Archived World Gold Council Document

The announcement by the Reserve Bank of Australia (RBA) on July 3 that it had sold 167 tonnes of gold ‘over the past six months’ triggered a sharp fall in the price and bitter protests from the Australian gold industry. The Council issued a strong statement the following day, drawing attention to the wider economic and financial implications, and this was widely quoted in the Australian media. At the time of writing (July 15) the debate in Australia continues.

Australia’s central bank stated that 'the sales were made gradually, taking care not to disrupt market conditions'. It went on to state that 'the new level is consistent with Australia’s longer-term requirements, and the bank has no plans for further sales'.

The sales were undertaken forward, with 125 tonnes being delivered in June, and the remainder to be delivered in August and September. The proceeds, which the Council estimates totalled about US$2 billion, were immediately invested in foreign currency assets (government securities denominated in US dollars, Japanese yen and German marks).

Damaging statements

The market was surprised - and the industry itself exasperated - more by the accompanying commentary than by the sales themselves. This took the form both of an attempted justification in the press release and accompanying interviews by RBA and government officials. The press release, after the initial bald announcement, stated that:

"Over the past five years, a number of central banks have sold gold from their reserves, the most prominent being the central banks of Austria, Belgium, Canada, the Netherlands, Portugal and South Africa. The Australian sales program followed a review by the Bank of the costs and benefits of holding a significant part of international reserves in the form of gold. Following the review, the Bank’s Board concluded that, while there was a case to hold some gold as a contingency against unforeseen events, the previous holdings (which amounted to about 20 per cent of international reserves) were no longer justified. The principal reason for this conclusion was that a country in Australia’s position, with large gold reserves in the ground and high annual production, derives negligible diversification benefits from holding a significant proportion of its international reserves in the form of gold."

Further statements widely seen as damaging to gold’s reserve role were made by senior officials. These included a Reuters interview with Mr Ric Battelino, Assistant RBA Governor for financial markets. He revealed that the RBA had wanted to sell gold for some time; 'the actual sales were in 1996' - apparently contradicting the press release - and added that at least for the present no further sales were planned. 'For the moment we’re quite happy to have a bit of gold around'. A bit!

An accompanying press release from the Federal Treasurer, Mr Peter Costello (July 3) said that 'The Bank has decided that it was no longer appropriate to hold a significant part of the RBA’s international reserve in the form of gold' (thus implying the remaining 80 tonnes held were ‘insignificant’), and gave two reasons:

'As Australia is a significant gold producer with large reserves, there are negligible diversification benefits from holding gold;

Gold no longer plays a significant role in the international financial system'.

Mr Costello further stated that the RBA had sought and received his approval to re-invest the realised gains from the sale in other assets, rather than return them as a dividend ‘to the government’. It is understood that the previous government had been unwilling to give this permission.

'Given that the re-invested proceeds will yield higher annual profits for the Reserve Bank than if they had been retained as gold reserves, this should mean a better stream of dividend payments to the government over the longer term.'

The World Gold Council issued a press release the following day drawing attention to the wider economic damage that would follow from Australia’s decision. As a leading producer, Australia would now suffer the negative impact on employment, taxes and foreign earnings:

'The action appears to have been motivated by narrow financial considerations... For a leading gold producer to take unnecessary actions that prejudice the well-being of a key sector of its economy suggests a lack of sensitivity to the factors impacting the market'.

These phrases were widely quoted in the Australian media, and helped fuel the public protests against the decision and the way it was presented.

The price falls

The market reaction to the announcement was much sharper than that following previous announcements of sales by other central banks. In the week after the Australian announcement, the price fell by US$13 (from US$332 to US$319 six days later), whereas the maximum price change following previous announcements was US$10 and the average only US$4.

There are a number of reasons for this difference. But the crucial factor is that the Australian sale is widely seen as different because of the reasons it was sold - with the aim of improving the return on its international reserves. All previous central bank sales or proposed large-scale gold mobilisations were motivated at least in part by special factors. Thus EU central banks like the Netherlands and Belgium were motivated by a desire to qualify for European Monetary Union (EMU). The proposals by Switzerland and Germany were motivated by a need to finance projects considered of overriding national importance - the setting up of a Solidarity Fund to assist victims of injustice or natural disasters in the case of Switzerland and to reduce the debts resulting from the re-unification of the country in the case of Germany.

