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Why is the Swiss central bank selling gold?

The Swiss National Bank is selling 250 tonnes of gold. Why...?

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WITH THE Swiss central bank selling 250 tonnes of its gold reserves, the classic question has to be asked again, what is the price of gold? If we answer that it's worth a certain number of Dollars, then we have to ask the next question:

   Just what is the price of a Dollar?

   Is the US Dollar such a reliable a store of value that it can be used as a measure of gold's value? To ask would be to question the very foundation of the paper currency system. Can one trust the Dollar or even the international monetary system? It’s all a question of degree.

   The US government itself holds mainly gold in its reserves, because it is the issuer of the world’s reserve currency. This does imply that it is completely dependent on its own currency, the Dollar, in the global economy. As the foundation of the world’s monetary system, should this currency lose the confidence of its own or other nation’s citizens, the international money system – and trade relations across the world – will be damaged severely. It is thought that this process is well under way.

   The Eurozone community’s Central Bank drew off 15% of its reserves in gold from its members. This does not mean it intends to only hold 15% of its reserves in gold, nor does it imply that there is a rigid exchange rate between gold & the Euro. But the question of how to measure 15% of reserves is raised.

   From the beginning of the Central Bank Gold Agreement, the European Central Bank decided to sell a fixed tonnage of 235 tonnes of the reserves it inherited from its member banks in return for paper currencies. Ostensibly, this was to keep gold's proportion in the ECB's reserves roughly fixed. The ECB is fully aware of the dangers of measuring gold in the Dollar – and in the Euro for that matter – but for the sound functioning of our paper-currency world, it is crucial that gold be subject to measurements in paper currency terms, and not the other way around.

   With gold now higher from seven years ago, bullion is now around 25% of the ECB's reserves. Perhaps that's a level the Frankfurt policymakers prefer?

   Germany, who gained the right to sell up to 500 tonnes of its gold under the CBGA, has not taken this option yet, citing that “gold is a useful counter to the swings in the Dollar.” Of course, a doubling in the price of gold since making this decision is paying off handsomely. We commend the pragmatism of the German Bundesbank; its reserves are there for a rainy day. They are not a pension fund scheme requiring profitable investment.

   Certainly, growing a nation's reserves through investment and trading can be a secondary objective, but it should never take over first place. The reserves have to be credible in times of distress, and they have to acceptable to all trading partners.

   Germany is aware that the times they are a-changing, and so it is keeping one eye on the future of the global economic and monetary order – and guarding against it.

   Italy has no plans to sell any gold, which is unsurprising given the very poor history of the Italian Lira. They too have seen several currencies come and go in the last one hundred years, so they have few illusions about the joys of compound interest. After all, adding noughts to a currency doesn’t make it more valuable. It’s only the buying power that counts.

   So will the Dollar today, with interest added over the next decade or two, be worth more than today’s equivalent in gold in a decade or two?

   The Swiss Franc has always been one of the most stable of the globe’s currencies, based upon one of the most stable and constant of economies. In times of global war or uncertainty, this peaceful anti-war country becomes itself a ‘safe haven’ for foreigner’s savings. So it is almost a source of safe money and financial security in itself.

   The Swiss concept of a rainy day contains far less moisture than most other countries fear. Switzerland is therefore financially more secure and less dependent on its reserves than other countries, whilst also being small enough to adjust its reserve holdings within the foreign exchange markets capacities at present. With the mix of gold and currencies in the Swiss National Bank's portfolio, you can be sure they have covered their backs on the risk front and stand to gain either way the cookie crumbles.

   It is of little account whether the Swiss sell some more gold or not. We see their latest move – announcing the sale of 250 tonnes by 2009 – as a gesture of support for the paper currency system. The SNB no doubt sees it as a gesture to protect its overall reserves portfolio.

   Again a key question: Why sell gold at all – or more pertinently, why sell a little gold and retain sufficient for rainy days ahead? It is to ensure the retention of value in the overall portfolio. The SNB is not the getting rid of the gold content therein.

   Clearly Switzerland – with its constantly sound position as banker to the wealthy of Europe, alongside its dependence on the banking industry – has a vested interest in a mix of global paper currencies. It retains a greater vested interest than those nations with an unsound Balance of Payments, smaller reserves, and facing greater economic risks in the global economy. Besides the United States, nations now suffering a poor balance of payments include Australia, New Zealand, Britain, France, Italy, Greece, Spain, Czech Republic, Poland, India, Pakistan, Colombia, Mexico, Hungary, Turkey, South Africa and many others.

   The big question: will gold have a greater real value in times of distress than yield earning national currencies? In the last world war, what value did the Deutschmark – or indeed the US Dollar –have internationally? Remember, forgery is one of the acceptable weapons of war. And what value did gold have? No contest.

   With economic power shifting Eastwards, and the Asian nations growing away from their dependence on the US economy, it is inevitable that reserve currency dependence such as we are used to with the Dollar is now changing. It is fragmenting, with other currencies coming onto the scene and with national interests clashing and exerting pressure on the different leading world currencies.

   Should these pressures grow beyond a certain almost indefinable point, then paper currencies will not garner the same level of confidence as they do now, and the unquestionable international reliability of gold as a measure of value will ascend further still.

   Prime Minister Brown of the UK went the same way that Switzerland is, once again, going to go. Looking for a more profitable content to the UK’s gold and foreign exchange reserves in 1999, the UK paid a heavy price that continues to grow as the gold price rises. Did Brown act for political reasons in support of the Euro and the more controllable paper currency system? We believe Switzerland may be following the same line of reasoning as Brown did then.

   After all, if we measured the proceeds achieved from the last sale – and the total value plus the interest thereon – what would the shortfall be against today’s value of gold?

   The mix of foreign exchange and gold reserves is essentially a gamble on the future.

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JULIAN PHILLIPS – one half of the highly respected team at – began his career in the financial markets back in 1970, when he left the British Army after serving as an Officer in the Light Infantry in Malaya, Mauritius, and Belfast.

First he worked in Timber Management and then joined the London Stock Exchange, qualifying as a member and specializing from the beginning in currencies, gold and the "Dollar Premium". On moving to South Africa, Julian was appointed a macro-economist for the Electricity Supply Commission – guiding currency decisions on the multi-billion foreign Loan Portfolio – before joining Chase Manhattan and the UK Merchant Bank, Hill Samuel, in Johannesburg.

There he specialized in gold, before moving to Capetown, where he established the Fund Management department of the Board of Executors. Julian returned to the "Gold World" over two years ago, contributing his exceptional experience and insights to Global Watch: The Gold Forecaster.

Legal Notice/Disclaimer: This document is not and should not be construed as an offer to sell or the solicitation of an offer to purchase or subscribe for any investment. Gold Forecaster/Julian D.W. Phillips have based this document on information obtained from sources they believe to be reliable but which it has not independently verified; they make no guarantee, representation or warranty and accepts no responsibility or liability as to its accuracy or completeness. Expressions of opinion are those of Gold Forecaster/Julian D.W. Phillips only and are subject to change without notice. They assume no warranty, liability or guarantee for the current relevance, correctness or completeness of any information provided within this report and will not be held liable for the consequence of reliance upon any opinion or statement contained herein or any omission. Furthermore, they assume no liability for any direct or indirect loss or damage or, in particular, for lost profit, which you may incur as a result of the use and existence of the information, provided within this report.

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