• Speculation is rife that the BRICS will soon introduce a gold-backed currency for trade settlement
  • I’ve been writing on this topic for nearly two decades
  • This includes what it implies for currencies, gold and financial markets generally

I’ve been writing about a possible future “de-dollarisation” and reintroduction of gold in the international monetary system for nearly 20 years. First in my research roles in the City, then in my independent newsletter, The Amphora Report, and subsequently in my books and here at Southbank Investment Research. All along, I’ve considered the possibility that the BRICS – Brazil, Russia, India, China and South Africa – would lead the way.

Now it appears this may indeed be happening. D-Day for de-dollarisation may be approaching. To paraphrase Churchill’s comments following Field Marshal Montgomery’s success at El Alamein, “Now this is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning of a major restructuring of the international monetary system.”

In late August, the BRICS will hold their fifteenth annual summit. This year, it will be in Durban, South Africa. Over a decade ago, they began to voice their displeasure with the dollar-centric international monetary system.

Here is an excerpt from their 2011 Sanya, China, summit declaration:

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.

I included the above in my introduction to section II of The Golden Revolution. What follows are excerpts from the text of chapter 10, part of that section, which helps to explain why I believe that the BRICS will continue to take steps to introduce a gold-backed currency for settling international trade.

The relative growth of the BRICS in recent years has been dramatic. As a group, they are already larger than the US economy and, by extrapolating recent trends, will continue to outpace the US and other developed economies in the coming few years (Figure 10.1). Importantly, they also trade increasingly with each other, rather than bilaterally with the United States. Taken together, these trends imply a growing preference to use their own currencies in bilateral trade, rather than the dollar. But with no single BRICS economy in a position to dominate the others, it is far more logical for them to move toward the use of an objective reference currency that can be trusted and accepted by all. A gold-backed currency of some sort would be ideally suited for that.

Of course, most countries implement monetary policies that are not necessarily appropriate for others. But few currencies are widely held as reserves and none anywhere near the scale of the dollar. In any case, it would be a non-solution to the BRICS and others’ problems to simply replace the fiat dollar with another fiat reserve currency.

Even a basket of currencies could be problematic, as all major economies are currently suffering various forms of economic and financial crises which raise the temptation to inflate away their debts. The euro-area, UK and Japan all fall into this category.

Gold is the only alternative to the dollar which is not as risk of arbitrary and expedient devaluation. From the perspective of exporting countries, in particular the large oil exporters, with their vast accumulated wealth and large export revenues, transacting in gold, or in an explicitly gold-backed currency, would be most desirable.

By acting in concert, rather than individually, the BRICS and others could probably more effectively deal with the increasing global monetary disruption that such actions would cause. It is thus entirely plausible to assume that there have been some cross-border discussions on the possibility of coordinated action…

There have also been reports of increased official gold purchases in recent years, an implicit indication that a growing number of countries are seeking to reduce their dependence on dollar reserves. Unlike currency swap and bilateral trade arrangements, the accumulation of gold reserves need not be coordinated. Indeed, a growing preference for gold reserve accumulation could be an indication of a relative lack of global cooperation in monetary affairs. Notwithstanding the various bilateral agreements cited above, these are hardly sufficient to restore the degree of confidence and credibility in global monetary arrangements which prevailed prior to the undermining of the US economy and financing system from 2008, and to which this book argues there is no return absent gold.

But if the evidence indicates that a number of countries share a common goal of moving away from the fiat dollar toward something more credible, stable, and reliable, why does one of them need to be a first mover? Indeed, as bilateral commercial ties between a number of countries are now greater than those they have with the United States specifically, were a group of countries to move away from the dollar in concert, it would be much less disruptive for any single one of them. Consider also the danger that, if a single country moves first and establishes a gold-backed currency, it might suddenly face huge pressure to revalue as other countries seek to swap a portion of their dollar reserves for the new, gold-backed alternative. That would, of course, hurt relative economic competitiveness.

Recall our previous discussion of the Nash equilibrium: It represents the most desirable collective outcome when each player takes full account of the other players’ strategies. As the interests of a single player shift, so must others react, such that the entire equilibrium shifts. Such is the case in our Russia as first-mover example. But what of the present instance, which is, arguably, the opposite, where Russia is, in fact, in good company? What is happening today is that the interests of most players are shifting simultaneously. Only the interests of one major player, the United States, remain essentially unchanged—to inflate the dollar money supply as required to re-liquefy its insolvent banking system.

As such, it is entirely reasonable to assume that, at some point in the near future, the BRICS and possibly a larger collection of countries finds a way to move away from the fiat dollar in concert. It would be less disruptive for each to do so in such fashion. The relative impact on each participant’s economic competitiveness would be substantially less and the losses on the accumulated dollar reserve holdings would be more proportional, rather than any one country being stuck holding the ‘Old Maid’ fiat dollar reserve pile, as it were.

All four BRICS, joined perhaps by Germany and France and some oil-producing countries, could agree to the simultaneous implementation of gold convertibility for their currencies, at a conversion price that would be credible and, hence, sustainable. As is the case in our discussion regarding the United States, the key would be to make certain that, whatever price is chosen, that it does not require a deflationary adjustment that would threaten their respective financial systems.

The more that participated up front, the less overall disruption to global commerce and the sooner the world, having placed gold back at the center of the global financial system, could return to the business of generating sustainable economic growth, rather than continuing to fight the endless series of financial fires associated with the unstable fiat dollar.

Were other countries to take the lead, the United States would quickly find it had no alternative but to go along with whatever gold-backed arrangements this group of countries decided to implement. Gold-backed currencies are simply more credible in a world where trust is lacking. Indeed, if the United States resisted a global move back to gold, it would no doubt find that it faced higher interest rates as a result. Who would prefer to buy unbacked US Treasuries when they could buy gold-backed German, Brazilian, or Chinese government bonds instead?

Sure, the Fed could continue to buy ever-increasing amounts of Treasuries to keep interest rates as low as desired, but then the dollar would not only lose reserve currency status entirely but also become a chronically weak currency, leading to persistent high inflation above and beyond that which would occur were the United States simply to bite the bullet now and restore gold convertibility.

Well, I’m not holding my breath on that one. The US seems intent on maintaining the existing international monetary order. But the rest of the world, led perhaps by the BRICS, is clearly moving away from the legacy Bretton-Woods structures that have dominated global commerce for decades.

As investors, this may all seem rather intimidating. Frightening even. Any reduction in the dollar’s role as the core international reserve currency is likely to place upward pressure on dollar interest rates. By extension, this will place upward pressure on interest rates in the UK and elsewhere.

Financial asset risk premia will increase. Earnings multiples on stocks will decline and spreads on corporate debt securities are likely to widen.

The currencies of countries that are large net importers will devalue relative to those that are competitive exporters. Sterling will thus come under devaluation pressure.

From the perspective of a typical investor, all of that is bad news. Taking a stoical approach to it all, the best defensive actions to take would be to overweight defensive, real assets. Natural resources, metals, mining, basic industries, chemicals, energy, agriculture, consumer staples… There is still going to be demand for all of these.

There will also be a surge in demand for gold. Official institutions will shift reserve holdings along with the global monetary equilibrium. And investors, institutional and private, will shift their portfolio allocations to reflect the new global monetary order.

Strictly limited in supply, even small shifts in the demand function for gold will have a disproportionate impact on its price. In The Golden Revolution, I predict a price in the tens of thousands of dollars, or pounds, per troy ounce. Given all the money printing that has taken place in the interim, I would certainly stand by that view.

Until next time,

John Butler
Investment Director, Fortune & Freedom