Gold and US Dollar Hegemony

All currencies are substitutes for real money, i.e. gold. And because all governments inflate and destroy their own currencies, any potential alternatives to the US dollar are as bad or worse.

That doesn’t stop the dollar bashing, of course. In a general long-term sense, the condemnation is well-deserved. After all, the US dollar, under the care and watch keeping of the Federal Reserve Bank of the United States, has lost more than ninety-eight percent of its purchasing power.

The possibility of gold reasserting itself as the international medium of exchange continues to increase; but, a lot more bad stuff has to happen before we get to that point.

Also, governments around the world have too much at stake to capitulate when it comes to ceasing to issue ‘funny money’. For the time being, let’s focus on things as they are

PRICE OF GOLD IN EUROS AND FRANCS

Gold is priced in US dollars and trades in gold are settled in US dollars because of the hegemony of the dollar and its role as the world’s reserve currency. But what does that mean to others around the world? For example, what about those who live and work in Germany (euro), Japan (yen), China (yuan) or Switzerland (franc)?

When someone in Switzerland, for example, exchanges Swiss Francs for gold, they are quoted a price in Swiss Francs. That seems pretty straight-forward. But how is the price for gold in Swiss Francs calculated when the international market for gold is priced in US dollars?

The amount that someone pays in Swiss Francs (or any other non-USD currency) is determined by calculating the exchange rate between the US dollar and the specific non-USD currency involved. Based on that calculation, it is then known how many Swiss Francs are needed to equal the transaction amount in US dollars.

What is particularly important here isn’t necessarily obvious. However, it is a critical factor when assessing a transaction of this nature, and here is why…

On December 31, 2013, gold traded at $1210 per ounce. And on that day one euro could be exchanged for 1.3776 USD. Hence, 842 euros ($1210 USD divided by 1.3776 = 842) could be exchanged for $1210 USD which could then subsequently be exchanged for one ounce of gold.

Nine months later, on September 30, 2014, gold again traded at $1210 per ounce. But the exchange rate for one euro was 1.2629 USD. Even though the gold price in US dollars was unchanged, the cost for an ounce of gold in euros had increased nine percent to 958 ($1210 divided by 1.2629 = 958). To be technically correct, the cost of US dollars had increased for holders of euros.

On May 31, 2016, twenty months later, gold was again trading at $1210 per ounce. The euro had weakened further relative to the US dollar and the exchange rate for one euro was 1.1131 USD. Using the same math as before, the cost for $1210 US dollars had again increased, this time by an additional thirteen percent to 1087 euros.

Over the entire two and one-half year period (twenty-nine months in all) the cost to acquire gold for holders of euros had increased by twenty-four percent. And yet, gold priced in US dollars was the same. There are several things we can learn from this.

DEMAND FOR US DOLLARS

For one thing, there is always demand for US dollars since they are needed for use in international trade (oil transactions are priced in
US dollars, too).

For another, changes in exchange rates of any other currencies relative to the US dollar must be considered and applied in order to
complete the desired transaction.

The possible combinations are numerous and always different. An increase in the value of the euro relative to the US dollar in the examples above would have given us results opposite to those which actually occurred. And, of course, every currency other than the US dollar would show different results based on their changes in value relative to the US dollar.

Currency exchange rates are changing continuously. In addition, the exponential growth of online brokerage platforms, such as Olymp Trade, make it possible for almost anyone to have access to foreign exchange markets around the clock. This increases potential volatility.

It is possible to have an increasing US dollar price for gold and, simultaneously, a stronger US dollar relative to another currency. This results in a ‘double whammy’ to the holder of a non-USD currency.

In the examples cited, the US dollar price of gold could actually have declined for the periods indicated and still resulted in a higher
cost for holders of euros.

GOLD PRICE VS VALUE

The US dollar price of gold does not tell us ‘what gold is doing’. It tells us what the US dollar is doing. Or rather, has done. It also tells us what people think is happening to the US dollar currently and what they expect (further weakness, additional loss in purchasing power, etc.) in the future.

But what people think is happening changes all the time. Hence, changes in the US dollar relative to gold are ongoing and can be quite volatile. Over time, however, the gold price in US dollars is a reasonably accurate reflection of the value of the US dollar.

The US dollar price of gold does not tell us anything about other countries and their currencies. To know that we must look at exchange rates of those currencies relative to the US dollar.

The value of gold (see How Much Is Gold Really Worth?) does not change. It is original money. Gold’s value is constant and unchanging. The value of the US dollar, however, changes all the time. This is because the supply of dollars is manipulated by the Federal Reserve via the ongoing expansion and contraction of the supply of money and credit. Mostly expansion.

Kelsey Williams is the author of two books: How Much Is Gold Really Worth? and How Much Is Gold Really Worth?