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2011-08-15 "Dead" for 40 Years: The Gold Standard Is Back

With a De-Facto Gold Standard in Place...Is It Time For Bretton Woods 2.0? 

- In the aftermath of World War II, international finances were tied to the US dollar, which was backed by gold. It was known as the Bretton Woods system and it helped stabilize the currencies of participating countries.

All in all, it worked quite well as growth increased throughout the world.  Yet with President Johnson’s Great Society programs and the Vietnam War, the system started to fall apart as the US began to run deficits.

There was a growing fear that foreign central banks would have a run on gold. Since there was only a finite supply of gold -- unlike dollars which could be printed to manage fiscal policy -- there was significant concern. So it was on August 15th, 1971, that President Nixon radically changed the global monetary system by nixing the gold standard.

Despite espousing free-market principles, Nixon actually went on to impose wage-and-price controls as well as protectionist measures on foreign trade. He would even go on to say: “We are all Keynesians now.”

Unfortunately, the 1970s turned out to be a horrible time for the US economy. There were two oil shocks as inflation surged into double digits, interest rates eventually reached 20% and unemployment remained a big problem.  During the decade, there were three recessions as the US struggled to stabilize and grow its economy.

True, the US would return to growth during the 1980s and 1990s but there were still recurring crises. Of course, this became even more pronounced from 2000 to 2011.

So it should be no surprise that there has been more agitation to get back to the gold standard. Hey, just look at Texas congressman Ron Paul. He not only wants to reinstate it -- but also destroy the Federal Reserve.

Actually, I agree that some form of an international gold standard is a good idea. If anything, it will provide an opportunity for the major economies to find ways to bring about more stability. For example, a new system could involve a variety of currencies as well as gold.

However, the gold standard is far from a panacea. In a globally interconnected world, there are many areas of risk and contagion. In other words, we still need leadership on fiscal matters.

But in the meantime, the world is already moving aggressively towards gold. Sovereign wealth funds are buying up large quantities and so are central banks. There has also been a surge in investment demand, as seen with the spikes in the SPDR Gold Shares (NYSE:GLD) and the iShares Gold Trust (NYSE:IAU). It has also spurred massive interest in miners such as Yamana Gold (NYSE: AUY) and Hecla Mining (NYSE: HL) and has even spawned funds that seek to capture different sections of the gold value chain, such as the Market Vectors Gold Miner ETF (NYSE: GDX). In a sense, a de facto gold standard is emerging.

But again, to make the process smoother and more effective, it is better for the world’s leaders to get real about making changes to global financial system. Yes, it is time for Bretton Woods 2.0.