Vijay Kumar Gaba

In the US, banking panic started at regional level in 1930, with many smaller regional banks faced crisis. However, as Great Britain decided to leave the gold standard for GBP on 21 September 1931, the panic spread throughout the country. Foreigners became concerned that the US may also follow Great Britain and end gold convertibility of USD. There was a rush to convert USD into gold. The collateral was that depositors became concerned about the safety of their money and started withdrawing currency from their accounts. A global rush to convert USD into gold and an internal rush to withdraw currency from banks drained out the banking system reserves and choked the money supply – exacerbating the deflation and propagating the great depression. There was a spate of bank failures in the US during 1931-1933.

The Federal Reserve Bank of New York responded to the situation by hiking rates in October 1931, to encourage investors to deposit money in the US banks or buy US bonds. There was an immediate relief, but that did not last long. The Fed started buying bonds from the market in 1932 and hiked the rates again in February 1933. It did not help much in restoring the confidence of investors in USD. In March 1933, the Federal Reserve Board suspended the gold standard for USD; President Roosevelt announced a national bank holiday and suspended all outbound gold shipments. The provisions that allowed the holders of specific treasury bonds to convert their bonds into gold were also revoked (many commentators have implied this action to be a sovereign default by the US).

1931 was the first year in recorded history of the US when both US Treasury Bonds and US Stocks yielded negative returns in the same year. The following two years marked a watershed in the history of the US financial system.

Bretton Wood agreement of 1944, established USD as the reserve currency of the world. The agreement, inter alia, provided that all the participating nations would allow free conversion of their own currencies into USD at all times; and the US will allow conversion of USD into gold at a fixed exchange rate of USD35 per troy ounce of gold. At that time the US manufactured over half of the total global production, as most of Europe and Japan lay shattered due to WWII. Obviously no one objected to the reserve currency status of the USD.

In the next 25yrs, Germany and Japan made substantial progress. The US share in global GDP fell from 35% to 27% during 1950-1969. The US participation in the Vietnam war (1964-1970) took a significant toll on the US economy. Besides, other political efforts like “Great Society” etc., also weakened the US economy. The “reserve USD” became highly overvalued, impacting US exports and causing a sharp rise in trade deficit. The US was forced to print more USD to keep its obligation under the Bretton Wood agreement. This led to a sharp decline in the gold coverage ratio of the USD. The inflation also shot up sharply.

To stem the run on US banks, the Fed had increased its key policy rate to 9.75% by October 1969.

1969 was the second time in recorded history of the US when both US Treasury Bonds and US Stocks yielded negative returns in the same year. Two years later, in August 1971, president Nixon unilaterally abandoned USD peg to gold, hence rescinding the 27yr old Bretton Wood agreement. For other participants in the agreement, it was a virtual default on the part of the US. However, the advent of “petro dollar” a few years later sustained the reserve currency status of USD.

Presently, the USD is arguably highly overvalued. The Fed is hiking rates and reducing money supply. Inflation is high. The economy is on the verge of recession. Trade deficit is rising. Fiscal deficit is at an unsustainable level. The US share in the global economy is shrinking. Large trade partners of the US, like China, OPEC, Japan, etc. are exploring non-USD trade with other trade partners. The US is incurring huge costs in the Ukraine war. And 2022 is the third time in history when both US treasury bonds and stocks have yielded a negative return in the same year.

If history rhymes, we could see some material developments in the US and, perhaps the global, financial system. A sharp USD devaluation, replacement (or supplement) of USD with a new digital currency, end of petrodollar regime (and hence reserve status of USD) are some of the wild guesses I could make.

