I have been taking the INET course on Money and Banking by Perry Mehrling. It is a superb course and has introduced me to this concept that the financial/monetary system requires elements of elasticity and discipline to live.
In Lecture 14 of the course he introduced why the Keynes concept of the Bancor (more elastic system) was trumpted by the SDR (more disciplined system) concept for creating this higher level of money in the hierarchy between gold and national currencies and this post is being made to capture that idea. In fact he occassionaly shows Gold and SDRs (paper gold ?) as being equivalent but that is another future discussion!
Of course the BANCOR favoured the deficit nations since it provided for no limit on any required monetary system elasticity (bank of last resort) and dealt with the asymmetry issue of rebalancing the global monetary system by actually charging the surplus nation a negative interest rate so that they would spend the money. Perry’s arguement was that the US looked at the Keynes model and concluded that since they expected to be the major surplus nation that this concept was not really in their better interests. Hence it did not happen.
Instead what ultimately developed was a paper reserve called the SDR (Special Drawing Rights). It was more like a gold standard in that there would only be a fixed quantity created. SDRs would have the qualities of a more disciplined system and would benefit the higher GDP nations as opposed to the emerging nations because in the new IMF model the highest GDP nations (read USA) received the biggest share of the SDR allocations (paper gold) being created. That way all those SDRs allocated to the USA could be loaned by the USA to deficit developing countries when needed ?!!
Today the USA is the major deficit nation but continues to receive the largest allocation of SDRs. No surprise that China is fighting for a different system !? The SDR is hence not disciplined or elastic enough in it’s current construct. So what is the future ? Some say it is adding the RMB to the SDR basket of currencies and increasing the number of SDRs allocated to nations ?
Of course Perry Mehrling indicated that the entire gold standard system could have been saved (at any time since the 1920s) by simply revaluing gold to a higher price ! Is that still part of the ultimate fix ? Gold priced higher as the discipline and maybe a BANCOR like currency (not based on any nation’s currency) as the next layer in the new hierarchy of money ?!
So what is the gold lease market ?
Central banks don’t directly take their bullion to the market and lease it out. They use a vehicle called a bullion bank (BB). Although bullion banks are numerous, some of the more well known are Barclays, Goldman Sachs, JP Morgan, Bank of America, UBS, and Citibank. The central banks loan gold to the BBs at a rate of approximately 1%. The BBs take it to the LBM and sell it on the open market. The BBs take the cash from selling the bullion and in turn buy Treasuries.
So if the story were to end here, the bullion banks would just walk away with a net 4% return. But it doesn’t end, because they only have the leased gold for a certain length of time. They eventually have to give the gold back to the central banks, but now they are at risk of price swings in a very volatile market.
The answer to their problem is to go long the futures market. Essentially, they buy futures contracts to hedge their risk. In other words, they secure gold for delivery at a specific price, on a specific date in the future. Once they buy their futures contracts, it doesn’t matter what the price action of gold is.
Now in a declining future gold price market this Leasing Out of Gold no doubt generated easy profits. In todays rising gold markets does it become more problemmatic? Maybe because the gold futures potentially will cost more to purchase and the treasuries are providing significantly less percentage return.
However observe that the FED is actually loaning out gold at a negative interest rate ? What ? Is this an error ?
So does the rising gold price not also allow the Bullion Banks (BB) to take increased cash out of the economy and with it buy increased government bonds?! It would actually appear that a “steady” rising gold price might be desired to accomplish just that?!! But why? Maybe to help soak up those excess reserves ? And the FED is paying negative interests to the BB to borrow gold and play this winning game !
Here is the updated Cheat Sheet.
A rising gold price was in the past always considered inflationary.
Why … because under the gold standard you first raised the price of gold against the “fixed exchange” of the national currency and that was an inflationary spike and was accomplished overnight. You were creating the high power reserves to be able to create new money but with the clear intention of spending the new money and causing price inflation. You were therefore creating actual new money secondly after an official currency devaluation.
