A Denial by Long-Term Capital Management

Section:

PART 2, HOUSE OF COMMONS SOUNDS LIKE GATA

I have already quoted Mr. Greenspan, who said that in
1944 Germany could not buy anything except with gold.
In a real crisis, there is no doubt that gold is
important. It is not just my taxi driver who takes that
view. When I was in Vietnam last year, everybody told
me that every Vietnamese peasant has gold underneath
his floorboards or his straw because the Vietnamese
have no confidence in their currency. We tend to talk
about gold in terms of official reserves, but a lot of
unofficial gold is hidden in China and Vietnam and, one
is always told, in France--although I have a French
wife and I have not yet managed to discover her gold
hoard. It is widely believed that people hold gold all
over the world secretly, against the possibility of
disaster, which is a tremendously important market
consideration. That is what is meant by the psychology
of gold and it is extraordinary that the Bank of
England should have taken this decision, and the way
that they have done so.

I do not wish to go into the question of International
Monetary Fund gold sales in any detail, because that is
a separate, although obviously related, subject. The
IMF is not a central bank. It is ironic that the
Chancellor, who is understandably keen to help the
poorer nations of the world, seems also to be keen to
persuade the IMF to sell gold. He hopes that it will do
so, but many poorer countries would be extremely hard
hit by that.

Hon. Members who are interested might care to read the
recently published pamphlet entitled "Gold mining's
importance to sub-Saharan Africa and heavily indebted
poor countries", because 41 HIPCs mine gold, and it is
an extremely important part of the exports of nine of
those countries. Curiously enough, the sale of IMF
gold, if it depressed the price of gold still further,
would seriously and adversely affect many of the
poorest countries.

The sale of our gold will not increase the size of our
reserves; they will remain the same, so that argument
cannot be used. Many countries feel that they ought to
be building up their reserves, and they are all trying
to do so. An extraordinary aspect of the situation is
how dangerously low Britain's net reserves are. Their
net value on 7 May was only $15 billion. A more
sensible policy than selling gold would be to build up
our reserves by buying dollars and other currencies
with our sterling. That would help to lower the
exchange rate of sterling, which is a desirable
objective at present, and increase our reserves of
foreign currencies, which the sale of gold will not
achieve.

Mr. Tyrie: In view of the experience in the '90s with
the huge movements of global capital, does my hon.
Friend believe that open market operations are an
intelligent way in which to try to alter the value of a
currency?

Sir Peter Tapsell: I would not normally take that view,
but our long-term economic aim ought to be the building
up of our reserves. That is what every country wishes
to do, and many of them are pursuing that. Our reserves
in relation to our imports are very low, so any step
that we can take to build up our reserves will be
welcome.

I have mentioned the aspects of public opinion. I am
not one of those who thinks that one should follow
focus groups and so on, but it is overwhelmingly
evident that public opinion in this country is opposed
to the whole policy of selling gold by 5:2. The
Government will have to be persuasive if they are to
change that view.

There have been previous attempts to reduce the role of
gold in central banks. The last was the introduction of
special drawing rights. At that time, I happened to be
an adviser to the monetary authority of Singapore. I
went to see Dr. Goh Keng Swee, who was then Singapore's
Finance Minister and who, in my experience, had the
most subtle and brilliant financial mind of any Finance
Minister or central bank governor I have ever known. I
said to him, "Dr. Goh, will Singapore take SDRs?" Dr.
Goh replied, "I have no intention of putting a paper
tiger into Singapore's tank." That is a slogan worth
keeping in mind.

The whole point about gold, and the quality that makes
it so special and almost mystical in its appeal, is
that it is universal, eternal and almost
indestructible. The Minister will agree that it is also
beautiful. The most enduring brand slogan of all time
is, "As good as gold." The scientists can clone sheep,
and may soon be able to clone humans, but they are
still a long way from being able to clone gold,
although they have been trying to do so for 10,000
years. The Chancellor may think that he has discovered
a new Labour version of the alchemist's stone, but his
dollars, yen and euros will not always glitter in a
storm and they will never be mistaken for gold.

