CHATHAM House yesterday launched a report on the role of gold in the international monetary system. It is a noteworthy event, not least because the group's last study on the issue was in September 1931, just as Britain was about to leave the gold standard, accelerating the system's demise (Keynes was on the original working group).
It seems a subject that is at least worthy of consideration, not least because central banks the world over are pursuing policies that would, in earlier decades, have been considered highly unorthodox. In recent days, I have ben struck by the number of investors who have told me that central banks have "thrown in the towel", citing the ECB's three year loans to banks (another €530 billion accepted today), the Bank of Japan's stepped-up commitment to QE, the extra £50 billion pledged by the Bank of England, the willingness of the Swiss to create money to cap their exchange rate and so on. The investors see all this as bullish for real assets, like equities, but potentially inflationary in the medium term.
It will be no surprise that the Chatham House experts do not view a formal role for gold as likely, given that
the lessons of both the Gold Standard era and the post-war Bretton Woods period suggest that reintroducing gold as an anchor would undoubtedly be impractical or even damaging, given bullion's deflationary bias.
The group does see a continued role for gold as a part of central bank reserves although that is hardly a surprise. There is a limit, given the metal's lack of liquidity, to the proportion of reserves it can form. The table (on page 21 of the report) shows that some countries have a lot of reserves, and some have a lot of gold, but only switzerland has both, with gold reserves at 9.5% of GDP. Of the rest, only Italy has a level above 5%.
The taskforce also rules out adding gold to the basket that forms the special drawing right (SDR), a portmanteau currency that some hope might become an alternative to the dollar. The reasoning is that
as SDRs are a right to claim reserve currencies from IMF member countries, their utility depends on the willingness of fund members to accept them. If they were gold-laced, the liability of the countries that undertake to provide US dollars and other leading currencies in exchange for SDRs would be dependent on the price of gold. The behavioural pattern of the price of gold means that such liabilities would increase in money value just at the time when they were hardest to meet. As a result, it is likely that the countries that provide liquidity to SDRs would resist the inclusion of gold in the basket, and their resistance would be decisive since they are essential to the functioning of the SDR scheme.
The most intriguing section is on the role of gold as an economic indicator. Here the taskforce decrees that
there appears to be no consitent and reliable correlation between bullion and a large number of key economic variables that could be employed to inform policy decision-making more effectively.
There is not much in the actual report to back up this assertion and Chatham House points to a paper on its website by John Gault (an in-joke for Ayn Rand fans?) which shows a variety of charts linking gold to various measures. At first sight, gold's role doesn't seem that bad; the correlation with the consumer price index (p13) is 0.749 and with commodities generally (p7) 0.862. There have been occasions when a rising gold price has given a useful signal, the panel says, but the lags are variable in length. It seems to me that gold's historic role suggests it's worth researching this subject rather more deeply; the recent Marsh, Dimson and Staunton report found, for example that gold was the only asset that had a positive correlation with inflation.
On this note, Dave Ranson of Wainwright Economics often argues that gold does lead other inflationary indicators and one could argue that its weakness in the late 1990s preceded the deflationary scare of 2002-03. Mr Ranson would also argue that commodity prices are real inflation in the sense that they measure constant quantities over time. Consumer inflation measures are adjusted for hedonics (improvements in quality) which may bias the numbers; one can adjust for improvements like computing power but not for deteriorations in quality (eg on airlines, the need to spend more time in security, pay to take baggage, the lack of meals and the restricted leg room).
I am not sure one can accept this argument whole-heartedly but it does seem that the persistent rise of gold over the last decade must be telling us something, and central banks should at least take note.