Gold in crisis times

November 22, 2009 01:06 pm | Updated December 17, 2016 05:25 am IST - Chennai

‘Magneto trouble’ is the title of a chapter that tells the story about the period 1930-31 in ‘Lords of Finance: 1929, The Great Depression, and the bankers who broke the world’ by Liaquat Ahamed (www.landmarkonthenet.com). Magneto is a device commonly used for creating electric spark in the ignition of automobiles, explains the author, tracing the phrase to Maynard Keynes who had, in 1930, compared the economy to a stalled car.

“We have involved ourselves in a colossal muddle, having blundered in the control of a delicate machine, the working of which we do not understand,” Keynes had bemoaned. He was, however, sanguine that the ‘magneto trouble’ could easily be cured through ‘resolute action’ by the central banks to ‘start the machine again.’

To jump-start the economy, though, a central bank had to have enough gold, the underlying raw material for credit creation under the then gold standard, narrates Ahamed. “The international monetary system was now operating, however, in a very perverse way. Because of investor fear, capital in search of security was flowing into those countries with already large gold reserves – such as the United States and France – and out of countries with only modest reserves – such as Britain and Germany.”

He describes how with American capital bottled up at home and US demand for European goods shrinking – a result of the weak US economy and of higher import tariffs imposed in June 1930 by the Smoot-Hawley Act – Europe could only pay for its imports and service its debts in gold. “During 1930, a total of $300 million in bullion was shipped across the Atlantic into the vaults of the Federal Reserve system.”

What was even more disruptive to international stability was the flow that year of $500 million of gold into France, the one country in Europe that had somehow remained immune from the world economic storm, says Ahamed. “By the end of 1930, the Banque de France, in addition to the $1 billion it held in sterling and dollar deposits, had accumulated a gold reserve mountain of over $2 billion, three times that of the Bank of England.”

Unknown to most people, much of the gold that had supposedly flown into France was actually sitting in London, the author notes. Since bullion is heavy – ‘a seventeen-inch cube weighs about a ton’ – central banks tend to ‘earmark’ the metal, that is, keep it in the same vault by simply re-registering its ownership, rather than ship crates of gold across hundreds of miles from one country to another and pay high insurance costs.

“Thus the decline in Britain’s gold reserves and their accumulation in France and the US was accomplished by a group of men descending into the vaults of the Bank of England, loading some bars of bullion onto a low wooden truck with small rubber tires, trundling them thirty feet across the room to the other wall, and offloading them, though not before attaching some white name tags indicating that the gold now belonged to the Banque de France or the Federal Reserve Bank.”

As 1930 was closing, gold holdings by the US and France were nudging to 60 per cent of the world’s total, with neither country doing anything to re-circulate it. And economists were not happy, as Ahamed cites in the book. For instance, Paul Einzig wrote that the French gold hoarding policy brought about the slump in commodity prices, which in turn was the main cause of the economic depression, and the unwillingness of France to cooperate with other nations aggravated the depression into a violent crisis. And Gustav Cassell said, “The Banque de France has consistently and unnecessarily acquired enormous amounts of gold without troubling in the least about the consequences that such a procedure is bound to have on the rest of the world, and therefore on the world economic position.”

Keynes lamented the disappearance of gold from circulation. “The little household gods, who dwelt in purses and stockings and tin boxes, have been swallowed by a single golden image in each country, which lives underground and is not seen. Gold is out of sight – gone back into the soil. But when the gods are no longer seen in a yellow panoply walking the earth, we begin to rationalise them; and it is not long before there is nothing left.”

The bullion reserves that backed the credit systems of the world, buried as they were in underground vaults – or in the case of the Banque de France, underwater, because its vaults lay below a subterranean aquifer – were invisible to the public eye, adds Ahamed. “They had acquired an almost metaphysical existence. Keynes thought that perhaps gold, its usefulness now outlived, might become less important… He would eventually be proved right but not before a wrenching upheaval.”

Topical read, at a time when gold is at a high, even as contrarian caution of a steep crash of the yellow metal looms afar in the fringes.

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