Thursday , October 22 2020
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Adopting a clean gold standard

Summary:
Last month I wrote an article about banning gold mining. It received plenty of feedback from different parts of the internet. Some loved it, some didn't. [ GATA | Boing Boing | Hackernews ]In this follow-up post, I want to outline a less draconian and more market-friendly alternative to banning gold mining.But first, let me quickly reprise the original blog post. Unlike coal or oil or wheat, gold never gets consumed. We mostly "use" gold by holding it in vaults where it is kept safe from wear and tear. If people collectively want to hold more of the yellow metal, then a simple rise in price will suffice. After all, if the price of gold jumps to 00/oz from 00/oz then the world's gold hoards will have doubled. Voila, demand satisfied.With price doing all the work of responding to

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Adopting a clean gold standard

 

Last month I wrote an article about banning gold mining. It received plenty of feedback from different parts of the internet. Some loved it, some didn't. [ GATA | Boing Boing | Hackernews ]

In this follow-up post, I want to outline a less draconian and more market-friendly alternative to banning gold mining.

But first, let me quickly reprise the original blog post. Unlike coal or oil or wheat, gold never gets consumed. We mostly "use" gold by holding it in vaults where it is kept safe from wear and tear. If people collectively want to hold more of the yellow metal, then a simple rise in price will suffice. After all, if the price of gold jumps to $4000/oz from $2000/oz then the world's gold hoards will have doubled. Voila, demand satisfied.

With price doing all the work of responding to higher societal demand, no new metal from mines is required. That's a good thing. The problem with gold mining is that it causes all sorts of environmental damage. That's why El Salvador, for instance, chose to ban gold mining back in 2017. Extending this ban to the entire globe would reduce all of the damage caused by mining without hurting gold's main consumers: investors, speculators, and hoarders.  

So that was the gist of last month's post.

In today's post I want to outline an alternative way to move in the same direction as a mining ban. The idea would be for a standards board, perhaps the London Bullion Market Association or the International Standards Organization, to create a new industry standard for gold called "clean gold." Unlike "dirty gold," clean gold would not be implicated in the environmentally damaging effects of mining. Environmentally-conscious gold investors would be able to migrate from their dirty gold to clean gold, which would likely trade at a premium to the dirty stuff.

Clean gold would be defined as all gold in existence before a fixed cutoff date, say December 31, 2023. Any gold produced after that would not be granted clean status. It would be dirty.

By committing to only buy and hold clean gold (i.e. the legacy already-mined stuff) a woke gold investor is choosing to avoid contributing to any additional mining-linked environmental degradation. These investors' collective choice to only buy pre-2023 gold would be a substitute for a gold mining ban. Together, they would be acting as-if gold mining had been banned by governments.

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One institution that could champion clean gold would be the London Bullion Market Association, or LBMA. The LBMA already maintains a set of standards that define London "good delivery" gold bars, including rules concerning permitted bar dimensions and purity. There are currently 8,790 tonnes of London good delivery gold, worth around $555 billion and accounting for about 5% of all gold ever mined. So the LBMA’s standards have a major influence on what sort of gold is considered legitimate for investment purposes.

The LBMA has already instituted some woke standards for good delivery bars. LBMA responsible gold guidance prohibits bars from qualifying as good delivery if they have been involved in financing conflict and the abuse of human rights. It also sets some environmental standards. For instance, the LBMA requires refiners who buy gold from artisanal miners to assist them in establishing processes to better use mercury.

How would the LBMA introduce a clean gold standard?

The LBMA could redefine its good delivery standard to be a clean standard by only allowing bars produced prior to the December 31, 2023 cutoff date to qualify. Alternatively, it could set up a second delivery standard, a "good & clean delivery standard," and anyone participating in the London gold market could choose their preferred standard.

Exchange-traded funds, say like the State Street's SPDR Gold Shares ETF, the world's largest gold ETF, would also be a natural set of institutions that could champion clean gold. Either in conjunction with an LBMA clean standard, or on it own, the SPDR Gold Shares ETF could commit to only holding gold bars produced prior to December 31, 2023.

Finally, major gold coin-producing mints like the Royal Canadian Mint and the US Mint could also apply a clean gold standard to the coins they produce.

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As I mentioned earlier on, clean gold would trade at a premium to dirty gold. Likewise, a clean gold ETF would trade at a premium to a dirty gold ETF and clean gold bullion coins would trade at a premium to regular bullion coin.

The reason for a premium is that the supply of clean gold would be fixed at the amount of gold in existence prior to December 31, 2023. But the amount of dirty gold is not fixed. Dirty gold includes not only all gold mined after 2023 but all pre-2023 gold. After all, an owner of a 1995 gold bar needn't seek clean status if they don't care for that designation.

