Financial System Gold Standard

The Gold Standard – The Past, Present and Future

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Most people have probably heard of the gold standard and most are under the notion that the gold standard is a system whereby a country’s currency was backed by a certain amount of gold stored as reserves in each country’s respective central banks. Well, to an extent this is true however; the ‘gold standard’ is much more complex than money representing the amount of gold held in reserves.

To begin with, it must be understood that the gold standard was a monetary system whereby anybody in a country that uses this monetary system would be able to take a certain amount of money to a bank and exchange that sum of money into gold or vice versa, this however is only in theory as the main function or objective of the gold standard was to maintain economic stability due to the fact that when a currency is backed by gold unit for unit, it creates trust in the currency. Historically the gold standard had its genesis in Great Britain, when in 1694 the Bank of England issued bank notes that were back by gold and convertible back to gold by the bearer of the bank notes. As time went by, towards the end of the 18th century a surplus of paper currency was observed which caused the suspension of the convertibility of these bank notes to gold (basically there was more bank notes than there was gold – the first incident of money being overprinted – causing the notes to lose value as they had to be re-valued according to the amount of gold that was actually physically present in the vaults). The suspension was eventually removed and the gold standard was re-established in 1821 and most other countries realising that it was a practical way to place value on paper money soon followed suit – hence the gold standard became the monetary system that lasted until the advent of World War I when it was again suspended only to be reinstated soon after. However immense pressure stemming from the post war world and the dawn of the Great Depression fractured the system to a point that by 1933 both Great Britain and the United States of America exited from the gold standard and withdrew gold from circulation entirely (Elwell, 2011) only to be replaced by the Bretton Woods system in 1944. The Bretton Woods Agreement was a similar monetary system that was is generally described as the ‘gold exchange standard whereby the gold standard was maintained without domestic convertibility.

The Bretton Woods Agreement

Without doubt the Bretton Woods agreement was the first completely negotiated monetary policy that was agreed by independent industrial nations collectively that was proposed in order to govern financial transactions. The system was conceptually sound when it was imposed as each participating nation was obliged to adopt a monetary policy that would bind the exchange rate of its respective currency to gold which would facilitate the International Monetary Fund (the IMF) to bridge the imbalance between trading nations temporarily, this system also addressed the need to keep competitive devaluation of currencies in check. This system effectively governed the global financial system for almost 3 decades by stemming destabilizing speculation and competitive depreciations which were rampant in the 30’s. The US dollar under the agreement will remain as the only currency that would retain convertibility to gold and since gold reserves in most countries were limited, countries with payment surpluses stabilized their exchange rates by purchasing dollars which were almost ideal surrogates for gold (Cohen, 2010). However the system was only optimal between 1959 up to 1968 (full convertibility) after which both official and private liquid dollar claims that were being held by foreign entities coupled with the lessening of official gold holdings especially the US gold reserves steered the system towards inevitable collapse (Garber, 1993).

Present Global Financial System

The global financial system that is currently in place is a labyrinth of legal frameworks that are ‘patch ups’ of a seriously flawed design that has been constructed on a fragile foundation to facilitate investments, trade financing and financial capital flows. The complexity of the banking systems that are currently in place make it virtually impossible to continue ‘patching up’ the global financial portrait into something that is acceptable, the recent reforms imposed via the Basel Committee and other governmental regulations have actually made assessing systemic risks even harder and financial risks continue to tear the seams of the financial system at different ends relentlessly. The collapse of Lehman Brothers and AIG and the current financial reforms that involve ring fencing, counter-cyclical capital buffers, and contingent convertible debt are complicated equations that even those who devise them are not able to provide explanations on how they will perform in different scenarios. As markets bubble and fluctuate and nations head towards insolvency, the complications of their implications become shrouded with more reforms that only manage to provide temporary relief. Eventually the rickety financial system is bound to collapse and a complete overhaul of the global financial system will be necessitated and the only system that is known and viable is the gold standard.

