EDINBURGH — Gold remains popular among the rich. It is perceived by some as a store of value, a counterbalance to other assets and a safe haven amid geopolitical turbulence. It ticked up amid jitters over US-North Korea tensions in October; this week the gold price rose on dollar weakness. But gold is also seen as an old-fashioned investment opportunity, with the metal set to be replaced by cryptocurrencies. In this article, South African investment advisor David Melvill argues that gold should be included in everyone’s portfolio. He tracks the history of gold in the economy and underscores that Russia and China are big buyers of gold – a signal that the metal is not about to be relegated to the annals of history. – Jackie Cameron
By David Melvill*
Will we ever go onto a gold standard again?
There is not an easy answer to this question. While central bankers, certain economists, and financial managers in favour of the FIAT monetary system (the printing of money where there is nothing backing it), love to “bash” those that believe in the role of gold in our monetary system, it would appear unlikely. Nonetheless there are others that are reverting to a closely allied form of the gold standard.
What is the gold standard? It refers to a monetary system whereby the amount of gold is held by the central banks in order for them to print the equivalent amount of paper money, as a medium for exchange. The paper currency in turn can be exchanged for the equivalent amount of gold.
It is therefore prudent to address some of the ardent critics and their arguments against holding gold as a standard and as an investment.
One of their strongest and most fervent arguments is the quoting of the famous English economist, John Maynard Keynes, his statement, “Gold is a barbarous relic.” Firstly, Keynes never said that. In his book, Monetary Reform (1924) he said: “In truth, the gold standard is a barbarous relic.”
Keynes was not discussing “gold,” but rather a “gold standard,” and in the context of 1924, and the turmoil after the First World War, he was right. Furthermore, to the contrary, the record shows that Keynes was in fact a great advocate for an appropriate gold standard and rather vehemently outspoken against a flawed and mispriced gold standard.
- Staying on the gold standard
Economist and author, James Rickard, in his book, The New case for gold, agrees with Keynes that the “notorious and flawed gold standard from 1922 to 1939, should never have been adopted and should have been abandoned long before it died with the outbreak of the Second World War.”
Keynes pointed out that most countries who enter the First World War abandoned the gold standard in order to finance their war efforts, by selling their gold.
On the basis of his belief that “gold is money and debt is elastic”, he argued that England should stay on the gold standard and uphold London’s role as the centre for global finance. In so doing, the UK’s credit would be enhanced, and London would be able to borrow the money to finance the war. That is exactly what happened.
Massive loans were made by the House of Morgan (present day JP Morgan) from New York to the United Kingdom, while Germany and Austria received none. This finance was crucial to sustaining Britain’s war efforts, until the United States decided to enter the war in 1917 and help secure the victory the following year.
- Staying on a gold standard at the correct price
It was in 1925, that Keynes disagreed with the Chancellor of the Exchequer, Winston Churchill, saying that returning to the gold standard should not be at the same price prior to the war of $20,67 an ounce, but at a much higher price, or deflation would occur.
He was spot on. The result was a massive deflation and depression that struck the UK, years before the Great Depression struck the world in 1929.
Furthermore, Keynes commenting on Lenin’s approach on how to destroy the Capitalist’s system said: “Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”
- Adopting an alternative gold standard
In order to get out of the Depression, in 1934, the US President Franklin Roosevelt devalued the dollar by 40%, making the price of one ounce of gold to be $35.Then towards the end of the Second World War, in July 1944, 44 nations gathered at a world conference in Bretton Woods, New Hampshire (US).
At this conference Keynes promoted a new form of world money, known as the Bancor. It was a system backed by a basket of commodities which included gold. It was not a classic gold standard, but it gave gold an important place in the monetary system.
Harry White and John Keynes
Keynes’ plan was unsuccessful in his proposal. The US economist, Harry White’s proposal of an alternative dollar-gold standard was adopted; it lasted from 1944 to 1971.
Thus it is evident that Keynes was an advocate for the role of gold in both his early and later years, in between he was outspoken about a flawed gold exchange standard.
- Leaving a gold standard – “closing the gold window”
Finally, in 1971, President Richard Nixon closed the “gold window”- known as the “Nixon Shock.” This was the closing down of the right to swap the dollars for gold. The world was no longer on any form of a gold standard.
In the following nine years, gold experienced its greatest bull run, it “charged” from $35 to $850 an ounce. A record return of 42% per annum. This was due to the mistrust of Central Bankers and governments, as they implemented the new FIAT monetary system. This is a currency established by a government without intrinsic value. It thus allows for freely floating exchange rates between national currencies.
- Rejoining a gold standard
Will we ever join a gold standard again, you may ask? I don’t know, but in the meantime it makes sense to return to your own gold standard.
I remember attending a lecture hosted by Gordon Institute of Business Science in 2003 presented by the then Deputy Governor of the SA Reserve Bank, Gill Marcus. I posed my question, “Would South Africa ever consider returning to a Gold standard?” her curt answer was, “In your dreams.”
Former US Federal Reserve Chairman, Alan Greenspan, was one who held positive views on the gold standard. In a 1966 essay entitled “Gold and Economic Freedom,” Greenspan argued the case for returning to a ‘pure’ gold standard. He described supporters of fiat currencies as “welfare statists” using monetary policy to finance deficit spending.
President Ronald Reagan before accepting his second term of office in 1980, was eager to return to a Gold standard, he urged Congress to appoint a Gold Commission to see how they could implement it. However he was persuaded to not pursue it if he wanted a second term of office.
It would appear that China is making a concerted effort to increase their gold reserves. They are not only the world’s biggest producers of gold, they also do not sell any of their gold.
Together with Russia they are the biggest buyers of gold, while they are able to keep the price subdued. Do they know something that we should know?
Could it be that once China has accumulated sufficient gold reserves in order to match the US’s current reserves of 8 000 tons, then they will declare that they too wish to have some form of the world’s reserve currency? Perhaps giving rise to a new or shared currency?
Bitcoin is rapidly being accepted by many as a new form of currency. It too has many similarities to a gold standard. Could it too lead to paving the way for a new globally acceptable currency and getting back to a form of a gold standard?
Financial advisor, Kevin Creasey, points out, “China and Russia are reintroducing a gold standard via the Petro Yuan oil contract which can be cashed out into the physical Shanghai Gold Exchange.”
Finally, we would do well to heed Rickard’s sage advice in his book: “Gold is money, monetary standards based on gold are possible, even desirable, and in the absence of an official standard, individuals should go on a personal gold standard, by buying gold, to preserve wealth.”
Suggestion: Ideally, one should aim to make an investment in gold of between 5 – 10% of your total assets. This should be in coins primarily, and maybe some in gold mining shares for the more aggressive investor.
- David Melvill is an investment advisor based in Montagu. His email is [email protected].