"If gold is 'past its
day', what of toxic derivatives and today's deluge of US Treasury
bonds...?"
JUST LIKE poor Pip in Dickens' Great Expectations, central banks keep
inheriting unwelcome bequests.
Today's
"legacy assets" are toxic derivatives; a decade ago it was gold
reserves. Both are proving hard to shrug off, but for very different reasons.
Both legacies also come thanks to previous central-bank history; the fossils remain
only too livid today.
And 10
years from now, if not sooner, just how welcome the current central-bank
must-have become – freshly printed government debt, bought with money
that doesn't exist until the central bank wills it?
Seeking first
to defend against inflation and war, the West's central banks built up huge
reserves of the ultimate hard money – Gold Bullion –
during the early-to-mid 20th century. Long before the turn of the millennium,
however, these hoards grew to look quaint and expensive. Unyielding and relatively
useless to industry, gold simply sat there, down in the vaults, costing money
to store but returning no interest.
Who needed
crisis-proof gold when Western Europe (if not the Balkans or Mid-East) was
enjoying its first generation of peace-time in history? And who needed fine
gold when the Nasdaq index of tech stocks was
priced for 20% annual earnings growth over the next decade and more?
In short,
who needed gold when we'd got Alan Greenspan, as the New
York Times asked in May 1999. "The
argument against retaining gold is that its day is past," wrote Floyd
Norris with uncanny timing, just two days before Gordon Brown's Treasury
announced its ham-fisted sale of half the UK's gold bullion hoard.
"Once
it was useful as a hedge against inflation that would hold its value when
paper currencies did not. Now financial markets have their own sophisticated
ways, using exotic derivative securities, to hedge against inflation."
You could
butter your toast with the irony. But it wouldn't taste sweet or provide much
nutrition. Whereas a further glance back at history might.
"With
huge gold stocks available for sale, [governments] may discourage excessive price
increases but naturally do nothing to prevent sharp
decreases," reported an investment piece for Medical Economics published in October 1977. (Our thanks to the
author for finding and faxing it to BullionVault this week.)
"The
government specter [over the gold market] can't be expected to disappear
quickly," F.D.Williams continued, some 32
years ago. "Gold will continue to be part of many national reserves for
a long time. The stocks are so large, they can't all
be dumped at once."
Compare
and contrast with today's unwanted bequest – those toxic derivatives
the US Treasury chooses to call "legacy assets" as if it played no
role at all in producing them. Unlike state-hoarded gold, it only encouraged
their creation; it didn't want to look after the damn things. And quite unlike
the market for state-hoarded gold, a ready stock of willing mortgage-bond buyers
also looks unlikely to gather.
"The
PPIP, which was beset by multiple delays as regulators tried to figure out
the best means of removing many of the troubled assets from banks'
books," as CNN reports, "is still not up and fully running
yet." It's not been for lack of incentives. The $2 trillion
Public-Private Investment Partnership, announced to much fanfare in March, offers
huge leverage – entirely at tax-payer expense – plus some or
other hold-to-maturity value to risk-cushioned investors, albeit as yet
unknown. Private investment groups can use up to $1 of non-recourse loans,
plus another dollar of Treasury finance, for every $1 they spend on taking toxic
housing derivatives off the banks' busted balance-sheets. Yet as a report
published this week by the Congressional
Oversight Panel put it:
"Whether the PPIP will jump start the market for troubled
securities remains to be seen. It is also unclear whether the change in
accounting rules that permit banks to carry assets at higher valuations will
inhibit banks’ willingness to sell. Similarly, it is unclear
whether wariness of political risks will inhibit the willingness of potential
buyers to purchase these assets."
Funnily
enough, as the US authorities struggle to sell toxic debt, Western Europe's Central
Bank Gold Agreement has also stalled in 2009. This comes, however, despite prices
and private-investor demand both holding near record
levels. First signed ten years ago this September, back when no one at the New York Times, Economist, Financial Times
or big central banks could see a use for the metal (simply owning this secure,
liquid store of value is use enough, by the way), the CBGA capped annual gold
sales and made them plain in advance for the coming five years. It aimed to avoid
a repeat of May 1999, when the UK Treasury's announcement drove prices down
to what then proved their floor. In contrast to Washington's PPIP, however,
central-bank gold sales weren't arranged in the hope of achieving maximum
price, but merely curbing a rush for the exits instead. And as it is, they
needn't have bothered.
