The Price of Gold Sets the Price of Oil and All Else

Gold Flash25 February 1999
From the World Gold Council

The World Gold Council has urged IMF leaders to lift their ban on member
countries' pegging their currencies to gold.

In a speech to participants at a two-day meeting in New York, organised
by the Re-inventing Bretton Woods Committee, and attended by senior
officials of the IMF, the World Bank, the European Central Bank and
other national central banks, the Council said that efforts by the IMF
to demonetize gold had largely failed and gold was still the second most
valuable component in official sector reserves - behind only the dollar
- accounting for 16% of the total.

Here are important excerpts from the Council's presentation:

"The result of the demonetisation attempt was to institutionalise the
hegemony of the U.S. dollar. The advent of the euro upsets this
stability. In this new environment, some would say that gold should be
put back on the agenda of those seeking to produce the blueprints for
the new financial architecture. Our contention, however, is that gold
has never been away - you have only to look at its continued role as a
major central bank reserve asset to accept that."

"Why should a Fund member not be allowed to link its currency in some
way to gold if it so wants? Currently Article IV 2(b) forbids this. The
move 25 years ago to "abolish" gold was designed to enthrone the SDR
instead. The SDR has not, however, succeeded in establishing itself as a
genuine international reserve asset. In such circumstances there should
surely be no reason why gold is precluded from competing on all fours
with other reserve assets. For the Fund to outlaw it in the Articles is
an outmoded restriction."

"One lesson from history was that international monetary arrangements
can and do change and the coming of the euro provides an obvious
opportunity to reconsider the whole system."

"For the last half-century the dollar has been the hegemonic currency.
Why? To start with - let us not forget -because of its explicit gold
link. Subsequently, because there was no possible competitor and the
U.S. was, after all, the strongest economy - and possessed the most
liquid capital markets - in the world."

"With a single hegemonic currency there were not many choices to make.
Now, there are two potentially equal reserve currencies - the dollar and
the euro. Although the combined capital market of the EU-11 is not yet
as large as that of the U.S., it is still dramatically larger than any
of the previously individual European markets. Any central bank looking
to diversify its reserves now has a real alternative."

"But one thing seems fairly clear. Now that countries have a genuine
choice between two global currencies, there are likely to be significant
moves in and out of them as sentiment ebbs and flows."

"Can the world live with competing currencies or will one eventually
become supreme? Or might gold, as a recognised store of long-term value,
stage a comeback on the international monetary scene? It is probably
worth noting here that all previous reserve currencies (including, at
the outset, the SDR) had some kind of link with gold."

"The problem with hegemonic currencies (be it the dollar or the
deutschemark) is that they are run purely for the benefit of their own
domestic economies, not for the benefit of any other country which
chooses to peg to them."

"Gold is the only external asset which is no one elses liability. Now
that we have the euro, some countries may decide to take the relatively
simple decision to define their basket as some weighted combination of
that currency and the dollar in order to hedge their bets. An even more
effective hedge, however, can be constructed by incorporating some gold.
Studies suggest that the volatility of a central bank's reserve asset
portfolio is reduced, and the risk/return balance enhanced, by holding
anything up to 20% in gold."

"Most central banks do not see it as their business to take risks. By
incorporating gold into both a currency basket used for exchange rate
management purposes and a reserve asset portfolio, volatility is reduced
and the risk/reward picture improved."

"Which brings us back to the IMF and - as we would contend - its
no-longer-justified prohibitions on various potentially useful roles for
gold. The IMF's own gold holdings - 103 million ounces, make it the
world's third largest single holder. In 1995, the Executive Board held a
long and thoughtful discussion on the subject and came to some important
conclusions. These included the view that gold provided a fundamental
strength to the IMF's balance sheet, and the Board felt that the Fund
should continue to hold a relatively large amount of gold among its
assets, not only for prudential reasons but also to meet unforeseen
contingencies."

"Nothing has happened in the outside world in the last 4 years to
invalidate these judgements. Indeed, given the systemic uncertainties
caused by the arrival of the euro, there are surely all the more reasons
for the official sector to preserve its gold holdings and actively
consider ways in which its real value can be utilised in this brave new
monetary world."

Contact: Dick Ware, Centre for Public Policy Studies
World Gold Council, London.
E-mail: dick.ware@wgclon.gold.org

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