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Congressional Testimony: On the IMF Gold Sales Proposal

by George Milling-Stanley, Manager, Gold Market Analysis, World Gold Council

Before the U.S. House of Representatives' Committee on Banking and Financial Services --
Subcommittee on Domestic and International Monetary Policy
Room 2128, Rayburn House Office Building
Washington, DC
April 21, 1999

 


Summary

  • The sale of gold, even a small quantity, from the IMF's reserves would bring further deterioration in the gold price.
  • Gold mining is a viable and productive sector in the economies of many developing countries, including more than half of the 41 countries included in the HIPC initiative.
  • Gold sales from the IMF would harm, rather than help, the economies of the HIPCs.
  • In several of the HIPCs that do not currently produce significant quantities of gold, there are advanced plans for major gold mining projects.
  • It would be cruelly ironic if the form of assistance chosen should deter investment in gold mining, which is potentially of enormous benefit to these economies.
  • Gold currently accounts for 5 per cent or more of goods exports from a number of other developing countries with troubled economies, even though they are not included in the HIPC initiative. They would also suffer harm.
  • Another danger lies in the message a sale by the IMF would send, the fear that this might be the thin end of the wedge.
  • There are alternatives to gold sales by the IMF.


Gold sales from the International Monetary Fund would harm, rather than help, the economies of the Heavily Indebted Poor Countries (HIPCs). Gold mining is a viable and productive sector in the economies of more than half of the 41 countries included in the HIPC initiative. In 10 of those countries, gold mining accounts for between 5 and 40 per cent of exports. It is consequently crucial to national economic well-being and employment ­ not to mention their ability to honor debt service payments. The sale of gold, even a small quantity, from the IMF's reserves would bring further deterioration in the gold price. It would be a bitter irony if the assistance that is being offered to the world's poorest countries in fact did further damage to the already troubled economies of the recipients.

In several of the HIPCs that do not currently produce significant quantities of gold, there are advanced plans for major gold mining projects. These plans will only come to fruition, and make a contribution to the economies of these beleaguered countries, provided that nothing happens to stem the inflow of foreign capital investment and technology. What sort of development could do that? Quite simply, any further deterioration in the gold price, the primary determinant of the economic environment against which such investment decisions are taken. Again, it would be cruelly ironic if the form of assistance chosen should deter investment in gold mining, which is potentially of enormous benefit to these economies.

Apart from the very real damage IMF gold sales would do to many of the HIPC countries, there is also the question of the potential impact on a number of other countries that are not covered by the initiative, but whose economies are also facing difficulties. Gold exports currently account for 5 per cent or more of goods exports from Fiji, the Kyrgyz Republic, Papua New Guinea, Peru, Uzbekistan and Zimbabwe, while South Africa is of course also heavily dependent on gold exports, as the world's leading producer.

Any reduction in income from gold mining in all these countries does real harm not just to the governments and to those people directly involved in gold mining, but also to the economic fabric of whole communities that are dependent on that income for their own livelihoods.

The current situation differs markedly from the late 1970s, when the IMF last sold some of its gold reserves for a similar purpose. At that time, global gold production was dominated by South Africa and the Soviet Union, and output from the developing world was insignificant. In addition, the gold price was on a strong upward trend, creating a much more auspicious climate for the IMF sales.

Gold mining has become more important to developing countries since then, and particularly over the last decade. Most of them have liberalized their foreign investment rules and mining codes, and many have also improved, often directly under the auspices of the IMF, the management of their economies. As a result, these countries have become much more attractive to the world's gold mining companies as targets for investment, and both exploration and development have increased significantly. Gold deposits that earlier were largely unknown, or exploited only on a very small scale by artisanal miners, are now playing, or are poised to play, a major role in the economies of these countries.

The economic performance of most of the HIPCs is heavily dependent on the production of commodities, and often on just a very small number of commodities. This fact limits potential earnings, and renders the countries extremely vulnerable to adverse price movements. In addition, almost all the HIPCs run a persistent current account deficit, aggravating an already serious debt problem. In many of the countries, the value of goods exports is exceeded by that of goods imports, even before services and other "invisibles" are taken into account. Thus they have a compelling need to develop other sustainable export products. With limited manufacturing capability, these often have to be additional commodities or commodity-based items.

