The first Washington Agreement on Gold, announced in September 1999 at the close of the annual meetings of the International Monetary Fund and World Bank in Washington, D.C., placed limits for the next five years on the official gold sales of the signatories as well as on their gold lending and use of futures and options. Put together at the instigation of major Euro Area central banks in response to the decline in gold prices caused by the series of U.K. gold auctions announced in May of the same year, WAG I caused gold prices to shoot sharply higher.

Within days, as gold shorts rushed to cover, the price jumped from around $265 to almost $330/oz. and gold lease rates spiked to over 9%. The rally caught the major bullion banks completely wrong-footed, resulting in the panic later described by Edward A.J. George, then Governor of the Bank of England (Complaint, ¶ 55):

We looked into the abyss if the gold price rose further. A further rise would have taken down one or several trading houses, which might have taken down all the rest in their wake. Therefore at any price, at any cost, the central banks had to quell the gold price, manage it. It was very difficult to get the gold price under control but we have now succeeded. The U.S. Fed was very active in getting the gold price down. So was the U.K.

So also, it appears, was the Bank of Russia. According to the Banque de France in its 1999 Annual Report (at s. 4.3), gold prices did not hold their gains over $300/oz. for long, “partly because sales of gold holdings to take advantage of the new price level, notably by the Russian central bank, boosted the supply.”

Blindman’s Buff. The immediate impetus for WAG I is easy to understand. The British gold auctions had caused a severe decline in gold prices just after the new European Central Bank and its member central banks had adopted the practice of regularly marking their gold reserves to market. However, as a rational strategy on the part of its signatories, WAG I is difficult to explain except on the hypothesis that the central banks themselves did not have adequate information about, or a sufficient understanding of, the gold lending and gold derivatives markets.

While these markets had grown up largely as the result of more active management by the central banks of the gold reserves under their control, as a practical matter much of the actual management took place on the advice and under the direction of the bullion banks. In Gold Wars (FAME, 2001), pp. 119-176, retired Swiss banker Ferdinand Lips reviewed the emergence of these markets in the 1990’s, concluding that the more sophisticated bullion banks had taken advantage of their positions as advisors to the relatively naive central banks (at 144):

Their [the bullion bankers’] only motive was to make money. They made legendary amounts of money with the ‘Gold Carry Trade’. By borrowing gold from the central banks at a 1% lease rate, then selling the gold (thereby flooding the physical gold market with an artificial supply) and investing the proceeds in Treasury securities at 5%, they were making fortunes. Who can blame them?

It was the Chairman of the Fed, Alan Greenspan, himself who invited them to do so by declaring before the House Banking Committee on July 24, 1998, and again on July 30, 1998 before a Senate Agricultural Committee, that “[…] central banks stand ready to lease gold in increasing quantities should the price rise.” By allowing an unprecedented manipulation of the gold price, the central banks laid the foundation for the biggest money game in history.

Nobody cared that the manipulating (a strong, but truthful assessment) governments, central banks and bullion banks, were completely ignoring the free market process. Greedy bullion banks were permitted to eat away the profits that should have gone to the gold mining companies, their shareholders, workers and last, but not least, the poor gold producing countries.

In fact, a year before his 1998 congressional testimony about gold leasing, Mr. Greenspan’s Federal Reserve handed the bullion bankers a powerful document with which to sell the practice of gold lending to central bankers. It released a staff paper arguing that government gold should be made available for private uses sooner rather than later, either by selling it all immediately or lending as much as possible at once and selling it gradually later. D.W. Henderson et als., Can Government Gold Be Put to Better Use? Qualitative and Quantitative Effects of Alternative Policies (Federal Reserve Board, International Finance Discussion Paper 582, 1997). With respect to the latter alternative, the paper suggested a future that may now have arrived (at p. 5):

The quantities of gold available for private uses are the same under the alternative policy as with an immediate sale. However, there is an important difference: under the alternative policy, governments relinquish title to their gold in the future and then only gradually. Therefore, to the extent that government uses can be satisfied by owning gold but not physically possessing it, most if not all of the gains associated with maximizing welfare from private uses can be obtained with little or no reduction in welfare from government uses until sometime in the future. [Emphasis supplied.]

Almost as soon as it was published, Goldman Sachs referred to the paper in 116-page report on gold stocks, calling it a significant negative for gold prices. See J. Tompkins, Portfolio Gold: Now You See It. Now You Don’t, Investor Features Syndicate (September 15, 1997). Used in this context by Goldman’s stock analysts, the Fed’s staff paper was actually relatively benign. But in the hands of its aggressive bullion bankers at J. Aron & Co. as they made their business development calls on the central banks, the paper carried considerable potential to inflict real damage on gold prices. Acquired by Goldman in 1981, J. Aron was transformed into an active and highly profitable trader in gold futures under the direction of Robert E. Rubin, then a new member of Goldman’s top management committee, but in 1997 Secretary of the U.S. Treasury. See R.E. Rubin et al., In an Uncertain World (Random House, paperback ed., 2004), pp. 91-92.

By 1999, with major gold mining companies acting — if they were not in fact — clueless as to what was really happening, the profit-driven bullion banks and manipulative central banks had turned the always secretive gold market into a sort of gigantic, rolling game of blindman’s buff. WAG I knocked the blinders off, but not before the major players had unwittingly trapped themselves in what one prominent gold analyst later described as “the prison of the shorts.” See Frank Veneroso et al., Gold Derivatives, Gold Lending, Official Management of the Gold Price and the Current State of the Gold Market (Presentation to Fifth International Gold Symposium, Lima, Peru, May 17, 2002).

WAG the Gold. Last March, the ECB together with 14 other European central banks issued a Joint Statement on Gold effectively renewing WAG I for another five years and increasing the level of sales from 400 to 500 tonnes annually for a total of 2500 tonnes over the term of WAG II. The United Kingdom is the only signatory to WAG I that did not agree to WAG II, leaving British officials free to increase “the total amount of their gold leasings and the total amount of their use of gold futures and options” above those “prevailing at the date of the signature of the previous agreement.” (Neither gold deposits nor gold swaps were expressly mentioned in either agreement.)

However, the official sellers under WAG II were left largely unidentified, and many expected further clarification in this regard following the 2004 meetings of the IMF and World Bank on October 2-3. See, e.g., K. Morrison, Europeans wait nervously for the golden revolution, Financial Times (London) (September 22, 2004). As it happened, no announcement was made, suggesting that the central banks are either unable or unwilling to meet the sales targets they had previously set for themselves. See J.D.W. Phillips, Central Bank Gold Sales to Cease?, Gold – Authentic Money (October 4, 2004) and “Official” with French Gold Sales, Gold – Authentic Money (December 1, 2004).

A week before this year’s meetings, U.K. Chancellor of the Exchequer Gordon Brown floated a new proposal for mobilizing the IMF’s gold to grant relief to the heavily indebted countries of the third world. See, e.g., L. Elliott, Brown to bail out world’s poorest, The Guardian (September 25, 2004). Whether his initiative contemplated actual sales or merely a revaluation of the IMF’s gold stocks similar to the off-market transactions carried out four years ago remained unclear. In any event, the proposal failed to garner much support. See, e.g., G. Le Gras, G-7 Majority Worried About IMF Gold Sale Idea, Reuters (October 2, 2004).

