In an article in the New York Times (August 2 2011) the question is asked: “Should central banks be buying gold?” The article goes on to discuss the latest upward trend of gold prices and raises the topic of a return to the gold standard as the backing for the value of our currency. Allan H. Meltzer is quoted as saying The unrestrained U.S. monetary policy since we abandoned gold has not provided stability which is a roundabout way of saying that the ever increasing reliance upon debt to generate money has been less than successful (for everybody except the banks of course). He also points out that historically we have turned to gold investment during times of depression and war in order to preserve wealth and it has always been a reliable hedge against the hard times. This raises a more interesting question about the central banks. Why are they investing so heavily in gold right now during the greatest fiscal depression in a century or longer?
One effect the higher demand for gold has had is to have inflated the price of gold to US$1,600 an ounce for the first time in history. This has made gold a less attractive investment now but if you had been holding gold for only a couple of years you would have seen a 60% increase or more on your original investment. Even accounting for inflation and the weakening spending power of most currencies this is a super return. But who has been holding the stockpiles of gold that have risen so sharply in value? The central banks who have been hoarding it for a century in general but who have been buying up big in the past decade in particular. The obvious objective of making such big investments is that the short-term increase in demand for gold (and other metals) causes a bubble in its value, just like any other commodity that is bought up by speculators for a short term buck. But even if the price holds relatively stable the only advantage to be had from holding large stocks of gold is that it is almost guaranteed to hold its value but it can hardly be expected to increase much in value beyond the amount that the cash that is used to buy it devalues through inflation. This would seem to make it a rather poor investment for the central banks that are in the business of earning much bigger returns. So why are they doing it really?
The only real threat to the current fiat currency system would be a return to using gold as currency. There is a lot of support in the USA for just such a radical change to the monetary system. Ron Paul said “There is no need for the government to hoard gold as backing for currency; gold itself should be the currency that circulates.” This would, no doubt, be a difficult and perhaps painful transition to make but it would eliminate debt as the basis for currency. One great obstacle to this happening would be if gold prices were over inflated and another would be if the supply of gold is limited in some way. By hoarding gold the central banks are maintaining their grip on the supply of fiat currency to the world- a very profitable business. It is obvious that there will be no one simple solution to our current fiscal problems but certainly ridding ourselves of the curse of debt based fiat money should be a significant part of the plan whatever it is.