ROME -- Gold is back in the news, big time, and not just because the
price may be on the verge of another upswing or that Peter Munk is
turning Barrick, the world's biggest gold company, into a CEO meat
grinder. It's because Germany, it appears, wants to make gold the
effective currency of the euro zone before the region plunges to the
bottom of the seas like a concrete U-boat.
The weakest euro-zone countries are tapped out financially and
economically. But a few of them are brimming with gold reserves. Take
Italy, the euro zone's third-largest economy. The Italians love gold and
it's stashed everywhere, in their central bank and in their jewellery
and safe deposit boxes. (I once saw a religious-festival parade of
children in a mountain town, with each child groaning under the weight
of heavy gold necklaces and other baubles.) At last count, the central
bank had 2,451 tonnes of gold, valued at close to E100-billion
($128-billion). That's not a fortune compared to Italy's E1.9-trillion
national debt, but it's not bad when Rome is raiding the pantry to pay
its ever-rising debt.
Germany's idea is coyly named the European Redemption Pact and it is
nothing if not creative. While details are scant, here is roughly how
this gilded baby would work.
Countries with debts greater than 60 per cent of gross domestic
product -- the (ignored) limit under the European Union's Maastricht
Treaty -- would transfer those debts into a redemption fund, which would
be covered by joint bonds. The scheme has been called "euro bonds
lite."
Here's the catch. Countries using the scheme (most would, including
Germany, because of generally high debt-to-GDP ratios) would have to
cover 20 per cent of their debt with collateral, payable in gold or
currency reserves. Default on the payments and you lose your gold. The
"sinking" fund would retire the debt over 20 years.
Italy set the precedent in the 1970s, when it was in the midst of one
of its blandly regular financing crises and resorted to a gold-backed
loan. The loan was quickly paid off, because there was so much political
pressure to do so. If the finance minister had forfeited the Italian
family jewellery, the entire government would have been embarrassed and
humiliated, then turfed from office.
There's a lot to like about the European Redemption Pact, politically
and economically, and a lot not to like if you're worried that this
German-inspired fund is the mother of all potential loot grabs.
On the positive side, the gold bricks are piled up like Lego in
central bank vaults. They are unpledged and devaluation-proof, meaning
the gold-backed loans would be ultra-cheap -- probably 1 per cent.
Politically, a gold-backed loan is defensible, in the sense that it's
cheap. The alternative is trying to flog sovereign bonds at crippling
yields -- 5 to 7 per cent. That in turn would mean ratcheting up the
austerity programs in an attempt to restore enough investor confidence
to bring yields down.
The downside, of course, is potential default, which would mean
transferring a huge chunk of a country's hardest, most gorgeous assets
-- and hence economic power -- out of the country. You would have to
presume, however, that any country would be ultra-careful to make sure
it gets the gold back, as Italy did.
The political consequences of the European Redemption Pact are one
thing; what the gold-backed loans say about the common currency is quite
another. The underlying message is not pretty. Germany, the supervisor
of the pact and presumed inheritor of the gold if the loans are not
repaid, seems to be saying: We don't trust the euro as it is; it's too
weak, so give us a stronger, gold-backed euro. Doubts about the health
of the euro only increased on Friday, with more reports that Spain would
formally seek a European bailout for its gutted banks as early as this
weekend.
If the ailing European countries accept the gold deal, it would
strengthen the euro. If they were to reject the deal, it would hurt the
euro. Why? Because rejection, in effect, would state that they can’t
muster the fiscal discipline to ensure they get their gold back.
The European Redemption Pact is a psychological biggie. If it were to
happen, it would say that gold is a key central bank reserve and that
it can be an effective crisis-management tool.
Two questions. If Europe goes for the gold-backed deal in an effort
to save its sorry butt, what does this say about the credibility, or
lack thereof, of fiat currencies around the world? And would it save the
euro from extinction?
Desperate times require desperate measures. We can all agree that the
euro is a pig. A pig stuffed with gold is an entirely different beast.
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