Satyajit Das: L’Age d’Or, Part 1 – “A Barbarous Relic”

By Satyajit Das, derivatives expert and the author of Extreme Money: The Masters of the Universe and the Cult of Risk (2011)

In Germany, gold is now available from vending machines in airports and railway stations – Gold to Go. Shoppers can buy a 1 gram wafer of gold or a larger 10g bar. Seeking safety for their savings, individuals have purchased 150 tonnes of gold, mainly in the form of coins. Investors poured money into special funds (known as exchange traded funds (“ETFs”)) which pool investor monies to buy over 1,000 tones of gold.

Having earlier sold off their holding, some central banks are now re-building their gold reserves.

Refiners are unable to keep up with demand for gold bars and coins. New gold vaults are being built to accommodate demands for secure storage.

As the Global Financial Crisis continues and the cure of easy money proves as dangerous as the disease, the gold price has increased from around $250 per troy ounce in 2001 to a peak of around $1,900 in 2011. It now trades at around $1,750 per ounce.

As poet John Milton wrote: “Time will run back and fetch the age of gold.”

Gold’s Hold …

Gold, chemical symbol Au and atomic number 79, is a dense and malleable lustrous metal. It is highly ductile and does not rust in air or water making it useful in dentistry and electronics.

Gold is edible. It can be beaten into super thin often translucent sheets – a single gram can be beaten into a sheet of one square meter, or an ounce into 300 square feet. Gold beaten into super thin paper covers certain Indian sweets. But unless you are in need of a lot of dental work or require a golden Pharonic sarcophagus for your trip to the next life, the actual use of gold is limited.

Gold has qualities desirable in money – it is rare, durable, divisible, fungible, easy to identify, easily transported and possesses a high value to weight ratio. Gold and other precious metals, particularly silver, formed the basis of all money for substantially all of recent human economic history. Only since the early 1970s has pure paper money been the monetary lingua franca of the world. For some, gold coinage remains the only real money, universally recognised and acceptable as money and exchangeable for goods or services and a true store of value.

Gold’s hold on humans is complex. Nowhere is this more evident than in India where gold is deeply embedded in the culture.

All major events in life require the giving of gold. A child’s baptism or eating of its first solid food, usually rice, requires offerings of gold. Marriage traditions require a dowry of gold treasure – heavy necklaces, ornate bangles, dangling earrings, jewel-encrusted rings, delicate headpieces and saris woven with gold thread.

Beyond its cultural significance, for Indians gold is the ultimate store of wealth that can be pawned or used as security to raise money quickly. For Indian women, gold may also be the only real property of their own and hope of financial security – their only “nest egg”.

Dowry related violence and abuse is not uncommon. For less fortunate families, the inability to provide an adequate gold dowry restricts the choice of husband in a society where the majority of marriages are arranged by parents. In many cases, the requirements of the gold dowry is beyond the means of parents condemning daughters to an unmarried life or forcing the parents to take on debt from usurious moneylenders to avoid the shame of an unmarried daughter. Female infanticide and selective abortion is also common to save families from the burden of a daughter.

Golden Conquests…

Throughout history, gold and silver’s monetary role has conferred extraordinary riches on those who control it and was once the key to wealth and economic dominance. Thirst for gold fuelled war and conquest. As King Ferdinand V of Spain once commanded: “Get gold, humanely if you can, but at all hazards get gold”.

The Spanish, who followed Columbus, took around half a century to strip the major treasures of gold and silver accumulated by the indigenous people of South and Central America. In the process, the Spanish enslaved and virtually wiped out the rich Indian nations until they literally ran out of things to loot.

The Spanish melted gold and silver artworks and cultural icons into ingots to ship back to Europe saving only a few pieces. Albert Durer, the German artist, who saw some of the artefacts before they were minted into coins observed that: “All the days of my life I have seen nothing that rejoiced my heart so much of these things, for I saw amongst them wonderful works of art and I marvelled at the subtle ingenia of men in foreign lands”.

Today, armed groups fight for control of gold mines in the Democratic Republic of Congo. The earnings from gold mines are the currency that allows the purchase of weapons and finances wars. Governments have sanctioned forcible eviction of local people and small-scale miners to make way for large commercial gold mining operations in Indonesia and Peru.

As the more easily accessible rich deposits of gold have been exhausted, mining gold in more remote, inhospitable and often more fragile environments increasingly leads to irreversible damage. Mining flattens mountains and destroys pristine forests. Extracting a single ounce of gold sometimes requires mining around 250 tones of ore and rock. Mercury, used to separate gold from the ore, is highly toxic. Gold mining generates probably more waste per ounce of metal extracted than any other comparable metal. The United Nations Industrial Development Organisation (“UNIDO”) estimates that a high percentage of mercury released into the environment is the result of gold mining.