Sincere concern for the world’s poorest nations does not exclude the possibility that Mr. Brown’s proposal was motivated by other factors as well, including the difficulty of reaching the sales targets set by WAG II or even a dangerous short position at the Bank of England in connection with its always murky gold banking activities. After all, he is the same finance minister who in May 1999 unexpectedly unveiled the British gold auctions just as gold prices threatened to push above $300/oz. in response to the increasing perception that a pending IMF proposal to sell 300 tonnes of gold to fund relief for the world’s poor would fail, as it subsequently did due largely to strong opposition in the U.S. Congress. See Complaint, ¶¶ 42-43.

In any event, the sales targets in WAG II appeared overly ambitious from the outset. They implied significant sales not only from Germany, where the Bundesbank had previously expressed an interest in selling a portion of its gold, but also from France and Italy, both widely regarded as having no plans to sell gold. See, e.g., Banque de France, 1998 Annual Report, s. 4.3.

After the announcement of WAG II, the Banque de France indicated a willingness to sell 500 to 600 tonnes under appropriate market conditions. In a press release on November 17, 2004, Nicolas Sarkozy, the French finance minister, stated that he had reached an understanding with Christian Noyer, the bank’s governor, calling for gold sales in this amount over the next five years. Conséquences pour le budget de l’État d’une gestion plus active des réserves de change de l’État (19 novembre 2004) (cliquez sur Le ministre, puis Communiqués de presse). The Banque de France is expected to employ the proceeds in the more active management of its foreign exchange reserves, with the additional revenue going to the French state for purposes of deficit reduction and financing long-term employment, especially in research.

In describing this development, one correspondent wrote that the Banque de France had confirmed its intention to sell “500 to 600 tonnes of the 3000 tonnes of gold kept in vaults underneath [its] headquarters in Paris.”, Bank of France to Sell Gold From Reserves, Associated Press (November 19, 2004). But in fact, whether any of the gold that the bank proposes to sell still sits in its vaults is far from clear. Some or all of these sales may simply represent cash settlements of gold deposits, swaps or loans already entered into with gold that has long since left the bank’s vaults and entered the physical market.

Let’s Get Physical. The IMF allows (but does not require) central banks to report their gold holdings as a single entry without separately identifying vault gold from gold receivables, including not only deposits and loans but also swaps. See, e.g., IMF Statistics Department, The Macroeconomic Statistical Treatment of Reverse Transactions (Thirteenth Meeting of the IMF Committee on Balance of Payments Statistics, Washington, D.C., October 23-27, 2000); see also This suggested accounting treatment is codified in the IMF’s Special Data Dissemination Standard (SDDS) for External Statistics, described in detail in Anne Y. Kester, International Reserves and Foreign Currency Liquidity: Guidelines For A Data Template (IMF, 2001) (the “SDDS Guidelines”).

The following table shows the gold reserves at December 31, 2003, of the 15 signatories to WAG II as detailed in their annual reports for last year. (These figures correspond in most instances with total gold reserves as reported by the IMF in its International Financial Statistics; where they do not, the differences are minor and of no significance for present purposes.)


Gold & Gold
Deposits Gold
Sight Term Lending Swaps
Germany 3452 NR NR NR NR NR
Italy 2452 NR NR NR NR NR
Netherlands 778 NR NR NR NR NR
Spain 523 NR NR NR NR NR
Portugal 517 173 45 78 222
Austria 317 NR NR NR NR NR
Belgium 258 NR NR NR NR NR
Greece 138 NR NR NR NR NR
Finland 49 NR NR NR NR NR
Ireland 6 NR NR NR NR NR
Luxembourg 4 NR NR NR NR NR
Switzerland 1633 1400 233
ECB 767 “gold assets not managed actively”
Sweden 185 “holds 5.96 million ounces”
“Avoirs en or”*
France 3025 *see discussion below

As the table indicates, 11 signatories reported their total gold reserves under a principal line item labeled “gold and gold receivables” or the equivalent, and of these only Portugal provided a further breakdown in subsidiary line items. (This higher level of candor may be related to its highly-publicized loss of gold loaned to Drexel, Burnham, Lambert in 1990 when that investment banking firm went bankrupt.) However, several other signatories confirmed the existence (although not the amount) of their gold receivables in notes. See, e.g., Spain (“slight differences arising from deposit and swap transactions”); Austria (“physical and nonphysical gold”); Belgium (“lends part of its gold assets against a guarantee covering the credit risk”).

Three signatories, Switzerland, the ECB and Sweden, reported their gold reserves under a principal line item labeled “gold,” but only Switzerland provided further detail. The ECB and Sweden made no express mention of any receivables but included text or notes that could be read to suggest their absence. Unlike the other 12 signatories (including France), these three are still responsible for issuing a paper currency and thus have more reason to hold physical gold, which serves to promote additional confidence in their paper.

Cooking the Books à la française. France presents a somewhat ambiguous case. Literally translated, “avoirs en or” means “assets or holdings in gold” and is no less inclusive than the single word “or” or “gold.” The following table compares the English and French terminology for the same line items related to gold in the annual reports of the BIS, Swiss National Bank and National Bank of Belgium as well as the Banque de France for the years 1995 and earlier and 1996 and later. Principal line items are in boldface, and subsidiary line items are indented.

English French
BIS (2003) Gold and gold deposits
Gold and gold deposit assets
Gold bars held …
Or et dépôts en or
Or et dépôts en or à l’actif
Barres detenues …
SNB (2003) Gold
Gold ingots
Gold coins
Claims from gold lending
Pièces d’or
Créances résultant d’prêts d’or
NBB (2003) Gold and gold receivables Avoirs et créances en or
Banque de France
thru 95 Gold Or
from 96 Gold Avoirs en or

As the table shows, whether in English or French, physical gold at both the BIS and SNB is specifically identified in a subsidiary line item, i.e., bars, ingots, coins. The single word “gold” or “or” as a principal line item at the SNB neither excludes gold lending nor refers to physical gold only. Thus, while a reference to “receivables” or “créances” in a principal line item may be taken as an affirmative indication of their existence, the lack of such a reference does not necessarily indicate their absence.

“Avoirs en or” replaced “Or” as a principal line item in the official French language balance sheet of the Banque de France in 1996, but the English language version has continued to use the pre-1996 “Gold” to describe this account. See the annual reports of the Banque de France available at its website. While this line item is often read to refer solely to vault gold, this interpretation is not supported by either the language or the accounting practice of other central banks.

The IMF’s SDDS Guidelines cover gold in paragraphs 98-101 under the heading “Gold (Including Gold on Loan)—Item I.A.(4) of the Template” (reproduced below in the Addendum). Appendix II of the Guidelines provides a sample form which includes the following line item: “I.A.(4) gold (including gold deposits and, if appropriate, gold swapped).” Thus the SDDS Guidelines seem to allow, even if they do not require, the language of the gold line item to be conformed to the actual facts. A country or central bank that has no gold on loan, deposit or swap need not slavishly adopt any of the parenthetical language, and to do so for holdings that consist solely of physical gold would imply a weaker balance sheet than actually exists.