The First World War resulted in the decimation of some large empires like the Ottoman Empire, Russian Empire, and Austro-Hungarian Empire. By the end of the war, the map of Europe had changed dramatically. The communists had taken over power in Russia and neighboring smaller states to form the Union of Socialist Republics (USSR). Many other states in the Eastern Europe also saw the rise of communism. Germany and Italy fell for an ultra-nationalist (fascist) propaganda. The European imperialists like Portugal, Spain, France, Netherlands (Holland) and Britain started to lose their grip over their colonies in Asia and Africa. The Spanish Flu and the Great depression also shaped the politics of Europe in the post war period. This war also saw the emergence of the USA as a formidable global power.

The Second War completed the transition to the new world order with the decline of the British Empire, division of Germany and Korea, destruction of Japan and strengthening of the USA and USSR. The process of decolonization that started post second war resulted in about 3 dozen states in Asia and Africa gaining autonomy or independence.

Many new institutions were created and multilateral treaties were signed, palpably to maintain peace and accelerate the process of rebuilding the countries destroyed by deadly wars, natural disasters, and colonial exploitation, many global institutions. United Nations, International Monetary Fund, NATO, Bretton Woods, WTO, Warsaw Pact, Vienna Convention, Paris Peace Accord, Geneva Convention are some of the prominent institutions and treaties.

Within a decade of the end of WWII, the world became bi-polar with the USA and USSR holding the pole positions. The USA was leading the larger non-communist world, providing technological and strategic support to the countries. Its currency US Dollar (US$) obviously became the preferred medium of exchange and also store of value. The USSR was extending its influence in communist Eastern Europe and Central Asia.

Colonialism was now reinventing in the form of economic and strategic dependence. The wars were now more driven by economic maneuvering rather than the movement of troops. The global energy crisis triggered by the events in Iran in the 1970s, led to the USA denouncing the gold standard (free convertibility of US into defined quantity of Gold) in 1974. The US and Saudi Arabia deal to price its oil only in US$ terms established the greenback as unquestionable global reserve currency, as most post war financial institutions were already under US control and dealing in US$ mostly; and major commodity markets (CBOT, LME, NYMEX etc.) were already pricing global commodities in US$ terms. Post dismantling of the USSR in the 1990s and China joining the WTO in the 2000s, the position of US$ in global trade and finance strengthened further.

However, post the global financial crisis of 2008-09, the unprecedented expansion of the US Federal Reserve balance sheet (implying quantitative easing or printing of new money) has triggered a debate over sustainability of US$ as global reserve currency. Emerging global powers like China and India have also been aiming for a larger role in the global institutions like IMF, to the detriment of US influence over these institutions.

The currency (and tariff) wars between US and China and US and Europe in the past one decade are other manifestations of the global reset. China has also been motivating its trade partners to deal in CNY. Covid-19 pandemic caused recession and lockdown has allowed time to global powers to rethink their strategies and plan their futures.

The recent Russia-Ukraine war shall give further impetus to the Reset. Russia engaging in non USD denominated trade with partners like China, India, and Iran etc. Reportedly, China and Saudi Arabia are meeting to discuss pricing of oil in non USD terms.

It is not WWIII or the nuclear threat that investors should be worried about in this decade. It is the diminution of the USD as a global reserve currency. If the US cannot borrow in US$ to fund its profligate fiscal and monetary policies, the inflated asset prices will face a reality test almost immediately.

Insofar as India is concerned, I believe that it would be the first time in the past 200 years that India would be participating in a global reset from a position of strength. In all previous resets (colonization, industrial revolution, post war realignments, fiat currency, etc.), India was mostly the adversely affected party.

This time however our exposure to the global economy and geo-politics is much wider and deeper; and so would be the impact of any material change in the global order. It is critical that India demonstrates its competence and willingness to play a prominent role in the global affairs, economic, strategic as well as geo-political, to be accepted as a main player in the game.

In my view India will not be a water boy in the next game. It will be included in the final playing XI as an all-rounder, i.e., an economic, strategic and geo-political major. Look forward to good times ahead, and brace for the turbulence.

