Enlightened Economics

Economics for an Enlightened Age

Posts Tagged ‘gold’

• Gold and Silver Rise Again as History’s Chosen Currencies

Posted by Ron Robins on March 13, 2011

By Ron Robins. First published February 25, 2011, in his weekly economics and finance column at alrroya.com

Gold, “the ancient metal of kings,” is reasserting itself as the currency of choice as it has done again and again since the earliest of human times. In our modern era, as central banks and governments fight to devalue their currencies to gain purported trade advantages, gold rises in value against them all. And central banks are buying gold again amidst serious doubts as to the size of some of their real physical gold holdings. Silver too is experiencing a similar re-emergence. The reasons for gold and, to a lesser extent, silver acting as currencies, are easy to understand.

Gold’s history as a currency extends back thousands of years. The western world’s first known standardised minting of gold currency took place in 564 BCE by King Croesus of western Asia Minor. However, it is also believed that China in the fifth and sixth century BCE, minted the Ying yuan gold coin as well. In the great Gupta Empire of India, from 320 to 550 CE, gold coins were used throughout its domain. And in the early Islamic world around the time of the Prophet Muhammad, the gold dinar coin led as its currency. In Europe, gold coins became an important or central monetary unit for the Greeks, Romans, Venetians, Dutch, Spanish and British.

During approximately 1870 to 1910 all major countries linked their currencies to gold, thereby adopting the gold standard. However, China was the exception preferring a silver-based standard. The first silver coins are reported as being minted by King Pheidon of Argos around 700 BCE.

Gold and silver have historically asserted themselves as monetary mediums due to their intrinsic value. They are consistent, divisible, durable and convenient, and they are nobody’s liability.

Unlike paper money, gold, particularly, has proven itself in maintaining its value over many centuries. The World Gold Council (WGC) says that, “since the 14th Century, gold’s purchasing power has maintained a broadly constant level… an ounce of gold has repeatedly bought a mid-range outfit of clothing… in the fourteenth century… in the late 18th century and… at the beginning of this century (2000 to 2008)… On the other hand, the US dollar that bought 14.5 loaves of bread in 1900 buys only 3/4 of a loaf today. While inflation and other forces have ravaged the value of the world’s currencies, gold has emerged with its capacity for wealth preservation firmly intact… [whether] in the face of financial turmoil… [as] a crisis hedge… [or] as an inflation hedge.”

Since their origins, central banks have realised the importance of gold, and sometimes silver, as a strategic part of their reserves. Commenting on the rapidly rising price of gold, Alan Greenspan, former chairman of the US Federal Reserve, said in a Bloomberg report on September 9, 2009, that, “[the rising gold price is] an indication of a very early stage of an endeavor to move away from paper currencies… What is fascinating is the extent to which gold still holds reign over the financial system as the ultimate source of payment.”

And this is also because, “[the central banks] no longer trust each other… [and] there’s this perception that different countries are trying to weaken their currency in order to get a competitive advantage,” said Francisco Blanch, head of global commodity research at Bank of America Merrill Lynch at a New York City November 2010 conference, reports Fastmarkets. Among the countries whose central banks are increasing their gold reserves are China, India, and Russia—all countries with mammoth trade surpluses and foreign exchange reserves.

However, as throughout history, he who owns gold and how much he owns is often shrouded in secrecy. For a central bank, covertly selling and buying of gold and its currency can be used to secretly manipulate the value of its currency. Some indirect proof of this comes again from Mr Greenspan during testimony to a US Congressional committee in 1998. He remarked that, “central banks stand ready to lease gold in increasing quantities should the price rise.” Therefore, declaring the precise gold holdings of a central bank might be akin to giving away ‘trade secrets.’

Central banks worldwide supposedly hold around 30,000 tonnes of gold, perhaps 20 to 25 per cent of all the gold ever mined. But true independent verification of their holdings is not available. The US based Gold Anti Trust Committee (Gata) has compiled extensive and critical information concerning western central bank gold holdings. Their information and that from other sources suggests the actual physical gold holdings of some western central banks could be 30 to 50 per cent lower than publicly reported.

