Basel III Discussing Lifting the
Accepted Value of Gold on Commercial Banks Balance Sheets from 50% to 100%
Part of the side-lining of gold from the monetary
system was through either taxation on its sale (in some countries) or by
undervaluing it as an asset.
When the 2007
credit crunch hit hard, the loss in value of so many paper assets forced the
sale even of those assets that did manage to retain both value and liquidity.
Individual investors often sold gold, silver, and the like to cover margin
requirements that screamed to be topped up in the hope of retaining assets
that were losing value. That’s why asset values on so many fronts
declined so markedly. Even assets whose market fundamentals remained solid
were sold down only to recover when the storm passed. Gold and silver were
among those.
At banking
level, the pressure to go against investor logic was due to the regulations
of the system. With gold a Tier II asset in bank’s balance sheets, only
50% of its value could be credited as an asset to that balance sheet. So its real market value could only be given meaning when it
was sold. By selling gold and using the proceeds to buy Tier I assets, such
as Treasuries, the bank ensured that their balance sheets benefitted fully
from its value. Even when the gold price fell 20% it was worth selling, so
that at least 80% of its former [$1,200] value could be credited to the
bank’s balance sheet instead of just 50% [or 40% at the value after a
fall in the price of 20%].
As the value
of assets of various governments and potentially U.S. bonds are threatened by
over-indebtedness, commercial banks are left little recourse except changing
the situation by changing the rules for the banks. Hence, the current
discussions on its definition in the bank’s
balance sheets. If gold is redefined as a Tier I asset, then when any future
loss of asset value of paper assets occurs, there will be no need for banks
to sell gold to compensate for such falls. And, as gold has amply
demonstrated, the gold price is more than likely to rise in such situations,
proving to be a ‘counter to all paper assets’ on the bank’s
balance sheets.
Such a change
will do a great deal to remove the shock to the solvency of so many
commercial banks in credit crunches and the like.Will
the change happen? We believe so and expect this to take effect on January 1st
2013.
Why Clearing Entities Are Accepting Gold
as Collateral
LCH.Clearnet is a
clearing house for major international exchanges and platforms, as well as a
range of OTC markets. As recently as 9 months ago, figures showed that they
clear approximately 50% of the $348 trillion global interest rate swap market
and are the second largest clearer of bonds and repos in the world. In
addition, they clear a broad range of asset classes including commodities,
securities, exchange traded derivatives, CDS, energy
and freight. The development follows the same significant policy change from
CME Clearing Europe, the London-based clearinghouse of CME Group Inc.,
announced recently that it planned to accept gold bullion as collateral for
margin requirements on over-the-counter commodities derivatives. Both C.M.E.
and now LCH.Clearnet Group have decided to allow
use of gold as collateral from 28th August. It is likely that they
too have the same concerns about the possibility of another ‘credit
crunch’ and the danger forced asset sales can have on liquidity. They
too see the benefits of treating gold as money and collateral.
LCH.Clearnet Group Ltd. said it will accept
‘loco London’ gold [0.999 or 0.995 quality gold] as collateral
for margin-cover requirements on OTC precious-metals forward contracts and on
Hong Kong Mercantile Exchange precious-metals contracts starting Aug. 28.
‘Loco London’ gold is London ‘Good Delivery’ Bars
(roughly 400-ounce or 12.5 kilograms gold bar) held with LBMA members within
the London bullion clearing system. The clearing house has already been using
gold bullion as collateral since 2011 but now will accept ‘loco
London’ gold as collateral.
Additionally, Intercontinental Exchange
Inc. too has allowed the use of gold as collateral. LCH.Clearnet
limited the amount of gold that could be used as collateral to no more than
40% of the total margin cover requirement for a member across all products
and at a maximum of $200 million, or roughly 130,000 troy ounces, per member
group. David Farrar, Director, LCH.Clearnet said at
the time that “market participants want greater choice when it comes to
assets that can be used as collateral. Gold is ideal; as an asset it
typically performs well in times of financial stress, remains liquid and has
a well-established pricing mechanism.”
Thus the commercial banking system is
and has prepared to treat gold as full-bloodied money because of its
invaluable liquidity virtues and its acceptability even under pressure.
We believe that the markets have yet to
catch up to what’s going to happen. But the current gold price breakout
is not because of this aspect of gold; it’s because of both Technical
and seasonal factors. When gold is a Tier I asset and commercial banks appear
in the market place, then the gold market will also see a new driving force
behind the gold price. There is still a considerable distance to go before
the gold price really does discount these potential changes.
In summary, the banking system, overall,
is moving toward where gold will be an active, confidence-building monetary
asset.
Will ‘Powers that Be’
Continue to Allow Citizens to Own Gold?
With gold
moving back to such a pivotal position in the monetary system, won’t
the private sector interfere with the ‘stability’ of the gold
market, chasing its price up just as the Hunt Brothers tried to do in the
days of yesteryear? This is possible, but this time the gold price will not
be at a fixed price as it was under the gold standard. By
‘floating’ the gold price, every time it rises in price, it will
benefit bank’s balance sheets and liquidity levels, countering volatile
markets. The reverse is true if the gold price falls and other assets rise in
value as the markets seems to believe will be the case.
Overall there
will be a ‘value anchor’ as Mr. Zoellick, the last head of the World Bank, advocated last
year.
If these
changes are instituted, there is a danger of interference in the gold market
price by the public, but on the upside not the downside. After all, it will
be in the interests of the monetary system to see higher gold prices rather
than lower prices that the powers-that-be
appeared to want between 1985 and 2005. But they will want to see a level of
stability consistent with that of currencies and other monetary assets in
that situation. Their desire for this can be overwhelming, as we saw in 1933
when U.S. citizens were banned from holding most forms of gold in the
interest of the nation’s monetary system. It was not until 1974 that
they were again permitted to do so; however, this permission came with the proviso that owning gold from then on
was a “privilege, not a right” as though to warn us all that
things could change again. Even though governments attempted to write gold
out of the system, they made it clear that they considered gold as part of their
domain.
This is a real
danger and one that should not be overlooked by us all in all the nations of
the world. Any government that feels it is in their interests to take their
citizen’s gold will do so even if it means changing their laws.
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