Observing the Surge in Gold Prices

KOMPAS/KOMPAS/TOTOK WIJAYANTO

Employees of the Sharia Pegadaian Branch Office on Jalan Kramat Raya, Jakarta, use a magnifying glass to see the quality of the residents\' gold jewelery being pawned, Wednesday (29/7/2020).

Recently there has been a surge in gold prices on the world markets. The increase in the price of gold has been remarkable since the global financial crisis (GFC) 2008/2009, which was followed by the great recession. In terms of US dollar, the price of gold jumped from US$650 per ounce in 2007 to US$1,300 in 2017, an increase of 100 percent.

Then it increased to nearly US$2,000 per ounce recently. The following article attempts to interpret this development in order to see its implication and the need for vigilance to overcome any negative impacts on the national economy that may arise.

The prices of gold reported on the domestic market and in the world do not always use the same basis, so that it can be confusing. Frequently what is reported is the prices of gold jewelry in stores or the retail prices using a measure of price per gram. However, the prices discussed in the world\'s precious metals market reports are calculated in units of weight of ounces or troy ounces. One troy ounce is 31.1 grams. This is the measure usually used in trading the precious metals market. For other commodities, the size of the ounce is usually used in the standard sense, where one ounce is equal to 28.35 grams. And of course if US dollars are used, for conversion to rupiah it must be seen in the exchange rate at what time.

Interpreting the spike in gold prices

The prices of gold in the world experienced an increase in the period of the 2008/2009 global financial crisis, which was followed by a prolonged recession. During this period there was also a financial crisis in a number of European countries that are members of the European Union (EU) Community. One that was widely reported was the Greek financial crisis in 2011.

The global financial crisis originated from the financial crisis in the US, which arose due to the subprime mortgage loan crisis in 2007/2008. The crisis became systemic after Lehman Brothers, a Wall Street mega bank, was allowed to bankrupt itself in September 2009, which then spread to Europe and Asia to become a global financial crisis.

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Kompas

Gold price

Fiscal stimulus policies and policies of central banks using new techniques and means, especially the securitization or monetization of debts by banks and the large-scale purchase of bank and corporate securities or quantitative easing (QE) by the central banks of Britain, the EU, and Japan, saved the world economy from the brink of depression. However, the world had to pay a price that was not cheap either, namely the occurrence of a prolonged recession or very weak economic growth for a long time, known as the great recession, from 2009 until recently. Not all economies have really revived, after the Covid-19 pandemic broke out earlier this year, with a very heavy negative impact on the world economy.

The development of the prices of gold has attracted attention not only because of the role of gold as jewelry or a means of investment or its use in health science and technology. Perhaps what is more interesting is the use of gold as currency or a medium of exchange and payment, and with the determination of the value of currencies or the world currency exchange rate system.

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Gold has indeed been part of the money supply as a medium of exchange and payment in national and international trade. Even after the introduction of the banknotes issued by the state for payments among nations, the system of exchange rates among world currencies has also been associated with gold. Likewise, when the exchange rate system was determined using the US dollar as the benchmark, gold is still used as its basis.

The trade payment system among nations, that has been in effect since the end of World War II, known as the Bretton Woods system, requires all countries that agree on a payment method using this exchange rate system to determine the value of their respective currencies against the US dollar on a permanent basis plus-minus one percent. If there is an increase in the exchange rate of its currency (appreciation) or conversely (depreciation) is greater than this limit, the country must intervene in the market to restore its original value by using its foreign exchange reserves in US dollars.

In this system, the US promised to exchange US dollars held by other countries with gold and precious metals, which are held at a fixed price, namely one ounce (28.35 grams) is US$35. This value was maintained until 1973 when the US was forced to depreciate the US dollar by changing the price of one ounce of gold to US$42. Promises to exchange US dollars held by other countries were also canceled in 1971.

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The US is the guarantor of the Bretton Woods system with the US dollar as its base, which is secured by the gold reserves behind it. Since then the Bretton Woods fixed exchange rate system, officially the adjustable fixed exchange system has lost its prestige and one by one the countries left it to be officially converted into a flexible or floating exchange system in 1978 under the so-called Jamaica Agreement, at the annual session of the International Monetary Fund (IMF)-World Bank in Jamaica.

Safe haven?

The relationship between gold and the US dollar was very close and the fluctuation of gold prices in the precious metal market in the world was related to the perception of market players toward the US dollar as the world currency, which was measured by its status as a support for the exchange rate system decades since World War II and continued in the floating exchange rate system since the late 1970s. Even though the currencies that are used as a guide for the country to store foreign exchange reserves are not only the US dollar, but in line with the IMF\'s custom in calculating special drawing rights (SDR), which with the inclusion of China\'s renminbi (RMB) in 2016 become five currencies, the US dollar still dominates the size of the foreign exchange reserves of the countries.

The relationship between gold and the US dollar was very close.

According to 2019 statistics on the foreign exchange reserves held by countries in the world, 60 percent is in US dollars. The percentage is even higher for trade transactions in US dollars, which cover 90 percent of all trade globally.

In such a position, the US dollar is often mentioned as the safe haven for asset storage. But this is where the link with gold becomes the measure. When the prices of gold recently approached 2,000 per ounce, market players began to doubt the position of the US dollar as a safe haven asset, and moved to gold. Therefore, what has been causing the recent turmoil to the point that the US dollar, which has traditionally been considered the safest place to store assets, seems to be shaking and being questioned? I will discuss this later.

KOMPAS/RIZA FATHONI

J. Soedradjad Djiwandono

The prominent increase in the prices of gold occurred when the 2008/2009 world financial crisis happened, which was followed by a prolonged recession until recently. And this development appears to be related to a massive fiscal stimulus supported by similar monetary policies by the governments and central banks of developed countries. The monetary policies are characterized by the monetization of debts and purchases as well as bonds and securities of banks and corporations (quantitative easing), known as the modern monetary policy. These policies have saved the world from depression, but the world must go through a prolonged recession.

J SOEDRADJAD DJIWANDONO, Emeritus Professor of Economics, University of Indonesia.