Thursday, 19 October 2017


Gold and The Central Banks: The Game Theory

Posted by
May 24, 2012
in Blog

“Collectively, the central bankers of the world might agree that they do not want gold to be remonetized. Individually, it is in their interest to defect from this consensus. As the American Century decays, individual motivations tend to become more prominent. You and I are not in a free market – but the central banks are.”

In case anyone with a lot of dollars is reading today, my position on the gold price is the same as in 2006. If gold will eventually be remonetized, gold is insanely cheap. If gold will never be remonetized, gold is insanely expensive. It’s one or the other. Therefore, if you guess right about this question, you will make huge profits, and if you guess wrong take huge losses.

Your guess is probably better than mine, so I will refrain from making one. I note, however, that in 2006 the remonetization of gold was a decidedly fringe perspective. Now it appears regularly in the headlines. It is still a long way from happening. So there is plenty of time to hop on this bandwagon before it either rolls to glory, or off a cliff.

My specific prediction for the future of the gold-dollar exchange rate is: if there are more sellers than buyers, the gold price will go down. Otherwise, it will go up. You can quote me on this.

Aside from the traditional jewelry markets, which remain quite important as a demand contributor, what sets the gold price is the balance of buyers and sellers in the market for monetary or “investment” gold. If money is moving into gold, gold goes up. If money is moving out of gold, gold goes down. Given the existence of involuntary sellers (such as gold miners), some money always has to be moving in.

(Actually, I’ve never really understood why gold miners sell gold, beyond recouping the cost of mining. Why don’t they just retain all profits, in gold, on their balance sheets? Why resort to old-fashioned dividends? That’s certainly the way we play it here in Silicon Valley. All the more so for a gold miner which voluntarily sells gold, and whose shareholders are thus betting both ways in the gold market. Ideally, of course, the shares of a gold miner would be priced in gold, but this is really asking too much of 21st-century financial innovation. The 22nd might get to it.)

There is some interesting news on the flow front, which is that central banks have become net buyers, rather than sellers, of gold. Obviously, this trend changes the flow and drives the price up. If it reverses, of course, the gold price will go back down. Most industry observers believe that reserve-accumulating central banks will continue diversifying into gold. I am not an industry observer, but I agree.

Now, here is the interesting part. The game-theoretic process which in the past has selected gold and/or silver as monetary goods, which may just as easily operate in the future, and which may even be starting to operate now, is a form of distributed coordination. Previously, I have described this coordination game as a game involving a large number of small players – retail investors, as Wall Street would put it. However, the game theory works just as well for a small number of large players. Such as the central banks…

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