HUMANITY'S OBSESSION with gold has been a perpetual enigma. On one hand there is Henry Ford, the astute businessman, who claims, “Gold is the most useless thing in the world. I am not interested in money but in the things of which money is merely a symbol.” On the other hand there is Friedrich Nietzsche, the man who delved into the depths of the human psyche. Nietzsche ponders, “But tell me: how did gold get to be the highest value? Because it is uncommon and useless and gleaming and gentle in its brilliance; it always gives itself. Only as an image of the highest virtue did gold get to be the highest value.”

Ironically, the businessman and the philosopher both seem to agree that gold is inherently useless.

And yet, gold seems to have the mysterious power to change the course of human civilisation. Take the case of a recent tweet by the Russian Embassy in Kenya that simply mentioned that the BRICS nations were planning to introduce a new international currency backed by gold. And lo and behold, the Dollar Index corrected to 100 in the global currency market post the tweet.

Gold vs Fiat

The dollar hegemony has been facing quite a few challenges of late through the concerted efforts led by Russia and China. The cohort of their supporters seems to be getting bigger, with the BRICS bloc tinkering with the idea of launching a new trading currency backed by gold. It is quite obvious that this currency will rival the U.S. dollar in the international arena. The leaders of BRICS nations are meeting on August 22 in South Africa to probably initiate a seismic upheaval in the Fiat currency regime that started about half a century ago.

“The day the U.S. seized Russian reserve assets will go down in history as the equivalent of 1944 (Bretton Woods) or 1971 (Nixon closes the gold window). It’s a currency shift. It made it obvious to every country on earth that USD reserves that they hold can be confiscated at the discretion of the American government,” says Chris Galizio, former Fidelity Fund manager and executive producer of Money Game.

The global financial terrain has been dominated by the U.S. dollar since the end of World War-II. The dollar emerged as a global reserve currency through the Bretton Woods agreement in 1944. The era of Petrodollar dawned with the dissolution of the Bretton Woods agreement by Richard Nixon in 1971. The U.S. dollar has dominated the global trade since then as petroleum was traded and settled mostly in U.S. dollars.

According to the Federal Reserve research report of October 2021, between 1999 and 2019, the dollar accounted for 96% of trade invoicing in the Americas, 74% in Asia-Pacific (APAC) and 79% in rest of the world. About 60% of international and foreign currency liabilities and claims are denominated in U.S. dollar . Also, the U.S. Treasury market is over $20 trillion in size, and according to the U.S. Treasury Department, foreign nations owned $3.7 trillion of U.S. Treasuries (UST). Japan and China have the biggest share of U.S. debt with holdings of $1.1 trillion and $859 billion, respectively.

But, over the last 25 years, foreign reserves held by nations in U.S. dollar have fallen from 75% to 58%. Currently, the U.S. dollar is the global currency of choice and the U.S. has no capital controls. Also, by running a huge current account deficit, the U.S. provides a big export market to the rest of the world.

Hence, replacing the U.S. dollar with gold-backed international currency will be an uphill task for the BRICS bloc. Nevertheless, by choosing gold as the foundation to rival the U.S. dollar, the BRICS nations are treading the well-grooved path that many countries adopted during desperate fiscal situations.

At this point, it can only be speculated whether the gold standard, the hallmark of global economy till World War-I, is staging a comeback, or the gold-backed currency is just a pipe dream. How would gold, with its limited supply, match the never-ending thirst of growth that demands expansion of credit? And whether it is in the interest of a nation like India to be part of the de-dollarisation cohort.

How Gold Made Empires

Ironically, it was gold that laid the foundation of the economic prowess of the U.S. Much before that, Britain attained its colonial supremacy through the yellow metal.

After the end of the Napoleonic War in 1815, Britain focused on rebuilding its fragile economy and adopted the gold standard in 1821. That move propelled Britain to become the superpower of the imperial age.

The story of America as a global economic powerhouse also begins with gold. During World War-I, enormous European purchases of war materials and the massive flight of European capital seeking safety across the Atlantic carried over $2 billion worth of gold into the U.S. The country held close to $4 billion in gold by 1920. The massive inflow of gold shifted global financial might from London to New York and ushered the roaring '20s for the U.S. economy and its equity market.

During the gold standard regime, central banks were required to maintain a certain quantity of the bullion as backing for its paper money. The Federal Reserve, for instance, was required to have 40% of all currency issued on hand, in gold.

“Before World War-I, in 1913, a little over $3 billion, about a quarter of the currency actually circulating around the world, consisted of gold coins, another 15% of silver, and 60% of paper money,” wrote American author Liaquat Ahamed in Lord of Finance.

In 1913, the total amount of money circulating in Britain amounted to $5 billion, backed by $800 million worth of gold. By 1920, the money supply ballooned to $12 billion while gold reserves remained roughly the same. After World War-II, gold reinforced its hold on the world economy via the Bretton Woods agreement. The U.S. dollar got pegged to gold while rest of the world currencies got pegged to the dollar. In a way, gold paved the way for the hegemony of the U.S. dollar.

“Gold is a scarce commodity which has maintained its value against the rapidly-depreciating value of Fiat currencies, making it an attractive candidate against the U.S. dollar,” says Ritesh Jain, co-founder, Pinetree Macro, an India-based advisory firm that helps investors in global asset allocation. Jain believes, gold prices will not only move up against the dollar but will also move up sharply against US Treasuries which is where all global surplus is recycled.

