It has long
been a standard policy of central banks to sell gold and invest
the money gained in interest-bearing securities, which are usually
government bonds of their own national treasuries.
are non-inflationary. They do not represent an increase in the
monetary base. The increased holdings of Treasury bills are offset
by the reduction in gold holdings, which also serve as monetary
reserves, i.e., high-powered money. Nothing changes with respect
to the money supply.
are applauded by those politicians who believe academic monetary
theory, whether Keynesian or monetarist — a small group,
indeed. Nobody else in government pays any attention.
Gold is regarded
as a dead asset or an unproductive asset because it doesn’t generate
interest. (I mean interest as money, not interest as public awareness.)
It just sits there, gathering dust.
If a central
bank leases gold, this also doesn’t change its monetary base,
since the central bank pretends that an IOU from a private "bullion
bank" — a bank that sells off all of its borrowed bullion
— is equal to gold bullion in the vault. Therefore, the lease
is not treated as a sale. The IOU for gold is as good as gold,
arises when gold’s price rises in the nation’s currency. This
calls into question the ability of the bullion bank to enter the
gold market and buy gold, so that it can repay the gold it borrowed
from the central bank, which the bullion bank has promised to
do one of these days, Real Soon Now. If the bullion bank cannot
repay the loan, then its IOU is publicly exposed as not being
as good as gold. If the central bank were to press the bullion
bank for repayment, rather than rolling over the loan, then the
bullion bank could go bankrupt, which would reduce the value of
its IOU’s to something less than face value. This would create
a legal crisis for the central bank, which would lose reserves
on its books.
a central bank do then? Simple: buy more government bonds to offset
the reduction in gold reserves.
problem would not be the lack of repayment but a lot of unwanted
public interest. "What did the central bank do with our gold?"
A default by bullion banks would be a public relations problem,
not a monetary problem.
this PR problem, central banks are prepared to sell off more gold
to keep its price down. This will enable the bullion banks to
continue to draw interest from the investments they made with
the money they generated by selling the leased gold.
is happy, except for people who think that government currencies
should be backed by gold, something that has not been true ever
since Roosevelt issued his executive order to confiscate Americans’
gold. The number of people who feel this way are few and far between.
I am surely not one of them. For almost three decades, I have
called for exactly what is happening: the sale of stolen gold
by central banks to the public, in order to get gold back into
private hands. I even had an article published in The Wall
Street Journal in the 1970’s that recommended this. The gold
should be in private hands. Gold is too important to be left to
the discretion of central bankers.
are conservatives who don’t believe this. They trust central bankers.
They think central bankers are not agents of the national government.
They think the government can be trusted to fulfill one (and only
one) promise: "Bring in an IOU for gold at any time, and
your government will give you gold." The more times governments
default on this promise, the more strongly certain economists
(few in number) assert, "Next time, it will be different."
their money are soon parted, but economists are always with us.
They are there to encourage the next generation of fools. That’s
the way the world works.
THREAT TO SELL GOLD
by the Financial Times’s Kevin Morrison appeared
on July 23. In it, we read:
central banks are expected to extend their four-year-old gold
sales agreement when it comes up for renewal next year.
returns to be made from lending gold to market participants
hedging forward sales and the budgetary pressures on Germany
and other leading economies will encourage the banks to continue
sales of the precious metal.
a bit odd. The low returns made by gold mining firms that have
promised to deliver gold at a fixed price should be of no concern
to central bankers. Why should central bankers care one way or
they don’t care about gold mining profits. They care about the
bullion banks’ inability to repay in gold. They care because defaults
by bullion banks could create a PR problem for central bankers.
Bureaucrats don’t like PR problems. So, they don’t want gold’s
price to rise.
will also want to retain the stability of the gold price created
by the restrictions imposed by the sales pact.
agreement, which expires in September 2004, allows for 400 tonnes
of gold to be sold each year. One central banker told the Financial
Times recently that he thought there was room for an increase
in gold sales.
central bankers tell the media the same story every time gold’s
price rises. I mean, it’s not as though it would be a good idea
for a central bank to own an asset whose price is rising. What
kind of speculative nonsense is that? "Buy low, sell low"
is their motto. Well, sort of. "Buy low, lease low, get stiffed"
is closer to it.
expect the new pact to allow the sale of 500 tonnes a year over
a five-year period, or 2,500 tonnes in total. This would allow
additional banks — from Greece and the European Union accession
countries — to join.
arrangement was signed in September 1999 in response to increasing
concerns that unco-ordinated central bank sales of gold were
adding volatility to the market and pushing prices lower.
