On the Road to Freegold: Rogoff Tells EM CBs To Buy

Kenneth Rogoff: Emerging economies should buy gold
No, I am just proposing that emerging markets shift a significant share of the trillions of dollars in foreign-currency reserves that they now hold (China alone has official reserves of $3.3 trillion) into gold. Even shifting, say, up to 10% of their reserves into gold would not bring them anywhere near the many rich countries that hold 60-70% of their (admittedly smaller) official reserves in gold.

...Emerging markets hold reserves because they do not have the luxury of being able to inflate their way out of a financial crunch or a government debt crisis. Simply put, they live in a world where a large fraction of international debt – and an even larger share of global trade – is still denominated in hard currency. So they hold reserves of such currencies as a backstop against fiscal and financial catastrophe. Yes, in principle, it would be a much better world if emerging markets could somehow pool their resources, perhaps through an International Monetary Fund facility; but the trust required to make such an arrangement work simply is not yet there.
The problem with EM central banks taking the lead is that the gold price is pro-cyclical. EMs accumulate USD as it falls in value and gold prices rise. They would be swapping a depreciating asset for an appreciating one, and then be holding a depreciating asset when the crisis hit. USD is the better asset for counter-cyclical protection because USD rises during a crisis and if debt is denominated in dollars, you need dollars to repay it.
Gold, despite being in nearly fixed supply, does not have this problem, because there is no limit on its price. Moreover, there is a case to be made that gold is an extremely low-risk asset with average real returns comparable to very short-term debt. And, because gold is a highly liquid asset – a key criterion for a reserve asset – central banks can afford to look past its short-term volatility to longer-run average returns.
Gold can be remonitized as follows: it is made the premier reserve asset, and all central banks are allowed to devalue against gold. Then the central bankers can have their permanent inflation. Instead of USD falling during the booms and soaring in the recession, all currencies would fall versus gold. It would be an orderly decline during the boom, and then a rapid decline during the devaluations after the build up of bad debts. Investors would sell gold during the booms for more rapidly appreciating assets, then buy gold during the busts.

Since gold isn't a medium of exchange or a currency, there will be no gold debts. Gold will serve only as a store of value, the ultimate cash asset. Central banks will monetize it and give it a consistent positive return because they will never stop devaluing against it.

Countries will still run into trouble because they will borrow more than they can repay. There will still be financial market crises, but countries would have a superior asset.

Of course, if countries decide to hold more gold as a reserve asset, the price will rise several times over.

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