< Magazine Index > < Index For This Edition > < Subscribe >

Just six weeks ago, the price of gold reversed its steady decline of the past several years. The European Central Bank (ECB), as well as the central banks of 14 other European countries, announced a moratorium on more gold sales and loans for the next five years.

The story is far from over, however. In my opinion, this was just the first shot in war that will force new highs in the dollar price of gold, and make fundamental changes in the balance of economic power between Europe and the US.

Why did the banks make this decision? "The commando operation, which the Bundesbank and the Bank of France prepared for three months in the greatest secrecy to force the gold price higher, has fully succeeded". This is from the September 27 issue of "Le Monde", the prestigious French daily newspaper. The article goes on to say that the central banks of both France and Germany were not amused that Britain had announced a sale of some of their gold reserves in July. In this article's words, "Both of these banks are philosophically attached to gold as a strategic part of their countries' monetary reserves. Gold remains an element of long-term confidence in money. For psychological motives, central bank gold reserves are a gauge of prudence in management in the spirit of savings and of the public. Politically, maintaining gold reserves is a sign of monetary sovereignty…being….still today insurance against major international monetary instability." So they planned a secret commando operation for three months that involved the other central banks mentioned? The stated target may have been one gold sale by the Bank of England, but the effects will be much broader. Anyway, the Bank of England was one of the signatories to the announcement. The Bank of England certainly did not take part in a commando operation against itself!

There are a number of hidden references in these words. Although the US dollar is never mentioned specifically, it is the reserve currency for most of the world. As the US dollar goes, so go the rest of the world's economies. But for the past several years, many European commentators have been severely critical of the financial health of the US. In an article entitled "The Fed Is Not A Model" (Die Welt of October 7), Joerg Eigendorf writes: "Monetary policy in the USA is at present a tightrope, because on the one hand it is the priority function of the Fed to hold prices in check with its monetary policy; on the other hand Greenspan must make certain that he does not bring down the house of cards. US shares are overestimated, the rate of saving is negative and the balance of payments is in the red. A false signal from the Fed chairman, and the market could fall - with bad consequences for the US." This is a hardly subtle criticism, and is by no means the only article that has been written in the European press concerning this subject.

So, at first glance, this move may be seen as defensive, protecting the EU from what they see as a dangerous situation that has developed in the US. No one could fault Europe for wanting stability. This is a keyword in many of the writings and speeches published at the ECB website (see www.ecb.int). Europeans are just beginning to feel the strength of their newborn power in unity, and they perceive the possibility of infanticide by a failure in the US markets. Perhaps I am overly suspicious, but I see more at work here.

There has been some commentary on these developments in the press, but by and large the predominant sentiment is that gold remains demonetized. On October 19, Radio Free Europe published an article by Ben Partridge quoting Haruko Fukuda (new CEO of the World Gold Council) as saying, "a recent strengthening in gold prices is encouraging, since it shows the precious metal still has a role as a reserve asset and a store of value against inflation." Opposing views in the article state the more generally accepted view in today's world: "Commentator Martin Vander Weyer, writing this week in Britain's Spectator magazine, says gold has lost its fascinating mystique and become merely a commodity -- one that is expensive to look after and insure, and pays no dividends. Vander Weyer argues that gold's traditional role as a sure protector of wealth has disappeared in today's low-inflation world. Other investments have proved far more lucrative." From the same article: "Professor Michael Wickens, of Britain's York University, says that in the past, countries traditionally held gold as the ultimate hedge against inflation. But in today's low-inflation world, he says, it makes no sense to hold on to a nonproductive asset as a sort of 'magic totem'. Wickens, a former economics adviser to the British government, says gold is now a very small part of the global financial system, as the world has shifted to a system based on highly reliable paper debts. For the countries aspiring to EU membership, Wickens says it is the strength of their economies, not the size of their gold holdings, that will be the crucial factor in deciding EU membership."

More opinions from Europe discounting the price surge:

Berlin Online: "The boom is not anything, on which one should rely as private investors…. from the fundamental point of view gold remains an investment without potential. The seeming so solid metal is only an object of speculation between issuing banks and financial markets."

