Memo To: SSU Students
From: Jude Wanniski
Re: An Islamic monetary union
It has always been the responsibility of the most powerful nation to provide the monetary standard for the world, or at least that part of the world it dominated in commerce. At the time of the birth of Jesus, Caesar Augustus gave Rome a gold sesterce that ended decades of inflation, which led to the golden age of the Roman Empire for the next two centuries. The Byzantine Empire was silver based. The British Empire flourished with a gold standard and foundered after WWI when it could no longer maintain sterling's link to gold, with the United States taking the lead. Washington held to gold through the Depression and in 1944 pledged to the allies at the Bretton Woods conference that it would maintain the dollar value of gold at the center of a new international monetary system, at the same $35 per ounce that was kept from 1934 in the first term of Franklin Roosevelt.
As we have learned in earlier lessons this semester, President Nixon in 1971 was persuaded by the demand-side economists inside and outside his administration that the U.S. economy was being held back by the Bretton Woods gold standard. Because all other countries of the world were linked to the dollar, not directly to gold, when Nixon broke the gold link he effectively took the entire world off gold. For the first time in all of history, there were no currencies defined in terms of gold or silver.
The world is still without a gold standard, largely because the economics profession that guided Nixon into the dollar's floating regime still clings to the idea that the world would have been worse off if Nixon had kept the gold link. If there is to be a new international monetary system with gold at its core, to keep all the paper currencies anchored to something real, the most monetary of all commodities, perhaps the lead will have to come from another major trading bloc. This week's lesson is about the possibility that the Islamic world, which covers 1.3 billion people in 57 countries, could pull together an Islamic Bretton Woods behind a gold unit of account, a gold dinar.
The Islamic english-language website of Al Jazeera has asked me to contribute occasional columns that I think will be of interest to its audience. The most recent I devoted to this topic and it was posted on November 24. With the dollar collapsing against major currencies in recent weeks, a new sense of impending financial crisis is creeping into discussions about the dollar's role as the key currency and whether there are alternatives. Read on. Questions will be welcomed, perhaps for a Q&A lesson in the weeks to come.
Where is that gold dinar?
by Jude Wanniski
When Malaysian prime minister Mahathir Muhamad last November retired from his 22 years in power at age 77, I had hoped he would devote his energies to a monetary reform of the Islamic world built around a gold dinar.
But after a few speeches and press releases on this subject, he has disappeared, practically dropping out of sight.
With the dollar price of gold now soaring and the US dollar sinking against the euro, the whole world could now make good use of Mahathir's idea, but what happened to it?
US Federal Reserve Chairman Alan Greenspan last week shook the financial and commodity markets with his comments at a banking conference in Frankfurt, saying the dollar would continue to fall against other currencies because of US trade deficits.
But if the United States had a gold dollar, this could not happen, and Greenspan, who I have known personally for 32 years, knows this.
Because the dollar "floats", with no gold anchor, it has been launched into a new inflationary cycle, one that threatens to drag all of Asia into another inflation through the dollar's links to the Chinese and Hong Kong currencies.
It is worthwhile thinking about Mahathir's inspiration as well as his failure, and how another run at a gold dinar might work with a different design.
Why am I interested? I've been trying for the last quarter century to persuade my country to restore the gold dollar as the core of a new international monetary system. But as turbulent as the world of commerce has been with the floating US dollar, inflating and deflating in random cycles, I've had no luck.
One of the problems Mahathir faced is that Washington had earlier used its influence to get the International Monetary Fund to prohibit any member state from re-instituting a gold-backed currency
The power elite that dominates money and banking in the US seems persuaded that a floating paper dollar is good for America even if it causes difficulties for global commerce and the rest of the world.
With an Islamic gold dinar, I reasoned, the Islamic world would have the best money in the world. The US would be forced to again fix the dollar to gold and the euro and the yuan/yen bloc would join as well.
The reason is that the best money becomes a magnet for international finance, because exporters and importers of every country in the world can save the many hundreds of billions of dollar a year now spent hedging against currency losses in the global trade.
When president Richard Nixon abandoned the Bretton Woods gold-exchange standard on 15 August 1971, believing it would help the US at the expense of the rest of the world, American banks were the biggest and most profitable in the world.
That soon ended when the Japanese government kept the yen from depreciating against gold as fast as the dollar was, which meant it suddenly had "the better money". In 15 years, seven of the biggest banks in the world were in Japan.
That heady experience for Japan ended when the US Treasury in 1989 threatened Tokyo with trade penalties unless it changed policies to suit US interests.
