Should the U.S. Sell Gold Reserves to Save the Economy? By Jon A. Nones 16 Oct 2007 at 11:13 PM
St. LOUIS (ResourceInvestor.com) -- The U.S. dollar has spent much of the past 6 months hitting record lows against most of the world’s leading currencies. Our beloved greenback has fallen 20% against the Canadian dollar since March, 15% against the Australian dollar since August and 7% against the euro in the past 7 weeks.
Tighter global credit conditions following the plummeting U.S. housing market have hampered the U.S. dollar. But it is not hard to see why the twin deficits, the current account and fiscal deficits, could push the U.S. dollar lower still. The U.S. current account deficit reached $850-$875 billion in 2006 while the fiscal deficit hit $395 billion.
So with gold hitting 28-year highs, why not sell some of those fabled U.S. gold reserves to offset the twin deficits or pump some life into commerce to help bolster the ailing economy?
In the interest of time, let us first bypass the possibility that the reserves are no longer there (as largely believed by the Gold Anti-Trust Action Committee) and assume Fort Knox is stocked, even though the government seems cheerfully ignorant of the holdings. That aside, here is a breakdown of what the return would be in the market.
Gold has risen by well over $100 since mid-August, mostly on dollar weakness and safe-haven buying sparked by turmoil in the mortgage lending market. Spot gold was last trading at $756.80 per ounce, hitting a high of $767.05 this morning - its highest point since January 1980.
The United States has huge gold reserves, which were built up to honour the gold standard that was in place until 1973. It has more than any bank in the world and more than twice as much as the second largest holder. According to the World Gold Council, the government of the United States of America holds gold reserves in the amount of 8,133.5 tonnes (262 million ounces).
At current gold prices, this comes to almost $200 billion dollars worth of gold. The U.S. last valued the gold at $42.22 per ounce, so that’s a 1700% return of unrealized gains. But let us delve a bit deeper before we make any conclusions.
Central banks around the world have sold gold to lower their percentage of holdings as they stand up against euros and, to a lesser extent these days, U.S. dollars. Even the International Monetary Fund, with about 3,200 tonnes of reserves in banks around the world, has alluded to the possibility of selling 400 tonnes.
European signatories have about 12,600 tonnes and can sell up to 500 tonnes of gold per the Central Bank Gold Agreement of 27 September 2004. According to the Bank of International Settlements, central banks sold 475.75 tonnes in the third year of the agreement ending 26 September 2007, following 395.8 tonnes in the second agreement year.
Spain was the largest seller of gold last year at about 165 tonnes, representing more than 30% of the 475 tonnes of total gold sales. The Swiss reported sales of 113 tonnes between 15 June and 26 September 2007 and intend to lower their gold holdings to 1,000 tonnes by 2009. France sold 99 tonnes in the last agreement year, while the European Central Bank announced sales of 60 tonnes.
Germany is the world’s second largest gold holder with about 3,400 tonnes, France is third at about 2,750 tonnes, Italy is the fourth largest with some 2,450 tonnes and Switzerland is fifth at about 1,200 tonnes. Italy has 66% gold in percentage terms of total reserves, Germany 63%, France 56% and Switzerland 42%.
The U.S. has 76% of its total reserves in gold. In comparison, Portugal and Greece are the only major central banks that beat the U.S. with 80%. However, Portugal has less than 400 tonnes, while Greece has less than 100 tonnes.
If these banks were to reduce their reserves to 30%, Germany would have to sell 1,802 tonnes; Italy 1,341; France 1,273; Switzerland 394; Portugal 235 and Greece 50. The U.S. would have to sell 3,741 tonnes worth $91.4 billion.
Neither Italy nor Germany has sold gold in any of the agreement years. Germany recently said it plans no substantial gold sales in 2008 and Italy has made no indication it plans to sell any gold, aside from some political posturing. So if the U.S. wants to remain top dog, it would have to retain most of its reserves.
Therefore, based on a revaluation as compared to other major central banks, if the U.S. were to reduce gold holdings to say 65% of total resources, perhaps by only 1,400 tonnes, this would still come to about $34 billion. Now the question becomes, where would the new money go?
If the money is used to pay down some debt, which should be on everyone’s mind at this point, it would really only scratch the surface of the twin deficits. Not to mention a war that has cost $750 billion thus far. The priority should be a better fiscal policy and not a quick fix. So like a rare coin, in this case the reserves may be worth more as store of wealth.
Alternatively, the U.S. government could use the proceeds to benefit commerce, perhaps by rebuilding infrastructure and the like. This would seem the most logical use for the proceeds, since money injected into the economy will come back in the form of taxes. And as we all are aware, infrastructure upkeep is increasingly becoming a problem; note the levy in New Orleans or the bridge in Minnesota.
The drawback, however, would be the ‘creditworthiness’ that is lost. The U.S. economy functions on debt financed from abroad. If the government were to sell its gold reserves, the U.S. may lose the ability to function properly as an economy. Perhaps a middle ground might be the best option here, with partial sales.
Even still, any sales of gold into the market would have to be done with extreme caution not to upset the market with either the decision or the actual process. Similar to the European gold sales agreement, the U.S. would have to limit its sales per year.
Gold bugs may cry foul at this notion, but it stands to reason that if the U.S. has been the global purchasing engine, buying up those cheap Chinese goods, for example, then a recession would affect all commodities including precious metals. Therefore, it is not a matter of protecting the engine versus the asset, but protecting the engine to protect the asset.
If it takes selling some of the U.S. gold reserves to stave off a potential recession or worse, then so be it. But until the government realizes that the gold in the basement is worth 20 times as much as first valued, there it will remain.