John Rapley
LAST YEAR, following three years of declines, the world's major stock markets climbed back out of their slump. Recording impressive gains, they appeared to signal that happy days had returned to the global economy.
However, if stocks performed well, they were dramatically outpaced by one of the world's oldest investments: gold. And the fact that gold regained its shine after decades of neglect is taken by some analysts as a worrisome sign.
When you stop to think of it, gold is an odd treasure. The billionaire financier Warren Buffet once pointed to the anomaly of sending armies of labourers to dig a rock out of the ground, only to bury it back in the ground with a guard posted atop it.
Nevertheless, throughout history, the gold bug has stricken humans all over the planet. The attractiveness of the metal, coupled with its rarity, conspired to make it valuable as a stock of wealth. Until recently, many of the world's governments denoted the value of their paper currencies by a measure of gold, allowing note-bearers to redeem their cash for gold if they so chose.
When the United States abandoned the gold standard at the start of the 1970s, it signalled the start of a new era in the history of money. Rather than having their value denoted by gold, currencies now became commodities like any other, freely traded on currency markets. Their value would thus be determined by demand and supply conditions in the global economy.
Instead of holding gold in reserve to pay for their imports, governments now held foreign currencies. The most attractive currencies were those which were most widely accepted, and thus those most widely seen as solid, secure and reliable.
As a result, those countries with both strong economies and sound monetary policies produced the strongest currencies. Accordingly, the U.S. dollar became the most attractive currency, and over the decades the world's governments built up vast reserves of U.S. dollars.
This gave the U.S. a uniquely privileged position. The reserves of foreign governments sometimes even enemies of the U.S. that were held in dollars were deposited in American bank accounts. Since the world banked in America, the U.S. economy had access to a vast pool of capital that no other country enjoyed.
CREDIT
In addition, since just about everyone was willing to accept dollar deposits in payment for their goods or services, the U.S. could live beyond its means. If the U.S. imported more than it exported that is, if its current account went into deficit the American government could simply give its trading partners credit in their U.S. bank accounts, which could be used to buy goods or services later.
Trading partners were willing to give the U.S. credit for as long they remained confident that the U.S. economy would eventually grow to catch up with this 'dollar overhang'. Unfortunately, Americans seemed to grow too comfortable with free credit, and in the 1990s the current account deficit reached record levels that, anywhere else, would be seen as unsustainable. There it remains to this day, with no signs of improving anytime soon.
Many economists speculate that it is the fear the U.S. might one day be unable to come clean on its bills that is driving the rise of gold. Old hands in the gold market are predicting that the precious metal's rise will thus continue into the foreseeable future.
It is highly unlikely that the U.S. would ever default on its debt or refuse to honour its commitments. Rather, fear some observers, the US might try to inflate its way out of debt. That is to say, it would cover its bills simply by printing money. Since the surge in money supply would devalue the dollar, investors would switch from dollar reserves to gold as a hedge against inflation.
Indeed, some experts believe they are already seeing the first signs of this downward spiral. With the U.S. government meeting its bills through record deficits, and the Federal Reserve pursuing an ultra-loose monetary policy, they fear the U.S. is trying to clear its accounts by devaluing the dollar.
A wholesale flight to the dollar would have deleterious consequences for the world economy. But it might finally bring smiles to the faces of gold-hoarders.
John Rapley is a Senior Lecturer in the Department of Government, UWI, Mona.
