That we live in an age marked by a relentless assault of images and sound-bytes is self-evident. The half-life of these visual and aural stimulants are however remarkably short. Nowhere is this ephemeral nature more visible than on our televisions where sanctimonious presenters rail against windmills of their imagination and willfully confuse them for their private demons.

In such an atmosphere of combative narratives, the joys of an old-fashioned debate on ideas cannot be overstated, especially one where ideas affect our collective well-being.

One such debate recently occurred in Manhattan, when over 900 people got together to hear about the gold standard. The arguments for gold standard were presented by David Stockman, who was a dir-ector in the Office of Management and Budget in the Reagan administration, and James Grant, who is widely read financial journalist and the publisher of the influential Grant's Interest Rate Observer.

Argument

Those arguing against the gold standard were Richard Sylla, professor of economics from New York University, and Edward Chancellor, an asset manager from GMO (a global investment house with $108 billion management book). Like all debates on great and vexingly complex topics there was no winner.

If at all, the sole conclusion that both sides of the arguments agreed upon was that the monetary system has elided into a system that is unstable and promotes indiscipline.

The remedies to this punctuated evolution of the system, as it lurches from crises to crises, is not what both sides disagree upon. The remedy is clear: reduce debt, avoid socialising risk and privatising gains. But the contention is how to achieve this. Is a return to a gold standard the answer?

Gold, and occasionally other metals like silver and even cowries, has been how humans have over centuries encapsulated the value of their labour and enterprise. Gold has been either a unit in itself in circulation (gold specie) or another object can be traded (Treasury paper, notes, electronic money) with explicit linkages to gold (gold standard).

The gold specie-standard was the de facto method by which the British Empire financed itself. However, with the end of the Second World War which led to massive arms purchases, the British exhausted most of their gold reserves. The US then stepped into the void and under the Bretton Woods framework it offered to peg the dollar to gold reserves at $35 per ounce. i.e., the US guaranteed the value of the dollar to every unit of gold it possessed.

Licence

So, if the US exported more and collected more gold, this would be tantamount to a licence to print more money. However, to do so without enough gold to back its currency would mean devaluation or inflation. In essence, backing-by-gold imposed an external discipline on how much money was allowed in the system. Other countries then fixed their currencies to the dollar. In the early 1970s this system unravelled. Thanks yet again to war-making. The expenses incurred by the Vietnam war led the US to print more money, without the corresponding gold base to back it.

Thus those countries that were linked to the dollar were importing inflation. Predictably, currencies across the world broke off from this arrangement. Richard Nixon, then President of the US, formalised this break-up by disallowing the dollar's convertibility to gold. And thus for all means and purposes, since then we have entered the free market of global currencies. In this brave new world of global finance the relative value of exchange rates is set in the international market.

In a system where the relative value of currencies determines debt burden and export competitiveness, such aggressive monetary infusions threaten to devalue the dollar. More strikingly, the prospect of inflation is clear and present. But reality is more complex. On one hand the gold standard disallows governments to inflate away or even opportunistically bail out select classes of the economy at the cost of others. Yet the gold standard cannot prevent speculative mania as seen over the past centuries in commodities ranging from tulips to railway bonds.

 

The columnist works for a major European investment bank in New York City. All opinions are personal and don't reflect any institutional perspectives.