The gold market woes of late are a tribute to government ingenuity. Through regulation of the banking industry it has succeeded not only in keeping the interest on its own debt absurdly low, but also in providing itself with a captive market for further debt.
The American people don’t have the luxury of stipulating the interest rates on their debt, so we have had to come to terms with the crippling effects of rates many times that which the government pays. It is a hard lesson, and one the government must eventually learn as well.
One unwitting teacher might be the Basel Committee on Banking Supervision (BCBS), which sets guidelines for central banks to follow in regulating the banking industry in their countries. To uniformly evaluate the strength of banks, BCBS classifies assets and weighs them according to risk. The top level is reserved for those perceived to have the lowest possible risk, predominantly government notes and cash. Gold, the historically safest haven, is not among them.
The central bank stipulates the percentage of a bank’s total holdings that must be top-level assets. When a bank falls below the established minimum it must move quickly to bring its capital ratio back up, usually by buying more government notes.
To raise the capital needed to buy the notes the bank has to sell its most liquid assets, which also happen to be those bearing the lowest risk. Lately that asset has been gold.
The BCBS is considering elevating gold to a Tier 1 asset, however, which would put it in direct competition with government debt and currency.
Given the choice between negative-yield Treasuries and gold, it is highly likely that banks would opt for the latter. Suddenly a sizeable bloc of sellers in the gold market would become buyers, and a small but symbolically significant piece of the Treasuries market would vanish altogether.
Regardless of what the BCBS may do, our government cannot hold rates artificially low indefinitely. Not if it needs to borrow more. Lenders have their limits, and according to a recent column in the Wall Street Journal, we are pushing them.
“Foreign purchases of U.S. Treasury debt plunged to 1.9% of GDP in 2011 from nearly 6% of GDP in 2009,” the columnist says. The domestic private sector has cut “purchases of U.S. government debt to a scant 0.9% of GDP in 2011 from a peak of more than 6% in 2009.”
There has to be a tipping point, after which the house of cards must fall. The gold market is patient, and it will prevail as the one true safe haven.