“Is Gold money?” this question was asked to Fed’s Ben Bernanke at a US Congressional Hearing last July 13th. His answer: “No, it is a precious metal”. Not so fast Mr Chairman, Gold may become a useful tool to address the critical crisis of sovereign debt that has been gripping the world financial markets and is putting at risk economic growth for years to come.
As we all understand, credit is all about confidence. In fact “credit” comes from the latin word “credere”, i.e. “to believe”. And credence is indeed the commodity that has become in short supply among sovereign debtors. Could gold change that?
Gold has been the cornerstone of a state’s treasury for more than two thousand years. In fact it has been only until very recently, 1971, a mere 30 years ago that gold was indeed a synonym of money. It was in fact on August 15th 1971 that Nixon shocked the world by ending the convertibility of US dollars into gold.
Today most nations still hold gold reserves. The reason is far from clear if Bernanke’s answer is to be taken at face value. Yet such reserves appear to be considered as nothing more than the legacy of the past. So much so, that the UK famously sold between 1999 and 2002 60% of the country’s gold reserves at a 20 years price low. Yet, since 2000 the price of gold has increased from $300/oz to the recent high of 1,917/oz. The sovereigns’ gold reserves have therefore appreciated in value more than 600%, just in the last decade. Below a very simple table including Sovereign Debt data and the value of gold reserves at current prices (Nov 8th 2011) for the Euro Zone and some of the largest economies and international institutions.
It is interesting to observe that while the overall value of Gold is low relatively to the debt stock, in the case of Italy, Spain and Portugal, three of the most troubled economies in the Euro Zone, the value of reserves relative to the debt is material and could serve to cover at significant amount of the countries annual bond issues.
What if those reserves were used as a collateral to shore-up the present and future issuance of sovereign bonds? In the case of Italy, clearly the weakest link at the moment in the Euro Zone, where the Gold/Debt ratio is almost 6%, the besieged Italian Treasury could start issuing, upon expiration, new bonds guaranteed, in some way, by their gold reserves on the basis of the current price. Furthermore, institutions like ECB or IMF could also deploy their substantial reserves if necessary to shore-up specific debt issues, perhaps conditionally to the implementation of specific reforms in the debtor countries.
The consequences of any use of gold as a collateral to sovereign bonds would arguably be very positive:
- The sovereign would be able to provide at least a degree of confidence boost to investors. Not just because of the measure of “insurance” behind the bonds, but also because the sovereign issuing would have some “real” value at stake as opposite to offer only paper and promises. Such stake, and the spectrum of loosing the bullion, may even be able to force those virtuous policies and reforms that politician are typically at loathe to pursue, especially if unpopular with the electorate.
- While the guarantee, ie the access, to the bullion offered as a collateral would only take place in case of default, the potential increase of the price of Gold may even create a very healthy demand for the bonds themselves, such demand may even have the beneficial effect of reducing rates.
- Lastly, the use of Gold as a collateral on Sovereign Bonds, it is also likely to validate the status of Gold as a major store of value, arguably a belief already largely present in the global financial discourse. Such endorsement is in turn likely to increase demand for Gold and therefore, increase the Gold/Debt ratio with the obvious benefits for both Sovereigns “credit” and investors peace of mind. Such virtuous cycle may even be able to provide Sovereign to issue new debt earmark specifically for pro-growth policies, a logical requisite for the repayment of the debt itself.
In conclusion, while the use of gold reserves would not be a substitute for structural economic and fiscal reform, it would probably have the effect of buying debtor countries some time and reassure investors confidence.
Whilst some more modelling and research would have to be pursued ahead of the implementation of such concept, it is hard to believe such simple idea may have been eluding central bankers. A more possible explanation of why there is so little discourse around this seemingly obvious and ancient idea (let’s not forget that Sovereigns have for centuries guaranteed their debt with the precious metal) is that such decision would suddenly expose the notion that Gold is indeed money and, because of that could become a a competitor to central bankers favourite toy, ie fiat currencies.
Yet the luxury for preventing Gold to competing with “fiat” currencies may be longer affordable. Not only because the crisis maybe be reaching a breaking point, but also because the “cat” is already out of the proverbial bag given the growing interest for Gold demonstrated by individual and institutional investors alike.
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