Is gold money? Or is it a store of wealth? Or both? We’ll have a crack at answering these questions in today’s Markets and Money. We’ll also delve into some very interesting recent developments in the gold market, which suggest the interminably long correction in the gold price could be coming to an end.
Right then, let’s talk ‘money’. Many gold bugs claim gold is money. But is it really? In a recent issue to subscribers of Sound Money. Sound Investments, we looked back through thousands of years of history to show that gold was simply one form of money.
But it rarely passed from hand to hand. It was too valuable for that. The value of gold was a store of wealth and as a unit of account.
As societies and economies grew and became more sophisticated in the 19th century, gold performed a little too well as money. Back then, gold used to be the monetary base of the financial system. Banks could still expand credit, if enough good credits walked through the door. But when those credits turned bad, the ‘money’ previously created by the granting of credit disappeared. There was no central bank around to monetise this debt and so deflation set in.
That’s why the 19th century was one of booms and busts. Gold as money didn’t stop economic volatility. It kept a check on the price level over the long term, but in the short term the price level moved around quite a bit – both up and down.
When the First World War forced the abandonment of the gold standard in 1914, it was pretty much game over for gold as money. The ‘Genoa Conference’ of 1922 devised the ‘gold-exchange standard’, which was a gold standard in name only. It allowed the reserves of the banking system to grow (by making the pound ‘as good as gold’) which allowed the banks to find many more ‘good credits’ in the economy than had previously existed. In other words, lending standards dropped…a lot.
That’s why the 1920’s was one long credit boom. It finally ended when no more ‘good credits’ walked through the banks’ doors. This ended the Ponzi scheme and the bubble burst.
But central banks didn’t know how to handle the aftermath. They still thought gold was money, even though they stood by and watched the ‘gold as money’ function hijacked during the boom.
Hence a nasty deflation ensued. It put a nail in the coffin for the ‘gold as money’ function for some time. The post-Second World War Bretton Woods system revived it for a time by trying to attach gold to the reserve asset, the US dollar, but it didn’t last for long.
Ever since, gold has not performed as ‘money’ in any official sense. And we’re not sure if it will again. But as a store of wealth? That’s another matter.
Check out this article from Sober Look. It looks at the recent turmoil in Egypt, the run on the Egyptian pound and the search for dollars. It quotes a story from Fox News:
‘A run on Egypt’s pound has left foreign currency in short supply and driven some dealers into the streets in search of people with U.S. dollars to sell, spawning a new black market.
“There are no dollars. Everyone that walks in asks for dollars but supply is scarce,” said one of the dealers.’
Those in need of liquidity and ‘money’ are after dollars. But those with ‘wealth’ want to store some of that wealth in gold too.
‘Anecdotal evidence suggests that a number of wealthy individuals and businesses are quietly converting savings into hard currency and to the extent possible depositing funds abroad. Some are buying gold as inflation accelerates.’
That’s just an isolated anecdotal case of what people do when their currency fails to perform adequately as money. But it’s telling nonetheless.
The other case for gold as a store of wealth and not money is a developing one, with a couple of parts to it.
Overnight, the World Gold Council reported ‘Gold Demand Trends Q4 and Full Year 2012’. Amongst the highlights was central bank demand of 534.6 tonnes for 2012, up 17% on 2011 and the strongest demand since 1964. This could be an unwinding of the gold leases undertaken by western central banks in the 1990s and early 2000s, or fresh buying, we’re not sure.
Either way, it indicates the central banks are increasingly interested in a store of wealth to support their currencies (money).
And earlier this week, Goldcore reported:
‘Gold continues to flow from the west to east. Reuters reports that U.S. Commerce Department data showed U.S. exports of nonmonetary gold, which excludes central bank transactions, climbed by 43% to $4 billion in December from the prior month.
‘That’s the highest total and the largest month-on-month jump in U.S. private gold exports since September 2011, when gold rallied to a record nominal high over $1,920/oz. Hong Kong accounted for nearly half of the $4 billion.’
On a net basis, the US exported about $20 billion in gold in 2012. On the other hand China imported over 200 tonnes in 2012. At US$1,650 an ounce, that’s US$11.76 billion. That’s not big ‘money’ in this world where trillion is the new billion. Perhaps that’s all China can buy without causing a price explosion?*
With new storage vaults for gold opening up in Asia, you have to suspect that the ‘gold flowing from west to east’ meme has merit.
After all, the gold ‘in the west’ is a remnant of the days when gold was money. That’s why the gold/dollar swap trade is still massive in London. It’s where the bullion banks get together to swap gold for dollars and vice versa. They’re still behaving as if gold is money.
But the interest rate on gold, the ‘Gold Forward Offered Rate’ (GOFO) is now mysteriously low. It hasn’t been this low since mid-2011 when Europe was falling apart. And soon after, the price soared. According to the London Bullion Market Association (LBMA), ‘the major determinant in the calculation of this rate (GOFO) is the availability, or ‘liquidity’, of gold…’
So as gold liquidity dries up, GOFO heads lower. One would think the weakness in the gold price would suggest lots of selling and abundant liquidity. But that’s not the case. Maybe it just reflects abundant US dollar liquidity, in which case you could be seeing Gresham’s Law in action…bad money pushing out the good.
Perhaps our theory is completely wrong, but maybe, just maybe, the West still thinks of gold as money, but in the East it’s a store of value. With the way the West treats its money, no wonder gold continues to flow east. The bad money is pushing the good money into another function, as an exclusive store of wealth, with an eventual much, much higher price to safely store all that wealth.
*[Editor’s Note Correction]: China’s gold demand was 200 tonnes for the 4th quarter of 2012, not all of 2012. Total demand for the year, according to the World gold Council, was 777 tonnes. At US$1,650 an ounce, this equates to a value of around $45.7 billion. That’s a good deal more than the $11 billion I quoted in the article but still peanuts in the scheme of things.
for Markets and Money
Money in the Time of Financial Cholera
8-02-13 – Satyajit Das
Dishonest Leaders and Delusional Voters
7-02-13 – Bill Bonner
Uranium: The Commodity Like Gold Ten Years Ago
6-02-13 – Byron King
How Australia-China Relations Are Caught in the Monetary Battle Space
5-02-13 – Dan Denning
The Great Rotation Into Stocks
4-02-13 – Dan Denning