Saturday, June 6, 2009

Gold Currency System Proposed for Gulf Countries

By Robert Blumen
Mises Economics Blog
Sunday, March 13, 2005

An eclectic document published by the Gulf Research Center of Dubai discusses "The Role of Gold in the unified GCC Currency". The point of the paper is to examine an increased monetary role for gold in the Persian Gulf national banking and monetary systems.

The author, Eckart Woertz, a bond analyst in Dubai, cites Mises, Rothbard, Skousen, Sennholz and other Austrian economists, although in some cases critically. His discussion of the current monetary system, dating from the Bretton Woods agreement, though present dollar buying cartel follow lines that are familiar to readers of this site. The gulf countries, in his view, have tied their economies unwisely to the value of the US dollar.

Austrians will be disappointed to read that author believes that the growth of government is necessary for economic growth. Woertz also recognizes that a gold-based monetary system would bring about the end of the current welfare state, regrettably in his view.

There is some discussion of the "Islamic Dinar", a proposal by Prime Minister Mahathir of Malaysia to set up a gold-exchange standard for trade among Islamic nations, with the intention of protecting the regions from currency crisis. Woertz explains that the proposal failed for various reasons, not the least of which that some gulf countries have sold off most or all of their central bank gold reserves.

Quoting from the conclusion:

The paper dollar standard is a dead man walking. Its debt, accumulated over the recent decades, is too high to be effectively repaid. It will either default or be inflated to such an extent that it will not hurt to “pay"? it back. Therefore, the accrued imbalances in global finance and the inherent weakness of worldwide growth models that rely on a continuance of US deficit spending are likely to usher in a serious crisis of currency systems during the course of the coming years. As the dollar is not only the currency of the US but the most important reserve, trade and debt currency on which all the other nations rely, it will not be a regionally confined currency crisis as happened in Mexico, Asia or Russia in the nineties; but will affect all other currencies and economies as well. That is also true for the Euro. Although it is less weak than the dollar, it will be affected and eventually engage in competitive devaluations with other currencies rather than emerge as a new world currency.

Gold will be a suitable means of asset protection and ultimate payment in such a scenario. It will preserve the wealth of individuals and central banks alike and will ensure important manoeuvrability for the latter. At the same time, the need for Gold accumulation could lead to serious conflicts between citizens and government agencies, should the latter try to get a hold of the accumulated gold of its citizens by declaring it illegal like in the SA in 1933, or by pressing for an exchange into local paper currency like in Korea and Thailand in 1997/ 98.

While individuals in the GCC countries highly value gold as a means of asset protection, GCC central banks are particularly ill prepared for such a crisis scenario. With currencies pegged to the dollar, oil factored in dollars and most of its currency reserves and investments in dollars, they are highly affected by the woes of the paper dollar standard. At the same time, they only have tiny gold reserves or none at all. In contrast to other central banks that have cautiously started to anticipate a post paper dollar standard environment (e.g. Euroland, Russia, China), the GCC monetary authorities indulge in official oaths of allegiance. During the recent GCC monetary union conference in Bahrain, the IMF asked the GCC countries to peg their common currency in 2010 to the dollar.

The justification given rested solely on the successful maintenance of the paper dollar standard. As stated: “Since most exports and external assets have been dollar-denominated, the peg assured external stability. It also provided a credible nominal anchor for monetary policy, ensuring price stability." Yet while may be true for the past, once the paper dollar standard is tumbling the whole argument takes the opposite direction - to instability of external trade, prices and monetary policy. Thus, apart from further diversification of their economies and gradual diversification into “second worst"-currencies like the Euro, GCC countries would need to reclaim their leased out gold and build up a substantial gold reserve, as long there is still the time to buy it. Once the crisis scenario unfolds and the attempts of central and commercial banks at gold price suppression fail, the gold price will more than rise – it will explode to the upside.

Robert Blumen is an independent enterprise software consultant based in San Francisco. Some comments to this post discuss the emerging role of digital gold currencies.

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