On New Year's Eve I dubbed 2011 "Year of the
RPG" in deference to Robert Zoellick's recent
editorial in which he described gold as "a key reference point to allow
people to assess the relations between different currencies." This
description was so close to Freegold that Zoellick's FT editorial led us to an additional name,
"Reference Point Gold" or Freegold-RPG.
Throughout the year I posted "RPG Updates" every time the ECB
published its quarterly Consolidated Financial Statement for the Eurosystem in which it revalues the system's reserves to
market value denominated in its own currency, the euro. Such "marked to
market" (MTM) revaluation is an important first step in allowing gold to
be "a key reference point to allow people to assess the relations
between different currencies." Here are the links to my first three
There has been some confusion about the details and the relevance of this
quarterly, system-wide or consolidated revaluation of reserves and the ECB's
role as the system's aggregator. In the beginning, each participating country
had to "buy in" to the system with a specified, euro-denominated
value of foreign currency/gold reserves.
On April 18, 1998, eight months before the launch of the euro, ANOTHER
explained that the idea of any gold being part of the initial buy-in
had been a recent development. He wrote that it was initially discussed that
gold would be only 5% of the buy-in, but that the BIS had decided that making
gold 15% to 30% would render a euro that was stronger in oil. Less than three
months later, on July 8, 1998 at a press conference, Willem Duisenberg, President of the ECB, announced the final
Ladies and gentlemen, the Vice-President and I are
here today to report on the outcome of the second meeting of the Governing
Council of the European Central Bank held yesterday.
…The Governing Council decided on the size and form of the initial
transfer of foreign reserve assets to the European Central Bank from the
national central banks participating in the euro area. This transfer is to
take place on the first day of 1999. It has been decided that the initial
transfer will be to the maximum allowed amount of EUR 50 billion, adjusted
downwards by deducting the shares in the ECB's capital subscription key of
the EU central banks which will not participate in the euro area at the
outset. The transfer will thus be equal to 78.9153% of EUR 50 billion, i.e.
approximately EUR 39.46 billion.
The Governing Council furthermore agreed that this initial transfer should
be in gold in an amount equivalent to 15% of the sum I have just mentioned,
with the remaining 85% being transferred in foreign currency assets. I should
stress that the decision on the percentage of gold to be transferred to the
ECB will have no implications for the consolidated gold holdings of the ESCB.
The precise modalities of the initial transfer will be finalised
before the end of the year.
Before the end of the current year the Governing Council will also have to
adopt an ECB Guideline pursuant to Article 31.3 of the Statute of the ESCB,
which will subject all operations in foreign reserve assets remaining with
the national central banks -including gold - to approval by the ECB.
In connection with the setting-up of common market standards, the Governing
Council also reached agreement on a number of issues related to the quotation
and publication of reference exchange rates for the euro. Specifically, it
was agreed to recommend to market participants the "certain" method
for quoting the exchange rates for the euro (i.e. 1 euro = X foreign currency
units) and to have daily reference exchange rates for the euro computed and
published by the ECB.
It should be noted that this initial transfer was not a surrender of assets
to a third party central bank, but instead it was a buy-in, a purchase of
equity in the system itself. So while a country might have contributed 8% of
the ECB's gold, that country now owned 8% of the interest in the system. And
being part of a system, that country also agreed to all operations in foreign
reserve assets, not just those transferred to the ECB, being centrally
coordinated by the system aggregator, the ECB.
So all this early talk about "gold backing" and various
percentages—5% or 15% or 30%—turned out to be quite confusing in
the beginning. Soon after the very first quarterly revaluation one astute
reader asked FOA about it:
Goldfly (5/8/99; 22:04:55MDT - Msg ID:5787)
FOA - 15% backing?
Actually, it looks like they're at 30%
From the Eurosystem Weekly Financial........
Asset 1 Gold: 105,323
Banknotes in Circulation: 332,280
Asset 1/Liability 1 = 31.69
$1000 gold would equal 100% backing(!?!?!)
22:24:54MDT - Msg ID:5790)
Goldfly (5/8/99; 22:04:55MDT - Msg
FOA - 15% backing?
Hello again. Truly the ECB percentage as a number does not mean much at this
time. It's the concept that is 180 degrees against the IMF / dollar system.
For anyone to measure the value of Euro backing at present,
is like looking at gold at today's price. It's out of context.
The beauty of the ECB ploy, is that it doesn't lock
them into a rigid gold exchange standard. With gold trading in the open, all
currencies are free to be exchanged for gold at any given point in time. The
old IMF / dollar manipulation of gold, used from the early 70s gained nothing
and cost the world dearly for the benefit of the fictional US living standard
it created. Had they just allowed gold to rise from the beginning, commerce
would have been much more balanced, nation to nation.
