A fter 1914, the gold standard was given up and in the 1920s countries unabashedly resorted to unbridled fiat money resulting in hyper-inflation in a number of European countries. World War II resulted in the virtual demise of the sterling as a reserve currency, and since then the US dollar has held sway as the dominant international reserve currency.
August 1971 is a watershed in the international monetary system when President Nixon de-linked the US dollar from gold. A reserve currency which is not linked to gold necessarily has to become weak. For the next 40 years international monetary pundits felt that somehow the system of a reserve currency would remain stable through so-called international monetary co-operation. Economist Wilhelm Röpke, 60 years ago, said that the more countries talk about international co-operation, the less countries co-operate with one another!
Potential reserve currencies such as the yen and the euro wisely took conscious steps to ensure that their currencies did not become reserve currencies.
With the increasing significance of the emerging market economies (EMEs), it is being suggested that the BRICS countries (Brazil, Russia, India, China and South Africa) could emerge as reserve currencies. As a first step, the BRICS countries have been talking about settling bilateral trade and payments in their local currencies and undertaking pluri-lateral settlements among themselves. This would be disastrous and one hopes that saner counsel will prevail and these countries would not proceed with such scatterbrained ideas.
PRE-EMINENT ASSET
International monetary pundits are inherently averse to restoring the gold standard. The real question is whether they can prevent gold from becoming a pre-eminent international reserve asset.
Gold accounts for about 11 per cent of total international reserves. But this average conceals a skewed distribution among countries. A number of major countries have a very high proportion of gold in their reserves such as United States (80 per cent), Germany (69 per cent), France (60 per cent), Italy (70 per cent), Switzerland (43 per cent) and Netherlands (63 per cent). Among the major developed countries with a low proportion of gold are UK (15 per cent) and Japan (2 per cent).
EMEs which have witnessed a large accumulation of reserves in recent years, such as China, Russia, Taiwan, India, and Brazil, have a nominal percentage of gold in their reserves.
China, Russia, India, Mexico and Thailand have undertaken sizeable increases in their gold holdings in the last three years — this is a prudent policy. China increased its gold holdings from 600 tonnes to 1,050 tonnes and India increased its holdings from a little less than 360 tonnes to 560 tonnes. Gold still accounts for only 7.5 per cent of India's total reserves.
The major developed countries with a high proportion of gold reserves have reaped a bountiful harvest as much of their gold purchases were at prices as low as $35 per fine ounce. With the structural weakness of the US dollar as a reserve currency, the role of gold will become more important.
Countries with a low proportion of their reserves in gold would be well advised to gradually step up their proportion of the yellow metal. In recent years, the Reserve Bank of India (RBI), in a brilliant move, was the first country to undertake a large bulk purchase of 200 tonnes from the IMF; India should gradually increase its holdings of gold.
The International Monetary Fund (IMF) must give up its strong aversion for the precious metal. The SDR basket should include gold with an initial weightage of, say, 15 per cent and this should be progressively raised over the next five years to a third. Gold is no country's liability and it does not suffer the inherent disadvantages of other reserve currencies.
GOLD BACK IN VOGUE
Although a full restoration of the pre-1914 gold standard cannot take place immediately, there is an inexorable march to a gold standard.
Serious work on a return to gold is gathering momentum. In the US, the State of Utah has made gold the legal tender and 13 States are contemplating a move in the same direction.
The Washington D.C. based American Principles Project (APP), on the Gold Standard 2012, is an attempt to reach out to lawmakers to advance legislation to put the US back on to a gold standard. The APP has recently prepared a White Paper on the “Use of gold as the primary reserve asset by international central banks” by Ralph Benko, Charles Kadlec, Richard Danker and Nick Arnold (December 2010).
The Lehman Institute has also been in the forefront in the advocacy for gold. The Royal Institute of International Affairs (Chatham House, London) has set up a Task Force to Review the Role of Gold in the International Monetary System with Nick Maxwell as the Programme Manager.
Central banks the world over would do well to touch base with this broad-based work on gold and the early birds who recognise the role of gold in the international monetary system would be the beneficiaries.
(Disclosure: The author, an economist, is a member of the APP Advisory Board on the Gold Standard Project 2012. blfeedback@thehindu.co.in )