The Hidden Role of Gold at the IMFApril 24, 2012
James Rickards is a hedge fund manager in New York City and the author of Currency Wars: The Making of the Next Global Crisis from Portfolio/Penguin. Follow him on Twitter: @JamesGRickards.
The International Monetary Fund completed their spring meetings last weekend amid communiqués and good feelings about what had been accomplished. There was optimism about improvement in the global economy albeit tempered by warnings that risks remained. Christine Lagarde, the organization's managing director, was upbeat about new financing pledges to help build an IMF firewall to prevent contagion from countries in financial distress.
Yet, behind this facade of goodwill were stresses between the rising economic powers, notably Brazil, China, and India, and developed economies in Europe. In the middle of these stresses is the United States, which is the only country in the world with veto power over IMF decisions. To understand what is driving the International Monetary Fund today, it is necessary to look behind the jargon of the communiqués and examine the hardball politics actually playing out. These politics involve the U.S. response to the firewall, the relative voting rights of IMF members, and the hidden role of gold.
[See a collection of political cartoons on the European debt crisis.]
The most urgent task at the organization today is the construction of a financial firewall that can be used to lend to countries in distress to prevent a default and worldwide panic of the type that emerged in 2008. The most likely country to need this kind of help is Spain, although some assistance to Italy cannot be ruled out. The International Monetary Fund builds the firewall by obtaining commitments to lend from its member countries. The commitments can then be converted to cash quickly by sending a borrowing notice to the lender—something like drawing on a line of credit at your bank.
The United States committed about $100 billion to this effort in 2009. However, the United States is making it clear behind the scenes that it is not willing to fund that commitment now, and it can use its veto power to stop a borrowing notice if necessary. This is causing problems with other lenders such as China and Brazil who may only be willing to lend if the United States does likewise.
The United States justifies its reluctance publicly by saying that Europe needs to do more to finance its own bailout. In fact, the reasons the United States will not lend are purely political. A loan to the International Monetary Fund is a toxic election issue for President Obama. One can hear Republican opponents gleefully asking why U.S. taxpayer money is being used to bail out Greeks who take retirement and hit the beach at age 50 while Americans work well into their 60s or older because they cannot afford to retire. The financial fate of Europe and the world now hinges on the U.S. election calendar. We'll see if Europe makes it to November without the kind of panic that would require Obama to reverse course.
[See pictures of the EU in crisis.]
The second big issue at the International Monetary Fund involves the voting rights of the emerging economies. In this area, sore spots abound. One supposedly egregious example involves the comparison of Belgium and Brazil. Brazil's economy is five times the size of Belgium's. Yet, Belgium has more IMF votes than Brazil giving Belgium a slightly larger voice. Many examples of this type exist. The cumulative effect is that Europe as a whole is over-represented relative to the emerging economies. The fact that a European leads the International Monetary Fund adds insult to injury for some.
This highlights the most interesting but least discussed aspect of the international monetary system—the hidden role of gold. The organization itself has the third largest gold hoard in the world, over 2,800 tons, just behind the United States and Germany. It's interesting that the International Monetary Fund still has this much gold since it officially stopped counting gold as an international reserve asset in 1973. However, individual nations continue to include gold in their reserves for internal purposes.
This brings us back to the curious case of Belgium. Its gross domestic product may be only 20 percent of Brazil's, but it has almost seven times as much gold—Belgium has over 225 tons and Brazil has only about 33 tons. Indeed the countries that use the euro have a combined gold hoard of over 10,000 tons. This is more that the United States and more than Brazil, India, China, and Russia combined.
[See a collection of political cartoons on the economy.]
Paper currencies issued by Brazil and China that are backed by scant gold reserves are just paper. But currencies such as the dollar and the euro that are potentially backed by huge gold reserves are something more. The dollar and euro may be paper currencies today, but in a crisis the issuers have the ability to use gold backing on an emergency basis—an ability that other currencies lack. The International Monetary Fund has its own currency, the Special Drawing Right that can also be backed by gold in a crisis.
Despite decades of disparagement by mainstream economists gold is still the hidden hand of international finance. This is something that no finance minister or central banker will admit publicly because the implications for the leveraged paper money world are daunting. Yet actions and facts speak more loudly than words. Gold still determines who runs the system and who does not. China and Brazil will get their IMF votes—once they get their gold.