Tokyo slowed the rise in the values of real property with a higher effective capital gains tax that sent the Nikkei skidding from its peak in 1990.
The Bank of Japan was forced to manage its currency to keep it close to the dollar. This crippled the banks in the monetary deflation that began in 1997, with gold falling from $385 an ounce to as low as $255 in 2001.
In the process, the dollar deflation also crushed the commodity-producing countries of Asia.
It was against this background that Mahathir began thinking of insulating the Islamic world from the predations of Wall Street bankers.
He got the world's attention by blaming the Asian currency crisis on American Jews, but in an open letter to the prime minister that I posted on my website at the time, I noted that far more of my Jewish clients on Wall Street lost money in the crisis than gained from it.
The problem all along has been a breakdown in economic theory in the US, which led to Nixon's decision to break the dollar-gold link in 1971.
Mahathir was still in power in 2001 when he first announced the idea of a gold dinar and said he hoped that by 2003 there would be at least a dozen of the 57 countries in the Organisation of Islamic Conference joining the system of his design.
The world press was led to believe Iran would join Malaysia in the following year. None of this happened and the gold dinar has now become something of a joke in financial circles. Why has the idea faded from sight?
One of the problems Mahathir faced is that Washington had earlier used its influence to get the International Monetary Fund to prohibit any member state from re-instituting a gold-backed currency.
Why am I interested? I've been trying for the last quarter century to persuade my country to restore the gold dollar as the core of a new international
If all other currencies are forced to float freely from a gold anchor, the US dollar will preserve its status as the world's primary reserve currency.
Several Arab countries led by Saudi Arabia have instead been discussing the idea of an Arab common market linked to the euro.
The euro at least has been more stable relative to gold than the dollar, but it still fluctuates in ways that make commercial life difficult for the less-developed countries that are in its trading zone.
The mistake Mahathir made was in proposing a gold dinar that would only be used to settle trade accounts by the participating nations. It would not be available to ordinary people. There was to be no paper dinar kept as "good as gold" by individual Islamic central banks, by adding or subtracting liquidity to keep the dinar/gold exchange rate constant.
The mistake may have been in his belief that a nation-state actually needs gold bullion in order to manage an Islamic gold standard. It does not.
In fact, government banks would only need a nominal quantity of gold, with trade imbalances resolved through the exchange of financial assets - debt or equity, bonds or stock.
The idea of settling trade accounts with shipments of bullion is an obsolete 19th-century idea and should be discarded from any plan.
The main reason gold is such a stabilising force is that there is so little of it in the world, not more than 135,000 metric tonnes in all.
This is not even enough to build half the Washington Monument out of pure gold. This is not only my idea.
Mr. Greenspan said as much to the US Congress.
"The idea of settling trade accounts with shipments of bullion is an obsolete 19th century idea and should be discarded from any plan"
A modern gold standard would simply use the market price of gold as a signal, adding to the dinar money supply when the dinar/gold price showed the slightest drop and withdrawing from the dinar supply when the market price showed the slightest increase.
This simple concept was the one used by Alexander Hamilton, America's first treasury secretary, in persuading the US Congress to adopt a gold standard. This was at a time when the new republic had no gold at all.
Mahathir's second mistake was in thinking a gold dinar could be tried gradually, with two or three countries trying it out and others joining in as it proved itself.
It would be much easier to arrange an Islamic Bretton Woods conference of all 57 nations and arrange to have all, or almost all of them, agree to fix their domestic currencies to each other. They would use the market gold price as a signal to each on whether their central banks should be adding or subtracting from dinar liquidity that business day.
One small economy or even several smaller economies cannot arrange a gold standard by themselves because the US marketplace still dominates international trade by the sheer volume of its exports and imports.
Individual Islamic nations are now forced to take the dollar's value into account in managing their domestic currencies or their domestic enterprises that rely upon trade could be whipsawed into distress and bankruptcy.
In union there is strength, though, with the Islamic world now having enough total weight in combination to be able to stand up to the fluctuating dollar. And of course, the dollar would not fluctuate for long before Washington decided to give up on its ability to manipulate the dollar and join in its own stabilisation against gold.
It may be the time has passed for the Islamic world to take a lead in such an initiative, however.
With Greenspan now signaling no responsibility for the falling dollar, China may soon be forced to take the lead in breaking away from the inflating dollar and all the headaches it brings.
If Beijing were to take the lead in fixing its currency to gold at an appropriate, neutral level, Japan would soon cut loose from the weak dollar and use the Chinese yuan as its guide. So too would all of Asia, of course including Mahathir's Malaysia.