Gold vs. Central Bank Policy Man
By Adrian Ash
June 19, 2007
As comic-book superheroes go,
central bank policy makers look a bit weedy...
IS IT A BIRD? Is it a plane? Or is it a central
banker wearing his underpants over his trousers...?
As comic-book super heroes go, these mild-mannered
scholars would most likely admit that they look a bit weedy.
The massed policy makers of the US Fed and Bank of
England, for example, hardly ever leap over tall buildings in a
single bound. Ben Bernanke and Mervyn King don't own a flowing
cape between them, not judging by the much-delayed reaction in
long-dated bond yields to their gently rising overnight base
rates.
Buried deep in data and research reports, the Bank
of Japan rarely does whatever a spider can, either. Holding the
cost of short-term money at 0.5% or below for the last dozen
years, the BoJ has singularly failed to ignite Japanese consumer
spending.
And in Frankfurt, the head of the European Central
Bank – Jean-Claude Trichet – may claim to glare at Eurozone
money-growth data month in, month out. But now it's rising at
the fastest clip in more than two decades, the M3 money-supply
data shows up his "hard stare" as more Paddington Bear
than X-ray vision.
Of course, as Stan Lee wrote in Spider Man,
"with great Power there must also come great
responsibility!" And that might help to explain why the
world's central bankers have been so reckless with the interest
rates that their policy decisions are supposed to control.
Besides setting the short-term price of money
today, central bankers have few super-human muscles worth
flexing. As a sub-set of policy maker, the modern-day central
banker has gained ever more "independence" from
elected governments worldwide. But he no longer sets capital
adequacy standards (see Basel I and II instead, as agreed by the
Bank for International Settlement), and some central bank policy
makers have even lost control of banking reserve-ratio
requirements. The Bank of England, for instance, was forced to
cede this power to the UK government-run Financial Services
Authority nearly 10 years ago.
Capital controls tend to sit with the finance
ministry, meantime...sanctions are decided by government for
announcement through the central bank only...and with
outstanding derivatives contracts now outweighing the entire
global economy more than eight times over, you'd have to do more
than wear your underpants over your trousers to keep the bubble
in credit in check.
Then there's the foreign exchange rate – only
here, central bankers find their powers sapped not by government
meddling, but by that kryptonite known as "the
market".
"The Bank of Japan has not intervened in the
foreign exchange market since 2004," notes Tony Tassell in
the Financial Times. "It has been even longer for
the US Treasury and the European Central Bank, with neither
dipping a toe in since 2000. The hoo-ha over the Reserve Bank of
New Zealand's attempts last week to stem the NZ dollar's rise
highlights how rare interventions now are in the developed
world."
"Central bank reserves are just too small to
take on currency markets for long," Tassell explains.
"But even as a signaling device, much depends on
credibility and timing. There is no point putting money where an
authority's mouth is if it has lost the market's respect. Nor
should central banks try to stop a trend in full flow."
The hottest trend in full flow right now, of
course, is the sell-off in government bonds. It's matched by a
concomitant rise in government bond yields – and that's making
debt more expensive.
For example, it's now nearly four years after the
Bank of England picked its overnight lending rate off of a
half-century floor of 3.50%. Ten-year gilt prices have only just
sunk far enough – in the last month, in fact – for the bonds
to yield the same as the current BoE base rate at 5.50%.
Will Mervyn King and his team push rates higher
again in July? Even if the rise in 10-year gilt yields was
desired by the Trimmer, his boss at the Treasury would rather
the "bond market conundrum" remained an enigma. Gordon
Brown is now planning to raise a further £46.6 billion (more
than $90 billion) from the City of London before April '08. But
just as he's picking out new carpets and drapes to replace Tony
Blair's feng-shui'd furnishings at No.10 Downing Street, Brown
finds that borrowing to cover his programs and projects is more
expensive than any time since summer 2000.
Can Mervyn King and his team of central bank policy
makers fly to the rescue? The Sterling futures market now
expects 6.0% base rates by the end of Sept. – and slashing
rates now would most likely fail to cut longer-term debt costs,
just as raising the price of money took nearly four years to
reach 10-year gilt yields.
