Will Gold Rescue Debt Ridden Nations in the Eurozone?

Wall St. Cheat Sheet

Gold is considered to be the answer for many things. The precious metal is seen as a useful financial asset to address inflation, deflation, diversification and the seemingly endless amount of uncertainties in the global economy. A recent article now hints that gold could even be used to help solve the eurozone’s massive debt load.

Over the weekend, the Wall Street Journal published an article that echoed the idea from the World Gold Council that troubled nations in the eurozone could use the region’s gold reserves to help lower interest rates on debt. Central banks of the 17-nation area are estimated to be sitting on nearly 10,000 tonnes of gold. As of October 2012, statistics from the WGC show that Germany has almost 3,400 tonnes of gold, accounting for 72.4 percent of its total reserves and placing it second among world gold holdings. Other countries in the eurozone such as Italy, France and Portugal hold 2,452 tonnes, 2,435 tonnes and 383 tonnes of the precious metal, respectively.

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While there is little chance that Germany would be willing to risk its gold holdings, two countries may be desperate enough to use their own stash. The WSJ explains, “The idea isn’t to sell the stuff. Instead, the proposal is to bring down borrowing costs by using gold to guarantee the partial repayment of bonds to investors in case of a default. Italy’s gold reserves would cover 24 percent of its estimated borrowing needs over the next two years and Portugal 30 percent.”

The gold-backed bond idea does not currently appear to be on the table among policy makers, but there is some precedent. Ansgar Belke, an economist at the University of Duisburg-Essen in Germany, explained in a paper commissioned by the WGC, that Italy and Portugal both turned to gold reserves as collateral in the 1970s for loans from central banks. He finds that the move reduced Portugal’s borrowing costs for five-year bonds to 6 percent from 10 percent, as long as a one-third of the bond’s face value was guaranteed by gold. When gold backed half of face value, interest rates declined to 5 percent.

Using gold to lower interest rates may help temporarily, but it does not go far enough considering the debt levels in the eurozone, as well as the rest of the world. However, that does not mean that gold will not be part of the answer. Perhaps a higher valuation of gold will be realized over the coming years in order to help wipe out large debt amounts? One thing is for certain, central banks and investors are becoming more interested in precious metals as fiat currencies are called into question. On Monday, the German court of auditors has decided that the Bundesbank make an audit of its gold reserves. Additionally, the Bundesbank has started to ship its load of gold held at the Federal Reserve back to Germany to the tune of 50 tonnes per year.

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Disclosure: Long EXK, AG, HL, PHYS