U.S. Seeks Role for Gold in World Monetary System

Treasury Secretary James A. Baker III on Wednesday proposed a change in the global currency system that would restore a role for gold for the first time since 1971.

Under the unexpected proposal, the precious metal would be included in a price index of various commodities that would be used by the largest industrial countries to provide “an early warning signal” of future inflation.

If accepted by other countries, the plan would represent the first formal role for gold in the world monetary system since the link was ended by former President Richard M. Nixon in 1971 as part of a sweeping economic program. The U.S. government previously had promised to exchange gold for dollars at a fixed price.

Baker’s proposal, in a speech at the annual meeting of the International Monetary Fund and the World Bank, marks a major step toward a permanent system under which the seven leading industrial democracies would attempt to curb the excessive currency fluctuations and price instability that have battered the world economy for nearly two decades.

Baker’s suggestion, while far short of a return to the gold standard, is nonetheless certain to spark a major controversy because many monetary officials and economic analysts have ridiculed the idea of depending on the price of gold and other commodities as a guide to the conduct of economic policies.

Partly in reaction to Baker’s suggestion, gold prices dropped about $5 an ounce in New York trading to $453.75, while the dollar advanced against all other major currencies.

British Chancellor of the Exchequer Nigel Lawson, while avoiding any mention of gold, also called for establishing a joint system to manage currency levels that would monitor commodity price trends in an effort to avoid a resurgence of worldwide inflation.

Any relationship between gold and the dollar under the new U.S. proposal, however, would be weak. The precious metal would be only one in a basket of several basic commodities that would be monitored to indicate general price trends. At the same time, there would not be any automatic action to change policies, even if higher inflation were evident.

Under either Baker’s or Lawson’s proposal, the commodity basket would allow officials to monitor the price trends of key agricultural products, such as wheat, corn and cotton, principal metals such as gold, copper and tin, and other raw materials.

In theory, if these prices began to rise against a currency, economic officials would know that to prevent inflation, they should squeeze the supply of credit in that particular currency by boosting short-term interest rates. And, if such prices began to fall sharply, it would be an indication that monetary officials were being too tight in supplying credit to the economy.

‘Analytical Tool’

The commodity price indicator, Baker said, would be used as “an analytical tool” along with other measures of economic performance already followed by officials, such as real growth, trade and current account balances and exchange rates.

Economic policy-makers of the major nations made a pact last February in Paris to work together to stabilize the dollar against other currencies, a move that succeeded in halting the steep fall in the U.S. dollar of the previous two years.

This year, central banks have poured as much as $70 billion into currency markets and have nudged short-term interest rates relatively higher in the United States, compared to its major trading partners, to help hold the dollar steady.

The economic officials also have agreed to meet regularly in an effort to coordinate domestic economic policies in hopes of sustaining global economic growth while reducing massive trade imbalances among the United States, Japan and West Germany.

Only last weekend, finance ministers and central bankers from the seven leading industrial democracies--the United States, Japan, West Germany, Britain, France, Italy and Canada--agreed to continue to defend the dollar’s stability. But they made little headway in reaching agreement on ways to foster more balanced growth by stimulating economic demand in Europe while continuing to shrink the U.S. budget deficit.

Even with stability among currencies, it is difficult for nations to determine whether their economic policies might be leading to a dangerous round of inflationary price boosts or an equally serious general price deflation, Baker and Lawson told the 151-nation conference.

“It would be unfortunate,” Baker said, “if our efforts to foster exchange rate stability among currencies led to stable currency relationships--but, in a context of inflationary economic policies, that reduced the real value of all currencies.”

Therefore, Baker said, the United States proposes “to consider utilizing, as an additional indicator in the coordination process, the relationship among our currencies and a basket of commodities, including gold. This could be helpful as an early warning signal of potential price trends.”

After the speech, Baker told reporters that the proposal to use commodity prices to help guide policy decisions was supported by Federal Reserve Chairman Alan S. Greenspan. A Fed spokesman said that Greenspan has discussed the plan with Baker and “approves of it.”

But officials attending the meeting said that Japan was skeptical about the U.S. approach. In the past, French officials have been the only ones to express support for bringing gold back into the global money system.

West German officials said they are reserving comment until they have studied Baker’s proposal, as well as the suggested system of managed floating exchange rates announced earlier Wednesday by Lawson.

Lawson said it is now time for the major industrial countries to “maintain the maximum stability of key exchange rates and to manage any changes that may be necessary in an orderly way.”

While saying that he is not suggesting a “return to Bretton Woods”--under which currency values were fixed against each other--Lawson emphasized the importance of ensuring that there is no persistent inflationary or deflationary bias in the global currency system.

Many economists argue that commodity prices are not reliable as a guide to future inflation and contend that freely floating exchange rates serve as a better absorber of unexpected economic shocks than a system aimed at stable currency rates.