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2 INTERVIEW Gold emerges as euro debt-crisis
option By Lars Schall
AB: Not all
eurozone countries have enough gold in their
reserves for this to be a viable solution.
However, for those with significant holdings, such
as Italy and Portugal, which are accidentally
those in most need, this represents a real
alternative. Using gold as collateral would not
work for all countries but would do so for some of
those in most need. France and Germany hold
significant reserves but enjoy - in the case of
France relatively - low unsecured borrowing costs.
Of course, my gold-backed bond proposal
might gain popularity when France as a candidate
for severe problems will come to the forefront of
the euro dilemma. Greece, Ireland and Spain, on the
other hand, don't hold enough
gold for it to be a viable solution. Italy and
Portugal, however, hold gold reserves of 24% and
30% of their two-year funding requirements, and
gold-backed bonds could have a material impact of
their debt servicing costs. For the case of
Portugal, my paper demonstrates that a sovereign
bond backed by one-third with gold could reduce
yields on sovereign debt by as much as 3 basis
points.
It is important to note in this
respect that Gold has been already used in the
past by a couple of countries to raise loans. In
history, collateral schemes have been utilized
before on quite a few occasions. In the 1970s, for
instance, Italy and Portugal employed their gold
reserves as collateral to direct loans, not bonds,
from the Bundesbank, the Bank for International
Settlements and other institutions like the Swiss
National Bank. Italy, for instance, received a $2
billion bail-out from the Bundesbank in 1974 and
put up its gold as collateral. More recently, in
1991, India applied its gold as collateral for a
loan with the Bank of Japan and others. And in
2008, Sweden's Riksbank used its gold to raise
some cash and provide additional liquidity to the
Scandinavian banking system.
Countries
have in history headed towards their gold reserves
only in their toughest situations. What is more,
lenders are most probably requiring that this gold
is transported to a neutral location. This reveals
that gold-backed bonds could help in some respects
but would not be a full and all-comprising
solution. Questions arise, for instance, over the
unintended impact on unsecured debt yields.
LS: There are some legal
hurdles to be overcome. How do you think this can
be achieved?
AB: Like every
other solution being presented in the eurozone,
there are a number of legal issues that need to be
considered for gold-backed bonds to proceed. The
fact that eurozone gold is held and managed by
central banks and not governments is a key issue -
but these are surmountable. But clearly, it has to
be recognised that there are legal and political
considerations, as there were and still are with
the SMP and the OMTs, against which the German
Constitutional Court potentially will go to the
European Court.
The first critical issue
is reserve ownership. In most countries, gold
reserves are held and managed by central banks
rather than governments. Specifically, in the euro
area, gold reserves are managed by the Eurosystem,
which includes all member states' central banks
and the ECB. This is settled in the Treaty on the
Functioning of the European Union, Article 127,
and Protocol on the Statute of the European System
of Central Banks (ESCB) and of the ECB, Article
12.
The second issue is central bank
independence. National central banks must remain
independent of governments in pursuit of their
primary objective of price stability. This is
settled in the EU Treaty, Article 130. What is
more, the EU treaty expressly prohibits direct
monetary financing of governments by central
banks. This can be derived from the EU Treaty,
Article 123. The EU treaty expressly prohibits
direct financing of governments by central banks.
One should be mindful of the legal issues that
this will raise and that such a suggestion will be
highly controversial. It is specifically likely to
raise questions as to whether or not this
represents a breach of the prohibition on monetary
financing.
The third issue is related to
the limited potential of gold reserve sales. There
are longstanding gold sale limits, which are valid
until 2014, that could potentially limit
collateral transfers and would need to be
addressed. The Eurosystem central banks are
currently signatories to the 3rd Central Bank Gold
Agreement (CBGA), which restricts net sales of
gold reserves to 400 tonnes per annum combined.
[6] A number of other major holders - including
the US, Japan, Australia and the IMF - have
announced at other times that they would abide by
the agreement or would not sell gold in the same
period.
Hence, the CBGA agreement could
serve as a constraint on the size of potential
gold reserve transfers until 2014, as it commits
signatories to collectively sell no more than 400
tonnes of gold per annum between September 2009
and 2014. Gold collateral could be interpreted as
outside the scope of the CBGA, or the maturity of
the bonds could be staggered in order to limit the
amount of gold coming onto the market in the event
of a default.
To summarise: there are
clearly important legal issues that need to be
addressed, but then that was also the case with
the ESM, SMP and OMT. European legislation may
need to be amended to accommodate a gold pledge
for sovereign debt. This could be done by
elaborating an amendment to the Treaty which
establishes pledged gold as segregated from euro
system central banks and other national banks.
LS: Could that kind of gold
policy provoke a deflationary shock?
