In the 19th century, the Gold Standard took place and lasted until the First World War. It was partially reestablished during the interwar period. The Great Depression of the 1930s brought the gold standard to a final end.
In that era, the world subscribed to the Gold Standard which implied specific rules for the system of international payments. International payments lead to gold transfers between countries. Banque De France explains in its Focus (authored by Gong Cheng, Laurent Ferrara, Yannick K and Pascal T)
When a country runs a balance of payments deficit (surplus), it has to make (receive) a payment in gold. Domestic gold holdings decrease (increase) and domestic money supply contracts (expands). Domestic money supply is thus determined by the balance of payments. This provides an adjustment mechanism to external imbalances. Suppose for instance that a country runs a trade deficit. This leads to a decrease in gold holdings and a monetary contraction. This contraction generates a decrease in domestic prices. With lower relative prices, the country becomes more competitive and its current account is brought back to balance. This adjustment mechanism was described by David Hume in his famous 1752 essay.
However, the Gold Standard met its ending with the major economies moving away and after the Second World War, the Bretton Woods system replaced the gold standard. Instead of a gold parity, countries announced a fixed but adjustable parity to the dollar, which in turn was initially fully convertible into gold.
While there were many advantages but it got several drawbacks, which would probably turn out to be very dangerous and a source of instability for the world economy.
What led to Gold roaring a high of $ 1,431.25?
No doubt the financial crisis prompted investors in lapping up gold in big denominations; the back end analysis shows that the assets soared of Gold ETFs accumulating the major portion of world gold output. Globally, the 10 biggest such funds now hold a combined 2,113 metric tons of gold, more than the official reserves accumulated by every country in the world save four: the U.S., Germany, Italy and France. India and China hoard of major portion of gold outputs. Recently, the Central Bank of India, RBI bought a major portion of gold which also helped in showing investors’ interest in gold.
The story goes as below:
James Burton, the then Chief Executive Officer of California Public Employees’ Retirement System (CALIPERS) didn’t invest a penny in Gold of the total assets of $ 142.8 billion managed in 2002. The quiet obvious reason – the yellow metal had been in a bear market for two decades.
Christopher Thompson, the Chairman, World Gold Council convinced him to help in allowing investors to buy a previous metal they had shunned for generation. The key was dividing bars of gold into securities tradable on the New York Stock Exchange. And thus, the SPDR Gold Trust got its way and found the cheapest way of holding gold which now holds around 1,299 metric tons of gold valued at $ 57 billion, more than Swiss central bank. Their popularity (number of other Gold ETFs) helped driving unprecedented gains for the precious metal which can go even higher, as per analysts.
Should we continue subscribing to it?
Gold’s worth is determined by fears of inflation or financial collapse. Unlike other eatable assets which are determined based on economic factors, gold’s true value is hard to judge for retail investors. In India, the demand will be factored by its sparkle coupled with the ETF demand.
Happy Reading!
Amar Ranu
