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Saturday, August 15, 2009

How Gold is debased by counting Gold stores and Gold Recievables as the same event

© 2003 by The Freemarket Gold & Money Report.
One of the statistics complied by the International Monetary Fund is the quantity of gold owned by the world's central banks. That weight is reported to be 32,291 tonnes of gold. Most people accept this number at face value and without questioning its accuracy. However, central banks actually own less gold.

In reality central banks own 32,291 tonnes of gold AND gold receivables. This distinction is important. From both a legal and an accounting point of view, gold in the vault is clearly very different from gold owed to you. The reason is that gold in the vault is much less risky than someone's promise to pay you gold.

This distinction between these two unlike assets is one of the most basic principles of accounting, namely, that cash is different from a receivable. For this reason, cash and accounts receivable appear as two different line items on balance sheets prepared according to generally accepted accounting principles. But some central banks do not report their gold assets using these sound and well-established accounting standards.

For example, the Bundesbank discloses in its 2002 annual report that it has €36,208 million of "Gold and gold receivables". It further sustains the fiction that these two different assets are one asset by stating in the footnotes to its financial statements: "At the end of 2002 the Bank's holdings of fine gold amounted to 111 million ounces." The Bundesbank does not, however, state anywhere in its annual report what portion of its gold is stored in vaults and what portion has been removed from the vault and placed at risk by being loaned.

Another central bank with a large gold asset is the Banca d'Italia. According to its 2001 annual report, which is the latest report available: "Monetary gold reserves were 48.1 trillion lire (EUR 24.8 billion, or $21.9 billion)." One would think from this statement that this "gold reserve" is sitting safely in secure vaults, as a reserve. But this central bank too has been withdrawing gold from the vault and placing it at risk. Its balance sheet also records "Gold and gold receivables", and like the Bundesbank, it fails to disclose how much of its gold has been loaned.

In contrast to these reports by the German and Italian central banks, the annual report of the Banque de France shows that none of its gold has been loaned. There is no gold receivable reported by it, so none of its gold has been placed at risk by being loaned.

There is also a third category of reporting. The Swiss National Bank, for example, uses generally accepted accounting principles to prepare its financial statements. Not only does it disclose that 254.7 tonnes of its 1,661.9 tonnes have been loaned, it provides information to assess the level of risk. For example, 158.7 tonnes were loaned on an unsecured basis.

Another central bank that discloses its gold lending is Banco de Portugal. According to its latest annual report, it has removed from the vault and placed at risk 434.1 tonnes of its 606.7 tonnes, or 71.6%, which is relatively much greater than the percentage of gold placed at risk by the Swiss National Bank, which is 15.3%.

Accordingly, there is no question that some central bank gold has been removed from vaults and loaned into the market. But because the level of reporting by the central banks is inadequate, it has been impossible to precisely determine the exact weight of gold removed from central bank vaults. This unknown weight of gold has become one of the most contentious issues within the gold industry. And the debate that has arisen as a result is well warranted.

If gold is removed from a vault and sold into the market, this dishoarding obviously will have an impact on gold's rate of exchange to the dollar and other currencies. This result from dishoarding is a basic principle of economics, but with a twist. An adaptation is necessary in a post-Gold Standard world to account for the fact that national currencies are no longer directly tied to gold.

Economic models prove that the extension of credit debases a currency, which is a principle that is true for any money, whether dollars, euros or gold. However, because goods and services are today priced in terms of national currencies - all of which are fiat and are only exchangeable for but not redeemable into gold - the impact of credit extensions in gold is different than the impact of credit extensions in national currencies.

When credit is pumped up using a national currency, it's a process that usually results in inflation; the prices of goods and services rise. The new extensions of credit increase the supply of the national currency, and if this growth in supply is greater than the demand for the currency (which has always been the case since the abandonment of the last remnants of the Gold Standard in 1971), the currency loses purchasing power. In other words, it is debased, and that debasement is reflected by rising prices. Each unit of currency purchases less and less. However, goods and services are no longer priced in terms of gold, so gold credit extensions have a different result on gold's purchasing power.

If gold credit extensions are greater than the demand for gold, it is debased, and like national currencies, it's purchasing power declines. But because goods and services are priced in national currencies, gold's debasement is manifested by a decrease in its exchange rate, or to put it in the terms commonly used, the ‘gold price' falls. In other words, gold when debased in this way purchases less national-currency-denominated goods and services. Thus, it is clear from this analysis that it is important to know how much central bank gold has been loaned, so that these credit extensions can be analyzed to assess their impact on gold's rate of exchange - the so-called ‘gold price' - compared to the many national currencies.

In recent years several efforts have been made to overcome the inadequate reporting of central banks in order to determine the weight of gold dishoarded from their vaults. Many people continue to accept the results prepared by Gold Fields Mineral Services, which have generally stated that around 5,000 tonnes have been removed from central bank vaults. However, I dismiss this number because GFMS surveys do not capture the weight of gold borrowed by commercial banks to fund their national currency assets, and my assessment is that this weight of gold represents the largest portion of gold loaned out by central banks.
Continued at Source

James Turk is the founder of Goldmoney.com and a supporter of Goldmoneybill.org

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