Prior to the Euro, Europe had to play the IMF game. The same game that has
now backfired on the US today. They truly don't need the IMF and may pull out
Now there is an interesting note in this exchange to which I would like to
draw your attention. Goldfly was erroneously
looking at the consolidated value of Eurosystem
Central Bank gold versus the total number of euro bank notes. This is not
what we look at, and it is not even particularly relevant since they aren't
running a "rigid" (as FOA called it) Bretton Woods-style gold
standard, but what Goldfly observed at 31% in 1999,
has today grown to 50%.
We don’t look at the gold on the asset side of the balance sheet versus
the euros on the liability side. And we also don't look at the present value
of only the subscription fee to the system, the reserves held by the ECB
itself. We look at the aggregate reserves for the Eurosystem
as a whole (lines 1 and 2 on the asset side only) and how the proportion of
gold in those reserves has evolved over time.
On a CB balance sheet there is a distinction we can make between assets in
general and those assets that qualify as reserve assets. At the central
banking level such as the ECB, its institutional liabilities largely take the
form of issuance of currency banknotes and deposits held on behalf of
commercial banking institutions (such as those being held to meet a
commercial bank's reserve requirements, and to facilitate check-clearing
between institutions) which are denominated in its own domestic monetary unit
(i.e., the euro.)
The requisite assets to balance against these liabilities are largely in form
of euro-denominated claims on commercial credit/banking institutions. As
these claims are often collateralized by government bonds, at the very end of
the rope it is fair to say a large portion of assets held by the central bank
take the form of government bonds even though they were (largely) acquired
indirectly through typical financing operations to extend credit to the
These euro-denominated claims (assets) are suitable for offsetting
euro-denominated liabilities, but they do nothing in regard to your rare
"rainy day" when it is found necessary to defend the euro's stature
against its foreign peers. For that purpose a central bank needs to have
either gold (which is a universal asset) and/or a position in foreign
currency claims against non-resident (foreign) institutions. It is this
combination of gold assets and foreign currency assets that constitute the
official "reserves" of a central bank.
The proportion of RESERVE assets among the central bank's TOTAL assets is
normally a judgment call. Generally, the more unstable or insecure a central
bank deems its national government and economy to be on the world stage, the
larger the proportion of assets it will hold in the form of reserves. (Recall
the expansion of reserves among Asian countries following the 1997 Asian
And regarding the make-up of the reserve assets specifically, it is
ultimately a central bank's own internal management decision that determines
what proportion of reserves are in the form of gold versus foreign currency.
At launch, January 1, 1999, the make-up of the Eurosystem's
reserves was 30% gold and 70% foreign currency claims on non-euro area
residents (mostly dollars, in fact, probably mostly US Treasuries left over
from supporting the US trade deficit for 20 years to buy the time necessary
to launch the euro).
In addition to the distinction I just explained, another key definitional
aspect of CB reserves is that they are "readily
available to and controlled by monetary authorities for
direct financing of payments imbalances, for indirectly regulating the
magnitude of such imbalances through intervention in exchange markets to
affect the currency exchange rate, and/or for other purposes… the
concept of reserve assets should encompass those assets over which
authorities exercise direct and effective control."
(my emphasis, quote from the IMF BOP Manual)
So aside from being either gold or foreign currency-denominated claims on
non-residents, the two main criteria for an asset to qualify as reserve
assets for central banks are availability and control. This
official definition ought to translate loud and clear into an
institutional preference for in-house physical gold holdings over the
alternatives. (After all, try to truly consider and assess the concept of
"control" insofar as it applies to an asset defined as a mere
"claim" on a foreign entity denominated in a foreign monetary unit!
Does anyone remember Nixon?) That we have not yet fully attained this
operational reality despite the logical preference for it is what our
long-winded discussions regarding the slow evolution from dollar-centric
toward Freegold tries to explain in a rational
There is one other nuance in CB reserve reporting standards that I should
mention. The reason the ECB makes its "net position in foreign
currency" (claims minus liabilities regardless of residence) so
prominent in the commentary portion of its ConFinStats
is explained in Chapter III of the ECB's Statistical Treatment (Oct. 2000):
"Since the monetary crises which took place in
most of the Asian countries in the late 1990s, international organisations have gradually become more concerned with
the availability of reliable information on the capacity of a country to
contend with potential financial crises. Consequently, the IMF ... requires
additional details on international reserves and other foreign currency
claims and drains from those presented so far in international standards,
addressing, for the first time, the compilation of figures on reserve-related
In other words, taking the liability side into account for the "net
position in foreign currency" came into vogue thanks especially to the
experiences of the Asian contagion crisis wherein it was shown how quickly
and easily a nation could be stressed by its liabilities denominated in
foreign currency. So the net position in foreign currency is now a
fundamental part of any CB's overall Health-O-Meter. And so with this view in
mind, it is clear that a value shift away from foreign currency reserves
toward gold, the universal reserve asset, is also a shift in the overall quality
of a portfolio.
