Special Feature
BEN BERNANKE
Central banks own gold “because it’s tradition” said Ben Bernanke infamously at one of his regular appearances at Congress when grilled by the pugnacious senator Barney Frank. “Gold isn’t money… it’s an asset as treasury securities are [and it is often demanded] as a protection against tail risk”, ‘Helicopter’ Ben testified. But it seems that many of us quite simply don’t believe him and prefer to hold gold as opposed to paper currency; essentially as if it were money.
There’s no doubt that central banks traditionally owned gold as ‘reserves’ — similar to holding foreign currencies — but it would be naive to think they hold the yellow metal just because it is tradition. What leads the FED to hold around $366 billion in gold, the Bundesbank around $152 billion and the top 10 central banks around the globe more than $1 trillion is certainly something more than pure tradition. There is a solid economic rationale behind it. Central banks hold gold because it is a guarantee against a nation’s obligations and issued currency. People hold gold because it is a protection against inflation, a protection against fiat currency and perhaps the only real true means of universal exchange. Paper currency has no value other than the legal recourse given to it by the backing government. If that government is bust (like Zimbabwe was in the mid-noughties and certain Latin American countries regularly are) then the saying “It isn’t worth the paper it’s written on” takes on a whole new meaning. Fiat currency is controlled by a central bank or government which may change its value as it wishes, particularly where the currency is free floating. Gold in contrast isn’t controlled by any one single central source (not even JP Morgan!), but rather is subject to universal supply and demand rules, and without carrying a flag or having any national allegiance.
Unlike what many people think actually, paper currency isn’t really wealth. Wealth is measured by the hard assets we own and currency is just a means of obtaining those assets. Paper currency is valuable in terms of its purchasing power only, but it may drastically change from one period to another, particularly if governments allow inflation to take hold. Because gold is rare, resistant, has a stable supply and isn’t manipulated (over the long haul anyway!) by anyone, it is infinitely better as a reserve currency than the world’s only true current reserve currency — the US dollar. Even though gold is now seen as a commodity, throughout the 19th and 20th centuries it was a real currency as the major economies including the US & Britain subscribed to the gold standard. While the US dollar, the British pound and the French franc circulated as the official means of exchange in their own countries, the yellow metal was behind each of them in order to give them the credibility and the assurance demanded by those parties taking the legal tender as currency. During that period anyone wishing to exchange US dollars for gold could do so at a predetermined rate. The gold standard guaranteed a period of low inflation as we touched upon in the last edition of our magazine, quite simply because central banks weren’t able to print money as they so desired.
“Central banks hold gold because it is a guarantee against a nation’s obligations and issued currency.” 62 | www.financial-spread-betting.com | July 2013