The gold in money's future
Gold, the ancient standard of value, seems irrelevant to today's global money system. But Nobel Prize winner Robert A. Mundell says gold still plays a vital role in the new world of the U.S. dollar and the euro
Robert Mundell
National Post
Back in the 1960s, when people were deliberating about the future of the international monetary system, gold figured importantly in the discussions. Even today, gold is the only commodity held as reserve by the monetary authorities, and it constitutes the largest component after dollars in the total reserves of the international monetary system.
By and large, the total gold held by all central banks and international monetary authorities is not very different -- at about one billion ounces -- from what it was before the international monetary system broke up in 1973. Despite attempts to demonetize it, gold has kept much of its allure to the public and monetary officials.
It is useful to reflect on the mystique of gold. From the beginning of civilization, gold was such an attractive metal that it was coveted as an object of beauty and quickly monopolized by the upper classes. Many of the early empires used gold as reserves for their banking systems, with exchanges effected by means of clay notes and seals convertible -- at least nominally -- into the precious metal.
From its very beginning, probably in Lydia in the 7th century BC, coinage was overvalued; one could say that was its very purpose. The earliest coins of the Lydian kings were made of electrum (from the Greek word meaning amber), an alloy of gold and silver.
We mustn't be misled by the textbook fiction that coins were first struck to guarantee the weight, and therefore the value, of the earliest coins. There is no point stamping the weight on a lump of electrum metal if the fineness of the alloy is neither known nor constant; in fact, the electrum coins from the early hoards varied widely in fineness. The conventional wisdom that despots stamped coins to confirm their weight and thus provide a convenience for their subjects is sheer nonsense.
The earliest function of coinage was profit. Accepted at face value, as if they had a high gold content, the Lydian coins started out with a high proportion of gold but got progressively smaller, increasing the markup and the revenue for the fiscal authorities.
Coins cannot, of course, remain overvalued in a free market. Overvalued coinage implies artificial scarcity, a monopoly and government control. Without exception in the ancient world, the gold and silver mines were controlled by the government. This was the basis for all the doctrines that would later evolve around gold. Religious symbols -- Marduk, Baal, Osiris, Zeus, Athena --helped to reinforce the mystique. The gods changed but the principles stayed the same! Just look at the Masonic hocus-pocus that remains on our dollar bills! "In God We Trust," introduced to our dollar bills in 1862 when their gold backing was dropped.
When the international monetary system was linked to gold, the latter managed the interdependence of the currency system, established an anchor for fixed exchange rates and stabilized inflation. When the gold standard broke down, these valuable functions were no longer performed, and the world moved into a regime of permanent inflation. The present international monetary system neither manages the interdependence of currencies nor stabilizes prices.
An international monetary system in the strict sense of the world does not presently exist. Every country has it own system. Most people do not understand how unusual the system is. For thousands of years, countries have anchored their currencies to one of the precious metals or to another currency. But in the quarter century since the international monetary system broke down, countries have been on their own, a phenomenon that has no historical precedent in the co-operative game known as the international monetary system.
On paper, a collection of nearly 200 countries with individual currencies and flexible exchange rates would appear to result in incredible confusion. In practice, however, the system is not so bad. There is an important coherence in the world financial structure due to the special role played by the currency of the superpower.
Historically, whenever there has been a superpower, the currency of the superpower plays a central role in the international monetary system. This has been as true for the Babylonian shekel, the Persian daric, the Greek tetradrachma, the Macedonian stater, the Roman denarius, the Islamic dinar, the Italian ducat, the Spanish doubloon and the French livre as it has for the more familiar pounds sterling of the 19th century and the dollar of the 20th century. The superpower typically has a veto over the international monetary system, and because it benefits from the international use of its currency, its interest is usually in vetoing any kind of global collaboration that would replace its own currency with an independent international currency.
In the 1870s, the United States and France were campaigning for international monetary reform in the sense of an international return to bimetalism and the development of a standard international unit of account. Which country was saying no? It was Britain, the leading world power in the 19th century. As top power, or at least "first among equals," Britain always said no to international monetary reform, no to an alternative to the pound as a unit of account and the sterling bill as the most important means of payment. But when Britain's star faded and America's rose, the positions were reversed, with Britain wanting international monetary reform and the United States, the new superpower, rejecting it.