Gold Prices
have since risen three-fold and more against all major currencies, even while
the 16 signatories to date sold almost one-fifth of their hoard in aggregate.
Thus gold's weighting in their reserves portfolio has doubled regardless,
rising as gold outperformed all other assets from the start of this decade.
Hence the
dramatic slowdown in central-bank gold sales since the financial crisis began
in August '07. Because it's tough selling gold when its use becomes so clear,
so present. Here in the fifth and last year of 2004's renewed CBGA, "Net
central banks sales likely to be in the order of 140 tonnes
this year, down from 246 tonnes in 2008," reckons
London market-maker Scotia Mocatta. Yet the annual
ceiling for CBGA sales currently stands at 500 tonnes!
The new
agreement – just signed and due to commence on Sept. 27th – tips
its hat to the facts, reducing that limit by one fifth. But who's left to
sell any way? Just as in the gold mining sector worldwide, the "easy
metal" has already gone from West Europe's vaults, pretty much emptying Spain,
the UK and those excess Swiss holdings which maintained the Franc's 100%
gold-backing until the turn of this century. The two largest holders, Germany
and Italy, continue to face down political calls for "mobilization",
refusing to yield one ounce so far despite signing all three agreements. France,
the third largest owner, has pretty much sold the 600 tonnes
from its hoard announced when it joined the central-bankers' Cash4Gold party
in 2005. That leaves only the International Monetary Fund's 400-tonne sale, hardly
enough by itself to meet the next half-decade's 2,000-tonne limit.
Back at the
Federal Reserve, meantime, tomorrow's central-bank legacy – of freshly
printed Treasury bonds bought with magic money from nowhere – continues
to swell. Yes, the Fed's stockpile of T-bonds may be smaller today than it
was back in August '07 before the Great
Inevitable broke, thanks to record Wall Street demand for the safety of
Washington's debt. And yes, the Fed isn't quite collecting new bonds from the
Treasury door directly, waiting instead a few days or so before picking them
up (as Brian
Benton, Chris
Martenson and others have found) from those primary
dealers who do bid at auction, rather than out-and-out monetizing the debt for
all to see with its newly created cash.
And sure,
private-sector demand for Treasuries continues to look so strong right now
– what with overnight rates at 0%, plus the ongoing collapse of house
prices, world trade and jobs creation – that the Fed says it will stop
financing Uncle Sam's spending in, umm, October rather than in September as
previously stated.
But hoarding
gold looked rather more sensible amidst the violence and misery of the
mid-20th century, and no one at the Fed or Treasury guessed two years ago
that they'd be offering leverage incentives to try and revive the market in
mortgage-backed derivatives. When the global economy gets off the floor...or
risk assets become more attractive to private investment...or China and Japan
find they really don't have any space left for US debt in their central-bank
vaults, the market into which the Fed will want to sell its Treasury hoard
will look very different to the market from which it's currently buying.
Whether a
decade from now, in 2010, or perhaps this fall – when the $300 billion
of quantitative easing ear-marked for Treasuries is spent – trying to
quit the Fed's newest "legacy asset" could prove tougher even than
finding ready buyers for today's toxic junk. And given the soaring interest
rates and potential US bankruptcy that in turn might trigger, spurred by
whatever's added to the Treasury's $11.7 trillion of debt between now and
then, perhaps buying Gold will look a smart move to the Western world's central
bankers once more.
Adrian
Ash
Head
of Research
Bullionvault.com
Also
by Adrian Ash
City correspondent for The Daily Reckoning in London,
Adrian Ash is head of research at BullionVault.com – giving you direct access to investment
gold, vaulted in Zurich,
on $3 spreads and 0.8% dealing fees.
Please Note: This article is to inform your thinking, not lead
it. Only you can decide the best place for your money, and any decision you
make will put your money at risk. Information or data included here may have
already been overtaken by events – and must be verified elsewhere
– should you choose to act on it.
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