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Gold Trades Like a Currency Hence Goldania

Commodities / Gold and Silver 2010 Nov 25, 2010 - 06:52 AM GMT

By: John_Handbury

Commodities

Gold tends to trade like a currency.  This is because all the gold produced in the world mostly does not get used up, so, like a currency, the change in inventory at any time is a small proportion of the total supply.  Thus rather than being largely affected by supply and demand fundamentals, currency prices reflect the perceived value of a money based on the underlying fundamentals of the country such as stability, the economy, the central bank, etc .  A contrary example is say, corn, which gets mostly used up and the annual crop is a very large proportion of the total corn in storage.  Thus corn prices are driven largely by supply and demand.


Since gold trades much like a currency, let’s take this one step further and invent a virtual country, ”Goldania”, where all the gold in the world represents its currency.   In terms of money supply, Goldania’s reserves amount to about 6 trillion US dollars (145,000 tonnes of gold), about the same order as the US M2 money supply, which makes it no lightweight in the financial world.  Let’s say that its monetary policy is controlled by the Goldanian Federal Reserve which, since Goldania has no monetary policy, is manned by a group of indolent bankers who sleep all day long (we’ll resist drawing any parallels with the Federal Reserve Board).

Goldania’s money reserves increase annually by the amount of gold that is produced (less some industrial uses), which amounts to about 2,500 tonnes/year.  Thus the Goldanian money reserves increase about 2% per year.  This is small compared to other countries.  For example, the U.S. M2 money reserves have increased about 9% per year over the last 12 years.  The Euro money supply increases are about the same.  Thus comparatively, there are many more dollars and euros around today than there were 10 or so years ago, while not so much for gold.

Probably as a result of this, Goldania has enjoyed an unprecedented appreciation of its currency over the last few years.  In fact it has about doubled over the last two years.  Most countries would be alarmed at this appreciation since it would have a major negative impact on the ratio of imports to exports.  This should be putting a lot of citizens of Goldania out of work, and the unemployment rate should be skyrocketing.  However, Goldania has no imports or exports, zero unemployment, and in fact has no citizens.  Therefore the Goldanian Federal Reserve could give a rat’s ass whether its currency goes up or down.  In other words there is no higher power manipulating its currency to its (perceived) benefit.

Unless you’ve been stationed on mars lately, you will know that the financial world had a nasty shock in 2008 and has been reeling ever since.  World-wide production and employment rapidly shrunk, and governments are busy implementing policies to right the ship.  This has meant adopting policies to feed the unemployed, keep the bank afloat, and stimulate, stimulate, stimulate, i.e. spending a lot of borrowed money.  Every country is in a race to depreciate their currency against all others so their exports are more attractive than everyone else’s.  Inflation is at post-war lows and the crippling effects of deflation may loom ahead.  The interest rates the central banks are charging are at all-time lows.

In contrast the Goldania’s federal reserve fund rate never fluctuates - in fact it pays no interests on its reserves, so its fed fund rate is zero.  Add in the cost of storage of gold, and the rate is actually negative, something the US central bank would love to do, and is currently borrowing billions of dollars to get as low to zero as practically achievable.

What does the future hold for Goldania? Goldania, unlike the rest of the world, doesn’t owe billions of dollars to China.  It has no plans for any quantitative easing with borrowed money.  Its net debt is exactly zero, a position that many countries, Greece for one, Ireland for two, US for three, would kill for.  Goldania would be the only large country whose currency would be backed by something physical which is… ahem, gold.  To produce its currency requires labour, extracting, refining, which are processes far more complicated and valuable than running a printing press. Gold will exist forever, paper oxidizes.  Goldania is immune from any internal risks from terrorism, hurricanes, oil spills, floods, tsunamis, revolts, earthquakes, anarchy, wars, nuclear bombs, oil prices, depressions, the list goes on. Its currency will continue to expand about 2% per year over the foreseeable future, no more than this, and maybe less.  The Goldian fundamentals look sound.  A virtual country you would feel safe in investing in, which is why most investors are, and why gold is such a good investment right now.

By: John Handbury Independent Trader

© 2009 Copyright John Handbury - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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