Editor's Note: This editorial combines part 1 and 2.
Many of the leading fund managers in the U.S. and elsewhere are expecting that governments will confiscate their citizen’s gold. This will not be for the same reasons used in 1933. It will be to facilitate loans, swaps lower interest rates, and shore up international confidence in the turbulent, stressed paper-currency world in which we live. Each nation issues paper as money, dependent on the trust that nation can engender at home and abroad. But is this going to be sufficient, moving into an ever more turbulent 2012?
Traditional Use of Gold in Reserves
When gold was deemed money in the world under the Gold Standard, money was issued against the stock of gold a nation had –this formed the basis of the money supply. In 1933 as the Depression wreaked damage to the U.S. economy, the government needed to expand the supply of money to the economy, dramatically. The first step was to confiscate their citizen’s gold at a price of $20 per ounce. Two years later in 1935, the U.S. government devalued the dollar by 75% to $35 an ounce. This expanded the U.S. money supply by far more than 75% because of the additional gold in government vaults.
As U.S. influence spread abroad after the war, the need for a vast increase in global money supply and, in particular, the number of dollars outside of the U.S. (then limited to the amount of gold in U.S. coffers) the restraint on money supply was unbearable on the U.S., so it eliminated gold from its active role in the money system and replaced it with the USD, tied as it was to the oil price.
Thereafter, gold was relegated to the vaults as an important but passive, reserve asset. Now, we’re led to believe that central bankers feel that the amount of gold they should carry is either 3-months’ worth of international trade, or between 10 and 15% of total foreign exchange reserves –as though this is all it would take to resolve a crisis. Such formulae test credibility to the limit.
Uses of Gold in the Last Couple of Years in the Monetary System
But in 2011, the use of gold to fund a Eurozone bail-out implied was raised. A draft of the European Commission study on joint Eurobonds is the suggestion that gold could be used as collateral for them. It did not receive more than token recognition; the issue, however, was at least addressed in theory. Its use was not related to the expansion of the money supply –the suggestion did not imply any mobility as money at all. A new role for gold in official uses was starting to get recognition.
In 2010, gold was used by the Bank of International Settlements in currency swaps, giving little-to-no information as to the identity of their clients. Over 500 tonnes of gold was used in the currency / gold swaps. These did not relate to practical money raising, but to gold being used as collateral to facilitate cheaper and larger loans to the banks to provide liquidity where it was drying up. The stories came that gold was being used by commercial banks –who don’t hold gold on their balance sheets—but the only place they could get gold from was from central banks. So was it a dire need by commercial banks for liquidity or was it an attempt by central banks to cap the gold price? We might never know... But in 2011 these swaps were reversed, and the gold left the B.I.S. in the second half of the year [2011] gold lease rates dropped heavily into negative territory, telling us that central banks were lending gold again to banks at incredibly cheap rates –this coincided with the fall in the gold price from over $1,900 to current levels.
Irrespective of the reasons why, the most important feature of these actions was that gold came into use in the interbank monetary system yet again. And this happened at a time when European central banks had ceased selling their gold and the rest of the world began to steadily increase their central bank holdings.
Despite its passive role the U.S., Eurozone central banks hold nearly 20,000 tonnes of gold –worth nearly a trillion dollars; however and much to politician’s angst, this gold is not available to fund government borrowing; it would contravenes the Maastricht treaty which founded the Eurozone. Gold remains far too important to use in such financing. It will only be used if the very national structure of its money is in danger or in support of making a nation’s monetary system function internationally. But bullion could and is being used as collateral.
For prospective investors (no doubt including emerging market governments, sovereign wealth funds, and the like) the appeal comes from the likely hedge that gold would provide against an immediate default. If a country such as Italy were to default, most believe the price of gold (in Euros and in the USD) would skyrocket…
Uses of Gold (cont. for Member's only)
After more than a year’s delay and frustrations we are informed that there is now an entity whose objective is to counter any attempt to confiscate citizen’s gold. We will be informing Subscribers about this.
