In this five part series, we’re exploring the reasons gold remains the only shield against boom and bust cycles. In the final part, we ask what the future holds for currencies. Enlisting the help of currency expert Jim Rickards, we’ll also look at what plans global policymakers have in store for us.
Where Next for Paper Currencies?
Over the next few years, we’re going to see a change in the global monetary system. The US petrodollar, so long the world’s sole reserve currency, is coming to an end.
It’s not that the USD will collapse. Rather, other currencies will take on a more important role in global trade, with the most prominent of these coming in the form of the Chinese renminbi (yuan).
It’s been suggested for some time the world is being readied for a basket of currencies to replace the US dollar’s role as the reserve currency. A system that could give the world economy greater flexibility. One that depends on the fluctuations of a number of different currencies, not just the US dollar.
This new system is likely to come under the banner of the International Monetary Fund. It’s already been proposed that the dollar’s replacement could be the IMF’s existing Special Drawing Rights (SDRs).
SDRs were introduced following the collapse of the Bretton Woods system in 1973. This basket of currencies includes the US dollar, British pound, Japanese yen, and the euro.
In November, the IMF made an historic decision to include the Chinese yuan in the SDR basket. It’s the first time that an ’emerging market’ currency has joined the basket.
Unfortunately, the SDR isn’t backed by gold. And it’s not likely to ever be. But, as you’ll see, gold is having a significant say in this potential new reserve currency.
The suppression of gold and the question of China
This series began by positing that gold prices have been illegally suppressed. What we didn’t ask at the time was why that is and how it’s being done. So let’s answer those questions now.
The leading authority on global currencies, Jim Rickards, argues that gold manipulation is not only happening, but that it’s being done for the benefit of China.
China’s ascension to a global super power requires substantial gold reserves to match its growing influence.
As a result, markets accommodated China in buying up vast amounts of gold at artificially low prices. Why? Because larger gold reserves give China greater influence in global monetary affairs.
When it’s decided that China has enough gold, the path will be clear for the IMF’s basket of currencies to replace the US dollar in world trade. The yuan’s inclusion in the SDR was an important milestone in this shift.
We’ll get back to this shortly. But for now, let’s see how these manipulations actually take place.
Supply and demand
Gold prices fall based on two things.
The first is through low demand, which puts downward pressure on prices.
The second is oversupply. That applies to gold, as it would in any other market or industry.
In the current bullion market, gold prices are falling without either of these conditions present. In fact, prices are falling despite increasing demand for physical gold. Equally, supply remains limited and not as overabundant as you might expect.
You might be asking yourself whether that’s actually true. Is demand for gold really that robust? Well, yes…Contrary to what some will have you believe, demand for gold hasn’t bottomed.
In the first quarter of 2015, the Shanghai Gold Exchange saw a 19% increase in purchases. It did so because demand for bullion in China and India remains high. Then, in early July, purchases were equal to the annualised supply of global production. The arguments saying demand is nosediving don’t align with market realities.
With limited supply, and rising demand, it leaves us scratching our head as to why gold prices are falling. What explanation is there for gold to defy basic laws of economics?
There’s only one: manipulation. And here’s how.
Gold prices are determined in futures markets. This means that bullion contracts get settled using cash. This takes place outside of markets where the actual metals are bought and sold. In markets with cash settlements, there’s no risk to a boom in uncovered contracts.
Basically, these contracts are the equivalent of someone promising to give you something that’s not currently in their possession. So a seller might promise to give you gold at an agreed price in the future, without holding any reserves. Where’s the risk for him? There’s none at all.
This simple, yet overlooked, fact provides a perfect framework for why gold prices are falling. With uncovered contracts, it’s simple to artificially increase supply by creating these uncovered contracts. You get a situation in which the supply of contracts is increasing, but not the supply of physical gold itself.
The end result is that gold prices go down because supply is ‘going up’. Except, of course, bullion supply isn’t going up. Gold is down because the futures market determines today’s prices.
Once China has enough gold, you’ll see the shift away from the US dollar pick up. That’ll be the point that those behind the scenes are preparing the world for an SDR reserve currency. But there will need to be a seismic event that rocks investor confidence in the US dollar.
I don’t think we’re far off that taking place. Central banks are concealing the fact that currencies are depreciating faster than anyone can imagine. It’s only the price of gold, which remains at fixed low rates, that’s keeping the markets from realising what’s going on.
Jim is right about what’s happening with the artificially low price of gold. Bullion prices simply aren’t rising with the loss of purchasing power we’re seeing. Otherwise, we’d see this reflected in the actual price of gold.
That’s not the case.
As we’ve seen, China’s gold hoardings are increasing rapidly despite gold prices remaining flat. And that’s the whole point actually. Prices have to stay low for China to buy up the amount of gold it needs.
Too many people would catch notice of what’s happening if Chinese demand was allowed to reflect on the price of gold. As Jim explains:
‘China does not have enough gold to have a seat at the table right now. Think of it as a game of Texas Hold’em. What do you want in a poker game? You want a big pile of chips. Gold are gonna be your chips. It doesn’t mean that you automatically have a gold standard, but the gold that you have will kind of give you your voice at the table.’
The importance of what Jim says here can’t be underestimated. If, and when, the global reset takes place, those who hold gold will sit down to set the rules for a new Bretton Woods system.
In contrast to Europe and the United States, China still has fewer gold reserves by comparison. This would be a problem for China, as Jim explains, if the gold manipulations were to cease:
‘If you took the lid off and ended the gold price manipulation and let gold find its level, China would be left in the dust.
‘It wouldn’t have enough gold relative to the other countries, and because their economy’s growing faster and because the price of gold would be skyrocketing, they could never acquire it fast enough. They could never catch up. All the other countries would be on the bus. The Chinese would be off the bus.’
Once the leading nations sit down to discuss a new global monetary system, the amount of gold that nations hold, relative to their economy, will be crucial.
China wants a bigger role in global governance post the US petrodollar, and for that it will need gold reserves to match its position as the second largest economy in the world. Jim notes:
‘So the global effort is to keep the lid on the price through manipulation, which is very obvious. I tell people, if I were running the manipulation, I’d be embarrassed because it’s so obvious at this point.
‘So the price is being suppressed until China gets the gold that they need.
‘Once China gets the right amount of gold, then you can take the cap off. If it doesn’t matter where gold is because all the countries will be in the same boat. But, right now, they’re not, so Chinese has this catch-up.’
As Jim shows, the price of gold will skyrocket once this new reserve currency takes centre stage. China’s inclusion in the IMF’s basket of currencies was a big step towards that. Things will ramp up in the near future.
You can expect to see this monetary realignment take place before 2018. The bust is coming, and no asset — outside of gold — will come out looking better than before.
Those who hold gold today will not only protect their wealth, but stand to make enormous gains once a new currency system is in place. But that means investors only have the next 12-18 months to act. Eventually, like all reserve currencies, global markets will flock back to currencies. The cycle will begin anew, and gold will once again take a backseat.
Those with enough foresight to hold gold today will safeguard their wealth. Today’s US$1,000 an ounce gold will skyrocket beyond anything you can imagine. Gold may not pay anything in interest, but its worth can double, triple, or quadruple in the blink of an eye.
That’s something we’d all be wise to remember.
Junior Analyst, Markets and Money