Gold and Global Tensions – The Ground Shifts Beneath Global Markets And Few Realise It
25th April 2019
Tectonic shifts in how our world works are rare. When they do occur, they throw up the possibility of profound change and realignment.
In 2008, the world experienced one of the greatest financial turmoils in history due to the accumulation of debt that became unsustainable, markets around the world started crashing and major financial institutions, once thought invincible, started showing signs of collapse. Central banks like the US Federal Reserve, the Bank of England and the European Central Bank responded by introducing Quantitative Easing and slashed interest rates to historic lows whilst governments issued massive bailouts and stimulus packages in an effort to keep each of their economies, thus the world economy, afloat. And it worked.
The global economy has recovered quickly, expanding financial markets to new all-time highs over the last 10-year bull market. Global property prices have also reached record highs over the same period. Yet, economic growth has struggled to recover whilst inflation has risen faster than wages. The levels of government, corporate and household debt have increased rapidly. Global debt has skyrocketed from $84 trillion in 2008 now to nearly $250 trillion.
The massive build-up of debt in the global economy tells us the next recession will be greater than before. During this time, global demand for gold has also been steadily increasing, primarily from the east.
Putting aside the exhaustive ‘russian menace’ narrative, Russia has spent the past decade buying gold. A lot of gold. From 2000 until mid-2007, Russia held only 400 tonnes of gold in its official reserves. As the global economy began to weaken in late 2007, it’s policy on gold shifted to one of aggressive buying. Russia now officially holds 2,167.9 tonnes. Within the span of just a decade, Russia has quadrupled its reserves to become the world’s 5th largest gold holder. As one of the world’s biggest gold miners, domestic Russian gold buying in 2018 even exceeded mine supply for the first time, Russia’s buying is so voracious it’s about to become a net importer of metal.
According to the IMF, China has tripled it’s official bullion reserves from approximately 600 tonnes in 2007 to over 1,850, now the world’s 6th largest gold holder.
However whilst China does not export gold, it’s actually the world’s top gold miner. Producing 404 tonnes in 2018, there is a distinct possibility that China may be under-stating its official gold reserves this past decade by an nearly 4,000 tonnes. If true, can you imagine the effect this would have on current gold prices?
In contrast, US officially holds over 8,000 tons of gold which has remained static for nearly 50 years, but questions over the quality and actual quantity of gold is increasing due to lack of transparent auditing. Since 2008, the US has conducted QE which has seen total US public debt surge to over $22 trillion, with annual deficits now normally running at over $1 trillion.
The UK last bought gold in 1998 but between 1999-2002 (at the time, gold was less than $350 per ounce), then-Chancellor of the Exchequer Gordon Brown sold half our reserves therefore the UK today holds less than 320 tonnes whilst public debt has tripled to £1.8 trillion.
Countries in the Eurozone have been absent gold buyers as well, despite the ECB increasing debt by €2.5 trillion. That being said, Germany has withdrawn its gold held in the US back to their own custody and last year Hungary suddenly bought more gold than its held since 1947. Currently, Italy is passing a law to seize the country’s gold reserves from its own central bank.
The next time the global financial system comes under stress – and that time may not be far away – where the gold is, and who owns it, will be of great importance.
With Rising Economic Uncertainty Comes A Rise In Geopolitical Tensions
The US dollar has been the world’s reserve currency since 1944. It’s used to settle nearly all international trades and most central banks around the world hold assets denominated in the dollar as part of their reserves. International transactions are handled by the SWIFT payment system. This gives the US a strong dominance over international affairs and capital flows, control over ‘who’ can trade and ‘what’ can be traded within the global system dubbed the ‘free market’. Another word for this is hegemony.
Restricting the right to trade and threatening of sanctions aren’t helpful when the US and western markets are struggling to produce economic growth. Amidst these rising tensions, the development of alternative financial systems become more desirable once the current system can no longer be trusted as before.
In recent years, the US has increasingly used financial sanctions against those it doesn’t approve of – accusing them of malign activities. Russia has been sanctioned repeatedly over the past few years and China is in a dispute with an increasingly protectionist US imposing trade tariffs on their exports. Since 2010, both countries began using their own national currencies for bilateral trade instead of the US dollar. In 2014, Russia announced it was building the System for Transfer of Financial Messages (SPFS), a domestic alternative to SWIFT. That system now handles the financial transfer of more than half of Russia’s financial institutions.
“The number of users of our internal financial messages’ transfer system is now greater than that of those using SWIFT. We’re already holding talks with China, Iran and Turkey, along with several other countries, on linking our system with their systems”Anatoly Askakov, Head of Russia’s parliamentary committee on financial markets – Nov 2018
China launched is own international payment system in 2015, known as China International Payment System (CIPS), which serves cross-border yuan transactions. In other words, China wishes to settle international trades in its own currency rather than the US dollar.
