Today’s Notes:

1. Gold and the Currency System
2. Names Only in Montreal

1. Gold and The Currency System

Sunday Robert Zoellick, President of the World Bank, called for a new Bretton Woods, the third such agreement, to replace the current Bretton Woods II floating exchange rate system. In July 1944 a fixed exchange rate currency regime was created with gold backing in Bretton Woods, New
Hampshire with the US dollar at its center as the world reserve currency. It was subsequently
disassembled by the Nixon administration in 1971 after the United States unilaterally decoupled
the dollar from gold. By 1971 when France and other countries realized the inherent vulnerabilities
of the dollar-based system and French president Charles de Gaulle begin to exchange US dollars for
gold.
Zoellick, a former US Treasury official in the 1980s, recommended a new Bretton Woods
agreement to replace the current system which is inherently inflexible and prone to what I have
termed “a currency race to the bottom.” I believe we are now witnessing the beginnings of this
phenomenon. As the US depreciates its currency other countries purposefully depreciate their
currencies in response to inflate their prodigious debt loads away or simply to protect their
economies. In the view of most observers US currency depreciation appears to be the only
effective option the United States now has other than a sovereign debt default which cannot
occur. Last week’s $600 billion quantitative easing decision by the Federal Reserve is indicative of
this tendency to depreciate the dollar.  Competitive currency devaluations or currency controls
might now escalate worldwide resulting in a trade war. Associated problems such as trade wars,
capital controls, hot money flows due to carry traders are endemic to such a situation. One must
not forget that in the 20th century World War two, one of the most devastating wars mankind has
ever witnessed, resulted from such deflationary/ inflationary dynamics. Mr. Zoellick said, 
“The system should also consider employing gold as an international reference point of market
expectations about inflation, deflation and future currency values. Although textbooks may view
gold as the old money, markets are using gold as an alternative monetary asset today.”
Mr. Zoellick makes five major points in his recommendations in the November 7th issue of the
Financial Times, The G20 Must Look beyond Bretton Woods. He refers to the work done by James
Baker, then president Reagan’s Treasury Secretary, who avoided a global protectionist system with
the launch of the WTO and eventually North American free-trade. Mr. Zoellick’s five points are:
1. The US and China must agree on specific, mutual steps to boost growth. China must
agree on appreciation of the renminbi. The US, in turn, must desist from punitive, tit-
for-tat trade actions. Open-market agreements are critical.
2. Other major economies, starting with the G7 and not including all G 20 initially, must
agree to forgo currency intervention. This is the cause of what we called the global
currency race to the bottom. These situations tend to end badly for all participants.