The development of a viable gold mining industry is an attractive proposition for any HIPC. The demand for gold has increased steadily in recent years. The amount of incremental gold production the HIPCs are likely to add to global output is limited, and it is unlikely to cause any significant disturbance to the balance between supply and demand. But the effect on each individual country can be substantial. It is widely accepted that encouraging trade is normally the best way of helping a developing country.

Gold mining can have other benefits in addition to boosting export earnings. It attracts inward investment, and creates jobs. In some cases, the existence of a significant gold mine can cause previously remote areas to be opened up, encouraging the development of transport links and other infrastructure and enabling the whole region to move away from a purely subsistence economy. The benefits of foreign investment to a developing country are well documented, for example in the publications of UNCTAD. Capital equipment is imported, skills are transferred to the local population, sound legal, accounting and banking systems and practices are developed. All these phenomena encourage economic stability and promote development.

The sale by the IMF of part of its gold holdings would jeopardize all these highly desirable developments. The gold price fell sharply in 1997 and has not recovered, although it remained broadly stable during 1998. The average price for 1998 of $294 per ounce was almost $100 below the average for 1996. The ongoing fear of sales of gold from the official sector -- central banks and international institutions such as the IMF -- is the main reason why the gold price fell recently to its lowest level for 20 years. The discussion over the past few years about a possible sale of some of the IMF's gold has made a major contribution to the uncertainty and negative sentiment in the gold market, and therefore to the weakness in the price.

By way of illustration, in the two trading days immediately following the recent confirmation by President Clinton of his Administration's support for gold sales by the IMF as part of a far-reaching plan for debt relief for the world's poorest countries, the gold price fell $10. The IMF has not sold an ounce of gold since the 1970s, but the simple fact that the issue was once again under serious discussion clearly had an adverse impact on the price.

The danger in a sale of gold by the IMF lies not merely in the sale itself, but also in the signal that this would send. The market would perceive any sale from the reserves of the IMF as a powerful indication that, in agreeing to such an action, the official sector all around the world has finally renounced its belief in gold's role as a monetary asset. Such a sale would likely be seen as the thin end of the wedge, and the market would assume that further disposals, both by the IMF and by central banks around the world, would inevitably follow. There can be no doubt that the price would fall significantly. In this context, it is worth noting that the quantity under discussion in the proposed IMF sale has shifted from 5 million ounces to perhaps 10 million ounces, with some people suggesting considerably more than that.

The effect on gold-producing countries of the $100 per ounce decline in the average price between 1996 and 1998 has already become painfully apparent. Export earnings in gold producing countries have fallen, and by a substantial amount where the country was heavily dependent on gold. What is worse, low prices discourage exploration and development. There have been numerous examples in recent months of companies abandoning projects because of low prices.

It is vital that the IMF should seriously consider the potential impact on the HIPCs, and on other countries too, if the gold price were to fall, as it assuredly will if the Fund decides to sell some of its gold. Even last month's revival of the discussion as to whether the IMF should sell a small part of its holdings triggered a $10 drop in the price. It is worth asking how much further gold would fall if the IMF ever does start to sell. It would be bitterly ironic if an effort to help the world's poorest countries should result in direct harm to the economies of many of them, and prevent others from properly developing an industry that would otherwise bring them so many benefits.

The IMF holds 103 million ounces of gold, making it the third largest holder in the world, behind only the U.S. (262 million ounces) and Germany (112 million ounces). The Fund has acknowledged (Annual Report 1996, page 139) that this position gives it "a systemic responsibility". Specifically, that annual report stated: "The Fund must take great care to avoid causing disruptions that would have an adverse impact on all gold holders and gold producers, as well as on the functioning of the gold market."

It has always been recognized that the IMF would provide its own contribution toward the HIPC initiative. The original intention was that this contribution would come via grants and loans from wealthier IMF members. If, however, such member contributions were not sufficient, the Fund's Executive Board has discussed the possibility of selling up to 5 million ounces of gold, the profits from which (i.e. anything over $42.20 per ounce) would be invested to generate income to finance the Fund's contribution toward the HIPC initiative. In this context, it is worth noting that the proceeds from the sale of 5 million ounces of gold would be about $1.4 billion at a price of $285, giving a profit of about $1.2 billion. The annual interest income on that sum at a hypothetical rate of 5 per cent would be about $60 million per year. For the purposes of illustration, a further decline of $10 per ounce in the gold price from $285 to $275 per ounce, on the 1997 HIPC gold production of about 4 million ounces, would cost the HIPCs an annual aggregate of some $40 million.

