A role for gold?

Gold recently moved towards US$1400, a two-year high, having risen over 30% since January 2016.

This has been largely based on broad negative pressures in the global economy: ongoing economic troubles and terror attacks in the Eurozone; weakening demand in China; and domestic crises ending positive growth prospects for the BRICS. Not to mention political events Brexit and the growing uncertainty around November’s US presidential election too.

During pressures such as these, investors habitually “flee to gold”, assessing it as a safe bastion of value. However this tendency has been in direct contradiction to the most famous investor of the last 30 years, Warren Buffett, who famously dismissed gold as a “non-functioning”.

Still – from a historical central banking perspective – an oscillating value for gold was surprising. Historically, money in economies have been tied to gold – either using it physically for trade or symbolically under the Bretton Woods system. Then, when President Nixon ended the gold window in the August 1971 at $35, many economists predicted a collapse of the price of gold – because the core demand for gold as state reserves disappeared. Paper money was supposed to allow more direct control over economies through currency manipulation and gold would simply be used for jewellery. However, this has not been the case – with US$:oz values rocketing and gold becoming a consistent investment tool like no other.

And the truth is, in a world where government deficits are constantly growing, gold is unlikely to disappear from prominence. Increasing government deficits (where spending exceeds tax revenue), makes it more and more tenuous that states can pay off government bonds – preventing bonds from replacing gold as the habitual “safe investment”. Additionally, whilst governments use unorthodox monetary policy like quantitative easing – confidence in paper money ever shrinks also.

Those that argue that economies should return to “gold standards” – pegging the value for money entirely or symbolically to gold – suggest that it would create a completely stable foundation for value. A foundation that cannot be abused by governments by providing a completely stable basis for investments in the future.

From a sociopolitical point of view however, it should be noted that any potential return to an international gold standard is unlikely to be centred in the west – but rather in China or Russia. These two nations have been aggressively increasing their state gold reserves since the global financial crisis – and are therefore much better placed to act as future keepers of any post-2000 Bretton Woods systems.

Yet, the opportunity for a return to gold standards is slight. No one country could introduce a gold standard alone, because it would be ripe for arbitrage opportunities that would deplete that nation’s reserves. It would require almost nations to work in concert – and many individual governments would be far too hesitant to give up their modern controls on economies.

© Patrick Tsui and liminaleconomics.wordpress.com, 2016. Unauthorized use and/or duplication of this material without express and written permission from this blog’s author and/or owner is strictly prohibited. Excerpts and links may be used, provided that full and clear credit is given to Patrick Tsui and liminaleconomics.wordpress.com with appropriate and specific direction to the original content.

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