What about gold? Can't central bankers at least
control what happens to the "barbarous relic" that
still lurks in their vaults three decades after the
International Monetary Fund cut it out of the global financial
system? As the largest owners of gold, surely the world's
central bankers can repel its verdict on their management of
official government money?
"Despite the demonetization of gold, the
yellow metal continues to have a special significance for
central banks," noted Philipp Hildebrand, a member of the
governing board of the Swiss National Bank – and now it's
vice-chairman – at a conference in June 2006.
"Unlike currencies, the
value of gold does not depend on a national sovereign.
Moreover, payment transactions with gold are fully under a
central bank's control. These are two important reasons why
gold, more than any other type of investment, serves to ensure
the capacity to act in extreme crisis situations."
No one's talking about a crisis today, of course
– and perhaps our crisis-free future explains why the Swiss
National Bank is going to sell around one-fifth of its remaining
gold reserves between now and summer 2009. It wouldn't explain
the super-heroic turnaround in Hildebrand's thinking, however.
The official reasoning looks as mundane as Peter
Parker in his thick-rimmed spectacles. "As a result of the
sharp rise in the price of gold," said the SNB last week,
"the proportion of [our] currency reserves held as gold has
increased by about a quarter since mid-2005, from 33% to the
current level of 42%. The purpose of the SNB's gold sales is to
rebalance the composition of currency reserves with respect to
its monetary policy requirements."
In other words, the Swiss National Bank wants to
re-weight its portfolio – as any wise investor would do if
they had an institutional mandate to meet – by reducing its
gold holding and buying more of the under-performing assets that
litter its vaults. The SNB policy makers, in short, are joining
the worldwide scramble for higher-yielding assets. So are their
fellow supermen staffing central banks everywhere.
"Earlier this month," notes Tony Jackson – also in
the FT – "UBS polled 80 central bank reserve
managers on their investment intentions over the next decade.
Asked what the one biggest change would be, 38% said they would
buy more so-called 'spread product' – that is, any form of
credit except US Treasuries. A further 18% went for more
equities and 12% for alternative assets such as hedge funds and
private equity.
"So more than two-thirds said, by implication,
that they would reduce their weighting in Treasuries. This seems
perfectly healthy. To date, the vast majority of reserve
managers have not been allowed to buy riskier assets. As they
gain permission and the necessary expertise, the price of
Treasuries will cease to be distorted by massive forced
buying."
Does this quiet grant of "permission"
explain the sharp sell-off in US bonds starting in May? The
Japanese policy makers had put their purchase of US Treasuries
on hold so far in 2007 before growing their pile of Washington's
promises by 0.5% in April. China cut its holdings by 1.3% that
same month, however, while South Korea kicked out one US bill,
note or bond in every fifteen that it owned. The oil-rich Opec
states lightened up on US Treasuries by $0.5 billion in April.
"By reducing its gold reserves and increasing
its foreign exchange reserves, the overall risk on SNB assets
will decline," claims the Swiss National Bank. This view,
classing gold as a risk asset alongside bonds, equities and
foreign currencies, might seem to jar with the stated aims of
central banking at the start of the 21st century. Price
stability in the domestic economy – matched by a
smooth-running financial and banking system – is surely heroic
ambition enough!
But "what we aim to do is to sell gold, an
unprofitable asset, to reinvest in bonds, which are more
profitable," according to Spain's premier financial policy
maker, finance minister Pedro Solbes. He's presided over record
gold-sales from the Banca d'Espana in 2007 to date – and
"the objective of our reserves is to maximize their
profitability," he claims. Senor Solbes neglected to
mention the yawning trade deficit that Eurozone interest-rates
set below the rate of Spanish inflation have now helped to push
above 9% of Spain's gross annual economy.
What of his poor, cowed team of central bank policy
makers at the Bank of Spain? If they ever hoped to gain real
super-hero status, they might do much worse than hang onto what
little gold Madrid still has left in its vault. Turning a profit
on rainy-day money today would bring them far less glory than
having physical
gold bullion in the bank to cover an "extreme crisis
situation" – whatever it might prove to be next time it
shows up.
