The Case For A Higher Gold Price Based on Monetary History

People tend to forget quickly and fail to learn from history. As George Bernard Shaw once said : “What we learn from history is that  people don’t learn from history.” So it’s worth one’s time to look back to the past and learn what others before us learnt sometimes the hard way.

As far as Gold’s role in our monetary system is concerned, the most recent learnings and insights come from “the Bretton Woods period”. Apart from being a nice resort in the mountains, Bretton Woods stands for the agreements that created a new world monetary system in 1944. Courtesy of Scott Minerd, chief investment officer of Guggenheim Partners, who wrote the short but very powerful paper (bottom of this article), full of insights from monetary history. The learnings should be used by all of us, including our economic and political leaders.

Scott Minerd writes:

The early success of Bretton Woods, which relied upon weak currencies to successfully promote exports looks surprisingly similar to the policies being practiced by central banks around the world today. Some have referred to the current policies in foreign exchange markets as Bretton Woods II. Although not officially acknowledged, central banks are once again tacitly pegging their currencies to the dollar. As the U.S. is expanding its monetary base through quantitative easing (QE), other countries have few options but to join this race to the bottom. This situation is as unsustainable today as it was in the 1960s.

Gold was an important component of the Bretton Woods system. As a monetary anchor, it provided stability for the dollar as a global reserve currency. With the demise of gold convertibility under Bretton Woods, global price stability began to unravel. After being depegged from its official price of $35 per ounce in 1971, gold rose by more than 2,000% over the next 10 years. Investors migrate to gold when currencies no longer function as good stores of value.

Gold’s role to create monetary stability

As appears from the previous quote, Gold has proven to bring stability in the monetary system. That’s one of the key conditions for a sound financial environment and balanced economy. Gold is simply another form of currency. Nick Barisheff said in his latest Q&A with GoldSilverWorlds that when you look at the history of currencies, there is not one example where fiat currency didn’t go through a hyperinflation or complete collapse. Today we have a fiat currency system that is one way or another tied to the US dollar as a reserve currency but on a global basis. He believes that history is about to repeat itself as we are moving to the same kind of end game.

In that respect, the “gold coverage ratio” provides a reliable way of looking at the stability of the monetary system. It measures total Gold on the Central Bank’s balance sheet (expressed in a total value based on the spot price of a currency) compared to the total money supply. From the chart below it’s obvious that we are going through exceptional times, as the ratio is historically low today. The last time in history we saw a comparably low ratio, was just before the gold price  started to float which was the end of the Gold window (as decided by US President Nixon), also the end of Bretton Woods. Are we close to the end of the unofficial Bretton Woods II?

Gold price set to increase

Nick Barisheff mentioned some of the most common arguments against a higher gold price. It includes a further price increase would be irrational and it’s too late to invest. That’s very recognizable, right? One could come to that simple conclusion by just looking at a long term price chart. As Gold is a form of currency and currencies cannot be looked at in an isolated way, it’s not very wise to only look at the spot price for that purpose. In fact, Gold is tied to the system, no matter if it’s currently not tied to the money supply. The “gold coverage ratio” in the above chart is one of the ways to look at Gold. Scott Minerd looks this way at gold and the gold price:

The possibility of an upward revaluation of the official price of gold should not be minimized. Although I do not anticipate or advocate a return to the gold standard, an upward revaluation of gold by one of more central banks is possible. If the Federal Reserve, for instance, announced that it stood ready to purchase gold at $10,000 per ounce, the gold-coverage ratio of the dollar would return to 75%, roughly where it stood at the beginning of Bretton Woods. This could restore confidence in the value of the dollar if its ultimate role as a reserve currency were to be challenged.

Prescient investors should consider making allocations to gold and other precious metals as a hedge against the erosion of purchasing power of the dollar as well as for the potential upside from  positive market price appreciation or a possible intervention at the policy level. Despite the sizable appreciation in gold prices in the last decade, gold is far from overvalued. This makes gold a low-risk investment and leads me to believe that gold will never again trade below $1,600 an ounce.

GATA’s Chris Powell commented on the paper with this statement: “It’s another thoughtful speculation on the rationale for an official revaluation of gold to a price far higher than the current paper-suffocated price.”

We strongly recommend to read the paper a couple of times, as it helps in better understanding the role of gold in our society and in particular in the monetary system.


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