Gold mines bring jobs, wealth and development. In poor countries, miners work in dangerous conditions sometimes deep underground (as deep as close to four kilometers (over two miles)). The temperature in these mines is around 35 degrees centigrade despite the tonnes of ice pumped into the mine every hour. The work is dangerous and the rate of death amongst miners is high. In small scale, artisanal gold mining, safeguards are fewer and the risks higher. At Peru’s La Rinconada mine, miners have a saying: “Al labor me voy, no se si volvere”. It translates into “off to work I go I don’t know if I’ll make it back.”

Monetary Status

In the 19th and early 20th centuries gold played a key role in the international monetary system, being used to back currencies. The international value of each nation’s currency was determined by its fixed relationship to gold, with the precious metal being used to settle international accounts. The gold standard maintained fixed exchange rates that reduced the risk of trading with other countries.

Imbalances in international trade were settled by physical transfers of gold bullion. A country with a deficit (more imports than exports) would deplete its gold reserves and would thus reduce its money supply reducing demand for imports and boosting exports through lower prices. It is through this mechanism that the trade deficit adjusted. A country with high inflation lost gold as holders converted paper into gold decreasing the amount of money available reducing the inflationary pressure.

The system operated more or less continuously although from time to time countries went off the gold standard. Britain suspended the convertibility of pounds to gold in 1914 to fund military operations during World War I. A reluctant Winston Churchill, who was castigated by John Maynard Keynes, returned Britain to the gold standard in 1925 but abandoned it in 1931.

Monetary gold is in 400 troy ounce bars – each bar weighs about 28 pounds (about 11 kilograms). At the current price of $1,200/ ounce, each bar is worth $480,000. Each bar bears an assay mark recording quantity and quality of the gold and also the mint at which it was produced.

Gold bullion is stored in ultra secure vaults such as Fort Knox and the Bank of England in sealed lockers. Each locker belongs to an individual owner, perhaps, a central bank (the Bank of England, the U.S. Federal Reserve, the Bundesbank) or private banks (N.M.Rothschilds, Republic Bank of New York). At an appointed time, burly men dressed in drab gray uniforms move bars of gold using a combination of pallets and conveyor belts from one numbered locker to another in settlement of purchases and sales of individual sellers and buyers. This movement of gold bullion over the short distance had once signalled major changes in the fortunes and wealth of countries and kings.

In 1998, gold sceptic Warren Buffett pointed to the absurdity: “Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again, and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”

Wizards of Ounce….

In the 1890s, the issue of gold became central to the unlikely crusade of William Jennings Bryan, the populist Democratic Senator for the state of Nebraska and serial candidate for President. Southern farmers in the United States borrowed from North Eastern bankers to finance their farms, equipment and crops. The debt had to be repaid in gold. As gold prices rose and the price of farm produce fell, the farmers earnings fell and their debt repayment grew fuelling resentment of the bankers.

The U.S. was debating whether a gold standard should be adopted. The farmers wanted more money in circulation and advocated silver as well as gold currency – known as “bimetallism”. Bryan took up the cause and at the 1896 Democratic convention spoke passionately: “You shall not press down upon the brow of labor this crown of thorns. You shall not crucify mankind upon a cross of gold.” Bryan was defeated in the 1896 and 1900 election by William McKinley and the U.S. adopted the gold standard in 1900.

The Bimetallism debate spawned Frank Baum’s iconic work the Wizard of Oz, a satire on the currency debate. The Wizard of Oz is actually the Wizard of Ounce (of gold).

Dorothy, the Kansas farm girl, represented rural America. The Scarecrow, Tinman and Cowardly Lion represented farmers, factory workers and Bryan respectively. Dorothy and her companions’ journey down the golden road to fairyland is the 1894 Coxey march of unemployed men (named after its leader Jacob Coxey) to secure another public issue of $500 million of paper money and employment. The wizards and witches are evil bankers and politicians. The wizard was a caricature of Marcus Hanna who was widely seen as the controlling force of the McKinley administration’s economic policy.

Baum’s plot has Dorothy and her companions exposing the evil wizards and witches for frauds and establishing a new monetary order based on gold and solver. Dorothy returns to Kansas City courtesy of her magic silver slippers. In the film, version, Dorothy’s slippers are red in a concession to Hollywood cinematography.

Dorothy, Meet Mr. Goldfinger!

The problems of gold as a currency also dominate Ian Fleming 1959 work Goldfinger. James Bond, Agent 007, is sent to investigate and inevitably “terminate with extreme prejudice” Auric Goldfinger, the mysterious Swiss financier who is smuggling gold. Goldfinger’s real plot is to boost the value of his gold through an audacious attack on the Fort Knox gold depositary.

In the film version, the attack features lethal nerve gas to be sprayed from a squadron of crop duster aircraft. The pilots are a bevy of buxom lesbian beauties led by a female villain, the unlikely Pussy Galore, played by Honor Blackman.

Goldfinger’s plan entailed contaminating the gold by exploding a nuclear device –a dirty bomb in the age of terror. Goldfinger’s own stock of uncontaminated gold would increase in value astronomically in the process. Bond discerns the plot through dazzling mental arithmetic – Fort Knox’s $15 billion dollars of gold equated to over 400 million ounces which would weigh around 12,000 imperial tonnes making it difficult to carry off.

