GOLD PRICES & ECONOMY
Gold is just money -- has always been money -- and if I may add, will always be money. Currencies are just money substitutes that derive their value because of backing by money. Indeed, currencies gained widespread acceptance not only because of backing b
GOLD has been one of the most boring assets to hold on to over the last four years. An overwhelming majority of the investment community perceives gold as a riskoff investment. Self-fulfilling price actions have possibly reinforced that misperception during times of crises. I don’t even look at gold as an investment. Gold is just money -- has always been money -- and if I may add, will always be money. Currencies are just money substitutes that derive their value because of backing by money. Indeed, currencies gained widespread acceptance not only because of backing by money but more importantly due to their fungibility with money. Under the gold standard, the US dollar was defined as 1/20th an ounce of gold and anybody could have taken a $20 note and exchanged it for an ounce of gold within the US banking system. Incidentally, an Indian rupee was originally defined as 11.3 grams of silver. So for a bank or a goldsmith to issue a rupee note, he should first have 11.3 grams of silver in their vault. This system of fungibility of dollar gold was suspended in 1933 by President Franklin Roosevelt, who went a step further to make ownership of gold illegal. Ever major disruption in the world has been used to transfer power from the citizens to the Government, as citizens ever too willingly surrender their essential liberty to purchase a little temporary safety. The “demonetisation” of currencies thus happened in measured steps over a four-to-six-decade period. These temporary short-run steps have now established a truly depraved long-run policy. What this paper currency system has allowed is a near infinite expansion of the powers of Government through inflation. As American novelist Ernest Hemingway said, “The first panacea for a mismanaged nation is inflation of the currency; the second is war. Both bring a temporary prosperity; both bring a permanent ruin. But both are the refuge of political and economic opportunists.” What we consider today as money (US dollar, Indian rupee, euro etc.) are mere pieces of paper with nothing backing them other than the misplaced confidence of gullible citizens. A piece of paper printed by US Federal Reserve Chairperson Janet Yellen has pretty much the same intrinsic value as the one printed by Gideon Gono, former Central Bank Governor of Zimbabwe. In the long run, tulips have far greater intrinsic worth than unbacked currencies. Readers might well be tempted to ponder, “How in the hell did we reach this position today?” For greater insights on the issue, I would recommend one of the best books written on this topic, What Has Government Done to Our Money by Murray Rothbard.
Going by the price action of the last six years, readers might be tempted into believing that the demand for gold is less than the supply. Nothing could be farther from the truth. Annual demand has been running far ahead of gold mine supplies, and prices have been contained through a deliberate price suppression mechanism orchestrated by the Bank for International Settlements (BIS) through the US Federal Reserve and the Bank of England (BoE). Through a series of papers titled “Do The Western Central Banks Have Any Gold Left?”, Eric Sprott of Sprott Inc, a global precious metals investor, has shown that annual net consumer demand has been running for the last decade or so at about 4,000 tonnes/annum, whereas the new mines supply has averaged about 2,800 tonnes.
How prices have been contained under such conditions of demandsupply mismatch is a rather technical issue that will need a separate article by itself. Just to provide a one-line summary, it’s done in the futures market by holding concentrated short positions by non-verifiable participants. The central banks side-stepped the issue by showing owned and leased holdings of gold as one line item.
So, as happened during Raghuram Rajan’s tenure, the Reserve Bank of India (RBI) swapped/leased a good portion of its 557-tonne gold reserves with the BoE. The BoE, in turn, would lease this gold to one of the participating banks, which would then sell it on the open market. The gold would then reflect as being owned by both the purchasing individual as well as the RBI. This double counting of gold could well be to the tune of around 20,000 tonnes (around 15 per cent of total supplies above ground), and the chances that the RBI gets this leased gold back are very slim. Why so? It took Germany more than four years and that too with immense political pressure to get the 300 tonnes of gold that it had kept for safekeeping in a New York vault during the days of the Cold War. The repatriation request that Germany raised in 2013 was completed only a few weeks ago.
If gold were indeed as plentiful, why did it take four years for sending just 300 tonnes? That too, this was given to the US Fed for safekeeping, to be made available on demand by Germany, and not to be leased into the market. My guess is that when the time comes for our gold repatriation, we will get worthless printed dollars or pounds instead of the gold.
Would Rajan have been aware of the entire gold price suppressing mechanism when he leased the RBI gold to the BoE? As somebody who later became the vice chairman of the BIS in 2015, I would suspect that he would be well aware of the extent of demandsupply mismatches and more importantly, about the role of gold itself. Of course, he sugar-coated the gold leasing episode by saying that we will get gold of greater purity when we need it back. Our gullible media swallowed this and even praised him for it. Without a second line in the RBI to question his actions and with Finance Minister in P. Chidambaram who did not know the difference between gold and copper or glass, he had a free hand to do what he wanted. I can’t really prove that Rajan was aware of all the above.
Rajan might well do what he does, but in either scenario, what we see is not what we get. If the US Fed and the BoE have been manipulating gold prices for a long time, why can’t they do it forever?
A more important question would be if the raison d’etre of central banks is to maintain their monopoly over issuing currencies, why would they ever allow gold to regain its monetary status?