This log entry was crossposted at TheOilDrum:Europe with the addition of my comments on the news that came out yesterday on the matter.
CNBC invited Jim Rickards, a senior managing director at a firm called Omnis to comment on the latest G-20 meeting and the future of the dollar. His testimony shows some rare lucidity about the present problems with our monetary system. Bearish on the dollar, bullish on gold, don't mistake him for a gold bug, for he is well aware of the consequences of a flight to the “barbarian's relic".
If gold goes to 1500$ […] it has to with the fact that the dollar is imploding [...]
Rickards links an oped article at the Wall Street Journal penned by Federal Reserve governor Kevin Warsh to the G-20 meeting in an interesting way: it is a camouflaged warning against a fast drop of the dollar against other currencies, especially gold.
The Fed needs the dollar to get down by about half in the next 14 years, we have 60 trillion dollars of liabilities [...] there's no feasible combination of growth and taxes than can fund those liabilities. […] They need to do that, but that's a dynamically instable process, they would like to do it gradually, and that's the plan, but if the market gets ahead of it, if the market sees this playing (which probably they will) you could have a very rapid collapse of the dollar [...]
The secular declining trend of the dollar has been resuming since early September, fueled by the carry trade proportionated by null interest rates in the US. This is leaving a lot of people uncomfortable, both those issuing the dollar as those pilling it up.
It is important to understand that pretty much all of the major player in the international market (read G-20) are looking at this perspective of their main unit of account and medium of exchange entering a downward spiral. This is where the SDR (Special Drawing Rights) comes about, a remnant of one of Keynes' bold ideas that may be materializing today.
The IMF is being sort of anointed as a Global Central Bank, they are now running a balance sheet, they've issued debt for the first time in History, they are issuing SDR, the last time they were issued was in 1980 or 1981 […] they are printing money, there's nothing behind these SDR.
An abstract version of the Bancor seems to be already in active duty, but is it the solution for the problem? It may be if the problem is simply one of having a regional entity (the Federal Reserve) managing the global monetary policy. But there is more to it.
In order to stimulate world trade and the world economy some hard currency country has to run persistent large deficits, but if you run persistent large deficits you eventually go broke. […] 50 years later the US is getting closer to going broke, we fueled the world economy the last 50 years.
The US is not “going broke" only because it ran persistent large deficits. Fifty years ago the US was the largest world oil producer, one of the largest energy and food exporters and held considerable amounts of gold; today it is the largest world energy importer and its gold reserves have become of little relevance. The physical basis of the world's medium of exchange has been depreciated to a point where international trade players have lost faith on it.
So how do you get out of that? The US can get its own house in order but that would cause world trade to contract. What you need is to kick the problem upstairs, we gonna use SDR to fuel the global economy so that we can take the dollar off into a corner and depreciate the dollar to solve our won debt problems.
Rickards also makes some sharp points on US security, although taking into account its nuclear arsenal the US will still be a super-power if the SDR comes to be the new world reserve currency. The problem is: if the US can't print money as before, wars like the ones being fought in Iraq and Afghanistan may not be possible anymore.
Warsh is saying: “We are not going to let that happen […] we sort of have to trash the dollar, but if the market gets ahead of us and we see gold from 1500$ to 2000$ we are going to raise rates a lot, maybe 50 or 75 basis points to defend the dollar".
That was largely what happened in 1980, when panic drove gold prices over 800$, well beyond 2000$ at today's prices. That same year the Federal Reserve pushed interest rates to 20%; after that the deepest world recession since WWII unfolded.
The problem is, when you own gold you are fighting every Central Bank in the World. Central Banks hate gold because it limits their ability to print money. But the market is the market, the market will do what it wants, and even Central Banks aren't bigger than the market.
Quite true, all Central Banks in the world are today working with paper, not precious metals. Moreover, many Central Banks have been dumping their gold reserves during these past decades of growth.
This is crux of the matter, Central Banks have very limited options regarding gold; being it a resource in very limited supply, the sort of expansionary monetary policies run especially since the early 1980s are impossible with it. With paper monies Central Banks can cast a floor on Velocity with Inflation (this means monetary mass expansion) guaranteeing that paper's function as wealth storage is limited in time. While with paper investors are compelled to feed their money into the economy, so to avoid its continuous loss of value, with gold such isn't the case – its limited supply and resilience to forgery makes it a wealth storage medium for the very long term. With gold investors simply do not have the same incentive to feed the economy and can opt for simply sit on it, killing Money Velocity and imparing economic activity. From a Keynesian perspective the Great Depression can be explained as a consequence of the post-WWI re-introduction of gold as de facto currency in Europe. Investors lost the incentive to invest, portfolios moved towards liquidity (gold is the most liquid of all assets, even without legal tender it is more liquid than paper) and Velocity collapsed.
Going back to the SDR, kicking the problem upstairs can indeed deal with the dollar's expiration as world reserve currency. A new reserve currency system seems to be well on the way of development, in similar terms to the old Ecu, opening perspectives for an orderly shift away from the dollar. But as I wrote last time on this issue, there's more to this problem than simply finding a new reserve currency system. What Rickards seems not be yet aware of is that the problems being faced today by the US may well become common to all other international players, even those adopting the SDR as reserve currency. What if there's no more growth, in physical terms?
If the flows of energy and matter to the economy fail to grow during an extended period of time, Central Banks will get locked between a rock and a hard place, they can either continue with present expansionist policies and assist powerless to the degradation of their currencies (and rise of precious metals) or limit the abstract currency supply and treat it essentially as a commodity currency. Whatever the option, in the long run, Central Banks will be dealing with limited supply currencies.
In the case of gold, Central Banks still have some options, like opening the Mints and mobilizing the dozens of tons of monetary jewelry worldwide into the bullion pool, thus effectively expanding supply (and even increasing velocity). But for the other precious metals this is not the case. Silver, for instance, can become a serious problem; industrial usage depleted the world stock to the point that in weight terms it is now down to less than a sixth of the world gold stock; compounding to that is the traditional lack of silver reserves at Central Banks. Silver is easy to falsify, having a density similar to that of lead, but in small bullion pieces it is still safe. With newer precious metals such as palladium or platinum the situation is similar. Platinum especially, is even denser than gold and also impossible to falsify in practical terms.
The End of Growth foreclosures a monetary system that existed during a brief period of time from an historical perspective, officially during the last four decades, in practice since WWII. It was feed by growth and in its turn feed growth itself, in a feedback loop that brought about the world of today. A world that tomorrow will be the past.
 World gold stocks are around 160 000 tones. World silver stocks are calculated to be circa 25 000 tones.