Central Bank Gold Market Operations

davefairtex
By davefairtex on Sun, Jan 25, 2015 - 6:35am

I ran across these two speeches the other day, referenced by a GATA article about gold price suppression.

The speeches were by the Director of Market Operations at the French Central Bank, and they were given to LBMA audiences.  In fact, you can see that both are sourced from the LBMA website.  They are from 2013 and 2014.

The first, "Managing Gold as a Central Bank":

http://www.lbma.org.uk/assets/Gautier%2020130930.pdf

The second, "Managing Gold as a Reserve Asset":

http://www.lbma.org.uk/assets/Speeches/S3_4_Gautier.pdf

One paragraph particularly caught my eye:

We are still active in the gold market for our own account. We have a desk dedicated to FX activity, which is small, but now we are diversifying into gold, meaning that we are in the market nearly on a daily basis. The question of loan restart is pending. Of course, we can see some yields that are attractive, but the point is that the environment is totally different. In the past, we used to lend some gold totally blank in the market, meaning without collateral and I am not sure it would be acceptable to the risk committee to lend gold for one or more years without collateral. This is the reason the issue is still pending.

What I hear him saying is (in context of this speech, as well as the other), they'd love to make money lending gold, but the current environment is seen as quite risky.  Still, they do engage in operations "almost daily" (although its not clear if those are FX operations or gold operations), and again in context of the other things in the other speech (several price charts with the caption "time to buy or time to sell?"), that clearly suggests  they do take positions and trade for their own account.  In a real sense, they operate as a hedge fund in the gold and FX markets, with the goal of making money.

He also talked about "balance sheet gains & losses" vs "P&L gains"; if their gold (or currency) drops in value, that's a balance sheet adjustment, while if they get interest on an asset, that's a P&L gain.  The structure of the bank and its goal of maximizing P&L gains suggests a bias against gold:

We have some specific rules in central banks which mean that we also have to take into consideration what we can call the accounting return. I will just summarise the point. Say I have an asset at the beginning of the year with a value of 100 and at the end of the year the value of this asset is 110. If the gain is only related to an unrealised gain in terms of FX, because the currency has increased, then this gain will go to the balance sheet in a dedicated buffer, meaning that we will not see one penny in the P&L. However, if the move from 100 to 110 is related to yield, then we will have 10 going into the P&L account. Due to this accounting rule, of course, you have a bias vis-à-vis currency or assets producing a yield.

The whole tenor of both speeches suggests that central banks really are motivated to make income, to increase those P&L gains, probably to make their operation self-funding.  They use this income to fund operations, and any remaining profit they send off to the government.  The more they can send, the better they look.

Charts on gold lease rates (LIBOR-GOFO) with the caption "Deposit rates back in positive territory" also suggest they are motivated to milk income out of those gold bars that are just sitting there, and that is a tempting thing to do.  If the risk weren't so high right now, they'd probably do more of it.

Overall, my impression is, Central Bankers view gold is an inconvenient asset - it makes them no money.  To cover their salaries, secure their pensions, and keep them able to go to the fancy parties, etc, they must make P&L income.   So they trade gold on their own account (buying and selling when they think it is a good opportunity) as well as executing gold swaps over short time durations to turn those stodgy gold bars into something that produces a yield.

Of course, that's just my interpretation of what this guy said.  I'm interested to hear what the rest of you read into these two speeches.

I found this peek into Central Banker thinking pretty interesting.

6 Comments

cmartenson's picture
cmartenson
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I read that differently...

Great find Dave.

For my part, I read that paragraph quite differently...I agree that the central bank admits to being 'in' the gold market on a daily basis.

This means they are actively buying and selling.

Where I depart from your interpretation is around the risk that is being managed.  I don't think central banks care all that much (anymore) about making or losing money.

That's not a risk for them because their books are never audited and do not have to balance.  Ever.

Instead I think the risk being worried about is the risk of not getting the gold back.  You see, I do think the central banks care very much about both the price of gold and their possession of gold.  All of their actions support this view.  This is why they said they were worried about putting gold into the markets 'blank' which is just another way of saying 'naked' as in uncovered and subject to loss.

A while back they could rather mindlessly perform both functions assured of both creating whatever gold price was supportive of their current policy aims and getting their gold back.

For the record, I happen to think that central banks might, under the circumstance of overt and worrying deflation, actually want a steadily (but not dramatically) rising gold price for the purpose of inserting 'inflation expectations' in the minds of what few legitimate investors remain in these deformed markets.

But mostly central banks want a well-contained gold price because anything else sends the wrong signal.

So, in summary, central banks don't give a hoot about making money...they care about achieving their policy aims, first second and third.  Gold is one of many things front and center on their main control panel of things to track and 'control' (manipulate, influence...whatever term you prefer).

 

sand_puppy's picture
sand_puppy
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Clarification request

DaveF,

For an entity like a CB that can print money and is not audited, why would they be interested in making a few percent interest in the FX or gold markets?

What am I not seeing here?  (I expect that may be a lot!)

 

davefairtex's picture
davefairtex
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i think we agree

Chris-

Where I depart from your interpretation is around the risk that is being managed.  I don't think central banks care all that much (anymore) about making or losing money.

That's not a risk for them because their books are never audited and do not have to balance.  Ever.

