Gold is Money: Iran Edition

Economic sanctions on Iran seems to be ushering in gold’s default role as money.

Earlier I pointed to a rumor where under economic sanctions from the US and Europe, Iran would circumvent these by using gold to trade with India.

Andrey Dashkov and Louis James at the Casey Research has an update

It proved to be nothing but a rumor, however: the sides decided to arrange the deal in a more tactical manner. India will partly cover the purchases with its own currency, and Iran will later use those funds to acquire imports.

But gold is not out of the equation yet. The US-initiated sanctions were effective, at least in the sense of making international institutions avoid the pariah nation. Reuters reported that Iran has failed to organize imports of even basic food staples for its population of 74 million. Prices on local markets rose sharply; and as the country nears parliamentary elections on March 2, the government is taking radical steps to provide citizens with basic necessities. One of those unconventional solutions was offering gold as barter for food.

"Grain deals are being paid for in gold bullion and barter deals are being offered," one European grains trader said, speaking on condition of anonymity while discussing commercial deals. "Some of the major trading houses are involved."

Another trader said: "As the shipments of grain are so large, barter or gold payments are the quickest option."

Trading in gold rather than a fiat currency is "cashless." That may sound as if there's no medium of exchange, but that is of course a misconception: gold is history's longest-standing medium of exchange.

As long as the sanctions remain in force and the Iranian government has limited access to international currency markets, gold will remain an obvious way to settle transactions. Decreasing oil imports to Japan, the world's third-largest importer, will impact the Iranian economy further, draining foreign currency inflows. Lacking foreign currency may push the country to continue using its foreign exchange reserves, or gold, to cover its international liabilities. Oil looks like a viable, though less convenient, alternative as well.

The Iranian economy is in a state of crisis, and due to the lack of trust in its currency, leaders are increasingly resorting to extraordinary offers to trading partners. The situation would clearly worsen if the country enters a state of war. While that's still speculation, imagine what would happen to the price of gold if a part of Iran's 29-million ounce gold reserve becomes a medium - not an object - of exchange in international trade.

That reduction in potential supply could be a game-changer, not only because of crisis-struck Iran, but because it could open the door for other countries to follow suit. The price of gold would likely respond very positively.

This scenario, while possible, may not happen very soon: large-scale trading in gold has occurred only rarely in recent years. Traces of deals are difficult to track down due to the anonymity of the yellow metal. This re-emphasizes our point regarding gold as money in extremis: when economic push comes to shove, gold will outlast any other medium of exchange in existence. As the evidence from Iran shows, even governments - the masters of the central banks - will resort to mankind's oldest form of money when pressed.

Which brings us to this evergreen conclusion: Gold is one of the best assets to own in both good times and bad. It can rise with inflation in a surging economy, and it can be practical for exchange when times are bad.

Gold isn't just a hedge; it's money.

The policies of inflationism, compounded by protectionism and imperial foreign policies account for as self-designed path towards the perdition of the current monetary standard. And if these conditions intensify, gold may redeem its role as money overtime.

In the meantime gold’s role in the financial system will deepen, expanding its functionality from hedge to collateral, and perhaps to become an integral part of financial securities, such as bond issuance backed by gold, and possibly in the fullness of time, towards a medium of exchange.

Japan to Offer Gold Coins to Debt Investors

From the Bloomberg/Businessweek

Japanese Finance Minister Jun Azumi will be rewarding investors who buy reconstruction bonds with half an ounce of gold, an added incentive that could boost the return by nearly six times.

Individual investors who purchase more than 10 million yen ($129,000) in the debt with a 0.05 percent return and keep it for three years will receive a gold commemorative coin weighing 15.6 grams (0.55 ounces), the Finance Ministry said in Tokyo today, worth about $948 based on current prices for the precious metal.

The offer suggests the return could be boosted to 89,000 yen should gold prices remain at current levels, more than the approximate 15,000 yen one would receive from the bond. Azumi, whose hometown was devastated by the March 11 disaster, said today he bought 1 million yen of the debt to support rebuilding efforts from the earthquake and tsunami.