Mr. Edward Davey (Kingston and Surbiton): I
congratulate the hon. Member for Louth and Horncastle
(Sir P. Tapsell) on keeping to a fairly balanced view
when he developed the theory of the role of gold in a
modern economy. However, I disagree with his
conclusions.

In answer to my intervention, the hon. Gentleman talked
about the psychological importance of this sale of gold
and explained the psychological role of gold in
monetary economics. He was right to focus on that,
because gold's main contribution in the modern monetary
economy is that it is, at the last resort, the store of
value and the provider of assistance in underpinning
market confidence. However, many other commodities and
assets retain value for investors, businesses and
Governments and there are many other ways of
maintaining market confidence in a modern economy, from
regulation to the lessons of history.

At the end of this century, many participants in the
financial markets--and in all product and labour
markets, for that matter--have much greater confidence
in the ability of capitalism and financial capitalism
to deliver success. That was not the case centuries
ago, when gold made a much more important psychological
contribution. The lesson of history is that we do not
need gold to underpin confidence and value. The role
played by gold has been declining, which means that the
hon. Gentleman's point about its psychological
contribution is much less strong today. I completely
agree with the hon. Gentleman that, in the past, gold
was absolutely vital--in the early days of financial
capitalism, it was crucial--but the role that he wishes
to attribute to it is not as strong as he suggests.

Mr. Gill: Does the hon. Gentleman think that these
matters should have been discussed in the House before
the decision to sell was made, given that money has
been put aside in reserves by the taxpayer? The
taxpayer clearly has a view, as my hon. Friend the
Member for Louth and Horncastle (Sir P. Tapsell)
explained in his excellent presentation. There is also
the question whether the taxpayer feels that that store
of value, which belongs to him, has been preserved by
putting the proceeds of the sale of gold into other
investments. Does the hon. Gentleman think that the
House should have been granted a debate on these
important matters before the Government took the
decision to sell the gold?

Mr. Davey: I do not agree with the hon. Gentleman about
that. One of the criticisms that can be made against
the Government is that they were too open and
transparent about the sale of the gold, and that that
has moved the market price. I do not subscribe to the
criticism that has been made of the Bank of England's
approach, because I think that the way in which it has
set out these sales over the next 12 months will help
to bring order and stability to the gold market, which,
as has been said, is characterised by volatility.

The hon. Member for Ludlow (Mr. Gill) tempts me a
little. The problem with the House is that we do not
analysis Government expenditure in enough detail. The
House grants 300 billion to 350 billion of public
expenditure without full debate. We should scrutinise
the Government on that expenditure: not on technical
gold sales. There is a strong argument for not having a
full debate on gold sales, because that could move
markets.

The role of gold can be overplayed. That is not to say
that gold markets are not important and that we should
not have gold reserves: of course we should. I do not
pretend to have all the financial knowledge before me
properly to take a view about whether the Bank of
England is right in its portfolio adjustment, but I
concede that the people who are overseeing the
portfolio of assets that the Bank of England holds in
its vaults must from time to time decide whether to
make changes and adjustments. It would be nonsense if
the Bank of England were to hold static for ever a
particular set of assets in particular proportions.

Mr. St. Aubyn: Does the hon. Gentleman think that it is
right that the Government took this decision without
giving any thought to the effect on the developing
world and on the gold price? Jobs are now being lost in
very poor countries as a result of this decision.

Mr. Davey: I am grateful to the hon. Gentleman for
raising that issue, because that is also one of my
concerns. Will the Minister explain a little more the
thinking behind this decision? Now that we have this
debate, it would be sensible for the Government to
outline the thinking behind this sale, particularly
with respect to employment in developing countries that
have gold as one of their key commodity exports and the
Government's policy to promote the sale of gold from
the International Monetary Fund to help to deal with
debt relief in poor countries. I hope that all parties
in the House support that policy, because it is crucial
that we try to forgive the debts of the poorest
countries--the debts that are deemed to be, in Jubilee
2000 language, unpayable. The Government have made a
good start, and I hope that they go further. It would
be wonderful if the Minister were to announce today
further gold sales for that purpose, but I doubt that
she will do so.

