In the gold space, it’s often assumed that Western central banks are still against gold, but this has changed…
I was interviewed by Polish financial journalist Piotr Rosik this week. Because I found his questions interesting, I would like to share this publication with my regular audience too. Piotr asked me what was causing the spread between the gold futures price in New York and the London spot price, the high gold-silver ratio, if there can be a shortage of gold, and more.
In one of my answers, I told him that I think central banks actually desire a higher gold price. In the gold space, it’s often assumed that Western central banks are still against gold, but this has changed in recent years. As an example, many Western central banks have changed the way they communicate about gold fundamentally; from downplaying gold’s role in finance, to praising it for its quality as the ultimate store of value. The narrative of central banks trying to discourage you from buying gold, even suppress* the price of gold, is outdated. No central bank that is against gold would concurrently praise it. In my article “German Central Bank: Gold Is the Bedrock of Stability for the International Monetary System” you can find more information on the changes in gold policy by European central banks since 2013. It should be said, though, the U.S. central bank hasn’t joined its European peers in this change of policy. As a group, central banks became net buyers after the Great Financial Crisis.
Why have central banks slowly shifted towards gold? Because the world is submerged in debt (relative to GDP). Debt saturation causes the economy to stagnate—and the Corona crisis fuels even more demand for debt. There are several ways to deleverage (lower the debt burden).
– Reduce spending to pay off debt.
– Increase taxes.
– Defaults or debt restructuring.
Amid the current crisis, the first two options won’t fly, which leaves defaults and inflation. In my view, the debt burden will be lowered by a combination of these two.
The Dutch central bank (DNB) launched a new webpage in April 2019 stating:
Shares, bonds and other securities are not without [counterparty] risk, and prices can go down. But a bar of gold retains its value, even in times of crisis. Gold is the perfect piggy bank—it’s the anchor of trust for the financial system. If the system collapses, the gold stock can serve as a basis to build it up again.
If this is not a clear signal for us to own gold, I don’t know what is.
According to my analysis, the message is two-fold. First, acquiring gold reduces exposure to risky assets; second, it gradually stimulates inflation, i.e., currency depreciation.
When central banks started loading up on sovereign bonds a few years ago, they took a risk. These assets can decline in value, which is increasingly likely now central banks continue to buy bonds that the market considers unsafe. Bond buying programs by monetary authorities create a vicious cycle. Ultimately, these assets will damage the balance sheets of said central banks. But central banks also hold gold. If the price of gold rises, the nominal increase in the value of their gold will make up for the losses on other assets. Possibly, central banks will use the nuclear option: print money to buy gold. The currency created would rapidly fall in value versus gold. In other words, the price of gold would go up.
The gentler approach is the one adopted by the Dutch central bank. To slowly change the psychology of people regarding gold. When people slowly shift their savings to gold, making the price rise, this is likely to have an inflationary effect.
Former Chair of the Federal Reserve, Allan Greenspan, wrote in 1988:
[The] judgement [that a return to the gold standard requires a higher gold price] is quite consistent with the view that the price of gold should be included along with other commodities as one indicator of global inflation or disinflation. Gold is relevant and useful in that regard wholly because of the historic and widespread perception of gold as an indicator of a flight from currency.
An increase in the gold price would spur inflation, lower the overall debt burden, and repair central bank their balance sheets. That would be the good news. The bad news is that inflation does a lot of damage to the economy. People owning bonds or cash, see their savings decline in real value, to give an example.
“There’s definitely more upside for gold” – says Jan Nieuwenhuijs, Voima Gold analyst
*: I have been researching if central banks, or other financial entities, have been covertly suppressing the price of gold over longer periods. There is ample evidence that Western central banks have openly been suppressing the gold price in the past 50 years. For example, the London Gold Pool in the late 1960s and the gold auctions by the U.S. from 1975 until 1979. A smoking gun, however, of covert suppression in recent years I haven’t found. I’m planning to write many articles on this topic, covering the physical and derivatives market. Note, suppression is not the same as short term manipulation of the gold price to the up or down-side by investment banks to scalp markets. The latter has been proven time and again.