CHATHAM House yesterday launched a report on the role of gold in the international monetary system. It is a noteworthy event, not least because the group's last study on the issue was in September 1931, just as Britain was about to leave the gold standard, accelerating the system's demise (Keynes was on the original working group).

It seems a subject that is at least worthy of consideration, not least because central banks the world over are pursuing policies that would, in earlier decades, have been considered highly unorthodox. In recent days, I have ben struck by the number of investors who have told me that central banks have "thrown in the towel", citing the ECB's three year loans to banks (another €530 billion accepted today), the Bank of Japan's stepped-up commitment to QE, the extra £50 billion pledged by the Bank of England, the willingness of the Swiss to create money to cap their exchange rate and so on. The investors see all this as bullish for real assets, like equities, but potentially inflationary in the medium term.....

Silver Settles At 19-Month Low

The carnage in commodities has now pushed silver to a 19-month low. But as ETF Trends’ John Spence notes, there’s no visible rush for the exits from the iShares Silver Trust (SLV), the popular exchange-traded fund tracking the metal. Not at this point.

We may be getting close to dangerous territory, though. Michael Shaoul of Marketfield Asset Management predicts that if silver can’t hold $26 — that’s 22 cents from current levels — then financial investors (e.g., ETF holders and other non-industrial buyers) could push this market into a truly nasty torpor:

The gold standard has returned to mainstream US politics for the first time in 30 years, with a “gold commission” set to become part of official Republican party policy.

Drafts of the party platform, which it will adopt at a convention in Tampa Bay, Florida, next week, call for an audit of Federal Reserve monetary policy and a commission to look at restoring the link between the dollar and gold.

The move shows how five years of easy monetary policy – and the efforts of congressman Ron Paul – have made the once-fringe idea of returning to gold-as-money a legitimate part of Republican debate.

Marsha Blackburn, a Republican congresswoman from Tennessee and co-chair of the platform committee, said the issues were not adopted merely to placate Mr Paul and the delegates that he picked up during his campaign for the party’s nomination.

“These were adopted because they are things that Republicans agree on,” Ms Blackburn told the Financial Times. “The House recently passed a bill on this, and this is something that we think needs to be done.”

The proposal is reminiscent of the Gold Commission created by former president Ronald Reagan in 1981, 10 years after Richard Nixon broke the link between gold and the dollar during the 1971 oil crisis. That commission ultimately supported the status quo.

“There is a growing recognition within the Republican party and in America more generally that we’re not going to be able to print our way to prosperity,” said Sean Fieler, chairman of the American Principles Project, a conservative group that has pushed for a return to the gold standard.

A commission would have no power except to make recommendations, but Mr Fieler said it would provide a chance to educate politicians and the public about the merits of a return to gold. “We’re not going to go from a standing start to the gold standard,” he said.

The Republican platform in 1980 referred to “restoration of a dependable monetary standard”, while the 1984 platform said that “the gold standard may be a useful mechanism”. More recent platforms did not mention it.
Any commission on a return to the gold standard would have to address a host of theoretical, empirical and practical issues.

Inflation has remained under control in recent years, despite claims that expansion of the Fed’s balance sheet would lead to runaway price rises, while gold has been highly volatile. The price of the metal is up by more than 500 per cent in dollar terms over the past decade.

A return to a fixed money supply would also remove the central bank’s ability to offset demand shocks by varying interest rates. That could mean a more volatile economy and higher average unemployment over time.

The Republican Party’s idea to relook at the gold standard is ludicrous and nonsensical, and is simply a plan put forward by the political opposition to score points, according to analysts.

The Financial Times reported on Friday that the Republican Party plans to set up a commission to look into re-establishing the link between the dollar and gold as part of its platform to be unveiled at the party convention in Tampa Bay, Fla., next week.

But analysts told CNBC that the idea would not work.

“I think it’s absolutely nonsensical,” Moorad Choudhry, head of treasury at the corporate banking division of the Royal Bank of Scotland told CNBC Friday. “There’s a very good reason they unhooked it in 1971, because their deficit didn’t enable them to maintain it with the supply of gold. In fact, is there enough gold in the world to back the U.S. debt?”