France’s monthly report on its International Reserves and Foreign Currency Liquidity (SDDS) as of October 31, 2004, submitted to the IMF contained the following line item: “I-A-4) Gold (including gold on loan) … 32.765 [in millions of Euro].” See also Avoirs de réserve et disponibilités en devises (NSDD) au 31 octobre 2004: “I-A-4) Avoirs en or (y compris or prêté) … 32 765.” An online search revealed that France had submitted monthly SDDS reports containing a gold line item in identical language starting as early as May 2000. See Minéfi, Communiqué de presse (3 juillet 2000).

The French Connection. The 1996 change from “Or” to “Avoirs en or” on the balance sheet of the Banque de France took place in connection with a complete revamping of its accounting system occasioned by its transition to a more fully independent central bank pursuant to a 1992 constitutional amendment and implementing legislation enacted in 1993. See Banque de France, 1996 Annual Report, Introductory Letter by Jean-Claude Trichet and s. 9.

Indeed, 1996 was a pivotal year for the Banque de France. In October, it announced a strategic plan covering the next decade, including six major projects. Id., s. 8.2.1. Among the “main responsibilities” expressly entrusted to it was “hold[ing] and manag[ing] the State’s gold and foreign exchange reserves.” Id., s. And in this connection, frank note was made that “certain confidential information relating to operations carried out within the framework of the Bank’s main responsibilities is not disclosed.” Id., s. 9.3.4.

In the rapidly growing area of financial derivatives, the Banque de France worked with French banks to implement the global reporting system then being introduced under the auspices of the BIS. Id., s. Addressing the gold market in 1996, the report noted significant gold sales by Belgium and the Netherlands and observed that “mining companies’ futures and options positions were more limited in volume than during the preceding year.” Id., s. 4.3.

In the context of these developments and other preparations for switching from the franc to the euro, the notion that the change from “Or” to “Avoirs en or” on the balance sheet of the Banque de France in 1996 was in any way intended to limit its flexibility in managing the French gold stock is difficult to credit. However, if the former terminology, despite its accounting usage in other countries, had come to signify at least to much of the French citizenry vault gold alone, the new terminology might constitute a subtle acknowledgement that French gold reserves were then, or might in the future be, subject to more active management.

What is more, there is no obvious reason to suppose that the Banque de France would eschew all forms of active management, which include not just gold lending to bullion banks, mining companies or even the carry trade, but also gold deposits with official sector institutions like the BIS and the Bank of England, not to mention swaps and options, especially writing covered calls. The range of possibilities is extensive, as is the range of risks. See, e.g., Addendum. Against this backdrop, a simple statement by a bank official that “we do not lend gold” is hardly tantamount to a complete denial of any activity in the gold deposit, swap or derivatives markets.

That the Banque de France has tried to appear aloof from participation in these markets does not negate their special importance to all member banks of the ECB. Apart from the transfer of 767 tonnes from their collective gold reserves to the ECB to support the euro, these banks appear to have received carte blanche to manage their remaining gold reserves as they wished and without reference to any central direction or policy from the ECB. Under these circumstances, it is not surprising that they have looked on their gold reserves more as an investment asset to be actively managed for higher returns than as a monetary reserve to be conserved at a minimum of risk.

Both leading up to and following the changeover to the euro, their increased willingness to place gold on deposit and to use gold loans and swaps undoubtedly facilitated the operations of the cabal described in the Gold Price Fixing Case. Nor were these central banks without incentive to assist in the implementation of the Clinton administration’s strong dollar policy by helping to suppress gold prices. They held substantial U.S. dollar reserves. Successful introduction of the euro would be easier in relatively calm forex markets.

But having surrendered principal responsibility for their own national currencies and money supplies, they also needed to justify their continued custody and management of their nations’ gold reserves. Viewed in this light, their less than forthright accounting for the gold reserves on their balance sheets is not just an effort to mislead participants in the gold market. It also hides the true state of these reserves from the general population and their elected representatives, and thus lessens public agitation to sell gold and apply the proceeds to other public purposes.

Central banks have a far more plausible claim to expertise in the management of gold assets than to any special competence in the management of general investment funds for public purposes, especially in nations with democratic governments. Were it widely known that much of the gold under their management is not only no longer in their vaults but also effectively irrecoverable at least in physical form, there would almost certainly be considerable public demand to convert the questionable deposits, loans and swaps into outright sales, followed by further public debate about how to apply the proceeds.

Earmarks of Strain. As the table above shows, of the more than 14,000 tonnes of gold reserves held by the signatories to WAG II, just a little over 2500 tonnes is identified with any specificity as being vault gold. More than this amount almost certainly is held in bullion form, but how much and who holds it cannot be determined. However, many if not most central banks hold bullion in earmarked form at the Federal Reserve Bank of New York and in smaller amounts at the BIS.

The NY Fed reports on a monthly basis its total holdings of official foreign earmarked gold, which until 2001 was one of the gold cabal’s most important sources of supply. See Plaintiff’s Second Affidavit, ¶¶ 2-4, and commentaries cited. The total amount of earmarked gold held by the BIS is disclosed as an off-balance-sheet item in its annual reports. From these figures, Mike Bolser has constructed the following chart showing the year-end balances in these earmarked gold accounts since 1992.

The NY Fed

As the chart shows, the flow of gold out of these accounts has now dwindled to a trickle if not completely ceased, leaving the New York Fed with 6609 tonnes of earmarked gold and the BIS with 168 tonnes. Worthy of special mention is the sharp upward spike in earmarked gold at the BIS in 1995, for it coincides with three major developments in the world of central banking.

First, the Maastricht Treaty took effect at year-end 1994, kicking off the transition to the euro and the creation of the ECB, but also leading to a substantially diminished role for the national central banks of the Euro Area as well as the BIS, which had previously served as Europe’s closest approximation to a common central bank.

Second, seeking to take advantage of the BIS’s reduced status within Europe and its search for new roles to play, the United States in the fall of 1994 assumed for the first time the two seats allocated to it on the BIS’s board of directors. See Plaintiff’s Affidavit, ¶¶ 8-9. These seats had been vacant since the founding of the BIS in 1930. See id., ¶ 2. However, the United States did not purchase any shares in the BIS, ordinarily a requirement for membership and board participation. See Plaintiff’s Second Affidavit, ¶¶ 43-45.

Third, as discussed in War against Gold: Central Banks Fight for Japan (1999), with the Japanese economy threatening to implode and carry the world economy into depression, the Bank of Japan in mid-1995 adopted a policy of near zero interest rates. Gold prices began to shake off their slumber around the $380/oz. level and gold lease rates moved higher, putting gold prices expressed in yen into backwardation and adding further fuel to the fire building under world gold prices expressed in dollars.

The source of the sudden upsurge in earmarked gold at the BIS in 1995 remains a mystery, but the possibility that it represented some sort of American contribution in lieu of the purchase of shares cannot be dismissed. Less mysterious is the likely purpose of this movement of gold to the BIS. The equally sharp decline in this account the following year coincides exactly with two major incidents of preemptive selling — strong statistical indicators of price fixing — on the Commodities Exchange in New York. See Complaint, ¶¶ 46-52.

