T H E L O N D O N B U L L I O N M A R K E T A S S O C I AT I O N

The Golden Revolution:

- Why a Gold Standard lies in our near future,
and how we might get there
By John Butler, Chief Investment Officer, The Amphora Commodities Alpha Fund

Contrary to the conventional wisdom of the current economic so wrong. They look for explanations in
bank regulation and oversight, the growth
mainstream that the gold standard is but a quaint historical of hedge funds and the so-called shadow
banking system. They wonder how the US
anachronism, there has been an unceasing effort by prominent housing market could have possibly crashed
to an extent greater than occurred even in
individuals in the US and also a handful of other countries to try and the Great Depression. Some look to global
capital flows for an answer, for example
re-establish a gold standard ever since President Nixon abruptly ended Chinas exchange rate policy. Where the
mainstream generally fails to look,
gold convertibility in August 1971. The US came particularly close to however, is at current global monetary
regime itself. Could it be that the fiat-
returning to a gold standard in the 1980s. This was understandable dollar-centred global monetary system is
inherently unstable? Is our predicament
following the disastrous stagflation of the 1970s and severe recession of today possibly a long-term consequence of
that fateful decision to close the gold
the early 1980s, at that time the deepest since WWII. Indeed, Ronald window in 1971?

Reagan campaigned on a platform that he would seriously study the I believe that it is. But what that
implies, given the damage now done to the
possibility of returning to gold if elected president. global financial system, is that there is no
way to restore a sufficient degree of
Once successfully elected, he remained Alan Greenspan and his colleagues at the credibility and trust in the dollar, or other
true to his word and appointed a Gold Fed and their counterparts in many central major currencies for that matter, without a
Commission to explore both whether the banks elsewhere in the world were return to some form of gold standard.
US should and how it might reinstate a admired for their apparent This may seem a rather bold
formal link between gold and the dollar. achievements. prediction, but it is not. The
While the Commissions majority concluded evidence has been
that a return to gold was both unnecessary We now know, of We now know, of accumulating for years and is
and impractical Fed Chairman Paul course, that this was all a now overwhelming.
Volcker had successfully stabilised the dollar mirage. The business course, that this was all
and brought inflation down dramatically by cycle has returned with Money can function
1982 a minority found in favour of gold a vengeance with by far a mirage. The business cycle as such only if there is
and published their own report, The Case for the deepest global sufficient trust in the
Gold, in 1982. Also around this time, in recession since WWII, has returned with a vengeance monetary unit as a
1981, future Fed Chairman Alan Greenspan and the global stable store of value.
proposed the introduction of new US financial system has with by far the deepest global Lose this trust and that
Treasury bonds backed by gold as a sensible been teetering on the form of money will be
way to nudge the US back toward an edge of collapse off recession since WWII, and the abandoned, either
explicit gold link for the dollar at some and on for several suddenly in a crisis or
point in future. years. While consumer global financial system has gradually over time in
price inflation might be favour of something
In the event, the once high-profile low in the developed been teetering on the edge of else. History is replete
debate in the US about whether or not to economies of Europe, with examples of
return to gold eventually faded into relative North America and Japan, collapse off and on for Greshams Law, that
obscurity. With brief exceptions, consumer it has surged into the high bad money drives good
price inflation trended lower in the 1980s single- or even double-digits several years. money out of circulation; that
and 1990s, restoring confidence in the fiat in much of the developing is, that when faith in the
dollar. By the 2000s, economists were world, including in China, India stability of a money is lost, it may
talking about the great moderation in both and Brazil, now amongst the largest still be used in everyday transactions
inflation and the volatility of business economies in the world. in particular, if it is the mandated legal
cycles. The dollar had been generally strong The economic mainstream continues to tender but not as a store of value. The
versus other currencies for years. Maestro struggle to understand just why they got it good money is therefore hoarded as the

