What if the Fed Is Short Germany’s Gold?
by Gijsbert Groenewegen
Why are central banks buying gold, the opposite of their own creation, paper money?
Money is the opposite of gold and silver. Fiat money is based on ordinance and credibility and is not self-limiting (can be printed infinitely) whilst gold and silver is commodity based and physically limited to the amount of physical gold and silver available and mined, you choose either one or the other. One is purely based on credibility hence why notes need to mention the nominal value in order to give the piece of paper value. American paper money is backed by only the size and strength of the American economy. The other money is based on real value, the value of the gold itself. And especially for that reason investors should be warned considering the fact that more and more central banks are buying gold, the opposite of their own creation: paper money. This is so contrarian. It is like the butcher who doesn’t want to eat his own sausages because he knows what is in it. Why would central banks buy gold, which “limits” their creation of credit? The answer is: the fear of lost credibility of paper money, because of the constant undermining, dilution, debasement of their currencies with quantitative easing measures not sorting the desired effect of sustained economic growth because we have passed the tipping point whereby the overwhelming debt levels (Debt/GDP > 77-90%) have started to depress economic growth.
Central banks have been buying gold since 2008!
In this context it is interesting that the world's central banks have been net buyers of gold since 2008. In 2011, global central banks continued to be net buyers of gold as they attempted to “diversify” from their dollar and euro holdings, rebalance reserves, and protect national wealth. Why, if gold has no monetary function any longer, why buy gold? Why buy the opposite of the US dollar, the anchor of the financial system? Total world production is around 2,700 tonnes, in other words central banks are purchasing about 20% of the world’s gold production!
A growing number of emerging countries have also increased their purchases of gold in recent years to bolster their rapidly growing currency reserves, as sovereign debt crises have weighed on traditional reserve currencies such as the U.S. dollar and the Euro. Nations from Brazil to Iraq to Russia are buying the precious metal to add to official reserves. National Bank of Ukraine (NBU) said in late December it raised the percentage of gold in its reserves in 2012 to 7.72% from 4.36% a year ago. The bank said it is boosting its gold reserves “to avoid the negative impact of the global crisis on the economic development of the country as it works on diversifying the components of international reserves in Ukraine.” Brazil doubled its gold holdings in two months last year, buying 17.2 metric tons in October and 14.7 metric tons in November. According to data released late last month by the International Monetary Fund, Iraq bought gold during August-September, lifting its official precious metals reserves from 5.8 metric tons to 31.07 metric tons. The worldwide stimulus measures and ultra low interest rates will continue to support investor interest in gold in the absence of low-risk investments that can offer acceptable yields. The conclusion is that the central banks have been a major force behind the increase in the gold price. The gold price rose more than threefold between 2007 and late 2011 -- from around $600/oz to a peak of $1,895/oz. The most important question is why all these banks buy gold, the opposite of their own creation: paper money?
The “objective” of the Washington Agreement was “reversed”.
The irony is that the central banks created the so-called Washington Agreement in 1999 in order to ensure an orderly disposal of their gold inventories. The agreement came in response to concerns in the gold market after the United Kingdom treasury sold the UK gold reserves through Bank of England auctions starting in 1999, coupled with the prospect of significant sales by the Swiss National Bank and the possibility of on-going sales by Austria and the Netherlands, plus proposals of sales by the IMF. Under the agreement, the European Central Bank (ECB), the 11 national central banks of nations then participating in the new European currency, plus those of Sweden, Switzerland and the United Kingdom, agreed that “gold should remain an important element of global monetary reserves” and limited their sales to no more than 400 tonnes (12.9 million oz) annually over the five years from September 1999 to September 2004, being 2,000 tonnes (64.5 million oz) in all. These agreements were extended every five years with varying quota ranging from 2,000 to 2,500 tonnes. As above mentioned its purpose was to deal in a controlled way with the fear that central banks had abandoned gold as a reserve asset, and were planning to sell all that they had in their vaults. Well that fear has clearly been reversed since 2008 when they started buying gold instead of selling it!
