GOLD STANDARD … DEBUNKED OR ANOTHER BUBBLE?

The financial liquidity crisis is in full swing around the world. It is no wonder that experts and novices alike seek ways and means to prevent a future recurrence. Many different solutions are enacted and proposed. All of them center on wealth and money or votes.

Questions regarding the reemerging push for a return to a gold standard and our discussions of earlier Austrian school of economic theories abound.

Such discussions especially flourish during major financial crises.

Certainly, gold has been viewed by civilizations for some five thousand years as stable and desirable. Why? Simple – man cannot easily destroy it, nor create it. It has been considered both wealth and money.

It certainly meets both ancient and modern economics’ criteria for wealth. To a lesser degree, it meets the definitions for money.

First, it is a medium of exchange. Almost everyone agrees to trade if gold is involved.

It serves as a store of value. In other words, gold cannot only serve as money, but it is actually a tangible representation of wealth.

It is a standard of value. People can agree that one ounce of gold is equal to a fixed amount of some other good or service.

Since it is rare instead of plentiful, that standard remains in tact as long as people agree. Richard Nixon unilaterally arranged for the United States to leave the gold standard in 1971 for political and economic interests. Gold prices “floated” against other currencies, and no country since then has remained on a gold standard.. Nonetheless, gold has been and can remain a basis for contracts, debts and other private or national obligations.

Finally, it is a unit of account. That simply permits us to set prices, costs, or profits. In short, any money, whether gold or silver or fiat (paper) money issued by a government, gold can fulfill that function.

Without too much difficulty, gold can also simply exist to guarantee the use of fiat money. That places a currency on the gold standard, and simply means that a government certifies that it has enough physical gold (as in Fort Knox or the IMF vaults in New York) for every dollar of fiat money it issues.

Your, or a country’s credit, is limited by the amount of gold owned.

Enter the problem.

It may be simplistic, but bears repeating. It is, after all, the reason why economics came into being in the first place. Supply and demand.

The fundamental law of economics assumes that mankind wants an almost limitless amount of goods or services. That includes everything from basic foods to intangible things like religion.

Those “wants” may have both positive and negative effects.

In a world where all physical goods are limited, if supplies are finite while wants are unlimited, we instantly see the basis for having to make choices. The choices can be resolved in civil manner by trade or, in the extreme, by war.

Therein lies the fundamental problem of gold as a backing for fiat money, or as a direct global currency.

There simply is not enough gold on the planet, existing above ground or yet to be mined, to back all the fiat currencies that have been created to accommodate the continually rising population in this world.

Better yet, if we applied simple supply and demand laws, the price of gold would reach enormous proportions compared to the universally accepted world standard of the equivalent US$700 per ounce at today’s values. Careful, please, the price may rapidly move or down from that level!

We know reasonably well how much gold there exists on the planet. We also know approximately who owns how much, both in physical gold and in reserves still to be mined. With the expected gold craze to continue, major exploration and mining companies are hoping to bring those underground reserves to daylight to join in the speculative fever of potentially recovering gold.

For example, Northgate Minerals Corporation (TSX: NGX, AMEX: NXG) announced September 8, 2008 that it found new mineral reserves at its Australian site, including some 140,000 ounces of gold. In their press release, the company stated that the find “will extend the current mine-life by an additional 18 months until the fourth quarter of 2011.” (biz.yahoo.com). (www.northgateminerals.com)

If you do simple math and use today’s value at $700/oz., that results in some $98 million. At a cost of some $20/oz, that results in a nice profit for the company and its shareholders.

However, that amount pales on a macroeconomic level.

It would make little difference on a world-wide basis for the United States, the International Monetary Fund, South Africa, Russia or Canada as countries. Russia, for example, recently announced continued progress in its Kamchatka gold discoveries.

Trans-Siberian Gold’s Asacha mine is estimated to process some 608,000 ounces of gold over the expected six and a half year life. It has not yet commenced drilling. The company is traded on the London stock exchange. (TSG-L)

In short, the supply of gold is reasonably fixed with only relatively small increases foreseen in the near future.

We can also reasonably predict general industrial and commercial uses for gold, such as electronics, medicine and personal jewelry.

With normal supply and demand predictable, the excess demand for speculation drives the price on the international gold market. It is a speculator’s and gambler’s heaven!

There are good and bad aspects to a national or world-wide gold standard.

Making gold convertible into a certain amount of dollars, yen, Euros or whatever would certainly restrict the amount of money each nation could spend. As such, it would artificially impose a certain financial prudence on the part of government issuance of fiat money. It would be likely to sharply curtail spending and investment.

It should certainly cause policymakers to think twice before wasting assets in such futile endeavors as wars not designed merely to defend a nation’s borders against intruders.

However, a return to the gold standard would impose a limit on growth, and thus on employment. History shows that unemployment was far more extensive under the gold standard than without it. Despite the speculation, irresponible credit use and eveb criminal activity, no one can challenge the tremendous growth in entrepreneurship worldwide sice the Reagan and Clinton administrations.

Whether it is the Federal Reserve or another central bank, interest rates would still have to be adjusted – even in a 100% gold-backed currency – to maintain that currency’s value relative to the arbitrary value agreed to and set upon an ounce of gold.

It all ultimately depends whether you want to put your trust in your fellow man (or woman) based on a shiny metal to back your country’s currency or on a piece of paper backed by the “full fait and credit” of the United States or any other country.

If you truly believe more in gold than in the ultimate productivity of the dollar, the yen or the countless others, by all means buy some gold directly through any one of dozens of legitimate gold currency dealers. Not issued by any bank, but backed directly by the gold you purchase, some of that gold is denominated in Dinars or Dirhams or Rials. Islam does not believe in interest or usury, but fixed fees. Remember, though: the value of your gold could rise or fall, depending on what the market dictates.

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