Even these estimates based on known mining output and known imports must be qualified by the fact that certain gold imports to China are completely unreported. A senior manager of G4S, one of the world’s leading secure logistics firms, recently revealed to a gold industry executive that he had personally transported gold into China by land through central Asian mountain passes at the head of a column of People’s Liberation Army tanks and armored transport vehicles. This gold was in the form of the 400-ounce “good delivery” bars favored by central banks rather than the smaller one-kilo bars imported through regular channels and favored by retail investors. What is clear from such disclosures is that any estimates of China’s official gold reserves are more likely to be too low than too high.
An announcement by China in 2015 that it holds 4,000 tonnes of gold in its official reserves will discredit the view of Western pundits and economists that gold is not a monetary asset. With 4,000 tonnes, China will surpass France, Italy, Germany, and the IMF in the ranks of the world’s largest gold holders, and it will be second only to the United States. This would be in keeping with China’s status as the world’s second-largest economy.
China’s covert gold acquisition is in sharp contrast to Russia’s far more transparent efforts to increase its own gold reserves. In the nine years from early 2004 to late 2013, Russian gold reserves increased over 250 percent, from approximately 390 tonnes to over 1,000 tonnes. Unlike China’s, this increase was achieved almost entirely through domestic mine production and did not rely on imports. Russia is the world’s fourth-largest gold producer, with output of approximately 200 tonnes per year. The Russian reserve increase was also done in steady increments of about 5 tonnes per month, announced regularly on the website of the Central Bank of Russia. Since the central bank does not rely on imports or the London bullion market to increase its gold holdings, Russia can afford to be more transparent than China because it is less vulnerable to price manipulation and front-running by the London bullion banks. Russia’s acquisition program is ongoing, and its official gold holdings should surpass 1,100 tonnes in 2014. Reserves of 1,100 tonnes are over one-eighth the size of U.S. gold reserves, but the Russian economy is also about one-eighth the size of the U.S. economy. Measured in proportion to the size of their respective economies, Russian gold reserves have pulled ahead of those of the United States.
Many analysts have been baffled by the paradox of strong demand for physical gold around the world and the simultaneous weakness in the price of gold futures traded on the COMEX exchange since the August 2011 peak in gold prices. Physical buying is coming not only from central banks but also from individuals, as reflected in the demand for one-kilo bars versus the 400-ounce “good delivery” bars favored by central banks. Swiss refineries have been working overtime to convert large bars to smaller ones to meet this demand. This seeming paradox is easily explained. If the price of any good, whether gold or bread, is held below its intrinsic value by intervention in any form, the behavioral response is always to strip the shelves bare.
The scramble for gold, epitomized in the central bank gold-acquisition programs of China and Russia, also manifests itself in the urgency with which central banks are attempting to repatriate gold from foreign depositories to vaults on their home soil.
Apart from the U.S. hoard, almost half the official gold in the world is not stored in the home country of the holder but in vaults at the Federal Reserve Bank of New York and at the Bank of England in London. The Federal Reserve vaults hold approximately 6,400 tonnes of gold, and the Bank of England vaults approximately 4,500 tonnes. Almost none of the gold in the New York Federal Reserve vaults belongs to the United States, and less than 300 tonnes of the gold in the Bank of England belongs to the U.K. U.S. gold is mostly kept in two U.S. Army facilities at Fort Knox, Kentucky, and West Point, New York, with a small amount held at the U.S. Mint in Denver, Colorado. The Federal Reserve and the Bank of England together have about 10,600 tonnes of official gold belonging to Germany, Japan, the Netherlands, the IMF, and other large holders, as well as many smaller holders around the world. Third-party gold held at the Fed and the Bank of England constitutes 33 percent of the official gold in the world.
This concentration of official gold in New York and London is mostly a legacy of the various gold standards that existed on and off from 1870 to 1971. When gold was used to settle balance of payments between countries, it was easier to keep the gold in financial centers such as New York and London, then reassign legal title as needed, rather than ship the gold around the world. Today balance of payments are settled mostly in dollars or euros, not gold, so the money center rationale for gold no longer applies.
