Ramifications around gold

Whenever the topic of possible collusion in the manipulation of the gold price is raised, there are people who ask why such a fuss should be made of what has become, surely, a mere commodity. That gold has been demonetised, first when Roosevelt banned private ownership of god coins, effectively promoting a sole paper currency, and then later when Nixon closed the so-called “gold window”, which action severed the last formal link between the dollar and gold.

In other words, now that gold has no monetary role to become a pure commodity, there is no benefit to be gained from the manipulation of its price. Yet this analysis loses sight of the fact that while gold may have lost its explicit monetary role, it still forms a significant portion of the national reserves of many countries – reserves that are under the effective control of independent central banks. By virtue of this role as official reserves, supported by age old tradition, gold still remains “money” in the minds of most investors. For many people, the gold price remains a standard against which other prices are compared.

When the price of gold increases faster than the price of goods and services, i.e. faster than inflation, it is an indication that people prefer to own gold despite the fact that it offers no return, over spending the money on other goods and services. The question now is under what conditions would people prefer to buy gold rather than to place the money in a bank where it can earn interest or to spend it in some manner.

Obviously, this trend of a rising gold price should only happen when there is widespread uncertainty about the future of the economy and perhaps even about the basic conditions and structure of a society. This reasoning can be inverted to say that when an outside observer sees the price of gold is rising, then that by itself is a warning that somewhere something is drastically wrong. A prudent person would then proceed to take action to ensure that he or she also is prepared for whatever lies ahead, even without knowing the exact nature of the threat to stability.

This fact by itself means that authorities who contemplate a risky strategy would be very happy to see the gold price steady or declining while they are pursuing such a strategy. If, for example, as happened during the 1960’s, the US is printing money to fight the war in Vietnam, they would be concerned about the risk of the US dollar losing its purchasing power in the forex markets – suffering from inflation, in effect and soon resulting in high inflation within the US as well. To protect the dollar at that time, the solaced London Gold Pool was established. It was a consortium of central banks under leadership of the Bank of England that used their resources to prevent a rise in the gold price, which at that time was fixed at $35/oz.

A rise in the gold price would imply a weaker dollar and that had to be prevented. ‘at all costs’, as was said at the time. The effort failed and in due course the official price of gold had to be raised to $42/oz – the price at which most central bank gold is still valued.

The closing of the gold window by Nixon in 1972 meant that currencies ‘floated’ against each other. Some floated while others sank. One dollar was worth ¥357 in 1972, but by 1995 only ¥80 were needed to buy one dollar. It was at this time that president Clinton and his Secretary of the Treasury, Robert Rubin, for a variety of reasons, mostly political in nature, opted to restore the dollar to its erstwhile glory through their “Strong Dollar” policy. And, of course, this policy demanded a weaker gold price else the cracks in their policy would be revealed to a sceptical observer.

Why the strong dollar policy? So as to obscure the fact that the US was about to launch a campaign of increased monetary liquidity and lower interest rates, which was designed to stimulate the economy and thus ensure a second Clinton term in office after 1996. But it was essential, as in the 1960’s, to ensure that inflation would not be resurgent and again this hinged on keeping the gold price under control.

One problem with the effort by the London Gold Pool was that they had to sell their gold reserves in order to keep demand satisfied. This they could not maintain indefinitely and that is why the effort collapsed. This time around they invented a strategy where they could have their cake and eat it.

Rather than selling their bullion, they leased it to the money centre banks. In this way, the gold would effectively remain on their books as an asset, while the bullion banks actually sold the gold into the market, achieving the desired objective of a lower gold price.

Until recently this strategy has worked well. What was not foreseen was the eruption of all kinds of crises – financial, corporate and international – over the past few years that have stimulated new demand for gold, specifically in countries where ownership of gold has traditionally been seen as the best strategy for survival, namely in Japan and the Middle East.

Now that this trend is expanding to other countries, it should be just a matter of time before cumulative demand increases to where efforts to keep the gold price under control fail, as they did in an earlier era under much the same circumstances.