Is it a good idea to borrow in gold?
The idea of borrowing and making payments in gold, which was first floated by President Recep Tayyip Erdoğan back in 2016, is in circulation again.
This idea suggests “the dollar constitutes a constant source of exchange rate pressure in the world. We have to free the states and nations of this exchange rate pressure.” Thus, it offers a model that proposes using gold instead of the U.S. dollar when borrowing.
Looking at how gold prices have fluctuated may be illuminating. Let us begin with this question: “We borrowed with gold equivalent to 100 Turkish liras at the end of 2002. Let us assume we need to pay back this debt in March. How much do we need to pay now?” The answer is 980 liras.
The price of an ounce of gold in international markets has quadrupled between the end of 2002 and the end of March 2018. Let us add the lira’s depreciation: The price of gold in terms of the lira has increased 10 times. The debt of those who borrowed in U.S. dollars in 2002 increased by 2.5 times in terms of the lira, while the debt of those who borrowed in gold rose by 10 times in terms of the lira over the same period. At a time when prices have gone up 3.8 times, it would not be possible to survive financially. This is the picture we get when we take both the price of gold and the depreciation of the lira into account. Past experiences also shed some light on the future.
If gold is proposed to be held in reserves, this idea could be seen as a political choice. Some nations, indeed, do this. Recently, China and Russia have increased their gold reserves.
The problem is that borrowing and making payments in gold is not a reliable method in the current financial architecture.
One may claim “borrowing in dollars and paying back in dollars leaves us vulnerable; we suffer damage.” However, this is not very true. What causes damage is not currency, which you use to borrow or pay back your debt, but rather an insufficient amount of foreign currency you have in reserves compared to the level of your debt or insufficient foreign currency revenues. In other words, it means you fail to take precautions against your high level of debt.
Contrary to what is believed, replacing the dollar with gold may not provide any “relief.” The gold market has its own peculiar rules and the payment systems through which gold transfer is conducted may be even more expensive.
Market analysts know borrowing in gold is much more complex than borrowing in the dollar for local institutions and companies because there are many elements to be taken into account. In case of borrowing in foreign currency, exchange rates pose a risk, whereas in case of borrowing in gold, there are both exchange rate and gold price risks.
Each nation defends the value of its own currency, but there is no institution that tries to keep the price of gold stable.
There are a number of elements that affect the price of gold; global gold mining production, labor disputes, the costs involved in extracting gold and other financial costs, the fluctuations in central banks’ gold reserves and most importantly, demand for gold outside of reserves.
In the world of finance, there is no such thing as “taking shelter in a single instrument.” There are multiple factors that affect the gold market. Still, the depth of the gold market is not deeper than the markets where the dollar and other currency reserves are traded. That is why a change in a single factor affects prices.
Moreover, in a world where populism has been rising on a global scale and where leaders post “missiles are on their way” tweets as soon as they get out of bed, it is very likely the price of gold may skyrocket.