 In the decade of 2000s (2001 to 2010), gold gave superlative returns. The prices of yellow metal increased 3.8x (in USD terms) for the decade. This return had however come on the back of the negative returns for two successive decades (1981-1990 and 1991-2000). In the last decade (2011-2020) the precious metal yielded a return of 39%.

Traditionally it was believed that during periods of high inflation, geopolitical uncertainties, war, money debasement (due to quantitative easing or hyperinflation) etc. gold is a preferred refuge. However, this safe haven status of gold appears to have diminished in the latest episode of high global inflation, unprecedented quantitative easing, and geopolitical uncertainties.

The shortages of goods and skilled workers are troubling the global economy. Unprecedented borrowing and printing of currencies by the US Federal Reserve, Bank of Japan, and European Central Bank has eroded peoples’ trust in official currencies to some extent. As per the conventional wisdom, the situation is quite ripe for a super bull market in Gold. However, so far gold has not witnessed any extraordinary interest. Rather, independent digital assets (popularly known as cryptocurrencies and NFTs) have mushroomed world over to fill the trust vacuum. The new age investors have even preferred equities to hedge against debt and inflation rather than gold.

So far, the movement in gold appears to be driven more by technical trade rather than any fear psychosis, refuge seeking or hedging against risk of large scale war, hyperinflation, or money debasement due to excessive and/or unsustainable debt.

Despite the massive volatility in the exchange rate of Russian Ruble, Shutdown of Russian markets, sanctions on many large Russian global energy corporations, and freezing of billions of dollars in Russian foreign assets, the gold is higher by -11% YTD 2022 in international markets. This is in sharp contrast to the crisis in peripheral Europe (Greece, Iceland, Portugal) in 2011. The prospective default of Greece was less than US$50bn, but gold had spiked more than 30% higher in 2011.

The opinion of market participants is vertically divided on the prospects of an imminent gold bull market similar to the 1970s and 2000s. But I would like to draw attention of the readers to following points:

·         Gold traditionally been a refuge in the periods of crisis, but in recent years the preference for gold has been diminishing.

·         During the decade of 1970s (1971-1980), significant turmoil was witnessed in the global economy. That was perhaps the best decade ever for gold prices. The gold prices recorded an increase of 9x in that decade. But most of that increase came in the last two years of the decade when global crude prices witnessed a sharp increase. In the following two years (1981-1982) the gold gave up 2/3^rd of these gains.

·         During the decade of 2000s (2001-2010) the gold prices increased 3.8x as the world struggled with an unprecedented financial crisis. But most of the gains came in last two years of the decade (2009-2010); and almost the entire crisis time gains were given up in the next five years. Again the rise in gold prices coincided with the sharp spurt in oil prices.

·         Gold has gained about 39% in the decade of 2010s (2011-2020). But ~75% of the gains have come in just 9 months of 2020 when the world was shut down due to the pandemic.

·         The Gold has lost ~11% in the current decade.

·         The gold has shown strong correlation with the oil prices; though correlation with USD and Copper has weakened in recent years. Given the global trend towards clean energy, it is possible that the relevance of gold as a safe haven also diminishes with the use of fossil fuels.

Thus, it could be reasonably assumed that gold continues to be one of the safe havens but much less volatility. The risk reward profile of gold is definitely worsening with the time.

I continue to maintain my stance on Gold. In my view, a new global order will definitely emerge out of the pandemic and subsequent geopolitical events. The new order will address sustainability and equity issues. Gold will not be a key component of the new order. USD may retain its dominance but it shall face serious challenges from other currencies, including the digital currencies.

You may read in detail here:

Gold is not the end game

Bretton Wood is not about Gold

 In the aftermath of devastation that took place due to the second world war (WWII), some key global institutions were created and multilateral agreements signed to (i) avert chances of another major war; (ii) enhance global cooperation for accelerated reconstruction work; and (iii) promotion of globalization of trade and commerce to ensure equitable growth and development. Bretton Wood agreement signed in 1944 was one of such efforts.