AB: No, in terms of
inflationary or deflationary dangers, it seems to
be neutral because if you look at the balance
sheet of the ECB, you can compare sovereign bond
purchases with the kind of solution I propose, the
gold-backed bonds. In the case of bond purchases
you have an increase on both the asset and the
liability side of the balance sheet. You buy the
bonds, and on the right-hand side the monetary
base has increased. If you try to do the
bookkeeping for gold-backed bonds, you instead
have a change of positions at the claims side of
the balance sheet. You give up some gold, but in
exchange you receive a claim on a debt agency
which receives this kind of gold, and because this
kind of gold makes the sovereign bonds a kind of
covered bond, they are safer.
And what you
have in exchange does not necessarily lead to a
decline in the monetary base in the ECB and ESCB
balance sheet because this is structurally
different. By the way, this has nothing to do with
the working of a gold standard, for instance,
where, of course, the limited availability of gold
might hamper growth. This is something completely
different.
A deeper analysis of this issue
thus has to take into account that our proposal
leads to a change of items on the asset side of
the ESCB, ie an exchange of gold against claims of
the debt agency. But whereas gold is a pledge and
thus automatically returns onto the ESCB's balance
sheet, the purchased sovereign bonds have in the
end to be sold actively by the ESCB. (Note also
that, for the same reason, a gold-backed bond very
much like a covered bond is much more attractive
for risk-averse private investors.) This makes
significant and permanent fiscal transfers under
bond purchasing programs even more likely.
However, it would clearly be preferable to a
revival of the ECB bond-buying program SMP in the
shape of the OMT, which shares the same inherent
flaw.
LS: Do you think that
this response could be the trigger for inflation
or create a fiscal transfer between northern and
southern Europe?
AB:
Gold-backed bonds would not represent a fiscal
transfer from north to south. It would increase
incentives for economic reforms and would not have
the same inherent inflation risks as the ECB's
Outright Monetary Transactions (OMT) scheme. Not
all eurozone countries have enough gold for this
to be a viable solution for, but some - in
particular Italy and Portugal - do.
LS: What is the response of
the EU with regards to your paper?
AB: The paper received a lot
of attention in the European Parliament because it
was published there as a regular briefing paper in
advance of the visit of ECB president Mario Draghi
and is made available online to all the
parliamentarians. Note again that making use of
the national central banks' gold reserves is much
more transparent, being an important argument
vis-a-vis the euro area population and also the
European Parliament traditionally lays much
emphasis on transparency of EU governance.
In addition, I had some press conferences
on the paper in Brussels, Frankfurt, Rome and
London. These were attended by a lot of people,
from different peer groups such as politics, the
finance industry and science. Of course, I was
totally clear about the fact that you have, in the
first instance, to persuade central bankers of
this idea, and that especially Italian central
bankers would not be very pleased by this proposal
- although they went in very strongly in favour of
the OMPs or SMPs which to a certain extent pose
the same legal problems.
They are mainly
arguing with reference to central bank
independence, which is difficult to give up just
to monetary finance public debt via gold sellings.
This caveat has to be treated carefully, but I am
sure that we can deal with it because EU law is in
flux.
If you are careful and the ECB would
decide in independence this would be manageable,
because this would have nothing to do with
monetary financing of public debt. The reasons is
that you have a debt agency included and the
gold-backed bond is stabilising the bonds at
hands.
Under gold-backed bonds, monetary
policy would have a lower probability to be called
in as a lender of last resort. If a country is
stabilised also, the financial power of the ESM
would be enhanced because the guarantor capacity
of a country like Italy would be strengthened by
this. So, in turn, the probability for the ECB to
be caught in a risk of default in would be lowered
and this proposal would receive higher acceptance,
of course, in member countries such as Germany.
The reason is that the potential losses are borne
by specific countries and not by the largest
shareholder of the ECB.
Some even say that
gold-backed bonds do not imply any transfer of
credit risk between high risk and low risk
countries. This is different as compared to the
ECB's sovereign bond purchases, which let the
central bank incur many credit risks along
national lines and in effect re-nationalises the
eurozone's monetary policy.
LS: Is the gold variant as a
solution politically enforceable at all?
AB: My answer is yes: the
concept of gold-backed bonds certainly is worth a
closer discussion. As noted by myself earlier,
sovereigns should only consider gold-backed debt
in specific and distressed circumstances. Hence,
the need for refinancing within the euro area must
be overwhelming in order to receive political
support from the South for gold-backing. Clearly,
financing costs must have become unsustainable as
a requirement for public support of a gold-backing
of sovereign bonds: a high inflation perspective
limits the ability to perform quantitative easing,
that unsustainable sovereign yields are offered by
the public markets and the debt-to-GDP ratio is
untenable. With an eye on the legal issues
involved it is, above all, the members of the ESCB
which have to be persuaded.
Too bad that
the arguments against the use of gold are raised
by central bankers such as Banco d'Italia governor
Ignazio Visco from Italy - a country abundantly
equipped with gold reserves - who themselves have
favoured a revival of the SMP, now in the form of
the OMT, implying even larger legal problems than
gold-backed bonds. Both variants of unconventional
monetary policy collide significantly more with
the EU Treaty and the ECB Statute.
LS: Do you think your paper
will gain popularity when the candidates for
severe problems, Italy and France will come to the
forefront of the euro dilemma?