In Goldfinger, Colonel Smithers explained the monetary role of gold succinctly: “Gold and currencies backed by gold are the foundation of international credit…We can only tell what the true strength of the pound is… by knowing the amount of [gold] we have behind our currency.”

The monetary status of gold even attracted Oscar Wilde who in the Importance of Being Earnest has Miss Prism, the tutor, instruct her pupil as follows: “Cecily, you will read your Political Economy in my absence. The Chapter on the Fall of the Rupee you may omit. It is somewhat too sensational. Even these metallic problems have their melodramatic side.”

Barbarous Relics…

In July 1944, politicians, economists and bankers gathered in Bretton Woods, New Hampshire at the Mount Washington Hotel, to establish the post-Second World War international monetary and financial order. The pivotal figures were the famed economist John Maynard Keynes, representing the UK, and Harry Dexter White, representing the USA. White was an economist, a senior US Treasury department official and probably a Soviet spy.

The gold standard was not feasible for the post-war economy. There was insufficient gold to meet the demands of growing international trade and investment. The communist Soviet Union, emerging as a rival to the U.S. in the post war order, also controlled a sizeable proportion of known gold reserves.

Keynes, who famously described the gold standard as “a barbarous relic”, proposed a bold and imaginative solution – a world reserve currency (the “bancor”) administered by a global central bank. White, representing the world’s richest nation and then the biggest creditor, rejected the proposal: “We have been perfectly adamant on that point. We have taken the position of absolutely no.”

The U.S. was now the undisputed pre-eminent economic and military great power. She sought a leading role in global monetary affairs. The British and the French had been devastated by two World Wars. They were unable to compete and needed American money to rebuild their economies. White’s view prevailed.

The meeting wanted the advantages of the gold standard without the disadvantages. Bretton Woods established a system of fixed exchange rates using the U.S. dollar as a reserve currency. Countries would establish parity of their national currencies in terms of gold (the “peg”) and maintain exchange rates within plus or minus 1% of parity (the “band”).

In practice, other countries would peg their currencies to the U.S. dollar as the principal ‘reserve currency’ and — once convertibility was restored — would buy and sell U.S. dollars to keep market exchange rates within plus or minus 1% of parity. The U.S. dollar, effectively, took over the role that gold had played in the international financial system under the gold standard.

The U.S. dollar was to have a fixed relationship to gold ($35 an ounce). The U.S. government committed to fully convertibility. They would convert dollars into gold at that price. This was the gold standard once removed. The dollar was now “as good as gold”. It was more attractive as dollars unlike gold earned interest. The U.S. dollar reigned supreme as the world’s currency.

Barbarism – gold – had triumphed. Keynes was defeated. George Bernard Shaw observed: “You have to choose between trusting the natural stability of gold and the… honesty and intelligence of the members of the government … I advise you, as long as the capitalist system lasts, to vote for gold.”

Collapse…

The Bretton Woods system was ultimately undermined by the decline in U.S. power. In 1944, the U.S. produced half of the world’s manufactured goods and held more than half its reserves ($26 billion in gold reserves of an estimated total of $40 billion). Over time, the burden of the Cold War and being at the centre of the global financial system weighed heavily on the U.S.

In the 1960s, President Lyndon Johnson’s administration refused to increase taxes to pay for the increasingly expensive Vietnam War and its Great Society programs. This increased dollar outflows to pay for the expenditures and created inflation. The dollar became overvalued relative to the German Deutsche Mark and the Japanese Yen, forcing the US to either devalue the dollar or impose protectionist measures, President Johnson recognised the problem: “The world supply of gold is insufficient to make the present system workable—particularly as the use of the dollar as a reserve currency is essential to create the required international liquidity to sustain world trade and growth.”

By the early 1970s, the ratio of gold available to dollars had deteriorated from 55% to 22%. Holders of dollar lost faith in the ability of the U.S. to back currency with gold. Increasingly deregulated, global money markets placed pressure on U.S. reserves as traders sold dollars seeking profit from devaluation. Traders redeemed dollars for gold.

On August 15, 1971, President Richard Nixon, not known for major economic initiatives, unilaterally closed the gold window making the dollar inconvertible to gold directly. The ‘Nixon Shock’, as it came to be known, was announced in an address on national television on a Sunday evening. Nixon was hesitant about interrupting the popular TV program Bonanza. The need to make an announcement before markets opened on Monday forced the President to risk antagonising fans of the cowboy drama.

Frantic efforts to develop a new system of international monetary management followed. The Smithsonian Agreement devalued the dollar to $38/ounce, with 2.25% trading bands. But the sale of dollars continued. By 1972 gold was trading at $70.30/ounce. Other countries began abandoning the link between their currency and the dollar. In February 1973 the Bretton Woods currency exchange markets closed. The world moved to the era of floating currencies with no link to dollars or gold. The age of gold was over, at least for a time.