But the strict definition of reserve assets within the Eurosystem
is simply the GROSS total of the qualifying asset items and
foreign-denominated claims on non-residents of the euro area as summed from
the asset side of the balance sheet, without any further adjustment for items
on the liabilities side. In other words, the official reserves are calculated
through the simple addition of asset items #1 plus #2, which is what I use in
The De Facto Ascent of Gold
It is a common misconception that any retreat from dollar-denominated CB
reserve assets would, in itself, destroy the value of the CB's portfolio of
reserves. This canard is often used by the anti-gold financial media to
explain the dollar's apparent strength, claiming that the world is trapped in
perpetual dollar use by the existence of its humongous dollar reserves. Here
is Randy Strauss from my post Gold: The Ultimate Hedge Fund:
[article] ...Even in light of all of this shifting
by central banks into other currencies, the dollar still comprises 2/3 of
global reserves and attempts to shift away from the dollar would destroy the
value of central banks’ portfolios.
Although I should be well used to it by now, it still amazes me every time I
see comments like the final remark here regarding any significant shift from
dollars will lead to the destruction of central banks’ portfolios.
It’s almost as if the commentator is trying to help indoctrinate a
paralyzing fear as a means to prevent any such attempt on the part of the CBs,
and to also create enough grass-roots doubt against such an attempt ever
being made that we the people won’t perceive any benefit in trying to
front-run with our own flight out of dollars and into gold...
It is an error in thought or judgment, however, to believe that a
“destruction” of the dollar portion of the portfolio would
therefore proportionately destroy the portfolio as a whole. That would only
be the case if all other things remained unchanged, but life seldom works out
so neatly as that. Sometimes an action can set forth
an immediate chain reaction that literally changes EVERYTHING you thought you
knew about the situation!...
In the world of the “new normal,” it is indeed possible (and
someday soon desirable) to let the fuse be lit and allow the CB store of
dollars be consumed. And to be sure, it is singularly the latent potential
energy of the gold component that allows us to make this analogy with
gunpowder. The natural chain reaction in the tiny open market for physical
gold would immediately bring to bear massive “heat” and
“pressure” upon its price… **POW** thus swelling the
“volume” of its value relative to all other things. So even
without radical changes to the quantity of physical holdings, a simple
expansion in golden value will more than compensate the average portfolio of
the central banks against the destruction of the dollar component.
Still can’t wrap your head around it? Bear in mind that the gold price
is not a simple one-to-one inverse relationship with the dollar. There is a great
leverage lurking in there, but it has been largely masked by the artificial
abundance of paper gold which weighs down upon the equilibrium price. And
even so, since 2002 the dollar value has decline by just 20% on a
trade-weighted basis, whereas the gold price has responded with a 300% gain.
And the moreso that the public and private parties
of the world rightly gravitate toward physical gold instead of the illusion
of paper derivative gold as the solid foundation of their savings and
diversifications, the moreso you will see this
price leverage grow in favor of larger multiples of gold price gains against
modest dollar losses....
Central bankers will increasingly prefer gold reserves over the paper
reserves created by other countries. Not only for the reasons of
reliability/trust as cited in this article, but moreso
because in choosing predominantly gold over foreign paper for central banking
reserves will give those various national monetary officials an improved
degree of latitude in their pursuit of an independent monetary policy.
WITH gold reserves, a central banker in a vibrant national economy can choose
to enjoy a strong currency relative to gold, but, importantly, it can still
alternatively choose to exercise loose monetary policy (for economic or
political reasons) in which its currency is made weak as measured relative to
gold. But regardless of choice for the relative strength or weakness of the
national currency, the abiding benefit of choosing gold reserves is the
superior stability — the systemic strength against procyclicality
— that gold offers to the asset side central banking balance sheet.
