Gold moving from West to East

The gold price has risen to a series of new all-time highs of late, a development that has received only cursory attention in the mainstream financial media.

But as is the case with so much else these days, there is much more going on than meets the eye. In fact, the rise in the dollar price of gold is almost the least interesting aspect to this story.

For thousands of years, gold was the ultimate store of value and was synonymous with the concept of ‘money’. Trade was often settled either in gold itself or in bank notes backed by gold and directly exchangeable for it.

Currencies backed by nothing but government decree – called ‘fiat’ currencies – have tended to eventually fail.

However, in 1971, after the Vietnam War bankrupted the USA, gold found itself cast out of this ancient role when the Washington DC unilaterally suspended dollar convertibility into gold as enshrined in the Bretton Woods agreement that established the framework for the post-war economy after the Vietnam War enhanced bankruptcy of the USA.

Shortly thereafter, in an act that medieval alchemists only dreamed of, gold was created out of thin air in the form of futures contracts, meaning bullion could be bought and sold without any metal changing hands – or even existing.

Besides the obvious ramification of all of this – the removal of gold backing to the dollar and thus implicitly to nearly all currencies – there are two important features of how the gold market has subsequently functioned:

First, gold has essentially been reduced to trading like any other cyclical financial asset; second, the price of gold has largely been determined by Western institutional investors.

Both of these longstanding trends are now breaking down. As we will see, the importance of this development is hard to overstate.

But let’s begin with a very quick examination of how gold went from being the ultimate source of value to just another ticker moving in predictable patterns in the constellation of financial instruments.

The collapse of Bretton Woods in the late ‘60’s and early ‘70’s – culminating in the gold window being shut in 1971 – was a messy period of transition, uncertainty, and instability.

The dollar devalued and a fixed-rate system was negotiated and soon thereafter abandoned. But what was clear was that the USA was steering the world away from gold and toward a dollar standard.

So the US government had a strong interest in managing the perception of the dollar through gold. Most importantly, it didn’t want to see gold recreate a pseudo reserve currency by strengthening substantially.

Legendary Fed chairman Paul Volcker once said “gold is my enemy.” And indeed it traditionally had been the enemy of central banks: it forced them to tighten rates when they didn’t want to and imposed on them a certain discipline.

The fractional-reserve paper gold scheme that persists to this day. And indeed, there is now vastly more paper gold than physical, some $200-300 trillion compared to $11 trillion, according an estimate by Forbes magazine.

Others put the discrepancy even higher. Nobody really knows. Comex, the primary futures and options market for gold, has also become more paper-driven.

According to analyst Luke Gromen, whereas 25 years ago some 20% of the gold volume on Comex was related to a physical ounce, that number has fallen to around 2%.

What is important to understand here is that the creation of a derivative market satisfies demand for gold that would otherwise go to the physical market.

Only a limited amount of gold exists and can be mined but an unlimited amount of gold derivatives can be underwritten.

As Gromen explains, when monetary expansion drives demand for gold (due to the inflation this brings), there are two ways this demand can be dealt with: let the price of gold rise as more dollars chase the same amount of gold;

Or permit more paper claims to be created on the same amount of gold, which allows the pace of gold’s rise to be managed.

So coming into focus is a picture of Western institutional investors responding like Pavlov’s dogs to rising interest rates and ditching gold in favor of higher yielding assets such as bonds, stocks, money market funds – you name it.

And normally, like clockwork, this would have driven the price down.

Let’s now zoom out a little bit and try to put this into some kind of perspective. The first obvious point here is that gold pricing is increasingly being determined by demand for physical gold rather than mere speculation.

Let’s be clear: the People’s Bank of China is not loading up on 25:1 leveraged gold futures contracts with cash settlement. Neither is Russia. They’re backing trucks laden with the real thing into the vaults.

And in fact we have seen net exports from wholesale markets in London and Switzerland – i.e. representing Western institutional gold. That gold has been moving East.

This will, of course, further debase the dollar. For those holding significant amounts of dollar assets, such as China, this is a grim outlook, and it goes a long way toward understanding the current gold-buying spree.

Another aspect to this is that as BRICS countries increasingly trade in local currencies, a neutral reserve asset is needed to settle trade imbalances.

In lieu of a BRICS currency, which may or not be forthcoming in the near future, Luke Gromen believes this role is already starting to be performed by physical gold.

If this is the case, it marks the return of gold to a place of prominence in the financial system, both as a store of value and a means of settlement. This, too, represents a hugely important step.

As these momentous tectonic shifts take shape, the gold selling by Western investors over the past two years has something of a feel of throwing one’s lot in with the Habsburgs around 1913.

The denizens of Wall Street have been slow to understand that the wheel has turned. Mainstream Western analysts have repeatedly expressed surprise that the relentless pace of central-bank purchases has not abated.

The hurricane that is bearing down upon the Western world is the debasement of the dollar owing to the weaponizing of the financial system and the spiraling US debt crisis.

These are epochal developments that have combined to break the familiar financial world beyond repair.

The flow of gold from West to East is both a real transfer of wealth, but it is also symbolic of just how profoundly the West has been underestimating the significance of what is happening.

RT. com / ABC Flash Point News 2024.