EURODAD response to Gold revaluation

[Robert Weissman <rob@essential.org>]

Gold Revaluation: Eurodad response

>From EURODAD - European Network on Debt and Development


Whatis it? (drawing on information from the Financial Times & the 
    World Bank's 'Development News' bulletin)

This is a compromise plan to allow the Fund to utilise its gold resources 
in order to finance its obligations under the HIPC Initiative, whilst not 
actually selling the gold on the open market, which was likely to be 
opposed by the US Congress. The original plan of open market sales was 
considered to be 'politically unreachable'.

The plan is that 10 million ounces of gold, currently valued in the IMF's 
books at the original purchase price of around $47 an ounce, would be 
sold to a group of central banks at market value, realising a profit of 
around $209 an ounce or $2.09 billion based on Tuesday's spot price of 
$256 (however, for some reason the Financial Times suggested that the 
profit realised would only be $1.1 billion).

The central banks will then sell the gold back to the IMF at the same 
price. The effect would be to enter the 10 million ounces of gold into the 
IMF's accounts at the current market value, rather than the $47 an ounce 
currently registered. These extra funds would then be transferred to a 
new fund for investment in market securities, such as US Treasuries. 

However, we do not understand all the technical details of how this 
mechanism releases 'liquid' capital in place of gold without actually 
selling the gold. See note 1.

Overall, the status of the new proposal is unclear. Details derive from a 
Dutch Finance Ministry briefing that apparently summarises an IMF note 
setting out the basis for discussion on the issue by the Interim 
Committee. However, the technical details of how liquid resources are 
free up are perhaps not too important - until further details are released, 
we can assume that by some magical financial alchemy, the value 'locked-
up' in the undervalued gold is released (without open-market sales) to 
create new liquid capital. The political implications are still the same.


What is it not?

Jim Saxton, vice-chairman of the Joint Economic Committee, rejected the 
new plan, stating that no more taxpayer resources should be provided to 
the IMF until questions about misuse of Fund loans in Russia and 
Indonesia are settled. However, linking this new proposal to unrelated 
political developments is clearly unhelpful - it should simply be 
evaluated in terms of how the funds are used by the IMF for financing its 
HIPC Initiative obligations. This would include the amount of resources 
freed up, the way in which they are used, and the implications for the 
Fund's ESAF facility.


A   revaluation of gold  - not a sale

Despite the 'sale & repurchase' mechanism, this proposal is not a market 
sale. The Central Banks involved would clearly buy and sell back the 
gold at the same rate, and in this way would be merely facilitating what 
is a straightforward revaluation of the Fund's gold reserves. There would 
thus be no impact on the current market gold price. This original 
proposition to sell the gold on the open market had political implications, 
as the gold mining companies claimed that the financial viability of some 
of their operations would be threatened, with the resultant possible loss 
of thousands of jobs in the sector. [see note 2] 


Sleight of hand

The new proposal is clearly a better way to proceed, as it avoids the 
possibility of impact on the gold price, whilst  achieving the same aim of 
gold sales - increasing the liquid capital available to the Fund. It can be seen in 2 ways - in official terms, this move recognises the previous 
understating of the capital in the Fund. However, because the Fund 
refused to recognise this previous understating, in de facto terms the 
revaluation can be seen as literally creating new capital for the Fund out 
of thin air. This new capital can then be used to fund debt relief.

Clever - but it merely underlines the fact that debt relief is largely about accounting sleights of hand. It is a reminder that debt relief for ESAF 
loans was never going to involve any money ever leaving Washington 
in the first place (the revaluation will allow the ESAF HIPC Trust Fund to 
be credited, and grants released from this fund repay loan payments 
which were due to come back to the ESAF accounts from the HIPC 
countries). Revaluing gold and using this to cancel ESAF loans will 
simply involve changing numbers on pieces of paper and debiting and 
crediting different internal IMF accounts.


Cancelling debts …or enlargement of ESAF capital ?

As outlined above, the mechanism of cancelling an ESAF loan is that a 
grant is made from the ESAF HIPC Trust Fund to cover loan repayments 
due to be made by the HIPC countries. This does not make ESAF any 
bigger: paying loans off merely boosts the liquid capital available for re-
loaning under new ESAF programmes. This is the same whether the 
repayment comes from the HIPC itself (assuming that it is not in arrears), 
or from the ESAF HIPC Trust Fund. 

One alternative that the Fund refuses to envisage is simply to put a line 
through the loans, thus cancelling all  reflows to ESAF instead of 
receiving the equivalent amount from the ESAF HIPC Trust Fund. This 
alternative would result in the gradual shrinking of the size of ESAF over 
time, as there would be no money coming back in to lend out again. The 
reason that this is impossible is that it contravenes the Articles of 
Agreement of the Fund - but see comments on this in section 7 below.

However, this possibility aside, the Fund does not envisage using all the 
resources freed up by gold revaluation to finance the ESAF HIPC Trust 
Fund. Instead, a stated objective is to use resources from gold 
revaluation to increase the overall size of ESAF directly, by adding new 
capital to it. The Fund states that it wants $1.3 billion to do this, as 
compared to $2.3 billion needed in the ESAF HIPC Trust Fund for loan 
cancellation under the HIPC Initiative. 