WITHOUT gold reserves, pursuit of a national currency policy that is
(according to their preference) generally strong OR generally weak is made
less expedient either way because the health of the central bank’s
balance sheet is subordinated to the quality of its foreign paper reserves
which are themselves subordinated to the particular monetary policies being
pursued by those foreign governments. Generally this structure of foreign
paper reserves offers only the option for national monetary weakness built
upon other international weaknesses, and worst of all it exposes the national
monetary balance sheet to procyclical systemic
failure — a domino whose fate is written largely in the hand of its
When you understand how it is that it is economically (and therefore
politically) undesirable for other major currencies to appreciate against
their peer currencies (which is exactly what would happen to any currency
replacing the dollar’s reserve status), you will subsequently know why
gold shall continue to emerge as the de facto solution to the
international reserve question.
And here I emphasize de facto rather than de jure because this has
become a global phenomenon driven by a natural evolution (survival and
ascent of the fittest) and does not require any additional international
treaty or enabling legislation as a prerequisite or for motivation.
The breeze is fair and the road ahead is clear for the ascent of gold.
From my post Your Own, Personal, Freegold,
here's how the leverage in gold as a reserve asset behaves. This is
what the Eurosystem's quarterly MTM parties reveal,
and it can work on an individual level the same as it does for central banks,
thus the title of my post. BTW, the pivot point in these illustrations is the
physical plane of real goods, real services and real world capital:
Whoop There It Is
And now let's have a quick look at the results of the latest MTM party:
In the week ending 30 September 2011 the increase of
EUR 56.8 billion in gold and gold receivables (asset item 1) reflected
quarterly revaluation adjustments.
The net position of the Eurosystem in foreign
currency (asset items 2 and 3 minus liability items 7, 8 and 9) increased by
EUR 13.2 billion to EUR 191.1 billion. This change was due to the effects of
the quarterly revaluation of assets and liabilities, the customer and
portfolio transactions carried out by Eurosystem
central banks during the period under review and US dollar
Quarter-end revaluation of the Eurosystem’s
assets and liabilities
In line with the Eurosystem’s harmonised accounting rules, gold, foreign exchange,
securities holdings and financial instruments of the Eurosystem
are revalued at market rates and prices as at the end of each quarter. The
net impact of the revaluation on each balance sheet item as at 30 September
2011 is shown in the additional column “Difference compared with last
week due to quarter-end adjustments”. The gold price and the principal
exchange rates used for the revaluation of balances were as follows:
Gold: EUR 1,206.399 per fine oz.
USD: 1.3503 per EUR
JPY: 103.79 per EUR
Special drawing rights: EUR 1.1564 per SDR
In other words, the decade-long trend continues, even in the face of all that
"dollar strength." Last quarter gold made up 62.7% of the Eurosystem's reserves. This quarter it rose to 65% of the
reserves. This is especially remarkable given not only the dollar's recent
"strength" which accounted for most of the rise in currency reserves,
but also the dramatic price plunge in gold just a week before the party.
You'll find much more on the Euro-MTM/Freegold-RPG
model in the earlier "Updates" listed at the top as well as the
other posts I linked including this one: Gold: The Ultimate Wealth
Don't make the mistake of assuming central bankers are stupid, or anti-gold,
or that they are not fully aware of the concepts and principles I am writing
about. When I write about the "logical preference" for gold, or the
"de facto ascent of gold" to global IMFS reserve asset par
excellence status, or gold as "the de facto solution to the
international reserve question," these are logical, de facto realities
of which central bankers are acutely aware. So when you hear them talking
about complex solutions requiring massive[ly
unlikely] global cooperation, new international treaties and enabling
legislation, realize that they are talking about ditching the dollar in the
most diplomatic terms they can, and then recall Randy's words:
When you understand how it is that it
is economically (and therefore politically) undesirable for other major
currencies to appreciate against their peer currencies (which is exactly what
would happen to any currency replacing the dollar’s reserve status),
you will subsequently know why gold shall continue to emerge as the de facto
solution to the international reserve question.
And here I emphasize de facto rather than de jure because this has become a
global phenomenon driven by a natural evolution (survival and ascent of the
fittest) and does not require any additional international treaty or enabling
legislation as a prerequisite or for motivation.
The breeze is fair and the road ahead is clear for the ascent of gold.
And after you think about it for a while, maybe you'll start to understand
why gold was the asset chosen to occupy the #1 spot on the Consolidated
Financial Statement of the Eurosystem, and why this
is a key driving force (along with impartiality and systemic stability)
behind the evolution to a 90+% gold proportion of reserves in the new
international "Freegold-RPG" monetary
system. And then, as Randy suggested above, you might want to front-run the
CBs with your own flight out of dollars and into gold. Randy ended with this,
and so will I:
"Again, on average the central banks have 10%
gold. The ones who have less are scrambling. How about you? Do you have
enough gold to put a suitable *BANG!* in your portfolio?"
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