As an example, the US boasts official gold holdings of 8,133.5 tonnes. However, it is known that some, perhaps a significant portion of these holdings, have been leased out to various financial entities and might not be returned without huge financial losses. Ron Paul, the chairman of the influential US Congress’s Domestic Monetary Policy Subcommittee of the House Financial Services Committee, is so concerned about such activities that he is calling for a full public audit of US gold holdings.

Additionally, gold is possibly set to play a reinvigorated role in the international monetary system. The International Monetary Fund (IMF) as well as most members of the G20 are seeking alternatives to the US dollar as the world’s principal reserve asset. And in this regard, gold—perhaps silver too—could be included in a basket of currencies and commodities that create the basis for a new international unit of exchange (currency).

Moreover, an RBC survey of global financial executives and business leaders reported on Yahoo! Finance on February 3 that “just 52 per cent of respondents expect the dollar to be the world’s currency in five years,” and that “gold is coming back as a reserve currency ‘of sorts,’” says Marc Harris, head of global research at RBC Capital Markets.

Probably since the beginning of civilisation, gold especially, but silver as well, have served as monetary vehicles. Gold has demonstrated itself to hold its value over centuries and in many diverse cultures. And despite today’s sophistication with paper money, gold is still seen by central banks as the ultimate source of payment. Concerns are growing that the real physical gold holdings of some major central banks might be substantially lower than they have reported, and as they unabashedly devalue their paper money, gold and silver rise once again as history’s chosen currencies.

Copyright alrroya.com

Advertisements

Posted in Banking, Economics, Finance & Investing, Gold & Precious Metals, Monetary Policy | Tagged: , , , , , , , , , , , , , , , , | Leave a Comment »

• A Global Central Bank and Currency?

Posted by Ron Robins on February 16, 2011

By Ron Robins. First published January 27, 2011, in his weekly economics and finance column at alrroya.com

There are many paths forward for the global monetary system, but the hitherto unthinkable is becoming debatable: a global central bank and currency. However, despite the recent financial distress and potential for further financial calamity, the creation of such a new institution or currency is far off. But would a global central bank with possibly its own currency help bring monetary solace, universal prosperity and humankind together? Or would such a bank and currency result in yet another calamitous monetary failure?

The 2008-2009 financial debacle showed just how unprepared the global financial system was to deal with a loss of faith in, and imploding of, the global banking system. To stave off a global financial meltdown, the central banks of the US, the EU, Japan and many others around the world advanced vast sums in loans and guarantees to banks and financial entities. And the US Federal Reserve (the Fed) in particular loaned out hundreds of billions of dollars to foreign-owned banks, in effect acting as a bank of last resort to the global banking system.

As big as the Fed is, it and other central banks, for many reasons, may not be able to address the demands of a future global financial maelstrom with possibly even larger calls for loans of last resort. For the Fed, this is due to 1) the declining relative importance of the US economy and the dollar in relation to the global economy, and 2) potential political interference in its activities.

The mounting problems and lessening importance of the US economy and its dollar globally are obviously why a new international currency regime is being considered. International Monetary Fund (IMF) data (published in The Economist magazine) shows that while the US now makes up about 24 per cent of global gross domestic product (GDP), its dollar accounts for 84 per cent of foreign exchange transactions. Furthermore, over 60 per cent of international central bank reserves and about 60 per cent of global bank deposits are denominated in US dollars.

The continuing use of the US dollar internationally is largely dependent on the performance of the US economy and its domestic fiscal and monetary policies. Domestically, the US government is growing massive unsustainable debts while the Fed is hugely expanding the creation of new money and the buying of US government bonds (its quantitative easing programs). These actions are likely to further devalue the US dollar globally. Thus, holders of US dollars and assets will increasingly be less interested in retaining them.