Many central banks store part of their gold reserves at the NY Fed
Many central banks besides the Bundesbank store their gold at the vaults of the Fed of NY and the BOE and this should make people think. Why would a country, when there is no geopolitical threat, keep an important part of its wealth in foreign hands. According to a recent report The Bank of Mexico holds less than 5% of its gold reserves within Mexico, while the remaining 95% of it’s ‘physical’ gold reserves are held in the US and London (translation - nearly the entirety of Mexico’s gold reserves are held at the Bank of England and the NY Fed basement, and have likely been leased more times than MFG client’s assets).
The Austrian central bank keeps most of its 280 metric tons of gold reserves in the United Kingdom, Vice Governor Wolfgang Duchatczek was quoted as saying in the finance committee of the country’s parliament, according to Bloomberg.
According to Former Dutch central bank governor Nout Wellink, the Netherlands now holds 612 metric tons of gold and has no plans to sell. The Dutch gold reserves are vaulted in New York, Ottawa, London, and Amsterdam. The Dutch central bank declared that it has no plans to physically inspect its gold reserves held in other countries, despite recent demands of the German Bundesrechnungshof to do so with respect to the German gold reserves. Finance Minister Jeroen Dijsselbloem cited yearly accounting procedures and his trust in foreign central banks where Dutch gold is stored, in a letter to parliament published in December 2012. Dijsselbloem said that 51% of Dutch gold reserves are in New York, 20% per cent in Ottawa, 18% in London and 11% in Amsterdam.
But what do you really have if you don’t have real possession of the country’s gold reserves, why hold the reserves in foreign vaults, why give foreign powers “possession” over “real money” that belongs to the Dutch people. We all know that trade surpluses and the Cold War and fear of a Russian invasion were the main reasons to keep most of the gold reserves with the New York Fed. Though that situation doesn’t exist any longer and therefore the question begs why keep a large part of the Dutch gold reserves in the NY Fed vaults? What ensues if the markets and the financial system or credit system collapse? What happens then to the Dutch gold in foreign central vaults? Who can one trust if all the trust and credibility in the financial system is completely erased? I can’t emphasize enough; paper obligation or no possession of a physical asset represents counter party risk. Counter party risk is the risk to each party of a contract that the counterparty will not live up to its contractual obligations. When the proverbial *&%$#@ hits the fan will the gold still be in the vaults or will there be only an IOU and a letter stating, “I am sorry.”
Why did the Dutch central bank order a pension fund to reduce its gold holdings?
In the context of the “relaxed” stance of the Dutch vis a vis the Dutch gold being stored in foreign vaults the following case is the more remarkable. In February 2011 a Netherlands-based $400 million pension fund for workers at several Dutch glassmaking plants was ordered to significantly reduce its gold allocation, from 13% to 3%, by De Nederlandse Bank (DNB), the Dutch central bank and also the Dutch pensions regulator, which ruled the scheme's exposure to the precious metal as too risky. How risky can it be to hold gold when the gold price has risen from $255/oz in 2001 to $1,700/oz today as a result of the debasement of the currencies and fall in purchasing power? Spurred by concerns over inflation and the stability of the euro, the pension fund began purchasing gold in July 2008. "We invest in members' interests, and have benefited from the appreciation in the gold price. Especially in uncertain economic times, it proved a refuge, we trust in gold as an investment." Since then, the price of gold has increased substantially from $600 per ounce. The pension fund had wanted to maintain its gold allocation. Yet a Rotterdam court sided with the Dutch central bank. The regulator argued that the average fund has just 2.7% in commodities, including gold.
The DNB expressed concerns that the pension's solvency ratio could be hurt if the price of gold were to suddenly drop now. The DNB claimed that investment of such amounts in gold is too risky; the price of gold fluctuates too much for it to be classified as an investment and that it does not share the risk analysis of the pension fund! And that wouldn’t be the case with other investment classes!? I think the DNB should first check the volatility and performance of other asset classes before it makes a statement as stated. In fact gold has a lower volatility than many other asset classes. However, the scheme says the gold was kept as a security against the instability of the Euro and there is only one obligation the scheme has to consider; to pay members upon retirement. How are pension funds going to meet actuarial interest rates of between 7-8% when worldwide interest rates are sub par because of massive stimulus measures? It had no risky investments such as equity and holds gold as a back up against the dangers of a turbulent Euro market and rising inflation. The argumentation of the pension fund couldn’t have been more spot on and the reasoning of the DNB couldn’t be more wrong; see an article by Blackrock’s iShares...
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