A plea for sanity

2012-APR-25

An article by Professor Lew Spellman has caught the attention of the sharp-eyed, and may indeed be important. Spellman, who in the past has been an economist at the Fed and served as an assistant to the Chairman of the President’s Council of Advisors, makes the point that gold is quietly becoming a core banking asset for collateral purposes, at a time when the alternative, sovereign obligations, is becoming dangerously unstable as a bedrock of value. This is an establishment economist suggesting that gold is being chosen by markets as an alternative to money issued by government diktat.

He even suggests that ownership of gold would allow banks to increase leverage of their balance sheets. The London Bullion Market has been lobbying for this for the last six months, and at government level the Chinese have long pressed for gold to have a monetary role on a supra-national basis. Powerful forces recognise the benefits, and if the Basel Committee which is considering the matter agrees to banks using gold as Tier 1 Capital, it would create substantial demand for physical bullion, for any such gold would have to be physically held on an allocated basis.

Anyone who understands gold’s historic role will grasp the importance of the argument behind extra bank leverage. Direct ownership of bullion by a bank is superior to holding the fiat money issued by a central bank. It should increase confidence in any bank and the system as a whole. Given relative values, bank purchases of bullion will drive the value of gold as Tier 1 Capital up relative to other qualifying assets, increasing its desirability for regulatory purposes further without a gold-owning bank doing anything.

The fly in the ointment is politics. Ever since the Nixon shock in 1971, the US Government has tried to convince the world that gold has no monetary role. It would require the US Treasury to accept that gold might be superior to the paper dollar after all. No doubt that U-turn can be performed, but the concern would be that gold being officially recognised as a form of money would disadvantage the dollar and hand substantial power to the Chinese, who have been accumulating gold from their own mines.

This raises the question about how much gold the Chinese actually own. They have been mining the stuff for over a thousand years, and if Marco Polo is to be believed, seven hundred years ago there were enormous quantities of gold throughout both the Chinese Empire and Japan. This is certainly under-recorded by the World Gold Council, and while it and subsequent production may be tucked away, it won’t have been destroyed. It is a fair bet that some of it is still in China, under the control of the government, the ultimate inheritors of the dynastic legacies.

Why does this matter? It matters because if gold is accepted as the ultimate collateral, the balance of monetary power shifts from the US to China. China is already angling to conduct Asian trade settlements without using the dollar, and is ready to start using gold for settling her trade balance with Iran. This is an important development, the predictable result of US attempts to dictate terms of trade.

China is ready to use gold for monetary purposes, as is much of Asia and the Middle East. Europe is falling apart and needs gold as collateral for its banking system. Central banks everywhere, from Mexico to the Ukraine, are adding to their gold reserves, and according to the IMF in March alone twelve of them added 58 tonnes to their reserves, presumably in anticipation of its monetary return. The official price of $42.22 is an old joke that no longer amuses. How about it, Mr President?