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US Dollar get stronger among bearish markets

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Every bit of bad news coming from Greece achieves a strike at peoples confidence in the European Union, and with it, its currency, the Euro. The Eurogroup decided that it was too late for extending the existing bailout on Greece and a threat was added to the declarations. The Greeks stance in front of its creditors must change before a future possible agreement on payments and financial rescues.

In other times, when a currency suffered an important blow on its value, most investors used to consider the precious metals as a safe option, now things have changed. With a very weak Euro against an everyday-stronger US Dollar, no one is looking for gold or other similar commodities.

With near FED’s announcements about the numbers of the domestic US production (the Nonfarm Payrolls reports and the similar other coming up next weeks), everybody is betting in the US Dollar favour.

The market is solid right now thanks to the popular Dollar but if the reports shows unfavourable numbers about the economy, may be this the opportunity for precious metals to experience the first important price gain in months.

On that issue, the FED is confident that economy is improving every day and that the numbers will be one hundred percent positive. Also they think that the Grexit event and the default happening right now will not affect in a significant way the US and its important growth. Maybe there is no over-confidence on the US numbers.

John Fox, director of research at Fenimore Asset Management in Cobleskill told to Bloomberg News the following: “Our stocks are trading at one hundred percent fair value. They’re not really over-valued but they’re not cheap. Fixed income has really struggled.”

If we study the numbers, looks like things for gold are not going to improve any time soon. US equities benchmark climbed as 3 percent at the last quarter. Also consumer confidence in June increased more than expected, thanks to an optimistic attitude from Americans about the economy growth and the health of the labor markets.

Good things are happening in those aspects: 280.000 new jobs created and an hourly earning had an important raise for the first time in several months. Domestic finances are looking good and prosper at this point. So all the “smart” players in the markets will aim the productive sector of the US economy.

The upcoming crisis for the European Union can be a window for the United States to boost their indexes’ performances. The Dollar, once again, is consolidating itself of being the most solid and safe currency available. In the meanwhile, investors feel safe with it and the gold is still out of the picture.

But other markets still suffering. The German DAX fell 8.5 percent in the quarter. This represents the biggest fall in the last couple of years. European markets are not looking better than this. The Greek crisis is creating a state of panic between investors and society in general. The Consumers Confident is dropping harder every day, especially in Germany.

As expected by many, China is not getting affected in a significant way by the Grexit event. Even the Shanghai Composite Index enjoyed a raise for the first time in four days. They have their own problems but the People’s Bank of China (PBOC) already had executed actions about it. Problems on China’s markets has affected directly the marvellous gold import, so, again, the things are not looking good.

Further in Asia we can see how Japan is feeling the Grexit. The Topix Index rebounded from an important drop during the beginning of the year to finish the quarter above the numbers by 5.7 percent. Now the Asian markets can demonstrate their solitude facing the upcoming European turbulence. The US markets are already demonstrating their strength.

Back to Europe, everything seems to be tough. The already-considered failed negotiation between Greece and its creditors is affecting all the block. The measures imposed by the International Monetary Fund have bothered and offended the Greek people. Now a referendum on Sunday will decide the short-term fate of the country.

According to the global media, the popular demand selected on Sunday will be the “No”, making everything worst for the European block. This will consolidate the idea of the Grexit. The sudden withdrawal of Greek country from the EU could entail a serious list of financial consequences for the zone and for the rest of the world. The Euro could reach an historic low, giving a win to the US Dollar but also providing the FED a headache, because their constant intention to devalue the currency and, in that way, give the US economy an important boost at exports.

With several finance trends falling can be the appropriate time for the long time expected measures by the Federal Reserve. But with an unstable situation, any risky move can be counter productive and irremediable. The American executive has to study the possible devaluation and the scenario that they are facing.

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Fiat money and its house of cards

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Popular ignorance can be harmful for all of society. Lack of knowledge in economic theories and affairs is very common right now and hurts the financial system, at least for middle and lower classes. It begins to be a political matter when you study the actual foundation and characteristics of fiat money. Millions of people ignore it but it must be an obligation to spread the word about this particular issue.

