Basel III Brings Gold Back

December 5, 2012 Topic: EconomicsBanking

Basel III Brings Gold Back

New banking standards are pushing a rush for gold. Why isn't America joining in?


All the gold ever mined aggregates to 165,000 metric tons (tonnes). That is barely enough gold to fill three Olympic-sized swimming pools.

The U.S. government is reputed to hold 8,134 tonnes, the largest gold horde of any nation.


But the United States has not added any gold to its reserves since August 1971. That is when President Nixon, seeing the rapid depletion of U.S. gold reserves stemming from European fears of an oversupply of U.S. dollars, abandoned Bretton Woods. That action ended the convertibility of the dollar (the reserve currency for the world’s central banks) into gold for government-to-government transactions.

The United States is nearly alone in its failure to supplement its gold reserves. Countries the world over have been adding to their gold reserves at a frantic pace:

Since October 2011, Turkey has added more than 123 tonnes of gold to its reserves.

Since February 2011, Mexico has purchased more than 100 tonnes of gold.

In March 2012, the Philippines added 32 tonnes to its reserves. This gold was over and above the gold purchased from its domestic mines.

Russia has been buying large quantities of gold for several years, adding 15.5 tonnes to its reserves in May 2012. Russia’s total gold reserves now stand at 911.3 tonnes, the highest level since 1993.

Thailand has raised its gold holdings by more than 80 percent since mid-2010.

South Korea has bought 40 tonnes of gold since May 2009, a 180 percent increase in its reserves.

China refuses to say how much gold it is buying from abroad, but it is the world’s largest gold producer and requires domestic producers to sell 100 percent of their output to the central bank.

At the end of 2011, Venezuela ordered the repatriation of 211 tonnes of its gold reserves held in Switzerland, the U.K. and Canada.

Germany is contemplating taking similar actions.

Just a few years ago, central banks were selling their gold. Between 1999 and 2002, Gordon Brown, then England’s chancellor of the exchequer, sold off 395 tonnes, half of the U.K.’s reserves. Between 2002 and 2009, the world’s central banks were net sellers of over 3,000 tonnes of gold.

But since 2010, central banks the world over have “turned on an Eagle” (to “coin” a new phrase), becoming huge net buyers of gold, buying back more than a thousand tonnes.

Why the turnaround, and at prices much higher than those at which the central banks sold? Because the rules have changed: The Basel Committee on Banking, the body that sets the standards followed by the industrialized world’s central banks (and the commercial banks they oversee), has reclassified gold bullion as a “tier one asset.” According to the Basel Committee’s new rule, known as “Basel III,” as of the New Year, gold will be counted at 100 percent of its market value when a bank’s assets are audited. Moreover, under Basel III, a bank’s tier one assets must rise from 4 percent to 6 percent of its total assets. This means that many banks are likely to replace substantial portions of their mortgage-backed securities and bond portfolios with gold.

Basel III’s increase of gold to full market value doubles the value of gold reserves held by banks (central and commercial). Previously, according to the dictates of Basel I (in 1988) and Basel II (in 2004), gold was a “tier three asset”, counted at only 50 percent of market value on the banks’ books. Interestingly, those same Basel I and Basel II rules valued government bonds and mortgage backed securities (“MBS”) as “tier one” assets. As such, they were counted at 100 percent of face value. Recall that a substantial percentage of MBS lost all or most their value after the financial crisis of 2008. Today, many sovereign-debt securities (e.g., those of Greece, and perhaps those of Spain and Italy) are worth only “pennies on the dollar.”

Basel I and Basel II were based on the now debunked belief that sovereign bonds were as good as cash. In fact, for banks, those bonds were even better than cash, as bonds carried an interest rate while acting as bank reserves. But, as the events in Europe have so amply demonstrated, bonds are only as good as their counterparty issuer. If that issuer cannot repay, or repays in a debauched currency, the bonds lose value.

Basel III acknowledges what many people forgot after Nixon’s bold action on August 15, 1971, namely, that gold is money. There is no counterparty to gold. It is immutable. It never changes in real value (as opposed to nominal value). What an ounce of gold could buy in 1913, when the Federal Reserve began inflating the money supply, an ounce of gold can buy today. But it takes $23 today to purchase what a $1 could buy in 1913.

Basel III is an attempt to harden banks’ balance sheets against another financial meltdown. The more gold a bank acquires, the more likely that bank will survive the next wave of sovereign defaults, either through outright inability to pay (such as Greece, as long as it retains the Euro) or debt monetization (like the endless “quantitative easing” programs of the U.S. Federal Reserve).

But all this leaves a big question unanswered: How high will the implementation of Basel III force the nominal price of the yellow metal?

Jay Zawatsky is the CEO of havePower, LLC (a natural gas infrastructure developer) and a professor of business in the dual degree MBA program of the University of Maryland University College.