Basler Zeitung: "In former times one could always observe a certain correlation in the precious metal trade at the prices of crude oil. But this is like the long history of the role of the precious metal as an inflation hedge, which revives only in the dreams of old goldfreaks…. Anyway, the gold price will not be going sky-high… it still depends on the dollar rate, and this prognosticator sees prices in the near future rather lower than today."

These are a few examples. In short, very little has been written in the popular press that even begins to connect the dots for the average investor. Certainly there has been some criticism, an occasional lone voice in the wilderness, that tries to point out that the situation in the US cannot last forever. But not much has been written about the fundamentals of the gold market in the mainstream press. Some has been written about the situation of forward sales by gold producers, here and on other sites. This alone is enough reason that the price of gold cannot be allowed to rise without disastrous consequences for many gold mining companies and their bankers. But there may also be other reasons why the time is not yet ripe for a rise in the price of gold.

The Euro is a very new currency, but European banks have been aggressively making inroads in developing countries, up to this time primarily as lenders. From "Possible Effects of EMU on the EU Banking Systems in the Medium to Long Term", excerpted from sec. 4.2 "Internationalisation and Geographical Diversification":

"The degree of internationalisation of the EU banking systems may be seen from two basic perspectives: inward and outward internationalisation. Given the difficulty of obtaining reliable data on branches and subsidiaries, the figures currently available may underestimate the importance of internationalisation, at least with regard to larger players, due to a high proportion of off-balance-sheet business (which is not taken into account in the respective figures in Tables 5.1a to 5.2b).

"Overall, the EU banking systems seem to have adopted an important, if not leading, role as international lenders in comparison with other banking systems, as total lending by EU banks to all reported emerging, transitional or developing "BIS debtor countries" amounted to 57% of all international banks' lending, compared with 14% for Japan and 12% for the United States. The rest is covered by Swiss, Canadian and other banks. This may partly be explained as a reaction to increased diversification efforts due to EMU, but can also be seen as a sign of excess capacity and liquidity, as well as market saturation and low returns within the European Union.

"In terms of different regions, EU banks hold the majority of claims to emerging Asian countries (46% compared with 35% of Japanese banks still being important lenders to this region and 9% for US banks). The EU countries show a higher relative share in lending to Eastern Europe (including the former Yugoslavia) (see Table 7.1a) than their share in total international lending to all reported debtor countries.

"As of mid-1998 the EU lending to Eastern Europe amounted to 79% of all international banks' lending, compared with 3% for Japan and 9% for the United States. With regard to lending to Latin America, the relative market share of EU banks is also highest (56%), followed by the United States (22%) and Japan (5%). The recent financial crisis prevailing in emerging countries might induce the EU banks to become more cautious in the process of geographical diversification. The total Asian exposures of EU banks fell during the first half of 1998, while exposures towards Latin America and Eastern Europe (including Russia) continued to increase. EU banks have generally had faster growth rates in their exposures towards the selected debtor countries than US and Japanese banks over the past two years. This development has significantly increased EU banks' exposures towards these countries. EU banks have replaced Japanese banks as the most important lenders to the emerging Asian economies and increased their dominance in lending to Latin America, and recently also to Eastern Europe."

Note the size of market share obtained by banks of the EU. Note that these loans are not likely to be forgiven and repaid by taxpayers, as is often the case in the US.

The following are excerpts from a speech delivered by Dr. Willem F. Duisenberg, President of the European Central Bank, at the conference "Resilience and Resurgence in Latin America" in New York on 1 October 1999

"The Euro Area: Prospects, Challenges and Opportunities

"Ladies and Gentlemen,

"Europe's strong ties and close affinity with Latin America stem from its people's common origins, culture, and trade. I am particularly pleased, therefore, to be able to participate in this conference.

"During the past few months, the prospects for the global economy have gradually improved and the world economy appears to be heading towards a more balanced growth path. While uncertainties still remain as to the strength of the recovery, especially in regions which were most affected by the global slowdown in 1998, the risks of a world-wide recession have receded and inflationary pressures generally remain subdued.