U.S. federal debt grew to $15 trillion at the end of 2011 from around $400 billion in 1971.

The Richard Nixon administration originally broke the link between gold and the dollar in the early 1970s amid surging inflation (learn more), rising costs from the Vietnam War, and an oil crisis.

Before that, fixed amounts of gold were directly convertible to the U.S. dollar and vice versa. That meant money supply theoretically was limited by the amount of gold backing it, and exchange rates were based on the difference in price for an ounce of gold between the dollar and a foreign currency.

“The idea for the U.S. economy is fiscal retrenchment, but it isn’t the gold standard,” Choudhry said, adding that the U.K. tried the same idea in the 1920s to no avail.

“The U.S. deficit since 1971 is exponentially greater in size and it’s not possible now, whether you want to fight inflation, whether you want to fight fiscal control, gold standard is not the answer.”

Ralph Silva, director at Silva Research Network, told CNBC that when politicians were in opposition they could say “some ludicrous things.”

“Back in the ’50s and before that, when you were making economic decisions on a quarterly basis you could move slowly. You’ve got to make decisions on a quarter-of-a-second basis here, and having a gold standard doesn’t allow you to make those changes as quickly,” he told CNBC Friday.

Silva said however that a gold standard would benefit Canadian and South African gold miners, as there simply wasn’t enough of the commodity available to back the money supply.

But the Republican proposal may not come to much. In 1981, for example, former U.S. President Ronald Reagan created a “gold commission” which decided not to go back to the gold standard.

Mary Jo Jacobi, former special assistant to President Reagan and Assistant U.S. Secretary of Commerce for President George G.W. Bush, told CNBC that a lot of the Republican Party faithful are keen to look at the adoption of the gold standard.

However, she couldn’t confirm it was an idea put forward by Mitt Romney’s newly announced running mate, Paul Ryan.

“As I understand it there is an ‘audit the Fed’ plank in the Republican platform that was drafted yesterday,“ she said, suggesting that the GOP are planning to scrutinize the U.S. Federal Reserve (learn more) as a key part of their election manifesto.

“What the commission will be able to do is look at all of the issues big and small,” she said. “Utah accepts gold now as a medium of exchange, so what do you do about all the gold that’s out there when you have the federal government, the central bank holding it?”

Jacobi accepted that in the short term a return to the gold standard would be highly destabilizing, despite it being designed to naturally control government spending. She also conceded that in the short term it may mean more volatility and unemployment (learn more), as the central bank wouldn’t be able to vary interest rates in certain situations.

Both analysts, Choudry and Silva, said the key goal for the U.S. should be fiscal discipline with the economy set to be the key issue in this November's presidential election.

“I’m always intrigued how (Paul Ryan’s) prescription for cutting public expenditure looks at things like medical care and things like that, not at say the defense budget,” Choudhry said.
“You could pull out of Afghanistan and save yourself a few hundred billion dollars a year. We didn’t have to fight wars through the last ten years and spend maybe a trillion on that.”

An under-reported development of this campaign season is the Republican Party's decision this week to send Gov. Mitt Romney into the presidential race on a platform effectively calling for a new gold commission. The realization that America's system of fiat money is part of its economic problem is moving from the fringes of political discussion to the center.

This is a sharp contrast from the last time a gold commission was convened, in 1981, a decade after President Nixon abandoned the Bretton Woods system and opened the era of a fiat dollar. The 1981 commission recommended against restoring a gold basis to the dollar. But two members—Congressman Ron Paul and businessman-scholar Lewis Lehrman—dissented and outlined the case for gold.

The new platform doesn't use the word "gold," describing the 1981 United States Gold Commission as looking at a "metallic basis" for the dollar. But the metal was gold, and the new platform calls for a similar commission to investigate ways "to set a fixed value for the dollar."

What has stayed with me from 1981—I covered the commission as a young editorial writer for this newspaper—is how momentum for a new gold standard faded amid the successes of the supply-side revolution. President Reagan pushed through his tax reductions and Federal Reserve Chairman Paul Volcker maintained tight money. Inflation was defeated. The value of the dollar, which had sunk below 1/800th of an ounce of gold during President Carter's last year in office, soared.