I hope that the Minister will explain the thinking to
reassure us that the left hand knows what the right
hand is doing, that there is some co-ordination between
the Treasury and the Bank of England on all aspects of
policy, and that the policy on assisting debt relief
has been linked to the policy of portfolio adjustment
at the Bank of England. If those decisions are not co-
ordinated, the Government are not doing their job
properly.

I congratulate the hon. Member for Louth and Horncastle
on securing this debate. It will help the House to
focus on the role of gold in a modern economy. I take a
different view from him. In international monetary
economics in the late 20th century, money creation and
the complexity of global financial markets is such that
the role of gold is much diminished. Money creation in
modern financial capitalism is almost endogenous and
does not rely on a stock of yellow commodity lying in
the central bank's reserves. The workings of financial
capitalism have almost no relation to gold.

The hon. Gentleman is right that, in extremis, if the
whole structure of financial capitalism were to fall to
the ground with a nuclear meltdown of the financial
markets, the role of gold would come to the fore. It is
right for central banks to consider all potential
future risks to ensure that our society and our economy
can function even in such disaster scenarios. They
should hold gold, but they do not need to do so as they
have in the past.

I do not know whether selling 125 tonnes of gold over
the next 12 months and buying yen, euro and dollar
assets is the right portfolio adjustment. Not many hon.
Members have the information and expertise to make that
full analysis. However, I think that it is right that
the Bank of England is considering how best to deploy
its assets.

The total amount being sold is very small compared with
the amounts that have been sold by other countries in
recent times and that are expected to be sold in the
future. Switzerland has announced future sales of 1,300
tonnes of gold, which is much greater than the amount
that the Bank of England proposes to sell. We should
put this matter in context, and should not get too hot
under the collar about it.

10.36 am Mr. Andrew Tyrie (Chichester): I agree that
more attention should be given to this subject. The
Government should have called a debate, and I regret
that they did not. I also agree about the mystique--
"Goldfinger" is on television tonight, so it is an
apposite day on which to hold this debate, and I have
set my video recorder.

The key issue is whether gold can still play a monetary
role. It used to play a big monetary role because
people did not trust paper money. It played a crucial
role in the development of the international traded
goods sector in the 19th century. It was very
effective, because it was difficult to cheat. It
coincided with a period of stable prices in the 19th
century. I say coincided because it was largely luck:
it was because gross domestic product grew at roughly
the speed of the monetary base--the increase in the
amount of gold available--and thereby serious deflation
was avoided. That history of success in the 19th
century was carried over into the 20th, and gold was
used as part of the stabilising function in the Bretton
Woods system in 1944--the dollar link. When inflation
created by the Vietnam war destroyed Bretton Woods,
that should theoretically have led people to rush back
to gold. They did a little, but no serious analyst
suggested that gold should be brought back as the
monetary base. There were more sophisticated arguments
for commodity-based standards, which I think had some
merit, but virtually no one, even during the crisis
created by global inflation, thought that gold was the
right way to go.

Since that time, gold has steadily fallen in price. Can
gold once again play a role as a reserve currency? I do
not think so. It is no longer a good store of value: we
have seen that in recent years. I do not think that
gold is a suitable vehicle for open-market operations,
which are themselves far less relevant in an age of
such huge global capital flows. Nor do I think that we
will go back to gold as a vehicle for dealing with
inflation, if that returns.

Gold is, as the famous phrase goes, a barbarous
economic relic. I cannot believe that it makes good
economic sense to spend a huge amount of money digging
something up, turning it into ingots and then burying
it again in vaults. These gold sales are not primarily
a monetary issue. I note that the Monetary Policy
Committee did not even discuss the matter. The case for
the demonetisation of gold is strong.

I cautiously support the sales, but I am sorry that the
Government have not moved more carefully. I do not
think that there was any need to rush into these sales.
We do not know whether the gold price will go down or
up. My hon. Friend the Member for Louth and Horncastle
(Sir P. Tapsell) said that he thought it was at a low
point.

