The Death of Money (30 page)

This covert, piecemeal gold-acquisition program makes perfect sense. Physical gold
is marketable in the sense that it can be readily purchased or sold, but it is also
thinly traded, and the price is volatile. Large buyers in any thinly traded market
try to disguise their intentions to avoid market impact, in which bank dealers move
the price adversely to the buyer in anticipation of large, inelastic buy orders.

China minimizes the market impact of its buying program through the use of secret
agents and direct purchases from mines.
The agents are principally located in the HSBC headquarters building on Queen’s Road
Central in Hong Kong and in the Shanghai branch of ANZ Bank, although the network
of buying agents is worldwide. These agents place purchase orders for commercial-size
gold lots of several tonnes each with brokers and London-based bullion banks. The
buyer’s true identity is not disclosed. The gold is paid for by one of China’s sovereign
wealth funds, the State Administration for Foreign Exchange, which is managed by former
PIMCO bond trader Zhu Changhong. Once purchased, the gold is shipped by air transport
to secure vaults in Shanghai. The agents are highly disciplined and patient in their
buying activity and typically “buy the dips” in market price, as indicated on the
New York–based COMEX exchange.
In a masterpiece of market savvy, China bought 600 tonnes of gold directly from Australia’s
Perth Mint and other sellers near the interim low price of $1,200 per ounce reached
in the April to July 2013 price dip.
Partly as a result of these large-scale covert operations, in
addition to more customary commercial purchases, China is estimated to have imported
approximately 1,000 tonnes of gold per year in 2012 and 2013.

China’s direct gold ore purchases are principally from gold mines located in China,
but they have expanded rapidly to include newly acquired mines in southern Africa
and western Australia. As recently as 2001, China produced less than 200 tonnes per
year from its own mines. Output increased steadily from 2001 to 2005 and then surged
in 2006, so that by 2007 China surpassed South Africa as the world’s largest gold
producer, a position it has maintained since.
By 2013, China was producing over 400 tonnes per year—about 14 percent of worldwide
mine production. Gold ore produced in Chinese-controlled mines, whether inside China
or elsewhere, is sent to refineries in China, Australia, South Africa, and Switzerland,
where it is refined to pure gold, cast into one-kilo gold bars, and shipped to vaults
in Shanghai. Through these channels, Chinese gold bypasses the London market, minimizing
the market impact and keeping the exact size of China’s gold hoard a state secret.

The combination of internal gold mining output and imports from abroad means that
China has increased its domestic gold holdings, both public and private, by approximately
4,500 tonnes since the last official update of its central bank gold reserves in 2009.
It is impossible for observers outside the Chinese government to gauge exactly how
much of that increase is waiting to be added to official reserves at the next announcement,
and how much was devoted to Chinese domestic demand from consumers for jewelry, bars,
and coins. It is well known that Chinese citizens are avid gold consumers, both for
reasons of wealth preservation and as a convenient medium for flight capital. Gold
is sold in various forms in thousands of bank branches and boutiques throughout China.

In the absence of better data, a first approximation is that half the increase in
China’s gold since 2009 went to domestic consumption and half, or 2,250 tonnes, has
secretly been added to official reserves. If this approximation is correct, then China’s
official gold reserves as of early 2014 are not the reported 1,054 tonnes but instead
are closer to 3,300 tonnes. At the current pace of mine output and imports, and assuming
half the available gold goes to official reserves, China will add another
700 tonnes to its reserves-in-waiting throughout 2014, which would put total Chinese
gold reserves at 4,000 tonnes by early 2015. China waited over six years, from late
2002 to early 2009, before publicly announcing its last increase in official reserves.
If China repeats that tempo, the next update to the gold reserve figures can be expected
in 2015.

Even these estimates based on known mining output and known imports must be qualified
by the fact that certain gold imports to China are completely unreported. A senior
manager of G4S, one of the world’s leading secure logistics firms, recently revealed
to a gold industry executive that he had personally transported gold into China by
land through central Asian mountain passes at the head of a column of People’s Liberation
Army tanks and armored transport vehicles. This gold was in the form of the 400-ounce
“good delivery” bars favored by central banks rather than the smaller one-kilo bars
imported through regular channels and favored by retail investors. What is clear from
such disclosures is that any estimates of China’s official gold reserves are more
likely to be too low than too high.

