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undeniable so leaders are scrambling for Plan B.  For the U.S., Plan B is to double-down on Plan A.  Others are not so sure.  One problem is timing.  There are several Plan B's, but they all take 5-7 years to implement, e.g. yuan as reserve asset, SDR's as a new liquidity source, etc.  The two-tier Euro plan is just another Plan B although it might possibly be implemented in 2-3 years rather than 5-7.

None of these plans is totally ridiculous, but they all suffer from the same weakness which is that they depend on continued faith in paper money in a world where that faith is rapidly eroding.  So the meta-political question becomes: can one or more of these plans be implemented faster than the paper currencies collapse? My spot estimate is "no".  The avalanche has already started; there is no way to push the snow back uphill; it's just a matter of time before the paper money village below gets buried.  Plan A and the the system it represents will collapse before there's time for Plan B.

This brings us to Plan C of which there are several: (x) chaos, autarky, neomercantilism and heavy-duty protectionism; i.e. playing to win a negative sum game, (y) draconian policy responses including seizure, delegitimization and/or taxation of private gold and forced use of paper money, or (z) gold and commodity backed currencies and a gradual return to stability (albeit with a depression between here and there).  Options (x) and (y) more or less speak for themselves.  Option (z) is the most interesting because it involves a host of policy choices and political considerations such as: what is the non-deflationary price at which the gold standard should be reestablished (probably $5,000/oz or higher); and who gets to participate and at what levels, (and this is where the true weakness of players like China, India and Brazil comes into sharp relief).  Russia is the most interesting case because although it has a relatively small GDP (less than 3% of world GDP) it is a natural resource powerhouse which could play with the big boys in a world of commodity backed currencies.  Italy is another interesting case because it is a true gold power (over 2,400 tonnes) although it is frequently lumped in with the Club Med miscreants.

Given the dynamics and cross currents, a likely scenario consists of elements of all of the above.  The U.S. and China will continue to lead the world to a new regime of dollars and yuan as reserve currencies and SDR's plus IMF leverage as the key instrument for increasing world liquidity and settling international payments imbalances.  As the system breaks down anyway (because of private demand for gold due to lack of faith in official solutions) one political response will be protectionism (to appease local populations) and efforts at confiscation (to put the gold genie back in the bottle). At that point, and amid the chaos, one or more countries will "go for gold" on their own to preserve wealth and the purchasing power of export income; the most likely axis here is Germany-Russia with Austria, the Netherlands, France and possibly Italy joining in.  The German-Russian axis is the most natural in the world because each has what the other needs; technology and manufacturing in the case of Germany and energy and other natural resources in the case of Russia.  At that point, the U.S. may have to give up its alternative paper plans and join the gold rush leaving China heavily exposed to collapse because of its shortage of gold relative to GDP.  It seems likely that China sees the same scenario which explains its own rush to gold, albeit mostly from captive domestic production in the short run. 

The end result is a chaotic, ad hoc, but nevertheless eventual return to a global gold standard.  It would be far better for G20 to set up the processes, study groups and other mechanisms to make this an organized and efficient transition.  That is the one thing I do not expect to happen this weekend.

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