The 1981 commission was also stacked against a gold-backed dollar from the start. The ruling philosophy was monetarism—which, as propounded by Milton Friedman, seeks to keep prices steady by adjusting the money supply. The commission's executive director was Anna Schwartz, co-author of Friedman's "Monetary History of the United States," and the Democratic-controlled House held firm to monetarist orthodoxy.

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Today things have changed. Both Friedman and Schwartz died as heroes of capitalism and freedom, but monetarism lacks the sway it once had. Even Friedman before he died seemed to adjust his thinking on using the quantity of money as a target. Schwartz predicted that monetary instability would be a breeding ground for a restoration for the role of gold.

In the ferment within today's Republican Party, the gold standard has become almost the centrist position. On the left would be those who favor a system of discretionary activism in which brilliant technocrats, such as Ben Bernanke at the Fed, use their judgment in setting interest rates. A bit to their right would be advocates of a rule, such as John Taylor's rule linking interest rates to various conditions, or one that requires the Fed to target the price of gold but stops short of defining the dollar in terms of specie.

In the center would be advocates of a classical gold standard, in which a dollar is defined as a fixed amount of gold. These include, among others, Mr. Lehrman, James Grant of Grant's Interest Rate Observer, publisher Steve Forbes, economist Judy Shelton, and Sean Fieler of the American Principles Project.

A bit further to the right would be partisans of the Austrian school of economics, including Rep. Paul. He advocates less for a gold standard than for an idea of Friedrich Hayek, the Nobel laureate who came to favor what he called the denationalization of money and a system centered on private coinage and currency that would compete with government-issued money. Further right are purists such as the radical constitutionalist Edwin Vieira Jr., who would simply price things in weights of gold or silver.

A good bit of overlap exists among the camps, but Congress has come alive to all points on this spectrum. Rep. Kevin Brady, a Texas Republican who is vice chairman of the Joint Economic Committee, is seeking to pass the Sound Dollar Act, which would end the Fed's mandate to keep unemployment down, instead having the central bank focus only on stable prices. Rep. Paul is pressing the Free Competition in Currency Act, which would end legal tender and put Hayek's ideas into practice.

In the Senate, Jim DeMint, Mike Lee and Rand Paul are offering the Sound Money Promotion Act, which would remove the tax on the appreciation in the value of gold and silver coins that have been declared legal tender by the federal or a state government. Utah has already made gold and silver coins legal tender in the state.

Then there is Mr. Romney. In Paul Ryan he chose a running mate who understands the idea of sound money. In June 2010, as chairman of the House Budget Committee, Mr. Ryan asked Mr. Bernanke what he made of record-high prices of gold. (The value of the dollar had just slid to below 1/1,200th of an ounce of gold; it has since plunged to below 1/1,600th of an ounce.)

"I don't fully understand the movements in the gold price," Mr. Bernanke replied. He confessed his belief that some people were hedging "against the fact that they view many other investments as being risky and hard to predict at this point." No wonder the eventual House bill to audit the Fed passed with overwhelming bipartisan support.

This is the context in which Mr. Romney last week moved so pointedly to distance himself from a suggestion by one of his advisers, Glenn Hubbard, that Mr. Bernanke should be considered for another term. Mr. Romney made clear that he would be looking for a new Fed chairman, an important signal from a candidate who has made some mistakes—such as suggesting that monetary policy should be kept away from Congress. In fact, it is precisely to Congress that the Constitution (in Article 1, Section 8) grants the power to coin money and regulate the value thereof.

The New York Sun, the online paper I edit, has warned that a gold commission could prove to be the graveyard for sound money—on the principle that if one wants to bury an idea, one need but name a commission. But it's possible that a well-conceived and well-staffed gold commission could actually sort out the debate.

It's no small thing that Mr. Romney's platform calls for a gold commission and an audit of the Fed. The last Republican to run on a platform calling for a dollar "on a fully convertible gold basis" was Dwight Eisenhower, who cast the promise aside once in office. That's a strategic misstep for Mr. Romney, should he win in November, to avoid.