Here’s the problem with the debt crisis in Europe…
Every time we see another ailing European nation bailed out, the stakes get higher and higher. As the debt piles up, so do the interest payments. And everyone begins to wonder how long the likes of Greece and Spain can keep up.
If this were a standard loan, like a bond, you would expect some collateral for all this debt – a mortgage over some property, or at least a contractual commitment that’s darned difficult to wriggle out of.
But sovereign bonds come with neither. There’s no collateral and a government can always re-write the contractual rules. The upshot is a growing demand that any new bail-outs must come with some sort of security.
That has many people talking about gold. After all, historically it was the gold standard that provided this security for currencies. So are we, ultimately, heading back to a gold standard?
Well, yes… and no.
Today I want to show you my roadmap for how gold ends up back in the financial system. It won’t be a fully-fledged return to the gold standard. But I do think we will see some serious stockpiling by global authorities in the year ahead. Here’s why…
Let’s start by considering what kind of collateral the ailing European states can offer.
Well, first they could offer a solemn promise to repay these loans in full. Would that be enough? Certainly not. The German economy isn’t keen on handing over its hard-earned cash on vague promises offered by southern European nations.
So what else? Buildings, plant and machinery? No, too messy; and they’re not exactly mobile. The same problem applies with property. Despite their best efforts, the Greeks are unlikely to be able to sell enough islands to cover their debt payments.
Luckily the Germans have a solution. An influential report by a group of German economists, the so-called ‘German wise men’ has come up with a cunning plan to securitise any new bonds coming out of the southern European states.
The euro rules state that no nation should run up a debt of more than 60% of GDP. Effectively, any debt above this level is simply not allowed. So, the wise men say that any borrowings over and above this amount should be collateralised by the nation’s gold holdings.
They say that if they want nations like Germany to stand behind any new bonds to help finance economies like Italy, or Spain, then they must pledge their gold as collateral.
The good news is that these countries actually do have gold to pawn.
In fact, this is one way I see gold drifting back into the system. And I’m not the only one who sees it that way. Many lenders aren’t hanging around. They’re already picking up gold in anticipation…
Data from the World Gold Council reveals that central banks, largely from the emerging markets, are diversifying their currency reserves by going back into the classic reserve: gold.
It’s estimated that China bought around 490 tons of gold during 2011 – double the estimated 245 tons bought in 2010.
And latest International Monetary Fund figures show the central banks of Kazakhstan, Russia, Turkey and Ukraine were among those who added to their gold bullion holdings last month, reports BullionVault.
In fact the central banks have little choice. The real return (after inflation) on even the most robust government bonds right now is negative. And that places central banks in a bind. They need to diversify their assets. And what better than gold – the money that is no one’s liability. Not only is gold the international currency of central banks, it’s also portable and it comes with no strings attached.
As the financial system continues to convulse, lenders will want to see tangible security to back a bond. If they can’t get it, then they’ll just go for gold itself.
Remember the golden rule… The one that holds the gold, makes the rules!
Ok, so gold is working its way back into the financial system. But that doesn’t mean you should expect to see it in everyday use. Frankly, the world has moved on from the days of gold ducats, florins and sovereigns. If anything, money is going virtual. Soon all manner of things from phones to thumb-prints will be used for transactions of digital money.
The fact that gold is heading into the system to settle international trade balances doesn’t affect you directly. But it does affect the value of our currency on an international stage – and that certainly affects you.
Without the collateral to back a currency, the currency becomes worthless. Think about gold as the score-card among the central banks. Nations doing well get the gold – and their currency appreciates.
Gold gives you a chance to maintain your personal purchasing power. You can put your money into the same asset as the wealthy central banks of the emerging nations. You can be your own, private central bank.
Because of how gold’s traded, the gold price can fluctuate massively… that’s unfortunate. But I suspect that over the long run, gold will maintain its bull path. After all, the gold standard is working its way back into the system through the back door.
Bengt Saelensminde
Contributing Editor, Money Morning
Publisher’s Note: This is an edited version of an article that originally appeared in MoneyWeek (UK)
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