Australia is seen as the first country to sell primarily for portfolio reasons. Thus the Australian action is viewed in the market as widening the ranks of potential central bank sellers.

Industry protests

Any economic assessment of the costs and benefits of the move is likely to show the results to be overwhelmingly negative. The RBA will gain an estimated A$100 million a year in interest earnings. Yet the fall in the price in the week after the announcement reduced the value of Australia’s gold reserves ‘in the ground’ by an estimated US$1 billion, and gold resources (not yet proven) by a further US$2 billion. Also, part of these resources and of current mining operations has been rendered uneconomic, jeopardising some of the 25,000 jobs in the sector. Business confidence has been shaken.

Moreover, the assumed gain on the management of the reserve portfolio depends on the assumption that the RBA will be lucky. Through a mixture of luck and skill, the RBA has in past years, on balance, made a positive return on its investments, but there is no guarantee that it will do so in future. If it gets the allocation of its assets between the various currencies wrong, it could easily make a sizable loss.

In the circumstances, it is ironic that in reality the RBA accepts many of the arguments for gold as a reserve asset. It accepts that gold can provide a means of diversifying reserves. It accepts that gold still is special.

Central bank delusions

The odd thing is that Australia’s central bank seems to think it is in line with other central banks, whereas in fact it is way out of line. Contrary to the impression being given in the Australian media, very few central banks have sold on any significant scale; the table gives a complete list (Canada’s extended sales programme is in a different category, since this has been spread over many years; also, the references to Portugal and South Africa in the central bank’s statement were erroneous - Portugal has not sold gold recently, and South Africa, only because it is the agent for gold sales).

According to the IMF, total official holdings have been reduced by 3,000 tonnes, or less than 10%, over the past 30 years. As of March 1997, official holdings still amounted to 34,096 tonnes. The overall picture is one of massive stability.

Other central banks have on the contrary been acquiring gold. These include China and Russia. Last year, it is estimated by Gold Fields Mineral Services that 19 countries acquired gold, against 16 that were net sellers. Again, Australia is out of line.

Reasons for holding gold

Moreover, leading central bankers have recently reaffirmed positive reasons for holding gold. Thus Mr Jean-Pierre Patat, Director of the International Department of the Bank of France, said at the FT Gold Conference on June 16 that 'the historical reasons for which central banks hold gold remain valid'. Gold, he said, remained an element of long-term confidence in a currency. It was a sign of monetary sovereignty. It was seen as a guarantee of prudent monetary management.

As an asset of last resort, ‘central banks only draw upon it in the event of dramatic difficulties’. Lastly, gold was ‘an insurance against a major upset in the international monetary system’.

If the Australian authorities accept such arguments for gold, why have they sold? The official excuse is that ‘a country in Australia’s position, with large gold reserves in the ground and high annual production, derives negligible diversification benefits from holding a significant proportion of its international reserves’ in gold. The idea is that they can always acquire gold from domestic producers if needed, in an emergency.

The Council and the Australian debate

The Council has pointed out that this view ignores several key facts. First, gold in the ground takes a long time to produce and refine - and in an emergency, time is of the essence. Second, it is in the hands of the private sector, and would doubtless command a very high price in the circumstances in which it would be needed. Thirdly, diverting central bank assets for this purpose would deprive the country of foreign earnings.

Another argument appearing frequently in the Australian media - though not attributed to official quarters - is that there is no reason to ‘stockpile’ gold any more than there is to stockpile wool or other commodities. This view ignores the fact that gold is the only commodity still widely held as a reserve asset - a fact that gives it indisputably a continuing monetary role.

Moreover, even if the RBA’s arguments were accepted, does that justify doing harm to the reputation of an important international asset which is held by all leading central banks? Central banks are supposed to look after the longer term interests of the economy and to safeguard future generations from unknown and unpredictable contingencies. Gold is generally viewed by central banks as a good asset against such long-term dangers.

The RBA has stressed that it is not walking away from gold. Government spokesmen have tried to repair the damage by emphasising the importance of the Australian gold industry. That is small comfort to a world-wide industry which has received such a sharp shock from such an unexpected quarter.

Contact: R. Pringle, Head, Centre for Public Policy , World Gold Council, Kings House, 10 Haymarket, London SW1Y 4BP, U.K. Tel. +44.171.930 5171, Fax. +44.171.839.4314, or by e-mail: info@gold.org.