Centralized gold holdings are also a legacy of the Cold War (1946–91), when it was considered safer for Germany to keep its gold in New York than to risk confiscation by the Soviet armored divisions that surrounded Berlin. Now the risks to Germany of gold confiscation by the United States in the event of a financial meltdown are considerably higher than the risks of confiscation by Russian invasion. Countries such as Germany no longer have a compelling reason to keep their gold in New York or London, and there are significant risks in doing so. If the United States or the U.K. suddenly deemed it necessary to confiscate foreign gold to defend its paper currency in a crisis, that gold would be conveyed from the original owners to the possession of the United States or the U.K.
As a result of these changed circumstances and emerging risks, gold-owning nations have begun a movement to repatriate their gold. The first prominent repatriation was initiated by Venezuela, which ordered the Bank of England to return 99 tonnes from London to Caracas in August 2011. The first gold shipments took place in November 2011, and upon their arrival, President Hugo Chávez paraded the gold-filled armored cars through Caracas streets, to the cheers of everyday Venezuelans.
A larger and more significant gold-repatriation program was launched by Germany in 2013. Germany holds 3,391 tonnes of official gold and is currently the world’s second-largest holder after the United States. At the end of 2012, German gold was located as follows: 1,051 tonnes in Frankfurt; 1,526 tonnes in New York; 441 tonnes in London; and 374 tonnes in Paris. On January 16, 2013, the Deutsche Bundesbank, the central bank of Germany, announced an eight-year plan to repatriate all the gold in Paris and 300 tonnes of the gold in New York back to Frankfurt. The gold in London would be left in place, and at the end of the repatriation plan in December 2020, German gold would be 50 percent in Frankfurt, 37 percent in New York, and 13 percent in London.
Commentators quickly fell upon the fact that the 300-tonne transfer from New York to Frankfurt would take eight years to complete as prima facie evidence that the New York Fed did not have the German gold in its vaults or was otherwise financially embarrassed by the request. But the Deutsche Bundesbank does not want the gold returned quickly. It prefers to have it in New York, where it can more efficiently be used for market manipulation. The Deutsche Bundesbank did not want to request the transfer at all but was pressured to do so by political supporters of Angela Merkel, who was facing reelection in September 2013. The physical security of Germany’s gold had become a political issue in the Bundestag, the German parliament. The Deutsche Bundesbank’s announced plan was merely a way to defuse the political issue while still leaving most of Germany’s gold in New York. Even after full implementation of the plan in 2020, Germany will still have 1,226 tonnes in New York, an amount greater than the total reserves of all but three other countries in the world. It is more convenient for the Deutsche Bundesbank to have its gold in New York, where it can be utilized in gold swaps and gold leases, as part of central bank efforts to manipulate gold markets. Still, a significant amount of gold is on its way to Frankfurt—part of a global movement to repatriate national gold.
The same populist political pressures that forced the German central bank to repatriate part of its gold have also swelled up in Switzerland. While the central banks of Chi
na, Russia, and other nations were avidly purchasing gold, Switzerland was one of the largest sellers. At the beginning of 2000, Switzerland’s gold reserves were over 2,590 tonnes. That amount dropped steadily, as the gold price was rising sharply, and by late 2008, Switzerland held only 1,040 tonnes, down 60 percent from the amount eight years earlier. Swiss gold reserves have remained at this level since, while gold’s price rose significantly from its 2008 level.
There was sharp reaction in the Swiss parliament to these massive sales despite rising prices. On September 20, 2011, four Swiss parliament members, led by Luzi Stamm of the Swiss People’s Party, introduced an initiative that requires all Swiss gold to be stored in Switzerland and that strips the Swiss National Bank of its ability to sell Switzerland’s gold. The initiative also requires the Swiss National Bank to hold at least 20 percent of its total assets in gold. The last provision might actually require Switzerland to acquire even more bullion, since gold was only 8.9 percent of total Swiss reserves as of July 2013. On March 20, 2013, the initiative sponsors announced they had obtained the one hundred thousand signatures required to place the initiative on a ballot to be voted on by Swiss citizens—a key feature of Swiss democracy. The exact date of the Swiss gold referendum is not known but is expected by 2015.
