Last month I watched one of James Bond’s movies called ‘Golden Finger’, which was produced in 1964. The story was about a villain who wanted to contaminate the US gold reserve in Fort Knox, his notion was to save gold bullions that will eventually multiply its price. As I was watching this movie, I wondered about the reason of any government to own gold, and how important is that process? What will be the consequences if the movie’s events occurred in reality?
At first glance you may think that all governments are rushing to own gold by all means; however, the fact is not exactly the same. Gold used to be the historical unique reserve asset by any government and civilians for decades due to its unique chemical specifications which made it unable to react with any element including acids, which made it a store of the value.
Nevertheless, that form was changed in the 20th century. All governments represented in their central banks or the treasury secretaries own a significant amount of reserve in the form of diversified portfolio of foreign currencies, foreign governmental bonds, and precious metals.
Most published researches and articles focus blindly on the gold amount owned by the governments regardless of how much gold represents of the total reserves. This research focus on the gold percentage compared to the total countries reserve, which will reflect the political and economical perspective of the policy makers of any country. The research classifies countries relation to gold reserves in two groups. First group is expanding gold policy countries; second, shrinkage gold policy countries.
The Gold Standard Era
Without delving too deep in history, in 1694 the Bank of England established the gold standard system to the world by replacing gold direct dealing with written banknotes to a promise of exchanging notes into gold when asked for that. This system was accepted worldwide, and stayed for more than two centuries to create an efficient economic system.
Under the gold system, the value of each currency was fixed in terms of gold, implied that the exchange rate between two currencies are fixed. The gold standard system put a lot of heavy weight on the big and smaller countries jointly. From the bigger countries side, the absolute ascending inflation for more than two centuries made the people doubt the capability of central banks in covering the banknotes into gold; as a result, speculators started selling off currencies to exchange it by gold. Such speculative actions depleted the central banks gold including BOE in the forefront. On the other side, smaller countries were enforced to raise their interest rates when rates were raised abroad; otherwise, it will find itself exposed to severe losses. Mass selloff of the local currency triggered the obligation of gold reserves or trade the local currency to other foreign currencies with higher interest rates.
During WWI the gold standard system was suspended by all countries, yet, the US remained on gold standard during the war. The war burdens left its shadows on countries, which were loaded by the war debts and hyperinflation. However, the most effected was the banking sector as many banks faced insolvency. By the end of WWI central banks made extensive efforts to reconstitute the gold standard system. Notwithstanding of printing large amounts of money bills during the war without its covering gold reserve, countries could reestablish the gold standard system. Despite these facts, the post WWI period lacked monetary stability, and countries including the UK itself seemed to give up the adoption of this system.
With the lack of political and ideological support of the gold standard system, central banks started to reevaluate its policies, especially after the world great depression era in the 30s. A significant amendments was made on the system by president Roosevelt.
Top Countries with Expanding Gold Reserve System
- Untied states of America
As the markets crashed in 1929, UK left the gold standard system after the frequent attacks made by the speculators effected the pound price to float and to determined by the market forces. Countries started to disbelieve in the gold standard system, and one after another gave up the system.
By the collapse of the pound against the gold, speculators started to focus on US Federal gold reserve, which refused to give up the gold standard system. The US took new actions to recover the world crisis. One of the actions was to raise interest rates that was below 20% in order to break down speculations against the dollar. As the government pressured the Fed, the Federal Open Markets operations Committee (FOMC) was established to increase supply by decreasing interest rates on governmental and corporate bonds. Eventually the Fed and the government realized that they were not on the right track and they have had to change something. They realized that the gold was the pivot point of the fiscal policy and nothing can be changed without system revision.
By the beginning of President Roosevelt period, reconsideration of the gold standard system was a priority. It didn’t take too long to recognize that lifting the gold standard up was a key element to recover the great depression. Straightaway, Roosevelt took a decision to let the dollar price float against gold by resetting its value at significant low level.
WWII burdens were insufferable, by that time every country took the decision to give up the gold standard system as it became very exhausting. In 1944, before the end of the war, the big governments signed the Breton Woods agreement, which stated currencies prices to be fixed to the US dollar instead of gold.
Nevertheless, the US Dollar should be converted in gold whenever there was a demand and gold to be priced at $38 per ounce. The final destination for gold role in the fiscal policy came in 1971 when President Richard Nixon decided to terminate the gold standard system and to replace it by the petrodollar system. Starting from that date, interest rates replaced gold and became the pivotal point of fiscal policy.
By that time, gold was out of the Federal Reserve fiscal policy; although the importance as a reserve asset did not diminish for the Treasury secretary. According to the world gold council, USA lead the countries gold reserves list. It stated that the USA holds 8133.5 (USD12 000 000 000) which consists 74% of the total reserves held by the treasury. The treasury is responsible to reserve the gold in deep storage since January 31 1934 in three places: Denver, CO, Fort Knox, KY, and West point, NY. US is the forth gold producer with 209 tons a year.
Moreover, If we’re consider the classification of gold percentage out of total reserves as no other country is keeping that high percentage of gold reserves but Tajikistan, the US is placed as the second on that list. A question should arise here, what does that means? a) USA, as the producer of the most dominating currency doesn’t need a large amount of foreign currencies. b) Gold has an inverse movement with the dollar, meaning that as the demand for gold rises by the treasury, gold price will go up and US Dollar will devalue. In other words, weakest dollar can boost economy, and higher reserved gold value.
- European Countries Using the Euro
Similarly to the US policy, the Euro considered to be one of the world economy columns. Despite the fact that ECB holds 26% of its gold reserves by 504 Tons, every country in the EU represents its treasury by holding a separate amount of gold reserves. The form of ‘sell Euros buy gold’ as a reserve is a common policy within Eurozone countries. Germany comes second on the list by holding 3377 tons representing 68.8%, followed by Italy with 2451 tons representing 67.8% of the reserves. However, Cyprus holds only 33tons, represents 64.1% of its reserves. France 2435T 63.8%, Netherlands 612T 63.9%, Portugal 382T 59.1% and Austria 280T 45%.
The European countries maintain structured formula to hold high gold reserves of their total reserves(commodities, currencies, etc.). As the Gold standard system rules global economy, a country must sustain gold reserves in order to control its currency and economy.
- Venezuela Learnt the Lesson
Venezuela, one of the top oil producer, was determined to hold anti-west policy, adopted the anti-dollar system by putting 64.8% of its reserves in gold instead of foreign currencies which represents only 187.5 Tons, the lowest in three decades.
That wasn’t the plan of Venezuela; in December 2009, Venezuela’s central bank released the “gold reorganizing”. They had a 10 year plan to increase gold reserves – they didn’t declare the amount they plan to increase due to the financial crisis and the decreasing confidence in USD, and they called this year “the year of gold”. Actually the plan worked for while, where the reserved amount rose from 355T to 365T by 2011; Nevertheless, it didn’t work for a long time. The country faced a severe crisis in 2016 caused a sell-off of two thirds of its gold reserves in a lower price than 2010.
As a result, the increased amount bought after the 2009 “Reorganization” was sold by loss, and Venezuela is classified as shrinking economy. Important lesson we should learn from the Venezuela model as we go through this research.