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The golden way
Commentary: Industrialized West shows India, China how it's done
By David Marsh, MarketWatch
Last Update: 12:01 AM ET Nov 9, 2009
LONDON (MarketWatch) -- "Don't do as I say, do as I do."
The large gold-holders of the industrialized West may offer lip service to the sanctity of paper money and the ability of central banks to uphold currencies against the ravages of inflation. In reality, though, they put their faith in gold.
That lesson has not been lost on India, a nation of buoyant foreign exchange reserves that last week announced it was converting $6.7 billion worth of dollars into the yellow metal via purchases from the International Monetary Fund. The purchase helped push the gold price to a record last week.
New Delhi's acquisition came months after China revealed it had almost doubled its gold reserves in the past six years, and as bullion disposals from European central banks have fallen to a trickle after two decades of large sales. India is certainly flexing its monetary muscle. Pranab Mukherjee, India's finance minister, contrasted India's strength with weakness elsewhere: "Europe collapsed and North America collapsed."
Uncauterized wounds from the past appear to have played a role in stiffening Indian resolve to finding an alternative to the dollar.
After years of net selling, central banks have started to sit on their bullion, with net sales this year forecast at just 50 tonnes -- the lowest since 1988. The race is now on for Asian and Middle Eastern countries to snap up the rest of the 403 tonnes the IMF plans to sell.
India has a foreign exchange stockpile of $286 billion, Asia's fourth largest. The transaction with the IMF raises the share of gold in the foreign assets of the Reserve Bank of India from 3.6% to just over 6%. But, plainly, India has a lot of ground to make up.
A lead has come already from the industrialized West -- and China and India are showing that they have got the message. The four largest gold holding nations are the U.S. (8,100 tonnes), Germany (3,400 tonnes), Italy and France (both 2,400 tonnes), which have sold next to no gold (in the case of the first three) or only relatively small amounts (in the case of France) in recent years. In these four countries, gold makes up 77%, 69%, 67% and 71%, of reserves, respectively. Even after relatively large purchases in recent years, China's gold holdings, based on officially-declared figures (the real story may be different) make up just 2% of reserves.
A principal motivation behind India's gold purchase was India's unease at the decline in value of dollar assets -- and frustration about ability to find reliable currency assets to put in their place.
Since the euro and yen already look overvalued on many grounds, there must have been considerable reluctance on India's part to diversify assets in substantial fashion into these two currencies. Additionally, any significant move out of the dollar and into the euro would have depressed the dollar exchange rate -- and with it the lion's share of currency holdings in its reserves stockpile. Purchasing gold, by itself, does not alter the cross-rates of the dollar against any other alternative reserve currency -- an important advantage of the transaction.
Uncauterized wounds from the past appear to have played a role in stiffening Indian resolve to finding an alternative to the dollar. In 1991, when a sharp decline in remittances to the sub continent caused by the Iraq war critically exposed India to large-scale funds withdrawals and a run on the reserves, the Indian authorities were forced to freight gold to London and New York to act as surety against foreign loans. Finance Minister Mukherjee made clear how this episode has left unhappy memories when he spoke about "outrage" of having to pledge gold to the Bank of England two decades ago to borrow dollars abroad.
The statement of chutzpah from an economy that laid claim to the fifth-largest global foreign reserves could hardly be more striking: "We have money to buy gold. We have enough foreign exchange reserves."
Even if the dollar's decline against the Euro bottoms out -- which appears likely -- more gold purchases by India and other (re-)emerging nations appear on the way.
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