ROLLOVER (1981)

Moneycapitalhas a life of its own. Its a force of nature, like gravity. Like the oceans, it flows where it wants to flow. This whole thing with gold is inevitable, were just going with the tide. The only question is whether you want to let it go like an unguided missile and raise hell, or whether you want to keep it in the hands of responsible people.
Maxwell Emery, fictional financier, Rollover, 1981

WHAT IS A DOLLAR?
THAT WAS THEN: Three-hundred and seventy-one grains of four sixteenth parts of pure, or four hundred and sixteen grains of standard silver.
Original definition of a US dollar, 1792 US Coinage Act

WHAT IS A DOLLAR?

THIS IS NOW: This note is legal tender for all debts, public or private.
Current definition of a US dollar, as stated on each Federal Reserve note

WHAT IS A GOLD STANDARD?

See the fine print?

WHY DID THE WORLD ABANDON GOLD?

Any workable and acceptable international monetary system must not bear the stamp or control of any one country in particular. Truly, it is hard to imagine any standard other than gold. Yes, gold, whose nature does not alter
Charles De Gaulle, 1965

Perhaps never before had a chief of state launched such an open assault on the monetary power of a friendly nation.
TIME, 1965
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WHY DID NIXON TEMPORARILY CLOSE THE GOLD WINDOW?

In the past seven years, there has been an average of one international monetary crisis every year. Now who gains from these crises? The international money speculators. Therefore, I have directed Treasury Secretary Connolly to suspend temporarily the convertibility of the dollar into gold or other reserve assets. (Emphasis added)
President Richard M. Nixon, August 15, 1971, speech suspending (temporarily) the dollars gold convertibility

FIAT DOLLAR RESERVE GROWTH IS INFLATIONARY

DOLLAR FX RESERVE GROWTH
3,500,000 3,000,000 2,500,000 2,000,000 16% 1,500,000 14% 1,000,000 500,000 0 1995
Source: IMF

24% 22% 20% 18%

The fiat dollar provides the reserve for the bulk of the global monetary base, in particular for the US, China, other Asian and Latin American economies Global dollar reserves are now in excess of 20% of US GDP and growing rapidly. This is highly inflationary for the global economy as a whole While the price inflation may not be showing up in the US, it has already become a problem in much of Asia and most of Africa and Latin America The US Fed continues to grow the US monetary base at a rapid pace, in response to protracted US economic weakness

12% 10% 8% 1997 1999 2001 2003 2005 2007 2009 World Dollar Reserves (mn) Dollar Reserves to US GDP (rhs)

Source: IMF; Federal Reserve

SIGNS THE FIAT DOLLAR STANDARD IS BREAKING DOWN

The rise of gold!

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SIGNS THE FIAT DOLLAR STANDARD IS BREAKING DOWN

Recognizing that the international financial crisis has exposed the inadequacies and deficiencies of the existing international monetary and financial system, we support the reform and improvement of the international monetary system, with a broad-based international reserve currency system providing stability and certainty.
BRIC+SA Summit Sanya Declaration, Hainan, China, April 2011

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A BRIC ULTIMATUM?
We are concerned about the situation that is emerging around Irans nuclear issue. We recognize Irans right to peaceful uses of nuclear energy and support resolution of the issues involved through political and diplomatic means and dialogue between the parties concerned.
BRIC+SA Summit Delhi Declaration, New Delhi, India, April 2012

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THE END OF USD MONETARY HEGEMONY?

BRIC SHARE OF GLOBAL GDP SURPASSES THE US
25,000

Ever since 2009 all four of the BRICs have sought to reduce their dependence on the USD:
- Bilateral currency agreements - Diversification out of USD reserves (currencies, gold)

20,000

15,000

10,000

This move away from the USD has accelerated recently, due in part to geopolitical considerations
- Growing inter-BRIC vs. extra-BRIC trade - BRIC dependence on Iranian/Venezuelan oil

5,000

0 2000 2003 2006 US GDP (bn)

Source: IMF

2009 BRICS GDP (bn)

2012

2015

The USD is now at serious risk, even in the near-term, of losing its pre-eminent reserve currency status around the world But amid global deleveraging, monetary instability, geopolitical tensions and general lack of global cooperation, what currency can possibly replace it?

