Excerpt from a long 2 part article on Gold titled “Gold and the Casino Capitalism House of Cards “
The IMF is the world’s third largest holder of gold ranking only after the U.S. and Germany. It holds 103.4 million ounces (3,217 metric tons) valued on its balance sheet at SDR 5.9 billion (about $8.7 billion) on the basis of historical cost. As of March 31, 2009, the IMF’s holdings amounted to $94.8 billion at current market price. The Second Amendment to the IMF Articles of Agreement in April 1978 eliminated the use of gold as the common denominator of the post-World War II exchange rate system and as the basis of the value of the SDR. It also abolished the official price of gold and brought to an end the obligatory use of gold in transactions between the IMF and its members. And it required that the IMF, when dealing in gold, avoid managing its price or establishing a fixed price.
The April 2nd G20 communiqué confirmed a decision calling on the IMF to sell about 400 tons from their holdings and an intention to encourage further sales to fund anti poverty initiatives. The further sales are not committed at this stage and the 400 ton sale has still to be formally ratified by IMF members. Commentators have suggested the US Congress may block the sale but it’s is unlikely they will. President Obama supports it. Following advice from an IMF advisory panel that included Peoples Bank Of China Governor Zhou Xiaochuan and South African Reserve Bank Governor Tito Mboweni when the decision to sell the 400 tons of IMF gold was taken almost two years ago the panel imposed provisos that the sale should not be undertaken in a way, or over a time frame, that will disrupt the market. The IMF’s policy on gold is governed by the following principles:
As an undervalued asset held by the IMF, gold provides fundamental strength to its balance sheet. Any mobilization of IMF gold should avoid weakening its overall financial position.
The IMF should continue to hold a relatively large amount of gold among its assets, not only for prudential reasons, but also to meet unforeseen contingencies.
The IMF has a systemic responsibility to avoid causing disruptions to the functioning of the gold market. Profits from any gold sales should be used whenever feasible to create an investment fund, of which only the income should be used.
The annual sales quota under the Central Bank gold sales agreement for this year is 500 tons and the agreement has yet to be renewed beyond September 2009. In a strong market a further 400 tons may not be a serious challenge. But in a weak or volatile market, unless the sale is concluded by private treaty between central banks, it could affect prices.
There has been speculation that the 400 tons will be bought directly by a central bank. China’s recent announcement that it had increased its gold reserves by 454 tons to 1054 tons ignited gold prices and reversed weakness over previous weeks. If indeed China plans to significantly increase its gold holdings this will obviously have sustained long term positive effects on gold prices. This comment from an article in the South China Morning Post puts a useful perspective on developments:
‘At the end of 2002, the People’s Bank of China (PBOC) was sitting on foreign reserves worth a total of US$286 billion, so gold made up 3.9 per cent of its overall reserves. Today, after years of massive accumulation, Beijing has foreign reserves worth US$1.954 trillion. With gold at US$910 an ounce, the 1,054 tonnes of gold it now holds are worth US$30.85 billion. That sounds a lot, but it is only 1.6 per cent of overall foreign reserves…..’
As China is now the world’s largest producer of gold the case can be made that apart from its intention to diversify its currency reserves China has an economic interest in a strong gold price. A case can also be made that the reason China does not hold more than a notional percentage of its reserves in gold is that it regards gold as associated with 20th century imperial economic power exercised by the US and Europe and of little relevance now.
Considerations on the stability and future purchasing powers of the dollar and other fiat currencies, the direction of the global economic contraction, deflationary and inflationary threats, reviving the global economy and geo-political challenges to security and stability are more likely to drive the gold price than modest IMF sales unless the IMF acts irresponsibly, and that’s unlikely.
