A BUREAUCRATIC PIPE-DREAM
Bureaucrats are naturally drawn to bureaucratic ‘solutions’ to problems. But cooperative solutions become unworkable when cooperation breaks down, as is increasingly the case in global monetary relations. In this context, the OMFIF report, while it sounds nice on paper, is a futile attempt to hold an unstable equilibrium together. The fact is the BRICs no longer trust the mature economies in monetary affairs.4 Lacking such trust, the only viable way forward is to ‘de-nationalise’ money for international trade, thereby disarming those who would opportunistically engage in currency wars.
4 Please see THE BUCK STOPS HERE: A BRIC WALL, Amphora Report vol. 3 (April 2012). The link is here.
Gold is the only such non-national money, a currency that cannot be printed or otherwise manipulated by one country at the expense of another. Its supply is strictly limited by that which can be got out of the ground at economic cost within a given period of time. Thus gold stands in sharp contrast to all unbacked fiat currencies, the weapons of the currency wars. The OMFIF report dances around this fundamental difference between the two but ultimately stumbles. Yes, the OMFIF report recognises that:
[T]he previously dominant western economies have attempted to dismantle the yellow metal’s monetary role, and – for a variety of reasons – this has comprehensively failed. Gold thus stands ready to fill the vacuum created by the evident failings of the dollar and the euro, and the not-yet requited ambitions of the renminbi.
But notwithstanding the recognised failings of fiat currencies and persistence of gold, the report then moves on to recommend that gold and the major fiat currencies be treated as equals in the future monetary order, specifically, by:
…extending the SDR to include the R-currencies – the renminbi, rupee, real, rand and rouble – with the addition of gold. This would be a form of indexation to add to the SDR’s attractiveness. Gold would not need to be paid out, but its dollar or renminbi or rouble equivalent would be if the SDR had a gold content. By moving counter-cyclically to the dollar, gold could improve the stabilising properties of the SDR. Particularly if the threats to the dollar and the euro worsen, a large SDR issue improved by some gold content and the R-currencies may be urgently required. (Emphasis added.)5
5 GOLD, THE RENMINBI AND THE MULTI-CURRENCY RESERVE SYSTEM, OMFIF, January 2013, p. 4.The link is here.
From ‘dance’ to ‘stumble’ may be the wrong metaphor here, unless the stumble is meant to serve as a distraction for some slight-of-hand on the stage. Did you catch the subtle trick of logic in the above?
Allow me to explain. The “failings of the dollar and the euro” vis-à-vis gold are indeed “evident”: This is why central banks everywhere are in a scramble to acquire more gold and, in some cases (eg Germany, Venezuela, Turkey) to strengthen their custody of it through repatriation and changes in regulations. The dollar and the euro are no longer trusted as stores of value, at least not to anywhere near the degree that they were in years past.
But if your agenda is to try and contain the scramble for gold and prevent it from further displacing fiat currencies in reserves, how convenient if you implemented an international monetary system that would limit, through official, global arrangements, the degree to which gold could compete as an international money while still allowing for whatever amount of fiat inflation policymakers believe is required to devalue their excessive debts.
If gold “need not be paid out” then, as the price of gold rises, you just print more paper currencies as required to make up the difference! In other words, gold would be unable to serve as a brake on a general global monetary inflation. And “if the threats to the dollar and the euro indeed worsen”, then yes, just print more of those SDRs—a basket of dollars, euros, renminbi, etc—and who cares if the price of gold rises in tandem? You’re still inflating!
In context of the changed global economic landscape, the OMFIF report thus reads as a desperate attempt to sue for a compromise peace in the currency wars, to find a basis for agreement between the US, euro-area, Japan, and China and the other BRICs, to inflate in coordinated fashion thorugh SDR issuance, while at the same time keeping the golden genie in the bottle where, according to central-planning inflationists, it belongs.
Of course, just because an olive branch is extended does not mean it will be accepted. Is it really in China’s or the BRICs’ interest to participate in such an arrangement? Does China really want the ‘failing’ dollar and euro to keep depreciating? Or might China want to get paid for its exports in hard currency for a change?
Again, it all comes down to trust. Currency basket arrangements such as the euro or, as the OMFIF proposes, a global SDR with a token role for gold, only hold together as long as all the major players perceive that they serve their interest. The moment a player perceives otherwise, the system, lacking sound money foundations, falls apart. If the OMFIF report is indicative of the next step in the evolution of the global monetary system, then the past and current failures of the dollar and euro are destined to become the future failures of the SDR.
China must know this. I suspect the other BRICs do too. And numerous small countries, hardly irrelevant in the matter, are watching intently to see where this goes, while accumulating gold in the meantime, unsure of the outcome.
WHY A RETURN TO GOLD IS THE INEVITABLE RESULT OF THE CURRENCY WARS
If the developments discussed above seem unprecedented, think again. We have been here before, namely, in the mid- to late1960s, when the US and other Bretton Woods participating countries were struggling to maintain the gold price at $35/oz. There was lots of monetary inflation in the US and elsewhere by the mid-1960s and it was assumed by many that this would lead to price inflation in time.
