Sunday, February 17, 2008

IMF? Whither Art Thou?

Fading the IMF

By Adrian Ash
The gold price now hovers near all-time record highs. Whereas the International Monetary Fund (IMF) finds itself short of $400 million per year. Can you guess what comes next? That's right; the IMF unloads some of its gold.
Will these sales weigh on the gold market? We think not. In fact, whenever the IMF or the major central banks in the West start selling gold, individual investors should be buying least that's the lesson of history.
"The IMF is rich if it wants to be," says Stephen Jen at Morgan Stanley, recommending IMF gold sales just before the idea was agreed by leaders of the world's top seven economies on Feb. 9th. IMF gold – the third largest hoard after the American and German government gold reserves – is now worth around $92 billion, tripling in value since the start of this decade. And if you were spending $1 billion a year but only bringing in $600m, as the IMF is today, wouldn't you want to sell a little of your 3,217 tonnes of gold bullion?
"The current gold price means a flow of income can be ensured," said the head of the IMF's steering committee, Italian finance minister Tommaso Padoa-Schioppa. It's the simple solution, agreed leaders of the G7 wealthy nations in Tokyo. But will IMF gold sales happen? And would it matter to the gold market anyway?
To answer these questions, let's take a brief tour though history...
Founded at the end of World War II with donations of cash and gold from its member nations, the IMF works at economic "crisis prevention" worldwide. Using the $338 billion or so in cash that it holds (but never the gold, which exists as a ballast of "fundamental strength," as the IMF explains), the IMF also lends to countries facing balance-of-payments problems. This is where the IMF earns its keep, charging interest on these short-terms loans.
The IMF also makes loans to low-income countries implementing poverty-reduction programs, currently helping 23 countries from Afghanistan to Sierra Leone. But more famously, the IMF offers advice and technical expertise to help developing economies emerge from crises by stabilizing their foreign-exchange rates and re-structuring government finances.
Since the Argentine crisis of 2001, however – blamed partly on the IMF's questionable advice – new IMF lending has contracted dramatically. Therefore, the IMF's income has also contracted. The world's developing economies have simply developed too fast; they don't need as many hand-outs from the IMF.
Indeed, many former clients are now so busy piling up foreign exchange reserves, you have to wonder why the IMF doesn't ask for help instead. Or the US, for that matter. The world's largest economy is now running a trade deficit worth 6.5% of its annual turnover. (Economists get nervous about any figure above 3%. Too bad U.S. politicians don't). The US government has run up $9 trillion in debt, and the US Dollar has dropped one-third of its value in the last five years to reach all-time record lows against the rest of the world's currencies.
Would selling some IMF gold help push the gold price lower – and by extension, help the US Dollar to recover? It's been tried before, and with little success. Between 1976 and 1980, the IMF sold gold in a bid "to reduce the role of gold in the international monetary system." The IMF unloaded one-third of its total gold holdings – 1,600 tonnes in all.

Half of that IMF gold was sold back to member nations at just $35 per ounce – the old "fixed" gold price until 1971. (But remember, these sales took place during the late 1970s, when the gold price was several times higher than $35 an ounce). The other half of that IMF gold was sold via auction, but the auctions were so well subscribed that the impact on the gold price was actually to forced it higher. The auctions were eventually suspended.
Come April 1978, the Second Amendment to the IMF's Articles of Agreement finally eliminated gold bullion "as the common denominator of the post-World War II exchange rate system," as the IMF explains on its website. "[The Amendment] also abolished the official price of gold and abrogated the obligatory use of gold in transactions between the IMF and its members. It furthermore required that the IMF, when dealing in gold, avoid managing its price or establishing a fixed price."
But trying to cut gold out of the world's monetary system did nothing to stem the flight of investment cash into gold. To the contrary, during the four years that the IMF conducted its auctions, the gold price soared by 400%.
Fast forward two decades and we find the IMF returning to its old tricks. Ever since the dawn of the new millennium, various IMF officials have proposed gold sales. The last such proposal came in February 2007, when a panel of notable "worthies" recommended selling 400 tonnes of IMF gold to cover debt-relief in poorer nations. That panel included an array of distinguished gold-scorners like former Fed Chairman Alan Greenspan and former UK Chancellor, Gordon Brown – the man who orchestrated the sale of 400 tonnes of gold from the British Treasury in 1999, just as the gold price was hitting a two-decade low. The panel's call for IMF gold sales came to naught however.
One year later, the price of gold in Dollars, Euros, Pounds Sterling and most other major currencies has risen more than 30%, thereby lending fresh urgency and "legitimacy" to the idea of selling gold. All seven leading members of the IMF – the G7 group of wealthy nations – agree the IMF should be allowed to decide for itself. But any sales of the IMF's gold must be approved by 85% of the organization's total voting power. The United States, as the largest single member nation, holds a crucial 17% of that power – giving it an absolute veto over that 85% requirement. And the US, as the largest single member of the IMF, also contributed the largest single share of the IMF's gold.
Would Congress approve a sale of this "IMF gold" to help shore up IMF finances? The US blocked a previous attempt to sell IMF gold in 2005. And with an election now looming, the idea of selling "legacy gold" to cover a short-term funding gap might not appeal to US politicians.
"Gold played a central role in the international monetary system until the collapse of the Bretton Woods system of fixed exchange rates in 1973," as the International Monetary Fund itself explains. "Since then, the role of gold has been gradually reduced," the IMF claims.
Au contraire! The "role of gold" may have been gradually reduced for governmental agencies like the IMF or the Bank of England of the U.S. Federal Reserve. But the role of gold has been rapidly increasing among individual investors. They seem to understand what most central bankers don't: gold holds its value better than paper money.
"Every time the IMF has sold gold it has actually triggered more buying interest," says Mario Innecco, a broker at MF Global in London, to Bloomberg. "It will just make it easier for the big sovereign buyers" – the big central banks outside the G7 who want to build up their gold reserves – "to snap up cheap gold from the IMF."
The IMFs sales would also make it easier for individuals to snap up cheap gold. The last time the IMF unloaded some of its gold, the price of the precious metal soared 400%. We would not dare to predict a repeat performance, but neither would we dare to rule it out. Instead, we would ask one simple question: If the IMF is dumping gold, what do you want to be doing?

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