He may be right, and he may be wrong--we do not know--
but he could be right, and if he is right we should
proceed more cautiously.

Mr. William Cash (Stone): Will my hon. Friend give way?

Mr. Tyrie: If my hon. Friend will forgive me, I will
not, because I have only two or three minutes in which
to finish my speech.

I am a little worried that we will sell too quickly. It
is a question not just of the amount, but of the speed.
There are good arguments for believing that the gold
price may continue to fall. The United States might
start selling gold. Has the Treasury a view on whether
major countries are now considering gold sales? Is
there any suggestion that they might?

I think that gold will be used less in the 21st century
as a store of value in Third world countries--Vietnam
was mentioned earlier--and that will result in more
gold coming on to the market. Improvements in mining
techniques will almost certainly increase the amount of
gold available. I worked in the European Bank for
Reconstruction and Development for a while, and it was
found to be profitable to "leach" the piles of slag
that had already been used for gold mining, to obtain
gold by means of more efficient industrial processes.
The supply side points to a weak gold price for some
time to come.

With great respect, I thought that my hon. Friend the
Member for Rochford and Southend, East (Sir T. Taylor)
was talking nonsense when he suggested that the
Government might be selling in order to influence the
price of the euro. They could do that perfectly well by
using the forward book, with or without gold, as a
reserve in the vaults. As I have said, I would like the
Government to explain why so fast, and why so much.
10.42 am Mr. Quentin Davies (Grantham and Stamford): I
congratulate my hon. Friend the Member for Louth and
Horncastle (Sir P. Tapsell) on securing this short
debate, during which he raised a number of points that
it would be remiss of the House not to discuss
seriously. He is a distinguished parliamentarian, and
brings to the subject a wealth of professional
experience as well as the depth of historical knowledge
for which he is famed in the House. I never listen to
him without learning something that I did not know
before, and I certainly was not disappointed on this
occasion.

The hon. Member for Kingston and Surbiton (Mr. Davey)
also made some sensible points, and we heard a
valuable--but sadly, owing to the shortage of time, all
too short--contribution from my hon. Friend the Member
for Chichester (Mr. Tyrie), who probably knows more
about the subject than any other Member except my hon.
Friend the Member for Louth and Horncastle.

The Government have left two questions in the minds of
parliamentarians and the public. First, why did they
decide to sell the gold? We are still no clearer about
that, and I hope that we shall be clearer by the end of
the debate. Secondly, why have the Government adopted
such an astonishing method of conducting the sales?

Because the Government had not given us sufficient
explanation, my right hon. Friend the Member for
Horsham (Mr. Maude), the shadow Chancellor, wrote to
the Chancellor of the Exchequer, but all that he
received was a lot of waffle. The reply stated:

"As we have been careful to explain this is a prudent
restructuring of the reserves." This is to do with:
"Prudent management of public finances" to achieve a
"better balance in the portfolio." Those are evasive
answers. We need an answer to the question, why is it
more prudent for gold to constitute 20 per cent. of the
net and 7 per cent. of the gross reserves, rather than
40 per cent. and 17 per cent., or whatever the current
figures are? We have heard no explanation of the
factors that determined the Government's course of
action, and we badly need one.

Gold has traditionally been held as a reserve because
its value is a negative function of the strength of the
dollar, a positive function of inflation rates and a
negative function of real interest rates. It is
possible to construct a hedge against the dollar simply
by holding other currencies, but there is no such
obvious way of obtaining protection against a
resurgence of inflation, a collapse of real interest
rates or interest rates becoming negative again, as
they have during all our lifetimes, that is better than
holding gold. As my hon. Friend the Member for Louth
and Horncastle pointed out, gold is a long-term
insurance policy against contingencies that we do not
foresee in the immediate future, but which could always
return. We need to know why the Government have decided
that they want to roughly halve that insurance policy.
After all, 700 tonnes of gold is not very much for an
economy the size of ours.

