GOLD AS MONEY The inefficiencies of barter meant that all civilisations adopted some form of money, from coins to sea shells, which were easily recognised and readily accepted in exchange for something of value. Money is just a convenient token of exchange, and a limit to supply and stability is desirable to prevent price inflation.


A stable, transportable store of wealth was essential for international trade, and gold and silver coins were the international trading currency for almost 400 years up until the late 19th century. Building and maintaining reserves was very important to European trading states, evidenced by the seizure, exploration and development of gold and silver wealth in the Americas and Africa.


British traders used their silver reserves to buy Chinese goods in the 18th - 19th Centuries but, with the Chinese not purchasing goods in return, the British channelled opium to China to recover their depleted silver holdings. The damaging effects of opium addiction spurred the Chinese to ban the trade, sparking the opium wars.


As well as being accepted for trade around the world, price stability was essential. The gold/silver ratio was set in law, with the US fixing the ratio at 15:1 in 1792, and French law set the ratio at 15.5 in 1803, similarly adopted in England thereby avoiding a physical arbitrage.


The ratio set in the early 19th century wasn’t far removed from the 10/1 to 15/1 ratios noted in ancient Greece and Rome, an impressive history of relative value stability and continuous use spanning a couple of thousand years. This gold/silver ratio wasn’t picked at random, but derives from historic recovery rates in bi-metallic deposits before the advent of modern processes improved the relative recovery rate for gold.


A STABLE, TRANSPORTABLE STORE OF WEALTH WAS ESSENTIAL FOR INTERNATIONAL TRADE, AND GOLD AND SILVER COINS WERE THE INTERNATIONAL TRADING CURRENCY FOR ALMOST 400 YEARS UP UNTIL THE LATE 19TH CENTURY.


GLOBAL ECONOMY OUTGROWS GOLD Financial systems backed by physical bullion favour countries with below and above ground deposits, with economic activity limited by the amount of physical held. Strains of the 20th century brought an end to gold backed currency, starting with the UK increasing money supply beyond gold holdings during WW1, before finally dropping the gold standard in 1931 during the Great Depression.


In the US, where Federal paper required 40% gold backing, the public were banned from holding significant investment gold in 1933, requiring holdings to be exchanged at the statutory price of $20.67/oz. In 1934, the US raised the price to $35/oz, and an influx of physical gold into the US allowed more money to be printed devaluing the US$, credited by some for helping lift the US out of the Depression. The Bretton Woods Agreement in 1944 saw the US$ become the world’s reserve currency, with President Nixon ending the US$ link to gold in 1971.


Central Banks (CBs) still held a lot of physical gold reserves until the 1990s, but earned a sub US$ return by leasing their gold to bullion banks to facilitate producer forward hedging. With a robust and efficient global financial system, many CBs saw little need to hold gold and decided to divest. CB selling and lending drove gold prices down from $400/oz towards $250/oz by 1999, but the slump was reversed dramatically by the Washington accord of Sept 1999, which limited Central Bank sales and lending and triggered a short covering price rally.


Since 1999, a number of events have damaged faith in the robustness of the financial system. The equity and dot.com sell-off in 2000 was fought with low interest rates, which contributed to the housing boom and sub-prime crash in 2008, followed by QE programs and jump in Government debt since 2009, exacerbated by the debt response to the COVID crisis since 2020.


Whilst some fringe gold bulls call unrealistically for the return of gold backed currency, it would seem more reasonable to expect higher gold prices given questions over the strength of paper assets?


However, since Bitcoin was hailed as the “new gold”, it seems to have stolen gold’s thunder.


Chart 2: Bitcoin Futures and Spot Gold, US$


Source: ADMIS / Reuters / CME


17 | ADMISI - The Ghost In The Machine | Q1 Edition 2021


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