In recent days the Canadian and Swedish central banks have joined
the majority of other G10 central banks by indicating that they too may
engage in quantitative easing now that the interest rates have been reduced
to 25 and 50 basis points respectively. The ECB is wrestling with ways to
extend its own form of quantitative easing and an announcement is likely at
its next meeting on May 7th.
While some observers have
focused on the potential debasement of the US dollar by the aggressive
monetary and fiscal policies of both the Bush and Obama Administrations,
many investors are worried about the viability of the whole universe of
paper money.
As Gillian Tett, award-winning journalist at the
Financial Times, put it earlier this month, there has been a four-decade
long experiment with fiat currencies not backed by gold or silver. This
crisis is so profound that increasingly it appears to have shaken
confidence in the experiment. At the same time, the crisis looks to have
widened the range of possibilities.
The Special Drawing
Rights that the Chinese and others have suggested to eventually replace the
dollar does not get beyond paper money. The SDR is a basket of fiat
currencies. It is not and cannot be a serious alternative to the US dollar.
Consider that 44% of an SDR is the dollar. The IMF’s
figures show that roughly two-thirds of the world’s reserves are in
dollars. If countries' reserves were allocated according to the SDR, the
dollar’s share of reserves would fall by about a third. While the
euro would pick up some slack the big winners would be the yen and
sterling, whose share of the SDR is 11% a piece, two to three times larger
than their reserve allocation.
If there has been a shift in
reserve allocation over recent years, it is not away from the dollar, as so
many wrongly claim, but rather away from the yen and toward sterling. And
even this shift has been marginal at best. Reserve managers generally want,
in order of importance: Security, liquidity, and yield. Japanese bonds are
often seen as deficient in both liquidity and yield.
All that Glitters
Can gold return to its role
as the anchor for currencies? The advocates of gold are a passionate and
vocal minority which appear to be second only to Ayn Rand devotees in terms
of intensity. Of course there is a large overlap as Alan Greenspan’s
1966 essay “Gold and Economic Freedom” illustrates.
Data from World Gold Council and
China Figures in Metric Tonnes
To appreciate though
why gold is ill-suited today to once again back paper money, we need to
consider why the gold standard ended in the first place. Simply put, the
gold standard provided an economic barrier to the political agenda. That
political agenda called for rapid growth to resist the spread of communism.
It called for “guns and butter” in the US with the Great
Society and the war in Vietnam. The European political agenda included the
expansion of the welfare state—from cradle to grave.
Jettisoning gold not only allowed for the pursuit of the political agenda,
it helped create the conditions for the rapid and dramatic expansion of
trade, capital flows and globalization. What is all too often lost amid the
despair and cynicism that the crisis has wrought is the amazing success of
that regime. Since 1980, for example, the world economy has grown by 145%.
Taking into account the increase in the world’s population, roughly
1.6% per annum, there has been a nearly 40% increase in per capita income.
How such wealth is distributed is an important issue beyond
the scope of this discussion. Yet it is interesting to note that longevity,
a measure that subsumes numerous other metrics, has risen sharply in both
developing and developed countries and that gap between the two has
narrowed.
Not Enough
The same
problem exists with a new gold standard that existed with the old. There is
simply an insufficient amount of gold. Or to say the same thing, the price
of gold necessary to put the international monetary regime back on a gold
standard is so astronomical as to make it unworkable.
There
are different ways to go about conceptualizing the magnitude of the
challenge. As the table above indicates, the US has more gold than Germany,
France, and Switzerland combined. Given that foreign investors own about
$2.5 trillion more of US assets than Americans own of foreign assets, what
price of gold is necessary for the US to no longer be a debtor? Answer:
More than $8,500 an ounce.
Another approach, suggested by a
Swiss investment bank, is to relate the price of gold needed to cover some
measure of money supply. By its reckoning, the US would need gold to be
worth about $6,000 an ounce to reintroduce a gold standard. However, it may
not be sufficient to simply have the US adopt a gold standard. For the US,
China, and Japan, the three largest economies as measured by purchasing
power parity, to back their money with gold would require a price closer to
$9,000 an ounce.
The current price of gold is just above $900
an ounce. Peaking in March 2008 near $1,032, it has averaged $638 over the
past five years and $473 over the past ten years. For the yellow metal to
reach the kind of levels necessary to make a gold standard mathematically
feasible in the present day, the protracted period of deflation necessary
would not be politically acceptable. Where Does that
Leave Us?
There is no realistic alternative to the
dollar. Not SDRs. Not gold. Not the euro. Not the yuan. That might not be
deducible from macro-economic first principles, but it is proven by what
central banks are actually doing.
This does not mean that
there is no role for gold in individual portfolios, though often people
seem to confuse a paper claim on gold for the actual bullion. Also, the
touts for bullion often do not include the costs of storage and insurance
for gold which has gone decades without appreciating and, of course,
generates no income stream.
Central banks that have
accumulated large holdings of foreign currencies, like those in Asian and
Middle Eastern countries, tend to have relatively little gold. European
central banks, which could not get enough gold during the late 1960s and
early 1970s, have turned into sellers over recent years. Paradoxically, as
they sold off their gold in an orderly way, the price of gold trended
higher. Yet many seem to believe that it is a given that the dollar will
fall if these same or other central banks sell dollars. Huh?
On April 24th China revealed it has dramatically increased its gold
holdings since 2003. In 2001, China said it had roughly 500 tonnes of gold.
By 2003, it had risen to a little over 600 tonnes. Now it says it has 1,054
tonnes of gold, more than a 75% increase. Still this means that gold
accounts for only about 1.6% of China’s reserves.
China
is the world’s largest producer of gold, but it also refines scrap
gold. As part of the standard arguments, gold advocates assert that all the
gold that has ever been mined is still here. That is true up to a point and
it is at that point that it gets interesting. China is exploiting the fact
that a ton of computers and cell phones contain several times more gold
than a ton of gold ore has.
Central banks in Asia and the
Middle East may buy more gold going forward and European sales seem set to
slow (though the IMF sales will reportedly go ahead), but it will be barely
noticeable in terms of the international monetary regime and the role of
the dollar.
About the author:
Marc Chandler joined Brown
Brothers Harriman in October 2005 as the global head of currency strategy. Previously he was the chief
currency strategist for HSBC Bank USA and Mellon Bank. Marc is a
prolific writer and speaker. In addition to being frequently called up to
by the newspapers and news wires to provide insight into the developments
of the day, Chandler's essays have been published in the Financial
Times, Barron's, Euromoney, Corporate
Finance, and Foreign Affairs. He is also the contributing
economic editor for Active Trader Magazine and to TheStreet.Com. Marc
appears often on business television and is a regular guest on CNBC. He
frequently presents to business groups and investors.
His current research projects include global imbalances, Islamic
finance, and the relationship between savings, investment and growth. Marc
has been analyzing the foreign exchange market for more than 20 years. He
holds a Master's degree in American history (1982) from Northern Illinois
University and a Master's in International Political Economy from the
University of Pittsburgh (1984). He has taught classes on International
Political Economy at New York University since the early 1990s.
DISCLAIMER: All of the provided information is believed to be accurate, however errors are possible. The opinions in the Commentary section do not necessarily reflect the opinions of GoldIRAS.com. Past performance of any investment is no guarantee of future performance. All investments have risk.
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