Gold as a Substitute for Dollar in Trade - Research Paper Example

?Gold as a Substitute for Dollar in Trade: A Critical Report The gold standard has been adopted by global economy as a standard mode of exchange for a longer period of time. Gold standard was considered by many economists as well as economies as a reliable tool for justified trade and financial transaction. But due to the political interests, the hegemonic powers such as UK and US have been terminating the gold standard era and modernizing the economy by making pound sterling or US dollar as the standard mode of exchange all over the world. The prices of gold have been remarkably stable for long periods of time. For example, the price of gold had been remained the same for about two hundred years after when Sir Isaac Newton had set the gold price at L3, 17s. 10d. per troy ounce in 1717. The gold prices have been raised to extreme levels after 1973. The gold rate in 1973 was $97.39 which was average price, and it rose to $444.74 in 2005, which has now become $1224.53 at the end of 2010. The calculation of five-year annualized rate of return on gold as an investment alternative has been given below. The gold rates have been taken for year 2005 and 2010, which are $444.74 and $1224.53 respectively. The formula for computing the rate of return of gold is as follows: 100*(second price/ first price) ^ (1/ (second year – first year))-100 Putting the values for second price ($1224.53), first year ($444.74), second year (2010), and first year (2005), we will get the rate of return on gold as an investment alternative for the period of 2005-2010 as follows: 100*(1224.53/444.74) ^ (1/(2010-2005))-100 = 22.4539074 From the result we have got, we can get the rate of return on gold as an alternative investment, which is in this case is 46%. Relationship between gold and USD value: This section will provide the necessary details about the relation between the gold and USD value in both the domestic as well as in the international economy. Some of the key factors will also be presented that affect key changes into the value of USD. Firstly, we will be talking about some of the factors affecting the US economy on the domestic economy. The domestic economy actually tends to affect the exchange rates of a country. The apparent position of the US economy in the economic cycle is one example, in which we experience a boom, bust, and then expansion or contradiction. Factors such as economic growth, inflation and economic outlook actually highlight the economic condition and health of the country. The level of interest rates will be influenced depending upon the economy’s position in the economic cycle, e.g. the economic cycle’s booming phase will experience the interest rates to be increasing despite the slow demand. The possibility of the occurrence of the inflation is also reduced. The monetary policy of the US is quite similar to that of Australia in terms of interest rates rising to lower down the pressures from the inflation or monetary demand. On the other hand, an increase or a decrease in the interest rates in the US causes the demand or supply of the currency to increase or decrease. ‘Debt levels’ is considered to be the major problem with the US economy. The USA is still facing the severe debt crisis as it owes to the other countries trillions of dollars. This has the effect of pressurizing the economy of the US. Another alarming factor is that the US financial institutions pay more interests to their lenders than the one they receive from their borrowers. The difference in the two countries’ interest rates really affects the demand of the foreign currencies. In simple terms a country will only invest into another country if the former is getting a good return from the latter on the investments. The most suitable example for this event is the higher interest rates in Australia in 2009 and the US interest rates were lower. Hence the investors moved to Australia instead of US. The overall effect of that was the upward pressure imposed on Australian dollar and a downward on US dollar. Now about the gold prices; there are only two things that directly affect the gold prices. The first reason is the geopolitical tensions, and second one being the inflationary expectations. When there were tensions in the Middle East, and the geopolitical situation got worse and dangerous than ever, due to boiling over and causing a war in some countries, or the supply of oil is affected, then the people will start investing in gold. Hence, worsened political situation in a land can really be a case when people start using gold as the mode of their investment. Gold is always seen as a safe asset which can be held for a long period of time and in such hard times. On the other hand, when people expect the inflation to raise that will ultimately increase the price of gold, they will start investing their money into gold so when they will sell it, they will have net gains in monetary value. For example, when inflation got very high in 1970s, the price of gold also increased, and those who invested on gold before the inflation rises, gained a lot of money as a profit in the later periods. The question that has to be answered now is that what is actual linkage between the gold and USD. USD was once considered by many investors and economists as a safe haven which will never disappoint them in terms of the losses incurred or any inflationary pressures. But the situation has become completely the other way round. Because many investors as well as the money lenders now consider the safe haven to the gold as it is to them the best resort for feeling protected from the economic recession that has been surrounding the whole world gradually. The USD value will continue to lower down in terms of its credibility as the own US financial system is collapsing by becoming the largest debtor in its history. US owes trillions into the foreign debt and the weakening economic conditions have led US to go at the back stage where as the other developed economies like China are emerging as the major lender to the countries including US. Due to these unusual circumstances, which to many seemed usual after sometime when the gold standard was recently terminated, the inverse relationship between USD and Gold is now seeming quite obvious. And this is the main reason that many people are now shifting back to the gold standard where they are feeling more safe in terms of their financial protection. Now that many investors and economists have believed that in the current scenario, gold is the haven for them to protect their financial stability and credibility – they are discussing about making an ultimate decision of taking this to the next step – making the gold the primary source for trade in local as well as international markets. This clearly means that the investors and financers are now deciding to substitute gold with USD for trade at both, the national as well as international level. The rise in inflation with the increase of 1 barrel oil up to $105 has really made the economists anxious about the future of the global economy. Many of the political forces are also considering making radical changes to the global financial system. One of the radical changes is the substitution of the gold with the USD for international trade. This will be considered a huge step as the people might not be comfortable in that, but at least their credit will stay comfortable. Additionally, the introduction of USD as the primary mode of exchange in 1953 by replacing the gold with it was also a decision forced by the governments. Now is task of the governments to retrieve back to the gold standard so that economic and financial legacy of the global business could be taken back. There has also been going a long debate for the last 2 years regarding this substitution and many people now have disbelief over USD as the world’s reserve currency. The dollar index has also become extremely vulnerable, whereas the gold is increasingly becoming an evading tool for a large number of investors. They are probably still waiting for a time when USD will win its legacy back, but three years have passed and investors are now thinking to move on with the gold. Even many stakeholders believe that in order to make a transaction, they have to have some gold which actually should be contained by everyone. The stakeholders’ stance over the importance of gold in the modern economy does tell the attitudes of those people that the gold standard is soon going to win back it legacy in just the way it was 60 years back. References: Holahan, C. (2011). Morning Note: Gold Replacing Dollar as World’s Reserve Currency?. Available: http://www.cnbc.com/id/42250806/Morning_Note_Gold_Replacing_Dollar_as_World_s_Reserve_Currency.  Laidi, A (2009). Currency Trading and Intermarket Analysis: How to Profit from the Shifting. New Jersey: John Willey & Sons Inc,. 23-25. Nanto, D. (2009). Global Financial Crisis: Analysis and Policy Implications. New York. Clark, W (2005). Petrodollar warfare: oil, Iraq and the future of the dollar. Canada: New Society Publishers. 12-23. Read More