Thus this new revaluation proposal will still make possible the Fund's 
intention of using significant amounts of the freed up gold resources to 
increase the capital of ESAF. And with only about $2 billion available 
from the revaluation, compared to the $2.3 billion cost of financing the 
IMF debt cancellation obligations, such an intention would mean that 
the Fund would be unable to meet its obligations under HIPC. 

In summary, the revaluation proceeds must be used for debt cancellation 
- which was, after all, the original reason that the gold sales/revaluation issue was raised - and not for expansion of ESAF.


Why not use the new capital directly?

The new plan does not differ from the original one of investing the liquid 
capital realised from the revaluation in a fund that invests in market 
securities (e.g. US Treasury bonds). It is only the income from these 
investments that will go to the ESAF HIPC Trust Fund.

However, because in de facto terms this plan is creating new capital, 
there is no reason why it would not
be possible to use the new capital created to directly cancel ESAF loans, 
rather than using the interest income from investments (i.e. directly 
crediting the ESAF HIPC Trust Fund with the new capital, rather than 
waiting for the interest income to trickle in).  IMF officials have stated 
that the Fund's rules do not allow the capital base to be used in that way, 
and that in any case it  would be akin to "selling the family jewels". 
However, the point is that this is akin to discovering new jewels - the 
capital is thus 'free', and should be used where it is most needed, which 
is financing the Fund's obligations under the extended HIPC Initiative. 
The Fund claims that even with gold sales / revaluation, the extended 
Initiative will require bilateral assistance to fulfil its obligations, 
particularly given the speeded-up timetable of delivery of Fund action.  If 
parts of the $2.09 billion in 'new capital' were to be used to directly fund 
the ESAF HIPC Trust Fund, then this would not be the case. 

Our suspicion is that this direct approach would - unlike using profits 
from investment - deny the Fund access to a rather handy new source of 
capital that it has created for itself. Via this method, it can claim to be 
financing debt relief, but at the same time it is also bolstering its own resources, 
which it wants to use inter alia for expanding the overall size of ESAF. 
Overall, one could argue that the Fund does rather nicely out of this 
arrangement - in many ways, without the debt relief debate, it would have 
been harder for them to justify selling/revaluing the gold in the first place.


Changing the Rules

The proposal to revalue the gold through an artificial 'sale and 
repurchase' mechanism shows that the operating rules of the Fund are in 
fact more flexible than Fund officials sometimes claim. The obvious 
question then is that if it is possible to 'create' new capital in this way, 
then why is it not possible to do the opposite and simply put a line 
through the ESAF loans that will be cancelled? Or why can't the new 
liquid Fund capital be used to directly fund the ESAF HIPC Trust Fund? 

The IMF answer is, of course, that the rules of the institution do not
allow you to do that - but this episode shows pretty clearly that in some 
matters it's a question of "where there's a will there's a way".  
There is a parallel here with the Fund's attempt to change the Article of Agreements 
to make Capital Account Liberalisation a stated objective of the Fund. 
There is apparently little problem with changing the Articles for policies 
that the Fund agrees with - but little chance of doing so for policies that 
they do not like. A touch of hypocrisy here perhaps?


Conclusion

There are still questions on how the Fund can realise liquid assets 
from gold sales without actually selling gold for cash.
The whole proposal demonstrates that the operating procedures 
(and even the Articles of Agreement) of the Fund are open for 
debate, and that it is often political expediency rather than 
economics that dictates decisions.
Becauseof this, NGOs should push for using the 'new' capital from 
gold revaluation to directly fund cancellation of ESAF loans - and 
not to wait for the trickle of interest income from reinvestment.
NGOsshould question why the Fund wants to use resources from 
gold revaluation for financing an expansion of ESAF, when there are 
already constraints in financing cancellation of existing ESAF loans 
via the ESAF HIPC Trust Fund.



**************

Note 1: This is the theory. However, there are important issues here that 
we do not understand:

- The point is that gold is not a liquid asset that can be used in the 
Fund's operations and accounts. That was the original intention of 
selling it - the Fund gets cash for it, which can then be used wherever 
required. If the gold is sold to the Central Banks, and then bought back 
at the same price, then it is true that the gold would be entered into the 
accounts at the new value - but it would still be gold, and there would 
still be no cash realised. The market securities that the freed-up 
resources would be invested need to be purchased with cash, not lumps 
of gold. Similarly, the resources put into the ESAF HIPC Trust Fund are 
presumably cash, not gold bars. 

- On the other hand, if the intention is to keep the gold and not realise 
the cash value - then why does the 'sale & repurchase' need to be done 
in the first place? The same result could be achieved by a straight 
revaluation at market price of the gold reserves.

Note 2: There was of course debate on this in the context of (a) the 
impact on the gold price of Fund sales in the context of the larger, 
quicker and less-anticipated sales of central banks; (b) analyst 
projections of a future hardening, rather than softening, of the gold 
market price; (c) the recently announced increased profitability of the 
same mining companies and (d) forward sales of hundreds of tonnes of 
gold by the (again) same mining companies that claim that gold sales 
would hurt them. However, if the new revaluation proposal goes ahead, 
this is of course now all irrelevant.


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