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Neil Reynolds: Paper currency has too much bull, not enough bullion

Section: Daily Dispatches

Maybe that's because the bullion really isn't in central bank vaults anymore.

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By Neil Reynolds
The Globe and Mail, Toronto
Tuesday, October 25, 2011

Sir Mervyn King, governor of the Bank of England, ordered up another US$300 billion in easy money this month, then mentioned, by way of explanation, that we are living through the most serious financial crisis since the Great Depression -- "if not," he said ominously, "ever." Sir Mervyn's warning was only marginally more sobering than the collective warnings of Prime Minister Stephen Harper, Finance Minister Jim Flaherty, and Bank of Canada Governor Mark Carney.

This is not to mock. These men know enough not to scare people out of their wits unless it necessary to do so. So the question is: What do these people know that the rest of us don't?

To put Sir Mervyn's warning into its historical perspective, it must be noted that "ever" goes back a long way. The biblical record cites one calamitous meltdown 4,000 years ago, "when money failed in the land of Egypt." Did Sir Mervyn deliberately or inadvertently include the financial crashes of antiquity in his portentous warning? Isn't it the failure of money that now threatens the world?

... Dispatch continues below ...


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The governors of major central banks shouldn't use apocalyptic language without providing a little more detail. Why the Delphic utterances? Were they a sell signal for stocks? Were they a buy signal for gold? Whatever else you think of gold, it holds its value in times of tribulation. During the Babylonian reign of King Nebuchadnezzar, 2,500 years ago, an ounce of gold (it is said) purchased 350 loaves of bread. The same ounce of gold still bought 350 loaves (at $2 a loaf) in the 1980s (when gold sold for $700 an ounce).

This is superficially interesting but, by itself, means little. What about every other product in the Babylonian supermarket? As a matter of fact, an ounce of gold today does buy 800 loaves (at $2 a loaf). This is a better performance than paper. In 1900 one dollar bought 14 loaves of bread; in 2010, it bought 16 slices from one 20-slice loaf.

The London-based World Gold Council cites a more relevant example of gold's ability to preserve value. Between June 2007, when the financial meltdown began, and June 2009, when it bottomed, gold prices increased 40 per cent (in U.S. funds). In contrast, financial stocks fell 60 per cent and the S&P 500 fell 40 per cent. U.S. Treasury bonds, the safe hideaway for panicked investors, increased 20 per cent -- providing only half the protection of gold.

The solution appears obvious, although it's probably too late to help with the world's worst financial crisis ever: Add some gold to the paper.

You don't need to believe that gold will solve the world's economic problems. It won't. But it might help paper hold some of its value. The lesson of 2007-09 is instructive. A gold component to paper currency -- as mused briefly a year ago by the Group of 20 -- would slow the disintegration of fiat money. (World Bank president Robert Zoellick caused a stir when he publicly proposed that the G20 bring gold back as "an anchor" to the global monetary system -- a proposal Russia, for one, endorsed.)

Oddly, Sir Mervyn favours quantitative easing (QE) over gold. QE can be defined as easy money and lots of it. Who would willingly exchange $1,600 in QE paper for an ounce of physical gold? QE debt just doesn't do it. Gold has a track record that paper can't touch. In 1717 Sir Isaac Newton, England's Master of the Mint, pegged the price of gold at roughly $6 an ounce -- a price that held (war years aside) for 200 years.

Gold is unique. It is no one's liability. It is no one's debt. It is no one's promise. It simply is what it is. As the World Gold Council notes, gold creates no credit risk, no inflation risk, and no debasement risk. Yet our central bankers unequivocally prefer printed paper with its certain risks and frequent debasements.

In his classic 1977 work The Gold Constant, Roy Jastrow, a professor of business administration at the University of California (Berkeley), noted that Great Britain's wholesale price index, expressed as 100 in 1717, still stood at 100 in 1930. Separated from gold, the index then increased by 2,000 per cent in less than 50 years, when (you might say) money failed in lands of plenty.


Neil Reynolds is a columnist for the Globe and Mail.

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