now begun to do their business in gold coins.

   There really isn't enough gold in the world, however, to run today's economy with gold coins. And since all of the existing gold is already owned, the question is: what is everyone else going to use?

   Unless we are going to have a worldwide collapse of the most dramatic proportions (it would make the Great Depression look like a hiccup), it will be necessary to establish a paper currency linked to gold. A few governments have indicated their willingness to step up to the plate, including a number of Islamic states share the tradition of the Gold Dinar. Russia has also shown some interest.

   These early attempts have generally foundered, thanks to a lack of confidence in the technical ability to actually get the job done right – a conclusion which appears to be correct. It is better to have no gold standard than one that soon collapses due to incompetence. Operating a proper gold standard is easy, but it does take more than simply declaring a hope and crossing fingers.

   That said, it is also necessary to know how to create and maintain a viable gold standard. That subject is rather more complicated than we can deal with here, but at least we can now identify the steps from the present state of worsening chaos to the land of monetary milk and honey.

   If the man-in-the-street had the knowledge of why and how to operate a gold standard, governments would likely follow along. People get the government they deserve, it is said, and by increasing the average person's understanding they will come to deserve a better monetary system as well.

   Another crucial stage will be to sweep away the encrustations of generations of misunderstanding of what a gold standard is supposed to accomplish. Many of today's gold standard advocates cling to the most implausible notions – decade after decade – just as today's lovers of floating fiat currencies spout their own brand of ridiculous nonsense.

   Here are some fallacies debunked:

  • A gold standard does not prevent a government from running a budget deficit. For example, the British government piled up impressive amounts of debt in the 18th and 19th centuries under a gold standard.
  • A gold standard does not prevent a current account deficit, which is another term for the importation of capital. The United States ran a current account deficit in every single year of the 19th century, with a gold standard, as European capital flowed to the New World.
  • The fact is, a gold standard makes both government deficit financing and capital importation easier, because it tends to lead to lower interest rates and currency stability.

   Governments and other economic actors are forever engaged in all sorts of reprehensible behavior, and it is foolish to expect a gold standard to solve all those problems – just as it is foolish for the floating-currency advocates to think that the Fed can make any economic difficulty disappear by waving its magic wand over interest rates.

   What can you do today in the face of the turmoil ahead? Imagine that a world of gold-linked money already exists. Things are considered politically impossible, but when they happen, historians call them inevitable.

   In this alternate universe, you can't even remember when Europe was a grab bag of over a dozen currencies. Now the Euro is more commonly used in the world than even the US Dollar.

   In this hypothetical world, the Euro may be in turn replaced by the Gold Dinar, which got its start in Dubai in the autumn of 2007. The Gold Dinar was equivalent to one gram of gold. The Dubai Commerce Bank – it was supported by the government, which provided deposit insurance on amounts less than 5 kilograms – offered certificates of deposit in Gold Dinars, which proved popular as they paid 1% interest and were redeemable in gold bullion. (Exchange-traded funds based on these CDs almost immediately appeared worldwide. After deducting management fees, they paid a 0.80% dividend.)

   The bank then lent at 4.5%, in Gold Dinars. The Gold Dinar was quickly adopted as payment for oil exports throughout the Middle East, especially since the oil futures exchange in Dubai priced its crude oil contract in Gold Dinars. Soon the Middle Easterners were anxious to reinvest their oil revenues, leading them to make loans to governments and corporations around the world – loans (and bonds) denominated in Gold Dinars, of course.

   Consequentially, governments and corporations were eager to borrow in Gold Dinars because they bore interest rates of only 3.5% for a ten-year bond for governments, and 4.5% for corporates, rates that were common in the 19th century. This was far better than borrowing in Dollars or other local fiat currencies, which bore rates in excess of 15% due to worsening inflation. The trade-dependent countries such as Korea or Malaysia, which had always linked their currencies to those used in international trade, soon gravitated towards the Gold Dinar (local corporations were doing more and more of their financing in dinars), and eventually finalized their links via currency boards.

   China's sheer size and international ambitions were too great for that country to become a monetary vassal of Dubai, so China established an independent gold-linked currency. The Gold Yuan soon became popular in Africa, where it was received in payment for commodities exports. Because both the Gold Dinar and the Gold Yuan were linked to gold, their exchange rates were effectively fixed. Russia followed soon thereafter, with an independent Gold Rouble. Japan and Switzerland were next.

   The US Federal Reserve eventually raised its interest rate target to 85% in an attempt to support the Dollar, but that policy was not able to counteract the Dollar's worldwide rejection. Cindy Sheehan, who had camped outside the White House to protest against the War in Iraq, camped out in front of the Federal Reserve building, asking for a meeting with Chairman Bernanke.

   "I just want him to explain what 'In God We Trust' is supposed to mean," she told the media. She was soon joined by over two hundred others.

   Despite becoming the first Chairman of the Federal Reserve to win a Nobel Prize in economics only six months earlier, Chairman Bernanke stepped down in disgrace, in the middle of his term. He then became president of the World Bank, replacing Paul Wolfowitz. Hyperinflation in the United States eventually led to a new political party, formed by dissatisfied Congresspeople from both the Republican and Democratic parties, which took a strictly Constitutionalist approach to monetary affairs.

   The unused Federal Reserve building in Washington DC was eventually converted into a museum of Native American art.

Formerly a chief economist providing advice to institutional investors, Nathan Lewis now runs a private investing partnership in New York state. Published in the Financial Times, Asian Wall Street Journal, Huffington Post, Daily Yomiuri, The Daily Reckoning, Pravda, Forbes magazine, and by Dow Jones Newswires, he is also the author – with Addison Wiggin – of Gold: The Once and Future Money (John Wiley & Sons, 2007), as well as the essays and thoughts at New World Economics.

See the full archive of Nathan Lewis articles.

Please Note: All articles published here are to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it. Please review our Terms & Conditions for accessing Gold News.

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