A State-Level Gold Standard?

Barry Eichengreen provides "A Critique of Pure Gold" in the September/October issue of the National Interest. He speaks for most economists in referring to the idea of a return to the gold standard as "an oddball proposal," and explains why in some detail. What caught my eye is that apparently some states have been considering requiring payments in the form of gold--a sort of mini-gold standard. Eichengreen writes:

"A Montana measure voted down by a narrow margin of fifty-two to forty-eight in March would have required wholesalers to pay state tobacco taxes in gold. A proposal introduced in the Georgia legislature would have called for the state to accept only gold and silver for all payments, including taxes, and to use the metals when making payments on the state’s debt.
In May, Utah became the first state to actually adopt such a policy. Gold and silver coins minted by the U.S. government were made legal tender under a measure signed into law by Governor Gary Herbert. Given the difficulty of paying for a tank of gas with a $50 American eagle coin worth some $1,500 at current market prices, entrepreneurs then floated the idea of establishing private depositories that would hold the coin and issue debit cards loaded up with its current dollar value. It is unlikely this will appeal to the average motorist contemplating a trip to the gas station since the dollar value of the balance would fluctuate along with the current market price of gold. It would be the equivalent of holding one’s savings in the form of volatile gold-mining stocks.

Historically, societies attracted to using gold as legal tender have dealt with this problem by empowering their governments to fix its price in domestic-currency terms (in the U.S. case, in dollars)."

 It is odd, to say the least, than many of those who favor a gold standard have also been investing in gold hoping to see its price rise. But as Eichengreen notes, in a gold standard, the price of gold would typically be set at a fixed level--historically, often a level below what would otherwise have been the market price. When President Richard Nixon officially ended what remained of the gold standard in 1971, gold was only used to pay debts to foreign governments holding U.S. dollars, and at a fixed price of $35/ounce.

Eichengreen traces how the idea of a gold standard has re-entered public discourse, championed by Ron Paul, who in turn refers to the work of Friedrich Hayek. But as Eichengreen reminds us, while Hayek was a fierce critic of central banking, and argued that central bankers needed to be controlled lest they conduct monetary policy in a way that feeds cycles of boom and bust in the economy, Hayek did not support a gold standard. In Eichengreen's words, summing up Hayek's standard arguments against a gold standard:

"At the end of The Denationalization of Money, Hayek concludes that the gold standard is no solution to the world’s monetary problems. There could be violent fluctuations in the price of gold were it to again become the principal means of payment and store of value, since the demand for it might change dramatically, whether owing to shifts in the state of confidence or general economic conditions. Alternatively, if the price of gold were fixed by law, as under gold standards past, its purchasing power (that is, the general price level) would fluctuate violently. And even if the quantity of money were fixed, the supply of credit by the banking system might still be strongly procyclical, subjecting the economy to destabilizing oscillations, as was not infrequently the case under the gold standard of the late nineteenth and early twentieth centuries."

Hayek's answer to the problems of unrestricted central bankers was to allow the rise of private sources of money. Eichengreen continues:

"For a solution to this instability, Hayek himself ultimately looked not to the gold standard but to the rise of private monies that might compete with the government’s own. Private issuers, he argued, would have an interest in keeping the purchasing power of their monies stable, for otherwise there would be no market for them. The central bank would then have no option but to do likewise, since private parties now had alternatives guaranteed to hold their value."

USD , Gold & Sarah Palin

The media have been making a big fuss on the surge in gold price above $1,000 and on the demise of USD over the past few weeks. Just like my opinion of Sarah Palin, I just shrug my shoulders and ask "so...". Why are we acting as if these developments are a big shock to the system??? Its not, to the general investors, a weaker USD and a higher gold price are what's needed to bring the global economy to an equilibrium. Its only the papers, magazines, business dailies and business networks that have you thinking that these developments were highly surprising and "unanticipated". I guess these people have to sell papers and advertisements, hence they yell through their headlines: "Obama Comes Under Fire As Falling Dollar ...", " "Gold Prices Goes Off The Charts ...", etc...

There is nothing new. If anything, it shows that the global finance paradigm is realigning itself quite well. You cannot have such a huge credit and leveraged implosion in the US and parts of Europe without taking away some of the "wealth" from these countries. You cannot always ride on the fact that you are the reserve currency and everything will be business as usual.

Just look at the printing press at work in the US ever since Greenspan took over, these notes are not backed by anything but the nuclear warheads and flying bombers. Granted we need a superhero to safeguard democracy in the global platform, and its a price we all have to pay, but there comes a time when less and less will want to hold USD papers, and the day is now.

China and some Asian leaders have been warning that the US indebtedness cannot be allowed to go on unchecked. Now the US have been awaken to the fact that those are not hollow warnings at all. While I think the USD will still be the reserve currency, it is well on its way to losing a large part of its "premium".

Unbelievably, CLSA invited Sarah Palin to the big annual conference in HK. Gee... why listen to that woman who has not traveled out of Alaska or the US. What kind of value add commentary does she bring to the table? I am not even going to quote what she said about the USD weakness and gold price (she did say something) as ... seriously folks, I am being nice here, she is nowhere qualified to contribute with any sense or participate in this discussion. I'd be better off talking to my taxi driver who can give me a more nuanced view on these issues.

In fact, what is so bad about a weaker USD??? Most Americans don't really travel overseas anyway. They have almost outsourced everything they can to China, Brazil and India anyway - they don't really make anything anyway. A weaker USD will boost the competitiveness of US companies though and make their stocks a lot more attractive.

