World Gold Council opinion on ECB gold reserves.
Reuters 12/30/97
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12/30 12:22 ECB should include gold in reserves - WGC
The following is a contributed article by Robert Pringle, head of the Public Policy Center of the World Cold Council (WGC) in London, and George Milling-Stanley, manager of market analysis for the World Gold Council in New York.
A spokesman for the WGC in New York said the article represents an official statement by the World Gold Council, a non-profit organization based in Geneva whose members are the major gold mining houses of the world.
New York, December 30, 1997 - European Monetary Union (EMU) represents a major step in the evolution of the international monetary system and in the early years, it is bound to face many challenges, some of them perhaps unexpected.
The European Central Bank (ECB) is scheduled to come into formal existence on January 1, 1999, but for six months before that will exist in embryo, and its Governing Council will take a large number of key decisions in that time.
One of these will be the composition of the foreign reserve assets to be pooled at the ECB by the central banks of member countries.
This note outlines some of the reasons why gold should be included in the reserves of the ECB.
One necessary condition toward assuring the success of the new monetary arrangements will be acceptance by the citizens of perhaps fifteen European countries that monetary affairs are being conducted prudently.
The ECB must lose no time in convincing people that this is the case; it can afford no mistakes, and it must neglect no opportunity of building people's confidence.
In recent years we have all come to expect that central banks will operate to secure and maintain an environment of low inflation and overall financial stability.
This process has been reinforced in Europe by the general move by governments to give their central banks formal independence, as required by the Maastricht Treaty for those countries participating in EMU.
But the new central bank will not automatically inherit the "credibility bonus" of, for example, the Deutsche Bundesbank.
The ECB will have to earn its credibility.
All 15 potential members of the EMU currently hold gold in their official reserves. In order to inspire confidence from the outset, the ECB will be expected to resemble the bodies it supersedes, in appearance as well as in behaviour.
It is true that independence and the prime goal of fighting inflation are enshrined in the ECB's constitution. However, the composition of its reserves will be equally important in demonstrating that the ECB has not only the right level of resources it might need to ride out unexpected shocks, but also the right mix.
It has often been pointed out that gold has the important virtue of being no-one's liability. It is an asset independent of the monetary policy, inflation record or vulnerability to exchange controls and/or asset freezes that can afflict holdings of foreign exchange.
Central banks cannot, of course, use gold directly for purposes of intervening in the foreign exchange markets; for that they need dollars.
But gold is liquid in times of need; it is universally acceptable as a means of settling obligations between governments; and it can be readily mobilized - for instance, it is a ready form of collateral against the need to borrow.
The new tri-polar international monetary system, built around the U.S. dollar, the yen, and the euro will take time to settle down, and it is impossible to predict what shocks might hit it in the meantime.
Never before has a monetary experiment such as the launch of the euro - a new currency not accompanied by the formation of a corresponding new sovereign entity - been attempted.
In the face of such a high degree of uncertainty, Europe's central bankers and the political establishment - whose credibility is riding on the success of this experiment- should not pass up any opportunity to build confidence in the new currency from the outset.
Gold provides such an opportunity. Including gold in the reserves of the ECB offers huge upside potential and zero downside risk.
Gold's detractors have largely abandoned the inaccurate assertion that gold is a sterile asset and now content themselves with claiming that the yield on gold is inferior to that on other financial assets.
In recent years the interest available on gold has compared favorably with that on Japanese yen or German marks; only U.S dollars have consistently offered a better yield among the realistic alternatives to gold.
But what happens when the dollar itself depreciates against gold?
The long term story is one of large-scale depreciation of all currencies, including the dollar, against gold, while over the centuries gold has maintained its real purchasing power.
The opportunity cost of holding gold (ie the additional income that could have been earned on investments offering a higher rate of interest) should be regarded as an insurance premium - the price paid to guard against an improbable but potentially disastrous event.
Such an event might be a war, an unexpected resurgence of inflation, a generalised debt crisis involving the repudiation of debt by major sovereign borrowers, a regression to a world of currency and trading blocs, or the international isolation of a region.
Gold has the signal virtue of offering protection against such catastrophes, while simultaneously underpinning both internal and external confidence in the currency in normal times.
For all these reasons, gold is a symbol of monetary independence.
If Europe wishes to have an independent say in international monetary affairs, the lesson of history is that the ECB should hold gold in its reserves.
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