B.I.S. Gold / Swaps Reversed

In the last year, according to the B.I.S.'s annual report Central banks have pulled 635 tonnes of gold from the Bank for International Settlements in the past year, the largest withdrawal in more than a decade. The move, disclosed in the BIS's annual report, marks a sharp reversal from the last year when central banks added to deposits of gold at the so-called "bank for central banks".

The Bank for International Settlements did not disclose the reasons why the Gold/Currency swaps were initiated in the first place, nor have they disclosed why these transactions were reversed...

• Some have speculated that they did not earn enough on the gold they lent out. Lending gold for six months earned a rate of 0.1% recently, according to benchmark market assessments published by the London Bullion Market Association. This is certainly not worth any risk at all.

• Some say that it was central bank desires to keep their gold inside their vaults and not loaned outside it.

• Some say that the gold is now being lent to the private sector for a better yield. This may well be true, but we note that the risks have heightened well beyond the rewards they may earn.

To know for sure, we need to be told by the B.I.S. themselves, and that is not likely to happen. Few except ourselves have suggested it had been loaned out as collateral. The return of the gold to the central banks involved -- in the light of the worsening international debt situation and the risks to international banks -- could easily have played a part.

The BIS confirmed that the fall in the value of gold deposits disclosed in its annual report represented, 'a shift in customer gold holdings away from the BIS'. Comparisons with previous annual reports showed the withdrawal was the largest in at least 10 years. This implies that more than improved yields were involved. In our opinion, the return of gold to its original owners reflects the higher risks out there for the banking system. No central bank will want it to be known that they have a creditor that cannot return their gold. Should the worst happen that the Eurozone membership changes, then the ensuing financial chaos calls for central banks to be able to cope with any dramas that might come their way.

It would be prudent for all such guardians of national reserves to have their assets in house. To us, this seems the most plausible reason and one all central banks would never dare express!

Extreme Times

One of the most difficult definitions to make is the definition of extreme times for central bankers. Are we in extreme times for most gold holding central banks based in Europe? We would think so, as the abilities of European Finance Ministers are falling short of what's needed to rectify the Eurozone debt crisis. Matters are worsening every day, and we haven't seen the worst yet. If matters do decay any further, or if Greece leaves the Eurozone and the Drachma is reinstated, then it will need all the help it can get from its central bank.

While the Greek government cannot instruct the central bank to compromise its independence (unless it leaves the Eurozone) in extreme times the central bank may, on its own initiative, step into the breach of international trade and use gold as collateral, to keep international trade flows moving. That is what really extreme times means.

With Greece, Ireland, Portugal, Spain and now Italy on the danger list of debt-distressed members of the Eurozone we are in extreme times in Europe. This would be gold's time!

So what can happen to make gold serve as more than its dollar value? Gold is money as a last resort amongst bankers. What would make them activate it?

Departing from the E.U.

We have to do more than sit and wait to see what happens. At the moment the gold price has shot up to €1,107 at Tuesday's Gold Fix in London, a record almost €30 higher than the previous peak. Confidence in the euro is crashing. It is clear that even Europe's Finance Ministers recognize that Greece is completely bust. Whichever way the country goes -- whether it is into austerity for the next decade or perhaps into a booming exit from the E.U. -- it is going to have an extremely hard time. If it does leave the E.U. then what does it do?

Take a look at Argentina, when it left the dollar peg and let the Peso drop. Argentina is still not welcome in the markets, but it benefitted more than it would have suffered if it had kept the dollar 'peg'. If Greece followed the same road it would have to reinstate the Greek Drachma at a hugely lower rate per Euro, so that its cheapness would attract euro-bearing tourists in droves. The banks would need to be saved by the forcible conversion of euro deposits to Drachmas at a lower level. Capital flows would have to be stopped or heavily penalized through a deep discount to the Drachma used for commercial transactions.

This would give rise to a Financial Drachma and a Commercial Drachma. New investors in Greece would be rewarded with the deep discount that would prevent money flowing out of Greece. Commercial transactions would follow the value of the Drachma established in trade with Greece. If foreign banks wanted to remove the blocks on their capital they would be asked to invest it in 10-year government bonds or bank deposits before it could be repatriated.

The big advantage to new investors would be that they would not simply earn good interest on their deposits but would see a capital profit of the deep discount at the end of 10 years, a boost to their interest income in the amount of the deep discount as income would leave the country as a commercial transaction.

With an economy not built to perform well by itself, the benefits of these changes would enhance the performance of the economy remarkably. Property investments would enjoy the deep discount on capital alongside the new tourist boom. Under any long term bailout none of these benefits would come to Greece.

What will happen to Greek Gold now and in the Eurozone?
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