Reprinted with Permission

IMF's Off-Market Gold Sales: Toward the New Order?

Speaking this week in Gabon, Michel Camdessus, the retiring managing director of the IMF, revealed that the Fund has "almost tripled the resources of gold" that it is prepared to use in support of its plan to lower the debt burden of poor countries (www.imf.org/external/np/tr/2000/TR000112.HTM).

Originally the IMF, with the support of Britain and the U.S. but not that of several European countries, particularly Germany, proposed to sell some of its gold reserves to finance its so-called Heavily Indebted Poor Countries (HIPC) and Enhanced Structural Adjustment Facility (ESAF) initiatives. The income from investment of the proceeds of these sales was to be applied to fund these initiatives. However, given the relatively small amount of income likely to be generated, there were suspicions in many quarters that the scheme had an important ulterior purpose: namely, to help balance the growing gap between annual gold demand -- in excess of 4000 metric tonnes -- and new mine production -- around 2500 tonnes. Gold bugs, of course, smelled manipulation aimed at capping the gold price.

The weak gold prices that followed in the wake of the Bank of England's May 1999 announcement of its own gold sales program galvanized additional strong opposition to the IMF's original plan, which also required approval of the U.S. Congress. As a result, the IMF advanced and secured approval of an alternate plan to fund its HIPC-ESAF initiative. This plan replaced the proposed gold sales with certain off-market transactions in gold (www.imf.org/external/np/sec/nb/1999/nb9962.htm).

These transactions, which involve settlement of certain obligations coming due to the IMF by member countries, operate as follows. First, the IMF sells gold to the member at the current market price, placing the profits from the sale in a special account to be invested for the benefit of the HIPC-ESAF initiative. The profits are the difference between the IMF's book carrying value of the gold (i.e., one ounce = 35 SDRs, or approximately US$ 48) and its market value. Second, the member purchasing the gold then satisfies its obligation to the IMF by returning the gold at the same market price. Accordingly, the amount of gold involved in any single transaction will be that amount which at the current market price equals the member's obligation. The IMF explains further:

The net effect of these transactions will be to leave the IMF's holdings of physical gold unchanged. No gold will be released to the market, and thus there will be no impact on the supply and demand balance in the market. The IMF's gold holdings accepted in settlement of members' obligations ... will be recorded at a higher value in the IMF's balance sheet, and acceptance of this gold (instead of currencies or SDRs) in such settlements will reduce the IMF's liquidity, by the amount of profits transferred for the benefit of the HIPC and ESAF initiatives ... , and its net income.

According to the above link, the original plan called for transactions involving in total 14 million ounces (about 435 tonnes) of gold. Taking M. Camdessus at his word, it appears that now more than 40 million ounces are committed to the plan. The IMF's total gold stock exceeds 103 million ounces (3200 tonnes), making it one of the largest official gold holders in the world. More information on its gold holdings and policies with respect thereto can be found at www.imf.org/external/np/exr/facts/gold.htm. Subject to approval by an 85% majority vote, the IMF can sell gold at market prices and accept gold in settlement of members' obligations at agreed prices based on market prices. It cannot buy gold or engage in any other transactions in gold (e.g., loans, leases, swaps, etc.), nor can it use its gold as collateral for loans.

The IMF's second off-market gold sale, involving just over 655,000 ounces, was completed with Mexico on December 17, 1999 (www.imf.org/external/np/sec/nb/1999/NB9986.HTM). The press release states in relevant part:

The IMF retained about SDR 23 million on its own account as required by the Articles of Agreement. The remainder of the proceeds -- SDR 111 million (about US$ 152 million) -- was invested with the Bank for International Settlements to generate income for the Heavily Indebted Poor Countries (HIPC) initiative.

