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Gold's Role in the Monetary System

by The World Gold Council

The WGC recently urged IMF leaders to lift their ban on member countries' 'pegging' their currencies to gold. In a speech to participants at a two-day meeting in New York, organised by the Re-inventing Bretton Woods Committee, and attended by senior officials of the IMF, the World Bank, the European Central Bank and other national central banks, the Council said that efforts by the IMF to demonetize gold had largely failed and gold was still the second most valuable component in official sector reserves - behind only the dollar - accounting for 16% of the total.

Excerpts from the Council's presentation follow:

The result of the demonetisation attempt was to institutionalise the hegemony of the U.S. dollar. The advent of the euro upsets this stability. In this new environment, some would say that gold should be put back on the agenda of those seeking to produce the blueprints for the new financial architecture. Our contention, however, is that gold has never been away - you have only to look at its continued role as a major central bank reserve asset to accept that.

Why should a Fund member not be allowed to link its currency in some way to gold if it so wants? Currently Article IV 2(b) forbids this. The move 25 years ago to "abolish" gold was designed to enthrone the SDR instead. The SDR has not, however, succeeded in establishing itself as a genuine international reserve asset. In such circumstances there should surely be no reason why gold is precluded from competing on all fours with other reserve assets. For the Fund to outlaw it in the Articles is an outmoded restriction.

One lesson from history was that international monetary arrangements can and do change and the coming of the euro provides an obvious opportunity to reconsider the whole system.

For the last half-century the dollar has been the hegemonic currency. Why? To start with -- let us not forget -- because of its explicit gold link. Subsequently, because there was no possible competitor and the U.S. was, after all, the strongest economy -- and possessed the most liquid capital markets -- in the world.

With a single hegemonic currency there were not many choices to make. Now, there are two potentially equal reserve currencies -- the dollar and the euro. Although the combined capital market of the EU-11 is not yet as large as that of the U.S., it is still dramatically larger than any of the previously individual European markets. Any central bank looking to diversify its reserves now has a real alternative.

But one thing seems fairly clear. Now that countries have a genuine choice between two global currencies, there are likely to be significant moves in and out of them as sentiment ebbs and flows.

Can the world live with competing currencies or will one eventually become supreme? Or might gold, as a recognised store of long-term value, stage a comeback on the international monetary scene? It is probably worth noting here that all previous reserve currencies (including, at the outset, the SDR) had some kind of link with gold.

The problem with hegemonic currencies (be it the dollar or the deutschemark) is that they are run purely for the benefit of their own domestic economies, not for the benefit of any other country which chooses to peg to them.

Gold is the only external asset which is no one else's liability. Now that we have the euro, some countries may decide to take the relatively simple decision to define their basket as some weighted combination of that currency and the dollar in order to hedge their bets. An even more effective hedge, however, can be constructed by incorporating some gold. Studies suggest that the volatility of a central bank's reserve asset portfolio is reduced, and the risk/return balance enhanced, by holding anything up to 20% in gold.

Most central banks do not see it as their business to take risks. By incorporating gold into both a currency basket used for exchange rate management purposes and a reserve asset portfolio, volatility is reduced and the risk/reward picture improved.

Which brings us back to the IMF and, as we would contend, its no-longer-justified prohibitions on various potentially useful roles for gold. The IMF's own gold holdings (103 million ounces), make it the world's third largest single holder. In 1995, the Executive Board held a long and thoughtful discussion on the subject and came to some important conclusions. These included the view that gold provided a fundamental strength to the IMF's balance sheet, and the Board felt that the Fund should continue to hold a relatively large amount of gold among its assets, not only for prudential reasons but also to meet unforeseen contingencies.

Nothing has happened in the outside world in the last 4 years to invalidate these judgements. Indeed, given the systemic uncertainties caused by the arrival of the euro, there are surely all the more reasons for the official sector to preserve its gold holdings and actively consider ways in which its real value can be utilised in this brave new monetary world.

25 February 1999
Copyright © 1999 World Gold Council. All Rights Reserved
Contact: Dick Ware, Centre for Public Policy Studies,World Gold Council, London.
E-mail: dick.ware@wgclon.gold.org
Reprinted by permission of World Gold Council. Further reproduction requires permission by World Gold Council.

Addendum from USAGOLD:

USAGOLD (2/24/99; 09:19:09MDT - Msg ID:2700)
Today's Gold Market Report: Backwardation, Gold Eagles Availability Dries Up, Inside the World Gold Council Appointment of Haruko Fukuda
MARKET UPDATE (2/24/99):

The World Gold Council today appointed Haruko Fukuda chief executive officer. Fukuda, a graduate of Cambridge University in Britain, takes the reins at a time when the Council is attempting to recover from budget cuts associated with reduced support from the mining industry. There is a split in the mining industry between firms which make substantial profits hedging and forwarding their metal and those that take a more traditional approach to their mining activities. Many in the gold industry feel that the advanced hedging and forwarding strategies have worked to keep the metal's price in check -- a long term negative for the industry.

In the press release announcing Fukuda's appointment, Don Morley, the Council's chairman, stated that, "We have recently refocused the organization's priorities. We believe those changes, and in particular the new leadership that will be provided by Miss Fukuda, will generate the basis for increased support from the world's gold producers."

What are these "refocused priorities?" A reliable source close to the situation tells USAGOLD that the World Gold Council has changed its emphasis and budget away from jewelry issues to economic priorities revolving central bank holdings and investor issues.

"We want gold," says this source, "to be understood as a currency not as a commodity and this is the direction that the Council is taken. Fukuda's appointment reflects that change. Shrewd investors both institutional and individual have begun to look at gold as a portfolio holding and a currency hedge in view of what's going on in the world economically -- the Brazils, the Indonesias, the Russias -- and are diversifying accordingly. Diversification becomes the key and that balance requires alternative assets like gold."

"In addition," he went on, "the council will take an aggressive approach in educating the central banks about the holding of gold as a reserve asset. The younger central bankers have taken a view like any commercial or merchant banker by simply seeking the best return. This has led to the mobilization of reserves that may not be in the best interest of that country in the long run. We are asking: 'What happened to the central bank mandate to protect the value of the currency and the assets of the country?' With Fukuda's grasp of international finance, we hope to educate central bankers about the future role of gold in central bank portfolios."

And how will this "generate the basis for increased support from the world's gold producers?"

"There has been a renewed enthusiasm, " says our source, "for the traditional view of gold within some of the top mining companies. This view is being translated to World Gold Council philosophy and operations as you can tell from some of my previous statements. The growing opinion is that we should rally around gold as an industry. We feel that the appointment of Ms. Fukuda is a step in that direction."

From the USAGOLD Daily Gold Market Report

Reprinted by permission of USAGOLD / Centennial Precious Metals, Inc. All Rights Reserved.

February 1999

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