ROME — Gold is back in the news, big time, and not just because the
price may be on the verge of another upswing or that Peter Munk is
turning Barrick, the world's biggest gold company, into a CEO meat
grinder.
It's because Germany,
it appears, wants to make gold the effective currency of the euro zone
before the region plunges to the bottom of the seas like a concrete
U-boat.
The weakest euro zone countries are tapped out
financially and economically. But a few of them are brimming with gold
reserves. Take Italy, the euro zone's third-largest economy.
The
Italians love gold and it?s stashed everywhere, in their central bank
and in their jewellery and safe deposit boxes. (I once saw a
religious-festival parade of children in a mountain town, with each
child groaning under the weight of heavy gold necklaces and other
baubles). At last count, the central bank had 2,451 tonnes of gold,
valued at close to US100-billion ($128-billion). That's not a fortune
compared to Italy's 1.9-trillion national debt, but it?s not bad when
Rome is raiding the pantry to pay its ever-rising debt.
Germany?s idea is coyly named the European Redemption Pact and it is
nothing if not creative. While details are scant, here is roughly how
this gilded baby would work.
Countries with debts greater than 60 per
cent of gross domestic product ? the (ignored) limit under the European
Union?s Maastricht Treaty ? would transfer those debts into a redemption
fund, which would be covered by joint bonds. The scheme has been called
?euro bonds lite.?
Here?s the catch. Countries using the
scheme (most would, including Germany, because of generally high
debt-to-GDP ratios) would have to cover 20 per cent of their debt with
collateral, payable in gold or currency reserves. Default on the
payments and you lose your gold. The ?sinking? fund would retire the
debt over 20 years.
Italy set the precedent in the 1970s, when
it was in the midst of one of its blandly regular financing crises and
resorted to a gold-backed loan. The loan was quickly paid off, because
there was so much political pressure to do so. If the finance minister
had forfeited the Italian family jewellery, the entire government would
have been embarrassed and humiliated, then turfed from office.
There's a lot to like about the European Redemption Pact, politically
and economically, and a lot not to like if you?re worried that this
German-inspired fund is the mother of all potential loot grabs.
On the positive side, the gold bricks are piled up like Lego in central
bank vaults. They are unpledged and devaluation-proof, meaning the
gold-backed loans would be ultra-cheap probably 1 per cent.
Politically, a gold-backed loan is defensible, in the sense that it's
cheap.
The alternative is trying to flog sovereign bonds at crippling
yields 5 to 7 per cent. That, in turn would mean ratcheting up the
austerity programs in an attempt to restore enough investor confidence
to bring yields down.
The downside, of course, is potential
default, which would mean transferring a huge chunk of a country's
hardest, most gorgeous assets and hence economic power out of the
country.
You would have to presume, however, that any country would be
ultra careful to make sure it gets the gold back, as Italy did.
The political consequences of the European Redemption Pact are one
thing; what the gold-backed loans say about the common currency is quite
another. The underlying message is not pretty. Germany, the supervisor
of the pact and presumed inheritor of the gold if the loans are not
repaid, seems to be saying: We don't trust the euro as it is; it's too
weak, so give us a stronger gold-backed euro. Doubts about the health of
the euro only increased on Friday, with more reports that Spain would
formally seek a European bailout for its gutted banks as early as this
weekend.
If the ailing
European countries accept the gold deal, it would strengthen the euro.
If they were to reject the deal, it would hurt the euro. Why? Because
rejection, in effect, would state that they can't muster the fiscal
discipline to ensure they get their gold back.
The
European Redemption Pact is a psychological biggie. If it were to
happen, it would say that gold is a key central bank reserve and that it
can be an effective crisis management tool.
Two
questions. If Europe goes for the gold-backed deal in an effort to save
its sorry butt, what does this say about the credibility, or lack
thereof, of fiat currencies around the world?
And would it save the euro
from extinction? Desperate times require desperate measures. We can all
agree the euro is a pig. A pig stuffed with gold is an entirely
different beast.
