MONEY AND THE CITY
The future of gold
Nicholas Davenport
It was observed last week that the price of gold on the free market jumped to its highest ever — $68f per ounce. It has risen nearly 50 per cent since last December when, as part of the Smithsonian agreement fixing the new parities, the monetary price of gold was raised from $35 to $38 per ounce. This sensational leap had nothing to do with the English sickness or the dock fever. It was due to increasing distrust of the dollar. As there are now stricter exchange controls making it more difficult to sell dollars in the exchange markets gold has become the best hedge for the dollar bears. What, you may well ask, is then the future for gold?
This fascinating question will not, of course, be allowed to come up for formal discussion at the September meeting of the IMF but it will be debated hotly behind the scenes. Everyone is suspicious of the French who are believed to be plotting a new role for gold when the monetary union of the EEC is finally reached, if ever it is. No one for the moment can be sure Which way the French cat will jump but it seems to me that while the world monetary and economic situation remains so unsettled no government will agree either to write up the monetary price of gold to, say, $70 or $76 per ounce or to demonetise gold altogether.
Take the first of these alternatives, Which the French have long been desiring and the Americans opposing. While it seems logical enough to double the monetary price of gold when there is not enough gold produced to meet the finance needs of an expanding world trade there is always the objection of the conservative Establishments that it would be dangerously inflationary at a time when most governments are already fighting a galloping wage-cost inflation. It would, for example, frighten the life out of the Bank of England which is already worried enough by the growth of its money supply. The Money supply figures to mid-June have Just been published and disclose a rise of over 40 per cent on an annual basis against a rise of 25 per cent per annum over the last three months. Of course, the Money increase in the value of the gold reserves which would resullt from doubling the monetary price of gold need not be pumped into the banking system. It could be put into a special Treasury account and sterilised, as the Americans did in 1934 when they wrote up the monetary price of gold from $20 to $35 per ounce. But what would be the point today of giving an enormous bonus to the producers of gold — South Africa and Russia — if the. central bank buyers of gold got nothing out of it?
The gold and SDR tranches of the IMF reserves would have to be written up in any case and the 'profit' on them might well be used in giving the developing countries credits for the purchase of goods from the developed countries up to the amount of each developed country's 'profit' in the IMF. This is the strongest argument that can be advanced for writing up the monetary price of gold and it is hard to see what valid objection the Americans could make to it.
Here it is important to bear in mind what proportions of the world's monetary reserves are held in gold and in so-called 'convertible' currencies. In the case of the UK's total reserves only £313 million are in gold, £384 million in SDRs (gold guaranteed) and £2,000 million in convertible currencies. In other words gold is roughly 25 per cent only of the total. This was the proportion paid in gold and SDRs when we had to settle recently with the central banks for their $2600 million support of sterling before the floating. For the would as a whole the gold proportion is much higher — nearly 35 per cent. The figures are roughly $45,000 million in gold and SDRs out of total of $130,0000 million.
This makes it very clear that gold has fallen back into the role of a mere adjunct in the monetary backing for the world's trade. It is paper which does the main job and to have confidence in the paper it is not only necessary to have confidence in the integrity of the government which issues the paper but to have faith in the purchasing power of the paper in terms of the goods of its own country. That is why the Americans cannot understand why foreigners will not accept a dollar standard. There is less inflation in the US than in other industrial powers because of the greater productivity of its labour.
When the hideous and inflationary Vietnam war ends and Washington can concentrate on its home economy the dollar could become once again the world's most stable currency.
It should now be clear why it might be as deflationary to demonetise gold as it might be inflationary to double its monetary price. If central banks began to unload some of their gold stocks on the free market — they have nearly $45,000 million of the stuff — the price would collapse and the world's potential buying power would shrink. The price has only just risen to $68 per ounce because the South African government has been withholding supplies from the market. I am not accusing Dr Diederichs of any deliberate intent to squeeze the market and force up the price. He has been trying to maintain the gold content of his reserves which have been pushed up by the inflow of direct and portfolio investment. At the end of December the gold content was around 70 per cent and, the end of June just over 50 per cent. It would have been lower if he had not taken in over fifty tons of gold this year instead of selling it on the free market.
It is all very well for the bulls of gold to argue that the demand for gold from commercial fabricators and the normal hoarders of the Middle and Far East now exceeds the output of the South African mines. The truth is that the free market is entirely in the hands of Dr Diederichs who can manipulate the price by withholding or dumping gold as he pleases. (We must not forget the unpredictable Russians who can do much the same thing.) Dr Diederichs actually withheld 45 per cent of the mines' output in the week to July 21. The recent jump in the price must therefore be regarded as freakish and unsustainable over the short term.
The bulls of gold shares must therefore watch their step. For the long term they are probably on a good wicket, for even if we regard gold as a mere commodity its price rise is negligible as compared with the rise in commodity prices as a whole since 1934, The average price received by the South African mines was $47 per ounce for the March quarter and $481 for the June quarter. The September quarterly results should be well up on these if Dr Diederichs releases, as he should, a much higher proportion of the mines' output. But South African gold shares are a highly specialised, and restricted market — now subject to the investment dollar premium — and the prejudice against South Africa grows rather than diminishes. If only we were free to buy a lovely bar of gold!
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