"A more optimistic view of the global economy is warranted, as macroeconomic policies around the world have become more stability-oriented over the past decade. A general consensus has emerged on the need for monetary policy to focus on the achievement and maintenance of price stability. In many countries, a higher level of fiscal discipline has also favoured the pursuit of a stability-oriented monetary policy and has set the conditions for a more sustainable economic growth.

"The European Central Bank's (ECB's) stability-oriented monetary policy for the euro area is contributing to these developments by aiming, in fulfillment of its mandate, to maintain price stability, thereby fostering a favourable environment for business activity. The ECB has defined price stability as a year-on-year increase in the harmonised index of consumer prices of below 2% in the euro area, and has stated that price stability is to be maintained over the medium term."

There is much talk in Latin America about tying currencies to the US dollar. Latin American countries have been unable to discipline themselves to create stability in their currencies. This speech is pure courtship from Europe and the ECB, to use the Euro as an alternate reserve currency. We should expect a marriage proposal in the near future. Remember the adage from real estate about the three factors in property values: "Location, location, and location"? The ECB recognizes three factors in currency value: "Stability, stability, and stability".

At this point in time, this idea may sound like a far-fetched speculation. But it would not take much to change the scenario.

As pointed out previously, the US markets is in a precarious position, recognized by Europeans, but not by many in America. What would happen if the ECB raised rates and caused a major change in the balance of US debt ownership? Could the US stock market, the US government, and US taxpayers handle such a shift, even if it were to happen at a gradual pace?

How much of the US government and private debt is currently in foreign hands? Could the US stock market absorb a significant rise in interest rates that would be necessary to prevent a flight of foreign investment away from US government securities and into Euro equivalents?

Take a look at the valuation of European stocks in general. Valuation of securities at prices nearer to book value allows much more of a healthy chance during volatile interest rate markets. Americans, however, do not think of this as being a strategic vulnerability in our markets.

When you consider this, remember some of the interesting words used in the above articles: "commando", "sovereignty", "tightrope", and "stability". Of course Europe is not going to declare war on the US. But they have already demonstrated great aggressiveness in making loans. What if this extends into areas where the US economy starts to feel it?

Yet if any of this really is based on strategy, it will proceed in an orderly fashion. For the strategic players, the price of gold must not go through the roof at this point. The keyword of the EC and ECB is stability.

The remonetization of gold is the first step in a significant power shift in the economic and political world scene. This is one front in the war. There are others, just as threatening and just as invisible, that I have not covered in this article. But the stakes are too high for the gold market to be allowed to regain its normalized price level at a rapid pace. There's a lot more going on than short covering. The European Central Banks know something that most Americans don't, or at least that they have forgotten.

At least the silence from the mainstream media makes it clear: It just will not do to give a lot of public attention to the gold market at this time. That's where readers of this forum have the inside track.

Willy Smith
10-November-99

References:

The fourteen banks involved in the announcement are: Germany, England, Austria, Belgium, Spain, Finland, France, Italy, Ireland, Luxembourg, Netherlands, Portugal, Switzerland, and Sweden

Note: If you can't read French or German but you want to study the articles, you can paste the URL or the text into Babelfish for a decent translation. (http://babelfish.altavista.com/cgi-bin/translate?)

Les banques centrales européennes provoquent une flambée des cours de l'or:
http://www.lemonde.fr/article/0,2320,24556,00.html

Die Fed ist kein Vorbild:
http://www.diewelt.de/daten/1999/10/07/1007fi132368.htx

World Gold Council Recommends Gold for European Central Banks:
http://search.rferl.org/nca/features/1999/10/F.RU.991019135111.html

Other references:
http://www.BerlinOnline.de (use search engine for articles on gold)
http://www.baz.ch (use search engine for articles on gold)

From Possible effects of EMU on the EU banking systems in the medium to long term, pdf 409 kB, February 1999.
http://www.ecb.int/pub/pdf/emubnk.pdf

The role of the euro as a new European currency:
http://www.ecb.int/key/sp990929.htm