Gold, sovereign reserves and credit worthiness – Part 1

What originally started as a walk through the history of US Treasury yields since the year 1900, has ended up a revelation of the historical use of gold as a measure of credit worthiness (as central bank reserves). This particular research article identifies my conclusions of a balance sheet review of the US Treasury during the period 1900 to 2010 with respect to gold, US Treasury monetary base and the Federal Reserve System. The Part 2 will conclude with my extrapolation of an idea that was derived from this examination to gauge the creditworthiness of a nation based only on GDP and gold reserves.

My initial goal was in piecing together some history on Japan and her trade and investment performance over the 1945-2010 timeframe, particularly for the period in which Japan was the largest global creditor nation in 1980-1990. I was investigating how Japan’s foreign debt purchasing of US Treasuries during the 1980’s trended then (with double digit yields on offer for the US public debt) versus bonds as issued by the Treasury now. It confirms my thinking of chalk and cheese, but the source data highlighted something more intriguing. That was US gold reserves.

Long term foreign debt really only started post 1971 with the limited offering of 7 year Treasuries (see below). A brief walk through the many pages of Treasury Bulletins dating back to 1939 shows the US debt has always operated at the statutory limit, and that statutory limit was regularly lifted.

For the record – US Statutory Debt limits at selected periods:

  • 1955 $281Bn,
  • 1981 $1.0Trn (5.0%CAGR from 1955),
  • 2007 $9.81Trn (9.2%CAGR from 1981),
  • 2010 $14.3Trn (13.4% CAGR from 2007).
  • Projecting 10% CAGR  from 2007 (pre-crisis) US statutory debt ceiling limit needs to be $15.8Trn – the historical trend is on their side.

Whether through happenstance or serendipity, I regularly chance upon beneficial explanatory material while researching even simple topics. Perhaps it is maintaining a lateral vision while reading into the depths of subjects. I refer to an 1898 review of a study of currencies by EL Bogart, in which he states (extracted)

Credit money cannot multiply indefinitely without reference to the quantity of gold in a country; and Lord Farrer is, therefore, not entirely correct when he says that the reserves have ” little or no relation to the quantity of credit which is said to be, and, in one sense is, based upon them ” (p. i66). Still less defensible is the statement that ” this gold need not be in the till of the banker ; it need not be in the pocket of the creditor. It need not even be in the country of either, provided that there exist the means of procuring it. For the sake of convenience a certain quantity of it is kept in the reserves of the bankers ” (p. i 65). That is just the point. This reserve of gold, on which credit is based, must be kept on hand, as a guaranty of solvency, not only by banks but by individuals also. It is not even sufficient to possess the means of procuring it: the gold itself must be immediately available.

It should become obvious from the material below that 114 years after the above review was penned, it is the UK (Britain) that is leading the developed world by several galloping lengths in following the trail blazing Japanese downwards but with next to nil tangible reserves of any kind backing large and growing amounts of debt. While I remain critical of the US double standards and hypocrisy, this appraisal of economic performance places the US as a leader amongst her many peers. Another outcome of this study is the safety net afforded to Germany, France and Italy in currently (2010) having proportionately large reserves of gold per GDP ratio (refer below). Precisely in accordance with the prescient passage by Bogart above.

Of note: US Federal Debt (1975) extracted from Treasury Bulletin

The average maturity of the privately held marketable Treasury debt has increased gradually since it hit a trough of 2 years, 5 months, in December 1975. In March 1971, the Congress enacted a limited exception to the 4-1/4-percent interest rate ceiling on Treasury bonds that permitted the Treasury to offer securities maturing in more than 7 years at current market rates of interest for the first time since 1965. The exception to the 4-1/4-percent interest rate ceiling had been expanded since 1971 to authorize the Treasury to continue to issue long-term securities. The 4-1/4-percent interest rate ceiling on Treasury bonds was repealed on November 10. 1988. The volume of privately held Treasury marketable securities by maturity class reflects the remaining period to maturity of Treasury bills, notes, and bonds, and the average length comprises an average of remaining periods to maturity, weighted by the amount of each security held by private investors (i.e., excludes the Government accounts and Federal Reserve banks)

You have to wonder at the meaning and purpose of Congress setting a statutory limit at all if it is only going to be raised at a periodic interval. In any event, the act of raising the Statutory Debt limit does not in itself initiate any additional reserve requirement. The reserve requirement is set by the amount of monetary base as issued by the various soveriegn treasuries from time to time.

