by The World Gold Council

The WGC recently urged IMF leaders to lift their ban on member countries' 'pegging' their currencies to gold. In a speech to participants at a two-day meeting in New York, organised by the Re-inventing Bretton Woods Committee, and attended by senior officials of the IMF, the World Bank, the European Central Bank and other national central banks, the Council said that efforts by the IMF to demonetize gold had largely failed and gold was still the second most valuable component in official sector reserves - behind only the dollar - accounting for 16% of the total.

Excerpts from the Council's presentation follow:

The result of the demonetisation attempt was to institutionalise the hegemony of the U.S. dollar. The advent of the euro upsets this stability. In this new environment, some would say that gold should be put back on the agenda of those seeking to produce the blueprints for the new financial architecture. Our contention, however, is that gold has never been away - you have only to look at its continued role as a major central bank reserve asset to accept that.

Why should a Fund member not be allowed to link its currency in some way to gold if it so wants? Currently Article IV 2(b) forbids this. The move 25 years ago to "abolish" gold was designed to enthrone the SDR instead. The SDR has not, however, succeeded in establishing itself as a genuine international reserve asset. In such circumstances there should surely be no reason why gold is precluded from competing on all fours with other reserve assets. For the Fund to outlaw it in the Articles is an outmoded restriction.

One lesson from history was that international monetary arrangements can and do change and the coming of the euro provides an obvious opportunity to reconsider the whole system.

For the last half-century the dollar has been the hegemonic currency. Why? To start with -- let us not forget -- because of its explicit gold link. Subsequently, because there was no possible competitor and the U.S. was, after all, the strongest economy -- and possessed the most liquid capital markets -- in the world.

With a single hegemonic currency there were not many choices to make. Now, there are two potentially equal reserve currencies -- the dollar and the euro. Although the combined capital market of the EU-11 is not yet as large as that of the U.S., it is still dramatically larger than any of the previously individual European markets. Any central bank looking to diversify its reserves now has a real alternative.

But one thing seems fairly clear. Now that countries have a genuine choice between two global currencies, there are likely to be significant moves in and out of them as sentiment ebbs and flows.

Can the world live with competing currencies or will one eventually become supreme? Or might gold, as a recognised store of long-term value, stage a comeback on the international monetary scene? It is probably worth noting here that all previous reserve currencies (including, at the outset, the SDR) had some kind of link with gold.

The problem with hegemonic currencies (be it the dollar or the deutschemark) is that they are run purely for the benefit of their own domestic economies, not for the benefit of any other country which chooses to peg to them.

Gold is the only external asset which is no one else's liability. Now that we have the euro, some countries may decide to take the relatively simple decision to define their basket as some weighted combination of that currency and the dollar in order to hedge their bets. An even more effective hedge, however, can be constructed by incorporating some gold. Studies suggest that the volatility of a central bank's reserve asset portfolio is reduced, and the risk/return balance enhanced, by holding anything up to 20% in gold.

Most central banks do not see it as their business to take risks. By incorporating gold into both a currency basket used for exchange rate management purposes and a reserve asset portfolio, volatility is reduced and the risk/reward picture improved.

Which brings us back to the IMF and, as we would contend, its no-longer-justified prohibitions on various potentially useful roles for gold. The IMF's own gold holdings (103 million ounces), make it the world's third largest single holder. In 1995, the Executive Board held a long and thoughtful discussion on the subject and came to some important conclusions. These included the view that gold provided a fundamental strength to the IMF's balance sheet, and the Board felt that the Fund should continue to hold a relatively large amount of gold among its assets, not only for prudential reasons but also to meet unforeseen contingencies.

Nothing has happened in the outside world in the last 4 years to invalidate these judgements. Indeed, given the systemic uncertainties caused by the arrival of the euro, there are surely all the more reasons for the official sector to preserve its gold holdings and actively consider ways in which its real value can be utilised in this brave new monetary world.

25 February 1999
Copyright © 1999 World Gold Council. All Rights Reserved
Contact: Dick Ware, Centre for Public Policy Studies,World Gold Council, London.
Reprinted by permission of World Gold Council. Further reproduction requires permission by World Gold Council.

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