Bretton Woods Revisited

Submitted By Ahmed Bin Sulayem, Executive Chairman of DMCC in Dubai

It’s been a busy few weeks for both Bitcoin (BTC) fans and gold hawks, with both assets reaching record highs on the back of soaring inflation, market volatility and high rates, and while both assets typically attract quite polarising investors, their simultaneous rallies are united in their speculation that the U.S. and other western economies may not be able to maintain high interest rates, given their sky-high debts.

As stated by XTB research director Kathleen Brooks, “When gold and bitcoin rise in unison, it is worth interrogating the reasons behind this, in case they can give us clues about investor behaviour. Both seem to be rallying on the back of the overall market mood: U.S., Japanese and several European indices have made fresh record highs recently. However, for gold and bitcoin there are other internal factors at play that could be pushing up their value even when stocks take a breather.”

For gold, as the age-old investment hedge, a potential shift in Federal Reserve policy in conjunction with geopolitical uncertainty and a possible downturn in equity markets saw its price break through to $2,194.99 before rolling back. However, with U.S. inflation unexpectedly rising to 3.2 per cent in February, the yellow metal is well positioned to maintain or even exceed its recent highs until 20th March, when the Fed will announce its rate decision, with most economists anticipating no change. As outlined by Tim Murray at T Rowe Price, “This last mile of inflation – getting from 3 per cent to 2 per cent – is going to be really hard. Much harder than getting from 9 to 3 per cent.”

As a digital store of value, Bitcoin’s record-breaking rally to USD 73,794 on 14th March 2024 was further propelled by buoyant market confidence, as demonstrated through the $10bn poured into Bitcoin ETFs since the beginning of the year, and will likely continue its run through an imminent ‘halving’, which is currently on schedule to take place in April. As outlined by Bitfinex, “The recent surge in Bitcoin’s value… underscores the remarkable strength and resilience of the leading cryptocurrency. This achievement not only marks a significant milestone but also reflects the continued confidence and demand in the market”. 

With both assets illustrating a clear trend towards safe-haven investments and weakening fiat currencies, it is critical to ask the following questions:

Are the record-breaking prices justified against the convergence of inflation and debt?
What are the fundamental differences between BTC and gold?
What are the underlying responses beyond consumer investment?
And what could a return to a gold-backed economy mean for the geopolitical landscape?

Are record highs justified?

Asking the obvious question, as headlined by City Index, “Are Traders Afraid of Sovereign Debt Loads?” In short, yes, and for good reason. While many traders are simply seeking a short-term alternative to hedge risk, there is undoubtedly a longer-term appetite for what happens if the U.S. and other developed economies are unable to maintain high interest rates, given their existing debt loads. Starting with the most glaring information, U.S. national debt is currently on the rise to the tune of $1 trillion roughly every 100 days, reaching a total of just over $34.4 trillion in February – a figure certainly not helped by wild printing under the current U.S. administration, which included $3 trillion in 2020 alone. Speculation as to whether a default occurs or not is yet another polarising debate. As stated by Lawrence J White, an economics professor at the Stern School of Business at NYU, no one knows because it is “a political issue”. However, as an investor hedging for a worst-case scenario, the default outcome would likely be “cataclysmic”, followed by a recession of the order of the financial crisis of 2008, according to Bernard Yaros, assistant director at Moody’s Analytics. Even a short-term breach could cause more seismic shifts in the international financial markets, fuelling credible calls for alternatives to the U.S. dollar. “The world will say we can’t rely on the U.S. Treasury as much as we used to, and that will make people more reluctant to hold Treasury obligations. Interest rates for Treasury bills and bonds will go up, and that will ultimately lead to a bigger tax burden for Americans”, stated White.

Sovereign Response

It’s no secret that central banks have been buying physical gold in record volumes over the past two years, as outlined by the World Gold Council in January: “Central bank demand, a key driver of gold in recent years, maintained its momentum in Q4 as a further 229t was added to global official gold reserves. This lifted annual (net) demand to 1,037t, just short of the record set in 2022 of 1,082t. Global official sector gold reserves are now estimated to total 36,700t. Two successive years of over 1,000t of buying is testament to the recent strength in central bank demand for gold. Central banks have been consistent net buyers on an annual basis since 2010, accumulating over 7,800t in that time, of which more than a quarter was bought in the last two years.”

However, this still seems to have evaded public sentiment, as outlined by Peter Schiff: “What’s unprecedented about gold’s new high is that there’s no fanfare, there isn’t any media coverage, there isn’t even any retail participation. Not only is the public not buying into this rally, they’ve been selling during the entire rally, in fact going into the gold ETFs, there’s been net outflows every week this year. The public keeps on selling as gold keeps rising. That’s not normal. Normally people buy on the way up, and sell on the way down, that’s wrong, but that’s human emotion. If everyone’s selling, how can the price of gold be going up? Because if the price of gold is going up it means somebody is buying to drive it up and if the public is dumping their gold why isn’t the price falling; well because somebody else is buying. Somebody who knows a lot more than the people who are selling. Who’s doing that buying? It’s central banks. There’s a reason they are doing it, and it’s because they are de-dollarising.” And they’re not alone.