On top of the flows of earmarked gold from the New York Fed and the BIS shown in the chart, another large and unusual physical dishoarding of gold occurred in 1997. That year net exports of financial gold from the United Kingdom reached 2473 tonnes, an amount roughly equal to that year’s total new mine supply and almost five times the amount exported in 1995, the next highest year at 544 tonnes. See J. Turk, “More Proof,” Freemarket Gold & Money Report (Letter No. 323, April 21, 2003).

Liquidity Squeeze. Unlike earmarked gold, which is held under bailment in allocated storage for the depositor, gold deposits are available to the banking institution that holds them for its own use. Earmarked gold is thus properly treated as an off-balance-sheet item. Gold deposits, on the other hand, require matching asset and liability entries on the balance sheet just as do cash deposits in any bank.

Both the BIS and the Bank of England accept gold deposits, but the latter reportedly serves a broader clientele not limited to central banks and official institutions. Unlike the BIS, the Bank of England does not report publicly on its gold banking activities. Nor does it disclose amounts of gold held under earmark or its activities as agent for the Exchange Equalisation Account (the British equivalent of the U.S. Exchange Stabilization Fund), but some information on the EEA’s gold operations is disclosed its own most recent report. See Exchange Equalisation Account: Report and Accounts 2003-04 (House of Commons, July 19, 2004).

The EEA holds the United Kingdom’s gold reserves, which as of March 31, 2004, consisted of total “Gold and gold receivables” amounting to approximately 315 tonnes, including a “Gold stock” of 283 tonnes and “Gold deposits” of 32 tonnes. Id., p. 28, note 8 (conversions at London PM Fix). The EEA’s “authorised investments” include “gold deposits, location swaps and quality swaps” (id., p. 2, ¶ 8), and it reported (id., p. 4, ¶ 17):

The EEA continued to lend part of its gold holdings to market participants. The maximum amount of gold lent at any one time during the year was 123 tonnes (2003: 153 tonnes) and interest received on gold lending during 2003-04 amounted to £1.2 million (2003: £4.2 million). The reduction in interest received reflected the low gold lending rates that prevailed during the period and the lower volume of lending.

Pursuant to the series of auctions announced in May 1999 and concluded in March 2002, the EEA through the Bank of England sold 415 tonnes from its reserves at an average price of $275/oz. See A.V. Wetherilt et al., An analysis of the UK gold auctions 1999-2002 (Bank of England, Quarterly Bulletin, Summer 2003), p. 188. Whatever their original purpose, no amount of spin can hide the fact that these sales have proved a poor deal for the British taxpayer. See, e.g., T. Freinberg, Brown’s gold sale ‘cost the UK £1.5bn’, The Telegraph (London) (November 28, 2004). The EEA’s recent pull back from gold lending likely reflects a new caution born in part by the desire to avoid further embarrassment in the management of its gold assets and in part by the need to conserve what remains of its gold stock, which at 315 tonnes is roughly what it might expect to transfer to the ECB were the United Kingdom to join the Euro Area.

The reduction in gold lending by the EEA also represents a potential squeeze on the gold banking activities of the Bank of England, particularly if some of its other gold depositors have also experienced sudden fits of prudence. Indeed, given the danger of asset seizures related to the war on terror, many official and semi-official depositors particularly from the Middle East or other predominantly Muslim countries might harbor quite reasonable concerns about the safety of gold deposits with the Old Lady of Threadneedle Street. See, e.g., S. Johnson et al., Opec sharply reduces dollar exposure, Financial Times (London) (December 6, 2004).

In the absence of published financial reports, there is no way to assess directly the soundness of the Bank of England’s gold banking operations. However, since they are similar to those of the BIS, an analysis of its gold banking business becomes doubly useful. As graphically displayed in the following stacked charts by Mike Bolser, the picture at the BIS can be summed up as less gold working harder, i.e., falling vault gold and gold deposit liabilities supporting rising gold deposits. See Long Con: Mother of Bank Runs (5/11/2003); Gold Derivatives: Moving towards Checkmate (12/4/02).

BIS Holdings

The key point to note in this graphic is a classic sign of trouble: a mismatch in maturities where the bank borrows short and lends long, creating the conditions for a liquidity squeeze if its depositors suddenly withdraw their deposits. In the case of the BIS, however, the liquidity risk appears fully covered by gold held in physical form, but only when its own gold reserves are included.

The BIS reported total gold deposit liabilities equal to SDR 7294 million, of which 77% (SDR 5625 million) had maturities of one month or less. On the asset side, it reported total gold deposits equal to SDR 3610 million, of which 93% (SDR 3362 million) had maturities over one month and nearly 40% (SDR 1397 million) were between one and five years. However, its gold assets also included “gold bars held at central banks” with a total value of SDR 5464 million, of which SDR 1781 million (192 tonnes) represented its own gold holdings.

At the same conversion rate, its total bars amounted to 589 tonnes and its net gold liabilities of one month or less represented 580 tonnes (SDR 5625 million less gold deposits at the same short maturities of SDR 248 million = SDR 5377 million times 0.1078227). Accordingly, except to the extent that it might be able realize early withdrawals on its own gold deposits at longer maturities, the BIS would need to exhaust almost all its own gold reserves to meet simultaneous withdrawals by its shortest term depositors.

Of course, a run of this nature on the BIS is unlikely, partly because of its reputation and the nature of its clientele, but partly also because its published and independently audited financial statements indicate that it has the resources to handle such an event. So far as can be determined from the public record, depositors in the Bank of England do not have the latter comfort. Nor do they have any reason to believe that the gold banking accounts of the Old Lady of Threadneedle Street would be as comforting as those of the BIS, and many reasons to suspect that hers would present a rather more parlous picture.

In Plain Sight. The IMF holds 3217 tonnes of gold, which it regards as “an undervalued asset” that “provides fundamental strength to its balance sheet.” See Gold in the IMF, (IMF Factsheet, September 2004). Any sale (or permitted acquisition) of gold by the IMF must be approved by 85% of its voting power, and thus requires an affirmative vote of the U.S. Congress, which on this issue by statute exercises America’s 17% of the voting power. What is more, the IMF “does not have the authority to engage in any other gold transactions — such as loans, leases, swaps, or use of gold as collateral — nor does it have the authority to buy gold.” Id.

According to information provided to Congress in 1998 by the General Accounting Office (since renamed the Government Accountability Office), the IMF’s gold is kept at depositories in four member countries: France, India, the United States, and the United Kingdom. See Statement by Harold J. Johnson, Jr., Associate Director, International Relations and Trade Issues, National Security and International Affairs Division, GAO, before the Joint Economic Committee of the United States Congress (July 23, 1998), note 15.

Reports from credible sources suggest that some IMF gold has leaked into the market notwithstanding the above-mentioned prohibitions. If so, the most likely route would be through gold deposits placed at sight with official institutions such as the BIS or Bank of England. Viewed in historical perspective, deposits of this nature are akin to putting cash in checking account. Although technically a “loan” for legal purposes, a bank deposit arguably falls outside the ordinary meaning of the word.

In 1999 and 2000, following the collapse of its planned sale of 300 tonnes, the IMF engaged in certain off-market transactions under which some of its gold reserves were revalued and the proceeds applied for the benefit of Mexico and Brazil. However, no physical metal reached the public markets and the weight of the IMF’s gold reserves remained unchanged. See IMF’s Off-Market Gold Sales: Toward the New Order? (1/22/00).

