Three Signs Gold is Returning to the Monetary System

The author of this article explains the signs that point to gold returning to the monetary system. These signs include continued purchases of the metal by central banks all over the world, the continued crisis in the euro zone and the announcement of the Basel Committee considering making gold a "Tier 1" asset.

By Simit Patel
21 June 2012 15:51 GMT
Daily FX

The purpose of this post is to illustrate the signs that gold is returning to the monetary system. In other words, gold is in the process of being formally acknowledge as money by nation-states. The implications of this are significant; they are immensely bullish for gold, and for any currency that chooses to embrace this trend and align itself with gold.

Specifically, there are three signs investors/traders should pay attention to that support the notion that gold is returning to the monetary system:

1. Central Banks Have Become a New Class of Gold Buyers. The Wall Streeet Journal reports that central banks have "increased their gold hoards by 400 metric tons -- each equal to almost 2,205 pounds -- in the 12 months through March 31, up from 156 tons during the prior year.” Why would central banks -- the institutions that print money and manage the money supply -- be so interested in accumulating gold? Perhaps they fear the current international monetary agreement will need to be revised, as the US dollar and all other prospective reserve currencies show no signs of resisting the temptation to debase the value of money via inflation of the money supply. Central banks accumulating gold also gives these banks the option of increasingly converting gold into a form of money -- of backing the debt they issue with gold. This becomes especially intriguing when we consider the next piece of evidence suggesting gold is returning to the monetary system, which is......

2. Eurobonds and the European Redemption Pact. The idea that the solution to the debt crisis in the European Union is greater fiscal unity is growing in popularity, for better or worse. Witness the EuropeanRedemptionPact, which proposes that the excess debt of the EU's member nations -- an amount determined to be any debt greater than 60% of the respective country's GDP -- should be aggregated into a Eurobond, to be managed by Europe. Moreover, the country rolling its debt off into Eurobonds would be required to put up 20% collateral of the amount it is writing off to Eurobonds, and this 20% could be payable in gold. We now have a situation where member countries of the EU have an incentive to see a higher gold price -- as the higher the price of gold, the less gold they will need to put up as collateral. While this plan has been criticized as little more than a scam to consolidate gold and power, a criticism for which I have some sympathy, the fact remains that there is no major faction that supports any country exiting the EU: the governments of Germany, Spain, Greece and others have all expressed a desire to stay in the EU, as has even more rebellious and radical political factions like the Syriza party in Greece. If all insist upon staying in the EU, I don't see any solution aside from progressing towards greater monetary and fiscal unity with the European Central Bank printing money, issuing Eurobonds, and bailing out everyone. This amount of money printing can only be sustained if there is gold behind it; that is the only way, in my opinion, that the market as a whole will place their confidence in the Euro. In fact, if one considers that yieldsarerisingthroughout the European Union, a case can be made that the market is already losing faith in the Euro. But if we see the emergence of gold-backed Eurobonds, the Euro could go from being a despised currency to the new premiere safe haven.

3. Basel Committee Considers Re-Evaluating Gold. An underreported development in the monetary world is the announcement from the Basel Committee for Bank Supervision (BCBS) -- a division of the Bank of International Settlements whose role is to define capital requirements for banks engaged in international transactions -- that they are considering making gold a "Tier 1" asset. In other words, banks that have gold on their balance sheet will have a higher regulatory score in the BCBS' international framework. If BCBS decides to move ahead with this proposal, commercial banks, like central banks, will have strong incentive to own gold to ensure they are in compliance with the highest regulatory standards. Such a decision would basically create a regulatory environment in which gold plays a role as a tool to enforce monetary integrity. This is very similar in concept to a gold standard.

The trends that suggest gold is returning to the monetary system are worth watching for all currency traders -- even those who do not trade gold, as well as those who do not rely on fundamental analysis. If gold returns to the monetary system, it will likely come with one or more new international monetary agreements, which in turn has the potential to impact trading conditions -- i.e. allowable leverage and contract size -- as well as which currencies become perceived as safe havens. The more a nation-state chooses to align its monetary policy with gold, the more it will be a safe haven that can attract long-term, committed capital. In doing so, the currency will increase its value as a stable source of value, and will increase the purchasing power of its holders. This increased purchasing power can lead to an increase in capital available for investing and for consumption, which in turn can help the global economy heal and exit the depression it is currently mired in.

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