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Return to gold standard would be damaging, study group says

Section: Daily Dispatches

Why would anyone want to replace the current monetary system anyway?

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By Amanda Cooper
Tuesday, February 28, 2012

LONDON -- A return to the gold standard would be impractical and could even be damaging to the financial system, even though it can serve as a hedge against declining values of fiat currencies and plays a role as a reserve asset, a think-tank said on Tuesday.

The price of gold, which last year hit a record high above $1,920 an ounce and on Tuesday traded near $1,780, has been rising for the last 11 years, driven by widespread appetite for the metal including from central banks, whose purchases are at their highest for at least two decades.

Gold has gotten a boost since the financial crisis from Western central banks' attempts to reinvigourate domestic growth with near-zero interest rates and trillions of dollars in government bond purchases.

... Dispatch continues below ...


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A team of researchers at Chatham House, the London-based policy institute for international affairs, examined the potential for gold to play a more formal role in the international monetary system by looking at the four main ways in which it could do so: as an anchor, as a safe-haven, as collateral, or as a policy indicator.

They determined that as the dominance of the United States in the global financial system waned and other powers emerged, the likelihood for greater financial volatility and uncertainty would grow.

"In such an environment, gold is likely to continue playing a useful role as an effective hedge and safe haven. But despite gold's positive attributes, the evidence which emerged from the taskforce's deliberations led to the conclusion that in today's world there is little scope for gold to play a more formal role in the international monetary system," they said.

The end of the Bretton Woods agreement in 1971 decoupled national currencies from the gold price, allowing them to float freely as national central banks put independent monetary policies into place.

A return to using gold as an anchor would "undoubtedly be impractical or even damaging, given bullion's deflationary bias," the report said.

"In fact, a serious drawback is that a gold anchor can become particularly unstable precisely when a stabilizing force is needed most. As gold prices tend to rise when inflationary expectations and/or other risks in the fiat monetary system increase, the gap between the reference price and the market price is likely to widen at times of uncertainty," the report said.

"Although it is far from clear what is the 'right' price for gold, given the large volume of global money in circulation, the disadvantages of using bullion as a monetary anchor are clear: a return to a gold standard could inflate the price of gold significantly, while restrictions on money supply growth could provoke a severe downturn in the growth cycle of global economies."

Gold has a role to play as a reserve asset and as a hedge against the declining values of fiat currencies, but it also carries inherent risks due to the price volatility of bullion and its lack of yield.

"Gold can therefore have some utility in a portfolio of assets by spreading valuation risk but would not be very effective as a sole reserve asset," the report said.

According to the World Gold Council, an industry group, central banks bought nearly 440 tonnes of gold in 2011, more metal than at any time since the end of the gold standard, as they sought to cut the amount of foreign reserves that they hold in U.S. dollars or euros.

Even though the Chatham house taskforce said gold had a role to play in a reserve portfolio, it said there was little evidence that including gold in the International Monetary Fund's Special Drawing Rights (SDRs) basket of currencies would prove effective.

The IMF's SDR basket is not a currency itself and is only used as a reserve asset by central banks. It is backed by currencies that are freely traded and at present includes the U.S. dollar, the pound sterling, the euro and the Japanese yen.

The IMF said in November it was considering dropping the requirement for currencies to be "freely usable" to be part of the SDR basket but did not mention including gold.

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