Monday, August 8, 2011

The Case for Gold as a Reserve Asset in the GCC

The Case for Gold as a Reserve Asset in the GCC

Dr. Nasser Saidi, Dr. Fabio Scacciavillani

The international role of the dollar as a vehicle currency and international reserve asset has come under strain during the financial crisis of 2007-2009.

The Triffin dilemma is strongly resurgent: the large balance of payments deficits that the US has been running over the past decade and therefore the piling up external liabilities that have gone to finance the swelling size of international trade and financial markets, has undermined confidence in the US dollar as a reserve asset. Second, the US has been running large fiscal deficits since 2001, leading to a large buildup of public debt, with more than 60% being foreign held. The debt service is becoming a burden which puts the country at risk of negative repercussions when global interest rates will be on the rise again. Over the years and decades to come, the dominant role of the dollar is likely to give way to a multi-currency arrangement as has been typical of historical phases where three or more economies in the world had roughly the same size and none was clearly dominant as in the late XIX century.

The size and composition of international reserves depends on the choice of exchange rate regime, mandate of the central bank and its policy objectives. Obviously if the national currency is pegged to a foreign currency like the US dollar, as is the case in most of GCC (excluding Kuwait) the reserves will be predominantly kept in US dollar denominated liquid assets. Since oil is priced in US dollars and oil contributes significantly to GCC countries’ government revenues and gross domestic product, governments have preferred to fix the domestic currency against the US dollar. While this has provided an anchor, the obverse is that Gulf currencies have been volatile against the euro, the Yen and other currencies, while trade and investment patterns have been shifting eastward, with Asian countries being the main trade (and increasingly investment) partner of the GCC.

The GCC countries are also considering moving towards a Gulf Monetary Union and potentially a Gulf Common Currency. We examine the backing for such a common currency in terms of a basket of currencies and whether the composition of reserves could help in conferring the new currency credibility and whether it is possible to demonstrate quantitatively that including gold would help to achieve better macro-economic stability..."


"“The main thing we miss today is universal money.
Gold fulfilled this role from the time of Augustus to
1914. The absence of gold as an intrinsic part of our
monetary system makes our century, the one that has
just past, unique in several thousand years… I firmly
believe gold will be a part of the international monetary
system sometime in the twenty first century.”
Robert Mundell, Nobel Laureate in Economics,
Acceptance Speech—December 1999"


"...Empirical studies have found that central banks have tended to pursue portfolio rebalancing in which they buy (sell) falling (rising) currencies rather than market trend strategies in which one would buy (sell) rising (falling) currencies. Lim (2007) concludes that these findings are consistent with relatively stable currency shares in the COFER database. Papaioannou et al. (2006) finds that the choice of reference currency, currency pegs, and currencies of foreign exchange market intervention strongly influence the composition of reserves. In addition, rising prices for oil and raw materials have increased foreign reserves in commodity exporting countries. These reserves are financed primarily from US current account deficits. Even a limited shift out of dollar assets could result in significant exchange rate movements - in particular, sizable dollar depreciation. Swapping dollars for gold, rather than other currencies, can also sidestep, albeit temporarily, undesirable exchange-rate shifts. Given its characteristics, gold is an effective alternative to dollars in a major financial crisis...."

"...The Role and Value of Gold 
Gold as an asset has a hybrid nature: it is a commodity used in many industries but also it has maintained throughout history a unique function as a means of exchange and a store of value, which makes it akin to money. The reasons for this function cannot be explained rigorously in terms of conventional asset pricing models. This has prompted, even recently, some economists to quote Keynes who famously described the gold standard as “a barbarous relic of the past” in order to cast doubts on the usefulness of gold in financial markets. Nevertheless, this function, which seems at times to be waning, resurfaces powerfully in periods of unusual tensions or heightened risks. The dollar and gold have always been competitors as a monetary store of value. It can even be argued, that it was the commitment of US to maintain a fixed gold price that made the US dollar the dominant monetary asset. The dollar is presently the world’s main reserve currency - a role once held by gold. Despite having ceased to be the cornerstone of the monetary systems almost 40 years ago, gold has never been priced purely as a commodity by virtue of its non-fiat money function. Particularly when trust in fiduciary paper dims gold price surges: gold acts as a safe haven in times of financial panics, uncertainty or bouts of inflation...."

[Mrt: An interesting paper worth of full read. Oil must take now a stance in this move, or not? :o) OPEC still silent atm.]


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