Monday, February 4, 2008

Gold Rising: Forbes

The Allure Of Gold Is Rising

Once consigned to monetary oblivion, gold is re-emerging as an asset class. Restoration of its monetary use, though still a distant possibility, has moved a step closer to reality.

Gold for immediate delivery in London reached $929 per ounce in Asian trading on Jan. 29, an all-time nominal high. A main impetus to gold's current price ascendance is inflation fears: Gold is seen as a hedge against loss of currency purchasing power. Demand for the metal is also strong in Asia, for jewelery and as a store of value.

Despite gold's recent climb, it remains off its 1980 peak in real terms. In today's dollars, gold hit $1,766 in January 1980.

Understanding gold's monetary context is key: At that time, memories of gold's use in the international monetary system were fresh, and gold's place anchoring the system seemed natural. As economic and geopolitical difficulties beset the system, gold appeared a safer store of value.

Since then, no similar instability has driven gold prices as high. Shortly after 1980, expectations of an eventual restoration of a monetary role for gold were resolutely dashed:

--U.S. Congressional commission. Congress on Oct. 7, 1980, established the U.S. Gold Commission, whose aim was to make policy recommendations "concerning the role of gold in domestic and international monetary systems." Yet the commission's March 1982 report did not recommend restoring a monetary role for gold.

--Academic report. In the 1982 Brookings Papers on Economic Activity (Volume 1), economist Richard Cooper published a lengthy history of the gold standard and its future prospects. Cooper concluded that "both history and logic" refute the contention that stabilizing the gold price in dollar terms would stabilize the price level.

As these sentiments became policy orthodoxy, central banks rushed to offload gold holdings, putting further downward pressure on the metal.
Perceptions of transition in the international monetary system are now heightening gold's allure. Uncertainty over current world system longevity has three foundations:

1. Credit crunch. The current credit market crisis has led to a striking loosening of U.S. monetary policy, pushing yet more dollars onto an already over-supplied foreign-exchange market. Additionally, it has highlighted troubling aspects of recent innovations in the international financial system, particularly increasing systemic risk due to poorly understood synthetic securities and credit underwriting.

2. Bulging reserves. The current system undeniably is characterized partly by pegs to the center currency--the dollar. As in the 1971 death throes of the Bretton Woods system, dollar abundance is testing these pegs. Under Bretton Woods, commitments to peg demanded heroic reserve accumulation by U.S. trade partners. Inability to contain associated inflationary pressures led to the demise of pegs--and the system.

3. Center solvency. Typical concerns over the U.S. external position focus on U.S. national savings, or lack thereof. In fact, there are valid reasons for supposing that U.S. savings, and hence the strength of U.S. external accounts, are undercounted. A more pressing concern is solvency: Without reform, U.S. fiscal accounts might not be solvent on a long-term basis.

Gold's role as value store in uncertain times underpins its current high price. The shakier the international system appears, the greater the strength of gold. However, to recapture its 1980 peak, gold needs to be seen as standing a greater chance of reclaiming its historic role as a monetary asset. Yet:

--The business cycle is an unremarkable phenomenon; the greater likelihood is that the credit crunch will prove transitory, as will associated monetary easing and financial innovation worries.

--Compared to the 1970-73 cycle, today's reserve accumulation has been unspectacular. German and Japanese reserves rose nearly six-fold then, compared to less than a tripling of Chinese reserves in the 36 months to October 2007.

--More pressing is U.S. solvency: While the international monetary system cannot be based on the currency of an insolvent state, this issue has yet to permeate bond market expectations.

No comments: