Gold in the Core of the Banking System

I originally published this piece in The Gold Standard, the journal of the Gold Standard Institute.  I reproduce it here because people have been asking about it.

 

On June 4, Department of the Treasury Office of the Comptroller of the Currency (OCC), the Federal Reserve System (the Fed), and the Federal Deposit Insurance Corporation (FDIC) issued a joint notice of proposed rulemaking (http://www.fdic.gov/news/board/2012/2012-06-12_notice_dis-d.pdf).  On June 18, the FDIC issued a Financial Institution letter with the stated goal of updating banking regulations to implement changes made by the Basel Committee on Banking Supervision and the Dodd-Frank Act (http://www.fdic.gov/news/news/financial/2012/fil12027.html).

 

Both documents propose a positive for gold.  Under the proposed new regulations, gold is to have a zero risk weighting, like dollar cash and US Treasury bonds.  This will allows banks to own gold on more advantageous terms, as they won’t need to tie up other capital just to support their gold position.

 

One can only imagine what stress the banks must be under if the regulators and the Fed are willing to consider this extreme measure!  Do they not have sufficient other assets?  Or is the issue that most other assets are either garbage or already encumbered?

 

This segues into a theme that I plan to discuss more in the future.  The re-monetization may not take place by passage of a monolithic law, but in increments.  This change, and not even in law but in regulation—not even considered by Congress but by unelected bureaucrats—is an important step towards a gold-based monetary system.  For the first time in many decades, banks can hold actual gold as part of the backing of their deposits, and not just as a trading position.  Regardless that this may be a “hail Mary” pass thrown in desperation and lack of anything else that the government would prefer, I think it heralds a sea change and a highly important milestone in our fight to return to a sound monetary system!

 

In 1933, when President Roosevelt outlawed gold ownership for US citizens, he removed the only real competition of US Treasury bonds.  Those investors who wanted absolute safety of their capital were deprived of the only risk-free financial asset.  So they were herded into government bonds, like cattle to slaughter (thus driving down the rate of interest and crushing the debtors).

 

Now, gold may be a viable competitor to the bond (assuming this proposed rule goes into effect) in the banking system.  While individuals can and do buy and hoard gold today, there have been significant disincentives for banks to own gold.  Now, what is arguably the biggest obstacle is being removed.

 

What will the impact be?  Obviously, additional demand will come into the gold market.  So the price will go up.  But The Gold Standard Institute is not about speculating on the dollar price of gold.  From a monetary perspective, there are two interesting angles to consider regarding this development.

 

With competition from gold, some of the demand is taken away from US Treasury bonds.  Could this mean falling bond prices, and hence rising interest rates?  The wildcard is the Fed and its perpetual purchases of bonds.  I don’t think anyone in his right mind would buy bonds in this world, except as a speculation on the next action of the Fed, and the speculators (the survivors) are adept at figuring out what they will do next.

 

Another interesting thought is that to the extent they switch out of the Ponzi scheme of bonds that are never repaid, only “rolled” into gold, the banks will become more sound.  As gold is the one asset whose dollar price can rise without any particular limit, it may be a matter of time before banks are substantially recapitalized simply due to the rising price of gold held outright as an asset on their balance sheets.

 

This is exciting!  I hope every reader goes out tonight and has a glass of wine to toast “to the return of gold!”

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