Could the Gold Standard be Making a Comeback?

Posted by: Courtney Boedeker | July 9, 2012 - 11:21am

Alphaville | the Financial Times blog
“The unwitting move towards a global gold standard”
April 23, 2012

Finance experts say there may be a shift to a new global gold standard driven by the "debt-to-safe asset ratio” and the hunt for “safe collateral.”

A recent article from the Financial Times blog, Alphaville, calls the shift "a game of musical chairs," explaining that stakeholders begin to eye their seats a little more closely when stakes are higher, even reserving seats in the process. The article also features thoughts from McCombs Finance Professor Lew Spellman, whose blog post “Warren Buffet and the New Calculus of Gold,” has captured the attention of several other finance experts.

See why Spellman believes gold is beginning to look incredibly attractive for solving the collateral crisis. Here’s an excerpt:

As Spellman explains:

'Hence, the great corollary of over-indebtedness is the relative scarcity of good collateral to support the debt load outstanding. This imbalance of debt to collateral is impacting the ability of banks to make loans to their customers, for central banks to make loans to commercial banks, and for shadow banks to be funded by the overnight Repo market. Hence the growth of gold as a collateral asset to debt-heavy markets is inevitably in the cards and is de facto occurring. Gold is stepping up to the plate as good collateral in a world of bad collateral.'

What does this tell us about what’s happening to the global financial system?

In Spellman’s opinion, it seems to indicate that the market may unwittingly be moving towards a collateral-backed global currency (of its own accord). Possibly, even, a new gold standard altogether:

'What we are witnessing is a sea change in which market forces are driving a de facto return to the gold standard. All that is missing for this to be a de jure gold standard is some regulatory and legal recognition and one has been proposed. The Basel Committee for Bank Supervision, the maker of global capital requirements is studying making gold a bank capital Tier 1 asset.'

Which foretells the following for gold:

'The world has gravitated from one gold-backed paper currency to another before, and it likely is happening again. It would depend on whether investors in liquid, default-free, inflation-free paper prefer gold-backed Chinese Yuan to Swiss warehouse receipts or deposits from large international banks with large gold positions that operate with lots of leverage. This is a market choice that will determine the gold-linked paper store of value, but the point is that all the paper contenders derive value from the gold backing, and thereby expands the demand for the shiny metal. This is the new calculus of gold. This state of affairs is likely to remain until developed world governments no longer reach for the unreachable and pressure their central banks to finance it.'

Check out Spellman’s other mentions from these sources: