From the vault: the gold fetish
With the Republicans indulging their gold fetish, I thought this would be a good time to reprint the “currencies” section of the first chapter of my book Wall Street (Verso, 1997). The book is available for free download here. Numbers and institutional details are, of course, out of date, but the conceptual frame is as fresh as a daisy. For a psychoanalysis of money, credit, and gold, see From the vault: money and the mind, a psychoanalysis.
Trading in currencies is the largest and probably the oldest market of all. It used to be that the buying and selling of foreign exchange (a/k/a forex or FX) was an intermediate process, a step between, say, liquidating a U.S. Treasury bond and buying shares of Matsushita in its place, or between a multinational corporation’s taking its profits in German marks and shipping them back to headquarters in London. Now, however, hedge funds, pension funds, and other institutional investors have increasingly been treating foreign exchange as an asset class in itself, separate from any underlying stock or bond (Bank for International Settlements 1993, p. 7). That means that trading in money itself, rather than monetary claims on underlying real assets, is now one of the most fashionable strategies available to big-time plungers.
Trade in foreign currencies is ancient — and not only in coins and bills, but in financial exotica. As Marcello de Cecco (1992a) noted, Aristotelian,  Christian, and Islamic restrictions on usury prompted clever forex transactions, so priced and structured as to allow the furtive bearing of interest. That means that from the outset, FX markets were only partly about the cross-border trade in real goods; financial considerations have long been central.
With the breakup of the Roman empire, currencies proliferated, as did opportunities to profit from their exchange and transformation. Italians were well placed to profit from the new trade — Italy being the center of the former empire, and also the home of the church doctors, who were adept at devising schemes for evading usury prohibitions. As the church ban began to lose its bite, and as the center of European economic activity moved north and west, Italian dominance of FX waned; first Belgian and Dutch dealers inherited the business, only to lose dominance to London, where it pretty much remains, though of course there’s still plenty to go around.
In myth, the old days were ones of monetary stability, with gold acting as the universal equivalent for all national monetary forms. In fact, the temptation of states to manipulate their currencies — to declare their coins’ purchasing power to be greater than the intrinsic value of their metal — is ancient and nearly irresistible, and the more insulated a country is from FX markets, the less resistible it seems to be. The triumph of the international gold standard was the result of the Enlightenment and the consolidation of British industrial and financial power; the political economists of the 18th and early 19th centuries provided the theory, and the development of capitalist finance provided the impetus from practice.
With Sir Isaac Newton as Master of the Mint, Britain set the value of the pound sterling at 123.274 grains of gold at the beginning of the 18th century. That standard was suspended in 1797, because of the financing needs of the Napoleonic Wars. When peace came, creditors’ calls for restoration of the gold standard were resisted by industrialists and landowners. In 1818, the government faced major funding difficulties, and was forced to return to the old formula. The ensuing deflation savaged home demand, forcing British industrialists to search abroad for export markets.
The classical gold standard was nowhere near as stable nor as universal as it’s usually painted by metal fetishists. Wild booms alternated with equally wild busts. And while the Bank of England stood at the center of the world gold market, silver prevailed elsewhere, especially in France, which provided Britain with a reservoir of liquidity in tight times.
And then there was America, which was constantly disrupting things throughout gold’s heyday. The often imprudent, even anarchic American credit system helped finance the country’s extraordinary growth, but the system’s indiscipline led to manias and panics in near-equal measure. The Bank of England was often forced to act as a lender of last resort to the U.S., which had no central bank, and often little sense of fiscal management (de Cecco 1992b). Had America been forced by some pre-modern IMF to act according to modern orthodox principles, the U.S. and perhaps even the world would be a poorer place — at least in monetary terms.
The U.S. went off gold during the Civil War — war, it seems, is the greatest enemy of financial orthodoxy — and didn’t return until 1879, with most other countries following suit. That began the period of the high classical gold standard, which lasted only until 1914, when it was destroyed by the outbreak of war — a much shorter reign than the propaganda of modern goldbugs suggests. There were attempts to put it back together between the two world wars, but countries set their currencies’ values (relative to gold) unilaterally, with no sense of how the values fitted together. That system collapsed in the 1930s, and there was no stable global monetary order until after World War II, when the Bretton Woods fixed exchange rate system was established. Unlike the classic gold standard, in which all countries expressed their national currency in terms of gold, the Bretton Woods system used the dollar as the central value, and the dollar in turn was fixed to gold. Countries could hold dollar reserves in their central bank for the settlement of international trade and finance on the knowledge that they could cash those dollars in for a fixed amount of gold. The dollar, as was said, was as good as gold.