European central banks, most of whom had accumulated substantial dollar reserves, were beginning to swap these for gold. Private investors sought to protect themselves with gold purchases. By 1967, while the official price for gold remained $35/oz, there was steady upward pressure on the market price in London. ‘Two-tier’ markets create arbitrage opportunities and, as more speculators got in on the game, the upward pressure on the gold price intensified.
In 1967, France, already having indicated from early 1965 that it was dissatisfied with the dollar-centric Bretton Woods system, abruptly withdrew from the pool. While this was a clear message to all that the official $35/oz gold price was unsustainable, encouraging yet more speculation, at the same time it meant that the remaining London gold pool participants had to cover for France’s significant absence by making even more gold available to the growing number of buyers.
This unsustainable arrangement lasted less than a year, with the pool collapsing entirely in 1968. The situation was now critical as the monetary system was without solid foundation. The upward pressure on the price of gold intensified yet again. The Federal Reserve was now frightened that a run on the dollar was imminent, with the pound sterling already under renewed attack. At one Fed meeting that year it was claimed that, “the international financial system was moving toward a crisis more dangerous than any since 1931.”6
6 Amateur historians take note: Federal Reserve Open Market (FOMC) minutes may be tedious for the most part but occasionally there are real gems to unearth, as is the case here. However, the transcripts are only released with a five-year lag. It will be interesting to see what was discussed—and not redacted—from transcripts from 2008 and 2009, when the Fed was involved in bailing out the bulk of the US financial system.
By 1971 the day of reckoning had arrived. The US had continued to sell gold into the market to suppress the price and to convert foreign reserves on demand into gold since 1968 but when even the UK was asking for a substantial portion of its gold back in summer 1971, it was clear that this effort was futile. Either the US would run out of gold or it would allow the gold price to rise and the dollar to ‘float’, that is, to devalue substantially.
President Nixon opted for the latter course, as he announced to the world on 15 August that year. The dollar was devalued and gold convertibility suspended indefinitely as a ‘temporary’ measure. But why did the world continue to use dollars as reserves when these were unbacked by gold? Because the US was still by far the largest economy in the world, the biggest importer and exporter. And while US finances were deteriorating at the time, they were in far, far better shape than they are today, with trade and budget deficits tiny as a percentage of GDP. Today, the picture is the complete opposite. US finances are in a far worse state than those of the BRICs.
The US and the other developed economies are thus no longer in a position to dictate terms in international monetary matters. The BRICs have made the point clear. They are going to begin to demand hard currency in exchange for their exports. A plan to this effect could be announced as early as their annual spring summit, held this year in Durban, South Africa, on March 26-27.
KEEP CALM, BUY GOLD, GET OUT OF BONDS
If the recommendation to accumulate gold in advance of its remonetisation for use an international money seems obvious, perhaps less obvious is to reduce holdings of bonds. Why should a remonetisation of gold lead to higher bond yields/falling bond prices? After all, the economic dislocations associated with international monetary regime change could well tip the world into yet another recession as the associated economic rebalancing takes place.
While we have come to associate rising yields with economic recoveries and falling yields with recessions, in fact, on a sound money foundation this relationship does not hold. Back when the world was on the gold standard, for example, yields sometimes rose in recessions and declined in recoveries. This is because the central bank was unable to manipulate the bond market with monetary policy.
Take the euro-area today as a contemporary case in point. As Greece, Portugal and Spain have tipped into deep recessions, their bond yields have risen as they lack national central banks which can buy their bonds with printed money. And investors have a choice whether to hold these bonds, or to hold the bonds of sounder euro-area governments, such as Germany, hence the wide spreads that investors demand in compensation.
A return to gold-backed international money will have much the same effect but at the global level. US Treasuries and other bonds will need to compete more directly with gold itself as a store of value or as official reserves. Interest rates will therefore need to rise to compensate investors for the very real possibility that the supply of bonds will just keep on growing to finance endless government deficits while the supply of gold remains essentially fixed.
Now I am under no illusions here. If the US, euro-area, UK and Japan face sharply higher borrowing costs in future, they are going to have debt crises similar to those faced by Greece, Portugal and Spain today. Indeed, with no one willing or able to bail them out, the associated crises may be more severe. The US and other indebted countries may resort to capital controls and even to selective default on their debt, such as that held by foreigners abroad.
If so, this will be another major escalation in the currency wars, one that will begin to resemble the 1920s and 1930s in its intensity. Those were sad decades, to be sure, in which much of the global middle class saw its savings wiped out at least once and, in some cases, twice. They didn’t care whether this occurred via inflation/devaluation or via deflation/default. Investors today shouldn’t care either. They should accumulate gold and certain other real assets in limited supply. These are the ultimate insurance policy against inflation, deflation, devaluation, currency and trade wars, financial crises, monetary collapse … you name it. The time to do so is running out.