Much of what is currently happening right in front of our eyes provides evidence of an unfolding sea change in the global monetary order. As the US Fed turns from monetary easing to monetary tightening, with uncertain outcomes for the global economy, investors’ trust in currencies issued by central banks is eroding. Blockchain technology has enabled a much-hyped boom in cryptocurrencies as investors seek alternatives to the US dollar, once perceived as an invulnerable safe haven. These shifting tides in the monetary system are coming to pass in different ways, at different velocities, and at different levels of visibility. On the cusp of fundamental change, it is particularly important not to lose sight of the forest for the trees.
The global economic order was and is undoubtedly dominated by the US. The US produces the world’s largest economic output, enjoys far-reaching diplomatic clout, and is an uncontested military hegemon, all of which testifies to its global dominance. On the currency front, the global balance of power is embodied in the long-standing US dollar-centric global currency architecture, which critical observers have warily referred to as an “exorbitant privilege”.
Confidence in the US dollar has evolved historically. The status of the US as a free market economy with strong property rights and a robust rule of law, deep and highly liquid capital markets, and a hard currency under the gold standard, have propelled the country to a global leadership position. Moreover, the fact that commodities are traded and settled in USD is of particular importance.
However, faith in the US dollar-centric dispensation is not carved in stone. One measure of international trust is the proportion of global currency reserves held in US dollars. So far, it remains relatively static, as central banks tend to be cautious and deliberate and are not exactly prone to shooting from the hip. As Alan Greenspan pointed out, the price of gold is a useful indicator of global confidence in the US dollar as a reserve currency. Combined with the Dow Jones index one can calculate the well-known Dow/gold ratio which also serves as an indicator of the degree of confidence or distrust in the US-centric economic and monetary order.
By the end of the 1970s, confidence in the US monetary system had eroded substantially. The Dow/gold ratio hit an all-time low of 1.29x in January 1980, well below its median of 6.5x. Due to the abysmal economic environment in the 1970s and the assumed strength of the Soviet Union, it was not entirely clear at the time whether the West would prevail in the struggle against communism. To almost everybody’s vast surprise, by the early 1990s the US emerged as the only remaining superpower, apparently inviolable in every respect. The US dollar index reached an all-time high around the 120 level; budget surpluses were rolling in; and by the turn of the millennium the Dow/gold ratio hit an all-time high.
Alas, prior to the Great Financial Crisis of 2007–2009 the Dow/gold ratio suggested that faith in US leadership had already begun to sag. The boom in equities and housing markets was driven by a major credit bubble; its eventual unwinding made clear that a high price had been paid for prolonging the “good times” of the 1990s by a few years. Contrary to the late 1990s, on this occasion the gold market sensed early on that something was amiss.
The Fed reacted decisively to the onslaught of the financial crisis. While the ensuing years of money printing pushed nominal share prices up, the reservations of market participants found expression in the performance of share prices relative to the gold price. Trust was finally fully restored to the markets in 2012 to 2013, after the ECB promised to intervene in the sovereign debt crisis in the euro area and the Fed announced that its monetary emergency measures would be tapered and eventually discontinued. Today, ten years after the crisis, the Dow/gold ratio seems to indicate that US economy is well on the way to regain its former strength.
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