Are the central banks running a fractional gold system?

by Alisdair McCleod 

This thought is prompted by a forensic study of the Bank for International Settlements’ records and accounting procedures with respect to its dealings in gold, which was presented by Robert Lambourne to the Gold Symposium in Sydney on 9^th November. The link to his report is here. Lambourne points out that the BIS was founded in 1930, when settlements between central banks routinely involved gold, and the primary function of the BIS was to facilitate these settlements without the physical transfer of bullion. This involved gold accounts being maintained at the BIS for gold owned by central banks, with other central banks at the main depository centres. Lambourne cites the example of the pre-war German Reichsbank, which held gold through the BIS in Amsterdam, Berne, Brussels, London and Paris.

Central banks were offered two different types of account at the BIS, earmarked and sight: earmarked accounts recorded gold held separately and specifically for a central bank, and sight accounts were non-specific. Earmarked gold is allocated, while sight gold is unallocated; earmarked is custodial and sight is co-mingled.

The flexibility of the system allowed a central bank to diversify its gold reserves in a number of centres through a politically neutral institution, and it made sense to allocate some of this into a fungible account to settle transactions with other central banks. But that was pre-war, and before the US, with the co-operation of the IMF and other European central banks, demonetised gold.

Today, the BIS still operates earmarked and sight accounts for central banks, but crucially, rather than have the bulk of gold in earmarked accounts with a smaller float in fungible sight accounts, the bulk of central bank gold is now held in unallocated sight form. Lambourne brings this point out in his analysis of the 2009/10 BIS Annual Report, which shows in Note 32 that the BIS holds only 212 tonnes for central banks in earmarked accounts, and 1,704 tonnes on its balance sheet in sight accounts. Furthermore, the BIS accounts disclose that almost all of the 1,704 tonnes is held at central banks in unallocated sight form. This confirms that the central banks themselves also operate sight accounts.

So to summarise so far, out of 1,912 tonnes at the BIS, 90% of it is now unallocated and nearly all of this gold is held in unallocated accounts at other central banks.  While this sight gold at central banks is technically deliverable on demand, there is no apparent requirement for them to actually have it.  It is therefore entirely possible for a central bank to retain only a small portion of the total owed on sight accounts, which after all is what banks have done from time immemorial.

The temptations to use physical gold from these unallocated sight accounts to supply the market have been enormous, given the progressive demonetisation and discreditation of gold by the BIS founder members. It is easy, without proper audits, to keep these activities secret from the markets and even from other central banks not in the inner circle. It would be very interesting to know, for example, the terms under which India agreed to buy 200 tonnes of gold from the IMF.  Did she actually take delivery into an earmarked account, or was it a pure paper transaction across sight accounts? If she had insisted on an earmarked account, would the deal have gone to someone less picky?  Was the IMF gold itself earmarked or sight, existing or non-existent? As an outsider from the inner BIS circle the Bank of India is not in a position to suspect she may be the victim of a pyramid scheme run by her superiors; nor indeed is any other of the minor central banks with sight accounts in London, New York or Zurich.

We must hope for the sake of financial stability that such suspicions are without foundation, but this hope is untenable while the major note-issuing banks refuse to provide independent audits of their activities.  If these central banks have been operating a fractional sight system, then it could explain how they have managed to supply so much bullion into the markets while appearing to maintain their official reserves. 

China and Russia must be watching this with great interest.  We can assume that their intelligence services are more aware of the true position than the general public, and if they also conclude that the Western central banks are running a fractional system using sight accounts, this knowledge hands them great economic power.

It is relevant to bear this in mind, because it will condition the US’s response to what is developing into a destructive gold crisis.  Political and strategic considerations will have to be weighed as well as purely financial and practical ones. It would be downright stupid, for example, for the US to confiscate privately owned gold, without international agreement from Russia China and India as well as the Europeans to take similar action. And how co-operative would any nation be when they discover that the gold they thought they had at the BIS, the Fed and the Bank of England has actually vanished?

This is important because the basic problem is that government and banking debt around the world are both rapidly moving towards default, and since governments are guaranteeing the lot, the pace of monetary creation is accelerating.  The consequence is that the gold suppression schemes, which have existed for the last one hundred years in one form or another, are finally coming to an end. We are trying to guess how dramatic that end will be. It will be difficult enough to stop a run by unallocated account holders on the bullion banks, without forcing a cash-payout amnesty. But if the central banks themselves cannot supply the necessary bullion to prevent this, the prospect of a total collapse of paper money will be staring us all in the face. 

16 December 2010

http://www.financeandeconomics.org/Articles%20archive/2010.12.16%20BIS.htm