Two Non-Starters to Begin the Week

Two ideas percolated last week.   Although widely different, they will have the same fate.  Ignoble deaths.  Yet, an understanding of their brief lives may help shed light on the current investment climate.

In the US, a draft of the Republican Party platform calls for the establishment of a commission to look into re-linking the dollar to gold.  In Europe, there was some talk of a possible temporary Greece exit from the monetary union.  Neither is very practical.

Oh, a commission can easily be established and it can investigate as much as it wants.  It won't be the first.  There was such a commission under Reagan in the early 1980s and it ultimately found against a new gold link.  A new commission's findings will not be much different.  If any thing, given the size of monetary base, which has swelled under the Fed's attempt to prevent deflation and provide liquidity to promote stronger growth, linking the dollar to gold is even more difficult/costly.  

The US holds roughly 8,130 tonnes of gold.  At current market prices, it is worth about $430 bln.  When economists talk about backing the dollar with gold, they mean tying the supply of the former to the price of the latter.  Coins and notes in circulation amount to around $1.05 trillion.  The monetary base, is coins and notes in circulation, demand deposits (including checking accounts) and bank reserves.  This is closer to $3 trillion.  

The only way that the US current gold holdings can back some meaningful measure of dollars is if the price of gold was sharply higher.  James Rickards' popular Currency Wars:  The Making of the next Global Crisis (2011), suggests $7000 an ounce for gold (or the dollar is backed by 1/7000 of an ounce of gold).  

However, other countries both friends and rivals would benefit at the US expense.  The US would have to defend the new dollar price of gold.  If the world price for gold were higher, the US would lose its gold and experience a domestic contraction.  If the world price for gold were lower, the US would experience a credit boom as gold flowed in. 

Europe stands to benefit.  It has a higher gold to money supply measures and is not formally committed to defending a price of gold or parting with its gold holdings.  It marks its gold to market (quarterly) and thus has a substantial cushion of "capital reserve" that can be used to absorb losses elsewhere if experienced.  

A new gold standard might not be convincing if it were just in the US.  The US broke the gold standard unilaterally, first in 1968 when Congress limited its gold transfers for dollars to foreign governments and central banks, excluding the private sector, and then 1971 when Nixon closed the gold window for officials as well.  

Unilateral adoption of a gold standard would be particularly vulnerable to attack. A global gold standard would likely require the backing of not only some measure of US money supply, but also Europe's, Japan's and China's.   This would require an even higher price of gold and, in turn, increase the incentives for defectors from the gold regime.  

During much of the presidential primaries, the Republican rank and file appeared to look for "anyone but Romney" until it became inevitable.  This has denied Romney an element of legitimacy within the party, and the need to secure his base has been the dominate consideration.  To secure his base seems to require moving further away from the so-called Reagan Democrats, other independents and important constituencies, like Hispanic and women voters.  A gold commission is another albeit small bone to the libertarian, Ron Paul, and Tea Party wing. 


The other non-starter is the idea that Greece can temporarily exit monetary union, get its house it order and rejoin.  This is a simply an attempt at a compromise formation and has no natural constituency.  The problem is that there does seem to be a vocal number of officials in creditor countries, including Germany, who want Greece to leave.    

Recall that leaders of CDU's sister party in Bavaria the CSU have sought legal redress for having to support its fellow Germany who live in poor states.  These creditors within Germany do not want to provide fiscal transfers to its debtor German neighbors.  They cannot sanction any meaningful aid to foreigners.  

While we often have emphasized the political economy, what is happening in Europe is a useful reminder that it is also a moral economy.  Under ordo-liberalism that has developed in Germany and other to some extent in other creditor countries in Europe, debt and indebtedness is a sign of a moral corruptness.  The fact that some countries, such as Spain, had lower debt (to GDP) than Germany before the crisis broke is conveniently swept away.  The fact that a ranking of overall debt, which combines private and public sector, would find Italy near the lower end is also largely ignored.  

There cannot be a temporary exit from monetary union.  Although there continues to be much talk about a Grexit, few have really provided much insight into what it would really look like.  There is no mechanism for it.  It is not clear what it means that it would be "manageable" as officials are wont to say.  What is not manageable from a bureaucratic point of view?  

Consider that the Maastricht requirements are used as re-entry conditions, which appears a fair assumption.  Maastricht required, for example, debt/GDP ratios no larger than 60%.  The Troika have been seeking a path to get Greece's debt/GDP to 120% by 2020 and this seems doubtful at this juncture.  

The word "temporary" has been asserted in the arguments so as to make it seem more palatable, but has no real meaning and does not change the substance of the issues.  Nor does it address the contagion of re-denomination risk. 

It reflects a misunderstanding of the problem.  The cauterization of Greece, even if possible, which we doubt,  will not resolve any of Europe's fundamental problems.   It will not bring the monetary union any closer to a fiscal and political union.  It will not bring forward a banking union.  Greece is not the big obstacle here.  It will not help Spain address the its banking crisis or high unemployment.  It will not spur growth in Portugal or Italy, where it has been sorely lacking.   

It is too easily forgotten that nearly all of Greece's aid, outside of funds for bank recapitalization, is directed to allow it to keep its creditors whole.  After the private sector hair cuts (PSI), Greece's largest creditors are in the official sector.  

There are solutions shy of a Greek exit that can help put the country on a more sustainable path and would not cost tax payers a penny.  Greece just raised several billion euros in bill sales to pay the ECB back full on some debt that came last week.  There are three areas that Draghi and the ECB could help Greece within the mandate and demonstrate its independence.  It can extend maturities on Greek bonds its holds.  It can negotiate a lower coupon.  It an accept being repaid at cost instead of par.  These seem  potentially more fruitful than a putting wreaths and flowers on the Trojan horse. 
Two Non-Starters to Begin the Week Two Non-Starters to Begin the Week Reviewed by Marc Chandler on August 26, 2012 Rating: 5
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