Robert Zoellick, president of the World Bank, has said that gold is the “elephant in the G20 meeting room” and has suggested that the metal should be given a role in any fundamental reshaping of the global monetary system which may emerge from current international discussions. Although this was initially interpreted as a call for a return to the gold standard, Mr Zoellick on Wednesday said that this would be impractical. Instead, he seems to believe that gold should act as a kind of signalling mechanism, which flashes warning signs when uncertainty is rising, and confidence is falling, in the global economy. Maybe, but I am struggling to understand how this could be made to work in practice.
This is the kernal of the proposal which Mr Zoellick made in the FT on Monday:
The system should consider employing gold as an international reference point of market expectations about inflation, deflation and future currency values. Although textbooks may view gold as the old money, markets are using gold as an alternative monetary asset today.
Subsequently, Mr Zoellick has explained that markets are using gold as an alternative “currency” because there is so much uncertainty about other currencies, presumably as a store of value. It seems that he sees the rise in the price of gold as a measure of dissatisfaction in the markets about the value of fiat currencies like the dollar. He describes an allocation to gold as a “hedge on uncertainty”.
This is a fair point. It is clear that some asset allocators have indeed been using gold as a hedge against uncertainty, but it is difficult to see how this can be used to give gold a helpful role in the international monetary system. The price of gold has been rising at a cumulative annual rate of 17.7 per cent since 2001. In the graph, which is drawn on a log scale, the gold price has risen in a virtual straight line for the whole of the past decade. There have been some periods when the gold price has fallen, but these have not lasted very long.
Over the same period, global price inflation has had periods of rising (before 2007) and falling (after 2007). Government debt ratios and budget deficits have similarly had periods of improvement and deterioration. The dollar has seen years in which its trend has been rising, and years where the reverse has been true. Global current account imbalances have widened, and then narrowed. The gold price has risen when measured in “inflationary” currencies like the dollar, and it has also risen (though by less) when measured in “deflationary” currencies like the yen. In other words, it is not at all clear what the rise in the price of gold has been warning us about.
Since the financial crisis in 2008, investors have become far more concerned about the deterioration in government balance sheets, and about the consequences of quantitative easing by the central banks. Yet the price of gold has risen at broadly the same rate as it did in earlier years. (Admittedly, it has risen more rapidly if you measure the change from the low point in October 2008, but in a big picture sense the gold price has stayed on its longer term trend line, with some volatility around that trend.)
Consequently, I am genuinely unsure about what the gold market is signalling which could be useful to policy makers, unless it is just a general message that “things are worrying, so get your house in order”. That may be true, but it does not tell us what to do next.
Related reading:
Could the world go back to the gold standard? Martin Wolf, FT
Latest news on the G20 – FT
