The Golden Elephant

There is a “golden elephant in the room,” according to Robert Zoellick, the American who heads the World Bank.

As world leaders headed to Seoul for the G-20 summit last week, gold hit a record-high price of $1,400 an ounce, and Zoellick made a surprising proposal. In an opinion piece in the Financial Times, he wrote that “The system should…consider employing gold as an international reference point of market expectations about inflation, deflation and future currency values.”

The media were quick to interpret Zoellick’s statement as a call for the return of the gold standard, a system in which the value of paper currency is directly pegged to the supply of gold. However, in an interview with CNBC, Zoellick explained that he did not mean to propose tying currency values directly to any hard asset.

Zoellick said he had simply intended to suggest that governments pay more attention to what gold says about the financial community’s confidence in national currencies. Right now, that confidence looks very shaky.

In his Financial Times column, Zoellick noted that markets are already “using gold as an alternative monetary asset.” The peak in gold prices before the G-20 summit demonstrated investors’ worries over fluctuating currency values and their desire for more stable assets. What “the price of gold has been telling people is that there is a lack of confidence in some of the fundamental growth policies,” Zoellick said. He called for a new package of international reforms aimed at spurring growth.

But while Zoellick may never have intended to raise the possibility of a gold standard, the fact that people instantly interpreted his comments that way demonstrates the persistent support in some quarters for that idea – a very misguided one – and the mounting concern that the world’s major trading currencies are all being manipulated or debased.

I doubt any central banker today would support the idea of tying the money supply directly to gold. The reason is that there is essentially a fixed supply of gold in the world. Annual mining output does not have much impact, since the gold that can be mined in any one year represents a small fraction of all the gold which has been mined previously. Unlike, say, oil, gold that is produced is almost never consumed. It just ends up in someone’s jewelry box or coin collection or, most likely, in a bullion vault, where it sits until it is sold to someone who will put it in a similar place.

Thus, if the supply of money is set as some fraction of the supply of gold, the money supply becomes fixed. The need for money, however, is not fixed; it expands as commerce expands. The need for money also increases when the money’s “velocity,” the rate at which people spend it, slows down. If the money supply is not increased in response to decreases in velocity, the economy contracts sharply.

Back in the days of the gold standard, recessions were sharp and frequent, and bouts of deflation were common. There were literally shortages of money. The greatest money shortage of all became known as the Great Depression. In 1933, one of President Franklin D. Roosevelt’s first acts in office was to break the tight link between gold and the U.S. money supply.

But those who wanted Zoellick to advocate a gold standard are not entirely misguided in their thinking. The public is becoming increasingly aware that the supply of money needs to be related to something. The Federal Reserve’s “liquidity injections” have left many worried that paper currency, or at least green paper currency with the word “dollar” on it, will soon become meaningless.

A country’s money supply needs to be related to something, but that something is not gold; it is the county’s output of goods and services. Ideally that output should also be closely related to the country’s consumption. In the United States we have a chronic problem balancing the two. We consume more than we produce, and we borrow the money, or accept foreign investment, to make up the difference. By effectively printing up as much money as we need to finance the stuff we want to buy, the Federal Reserve is matching the money supply to consumption (or the consumption it wants to promote), rather than to output.

This policy is only supposed to last long enough to stimulate the economy over the next eight months, but if the economy remains sluggish, it’s possible that the Fed will dump in even more money. And, as the value of the dollar declines, foreigners may be reluctant to buy the newly issued Treasury debt, demanding interest rates higher than the Treasury can afford to pay. In that case, the Fed will have to choose between allowing the Treasury to default and printing up more money. Given the choice, the Fed will immediately kick the printing presses back into high gear, further eroding the value of the dollar.

Imposing a gold standard would be similar to erecting a brick wall to stop a runaway train. It might halt the collapse of the dollar, but it would do a lot of damage in the process. Rather than throwing up a wall, we need to get the train back under control. That will require us to restore balance between what we produce and what we spend.

About Larry M. Elkin 525 Articles

Affiliation: Palisades Hudson Financial Group

Larry M. Elkin, CPA, CFP®, has provided personal financial and tax counseling to a sophisticated client base since 1986. After six years with Arthur Andersen, where he was a senior manager for personal financial planning and family wealth planning, he founded his own firm in Hastings on Hudson, New York in 1992. That firm grew steadily and became the Palisades Hudson organization, which moved to Scarsdale, New York in 2002. The firm expanded to Fort Lauderdale, Florida, in 2005, and to Atlanta, Georgia, in 2008.

Larry received his B.A. in journalism from the University of Montana in 1978, and his M.B.A. in accounting from New York University in 1986. Larry was a reporter and editor for The Associated Press from 1978 to 1986. He covered government, business and legal affairs for the wire service, with assignments in Helena, Montana; Albany, New York; Washington, D.C.; and New York City’s federal courts in Brooklyn and Manhattan.

Larry established the organization’s investment advisory business, which now manages more than $800 million, in 1997. As president of Palisades Hudson, Larry maintains individual professional relationships with many of the firm’s clients, who reside in more than 25 states from Maine to California as well as in several foreign countries. He is the author of Financial Self-Defense for Unmarried Couples (Currency Doubleday, 1995), which was the first comprehensive financial planning guide for unmarried couples. He also is the editor and publisher of Sentinel, a quarterly newsletter on personal financial planning.

Larry has written many Sentinel articles, including several that anticipated future events. In “The Economic Case Against Tobacco Stocks” (February 1995), he forecast that litigation losses would eventually undermine cigarette manufacturers’ financial position. He concluded in “Is This the Beginning Of The End?” (May 1998) that there was a better-than-even chance that estate taxes would be repealed by 2010, three years before Congress enacted legislation to repeal the tax in 2010. In “IRS Takes A Shot At Split-Dollar Life” (June 1996), Larry predicted that the IRS would be able to treat split dollar arrangements as below-market loans, which came to pass with new rules issued by the Service in 2001 and 2002.

More recently, Larry has addressed the causes and consequences of the “Panic of 2008″ in his Sentinel articles. In “Have We Learned Our Lending Lesson At Last” (October 2007) and “Mortgage Lending Lessons Remain Unlearned” (October 2008), Larry questioned whether or not America has learned any lessons from the savings and loan crisis of the 1980s. In addition, he offered some practical changes that should have been made to amend the situation. In “Take Advantage Of The Panic Of 2008” (January 2009), Larry offered ways to capitalize on the wealth of opportunity that the panic presented.

Larry served as president of the Estate Planning Council of New York City, Inc., in 2005-2006. In 2009 the Council presented Larry with its first-ever Lifetime Achievement Award, citing his service to the organization and “his tireless efforts in promoting our industry by word and by personal example as a consummate estate planning professional.” He is regularly interviewed by national and regional publications, and has made nearly 100 radio and television appearances.

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1 Comment on The Golden Elephant

  1. There is also a very limited supply of pope crap but that doesn’t mean it’s worth something because of it…Plus, I see no production increases any time soon! Gold is the same, first thing we’ll know, someone will discover that there is actually tons of gold hidden somewhere (hidden just so to boost prices, it’s soooo limited, remember?) and then the whole scam will come crashing down… Do you REALLY think if a mining company discovered huge chunks of gold somewhere that they would scream it from the top of their lungs for every one to hear? That would be a costly mistake on their part, no? Come on…gold is almost useless, at least crap has a chance of powering generators, powerplants, etc , in the near future but who is going to put 1400$ chunks of gold in a generator EVEN if it could power it anyway??? I say invest in CRAP, it’s much better than gold!

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