SDR Allocations and the Gold Price
After writing Bombshell from the IMF, I decided to take an in-depth look at the introduction of the Special Drawing Right (SDR) and see if there was an effect on the gold price.
First, an SDR is a reserve asset that is issued by the International Monetary Fund (IMF). Gold is also a reserve asset that is found on the balance sheet of a central bank.
My theory was that if there is X amount of gold on the balance sheet and a new asset is created that is designed to be a reserve asset, then the SDR would be filling a slot that would normally be held by gold.
Using that basis of thought, one would expect a decline in the gold price as the SDR was introduced. To date there have been two allocations of SDR's. The first period shows a link to a gold price decline, the second does not. The current period of the third allocation indeed does show a relationship with the decline in the gold price.
It is important to note that the third SDR allocation is not formally approved and awaits the vote of the United States to approve the Fourth Amendment to the IMF's Articles of Agreement.
First, I will cover the first allocation period of the introduction of the SDR.
The First Allocation
A plan to establish these new monetary units was devised on September 29, 1967 by the Board of Governors of the IMF. This was 5 months before the collapse of the London gold pool. Perhaps the intention was to put SDR's in play in time to overlap the pool's closure, but for whatever reason, this was not to be.
To implement the SDR's a few things had to happen. An amendment would have to be introduced by the Managing Director of the IMF. The Managing Director cannot just put together an amendment and throw it on the table for a vote; it just doesn't work that way. He must first show clear and broad support for the measure first. The amendment then must pass with the required 3/5 of members voting that represent 4/5 of the total voting power.
Clear and broad support was not gained for the Amendment until just prior to July 28, 1969, nearly two years after the idea was first generated. Likely then, it can be assumed that much fine-tuning in the wording and structure was required to appease a majority of the participants.
On October 3, 1969 the first SDRs were authorized to be allocated by the IMF. These were allocated over a three-year period every January in the years 70', 71', 72' totaling 9.5 billion USD.
The official US price of gold was equal to $35 dollars and thus one SDR was equivalent to 1/35 of an oz. of gold. Therefore 9.5 billion SDR equaled 271,428,571 ounces, roughly 8,442 metric tonnes. To give you a perspective, that is slightly above the official gold stock of the US today at 261 million ounces.
The total price drop between May of 1969 to January 1970 was $8.52. A whopping 20% drop in price. More unusual however, is that the average monthly price of gold in January and February of 1970 was BELOW the official price of gold set by the United States of $35 an ounce!
Gold Prices and the Introduction of the SDR
The Third SDR Allocation
The third proposed allocation is currently in development. I have documented this development with significant dates in bold type and follow up with a similar chart like the above.
In April 1995, the Interim Committee of the IMF held its regular meeting, which resulted in mandating a review of the SDR as an international reserve asset. A seminar was to be held to discuss the future role and functions of the SDR in light of changes in the world financial system. This seminar was to include the use of outside experts. Somehow I envision "outside experts" to mean the likes of the BIS, Goldman Sachs and JP Morgan.
The seminar was held in March of 96' to fulfill the mandate of the committee. While reviewing this information, something caught my eye. Something that could be a key to gold price action over the last 5 years. I present this revealing piece below.
"Since the great majority of the Fund's membership faces costs of holding reserves that are substantially higher than the true economic costs of creating reserves, it could be argued that an SDR allocation would meet the criterion of global need."
The argument for "global need" was extremely weak from my point of view. The battle over SDR's seemed to stem from an equity sharing issue. Rather than redistribute existing SDR' to compensate for inequities, a decision was made to create additional SDR's. Perhaps the real reason was to give gold a kick in the seat of the pants.
In my Bombshell from the IMF?, I discuss the possibility of what might happen when the Fourth Amendment is approved, adding an additional 21.43 billion SDR of new international reserves in the world monetary system. I have now changed my opinion; I believe that dishoarding of gold reserves in expectation of the SDR allocation may have been happening since as early as 1996.
The seminar with members of the IMF is the first key date. The second key date is the introduction of the Fourth Amendment on September 23, 1997. This is when the Board of Governors Approved the SDR Amendment and is now up for vote by the membership.
The third key date in the allocation process comes on April 27, 1999, in the form of a communiqué from the International Monetary And Financial Committee of the IMF. The last two sentences of that document follow.
'The Committee noted the relatively slow progress in members' acceptance of the Fourth Amendment of the Articles, allowing for the special one-time allocation of SDRs. The Committee called on members that have not done so to complete the necessary procedures promptly.'
I am not sure what the necessary procedures are but I do know that the Bank of England (BoE) auctions immediately followed. I call this period "Executive Committee cracks whip".
Do "necessary procedures" require that the BoE gold sales be completed to allow room for SDR's on the balance sheet? That I do not have an answer for, but it seems suspicious that it follows immediately after the whip cracking from the Executive Committee. The announcement came out of the blue and many are still mystified by the BoE action announcement.
A very savvy man by the name of Andrew Hepburn has led to a discovery. His tenacity has resulted in the revelation of the treatment of gold swaps by the IMF. Central bank after central bank responded to his e-mails saying that swapped gold was kept on the balance sheet under IMF accounting rules.
In fact, all gold involved in reversible transactions including gold loans is kept on the books of the central bank. I believe that this treatment is to accommodate the upcoming SDR allocation.
In all likelihood, a substantial amount of gold involved in these transactions will likely be sold and replaced with SDR's issued by the IMF. The IMF initially denied the treatment of gold swaps being kept on the balance sheet. When confronted with evidence that this is indeed the case, the IMF has refused to respond to subsequent inquiries.
Perhaps they are embarrassed at being found out.
Progress of Third Allocation Period
So why would the IMF allow practices that keep gold on the balance sheet when in fact legal ownership has changed hands? Perhaps it is to prevent everyone unloading gold at once. After all, 21.43 billion SDR equates to approximately 3000 tonnes at current market prices. This is far moiré than the market can absorb in one shot.
I think that it is worthy to note that twice a year, usually in late April or September, the International Monetary And Financial Committee of the IMF (previously the Interim Committee of the Board of Governors.) meet. This group is made up of the Secretary of the Treasury of the United States, the United Kingdom's Chancellor of the Exchequer, and Minister's of Finance and Treasury the world over.
After the meeting, a communiqué is issued that updates the fund members of world monetary developments, fund liquidity, and other goings on. In every communiqué since the initial meeting in March of 96', an update of the progress of the SDR allocation was included. That is up until the Washington Accord (WA) in September of 99' that put a cap on central bank gold sales.
Since the WA, communiqué's have been void of any mention of the allocation. Is this just a coincidence? Is the amendment now hostage to the WA's support of a gold price floor? I see no other apparent reason for the omission of current progress.
So what happens now?
Perhaps our best guess of what happens to the future gold price is to go back to the first set of allocations which transpired over a three year period between January 70'-72' (in black). As you can see from the following chart, when the allocations were completed, an explosive rise in the gold price followed.
First Allocation Period
As you can see, the previous pre-allocation period price drop which seemed so significant at the time, is now dwarfed and can hardly be noticed unless you knew what you were looking for. I expect similar results when this latest allocation is completed.
As of now, the amendment will be passed with the vote of the United States, which holds 17.16% of the voting power of the IMF. For some reason, the United States seems to be having difficulty completing the "necessary procedures".
Hopefully at that time, gold will once again be set free to seek its rightful price equilibrium. Of course, the IMF could find another excuse creating "global need" to accommodate future allocations.
November 10, 2001