Are you following
this? They worry about a repetition of 1999, when gold sales pushed
prices lower. You may also recall Mr. Morrison’s explanation,
presented in paragraph two, for the need to sell gold next year
because of "The low returns to be made from lending gold
to market participants hedging forward sales. . . ." So,
let’s see now: the banks sold gold in 1999, lowering its price,
thereby making a potful of money for the mines that had sold gold
forward at a fixed price, which had been higher. But now they
worry about a replay of that event, while, simultaneously, they
worry about the absence of profits for forward-selling gold mines.
dutifully reports all this. No bells went off it his mind. Nothing
said, "does not compute!"
price fell to a 20-year low of $252 a troy ounce when the Bank
of England announced its gold sales in the summer of 1999. The
current pact has proved successful in adding order to the market.
exactly is order? A stable price? This is not what we have seen
to about $320 shortly after the agreement was reached. After
a brief subsequent fall it has risen steadily for the past two
He then added
the gold price has firmed, the rate central banks can charge
borrowers such as gold miners — which use it to hedge forward
sales of the metal — has fallen. The miners have needed
less gold as they have unwound their long-term hedge positions.
He is saying
that some gold mines have borrowed gold from the central banks
at low interest rates, so that they could unwind — i.e.,
deliver — their forward sales obligations. Let me get this
clear. The mines had debt positions — promises to deliver
gold at a higher price — which became less profitable when
gold’s price rose, so they borrowed gold from central banks to
pay off their gold debts. That is, they took on a debt in gold
to pay off a debt in gold. This is called "unwinding."
You bet it
is! The forward gold contracts were made in a free market, where
those who are owed gold on a fixed date can bring gold mining
officials into court for payment if the mines don’t deliver physical
gold. In contrast, gold leasing debts to central banks are assumed
to be open-ended, never to be repaid, only rolled over.
gold deposits rates are zero, against more than 3 per cent at
the time of the agreement.
a deal. Borrow gold at 0 percent, sell it, take the money received
by the sale, lend it to someone at some rate of interest, and
pocket the money. Nice work if you can get it. There is only once
catch: the price of gold could go up. But bullion bankers don’t
seem to care. Why not? I suggest this reason: they know they will
not have to repay. At worst, the loans will be rolled over at
low, low rates. Nice work if you can get it.
will play a key role in any future agreement. Gold accounts
for an estimated two-fifths of its foreign exchange reserves.
It is the
largest holder among the 15 signatories to the gold agreement,
whose members, all European central banks, hold about 40 per
cent of the world’s official gold reserves.
banks hold 22 per cent of the 147,000 tonnes of the world’s
gold that is in circulation, in the form of jewelry, in industrial
uses and in official or investment holdings.
quotes Matthew Turner.
there are also ways that funds can transfer from the central
banks to the treasury, such as dividend payments," said
Matthew Turner, an analyst at Virtual Metals, a consultancy.
would be motivated to sell gold because it could probably earn
a better return from a switch to other investments, he noted.
And if Germany had sold gold at $800 an ounce in 1980, and had
bought 30-year U.S. Treasury bonds at 13%, it would be sitting
on a huge pile of money. But the central banks did not do this
in 1980, when they could have gotten a huge return on their gold.
Yet they are now talking anonymously about selling it at $350,
when the available return on bonds — highly risky, as we
have seen in recent weeks — is 4%, and short-term rates are
no interest return. Quite true! It never has. So, Mr. Turner’s
observation would have been equally true in 1980, 1960, and 1800.
"Gold held by the central bank earns no interest return."
To invoke this fact as a guide to understanding central banking
policy is the equivalent of arguing that a lot of people will
go to bed because the sun will go down.
said central bank sales were part of a long-term trend which
will further reduce the banks’ role in the international gold
think there will be a day when they will be able to conduct
buying and selling activity without disrupting the market too
much," he said.
that ever be? Only because the central banks will have sold their
gold to the public.
quite: to the public and to China’s central bank.
read explanations for anything central bankers have done or plan
to do regarding gold, bear the following in mind:
explanation makes no sense.
explanation was never intended to make sense.
bankers want to avoid PR problems.
have leased out gold that will not be repaid if gold goes over
they try to get their gold back with gold at $800, their debtors
will declare bankruptcy.
on the books to defunct debtors will reveal the fact that leased
gold is not the same as gold in a vault.
has bad PR implications.
central banks are trapped by their own gold-leasing programs.
must now sell gold in order to create the illusion of bullion
will act as a depressant on the price of gold for as long as
central banks continue to lease gold and sell it.
public will slowly get back that portion of its gold that China’s
central bank doesn’t buy at these subsidized prices.
fathers will continue to receive their gold subsidies from Western
daughters will have dowries in gold, just as they have had for
exchange, Americans will have Alan Greenspan, who seems to have
been around almost as long as Indian dowries — and is beginning
to look like it.