Global fiat currency began when Nixon declared the Gold Standard as an ineffective and discontinued financial means of determining true value of the US Dollar. That’s when the fiat money scam began. Now the value would be determined by the trust of the consumer on the currency and not by a physical hard asset as backup, money just represents paper with numbers on it. A few years later the prices of precious metals and oil multiply several times. The prices of the sugar went up forty times. The consumers were petrified by fear. The trend of hoarding primary goods began with these odd events. Speculation took hold in every area of economy.

By that time, the Government invented another good term for controlling the financial expectations of the people. “Inflation Targeting” was presented as a useful tool that the Federal Reserve and political leaders had for getting “realistic and practical information” about the national indicators of economy. In that way, the concept of Central Banks acquired supreme powers over the economic health of countries. Now they could make some choices when it comes to price increases.

If you see the events in an objective way, you can understand the great abuse of power that exists in having a Central Bank who can choose inflation rates at will. Added to that, the fiat money clearly represents a modifiable instrument for political purposes. There is unrealistic facts about a currency that doesn’t have a physical asset supporting it. It is like a house of cards. A fragile structure with no foundations or securities about its strength.

The financial authorities adopted a god-like status between all those privileges that fiat money allowed to and things went even worst. Many important journalists in the financial world supported all these dangerous politics in the currency matter. The levels of complacency were insane. In 2007, The London Times published a festive article called “The Great Moderation” which began with: “History will marvel at the stability of our era”. All those unhealthy measures were well accepted and speculation in every aspect continued.

The Federal Reserve (functioning as the central bank of the United States) and its chairman, Mr. Ben Bernanke didn’t expect any financial disaster or anything like that. They were blinded by pride and arrogance, belonging to the achievements of another era. The virtual success created by they was expected to be everlasting. The several manipulations of a fragile system and a currency backed by smoke were lethal for the already injured markets.

Even one of the most supportive journalist in this matter, Mr. Martin Wolf, said “If fiat money is not made to work better than it has, who knows what our children might decide to do in desperation. They might decide to bring back and embrace gold”. This was declared after publishing a lot of articles supporting the irresponsible measures. Also, in the quoted article, Wolf still declares an aversion to the Gold Standard.

Now, the real question is: this disaster was the product of the ignorance or corruption, or both? Because the manipulation of inflation rates and fiat money can’t be done without ignorance on the subject. The bubble would explode at any time. They had to know that and more. Were economic and financial principles ignored for pursuing a greater and private goal? We can always distrust on the Government actions and purposes and it is clear that they use in their favor the unstable fiat money, but they cause this disaster by design?

Some considers that the Gold Standard is a fundamental element of the freedom, because offers security, and better than that, offers the capacity of saving and creation of wealth being independent of Government actions, politics, measures and intentions. The State must be guarantor of security and justice, not of choosing without foundations the value of the national currency or the prices increases. This is what happens when Government and banks team up and decide to oppress the people in a way that they don’t even realize.

When a country hoards millions of tons in gold and reflects the value inside their vaults into their currency, making every bill a representation of that wealth, you get financial safety and the Government gains trust. When your bank account shows numbers that are only that, numbers, no one can have safety. They are living day after day in a house of cards, built by speculators. The consequences of these financial politics are alive to this day. The Gold Standard works hand by hand with democracy and with all the freedom principles proposed in the Constitution.

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Gold and the Feds

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Everybody knows that federal banks have a lot of ‘pull’ on the state of the economy, however how these institutions affect the prices of gold is an entirely new paradigm. Federal Banks or central government controlled banks and the International Monetary Fund (IMF) are major forerunners that determine the prices of gold despite the daily London Gold Fix that takes place daily in London. According to statistics released by the World Gold Council at the end of 2004 19 to 20 percent of all the gold above ground was held by Federal Reserve’s through the world. Central banks as well as official government sanctioned organizations held the official role as official gold reserves.

