Is gold the solution?

Reckless central bank money-printing will usher in a new monetary system, says Simon Popple. Gold will play a central part.

Surprise, surprise, the Fed didn't taper!

Printing $85bn a month does not seem to be working, so more rather than less stimulus would seem the logical solution.

The fiat currency system is now in one hell of a mess. Nobody knows what's going to happen. But people are realising that fiat money is under more pressure every month and that something's got to give. When will the change come? No one knows for sure. But gold is certainly a contender to be part of the solution when the end finally comes.

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Although, as you know, my expertise is really in miners, and now and again it's important to revisit the gold story and remind ourselves why it's such an important asset.

So, in this edition I want to touch on why gold is going to be an important component of the next monetary system.

Why gold?

For a commodity to be used as money, its supply needs to be stable and small relative to the total amount of it.

There's a huge difference between the annual gold supply or mine production and the total quantity of gold in existence. The total quantity of gold in existence is 172,000 tons. Annual production was approximately 2,700 tons last year.

If one divides the two amounts, one arrives at the stock-to-flow ratio of 64 years the amount of time it would take to replace the global stock of gold with fresh production.

That ratio is the fundamental reason why gold has been used as money across thousands of years and different continents. Gold has a stable value because it's rare and its supply grows slowly.

So why is gold so valuable?

Fiat money has always failed, because its supply is infinite, and when push comes to shove, the authorities create too much of it and destroy its value.

Just a reminder the Fed announced on 18 September that it had no plans to slow down its money-printing programme. It plans to keep printing dollars at a rate of $85bn per month.

When debt and inflation collapse the US economy, the US dollar's reign as global reserve currency will be over. But what will replace the dollar? The new currency will be:

  • globally acceptable,
  • widely held,
  • portable,
  • divisible, and
  • backed by a globally recognised 'real' asset with known inventories and steady supplies.

"As the international community attempts to take on these challenges, gold waits in the wings. For the first time in many years, gold stands well prepared to move once more towards the center-stage. This could be the start of an immensely important phase in the history of world money." - Official Monetary and Financial Institutions Forum (the OMFIF is a global think-tank for central banks and sovereign wealth funds).

Due to its high liquidity and its unique characteristics, gold is increasingly used as collateral. Following Eurex, CME Group, the International Exchange and JP Morgan, LCH Clearnet, the largest clearing house in the world, now also accepts gold as collateral.

OMFIF recommends the inclusion of gold in the IMF's special drawing rights (SDRs). This possibility was also mentioned by the governor of the People's Bank of China. He regards SDRs as a "light in the tunnel of reform of the international currency system".

SDRs are a currency unit introduced by the IMF, which isn't traded on foreign exchange markets. Currently the US dollar has a weight of 41.9%, the euro 37.4%, the Japanese yen 9.4%, and the British pound 11.3%.

Apart from gold, the 'R-currencies' (Chinese renminbi, Indian rupee, Russian rouble, Brazilian real and South African rand) are also supposed to receive a higher status in the international currency framework and are to be included in the SDR basket.

The growing calls for repatriation and audits of state-owned gold reserves also illustrates the growing importance of gold. Central bank-buying amounted to 534.6 tons last year. That is the largest quantity since 1964. In 2013, the IMF expects a net amount of 550 tons.

We'll get used to the Fed continually pushing the 'taper' deadline further into the future. The Fed can't stop printing money, so it won't. And that will ultimately be its undoing.

Simon is an expert in investing in gold and commodities which he shares for our MoneyWeek readers. He studied at the University of Surrey where he achieved a business degree and a marketing diploma. After taking his studies further and doing an MBA at Birmingham University, Simon was the first MBA student offered an internship in the U.S. Since then, Simon has been a part of the Senior Banker team at ABN Amro where he became the founding member of their Financial Sponsors team, and then joined Strutt and Parker Financial Services where he was appointed as Head of Investment Management. He also became a director at one of the world’s biggest private property companies, Topland. Simon Popple has written for MoneyWeek and Agora Financial.