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 ALCHEMIST ISSUE SIXTY FIVE

superior store of value until such in global trade continues apace, to power is in the ascendant, where there are
time as the bad money finally History the benefit of nearly all large and growing current account surpluses,
collapses entirely and a return economies. A global currency and where a meaningful amount of gold has
to good money becomes is replete with facilitates global trade. already been accumulated, will be the first
possible. This monetary movers. All of the BRICs are potential
cycle, from good to bad examples of Greshams It was precisely a candidates, as are certain oil-producing
to good again, has been multipolar world amid countries and, possibly, Germany and Japan.
a central feature of Law, that bad money rapidly growing
history. international trade that When presented with a fait accompli,
drives good money out of ushered in the classical the US will have little choice but to go
In the present gold standard in the along or find that the dollar not only loses
instance, we find a circulation; that is, that when 1870s. Although gold reserve currency status entirely, but also is
growing number of had been in the no longer accepted for international
countries expressing faith in the stability of a money ascendant in global transactions. In the event, we believe a
concern about the monetary affairs for decision to accept the new global gold
stability of the dollar is lost, it may still be used in several years, growing standard will be rather easy to reach.
amid relentlessly German political and
expansionary US everyday transactions in economic clout While it is unclear just what kind of
monetary policy, provided an important gold standard will prevail history provides
excessive dollar reserve particular, if it is the tipping point as a range from which to choose, some of
accumulation and the Germany favoured gold which worked better than others the key
associated surge in mandated legal tender for settlement of point is that, whatever form of standard
inflation, including China, international balance of prevails, it must restore a sufficient degree
India and Brazil. The Arab but not as a store of payments. While the of credibility and trust in global
Spring of 2011 originated Bank of England monetary affairs. That requires that,
in part from soaring food value. was the dominant simultaneously alongside the
price inflation. central bank of its return to gold, there must be
day, reflecting While it is a dramatic deleveraging of
Concern is increasingly giving British economic the undercapitalised financial
way to action. China has entered into power, it never sought to unclear just what kind system in the US, euro
bilateral currency swap arrangements with impose a gold standard area, UK, Japan and also
Russia, Brazil, Argentina, Japan, South on its trading partners. of gold standard will prevail a handful of other
Korea and Thailand as all these countries Rather, it accepted the countries. Fortunately,
seek to reduce their dependence on the gold standard as an history provides a range this is easily
dollar as a transactional currency. As the international fait accomplished. All that
dollars role gradually declines, global accompli. from which to choose, some of is required is that the
monetary arrangements are likely to rate of gold
become increasingly multipolar, as there is The US Federal which worked better than others convertibility is set at
no single currency that can realistically Reserve may find it a gold price
replace the dollar as the pre-eminent global plays a similar role in the key point is that, whatever sufficiently high to
monetary reserve. The euro area has major the near future. While imply that existing
issues with unsustainable sovereign debt it is certainly possible form of standard prevails, it debt burdens, now
burdens and an undercapitalised financial that, in order to clearly excessive, are
system. Japans economy is too small and restore confidence and must restore a sufficient degree reduced to levels that
too weak to provide a dollar substitute. trust in the dollar, the can be credibly serviced
And while Chinas economy has been US relinks the dollar to of credibility and trust from existing levels of
growing rapidly, its financial system is not gold on its own initiative, national income and, in
yet mature or robust enough to instil the more likely is that another in global monetary the case of sovereign
necessary global confidence in the yuan as country, or group of debts, from tax revenues.
the dominant reserve currency. Yet growth countries, where economic affairs.

