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Section: Daily Dispatches

... perhaps as a rationalization for the
imminent exhaustion of central bank reserves.

* * *

Going, going, gold

Financial Times
Friday, April 16, 2004

The barbarous relic, as Keynes called it, is crumbling to
dust. When even the venerable N.M. Rothschild has quit
the gold market and the Bank of France, among the
most stubborn of the official goldbugs, is thinking again
about its bullion holdings, the end of gold as an
investment has come a little closer.

It will not be before time. The fetishisation of shiny
yellow metal, decades after it ceased to be used as the
anchor of the international monetary system, is a
lingering anomaly in modern financial markets. Perhaps
Rothschild's last service to the bullion market could be
to keep a live gold trader on display behind glass as a
reminder of a bygone age, like the former coal miners
who now make a living giving tours of defunct pits.

The one advantage of gold as a reserve asset is that,
unlike assets based on fiat money, governments
cannot make it worthless by inflating it away. But in
an era of low inflation, and given that independent
inflation-targeting central banks are the norm across
the industrialised world, that risk has very sharply

Indeed, for both private and official investors, gold is
now a rather risky asset with a nil or low return. The
intrinsic value of gold, determined by its use in
various industrial processes, is well below its market
price. Gold does not grow. So its value to any one
investor as an asset is dependent on other investors
also holding it as an investment asset. The gold
price hangs precariously by its own bootstraps.

For private investors to hold gold on this basis is their
own foolish affair. For central banks and governments
to hold it as a reserve asset is a betrayal of the public
on whose behalf they are acting. Despite recent
selloffs, governments and central banks still hold about
a fifth of the world's bullion. Their large holdings
relative to the size of the market by themselves make gold
particularly ineffective as a reserve asset: the very act
of official selling of bullion on any large scale to raise
cash will itself drive down the price.

This danger was amply demonstrated by the UK's unhappy
experience of trying to sell some of its gold holdings.
Announced in 1999 in a sensibly open and transparent
fashion, the sales sparked such a fall in the global
bullion price that a group of central banks signed a
concord limiting such sales. That has recently been
superseded by a new agreement providing for limited
official sales.

Given the pointlessness of holding gold, the speed of its
official selloff scarcely matters, unless leaching the gold
into the market bit by bit somehow maximises the return
to the public purse by limiting the impact on the price.
That would imply some irrationality on the part of the
market. But then holding gold is irrational in the first
place. Perhaps the central banks are right to go slowly.

Whatever the speed, the direction is clear. Gold is on
its way out as an investment and a reserve asset. Three
cheers for that.


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