THE MONETARY COLD WARTHE MONETARY COLD WAR
By Eric J. Fry
Who is Oleg Mozhaiskov? A Russian spy? A defecting nuclear
scientist? A gold-medal winning weightlifter? A gold-metal
loving central banker?
Mr. Mozhaiskov is, in fact, a central banker - that rarest
breed of central bankers that favors buying gold instead of
selling it. Since this particular banker's affinity for
gold is not a fleeting fancy, but the studied result of a
thoughtful macro-economic analysis, this particular banker
may urge his comrades at the Russian central bank to buy
more of the stuff.
Meanwhile, central bankers in China and India have begun
musing publicly about diversifying out of dollars.
Presumably, any diversification out of dollars would
include a diversification into gold. Is the ancient
monetary metal, therefore, becoming the modern monetary
metal? Oleg Mozhaiskov suspects so.
"Gold is predominantly a financial asset," he says, "not
merely a precious metal...the time has come to admit that
investment demand was, and still is, the main driving force
behind price fluctuations on the gold market. The changing
character of demand heavily depends on what is going on in
the international foreign currency and financial markets."
A few months back, at the Baltschug Kempinsky Hotel in
Moscow, Mr. Mozhaikov addressed the London Bullion Market
Association. "I would like to thank the conference
organizers for this opportunity to share my thoughts on
such a complex, even mythical subject as gold," Mozhaikov
begins. "I assume that the request was made for one simple
reason: that I, as a senior executive of the Bank of
Russia, should know more than other ordinary mortals.
"In general, this logic is flawed," Mozhaikov jokes, as he
launches into an articulate, reasoned examination of the
gold market that reflects far more knowledge and insight
than most mortals posses.
"What is gold currently, and what will it be tomorrow?"
Mozhaikov wonders aloud. "Real money with intrinsic value?
A raw material? A cash commodity that has lost some of its
monetary functions? If so, what are the prospects -
complete loss of gold's role or a restoration of lost
functions, in one form or another...?
"There is a wide circle of leading financiers who...are
convinced that the heads of the world's richest
countries...have demonetized gold altogether. In their
eyes, the existence of official gold reserves is simply a
remnant of the past, a financial monument to the gold and
gold-currency standards, which will ultimately be absorbed
by the global gold market."
But the Russian central banker takes issue with this
conventional "wisdom."
"The modern monetary system, although undoubtedly robust
and long-standing, in fact has a number of flaws and
weaknesses," Mozhaikov asserts, as he issues a scathing
indictment of American monetary and fiscal profligacy.
"Although there are several reserve currencies, the blatant
lack of discipline is demonstrated by the U.S. dollar. I am
leaving aside the main aspects of this problem, such as the
social and economic injustice of a world order that allows
the richest country in the world to live in debt,
undermining the vital interests of other countries and
peoples. What is important for us today is another aspect,
which is connected with the responsibility of the state
issuing the reserve currency and for the international
community preserving that currency's buying power.
"Given the actual behavior of the dollar on the forex
markets," says Mozhaikov, "the problem could be more
accurately termed the irresponsibility of the U.S.
government in relation to the market valuation of its
currency in international circulation. Today the net debt
owed by the United States to the outside world (the so-
called 'international investment position') is in the
region of $3 trillion. To understand the scale of this
figure, let me remind you that it exceeds the total
official currency reserves in all the world's countries
(including the United States itself). According to the
International Monetary Fund statistics at last year-end,
the world pool of foreign currency reserves totaled...about
$2,800 billion. The volume of cash only ('greenback'
banknotes) available outside the United States totals about
$400 billion.
"The world has come to a paradoxical situation in which the
creditor countries are more concerned with the fate of the
dollar than the U.S. authorities themselves are. Thus,"
says Mozhaikov, "the evolution of the U.S. dollar's reserve
role in recent years has given ground to some quite
pessimistic forecasts, based on rational economic theory.
No wonder that the number of people who have held assets in
dollars and now wish to diversify them partly into gold -
the traditional shelter from inflation and political
adversity - is steadily growing."
The Russian central bank, itself, is a significant dollar
holder and - if we are to trust Mozhaikov's remarks - is
one of the significant dollar holders that may now "wish to
diversify partly into gold." Russia, which defaulted on its
foreign debt in 1998, has since become a model citizen. The
country's $113 billion of foreign exchange reserves would
rank it seventh on the list of the world's largest central
bank reserves. Yet its gold reserves total a mere 500 tones
- or $7.8 billion dollars worth. In other words, gold
represents less than 7% of its total reserves.
Meanwhile, the People's Bank of China holds about the same
amount of gold as its Cold War ally, despite holding four
times the foreign exchange reserves. As the nearby charts
illustrate, China's gold reserve represents less than 2% of
its massive $474 billion foreign exchange reserve. By
comparison, many European central banks hold more than 30%
of their reserves in gold, even after unloading much of it
in recent years.
These data suggest a very provocative "what if?" for the
gold market. What if the countries that are amassing
sizeable stacks of dollar bills were to swap some of those
stacks for gold? A mere flinch in the direction of adding
gold reserves by China or Russia or India - or all three at
once - would place a sizeable bid under the gold market.
"The internal imperfections of the international monetary
system," Mozhaikov concludes, "have already led to a number
of regional financial crises and still carry the danger of
larger upheavals. Under these conditions, the growing
interest of investors in real assets, gold in particular,
is more than justified."
Comrade Greenspan...any rebuttal? [Ed. Note: “I’m positioned
against almost every single piece of editorial I’ve written
for the last three and a half years,” Dan Denning notes in an
email to Baltimore this morning, when we complimented him
on his new put position in NEM. It’s not just some blind
contrarian pig-headedness, but a careful analysis of risk and
reward that generates Dan’s trades. Here are the details:
Kick It Up a Notch
https://www.agora-inc.com/reports/STA/superB01
Did You Notice...?
If individual investors wish to follow Mozhaikov's lead,
the New York Stock Exchange has just made the task easier.
Yesterday, the "streetTRACKS Gold Trust" commenced trading
on the NYSE under the symbol "GLD." The new exchange-traded
fund (ETF), which represents 1/10 of an ounce of gold,
provides investors a very handy way to buy gold, without
also having to buy a mattress under which to store it.
A few gold bulls believe the new ETF, by facilitating gold
ownership, will actually increase investment demand for
gold. We aren't so sure about that. But the new ETF does
seem very likely to DECREASE demand for shares of Newmont
Mining (NEM), the "go-to" gold stock. For several years,
NEM has served as the preferred proxy for the gold market.
Its sizeable $21 billion market capitalization and ample
trading liquidity enabled institutions and individuals
alike to enter and exit the stock at will.
But now there's a new kid in town: 6 million GLD shares
changed hands on its very first day, which was only 300,000
less than the 6.3 million shares of Newmont that traded
yesterday. We would not be surprised to see GLD's daily
trading volume surpass NEM's very soon.
If "proxy demand" for Newmont withers, the stock's lavish
PE multiple of nearly 50 times earnings may wither as well.
It's just a theory, of course, but since it's OUR theory,
we rather like it. [Ed. Note: See...Eric thinks so too. NEM
is looking a little ‘exuberant.’ Dan just bought puts in a
short-term profit play with no consideration for fundamentals.
It’s a beauty...