Central Banks, Gold & the Currency Market, Part II

Yes, governments plainly manipulate markets all the time. They also hold gold...

 

The LATEST TARGET of governmental investigation and criminalization are foreign exchange traders at the big banks, writes Miguel Perez-Santalla at Bullionvault in the second part of this essay on central banks, currencies and gold.

 

No matter that manipulating underlying rates or direction in the foreign exchange markets is close to impossible. What it is currently being alleged is the idea that the FX market "fixing price" is being manipulated.

 

These rates are set by market trading during a one-minute window, across three different trading platforms, averaged out by an independent company at which time the news agency Reuters publishes the data.

 

To make it clear, during that one-minute period actual transactions occur between trading parties. The prices of these transactions are transparent because they are posted on the market trading systems, which make it public knowledge as they occur. All the actual prices at which transactions were negotiated are then tabulated into an average price and posted. The posted price is a reference price that is used by many to settle outstanding orders that were left for the fixing.

 

Whatever the outcome of this latest attack, central banks – who are taking a lead role in investigating the banks – plainly hold the power to manipulate (or control) markets without anyone saying they shouldn't. Setting interest rates and buying bonds while releasing more money into the economy, their actions are instead called "easing". On the other hand, government and the central bank can of course use their policing power to bully the markets by restrictive policies or regulations. Witness the " short selling bans" imposed during the worst of the financial crisis in 2008, apparently to protect banking stocks from hedge funds, but attempting instead to prevent the market from clearing at a freely-decided price. Similar blocks were applied across the Eurozone during their 2010-2012 credit crisis too, with traders banned from profiting if weaker government bonds fell.

 

Venezuela, while under the tutelage of the late, unlamented Hugo Chavez, was driven into the worst economic environment in its history following such policies. Exchange controls and other blocks on what citizens could do with their money led the economy to stall and then shrink.

 

Further attacking his own country's economic growth by seizing foreign-owned assets, and so blocking that flow of free trade and capital which leads to prosperity, the Chavez government began to fear reprisals by foreign governments. So they moved their national gold reserves from the vaults in the Bank of England in London, heart of the world's bullion market, back to Venezuela. That cut them off from the international market entirely. Chavez's government fixed the currency rate, which with restrictions on the trade and flow of money as a consequence created a parallel (or black) market. Untrusted and closed to the world's free markets, Venezuela lost its access to international credit, damaging its economy yet further.

 

If Venezuela were to get back into the business of allowing prosperity to flourish under the guidance of hard working business, then sending some of their gold back into a major Western bullion market would be a good first step. Indeed, recent reports from Caracas say that is what the government will do, raising cash from Goldman Sachs through a "gold swap".

 

This is a great example of why central banks hold gold, and why most hold a portion of their reserves outside their own borders, ready for use in a major center. Gold, the one commodity that has never seen a complete decline in demand, is a vital form of guarantee between countries, enabling those with tenuous economies and collapsing markets to revive credit and trade.

 

The USA holds the largest gold reserves in the world and maintains 8,133 tonnes of gold currently priced at $42.22 per ounce. Germany holds the second largest reserves with 3,387 tonnes of gold. Incidentally it is no surprise that these holdings have enabled these countries to be the most powerful economies in the world. It is clear that gold has not lost its allure to the rest of the world's central banks either.

 

Though the price does not determine central bank activity in buying or selling gold, it is no doubt that "Gordon Brown has had many sleepless nights," as George Milling Stanley put it in a recent interview with Bullionvault's New York Markets Live. Brown decided to sell half of the UK's national gold stocks at an average price of $275 per ounce. Even after falling more than 35% from its 2011 peak, the price today is over four times that level.

 

George Milling Stanley also told us that the growing emerging market economies will continue to buy gold for their national reserves as well, to grow their overall strength in the global forum. For instance China. The world's second-largest economy may have increased its reserves to 2,710 tonnes, up from 600 tonnes a decade ago, according to Kenneth Hoffman, a senior analyst at Bloomberg Industries. If correct, that would make China's national gold bullion reserves the third largest behind the US and Germany.

 

For comparison, the average gold holding of the top 100 central banks is 15% of reserves. Yet many of the largest Asian central banks, including China, hold less than 5% in gold, based on data on the World Gold Council's website. This lack of equilibrium is why they will continue to work on building these holdings on their balance sheet into the future.

 

As central banks and governments work to protect themselves from unknown currency or economic crisis, by holding gold as part of their crucial reserves does it not make it abundantly clear that we should too as private individuals?