An announcement by China in 2015 that it holds 4,000 tonnes of gold in its official
reserves will discredit the view of Western pundits and economists that gold is not
a monetary asset. With 4,000 tonnes, China will surpass France, Italy, Germany, and
the IMF in the ranks of the world’s largest gold holders, and it will be second only
to the United States. This would be in keeping with China’s status as the world’s
second-largest economy.

China’s covert gold acquisition is in sharp contrast to Russia’s far more transparent
efforts to increase its own gold reserves. In the nine years from early 2004 to late
2013, Russian gold reserves increased over 250 percent, from approximately 390 tonnes
to over 1,000 tonnes. Unlike China’s, this increase was achieved almost entirely through
domestic mine production and did not rely on imports.
Russia is the world’s fourth-largest gold producer, with output of approximately 200
tonnes per year. The Russian reserve increase was also done in steady increments of
about 5 tonnes per month, announced regularly on the website of the Central Bank of
Russia. Since the central bank does not rely on imports or the London bullion market
to increase its gold holdings, Russia can afford to be more transparent than China
because it is less vulnerable to price
manipulation and front-running by the London bullion banks. Russia’s acquisition program
is ongoing, and its official gold holdings should surpass 1,100 tonnes in 2014. Reserves
of 1,100 tonnes are over one-eighth the size of U.S. gold reserves, but the Russian
economy is also about one-eighth the size of the U.S. economy. Measured in proportion
to the size of their respective economies, Russian gold reserves have pulled ahead
of those of the United States.

Many analysts have been baffled by the paradox of strong demand for physical gold
around the world and the simultaneous weakness in the price of gold futures traded
on the COMEX exchange since the August 2011 peak in gold prices. Physical buying is
coming not only from central banks but also from individuals, as reflected in the
demand for one-kilo bars versus the 400-ounce “good delivery” bars favored by central
banks. Swiss refineries have been working overtime to convert large bars to smaller
ones to meet this demand. This seeming paradox is easily explained. If the price of
any good, whether gold or bread, is held below its intrinsic value by intervention
in any form, the behavioral response is always to strip the shelves bare.

The scramble for gold, epitomized in the central bank gold-acquisition programs of
China and Russia, also manifests itself in the urgency with which central banks are
attempting to repatriate gold from foreign depositories to vaults on their home soil.

Apart from the U.S. hoard, almost half the official gold in the world is
not
stored in the home country of the holder but in vaults at the Federal Reserve Bank
of New York and at the Bank of England in London.
The Federal Reserve vaults hold approximately 6,400 tonnes of gold, and the Bank of
England vaults approximately 4,500 tonnes. Almost none of the gold in the New York
Federal Reserve vaults belongs to the United States, and less than 300 tonnes of the
gold in the Bank of England belongs to the U.K. U.S. gold is mostly kept in two U.S.
Army facilities at Fort Knox, Kentucky, and West Point, New York, with a small amount
held at the U.S. Mint in Denver, Colorado. The Federal Reserve and the Bank of England
together have about 10,600 tonnes of official gold belonging to Germany, Japan, the
Netherlands, the IMF, and other large holders, as well as many smaller holders around
the world. Third-party gold held at the Fed and the Bank of England constitutes 33
percent of the official gold in the world.

This concentration of official gold in New York and London is mostly a legacy of the
various gold standards that existed on and off from 1870 to 1971. When gold was used
to settle balance of payments between countries, it was easier to keep the gold in
financial centers such as New York and London, then reassign legal title as needed,
rather than ship the gold around the world. Today balance of payments are settled
mostly in dollars or euros, not gold, so the money center rationale for gold no longer
applies.

