Robert Zoellick put a few sentences about gold toward the end of a column in today’s FT that are drawing a lot of attention.   I doubt very much if the World Bank President has in mind a return to the gold standard, but goldbugs and critics alike are talking as if he does.

      Even if one placed overwhelming weight on the objective of price stability — enough weight to contemplate a rigid straightjacket for monetary policy — gold would not be a suitable anchor.   The economy would be hostage to the vagaries of the world gold market, as it was in the 19^th century:   suffering inflation during periods of gold discoveries and deflation during periods of gold drought.   This is well-known.   I am confident Zoellick understands it.   (He and I were in the same macroeconomics seminar at Swarthmore College in the 1970s.)

      I think he is making another point.  The world is moving away from a monetary system in which the dollar is the overwhelmingly dominant international reserve asset.  The dollar’s share of international reserves has been declining ever since Richard Nixon unilaterally ended the Bretton Woods system in 1971.   The dollar’s unique role is not an eternal god-given constant of the universe, any more than it was for pound sterling.  The US currency of course replaced the pound in the first half of the 20^th century, with a lag of 25 years or more after the US surpassed the UK economically.

      Will some asset replace the dollar, then?  No, not a single asset.  But we are probably moving to a system where there will be as many as a half dozen international reserve assets.  First, there is the euro.  Despite the serious troubles facing it this year, the euro has been a competitor for the dollar since it came into being 11 years ago.  Both the yen and the Swiss franc have to some extent played safe haven roles during the last three years of global financial turmoil.  The pound is not out completely.   Some day the renminbi will be added to the roster of major international currencies, when China’s financial markets are sufficiently developed and open.    Even the SDR (special drawing right) came back from the dead in 2009.

      And, yes, gold too has re-joined the world monetary system.  Gold was seen as an anachronism as recently as a couple of years ago.  The world’s central banks had been gradually selling off their stocks.   But all that changed in 2009.  The People’s Bank of China, the Reserve Bank of India and other central banks in Asia have bought gold.  Understandably, they want to diversify their reserves.    It appears that central banks have stopped selling gold even among advanced countries and that aggregate gold reserves have risen over the last year.   This is a multiple reserve asset system.      

[For those interested in gold and other mineral commodities, I have some relevant writings.  Others' views on Zoellick are at the New York Times.]

          Numbers newly reported from the IMF’s COFER data base show that in the most recent quarter, the spring of 2009, the share of central banks’ foreign exchange reserve holdings that they allocate to dollars resumed its downward trend.   The dollar share has been gradually sliding since the beginning of the decade – perhaps because of the birth of a possible rival, the euro, in 1999, or perhaps because of the long-term path of tremendous fiscal and monetary expansion on which the United States embarked in 2001.   

          During the four quarters preceding the most recent one, the share of the aggregate portfolio that the world’s central banks allocated to dollars had temporarily reversed its downward direction.  Arithmetically, the main source of this increase in the dollar’s share was its appreciation against other currencies.   But another source was the action of central banks in industrialized countries, acquiring dollars more rapidly than other currencies.   The movement of the raw quantity shares can be seen in the first graph below, and the movement in the shares properly valued at current exchange rates in the second graph.   (I am grateful to Ted Truman and Dan Xie, both of the Petersen Institute for International Economics, for these graphs.)   

          Whether the temporary reversal from Q2 of 2007 to Q1 of 2008 is measured in quantity terms or in valuation terms, the phenomenon was presumably a (surprisingly strong) safe-haven reaction to the global financial crisis.  Apparently the recent easing of risk and liquidity concerns has now mitigated the flight into dollars.  The central banks that had shifted into dollars have begun to shift back a bit, into euros in particular.

          The gradual downward trend of the dollar’s share during the past decade is a continuation of the trend that began after the end of the Bretton Woods system: from the late 1970s until 1991.  The dollar’s share recovered from 1992 to 2000.  That temporary halt in the longer run trend may have been in part a result of the deficit reduction path that began with George H.W. Bush’s unpopular fiscal reversal and continued through the time of Bill Clinton achievement of fiscal surpluses, until George W. Bush took office and reinstated the chronic deficits.

          The usual response to worries that US macroeconomic profligacy will eventually end the dollar’s privileged position as lead international currency has always been that no asset constitutes a credible alternative for central banks to hold in their portfolios.   I have argued that, since 1999, the euro has constituted a credible alternative.   Based on econometric estimates of the determinants of central banks’ reserve holdings in research with Menzie Chinn, we have even gone so far as to report simulations that show the euro overtaking the dollar by 2022.  Many, like Truman, consider such speculation exaggerated.  They may be right.

           But the euro is not the only alternative to the dollar.  The yen, pound and Swiss franc remain viable alternatives for national authorities to put some of their reserves.  Furthermore, 2009 has seen the resurrection of two international reserve assets that had previously been written off as dead:  the SDR and gold.  My forecast is that we are gradually moving from the dollar standard to a global monetary system that features multiple reserve assets.

Share of central banks foreign exchange reserves allocated to dollars, 1999 QI – 2009 QII       (among industrial countries, among developing countries, and overall)

[Readers wishing to post comments are referred to the SeekingAlpha version.]

The field of International Monetary Economics is not without its own cycles and fads.

In a speech at the European Central Bank over the summer, “On Global Currencies,” I identified eight concepts that I saw as having recently “peaked” and eight more that I saw as newly rising in relevance. Those that I viewed as losing traction were: the G-7, global savings glut, corners hypothesis, proliferating currency unions, inflation targeting (narrowly defined), exorbitant privilege, Bretton Woods II, and currency manipulation. Those that I saw as receiving increased emphasis now and in the future were: the G-20, the IMF, SDR, credit cycle, reserves, intermediate exchange rate regimes, commodity currencies, and multiple international currency system.

A condensed version appears this month in Finance and Development, from the IMF, titled “What’s ‘In’ and What’s ‘Out’ in Global Money.”  I boil the list down to five concepts that I pronounce “on the way out” and five more that I see as replacing them:

• The G-7 has been rendered largely obsolete by its lack of representation of developing countries, and thus in the course of 2009 has been overtaken by the G-20.

• The corners hypothesis had become conventional wisdom by the end of the 1990s. This was the idea that all countries were or should be abandoning intermediate exchange rate regimes (bands, baskets, crawling pegs, adjustable pegs, and heavily managed floats) in favor of either the floating corner or the institutionally fixed corner (currency boards, dollarization, or monetary union). Since 2001 the tide has turned against the corners hypothesis, and far fewer economists would now assert it as a sweeping generalization.  Certainly a huge fraction of the members of the IMF continue to follow intermediate regimes.

• The language of “unfair currency manipulation,” has been in US law since 1988 and the IMF Articles of Agreement for longer. China during the years 2004-2008 was pretty much the first large country to face charges of unfairly manipulating its currency to keep it undervalued. But US Congressmen who have for years urged China to abandon its link to the dollar could well live to regret it, if they were to get their way and the People’s Bank of China did in fact stop buying US treasury bills. It is finally beginning to sink in among Americans that having China as its largest creditor carries with it some new constraints.  What concept is “on its way in,” to replace the idea that intervening to prevent one’s currency from appreciating is anathema?   Reserves.  Two short years ago, Western economists were lecturing surplus countries that they were acquiring too many reserves.  Today we see that the developing countries that have weathered the 2007-09 crisis the best are countries that had previously piled up the most reserves, other things equal.

• Most controversially, I assert that Inflation Targeting — narrowly defined, I hasten to add — has seen its best days. The definition of IT I have in mind is the proposition that the monetary authorities should set a target range for the increase in the CPI each year, and then should focus all their efforts on hitting it. This orthodoxy says that the central bankers should pay no attention to asset prices, the exchange rate, or commodity prices, except to the extent that they carry implications for the CPI. For large rich countries, it has become clear since 2007 that Alan Greenspan was wrong when he (plausibly) abjured all attempts to identify or discourage bubbles in real estate and stock markets. As a result, the credit cycle view of monetary policy has been resurrected , after a long period when only inflation was thought to matter. For smaller and developing countries, I would also argue that volatility in commodity prices has made it clear that monetary policy should let currencies depreciate, at least somewhat, when the terms of trade worsen, rather than the opposite as is implied by a strict interpretation of CPI targeting. For them, I would propose replacing the CPI target with a more production-oriented price index, such as a target for the PPI or even an export price index.

• The United States has benefited throughout the post-war period by an unlimited ability to borrow in dollars. A popular view two years ago, supported by some of the best scholars, was that the US had earned the dollar privilege by establishing a unique comparative advantage in supplying a saving-glut world with high-quality assets. Then the sub-prime mortgage crisis in 2007 revealed that US assets were not so high-quality after all. The dollar did retain the benefit of being the safe haven currency in 2008, as an exorbitant privilege — contrary to the predictions of those of us who had predicted that the unsustainable current account deficit would lead to a large depreciation. Nevertheless, some developments in the course of 2009 have suggested a global movement away from the unipolar dollar standard, and toward a new multiple international reserve system. These events include the gradual rise of the euro as an international currency to rival the dollar, the sudden and unexpected resurrection of the SDR from near-death, new interest in the yen and gold as safe haven assets (including among central banks), and the very first glimmerings of an international role for the RMB.

[Any readers wishing to post comments are referred to the Seeking Alpha version.]