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GOLD IS THE RESERVE FOR A MULTIPOLAR WORLD

The seven problems of the present international monetary system are all related to the change in the role of the dollar.
Nobel laureate Robert Mundell, presentation to the China G-20 Seminar, March 31, 2011

We can look upon the period of the gold standard as being a period that was unique in history, when there was a balance among the powers and no single superpower dominated.
Mundell, March 1997

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GOLD IS THE RESERVE FOR A MULTIPOLAR WORLD

To the extent that they fail to correct for the negative effects of power, governments choose foreign policy strategies that are ultimately selfdefeating.
Professor Giulio Gallarotti, 2010

[T]he gold standard showed very little cooperation among national governments in the process of formal regime building. The rise of the gold standard can be seen more as a case of a regime emerging from the failure to cooperate.
Professor Giulio Gallarotti, 1997
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A BEAUTIFUL MIND (2002)

Stability is crucial in practical applications of Nash equilibria [U]nstable equilibria are very unlikely to arise in practice, since any minute change in the proportions of each strategy seen will lead to a change in strategy and the breakdown of the equilibrium.
Wikipedia article on the Nash equilibrium

No one goes for the blonde... Its the only way we all win.
A fictional John Nash in the film A Beautiful Mind, 2002
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THE RISE OF A DE FACTO GLOBAL GOLD STANDARD

What we are witnessing is a sea change in which market forces are driving a de facto return to the gold standard. All that is missing for this to be a de jure gold standard is some regulatory and legal recognition and one has been proposed. The Basel Committee for Bank Supervision, the maker of global capital requirements is studying making gold a bank capital Tier 1 asset.
Financial Times, 23 April 2012

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WHAT PRICE FOR GOLD?

US TOTAL ECONOMY DEBT AND DEBT/GDP
50

US financial leverage grew at an accelerating rate in the late 1990s and 2000s
The protracted global financial crisis of 2008present indicates that the limits of leverage have been reached While global financial leverage is no longer increasing, it has yet to decline materially. There is a long, long way yet to go

3.5
40 3

30

20

2.5

10

1.5

Given that central banks are printing money to prevent the economic deleveraging from becoming deflationary, the price of gold must rise to a level that makes the debt serviceable
Otherwise, interest rates will eventually rise to punishing levels, collapsing the financial system

Debt (tn)
Source: Federal Reserve

GDP (tn)

Debt/GDP (rhs)

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WHAT PRICE FOR GOLD?

LOW BOND YIELDS PROPEL GOLD HIGHER
18 16 14 12 10 8 6 4 2 $250 $2,500

$25

10 Yr Treasury Rate
Source: Federal Reserve

Gold Price (rhs)

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WHAT PRICE FOR GOLD?

THEORETICAL IMPUTED GOLD PRICES
14,000
12,000 10,000 8,000 6,000 4,000 2,000 0

To return to gold requires the currency authorities to determine what gold exchange ratio would be credible
Otherwise, the currency would come under speculative attack and any accumulated gold reserve would be drained Ideally, countries would re-peg to gold at a price that did not impose further deflationary pressure on the global financial system

1970

1973

1976

1979

1982

1985

1988

1991

1994

1997

2000

2003

2006

2009

Imputed Gold Price - M0

Imputed Gold Price - M1

Imputed Gold Price - M2

Source: Federal Reserve; Amphora Capital LLP estimates

That requires a far higher gold price than today, as at current prices (~$1,600/oz), the market capitalisation of the global gold stock is only a small fraction of the global money supply

Great Britain made precisely this mistake in 1925, re-pegging to gold at the pre-WWI parity, thereby contributing to the Great Depression

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WHAT LEVELS FOR EXCHANGE RATES?