The Government must think that there is some reason for
holding gold in the reserves, or they would have
decided to get rid of the entire gold reserve. We need
a clear explanation of why they think it prudent to
hold a mere 300 tonnes. If they agreed with the
arguments advanced by my hon. Friend the Member for
Chichester, it would be logical for them to get rid of
gold altogether; but they have not, and their actions
lack credibility.

Do the Government have formal models for determining
their management of the portfolio of the reserves? Is
there a formal risk management model? If so, will they
place it in the House of Commons Library, so that all
of us, including the public, can learn on what the
portfolio decisions are based, and why such adjustments
are apparently required? After all, the Government are
acting in an agency capacity, managing the taxpayer's
money.

The Minister must reply to the serious point made by my
hon. Friend the Member for Louth and Horncastle. We
cannot allow the rumours to grow, because they are
extremely dangerous to public confidence. It has been
suggested that the market is very short of gold, that
the short positions may be a substantial multiple of
the total amount of gold currently held by the Bank of
England, and that the Bank's real motive is to save the
bacon of firms that are running those short positions.
If such a suggestion is being made seriously, it must
be dealt with authoritatively and definitively, and we
want an answer from the Government now.

Apart from the question "Why do it?", the obvious
question in the minds of the public is, "Why do it in
what is apparently such an incredibly incompetent and
foolish fashion?". Someone who is going to sell
something does not announce it in advance to the world,
and certainly does not try to talk down the price of a
commodity in which he is rather long. In normal
circumstances, that makes no sense. If these
circumstances, or these rules, are abnormal, we had
better hear why it is sensible to make a public
announcement. On the facts, it is extremely foolish and
damaging. As my hon. Friend the Member for Louth and
Horncastle said, they have reduced the value of the
whole gold reserve by 10 per cent. or more since the
announcement, and it is clear that the announcement has
been one of the major factors in the fall. This is,
prima facie, a clear case of incompetence on the part
of the new Labour Government.

As if that were not enough, how extraordinary it was to
try to talk the International Monetary Fund into
agreeing on a programme of gold sales a few weeks
before trying to sell our own gold. That was madness.
You have to be as incompetent as the Government appear
to be to damage the market in advance of such a major
sales operation. The Minister and, indeed, her boss the
Chancellor, owe the taxpayer an explanation. Why have
the taxpayer's assets been squandered and their value
gratuitously reduced? No sensible business man or woman
would dream of conducting his or her affairs in such a
way. Or is it perhaps that the conspiracy theory is
right? Has the Government's whole plan been simply to
drive down the gold price by whatever means, fair or
foul, to save the position of certain figures in the
City--the firms that were hinted at by my hon. Friend
the Member for Louth and Horncastle--which, apparently,
are so short and potentially in such trouble? The
Minister has an opportunity to throw light on that. I
hope that she will do so.

Given the appalling mistake of having alerted the rest
of the world that we were going to sell the gold, why
did not the Minister think of alternative ways of
proceeding? If she did, why did she not choose them? A
private placing is one obvious route that I would have
wanted to explore. Some central banks are buying gold.
As their balance of payments improve, perhaps China and
some of the far east countries will add to their
reserves. We have already heard that the Bank of France
and the other major gold holders are not selling.
Perhaps they might have been prepared to buy a little
more, particularly if the alternative was a public
auction. They might have said, "We'll help the British
out a bit and take some." The discount would almost
certainly have been a good deal less than the 10 per
cent. and more that has been the effective discount
following the manner in which the Government decided to
proceed.

Alternatively, what about "feeding the fix"--feeding
the market over time? Was that alternative properly
explored? If so, why was it not chosen? Of course, the
amounts are significant, but, for years and years, the
South Africans fed the fixing in the opposite
direction. They sold their annual gold production over
time, spreading it over the year. They found that to be
a good way of doing things, so why, conversely, is it
not a good way to reduce one's gold reserves? We want
to hear whether that potential solution was explored
and, if so, why it was rejected.

