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Much has been
made recently of the news that the BIS last year completed a 380-tonne gold
swap with an unnamed commercial bank. This BIS transaction intuitively
strikes me as being hugely important. Unfortunately, the BIS and the bank
involved have disclosed too little information for any of us outside the
inner circle of central bankers to truly understand what is happening behind
the scenes.
Consequently,
there have been various interpretations by market participants of what the
swap means, but the fingers kept pointing at Portugal. First, Portugal
reports owning 382 tonnes of gold, which is very close to the weight of metal
swapped with the BIS. Second, as one of the notorious over-indebted and
spendthrift PIGS (Portugal, Italy, Greece and Spain), it is likely that
Portugal might be willing to complete unusual and even extraordinary
transactions in order to try improving its financial position.
I did not agree
with the conventional interpretations of the BIS swap, but have held off
airing my comments, until now. I have been waiting for at least some
anecdotal evidence to substantiate my hunch about what the BIS swap means,
and that evidence has now been reported by the Financial Times.
Noting that “sovereign borrowers typically do not post
collateral” on derivative trading, the FT reports that “Portugal
has become the first eurozone country to agree to set aside cash – or
other assets [possibly gold?] – against derivative transactions in a
decision intended to reduce its funding costs.” Here is my thinking,
beginning with some background information.
There are two
sides to a swap, and therefore two potential reasons a swap would be made.
Before
it was announced that the BIS completed the swap with a commercial bank, the
mainstream interpretation was that a troubled sovereign borrower or perhaps
even the ECB itself needed liquidity, so they used gold to borrow currency.
But given its two-sided nature, there was also another potential reason for
the swap even if it received little attention – the BIS may be running
out of physical metal for its interventions in the gold market. So it needed
to get its hands on some physical metal. Consequently, it swapped currency
for physical gold (or perhaps to deliver on calls it had sold and were
exercised).
Then after the BIS announced that it had completed the swap with a commercial
bank, many observers – including me – were perplexed. If it were
a traditional swap, the commercial bank would have 380 tonnes of gold in its
possession, which is a highly unlikely proposition. Commercial banks
are not in the business of owning gold; they are in the lending business.
Clearly, if any commercial bank had owned gold, which is highly unlikely I
might add, the gold would have already been loaned out.
So this news by
the BIS that it completed the swap with a commercial bank left me scratching
my head.
One possibility
was that the commercial bank would have had to borrow the 380 tonnes from a
central bank and then swapped with the BIS, but this supposition raises
another question. Why would there be any commercial bank involved?
Why wouldn’t the central bank with the gold just swap directly with the
BIS, as France did with Germany in a currency crisis some two decades ago
when the Exchange Rate Mechanism was still in place? Undoubtedly, some other
factors are at work here, which is why the FT report is important. My
conclusion is that we are seeing with the BIS announcement some ‘window
dressing’ of a sovereign debtor’s balance sheet, and the early
finger pointing at Portugal was probably accurate.
It has long been
recognized that Portugal is active in the gold market. It had loaned
gold to Drexel Burnham in the 1980s, which became public information as a
consequence of that high-flying investment bank’s collapse. So it is
not farfetched to assume that Portugal had loaned its remaining gold to a
commercial bank, which meant that Portugal was exposed to the credit risk of
this bank.
Now consider for
a moment, what if that gold loan had been made by Portugal to Citibank or
some other zombie bank? It wouldn’t look very good on Portugal’s
balance sheet to be owed 380 tonnes of gold by a near-bankrupt institution.
Given that Portugal is taking steps to “to reduce its funding
costs” as the FT reports, it would be logical for it to get rid of that
gold loan.
The best choice
of course would be to demand repayment of the loan and put the 380 tonnes of
gold back in its vault. That action though would drive the gold price
sky-high, given the dearth of sellers of physical metal at current prices.
Sky-high prices would blow-up the gold cartel and its efforts to continue
capping the gold price as it operates its staged retreat, letting gold rise
every year but not too much so as to not draw everyone’s attention to
it and the resulting consequences of ever-depreciating fiat currencies. So
enter the BIS.
It swaps currency
for the gold loan at the commercial bank. In other words, the 380
tonnes of gold is now owed to Portugal by the BIS, improving considerably the
quality of Portugal’s balance sheet. After all, who would you rather
have owing gold to you? Some commercial bank like Citibank or central
banks’ own central bank, the BIS? Clearly, being owed gold by the BIS
instead of a zombie bank would be one way for Portugal to “reduce its
funding costs” by improving the quality of its balance sheet.
Of course, all of
the above is just reasoned speculation at this point. My explanation to
decipher the BIS swap seems logical, but we will never know for sure the true
reason because central banks continue to operate in secret behind closed
doors.
James Turk
Free Gold Money Report
Article
originally published by the Free Gold Money
Report.
James Turk is the founder of the Free Gold
Money Report and of GoldMoney.com. He is also the co-author of The Coming
Collapse of the Dollar (www.dollarcollapse.com).. Copyright © by James Turk.
All rights reserved.
Copyright
© 2008. All rights reserved.
Edited by James Turk
This material
is prepared for general circulation and may not have regard to the particular
circumstances or needs of any specific person who reads it. The information
contained in this report has been compiled from sources believed to be
reliable, but no representations or warranty, express or implied, is made as
to its accuracy, completeness or correctness. All opinions and estimates
contained in this report reflect the writer's judgement as of the date of
this report, are subject to change without notice and are provided in good
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