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Too Little to Gold to Restore the Gold Standard?
The debate around a return to a gold standard is being revisited after the US Republican Party called for a commission to look at such a system.
Under a gold standard, the authorities commit to exchange their paper currency for gold at a fixed conversion rate, which would effectively put a set price on the dollar.
Fans say this would increase confidence in the currency by tying it to something that is in finite supply, thus hobbling the ability of central bankers to print money at will.
Amid the chorus of opposition to the gold standard , the argument that there is simply not enough gold to do this is well-aired. But that’s not quite the full story, according to Paul Donovan, an economist at UBS.
“More accurately, the supply of gold is not growing fast enough,” he says. “This is the fatal flaw.”
As economies grow, they need more currency to carry out trade at home and abroad. Donovan argues that in past times when the gold standard was in operation, the mining industry was benefiting from new discoveries and improved techniques which meant supply could grow more rapidly than today.
If the world economy today has a trend growth rate of around 6pc a year (“perfectly realistic” says Donovan), then the supply of currency it needs has to climb by 6pc annually. But the supply of gold rose less than 3pc last year.
If the gold supply cannot grow quickly enough to facilitate trade, either global trade has to shrink translating into reduced living standards or the world faces deflationary pressures, he warns.
His analysis may not convince those calling for the gold standard, who often question the received economic wisdom that deflation is undesirable.
But it is food for thought for any future commission mulling the practicalities.