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Currency
Debasement & Price Stability Risks
Despite the small moves in exchange
rates between the U.S. dollar and the euro, confidence and trust has been
debased. Looking forward to 2012, we see that deflation is becoming a rising
danger. After the decay in 2011 that has hammered confidence in the euro, the
need to issue more and more ‘new’ money is growing. The Eurozone
is moving into recession (if it is not already in one). The Eurozone is more
than likely to lose one or more of its weaker members –this will be
good for the euro itself though—so liquidity shortages may force more
money supply growth already exceptionally high in many countries.
Despite the
40-year long campaign to prevent gold from returning to any active role in
the developed world’s monetary system, gold remains the only
universally-accepted currency whose supply cannot be increased by policy-makers.
The equivalent of money issuance for gold is new mine production, which has
been on a relatively flat trend for the past ten years.
Shortage
of Gold in Monetary System Relative to Amount of Money
In a recent
report, the World Gold Council examined the quantitative relationship between
money supply and gold. Data showed that a 1% change in US money supply growth
six months prior has an impact of 0.9% on the price of gold, on average.
Meanwhile a 1% change in money supply in India and Europe six months prior
affects the price of gold by 0.7% and 0.5% respectively.
So gold,
whether accepted or recognized by ‘official’ bodies, has
a role in money, and this role is growing as the real value of currencies
declines in terms of trust and confidence. For gold to do an effective job of
restoring confidence and trust, its value has to relate to the global supply
of money (i.e. financial assets). Take a look at the first pie chart (thanks
to BMG/WGC and McKinsey) showing the value of gold verses the world’s financial
assets. We leave it to you to estimate the growth of the gold price so that
the value of gold closely relates to the value of global financial assets.
A
multiplication of 10 to the gold price would fall short of this figure!
Percentage of Gold in
Reserves
So often the percentage of gold in
reserves is used as a measure of how much gold should there be in the
reserves. But in the context of the amount of money there is out there, this
number is meaningless. We looked at the traditional use of gold in reserves
and found the measure was 3-months worth of
international trade, as though this is all it would take to resolve any
crisis. Where on earth was that formula concocted from?
If we look back to the days when the
developed world accumulated the reserves they’re now thought to have
and the amount of money on issue, a more pertinent number would be the percentage of money, gold, at current
prices, represents in reserves. The two, relevant points in this
valuation of gold would be when gold was a basis of the world’s monetary
system (before the Second World War) and then in the 1960’s under the
Bretton Woods system, just before it was effectively torpedoed.
It quickly becomes clear that this
percentage has been dropping heavily as total money has expanded. For gold to
function, as it used to, something has to change. Either the amount of gold
in foreign exchange reserves has to increase, or the price of gold in each
currency has to rise to compensate for the increase in total money, or a
combination of both. Even with a massive hike in the price of gold, two
problems will still persist.
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