By Julian D.W. Phillips
The critical requirements of gold’s return to the monetary system are twofold:
- It must easily dovetail into the current monetary system.
- It must provide a workable application, right down to consumer level.
Without meeting these requirements any attempt to mobilize gold in the system will fail eventually. So many writers have focused on ways to re-introduce gold in, for instance, a repeat of the old gold standard. We are of the opinion that this will not work, not simply because there is nowhere near enough gold at current prices to do the job, but it does not meet the first requirement above.
One appreciates the results of the study sponsored by the World Gold Council that the demand for gold since the twin global crises has increased substantially – globally. But for it to return to the ‘official domain, it must be implemented in a way that central banks can control and dominate its use in a way that supports the current global monetary system.
Right now these officials are caught in a cleft stick as they watch their currency systems stumble, first in the U.S. then in the Eurozone and then again, we expect in the U.S. in the months to come. It is clear to all in the banking world that the system as it stands now cannot take five more years of what has happened in the last five years. Something must be done and quickly, to prevent such a future.
With every nation’s monetary system based on the model forged by the U.S. and reliant on it as the world’s sole reserve currency [at the moment] what happens in the discussions on gold at Basel III and in the U.S. will dictate the way forward for gold and consequently silver.
Change in the Developed World to a Tier I Asset
The developed world, as a whole, has not been convinced that gold can add any real value to the paper currency system in the last forty years. But the stresses and strains seen in that system over the last five years and possibly for the foreseeable future has seen instances where officials of that paper system have found a need to use the gold in their reserves to enhance liquidity and to facilitate the offer of loans to those nations in need.
The entire subject of gold being mobilized in the developed world’s monetary system is now firmly center stage as commentary on re-defining gold from a Tier II asset to a Tier I asset has been called for by the Fed in the U.S. and at the same time is being proposed to the Basel III Committee on monetary reform. If it is so re-defined this will mean that 100% of its value can be attributed to a bank’s balance sheet as required assets from the current 50%. Why is this so important to gold investors? If commercial banks can now hold gold in this way then it will act [to quote Herr Weber ex-Bundesbank President] “as a counter to the swings of the dollar”.
Irrespective of the virtues and failings of these discussions, what has happened to gold at retail and official levels is that the need for it to support a stumbling paper system has grown increasingly urgent over the last five years. It path to a central place in the monetary system is now inexorable!
The practical application of this is that instead of gold being sold off when bank ratios come under pressure as sovereign bonds lose value [these are Tier I assets], gold will be retained by those banks as a confidence inspiring assets when those rainy days come. By way of example, when the mid-2007 credit crunch impacted, the most easily liquidatable assets such as gold were sold off to get 100% of their value into the bank’s [instead of only 50%] balance sheets to fill the value hole left by the declining value of sovereign bonds and property linked assets. If gold had been defined as a Tier I asset then, gold would not have been sold off and the price would not have fallen from $1,200 to $1,000.
Thereafter, it did recover when such selling abated, to reach a new peak of $1,920. If it had been defined as a Tier I asset then, where would the price have gone to? If gold had been defined as such, how much gold would commercial, as well as central banks, be holding now? And where would the gold price be sitting at now? We believe it would be far higher than it is at present.
With the Basel Committee proposing that January 1st be the date of its re-definition [this can of course be changed] we would define this moment as the most significant step in the re-monetization of gold seen since it was written out of the global monetary system back in 1971.
Such fundamental changes to the banking system will have to be combined with a practical day-to-day use of gold in the system. It should not be mobilized only in an emergency but used so as to avoid those emergencies in the first place. One of the biggest hurdles in this regard is accessing the above ground stocks of gold not already in the hands of central banks. The tonnages held in central banks can, with the innovative thinking that we have seen in the last five years [currency/gold swaps as a facilitator of international loans] opens up a way for gold to be far move than just one of the reserve asset holdings of central banks. We will have to wait until the New Year for this discussion to reach a crescendo, but it is on the way.
The events of the last five years and the direction that the monetary system is headed in shows us that gold as an asset in the monetary system is gaining in importance. If the fiat money system suffers any more body blows from debt crises and the like, gold will be deemed a very necessary strategic asset for banks. As we discussed above the re-defining of gold as a Tier I asset will advance gold’s desirability enormously, next year.
Where gold is held privately or by institutions outside the banking system we expect to see concerted efforts from the banking system to be made to harness this private gold. It will be easiest in the case of gold Exchange Traded Funds as this gold is in the hands of banking Custodians such as Barclays and HSBC right now. It is the moving of this gold under the roof of banks that we believe will gather momentum in the days to come. We are hearing of success in these endeavours in Turkey.
Turkey Leads the Way
The experiments using gold in the monetary system in Turkey are being watch with fascination by all monetary authorities. Granted, Turkey is a special case, a nation that trusts gold above all other money and just will not change from using it. The Turkish monetary authorities, by necessity, have had to be pragmatic and find ways of harnessing the gold in their citizen’s hands so as to complement their existing paper monetary system.
Encourage Gold Deposit Schemes
In September 2011 the central bank of Turkey increased the ratio of lira reserves that could be held in the form of gold from zero to 10%, raising it further to 20% in March 2012 and 25% last month. This had the effect of drastically increasing banks' appetite for gold. As a result such deposits have increased four-fold in the past year. The country's commercial banks are targeting customers to open gold deposit accounts. Customers give their gold to a bank and can make withdrawals from their accounts in gold bars or the lira currency. Understandably, the accounts offer interest rates that are substantially lower than those on normal time deposits.
Turkish gold investors who take up these offers are happy to hold their gold in a secure environment and earn even low interest rates on their holdings. But just how far will they succeed in the emerging world? In the developed world, the trust in the banking system and its people is considerably higher than in India, for instance, as we can see in the size of the holdings of gold Exchange Traded Funds now close to 2,000 tonnes. No interest is offered on these holding, normally held by Custodians such as the bank HSBC.
So what? Can the practical steps is Turkey taking to harness gold in a workable pragmatic way in its system be applied in the developed world and other parts of the emerging world in the same way?
Applicable in India
While the Indian government have attempted to discourage the imports of gold since 1948 [for a while banning them completely] they have failed for gold continued to enter the country illegally, during this time.
While distrust of government there and a natural propensity to hide private financial affairs from government, adds to the reasons why gold is such a favored investment in the sub-continent, it is hoped that the Turkish experiment may well blaze a trail for Indian Authorities. For the Turkish model to succeed in India it will have to offer sufficient benefits to overcome the jaundiced view of government by gold investors. With Indian, private gold investments standing over 20,000 tonnes, currently the proportion of those investors who would hand their gold to banks is miniscule and likely to remain so as the country, by nature, likes to keep their financial affairs close to their chest.
But the scheme is moving ahead where commercial banks, in particular, the State Bank of India, offer gold deposit schemes at low rates of interest. Gold savings deposits and term deposits are being encouraged. Let’s see how much these schemes will grow in tonnage terms.