Disadvantages of Gold Standard

The gold standard was disliked by both politicians and businesses as it restricted the credit in the system that hurt producers and debtors during periods of falling price. It also constrained growth by restricting money supply. Also, during calamities, the much-needed capital supply for relief and rebuilding fell short of requirement. The Fiat currency regime solved these problems by supplying the market with more than enough money to fund high-growth, but high-risk ventures. Fiat also allows political regimes to fund public welfare schemes without worrying much about credit repayment.

Ironically, the very advantages of the Fiat regime have now resulted into too much money in the system, rise of speculative venture funding, unbridled welfare spending, and high inflation across the world.

Unrestricted currency printing along with the supremacy of the dollar brings unique advantages to the U.S. and its allies. For instance, it has been a common practice for countries to export to the U.S. to earn dollars and then invest the same in U.S. Treasuries. Countries also export to the U.S. to earn dollars to maintain and augment their dollar reserves to meet domestic needs through imports. While other countries are producing material goods or offering substantial services to the U.S. market, many nations are figuring that the U.S. primarily seems to be producing dollars.

Commodity, manufacturing, and services-oriented nations are now teaming up against too much money supply by the U.S. and its allies. Unfettered printing of money by the Federal Reserve and the European Central Bank has been blamed for rising global inequality. Expansion of balance sheets by the Fed and the ECB has triggered speculative activities as excess money is flowing into paper assets such as equity and bonds, while the real economy is suffering due to rising inflation.

While the BRICS bloc plans to tackle the U.S. and allies through the gold-backed international currency, the question is, given its limitations, can gold standard fulfil the financial needs of today’s world?

Two Sides of the Same Coin

According to the World Gold Council (WGC), 209,000 tonnes of gold worth $12 trillion have been mined throughout human history. Of this, jewellery accounts for 46% (95,547 tonnes), central banks’ reserves constitute 17% (35,715 tonnes), bars and coins represent 20.5% (43,044 tonnes), industrial applications and holdings by financial institutions amounts to 14.5% (31,096 tonnes), and physical-gold backed ETFs hold 2%.

Liaquat Ahamed writes in Lord of Finance: “Most of the monetary gold in the world, almost two-thirds, did not circulate but lay buried deep underground, stacked in the form of ingots in the vaults of banks. This hidden treasure provided the reserves for the banking system, determined the supply of money and credit within the economy, and served as the anchor for the gold standard.”

Gold stocks have been growing at a slow pace of about 2%, or between 3,000 tonnes and 3,500 tonnes annually, for many years. While Fiat currency aficionados question whether this meagre annual increment of gold stocks would address the credit requirement of BRICS nations, gold buffs opine that its limited supply is useful in restricting manipulative powers of nations that artificially boost the economy by printing currencies.

According to WGC, the gold market is more liquid than many other major asset. Gold trading volumes have averaged around $149 billion per day over the past five years, more than the Dow Jones Industrial Average and comparable to those of U.S. 1-3 year Treasuries and U.S. T-Bills among primary dealers, as per WGC.

The size of the gold market allows it to absorb large purchases and sales from institutional investors and central banks without resulting in price distortions. In contrast to many financial markets, gold’s liquidity has not dried up even during times of financial stress, making it a less volatile asset.

Despite being a large and liquid market, the stock of gold bullion held by investors through ETFs currently stands at around $3 trillion, which represents around 1% of the estimated $266 trillion invested in financial assets globally excluding foreign reserve holdings by central banks.

Will India Benefit?

India was aptly nick-named as the Golden Sparrow eons ago as it eagerly accumulated the yellow metal in lieu of its abundant exports. It is also the second-largest bar and coin market globally. In the last decade, an average of 187 tonnes of gold has been annually utilised in India for this purpose.

WGC MD Somasundaram P.R. says due to high ownership of gold in Indian households, people feels richer since when gold prices go up. It brings in positive sentiment and promotes risk-taking behaviour. “Gold sitting in vault is of no use until it gets monetised for economic activity,” he adds.

Somasundaram says Indian households are sitting on around $2 trillion (₹165 lakh crore) worth of gold reserves. In contrast, total bank deposits in India currently stands at around ₹175 lakh crore.

Indian households own around 27,000 tonnes of gold, says V.K. Vijayakumar, chief investment strategist at Geojit Financial Services. “Around 20% of this is pledged. But the money is used mainly for financing contingencies and consumption. It is seldom used for investment,” he adds.

According to a KPMG study, in 2019, total gold loans outstanding in the organised sector were 5.5% of India’s total household gold holdings, which indicates a low market penetration. The organised gold loan market in India is estimated at ₹6 lakh crore, of which 80% is accounted for by banks and 20% by NBFCs.

There is a huge gold reserve that can be utilised for monetisation, says Umesh Mohanan, executive director and CEO, Indel Money, a gold loan provider. “But, more than converting this reserved gold into investments, the common man is taking gold loans as alternative capital or as a captive source for debt funding,” he adds. The RBI has advised banks to take initial exposure of up to 90% of the value of gold, and gold-loan NBFCs have been restricted to lend only up to 75%.

Experts believe with its huge gold reserve and a rapidly-burgeoning gold loan market, any monetary unit based on the yellow metal would help India more than any other nation.

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