Cognitive Dollar Dissonance: Why a Global Deleveraging and Rebalancing Requires The De-Rating of the Dollar and the Remonetisation of Gold
For most of the 1990s and 2000s, the economic academic and policy mainstream essentially ignored gold. No longer. Notwithstanding a decline in price over the past two years, the longer-term secular bull market has returned gold to a subject of active debate. Moreover, following 2008, monetary debasement by most central banks has been far greater and has continued far longer than the mainstream originally thought at all likely or even possible. As some have recently claimed, referring to Japan’s lost decades amidst perennial quantitative easing, “we are all turning Japanese.” However, to the extent that the mainstream acknowledges gold, the debate remains relegated primarily to its role as an alternative store of value, rather than as a monetary alternative to the fiat currencies that provide the bulk of the global monetary reserve base, including most importantly the US dollar.
To bifurcate the debate around the gold in this way, however, is to demonstrate cognitive monetary dissonance. This is because, as Kopernick, Gresham, Carl Menger and others have demonstrated, money must be both a medium of exchange and a store of value. It cannot be just one or the other, or it will be abandoned over time in favour of something else. The economic academic and policy mainstream, therefore, cannot claim on the one hand that a global deleveraging and rebalancing requires a much weaker dollar, as is generally acknowledged, and then claim on the other that the dollar can remain indefinitely a reserve currency. Yet this is what many appear to believe. As we know, cognitive dissonance is not uncommon, but when such dissonance dissipates, it tends to do so abruptly, in an ‘awakening’ of sorts. Hence the international remonetisation of gold, while an inevitable consequence of the global debt crisis in my opinion, is likely to occur in spontaneous, unpredictable fashion, rather than being driven in any conscious way by economic or monetary officials.
In a previous article I wrote in this Journal about how a reallocation of global monetary reserves away from the dollar and into gold is already well underway. Recent data suggest that, if anything, this process has accelerated over the past year. China and Russia, among others, appear to be growing their gold reserves at an elevated rate. In both cases, it is impossible to know exactly how much is being accumulated, but available mining and import data are supportive of this view. Many other countries also continue to accumulate gold reserves. Accumulation of dollar reserves, conversely, has clearly slowed over the past year and, far more importantly, is increasingly concentrated in a few hands. The fewer the countries still accumulating dollar reserves, the more unstable the current global monetary equilibrium becomes. This is because, according to game theory, stable systems require that one or more players can adjust their strategies to address changes in their own specific internal circumstances without forcing a change in other players’ strategies. Yet if only a few countries are still willingly accumulating dollar reserves, then if just one of them changes policy in favour of building up gold reserves, the other players must take up the remaining slack or the value of dollar reserves will fall. And each time another player does so, the process accelerates non-linearly, as ever fewer players accumulate a comparable amount of dollar reserves. The last player in the game, of course, will be left holding the entire bag of sharply devalued dollars. As with many such games, while there is only a small ‘first-mover advantage’ in this game, there is a disproportionately large ‘last-mover penalty’, hence the fundamental instability of the equilibrium, regardless of the number of players involved.
By corollary, as the move away from dollar to gold reserves accelerates, so does the requirement that future cross-border balance of payments are settled not in depreciating dollars but in gold, as reserves will be increasingly so comprised. This process can and is occurring spontaneously as the system evolves away from the essentially 100% dollar-centricity of Bretton Woods, the legacy that explains why a purely fiat dollar, rather than one backed by gold, has been able to remain a reserve currency at all. That said, it does appear that certain players in this evolving game, in particular the BRICS, are beginning to coordinate their strategies in ways that might include certain pro-active initiatives in future. Various bilateral currency arrangements are now in place between the BRICS and also many of their various trading partners, contributing to a reduced role for the dollar. This process could easily accelerate, especially if US monetary, economic or foreign policies are perceived to impinge upon one or more vital BRIC national interests. The recent showdown over Syria is but one obvious case in point. The process could also accelerate if it were perceived that the US Fed remained unconcerned about maintaining a stable dollar, as the recent flip-flop regarding the so-called ‘taper’ could well have done.