The Bretton Woods agreement established the U.S. dollar as the reserve currency for world. The idea was to prevent competitive devaluations of currencies, avert trade wars and promote international economic cooperation for growth & development. The Bretton Wood signatories agreed to maintain fixed exchange rates between their respective currencies and the US Dollar. The US dollar in turn was pegged to the price of the gold.

Until WWI, most countries followed the gold standard for their respective currencies; which essentially meant that they promised to exchange their currencies for gold of equivalent value as per the current international prices of gold. This significantly constricted the flexibility in their monetary policy, as only a few countries had enough gold reserves to back their monetary requirements for development efforts needed in post war period. Abandoning the gold standard, they printed massive amount of money leading to hyperinflation, which eventually led to great depression and another great war.

Post WWII, most countries considered reverting to gold standard. However, since at that time, US had held more than three fourth of global gold reserves at that time, it was felt that making the gold pegged USD the reserve currency, instead of gold, would provide the necessary flexibility in monetary policy (since unlike gold, the USD supply could be flexible) to support growth and development.

The energy price led stagflation in US eventually led to the demise of Bretton Wood agreement. To get the US economy out of stagflation (no growth and high inflation) President Nixon sharply devalued the USD. Thus sharp devaluation led to a run on the US gold reserves, forcing the US to unpeg USD from gold prices and thus violating the Bretton Wood Agreement. The gold peg ended in 1971 but USD continued to remain the reserve currency of the world in absence of a viable alternative.

Last week, Kristalina Georgieva, IMF Managing Director, in her speech called for a new Bretton Wood Moment for the world (see here). Comparing the damage to the global economy caused by Covid-19 pandemic, she emphasized on the greater need for global cooperation to put the global economy back on growth path. She said, “Today we face a new Bretton Woods “moment.” A pandemic that has already cost more than a million lives. An economic calamity that will make the world economy 4.4 % smaller this year and strip an estimated $11 trillion of output by next year. And untold human desperation in the face of huge disruption and rising poverty for the first time in decades. Once again, we face two massive tasks: to fight the crisis today — and build a better tomorrow.”

She further adeed, “We face what I have called a Long Ascent for the global economy: a climb that will be difficult, uneven, uncertain—and prone to setbacks.

But it is a climb up. And we will have a chance to address some persistent problems — low productivity, slow growth, high inequalities, a looming climate crisis. We can do better than build back the pre-pandemic world – we can build forward to a world that is more resilient, sustainable, and inclusive. We must seize this new Bretton Woods moment.”

She specifically called for “Prudent macroeconomic policies and strong institutions”, “people centric policies” and “climate change” as three imperatives for the new system.

Obviously, the emphasis is on greater global cooperation, sustainability and equality. Unfortunately, a number of analysts, traders and strategists have read her comment to mean return of gold standard.

Neils Christensen, quoted some of the popular comments in his blog post (see here) highlighting how the people are misreading her comments for a BULL call on gold—

“Gold is on its way back to monetary policy in a direct way. The IMF last week confirmed they WILL NOT sell gold reserves. Now they are calling for a new Bretton Woods arrangement. WELCOME TO THE ERA OF GOLD ? — Gold Telegraph

Imf calls for a new Bretton Woods. A new gold standard. Sit tight. Evidence is piling. — Gold Ventures

IT'S OFFICIAL IMF CALLS FOR 'A NEW BRETTON WOODS' 'A New Bretton Woods Moment'— Willem Middelkoop

A New Financial System Backed By Gold. It Will Never Happen You All Said Bretton Woods Was A Gold Backed Monetary System. The Best Is Yet To Come? Baba & Riddlers”

In my view, a new global order will definitely emerge out of this pandemic. The new order will address sustainability and equity issues. Gold will not be a key component of the new order. USD may retain its dominance but it shall face serious challenge from other currencies, including the digital currencies.