By Julian Phillips, June 3, 2011
The implications of the acceptance of gold as collateral are seen as extremely significant – particularly in the context of the Eurozone debt crises.
If gold were generally accepted as collateral in global monetary dealings, would we see it used as such? Strangely enough -No! In certain transactions, however, where no other collateral -whether currencies, government bonds and the like-is used, gold may be used, as a last resort.
There has been a very long history of gold being sought as collateral, but only the most desperate of debtors has allowed their gold to be used as such. Government bonds are easier to produce and are limited only by market confidence. Moreover they remain in the jurisdiction of the issuer, leaving the issuer in control of them. Gold is different and can only be used once, held outside of the owner’s jurisdiction. Control is therefore lost. It cannot be printed and becomes a complete commitment by the owner to honor his obligations.
So why is gold as collateral such an important step for gold in the global monetary system?
THE LATEST MOVES
Last week, the European Parliament’s Committee on Economic and Monetary Affairs agreed to allow central counterparties to accept gold as collateral. Once ratified, we would see gold redefined as a highly liquid asset under the Capital Requirements IV Directive, due in June from the European Commission.
This is not the first time gold has been accepted as collateral. Late in 2010 ICE Clear Europe, a leading European derivatives clearing house became the first clearing house in Europe to accept gold as collateral. In February of this year JP Morgan became the first bank to accept gold bullion as collateral. The Chicago Mercantile Exchange is now accepting gold as collateral for certain trades and the London-based clearing house LCH Clearnet has said it also plans to start accepting gold as collateral later this year subject to regulatory approval.
Despite comforting words from the U.S. the Eurozone, government debt is being regarded with somewhat less enthusiasm than in the past. Both monetary zones are experiencing awful problems regarding their debt, particularly on the international front. A look at the Mediterranean members of the E.U. shows nations either unable to repay their debts or on the brink. This makes their debt dubious collateral. The sight of the E.U. wanting to control taxation -sell state owned assets on condition that more funds are poured into the country-is really what happens when an individual is liquidated (sequestrated). It’s nothing short of that. Will Greece accept this without some dramatic moves? If Greece had lost a war, then this is what the spoils would be. That is certainly how the Greek people will see it.
ARE DEBTOR OBLIGATIONS MORE IMPORTANT THAN NATIONAL SOVEREIGNTY?
The answer to this big question is not as apparent as it seems….
If they are at the very least social unrest is likely, which in turn will further damage one of their main sources of revenues, tourism. But Greek voters are aware (as much as their government is aware) that Greece retains jurisdiction over Greek assets in Greece. It is their decision, not the E.U.’s.
Other potential reactions may include…
- A refusal to accept anything but a 50% write-off of debt and leave the banks to sort themselves out.
- Leave the E.U. with the obligations unmet or a massive extension to the maturity dates made by the Greek government.
- The reinstatement of the Drachma and make holidays in Greece very cheap, as inflation takes off, euro prices drop and Greece experiences a boom in Tourism.
No doubt the Greeks are weighing up all these options and will do what serves Greek interest best in the end. Let’s glance at the dominant principles that will guide the process in the days and weeks ahead.
On the banking side, the concept of debt re-scheduling is unacceptable because it would reduce the asset base of the banks and undermine their solvency. The extension of debt and lowering of interest rates would overcome that problem, but it is paramount that the debt be repaid eventually, in a manner that an impoverished Greece can bear. The sell-off of state-owned assets will reduce state revenues and likely cause a tremendous amount of employment cutting (as the operations are made profitable) which will exacerbate the situation. The severity of a new debt package will hurt Greece and ensure that its economic woes last for up to a generation.
On the Greek side the principles of democracy demand that Greek government act in the interest of the voting public. This means that they must assess whether the solutions are acceptable to the Greek public. If they lead to the nation’s impoverishment for a generation then the Greek public will not accept them. A pragmatic assessment of the worst of the two situations must be made, an onerous set of repayments, or
The loss of financial credibility in the E.U. and the ejection of Greece from the E.U. (might be the lesser evil)
Such an isolation of the country may raise employment and improve tourism just as sanctions in relatively developed nations often produce a boom. Whatever the outcome you can be sure that politicians will follow voter’s first, ahead of banking requirements.