Rising to compete with the US dollar has principally been the euro. However, with its member countries’ debt problems, the attention is turning primarily to China’s yuan. It is probably no accident that on January 12 China made a significant step forward in yuan foreign exchange convertibility by allowing it to trade in the US. China has also recently made deals with Russia, Brazil and other countries to settle trade accounts in yuan.

Such gains in the international acceptance of the yuan make it likely to be included in the revised and re-invigorated Special Drawing Rights (SDR) issued by the IMF. The SDR is presently a type of currency used in a limited way among central banks and the IMF. However, its role could eventually be expanded and in the decades ahead might even form the basis of a global currency.

The SDR comprises a basket of currencies that include the US dollar, yen, euro and pound sterling. Besides including the yuan, a revised form of SDR might include additional currencies and even gold or other commodities as well. As gold has an inherent market value, proponents for its inclusion suggest it could help bring further stability to the SDR. Changes to the SDR are favoured by many countries such as Russia and France.

Hence, the IMF may well begin to act in the coming years as a quasi global central bank. However, Barry Eichengreen of the University of California in the US cautions—quoting the Economist magazine of November 4, 2010—that, “no global government… means no global central bank, which means no global currency. Full stop.” Economists like Mr Eichengreen have the weight of evidence on their side regarding the need for a global government before a true global central bank and currency could come about. One only needs to look at the European Central Bank’s problems to see how the lack of an overarching, integrated and authoritative governance structure greatly impeded its ability to deal with the recent crises.

Advocating against the concept of a global central bank and currency are some free market proponents such as Ron Paul, a US Republican and now chairman of the powerful US Congress’s Monetary Policy Sub-committee. He and many others believe currencies should be freely chosen and have intrinsic value, backed by commodities, most likely that of gold. They say without gold backing, any currency and central bank issuing such currency, is deemed to eventual failure due to the historical fact that governments inevitably print excessive amounts of money. This ‘printing’ thereby debases the currency’s value and essentially commits fraud against the holders of the affected currency.

It is possible that the world may proceed towards a global central bank and currency over time. In the near future, the IMF will probably revise, re-invigorate and expand its SDR program to assist in the transition from reserve dependence on the US dollar. But the dangers with the SDR are that it is still largely linked to the viability and variability of national economies and their domestic policies and currencies. Advocates of a completely free market approach such as that proposed by US Congressman Ron Paul might also hold sway. The idea of a global central bank and currency is still just an idea. But it is an idea arising out of the calamity of our present day reality. It deserves hot debate.

Copyright alrroya.com

Posted in Banking, Economics, Monetary Policy | Tagged: , , , , , , , , , , , , , , , , , | Leave a Comment »

• Manipulated Markets Can Cause Ruin

Posted by Ron Robins on December 10, 2010

By Ron Robins. First published October 9, 2010, in his weekly economics and finance column at alrroya.com

Market manipulations eventually led to Soviet economic collapse. Though not as overt as the Soviets, it is the manipulation of currencies and interest rates by major economic powers that has mostly led to massive misalignments in investment and consumption that pose extraordinary dangers to global economic health.

Ask anyone if they believe that the Chinese currency, the renminbi, is manipulated. Almost everyone agrees that it is. Are US interest rates manipulated? Again, everyone knows they are. (Not too long ago it was only the short term rates that were controlled. Now the US Federal Reserve [the Fed] is buying longer dated US treasury bonds to bring their rates down too.) Countries all over the world are manipulating their currencies lower to gain export advantages and maintaining near zero interest rates to spur domestic demand and cheap government borrowing.

It is basic economics that where markets are manipulated, supply and demand are distorted. And one distortion creates the need for a further distortion, and so on. The longer the distortions continue the greater the possibility of total market failure. We are near that point today with currencies and interest rates.