Possessing what appears to be one of the largest untapped hoards of official gold on the planet, the IMF is an inviting target for governments or central banks in need of bullion to carry out their manipulative schemes or to cover their own imprudent lending. However, the IMF’s governing structure does not permit successful raids on its gold absent widespread consensus among its members, which is never easy to achieve since it requires members to forego their own claims on the proceeds. Indeed, in the past the IMF has sold some gold at market prices and some in “restitution” to members at its historic value, allowing them to realize the profits on revaluation for themselves.

The British finance minister’s recent proposal to mobilize additional IMF gold to aid the world’s poor apparently failed to gain much traction among his colleagues, suggesting that they may have competing ideas in mind with respect to its use. In this connection, it is worth noting that having forced out its private shareholders, the BIS has switched its financial accounts from the 1929 Swiss gold franc to the IMF’s SDR (Special Drawing Right), a change that might presage some sort of merger or reorganization of these two institutions, both of which have now outlived their originally intended functions.

Going Deep. The absence of an independent audit makes uncertain the true state of claimed U.S. gold reserves amounting to some 8135 tonnes (261.5 million ounces). For a historical discussion of the government audits of the gold stock performed through 1980, see Report of the U.S. Gold Commission, Volume I, pp. 11-12, and Annex D: Continuing Audit of the United States Government-Owned Gold.

A careful reading of the 2003 Financial Report of the United States Government (available with past reports at discloses that as in prior years, the GAO declined to express (at p. 29) “an opinion as to whether the consolidated financial statements of the U.S. government are fairly stated in conformity with U.S. generally accepted accounting principles.” Among the “material weaknesses” noted by the GAO were those involving “Property, plant, and equipment and inventories and related property” (at p. 52, Appendix II):

Without accurate asset information, the federal government does not fully know the assets it owns and their location and condition and cannot effectively (1) safeguard assets from physical deterioration, theft, or loss, (2) account for acquisitions and disposals of such assets, (3) ensure the assets are available for use when needed, (4) prevent unnecessary storage and maintenance costs or purchase of assets already on hand, and (5) determine the full costs of programs that use these assets.

However, the GAO did give an unqualified opinion on the financial statements of certain departments (at pp. 50-51, Appendix I), including the Internal Revenue Service, the Treasury Department’s Schedules of Federal Debt, and the Federal Deposit Insurance Corporation. Notably absent from this list were any accounts relating to the U.S. gold stock, including the Audit of the United States Mint’s Schedule of Custodial Gold and Silver Reserves as of September 30, 2003 and 2002 (October 29, 2003) performed by the Treasury’s Office of Inspector General, which stated (at p. 4):

This report is intended solely for the information and use of the management of the US. Mint, and the US. Department of the Treasury, OMB, the Congress, and Urbach Kahn & Werlin LLP [the Mint’s auditors], and is not intended to be and should not be used by anyone other than these specified parties. However, this report is available to the public as a matter of public record. [Emphasis supplied.]

In other words, neither the GAO nor the general public is entitled to rely on the Treasury’s audit of the gold reserves under its custody and control. They are no mere bagatelle even amidst the large numbers associated with government finance. Note 2 claims that at September 30, 2003, “custodial” gold inventories held “primarily in bar form” by the U.S. Mint for the Treasury consisted of 245,262,897.040 ounces (7629 tonnes) having a statutory value of $10,355,539,091 and a market value of $95,162,004,052 at $388.00/oz. Note 1B states:

The books and records of the U.S. Mint have served as the source of the information contained herein. The Schedule has been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) and U.S. Mint accounting policies.

This Schedule includes all gold and silver classified by the U.S. Mint as “custodial reserves” as defined in Note 2. This Schedule does not include gold and silver withdrawn from the “custodial reserves” for use in the operations of the U.S. Mint’s PEF. The U.S. Mint’s PEF is authorized to use gold and silver from the custodial reserves to support its numismatic operations. This Schedule does not reflect any United States’ gold and silver reported by the U.S. Mint in its operating inventory or any reserve amounts due to be replenished by the PEF, nor does it include gold held at Federal Reserve Banks.

The Mint issues monthly status reports covering all the gold owned by the Treasury. According to the Status Report of U.S.Treasury-Owned Gold (October 31, 2004), 7629 tonnes are now classified as “Deep Storage Gold” and held at Fort Knox (4583 tonnes) and the U.S. Mints at West Point (1682 tonnes) and Denver (1364 tonnes). The U.S. Mint also holds a “Working Stock” of 88 tonnes, and the remaining 418 tonnes are held in the New York Fed. These classifications have been in place since May 2001. See Plaintiff’s Second Affidavit, ¶ 8. The gold at West Point but not at Fort Knox or Denver was reclassified from “Gold Bullion Reserve” to “Custodial Gold Bullion” in August-September 2000. See Plaintiff’s Affidavit, ¶ 29.

All these accounting issues have fed speculation regarding the true state of the U.S gold stock.

Whether the Fed or the Treasury ever adopted in whole or in part the policy prescriptions advanced in the Fed’s 1997 staff paper on gold is unknown except to senior government officials. (All such papers contain the disclaimer that they reflect only the views of the authors and “should not be interpreted as reflecting those of the Board of Governors of the Federal Reserve System or other members of its staff.”) However, the existence of that paper combined with the subsequent creation of an unprecedented account called “deep storage gold” has resulted in speculation that some of this gold may represent leased gold covered by the in-ground gold reserves of one or more major mining companies.

Another line of speculation suggests that some of the U.S. gold stock is under swap arrangements, most likely with the Bundesbank or other European central banks. Nor is this suggestion without factual support, including: (1) a reference — later denied — in the minutes of a 1995 meeting of the Federal Open Market Committee by Virgil Mattingly, the Fed’s general counsel, to gold swaps by the ESF; and (2) accounting instructions issued by the ECB using a gold swap between one of its member banks and the Fed as an illustrative hypothetical. See Plaintiff’s Affidavit, ¶¶ 31-33, and Plaintiff’s Second Affidavit, ¶¶ 8 and 32-37.

Fool’s Gold a/k/a Derivatives. On December 6, 2004, the BIS released its regular semi-annual report on the OTC derivatives of major banks and dealers in the G-10 countries for the period ending June 30, 2004, combined with its triennial survey covering the derivatives of a larger universe of banks and dealers in 44 countries. The total notional value of all gold derivatives in the G-10 fell to $318 billion from $344 billion as of December 31, 2003, with the total in the triennial survey coming in at $360 billion versus $278 billion at June 30, 2001.

Translated into estimated tonnes, these figures are shown in the chart below by Mike Bolser, together with the breakdown between forwards and swaps ($129 billion versus $154 billion at December 31) and options ($189 billion versus $190 billion at December 31) as reported in table 22A of the December issue of the BIS Quarterly Review. Also shown in tonnes are the gold derivatives held by U.S. commercial banks as reported through June 30, 2004, by the Office of the Comptroller of the Currency (


Regular visitors to The Golden Sextant will be familiar with this chart as well as the author’s view that the total notional value of forwards and swaps as reported by the BIS and converted into tonnes is a pretty good proxy for the total net short physical position in gold arising largely as the result of gold lending in one form or another by central banks. See Gold Derivatives: Hitting the Iceberg (12/20/03) and commentaries cited, updated in Hard Money Markets: Climbing a Chinese Wall of Worry (6/28/04). Put differently, the total net short physical position in gold consists in major part of bullion that has left the vaults of the central banks in the form of a deposit, loan or swap but remains on their balance sheets as a gold asset.

