Instead, we will evaluate how much gold central banks are willing to hold relative to foreign national currencies. Measuring the value of official gold reserves versus the monetary base (central bank money) may not satisfy to predict the future price of gold. In today’s article, we will use Mehrling’s hierarchy of money framework, and examine the relationship between national currencies and gold to get a sense of where the price of gold is headed.Ĭentral banks have created so much “money” since 2008 that from an economic perspective the relation with bank deposits has weakened. As a result, the price of gold denominated in dollars increases. In an economic downturn the US equity market cap to GDP ratio falls, and the dollar is debased through one of the four prices of money (par, interest rates, foreign exchange rates, price level) to boost the economy. Now my interpretation… A Long-term Gold Valuation Model You find out that deposits and currency are not the same thing. In a contraction, you find out that gold and currency are not the same thing. And in contraction, you find out that what you have is not money, it's credit actually. Forms of credit become much more liquid, they become much more usable to make payments with. In a boom, credit begins to look like money. Vertically, the pyramid is about quality: the higher up the better the quality of money. Horizontally, the pyramid is all about quantity and leverage. During a recession, balance sheets contract and the shape of the pyramid is remodeled. Throughout the business cycle balance sheets (assets and liabilities) are extended-credit is created-causing an economic boom. Securities, such as bonds and equity, are at the bottom.īecause everything underneath gold can be created out of thin air, the base of the pyramid can be easily widened. Then come deposits that are created by commercial banks. Below gold are national currencies issued by central banks. At the top of the pyramid sits the ultimate money, which is scarce, universally accepted, and has no counterparty risk because it’s no one’s liability: gold.
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