CHART – Historical perspective of – US GDP versus Monetary Base versus Base/GDP multiplier (as percent)

(current US dollars, nominal, 1900 to 2010, LOG axis left side)
US GDP, monetary base (annual) - click image

–          You might say the US economy just got a $1.8Trillion dollar shot in the arm. But remember this is purely a monetary event, and has rebuilt base capital stock of the banking system only (and it is also limited to the US economy by way of the limit of its eventual effect)

–          The bottom line, the journal of circulating money has increased massively, against the backdrop of stagnant economic growth. The ‘monetary base’ for eventual expanding credit has been expanded.

CHART – to highlight the recent change in money base, here is the same chart above expressed in % annual change (as percent)

US GDP, monetary base (annual, percent change) - click image

– Yes, the monetary base recently doubled in the space of 1 year from Dec2007 to Dec2008. In fact, the total increase from Dec2007 to Dec2011 is a staggering 207% increase over 4 years (20% CAGR 2007->2011, more than TRIPLE the historical annual average of 6.0% in 90 years prior to 2007).

– This alone tells you the magnitude of the credit event that reached a climax in 2008.

– Using the year 1913 of the Federal Reserve creation only as a benchmark starting point, Money Base has increased x773 factor for CAGR 7.0% to Dec2011, while GDP (nominal) has increased  x384 factor for CAGR 6.3%

– What is striking is that up to and until Dec2007, this situation was reversed; in that US GDP had outgrown the increase in monetary base.

So, the US Treasury using the Federal Reserve has laid bare a larger base for expanding credit as immediately available money stock for circulation. This obviously dilutes the purchasing power of the USD in the short term as it ‘could’ be inflationary depending on the lending standards of those banks who it was lent to (via the US Treasury in the first instance, utilising the services of the Federal Reserve). What it should mean in terms of the floating price of gold (POG), is that the 3 fold change in monetary base (a 200% increase) from Dec2007 to Dec2011 should initiate a 200% increase in $USD POG, from $783 to $2349 in USD (3 fold price) in order to maintain the same reserve ratio on a fixed quantity of gold reserves. But gold was already in stride of a large bull move which had commenced from a low of $254 in 1999. So something fundamentally larger behind the move in gold has already started that still has to do with the monetary base.

To understand this, it was necessary to explore the history of the gold reserves held by the US Treasury during the whole of the 20th century. Specifically, I think I show convincingly that the volumes and values of gold reserves throughout the 1900’s identifies gold remaining in use as a minimum reserve requirement of the US monetary system. Remember, the above is only the circulating monetary base (the money stock outside of the Treasury that is in circulation and/or held by the Federal Reserve, classified as money in circulation). In real terms, it is fair to call this the smallest but most tangible portion of a credit based monetary system. Also, remember that since roughly 1980, the US Treasury has maintained a fixed amount of physical gold as reserves. Looking back through the pages of the US Treasury Annual Reports reveals the mechanics of how and why this came to be.

{Edit} The following was corrected to the best of my (updated but) limited and recently acquired knowledge, having viewed limited but relevant historical source documents as made available in the public domain. The original  Act has since been amended and/or superceded.

The (original) Federal Reserve Act of 1913 provided that

    • every Federal Reserve bank shall maintain reserves in gold or lawful money of not less than 35% against its deposits, and
    • reserves of gold of not less than 40% of its Federal Reserve notes in actual circulation, and
    • not offset by gold or lawful money deposited with the Federal Reserve agent
    • can maintain on deposit in the Treasury a sum in gold sufficient in judgement of the Secretary of the Treasury …
    • that when the gold reserve held against Federal Reserve notes falls below 40%, the Federal Reserve Board shall establish a graduated tax … The tax shall be paid by the reserve bank …

Critical amendments to the original provisions of the 1913 Act are now known to be –

    • 1927 McFadden Act
    • Amendments 1945, 1967 and 1968 to reduce and then remove altogether the reserve requirements of the Federal Reserve, inclusive of dropping the tax

The subsequent amendments are specific to the operations of the Federal Reserve only. Since I consider the Federal Reserve a subordinate operation to the US Treasury, it now makes sense to me that the gold reserves now reside wholely within the US Treasury. I am certain that all the gold now in existence classified as reserves of the US Treasury monetary system are declared as held by the US Treasury (including Fort Knox). In response to the amendments of 1967 and 1968, it makes sense that nil gold for the purpose of satisfying any reserve requirement be held by the Federal Reserve, as can be readily observed in periodic statements issued by the US Treasury.

