Gold – The Narrative in The Current Long-Term Debt Cycle
Is gold another fiat currency? Gold listed on the financial markets, through derivatives or ETFs, I can see the argument. Driven by its interaction with other currencies, the price action of the US dollar contributed to gold prices falling in 2022. But looking at other currencies that haven’t performed as strongly as the US dollar, gold is up. Will we see a different story in 2023? Does the difference between paper gold and physical gold come into the discussion as its use as an inflation hedge?
In a central bank digital currency system, physical gold, and silver, could be one of the only safeties. But this choice of security could also be removed with ease.
In 1934, gold was banned. That’s right, the US government banned it. Through Executive Order 6102, in 1933 Franklin D. Roosevelt (FDR) made it illegal to “hoard gold coin, gold bullion, and gold certificates” within the US.
This hindrance to owning physical gold was reversed under President Gerald Ford at the end of 1974. 40 years later!
The reason for the rule was that private hoarding of gold had risen during The Great Depression. This was stalling economic growth and also the dollar was backed by a gold standard.
Types of Money
1) A Hard Currency System
2) Paper Claims on A Hard Currency System
3) A Fiat System
This all ties into the long-term debt cycle. Money starts as a hard-backed system. A system that contains very little debt. This can be due to debt restructuring or a reduction of debt burdens from the end of the last long-term debt cycle.
Note: The end of the long-term debt cycle always usually lines up with a period of geopolitical instability. Think World War Two. The reason the US emerged as a global power is that they were in the best position to build a brand-new financial system from the winning side. They had less rebuilding to do after the conflict. Their debt-to-GDP rose during war times, as it usually always does as wars need financing.
Then there are claims on this hard-backed system, through notes or paper money. These claims form a credit and debt system, from which borrowers and lenders can benefit, so this stage is inevitable. The number of these claims on hard money increases and so debt levels increase. We all know that rising debt leads to currency devaluations, crises, and sometimes even defaults. Whether devaluations or default occurs is based on who has a currency that can be printed.
The US dollar can be printed, and so has seen devaluations.
This is the current fiat system we see now. There can be fixed pegs, in which a currency is fixed to another currency or a basket of currencies. It is supposed to maintain a degree of stability between the two countries. Think of the Hong Kong Dollar peg to the US dollar. The central bank maintains the exchange rate through its foreign exchange reserves. If a fixed peg is too high, it leads to overconsumption of imports and can cause inflation when the peg collapses. A low fixed peg keeps living standards low and creates trade tension with other countries.
The alternative is a floating exchange rate which works based on supply and demand. Here, central banks can print money, and buy and sell government debt through the bond market. This will influence the money supply and demand dynamics.
The cycle ends with debt becoming too big. Then a restructuring or default can occur, and the system returns to a hard-backed currency system. The BRICS currency is rumoured to be backed by a basket of commodities, of which Russia and China are a part. They are two of the biggest commodities players in global trade. This would see a return to a hard currency-backed system.
Note: Deflation in the 1930s is what caused the purchasing power of the dollar to increase, as prices drop during a deflationary environment. To review the supply and demand dynamics of a fiat currency such as the US dollar, the M2 money supply indicator can tell a lot of stories. Currently retreating due to quantitative easing involves selling bonds to reduce the money supply.
Who Buys and Holds The Most Gold?
We live in a period where debt has funded artificial growth through low-interest rates and money printing since 2008. COVID exacerbated this. This is a typical sign of the end of a long-term debt cycle. So, who is buying gold?
Russia, Turkey, India, and China are among the top countries. They haven’t had large amounts of reserves in the past. But they are trying to get there. The strength of the dollar as the global reserve currency also ties into this, and geopolitics can help explain the situation. The confiscation of Russia's foreign exchange reserves held in dollars scared many nations. The US could do it again. Having a large number of gold reserves could protect from this. The BRICS nations have realised this and so the process to buy gold is speeding up.
Even though the largest buyers are the BRICS and related nations, who actually holds the most Gold?
The US is leaps and bounds above any other nation in holding gold reserves. The US is positioned to return to a hard currency system if required. Unless it sells its reserves to other nations, which it currently isn’t. In fact, the US gold reserves haven’t changed since 2008. For other nations, Russia has more than quadrupled its holdings, and China has more than tripled its holdings.
So, the US, and many other western countries hold large gold reserves, but the amount isn’t changing. The BRICS nations are buying gold. The key periods of change in attitude towards gold reserves held were 2008, and 2020. The Great Financial Crisis and COVID. Both had drastic implications for the financial system. 2008 saw quantitative easing begin, which can cause inflation. 2020 saw quantitative easing shift into turbo, which can REALLY cause inflation. Physical gold is seen as a store of value against fiat currencies whose value gets eaten by inflation.
The multipolar world would see BRICS on one side, and a NATO, US-led western order. The BRICS nations are buying commodities at a rapid rate. This could signal a potential return to a hard-backed currency system. Or protection against the current fiat system so they have the choice to change the system if it arises.
This strikes me as a different attitude towards gold. A completely opposite attitude. If one side is hoarding it, could the west already deem themselves prepared? If not, could we see a ban on individually owned gold to boost a country’s gold reserves? Private ownership bans on physical gold have been used before during an economic downturn. This was in a period of the hard currency system, but could it be used in a fiat system? Knowing that debt levels are high and a return to a hard-backed currency system could be inevitable?
Where and How We Can Buy Gold?
If you want to trade short-term, ETFs and derivatives are your best bet. Shipping around physical gold if you only want to take advantage of a short-term move is not a suitable strategy. By the time you receive and sell your gold again, the price can be in a completely different place. Also, physical gold contains a premium. A premium is an extra cost above the market value. If you will resell in a small period of time, it is not worth paying the premium. Research the structure of ETFs. Some can track the physical price of gold. Some can contain a collection of gold miners. There are many options for gold ETFs, all with different fees. Research the structure of them and make sure you choose one suitable for how you want exposure to gold.
For long-term investing, physical gold can act as protection against inflation. It can also act as protection against fiat currency systems in general. If you’re worried about control of your money in a potential central bank digital currency system, physical gold can be great protection. But be aware. Study history to learn how bans on gold work. How paper claims on hard monetary systems work. How devaluations or defaults work in transitioning between the different currency systems. And gold’s role in each of these systems.
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