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October 3,1975 Tumbling Gold September was a calamitous month for gold bugs. Within a month, the price of gold nose-dived from $160 to $129 per ounce. Although prices later recovered, the steep decline left a hollow feeling that the market might be a bottomless pit. Financial analysts correctly attributed the decline to decisions on gold reached at the August meeting of the Interim Committee of the Governors of the International Monetary Fund. IMF decisions The Interim Committee's decisions were indeed momentous. First, the Committee recommended the abolition of the official price of gold, which had been set at $42.22 per ounce since the second devaluation of the U.S. dollar in February, 1973. Second, it recom mended removal of all the obliga tions under the IMF Articles of Agreement requiring the use of gold in transactions between members and the Fund. Third, the group agreed that the IMF should return one-sixth of its 153 million ounces of gold to members and should sell off another one-sixth at the market price, with the profit from the sale to be used to benefit the developing nations. In a parallel action, the Group of Ten (Belgium, Canada, France, West Germany, Italy, Japan, Nether lands, Sweden, U.K., and U.S.) agreed for a period of two years, (a) not to peg the price of gold, (b) not to increase the total official stock of gold now in the hands of the IMF and the Group 10 countries, 1 Digitized for FRA SER and (c) to abide by any further conditions governing gold arising from future meetings of their central-bank representatives. In a formal sense, the Interim Committee's decisions were merely recommendations to amend the IMF Articles of Agreement. Before becoming effective, the entire amendment process would take at least eighteen months. In fact, however, the impact of the Interim Committee's decisions will be felt much sooner. Because of the Committee's wide national representation—eleven major in dustrial nations and ten develop ing nations—as well as the Gover nors' favorable response, ultimate ratification of the proposed amendments is a foregone conclu sion. Ways may be found to short-cut the amendment process by arrangements which would permit the IMF to carry out the proposed measures. Moreover, events of the past four years have outstripped the IMF Articles of Agreement. Few members will feel constrained to conduct gold transactions any longer at the official price of $42.22 per ounce. Since mid-1972 the market price of gold has stayed well above the unrealistic official price. As a result, official gold holdings, in cluding those of the IMF and national monetary authorities, have been effectively frozen. The abolition of the official gold price thus frees the reserves for interna tional transfers. (continued on page 2) o Opinions expressed in this newsletter do not necessarily reflect the views of the management of the Federal Reserve Bank of San Francisco, nor of the Board of Governors of the Federal Reserve System. Some have hailed the decision as a move towards reactivation of gold reserves for payment purposes. The IMF Governor for South Africa, for instance, predicted that “ gold will be as sought-after as ever as an element of strength in an unstable world.” Others, how ever, were not as sanguine, argu ing that the freeing of gold reserves could bring about an avalanche of gold onto the market. The critical question is thus what this development portends for the future of the gold market. Gold as a store of value Advocates of gold stress its histor ical role as a universally accepted store of value. Especially during times of war, uncertainty, and inflation, gold provides a haven for the savings of both rich and poor. For national governments, the fear of foreign-exchange assets being frozen or expropriated by hostile foreign authorities rein forces the argument for keeping national reserves partly in gold. Gold bugs predict that the trend of gold prices will depend primarily on the expected rate of world infla tion and the expected degree of political disturbances. To the extent that the future is clouded with uncertainty and threatened with instability, individuals and governments will not only hang on to their gold but will even de mand more. The gold bugs' basic premise is that gold will continue to be a safe haven for personal and national Digitized for FRA SER savings. It is that very premise which needs to be re-examined in view of the recent IMF and Group-10 decisions. Gold's universal popularity extends far back into history. For centuries and in many lands, gold was used either directly as money or indirect ly as a backing of national monies. Even in the present century, when one after another national cur rency lost its gold backing, gold continued to serve as an interna tional means of payments at a fixed price in terms of some key interna tional currency. For most of the period from 1717 to 1934, gold could be converted into the British pound at the equivalent rate of $20 per ounce; from 1934 to 1971, it could be converted