Imputed Gold Price with 40% Backing of M0, M1, and M2

14,000
12,000
10,000
8,000
6,000
4,000
2,000
0
1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

Imputed Gold Price - M0 Imputed Gold Price - M1 Imputed Gold Price - M2

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T H E L O N D O N B U L L I O N M A R K E T A S S O C I AT I O N

However, given just how overleveraged upon them caused the global credit crisis,
financial systems are, and how large not gold. And what a world of too big to
sovereign debt burdens are becoming amid fail needs are reforms that indeed allow
unprecedented peacetime deficit spending, large firms to go bankrupt from time to
the rise in the price of gold will need to be time, so that capitalism can in fact work as
an order of magnitude higher than it is intended.
today. That may surprise some, given that
the price of gold has been rising for years. It is worth considering why bankruptcy
But what should really surprise us is that has become such a bad word. While no
the growth of money and credit has been investor wants to lose money on a bankrupt John Butler
far greater. Simply taking the numbers as enterprise, when looking at a capitalist Chief Investment Officer
they are and allowing the gold price to rise economy as a whole, bankruptcy is The Amphora Commodities
sufficiently to compensate for decades of absolutely essential to economic progress. Alpha Fund
cumulative, excessive money and credit Josef Schumpeters creative destruction, Currently serving as the Chief
growth implies that a credible gold unlocking resources in unproductive Investment Officer of a commodities
conversion price in dollars would be above enterprises and moving them to where they fund, John was previously Managing
$10,000. The credible, sustainable can be more efficiently employed, or mixed Director and Head of the Index
conversion prices in euros, yen, sterling and with new technologies or business Strategies Group at Deutsche Bank in
other developed world currencies would techniques, is what capitalism is all about. London, where he was responsible for the
also lie far higher than where they are Real long-term economic progress depends development and marketing of
today. on it. proprietary, systematic quantitative
strategies for global interest rate
From an investors perspective, There are other reasons not to fear markets. Prior to joining DB in 2007,
there are far greater implications gold but rather embrace it. A gold John was Managing Director and Head
of a return to a gold standard standard will reward savings, of European Interest Rate Strategy at
than merely the large rise in There are something that is sorely Lehman Brothers in London, where he
the gold price. The lacking in much of the and his team were voted number one in
dynamics and other reasons not to developed world. It will the Institutional Investor research survey.
determinants of interest rationalise government In addition to other research, he
and exchange rates, and fear gold but rather embrace finances, in particular by publishes the Amphora Report newsletter
risk premia for the making it difficult if not which appears on several major financial
entire range of assets, it. A gold standard will impossible for countries websites.
are going to change. to incur large debts and A cum laude graduate of Occidental
For example, for those reward savings, something then try to pass these College in California, John holds a
countries that return to off on future Masters Degree in International Finance
gold, exchange rates that is sorely lacking in generations, something and Economics from the Fletcher School
will become essentially of dubious morality. of Law and Diplomacy, associated with
fixed. Interest rates, much of the developed Absent easy money, it will Harvard and Tufts Universities.
however, while nominally force economies to become
still under the control of world. more flexible, and labour
central banks, will need to be and capital to become more
set at market-determined levels, mobile. By implication, financial
not below, or gold reserves will be leverage will also be limited and too
depleted, eventually leading to a funding big to fail will instead become too big to
crisis. Risk premia for most assets will need bail. Indeed, absent easy money or
to rise, primarily because, constrained by bailouts, the financial sector will only grow
the gold standard, both monetary and fiscal to the extent that it actually serves the
authorities will have less flexibility to broader, productive economy. Huge
provide stimulus during economic numbers of engineers and other quants who
downturns. As such, cyclical profit swings went to the City looking for outsize
will tend to be larger, as will the number bonuses will make their way back into real
of bankruptcies. industries making real things, where they
will be joined by fresh graduates and lay
While a lack of policymaker flexibility the groundwork for what is likely to be an
and increased risk of corporate bankruptcy era of great industrial innovation.
might concern some investors, consider that
it was precisely an excess of policymaker Investors should not fear the golden
flexibility chronically loose monetary and revolution. Rather, they should welcome it.
fiscal policy which got the developed After all, they dont call particularly
world into its current predicament. This prosperous historical episodes Golden Adapted from The Golden Revolution by John Butler.
Copyright 2012 by John Butler. Published by John
point is clear: poorly managed fiat Ages for nothing. Wiley & Sons. Used with permission.
currencies and the financial systems built

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