18 October 2012

WSJ: A golden solution for Europe's sovereign debt crisis

Central banks of the 17-nation currency union are sitting on more than 10,000 metric tons of gold. From the point of view of Europe's debt crisis, most of it is in the wrong place. Nearly a third of it belongs to Germany and almost a quarter of it is in France, neither of which is struggling with high debt-interest costs. For some countries burdened with debt—Spain, which holds 282 tons, Greece with 112 tons and Ireland with just 6—their holdings are too small to make much of a difference.

But two countries have enough gold to make a difference to their financing costs. Italy, which has flirted with unsustainably high borrowing costs, is sitting on the second-largest holding of gold reserves in Europe: 2,450 tons. The small economy of Portugal, which is in a bailout programme after it lost access to affordable government finance, has reserves of 382 tons.

The idea is not to sell the stuff. Instead, the proposal is to bring down borrowing costs by using gold to guarantee the partial repayment of bonds to investors in case of a default. Italy's gold reserves would cover 24 per cent of its estimated borrowing needs over the next two years and Portugal 30 per cent. If the two countries could issue some unsecured debt at the same time, they could bridge an even longer period.

First, some perspective on an idea that could hypothetically help Italy to avoid asking its neighbours for a bailout and aid Portugal to regain access to the bond markets. Moreover, a continuation of the current bond market respite—inspired by the European Central Bank's pledge to buy the bonds of governments that request an official credit line and meet the conditions attached—would render it of only academic interest.

There are precedents for using gold as security. Ansgar Belke, an economist at the University of Duisburg-Essen in Germany, points out that in the 1970s Italy and Portugal both used gold reserves as collateral for loans from other central banks and the Bank for International Settlements. In a paper commissioned by the WGC, he calculates that gold bonds could cut Portugal's borrowing costs for five-year bonds from 10 per cent to 6 per cent, if a third of the bonds' face value was guaranteed in gold, and to 5 per cent, if half was guaranteed.

Second, national central banks in the eurozone are meant to be independent. A transfer of gold to the government raises questions, says Mr Belke, about whether such transfers breach the prohibition on central banks providing monetary finance to governments.

Third, eurozone central banks are among those worldwide that have agreed to limit their collective gold sales to 400 tons a year, an agreement that persists until 2014. It's not clear whether using gold as collateral would be considered inside or outside the scope of this agreement.

Full article

© Wall Street Journal