Thus the most noteworthy feature of the new figures is the rather sharp $26 billion decline — equating to roughly 2000 tonnes — in forwards and swaps over the first half of this year. Also of note is the decline of approximately 3600 tonnes in the total gold derivatives covered by the triennial survey, from 31.9 thousand tonnes ($278 billion at an end-period price of $271/oz.) to 28.3 thousand tonnes ($360 billion at an end-period price of $395/oz.). Three points about these declines merit comment.

First, as estimated by Gold Fields Minerals Services and other industry sources, total central bank gold lending never amounted to more than around 5000 tonnes. According to these same sources, from 2001 to year-end 2003, the total world producer hedgebook was cut by more than half from over 4000 tonnes to less than 2000 tonnes, and continues to fall. See GFMS, Global Gold Hedge Book Analysis – Q3 2004 (November 2004). Nothing close to a proportionate reduction occurred in total gold derivatives as reported by the BIS, suggesting that: (1) the gold carry trade, not forward selling by gold mining companies, primarily drove the growth in both gold derivatives and the central bank gold lending required to support them; and (2) total central bank gold lending far exceeded 5000 tonnes.

Second, in absolute amounts, the recent declines in both the semi-annual and triennial figures are consistent with the reported reductions in producer hedgebooks. Admittedly, on a quarter-by-quarter basis, the timing of the hedgebook reductions does not match the changes in forwards and swaps reported by the BIS on a semi-annual basis. One explanation may be that much of the physical gold released by hedgebook closures has flowed into the market rather than back to the central banks, leaving their forwards and swaps with the bullion banks to be unwound by subsequent paper or physical transactions. In this connection, continued high levels of options are consistent with the central banks rolling forward their physical transactions with the bullion banks, which have then met their value at risk parameters with options.

Third, official gold sales under WAG II (or otherwise) are unlikely to cause significant further reductions in total forwards and swaps unless: (1) the sales take the form of cash settlements of outstanding obligations to deliver physical gold, thus reducing total official gold reserves; or (2) physical gold sold by one central bank is used to repay another in specie, leaving total gold reserves unchanged. In neither case would any additional metal enter the public markets. Indeed, given the current total net short physical position, the theoretical potential exists for future gold sales to reduce reported central bank gold reserves by some 10,000 tonnes with scarcely any additional metal actually reaching the physical market.

Interestingly, from the beginning of 2001 through June 2004, the industrialized countries as a group reduced their net gold reserves reported to the IMF by about 48 million ounces or nearly 1500 tonnes, of which Swiss gold sales accounted for almost 1000 tonnes. This reduction in official reserves amounts to roughly three-fourths of the reduction in the total world producer hedgebook over the same period.

With the additional supplies provided by hedgebook closures and Swiss gold sales running out, future reductions in the total net short physical position appear increasingly problematic except through cash settlements of outstanding forwards and swaps. On the other hand, if forwards and swaps remain at or around thcir current level, it will suggest that official gold sales are largely meeting the gold market’s persistent structural deficit in the vicinity of 1000 tonnes annually, and that the central banks are unable or unwilling to stop the hemorrhaging of their most precious asset.

Sucking the Suckers. WAG I brought the central banks to the abyss because they either did not know the full extent of the total net short physical position in gold or did not fully understand its significance. With WAG II they have arrived at the brink of a far more perilous abyss, for now their own survival, not just that of the bullion banks, hangs in the balance. What gold remains in their vaults has taken on a new lustre, burnished by strong physical demand especially from traditional markets in Asia and the Middle East, a weak and falling U.S. dollar, and more than three years of generally strong and rising gold prices notwithstanding continued efforts to cap them. See, e.g., J. Hathaway, Beardsley Ruml’s Road to Ruin – Gold Sector Review, Tocqueville Asset Management L.P. (November 4, 2004); K. Morrison, Gold market harking back to 1970s, Financial Times (London) (November 5, 2004); R. O’Connell, Gold demand growth outstrips production, Mineweb (November 25, 2004).

Rising investment demand for gold has been fed by growing awareness of the official price supression that has operated for nearly a decade, creating a buying opportunity not seen since the collapse of the London Gold Pool in 1968. See, e.g., J. Embry and A. Hepburn, Not Free Not Fair: The Long-Term Manipulation of the Gold Price (downloadable from; D. Hasselback, Price of Gold Manipulated, Embry Says;Central Banks Dumping; Sprott Manager Ruffling Feathers on Bay Street Again, Financial Post (National Post) (September 14, 2004); W. Stueck, Gold slips on lower oil, firmer U.S. dollar, The Globe and Mail (August 25, 2004); M. Ingram, In search of a golden fleece, The Globe and Mail (August 24, 2004) (copy). What is more, by their otherwise inexplicable risk taking, major bullion banks and dealers have exposed themselves as agents of the central banks in this price fixing scheme. See, e.g., D. Norcini, The Anomalous Open Interest Pattern of the Gold Market, Gold-Eagle and LeMetropoleCafe (October 5, 2004).

Adding to investment demand, some countries outside the G-10 and Euro Area have increased their gold reserves, or are thought to be doing so. From 2000 to 2003, Chinese gold reserves as reported to the IMF rose by 50% to 600 tonnes from under 400. Despite being in default on much of its sovereign debt, Argentina has added to its gold reserves this year. Argentina’s Central Bank Increases Gold Reserves, Reuters (September 28, 2004); Note on Argentina (8/23/04). So, reportedly, have some nations in the Middle East. See Gold May Top 15-Year High as Dollar Falls vs Euro, Survey Says, Bloomberg (10/4/04). Sauve qui peut!

The Russians Are Coming. At the spring meeting of the London Bullion Market Association held in Moscow on June 3-4, 2004, the Deputy Chairman of the Bank of Russia delivered an extraordinary speech that has recently been posted at the Gold Anti-Trust Action Committee’s website. See O.V. Mozhaiskov, Perspectives on Gold: Central Bank Viewpoint (authorized English translation courtesy of Moscow Narodny Bank Ltd., London), posted October 3, 2004, at

Given the content of the speech, it is hardly surprising that GATA’s efforts to obtain a copy of the Russian text distributed at the conference were all rebuffed by the LBMA as well as several conference attendees. Not since Jacques Rueff made the case for gold as spokesman for Charles de Gaulle has an important central banker presented a more pro-gold (or anti-U.S. dollar) brief.

Indeed, the Russian banker even took note of GATA and the Gold Price Fixing Case, observing:

This dualism in gold price formation distinguishes it from other commodities and makes the movements in the price sometimes so enigmatic that market analysts need to invent fantastic intrigues to explain price dynamics. Many have heard of the group of economists who came together in the society known as the Gold Anti-Trust Action Committee and started a number of lawsuits against the U.S. government, accusing it of organising an anti-gold conspiracy. They believe that with the assistance of a number of major financial institutions (they mention in particular the Bank for International Settlements, J.P. Morgan Chase, Citigroup, Deutsche Bank, and others), some senior officials have been manipulating the market since 1994. As a result, the price dropped below US$300 an ounce at a time when it should, if it had kept pace with inflation, have reached US$740-760.

I prefer not to comment on this information but dare assume that the specific facts included in the lawsuits might have given ground to suspicion that the real forces acting on the gold market are far from those of classic textbooks that explain to students how prices are born in a free market. [Emphasis supplied.]

But while diplomatically skirting the allegations of the Gold Price Fixing Case, Mr. Mozhaiskov’s comments on the use of gold derivatives and their effect on market prices sounded far more like GATA than the World Gold Council:

Now the time has come to admit that investment demand was, and still is, the main driving force behind price fluctuations on the gold market. The changing character of demand heavily depends on what is going on in the international foreign currency and financial markets.

The investors pay continuous attention firstly to the dollar rate of exchange and secondly to the level of interest rates for financial assets. The volatility of these indicators directly influences the investors’ interest in gold. Since this interest is realised not through operations with physical metal but through deals with gold derivatives on stock-exchange and non-stock-exchange markets (where gold is mentioned only as a base asset), the volume of these deals can exceed the volume of trade in physical metal dozens of times. Last year turnover with gold derivatives was about 4,000 million ounces (or 129,000 tonnes), but physical metal actually sold totalled 120 million ounces or some 3,860 tonnes. As it is said: Feel the difference!

It is true that the markets for derivatives linked to other raw materials also usually exceed the operations with base assets. The difference in volumes are incomparably less (five to 10 times). At the same time the markets for derivatives with foreign currencies and prime securities as base assets are developing every bit as rapidly as the gold derivatives.

What can we infer from that?

One conclusion, at least, is clear: Gold is predominantly a financial asset, not merely a precious metal. [Emphasis supplied.]

With respect to the recent management of central bank gold reserves, Mr. Mozhaiskov noted:

I would also like to note that recently the central banks have been playing a significant role in the gold market. Low interest rates in the money markets and revaluation of gold reserves in line with lower market prices have exacerbated the problem of the financial efficiency of gold stock management. To earn some income on the stock and compensate for “book losses” caused by its revaluation, a number of central banks have started to place a part of their reserves into deposits with commercial institutions — leasing operations.

However, in a curious and somewhat ambiguous passage, he cited figures on total gold lending by central banks that are usually associated with Gold Fields Minerals Services, but he then described the effects of that lending as “incomparable with the pressure” exerted by gold derivatives. How this large derivatives pyramid — and especially its component of forwards and swaps in excess of 10,000 tonnes — could have developed on such a small quantity of central bank bullion is not addressed.

Data available to me suggest that these banks deposited about 1,000 tonnes in 1991, and 10 years later the volume of the deposits reached 4,800 tonnes. Naturally, the central banks’ activity increased market liquidity and thus also put downward pressure on the gold price. The influence of these operations, however, must not be exaggerated. It is even incomparable with the pressure that was exerted on the market of gold derivatives.

What is of far greater significance than Mr. Mozhaiskov’s views on the gold market itself is his blunt indictment of the current international monetary system:

That brief look back into the past was necessary to make the following conclusion: The present state of the gold market and its future cannot be analysed in isolation from the problems of the international monetary system.

Some people may question this conclusion because of the incompatibility of the present volumes in the respective gold and foreign currency markets. I would suggest that the volumes do not matter for this particular purpose. The modern monetary system, although undoubtedly robust and long-standing, in fact has a number of flaws and weaknesses. These, like the birth of the new, can cause health problems to the participants of the system.

This disconcerting phenomenon occurs because, by taking gold out of international payments turnover, people are undermining payment discipline. The discipline I have in mind is at a macro-level; that is, the discipline of rich industrial countries whose convertible currencies have taken the role of an international trade medium by virtue of their economic strength and have been accepted by the world community as reserve units of payment.

Although there are several reserve currencies, the blatant lack of discipline is demonstrated by the U.S. dollar. I am leaving aside the main aspects of this problem, such as the social and economic injustice of a world order that allows the richest country in the world to live in debt, undermining the vital interests of other countries and peoples. What is important for us today is another aspect, which is connected with the responsibility of the state issuing the reserve currency and for the international community preserving that currency’s buying power.

Given the actual behaviour of the dollar on the forex markets, the problem could be more accurately termed the irresponsibility of the U.S. government in relation to the market valuation of its currency in international circulation.

Today the net debt owed by the United States to the outside world (the so-called “international investment position”) is in the region of US$3 trillion. To understand the scale of this figure, let me remind you that it exceeds the total official currency reserves in all the world’s countries (including the United States itself). According to the International Monetary Fund statistics at last year-end, the world pool of foreign currency reserves totalled Special Drawing Rights 2,013 billion or about US$2,800 billion. The volume of cash only (“greenback” banknotes) available outside the United States totals about US$400 billion.

The world has come to a paradoxical situation in which the creditor countries are more concerned with the fate of the dollar than the U.S. authorities themselves are.

Thus, the evolution of the U.S. dollar’s reserve role in recent years has given ground to some quite pessimistic forecasts, based on rational economic theory. No wonder that the number of people who have held assets in dollars and now wish to diversify them partly into gold — the traditional shelter from inflation and political adversity — is steadily growing. [Emphasis supplied.]

MAD Money. Just as war is too important to be left to generals, money is too important to be left to economists, even when they are anointed as central bankers. Too often, however, higher political authorities also show poor judgment or lack of wisdom in dealing with these important matters. Fortunately, the doctrine of mutual assured destruction has so far managed to restrain generals, statesmen, politicians and even dictators from launching a disastrous nuclear conflict. But in the international economic and financial arena, essentially the same doctrine now operates to produce dangerous instability.

Absent worldwide paper money wholly unchained from the discipline of gold, the twin deficits of the United States that lie at the heart of today’s global economy could not exist. But as it is, the U.S. Federal Reserve facilitates the creation of unlimited amounts of purely debt-based liquidity to support the American economy while foreign central banks accumulate huge amounts of U.S. paper to support the exports of their own economies to the United States. A reduction or even slowing of the debt buildup on either side threatens the economies and prosperity of all, yet there is widespread agreement that the process is unsustainable and must at some point end. See, e.g., P.G. Peterson, “Riding for a Fall,” Foreign Affairs (September-October, 2004), pp. 111-125, adapted from his Running on Empty (Farrar, Straus and Giroux, 2004); J.R. Laing, “Who’s Afraid of Stephen Roach?,” Barron’s (December 6, 2004), pp. 25-28; M. Wolf, Why America is switching to a weak dollar policy, Financial Times (London) (December 1, 2004); M. Auerback, The G-20’s Piecemeal Solutions Won’t Work, (November 23, 2004); B. Arends, Economic ‘Armageddon’ predicted, Boston Herald (November 23, 2004); P. Brimelow et al., Is foreign debt the wolf at the door?, CBS MarketWatch (November 1, 2004).

