In recent years, precious metals, most notably silver and gold, have played an unusual dual role as both monetary and non-monetary commodities. That may be in the process of changing for major financial institutions to favor holding metals as collateral as the Basel Committee ponders allowing banks to use gold as a Tier 1 capital asset.
Despite its well established and richly deserved safe haven status, gold is currently considered a Tier 3 asset. Ironically, this places the yellow metal lower on the asset totem pole than un-backed government bonds, which currently have low or even negative yields on an inflation-adjusted basis.
Furthermore, gold is generally misunderstood and ignored, while silver is largely viewed as a commodity among investors and central bankers. In fact, Fed Chairman Ben Bernanke, in response to the question of why central banks hold gold, simply answered "Tradition”.
Precious Metals Rule Exter’s Asset Class Pyramid
This perspective contrasts sharply with that of John Exter, whose classic asset class pyramid organizes assets with respect to their risk and issued amounts. In order from the widest point of the inverted pyramid to the narrowest, Exter places small businesses, real estate, gems, OTC stocks, commodities, municipal bonds, corporate bonds, listed stocks, government bonds, Treasury bills and paper money. Gold is placed squarely at the most narrow point of the inverted pyramid, just below paper money.
According to Exter’s model, when credit expands, money flows to the wide top of the pyramid as capital is placed in more speculative and less liquid investment vehicles. Nevertheless, when credit contracts and debts are difficult to repay, those assets near the broad end of the pyramid are sold and money flows to more secure assets situated near the pointed end where gold rules supreme.
Gold and Silver Hold Dual Roles
Like gold, silver holds a position in the center of Exter’s pyramid as a commodity, as well as at the narrow bottom of the pyramid as a hard currency to which safe haven funds flow in financially troubled times. In contrast to gold, silver is also an affordable monetary asset in the mind of the average individual. For the man on the street, it acts as Tier 1 capital and is valued as a savings asset with a price that can never go to zero.
Furthermore, silver is a good news metal since economic growth tends to increase industrial demand, but its price also benefits from bad news as it becomes the ultimate hard currency for the masses in case of a severe financial crisis.
Remonetizing Precious Metals
Many people concerned over the global trend toward the use of uncollateralized paper currency in commerce, have called for a return to a gold or silver standard in order to provide some hard currency backing for the ever growing supply of paper money being issued by governments.
Nevertheless, in order for precious metals like silver and gold to become "re-monetized", the price would need to rise exponentially relative to paper currency like the U.S. Dollar and the Euro to back all the money printed over the last 40 years since then-U.S. President Richard Nixon shocked the world by unilaterally removing the U.S. Dollar from the gold standard by ending its convertibility.
This traumatic move lead to the eventual demise of the post-WWII Bretton Woods fixed currency exchange rate system, of which the Dollar was the lynchpin, and ushered in the current era of floating exchange rates.
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