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Don’t get too sold on gold

india Updated: Aug 25, 2011 02:28 IST
Hindustan Times
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The American buys stuff in dollars, and pays his debt in dollars. Ergo, if his debts mount, it makes sense to pay them off in a cheaper coin.

The US has been consistent in its approach to foreign creditors. When its trade balance gets outrageously lopsided, and it does every 20 years, Washington simply debases the currency the world trades in. So we have Richard Nixon taking the dollar off the gold standard in 1971, devaluing it by 12% against the pound.

Then in 1991, George Bush Sr tells the Germans and the Japanese, running the largest trade surpluses of the time, that each dollar must fetch fewer marks and the yens. The yen rose 51% against the dollar and Japan has not recovered since from the recession it imported. And now, in 2011, when China, which shares a lesser burden of history with its biggest trading partner, refuses to revalue the yuan, Washington pulls the plug. The Federal Reserve has “printed” 600 billion extra bucks with a promise that there are many billions more where these came from.

Not fair, but that’s the price the world pays to do business with the elephant in the room. A full blown trade war would sock the rest of the world harder than it would the US. Central ban-kers can despair to see the American IOUs they hold shedding value furiously, but the hoped-for alternative reserve currency, the euro, is a half-hearted work in progress. China, India, Thai-land, South Korea, Kazakhstan, Mexico and Russia have all bumped up their gold holdings since Lehman Brothers went broke, yet that does not significantly alter the odds in any currency conflagration. Take India, for instance. The Reserve Bank of India’s purchase of 200 tonnes of gold from the International Monetary Fund in 2009 has raised the share of a tested hedge against currency movements to a mere 6% of its foreign reserves. In contrast, the US Federal Reserve holds nearly 80% of its foreign reserves in gold. The European Central Bank holds around a fifth, but the French, Germans, Italians and the Dutch retain well over half their reserves as gold.

Efforts to keep the world economy afloat will, the IMF estimates, see public debt swelling by a third in the 20 biggest economies. This ought to exert unprecedented pressures on the price of gold. That, however, does not render it fit to serve as the reserve currency for any length of time. At today’s value, all the gold in the world is worth $9 trillion. Last year, the world produced merchandise and provided services worth six times as much. There simply isn’t enough gold to go around. The latest gold rush will last only till the world regains faith in a paper currency. On current indications, that still looks like the greenback.

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