Buttonwood
All that glisters
Nov 30th 2004
From Economist.com
Is the rise in the price of gold merely the flipside of the dollar’s fall? Or does it point more broadly to a loss of faith in central bankers’ promises?
ALAS, the nearest that Buttonwood gets to visiting jewellery shops these days is a trip to Claire’s Accessories, a chain of fabulously tacky shops beloved of his daughters. To be fair, Claire’s (“Where getting ready is half the fun”) does not pretend to be anything other than cheap and cheerful. Nothing seems to cost more than £2.99. The jewellers in Bond Street, just round the corner from The Economist’s offices, are about as different from Claire’s Accessories as it is possible to get. The stuff in them costs rather more than £2.99. And their already steep prices have been going up because the prices of precious metals have been rising, gold’s not least. In the past week, gold has topped $450 an ounce, its highest level in 16 years—and up from a low of $253 in the late 1990s. What, if anything, does this tell us about investors’ faith in paper currencies.
The financial world, it sometimes seems, is broadly divided into those who believe in gold as the ultimate currency and those who don’t. In the latter camp are most economists, the most famous of whom, John Maynard Keynes, described gold as a “barbarous relic”. But even as late as the 1960s, Charles de Gaulle, then president of France, claimed that gold was the “unalterable fiduciary value par excellence”.
Gold or silver were money for most of human history, either directly or indirectly. Once paper currency was introduced, it was, in theory at least, backed by either of the two metals. Silver was gradually edged out as a monetary metal in the 19th century, from which time the “gold standard” reigned supreme. This arrangement, in its purest form, collapsed in the 1930s, but it continued in a bastardised form after the second world war, when America, which by then held three-quarters of the world’s gold reserves, again tied the dollar to gold, and the rest of the world’s currencies tied themselves to the dollar. In 1971, the dollar was forced off the gold standard because of mounting inflationary pressures. Since then the world has had so-called fiat currencies, which are backed by nothing more than the promises of central bankers and politicians that they will uphold the value of those currencies. Fans of gold—known as gold bugs—wonder whether those promises are worth the paper they aren’t written on.
They certainly weren’t in the early years. Inflation ate away at the value of anything with a fixed monetary value, and during the 1970s the price of gold rose from $35 to $850. But in 1979, Paul Volcker, then chairman of the Federal Reserve, stomped on inflation and the price of gold fell sharply. In its place came a bull market in the price of government bonds.
The dollar, it must be said, fared less well. It may have become the world’s reserve currency, even without the backing of gold, but it has been anything but a splendid investment, especially in recent years. While its internal value has not fallen as much as it once did, thanks to lower inflation, its external value—ie, in relation to other currencies—has been in remorseless decline, albeit punctuated by some longish rallies. In recent weeks, encouraged by malign neglect from American politicians and central bankers, the fall has shown signs of becoming a rout. As the dollar has fallen, so the dollar price of gold has risen.
It used to be that gold bugs touted the yellow metal’s credentials as a hedge against inflation. But the link was anyway pretty feeble, except for currencies with hyperinflation. And though consumer prices have risen a bit this year, it would be hard to make the case that inflation is about to roar anywhere in the developed world. Why, then, is gold prospering at a time when inflation is low? Perhaps it reflects nothing more than the fall in the dollar: gold transactions are denominated in dollars, and in euros the rise in the gold price has been anaemic.
However, there is no law that says a falling dollar must translate into a rising gold price. Apart from a rise in demand for jewellery, the rise in the price of gold may, at the margin, reflect demand for real, hard assets, as opposed to the paper sort. And the reasons are not hard to find, for across the developed world, debts have escalated alarmingly in recent years—and in America not least, hence the vast and growing current-account deficit. While central bankers are generally trusted not to “monetise” these debts by rolling the printing presses, history would suggest that this displays a touching naivety. As James Grant, publisher of an eponymous financial newsletter, and the most erudite of the gold bugs, says: “[Alan] Greenspan, the figurehead of the dollar, was trading at three times book in the late 1990s; I think he may return to book value.” Or lower.
Gold’s virtue, says Mr Grant, is that it is a monetary metal, because of its scarcity and, of course, its history. Actually, Buttonwood can’t help feeling, gold’s history counts against it. Of all the metals, the market for gold is probably the most rigged. It is because of history that central banks hold in their reserves almost a quarter of all the gold that has ever been mined. They would like to sell at least some of it, but the vast amount that they hold means doing so would drive the price down. In 1999, central banks therefore came to an agreement to restrict gold sales. The agreement—or cartel, if you will—was extended in September. But it would presumably be torn up if the gold price rose sharply: the Bank of France said this month that it wants to offload some 500 tonnes over the next five years.
And that would presumably limit gold’s upside. Perhaps a better argument can be made for other scarce metals: platinum, say, or silver. Silver, after all, not only spent centuries vying with gold as a form of money, but also has many industrial uses and is not held by central banks; annual demand is much higher than annual production. Along with many other metals, the price of silver fell sharply in April, but unlike gold it has not even regained the ground it lost. Also in its favour is that it is not exactly sold in industrial quantities at Claire’s Accessories.