The Chinese have scored a major mercantile advantage by pegging their currency, the renminbi, at a relatively set and undervalued rate to the U.S. dollar. Not only have US exports suffered, but the exports of many other countries have suffered as well. Under US law, the Chinese should probably have been labelled a ‘currency manipulator.’ However, by bowing to Chinese demands that they not be labelled a currency manipulator, President Obama’s administration is losing credibility everywhere.

So, Americans are waking up to find that not only does China dictate U.S foreign exchange policy, but China indirectly influences its domestic economic agenda as well. Everything from employment policies (export expansion) to government funding needs (requiring Chinese funding) are all partly defined by the present exchange rate policies.

Increasingly, Americans realize that on the foreign exchange front they have been ‘checkmated’—as in the game of chess—by China. Should difficult economic times continue, or worsen, increasing American anger is likely at this arrangement. It could pass the breaking point and encourage America to act unilaterally against China. Currency turmoil might then embrace the globe.

However, one never discussed but possible reason why the US government has been afraid to label China (and Japan previously) as currency manipulators may be because the US itself may be acting covertly to manage the dollar exchange rate.

According to the US government’s own legislation, it can act secretly in currency exchange markets to affect the dollar’s exchange rate using the Treasury’s Exchange Stabilization Fund (ESF). The US Treasury says that the ESF, “with the approval of the President, may deal in gold, foreign exchange, and other instruments of credit and securities.” The ESF was established by the Gold Reserve Act of 1934 and then amended in the late 1970s.

Also, the Fed engages in opaque currency ‘swaps’ with other nations, and there is significant evidence of U.S Treasury and Fed engagement in gold price suppression. Gold is the ‘anti-dollar’ and barometer of confidence in the dollar. (See my August 24 column, “The Ethics of Gold,” at http://english.alrroya.com/node/54671 and gata.org)

Another manipulation of the Fed is its control of short term rates—and now possibly long term ones as well—to smooth out the booms and busts of the economy. However, we see the falsity of this argument. After almost two years at a near zero per cent federal funds rate the US economic quagmire continues—or worsens.

Induced low rates over the past ten years or so created a massive real estate boom and bust, discouraged savings, led to inordinate financial risk taking and moral hazard, unsustainable consumer debt, and now excessive, possibly uncontrollable government deficits and debt.

In their seminal work, “Growth in a Time of Debt,” published January 2010, Professors Carmen M. Reinhart and Kenneth S. Rogoff found that when government debt/GDP ratios exceed 90 per cent, economic growth rates fall considerably. According to the BIS, U.S. government debt/GDP will be 92 per cent by the end of 2010 and 100 per cent in 2011.

Furthermore, on September 1, the International Monetary Fund said, “general government debt in the G-20 advanced economies surged from 78 per cent of GDP in 2007 to 97 per cent of GDP in 2009 and is projected to rise to 115 per cent of GDP in 2015.”

Unfortunately, the present and future private deleveraging of debt in the U.S. and some other developed countries means potentially continued high—or higher—government deficits as economic growth is retarded or declines further. The Fed has said that to counter any renewed softness in US economic activity it will significantly expand its purchases of US government bonds and possibly other assets. This has the potential for fuelling a huge expansion of the money supply and creating high or even hyperinflation.

The U.S. and some other countries are following a path whereby every manipulation begets further manipulation, and which then begets even further manipulation. With China, perhaps Japan again soon, and other countries controlling their currency values, the U.S. may be forced overtly or covertly to counter their currency manipulations. And with continuing economic difficulties, with interest rate policy having created a debt nightmare and becoming increasingly ineffective, the Fed may institute money proliferation policies that have the possibility of leading to high or even hyperinflation.

If a vicious circle of manipulations by US authorities and other countries occurs, given time, it might rival some aspects of the Soviet command economy—and with a possibly similar tragic outcome. Hopefully, Americans and others will wake up before it is too late and realise that manipulated markets can eventually cause ruin.

Copyright alrroya.com

Posted in Economics, Monetary Policy, Unethical Statistics | Tagged: , , , , , , , , , , , , | Leave a Comment »

 
%d bloggers like this: