Gold Standard


The New York Times had blog commenting on the suggestion that we should return to a gold standard. (NYT Back to the gold standard)

My question about such a proposal is what should be the price of gold in the new gold standard ?

The 18th century gold standard system that so many people view as a free market alternative to central banks determining credit conditions, money supply, etc., was not really a free market.

The system was dependent on the central bank, in this case the Bank of England and later the US Government offering to buy all gold tendered to it at a price established by the government. Moreover, that price had to be far above any foreseeable market clearing price.
If it was less than any foreseeable market clearing price the banking system could not accumulate the gold stocks necessary for the system to work. If the price was too low private individuals would see it as a one way bet to accumulate gold stocks, much as they did in the 1960s.

Many economist, including Robert Mundell believe that the supply of gold at the price of $21/oz. was too low and that this together with the French and the US holding too large a share of the gold stocks was the fundamental driving force behind the 1929-33 world wide depression. Yes, Bernanke blamed the depression on the central banks, but they were just following the rules the gold system imposed on them. The depression ended in each advanced countries soon after each left the gold standard. Moreover, Roosevelt did much to end the depression when he arbitrarily raised the price of gold to $35, increasing the world supply of gold by two-thirds.

In the 1960s the problems of an inadequate supply of gold reemerged and Nixon solved the problem by setting the price of gold free to be set by the market. In 1969 there were no significant central bank purchases or sales of gold so the 1969 price of around $39 probably was a good market clearing price that balanced the supply of gold and the non-monetary demand for gold.

Of course in a free market there is no reason for the price to remain stable and in the early 1970s I conducted a major study of the supply and non-monetary demand for gold –industrial, jewelery and hoarding in the less-developed countries like India and China.
Given the price elasticities of demand and supply — including the point that the single largest supplier of gold, South Africa has a negative price elasticity of supply. That is, when the price of gold goes up South Africa produces less gold. This happens because they are trying to maximize the life of the mines and when the price of gold rises they shift to mining poorer
quality gold veins.

In that study I concluded that to balance the supply and non-monetary demand for gold the real price of gold would have to rise at a 3% to 5% annual rate. Since then many things have impacted gold markets including the Russians selling their gold stocks, other central banks selling gold, technological improvements in gold mining, Japanese stagnation, India legalizing private gold holdings and gold imports — in the 1970s the most important industry in Dubai was smuggling gold to India — and the emergence of China as a major market.

But if since 1969 the real price of gold had risen at a 3% annual rate that would generate a current price of some $900 and if the trend growth rate had been 5% the current price would be about $2,225 as compared to the current market price of $1400.

Given these trends I would conclude that to reestablish a new gold exchange standard probably would require a gold price of about $5,000.

I wonder if any of those talking about reestablishing a gold standard have though about the implications of this analysis. If people are scared of the inflationary impact of QE II, what would they think of reestablishing a gold standard with the price of gold at $5,000. In addition, the central banks would also always have the power to raise the price of gold anytime they desire.