Good as Gold

Just about a year ago, when the price of gold hit an all-time high ($1,900/ounce), I wrote a blog entry discussing this price and the United States' gold reserves relative to the U.S.'s money supply (see: Gold Bug). Now that the Republicans are considering reinstating the gold standard if Romney is elected (see: CNBC Story), I believe my previous analysis deserves to be updated.

Primarily due to the strength in the dollar relative to other currencies, the price of gold has dropped to $1,670 per ounce and Bernanke’s printing press has expanded the U.S. money supply over the last year by 8%+ to slightly above one trillion dollars. Assuming that the U.S. stock of gold still stands at 8,965.6 tons (I can’t seem to find an updated number), this would value our gold reserves at $479.1 billion … less than one half of what would be needed to fully back our current money supply at parity … if we were to go back to a gold standard.

What are the implications of the U.S. re-adopting the gold standard? I can think of three possible impacts:

1) In order to back our money supply at parity, the price of gold could double to almost $3,500 per ounce … and continue to grow at the rate of the United States’ currency expansion. (I think this is result is quite unlikely.)

2) The U.S. might chose to back its currency with a fractional conversion rate … say one ounce of gold could be purchased from the Treasury for $8,000. This option might also be restricted to U.S. citizens or institutions. Even though this would effectively be a gold backing of our currency, very few rational investors would exercise this option. But countries, like China, with huge dollar reserves might be so tempted … only they would have convert their dollar reserves to actual currency and to go through U.S. proxies … and thus would be selling their dollars at a very steep discount.

3) The U.S. dollar would then have the most solid backing of any currency in the world. I could easily see the Euro exchange rate fall to 2 Euros to the U.S. dollar. And China would also be hard pressed to keep its own currency from inflating greatly (a good thing). This should dramatically drive down the price of gold (and oil) … resulting in a continued positive feedback loop. A strong dollar, of course, could impact U.S. exports adversely but this could be offset, balance of payments wise, by our much lower payments for foreign oil … and a stronger Chinese yuan.

Going to a gold-backed dollar would clearly engender very complex financial cross-currents and I’m certain that I have just scratched the surface of possible outcomes. However, it is clear to me that the hay days of United States’ economic hegemony have corresponded to periods of a strong dollar. This might be an easy template to apply to a move back to the gold standard.