If dirty gold were to ever rise to a premium to clean gold, then arbitrageurs would convert clean gold into dirty until the premium disappeared. There are no rules prohibiting movement from the clean to dirty designation. But careful, once dirty always dirty! There is no way to do the opposite, to convert dirty gold into clean in order to reduce the clean premium. The clean gold rules and standards prevent dirty gold conversions.

How large might the premium get? If the gold investment world were to completely migrate over to clean gold, quite high. Most existing gold is currently being held for hoarding purposes. By taking the totality of this demand and refocusing it on pre-2023 gold, the price of clean gold might trade at, say, $3,000 while the price of dirty gold trades at just $300.

On the other hand, the premium would remain low if the clean gold standards are poorly managed and lack credibility.

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Who would want to buy dirty gold?

Investors who are less concerned about the environment might be content to keep holding dirty gold kilo bars and 400-ounce bars. People who buy gold jewellery might not mind holding dirty gold either, since dirty gold necklaces will be cheaper than certified clean necklaces.

I suspect the main buyers of dirty gold would be manufacturers that use it for industrial purposes, like circuitry. Gold has excellent conductivity. It is also the most non-reactive of all metals, which means that unlike copper and silver it is resistant to corrosion & oxidization.

Given these advantages, manufacturers would love to use more of the yellow metal in their products. However, gold's high price prevents broader industrial usage of gold. The dominant group of buyers—hoarders & investors—keep gold's price perpetually high, thus pushing manufacturers out of the market. And so copper has become the most important metal in electronics. By diverting a large chunk of hoarding demand to a certain type of gold, clean gold, chip makers could finally get access to low-priced gold. Gold would displace copper and the overall quality of electronics products would improve.

Certain manufacturers that want to demonstrate a commitment to having sustainable supply chains (i.e. Apple?) would probably purchase clean gold, and so their products would be more expensive than those without clean gold.

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What about coins?

As I suggested earlier, mints such as the US Mint and Royal Canadian Mint would produce two streams of gold coins: clean coins and regular ones. They would buy clean gold feedstock from the LBMA's certified clean gold inventories. The mints would include branding on clean coins to certify their clean status. As for their regular coins, mints would continue to buy newly mined gold from miners.

I suspect that many gold coin buyers would default to the woke alternative. Say that Jack has $10,000 to invest in gold. He can either buy 4 clean Maples for $2500 each or 40 dirty Maples for $250 per ounce. At least with the clean option Jack can feel good he's doing the right thing. Either way, he ends up with the same nominal $10,000 in metal, and it's the nominal amount of metal that most gold investors care about, not the actual quantity of ounces. 

Of course, there are gold coin buyers who like to consume their gold (say like Scrooge McDuck) and prefer to get more bulk for their dollar. They will be happy to buy the dirty stuff.

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Gold laundering would be a big issue.

With clean gold trading at a premium to dirty gold, fraudsters would try to profit by converting gold mined in 2025 or 2026 into counterfeit gold bars with a 2016 or 2017 date, and then try to sneak the counterfeit bars through the LBMA's (or State Street's) verification process. These institutions would have to set up effective mechanisms for stopping counterfeit gold bars.

At the same time, the LBMA and State Street would have to find ways to ensure that they are not preventing legitimate pre-2023 bars from entering their systems. Central banks would probably account for a large proportion of pre-2023 bars. Going forward, their holdings would be a key source of clean gold.

Rogue gold coin manufacturers would buy mined gold at $250 an ounce and manufacture fake Maples or Eagles for $2500. Mints such as the Royal Canadian Mint and US Mint would have to introduce additional anti-counterfeiting measures into their manufacturing processes to guard against fake clean coins.

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There are plenty of other things that can be said about clean gold, but for now that's probably enough.

In sum, if a clean gold standard was carefully implemented and became popular with investors, it would synthesize many of the same effects of an outright ban on mining. By herding the gold investment community away from the newly-mined gold market, the amount of gold mining would fall, and so would associated environmental damage.

It would also correct a major defect of the gold market. Manufacturers who actually buy gold by the gram for use in their products have always had to compete with investors/speculators who aren't beholden to the same profit and loss calculation as a business. This is just silly. Disaggregating gold into two types corrects this. Investors & speculators can continue with their bets as before by focusing on the first type of gold, and it's clean to boot. And manufacturers finally get access to cheap type 2 gold. It's win-win.

About Jp Koning
Jp Koning
Working in the bowels of the finance industry. Blogging about monetary phenomena is my side gig.

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