Robert Zoellick, President of the World Bank, has created a furore in economic circles by suggesting that world economies should adopt gold as a reference for anchoring national exchange rates. He said: “The system should also consider employing gold as an international reference point of market expectations about inflation, deflation and future currency values.” [1]

While conventional economic thinking sees adopting the gold standard as too radical for consideration, Robert Zoellick’s suggestion may be motivated by the current currency crisis that is destabilising world economies. Nevertheless it has opened an important debate on the benefits of the gold standard.

Major economies are devaluing their currencies, in a calamitous race to the bottom, in order to artificially gain competitive advantage over rivals. They are able to do this simply by printing money or quantitative easing, to use a more modern phrase, due to the ‘fiat’ or paper nature of currencies. However, major dangers lie in hyperinflation or worse ‘stagflation’ where economies are plagued by depression and hyper inflation simultaneously. This would bring huge hardship for people as unemployment would rise at the same time as increased prices for foods, goods and services. Anchoring currencies to the gold value would halt such a disaster.

It is important at this point to remember that the recessions that are proving so difficult to recover from, which is the primary reason for currency devaluations, were also the result of the huge expansion in liquidity, credit and debt all of which were facilitated by currencies being essentially paper based with no intrinsic value. Fiat based currency facilitates fractional reserve banking which accentuated a boom in credit over the last few decades. However with the colossal expansion of the financial sector asset-bubbles built up because the real economy (market for goods and services) could not keep pace with the growth in financial assets. Consequently, western economies fell into deep recession from which many have yet to recover.

Thus fiat currencies both caused and greatly heightened the economic crisis. With the gold standard however, the world would not be in the current economic mess.

In spite of its manifest advantages some of those who dismiss the ‘gold standard’, which essentially means gold underwriting the total value of the money stock, argue that it harks back to a bygone age and would not be able to support modern global trade. Some insist the price of gold is too variable and would make for a poor reference, and quote the price of gold being $200 an ounce a decade ago to today’s $1400. Others dispute the ability of an economy based on the gold standard to generate sufficient growth to address unemployment.

Taking these points in turn.

Contrary to common opinion the complete removal of any link between currencies and gold is relatively recent – since the collapse of the Bretton Woods agreement in 1971 in fact. Prior to this relatively recent event, in the context of long term trends in global trade, currencies had been partly or completely backed by gold reserves yet international trade expanded, spurring industrialisation across the globe. Indeed if the gold standard causes such an economic constraint, world exports would not have expanded 12-fold and world manufacturing production would not have grown 8-fold as both, in fact, did between1900 and 1960 according to UN statistics. [2]

With respect to the apparent volatility in the gold price being a barrier to the introduction of the gold standard the answer is simple. Since gold is represented in dollar terms the apparent appreciation from $200 to $1400 an ounce in fact reveals the massive devaluation of the dollar due to the serial ‘printing’ of US dollars by every US administration since the removal of the gold standard.

Whether economies that adopt the gold standard are able to generate enough growth to address unemployment is also a misnomer. In actual fact unemployment has not been eradicated in so-called modern fiat currency based economies in spite of high debt financed growth rates. This implies economic growth is not a sufficient condition to address an important cause of poverty. In reality cyclical periods of boom then bust brought on by monetary expansion have increased the long term unemployed and worsened poverty.

Robert Zoellick’s apparent support of the gold standard has been heavily rebuffed by mainly vested interests aiming to close down an important debate that goes to the roots of capitalism. Here Islam with its insistence on a gold standard, based on Quranic texts, offers real solutions to today’s chronic economic realities. It’s a real shame capitalist policymakers are too insecure to engage in a proper debate.

[1] http://www.ft.com/cms/s/0/eda8f512-eaae-11df-b28d-00144feab49a.html#axzz14ml09lYz

[2] http://unstats.un.org/unsd/trade/imts/Historical%20data%201900-1960.pdf