Gold, the great recession and global prosperity

Wilberne Persaud, Financial Gleaner Columnist

On December 6 last year, Charlie Rose hosted a programme, 'All about gold'.

His guests included John Hathaway of Tocqueville Asset Management, Peter Munk, chairman and founder of Barrick Gold, and James Grant, editor of Grant's Interest Rate Observer.

Munk is in gold mining - he runs the Toronto-based largest gold-producing operation worldwide. Hathaway concerns himself with managing a gold fund for Tocqueville. Grant produces economic and investment analysis people trust.

Their discussion was, in reality, about money. Who manages its creation? What global implications are derived from the United States (US) Federal Reserve's quantitative easing? Will China and other holders of trillions of US-government debt join the stampede to gold? Is this response at all feasible? The basic question: why is the price of gold rising? The answer is at the same time simple and, not astonishingly, complex.

The average price of gold at US$1,225 per ounce in 2010 was 23.4 per cent higher than in 2009. Gold has always been thought of as money. Perhaps more realistically, people, for long periods of history, identified money with gold.

Days of the gold standard

During the industrially prosperous days of the gold standard, countries actually shipped gold across borders to settle imbalances in their payments for investments and trade. Currency in circulation - money supply - then adjusted up or down to the base of the actual gold reserve held by, say, Britain, France and the US.

After the devastation wrought by war, monetary gold flowed to the US from Britain, Germany and France. The fledgling US Fed, however, broke the rigid link between reserve gold and money supply, even as Keynes embarked upon his crusade to achieve the identical outcome. In his A Tract on Monetary Reform, he famously noted: "In truth, the gold standard is already a barbarous relic."

Later on in the same work, he tells his readers: "Dr Freud relates that there are particular reasons deep in our subconsciousness why gold in particular should satisfy strong instincts and serve as a symbol."

Keynes thought it ridiculous to base such an important element of economic and social life on the vagaries of gold production in the mines of South Africa, or elsewhere.

In the discussion, Peter Munk pointed out that, "We keep theorising about gold. In the meantime, the price of soya beans, the price of corn, the price of copper, the price of tin, the price of rubber, the price of oil has ten folded, gone up faster than gold. And nobody is worried about somebody conjuring up fake rubber."

The problem is people worry about conjuring up fake money. That is the fear of US Fed's Ben Bernanke proposing to unleash US$600 billion of money creation to assist in floating the economy, hoping to curtail the great recession. The idea is to 'trash the dollar'! Increasing US deficits promote fear.

Yet even with rising commodity prices, Americans don't feel the impact as inflation upon leaving the cash register at Walmart. This is where the Chinese come in. They keep churning out product while holding their currency value steady.

Here is the rub: is fear of China by the US going to lead to trade and currency war? This is an entirely real possibility if monetary cooperation fails. It is in China's interest neither to dump dollars nor revalue its currency. Imagine the speculative windfalls those gobbling up US dollars from the Fed at zero interest rate dream of on frosty nights.

Keynes, in 1936, had the measure of this problem. The "importance of money", he said, "flows from its being a link between the present and the future. Money in its significant attributes is, above all, a subtle device for linking the present to the future; and we cannot even begin to discuss the effect of changing expectations on current activities, except in monetary terms."

Rushing to gold is undoubtedly a result of fear. Wall Street's aggressive and amoral greed for profits and bonuses produced the sub-prime housing bubble, creating money - plenty of it.

Unaffordable real estate became the piggy bank from which Americans withdrew fictional equity to fuel negative savings and unconstrained consumption, without which China's unprecedented growth would be unthinkable.

That bubble burst in September 2008. To organise a fix by trashing the dollar has wealth holders worried about the future. To investors, devaluation is a not-too-subtle form of expropriation - in their view, it cheats them and creditors as well, out of the true value of their savings. So yes, we appear to be on the horns of recession dilemma. Yet, we've been here before. Monetary cooperation is the only true cure. Can it be sculpted, particularly in the current US political environment?

wilbe65@yahoo.com