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Can (and should) the US back the Dollar with gold??

*Dow Theory Letters, by Richard Russell, February 7, 2011

”Over the weekend I’ve been mulling over the US’s problem of its falling dollar (of course the US may want a weaker dollar in order to pay off its debts).  If I was Secretary of the Treasury, I would ask myself, ‘What could I do to render the dollar more attractive?’ Here’s an idea that occurred to me, and this is what I might do.

The US owns the largest hoard of gold on the planet (in terms of sheer number of ounces).  Suppose the US decided to back the ‘dollar’ with gold.  That would immediately make the dollar more attractive to dollar-holders.  But if the US decided to back the dollar with gold, skeptical investors, worldwide would be likely to turn in all their dollars to the US and soon clean out the US’s hoard of gold.

But suppose the US unilaterally announced that the price of US gold from now on would be $5,000 per ounce.  This would mean that an investor would have to turn in $5,000 in cash in order to receive just one ounce of US gold.  My guess is that few investors would be willing to turn in $50,000 of their money to receive only 10 ounces of gold.

The dollar would be backed by gold, making it a one-of-a-kind currency, but few people would be willing to turn in their dollars for ‘expensive’ US gold.

Nevertheless, the dollar would be the only gold-backed currency on the planet.  And that would render the dollar a wanted currency, perhaps the world’s most wanted currency, because it would be the only currency backed by something tangible.

This might effectively end the insane era of fiat currencies.  The US move might be copied by many other central banks.  And politicians would once again be bound by the discipline of gold.

But wait, there’s a problem.  If it requires $5,000 dollars to buy a single ounce of gold, isn’t the dollar being effectively devalued in that it would require an enormous amount of dollars to buy an ounce of gold?

So the key question — If the US unilaterally raised the price of gold, would it be inflationary or deflationary?  Do any of my subscribers have an answer?

In actual practice, the dollar price of gold has been rising for 10 years in succession.  Each year it requires more dollars to buy one ounce of gold.  Thus, against gold, the dollar has been declining for years.  This means that the dollar, in terms of gold, is being devalued by the market.

Gold is traded around the world, 24 hours a day.  Thus, it cannot be manipulated by the US or any single country.  Gold’s price is a function of what people around the world will pay for it at any given time.  If people believe their currency is declining, they will be willing to put up more of their own currency for an ounce of gold.

Thus, rising gold in terms of a specific fiat currency is a function of fear, fear that one’s currency is losing purchasing power.”

*This information is solely a highlight of the opinion of a third-party publication and is incomplete.  Please subscribe to this publication for the full and timely opinion of the author and call a Monex Account Representative for any additional up-to-date information. This is not an offer to buy or sell precious metals. Investors should obtain advice based on their own individual circumstances and understand the risk before making any investment decision.

Aftershock Investor