The Gold Market
Part 1
by J. Orlin Grabbe
The gold market is a unique 24-hour-a-day market for the purchase or sale of one of history's longest-valued commodities. What gives the market its special character is the use of gold simultaneously as industrial commodity, as decoration (jewelry), and as a monetary asset. To understand the gold market, it is important to understand the latter function. Because gold has often formed a component of the local money supply, its history is intertwined with national and central bank politics.
Gold as Money
Gold is only one of many commodities that over the years have served as money--as a medium of exchange--in international trade and financial transactions. Such commodities have frequently varied. In many local communities (including nation-states), the most widely used commodity, or the product most traded with outsiders, has often functioned as money. In the Oregon territory from 1830 to 1840, for example, beaver skins were a customary medium of exchange. Then, as the population shifted from fur trapping to farming, wheat became the chief form of money, and from 1840 to 1848 promissory notes were made payable in so many bushels of wheat. Later, with the California gold discoveries in 1848, the Oregon legislature repealed the law making wheat legal tender, and proclaimed that thereafter only gold and silver were to be used to settle taxes and debts. For similar reasons, tobacco long served as the principal currency in Virginia. When the Virginia Company imported 150 "young and uncorrupt girls" as wives for the settlers in 1620 and 1621, the price per wife was initially 100 pounds of tobacco--later climbing to 150 pounds.
Only a few currencies, however, have had long-run durability as well as multi-territorial acceptability. Silver and gold are two of these. Roughly speaking, from the time of Columbus' discovery of America in 1492 to the California gold discovery in 1848, silver dominated in common circulation in America and Europe, while gold came into dominance following the Californian and Australian gold discoveries (see Chapter 8 in J. Laurence, The History of Bimetallism in the United States, D. Appleton and Company, 1901). Under the rule of the British Empire, the British pound sterling and the gold standard were adopted in much of the world. Toward the end of World War Two, the U.S. dollar and gold became the principal international reserve assets under the Bretton Woods agreement--a market position the U.S. dollar and gold have maintained despite the de facto dissolution of that system in the early 1970s.
The Post-WW2 Politics of Gold
Under the Bretton Woods Agreement forged at the Mt. Washington Hotel in Bretton Woods, New Hampshire in 1944, each member of the newly created International Monetary Fund (IMF) agreed to establish a par value for its currency, and to maintain the exchange rate for its currency within 1 percent of par value. In practice, since the principal reserve currency would be the U.S. dollar, this meant that other countries would peg their currencies to the U.S. dollar, and--once convertibility was restored--would buy and sell U.S. dollars to keep market exchange rates within the 1 percent band around par value. The United States, meanwhile, separately agreed to buy gold from or sell gold to foreign official monetary authorities at $35 per ounce in settlement of international financial transactions. The U.S. dollar was thus pegged to gold, and any other currency pegged to the dollar was indirectly pegged to gold at a price determined by its par value.
What does it mean to fix the price (the exchange value) of a currency or a commodity like gold? If no trading other than with official authorities is allowed (as when something is "inconvertible"), then fixing the price is easy. The central bank or exchange authority simply says the price is "X" and no one can say differently. If you want to trade gold for dollars, you have to deal with the central bank, and you have to trade at central bank prices. The central bank may in fact even refuse to trade with you, but it can still maintain the lawyerly notion that the exchange rate is "fixed." (Such a refusal, of course, will only lead to black market trading outside official channels.) If, however, free trade is allowed, fixing the price requires a great deal more. The price can be fixed only by altering either the supply of or the demand for the asset. For example, if you wanted to fix the price of gold at $35 per ounce, you could only do so by being willing and able to supply unlimited amounts of gold to the market to drive the price back down to $35 per ounce whenever there would otherwise be excess demand at that price, or to purchase unlimited amounts of gold from the market to drive the price back up to $35 per ounce whenever there would otherwise be excess supply at that price.
In order to peg the price of gold you would thus need two things: a large stock of gold to supply to the market whenever there is a tendency for the market price of gold to go up, and a large stock of dollars with which to purchase gold whenever there is a tendency for the market price of gold to go down. No problem. The U.S. had plenty of gold--about 60 percent of the world's stock. And, naturally, it also had plenty of dollars, which could be created with the stroke of a pen.
After the Bretton Woods Agreement, the price of gold remained uncontroversial for the next decade. But around 1960 the private market price of gold began to show a persistant tendency to rise above its official price of $35/ounce. So, in the fall of 1960, the United States joined with the central banks of the Common Market countries as well as with Great Britain and Switzerland to intervene in the private market for gold. If the private market price did not rise above $35 per ounce, it was felt, the Bretton Woods price was de facto the correct price, and in addition no one could complain if dollars were not exchangeable for gold. This coordinated intervention, which involved maintaining the gold price within a narrow range around $35 per ounce, became formalized a year later as the gold pool. Since London was the center of world gold trading, the pool was managed by the Bank of England, which intervened in the private market via the daily gold price fixing at N. M. Rothschild.
The London Gold Fixing
In its current form, the London gold price fixing takes place twice each business day, at 10:30 A.M. and 3:00 P.M. in the "fixing room" of the merchant banking firm of N. M. Rothschild. Five individuals, one each from five major gold-trading firms, are involved in the fixing. The firms represented are Mocatta & Goldsmid, a trading arm of Standard Chartered Bank; Sharps Pixley, a dealer owned by Deutsche Bank; N. M. Rothschild & Sons, whose representative acts as the auctioneer; Republic-Mase, a bullion subsidiary of Republic Bank; and Samuel Montagu, a merchant banking subsidiary of Midland Bank (owned by HSBC). Each representative at the fixing keeps an open phone line to his firm's trading room. Each trading room in turn has buy and sell orders, at various prices, from customers located all over the world. In addition, there are customers with no existing buy or sell orders who keep an open line to a trading room in touch with the fixing and who may decide to buy or sell depending on what price is announced. The N. M. Rothschild representative announces a price at which trading will begin. Each of the five individuals then confers with his trading room, and the trading room tallies up supply and demand--in terms of 400-ounce bars-- from orders originating around the world. In a few minutes, each firm has determined if it is a net buyer or seller of gold. If there is excess supply or demand a new price is announced, but no orders are filled until an equilibrium price is determined. The equilibrium price, at which supply equals demand, is referred to as the "fixing price." The A.M. and P.M. fixing prices are published daily in major newspapers.
Even though immediately before and after a fixing gold trading will continue at prices that may vary from the fixing price, the fixing price is an important benchmark in the gold market because much of the daily trading volume goes through at the fixing price. Hence some central banks value their gold at an average of daily fixing prices, and industrial customers often have contracts with their suppliers written in terms of the fixing price. Since a fixing price represents temporary equilibrium for a large volume of trading, it may be subject to less "noise" than are trading prices at other times of the day. Usually the equilibrium fixing price is found rapidly, but sometimes it takes twenty to thirty tries. Once in October 1979, with supply and demand fluctuating rapidly from moment to moment, the afternoon fixing in London lasted an hour and thirty-nine minutes.
The practice of fixing the gold price began in 1919. It continued until 1939, when the London gold market was closed as a result of war. The market was reopened in 1954. When the central bank gold pool began officially in 1961, the Bank of England--as agent for the pool--maintained an open phone line with N. M. Rothschild during the morning fixing (there was as yet no afternoon fixing). If it appeared that a fixing price would be established that was above $35.20 or below $34.80, the Bank of England (as agent) became a seller or buyer of gold in an amount sufficient to ensure that the fixing price remained within the prescribed bands. |
