Is the World Poised to Embrace Gold?

Sporadically heard "exit strategy" scenaria there may be. They even include voices in favour of rises in interest rates from both sides of the Atlantic. The "consensus", however, remains intense that urgent big government spending is still needed, mainly in the U.S. and to a lesser extent in Europe, in order to confront the leading culprit of today's woes: namely, the purely behavioural phenomenon of diminishing confidence and growing uncertainty worldwide.

Even looking back at the great and the good of this world, also known as the G20, or a kind of stumbling prototype for world governance, they certainly emerge after several annual meetings largely responsible for this kind of policy and indeed less well versed in behavioural economies than might be expected. Needling doubts consequently surround the longer-term value of the U.S. dollar together with mounting anxiety about the status of the United States as the dominant force in the global economy.

Always deferring the ultimate resolution of the crisis for another day, we are today for example presumed to welcome as progress a recent messy and painful bipartisan agreement in the U.S. to extend the Bush Administration's tax cuts at all income levels for the next two years - only made possible under the threat of even more unpalatable challenges ahead.

In the circumstances, the U.S. budget deficit for the current fiscal year has quadrupled to $1.75 trillion. This is more than 12 percent of GDP and the highest level since World War II. A quantum jump keeping up with the awesome $3.6 trillion of deficit spending the administration is actively pursuing.

Equally disturbing is Great Britain's debt. It has reached a hitherto unimaginable level smashing the ₤1 trillion barrier for the first time - and is currently standing at ₤1.000.389.000 and rising. The relative enormity of this figure means that Britain must pay ₤40 billion in interest this year alone - roughly what is spent on the entire defence budget - borrowing at present ₤450 million a day.

Unthinkable? Not really, and recently made possible, in fact, with dazzling dexterity. By means of an unprecedented and expediently contrived artifice: known, somewhat esoterically, as Quantitative Easing. Which in plain English means that a central bank, such as the U.S. Federal Reserve or the Bank of England, "purchases" as it sees fit astronomical amounts of long-term Government and corporate debt, freely printing money and pumping it at will to the wider economy.

The entire process involves no particular checks or balances - so that a central bank this way becomes capable of literally flooding the system with (presumably stimulatory) liquidity. A slapdash manoeuvring that has become supposedly the sovereign remedy or universal cure-all, especially in the U.S., for ostensibly reviving growth and also addressing the high level of unemployment in the economy. Hence, too, the recent unveiling of the Federal Reserve's controversial plan, QE2, on Wednesday 3 last November, to buy an additional $600 billion U.S. Treasuries through June "in order to spur growth" in the United States.

But, after tens of billions of dollars in bank bailouts, hundreds of billions in fiscal stimulus and trillions more similarly produced in terms of such quantitative easing as QE1, wasn't last year supposed to be the year of resumed growth - and, more to the point, the year we were told that both the UK and U.S. economies would be rescued for good? No such luck, I am afraid.

And as if, after testing and indeed experimenting at so staggering a scale (that all Research Institutes in the world put together probably wouldn't even begin to fathom) were not evidence enough to discredit the entire hypothesis of QE2, the Fed encouraged by the Administration has nevertheless proceeded to print even more money. With a flick of the computer the "easy" way. Unmoved as well by the withering international criticism it has drawn for a beggar-my-neighbour policy which overtly undermines the dollar while driving up exchange rates in the rest of the world - but also forgetting in the process the global obligations that America's economic status dictates.

And so, back to the drawing board for the rest of us. Because lack of confidence, in terms of prolonged stagnation and persisting consumer and investor uncertainty, still reigns supreme. Certainly in the U.S. housing market first and foremost - where prices are now predicted to decline in 2011 by as much as 10 percent, as a record number of distressed properties floods the market.

It is a repeat condition, after all, that implies a multi-faceted behavioural state of mind. In fact, more of mind and less of one's pocket - considering that prevailing levels of confidence are the end product these days of a kaleidoscope of broader and more strenuous aggregate decision-making processes than ever before. And that consequently the issue becomes too complex or volatile in an unpredictable world (infested as well with widespread scams and swindles of all kinds) to presume it can be decisively manipulated or otherwise controlled by simply flooding the system with liquidity - of dubious origins at that. Meanwhile the annualized rate of consumption growth has been revised downward to 2.4 percent by the U.S. Bureau of Economic Analysis as business inventories continue to build.

The above key behavioural conditions unfortunately remain to date practically unexplored. Let alone, too, that with approximately 30 trillion dollars worth of economic activity in the U.S. over, say, the next two years, even the proposed extra ration of $600 billion the Administration apparently also believes the U.S. economy now needs in order to recover (whether as a stimulus package or a spending spree is unclear) hardly amounts to much.

Other, of course, than adding to the growing forces behind what might reasonably be described as the U.S. dollar's gradual demise under benign neglect. Predictably singing from the same hymn sheet of almighty quantitative easing, the Administration itself appears unperturbed by the adverse effect that such an unimaginative stance imposes on current expectations (which virtually shape the unfolding economic landscape of tomorrow). Literally stuck with the G20 motto of "unprecedented, comprehensive and co-ordinated" government spending - known historically to involve processes often immersed in corruption - it has largely given carte blanche as well to the generally falling markets (subject periodically to their classic "dead-cat-bounce" intervals), to go on discounting unchallenged even the possibility of an eventual implosion of the U.S. dollar.

