Q+A-Could world markets warm to a gold standard?

By Amanda Cooper and Tamawa Desai

LONDON (BestGrowthStock) – The president of the World Bank has made a bold call on leading global economies to consider readopting a modified gold standard to guide currency movements, but the proposal has met with a wall of skepticism.

Writing in the Financial Times, Robert Zoellick called for a new system of floating currencies as a successor to the Bretton Woods fixed-exchange rate regime, which broke down in the early 1970s and involved measuring currency rates against gold.

Zoellick called for a system that “is likely to need to involve the dollar, the euro, the yen, the pound and (yuan) that moves toward internationalization and then an open capital account.”

The gold price, which is trading near record highs just shy of $1,400 an ounce, has shown little reaction to Zoellick’s idea, at least so far.

Following is a Q&A on the likelihood of such a development:

WHAT IS THE GOLD STANDARD?

The gold standard was effectively an exchange rate mechanism created in 1944 by the Bretton Woods agreement, ratified by the U.S. Congress in 1945. It involved setting par values for currencies in terms of gold and the obligation of member countries to convert foreign official holdings of their currencies into gold at those par values.

The system was set up to help rebuild the international economy as World War Two still raged. It required each country to adopt a monetary policy that maintained the exchange rate of its currency within a fixed value (plus or minus 1 percent in terms of gold).

This system remained in place until August 1971, when U.S. President Richard Nixon removed the dollar peg to gold, which had been fixed at $35 an ounce.

In its most basic form, the gold standard involves the issuance of coinage in gold.

A more sophisticated system involves paper currency that can be converted to preset, fixed quantities of gold.

Another gold standard allows for a specific amount of gold to be used as standard unit of account for settling terms of trade and so on.

HOW MIGHT A NEW GOLD STANDARD WORK?

Zoellick’s comments were vague, but analysts say he may be pushing for a system in which the World Bank’s own currency — Special Drawing Rights or SDRs — is changed to reflect the value of the dollar, euro, pound, yen and the yuan and somehow incorporate gold.

The suggestion does not set out, for example, how such a standard might work when monetary authorities need to make extraordinary provisions such as quantitative easing or sterilized currency intervention.

It also does not make clear how it would prevent monetary authorities from trading around or outside of any bands that might be set.

IS IT A REALISTIC PROPOSAL?

The initial response, given the size of the gold market alone, is no. Gold is a precious metal by virtue of its limited supply, and annual gold supply could not keep pace with any increase in money supply, especially if central banks make use of quantitative easing to flush their economies with cash.

“Unlike the World Bank, we do not believe that a form of the gold standard will return. Very simply, there is not enough gold supply in the world for the metal to perform in this role,” says UBS precious metals strategist Edel Tully.

“As Paul Donavon, from UBS Global Economics points out, any reserve currency needs a supply that can grow as rapidly as global trade. Gold supply falls significantly short of this basic requirement.”

WOULD THERE BE INTERNATIONAL SUPPORT FOR IT?

Zoellick’s suggestion that gold be used as an international reference point of market expectations for price pressures and future currency values comes in the middle of a virtual international currency war.

The U.S. dollar has fallen broadly this year, having lost nearly 13 percent against a basket of major currencies in the past five months. That has triggered an outcry from many key emerging economies, which have seen the competitiveness of their exports dwindle as well as a pick-up in so-called “hot money” inflows from speculative investors.

The United States continues to exert pressure on China to allow its yuan currency to appreciate and wipe out some of the competitive edge of the world’s biggest exporter, and members of the G20 have rejected placing limits on currency and trade surpluses as a means of rebalancing the global economy.

With a distinct lack of accord over how to correct the surpluses of the emerging world and the deficits of the developed one, the chances of a deal on adopting a gold standard, in any form, appear limited.

“It is conceivable for greater cooperation in the currency region, but gold may not necessarily be at the heart of any realignment of the currency system,” says Daragh Maher, deputy head of global foreign exchange research at Credit Agricole CIB.

“More cooperation, such as a (U.S. Treasury Secretary Timothy) Geithner-like approach, but not specific target levels (for current account imbalances) but something that would involve not tolerating imbalances domestically may be something to be considered,” he says.

With the Federal Reserve set to pump over half a trillion dollars into the U.S. economy, the rise in money supply and subsequent rise in inflation would make it difficult to hold enough gold.

Hans Redeker, global head of foreign exchange strategy at BNP Paribas, says the supply of money would depend on the amount of gold one holds. So an increase in money supply would have nothing to do with economic circumstances.

“It’s a step in the right direction, but it is not going to fly. People are desperately seeking ways to stem the wave of liquidity (from U.S. monetary easing), but bringing back the gold standard is not realistic,” he says.

Redeker adds that throwing gold into the global currency mix would not help stem excess liquidity by the United States, which is fuelling inflation especially in China and emerging Asia.

(Additional reporting by Nick Trevethan in Singapore; Editing by Veronica Brown and Jane Baird)

Q+A-Could world markets warm to a gold standard?