Chatham House: Restoring the gold standard would hurt already damaged global financial system

Returning to the gold standard would be impractical and could even harm the financial system says a new report by London-based Chatham House.

That was the conclusion of the independent thin-tank's global task force of experts set up to assess what role, if any, gold could play in the international monetary system in the wake of the current financial crisis.

The group acknowledges that gold bullion can serve as a hedge against the declining values of fiat currencies and that it plays a role as a reserve asset, but concludes that for the bullion to play a more formal role in the international monetary system, “it would be imperative that it neither hinders the system’s performance nor creates unacceptable constraints on national economic policies.”

While the gold standard no longer exists, institutions hold 30,877 metric tons of bullion reserves, valued at about $1.77 trillion, according to the UK research house.

Although the discipline a gold standard imposes on monetary policy may have been helpful in limiting the reckless banking and excessive debt accumulation of the past decade, the rigidity of a fixed price for gold would likely have been a serious handicap at the onset of the financial crisis when a much more flexible monetary response was required.

Chatham House also concludes that there is no clear-cut role for gold as a policy tool:

Indeed, the historical behaviour of the gold price does not provide a particularly good indicator for either monetary or fiscal policy. In fact, since the financial crisis, the rise in the gold price has indicated the need for tighter policies that, if implemented, could have been deeply damaging.

Gold can be useful for central banks, but bullion’s role as a hedge is not cost free, warns Chatham, as a major downside of holding gold is that its price can be extremely volatile.

Also, it generates no yield, other than capital gains, which are only realized when it is sold. Gold, therefore, can form part of a portfolio of assets that spreads valuation risk, but on the other hand, it is not very effective as a sole reserve asset.

Chatham House was founded in 1920 and is based in London. Members of the gold task force include Gerard Lyons, chief economist at Standard Chartered Plc, Meghnad Desai, professor emeritus of the London School of Economics and a member of Britain’s House of Lords, and Catherine Schenk, a professor of international economic history at the University of Glasgow.

The full report can be downloaded here.