Gold and World Debt


Does world debt matter? After all, world governments owe the money to each other and their own citizens. But the rising total is important for two reasons. When debt rises faster than economic output (as it has been doing in recent years), higher government debt implies more state interference in the economy and higher taxes in the future. In the past debt has been inflated away, but central banks are still struggling to meet their current inflation targets of 2 percent. It is not clear that governments, which set the mandates central banks must follow, would be willing to put up with the high rates of inflation needed to reduce the real value of debt substantially, even if central banks could find a way of generating it.


The other solution is default or debt forgiveness, the old idea of a jubilee, as good as it sounds is dangerous for sovereigns because it creates major social unrest. Debt levels grew spectacularly in the rich world from 1970 to 2007. When the financial crisis broke, worries about the ability of borrowers to repay or refinance that debt caused the biggest economic downturn since the 1930s. Since the financial crisis in 2008 the global debt has increased even more. As you can see in the chart below from 1994 to 2015 global debt increased 5.6 times while GDP only 2.8 times.


As I mentioned above the preferred method for sovereigns to eliminate the debt is through inflation. Paper and now electronic currency has made inflation much easier to create in the last one hundred years. By a continuing process of inflation, governments can tax, secretly and unobserved, an important part of the wealth of their citizens to decrease or even eliminate public debt. Before paper currency inflation was much harder to archive. It required melting a gold or silver coin and add a percentage of a much cheaper metal like copper. One of the most famous is the devaluation of the Roman Denarius. Compare the devaluation of the Roman Denarius with the one of the US dollar through inflation in the next two charts.


For a global picture see below the world currency SDR (US dollar, EU euro, British Pound, Japanese yen, Chinese yuan). Introduced in 1969, it is a composite of the most important fiat currencies. The value of the SDR was initially defined as equivalent to 0.888671 grams of fine gold which, at the time, was also equivalent to one US dollar. Since it was revalued as an index of fiat currencies rather than gold it has lost 96% of its value and most of it in its first ten years.


In a fiat currency system gold correlates very well if not perfectly to public debt and inflation. Just look at the US consumer price index representing inflation since 1775 versus the price of gold in the chart below.


The following two charts show the close correlation between US debt and the price of gold since the collapse of the gold exchange standard in 1971. US debt since 1970 increased by 3,641 percent and the gold price increased by 5,206 percent. You must not ignore that through all this period world governments through their central banks have manipulated the price of gold by holding it down to support the fiat system. However, manipulations are always unsuccessful in the long term. Gold is not just the anti-dollar but anti all fiat currencies.


Since the financial crisis in 2008 central banks worldwide have tried to deal with the exorbitant world debt by trying to inflate it out but without much success until now. There are two solutions to create inflation besides printing currency.

One is to reset the price of gold to a much higher level as it was done by the US in 1933 when the gold price was reset from the nominal price of $20.67 per troy ounce to $35 per troy ounce. A year earlier in 1933, by an executive order it was made a criminal offense for US citizens to own or trade gold anywhere in the world, with exceptions for some jewelry and collector’s coins. A reset of the price of gold to represent 40 percent of the monetary base today would mean a gold price of around $5,000 and for a 100 percent of the monetary base it would mean a gold price of around $12,000.


The other solution is to increase the quantity of Special Drawing Rights (SDR) creating worldwide inflation. Soon after the 2008 crisis the amount of SDRs was increased and recently world governments have revised IMF’s rules making it possible to increase it again. Since the 2008 crisis the G20 and the IMF have been working discretely to update the international monetary system. The IMF’s staff has been publishing several papers on the international monetary system and the SDR. On its webpage the IMF provides information on the International Monetary Fund (IMF) and its relations and activities with the Group of Twenty (G-20). On this webpage the IMF states that “A strengthened International Monetary System (IMS) – one that is resilient to future turmoil – is a key goal of the world community as it recovers from the global economic crisis.” The SDR would become a world currency and a reserve currency replacing the underlining currencies. However, this requires global consensus in the G20 or at least in the G6 (US, EU, UK, Japan, China and Russia).

Central banks all over the world have been increasing their official gold reserves since the 2008 financial crisis which still represent today only 15.4% of official international reserves.


The next chart shows that even though central banks sold gold since the gold exchange system collapse in 1971 they resisted selling most of it. World official gold reserves dropped only 22 percent until 2007 from the top reached in 1965 and are now down only 14.5 percent from the top, retracing 34 percent of the drop since the 2008 financial crisis. Both United States and Euro Area hold respectively 8,133.5 tonnes and 10,786.2 tonnes of gold. China and Russia have been major buyers of gold since the 2008 crisis for their official international reserves representing in 2015 84 percent of all the world official gold purchases. The IMF itself is the 3rd largest holder of official gold with 2,814 tonnes. The IMF states on its website that, “Gold played a central role in the international monetary system until the collapse of the Bretton Woods system of fixed exchange rates in 1973. Since then, its role has diminished. But it remains an important asset in the reserve holdings of several countries, and the IMF is still one of the world’s largest official holders of gold.”


Close to the end of his life, in the last chapter of a negative book on gold as money, The Power of Gold, Peter Bernstein writes, “Gold may again serve as the ultimate hedge in chaotic conditions. Its return to its traditional role as universal money is unlikely, however, unless the time should come when the dollar, the euro, and the yen have all failed to function as acceptable means of payment across international borders.” What foresight he had! He passed away in 2009 just when a major financial crisis started, and gold returned into the international financial system as he predicted.

Prof. Antal Fekete says in a recent article that, “The present financial crisis in the world is a gold crisis. It cannot be properly diagnosed without an analysis of gold’s economic role in serving as the only ultimate extinguisher of debt – a role gold has played for thousands of years, as far back as written records exist, up to the fateful year of 1971. … Paying gold is the only ultimate extinguisher of debt. Any other method of paying down debt leaves total debt unchanged.”