However given 98% of the monetary base (above) is Federal Reserve notes, this means that a gold reserve to the value of 40% of the monetary base as originally set out in 1913. What we find is that the value of gold now held by the US Treasury is presently below this 40% reserve requirement as at Dec2011 when using the open market POG in $USD (not the much lower official price of $42.22 per ounce). The open market price of gold now required to allow the US Treasury to meet this reserve requirement is $3982 per ounce, or alternatively the US Treasury purchases additional gold reserves in the mean time (which would require an additional 332 million ounces at POG $1750, more than doubling current reserves of 261.5 million ounces).

Again, this is to meet only the original 40% reserve requirement of only the circulating money stock of the USA – which is a reserve of $1,041 Billion as at Dec2011. This minimum reserve requirement amounts to just 6.9% of 2011 GDP. Prior to the recent massive expansion, it was averaging just 3.3% of GDP. A chart of the 40% minimum reserve requirement is provided below –
US monetary base reserve requirement as percent of GDp (annual) - click image

– Historical reserve requirement expressed as a percentage of current GDP

– The current reserve value of 261.5 million ounces is $11.04 Billion, which is grossly short (just a fractional 1.1% of the desired $1,041 Billion). Using Dec2011 open market gold price of $1750, the reserve still falls short – meeting just 43.9% of the requirement.

– Without buying additional volumes of gold, the US Treasury requires an open market gold price of $3982. It does not need to officially recognise this price, but may do so via a similar process to the Par Value Modification of 1972.

Recalling the words of EL Bogart above it seems more than reasonable that the physical gold be on hand of recognised value in order to maintain credit worthiness. Before you get concerned, it gets interesting when you trend this reserve value through the century, as various times the value of reserve exceeded the requirement, and interspaced with other times it represented the same reduced marginal level. But the circumstances were very different in each instance. The last time the 40% reserve margin was satisfied was 1988 at a gold price of USD$410 per ounce.

Obviously another way to manage this requirement is to reduce the money stock, but this explicitly links the underlying gold price to a reserve requirement as valued floating against an expanding paper base. It is devaluing the USD in the exact same manor that Roosevelt started by doing in 1934.

It should be clearer now that in order for the US Treasury to continue to create a freeboard (buffer) of necessary operating cash in order to continue to fund the operation of the US Government, it needs

a)      Expanded debt ceiling (remove it altogether) – but is not a gold event

b)      Increased reserves, or increased reserve value – this is a gold event

c)       Immediate surplus income from the operation of the US Government

d)      Ongoing surplus income from the operation of the US Government

Knowing that in the current environment, the US Government maintains a $1.1Trillion per annum Federal Budget deficit, with the States also net deficit, we can rule out c) and d) for the next 2-3 years. Reducing tax revenues and maintaining present Government expenditures is only going to require expanding the debt ceiling. Pure and simple.



    • Pre 1900 not considered here for the sake of at least some brevity
    • 1900 March 14; Currency Act, also known as the ‘Gold Standard Act’
    • Establishes a minimum Treasury gold fund limit for redemption of paper to gold
    • 1913 Dec 23; Federal Reserve Act; Federal Reserve System is enacted
    • 1927 McFadden Act; Federal Reserve charter is indeterminate (perpetuity)
    • 1929-1936 World comes off the gold standard

Notable exits from gold standard:

    • 1929-30: Australia, Argentina, Brazil
    • 1931: UK, Austria, Germany, Canada, Japan
    • 1932: Greece, Peru
    • 1933: USA
    • 1934: Italy
    • 1935: Belgium
    • 1936: France, Switzerland, Netherlands
    • 1933 April 5; US executive order 6102 signed confiscated public gold at official price of $20.67 /ounce
    • 1933 April 19; UK established the EEA – exchange equalisation account
    • 1934 Jan 30; Gold Reserve Act surrender all gold and gold certificates held by the Federal Reserve
    • US establishes the ESF – exchange stabilisation fund
    • 1944 July 22; Bretton Woods, United Nations Monetary and Financial Conference
    • IMF and IBRD are conceived
    • 1958 Dec; Bretton Woods became operational when all European currencies floated
    • 1971 Aug 15; President Nixon closed the gold window, US gold price officially floats against USD
    • 1972 Par Value Modification Act
    • 1973 All Major foreign currencies become floating exchange rates

2/ Prior to December 1974, Treasury excludes gold held by the Exchange Stabilization Fund. On Dec. 9, 1974, the Treasury acquired all gold held by the Exchange Stabilization Fund.

It is evident that over the course of the 20th Century, that the US Treasury observed this reserve requirement for the duration, and most likely continues to do so.



About atradersrant

Self-employed private trader of equities, commodities and FX for income and investment; Follow me at your own risk! I provide analysis of major market & economic trends .. with too much commentary on fraud and corruption that is rife in the open market.
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2 Responses to Gold, sovereign reserves and credit worthiness – Part 1

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