By Patrick Heller
For 6,000 years, long before the first coins were created, gold has been used as a safe haven medium of exchange. Physical gold (and silver) have never failed in preserving wealth. This is in sharp contrast to fiat (paper) currencies that are not redeemable in gold or silver. Fiat currencies have a mean average lifespan of 40 years and a median age of 25 years before they collapse.
It is this stability of value that has served gold as a safe haven asset of last resort over the centuries. While real estate assets are also relatively durable, they are not portable and transportable. In fact, in times of economic crisis, real estate has a horrible history of not being liquid. That is why gold and silver have been so popular as safe-haven assets in troubled times.
When you look at all the tremendous political and economic turmoil in the world today, why haven’t the prices of gold and silver soared? Why isn’t demand for physical precious metals many times what it is now?
The basic question comes down to why is the price of gold now in the low $1,700s, which it reached over two months ago, instead of soaring above $3,000?
To find the answer, first look for who benefits from preventing a soaring gold price and also has the financial clout to achieve that result. In my judgment, there is one ultimate beneficiary from lackluster gold and silver prices that has such monetary capability—the US government. The government of China also is a beneficiary and has the clout to hold down prices, but that is nowhere near as important to that government as it is to the US.
How does the US government benefit from a lower gold price? The main reason is that the price of gold effectively serves as a report card on the US dollar. A rising price indicates an unstable dollar, meaning the US government would have to pay a higher interest rate to finance its deficit spending. Further, an unstable dollar would encourage the foreign holders of US currency and US Treasury debt to repatriate such assets to the US government in return for goods and services, and ownership in US real estate and shares of US companies. As of last I saw, foreigners held about $12 trillion of US currency and Treasury debt, representing a no-cost or low-cost way to borrow money.
A rising US dollar price of gold could discourage the use of dollars in international commerce (about 60 percent of global central bank reserves are held in US dollars or US Treasury debt and many if not most of the international transactions are still denominated in US dollars). Not only would the US government have to pay a far higher interest rate on its debt than it does now, but the repatriation of dollars and Treasury debt would also result in soaring increases in the US government budget deficits.
In contrast, China’s central bank has been aggressively adding gold reserves since 2003. It benefits by being able to acquire more gold at lower rather than higher prices. Also, as China’s central bank is the second-largest holder of US Treasury debt, it also has an incentive for the value of the US dollar to appear strong. Thus, holding down the price of gold helps the Chinese government in the long term, but it is not anywhere near the benefit that the US government receives by suppressing the gold prices.
For over 150 years, US dollars were convertible on demand for gold. This relationship led to a stable dollar. This stability encouraged the extension of credit to help build the US economy into the world’s largest. The convertibility of US dollars into gold also encouraged foreigners to hold dollars or dollar-denominated debt.
In July 1944, the Bretton Woods meeting resulted in the creation of the International Monetary Fund (IMF) with the US dollar pegged as the anchor of the world financial system. The dollar remained stable under a gold-exchange system where foreign governments and central banks could present US currency to the US Treasury and receive physical gold at the rate of $35.00 per troy ounce.
When the US government started running an almost continuous series of annual budget deficits in the 1960s (especially if calculated on the more accurate accrual basis of accounting), that discouraged foreign trust in holding US dollars. With pressure for the price of gold as measured in US dollars to rise, the US Federal Reserve Bank and the Bank of England led the establishment of an 8-government cartel called the London Gold Pool in November 1961.
The London Gold Pool managed to maintain the price of gold at US $35.00 per troy ounce for most of the 1960s. It eventually collapsed, which eventually led to the US government suspending gold-exchange operations in August 1971. (For further discussion of the London Gold Pool, see my column posted here.
In 1974, the New York COMEX began trading future gold commodity contracts. One of the explicit purposes of doing so was to enable the US government to hold down the price of gold. Early on this worked well. The price of gold fell from about $185 per ounce in early 1975 almost down to $100 by September 1976. The price of gold did not top $200 until August 1978. Then, in January 1980 it soared to over $800.
This time around, the price of gold closed on the COMEX at about $1,270 on May 2, 2019. Just over 11 months later, on April 14, 2020, it closed at about $1,757, a 38 percent increase. While that is a significant price increase in a relatively short period, the extraordinary financial turmoil of the past few months “should have” propelled gold’s price much higher.
Why hasn’t this happened?
- The Gold Reserve Act enacted on Jan. 31, 1934 created the Exchange Stabilization Fund (ESF) as part of the US Treasury. It was founded in April 1934 with $2 billion of the $2.8 billion paper profit the US government realized from raising the price of gold from $20.67 to $35.00 per troy ounce. The ESF can and does deal in gold, currencies, and government securities to help stabilize the value of the US dollar. Over the past three months, funds from the ESF were provided to establish multiple “special interest credit facilities” to enable the Federal Reserve Bank to prop up values across a wide spectrum of paper assets (primary and secondary corporate bonds, exchange-traded funds, municipal bonds, commercial paper, and the like). In holding up the value of these paper assets, investors are less tempted to abandon such investments to replace them with gold.
- The federal government’s wide range of bailout and subsidy programs also halted plummeting stock market prices and sparked a rebound. Again, this dissuaded many investors from cashing out their paper assets to replace them with gold.
- For its part, the COMEX has supported the effort to hold down gold prices by twice this year increasing margin requirements for leveraged gold contracts on its exchange.
- The prices of many industrial metals fell sharply as stock prices were dropping, caused by an expectation of lower demand for raw materials. Although this did not directly impact demand for gold, it did cast a psychological negative on the metal.
- Many of the tens of millions of people who lost their jobs, saw reduced compensation or were worried about either fate have been conserving their cash to be available for purchasing life’s necessities or paying existing obligations. Sales of discretionary goods such as jewelry, apparel, electronic equipment—and gold—have plummeted.
- As people were forced over the past few months to liquidate investments because of margin calls or the need to raise funds, the one asset that had risen in price was gold. As such, it was an attractive asset to liquidate to offset losses from selling other assets.
- Lockdowns of retail businesses sharply reduced demand for gold. India is the world’s second-largest gold consuming nation, much of it in the form of jewelry. Stores in the nation recently reopened. However, the reports I am getting from jewelry stores in that country is that customers have mostly not yet returned to them.
- The relative lack of available physical precious metals to purchase over the past few months has also discouraged retail customers.
These are not all the reasons why the price of gold has not continued to rise since mid-April.
As governments around the world go to more extreme measures of inflation of their money supply, the price of gold has much higher to soar from current levels. That it has not yet done so, even with all the uncertainty in today’s world, is in my mind only a temporary situation.
Patrick A. Heller was honored as a 2019 FUN Numismatic Ambassador. He is also the recipient of the American Numismatic Association 2018 Glenn Smedley Memorial Service Award, 2017 Exemplary Service Award 2012 Harry Forman National Dealer of the Year Award, and 2008 Presidential Award winner. Over the years, he has also been honored by the Numismatic Literary Guild (including twice in 2019), Professional Numismatists Guild, Industry Council for Tangible Assets, and the Michigan State Numismatic Society. He is the communications officer of Liberty Coin Service in Lansing, Michigan and writes Liberty’s Outlook, a monthly newsletter on rare coins and precious metals subjects. Past newsletter issues can be viewed at http://www.libertycoinservice.com. Some of his radio commentaries titled “Things You ‘Know’ That Just Aren’t So, And Important News You Need To Know” can be heard at 8:45 AM Wednesday and Friday mornings on 1320-AM WILS in Lansing (which streams live and becomes part of the audio and text archives posted at http://www.1320wils.com).