Predicting high inflation because of an expanding monetary base particularly within the US, ultra-conservative economists believe that countries around the world should accumulate gold in lieu of the greenbacks to protect themselves against the vagaries of the US Federal Reserve.
They seem to have a point. Emerging economies will receive a death blow if another recession in the future forces the US to default on its dollar-denominated debt obligations. While their argument appears to be valid, evidence from the real world suggests otherwise. If gold was a better reserve asset than the dollar, emerging economies like China and India would have abandoned the dollar in the aftermath of the global recession of 2008. Instead, data show that these economies have accumulated huge quantities of dollar-denominated securities to build up their international reserves following the 2008 crisis.
The total quantity of gold held by central banks worldwide in 2012 was lower by about 2,000 metric tonnes than in 2000. In fact, gold constituted less than two per cent of China’s total international reserves in 2013.
Similarly, the precious metal constitutes roughly three per cent of the international reserves held by all emerging economies combined. In Pakistan’s case, only 11 per cent of the State Bank’s assets consist of gold coins and bullion.
And the reason is simple: gold simply cannot catch up with the rising demand for non-gold reserve assets worldwide. While gold is being mined at 1.5 per cent per annum, the demand for non-gold reserve assets — mainly the US dollar — has been growing at 16 per cent every year. According to economist Eswar Prasad, gold does not have the liquidity of reserve currencies like the dollar. It will be insufficient even if all the gold that has ever been mined — 165,000 metric tonnes, to be precise — is turned into reserve assets overnight.
Meanwhile, the 2008 crisis seems to have strengthened the role of the dollar as the global reserve currency. Proof: instead of taking their capital out of the US, foreign investors actually financed as much as three-fifths of the $5.5 trillion increase in US public debt between 2007 and 2012.
Published in The Express Tribune, October 27th, 2014.
COMMENTS (3)
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The metals are being manipulated right now . If you look back at the historical gains of them they have done pretty well .Its only a matter of time before there is a crash again . The problem with farmland is that all the towns and cities are broke and the investment is at the mercy of rising property taxes . Id prefer income producing units .There is nothing more Russia and China would like more than to be able to trade out of the petro dollar . The current debt and spending will be forced to stop at some point and when it does things are going to get real ugly fast . The proof is what would happen if the USD wasn't the world reserve and the fed couldn't print cash out of thin air ?
A very valid debate especially with respect to Pakistan. No one can say with certainty what will happen with respect to gold prices, but do keep it in mind that Wall street has been exposed. Markets across the world are being manipulated by corrupt politicians, businessmen, bankers and central banks. Gold and currencies are no exception. Whilst it is prudent to diversify, gold unfortunately is a strange commodity. Man digs it out, refine it, moulds it, sells it and puts it back in the ground again. It doesnt earn like other financial assets. My 2 cents, dont invest more than 5% of your savings. Instead get a piece of farmland. I'll take a tract of land any day over gold.
I do however disagree with your opinion about China's gold reserve holding. Dont let the numbers fool you. The Chinese are as much in a fix as the Americans. If they try to sell their dollar denominated assets, they drive the price down and take a revaluation hit on their remaining assets. Hence why you will never see them diversifying at a large scale, they are stuck along with the west.
Who are Pakistan’s "fiscal conservatives" ?
Emerging economies like China, Malaysia, Indonesia will get death blow if US stops imports from them, that is why it is in their interest to invest their surplus into US treasury bills; its a way of financing US trade deficit. Earning debt on treasury bills would be less important for their economies.
"gold simply cannot catch up with the rising demand for non-gold reserve assets worldwide". Do you want to say that Gold cannot catch up with the rising demand by central banks to expand their monetary base? or the non-gold reserve assets are more popular among central bankers?
"2008 crisis seems to have strengthened the role of the dollar as the global reserve currency". You haven't given enough proof or source of this believe.