Muhammad Laraib Afzal 682-FMS/BBAIT/F09 The New Gold Rush As we stagger through the ruins of the global financial

system, surveying the wreckage left by the bursting of the debt bubble, a new bubble is already being inflated - a gold bubble that could become as inflated and unsustainable as the pre-millennium dotcom madness, tulip mania or the South Sea bubble. For the first half of the past decade, the gold price hovered between $200 and $500 per ounce, as investors poured money into equities, hedge funds and asset-backed securities. Only when the twin devils of recession and inflation reared their heads in late 2007 did gold begin to gleam once again. For now, gold is the one asset glimmering in the otherwise moribund financial markets. We are living through a second major crisis in three years, with European leaders dithering over Greece and the United States getting used to life on a credit rating below that of Johnson & Johnson and Microsoft. It used to be that, in times of panic; investors sold out of stocks and invested their money in the haven of government bonds. This time, however, it is government debt that is at the heart of the crisis. Investors are buying record amounts of gold to protect against inflation and hedge against currency devaluation - and, as with any other bubble, simply because everyone else is doing it. Exchange-traded funds (ETFs), which give retail investors easy access to gold, have had record inflows. Investment bank analysts are scrambling to upgrade their forecasts for the price of gold: JPMorgan believes it could reach $2,500 by the end of the year; Goldman Sachs, in a note suggesting a "one-in-three chance" of another US recession in the next six months, claims that gold remains "under bought". What everyone agrees is that the relatively smooth rise in gold prices since the beginning of the year will not continue. It will enter a period of volatility as commodity exchanges increase their margin requirements (the CME Group, the world's largest commodity exchange, raised margin requirements steeply on 11 August), as investors are forced to sell gold to meet margin calls or cover losses in other parts of their portfolio and, most importantly, as traders recognize that gold has reached bubble territory and try to call the top of the market. There is a science to investing in bubbles. George Soros has built a career and an extraordinary fortune on the back of his "theory of reflexivity", which identifies bubbles before they inflate and which, crucially, tells him when to get out. As early as the Davos conference in January 2010, Soros had dubbed gold the "ultimate bubble". Over the course of 2010, he continued to buy gold, both physically and through ETFs such as the iShares and SPDR gold trusts. He rode the price up from below $1,100 per ounce to $1,400 per ounce in the first quarter of 2011. Then he began to sell. John Paulson, the hedge-fund manager who correctly predicted the real-estate bubble and who now holds most of his personal wealth in bullion, believes that gold prices will reach $2,000 per ounce imminently and may rise as high as $4,000 per ounce over the next few years. In 1821, with the introduction of the gold sovereign, Britain became the first leading nation to adopt the gold standard. Over the course of the 19th century, gold came to underpin the global currency markets, giving tangible value to the fiction of paper money. Citizens could request that their banknotes be converted into gold at a predefined rate. Only in times of financial crisis or warfare was this right suspended. Thus, as crises approached, investors would rush to convert their currency into gold to pre-empt any suspension of the standard. In the 20th century, with the cost of world wars, rapid technological change and the Great Depression, it became clear that the gold standard was too inflexible a system for the modern financial markets, contributing to

rampant inflation and prolonging the economic slump in the United States. The Bretton Woods Agreement of 1944 established an international currency market based on a US dollar that was convertible into gold. Even this last link between the precious metal and paper money was severed with the "Nixon shock" of 1971, when the dollar became a fiat currency - one based solely on the government's promise to redeem it at its face value. When the financial storm subsides, we will see gold again for what it is - a pretty, expensive, rather useless metal. On 8 August, the price of gold rose above the price of platinum for the first time since late 2008. There are also negative signals for gold prices coming from the supply side. While gold production fell between 2006 and 2008, 2009 and 2010 brought a surge in supply, driven by the astonishing rise of China as the world's largest miner of gold. In 2010, China extracted 341 tones, up almost 9 per cent year on year, overtaking other major producers such as Australia and South Africa. With the latest price rises driving further Chinese investment in gold mining, the conventional scarcity of the metal may soon be a thing of the past. The biggest threat to the gold price is the economic crisis. It may be the case that governments, and not traders, will be the ones that identify and burst this bubble. With prices at such elevated levels, it makes sense for the treasuries of debtburdened nations to sell down their gold reserves. Italy, one of the countries at the centre of the crisis, is the world's fourth-largest holder of gold. German politicians have already lobbied for making liquidation of Italian reserves one of the conditions of any bailout package. France and the US are also major holders of gold that might be thinking about taking profits on their positions - but it is the International Monetary Fund (IMF) that everyone will be watching. The IMF is the world's third-largest holder, with almost 3,000 tons of gold, even after the organization bowed to pressure from the G20 and liquidated more than 400 tones in late 2010. China and India have called for further sales to be carried out and, with a new crisis to tackle; the IMF would be foolish not to consider dumping more of the precious metal on a ravenous market.