Gold and the Supra national currency issue:
Note: The article on Zhou Xiaochuan’s speech refers to a super sovereign currency. This appears to be a translation error. He is obviously referring to a supra sovereign currency
While the G20 communiqués remained silent on the question of the global financial crisis and the need for a supra national currency, Zhou Xiaochuan, Governor of China’s central bank has been articulate. He opened a March 26th speech on Reforming the International Monetary System with this question: ‘The outbreak of the current crisis and its spillover in the world have confronted us with a long-existing but still unanswered question, i.e., what kind of international reserve currency do we need to secure global financial stability and facilitate world economic growth, which was one of the purposes for establishing the IMF? Zhou goes on to develop the argument that ‘A supra-sovereign reserve currency not only eliminates the inherent risks of credit-based sovereign currency, but also makes it possible to manage global liquidity. A supra-sovereign reserve currency managed by a global institution could be used to both create and control the global liquidity. And when a country’s currency is no longer used as the yardstick for global trade and as the benchmark for other currencies, the exchange rate policy of the country would be far more effective in adjusting economic imbalances. This will significantly reduce the risks of a future crisis and enhance crisis management capability.” The following are the subjects he explores in support of his argument:
The outbreak of the crisis and its spillover to the entire world reflect the inherent vulnerabilities and systemic risks in the existing international monetary system;
The desirable goal of reforming the international monetary system, therefore, is to create an international reserve currency that is disconnected from individual nations and is able to remain stable in the long run, thus removing the inherent deficiencies caused by using credit-based national currencies;
The reform should be guided by a grand vision and begin with specific deliverables. It should be a gradual process that yields win-win results for all;
Entrusting part of the member countries’ reserve to the centralized management of the IMF will not only enhance the international community’s ability to address the crisis and maintain the stability of the international monetary and financial system, but also significantly strengthen the role of the SDR;
Zhou concludes his proposals ‘lay a foundation for increasing SDR allocation to gradually replace existing reserve currencies with the SDR.’
In a similar vein to the comment made on the property and debt bubbles in 1997 that a blind man could see them a blind man will see that China has a plan for ‘replacing the dollar as the dominant world currency and creating ‘an international reserve currency that is disconnected from individual nations and is able to remain stable in the long run’.
Beyond drawing attention in this article to the G20 having left comment on this issue out of their communiqué, without fully reviewing the dollar standard and current international monetary arrangements snippets of information will only be confusing. Chapter 5 of The Goldwatcher ‘The Dollar Standard and the Deficit without Tears’ is associated with the question ‘Is the dollar again America’s currency and everyone else’s problem?’ Chapters that follow also have information readers will find useful when taking a view on outcomes for the dollar and for gold.
Conclusion: In a room with an elephant:
G20 communiqués may sound reassuring. But wide ranging commitments generally deserve a second thought. All economies won’t benefit at the same pace, labour and capital will be affected in different ways and the G20 consensus may not last. It has been noted that the crisis has already led to contempt for policy makers, regulators, the financial establishment and the financial system itself. Members may not remain sufficiently unified to stay the course for a smooth transition from near chaos to prosperity – or even a steady shift from sliding towards an economic depression to managing a long recession. The message in the wake of the failure of socialism and the bankruptcy of capitalism from the distinguished 92 year old socialist historian Eric Hobsbawm is ‘None of the world’s governments, central banks or international financial institutions know how to resolve the crisis’ and ‘are all like a blind man trying to get out of a maze by tapping the walls with different kinds of sticks in the hope of finding the way out.’ To address the crisis Hobsbawn expects a major shift away from free market dogma towards public action will be called for. And it will be a bigger shift than Governments have envisaged. His conclusions are open to question but there is no doubt the global economy is in uncharted waters.
Zhou Xiaochuan’s remarks on currency reform quoted above leave little doubt that the dollar’s tenure as the global currency the US can print to order is being challenged. And, if policy makers and central banks don’t fully understand the challenges, noble as their intentions may be, we are all in a room with an elephant. OK if we know what the elephant is going to do. Likely to be crushed if we don’t. And no scope for wandering round tapping sticks on the wall to find the way out.
Of course, if we are going to experience the great new world order Gordon Brown forecast we won’t want gold and, keep in mind, Gordon Brown sold half Britain’s gold in the late 1990s at the lowest price recorded for decades. But, on the other hand, if we expect some disruptions in the role of paper money in the International Financial system we will keep owning some gold on the agenda as insurance against the consequences of what Zhou calls ‘the inherent vulnerabilities and systemic risks in the existing international monetary system’ and what Ray Dalio identified as the likelihood of countries with excessive debt denominated in their domestic currencies inflating the debt away.
John Katz is an analyst, strategist and financial writer based in London, U.K. To gain experience and qualifications in the Financial Services Industry he first completed the necessary exams to qualify as an approved Securities Dealer and Trader. While working for a London based hedge fund he was accredited by the United Kingdom Regulatory Authorities. He has contributed articles to the financial press, commentated for business television, and is the author of Portfolio 2001 – How to Invest in the World’s Best Companies, Random House Business Books, 1999. John was co-author with Frank Holmes of The Goldwatcher: Demystifying Gold Investing, John Wiley & Sons, 2008. He is also writes The Goldwatcher blog
Excerpt from a full article posted by StockResearch Portal