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A recent proposal by Republicans in the U.S. to examine the feasibility of a return to the gold standard –wherein the amount of dollars to be printed would be restricted by the supply of gold on hand – has sparked a furious debate among economists and the media.Ben Bernanke had a big takedown of the gold standard in a lecture back in March. UBS economist Paul Donovan also explained in a recent note to clients why the gold standard wouldn’t work in a modern economy.
Even Republicans themselves seemed to think a return to the gold standard wouldn’t work when they looked into it 30 years ago.
But Deutsche Bank analysts Daniel Brebner and Xiao Fu argue that, on the contrary, a gold standard is perfectly compatible with the workings of the modern global economy. In a new report, they explain why critics of the gold standard have it wrong.
Furthermore, the analysts suggest that perhaps it’s not such a bad idea, because “it would dramatically change the way that governments manage their economies – which some would say is a good thing given the results of their management skills thus far.”
The two big arguments that Brebner and Xiao choose to target are that there is insufficient supply of gold to back today’s currencies and that there is insufficient growth in the supply of that gold to keep up with the pace of a growing and globalizing world economy.
The analysts call the first argument – that there’s not enough gold – a “spurious” one, because the government could in reality ascribe any value they choose to an ounce of gold when returning to a gold standard. In this regard, according to Brebner and Xiao, “gold is infinitely divisible.”
The second charge by critics – that the growth of the gold supply isn’t growing quickly enough – is more serious. Nonetheless, the analysts consider it “fallacious” and say it “shows a certain lack of humility.”
The reason is because much of the economic growth the U.S. has experienced, according to Deutsche Bank, is really only accounted for by credit growth, which needs to be stripped out.
Here is their explanation of how they do this to arrive at an estimate of how fast the gold supply would actually need to grow in order to support actual economic growth:
We start by using general metrics for economic activity. There are several, including GDP and trade figures. The difficulty however is stripping out the impact of significant credit growth on these figures to get the genuine, unassisted, growth for a specific economy. For example, over the past 32 years real US GDP has averaged 2.7% (CAGR). Over the same time frame the US population has grown by 1.1% on average. On this basis average US GDP growth after a population adjustment is around 1.6%. Of this rate, what has been the debt contribution to growth? If, to keep things simple, we assume that credit has contributed roughly 0.5% per year, this leaves an average 1.1% per annum increase in value or productivity for the US. For this reason we believe that humility is a necessity – there is considerable evidence to suggest that the impressive growth rates and productivity advances experienced over the past several decades have been temporarily boosted by the assumption of unprecedented quantities of debt, on a global level. Perhaps we are not the geniuses we think ourselves to be.
On this basis our expectation would be that the US would need to grow its monetary base by only about 2.2% or so.
However, Brebner and Xiao admit that long-term growth of the gold supply has typically been closer to 1.6 per cent per year. Thus, there is still a 0.6 per cent gap in economic growth, by their calculations, and gold supply growth.
However, the analysts remind that “the exact value is still determinable by government” and suggest that “in fact periodic valuation adjustments for gold could conceivably be an ongoing option…thus a low growth rate in gold volumes could be offset by a small revaluation of the metal itself, thereby preventing deflationary price pressure in an economy.”
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