Since then China signed a series of bilateral settlement agreements with trading partners to pay for goods, particularly oil, in yuan. In 2018 China began transacting oil futures in yuan, and since then china’s futures contracts have overtaken in volume terms the dollar-denominated oil futures traded in Singapore and Dubai.
The US also pulled out of the international agreement with Iran over its nuclear program last year and has reimposed sanctions, using SWIFT to block all Iranian transactions. In January, wishing to continue with the agreement, the EU (Germany, France and the UK), created their own alternative to SWIFT called INSTEX (Instrument In Support of Trade Exchanges) to allow non-dollar transactions with Iran. The US has announced it sanction ANYONE who trades with Iran.
The threat of sanctions is also currently being used against European companies involved in the Nordstream 2 pipeline project to ship Russian gas to an energy-hungry Europe. The US opposes this, preferring Europe to import more expensive liquid natural gas across the Atlantic from them instead.
Like all countries, Russia and China’s economies are dependant on trade which means currently they have to use the US dollar to settle transactions. Russia exports energy to Europe and China runs a global trade surplus in good and services. To reduce trade in the dollar, as well as protect their economies from increasing uncertainty in the global economy they would need to ensure they had a way to trade with foreign markets using their own currency. They are already building it.
Maybe it’s just too big and complex to fit into the evening news but there has been little to no media coverage over the biggest and most ambitious infrastructure project the world has seen that according to Bloomberg has already cost more than the U.S. Marshall Plan that rebuilt Europe after World War II.
First announced by China in 2013, the ambitious vision is to resurrect the ancient Silk Road as a modern transit, trade and economic links extending more than 8,000 miles across the continent. The plan involves building high-speed railroads and highways, energy transmission and distribution networks for oil and natural gas, with cities along the route targeted for economic development. In addition to the land-based ‘road’, is the development of a sea-based ‘road’, linking China with Africa, the Persian Gulf and the Mediterranean sea through the South China Sea and Indian Ocean.
Although it will take years to fully realise, this exceptionally ambitious project is already underway and when completed, like its ancient predecessor, it will connect three continents: Asia, Europe and Africa. It will create the world’s largest economic zone, covering over a third of the surface of the earth, 4 billion people and an estimated $41 trillion in annual GDP.
KEY POINTS SO FAR
- §US and western economies conducted money printing (QE) to spur economic growth. 10 years on, growth remains stagnant whilst global debt levels have reached epic proportions and may be reaching saturation point.
- Non-western economies have been aggressively buying gold and making huge efforts to reduce their economic exposure to trading in the US dollar. (De-dollarization) If this trend continues, the demand for the US dollar and thus its value in global trade will decline
- Rising geopolitical tensions are spurring the development of alternative payment systems in the EU, Russia and China and development of China’s BRI is creating a growing market that bypasses using the U.S. dollar.
So What Does This Have To Do With Gold?
Everything – (financially speaking). With the shift of gold from west to east, we are seeing wealth and power follow. Gold’s importance as the bedrock of global wealth is occurring before us in real time. Quantitative easing policies by many central banks over the last decade have inflated financial asset prices at the expense of real economic growth. With interest rates still at historic lows, wage growth has struggled whilst inflation continues to raise the cost of living. The subsequent amount of debt in all sectors of the economy has skyrocketed, but with stagnant economic growth and recession fears increasing, the ability of many economies to pay off any of their existing debt is rapidly deteriorating.
As global tensions have risen, ‘de-dollarization’ efforts have increased: building new trade routes, creating financial systems that use their own national currencies in conducting trade, and finding an increasing global appetite for such alternatives. China has been particularly transparent in its desire to see the yuan gain larger use in settling its own international trade.
This is a threat to the US dollar, since less use (demand) in global trade means its value would drop.
It’s likely that gold plays a role in this ambition, since China and Russia clearly place great strategic importance on the precious metal. If either were to even partially back their currencies with gold (a gold standard), they would likely gain further favour around the world as reliable reserve currencies when viewed against the U.S. dollar, pushing gold prices significantly higher than their current price.
If you were a selling something to a foreign buyer paying in his/her currency, would you be more comfortable being paid in one backed by gold or one backed by trillions in debt?
There’s an increasing possibility that the next recession will shake confidence in many currencies characterised by extreme levels of debt in their economies. In the next downturn, what will the response be from our central banks – conduct more QE? With global debt in 2019 already at a record $244 trillion, would markets accept the creation of even more debt to pay off existing debts? As I mentioned earlier, ‘who’ owns gold, and ‘where’ its owned is important because all roads are leading to significantly higher prices as the world faces increasing challenges to financial stability, not less.
Is it still a wonder why precious metals have been rising higher overall the past few years? Why is the inherent risk and opportunity in all this so difficult for many to acknowledge?