Currency Debasement & Price Stability Risks
Despite the small moves in exchange rates between the U.S. dollar and the euro, confidence and trust has been debased. Looking forward to 2012, we see that debt deflation is becoming a rising danger. After the decay in 2011 that has hammered confidence in the euro, the need to issue more and more ‘new’ money is growing. The Eurozone is moving into recession (if it is not already in one). The Eurozone is more than likely to lose one or more of its weaker members –this will be good for the euro itself though—so liquidity shortages may force more money supply growth already exceptionally high in many countries.
Despite the 40-year long campaign to prevent gold from returning to any active role in the developed world’s monetary system, gold remains the only universally-accepted currency whose supply cannot be increased by policy-makers. The equivalent of money issuance for gold is new mine production, which has been on a relatively flat trend for the past ten years.
Shortage of Gold in Monetary System Relative to Amount of Money
In a recent report, the World Gold Council examined the quantitative relationship between money supply and gold. Data showed that a 1% change in US money supply growth six months prior has an impact of 0.9% on the price of gold, on average. Meanwhile a 1% change in money supply in India and Europe six months prior affects the price of gold by 0.7% and 0.5% respectively.
So gold, whether accepted or recognized by ‘official’ bodies, has a role in money, and this role is growing as the real value of currencies declines in terms of trust and confidence. For gold to do an effective job of restoring confidence and trust, its value has to relate to the global supply of money (i.e. financial assets). Take a look at the first pie chart (thanks to BMG/WGC and McKinsey) showing the value of gold verses the world’s financial assets. We leave it to you to estimate the growth of the gold price so that the value of gold closely relates to the value of global financial assets.
A multiplication of 10 to the gold price would fall short of this figure!
Percentage of Gold in Reserves
So often the percentage of gold in reserves is used as a measure of how much gold should there be in the reserves. But in the context of the amount of money there is out there, this number is meaningless. We looked at the traditional use of gold in reserves and found the measure was 3-months worth of international trade, as though this is all it would take to resolve any crisis. Where on earth was that formula concocted from?
If we look back to the days when the developed world accumulated the reserves they’re now thought to have and the amount of money on issue, a more pertinent number would be the percentage of money, gold, at current prices, represents in reserves. The two, relevant points in this valuation of gold would be when gold was a basis of the world’s monetary system (before the Second World War) and then in the 1960’s under the Bretton Woods system, just before it was effectively torpedoed.
It quickly becomes clear that this percentage has been dropping heavily as total money has expanded. For gold to function, as it used to, something has to change. Either the amount of gold in foreign exchange reserves has to increase, or the price of gold in each currency has to rise to compensate for the increase in total money, or a combination of both. Even with a massive hike in the price of gold, two problems will still persist:
- There is not enough gold in ‘official’ national reserves the world over.
Percentage of Gold in Reserves (cont. for Member's only)
After more than a year’s delay and frustrations we are informed that there is now an entity that whose objective is to counter any attempt to confiscate citizen’s gold that is soon to launch. We will be informing Subscribers about this.
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This document is not and should not be construed as an offer to sell or the solicitation of an offer to purchase or subscribe for any investment. Gold Forecaster - Global Watch / Julian D. W. Phillips / Peter Spina, have based this document on information obtained from sources it believes to be reliable but which it has not independently verified; Gold Forecaster - Global Watch / Julian D. W. Phillips / Peter Spina make no guarantee, representation or warranty and accepts no responsibility or liability as to its accuracy or completeness. Expressions of opinion are those of Gold Forecaster - Global Watch / Julian D. W. Phillips / Peter Spina only and are subject to change without notice. Gold Forecaster - Global Watch / Julian D. W. Phillips / Peter Spina assume no warranty, liability or guarantee for the current relevance, correctness or completeness of any information provided within this Report and will not be held liable for the consequence of reliance upon any opinion or statement contained herein or any omission. Furthermore, we assume no liability for any direct or indirect loss or damage or, in particular, for lost profit, which you may incur as a result of the use and existence of the information, provided within this Report.