Currently, there is no game for international reform, because the name of the game right now is the euro. Because of this prospect, Europeans do not want to talk about international monetary reform. If the United States started to talk about international monetary reform now, Europeans would interpret it as an attempt on the part of the United States to break up their play for a European money. But the United States would not talk about international monetary reform now anyway, because a superpower never pushes international monetary reform unless it sees reform as a chance to break up a threat to its own hegemony.
The more powerful the superpower becomes, the more it is tempted to expand beyond its international monetary potential and exact seigniorage from its clients (or victims?). Other countries became exasperated and moved to flexible exchange rates in the 1970s. They thought that would at least set them free from reliance on the dollar. But they were completely wrong, just as Milton Friedman was wrong when he predicted that under flexible exchange ratesk, countries would not need reserves. Countries need more reserves today under flexible exchange rates than they ever needed under fixed exchange rates.
Where is all of the money -- nearly $400-billion (US) -- that the U.S. Federal Reserve has created? Nobody knows precisely where. No one can track it down. But most of us think it is outside the United States, being used as the international currency of the world.
A staff member at the IMF estimated that only 10% to 15% of the $400-billion (US) in circulation would be held in the United States. The rest of it would be used outside -- not just by central banks but by travellers, the drug cartel, tax evaders and foreign banks. The dollar is everyone's second currency in the same way that English is everybody's second language. For this reason, there is little scope for international monetary reform without the intimate involvement of the United States, just as there is little hope for Esperanto to replace English as the world language.
So much for the past and present: We now move to the 21st century. The dollar is the pre-eminent currency of the world. I believe that Europe is going to be much more successful than people generally believe. It will take three years to put the currency into place. Then it will take another seven or eight years of growing pains. By the year 2010, we will probably have a European currency firmly in place and generally accepted.
The European continent, as a country, will have a GDP that is probably 10% to 15% larger than the United States. The European Community will produce a currency that is internationally important. Geographically, Europe is more convenient to all of the former Soviet Union countries, Africa and the Middle East than is the United States. The single Eurocurrency will become very important.
There will also be a role for gold. The total amount of gold mined since the days of Nefertiti is about 3.5 billion ounces. One billion ounces is in the central banks, more than another billion ounces is in jewellery, and the rest is in speculative hoards. This last holding is why Alan Greenspan says he looks at gold whenever he gets a chance. I look at three things for signs of inflation in the economy: I look at the money supply, I look at interest rates, and I look at gold. You can see this in the bond market. If there is a big outbreak in the price of gold, you know there is an increase in inflationary expectations and people will start to sell bonds, sending interest rates up. The stock of gold in the world is going to maintain itself as a viable reserve asset for a long time to come.
But I do not think that we will see the time when either of those two great economic powers, the United States and the European Union, will ever again fix their respective currencies to gold as they have in the past. More likely, gold will be used at some point, maybe in 10 or 15 years when it has been banalized among central bankers, and they are not so timid to speak about its use as an asset that can circulate between central banks. Not necessarily at a fixed price, but a market price.
The more countries start to think about gold as an index, as a warning signal of inflation, the more the monetary authority will try to keep the price of gold from rising. Imagine that tomorrow the price of gold rises from $350 to $400 (US). Don't you think that immediately the Fed will see that as a signal of an increase in inflationary expectations and the need to tighten? Europe has already done that. There are long periods when it appears Europeans have been stabilizing gold whenever the dollar has been depreciating against gold. This will be a major factor in moderating the exchange-rate fluctuations between these two great blocs. This is vital to Europe, because nothing could make Europe more uncomfortable than to have big fluctuations in the dollar-euro exchange rate. Looking at gold would be one way to circumscribe these fluctuations.
Gold is going to be a part of the structure of the international monetary system for the 21st century, but not in the way it has been in the past. We can look upon the period of the gold standard, the free coinage gold standard, as a period that was unique in history, when there was a balance among the powers and no single superpower dominated.
Let me just conclude with a final thought: Bismarck once said the most important event in the 19th century was that England and America spoke the same language. Let us hope that the most important event of the 21st century will be that the dollar and the euro learn to live together.
Robert Mundell, a Columbia University economist and recent recipient of the Nobel Prize in economics, delivered a longer version of this lecture at St. Vincent College, Letrobe, Pennsylvania, March 12, 1997.
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