The designers of the Bretton Woods system feared floating rate systems were unstable, undermining trade through uncertainty and market overreactions. Keynes wanted a much more elastic system than the U.S. paymasters would permit; ironically, though, the emergence of the dollar as the central reserve currency meant that world reserves were essentially a matter of U.S. monetary policy, and the U.S. did not stint on supplying these. From soon after the war was over until today, the U.S. has acted as the final source of world demand. There was the Marshall Plan, global military expansion, investment abroad by newly globalizing U.S. multinationals, and always more and more imports — all of which scattered dollars around the world. That cascade of greenbacks, plus rising domestic inflation, meant that the dollar was no longer worth as much as it was supposed to be — that is, the gold price was artificially low — and that cashing in dollars for gold at posted prices was a marvellous deal. (No one took more pleasure in pointing this out than Charles de Gaulle.) Strains began appearing in the system in the late 1960s; the outflow of gold from the U.S. to London was so great during the week of the Tet Offensive in Vietnam (March 1968) that the floor of the Bank of England’s weighing room collapsed (O’Callaghan 1993, p. 19). The German mark broke free and appreciated in 1969, and repeated the breakout in 1971. The French cashed in dollars for gold, and there were rumors that Britain was next. So in August 1971, Nixon closed the Treasury’s gold window, ending the sale of cheap gold. After some attempts at patching the system together, currrencies began floating, one by one, in 1973. Now the value of a dollar or a D-mark is set by trading on this vast market.
While governments are not free to set the value of their national currencies, they aren’t as powerless as casual opinion has it. Policies to manage the major currencies have been fairly successful since the major powers agreed to the gradual devaluation of the dollar in 1985 (the so-called Plaza agreement, named after the New York hotel where they met). Nor is central bank intervention necessarily the fruitless and expensive thing it’s thought to be. From the last quarter of 1986 to the first of 1996, the U.S. government made over $10 billion on exchange market interventions, mainly to support a falling dollar (by buying lots of dollars). The profits, divided about equally between the Treasury and the Fed, were added to the Treasury’s Exchange Stabilization Fund — $28 billion in D-marks, yen, and Mexican pesos — and the Fed’s holdings of $21 billion in FX reserves, denominated in the same currencies (Fisher 1996).
Central banks can’t change the underlying fundamentals that drive currency values — like productivity, inflation rates, and political stability — but they can influence the speed and gentleness of adjustment. But it’s worth saying a few words about those fundamentals. As loopy as currency trading can get from day to day, it’s no surprise that economic crises often take on the form of a foreign exchange melodrama. Despite all the hype about a borderless global economy, the world is still organized around national economies and national currencies; the foreign exchange market is where national price systems are joined to the world market. Problems in the relation between those countries and the outside world often express themselves as currency crises. Two recent examples of this are the European monetary crisis of 1992 and the Mexican peso crisis of 1994. In both cases, one could blame the turmoil on speculators, and one would be partly right — but also in both cases, the political momentum for economic integration had gotten way ahead of the fundamentals. Weaker economies like Italy’s and Britain’s were being thrust into direct competition with Germany’s, just as Mexico was being thrown into competition with the U.S. The relative productivity of the weaker partners in both cases wasn’t up to the valuations implied by the exchange rates prevailing before the outbreak of the crisis. Something had to give, and it did, with seismic force.
But day-to-day trading in money itself typically proceeds with little regard for such real-world considerations. That trading in money takes many forms. The longest-established are the spot and forward markets, dominated by the world’s major commercial banks. A spot contract allows a customer to buy a specified amount of foreign exchange — a million U.S. dollars’ worth of German marks, for example — for immediate delivery at prevailing market rates. (In practice, “immediate” usually means two business days.) The full amount involved actually changes hands. Conceptually, forward contracts are simple enough — they’re a kind of delayed spot deal, with buyers today fixing a price today for a deal to be consummated in a month or three. In practice, such straightforward forward deals have been eclipsed by swaps, in which the two parties agree to exchange two currencies at a certain rate on one date, and then to reverse the transaction, usually at a different exchange rate, some specified time in the future. The “price” of a forward contract — the difference between the forward and spot prices — is determined largely by the difference in interest rates in the two currencies, with an adjustment for the markets’ expectations of where the currencies are going in the near future. There are also futures and options contracts traded on the major currencies, and, of course, exotic custom derivatives are available as well.
A survey by the Bank for International Settlements (1993, pp. 109–137) reported that on an average day in the rather placid month of April 1992, $880 billion in currencies changed hands, up from $620 billion in 1989, an increase of only 42% — insignificant compared to the doubling between 1986 and 1989. To put that $880 billion in perspective, it means that the currency markets turned over an amount equal to annual U.S. GDP in about a week, and world product in about a month. Turnover almost certainly rose dramatically after 1992; the daily volume on the Clearing House Interbank Payment System (CHIPS), the network connecting all the major banks doing business involving U.S. dollars, hit $1.29 trillion in March 1995, up from just under $1 trillion at the time of the 1992 BIS survey and around $700 billion at the time of 1989’s (Grant 1995).
Britain (mainly London) was the biggest FX market, accounting for 27% of turnover; the U.S. (mainly New York) was next, with 19%; and Japan (mainly Tokyo) third, with 16%. So the big three centers accounted for 57% of world currency trading; surprisingly, Germany accounted for only 5% of the total, less than far smaller economies like Singapore, Switzerland, and Hong Kong. London’s dominance of the game is revealed by two striking facts: more U.S. dollars are traded in London than in New York, and more D-marks than in Frankfurt.
According to the BIS survey, 47% of the turnover was in the spot market, 7% in the outright forward markets (which are dominated by real-world customers, doing actual trading of goods and services), 39% in the swap markets, 5% in options, and only 1% in futures — though “only” 1% meant almost $10 billion in daily turnover. Around 75% of total daily turnover was between foreign exchange dealers themselves, and another 9% with other financial institutions. Only 12% involved real-world “customers.”
Around 83% of all trades in the 1992 survey involved the U.S. dollar. While this is down from 90% three years earlier, it’s evidence that the dollar is still the dominant world currency by far; even something as decentered as the FX market needs a fixed referent. Part of this dominance, however, is the result of “vehicle trading” — the practice of using the dollar as an intermediary currency. Instead of someone who wants to buy lire for D-marks waiting to find someone eager to sell D-marks for lire, the trader exchanges D-marks for dollars, and then dollars for lire. The dollar is also the world’s main reserve currency — according to the IMF, 55% of world foreign exchange reserves were held in dollars in 1993, down from 70% in 1984; the European currencies and their synthetic unit, the Ecu, gained market share. Press reports during the early 1995 dollar selloff said that Asian central banks were major sellers of dollars for yen. Loss of the dollar’s role as a reserve and vehicle currency would decrease demand, and would probably depress the price and push up U.S. interest rates, since reserves are usually invested in Treasury paper.
Though some sentimentalists still cling to the barbarous relic, the gold market is a fairly small one. Still, it remains a kind of money, worthy of discussion here rather than with more routine commodities like crude oil and pig parts. Trading takes the usual array of forms, from the spot and forward exchange of physical bullion — done mainly with the exchange of titles and warehouse certificates, rather than actual physical movement — to futures and options on futures. In 1989, total trading on world futures and options exchanges alone was the equivalent of 21 times the world supply of new gold, and about 38% of the total above-ground supply. That trading, plus trading in other markets, far outstrips the total of all the gold ever mined (about 80% of which is thought to be accounted for; people rarely lose or waste gold). Despite this vigorous trading, the world gold stock is not that impressive. At $400 an ounce, the total world supply of gold is worth about $1.5 trillion — about a quarter as much as all U.S. stocks are worth, less than half the value of all U.S. Treasury debt, and also less than half the U.S. M2 money supply.
But not all the world’s gold is available for trading. The leading holders are central banks, with 27% of the total world stock; they liquidate their holdings periodically, but are not major traders. Other official holders like the IMF account for another 6% of the world supply, meaning a third of all the world’s gold is in the hands of state institutions, even though goldbugs celebrate their metal for its freedom from the state. Jewelry accounts for nearly a third (31%), and industrial use, another 12%. That leaves less than a quarter (24%) of the world’s gold stock — under $400 billion, or not much more than the U.S. currency supply — in what are called “private stocks,” those that are likely to be traded. London’s annual bullion turnover alone accounts for all this easily tradeable supply, and derivatives account for another 160%. Every grain of gold is spoken for many times, but as long as everyone doesn’t demand physical delivery at once, the market will behave.
Despite the small physical foundation on which the gold market is built, the metal still has a psychological grip on financial players, who view its rise as a portent of inflation or political problems, and view its fall as a sign of deflation and placidity. Calls for a return to a gold standard regularly emanate from the right wing of Wall Street — supply-siders like Jude Wanniski and Larry Kudlow adore gold, and even Fed chair Alan Greenspan professes to be fond of paying close attention to it when setting monetary policy.