A Critique of Gold Gold is back, what with libertarians the country over looking to force the government out of the business of monetary-policy making. How? Well, by bringing back the gold standard of course. Theres no better place to see just how real this oddball proposal is than in Iowa, with its caucuses just a few months away. In June, prospective voters were entertained not just by the candidates but also by the spectacle of an eighteen-day, multicity bus tour cosponsored by the Iowa Tea Party and American Principles in Action, or APIA. APIA is the nonprofit 501(c)(4) arm of the American Principles Project, the parent group of Gold Standard 2012. Gold Standard 2012 works to reach out to lawmakers to advance legislation that will put the U.S. back on the gold standard. Businessman Herman Cain, having backed the gold standard in earlier speeches, acknowledged a change of heart on the grounds that one of my economic advisers said that its going to be more difficult than practical. A Montana measure voted down by a narrow margin of fifty-two to forty-eight in March would have required wholesalers to pay state tobacco taxes in gold. A proposal introduced in the Georgia legislature would have called for the state to accept only gold and silver for all payments, including taxes, and to use the metals when making payments on the states debt. Historically, societies attracted to using gold as legal tender have dealt with this problem by empowering their governments to fix its price in domestic-currency terms (in the U.S. case, in dollars). But the idea that government should legislate the price of a particular commodity, be it gold, milk or gasoline, sits uneasily with conservative Republicanisms commitment to letting market forces work, much less with Tea Partyesque libertarianism. More curious still is the belief that putting the United States on a gold standard would somehow guarantee balanced budgets, low taxes, small government and a healthy economy. Most curious of all is the contention that under twenty-first-century circumstances going back to the gold standard is even possible. Paul is also a more eloquent advocate of the gold standard. His arguments are structured around the theories of Friedrich Hayek, the 1974 Nobel Laureate in economics identified with the Austrian School, and around those of Hayeks teacher, Ludwig von Mises. In his 2009 book, End the Fed, Paul describes how he discovered the work of Hayek back in the 1960s by reading The Road to Serfdom. First published in 1944, the book enjoyed a recrudescence last year after it was touted by Glenn Beck, briefly skyrocketing to number one on Amazon.coms and Barnes and Nobles best-seller lists. But as Beck, that notorious stickler for facts, would presumably admit, Paul found it first. For according to Hayek, democratic governments are temperamentally incapable of resisting pressure from special interests (whether it be farmers, unions or big corporations) clamoring for assistance, and they turn to the central bank to help underwrite their responses. The central bank thus buys the governments bonds with newly minted currency and this, Hayek reasoned, inevitably fuels inflation. That inflation creates an unsustainable boom that eventually collapses, in turn creating further pressure for the government to intervene to stabilize an evidently unstable economy. Inflation, through its tendency to redistribute income and wealth largely to the detriment of the least advantaged members of society, further undermines popular support for the market system. Exiled from Austria as a result of the Anschluss, Hayek saw the slippery slope from managed money to state control of the economy, and from there to the suppression of political freedoms, as self-evident. And having firsthand experience with the Central European hyperinflations of the 1920s, Hayek certainly knew from monetary instability. On taking power the Nazis may have retained the facade of the gold standard, but among their first acts was to broaden the restrictions on imports and exports of gold originally imposed by the Weimar government during the 1931

financial crisis. This largely cut off international transactions, allowing Hitler to expand public spending, including on the military, unrestrained by fears that the mark would collapse as it had ten years earlier. BUT TO invoke the wisdom of Herman Cain, returning to the gold standard would be more difficult than practical. Envisioning a statute requiring the Federal Reserve to redeem its notes for fixed amounts of specie is easy, but deciding what that fixed amount should be is hard. Set the price too high and there will be large amounts of gold-backed currency chasing limited supplies of goods and services. The new gold standard will then become an engine of precisely the inflation that its proponents abhor. But set the price too low, and the result will be deflation, which is not exactly a healthy state for an economy. Credit Paul, once more, for anticipating the objection. The problem with the U.S. financial system, he argues, is not simply fiat money but fractional-reserve banking itself. And the solution, which should go hand in hand with restoring gold convertibility, is eliminating the latter. Banks should be required to limit their investments to liquid assets that can be sold off immediately in response to depositor demands. Banks would be forced to behave, in effect, like high-quality money-market mutual funds. . Sovereign defaults were far from infrequent under both the preWorld War I and interwar gold standards, as the Peterson Institutes Carmen Reinhart and Harvards Ken Rogoff show in their best-selling book This Time Is Different. Evidently, hard money is less of a guarantor of fiscal rectitude than popularly supposed. What is needed, it might be argued, is a good, old-fashioned sovereign default to focus the minds of the politicians and the bond-market vigilantes. That would seem to have been the subtext of the debt-ceiling debate. It would also be a very high price to pay. If these problems with restoring the gold standard are so profound, why then do they fail to register with the libertarian critics of big government? The answer, to the contrary, is that they do. At the end of The Denationalization of Money, Hayek concludes that the gold standard is no solution to the worlds monetary problems. There could be violent fluctuations in the price of gold were it to again become the principal means of payment and store of value, since the demand for it might change dramatically, whether owing to shifts in the state of confidence or general economic conditions. Alternatively, if the price of gold were fixed by law, as under gold standards past, its purchasing power (that is, the general price level) would fluctuate violently. And even if the quantity of money were fixed, the supply of credit by the banking system might still be strongly procyclical, subjecting the economy to destabilizing oscillations, as was not infrequently the case under the gold standard of the late nineteenth and early twentieth centurys.