The True Gold Standard (Second Edition)
Brazil’s President Dilma Rousseff used a visit to the White House on Monday to complain about US monetary policy as she made her case for international action against currency “manipulation” directly to Barack Obama.
In a meeting that highlighted the occasionally uneasy relationship between the two countries despite their potential to be strong partners, Ms Rousseff said that excessive monetary expansion in the US and Europe was hampering growth in countries such as Brazil.
Brazil is keen to win public support for its efforts to find a multilateral solution to what it calls the “currency war”, competitive devaluations of exchange rates by countries hoping to improve their export prospects.
Friday marked the third anniversary of the US stock market’s low following the Lehman bankruptcy. That was an epic buying opportunity, with the S&P 500 almost exactly doubling in those three years, in dollar terms. We are also only a week on from the fifth anniversary of the start of the credit crisis, when tumbling subprime credit in the US sparked a sharp rise in volatility.
That anniversary has been marked by what is in effect the biggest sovereign default in history, with Greece restructuring €206bn of its debt to private bondholders in an effort to qualify for a second instalment of bailout funds, so the narrative arc seems perfect. The anniversary also brings further evidence, from the non-farm payroll report, that the US economic revival is at last under way, as well as aggressive moves to ease monetary policy by big emerging central banks in Brazil and India, suggesting they are now more worried about growth than inflation.
But where exactly is it heading? The facts before us do at least show that the story is not over. Even after the great writedown, Greece’s debt is still priced at levels that only make sense if the market perceives a high chance that it will default at some point in the future.
Five- and three-year views give some extra clues to our destination. As the five-year chart shows, US stocks have clawed their way back to a slight profit over the past five years. Treasury bonds have fared far better (so there is no great loss of confidence in government credit yet). Oil has surged. The big winner has been gold.
This is continuing affirmation of gold’s role as the “reciprocal of the world’s faith in the stewards of paper money”, to quote James Grant, an inveterate supporter of a gold standard. Disaster has been averted, and stocks kept afloat by government intervention to print money. The performance of gold shows that many are nervous about how long this can continue.
Central banks increased the amount of gold they lent for the first time in a decade in 2011, as they used their bullion reserves to help commercial banks raise US dollars.
Although central banks hold one-sixth of all the gold ever mined in their reserves, their activities in the bullion market are opaque, with not a single institution revealing its day-to-day operations. In addition to holding gold for their reserves, some central banks also trade the metal, lending it on the open market in order to obtain a yield.
Thomson Reuters GFMS, the precious metal consultancy that publishes benchmark statistics on the gold market, on Tuesday said that the quantity of gold lent by central banks had risen last year for the first time since 2000.
The estimate by GFMS confirms a trend that bankers and gold traders have been privately discussing for the last six months. The increase in lending came as eurozone commercial banks, suffering a shortage of dollar liquidity, rushed to borrow gold from central banks and later swap it on the market in exchange for dollars.
Out there in the world today, a cabal of western central bankers is secretly determined to manipulate the world’s markets. They are doing this not via interest rates, but by rigging gold prices. More specifically, they have kept bullion prices artificially low in recent decades to ensure that our so-called fiat currency system – that is, money created by central banks – continues to work. For if the public ever knew the “real” price of gold, we would finally understand that our currencies, such as the dollar, are a sham … hence the need for that central bank plot.
Does this sound like the ranting of a Tea Party activist? A Hollywood screenplay? Or could there be a grain of truth in it? The question has been provoking hot debate among a small tribe of investors in America for many years, particularly those owning gold mining stocks. Right now it is also leaching into the more mainstream American political world.
As Republican candidates jostle ahead of the 2012 election, the question of whether America’s central bank has been debasing its currency – and how that is (or is not) linked to the value of gold – is cropping up with new force. Herman Cain, the former pizza executive who is now a popular Republican contender, hinted last month that he would like to return to a world where “a dollar is a dollar” and added that “yes, we do need a gold standard for that”. More recently, Newt Gingrich has voiced the same idea. Ron Paul, an outside Republican contender, has been lambasting the Federal Reserve for years over its easy money policies. He is now darkly warning of plots.
A group called American Principles in Action created a Gold Standard 2012 platform last year and is now fighting to make these issues an election issue next year. And on the extremes of the Republican party – and more libertarian circles of American life – a flock of theories about gold are now circling around, and taking root in the fertile soil of the internet.
The system of fiat money is 40 years old today. And quite frankly, it is looking its age.
The Bretton Woods system under which fixed exchange rates were linked to the gold price gave way to the current monetary system, in which currencies are backed by fiat, or trust, four decades ago.
For the gold market, it has been a tumultuous time. When Bretton Woods collapsed on August 15, 1971 – the Nixon Shock – gold lost its long-held role as the anchor for the global financial system.
But after a period in the wilderness, the yellow metal has come almost full circle. As currency markets become ever more volatile and global imbalances more entrenched, gold is once again in favour.
A return of any form of gold standard – by which the value of currencies is directly linked to gold – is unlikely. But make no mistake: gold is reclaiming is place at the heart of the financial system.
The most striking evidence of its return is the approach of central banks to the bullion market. After two decades in which central banks, mainly in Europe, were queueing up to dump their gold, central banks are now significant buyers.
The most recent figures from the World Gold Council show that as a group, on a net basis, central banks bought about 208 tonnes of gold in the first half of this year.
That is huge: since Bretton Woods ended in 1971, the largest annual net gold purchase by central banks was 276 tonnes in 1981. At the start of this year, only a few analysts expected full-year net purchases of even 200 tonnes.
But bankers – some of whom helped organise the gold sales of European central banks only a few years ago – are now falling over one another to buy gold on behalf of emerging market central banks. Following significant purchases by Thailand, Mexico and South Korea in recent months, bullion bankers are now setting off to Brasília, Buenos Aires and Riyadh to pitch gold as a reserve asset.