Managing Risk?
The Bank of England publishes a journal, Financial Stability Review, which:
"...summarises new developments in a clear and readable form, helps you understand the thinking behind regulatory changes, keeps you up to date with the latest research on financial risk management and informs you about changes to the structure of markets in which your firm operates."
If so, I wonder if they have considered the risk management views of Terry Smeeton, ex-head of the Bank of England's foreign exchange division, who said in February 1998:
"When measuring results over a reasonable period, for example the last 20 years rather than, say, the last five years (which is not a time period of relevance to the assessment of an asset with the properties of gold), then one finds some interesting results. Studies show that a gold component of close to 20% in a portfolio otherwise consisting of US dollars and Japanese yen provides a reserve composition exposed to the least risk. While it is the case that the benefits of a gold element of this size are reduced on a shorter term portfolio analysis, these are clearly based on the experience of relatively stable market conditions and make no allowance for crisis situations such as were experienced in earlier periods."
What might be the consequences of reducing gold reserves? Let me quote Alan Greenspan:
"Central banks can issue currency, a non-interest-bearing claim on the government, effectively without limit... To be sure, if a central bank produces too many, inflation will inexorably rise as will interest rates, and economic activity will inevitably be constrained by the misallocation of resources induced by inflation. If it produces too few, the economy's expansion also will presumably be constrained by a shortage of the necessary lubricant for transactions. Authorities must struggle continuously to find the proper balance..."
"For most of the period prior to the early 1930s, obligations of governments in major countries were payable in gold. This meant the whole outstanding debt of government was subject to redemption in a medium, the quantity of which could not be altered at the will of government. Hence, debt issuance and budget deficits were constrained by the potential market response to an inflated economy."
Remarks by Chairman Alan Greenspan at the Catholic University Leuven, Leuven, Belgium, January 14, 1997
Greenspan notes that without redemption in gold, central banks can issue too much many or too little paper currency. Of course, today gold reserves are held as assets without obligation to redeem, and since the bias today is towards maintaining liquidity, as that is seen as the means of preventing recessionary forces, the outcome is much more likely to be inflation.
Kamin's fourth law of economics states: "Government inflation is always worse than statistics indicate: central bankers are biased toward inflation when the money unit is non-convertible, and without gold or silver backing"
Baxter's Second Law of economics states: "The adoption of fractional gold reserves in a currency system always leads to depreciation, devaluation, demonetization and, ultimately, to complete destruction of that currency."
The study at the following link presents empirical evidence that when central banks sell gold reserves, their country's currency will devalue a little more than 1/2% for every one percent of gold reserve reduction. As the Bank of England proposes to sell 415 tons of gold out of 717, i.e. 58%, the British pound stands to devalue by 29%. (thanks CMH)
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