PRIMARY FACTORS DETERMINING INITIAL GOLD EXCHANGE RATIOS
Currency Potential Domestic Net foreign growth rate debt to GDP assets/GDP Gold reserves

The key factors determining which currencies would strengthen and weaken (in relative terms) in a global move back toward a gold standard are the following:
- Export/resource competitiveness (positive)

USD EUR GBP CHF SEK CAD AUD JPY CNY RUR INR BRL

+/+/+ + -+ +/+ +

---++ + +/+/-+ + +/+

-+/-++ + + + ++ ++ + +/-

++ ++ +/++ + + + + + + -

- Size of accumulated debt burden (negative)

- Accumulated gold reserves (positive)

Once back on a gold standard, with currencies fixed to gold rather than floating, relative interest rates will adjust according to
- Relative growth rates (or expectations thereof) - Economic shocks - Accumulating imbalances

Source: IMF data; Amphora Capital LLP estimates

With FX rates fixed, as in the euro-area today, relative interest rates can fluctuate dramatically. The same will be true under a gold standard

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WHAT LEVELS FOR INTEREST RATES?

REAL AND NOMINAL RATES TO CONVERGE
20.0

Absent monetary inflation, interest rates may still be set by central banks, but they will reflect a market-determined supply/demand for money
If rates are set artificially low, the gold reserve will flow out. If artificially high, the gold reserve will grow, but at the expense of growth In practice, under a gold standard, central banks could leave interest rates to the market entirely

15.0

10.0

5.0

-5.0 1962 1966 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 2010 Real 10y UST yield (%) 10y UST yield (%) CPI (y/y, %)

Indeed, under a gold standard, as with a so-called currency-board, central banking becomes optional, rather than required
- The market determines interest rates - The market determines the money supply

Source: Federal Reserve

- Bank regulation and reserve requirements can be determined by the government directly, rather than by a central bank

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WHAT LEVELS FOR RISK PREMIA/SPREADS?

RISK PREMIA LIKELY TO INCREASE
20 18 7 6 5 4 3 2 1 0

With no central bank able to hold rates artificially low to artificially stimulate demand, business cycles will be shorter and more volatile
This will increase the risk of corporate bankruptcy, as will the fact that, under a gold standard, bailouts will be more costly to implement Other factors equal, risk premia and spreads will be higher under a gold standard. This, however, will reflect a fair market pricing of risk Absent an implied bail-out, economic and financial risk will be easier to observe and to estimate, leading to more efficient investment decisions and a higher sustainable rate of economic growth

16
14 12 10 8 6 4 2 0

Moody's Baa corp yield (%) Corp spread (%, rhs)

Source: Federal Reserve

US10y yield (%)

While corporates or even financial institutions may fail from time to time, systemic crises should become considerably less frequent as there is likely to be less leverage in the system
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WHAT IMPLICATIONS FOR EQUITY MARKETS?

EQUITY VALUATIONS LIKELY TO COME UNDER DOWNWARD PRESSURE

Risk premium expansion implies higher equity risk premia and hence lower equity valuations
P/E ratios are likely to decline to levels that were more common under Bretton-Woods and under gold standards generally Taking the US stock market as a benchmark, P/E ratios in a range of 10-15 are more likely than the 20+ that was common in the 1990s-2000s

As for sectors, the ones that will suffer the most in relative terms are those that:
- Are highly dependent on financial activities, in particular the financial system itself
Source: Case-Schiller, Standard and Poors

- Are uncompetitive internationally and rely on various forms of public sector support, including low interest rates - Have the least flexibility to downsize/restructure operations that are exposed as uneconomic by a return to sound money and withdrawal of public support

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John Butler provides much illuminating detail on how the world's monetary system got into its present mess. And if you're wondering what comes next, this is the book to read. Bill Bonner John Butler has written an indispensable reference on the subject of gold as money. His book is a combination of history, analysis and economics which the reader will find useful in understanding the use and misuse of gold standards over the past century. He breaks the book into a long series of essays on particular aspects of gold which the reader can take as a whole or in small bites. It is technical yet accessible at the same time. The Golden Revolution is a useful and timely contribution to the growing literature on gold and gold standards in monetary systems. I highly recommend it. James Rickards, author of Currency Wars In The Golden Revolution John Butler makes a powerful case for a return to the gold standard and offers a plausible path for our nation to get there. Enlightened investors who blaze the trail will likely reap the greatest reward. For those still wandering in the dark, this book provides necessary light to keep you headed in the right direction. Peter Schiff , CEO of Euro Pacific Precious Metals

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