COMMENTARY — Gold and the Euro

Europe should have a new currency on Jan. 1, 1999, but the role gold will play (if indeed it plays any) has yet to be determined.

Planning for the new European currency, the Euro, gathered momentum in 1996. France, Germany, Belgium, Luxembourg and the Netherlands are all looking to be founding members. Finland also aims to sign on, whereas Italy, Spain and Portugal have recently begun efforts to get their domestic economies in shape so they can qualify for the first round. The United Kingdom, meanwhile, stays firmly on the sidelines with a wait-and-see policy.

Assuming the Euro does go ahead, it will be issued by a new European Central Bank. This is where gold comes in. In establishing its reserves, the European Central Bank will call on the central bankers of participating member countries to contribute about US$67 billion, mainly in the form of dollars and gold.

But what will be the proportion of gold in these reserves? For the gold market, the greatest issue over the next two years will be the amount of gold pooled into the European Central Bank reserve, and, thereafter, what will happen to it. The fate of the gold that remains in the reserves of the national central banks will also be an issue.

The European Union central banks hold almost 460 million oz. gold — more than 40% of all official gold holdings worldwide. The destiny of this gold, therefore, is of great significance.

The trouble is, no clear signals have yet been sent by the Frankfurt-based European Monetary Institute (EMI), which is charged with setting up the new European Central Bank and currency.

Currently, each central bank in the European Union keeps 20% of its gold reserves and 20% of its dollar reserves with the European Monetary Institute to provide backing for the existing European Currency Unit (ECU). The EMI, its reserves, and the ECU are scheduled to be wrapped up ahead of January 1999, when the European Central Bank and Euro are due. The new reserve will start from scratch, though the formula for its mix of currencies and gold has yet to be determined. (You can understand why many in Europe are confused by the whole thing.)

Despite the indecision and cloak of secrecy, however, gold is certain to form part of the European Central Bank’s reserves. The new currency is not likely to be formally backed by gold, despite suggestions that it might enjoy more public confidence if it were. The precedent for such confidence is the Swiss franc: bank notes in francs must be 40% gold-backed. The European Union central banks, however, do not have enough gold to provide similar levels of cover if gold is valued at US$385 per oz. Although analysts have said the new currency will not be backed by gold, it will be a necessary reserves asset for the European Central Bank. In other words, the new bank will hold gold, but will not lend, trade or sell it.

The European Central Bank will, however, call in only a proportion of the gold currently in the national central banks of the European Union. Those banks need contribute only 10% of their gold holdings to the European Central Bank to provide 27% of the proposed reserve of US$67 billion. That would leave plenty of gold in the vaults of the national central banks. However, the question regarding the fate of the remaining gold remains uncertain.

After January 1999, any purchases or sales by individual central banks would require prior approval by the European Central Bank. Some might be tempted to sell before 1999, as Belgium and the Netherlands have done so in recent years. Some central banks might sell more, partly to help them meet the stringent requirements for joining the monetary union. Some sales over the next two years cannot be ruled out (though the amounts may be modest), because the decision still rests with the individual country. After Jan. 1, 1999, however, the approval for sale will be more complex.

— The author is a freelance writer specializing in gold investment. The above is an excerpt from “Gold News,” published by the Washington, D.C.-based Gold Institute.