This can be viewed as tokenism—reward for not only buying government debt (thereby keeping politicians happy) but for also keeping them.

Even at the margins, such symbolism may be seen as enhancing gold’s image as safehaven asset. Yet this could serve as more evidence where gold will likely be used as prospective collateral for government/corporate debt issuance.

Lastly, with the rate of currency debauchery being undertaken by global central backs which includes the Bank of Japan, it would not be surprising that the current price differential of the gold 15.6 grams coin ($948) and the 10 million yen debt ($129,000) will most likely narrow overtime.

Chart from ycharts.com

Prices of gold based on the yen has more than doubled over a decade.

Will Gold Backed Bonds Play a Role in the Euro Debt Crisis?

From the Guardian.co.uk

A solution to the eurozone crisis is staring European leaders in the face. Remarkably, they have failed to consider gold as the asset of last resort. Eurozone member nations and the European financial stability facility (EFSF), the bailout fund, could use gold to back new bond issues.

The security of gold-backed bonds would encourage investors. Indeed, central banks purchased 4.8m ounces of gold worth $8bn (£5bn) in the third quarter. The application of gold backing would allow stricken nations such as Greece, Portugal, Spain and Ireland to depart from the restrictive eurozone and the accompanying depressive austerity policies, if they wished. The bonds would give them time to devalue, adjust and grow again, and also isolate the crisis from other European nations.

As at the end of October, eurozone nation central banks owned 347m ounces of gold worth $604bn. This compares with 400.5m ounces, then worth only $110.5bn, in the first quarter of 2000. The gold reserves fell because European central banks subsequently sold gold at knockdown prices of $250 to $350 an ounce after the 11 September terror attacks. Since then the lemming instinct of European finance ministers and central banks has once again prevailed and their gold sales have dried up, despite recent record prices of $1,800-1,900 an ounce.

Fortunately for eurozone leaders and their advisers, there is still a lot of gold left in the kitty. The current market value of the eurozone's 347m ounces has surged to $604bn, or €447bn – more than the current capital of the EFSF…

Eurozone leaders have devised several complicated partial loss guarantee schemes to persuade China and other potential investors to invest in EFSF bonds. Hardly surprising that the response has been: "Thanks, but no thanks." On the other hand, if EFSF bond issues had the backing of gold plus interest, it would be surprising if European and international investors didn't snap them up. Depending on demand, gold backing could be 25% to 50% of the total value of an Italian bond, for example.

Gold backed bonds have worked before. Take some precedents. In 1981 and 1982, South Africa, which was then the world's largest gold producer, swapped nearly 5m ounces of gold collateral in return for foreign exchange. In the late 1970s and early 1980s, indebted nations such as Brazil, Uruguay and Portugal either swapped or sold their gold to raise funds. In 1973, France issued 'Giscard' bonds, indexed to the price of gold.

While I think bonds collateralized by gold could indeed be tapped, I don’t think this would work like a magical wand that could wish away the debt crisis, where crisis afflicted EU governments can just “depart from the restrictive Eurozone”, elude “depressive austerity policies”, or “to devalue”. That would be oversimplistic and naïve.

Growth of Social Transfers (From Faz community) [hat tip Prof. Antony Mueller]

The Eurozone has been blighted by insolvency issues, mostly emanating from an overextended welfare and heavily regulated state which has been compounded by a debt overdosed dysfunctional banking system.

EU’s gold holdings would signify only a fraction of EU’s debts.

The US and Japan has not been immune to the same crisis, except that the EU has been the first to feel the crunch from an unsustainable political economic system.

Growth of government debt (From Faz community)

Gold backed bonds does nothing to change this dynamic, except to possibly gain access to funding in the marketplace which may help the EU to mitigate current conditions as reform programs are undertaken.

Nevertheless, the good news is that the urgency to address the current dire situation from the fiat money based debt mess has been prompting mainstream media to reconsider gold as part of the possible solution. Such is the gradual transformation of gold from an ignored “barbaric metal” to eventually “money”.