Saturday 1st November

An overhaul of the world's financial system is a possible outcome of the Global Economic Summit to be held in Washington between 20 global leaders, on November 14th. Sarkozy is pushing hard for major changes and he has much influence in Euroland. The Euro is, today, a challenger to the US Dollar as a future reserve currency. The point of this conference (as far as we have been told) is to find a new mechanism for exchange rate 'fixing' that allows rates to vary over longer time frames while providing a stable exchange rate over shorter times, to allow businesses to plan. Volatile exchange rates are difficult for businesses who either carry the risks (in which case they need to trade on higher margins), buy forward (expensive and they could lose if business levels don't meet the forecasts) or hedge (same problems as buying forward).

The whole point of the capitalist system is that success is rewarded and bad companies, products and services either improve or go bust. The same is true of currencies; if you postulated an environment in which a country could print as many banknotes as it wanted without affecting the exchange rate, that's exactly what governments would do! Nobody is going to accept crass stupidity like that. At the present time, the US Dollar is the world's reserve currency. Presently, the US Government is over-borrowing and over-issuing US Dollars as cash and new debt. Under normal circumstances, the markets would devalue the dollar but US Treasuries have become a safe haven - a "Flight to Safety" - as the last remaining refuge for cash, in the face of a possible meltdown of the financial markets. I am very doubtful whether the US Dollar is any safer or more immune than, say, the Euro right now. We have seen a huge distortion in capital movement from equities and commodities into government bonds and massive swings in exchange rates. This in itself is adding to the stress on the financial system.

Given that an artificial peg between currencies makes no sense (unless you move from being a capitalist free-market system to a command economy) what might this conference come up with?

I suggest that the most logical choice is a return to a Gold Standard in some form. The holding of gold reserves by governments (and the IMF) is still common, and the mechanisms are all still in place.

I don't think that there is any sound alternative to a return to a Gold Standard in some form. For the private investor considering buying gold the question is whether this would result in a rise in the price of gold, or a reduction. My best guess is that governments will manipulate the price of gold by foul means if not fair to a price at which the gold producers can still produce at a profit. The price of gold dictates which mines can produce at a profit - this is a political decision insofar as each government will require the price to support gold mining in its own territory. Taking this into account and considering the huge extra demand for new gold as the world returns to a Gold Standard, suggests to me that the price of gold would rise to around $1250 in the short term, in constant money, i.e. today's purchasing power of the US Dollar. With today's price of gold around $725, there looks to be a good upside opportunity for gold for the private investor.