Colin's Financial Pages
See disclaimer at foot of page.
# Hot Potato News # # Steve Blizard's News from Australia #
# Hot Quotes # # Hot Links # # Archives # # Investor Bios #
# Fora #
[ Bear Market, Long Wave, and Y2K Links ][ Charts & Quotes ][ News/Stats/Data/Misc ]
[ Philanthropists Wanted ][ 'Net at Risk ]
Hot Potato News Items
The UK Gold Sale Jigsaw
Bank of England governor Eddie George is expected to call for the pound sterling to devalue, in the quarterly report of the BOE's monetary policy committee [according to Financial Mail on Sunday].
British exporters have been complaining for some time that the strength of the pound is making it difficult for them to be competitive and is sucking in cheap imports at the expense of local producers.
However, the BOE does not want to lower interest rates any more. Perhaps this would make British gilts (treasury bonds) less attractive than those of other countries? The effect of more interest rate cuts, rather than overstimulating the economy and increasing inflation, is seen as predominantly lowering inflation, due to the larger effect of the reduced cost of imports. Chief economist at broker Monument Derivatives Stephen Lewis says: "I expect the MPC to say that for inflation to be on target [2.5%], the pound needs to weaken by 8% against a basket of currencies over the next two years". Isn't this a return to the "beggar thy neighbour" policy of competitive currency devaluations, and wouldn't this make the currencies in the basket overvalued against the pound?
One might suspect that the BOE fears a deflationary spiral into recession.
The government could devalue the pound through higher spending or decreased taxes. However, neither of these would improve the Treasury coffers, and chancellor Gordon Brown is not believed to be willing to allow government finances to deteriorate.
The Bank of England proposes to sell 415 tons of gold out of 717, i.e. 58%, which according to the British Financial Times reduces the gold reserves to around 20 percent.
According to the UK Treasury, the UK gross reserves total $37bn (valued at market prices), but its foreign currency liabilities amount to $22bn. The $6.5bn held in gold therefore makes up 48 percent of the unhedged or 'net' reserves, but only 18 percent of total reserves. Selling 415 tons would reduce the gold to 7% of total reserves.
Terry Smeeton, ex-head of the Bank of England's foreign exchange division, 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."
Some have suggested that this move is related to Britain joining the Euro system, which has been promptly denied. The ideal range for ECB gold reserves has been suggested as 5 to 20%. Apparently, if Britain joined the euro system, it would not be able to sell or buy gold without permission from the ECB.
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."
Now, I have some questions:
Does the 20% of the study refer to total reserves, or 'net' reserves?
What is the report or study that Mr Smeeton alludes to, and where can we get to read it?
Who carried out this study?
Are they independent from the BOE?
Could the authors be connected in some way to the Financial Stability Review?
To what extent does selling gold reserves perform the same function as interest rate reduction?
Why not sell the gold on the quiet, and get a better price?
Why not sell the gold through the normal markets which exist for the purpose, rather than the bizarre auction proposal, which some have suggested allows speculators to attack the market?
I would like to know what type of risk is increased by having less gold. The only one I can think of is the risk of making less money on asset appreciation in a gold bear market. However, when assessing risk one needs to take into account relative importance. Gold is there to guard against infrequent risks of great importance. So, can we have a look at the calculations? And what if gold enters a bull market? And what if the yen or dollar depreciates?
In the 17th century, the general public took to leaving their gold at the goldsmiths. These goldsmiths issued paper certificates to the gold on deposit. People then found it convenient to trade using the paper instead of real gold, which of course meant that a 100% gold backed currency was created. Then, the goldsmiths discovered that they could issue more certificates than they had gold to back them... thus started the practice of fractional reserve banking, which is really a kind of fraud, since if every customer turned up to demand their gold, only a few would get it. The remainder have been robbed of their gold. Eventually, the goldsmith bankers became banks and ultimately the biggest one of all, the Bank of England. Reducing the gold reserve is therefore logically another step in the fraudulent separation of most of the depositors of monetary value from an asset of intrinsic worth.
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)
(cont)
users.dircon.co.uk
Though, unlike the author, I'm glad to see an open gold vs hidden sale for a change, but I'm not sure I enjoy the BOE idea of what is & is not "open". |
