Matthew Lynn: Central banks need gold to manipulate currency markets

12:31p ET Wednesday, March 28, 2012

Dear Friend of GATA and Gold:

MarketWatch columnist and novelist Matthew Lynn earns his tin-foil hat for his commentary today, "The Next Leg of Gold's Bull Run," which acknowledges that central banks hold gold reserves for currency market intervention and manipulation.

Lynn notes: "You can't manipulate the markets without anything to sell, and that means holding reserves." He speculates that even Western central banks will start buying gold for "insuring themselves against their own profligacy. They print money. The price of gold goes up. And if they hold a lot of the stuff in their vaults, they are the big winners from the rise in price. If you can pull it off -- and there isn't anything to stop you -- that sounds like an easy way to make a living."

Lynn's commentary is appended.

CHRIS POWELL, Secretary/Treasurer
Gold Anti-Trust Action Committee Inc.

* * *

The Next Leg of Gold's Bull Run

By Matthew Lynn
MarketWatch.com
Wednesday, March 28, 2012

http://www.marketwatch.com/story/the-next-leg-of-golds-bull-run-2012-03-...

LONDON -- Has the great bull run in gold run its course?

On the surface it looks as if it might have. After running up close to $2,000 an ounce during the market panic of last autumn, it has slipped below $1,700. And it shows little sign of reclaiming its highs.

But here's one reason why it could have a lot further to go.

The big, developed-world central banks will start buying again. And if they do, it would put real rocket fuel into the price of the precious metal.

In his budget last week, British Chancellor George Osborne caused a small flurry in the markets with a line that suggested the Bank of England might start stockpiling gold. The U.K. Treasury quickly denied it, saying that he had just been talking about reserves in general, rather than gold specifically.

... Dispatch continues below ...

The developed-world central banks should all be increasing their reserves dramatically. The best way would be by refilling their vaults with the precious metal.

In his speech, Osborne said that he planned to increase Britain's reserves, something most developed countries have not worried about for the best part of three decades. They are certainly in a sorry state. For a major developed economy, the U.K.'s reserves are laughably tiny.

Under the previous prime minister, Gordon Brown, the country sold off a lot of its gold right at the bottom of the market. Its total reserves now amount to just $46 billion. That is up a bit from the $34 billion they stood at when the new government took office, mainly because of the increase in the value of its gold holdings and also the extra deposits committed to the International Monetary Fund.

But the U.K.'s hoard of gold and foreign currency is dwarfed by China’s reserves, which currently stand at a towering $3.18 trillion, as well as by Japan with $1.2 trillion, and by Saudi Arabia with $500 billion.

In common with most developed countries -- Japan excluded -- the U.K. has no reserves worth speaking of. In truth, what is interesting is how low the reserves held by all the developed nations now are. Switzerland is the only European country with significant reserves, with $340 billion squirreled away, while Germany has $257 billion and France has $172 billion. The U.S. has only $148.5 billion, although when you can print the world's reserve currency maybe that doesn't matter so much. Overall, however, it is only the emerging nations that have built up significant cash piles.

But, as Osborne hinted, they need to think about raising them. He probably isn't the only finance minister to be planning on stockpiling more assets. Even if they are not talking about it yet, others will have the same plan.

Here's why.

First, foreign exchange reserves are critical if you face a financial crisis. If the banking system needs to be propped up, then you need some assets to play with. Of course, the central bank can always print some money. But in a crisis the markets may demand something more solid -- and that means having reserves.

Next, they give you the ability to intervene in the currency markets. The U.K. has managed to devalue its currency substantially, one of the few factors saving its economy from an outright depression. Other countries may want to do the same -- getting your exchange rate right is a key plank of economic policy. But you can't manipulate the markets without anything to sell, and that means holding reserves.

Finally, the credit rating agencies offset reserves against government liabilities, so they can be critical to maintaining your credit rating. For most of the last 50 years, the developed nations have not had to worry about their balance sheets. For the next 50 years, with aging populations, and already downing in debt, they will have to worry about them a lot. The more reserves you have, the better (or at least less bad) your balance sheet looks.

So what is the best way to increase reserves?

Most paper currencies are sinking fast. Reserves with the International Monetary Fund have no real secure value and the IMF's quasi-currency, known as the Special Drawing Right, is made up of four funny-looking paper currencies rather than just one.

But reserves held in gold can be expected to grow in value every year. Indeed, cynically, by holding more gold central banks are insuring themselves against their own profligacy. They print money. They price of gold goes up. And if they hold a lot of the stuff in their vaults, they are the big winners from the rise in price. If you can pull it off -- and there isn't anything to stop you -- that sounds like an easy way to make a living.

Central banks in the emerging markets increasing their holdings of gold has been a big part of the bull market in the metal. At the end of last year, official net purchases of gold started to rise dramatically. In the third quarter of 2011, central banks added 148.8 tonnes to their gold stocks, more than double the entire amount of government buying in 2010, according to the World Gold Council. Interestingly, the Greek central bank has been slowly adding to its holdings of gold, which would be sort of handy, should they happen to decide to re-introduce the drachmas one day.

But the next phase will be developed-world central banks moving back into precious metal; the U.K., Germany, France, Switzerland, and potentially the United States as well.

The U.K. has given the first hints that policy makers are at least thinking about it. Actual buying maybe some way off. And if they start, it will be done discreetly, otherwise the price will shoot up.

But when it starts to happen seriously, it will provide the bull market in gold with a whole new impetus.

* * *