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When the euro was launched, the European Central
Bank (ECB) held approximately 15% of its assets in gold. That ratio has
remained reasonably stable, giving rise to a variety of chatter, including
suggestions that it may displace the U.S. dollar. We pursue the question on
whether the ECB’s gold holdings are an accident or strategy.
 
Let’s look at
the numbers. Below is a chart depicting the percentage of gold relative to
the ECB’s total assets. As one can see, the
percentage has remained reasonably stable despite a significant growth in
total assets.
Total assets of a central bank may be considered a
proxy for the amount of money that has been “printed”; it’s
a crude measure as it does not reflect physical money printed; nor does it
reflect money in circulation; neither does it reflect sterilization
activities that also show a rise in assets. Still, a central bank balance
sheet is often referred to as the printing press as money is literally
created out of thin air (by the stroke of a keyboard) when assets are
purchased. Federal Reserve (Fed) Chairman Bernanke has referred to this fiat
money feature as the printing press. We like to think of it as super-money,
as central bank purchases provide cash to the banking system, allowing them
to lend a multiple of the money that has been “printed”. While
banks have been reluctant to lend (the velocity of money has been low), the
analogy we like to give is that if you give a baby a gun, just because no one
gets hurt does not mean it is not dangerous. That said, let’s look at
total assets at the ECB:
The interpretation shows that while money can be
printed, wealth cannot be created out of thin air: as money is printed, gold
has appreciated versus the euro. So while inflation has not shown up in
indicators such as the Consumer Price Index, monetary easing is rightfully
reflected in the price of gold.
Diving a little deeper to determine how much of this
is strategy versus accident, let’s look at the gold holdings at the ECB
once more:
The ECB marks its gold holdings to market, i.e. uses
market prices for gold. The ECB was selling gold from the inception of the
euro until the onset of the financial crisis; since then, the ECB’s
gold holdings have remained stable. To understand the motivation, one needs
to note that when one refers to ECB gold holdings, one is actually talking
about Euro area gold holdings. While the ECB holds some gold, most gold is
held by the respective central banks (this is not a discussion of where such
gold is physically located):
Relevant is that each
nation in the Eurozone pursues its own agenda with regard to its gold
holdings. Germany has resisted political pressure within Germany to sell gold,
as Bundesbank (Buba)
profits would need to be transferred to the government; the hawkish Buba has indicated that it would be considered selling
gold to help finance the government’s deficit. Italy, as one can see,
has not sold any gold. Conversely, as a percentage of their holdings, the
Netherlands had been rather eager to sell gold up until the financial crisis;
Portugal, too, was an aggressive seller. As one can see, gold sales are not
particularly related to the financial health of a Eurozone nation, but more
to the cultural attitude in the respective nations towards gold.
Let’s cross the
Atlantic to see whether the ECB’s gold strategy is undermining the U.S.
dollar. The Fed’s gold
stock is valued at $44.22
per fine troy ounce. For purposes of the chart below, we adjust the
Fed’s gold holdings to market prices:
Note that the chart
above starts in 2006, so as to focus on the period of the financial crisis.
The Fed has been more aggressive than the ECB in printing money. As such, the
percentage of gold in relation to total holdings has declined at the Fed in a
more pronounced fashion. There is clearly no perfect relationship between the
size of the balance sheet and the price of gold, as other factors also
influence the supply and demand of gold; however, increasing the supply of
fiat money (dollar, euros) may decrease its value when measured in real
assets, such as gold. We have in the past referred to the Fed as the champ in
printing money (as measured by the percentage balance sheet growth since
August 2008), although the Bank of England has, as of late, taken on that
title. But we digress.
From what we see,
central banks have been scared into holding gold since the onset of the
financial crisis. Beyond that, we don’t see an active strategy at the
ECB to keep its gold reserves at 15% of total assets. Instead, the
ECB’s comparatively measured approach has simply lead to a reasonably
stable percentage of gold reserves. Of course that was before ECB President Draghi said on July 26, 2012, that he shall do
“whatever it takes to preserve the euro.” (an
interpretation of that may be that more money printing is on the way). For
now, the cultural differences in responding to the financial crisis (Europe:
think austerity; US: think growth) suggest that the euro should outperform
the U.S. dollar over the long term, assuming the not-so-negligible scenario
of a more severe fallout from the Eurozone debt crisis won’t
materialize.
It may help to keep
in mind that historically inflation is the response to a deflationary shock.
If market forces were left to themselves, we believe the credit bust of 2008
would have caused a major deflationary shock. It’s the reaction of
policy makers that fight market forces that may lead to inflation. Bernanke
as of late brushed off such pessimism. As the charts above show, however,
gold has been a sensitive – and sensible I might add - indicator to the
trigger-friendliness of our central bankers.
Axel Merk
We have long argued that investors may want to take
a diversified approach to something as mundane as cash. Please sign up to our
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