Only a Retail Gold Standard Could Dethrone the Dollar

The BRICS bloc is remaining coy about whether a global currency will be on the agenda of its 15^th summit, which is set to take place August 22 to 24 in South Africa. Experts from Joseph W. Sullivan to Jim O’Neill to the Council on Foreign Relations warn that a BRICS currency would threaten American economic hegemony. Precedent suggests, however, that dethroning the US dollar with anything short of a full retail gold standard will be difficult.

As students of monetary history, we know that only one of the three major alternatives available to the BRICs bloc would likely last long enough to dent the dollar. That alternative, the retail gold standard, predates the fiat dollar by centuries, if not millennia.

If the BRICS bloc forms a supranational fiat currency like the euro, where demand today is generated by the expected demand for the currency tomorrow, it will surely soon be torn asunder, just as the euro almost was. Unlike the United States, BRICS countries are not a de facto common currency area. They are widely dispersed geographically and share no common fiscal apparatus. Their economies are very different and do not sync cyclically. So, BRICS countries may want to maintain monetary policy discretion, or in other words the ability to raise interest rates to cool inflation or lower them to stimulate growth. 

But a supranational fiat currency could survive only if all BRICS national currencies are eliminated, lest one or more members become seigniorage-hungry “money pumps,” as Rhode Island was in America’s colonial period. That tiny colony caused a hyperinflation in New England but thankfully US policymakers learned from the experience and constitutionally banned states from issuing fiat money. That helps keep the US common currency area alive, as does the fact that America’s fiscal and financial systems are unified, a big advantage in terms of macroeconomic stabilization that the BRICS currency, like the euro, would not enjoy.

To prevent interest rates from integrating and converging, as they do in countries that share a currency and allow the free flow of capital internationally, the BRICS countries could impose draconian capital controls. Such controls are costly to monitor, however, and defeat one of the main purposes of forming a common currency in the first place.

The question of control also looms large. Without strong institutional controls or a shared system of taxation, a sudden, massive depreciation of the new currency is possible if one or more of the larger BRICS partners decide to exit by issuing their own money again, perhaps to regain control of domestic interest rates.

Cognizant of those difficulties, the BRICS bloc might instead try to create a gold-exchange system like the free world did at Bretton Woods in 1944. In such a system, each nation would continue to issue its own currency and enjoy some domestic monetary policy discretion. But by pledging to redeem their fiat monies at their central banks for gold at a known, fixed rate, they constrain themselves from becoming a money pump. They must impose capital controls, though, lest they lose all their gold reserves if their interest rates fall too far below those of other countries in the system. Or, their monetary authorities must periodically devalue the domestic currency, which can get politically ugly. Sometimes, a dominant country must revalue its currency to keep the system in balance, but often it proves reluctant to do so for fear of hurting its export sector.

Moreover, countries can stop gold redemptions and leave the system whenever it is in their perceived best interest to do so, like when the United States left the Bretton Woods system in the early 1970s, less than 30 years after its formation. Another fixed exchange rate regime initiated in 1979, the European Monetary System, fell apart even more quickly, in 1992. The crisis made a billionaire out of George Soros but disrupted several major European economies.

Some say that fiat common currency areas like the euro and gold-exchange systems can work long term if only the details can be gotten right. Maybe, but many say the same thing about communism. We believe that only a retail gold standard could topple the dollar in the short term and survive indefinitely. In that system, which the United States and many other nations relied upon until the Great War (1914-1918), anyone can exchange central bank notes or commercial bank notes or deposits for gold on demand at a fixed, known rate in terms of the local unit of account (yuan, rand, reals, etc.). That fixes exchange rates between countries while the free international flow of gold and other capital ensures domestic price stability. The main cost, the loss of domestic monetary discretion, is really a benefit because it means that markets, not politicians, determine domestic interest rates.

The fiat dollar in place since 1973 achieved global dominance because it only had to compete against the fiat currencies of countries like Switzerland with better institutions but much smaller economies, or with the currency of a supersized economy with weaker institutions, the euro. If a large subset of countries, like the BRICS, adopted the retail gold standard, the United States and the European Union would have to join, or watch demand for their fiat currencies decline.

In short, America has little to fear from a BRICS common currency or even a gold exchange system. If the BRICS implements a retail gold standard, though, it will likely be forced to give up the fiat dollar for bricks, goldbricks that is.

The authors of this piece recently published Explaining Money & Banking (Business Expert Press, 2023).

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