Gold at Center Stage

Economics, Premium POM

But Does That Mean a Valuation of $10,000/oz?

By JC Collins

An interesting thing happened on the way to the multilateral. China aligned its monetary policy with that of the US dollar interests and the Federal Reserve, which will slow renminbi internationalization to accommodate USD policy. It’s being reported that the Asian Infrastructure Investment Bank will not issue loans denominated in non-dollar currencies. This means that China will not be using the AIIB to promote RMB internationalization.

This communicates some extremely important information which all POM readers will need to consider. One of the main tenets of the POM thesis revolves around the internationalization of the renminbi and the gradual diversification of USD denominated foreign reserves with euro and RMB. It was reasoned that the internationalization of the renminbi would provide an alternative safe haven as the dollar depreciates.

The core and consistent theme in the above framework is that the USD will need to depreciate and the current global deflation will have to churn over into inflation in all major economies sometime in the next 6 to 12 months. Prolonged deflation is in no one’s interests.

Chinese monetary authorities are positioning the RMB for reserve currency status. The recent inclusion of the renminbi into the SDR weighting is but one step of this process. So is issuing RMB denominated loans, whether it’s through the AIIB, BRICS New Development Bank, or the New Silk Road Fund.

The forthcoming Chinese crude benchmark will also provide an opportunity for RMB internationalization and an alternative mechanism for USD diversification. But the moves are likely to be made in coordination with the Fed and the US Treasury.

Even the China International Payment System (CIPS) is functioning under the same base operating code as the SWIFT system. As I had previously written, this would suggest the level of coordination required to rebalance the international monetary system is being structured around the common need and ideal of a multicurrency framework.

But how does gold fit into this scenario?

It had been my conclusion that gold would see some devaluation before it would appreciate upward again. The reason for this expected devaluation was the very same dollar alternative, or safe haven, which the internationalization of the renminbi would provide when the dollar begins its eventual depreciation.

Though this may still be the case, we must consider the Chinese willingness to slow the internationalization process and not orchestrate an outright monetary assault on the dollar by issuing RMB denominated loans. The possibility of this being a red-herring, or miss direction by China, with them having full intentions of issuing massive renminbi denominated loans, is something I don’t seriously consider. Such things are the motives of unsubstantiated conspiracy theories (as opposed to substantiated), and would lead the world even further away from the multilateral monetary framework which all nations and institutions have agreed upon.

Since my first statements on gold devaluation, the metal had decreased by approximately 22% to a low late last year. It has since gained some ground, but could very well decrease again as the recent volatility due to the first Fed rate increase in almost a decade begins to settle down.

But what if this volatility doesn’t settle down? What if renminbi internationalization isn’t enough to create the type of safe haven required to offset USD depreciation?

Back on September 30, 2014, I wrote a piece titled The Coming SDR Gold Standard. Here is an important excerpt:

Sometimes what at first appears to be conflicting information is anything but, and what was originally considered to be opposing forces, or ideals, can quickly become unified for the greater good.

There has been much discussion and division over whether the world was moving towards a multilateral super-sovereign reserve currency by way of the Special Drawing Right of the International Monetary Fund or towards a new gold standard by which all currencies would be valued once again on gold.

Positions have taken up defense on both sides and all waited to see which side was going to be right. Were the BRICS countries going to overthrow the western banking cabal? Was the US dollar going to inflate into oblivion? Was the SDR going to become the new reserve currency? Was a new gold standard going to be implemented instead?

So many questions with no clear outline or determinations on what exactly was going to happen.

I have contested all along that the SDR was going to become the super-sovereign reserve currency of the emerging multilateral financial system. The supporters of a new gold standard have found this idea unworkable because gold is considered to be the only method of creating stability within the larger architecture of the global financial system.

But what if everyone is right? Or more correctly, what if all the obvious points and leverage of each potential system can be utilized to create the larger macro stability from which the multilateral will inevitably emerge?

Since the date of the writing we can make some additional determinations. We know that BRICS, and to a larger extent China, are aligned with the broader and more macro mandates of the international banking system. We also know that the renminbi is on the path to becoming a reserve currency and has in fact been included in the weighting of the SDR. (Effective date for the new weighting begins this October, which aligns with US domestic fiscal budgets.)