The decade long Washington Agreement on Gold (WAG), which was put into effect since September 1999 to 2009, limits the sale of gold at a ceiling benchmark to 500 tons or less. The members of this treaty were comprised of Europe, United States, Japan, Australia, and Bank for International Settlements and the International Monetary Fund. During the tenure of this treaty over the decade European central banks mainly banks such as the Bank of England and The Swiss National Bank, were the primary gold sellers to eager gold buyers. The viability of this treaty caused it to be extended to a further five year period beginning in September 2009 up to September 2014. However the extension also saw the further reduction of the limit of gold sales by twenty percent to 400 tons of gold that was sell-able.

Although huge amounts of gold reserves are stored in these vaults, most of the gold does not belong to them. The gold is tangible assets that are owned by corporations and foreign governments. The Federal Reserve Bank of the United States of America and Ford Knox collectively is said to have 50,000 tons of gold stored in their vaults. Of these 50,000 tons of gold only 10 percent of it belongs to the government of the United States of America, the rest yet again belongs to foreign governments and huge private corporations. Gold is the safest way to secure assets of any form. Be it property, cold had cash or stocks of goods and services, none of which are as tangible as the precious metals that include primarily gold, silver, bronze and copper.

The economy of the world depends on the stability of gold prices to be able to function in a healthy manner. Erratic and irresponsible speculations are the sole reasons for the prices of gold to become volatile and drive its value up and leave inflation in its wake.

Buying Gold / Selling Gold Economic Financial System

Is Warren Buffett confused about Gold?

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Warren Buffett is a well respected man in the financial world. People generally listen to what he has to say. He is after all the oracle of Omaha and everything he touches turns to gold. However, Buffett is not a fan if the yellow metal and he goes to great lengths to explain to people why he believes investing in gold is not a good idea.

Every year, Buffett sends a letter to his Berkshire Hathaway shareholders to share with them some of his wisdom about investing and financial management. His yearly missive just landed in the mail recently and as expected, he implores investors to put their money in stocks rather than gold.

Buffett started investing in the stock market in 1942. According to him, he started off by buying shares that were $114.75. He says that if those shares had been invested in a no-fee S&P 500 Index fund they would have a value of $606,811 today.

Had he used the amount of money to protect himself financially by buying gold, he would only have been able to get 3 1⁄4 ounces of gold. The gold would only be worth $4,200 which is less than 1% of the money he would have made had he invested in a no-fee fund.

Thee problem with Buffet’s illustration is that there was no S&P 500 index in 1942. The S&P 500 index only began in 1957 and non-fee funds only became available in 1976. In addition to that, Buffett would not have been able to buy gold because Franklin Roosevelt had already declared that private individuals could not own gold.

Buffet’s illustration also neglects to mention that the price of gold was tightly regulated for 30 years after 1942. The price was fixed at $35 an ounce and $42 an ounce between 1934 and 1971. During that time, America was trying to dig itself out of depression and recover from the wars. Public company shares were free to appreciate. However, there were only 60 companies of the 500 that initially made up the S&P Index in 1957. The share price of many of these firms plummeted to Zero dollars. Buffett sidesteps these facts in his comparison and makes it sound like shares of any stock would become more valuable than an ounce of gold sitting in a vault for a couple of years. What he fails to acknowledge is that gold is more reliable than stock in the long run. Another mistake that Buffett has made in his analysis is to think of gold only as an investment asset when it is so much more. Gold is treated as money that is more valuable than any fiat currency by central banks and governments. There are different ways of owning gold. You can buy gold bars or buy gold bullion coins and rounds or even own gold in the form of jewellery.

 

When you take all of the above into consideration you can see the holes in Buffet’s analogies. It would have been fairer had Buffet compared buying stocks to keeping the dollars in a savings account rather compare it with gold. However, that would make gold look compelling which is not what The Oracle of Omaha wants you to believe.

 

The reality is that gold has been a better investment that stocks for year. It outperformed the S&P 500 during the 1970s. Gold is money. Currencies can lose their value able but this yellow metal never does .

 

Sources:

https://www.fin24.com/Economy/World/read-warren-buffetts-just-released-annual-berkshire-hathaway-shareholder-letter-20190223

https://markets.businessinsider.com/commodities/news/warren-buffett-bashes-gold-2019-2-1027977003