The term SDR refers to the IMF Special Drawing Right, which is essentially an accounting convention of the Fund. SDRs are described at www.imf.org/external/pubs/ft/survey/sup0998/11.htm. The SDR is a weighted composite of the currencies of the U.S., Britain, France, Germany and Japan, which today means the dollar, euro, pound and yen. Its value is determined daily by the Fund on the basis of market rates for its components. The SDR interest rate is adjusted weekly on the basis of certain domestic short term rates in the five specified countries. SDRs can be used in transactions among the Fund, its members and 15 other "prescribed" institutional holders, presumably including the BIS. However, while the IMF can create international liquidity by allocating SDRs to its members, it cannot allocate SDRs to itself or prescribed holders.

In essence, the IMF's off-market gold sales are a mechanism for creating SDRs for the Fund itself by revaluing a certain portion of its gold from SDR 35/oz. to current market prices expressed in SDRs. These new SDRs are apparently being placed with the BIS, a prescribed holder, because IMF rules prohibit its Special Disbursement Account, which includes the HIPC-ESAF initiative, and other accounts administered by it from holding SDRs directly.

Although I have read speculation that some IMF gold may be reaching the market through its off-market gold sales, I am unable to come up with any plausible scenario as to how this might happen. On the other hand, the apparent success of the IMF's program may have favorable longer range implications for gold.

Certainly until all its gold is revalued from SDR 35/oz. to market prices, the argument for outright gold sales by the IMF will be difficult to make. Indeed, if ever there were a situation of eating one's cake and having it too, these current off-market gold sales would seem to be it. Of course, once all the Fund's gold is revalued to market prices, only further increases in the gold price itself will support creation of additional SDRs in this manner for the Fund's own use.

A good argument can be made that the EMU's ultimate vision is not a euro fixed to gold, but a euro regularly measured against gold at market prices. Under a system of this sort, the euro could serve as the domestic currency of the EMU countries without the rigidities of the classical gold standard. It could also serve as a major currency, possibly the dominant currency, for settlement of private international transactions and for international finance. But gold would resume its role as the international standard of value -- the yardstick for all currencies. It would also become the principal component of most nation's international monetary reserves and, at market prices, the standard medium for settlement among national governments (i.e., central banks) and international monetary authorities. The days of one nation's paper currency serving as the world's principal international monetary reserve would be over.

The beginnings of a system of this sort can already be glimpsed in both the EMU's practice of marking its gold reserves to market quarterly and the Washington Agreement affirming that gold will remain an important part of the Euro Area's international monetary reserves. Although starting with a proposal for gold sales much like the BOE's, the IMF ended with a system of off-market gold sales involving settlement of international obligations in gold at current market prices. In hindsight, this IMF program could well be perceived as another step, however small, toward restoring gold to a major role in the international payments system.

In any event, by dropping the fiction of gold at SDR 35/oz. and embracing market prices, the IMF has aligned itself with the EMU as an official sector institution in which the market price for gold has a significant and current balance sheet impact. In the long run, institutions operating in this manner are likely to find that it is more in their interest to have an honest, free market price for physical gold than an unrealistic price subject to manipulation in largely paper markets such as the COMEX, TOCOM and LBMA. Increasingly these large official holders of gold should come to realize that rising gold prices are not always a harbinger of rising prices or proof of bad monetary management. Instead, they can be at times an indicator of rising general productivity relative to gold, and in that context an opportunity for a fundamentally benign upward revaluation of existing gold stocks in accordance with market dictates and to the benefit of gold holders.

Put another way, if the IMF can do a lot for poor countries with a gold price near $300/oz., it could do twice as much with a gold price near $600/oz. That is the price that even today many knowledgeable gold analysts suggest may be necessary to bring physical gold demand and new mine production back into equilibrium. Why, then, should the IMF fight it? Indeed, why should any large official holder of gold, except of course the U.S. which now enjoys "the exorbitant privilege" of printing its way out of its international deficits?

Reg Howe
row@ix.netcom.com
http://www.goldensextant.com

26 January 2000