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Should we follow the yellow brick road? PDF Print
Written by Atul Sethi, TNN   
Saturday, 04 April 2009 18:30

Old is gold, they say. There can be little argument against that as the world's oldest stable currency, gold, continues to reign supreme over shaky 
currencies. Now, countries like China and Russia want gold to be more than a steady asset.

Russia recently advocated partial restoration of the gold standard — the old system of anchoring a country's currency to a specific amount of gold — to make for greater stability in the world monetary system.

China too has been pressing for the need to replace the dollar with Special Drawing Rights (SDR) as the world's main reserve currency. The Chinese contention is that a super-sovereign reserve currency not only eliminates the risks inherent in a credit-based currency such as the dollar but also makes it possible to manage global liquidity better. So, is it a good idea to revert to the gold standard?

Not really, says Arvind Panagariya, professor of economics at Columbia University. "I doubt if the countries are serious. For starters, it would require a return to a fixed exchange rate system. Not many countries in the world would be willing to make a switch. Nor would it be advisable in a world of high mobility of financial and other capital since it would mean losing control of the monetary policy at home."

There is also the practical problem of reinvestment of dollar assets. Jeffrey Nichols, managing director of American Precious Metals Advisors, says, "Although the talk of reverting to a gold standard may hearten the advocates of gold, the possibility of any sudden change in the world monetary system seems remote, if only because no alternative can provide the very large and very liquid capital markets necessary to accommodate reinvestment of reserve assets now held in US dollars."

Not everyone agrees. Economists who subscribe to the heterodox Austrian school of economics, which emphasises the spontaneous organising power of the price mechanism, say that the gold standard could have prevented the economic crisis. Robert Murphy, Adjunct Scholar at the Ludwig von Mises Institute in Alabama, USA, says, "A gold standard is essential today because it would force central banks to raise interest rates to their correct levels. In fact, it would work as a very good safety precaution, since it places a firm limit on how much inflation the central bank can create. Also, it's an excellent option for emerging economies like India, since any country with 100% gold backing for its currency would see its own currency appreciating against others, and more capital would begin flowing there".

But many see the call to revert to the gold standard as a political issue. "The idea behind China and Russia's advocacy of the gold standard is to wean the world away from its dependence on using the US dollar as the reserve currency and thus reduce US economic influence and, by extension, its political influence," says Jabin T Jacob, research fellow at New Delhi's Institute of Peace and Conflict Studies. "In fact, this is the first sign of another bipolarity emerging in the international political economy —US and Sino-Russia",adds Laveesh Bhandari of Indicus Analytics, an economics research firm.

So, how strong is the case for switching to the gold standard? Not very, says Panagariya. "Can China and Russia switch to a gold standard on their own? They will very quickly run out of the gold reserves necessary to support the exchange rate," he points out.

Jacob says recent history offers a warning against a new gold standard. "Remember, the gold standard failed because major powers were unable to restrain spending either in times of war or for implementing welfare policies. It is difficult to argue that governments today are more resistant to the temptation of spending than their predecessors were, least of all economies like China and Russia where mega-projects and corruption are defining characteristics of their economies." 
 
Source: The Times of India