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The Gold Standard

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It is a story surprisingly full of irony. Gold, the precious metal famously called a “barbarous relic” by the economist John Maynard Keynes, has been on an incredible bull run since 2001. This year marks the 10th straight year of gains for the yellow metal and a return for investors over that time span of over 400 per cent.  For a metal that has very little industrial or practical uses besides jewellery, the question of what is causing this rise seems like a particularly perplexing one.  For an idea as to why this may be happening and an explanation of the irony, let’s begin with Keynes himself.

Keynesianism

To begin; a quick history lesson. John Meynard Keynes was an economist who formed a macroeconomic theory later called Keynesianism. One of Keynesianism’s main tenets is that governments and central banks can help alleviate the economic suffering caused by recessions and depressions by spending their way out of them with public funds. Thus, when private business begins to falter, the public sector can step in and ramp up its spending to stimulate economic growth and employment until the private sector has mended itself and begun to grow again.

Quantitative easing

If these ideas sound familiar, it is because the principals have had a recent resurgence and have been put to test around the world over the course of the last decade and particularly in the past few years. When the global economy entered a steep recession in 2008, governments around the world stepped in with “stimulus” spending announcements to help revive their respective economies. The United States took even greater steps by employing an unconventional type of monetary policy called Quantitative Easing, which is an expansion of the money supply accomplished by creating new money out of thin air. All of these spending initiatives came at the cost of increased public debts to the countries that employed them, which brings us the effects of these actions.

Although the efficacy of these programs on the economy are hotly debated, what is not contended is that higher debt loads created by these spending initiatives worry investors as they are more difficult for governments to repay.  One important aspect of Keynesian theory is that although governments and central banks should stand ready to spend when times are bad, they must also save for a rainy day when times are good.  Throughout the 21st century, governments have been spending far more than saving and this causes worry in the holders of the debt of these nations. The expression of this worry is typically a depreciating exchange rate for a country’s currency.  However, under our modern monetary system, a country’s currency is valued only against another country’s. When all (or most) countries are involved in huge spending programs, the loss of trust in a nation’s currency is masked by the fact that all currencies are depreciating at the same time.

Gold irony

The canary in the proverbial coalmine however is gold.  To understand why, we need one further history lesson. Up until a mere 40 years ago, gold had been the fixed point used to reference currencies from different nations.  This system, called the Gold Standard, established a fixed price for gold and thus restricted the amount of currency in circulation for any given nation based upon their gold holdings. Although this system worked well for hundreds of years, some economists began promoting the idea of having privately-owned central banks control the supply of money and have the currency backed by nothing more than the scarcity of that currency and its acceptance by the government for the payment of taxes. One of the biggest proponents of this type of currency system was Keynes. He believed that a central bank can manage a nation’s currency much more effectively than having it arbitrarily controlled by a rare “barbarous” metal.

However, gold does have a tremendous virtue when compared to a centrally-managed currency: currency backed by gold cannot be easily expanded by a profligate government. Although a gold standard has been gone now for decades, investors and central banks still hold gold as a hedge against inflation and money creation. This time around, as countries print money and borrow wild sums in an attempt to spend themselves out of recessions, currencies around the world are losing their purchasing power and so we see gold rising in terms of almost all currencies.  Under this theory, it seems possible that gold will continue to rise as long as governments continue to accumulate ever larger debts.  How ironic, then, that its rise can, at least partially, be blamed on the theories of one of its biggest critics. 

Sean Weaser is a Principal at Integra: Private Investment Management.  Sean can be reached at sweaser@integra.com.