Charged with improving the operation of the classical gold standard, the central banks have degenerated into producers of MAD money. In the process, they have financed the new American empire, which despite its almost unchallengeable military power stands virtually defenseless to a global loss of confidence — spontaneous or engineered — in the U.S. dollar, the principal reserve currency in the MAD money system. See, e.g., D. Noland, Open Letter to the U.S. Dollar, (November 26, 2004). When it collapses, as have all prior experiments with unlimited paper money, neither that empire nor the central banks that invested too heavily in it are likely to survive in anything close to their present form. And though gold prices soar beyond their wildest dreams, gold bugs will not escape the nightmarish world thus unleashed. See, e.g., R.S. Appel, untitled commentary, Financial Insights (November 4, 2004); H. Salinas Price, Dark Thoughts on a Weekend, Le Metropole Cafe (September 11, 2004).

Sunrise in America. Alone among America’s founding fathers, Benjamin Franklin participated directly in crafting all three of the nation’s charter documents: the Declaration of Independence, the Treaty of Paris, and the Constitution. As he watched the members of the Federal Convention affix their signatures to the new Constitution, he remarked that during the debates he had often noticed the painting of a half sun on the back of the chair from which George Washington presided, and had wondered whether it was a rising or setting sun. “Now,” he said, “I am certain it was rising.” Later, asked by a Philadelphia matron what the convention had produced, Franklin replied: “A republic, if you can keep it.”

Exactly when the American republic became the American empire is a matter for historians to debate, but there can be little doubt that the American victory over Japan in World War II and the postwar security and economic arrangements between the two nations played a crucial role. Under the American military and nuclear umbrella, the land of the rising sun developed the export-oriented model for economic growth subsequently followed by most of its Asian neighbors and now the main generator of MAD money.

In the political as in the physical universe, a rising sun must eventually set. Rome fell. The sun has long since set on the British Empire. In historical perspective, the late Soviet Union disappeared with the rapidity of a shooting star, testimony to the folly of erecting an economy on the principle that markets do not work and cannot be trusted. Setting national stars have no guaranteed tomorrows. They almost always flame out amidst chronic currency debasement and depreciation. See, e.g., The passing of the buck?, The Economist (December 2, 2004); B. Bartlett, How Excessive Government Killed Ancient Rome, The Cato Journal (Fall 1994).

Yet the American republic need not fade into history along with MAD money and the American empire. What Abraham Lincoln called the “last and greatest hope of mankind on Earth” can again rise to lead the world by its example if the American people will return to the monetary principles of their Constitution, which requires sound money based on gold or silver for the reasons recognized by Ludwig von Mises in A Theory of Money and Credit, Ch. 21 (1952):

It is impossible to grasp the meaning of the idea of sound money if one does not realize that it was devised as an instrument for the protection of civil liberties against despotic inroads on the part of governments. Ideologically it belongs in the same class with political constitutions and bills of rights. The demand for constitutional guarantees and for bills of rights was a reaction against arbitrary rule and the nonobservance of old customs by kings. The postulate of sound money was first brought up as a response to the princely practice of debasing the coinage. It was later carefully elaborated and perfected in the age which–through the experience of the American continental currency, the paper money of the French Revolution and the British restriction period–had learned what a government can do to a nation’s currency system.

December 7, 2004


Reproduced from Anne Y. Kester, International Reserves and Foreign Currency Liquidity: Guidelines For A Data Template (IMF, 2001), pp. 18-19, including footnotes:

Gold (Including Gold on Loan)—Item I.A.(4) of the Template

98. Gold in the template refers to gold the authorities own. Gold held by monetary authorities as a reserve asset (i.e., monetary gold) is shown in this item.(28) All other gold held by the authorities (e.g., gold held for trading in financial markets) is not monetary gold and should be included under “other foreign currency assets” in Section I.B. of the template. In addition, holdings of silver bullion, diamonds, and other precious metals and stones (29) are not reserve assets and should not be recorded in the template. The term “gold on loan” used in the template refers to gold deposits (and gold swapped, if the swap is treated as a collateralized loan; see below).

99. Gold deposits are to be included in gold and not in total deposits. In reserves management, it is common for monetary authorities to have their bullion physically deposited with a bullion bank, which may use the gold for trading purposes in world gold markets. The ownership of the gold effectively remains with the monetary authorities, which earn interest on the deposits, and the gold is returned to the monetary authorities on maturity of the deposits. The term maturity of the gold deposit is often short, up to six months. To qualify as reserve assets, gold deposits must be available upon demand to the monetary authorities. To minimize risks of default, monetary authorities can require adequate collateral (such as securities) from the bullion bank. It is important that compilers not include such securities collateral in reserve assets, thereby preventing double counting.(30)

100. In reserves management, monetary authorities also may undertake gold swaps.(31) In gold swaps, gold is exchanged for cash and a firm commitment is made by the monetary authorities to repurchase the quantity of gold exchanged at a future date. Accounting practices for gold swaps vary among countries. Some countries record gold swaps as transactions in gold, in which both the gold and the cash exchanged are reflected as offsetting asset entries on the balance sheet. Others treat gold swaps as collateralized loans, leaving the gold claim on the balance sheet (32) and recording the cash exchanged as two offsetting asset and liability entries on the balance sheet.(33)

101. For the purpose of the template, it is recommended that gold swaps the monetary authorities undertake be treated in the same ways as repos and reverse repos. (See para. 85 and Appendix III.)

28. Such gold is treated as a financial instrument because of its historical role in the international monetary system.

29. These precious metals and stones are considered goods and not financial assets.

30. If the securities received as collateral are repoed out for cash, a repo transaction should be reported, as discussed earlier under “securities.”

31. Such gold swaps generally are undertaken between monetary authorities and with financial institutions.

32. This treatment is consistent with BPM5 (para. 434) to the extent that the swap is between monetary authorities. The rationale is that in a gold swap, the monetary authorities swap gold for other assets (such as foreign exchange) and that this involves a change in ownership. The ownership of gold is retransferred to the original owner when the swap is unwound at a specific date and at a specific price.

33. This treatment applies only when an exchange of cash against gold occurs, the commitment to buy back the gold is legally binding, and the repurchase price is fixed at the time of the spot transaction. The logic is that in a gold swap the “economic ownership” of the gold remains with the monetary authorities, even though the authorities temporarily have handed over the “legal ownership.” The commitment to repurchase the quantity of gold exchanged is firm (the repurchase price is fixed in advance), and any movement in gold prices after the swap affects the wealth of the monetary authorities. Under this treatment, the gold swapped remains as a reserve asset and the cash received is a repo deposit. Gold swaps commonly permit central banks’ gold reserves to earn interest. Usually, the central banks receive cash for the gold. The counterparty generally sells the gold on the market but typically makes no delivery of the gold. The counterparty often is a bank that wants to take short positions in gold and bets that the price of gold will fall or is one that takes advantage of arbitrage possibilities offered by combining a gold swap with a gold sale and a purchase of a gold future. Gold producers sell gold futures and forwards to hedge their future gold production. Treating gold swaps as collateralized loans instead of sales also obviates the need to show frequent changes in the volume of gold in monetary authorities’ reserve assets, which, in turn, would affect world holdings of monetary gold as well as the net lending of central banks.

Copyright 2004 – Reginald H. Howe