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There is still hope, however, notwithstanding the celebrated claim recently made by Professor Stiglitz, the Nobel Prize Laureate in Economics, in a public lecture at the University of Geneva, that "the U.S. dollar is no longer a reliable store of value". Heaven forbid! An unrealistic exaggeration, apparently shared equally prematurely by the President of the World Bank, Robert Zoellick, who has subsequently not quite exonerated himself "looking beyond Bretton Woods" for a multi-currency exchange system "employing gold as an international reference point" of sorts - all wrapped up in luminous fog, as it were, of his own making and further confusing the issue alluding to an altogether impractical return to the gold standard per se (Financial Times, 7 November 2010).

With everyday world trade entrenched in U.S. dollars and global banks still holding over two thirds of their reserves in dollars, the reserve currency status of the U.S. dollar - however tarnished under a whole variety of unauthentic influences so far - is nevertheless bound to survive. And not only. Because, if at this critical stage the American currency is revived in terms of the positively innovative influence of partial convertibility to gold, this will work wonders for the U.S. economy, naturally promoting over time sustained world recovery.

In fact, unless the U.S. dollar is first made partially convertible to gold - anywhere between 5 and 10 per cent of its market value would probably suffice as a minimum sensibile or smallest secured percentage - confidence in the dollar and in the U.S. economy as a whole will continue to dissipate. With further accelerating job losses and probably social unrest next.

Pure quantitative easing and an essentially unchecked process of printing money, impervious to the system's internal network of behavioural complexities and regardless of the level of interest rates, is simply no longer an option. Merely covering massive politically determined deficits could prove lethal in the end. Probably with some adventitious inflationary finale in store for us, despite the routine disclaimers on the (still cryptic) threat of inflation by the Federal Reserve and other central banks.

For example, the Bank of England already faces an acute policy dilemma, with its latest forecasts predicting inflation will hit 4 percent by the spring - higher than it expected just one month ago. Evidently needed now is an additional behaviourally oriented precautionary monetary measure as the only non-inflationary pragmatic stimulus capable of shaking off the persisting economic inertia. That is to say, seeking to determine, as a necessary and sufficient condition for restoring confidence worldwide, the optimal minimum sensibile or threshold-sensitive range of partial convertibility of the U.S. dollar to gold, with essential behavioural considerations and relevant theoretical detail naturally inherent in eventual policy.

It is fortunate, of course, that as opposed to other countries that have recently squandered their gold reserves, most notably Great Britain and Switzerland among them, the United States has wisely kept intact every single ounce of its almost 9,000 tons of gold stock. This favoured position means that the U.S. can now activate these vast gold reserves freely "monetizing" at will its stock by gently linking the dollar to gold.

If necessary, access to supplementary gold bullion would always be possible in the open market given that the world's stock of gold actually available today above ground is close to 160,000 tons. Virtually indestructible, all the gold that has ever been mined always exists in some solid form - and could therefore be easily mobilised. Along with the large additional reserves, if need be, physically available under the ground.

However, as diminishing confidence and growing uncertainty defiantly float about nowadays on our veritable oceans of dormant liquidity and widely unused excess reserves in the banking system, more disturbing here is the realisation that international investors, who so far have been willingly financing bulging U.S. deficits, are steadily beginning to distance themselves from the dollar: systemically eroding the relative attractiveness as well of most US dollar-denominated assets.

China, for example, known to have bought over $2 trillion in American debt, is already starting to keep more and more of its money at home in order to stimulate domestic recovery - promising at the same time to start buying into the rising debt of European countries as an act of "solidarity and goodwill". And as a stark reminder of Beijing's by now established economic reach in the world, Chinese lending has hit new heights with its own funding to poor countries exceeding that of the World Bank.

So today's official verbal assurances to the Chinese that the value of the U.S. dollar is safe cannot be particularly convincing: also considering the way exchange rate antagonisms are currently developing. Japan as well, the world's third largest economy in retreat and largest holder of U.S. Treasury bonds, is equally noticeably beginning to move away from the latter and in favour of quality corporate bonds. If this critical shift in international sentiment is intensified, other extraordinary challenges may even begin to destabilize the U.S. administration in the near term.

Against this intimidating background, a modest yet meaningful link of the U.S. dollar as indisputable reserve world currency to gold at prevailing prices - fluctuations notwithstanding - would at once produce an enormous psychological boost to consumer and investor confidence everywhere: offering a timely opportunity to be in dollars and effectively buy U.S. assets. Again, this will be a sensitive level to establish as the right stimulatory signal to sagging confidence and lingering uncertainty worldwide - and as stubborn resistance thresholds remain critically active in the U.S. economy.

Hardly an impossible task, however, and thereby facilitating a routine absorption internationally of the gigantic, and still rising, American debt and thus improving prospects for an imminent economic recovery worldwide. For who in their right mind would dump the dollar in such circumstances and as the marginal propensity all over the world to invest in the U.S. soars?

The perception that one - or, say, any sovereign fund - could practically access an optimally appreciable percentage of gold ounces on dollar balances held anywhere in the world would certainly make everything American emerge as singularly attractive - if not irresistible. And, as the total value of the U.S. gold reserves would rise, with the inevitable increase in the price of gold, the viability of the entire process would commensurably solidify.

What is proposed may appear "old hat" to some. It is not, of course. But I would gladly concede that old-fashioned medicine often works best. Compared to the mixed bags of one kind or other of "rescue billions-cum-trillions" ineffectively expended so far, beginning with the perennially disputed original Paulson $700 billion "bail out" plan a few years ago, which also sparked off the principal nosedive of the world's markets, this relatively simple approach seems worth pursuing. Hopefully, the U.S. President's Board of personal economic advisors will be receptive to this kind of benign, basically behavioural and reasonably anti-inflationary thinking - helping to develop it further in open debate.

With America on the march the rest of the world will happily follow.