When the people responsible for creating money explain why they keep gold, I think it’s probably good to pay attention to the reasons they give. At the LBMA conference in Sorrento this week, which GoldCore attended, Bundesbank president Joachim Nagel offered one that was rather more candid than the usual discussion of portfolio diversification.
He was recalling the experience of presenting his institution’s annual results, including losses arising from earlier quantitative easing. In those circumstances, he said, “it is absolutely of help to be the 2nd largest gold holder in the world.”
Of course, this observation tells us something about the purpose of an asset that is so often judged by what it fails to pay.
As we are all well aware, gold produces no interest. Its storage costs money, and its price can fall, sometimes considerably. Nagel acknowledged its disadvantages in his speech. Yet the institution he leads continues to attach considerable importance to owning it, including when the financial consequences of its own policy decisions are becoming uncomfortable. He was not saying gold had been sold to pay the losses. He was describing the support that a substantial reserve can provide when other parts of the balance sheet are under pressure.
The End of Normal: Central Banks Buy Gold In Low Trust System
For anyone trying to preserve wealth over a lifetime, that is a recognisable concern. We can make decisions for sound reasons and still find that the circumstances in which they must work have changed.
I don’t expect to have too much in common with a central banker, but when he told the audience, “The distinctive characteristic of physical gold is that it does not depend on an issuer or counterparty fulfilling a payment obligation.” I thought this was someone I could probably share a drink or two with. Anyone with even a scent of market knowledge knows that the financial system is dependent on counterparties, a government bond requires a government to pay. A bank deposit is a claim on a bank. These arrangements make much of modern economic life possible, but they also mean that a considerable share of our financial security rests on somebody else’s ability to meet an obligation. Gold has no issuer who must earn the money, refinance the borrowing or secure parliamentary approval before honouring it.
This is no clearer understood than by retail gold investors. In the week before the LBMA conference, we held our inaugural Summit in Dublin, ahead of which we surveyed 110 clients and readers about precious metals. This was a small, self-selected sample of our audience, rather than a representative survey of investors generally. Even so, 56% rated gold’s freedom from default risk as a highly relevant reason for holding it. The same percentage gave that rating to protection against systemic financial risk.
Those answers have something in common with Nagel’s explanation, despite the considerable difference between a household’s savings and a central bank’s reserves. Both have reasons to consider what remains dependable when another part of their financial arrangements comes under strain.
Much depends, of course, on what we have grown accustomed to regarding as dependable. In his speech, Nagel described how greater economic integration and international cooperation had made foreign financial assets relatively attractive. More recently, geopolitical tensions and financial sanctions have brought different considerations to the fore. Foreign securities and deposits can be frozen; physical gold held domestically does not face that same exposure. The metal has acquired no new physical property in the meantime. The circumstances in which its existing properties are valued have changed.
Nor does owning gold settle every question about security. In our survey, roughly one in five of the 107 questions submitted for the Summit panel concerned confiscation, ownership restrictions or capital controls. Others asked where their metal would be safest to store, and in which jurisdiction. These respondents were thinking beyond the number that might appear on a future valuation. They wanted to understand the conditions under which they would still be able to use their wealth.
That is a sensible question to ask of any asset. Gold’s independence from an issuer’s promise does not remove the need to establish legal ownership, choose suitable custody and understand how access works. Nagel himself expressed confidence in the New York Fed’s custody of Germany’s gold. His argument allows for trusted institutions while recognising the value of diversification.
Perhaps that is why his remark about the Bundesbank’s position stayed with us. We spend plenty of time asking which of our investments will do best, and considerably less asking what will help if some of our decisions turn out badly. The people who manage monetary reserves have to consider both. When they explain why they keep gold, those of us managing rather smaller sums have good reason to pay attention.
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