The New Gold - I

The global monetary system needs a financial and technological innovation.

In his book ‘The Power of Gold, the history of an obsession’, Peter Bernstein looked at gold from a historical aspect. From the start of Egyptian era in 3100 BC when Pharaoh’s ruled to the Roman Empire, the author illustrated how gold slowly and steadily became the real money.

The current stage of gold also gives it an aura, but this time it's the public that has been enamored by it not the central bankers. I don't know how Robert M. Solow will connect gold with economic growth, but just like Benjamin Disraeli, he would say, "Gold is not a cause of growth but a consequence of it."

Solow proved that only technological progress leads to real growth. A closer look at Bernstein’s history from a Solowian perspective based on technological innovations and other financial innovations reveals interesting aspects about gold.

Travel, Technology, Innovation: If it was not for the bold Spanish and Portuguese explorers, the golden benchmark for money would not have reached Europe. It was this innovation that opened up flood gates for trade, ransom for kings and for obsession. Some technological innovations came much before their time like Hien Tsung’s (860-21) introduction of paper money. This innovation was early, as trade innovation was still in its infancy and the amount of global gold tonnage and production was still less.

Minting Innovation: Bank of England could not have become the global financial centre if it was not for the minting innovations. Bernstein mentions that once the horses were so busy, £700 was paid to clear up their manure. It took metal rolling, stamping, milling the coin edges and evolving currency and bimetallic systems before Europe could overcome clipping, supply and measurement problems.

Banking and trade innovation: It was the banking and trade innovations owing to the acceptability of legal paper tenders first issued by Tsung. This was also the reason trade and currency wars took prominence as gold fixed era started to control political issues. It was trade at the heart of issues when Charles de Gaulle voiced his concerns regarding the policies of the then upstart nation USA. It was also banking and trade innovations that muddled the view for Hoover. J Pierpont Morgan on more than an occasion used financial innovations for America and European countries.

Keynes and Nixon: In 1925 Keynes argued against a return to the gold standard after the war. He said that it was no longer a net benefit for countries such as Britain to participate in the gold standard, as it ran counter to the need for domestic policy autonomy. It could force countries to pursue deflationary policies at exactly the time when expansionary measures were called for to address rising unemployment. The Treasury and Bank of England were still in favour of the gold standard, which had a depressing effect on British industry. Keynes responded by writing ‘The Economic Consequences of Mr. Churchill’ and continued to argue against the gold standard until Britain finally abandoned it in 1931.

Nixon had the courage to detach dollar from the gold standard. By the time Nixon took office, US gold reserves had declined from $25 billion to $10.5bln. Gold was an underpriced commodity, as the dollar was overpriced as a currency. The United States was on the verge of running its first trade deficit in over 75 years. Nixon’s decision (financial innovation) was the main reason for dollar getting competitive and a strong alternative to dollar for almost three decades. Dollar prominence gave paper money the credibility it has today as a value for money.

Market Innovation: Robert Mundell's currency innovation in terms of Euro has worked till now. Free trade innovations allowed gold mining companies to trade and hedge their gold risk with central bankers who wanted to reduce their large gold reserves. Market innovation was also the reason gold became a widely traded investment alternative for the public at large. And this brings us to 2010 QE1, QE2, historical low interest rates and a situation desperately looking for a new technological and financial innovation.

The new gold: What is on offer? Mundell's global currency? The failure of Euro as a regional currency punishes the group for the excesses of few members. Gold as a value of money has assumed mass fascination giving risk management a volatile meaning. Above this storage and delivery remains a cumbersome issue. Bernstein’s indifference (being the best economic historians of his time) to connect history with cyclicality (seasonality) does not help us find a solution. Peter details Schumpeter, Jevons and other cyclists but not even once mentions the visible cyclicality in the growth and decay of popularity in gold. So what to do? What markets need is a new gold, a new financial innovation, a new currency that averages the strength, weakness and volatility of the current major currency pairs. A stable currency system is what we need to come out of this currency wars. Can it be done? How should we trade it? On the exchange or over the internet? But before everything you need to measure your obsession for gold.

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