Monday, December 23, 2013

Gold & The Monetary System (1970s)

A couple of months ago I posted briefly on a cable that had been released from 1974 (Gold As Instrument Of International Settlement). It provided some interesting insight into discussions that were occurring at the time, but it's important to consider it in context.

In this document linked to by Koos Jansen on Twitter recently: 'THE INTERNATIONAL MONETARY FUND 1972-1978: Cooperation on Trial' (Warning: 35Mb PDF file) we find the necessary context for the discussions that were taking place at the time.

Officials agree that the SDR should be the "ultimate reserve asset", but what should they do with Gold:
In the 1950s and 1960s, as noted in Chapter 5, while gold remained de jure the base of the Fund's operations and transactions, its actual use among countries in their financial settlements was minimal, and de facto the dollar standard emerged. Consequently, when officials in the 1970s began planning a reformed system, they had to decide what to do about gold. Discussions about gold in the Committee of Twenty evoked controversy and emotion, and agreement proved exceptionally difficult. While members of the Committee of Twenty were able to agree quickly that, in general, the SDR rather than gold should be the ultimate reserve asset of the reformed system, they left undecided the precise legal arrangements to be made for gold and what to do about the large existing stocks of officially held gold. However, not even a non-reformed international monetary system could evolve without deciding how to phase gold out of the existing system.
It was decided a more flexible approach would allow central banks wishing to transact Gold in the open market:
In November 1973, while the discussions in the Committee of Twenty were going on, the first action was taken to give the authorities of central banks of the large industrial countries some freedom to deal in gold with each other at prices other than the official price and to sell gold in nonofficial markets in which gold was traded by private dealers. In these nonofficial or private markets, prices had reached $85 an ounce, double the official price of $42.22 established after the second devaluation of the dollar formally effective in October 1973.
However, a rising Gold price through the early to mid 1970s raised concerns over plans for the SDR to replace Gold as the prime reserve asset:
In early 1974 the price of gold was again approaching the previous record of nearly $130 an ounce, more than three times the official price. Mr. Witteveen was, therefore, also concerned that members might become increasingly hesitant to use any of the gold reserves held by their central banks. The gold component of official reserves would thus be even less available than before for international payments. In the absence of decisions about what to do with existing officially held gold stocks, Mr. Witteveen was worried, too, that the international monetary system would not evolve as it was supposed to. Gold was becoming so valuable that financial officials would soon be unwilling to hold any other asset, including the SDR, in its place, and the SDR, which under the Outline of Reform was eventually to overtake gold as the prime reserve asset, would be unable to compete.
That was the background leading to the 1974 meeting (covered in the last post) in which it was agreed that the SDR should remain as preferred principal reserve asset in the future system as well as allowing a more flexible approach to Gold so that it could be utilised as an international reserve asset. These initial discussions led to many more and in late 1974, France and the US came to an agreement that resulted in France revaluing their Gold higher than the official price and the US holding Gold auctions (who still today have their Gold reserves on the books at US$42.22):
A month after the Martinique agreement, French officials revalued their official holdings of gold at market-related prices. They planned to revalue every six months to reflect changing market prices. U.S. officials went in the opposite direction, taking steps to reduce U.S. gold holdings.In December 1974, U.S. citizens were permitted to buy, sell, and own gold without a license from the U.S. Treasury for the first time since 1933, and the U.S. Treasury announced a plan to dispose of some of its holdings of gold through a series of auctions starting in January 1975. These sales of gold in the market at premium prices were permitted under the Articles of agreement provided that the gold was not sold to the monetary authorities of members of the Fund.
Several years after the discussion took place the IMF changed the role of Gold as it related to the SDR:
The Second Amendment to the Articles of Agreement in April 1978 fundamentally changed the role of gold in the international monetary system by eliminating its use as the common denominator of the post-World War II exchange rate system and as the basis of the value of the Special Drawing Right (SDR).
In the prior post I asked whether Gold may still have a place as a reserve asset in whatever international monetary system comes next (post USD), many clues have been left that it does have a place and I will cover some of these in a new post soon.

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