Finally, what about the idea of a millennium issue--a
retail issue of gold, not sovereigns? The value of each
coin would presumably be much more valuable these days.
That might have had distinct marketing opportunities at
the millennium. Had we proceeded down that route, the
Government might even have sold the gold at a premium
and a discount would not have been necessary. Again, we
want a clear explanation of why that route was not
chosen.

The Economic Secretary to the Treasury (Ms Patricia
Hewitt): I congratulate the hon. Member for Louth and
Horncastle (Sir P. Tapsell) on securing the debate and
on his fascinating and wide-ranging speech, which, as
the hon. Member for Grantham and Stamford (Mr. Davies)
said, again displayed his skills and knowledge as a
historian. I also congratulate the hon. Member for
Grantham and Stamford on his promotion to the Front
Bench. We heard in yesterday's Finance Bill Committee
that we were to lose two of the Front-Bench team from
the Opposition. We welcome him and his colleagues to
their new places.

In this extremely interesting debate, we have heard the
two traditions, if you like, of attitudes towards gold.
We have heard from the hon. Member for Louth and
Horncastle of the mystical significance of gold--I was
waiting for that word to appear and he did not
disappoint me. During the sensible contributions of the
hon. Members for Kingston and Surbiton (Mr. Davey) and
for Chichester (Mr. Tyrie), we heard of the alternative
view that was taken by Keynes in the 1930s--of gold as
a "barbarous relic".

I regret only that I have been left so little time to
respond to the multiple points that have been raised,
but I dismiss first the wilder rumours to which the
hon. Members for Louth and Horncastle and for Grantham
and Stamford both referred. They are nonsense. It is
important that we do not in the House take at face
value such absurd rumours, which occasionally float
around the markets. We should be careful not to give
currency to such rumours by remarks in the House that
may verge on the irresponsible.

Several Members have asked why the Government have
decided to restructure the reserves and to reduce our
holdings in gold. The answer is simple. We have
reviewed the nature of our portfolio--the assets that
we hold in the reserves. We believe that the size of
the holdings and their spread across currencies and
gold should be determined by the balance of the risk
and reward that is offered by gold, and how that
compares with the other assets that are held in the
reserves.

As some hon. Members have pointed out, gold has been a
very poor investment over the past 20 years. The gold
price in June 1979 was $280 dollars an ounce. It is
little changed on that today, although it shot up to an
unsustainable peak of some $800 an ounce in 1980. By
contrast, other investments have offered capital gains,
or reinvestment of substantial interest earnings over
that period. What we are looking for in the
restructuring of the reserves is a sensible
diversification of the assets.

We are not saying that gold will continue to be a poor
investment. As the hon. Member for Chichester said,
none of us knows, but we would not be planning to
retain a significant proportion of the reserves in gold
if we believed that it had no place as a store of
value.

However, what has happened to the real value of gold
should caution the House against some of the more
exaggerated claims in its favour.

We continue to believe that gold is a valuable asset
and that it performs an important role in countries'
reserve assets, but it has to justify its share in
terms of its contribution to the overall balance of
risks in our reserves portfolio. A key objective in
that portfolio's management is to minimise the risk to
the taxpayer of fluctuations in the value of the
reserves. Financing a large part of the reserves
through borrowing in foreign currency largely
eliminates that currency risk, as the hon. Member for
Grantham and Stamford has acknowledged, but
considerable risk is borne on the remaining net foreign
currency and gold reserves, totalling the equivalent of
$14 billion.

The hon. Member for Louth and Horncastle asked why we
use that measure of net reserves. Perhaps I may draw
his attention to the advice of the International
Monetary Fund that countries should disclose not only
their gross reserves, but their currency liabilities,
so that a proper judgment can be arrived at of net
reserves.

Almost half of this country's net reserves have been
held in the form of gold. Without taking a view on the
prospects for gold, that is a very big exposure to a
single asset. Reducing our gold holdings from 715
tonnes to some 300 tonnes over a number of years will
gradually bring gold's share of the net reserves down
to about a fifth. We believe that that will achieve a
better balance in the portfolio.

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