Why Gold Bugs Freaked Out Over the World Bank President's Op-Ed

Last Updated Nov 10, 2010 5:09 PM EST

It's a measure of the gold fever that's overtaken the financial world that World Bank President Robert Zoellick's footnoted comment earlier this week appending his five-point plan for improving international monetary policy was seen both as an endorsement of returning to the gold standard and a catalyst to vault the yellow metal over $1400 an ounce.

Zoellick's main concern was that an asses-and-elbows approach to monetary policy would stifle international trade -- or, worse, cause an all-out trade war. But instead of focusing on how to bring the world's economies closer together, the financial world leapt toward the barbarous relic.

CNBC's fetching overnight anchor Nichole Lapin captured the confusion with this tweet early this morning:

A little perplexed on this whole Bretton Woods III talk-Net prod is flat + $5 trill is all the gold that's EVER been mined, Mr. Zoellick.
Zoellick's opinion piece was all about the need to move toward a new phase in the so-called Bretton Woods agreement that began after World War II, when international economies rebuilt under a U.S. dollar standard -- i.e., all currencies pegged to the dollar and the dollar fixed to gold. By 1971, that arrangement had ceased to function well, mostly because of the recovery of Europe and the rise of Japan. So the U.S. dropped the gold standard and began to act as a reference point for free-floating currencies.

After 37 years and a massive credit crisis, Bretton Woods II, as the post-1971 arrangement was known, has been ripe for an overhaul. The recent moves by central bankers in Japan and the U.S. has only increased the urgency. The U.S. dollar is no longer the sole reserve currency. The yen and the euro play important roles. Zoellick was trying to say that the Chinese yuan should begin to play its own part, too.

That brought up the subject of gold, which Zoellick -- a real world banker -- wanted to recognize as having become an increasingly important store of value -- i.e., a reserve currency. So he made this statement:

The system should also consider employing gold as an international reference point of market expectations about inflation, deflation and future currency values. Although textbooks may view gold as the old money, markets are using gold as an alternative monetary asset today.
For his trouble, the poor man got branded a gold bug. What he was trying to say was that it would be foolish to ignore the way gold is priced in various currencies when talking about how those currencies should be valued against each other.

Of course, when gold shot through $1400/oz. there was also a new panic about Ireland's banks and the effect that crisis would have on the euro. Which was sort of Zoellick's point. People are buying gold because they're fearful about the value of their currencies.

This is part of what led well-known fund managers like David Einhorn and John Paulson to vocally bet on gold over the last year. Let's hope they toughed it out and are now enjoying their big gains.

Which brings us back to Ms. Lapin and her worries that there's not enough gold in the world to support the financial system. (Read Alain Sherter's post to understand why gold can't be used as an alternative to money.) Gold's limited supply -- and its historic role as money -- is the only reason it is seen to have value. You can't eat it, burn it for warmth or find shelter under it. It has relatively few meaningful industrial uses.

Gold's only value is rarity. Someone who is fearful of inflation will exchange currency for gold and hope to get much more currency back in the future. On the other side of the equation, gold is defense against deflation in goods. You buy gold now and hope to use it to get more goods in the future when money is scarce and goods are plentiful.

Gold, in other words, is a way station between the money and goods. In fancy terms, gold is an arbitrage between both. For many, it's like taking a time out from the real and the financial worlds.

By this reasoning, gold is worth more over time because the supply of goods in the world and the supply of money are both increasing. The supply of gold isn't and can't. That's the attraction. Buyers of gold are looking for a place to hide out from all the danger and confusion in our economic and political worlds. They're hoping that when it's all over they can jump back in because someone, somewhere always thinks gold is valuable.

But this isn't what Zoellick has in mind. He isn't an alarmist. He's not filling the bunker with canned goods and shotgun shells. What he is saying is that in all the jockeying and confusion over the relative values of each major economy's currency, we should keep gold as part of the conversation. Which is funny. Because it seems like all anyone talks about these days is gold.

Image of gold courtesy of Mykl Roventine
Related: