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2 INTERVIEW Gold emerges as euro debt-crisis
option By Lars Schall
Ansgar Belke, former Research Director
for International Macroeconomics at the German
Institute for Economic Research in Berlin, talks
in depth about a paper that he authored for the EU
Parliament on using gold as collateral for highly
distressed sovereign bonds.
Belke is
Professor of Macroeconomics and director of the
Institute of Business and Economic Studies (IBES)
at the University of Duisburg-Essen in Germany. He
was the research director for
International Macroeconomics
at the German Institute for Economic Research
(DIW), Berlin until October 2012, and since 2012
he is (ad personam) Jean Monnet Professor.
He is, inter alia, a member of the
"Monetary Experts Panel" of the European
Parliament and the Committees for Economic Policy
and International Economics within the German
Economic Association. (For further details, see
end of interview.)
Lars
Schall: How did it come about that you
authored a paper for the EU Parliament related to
gold-backed bonds? [1]
Ansgar Belke:
This was really necessary because we lack
any solution to the current euro crisis, and
politicians tried on and on to solve the crisis
with ineffective and partly counterproductive
efforts to use monetary policy to solve the
structural issues the eurozone is currently
plagued with. The European Central Bank [ECB]
opened up its third round of secondary bond market
purchases on September 6, 2012. Whether they
deliver a permanent reduction in bond yields in
the South is highly uncertain. If the ECB's latest
sovereign bond purchase program consisting of
Outright Monetary Operations [OMTs] fails, then
Europe's options look grim.
Austerity and
growth program have not met expectations, and the
outlook is further clouded by the fact that the
funds available from the International Monetary
Fund [IMF] and EFSF/ESM [European Financial
Stability Facility and European Stability
Mechanism] are dwindling as a result of other
bailouts. Of course, sovereign bond yields have
been artificially driven down in the short run by
politically motivated too optimistic assessments
of debt sustainability in some eurozone member
countries.
What is more, downward pressure
on bond yields has been exerted by the expectation
of investors such as Blackrock, Goldman Sachs and
a couple of hedge funds that the ECB will step in
to buy sovereign bonds even if conditionality is
not met by these countries. This cannot be called
a healthy and sustainable thing. Thus, it seems
fair to state that Europe is gradually running out
of time and options.
Already the
now-terminated predecessor of the OMTs, the
Securities Market Programme [SMP] has always been
a controversial option, riddled with potential
dangers. It is seen by many as a de facto
fiscal transfer from the North to the South and,
moreover, a transfer made without democratic
consent.
By showing willingness to buy the
debt of poorly performing countries, the SMP was
seen as reducing credible incentives for necessary
long-term reforms. In addition, although the ECB
tries to "sterilize" these transactions, this is
far from an exact science, leaving a risk of
higher money supply fuelling inflation in the
medium to long run.
An alternative manner
which serves to lower yields might be to issue
securitized government debt, for example, with
gold reserves. This could achieve the same
objectives as the ECB's bond purchases programs,
but without the associated shortcomings. This
would clearly raise legal issues, but then so too
did the ESM, SMP and OMT.
This would not
work for all countries but would for some of those
in most need. In fact, Italy and Portugal have
gold reserves of 24% and 30% of their two-year
funding requirements. Using a portion of those
reserves as leveraged collateral would allow those
countries to lower their costs of borrowing
significantly.
LS: Are there
other advantages in using gold?
AB: Making use of the
national central banks' gold reserves is much more
transparent than the SMP, it is much more
attractive for investors, much fairer, and would
make it easier to get genuine consent amongst the
euro area population and the European Parliament.
Nor does it lead to unmanageable fiscal transfers
from the North to the South with huge disincentive
effects. It does not shift toxic debt instruments
onto the ECB. And it does not cause sterilization
problems or increase the difficulty of exiting
unconventional monetary policy - the gold-backed
bond solution avoids the path-dependence of the
existing solutions.
Simply speaking, a
gold-based solution is much less inflation-prone
because it is using a real asset and does not
reduce incentives for the reform of beneficiary
countries. It does not touch the ECB's balance
sheet but the SMP and OMTs deploy it.
I
saw that the Securities Market Program, the SMP,
which started in May 2010 did not solve many of
the problems. It had many disadvantages and, in
addition, the European Central Bank came up with a
proposal of unlimited sovereign bond purchases in
September 2012 which also had many obvious
drawbacks.
A couple of them were, for
instance, that this was not transparent. Just to
go for sovereign bond purchases in the SMP: it was
not made public which and at what amount sovereign
bonds were purchased, from which country for
instance. These bond purchases had a lot of
drawbacks, like elements of subsidy, there's moral
hazard included - if you buy sovereign bonds from
countries which do not sustainably stick to any
rules concerning the budget, it is a problem for
those who are sticking to it. The latter are
punished in a sense and the others are rewarded.
LS: The question may be
raised what will happen if the sovereign bonds
taken on board by the ECB will devalue; who will
feel the cost?
AB: This is
not clear. The problem with all these kind of
alternative solutions is that they endanger the
financial and political dependence of the ECB. You
do not know how to sterilize these purchases.
Maybe there's some inflationary danger included
because you have toxic debt instruments on board
of the ECB and there is a huge degree of path
dependence. And, of course, if you go for an
accommodative monetary policy stance, this has a
negative impact on the incentives to reform which
have to be pushed through in the southern part of
the euro area.
There are a lot more
problems with the SMP and OMT solutions. Only
sovereign funds, including gold-backed sovereign
bonds, disclose genuine opportunity costs to the
initiators. But choosing the money printing press,
opportunity costs of appropriate adjustment
programs wrongly appear to approach zero, since
ECB programs are not sufficiently transparent.
The interest rates are near zero and they
do not signal the opportunity costs of all rescue
measures currently implemented and conducted by
the ECB and the [rest of the] Troika [the European
Commission, European Central Bank and
International Monetary Fund, overseeing the euro
debt crisis] because all the negative side-effects
of it have to be neutralized in the future.
For instance if you buy bonds, sovereign
bonds, this is a huge problem because you damage
the value of other bonds and shares; this might
severely hamper refinancing possibilities of
healthy firms and banks. You take away sound
investment possibilities for pension and insurance
companies and there are other side effects.
Note also that the ESCB [European System
of Central Banks] can attach conditions to its
gold transfer such as implementation of structural
reforms. The move to gold-backed bonds would not
only fix the monetary transmission mechanism but
also provide time to implement necessary reforms.
Anyway, the potential loss of gold for a
country like Italy and Portugal might well serve
as disciplining device for the fiscal policy
behaviour of the respective government. This is
exactly what the Finnish government was keen on
when negotiation about the shape and the rules of
the future ESM.
LS: Is this
some sort of dark pedagogy? I mean, you punish
them in a way if they have to give up their gold.
AB: Yes, but using gold as a
pledge helps them like a covered bond does: it
attracts investors and thus strengthens the
position of financially distressed member
countries which themselves are guarantors of the
eurozone rescue mechanism ESM - an additional
benefit of gold-backed bonds which may not be
forgotten. If you try to simulate the effects of
gold backing of bonds, you can clearly see that,
for instance, for Portugal (where we did this)
that the sovereign bond yield can be lowered by
about 4 basis points. This is due to the fact that
the recovery rate is increasing in the case of
insolvency of a country and, in addition, the
default probability is going down.
So, the
process itself is rewarding for the country
itself, it doesn't lead to more damage but, on the
contrary, to less damage. So, it is an obvious
alternative to go for gold-backed sovereign debts
with the benefit of temporary effects and a
bridge-financing character. As I mentioned
earlier, gold has been used in the past already as
collateral to help some countries to raise loans -
we can look back to the '70s where Germany granted
a loan to Italy and this was gold-backed, whereas
the interest rate effect of this operation has
never been published. Instead, it was kept secret.
Moreover, gold prices tend to move
counter-cyclically. This reinforces its
stabilising effect in current situation of
financial stress. And what I would like to stress
again this is not intended to simply raise revenue
for many short selling of gold, this is more
intelligent solution. This gold is available to
the ECB.
LS: Why does the
gold-backed solution make sense in your view?
AB: Seen on the whole, if I
look at the SMP and OMTs, they are not quite
consistent, especially because the ECB uses or has
announced the OMTs (Outright Monetary
Transactions) in order to repair the monetary
policy transition mechanism, even if, for
instance, Spain approaches the ESM, asks for some
help and only has to fulfill very light
conditions. This is a problem of credibility then
for the ECB because everybody is betting that the
ECB will neverthelss engage in bond purchases,
although countries like Spain may not fulfill the
conditions because it would be inconsistent to
stop repairing the monetary policy transition
mechanism even if a country does not stick to the
conditions. What is more, after the retreat of
Mario Monti, [who resigned as Italian prime
minister on December 21] the political system and
reform activity in Italy currently does not appear
overall stable.
All this, taken together,
was the intended incentive to look for an
alternative means to help countries under
financial distress in order to get back to the
markets, [get] access to the markets.
Accordingly, it might turn out after some
weeks that the announcement of complementary ECB
measures announced on September 6 will not deliver
a permanent reduction in bond yields in the South.
Then, at the latest, one should look for a "last
resort" solution, since the supply of alternative
options looks to be exhausted because all
austerity and growth programs do not meet
expectations. Additionally, international support
from the IMF, the EFSF and other institutions
usually granted to troubled economies and
preferred over gold-backed issuance is stretched
as a result of other bailouts.
One obvious
alternative would be to go for gold-backed
sovereign debt. Despite all current denials, the
point in time may have come to use valuable and
fungible assets such as gold to provide the
Southern countries with temporary, but crucial in
the current crisis of confidence, bridge-financing
heading towards a complete long-term solution.
To be explicit, such a proposal does not
address the gold-backing of euro or stability
bonds whose usefulness is conceded by the EU
Commission only in the very long perspective. [2]
The EU Commission proposes in its Green Paper on
the feasibility of introducing Stability Bonds
that Stability Bonds could be partially
collateralised using cash, gold, or shares of
public companies.
Note in this context
that Prodi and Curzio argue that further
innovation is necessary with a European Financial
Fund (EFF) that issues EuroUnionBonds (EuBs). [3]
According to their proposal, euro area member
states confer capital to the EFF proportionally to
their stakes in the ECB. The capital should be
constituted by gold reserves of the European
System of Central Banks. Gold could be placed as
collateral.
Nor is my gold-backed bond
proposal directly related to the recent debt
redemption funds proposal by the German Council of
Economic Advisors according to which the EFSF and
later also the ESM firepower should ultimately be
increased by a gold coverage of bonds. [4]
It is by now clear that even in the fourth
quarter of 2012 and the first half of 2013 the
euro area will stay under significant stress. But
it is not at all clear whether the ECB or the euro
area governments will de facto be able to act
properly to choke market fears and bring down
(allegedly) overly high government borrowing
costs. As unease builds, it may be time to explore
new ideas to cut interest rates.
A new
idea would be the gold backing of new sovereign
debt. It is common knowledge that a few countries
which are the most affected by the euro crisis,
Portugal and Italy, hold large stocks of gold. In
aggregate, the euro area holds 10,792 tonnes of
gold, that is 6.5% of all the yellow metal that
has ever been mined, and worth some $590 billion.
As expected, this scenario was the trigger
for some to propose that not only the financially
distressed governments should sell some of their
gold. [5] Over the last couple of years, the value
of gold has soared. And a popular view is, if
there were ever a suitable time that euro area
member countries are in need of an unanticipated
windfall gain - for instance, to pay interest on
their sovereign bonds - it would be now.
LS: Would this be a mistake?
AB: Yes, for quite apart
from the fact that a massive dump of gold would
dampen its price, the euro area debt woes are now
so large such that gold sales would only scratch
the surface of the problem. This is because the
gold holdings of the financially distressed euro
area countries (Greece, Ireland, Italy, Portugal
and Spain) would account for only 3.3% of their
central governments' total outstanding debt.
Through issuing sovereign bonds backed by
gold, euro area member countries should securitise
part of that gold instead. The latter could be
enacted in a rather simple way. But one could also
structure it to contain tranches of different
risks. The main point in both variants is that
gold would serve to provide sovereign bonds with
further safeness - and thus comfort investors who
do not give credence to euro area government
balance sheets any more.
I am quite aware
of the fact that this is problematic from a legal
point of view because, as I just stressed, central
banks in the EU area are independent and also the
European System of Central Banks is independent.
But if you, for instance, have the ECB deciding,
in full independence, about offering gold for such
kind of a solution and this is working via a debt
agency, I am confident that these legal problems
are surmountable.
LS: You
believe that gold has an important role to play in
helping distressed eurozone countries and you have
investigated how this could work - what did you
find?
AB: Using gold as
collateral for new sovereign debt issues would
alleviate some pressure in the short term and
facilitate a return to growth. Gold-backed bonds
would have an advantage over the existing
non-conventional monetary policy tools to tackle
the Eurozone debt crisis to date. The ECB's
balance sheet would be unaffected, as the gold
that sits within national central bank reserves
would be more than sufficient to collateralise the
bonds. And it would lower sovereign debt yields
without increasing inflation and would give some
distressed countries time to work on economic
reform and recovery.
LS: Why
would this rather work for Italy and Portugal than
for other eurozone countries?
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