As highlighted in JP Morgan’s August 2023 report, the U.S. dollar’s hegemony is “in question due to geopolitical and geostrategic shifts”, and this isn’t just the outlook of the central banks, but also commodity and emerging markets. With Russia serving as an example of the potential risks of being ‘frozen out’ of USDs, albeit with negligible effect, many other countries took heed. In contrast, others reacted to the unfavourable conditions of rising interest rates. “In short, de-dollarisation entails a significant reduction in the use of dollars in world trade and financial transactions, decreasing national, institutional and corporate demand for the greenback”, commented Alexander Wise, strategic research, J.P Morgan. To date, the U.S. dollar’s share of F.X. reserves has declined to a record low of 58 per cent. At the same time, several nations, most recently Bolivia, Brazil, and Argentina, have started paying for imports and exports using the Chinese renminbi. In March, the Reserve Bank of India asked Gulf exporters to accept rupees for at least ten per cent of oil payments in the next financial year, while Russian news agency TASS said that the five-nation BRICS group will work on creating a payment system based on blockchain and digital technologies. In the Middle East, an MoU signed between the UAE and India in July 2023 signals the beginning of regional currency usage for bilateral transactions within a framework called the Local Currency Settlement (LCS) system. As a symbolic transaction on the same day, a UAE gold exporter sold 25 kgs of gold to an Indian buyer, invoicing the payment in Indian rupees.

BTC vs Gold

Based on the reality of Bitcoin and gold being the de-facto investment hedges, each investor has their own preference. As outlined by Fergus Hodgson, director of Econ Americas, roving editor of Gold Newsletter, “Gold has thousands of years of established history as a resolute store of value,” whereas, cryptocurrency, as a relative newcome to global asset markets means, “its future as a store of value is precarious. In my assessment, central bank digital currencies and altcoins will challenge Bitcoin’s value proposition as a medium of exchange.” Certainly, as a hedge, Bitcoin’s finite 21 million coins means it cannot be manipulated like fiat currencies. However, the same could be said for gold, albeit under the speculation of what resource remains unmined and what can be recycled. While previously, Bitcoin’s edge over gold was its accessibility, recent cases of fraud, theft and the rise of ETFs have made both assets safer and more accessible to all forms of investors.

While I am certainly not against cryptocurrencies, particularly in their capacity to support decentralised trade, all markets tend to follow power. Through that lens, it is simple to compare which nations hold Bitcoin and which hold gold. According to Elementus, a blockchain-analysis firm, most of the world’s governmental Bitcoin holdings are from government seizures, and between 2013 – 2022, only six nations held a balance – the United States, El Salvador, Ukraine, Bhutan, Venezuela and Finland. Meanwhile, according to the World Gold Council’s Annual Futures (2021), only eight nations do not hold any gold reserves, namely Nicaragua, Cameroon, Armenia, Gabon, Turkmenistan, Congo, Chad and Eritrea.

Follow the Yellow BRICS Road

Putting all these elements together, we are left with a likely trend that will not only see a continued transition away from the U.S. dollar but towards a new collective powerhouse in the form of the BRICS+ nations. Complete with the world’s top two gold producers in China and Russia and four of the largest consumers, it seems that the balance of power is migrating east, with the trading bloc progressing towards its own version of a gold standard. As explained by Nathan Lewis in Forbes just several weeks ago, “The BRICS countries have settled on using gold as the basis for international exchange, a role previously taken by dollars and euros. This does not mean today’s floating fiat ruble, real, or rand is going anywhere soon. Rather, just as the U.S. dollar was used alongside those domestic currencies in the past, today and in the future gold will be more commonly used. There would not be very much trade in actual gold coins — just as there is not much trade in actual dollar bills. Indeed, gold doesn’t work very well for this hand-to-hand exchange at all, since even small coins tend to be of very high denomination, worth $200 or more. Rather, it means that people around the world will increasingly use various vehicles — such as bank accounts, bonds, loans, and cryptocurrencies — denominated in gold, just as they use the very same set of tools today but denominated in dollars.”

A Globally Inclusive Future

If all that is stated up till now is a fair projection of what’s to come, other areas of demand will either need to be met or serve a useful purpose in the new economic landscape. For example, there are three major bullion banks with London at their centre. As a city with no closer tie to gold than its historical position as a centre for trade, a more equitable solution could be found in the form of a Global Gold Market Association, akin to the Kimberley Process with a rolling chairmanship that provides access to an exchange where vetted banks are among the liquidity providers, thereby supporting a free market model. As an outcome, global volatility could be reduced through democratic processes and regulations, resulting in greater trading stability and a fairer marketplace for all nations, regardless of economic status.

Conclusion

As summarised by Peter Schiff, “Everybody is writing gold’s obituary – it’s not dead, it’s alive and well, it’s over $2,000, but the most important thing is the fundamentals have never been better. Not only do the charts look great for gold, but the fundamentals are fantastic because we’re in a situation where inflation has just bottomed at about three per cent and is now headed higher, and there’s nothing the Fed can do about it. It is out of ammo, it can’t fight, there is no way the Fed is going to hike rates, it would crash the economy, and it would sink any chance Biden has of getting re-elected. So, it’s going to dismiss any increase in inflation; in fact, it’s already done that this week. It’s almost like it’s back on its transitory kick, only nobody is going to use the word transitory, but they’re basically looking at any hotter-than-expected inflation data as if it’s a one-off thing as if it’s a foregone conclusion that inflation is going back down to two per cent when there’s no reason to expect that that’s going to happen. Not with record high budget deficits, record high consumer borrowing and spending; a weakening in industrial production, money supply is now growing, and real interest rates are falling. So, all signs point to higher inflation and a weaker economy, and that’s the perfect environment for gold. It is stagflation, and as investors lose confidence in the Fed, they’re going to look for a real safe haven, a real store of value, and they’re going to buy gold.”

I, for one, agree. Driven by non-transitory inflation, massive deficit spending, questionable global economies, and an increasing momentum towards de-dollarisation, is it finally time to revisit Bretton Woods, and or any meaningful gold standard as the potential antidote to what will soon become an uncontrollable problem