Notwithstanding the evidence above that the game is changing, the economic academic and policy mainstream in the developed economies, in particular the US, nevertheless continues to embrace the cognitively dissonant narrative that, while gold may well be a superior store of value in a world with excessive debts and need to rebalance and deleverage, it has no business being remonetised, internationally or otherwise. Back in November 2010, Robert Zoellick, President of the World Bank, let the golden genie out of the mainstream’s bottle with the publication of an opinion piece in the venerable Financial Times, in which he observed that gold should henceforth “serve as an international reference point of market expectations about inflation, deflation and future currency values.” He also noted that, “markets are using gold as an alternative monetary asset today.”
At the time, considering of course the source, this came across as something of a bombshell. “Why on earth is the president of the World Bank talking about gold?” many must have asked, scratching their heads. Well, one must consider to whom Mr Zoellick was speaking at the time. With the western banking systems having stared into the abyss in 2008 and early 2009, and with their economies having received vital assistance via stimulus from the developing economies, including from the BRICS, perhaps he was acknowledging a certain pressure emanating from those quarters, that is, that there were limits to which the US dollar could be devalued without triggering a BRIC Treasury buyers’ strike. Perhaps he was also trying to control the terms of international debate, to ‘ring-fence’ gold into a purely nonmonetary role. This effort, however, will ultimately fail. A look at what has happened recently in India helps to illustrate why.
India is a country where gold has always been part and parcel of the culture. Gold is wealth. Rupees are nothing more than a medium of exchange. Among Indians, it is considered complete nonsense to ‘save’ in rupees, and, thus, the rupee only has economic meaning to the extent that it is the enforced legal tender of the land, required for use in legal (and taxable) exchange. This bifurcation between these two roles of money is arguably greater in India than in any other country in the world. It is thus instructive to see how the Indian authorities are responding to a surge in private demand for gold alongside clear evidence that the economy is slowing, government finances are deteriorating and the risks of monetary debasement commensurately growing.
Among other measures to shore up a weakening rupee, Indian economic officials recently imposed large taxes on gold imports. Prior to their enactment, there was a huge rush to import gold, accelerating the rupee’s slide. Now that the taxes are in place, gold smuggling has apparently soared as Indians try to avoid the tax, something that is seen by most as illegitimate anyway. Moreover, Indian officials have sought to learn more about the gold holdings at various temples and belonging to various religious groups and sects. These actions have not gone over well, meeting with stiff public resistance. Arguably they have backfired, fuelling a surge in distrust of the government, which is not exactly held in particularly high esteem by Indians in the good times, much less when the economic going gets rough.
The toxic combination of slowing growth, a dependence on imports and nervousness that the government might seek to arrogate to itself greater control of the country’s quasi-religious gold stocks have all contributed to a sharp decline in the external value of the rupee and a scramble for gold. Gresham’s Law is playing itself out, as indeed it always will do in such circumstances.
The plunging rupee recently resulted in the central bank surprising the financial markets with a rise in interest rates which, in short order, caused a sharp decline in the stock market. Spooked by this reaction, the central bank then reversed the hike and explained that it stood by to maintain financial market stability. Well, which is it then? Is the central bank committed primarily to maintaining the stability of the rupee, which has plunged in the gold terms in which it is measured by Indians; or is it committed to propping up the stock market, which no doubt has imparted a large wealth effect on the Indian economy in recent years, contributing, however unsustainably, to growth? The uncertainty so created is only going to contribute to an ever-greater propensity for Indians to accumulate gold at the expense of rupees, placing upward pressure on interest rates.