Gold remains, in Keynes’ (CW VI, p. 259) phrase, an important “part of the apparatus of conservatism,” and in more senses than one. Attend a conference of goldbugs and you are likely to be surrounded by the most fervent denizens of the far right, who love not only the austerity that gold symbolizes, but also the fact that it’s a non-state form of money. In a tremendous reversal of 19th century populist ideology, which was feverishly anti-gold, many of today’s right populists are very pro-gold, as the only antidote to the parasitical rule of Washington and Wall Street. A cultural bonus to right-wing goldbugs was the large presence of South Africa in the industry and of South Africans at their conferences; many, though certainly not all, aurophiles were admirers of apartheid. Ironically, many leftish South Africans now root for monetary disorder in the North, which would result in heavy demand for gold, allowing the country to play the role of a “prosperous undertaker at a funeral.” Though South African mines are getting pretty tapped out, the six largest South African firms controlled over a quarter of world gold production in 1993, with the huge Anglo-American combine alone responsible for over 18%. Canada, with 8%, and the U.S., with 7%, were a distant second and third (Tegen 1994).
Gold’s actual performance is a source of constant frustration to goldbugs. The metal’s main charm is that it retains its purchasing power over time; should inflation soar or the banking system implode, gold will not vanish like a paper claim. But its drawbacks are plentiful, and good reasons why all societies have gravitated to state-sponsored money. Gold pays no interest, is bulky, requires assay, and must be stored. It is heavy and physical in a world that tends towards ever more immateriality. Something that normally does no better than shadow the general price level is no fun, though goldbugs are always imagining some disaster — hyperinflation, the collapse of the state, climatic catastrophe — that will bring their beloved metal back to life.
For metallists, there were no better days than the 1970s. Gold first began trading freely in 1968, and it immediately broke away from the classic $35 an ounce price, set in 1934, when the Roosevelt administration banned private ownership of monetary gold. The price rose slowly, breaking gently above $40 as the decade turned. Once the U.S. abandoned convertibility, however, gold started a ripping bull market. Reaching a first peak just under $200 in oil-shocked 1974, the price settled back with the recession, and turned up with the world economy in 1976. in a spectacular rise that ended at $850 an ounce in January 1980. From there, when the Volcker clampdown took hold, gold sank almost unrelievedly to below $300 in 1985. After 1985, it spent ten years going nowhere — which should be no surprise over the long term, given the metal’s reputation as a sterile repository of value. Despite all the gyrations in between, the average gold price of $397 in early 1996’s was hardly different from 1934’s $409 (in constant 1996 dollars). Seen in a long-term perspective, the 1970s merely corrected the steady erosion of the metal’s purchasing power during the four previous decades when the price was fixed by law. From here on out, gold should rise with the average price level — making allowance, of course, for the occasional war, revolution, hyperinflation, or financial panic.
 “Aristotle thought that only living beings could bear fruit. Money, not a living being, was by its nature barren, and any attempt to make it bear fruit (tokos, in Greek, the same word used for interest), was a crime against nature” (de Cecco 1992a).
 Nearly half of the late 19th century in the U.S. was spent in periods of recession or depression; since World War II, only about a fifth of the time has been.
 The Fed does not make it easy to get this information. Calls to the press office inquiring about profits and losses from FX interventions are met with the declaration that the Fed isn’t in that business to make money, and no further help is offered. My research assistant, Josh Mason, was able to put together figures going back to 1986 at the New York Fed library, but the staff made it very hard to get earlier information.
 Dollar policy is the only area where the Fed takes instructions from the elected government, specifically the Secretary of the Treasury. On domestic monetary policy the Fed is largely its own boss. The ESF was tapped by the Clinton administration for the 1995 Mexican bailout, when it was prevented by Congress from using conventional sources of funding.
These figures are adjusted to eliminate all forms of double-counting (i.e., in which the same trade might be reported by both sides and counted twice). Gross reported turnover, before this adjustment, was nearly $1.4 trillion.
 U.S. figures are end-1994. Governments typically value gold reserves at well below market rates; the Fed values U.S. gold at $42.22 an ounce.
 Greenspan was an early acolyte of Ayn Rand, and wrote enthusiastically about the virtues of gold. He viewed the inflation that comes with loose money as a revenge of the have-nots on the haves, and saw gold a heavy weapon in the hands of the haves. He no longer speaks with that clarity, but his 2% inflation preference speaks for itself.