AB: At least with respect to
Italy, because 24 percentage points of the
country's two-year refinancing needs can be
covered by gold. This might become a topic, and it
is a topic right now. As mentioned before, in
Italy it is already discussed by some colleagues
who bring forward the idea of a gold-backed fund.
They even come up with two larger solutions based
on gold.
But I myself am quite skeptic
about whether we have sufficient amounts of gold
available in the eurozone to cover such long-run
solutions like the redemption fund, which is
proposed by the German Council of Economic
Advisors and explicitly alludes to a gold-backing
in order to persuade the countries to take part as
creditors and guarantors and also the stability
bond proposed for the longer run, ie for the
period beyond five years, by the Commission, which
also explicitly alludes to gold coverage.
I am more fond of thinking about the
bridge-financing idea, which is based on a
high-value collateral, namely gold. And I think
that, of course, gold comes to the agenda if Italy
comes again under financial stress and to the
forefront of the euro dilemma because Italy is a
country that suffers from a confidence crisis and
not of an insolvency crisis. And this is exactly
the case for implementing an additional
bridge-financing option and not a permanent fund.
The reason is that all the macroeconomic
data I'm aware of says that there's much wealth in
Italy available to cover foreign claims. They have
saved enough in the past, and also foreign debt is
not as high as in other countries. So, Italy is
clearly a case for gold-backed bonds, both from a
perspective of availability of gold collateral and
with respect to the character of the crisis.
One should remember that even the
ECB/ESCB, which consists also of the Banca
d'Italia, can attach conditions to their potential
gold transfers, such as the implementation of
structural reforms. Hence, Italy seems to be a
kind of ideal application of the gold-backed bond
solution.
LS: What do you
think are the implementation perspectives of
gold-backed bonds in general?
AB: Only a decade ago, it
appeared rather old-fashioned to ever suggest that
any investor would claim gold as collateral; in
the era of cyber finance, securities such as
treasury bonds tended to rule. However, over the
past few months, groups like LCH.Clearnet, ICE and
the Chicago Mercantile Exchange have to an
increasing extent begun to accept gold as
collateral for margin requirements for derivatives
trades. In addition, in summer 2012 the Basel
Committee on Banking Supervision issued a working
paper in which it suggested that gold should be
one of six items to be employed as collateral for
margin requirements for non-centrally cleared
derivatives trades, joint with assets such as
treasury bonds. [7]
Finally, Curzio
acknowledges that when [former Italian prime
minister] Romano Prodi suggested in 2007 that
Italy should use its gold reserve to pay the debt,
the reaction was negative. [8] The Italian finance
minister in 2009 wanted to tax gold and the
European Central Bank opposed the idea. Curzio
concludes that Italy at the moment has little
resources to invest in growth and should consider
asking Germany or any other Asian sovereign fund
for a loan with its gold reserve as collateral.
Rather, Curzio and Prodi suggest using gold
reserves as collateral for a bond. [9]
Much in the same vein, Giuseppe Vegas,
chairman of Consob, recently suggested a treasury
fund with the rating of "Triple A" collaterized by
the jewels of the state namely the shares of ENI,
ENEL, buildings, gold reserves and currency as an
instrument to reduce the interest payment on the
government debt. [10]
All these moves
taken together suggest to me that a creeping
change of attitudes is going on. This evolution
takes place less in terms of the desirability of
gold per se, but more through the growing
riskiness and undesirability of other allegedly
"safe" assets like sovereign bonds. This pattern
will probably not reverse soon. This is so
especially because markets long waited to see what
the ECB might really do after September 6 and,
after this date, whether Spain would be the first
case for outright market operations a couple of
months later.
Ansgar
Belke is Professor of Macroeconomics and
Director of the Institute of Business and Economic
Studies IBES. at the University of Duisburg-Essen
in Germany. Moreover, he was the Research Director
for International Macroeconomics at the German
Institute for Economic Research DIW., Berlin until
October 2012. 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. He is also an Associate
Fellow of the Centre for European Policy Studies
(CEPS), Brussels, a member of the professional
central bank watchers group "ECB Observer" and an
external consultant of the European Commission DG
ECFIN., Brussels. He successfully conducted
projects on behalf of the German Ministries of
Finance and of Labor and Social Issues. He was
visiting researcher at the IfW Kiel and OeNB
Vienna. Belke serves as the editor-in-chief of
"Kredit & Kapital", "Konjunkturpolitik -
Applied Economics Quarterly" and as a co-editor of
"Finance", "Empirica", "International Economics
and Economic Policy", "Vierteljahreshefte für
Wirtschaftsforschung", "Aestimatio - The
International IEB Journal of Finance",
"E-conomics" Kiel Institute of the World Economy,
and of the book series "Quantitative Okonomie",
Eul Verlag. He co-authored with Thorsten Polleit
the bookMonetary Economics in Globalised
Financial Markets, (Springer
Verlag).
Lars Schall is a German
financial journalist. (Copyright 2013 Lars
Schall)
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