Centralized gold holdings are also a legacy of the Cold War (1946–91), when it was
considered safer for Germany to keep its gold in New York than to risk confiscation
by the Soviet armored divisions that surrounded Berlin. Now the risks to Germany of
gold confiscation by the United States in the event of a financial meltdown are considerably
higher than the risks of confiscation by Russian invasion. Countries such as Germany
no longer have a compelling reason to keep their gold in New York or London, and there
are significant risks in doing so. If the United States or the U.K. suddenly deemed
it necessary to confiscate foreign gold to defend its paper currency in a crisis,
that gold would be conveyed from the original owners to the possession of the United
States or the U.K.

As a result of these changed circumstances and emerging risks, gold-owning nations
have begun a movement to repatriate their gold. The first prominent repatriation was
initiated by Venezuela, which ordered the Bank of England to return 99 tonnes from
London to Caracas in August 2011. The first gold shipments took place in November
2011, and upon their arrival, President Hugo Chávez paraded the gold-filled armored
cars through Caracas streets, to the cheers of everyday Venezuelans.

A larger and more significant gold-repatriation program was launched by Germany in
2013. Germany holds 3,391 tonnes of official gold and is currently the world’s second-largest
holder after the United States. At the end of 2012, German gold was located as follows:
1,051 tonnes in Frankfurt; 1,526 tonnes in New York; 441 tonnes in London; and 374
tonnes in Paris. On January 16, 2013, the Deutsche Bundesbank, the central bank of
Germany, announced
an eight-year plan to repatriate all the gold in Paris and 300 tonnes of the gold
in New York back to Frankfurt. The gold in London would be left in place, and at the
end of the repatriation plan in December 2020, German gold would be 50 percent in
Frankfurt, 37 percent in New York, and 13 percent in London.

Commentators quickly fell upon the fact that the 300-tonne transfer from New York
to Frankfurt would take eight years to complete as prima facie evidence that the New
York Fed did not have the German gold in its vaults or was otherwise financially embarrassed
by the request. But the Deutsche Bundesbank
does not want
the gold returned quickly. It prefers to have it in New York, where it can more efficiently
be used for market manipulation. The Deutsche Bundesbank did not want to request the
transfer at all but was pressured to do so by political supporters of Angela Merkel,
who was facing reelection in September 2013. The physical security of Germany’s gold
had become a political issue in the Bundestag, the German parliament. The Deutsche
Bundesbank’s announced plan was merely a way to defuse the political issue while still
leaving most of Germany’s gold in New York. Even after full implementation of the
plan in 2020, Germany will still have 1,226 tonnes in New York, an amount greater
than the total reserves of all but three other countries in the world. It is more
convenient for the Deutsche Bundesbank to have its gold in New York, where it can
be utilized in gold swaps and gold leases, as part of central bank efforts to manipulate
gold markets. Still, a significant amount of gold is on its way to Frankfurt—part
of a global movement to repatriate national gold.

The same populist political pressures that forced the German central bank to repatriate
part of its gold have also swelled up in Switzerland. While the central banks of China,
Russia, and other nations were avidly purchasing gold, Switzerland was one of the
largest sellers. At the beginning of 2000, Switzerland’s gold reserves were over 2,590
tonnes. That amount dropped steadily, as the gold price was rising sharply, and by
late 2008, Switzerland held only 1,040 tonnes, down 60 percent from the amount eight
years earlier. Swiss gold reserves have remained at this level since, while gold’s
price rose significantly from its 2008 level.

There was sharp reaction in the Swiss parliament to these massive sales despite rising
prices. On September 20, 2011, four Swiss parliament members, led by Luzi Stamm of
the Swiss People’s Party, introduced
an initiative that requires all Swiss gold to be stored in Switzerland and that strips
the Swiss National Bank of its ability to sell Switzerland’s gold. The initiative
also requires the Swiss National Bank to hold at least 20 percent of its total assets
in gold. The last provision might actually require
Switzerland to acquire even more bullion, since gold was only 8.9 percent of total
Swiss reserves as of July 2013. On March 20, 2013, the initiative sponsors announced
they had obtained the one hundred thousand signatures required to place the initiative
on a ballot to be voted on by Swiss citizens—a key feature of Swiss democracy. The
exact date of the Swiss gold referendum is not known but is expected by 2015.