into the U.S. dollar at the rate of $35 per ounce. Thus, for centuries, gold was considered a safe store of value because of its assured convertibility into a key interna tional currency at a fix ed rate. Gold's universal value stemmed primarily from its backing by a key international currency, which had relatively stable purchasing power over goods and services everywhere—not merely in the country of its origin. It is a common misconception—a sort of cartbefore-horse thinking—to hold that a key international currency is made so because it is backed by gold, which in turn possesses an “ intrinsic” value because of its general acceptability. Gold cut adrift So long as the dollar possessed relatively stable purchasing pow er, gold tied to the dollar provided a relatively safe store of value. However, as inflation accelerated in the U.S. in the late 1960's, gold was no longer such a safe asset. The U.S. monetary authorities had then two possible options—(a) raise the official price of gold, so as to preserve the purchasing power of gold, and (b) cut the link between the dollar and gold, permitting gold to find its own price in the market. In fact, the U.S. Treasury did both. It suspended gold convertibility of the dollar in Au gust 1971, and subsequently raised the official price of gold first to $38 per ounce and then to $42.22 per ounce. However, since the dollar was no longer convertible into gold, the official price of gold had little meaning in relation to its real purchasing power. Cut loose from its moorings, the market price of gold shot skyhigh, reaching $195 per ounce at year-end 1974. Most of the driving force came from specula tive demand, as industrial use accounted for merely 40 percent of the 1,180 metric tons supplied to the market in 1974. But gold prices then dropped precipitously in 1975. Without official price peg ging, gold has become a highly risky asset. Because of the recent IMF and Group-10 decisions, gold has lost its monetary support for the fore seeable future. Unless repegged to an international currency, it will float entirely on its own, with its price continually buffeted by cur rent market sentiment. The precari ousness of this market is en hanced by the existence of a huge gold stock in private and official hands, relative to the volume of current production and consump tion. In such a market, stability is constantly threatened by what might happen to that overhang ing stock. Indeed, under the present circumstances, it is diffi cult to conceive of a less safe store of value than gold. The advocates of gold may be mistaken in their indiscriminate trust in the “ intrinsic” value of gold, but they are correct in their belief in the social function of gold amid conditions of uncertainty. Individuals and governments alike need a safe store of savings in this imperfect world. Even with the SDR, one may question if the world's finance ministers and central-bank governors have devel oped an international financial asset capable of fulfilling all the functions which gold performed in the past. Hang-Sheng Cheng Digitized for FRA SER ucnSujqseM • i|ein • MBMBH • uo S o jo E |U J O p |E 3 . • epEAON . oqepi E U O Z J jy • • J j|B 3 'O D S p U B J J U E S ZSL ON UWlHd aivd a o v is o d s t i n v w s s v i d is a id BANKING DATA—TWELFTH FEDERAL RESERVE DISTRICT (Dollar amounts in millions) Selected Assets and Liabilities Large Commercial Banks Amount Outstanding 9/17/75 Loans (gross, adjusted) and investments* Loans (gross, adjusted)—total Security loans Commercial and industrial Real estate Consumer instalment U.S. Treasury securities Other securities Deposits (less cash items)—total* Demand deposits (adjusted) U.S. Government deposits Time deposits—total* States and political subdivisions Savings deposits Other time deposits! Large negotiable C D ’s 86,003 64,769 1,713 22,611 19,561 10,023 8,660 12,574 86,144 24,245 615 59,931 5,790 20,754 29,645 15,730 Weekly Averages of Daily Figures W eek ended 9/17/75 Member Bank Reserve Position Excess Reserves Borrowings Net free (+) / Net borrowed (-) Federal Funds—Seven Large Banks Interbank Federal fund transactions Net purchases (+) / Net sales (-) Transactions of U.S. security dealers Net loans (+) / Net borrowings (-) Change from 9/10/75 - + + + + - + + + - + + + - 20 119 99 + + 63 509 574 75 1 25 522 76 114 0 257 54 42 45 97 16 Change from year ago Dollar Percent + 1,348 3,267 598 1,639 318 + 341 + 4,620 5 + 4,873 + 1,516 229 + 4,261 172 + 3,035 + 954 + 481 W eek ended 9/10/75 + - + + - + + - + - + + + 1.59 4.80 25.88 6.76 1.60 3.52 114.36 0.04 6.00 6.67 27.13 7.65 2.88 17.13 3.33 3.15 Comparable year-ago period - 8 29 21 - 98 147 49 1,678 + 1,486 + 1,308 964 + 915 + 695 in c lu d e s items not shown separately. ^Individuals, partnerships and corporations. Information on this and other publications can be obtained by calling or writing the Public Information Section, Federal Reserve Bank o f San Francisco, P.O. Box 7702, San Francisco 94120. Phone (415) 397-1137. Digitized for FRA SER B>(SE|V
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