Whatever happens, it will prove very bad for the E.U. and the euro. Would you accept their debt as collateral? Unlikely! What’s worse is that any attempt to seize Greek assets without their approval may see Greece take itself out of the Eurozone. Would the E.U. actually invade to take Greek assets in payment of unpaid debts? A write-off of a good portion of what’s owed may be a disaster, but it may well be the only option left.
This may well prove to be a battle of ‘bankers’ against democracy!
Of critical interest to the gold markets is the sight of Greek gold. Greece currently owns 111.5 tonnes of gold in its reserves [79.3% of its reserves] which can be taken out of its reach and into the hands of creditors. The sale of its government-owned assets to private hands under the pressure of distressed finances may well not achieve anywhere near their value. Would the Greek government pay the proceeds across to creditors immediately? Their gold has far more value than its current market price.
But has it already been used as collateral in a Bank of International Settlement deal where it was swapped for foreign currencies? Last year the B.I.S. undertook many gold/currency swaps in mysterious, undisclosed situations. Were they tied to the bailouts? There will be no more devastating a blow to Greece’s financial credibility than a disclosure that the gold has already gone. It’s equivalent to the family jewels being sold off. And that is gold’s value, not its market price!
The current gold price is irrelevant to the repayment of debt. 111.5 tonnes is worth only $5.5 billion, which barely scratches the surface of Greece’s $350 billion debt. In a situation where monetary values are collapsing (the U.N. has just issued a report in which they state their fears of a U.S. dollar collapse) the gold price will leap to levels where national debt becomes relatively easy to repay and certainly worth all the promises a government can make at that time. Gold in extreme situations adds considerable credibility and value to any debt situations, way beyond its market price.
If the gold is there, then Greece would feel that it is the one asset which they can use when all credibility is lost. That’s why central banks hold so much gold in the first place! If Greece were to leave the Eurozone then Greece might have a chance, with their gold, to transition into a more prosperous country.
OTHER COUNTRIES IN DISTRESS
A look at the other debt-distressed nations that have received a bailout or may want a bailout…
- Ireland has only 6 tonnes of gold in its reserves, which (in current prices) is worth only $296 million. Ireland needs far more to solve its debt problems. The gold would be symbolic of the nation’s family jewels. The cleverest move Ireland has made was to insist on its low Corporation Taxes being maintained because this will allow much higher revenues to be achieved.
- Portugal is in a different category. It has 382.5 tonnes of gold in its reserves which has a current market value of $18.9 billion, which would make a significant contribution to their debt situation.
- Spain has 281.6 tonnes, whose value at current prices is worth $13.9 billion which again would make a significant contribution to its debt repayment.
- Belgium has 227.5 tonnes with a current market value of $11.2 billion.
- The U.K. has 310.3 tonnes of gold remaining in its vaults. This is worth $15.3 billion.
- Italy which has just come under the ratings agency’s spotlight holds 2,541.8 tonnes of gold in its reserves. This is worth $121 billion at current values.
- With the U.N. placing the U.S. dollar in the potential collapse category a glance at the published level of gold reserves shows that it holds 8,133.5 tonnes of gold, worth $4.01 trillion at current prices.
- What if the crisis spread and the E.U. gold reserves at the E.C.B. came under threat? Its gold is 502.1 tonnes valued at today’s prices at $24.78 billion.
Having showed these figures to you, we must stress that such gold reserves will only be used if there are no alternatives. It is a last resort asset, which when gone leaves the nation (almost) out of the international arena and in an (almost) isolated position. In some cases this may prove a good thing. An extreme example of this was seen when Rhodesia had international sanctions placed against it. It thrived, as all the imports had to be substituted for the local equivalents. South Africa, in the face of sanctions, also thrived. So you can be sure that some nations will be tempted to default rather than sacrifice their gold reserves.
As we said above, they may well have been pledged already via the gold/currency swaps last year and the current acceptance of gold as collateral is simply preparing the way for the publication of deals after the event.