24 April 2009
www.bbh.com/fxGold and the Dollar
In recent days the Canadian and Swedish central banks have joined the majority of other G10 central
banks by
indicating that they too may engage in quantitative easing now that the interest rates have been reduced to 25
and
50 basis points respectively. The ECB is wrestling with ways to extend its own form of quantitative easing and an
announcement
is likely at its next meeting on May 7th.
While some observers have focused on the potential debasement of the US dollar
by the aggressive monetary and
fiscal policies of both the Bush and Obama Administrations, many investors are worried about
the viability of the
whole universe of paper money.
As Gillian Tett, award-winning journalist at the Financial Times,
put it in a column earlier this month, there has been
a four-decade long experiment with fiat currencies not backed by
gold or silver. This crisis is so profound that
increasingly it appears to have shaken confidence in the experiment. At
the same time, the crisis looks to have
widened the range of possibilities.
The Special Drawing Rights that the Chinese
and others have suggested to eventually replace the dollar does not
get beyond paper money. The SDR is a basket of fiat
currencies. It is not and cannot be a serious alternative to
the US dollar.
Consider that 44% of an SDR is the dollar.
The IMF’s figures show that roughly two-thirds of the world’s reserves
are in dollars. If countries reserves
were allocated according to the SDR, the dollar’s share of reserves would fall
by about a third. While the euro would
pick up some slack the big winners would be the yen and sterling, whose
share of the SDR is 11% a piece, two to three times
larger than their reserve allocation.
If there has been a shift in reserve allocation over recent years, it is not away
from the dollar, as so many wrongly
claim, but rather away from the yen and toward sterling. And even this shift has been
marginal at best. Reserve
managers generally want in order of importance, security, liquidity, and yield. Japanese bonds
are often seen as
deficient in both liquidity and yield.
All that Glitters
Can gold return to its role as the anchor
for currencies? The advocates of gold are a passionate and vocal minority
which appear to be second only to Any Rand devotees
in terms of intensity. Of course there is a large overlap as
Alan Greenspan’s 1966 essay “Gold and Economic
Freedom” illustrates.
Top Gold Holders
US
8,133.5
Germany
3,412.6
IMF
3,217.3
France
2,508.8
Italy
2,451.8
China
1,054.0
Switzerland
1,040.0
Japan
765.2
Netherlands
621.4
ECB
533.0
Data
from World Gold Council and China
Figures in Metric Tonnes
Marc Chandler
212-493-8800
Win Thin
212 493-8361
Meg
Browne
212-493-8744
Audrey Childe-Freeman
44 207 614 8791
To appreciate though why gold is ill-suited today to
once again back paper money, we need to consider why the
gold standard ended in the first place. Simply put, the gold standard
provided an economic barrier to the political
agenda. That political agenda called for rapid growth to resist the spread
of communism. It called for “guns and
butter” in the US with the Great Society and the war in Vietnam. The
European political agenda included the
expansion of the welfare state—from cradle to grave
Jettisoning gold not
only allowed for the pursuit of the political agenda, it helped create the conditions for the rapid
and dramatic expansion
of trade, capital flows and globalization. What is all too often lost amid the despair and
cynicism that the crisis has
wrought is the amazing success of that regime. Since 1980, for example, the world
economy has grown by 145%. Taking into
account the increase in the world’s population, roughly 1.6% per annum,
there has been a nearly 40% increase in per
capita income.
How such wealth is distributed is an important issue beyond the scope of this discussion. Yet it is interesting
to
note that longevity, a measure that subsumes numerous other metrics, has risen sharply in both developing and
developed
countries and that gap between the two has narrowed.
Not Enough
The same problem exists with a new gold standard that
existed with the old. There is simply an insufficient amount
of gold. Or to say the same thing, the price of gold necessary
to put the international monetary regime back on a
gold standard is so astronomical as to make it unworkable.
There
are different ways to go conceptualizing the magnitude of the challenge. As the table above indicates, the
US has more
gold that Germany, France, and Switzerland combined. Given that foreign investors own about $2.5
trillion more of US assets
than Americans own of foreign assets, what price of gold is necessary for the US to no
longer be a debtor? Answer: More
than $8,500 an ounce.
Another approach, suggested by a Swiss investment bank, is to relate the price of gold needed to
cover some
measure of money supply. By its reckoning, the US would need gold to be worth about $6,000 an ounce to
reintroduce
a gold standard. However, it may not be sufficient to simply have the US adopt a gold standard. For
the US, China, and
Japan, the three largest economies as measured by purchasing power parity, to back their
money with gold would require
a price closer to $9,000 an ounce.
The current price of gold is just above $900 an ounce. Peaking in March 2008 near $1,032,
it has averaged $638
over the past five years and $473 over the past ten years. For the yellow metal to reach the kind
of levels
necessary to make a gold standard mathematically feasible in the present day, the protracted period of deflation
necessary
would not be politically acceptable.
Where Does that Leave Us?
There is no realistic alternative to the dollar. Not
SDRs. Not gold. Not the euro. Not the yuan. That might not be
deducible from macro-economic first principles. But it is
proven by what central banks are actually doing.
This does not mean that there is no role for gold in individual portfolios,
though often people seem to confuse a
paper claim on gold for the actual bullion. Also, the touts for bullion often do
not include the costs of storage and
insurance for gold which has gone decades without appreciating and, of course, generates
no income stream.
Central banks that have accumulated large holdings of foreign currencies, like those in Asian and Middle
Eastern
countries, tend to have relatively little gold. European central banks, which could not get enough gold during
the
late 1960s and early 1970s, have turned into sellers over recent years. Paradoxically, as they sold off their gold
in
an orderly way, the price of gold trended higher. Yet many seem to believe that it is a given that the dollar will fall
if
these same or other central banks sell dollars. Huh?
Marc Chandler
212-493-8800
Win Thin
212 493-8361
Meg
Browne
212-493-8744
Audrey Childe-Freeman
44 207 614 8791
On April 24th China revealed it has dramatically increased
its gold holdings since 2003. In 2001, China said it had
roughly 500 tonnes of gold. By 2003, it had risen to a little
over 600 tonnes. Now it says it has 1,054 tonnes of
gold, more than a 75% increase. Still this means that gold accounts
for only about 1.6% of China’s reserves.
China is the world’s largest producer of gold, but it also refines
scrap gold. As part of the standard arguments, gold
advocates assert that all the gold that has ever been mined is still
here. That is true up to a point and it is that point
that it gets interesting. China is exploiting the fact that a ton
of computers and cell phones contain several times
more gold than a ton of gold ore has.
Central banks in Asia and the
Middle East may buy more gold going forward and European sales seem set to slow
(though the IMF sales will reportedly go
ahead), but it will be barely noticeably in terms of the international
monetary regime and the role of the dollar.
Marc
Chandler
Global Head of Currency Strategy
