Gold Dinar & Gold Backed Currencies

Malaysia announced Saturday that it wants the Organisation of the Islamic Conference (OIC) member countries to reconsider the gold dinar for international trade, especially with the uncertainties in the currency markets and weakness in the international financial system.  A role for the gold dinar was already proposed by Malaysia in 2002 but at that time could not count on a lot of enthusiasts. This time it might be different though.

The idea of the gold dinar is simple: issue a currency (which can be dealt  electronically) but is fully backed by gold or silver bullion. Use this unit as a currency in global trade as it should be a steady store of value. This contrary to all other ‘fiat currencies’ which are out there right now and are based on nothing but trust and aren’t redeemable for any worth while commodity. Let me rephrase that, these currencies are not guaranteed to be redeemable against commodities in a fixed way. Today $45 buys you one barrel of oil or 1 gram old of gold. Next month it might only buy you half a barrel of oil and half a gram of gold. The uncertainty surrounding the redeemability of money against goods and services might something we might want less of.

A money system fully backed by gold isn’t a new idea by the way and certainly not specific to the Islamic world. In the West for example, James Turk’s goldmoney.com has been proposing a similar system for a long time.  But what exactly would be the advantage of such gold backed (electronic) currency systems?

Well the answer to that is straight forward. In a gold or silver backed system, money could not be printed ‘out of thin air’ as is the case is all fiat currency systems that currently dominate world finance. What we call money these days is backed by nothing and the amount of real goods and services it can buy is dependent on the amount of fiat currency in circulation. If there is little of fiat money around, goods and services are cheap, if a lot of it is around, the prices of goods and services rises.  Since fiat  money is issued by the central banks and is accepted by governments to pay for taxes, people seldom give this type of money a second thought. It is generally assumed that the masters who control the fiat currency system act responsibly.

Unfortunately that’s generally not the case though. Governments can finance their spending through taxing the people directly or indirectly. The indirect form of taxation is one through inflation: governments just spend money on one of those projects they deem necessary, but in stead of financing this spending through direct taxation, they simply print the money. The result is inflation through an increase in the money supply which can be seen as an indirect form of taxation. 

It is clear that the current credit crisis is leading to astronomical injections by world governments in the financial system and in the economy. Some of this money is borrowed from the public but the bulk is printed out of thin air. The result will without a doubt be that the currencies will start paying the price by means of loss of purchasing power. Expect the currencies of the ‘bailout crowd’ to be very volatile going forward and to depreciate substantially against hard assets. Such a currency crisis has -for the first time- the potential to be  a truely global one. 

Gold and silver have been store of value throughout the ages. A troy ounce of gold bought a pair of handcrafted sandals or a nice toga in ancient Rome. Today a troy ounce of gold will buy you a pair of handcrafted shoes or a nice suit. Value doesn’t change through the ages, only price does. Therefore the Malaysians have got a point: today’s fragile global currency system might be screaming for a good store of value which takes the volatility (and risk) out of the equasion for indviduals and businesses who want to protect their wealth.  Get ready for gold and silver backed currencies to start paying big(ger) role in world finance.