(This item originally appeared at Forbes.com on May 5, 2016.)
On April 19, the Shanghai Gold Fix officially began. The pricing mechanism is intended to be a replacement for the London Gold Fix, the primary price-discovery mechanism for gold bullion today. The London “bullion” market is not a market in bullion. Rather, it is a market in “unallocated” gold, defined as an unsecured liability of banks.
In short, it looks suspiciously like an exercise in paper-hanging. The London Bullion Market Association claimed 21.95 million ounces of “net” clearing per day on average in 2013, worth about $27 billion. Estimates of “gross” trading are considerably higher than this. Supposedly, one might be able to call in these unsecured liabilities of banks, and receive real bullion. However, when people actually try this, banks have a pattern of shunting clients into cash settlement.
The Shanghai Exchange appears to be a real market in bullion, with immediate physical delivery on every contract. Curiously, the opening of the Shanghai gold fix coincided with a dramatic admission by Deutschebank that it had been rigging the London gold and silver markets, accompanied by promises that it would help authorities identify other market manipulators.
Many have considered the phony “paper gold” markets, including the U.S. Comex futures market and also, potentially, gold ETFs, to be a significant impediment to using gold as a standard of currency value. Is China laying the framework for a new world gold standard system? One Chinese analyst called it “the culmination of a two-year plan to move away from a U.S.-centric monetary system.”
China’s longer-term intentions were perhaps made more apparent by an essay by Dr. Zhou Xiaochuan, governor of China’s central bank, in March 2009.
The outbreak of the current crisis and its spillover in the world have confronted us with a long-existing but still unanswered question, i.e., what kind of international reserve currency do we need to secure global financial stability and facilitate world economic growth, which was one of the purposes for establishing the IMF? There were various institutional arrangements in an attempt to find a solution, including the Silver Standard, the Gold Standard, the Gold Exchange Standard and the Bretton Woods system. The above question, however, as the ongoing financial crisis demonstrates, is far from being solved, and has become even more severe due to the inherent weaknesses of the current international monetary system.
Theoretically, an international reserve currency should first be anchored to a stable benchmark and issued according to a clear set of rules, therefore to ensure orderly supply; second, its supply should be flexible enough to allow timely adjustment according to the changing demand; third, such adjustments should be disconnected from economic conditions and sovereign interests of any single country. The acceptance of credit-based national currencies as major international reserve currencies, as is the case in the current system, is a rare special case in history. The crisis again calls for creative reform of the existing international monetary system towards an international reserve currency with a stable value, rule-based issuance and manageable supply, so as to achieve the objective of safeguarding global economic and financial stability.
I think that is pretty clear.
The idea of floating fiat currencies, and an active “monetary policy” to manage domestic economies, is very popular in the Anglophone world. The U.S. dollar, and British pound, are linked to nothing. But, much of the rest of the world has already abandoned a “soft-money” approach. Fifty-five countries use the euro as their standard of value, either the currency itself or as the reserve currency of a currency board system. Although the euro is a floating fiat currency not much different than the dollar or pound, every euro-using government has voluntarily abandoned any “domestic monetary policy” and has instead adopted an external benchmark of value. A gold standard system is not much different than a euro-standard system, except for the choice of the standard of value.
China has always used dollars as a basis of monetary value – all the way back to the 17th century, when China imported Spanish silver dollars in great quantity. Today, the yuan’s value is still based on the U.S. dollar, although in recent years, bending to U.S. political pressures, it has become something of a crawling peg instead of a fixed one.
Outside the Anglophone world, governments and leaders have long pined for the return of the world gold standard. In 2004, Malaysia’s president Mahathir Mohamad began a program to establish a pan-Islamic international gold standard currency. In 2009, at the Arab League Summit in Doha, Muammar Gaddafi of Libya called on African and Muslim nations to create an international gold-based currency, to be used in trade for oil. At a G8 currency meeting in 2009, Russia president Dmitry Medvedev held up a half-ounce gold coin and called it “an example of a future world currency.”
The long history of floating fiat currencies ends in their eventual self-destruction. I am not going to say that will happen right away, but I note that “helicopter money” is becoming a serious topic of conversation, and that legendary macro investor Stanley Druckenmiller is becoming a major owner of gold. If the dollar-centric era is coming to an end, we now know what will replace it.