Returning to our primary topic of international monetary dynamics, what is playing out in India with gold and the rupee today is but of microcosm of what is happening in the world as a whole vis-à-vis gold and the US dollar. The Fed has explicitly sought to support the US economy with higher asset prices in recent years. The dollar has been at times weak and at times strong versus other currencies. With the Fed’s recent decision to extend Treasury purchases indefinitely, the dollar has weakened yet again. As with India, the uncertainty created by a Federal Reserve that is demonstrably failing to deliver on its promises to get the US economy on a sustainable growth path is only going to increase the propensity for international economic agents of all stripes to accumulate gold at the expense of dollars, placing upward pressure on interest rates.
As higher interest rates naturally threaten the Fed’s goals and methods of supporting US economic growth via asset price inflation, they are likely to be resisted. Should Treasury yields continue to rise, the Fed might well accelerate their rate of purchases rather than scale them back. Trapped as they now are in a vicious circle of their own making, it is unknown just how many iterations of this process will occur before the dollar reserve game collapses entirely, to be replaced by a general remobilisation of gold reserves to settle those international balance of payments transactions. As with any iterative process, at each stage certain global investors or other actors will see the future endgame that little bit more clearly and, in my opinion, each stage will be accompanied by a renewed and quite possibly sudden rise in the price of gold.
Eventually, the gold price will rise to a level sufficient to allow existing gold stocks to settle existing global trade imbalances. These imbalances are huge; themselves a legacy of the dollar’s long-held reserve currency status. The gold price sufficient to imply sufficient cover for these imbalances is thus many multiples of where it is today.
The cognitive dissonance of the mainstream nevertheless continues. Professor Barry Eichengreen has long predicted a weaker dollar as a necessary requirement of a general global economic rebalancing, yet he does not see any likelihood or purpose of an international remonetisation of gold. More recently, at a US gold mining and investment conference, Walter Russell Mead, formerly the Henry A. Kissinger Fellow for US foreign policy at the esteemed Council on Foreign Relations, pointed out that, “There are some very grim facts out there about the dollar at home. There are also signs of serious opposition to the dollar abroad.” He then added that the outlook for gold was positive, because “There will always be a desire by a significant number of people to have that one kind of asset they feel would hold its value against the worst of catastrophes.” Yet although he acknowledged the challenges faced by the dollar and the likelihood that it will continue to decline in value, he nevertheless concluded his remarks by observing that the dollar is in no danger of losing its reserve currency status.
These comments, in effect, echo those of Mr Zoellick from 2010. Notwithstanding the accumulating evidence from China, Russia, India and elsewhere that the game is changing rapidly, the academic and economic policy mainstream refuses to acknowledge that a “game” is being played at all. Gold IS being de facto remonetised, because it is simply not possible to artificially and sustainably bifurcate money’s essential roles as both a store of value and medium of exchange. One look at India today illustrates the point; but stepping back and looking at the bigger picture of the broad history of international monetary relations does the same. Superior money has, always and everywhere, ultimately replaced inferior. And the verdict has always and everywhere been the same: gold and silver, or high-grade alloys thereof, provide the superior money. Thus gold and perhaps silver will provide the monetary foundation for the global economic rebalancing and deleveraging that all agree is both necessary and inevitable.
John Butler

John Butler is a founding partner and the CIO of Amphora, a commodity-focused hedge fund. He has 19 years’ experience in the global financial industry, having worked for European and US investment banks in London, New York and Germany. Prior to founding his independent investment firm, he was Managing Director and Head of the Index Strategies Group at Deutsche Bank in London, where he was responsible for the development and marketing of proprietary, systematic trading strategies. Prior to joining DB in 2007, John was Managing Director and Head of Interest Rate Strategy at Lehman Brothers in London, where he and his team were voted #1 in the Institutional Investor research survey. He is the author of The Golden Revolution (John Wiley and Sons, 2012), and author and publisher of the popular Amphora Report investment newsletter. His research has been cited in the Financial Times, the Wall Street Journal and other major financial publications, and he has appeared on CNN, CNBC, ReutersTV, RT and BBC programmes.