First of all I want to apologize to some readers because my thoughts this morning are about gold. Again! I’ve written about it many times recently and it may seem that I’m an obsessive about gold. As a subject, it is far less interesting to me than, say, history, or the modern life sciences, or even quantum physics (in so far as anybody knows what this really means!). But, it seems to me, that gold, although apparently a minor player in the modern money market, contains the key to today’s extreme apprehensions about our economic systems in the West, both now and in the years immediately ahead.
Within my ‘non-obsessive’ interest in gold, however, there is one phenomenon which pretty well does amount to an obsession. What is going to happen to the price of gold? From a price of about $250 an ounce 11 years ago, it has been steadily accelerating ever since. Initially, the price started growing at an annual rate from 2% to 5% and then accelerating year by year, During 2010 the price had grown by over 30%. So far this year the price has risen to well over 40% on an annual basis and, if present trends continue, it is likely to be growing at a rate well over 50% p.a. by the year-end.
If the price rise is plotted on a graph, then the slope, starting out at little more than horizontal at around the year 1999, has become steeper and steeper. It’s what mathematicians call an exponential (or geometric) curve. If you extrapolate this slope into the future then the price rise starts to shoot up so quickly that gold would have an infinite price per ounce! This would occur sometime during mid-2012. Clearly, when all the money in the world wouldn’t be able to buy a single ounce, this becomes an impossible situation. Something must happen to the rising price of gold between now and the summer of 2012.
There are only two alternatives. Between now and mid-2012 the price of gold will crash, or it will start to decelerate. In the latter case, the price rise will slow down and then stabilize at a new constant high level. In theory, the new stabilized price could then crash but it wouldn’t, as will be explained a little later.
But what about a crash between now and mid-2012? Those who pour scorn on gold — most Western bankers, politicians and economists — point to a previous rise and crash in the 1980s which they ascribe to fits of panic. They scarcely ever mention the reasons for these fits. As this took place longer than a normal career-lifetime ago then most politicians and bankers have no idea of the reason. All they’re aware of is that there was a spike and a crash in the past which journalists and financial advisors never tire of repeating.
Most economists know better. The reason for the spike was that the American dollar was inflating so rapidly that investors of all sorts (rich individuals, investments funds, pensions funds, endowments, hedge funds) feared the worst and started turning away from investing in American bonds and shares. They began to buy gold for defensive reasons in order to protect their money with an asset that wasn’t inflating but, rather, increasing in value. From trough to peak, the price of gold rose from $100 an ounce to over $800.
What happened then is that a very brave American central banker, Paul Volcker, raised the Fed’s basic interest rate to over 20%. The price rise of gold immediately stopped and fell somewhat. When it became obvious that the high interest rate was going to be reduced only slowly until the dollar was stabilized again, and over a long period if necessary, the big funds started to sell their gold and began to buy American bonds and shares again. From then on, the price of gold declined until it reached $250 an ounce by about 1999 — which is when the modern story starts.
Today, with an American interest rate at 0.5%, which cannot be raised by even as little as another 0.5% without causing an economic depression, there is no possibility of preventing the price of gold continuing to rise This applies whether we are talking of between now and mid-2012, or at a future post-2012 stabilized price level. The best that Bernard Bernanke can do is to raise interest rates to a normal level of about 3% to 4% in several years’ time when a normal economy and full employment resume — if they ever do within his term of office.
The reason for gold’s price rise since 1999 is that the European central banks had stopped selling gold. They had been under pressure from America to sell their gold ever since the end of World War II. America had forced this policy on Europe this in order to maintain the dollar in its primary position of world trade. Gold had to be eliminated as a competitive trading currency. But at last, in 1999, the worms finally turned, resisted America and some began buying again. Furthermore, other central banks in emergent countries around the world, worried about the badly inflating American dollars in their foreign exchange accounts, also started buying gold.
The purchase of gold by central banks, as with many of their operations, is not usually done publicly, but quietly. But from both hard news and from rumours, and at first in ones and twos, it is now eralized that non-European central banks have started to buy gold again since 1999. There are probably at least a score, perhaps two score, banks doing so now. Mexico was the latest country to admit buying significant quantities of gold. The very latest country in the news, Venezuela, has not only nationalized its own gold mines but is recalling all its gold which had been temporarily stored at various central banks around the world, including the Bank of England. Two of the largest gold producers in the world, China and Russia, are also buying gold.
Just as, say, the exhaust from a motor bike engine could gradually accelerate a spaceship to close to the speed of light, so have the steady purchases of gold by central banks been accelerating the price of gold in the past 11 years. This is not panic buying but a deliberate move towards the day when the American dollar will no longer be able to sustain any sort of stable price. As already described, this will lead to an ‘impossible’ situation of the gold price approaching infinity by about mid-2012, if we are to believe the evidence of the last 11 years or so. But there is also an other ‘impossible’ — or at least hitherto inconceivable — situation occurring in 2012. This is when the total trading area of the emergent economies will overtake that of present-day America, Western Europe and Japan.
It is therefore highly likely that, between now and mid-2012, there will come a point when the emerging world will decide it will be better to rely on the dollar no longer but to institute a new trading currency of its own based on the value of gold. At one particular price of gold, even as it continues to rise, there will be a point when, jointly, it suddenly makes sense. The emergent world market will decide that it can make it on its own if necessary. Of course, this will not be a declaration of war. Trade with America, Western Europe and Japan will still be highly desirable even if, as now, they are no longer growth economies.
China, Russia, some Middle East oil countries, Brazil, India and several more emergent countries have been calling for a dependable world trading currency for several years now. America has turned down such discussions repeatedly. Western Europe responded by trying to create a trading currency of its own, the euro, in 1999. Both the dollar and the euro, printed in such vast amounts such that governmental debts will never be repayable, are already in deep trouble. The Federal American dollar, not yet of 100 years’ vintage, and the euro of slightly more than 10 years’ vintage, will once again give way to a currency which has had a currency vintage of about 2,500 years and high value for at least a couple of thousand years before that. The central bankers of the emergent world are no mugs. They are as aware as anybody of the history of gold and trade. The only difference between them and the central bankers of America, Europe and Japan is that the former are no longer in denial about it. This acknowledgement to history is, in my opinion, likely to occur between now and mid-2012.