Instead I think the risk being worried about is the risk of not getting the gold back....

I actually think we see that paragraph in the same way; there was another paragraph where the speaker talked about risk:

In terms of risk, we have a risk framework that is very, very strict: we want to protect our capital. However, when I say ‘risk’ I also mean operational risk, which is now a very, very big issue.

It definitely does sound like they worry about getting their gold back, just exactly as you say, and that seems to be something relatively new.  He talked in another place about how they used to lend gold for 1-3 years without any collateral at all, but that today there's no way the risk committee would approve such a loan.

My goal was to analyze only what the writer was actually saying, without unduly projecting my own opinions into the mix.  (Whether or not I achieved this - not for me to say).  The original reference was from GATA, where of course they viewed the document through their own lens.  It struck me that this sort of source material could be a sort of Rorschach (Inkblot) Test - the temptation is to read into the document exactly what you want to see.  "Proof positive of manipulation."

Still, for a Central Bank as on-the-sidelines as the French Central Bank must be these days to be in the FX and gold markets nearly every day, is an interesting fact to know.  Is it to make P&L profits, or to suppress the price of gold?  The writer seems to state that P&L profits do matter.

I also read that as a matter of French Central Bank Accounting policy, Balance Sheet gains and losses are basically ignored, while P&L gains are something to be sought after.

I know the ECB does account for changing gold prices, as does the SNB.  It also appears that all Central Banks do not have uniform accounting policies.

Perhaps their policies in other areas differ as well.

davefairtex's picture
davefairtex
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Posts: 5064
its about accounting

SP-

For an entity like a CB that can print money and is not audited, why would they be interested in making a few percent interest in the FX or gold markets?

The key observation is in how accounting works for Central Banks.

Printing Money is a balance sheet event.  Interest income (and gold leasing) is a P&L event.  Let me try to explain, given my limited understanding about accounting.

Each year the CB gets to sort out how much money they made or lost, and after expenses, net income gets sent off to the government.  Only transactions that hit the P&L affect this calculation.   P&L events:

  • paying salaries (Fed has 19,000 employees)
  • utility bills
  • travel, lodging, and expenses (Davos, Jackson Hole, etc)building repairs (paint, etc)
  • interest income (from domestic and foreign bonds)
  • gold leasing income (LIBOR-GOFO x duration of gold lease)
  • fees collected from FedWire users
  • difference between sale price and buy price for balance sheet transactions

Balance Sheet events:

  • bond purchases, using printed money
  • bonds expiring, paid off by the borrower at par value
  • bonds sold, for market price; money extracted from circulation
  • bond defaulted upon

The Balance Sheet does not interact with the P&L until an item from the balance sheet is actually sold or defaulted upon.  Then, the difference between buy price and sale price lands on the P&L as income or expense.  In the typical transaction (bonds expiring, paying off at par), there is no P&L effect since in the normal case bonds are bought at par.  However during the recent QE period, many bonds were bought at a premium or a discount.  If too many bonds are bought at a premium, then when the bonds pay off, that will end up hitting the P&L, causing a P&L expense for the Central Bank for that period.

In addition, if a default occurs, the loss hits the P&L for that period, reducing income.

The Central Bank (from an accounting standpoint) cannot simply take something from the balance sheet, sell it, and spend the proceeds on expenses.  The money they spend on expenses can only come from interest income.

Having printed 4 trillion, the interest income the Fed is now receiving is immense.  The accountants at the Fed are happy, and the Fed is shipping billions to the government every quarter, but Chris is right - its the policy outcome that the Fed really cares about, not so much the interest income.  Still, the operating income slush fund the Fed has probably allows it to not worry too much about salaries & expenses.  It is a huge money maker - not by printing, but from the interest income.

That said, nobody really knows what happens if a CB ends up with a large P&L loss.  And it does seem that central banks really do want to make income.  Something that produces income for the government looks a lot better than something that costs money.

In truth, without an audit, we can't be sure these rules are being followed.  But this is how things should work if the rules are being followed, and if the rules are being broken, that's fraud.

And everything I read suggests that Central Banks really do seek to make P&L profits while leaving their balance sheets unchanged.  I don't believe it is just a fig leaf.  The more income they get, the larger their annual operational slush fund becomes.  After all, every bureaucracy seeks to maximize its budget; the greater the income, the larger the budget can be.  The mantra at a bureaucracy is to enlarge staff and responsibilities, thus justifying a bigger title, larger salary, more status & perks.

Again, I don't think P&L income maximization is just a fig leaf.  I think they really do care.

sand_puppy's picture
sand_puppy
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Thank DaveF

And I could follow your description.  :-)  

theordore's picture
theordore
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Posts: 48
tI's about accounting

Another "home run"  --  a highly educational thread!  Thanks to you all. Question: Even accepting your key point that P&L matters for a CB, can a CB nevertheless spend the same money it prints -- not as an 'okay thing to do' but why is that not *technically* feasible? Suppose a CB prints money, lends it to Comm. Bank B, and Bank B goes and spends it somewhere.  Would that not be the CB actually doing the spending IF Bank B was a behind-the-scenes subsidiary of the CB? What I am getting at is this: isn't this business of CB not spending what it prints simply a matter of arbitrary accounting practice? What am I not seeing here?

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