But as a side note to the SDR inclusion, I also stated the following:

But this theory has never accounted for the importance obviously placed on gold and the manipulation and mass movement of the precious metal which has taken place over the last few years.
No doubt the gold moving east has a lot to do with balancing old sovereign bond debts and building up reserves to support the renminbi denominated contracts which have just begun at the Shanghai Gold Exchange.

But this doesn’t fully explain the demand by other countries for gold, such as Russia and India, or even Germany demanding its gold back from the United States.

But neither does a gold standard fit the facts as all participating countries and economies have stated in official publications and speeches that a new gold standard is unworkable and the SDR provided the best opportunity moving forward to balance the financial structure of the world.

The obvious workaround is achieved by including gold into the weighting of the SDR. Such a scenario would achieve monetary and financial stability while the multicurrency system is adjusting and the renminbi increasingly rises to the status of full reserve currency.

In October 2011, Catherine R. Schenk of the University of Glasgow published a paper titled Adding Gold into the Valuation of the SDR. She explains how such a scenario would look and function:

Introducing gold into the valuation of the SDR might achieve several goals:

  • Re-introduce a role for gold in the international monetary system (meeting some calls for this to take place)
  • Provide a counterweight to the impact of the depreciation/appreciation of the US$ (and other currencies) since gold price tends to be inversely related to US$
  • Reduce vulnerability to the USD exchange rate (although this could also be achieved by reducing the USD weighting – but in favour of what currency? Euro is vulnerable, Japanese economy is not growing, UK is small)

There are several obstacles:

  • If gold operates similarly to other components in the basket, some agency would need to be ready to provide goldwhen SDR claims are presented
  • Gold price tends to be volatile in times of economic uncertainty (when stability is required) and may beprone to ‘bubbles’

Possible mitigation of obstacles:

  • Keep the gold share modest (proposed 5% of SDR value)
  • IMF gold could be used to back the potential claims on gold from holders of SDR (at end August 2011 holdings = 90.5 million ounces with a market value of $164.1 billion – total allocations of SDR = SDR205 billion or $323 billion worth)
  • Gold claims could be ‘residual’, i.e. gold could only be claimed when no convertible currency is available through voluntary agreements – this would reduce the strain on the IMF’s gold reserves
  • Countries in surplus with substantial gold reserves could be designated to buy SDR for gold in the same way they may be designated to buy SDR with freely usable currencies
  • Use gold only for valuation and not include any right to sell SDR for gold.

The fact that China is pursuing an incremental policy of RMB internationalization, and still utilizing the dollar framework, is very suggestive of a timeline which would see gold take center stage as national currencies depreciate and appreciate on a shifting sea of liquidity.

Though the renminbi will appreciate against the dollar, this appreciation could be managed to correlate with an increase in gold and the SDR. Such a transition and movement between assets and exchange rate arrangements would only function with a broader role for the SDR.

How this role would look will depend on the willingness of nations to relinquish control over domestic monetary policy to the International Monetary Fund. Before the SDR becomes the official reserve asset which replaces all national currencies in international trade, we could see a period of time where all currencies are pegged to the SDR.

The composition of this SDR could include gold under the framework which was defined above. Having gold in the SDR would offset dollar depreciation and encourage renminbi appreciation. It would bring a sense of stability to the multicurrency reserve arrangements and allow for a more orderly diversification of foreign exchange reserves.

Perhaps once reserve diversification has taken place at a pre-arranged ratio between nations and economic factors, such as GDP and percentage of trade, the official foreign exchange reserves could be substituted for SDR. This could be the purpose of the IMF’s substitution accounts.

Fundamental changes are taking place in the international monetary framework. Gold, one way or another, will play a role in this restructuring. But we need to keep in mind that the only way gold will increase to astronomic levels is if the national currencies collapse into runaway inflation. The fact that a multicurrency system is an important step towards the multilateral framework would suggest it is in no one’s best interests to see national currencies completely collapse, or allow gold to appreciate to levels which would skew the required weighting for the SDR to function as a pegging mechanism.

Management and manipulation of the international monetary transition is a foregone conclusion. It is a substantiated conspiracy from which a new monetary framework is being designed. Much like the Bretton Woods framework was designed in 1944. How well the mechanisms of the central banks and international institutions can direct the flow of capital and flatten the volatility will depend as much on human nature as on monetary and fiscal engineering. – JC