The weaker USD is basically a long overdue result of Fed's printing press. Its always the central banks that causes economic bubbles, not the consumers, not the banks... they only behave badly when given too many toys by central bankers.

The USD weakening is good for the majority, it shows that if you messed up your financials, you get punished. We need to push the USD down another 10% over the next 6 months so that we can force them to deal effectively with their indebtedness. You cannot just pump $1,000 bn over the last 12 months and pretend that all is fine.

Gold price is merely reflecting an inflationary hedge that many see is coming over the next year or two. Like it or not, higher gold prices actually is good for stock markets, because commodity prices will be higher as well as most assets. Its a reflationary cycle, much like pumping hot air into a balloon, all assets go up, including stocks. Yes, we are basically remaking a new bubble. Still early days though, maybe another 12 -24 months before we get pricked - key, watch the global interest rates movements.

We need higher gold prices because that means inflationary fears are rising. we need to have inflationary fears because that means that business activity is on the up and/or the reflationary cycle is up and running owing to the fact that the large amounts of liquidity being pumped in by central banks over the past 10 months are now being put to work (i.e. circulating in the system).

We all need a bit of inflation every now and then, you certainly don't want a deflationary or stagflation period (go ask Japan) ... a bit of inflationary fears now is good and needed.


p/s photos: Amigo Feng Yuan Zeng

Central Banks & Their Gold Strategy

We all know that the biggest demand for gold comes from central banks. Just how has their buying or selling strategy been over the last 12 months? Is their strategy influenced by the amount of USD being printed into circulation? Are they afraid of the dollar not being able to uphold its long term value? Will they ever regard holding US Treasuries as an option only? Is any of them seriously hinting of reverting back to the gold standard? By holding more gold and less USD does that mean more flexibility to their monetary policy?

• Reduced central bank gold selling and increased investor buying may have been helping to underpin high prices in 2008 at a time of turmoil in financial markets. The renewal of the central bank gold selling agreement with a lower threshold suggests that gold sales by central banks will be lower in the next five years, a move the could support gold prices.
• Gold's share in global foreign exchange reserves is about 10%, the third largest asset by value despite being unevenly distributed across countries. The U.S. and European central banks account for the highest amounts both in absolute terms and as a share of reserve holdings (about 50%). Emerging market central banks have a much smaller share. Gold's share in global reserves declined sharply since the 1950s -1960s.
  

Regulation of Central Bank gold sales


• In August 2009, the central banks party to the central bank gold agreement (CBGA), who collectively have a gold share of just under 60% in their reserves, agreed to renew the treaty but with a lower maximum sales threshold. Analysts suggest that the marginally lower threshold could provide a "mild support" for gold.
• The annual sales by the central banks party to the treaty will be less than 400 tons. The previous agreement had a cap of 500 tons per years. The IMF's planned sales of 403 tons are included in the overall cap of 2000 tons from 2009-2014. With the Swiss National bank suggesting it will not sell, only the European central bank and the Banque de France are likely to take advantage to sell. The Italian and German central banks have been reluctant to sell their gold holdings.
• In H1 2009, estimated net sales by official holders of gold were 39 tonnes, 73% lower than in H1 2008. Net gold official gold sales are expected to be only 140 tons in 2009, the lowest since 1994.
  
• In 2008, European central banks sold the lowest levels of gold in about decade, reversing the practice of recent years whereby official sales helped depress gold prices. Banks bound by the central bank gold agreement (most of the European central banks) sold about 343 tons of gold , the lowest since the first agreement was signed in 1999, and well under the 500 ton annual limit.
• In the fall of 2008, central banks stopped lending out gold to banks as they were afraid they would not get it back. This reluctance contributed to an increase in bullion borrowing costs to 2.649% for one month, the highest since May 2001 and high above recent levels (5yr average 0.12%).
  
• An asset allocation assessment would suggest European central banks still have too much gold. EM central banks have low gold holdings in part because of the rising cost of gold and worries about an inability to sell when forex liquidity is required.
  

Gold holdings of Emerging Market Central banks

• GCC private investors have much higher stocks of gold than its central banks do. However, Qatar increased its gold reserves in 2007.
• China announced early in 2009, that it had increased its total gold holdings by 75%, likely from shifting non-monetary gold to the central bank. Although that increase now makes China one of the top 5 official gold holders, gold makes up less than 2% of China's $2.1 trillion in foreign exchange reserve by value. On the margins, China is likely to keep adding slowly to its holding but it is unlikely to make purchases on the open market given the potential for disrupting prices and reducing the value of USD holdings
• Aside from China with 1054 tons, the emerging market central banks with the largest gold holdings are Russia (540 tons), Taiwan (424 tons), India (358 tons) and Venezuela (356 tons) as of May 2009. Aside from Venezuela and Lebanon, the gold shares of which make up 37.5% and 27.5% respectively of total reserves, most of the other large holders have a gold share of only about 4% of reserves.
  

Gold Sales by the IMF

• The IMF, the third-largest official holder of gold, intends to sell 403 tons (12%) of its 3217 tons of gold, pending approval from 85% of its members which will likely be given in the fall. Any sales are likely be gradual though and may be sold to central banks.
• IMF gold sales are unlikely to be disruptive for the gold market and could be positive if the gold is purchased by other official investors (like central banks).
  
• The IMF is likely to start selling in 2010, selling about 200 tons a year.

p/s photos: Aya Nakata