In 2003 Kaspar Villiger, then the Swiss minister of finance, when asked in parliament about the location of Swiss gold, infamously replied, “I don’t know . . . don’t have to know, and don’t want to know.” Such arrogance, typical of global financial elites, is increasingly unacceptable to citizens, who see their gold reserves being dissipated by bureaucrats operating behind closed doors in central banks and enclaves like the IMF and BIS. The actions of Swiss officials cost their citizens over $35 billion in lost wealth, compared to the value of their reserves had Switzerland kept its gold.
The Venezuelans, Germans, and Swiss may be the most prominent exemplars of the gold-repatriation movement, but they are not alone in raising the issue. In 2013 the sovereign wealth fund of Azerbaijan, a major energy exporter, ordered its gold reserves moved from JPMorgan Chase in London to the Central Bank of Azerbaijan in Baku. The gold-repatriation issue was also raised publicly in 2013 in Mexico. In the Netherlands, members of the center-right Christian Democratic Appeal Party and the leftist Socialist Party have petitioned De Nederlandsche Bank, the Dutch central bank, to repatriate its 612 tonnes of gold. Only 11 percent of the Dutch gold, or 67 tonnes, is actually in the Netherlands. The remainder is divided with about 312 tonnes in New York, 122 tonnes in Canada, and 110 tonnes in London. When asked in 2012 about the possibility of Dutch gold stored in New York being confiscated by the United States, Klaas Knot, then president of De Nederlandsche Bank, replied, “We are regularly confronted with the extra-territorial functioning of laws from the United States and usually these are not cheerfully received in Europe.” A small movement in Poland under the name “Give Our Gold Back,” launched in August 2013, focused on the repatriation of Poland’s 100 tonnes of gold held by the Bank of England. Of course, many countries, such as Russia, China, and Iran, already store their gold at home and are free of confiscation risk.
The issues of gold acquisition and gold repatriation by central banks are closely related. They are two facets of the larger picture of gold resuming its former role as the crux of the international monetary system. Major gold holders do not want to acknowledge it because they prefer the paper money system as it is. Smaller gold holders do not want to acknowledge it because they want to obtain gold at attractive prices and avoid the price spike that will result when the scramble for gold becomes disorderly. There is a convergence of interests, between those who disparage gold and those who embrace it, to keep the issue of gold as money off the table for the time being. This will not last, because the world is witnessing the inexorable remonetization of gold.
■ Gold Redux
There are few more tendentious comments on gold than the a priori statement that a gold standard cannot work today. In fact, a well-designed gold standard could work smoothly if the political will existed to enact it and to adhere to its noninflationary disciplines. A gold standard is the ideal monetary system for those who create wealth through ingenuity, entrepreneurship, and hard work. Gold standards are disfavored by those who do not create wealth but instead seek to extract wealth from others through inflation, inside information, and market manipulation. The debate over gold versus fiat money is really a debate between entrepreneurs and rentiers.
A new gold standard has many possible designs and would be effective, depending on the design chosen and the conditions under which it was launched. The classical gold standard, from 1870 to 1914, was hugely successful and was associated with a period of price stability, high real growth, and great invention. In contrast, the gold exchange standard, from 1922 to 1939, was a failure and a contributing factor in the Great Depression. The dollar gold standard, from 1944 to 1971, was a middling success for two decades before it came undone due to a lack of commitment by its principal sponsor, the United States. These three episodes from the past 150 years make the point that gold standards come in many forms and that their success or failure is determined not by gold per se but by the system design and the willingness of participants to abide by the rules of the game.
