German ministers think they have come up with the perfect solution to the Italian crisis: Italy should sell its gold.
Italy has the fourth largest gold reserves in the world. German ministers argued this week that it could easily flog its reserves and pay back a few of its nervous creditors. And boom – the euro crisis is put off for another day.
Could it work?
Well as you know I’m a gold bull. So I’m pleased to see some recognition that gold is at least being considered as part of the solution for this debt crisis.
But today I’ll tell you why a mass gold sale just isn’t going to happen. And why in fact we are entering a war between paper and hard assets – one that I intend to try and profit from.
This bankrupt nation hasn’t got enough gold anyway
Members of Angela Merkel’s party are calling for Italy to sell its gold, or at least move it over to the European Central Bank (ECB). They want some collateral in return for the ECB’s massive Italian bond purchases.
But there’s a problem. Though Italy has the fourth largest gold reserves in the world (around 2,500 tonnes), as this chart shows, its debts are much, much larger. The piddling little box on the left hand side represents the value of Italy’s gold – the more impressive one on the right is its debt!
So even if German politicians got their way, it’s hardly going to make a lot of difference.
Some have argued that a little bit of financial engineering could fix the problem. Writing in Friday’s CityAm a guy from Portman Capital suggests a way of leveraging up Italy’s gold reserves. The basic idea is to issue new Italian bonds that have a proportion of gold backing. If you issue bonds worth a billion that are backed by a quarter of a billion’s worth of gold, you should be able to sell the bonds to the Chinese.
The argument goes that China is so mad for gold they’ll buy any old bonds so long as there’s a bit of gold attached.
Call me a cynic, but I think the Chinese are a little more astute than that. Unfortunately for the Europeans, the Chinese have not been queuing up to prop up their bail-out fund. The general tone has been: “Sort out your own mess.”
In fact, global leaders have been calling on Germany to sort out the mess. At the recent G20 meeting in Cannes, it was suggested that Germany pledge its gold reserves to help raise cash for the bail-out fund.
Well, you can imagine the response. Germany’s vice-chancellor and economy minister Philipp Roesler said “German gold reserves must remain untouchable” – in other words, hands off our family silver!
Paper money is no substitute for the real stuff
Gold has been shunned over the last thirty years or so in favour paper backed by government promises.
Those that argued that this could only end up in one awful mess were side-lined and vilified. And to a degree they still are today. There’s no doubt that t fiat currencies have had an incredibly good 30-year run.
But there’s a big problem. The Western world is ageing. Post World War II baby-boomers are starting to drawdown on their promissory notes. They want goods and services in return for their paper. The world’s financial system is struggling to deliver.
Now that the cracks are beginning to appear in the world market for Western paper, the central banks have changed tack. Though many were keen sellers of gold over the years, they’ve now turned buyers.
In fairness to Italy, it didn’t dump its gold – and I strongly suspect it isn’t about to start now.
That’s because national bankruptcy is a very different affair to personal or corporate bankruptcy. If a business or individual suffers insolvency, then creditors have the right to their assets. The receivers sell off anything of value, put it all in a big pot and dole it out according to the rules.
James McKeigue explains .
But the bankruptcy of a nation state doesn’t adhere to the same rules. Short of declaring war and physically taking over a country, creditors have no choice but to write off paper promises. They become worthless bits of paper.
Unless the bankrupt nation wishes to voluntarily sell off its assets and hand the money over, then creditors may not get a penny. And that’s exactly why the EU is urging the peripheral nations to privatise national assets, or sell gold and shift the money over to the ECB.
But of course the peripherals don’t want to play ball. Paper promises are one thing. Your gold is quite another. The authorities and central banks the world over are finally beginning to understand.
Italy should ‘do a Greece’
It’s better to hold on to your hard assets and ‘do a Greece’. Effectively, Greece is demanding a write-down on its debt. This is how the game has played out for years in the emerging markets. Now it’s gone full-circle – and it’s coming home. Starting with the emerging European states, it’s now working its way to the core.
I’ve previously likened this scenario to a war between hard assets and paper assets. We’ve already been through many skirmishes. The rise of commodities prices is the gauge for which side is winning.
As the battle lines get closer to home, I expect commodities to keep rising in price. Or to put it another way, I expect the value of paper money to continue to decline.
By all means keep buying bonds and stocks (see below if you’re after ideas). But make sure you have some commodities in your portfolio, too. I’ve talked about a simple way to get exposure to physical gold and gold mining stocks.
And keep reading The Right Side. I’ll have more ideas for you soon.
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