By Mark Rogers

A discussion of Gold: Adjusting for Zero by Daniel Brebner and Xiao Fu, Deutsche Bank, London, 18 September 2012

2008 did not just happen. The financial squalor of recent years is the culmination of several long-standing factors, the most important being cultural, the “group think” of the Keynesian consensus. To begin with the analysts’ conclusions: while their report explains that a return to the gold standard is feasible, they are not sanguine that it will happen:

“The world economy has, over the past century, morphed into a highly integrated, government dominated system guided by conventional wisdom (group think). The self-reliant individualism of the free market has been left behind in favour of a ‘new age’ of coddled consumerism. Culturally this represents a very powerful force … one which minimises creative options/solutions to economic impasses.” (p. 16)

“Many economists shudder at the notion of a gold standard; this is understandable given the school of thought to which most adhere: Keynesian or Keynesian derivative.” (p. 14)

High on the list of Keynes groupies who are in powerful positions is Ben Bernanke, Chairman of the Federal Reserve: it would take a conversion of Damascene proportions to get him to change his view of gold, and where he leads, many other central bankers and finance ministers willingly follow.

The authors of the report are therefore to be congratulated for their sombre realism in discussing this issue.

Zeroing in

As we approach Keynes’s ideal of 0% interest rates, “[m]oral hazard continues to be encouraged … The financial system in fact remains oriented to encourage further leverage and risk-taking.” This has an important consequence that goes a long way to explaining the crises that engulf us: investment is made simpler “in the sense that one only needs to look to what is ‘easiest’ rather than what is ‘right’.” If probity is at a discount, and an extravagant one at that, then why should politicians and policy makers even care about the consequences of their decisions? The Libor scandal (here and here), for instance, is an almost inevitable consequence of such moral insouciance.

A pertinent consequence for investors of quantitative easing is, as the report points out, the increasing price of gold. This is in fact simply another version of Gresham’s Law: as bad “eased” money increases so true value is driven into gold, forcing its price upwards given its relative scarcity. This is not to say that quantitative easing is good for gold, that is, easing does not contradict their assertion that a return to the gold standard is desirable given that this would prevent any such easing. It is simply a recognition of the fact that bad money always has this consequence: a return to the gold standard would be a restraint, allowing money to have a secure measure of value and preventing the arbitrary manufacture of money that destroys value.

Human Effort

The most remarkable aspect of this report is not the advocacy of a return to the gold standard – after all others are making the same case. What is interesting is the space the authors devote to the fons et origo of value: human effort. They devote two and a half pages (9-11) of what is after all a very short analysis to this concept and make this extremely important point: “if capital is stored effort, then debt is borrowed effort: either someone else’s or your own estimated future output.” The effect of exceptionally low interest rates is therefore to devalue your future effort by selling it to yourself, if you borrow, at a discount.

It is in this context that a return to the gold standard must be judged as essential: the moral hazard that the authors identify as being at the heart of the crisis cannot be allowed to continue.

The full report is available here.

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"For a mountaineer, the important things are the effort, the posture and the muscles. The rope that holds him serves no purpose when everything works but it gives him a sense of security. In the same way, all gold does is ensure confidence; it's a safe haven."