There is no clarity at this stage about the state of play with respect to additional bilateral contributions. Even if insufficient bilateral contributions become available, there are several alternatives the Fund should consider. The following list is intended to be illustrative of some of the avenues the Fund should be encouraged to explore, rather than implying a specific recommendation:

  • The Fund could borrow from the private sector. Under Article VII, the Fund is able to do this, but in practice it has never done so.
  • The Fund could institute the necessary changes to its rules to allow it to pledge some of its gold against a currency loan.
  • The IMF could use its creditworthiness to underpin a bond issue that would be earmarked for debt relief.
  • The Fund could end its policy of deeply subsidized interest rates, including its current standard loan interest rate of 3.5 per cent.
  • The Fund could work with the countries of the developed world to encourage the reduction or elimination of trade barriers to exports.

Apart from its unintended adverse impact on the economies of the HIPCs and other economically-troubled gold producing countries, the proposed sale of gold by the IMF would have other unanticipated consequences. Many people would perceive the sale as weakening the Fund's capital base. With about 25 per cent of its outstanding credit owed by Russia, and 70 per cent of outstanding credits owed by only five nations, it is reasonable to ask whether further erosion of the IMF balance sheet is desirable at this time. In the current climate of instability in global financial markets, this is not the time to do anything that might be interpreted as threatening the Fund's own stability.

IMF gold sales would also have a significant adverse impact on the lives of individuals who hold gold all around the world. For millions of people throughout Asia, the Middle East and the Indian subcontinent, gold is the primary form of savings. In cultures where women's rights of ownership are restricted by custom or the law, gold is often the only asset they are allowed to possess.

There are even potential adverse implications in this issue for the U.S. This country holds the largest official reserves of gold in the world, and surely has an interest in preventing any erosion in the value of those reserves. In addition, the U.S. ranks second in terms of global gold mine production, and will suffer along with all other producing countries if there is any further weakness in the price. For example, as a result of the depressed gold price, about 1,800 mine workers have been laid off since the start of 1998 in Nevada alone, the largest producing state.

Apart from those directly involved in the industry, there is also public concern over the issue here in the U.S. A survey of public opinion carried out earlier this month found that 59 per cent of respondents disapproved of the proposal that the IMF should sell some of its gold reserves, with 32 per cent expressing strong disapproval. (Survey carried out in April by Opinion Dynamics Corporation of Cambridge, Mass.)

I want to close with a quotation:

 

"There are a whole host of proposals out there that on the surface seem sensible and have great political appeal, but which, when carefully analyzed, are deeply flawed. It is easy to make dramatic statements; it takes a lot of hard work to produce sensible proposals."

These are the words of Treasury Secretary Robert Rubin, speaking in March about some suggested remedies to fix other problems within the global financial system.

Secretary Rubin should be encouraged to subject his proposal that the IMF sell a part of its gold holdings to the same rigorous standard. If he refuses, the Congress should do it for him. The sale of gold by the Fund requires the support of 85 per cent of the votes on the Executive Board. The U.S. holds over 17 per cent of the weighted voting power on that body, and the U.S. representative on the IMF's Executive Board cannot cast her vote on this issue without the prior authorization of Congress. That gives the Congress an effective veto over the whole plan. The proposal is deeply flawed, it would hurt the very countries that most need help, and it would have other unintended adverse consequences. I urge the Congress to exercise that veto.


April 23, 1999

Copyright © 1999 World Gold Council. All Rights Reserved


For further information, please contact George Milling-Stanley in New York at Tel: (212) 317-3848, Fax (212) 688-0410
E-mail: george.milling_stanley@wgcny.gold.org.
World Gold Council, London.

The World Gold Council is an international organization formed and funded by leading gold mining companies from around the world to increase the demand for gold.

Reprinted by USAGOLD with permission. Further reproduction requires permission by World Gold Council.

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