The BIS 382 tonne Gold Swap - Good or Bad for Gold and Why?
Background
In its 2010
annual report, the Bank of International Settlements said that "gold,
which the bank held in connection with gold swap operations, under which the
bank exchanges currencies for physical gold," stands at 8,160.1 million
in special drawing rights, equivalent to 346 tonnes this year, up from nil in
2009." Apparently this amount has now climbed to 382 tonnes since the
report was issued.
Swaps - What are they and who does them?
Swaps are
financial instruments that allow for the exchange of one asset for another,
in this case, gold for currency. They are not gold leasing, futures or
options [which the 1999 and 2004 Central Bank Gold Agreement states would not
be increased - The 2009 did not contain the statement]. Swaps could be
undertaken by the signatories of the CBGA. as these were not included in any
of the three Agreements.
Gold swaps are
usually undertaken between central banks: One central bank exchanges foreign
exchange deposits (or other reserve assets) for gold with an agreement that
the transaction be unwound at an agreed future date, at an agreed price.
The monetary
authority acquiring the foreign exchange will pay interest on the foreign
exchange received, the rate of which is currently very low. Gold swaps are
usually undertaken when the cash-taking central bank may want foreign
exchange but does not wish to sell outright its gold holdings.
The Wall Street
Journal informs us that the B.I.S. did these swaps with commercial banks. We
know of no commercial bank that has 382 tonnes of gold on their books. It is
likely then that should these commercial banks have been in the deal, they
would have been acting for a central bank [or several over time] who wished
to remain anonymous.
The B.I.S.
received the gold into its safekeeping for the nation that required the
foreign exchange for the swap period. Swaps of this nature are renewable once
the time runs out, so it is impossible to say how long the swap will last
for. The central bank that undertook the swap would have to be certain that
it could return the currencies to get the gold back at some point in the
future. If that country defaulted, then and only then could the B.I.S. go
ahead and sell this gold. Any sale in the open market would be trumpeted
loudly to all as well as reported in the Press or by the World Gold Council,
B.I.S. or I.M.F.
Why use gold and not currency?
The financial
crisis has led to a decline in the number of credit-worthy counterparties and
a reduction in credit lines these counterparties can offer. This is
significant in a world where credit risk and debt problems have been the
subject of banker's fears since the appearance of the Greek debt crisis. For
someone in the trouble Greece is, gold swaps allow a central bank's reserves
to be lent in a credit-secure fashion. In other words, a gold swap
allows the lender of currency to benefit from greatly reduced credit risk, as
the gold can be held in an allocated account, usually at the Bank of England.
The currency deposit is secured with gold throughout the life of the deposit.
Any country such
as Ireland, Portugal, Spain, Italy, the U.K. and the U.S.A. can follow this
route. Yes, sales may not be permitted for fiscal reasons under
Eurosystem rules, but these are not sales, but swaps. So, of the utmost
importance is just who swapped this gold? Could it be one of the countries we
just mentioned? If so, their situation is far graver than previously thought.
The implication is that the collateral they offered just wasn't good enough,
so they had to use their gold. This is major news for the monetary system.
The Significance of the Transaction[s]
What is
significant about this or these transactions is that gold is being used in
international settlements after so many decades of being sidelined in the
monetary system! The transaction itself confirms that gold is being used in
international settlements, which is a dynamic confirmation of gold's return
to the monetary system. A "Swap" might be the first desperate step
in such a transaction with the swapping bank hoping to repay the foreign
exchange, but should it fail, the B.I.S . would have to decide either to keep
the gold on its books or to sell it. Again, keeping it on its books is part
confirmation that gold is active again on the monetary system, a big boost by
itself!
Gold is back and
alive in the monetary system!
What appears to
have really happened is that one nation or more needed foreign exchange to
counter some shortfall in its accounts and raised these funds as a short-term
liquidity measure, believing that it would be able to return the currency and
receive its gold back. The gold would then be returned at the conclusion of
the swap period in return for the currencies swapped. If it fails to return
these funds to the BIS, then the BIS could discreetly place the gold with
another central bank, should it not want to keep the gold. If it did so, the
BIS would simply report its disposal of the gold, the originating central
bank would report the drop in its gold reserves and the gold buying bank would
report its increase in the reserves.
This puts the
transaction into an entirely different category. It seems that one or more of
the developed world's central bank's credit is not good enough for other
governmental institutions. If word got out as to which this country is, then
the financial markets would go into quite a spin, shaking the global
financial system to its core. No wonder the B.I.S. is keeping such a low
profile!
Julian
D. W. Phillips
Gold/Silver
Forecaster – Global Watch
GoldForecaster.com
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