However today it will be deflationary !?
Why … because under the current fiat money system the money has been created first and is sitting on the FED balance sheets as reserves with no clear intention of being spent. In fact some people would argue the reserves are trapped. In this environment gold, as a global reserve currency, can be used to soak up any newly created fiat money to control the inflation as opposed to creating the inflation. Is this indirectly what Ambrose is trying to say about making gold a third reserve currency?
The world is moving step by step towards a de facto Gold Standard, without any meetings of G20 leaders to announce the idea or bless the project…..It is no secret that China is buying the dips, seeking to raise the gold share of its reserves well above 2pc. Russia has openly targeted a 10pc share. Variants of this are occurring from the Pacific region to the Gulf and Latin America. And now the Bundesbank has chosen to pull part of its gold from New York and Paris….Let gold take its place as a third reserve currency, one that cannot be devalued, and one that holds the others to account, but not so dominant that it hitches our collective destinies to the inflationary ups (yes, gold was highly inflationary after the Conquista) and the deflationary downs of global mine supply. That would indeed be a return to a barbarous relic…A partial Gold Standard – created by the global market, and beholden to nobody – is the best of all worlds. It offers a store of value (though no yield). It acts as a balancing force. It is not dominant enough to smother the system.
My guess is that gold will simply rise in price to the equalibrium required to soak up the excess fiat reserves or to bring the global reserves into balance ??? This is therefore a deflationary event because it occurs after money creation as opposed to before ?! Right ?
I guess it is only appropriate that my 100th post on OTP is related to SDRs since my first post back on 18 Dec 2010 was SDR #1.
Thanks Mystic for keeping this site alive and encouraging participation by all.
So how do you monetize a SDR ? Well first you need to have some SDRs and this takes us back to another post on OTP explaining where SDRs come from.
So Richard’s “Monetary Cheat Sheet” (MCS) needs to be updated to take into account:
1. the allocation of SDRs to the USA from the IMF,
2. the payment of the IMF quotas by the USA,
3. the Treasury issuing a SDR Reserve Certificate to the FED, and
4. the FED passing the newly monetized CASH to the Treasury !
That was a mouthful !? Remember I am not suggesting that this diagram is even 80% accurate!? Just trying to have one stop shopping for ”some” of the ideas that appear to be driving our monetary system.
Oh here is Jesse’s article from 2009 where he looks at SDRs and Gold and concludes:
Does any of this amount to a hill of beans? Perhaps, but probably not. At least the next time I need to look up some of these facts and history to explain or correct a question or misunderstanding, I will not have to look all around the web for it again, and wade through many links of incorrect misinformation and rubbish to find it.
Have a great 2013 !!
Happy New Year …. everyone. This post is really an attempt to position the Issue of Gold Reserve Certificates within the existing monetary system. I know that we are no longer on a gold standard but that does not mean that gold is still not part of our monetary system!
Remember a previous post back in Dec 2010 where I introduced ISO 4217 as the international standard describing the currency codes for use in the banking and financial industry? Yes gold is still in the list.
My real point is that the issue of a Gold Reserve Certificate to the FED, by the treasury in years gone by, resulted in the FED passing the Treasury new US dollars to spend without the issue of T-Bonds. I think this is called monetizing gold and it was last done at an adjusted gold price of $42.22 an ounce in 1973 and remains on the books at that price.
So below is my current summary of Monetary Realism!? It includes gold because gold is still on the books of all central banks. Can you also see the realism from Keen, Hudson, etc in that diagram ? Any others to add ?
This odd result has created what I think is one of the more amusing equilibriums in monetary politics. Hard money types would like nothing more than to see their favorite asset, gold, revalued. But they don’t actively pursue the idea because of the expansionary effects a revaluation would have on the Fed’s balance sheet. Easy money types would like nothing more than to see the government get billions in free cash, but don’t like the idea of the barbaric metal getting a leg up. The upshot is that gold stays valued at its archaic price of $42.22.
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