Consideration of a new gold standard begins with the understanding that the old gold standard was never completely left behind. When the Bretton Woods system broke down in August 1971, with President Nixon’s abandonment of gold convertibility by foreign central banks, the gold standard was not immediately deserted. Instead, in December 1971 the dollar was devalued 7.89 percent so that gold’s official price increased from $35 per ounce to $38 per ounce. The dollar was devalued again on February 12, 1973, by an additional 10 percent so that gold’s new official price was $42.22 per ounce; this is still gold’s official price today for certain central banks, for the U.S. Treasury, and for IMF accounting purposes, although it bears no relationship to the much higher market price. During this period, 1971–73, the international monetary system moved haltingly toward a floating-exchange-rate regime, which still prevails today.
In 1972 the IMF convened the Committee of Twenty, C-20, consisting of the twenty member countries represented on its executive board, to consider the reform of the international monetary system. The C-20 issued a report in June 1974, the “Outline of Reform, that provided guidelines for the new floating-rate system and recommended that the SDR be converted from a gold-backed reserve asset to one referencing a basket of paper currencies. The C-20 recommendations were hotly debated inside the IMF during 1975 but were not adopted at the time. At a meeting in Jamaica in January 1976, the IMF did initiate substantial reforms along the lines of the C-20 report, which were incorporated in the Second Amendment to the IMF Articles of Agreement. They became effective on April 1, 1978.
The international monetary debate, from the C-20 project in 1972 to the Second Amendment in 1978, was dominated by the disposition of IMF gold. The United States wanted to abandon any role for gold in international finance. The U.S. Treasury dumped 300 tonnes of gold on the market during the Carter administration to depress the price and demonstrate U.S. lack of interest. Meanwhile, France and South Africa were insisting on a continued role for gold as an international reserve asset. The Jamaica compromise was a muddle, in which 710 tonnes of IMF gold was returned to members, another 710 tonnes was sold on the market, and the remainder of approximately 2,800 tonnes was retained by the IMF. The IMF changed its unit of account to the SDR, and the pricing of SDRs was changed from gold to a basket of paper currencies. The United States was satisfied that gold’s role had been demoted; France was satisfied that gold remained a reserve asset; and the IMF continued to own a substantial amount of gold. The essence of this U.S.-Franco compromise remains to this day.
With the coming of the Reagan administration in 1981, the United States went through a profound shift in its attitude toward gold. It sold less than 1
percent of its remaining gold from 1981 to 2006, and it has sold no gold at all since 2006. The retention of gold by the United States and the IMF since 1981, as well as the continuation of large gold hoards by Germany, Italy, France, Switzerland, and others, have left the world with a shadow gold standard.
Gold’s continued role as a global monetary asset was brought home in a stunningly candid address given by Mario Draghi, head of the European Central Bank, at the Kennedy School of Government on October 9, 2013. In reply to a question from a reporter, Tekoa Da Silva, about central bank attitudes toward gold, Draghi remarked:
You are . . . asking this to someone who has been Governor of the Bank of Italy. Bank of Italy is [the] fourth largest owner of gold reserves in the world. . . .
I never thought it wise to sell [gold] 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 fairly good protection against fluctuations of the dollar, so there are several reasons, risk diversification and so on. So, that’s why central banks, which had started a program for selling gold a few years ago, substantially . . . stopped. By and large they are not selling it any longer. Also the experience of some central banks that liquidated the whole stock of gold about ten years ago was not considered to be terribly successful.
France’s insistence at Jamaica in 1976 that gold continue as a reserve asset has returned to the IMF’s monetary banquet like Banquo’s ghost. Just as Banquo was promised in Macbeth that he would beget a line of kings, so gold may persevere as the once and future money.
■ A New Gold Standard
How would a twenty-first-century gold standard be structured? It would certainly have to be global, involving at least the United States, the Eurozone, Japan, China, the U.K., and other leading economies. The United States is capable of launching a gold-backed dollar on its own, given its massive gold reserves, but if it were to do so, other currencies in the world would be unattractive to investors relative to a new gold-backed dollar. The result would be deflationary, with a diminution of transactions in those other currencies and reduced liquidity. Only a global gold standard could avoid the deflation that would accompany an effort by the United States to go it alone.
The Death of Money Page 27