Gold's flight to the developing world: A brief history

Western central banks have tried to shake off the constraints of gold (COMEX:GCG14) for a long time, which has created enormous difficulties for them. They have generally succeeded in managing opinion in the developed nations but been demonstrably unsuccessful in the lesser-developed world, particularly in Asia. It is the growing wealth earned by these nations that has fuelled demand for gold since the late 1960s. There is precious little bullion left in the West today to supply rapidly increasing Asian demand. It is important to understand how little there is and the dangers this poses for financial stability.

An examination of the facts shows that central banks have been on the back foot with respect to Asian gold demand since the emergence of the petrodollar. In the late 1960s, demand for oil began to expand rapidly, with oil pegged at $1.80 per barrel. By 1971, the average price had increased to $2.24, and there is little doubt that the appetite for gold from Middle-Eastern oil exporters was growing. It should have been clear to President Nixon’s advisers in 1971 that this was a developing problem when he decided to halt the run on the United States' gold reserves by suspending the last vestiges of gold convertibility.

After all, the new arrangement was: America issued the petrodollars to pay for the oil, which were then recycled to Latin America and other countries in the West’s sphere of influence through the American banks. The Arabs knew exactly what was happening; gold was simply their escape route from this dodgy deal.

The run on U.S. gold reserves leading up to the Nixon Shock in August 1971 is blamed by monetary historians on France. But note this important passage from Ferdinand Lips’ book GoldWars:

Because Arabs did not understand bonds and stocks they invested their surplus funds in either real estate and/or gold. Since Biblical times, gold has been the best means to keep wealth and to transfer it from generation to generation. Gold therefore was the ideal vehicle for them. Furthermore after their oil reserves are exhausted in the distant future, they would still own gold. And gold, contrary to oil, could never be wasted.

According to Lips, Swiss private bankers, to whom many of the newly-enriched Arabs turned, recommended that a minimum of 10% and even as much as 40% should be held in gold bullion. This advice was wholly in tune with Arab thinking, creating extra demand for America’s gold reserves, some of which were auctioned off in the following years. Furthermore, Arab investors were unlikely to have been deterred by high dollar interest rates in the early 1980s, because high interest rates simply compounded their rapidly-growing exposure to dollars.

Using numbers from BP’s Statistical Review and contemporary U.S. Treasury 10-year bond yields to gauge dollar returns, we can estimate gross Arab petrodollar income, including interest from 1965 to 2000, to total about $4.5 trillion. Taking average annual gold prices over that period, 10% of this would equate to about 50,500 tonnes, which compares with total mine production during those years of 62,750 tonnes, over 90% of which went into jewellery.

This is not to say that 50,000 tonnes were bought by the Arabs; it could only be partly accommodated even if the central banks supplied them gold in very large quantities, of which there is some evidence that they did. Instead, it is to ram the point home that the Arabs, awash with printed-for-export petrodollars, had good reason to buy all available gold. And importantly, it also gives substance to Frank Veneroso’s conclusion in 2002 that official intervention i.e., undeclared sales of significant quantities of government-owned gold was effectively being used to manage the price in the face of persistent demand for physical gold as late as the 1990s.

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