Time to turn to gold amid US dollar dominance?

A gold-backed currency would control inflation by curbing note and money supply due to the limited supply of gold, says analyst


IS REVIVING the long-buried gold standard the answer to reducing the US dollar’s hegemony in the foreign-exchange (forex) market?

Countries have long abandoned the gold standard — or currency backed by physical gold — for the fiat system, to support the expansion of currency usage beyond their respective gold reserves.

The ringgit, for example, utilises a flexible or floating exchange rate regime which adjusts to market conditions to manage domestic prices and demand, while keeping exports competitive.

The US dollar has been the standard to which the ringgit and other currencies were benchmarked against, following the 1944 Bretton Woods agreement which replaced the gold standard with the dollar as the US held most of the world’s gold.

While the US eventually abandoned the gold standard in the 1970s after foreign dollar holdings far exceeded its gold reserves, the 1944 agreement established the dollar as the de facto world currency and the country as the dominant economic force.

This dominance continues to affect a host of regional and risk-based currencies today.

This is what Prime Minister (PM) Tun Dr Mahathir Mohamad intended to challenge when he mooted the idea of an East Asian currency based on gold last May.

“What the PM is worried about is the US dollar monetary hegemony, where it can have far too much influence over lesser currencies and make them susceptible to currency speculation,” Vanguard Markets Pte Ltd managing partner Stephen Innes told The Malaysian Reserve (TMR).

He said the gold standard was adopted in the past to act as an “automatic rudder” and to stabilise the economy.

“It stops countries from printing more cash than what their stores of gold can support and prevent inflation from getting too much out of hand,” he added.

Oanda Corp senior market analyst Craig Erlam said the main benefit of adopting a gold-backed currency is that it would control inflation by curbing note and money supply due to the limited supply of gold.

“It would also reduce dependence on the US dollar and, as we’ve seen recently, having the greenback as the reserve currency does give the US extended powers, rendering many other countries helpless when oppo-sing them. The clear case here is Iran,” he told TMR.

Briefly, a gold-backed currency would be a fixed exchange rate whereby the value of every note issued is backed by an equivalent amount of physical gold and issuance is limited by the physical quantity of gold available globally or nationally (in this scenario, regionally), according to Erlam.

If issuance exceeds gold holdings, the currency would be devalued and risk inflation or hyperinflation.

This differs from the way currencies are traded today under the fiat system which sees notes deriving their value from a state authority as opposed to intrinsic worth, and is determined by numerous market factors including exchange rates, Erlam said.

If history is any indication, we are unlikely to see a gold rush in East Asia as the gold standard is ill-equipped in dealing with the demands of today’s market.

“History suggests the gold standard is not the best system, especially when spread across varied countries and economies.

“Moreover, it would be extremely difficult to implement and sustain over a longer period, and the US would likely put up strong opposition to effectively being replaced as the reserve currency,” Erlam said.

The limits of the gold standard were exposed as early as the World War I and the Great Depression.

“The problem with the gold standard lay in the fact that it was entirely dependent on the availability of physical gold, and there simply wasn’t enough global supply to support the expansion of currency usage,” Erlam said.

He said many countries abandoned the gold standard during World War I as they were desperate to finance their troops by printing more money.

“Several nations did actually return to the gold standard (after the war), although this was relatively short-lived and, in the end, it effectively became an unsustainable dollar peg.

“No government still uses the gold standard today,” he added.

Erlam cited gold’s “rigidity” as preventing economies from responding to changes in market conditions by either printing more money, or devaluing the currency to ensure competitiveness.

It is important to note that Dr Mahathir’s suggestion of minting a new gold-backed currency is just that — a suggestion. The Malaysian PM has had, at best, an ambivalent relationship with the forex market.

During his first tenure as PM, Malaysia introduced several capital controls to stem the decline of its economy during the 1997-1999 Asian financial crisis.

This included the repatriation of all ringgit assets held abroad and the elimination of offshore ringgit trading to contain speculation and capital outflows.

The measures effectively saw Malaysia shift from a liberalised to a highly regulated market.

The floating exchange rate is currently the preferred regime in Malaysia since the unpegging of the ringgit back in 2005, and provides the country the flexibility to adjust to international economic and financial developments.

But the US dollar’s dominance remains even in this scenario, and gold — while limited in today’s market — is perceived as one arsenal available to combat this hegemony.