The Bank for International Settlements equates gold and cash from a banking asset risk perspective. European financial regulators treat gold as equivalent to cash within their currency control framework. For all intents and purposes, gold is now being treated as money in Europe as it has for thousands of years, with one big time exception.
The government isn’t going to allow the people to use it as a replacement for the Euro, because that would disrupt their rule-making power.
Basel regulations now treat gold, held in their own vaults or on an allocated basis, as equivalent to cash, a low risk asset.
However, at national discretion, gold bullion held in own vaults or on an allocated basis to the extent backed by bullion liabilities can be treated as cash and therefore risk-weighted at 0%.
Secondly, the last 20 years of Central Bank Gold Agreements (aka CBGA) used for regulating sales of gold within the Euro area are coming to an end, as noted in a recent ECB press release.
The following chart shows that CBGA gold sales have already fallen off precipitously since 2011, with very little official selling occurring during the last CBGA agreement period.
Source: European Central Bank, via IMF
Natalie Dempster, Managing Director of central banks and public policy at the World Gold Council, noted the timing was right as central banks are buying more net gold.
“The biggest change is in central bank behaviour,” she said. “While back in 1999 they were net sellers to the tune of 500 tonnes, last year central banks bought record amounts of gold.”
In tune with the global trend, none of the signatories (central banks) from the Euro CBGA agreement see the need to sell or lease gold, noting the market is ‘mature’. The ECB’s press release on the decision to end the CBGA extensions notes:
The gold price has increased around five-fold over the same period. The signatories have not sold significant amounts of gold for nearly a decade, and central banks and other official institutions in general have become net buyers of gold.
The signatories confirm that gold remains an important element of global monetary reserves, as it continues to provide asset diversification benefits and none of them currently has plans to sell significant amounts of gold.
I believe the ECB press release illuminates the European Central Bankers view that gold prices are likely continue to rise substantially, for the following reason.
Basel III also changed the rules for Tier 1 capital requirements, as depicted in the following illustration from Moody’s Analytics. Gold falls within this category of assets.
Therefore, a rising gold price would go a long way to meeting the need for a higher Tier 1 capital ratio without requiring the liquidation of riskier assets already on their balance sheets. Should the quality of riskier assets fall, it is very likely gold’s price will continue rising to help balance the scales. Bankers know this.
All of this talk about Tier 1 ratios and ending gold sales in Europe is well and good. What I found interesting was another development in Europe with regards to movement of cash. Definitions of cash in Europe, for purposes of controlling movement of liquid financial assets, now include gold.
In December of 2016, the European Commission proposed new rules on cash controls for the purposes of fighting terrorism, money laundering, and tax evasion.
While the original proposal in 2016 did not consider gold as cash, the recently adopted rules clearly expand the definition of cash to gold and other liquid instruments. Travelers will have to declare gold and other cash items totaling over €10,000, both when traveling about or when using post services.
In practical terms, the new regulation extends the definition of cash to cover not only banknotes but also other instruments or highly liquid commodities such as cheques, traveller’s cheques, prepaid cards and gold. The regulation is also extended to cover cash that is sent by post, freight or courier shipment.
For purposes financial transfer, yes. For purposes banking system liquidity, yes. Realistically, Europe has not declared gold as a money equivalent to the Euro for purposes of every day trade.
VAT was removed on European investment grade gold in 2000, but capital gains taxes may be applied when gold is sold. It is debatable whether citizens of Europe could barter gold for goods without being liable to pay some form of gains taxes.
I do not believe that Europe will declare gold as an every day currency, but it is interesting that financial controls recently put into place recognize gold as equivalent, from a value perspective, to cash.
Interestingly, the more Euros are printed, the stronger gold’s price will be. One could easily argue that gold is the ultimate store of value against the devaluation of the Euro currency and the sovereign debt held by the banks.
And that’s why European central banks are very likely to be acquiring much more of it in the future. Even though they will never admit that gold is the ultimate form of money, their actions speak much louder than their words.
The next step is for regulators to remove all impediments for people to trade gold as currency, like the central banks are essentially already doing, starting with the elimination of capital gains taxes on individual transactions.