Saturday, July 26, 2014

Dispelling the Myth that Central Banks Hate Gold

One of the keys we watch here along with the US dollar is the price and movement of gold. If you do any research on gold at all on the internet, you will quickly discover that there is a commonly held view that Central Banks hate gold and think of it as a useless asset that does not earn interest. As usual, if you dig a little deeper and do more research you discover a different story. Let's take a look.

First some definitions and background. When we say there is a commonly held view that Central Banks "hate gold" we mean that hard asset advocates sometimes suggest that Central Banks think owning gold is pointless and also try to discourage individuals from owning gold by  using their power to suppress the price of gold in the marketplace at times. We think they are likely right on the second part of that, but not the first part. We will explain why below.

First, let's look at Central Bank reserves. They own gold and lots of it. Tons and tons of gold. The US owns over 8,000 tons (the most of any nation). The IMF owns nearly 3,000 tons of gold. The major EU nations all own tons and tons of gold. Here are the top 10 gold holders (excludes IMF which is not one nation). And there are also tons of articles pointing out how Russia and China have been rapidly moving to build up their gold reserves to try and catch up with the other top holders. So the first idea we can discard is that Central Banks and nations think holding gold is a waste of time. Clearly that is not true even if you hear a public official now and then say that gold is useless because it does not earn interest.

Another common view circulating among hard asset advocates is that the Western nations and Central Bank nations gold reserve holdings are deceptive because they do not disclose how much of their gold they may have leased or swapped into the market. This part is true and is impossible for anyone to know because the Central Banks are not transparent on this issue. They are not willing to disclose any gold leasing or swap arrangements they may have to the public. 

When the US organization GATA sued the Federal Reserve under the Freedom of Information Act (FOIA) to try and learn this information, they received a letter from the FED stating that this information would not be disclosed and the courts upheld their right to prevent disclosure. Here is a key quote from this letter:

"In connection with your appeal, I have confirmed that the information withheld (from disclosure) under exemption 4 consists of confidential commercial or financial information relating to the operations of the Federal Reserve Banks that was obtained within the meaning of exemption 4. This includes information relating to swap arrangements with foreign banks on behalf of the Federal Reserve System and is not the type of information that is customarily disclosed to the public. This information was properly withheld from you."

In addition, GATA also posts on their web site a 1999 IMF internal memo that discusses proper disclosure of reserve assets for Central Banks. Here is bullet point #15 (on page 6) from that memo:

"15. Central bank officials indicated that they considered information on gold loans and 
swaps to be highly market-sensitive, in view of the limited number of participants in such 
transactions. Thus, they considered that the SDDS reserves template should not require the separate disclosure of such information but should instead treat all monetary gold assets, including gold on loan or subject to swap agreements, as a single data item. They also confirmed a view, taken by a number of countries (both inside and outside the G-10) at the December Board meeting, that the disclosure of the composition of reserves by individual currencies would be market-sensitive but that they would have no objection to disclosure of such information by groups of currencies." 

The above IMF memo says that the IMF got feedback from Central Banks that they do not want to disclose any details about their gold leasing or swap deals. Instead they asked to just be allowed to list their gold reserves as one lump number (without explaining any liens that may exists against the gold). As an accountant, I understand what this means. It simply means they do not want to disclose the information because they feel it is too sensitive. This lack of transparency of course fuels a lot of speculation as to why the need for secrecy. That topic is beyond our scope here. 

What we can take from all this is that Central Banks clearly think gold is important. They think that their dealings with their gold reserves are so important and sensitive that they will not disclose them to the public. They do not feel they fall under the Freedom of Information Act as the FED clearly stated in their letter to GATA.

Need more proof? Let's just listen to European Central Bank (ECB) President Mario Draghi. Here is an article written by someone who was able to ask Mr. Draghi directly what he thinks about gold as a reserve asset. Here is the text of his answer:

"Dr. Mario Draghi: “Well you’re also asking this to the former Governor of the Bank of Italy, and the Bank of Italy is the fourth largest owner of gold reserves in the world, which is out of all proportion to the size of the country. But I never thought it wise to sell it, because for central banks this is a reserve of safety, it’s viewed by the country as such. In the case of non-dollar countries it gives you a value-protection against fluctuations against the dollar, so there are several reasons, risk diversification and so on. So that’s why central banks which have started a program for selling gold a few years ago, substantially I think stopped…most of the experiences of central banks that have leased or sold the stock of gold about ten years ago, were not considered to be terribly successful from a purely money viewpoint.”

If you prefer, you can listen to Mr. Draghi's answer here.

By now it should be clear that the idea that Central Banks hate gold is a myth. 
There are legitimate questions that can be asked such as:

-Do Central Banks at times sell or lease gold in the marketplace to control the price?
-Why do Central Banks resist transparency on their gold loan and swap dealings?
-What future plans do Central Banks have for gold?
-Do Central Banks view gold as "competition" for their fiat currencies?

We can't answer for the Central Banks. They know the answers and we don't. 

Jim Rickards says that any leases or swaps the US FED may have on gold don't really matter because in a crisis situation where gold reserves would become important, they can just refuse to deliver any physical gold that may be leased or swapped. Essentially, he says national security trumps everything else if push ever comes to shove. 

We will leave those questions and possible answers to others more qualified. We do think we can make these observations based on available evidence.

-Central Banks (and the IMF) own lots of gold and view it as a key reserve asset that helps back up the fiat system (unofficially). They don't hate gold.

-According to Mr. Draghi they view gold as a "safety" reserve asset and as a means of hedging a drop in value of any national currency (he specifically mentions the US dollar). He adds it provides "risk diversification."  He doesn't hate gold.

-It is very possible that in the future these Central Banks (and the IMF) may find new and creative ways to use their gold reserves (along with other assets) to provide better stability in currencies. We are following that possibility here over the coming months and years. 

Conclusion: It is understandable why some are skeptical and critical of Central Banks on the topic of how they use their gold reserves since they refuse to be transparent about that. Whether they should be more transparent is unknown to us. In general, we think the more transparency the better when it comes to building public trust. But there may be sensitive global financial system issues that justify it in the eyes of the Central Banks. We can't possibly know and are sure they aren't going to tell us:)    They refused to do so when sued under the FOIA.

We do think it is reasonable to believe that gold can be used by them in the future to improve systemic stability. How and when that happens is also unknown to us. But we do have some hints now and then. It's just another area we need to follow that could involve major monetary system change at some point in the future. We will try and do that.

Update 7-29-14: Silver Doctors ran this article on their site (which we always appreciate). In the comments below the article a reader questioned how I know the US really has the gold reserves they say they do. As I noted in the article, there is poor transparency on this issue so I cannot say that I know for sure how much gold the US actually owns (that is not loaned or swapped). 

However, the US does publish an inventory of the physical gold owned which is public information. I have to assume that is correct information unless proven to be wrong by verifiable evidence (which I have not seen). Here is the link to the US Treasury summary of gold owned and here is a pdf file on the US House Finance Committed that lists the gold inventory in detail by location. Unless someone can prove this information is false, I have to accept it as the best information I can verify from an official source.

In addition to all the above, as I noted in the article, Jim Rickards (who has contacts in the US intelligence community) says that in a crisis the US would likely take possession of ALL physical gold stored in the US if they felt national security was at stake (including other nations gold too). Jim Rickards does not question that the actual physical gold exists stored in vaults in the US. The question is whether that gold has been loaned or swapped.

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