Thursday, August 04, 2011

Gold Is The Only True Safe Haven

Because of the problems in the euro area, the U.S. and the U.K., investors are fleeing assets denominated in their currencies. Some are fleeing to gold and other precious metals, others are fleeing to the two fiat currencies that have managed to gain "safe haven" status, the Swiss franc and the yen. The latter reaction is in some way understandable, since historically (the last decades) Switzerland and Japan has had the lowest rates of inflation on average.

A key difference between gold and the franc and the yen is that the two latter functions as currencies of real economies, while gold doesn't. This means that when gold rises, exchange rates between countries are unaffected (at least not directly). By contrast, when investors flee to the franc and the yen, companies in Switzerland and Japan see their competitiveness vanish. Though other people in Switzerland and Japan benefit, these exchange rate shocks are usually not good for Switzerland and Japan, especially when they are as dramatic as now, with for example the franc appreciating 45% against the U.S. dollar and 30% against the euro in less than 14 months.

As a result, the central banks of Switzerland and Japan have used various means to limit the appreciation of their currencies. I discussed the latest Swiss actions yesterday and today we can read that Japan is also acting to lower the value of its currency.

Because of the active measures from the Swiss and Japanese central banks to lower the value of their currencies, the franc and the yen are not as good as safe havens as gold is. While it would be possible for central banks to lower the price of gold as well, no central bank see any interest in that right now. Indeed, as I discussed two days ago, central banks are unintentionally acting to increase the price of gold as they increase their gold reserves.


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