Bloomberg News

Gold’s Use to Back Value of Dollar Would be Impractical or ‘Even Damaging’

February 27, 2012

Gold’s use to back the value of the dollar would be impractical and there is little scope for the metal to play a more formal role in the international monetary system, U.K. research institute Chatham House said.

While a higher gold price may reflect a lack of confidence in key currencies and low returns on other assets, there’s no consistent correlation between bullion and economic variables that could be used to inform policy decision making, according to a task force that discussed possible roles for gold. The metal can be used to hedge against currency devaluation and other risks as part of a portfolio, but not on its own, it said.

Richard Nixon, the former U.S. president, abandoned the Bretton Woods arrangement four decades ago. Between 1968 and 1971, the metal and the dollar were officially exchanged at a fixed rate after the system had tied gold at about $35 an ounce, according to the World Gold Council. Central banks are expanding bullion reserves for the first time in a generation as prices gained for 11 consecutive years, reaching a record in September.

“Reintroducing gold as an anchor would undoubtedly be impractical or even damaging, given bullion’s deflationary bias,” the task force, which held discussions over eight months, said in a report today. “Gold can serve as a hedge against declining values of key fiat currencies, and can also be useful for central banks looking to diversify their foreign reserves.”

Gold Standard

While the gold standard may no longer exist, nations and international organizations still have 30,877 metric tons of bullion reserves, valued at about $1.77 trillion, according to the London-based council. Gold for immediate delivery reached a record $1,921.15 an ounce in London in September.

The dollar has been the world’s reserve currency since the U.S. and allies agreed at the 1944 Bretton Woods conference to peg it to a rate of $35 an ounce of gold. It remained the most- traded legal tender after global currencies began freely floating in the early 1970s. The greenback dropped 12 percent against a basket of six major currencies since March 2009. The U.K. suspended the gold standard in 1931, Chatham House said.

“Greater discipline on financial markets might have been helpful in inhibiting the reckless banking and excessive debt accumulation of the past decade,” the task force said. “However, with the onset of the global crisis, had gold had a more formal role to play, the rigidity it imposes might also have been a handicap when a more flexible policy response was required.”

SDR Inclusion?

Including gold in the International Monetary Fund’s Special Drawing Rights system probably wouldn’t bring substantial benefits, and adding developing economies’ currencies to the basket would be more desirable, according to the task force. SDRs were created in 1969 and are an artificial currency that IMF members use to settle accounts with each other and can be converted into hard currencies.

Chatham House was founded in 1920 and is based in London. Members of the gold task force include Gerard Lyons, chief economist at Standard Chartered Plc, Meghnad Desai, professor emeritus of the London School of Economics and a member of Britain’s House of Lords, and Catherine Schenk, a professor of international economic history at the University of Glasgow.

“For gold to play a more formal role in the international monetary system, it would be imperative for it neither to hamper the system’s performance nor to create unacceptable constraints on national economic policies,” the task force said. Gold may “continue playing a significant role in the international monetary system, serving as a valuable hedge and safe haven, particularly in times when tail risks predominate.”

To contact the reporter on this story: Nicholas Larkin in London at nlarkin1@bloomberg.net

To contact the editor responsible for this story: Claudia Carpenter at ccarpenter2@bloomberg.net


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