Thursday, August 18, 2011

The Gold Standard: In Memoriam

On August 15, 1971, 40 years and 3 days ago, President Nixon, remembered today for another of his “achievements” - the Watergate scandal, announced that the United States will go off the gold standard. Till then, the gold standard meant that the money supply in any country would be limited to a specified proportion of the gold reserves owned by the Government. The gold standard was abandoned when the consumption-hungry Americans found the fiscal discipline it imposed on all Governments too inconvenient, and substituted it with a promise of the United States Government, then the most powerful and richest country on Earth.
After this epochal action, demand for Gold fell worldwide. To such an extent that India (its citizens, not the Government) was the only net importing country in the world, importing what the rest of the world exported, for well over two decades. Till India reached its economic nadir in 1991, when the Government was forced to sell or pledge tonnes of gold to save the country from financial bankruptcy. After that, India has slowly picked up its gold buying again, and Indians are still the world's leading buyers of gold. The RBI has bought back all the gold it pledged, and more. I am also sure that the RBI has recently bought more gold – it announces the value of its foreign currency reserves in US Dollars, but the actual composition is India's best-kept secret. I suspect that the RBI has fallen back on the age-old wisdom of buying gold when all currencies' future looks uncertain.
For aeons, gold has been considered in India as a refuge against uncertainty, as well as a status symbol – something no family would sell unless they were in dire straits, and then too, with the internal understanding that they would buy it back at the earliest. So while India's Government is the 10th richest in terms of gold holdings officially declared, Indian citizens' private hoard of gold, if added to the RBI's holding, would probably make India the richest nation with the most liquid reserves in the whole world.
In the meanwhile, the freedom from the peg to gold allowed the United States to spend like there was no tomorrow. Whenever it looked like tomorrow would dawn, the United States would instigate a competitive devaluation game among other countries, which enhanced the external value of the dollar, which ensured that tomorrow was deferred yet again. Dollar prices of gold went up briefly following the 1974 oil price shock; and then again after the 1979 oil shock. Then, it continually fell till 2001. So, if one compared gold prices against inflation or any other currency value, gold always suffered, till end of 2001 when it was $272.22 in the NY market. After 9/11, some Middle Eastern countries and their residents, sharing the Eastern love for gold with India, began hoarding up on gold. So dollar prices of gold started looking up. But then, in 2007-8, tomorrow arrived.
By 2009, gold had crossed the hitherto unthinkable barrier of $1,000 an ounce. To put this in context, in August, 1971, when the gold exchange window closed, the price of gold per ounce (1 troy ounce=about 31.1 grams) was $37.60 (according to Niall Ferguson in his excellent book, The Ascent of Money). Going to $1,000 in 38 years means a CAGR of around 9% per annum. A handsome rate, but absolutely mind-boggling, if one allows for the fact that for almost 32 of these 38 years, gold prices hardly rose at a CAGR of 3% in dollar terms, when it rose at all. Do you know what the price of gold now is? It is $1,794 an ounce as I write this, in August 2011. Which means a growth of 79% over the 2000 value of gold.
Let us look at this from another perspective. If an American had turned in $1,000 before the US went off the gold standard, he would have got almost 26.6 ounces of gold. The same quantity of gold today would be worth $47,720. This is an index of how much the value of the dollar has slipped and that of gold has gone up. This means that gold worth $1,000 is now worth almost 48 times as much in 40 years – a CAGR of about 10.1%. Not bad, for something considered as a bad investment by the whole world, for almost 30 years! When the world realizes that gold has proved to be a safer haven than any other currency, there could be a renewed weakening in the belief in the US Dollar as a store of value and as a reserve currency.
Way back in June, 2008 I had written that it was time to buy GoldElsewhere, I have written that gold prices could touch $4,000 an ounce in 3-5 years. At the rate the price of gold has been shooting up in the last few months, this price point should be reached much sooner than 3 years, if only because of the expected continuing weakness of the dollar. So will we see a return to the Gold Standard, or some variant of that? That has to be counted as a distinct possibility after the S&P downgrade of the AAA+ rating of the US.
Till that happens, we Indians should thank our womenfolk for consistently ignoring advice that investing in Gold was a poor bet. Thanks to that, India is possibly the most liquid and financially secure economy in the world today. What's more, it is a hidden strength - it is the reason why Indian families will survive in a world without Medicare/ MedicAid/ Social Security.
(Historical gold dollar price data sourced from and current price from