All that glisters
Nov 30th 2004
From Economist.com
Is the rise in the price of gold merely the flipside of the dollar’s fall? Or does it point more broadly to a loss of faith in central bankers’ promises?
ALAS, the nearest that Buttonwood gets to visiting jewellery shops these days is a trip to Claire’s Accessories, a chain of fabulously tacky shops beloved of his daughters. To be fair, Claire’s (“Where getting ready is half the fun”) does not pretend to be anything other than cheap and cheerful. Nothing seems to cost more than £2.99. The jewellers in Bond Street, just round the corner from The Economist’s offices, are about as different from Claire’s Accessories as it is possible to get. The stuff in them costs rather more than £2.99. And their already steep prices have been going up because the prices of precious metals have been rising, gold’s not least. In the past week, gold has topped $450 an ounce, its highest level in 16 years—and up from a low of $253 in the late 1990s. What, if anything, does this tell us about investors’ faith in paper currencies.
The financial world, it sometimes seems, is broadly divided into those who believe in gold as the ultimate currency and those who don’t. In the latter camp are most economists, the most famous of whom, John Maynard Keynes, described gold as a “barbarous relic”. But even as late as the 1960s, Charles de Gaulle, then president of France, claimed that gold was the “unalterable fiduciary value par excellence”.
Gold or silver were money for most of human history, either directly or indirectly. Once paper currency was introduced, it was, in theory at least, backed by either of the two metals. Silver was gradually edged out as a monetary metal in the 19th century, from which time the “gold standard” reigned supreme. This arrangement, in its purest form, collapsed in the 1930s, but it continued in a bastardised form after the second world war, when America, which by then held three-quarters of the world’s gold reserves, again tied the dollar to gold, and the rest of the world’s currencies tied themselves to the dollar. In 1971, the dollar was forced off the gold standard because of mounting inflationary pressures. Since then the world has had so-called fiat currencies, which are backed by nothing more than the promises of central bankers and politicians that they will uphold the value of those currencies. Fans of gold—known as gold bugs—wonder whether those promises are worth the paper they aren’t written on.
They certainly weren’t in the early years. Inflation ate away at the value of anything with a fixed monetary value, and during the 1970s the price of gold rose from $35 to $850. But in 1979, Paul Volcker, then chairman of the Federal Reserve, stomped on inflation and the price of gold fell sharply. In its place came a bull market in the price of government bonds.
The dollar, it must be said, fared less well. It may have become the world’s reserve currency, even without the backing of gold, but it has been anything but a splendid investment, especially in recent years. While its internal value has not fallen as much as it once did, thanks to lower inflation, its external value—ie, in relation to other currencies—has been in remorseless decline, albeit punctuated by some longish rallies. In recent weeks, encouraged by malign neglect from American politicians and central bankers, the fall has shown signs of becoming a rout. As the dollar has fallen, so the dollar price of gold has risen.
It used to be that gold bugs touted the yellow metal’s credentials as a hedge against inflation. But the link was anyway pretty feeble, except for currencies with hyperinflation. And though consumer prices have risen a bit this year, it would be hard to make the case that inflation is about to roar anywhere in the developed world. Why, then, is gold prospering at a time when inflation is low? Perhaps it reflects nothing more than the fall in the dollar: gold transactions are denominated in dollars, and in euros the rise in the gold price has been anaemic.
However, there is no law that says a falling dollar must translate into a rising gold price. Apart from a rise in demand for jewellery, the rise in the price of gold may, at the margin, reflect demand for real, hard assets, as opposed to the paper sort. And the reasons are not hard to find, for across the developed world, debts have escalated alarmingly in recent years—and in America not least, hence the vast and growing current-account deficit. While central bankers are generally trusted not to “monetise” these debts by rolling the printing presses, history would suggest that this displays a touching naivety. As James Grant, publisher of an eponymous financial newsletter, and the most erudite of the gold bugs, says: “[Alan] Greenspan, the figurehead of the dollar, was trading at three times book in the late 1990s; I think he may return to book value.” Or lower.
Gold’s virtue, says Mr Grant, is that it is a monetary metal, because of its scarcity and, of course, its history. Actually, Buttonwood can’t help feeling, gold’s history counts against it. Of all the metals, the market for gold is probably the most rigged. It is because of history that central banks hold in their reserves almost a quarter of all the gold that has ever been mined. They would like to sell at least some of it, but the vast amount that they hold means doing so would drive the price down. In 1999, central banks therefore came to an agreement to restrict gold sales. The agreement—or cartel, if you will—was extended in September. But it would presumably be torn up if the gold price rose sharply: the Bank of France said this month that it wants to offload some 500 tonnes over the next five years.
And that would presumably limit gold’s upside. Perhaps a better argument can be made for other scarce metals: platinum, say, or silver. Silver, after all, not only spent centuries vying with gold as a form of money, but also has many industrial uses and is not held by central banks; annual demand is much higher than annual production. Along with many other metals, the price of silver fell sharply in April, but unlike gold it has not even regained the ground it lost. Also in its favour is that it is not exactly sold in industrial quantities at Claire’s Accessories.