Conference on Gold: The Euro, the Dollar and Gold, Berlin November 2001


Conference on Gold:
The Euro, the Dollar and Gold

Proceedings of the Conference held in Berlin 16 November 2001

Challenges for Europe: the euro, the dollar and gold


Proceedings of the conference held in Berlin on 16th November 2001


The views expressed in this study are those of the conference participants and not necessarily the views of World Gold Council. While every care has been taken, World Gold Council cannot guarantee the accuracy of any statement or representation made.

World Gold Council 45 Pall Mall London SW1Y 5JG UK Tel + 44.(0)20.7930.5171 Fax + 44.(0)20.7839.4314 E-mail: 2


Foreword by Haruko Fukuda ........................................................... 5 List of speakers .......................................................................... 7

Challenges for Europe
Introduction by Benedikt Koehler ................................................... The outlook for the international monetary system Hans Tietmeyer ......................................................................... The benefit of the euro for neighbouring countries Krzysztof Majczuk ...................................................................... Questions ................................................................................ 10 13 23 27

Gold in Eastern Europe
Introduction by Benedikt Koehler ................................................... The contribution of the EBRD to mining in Eastern Europe Mark Rachovides ........................................................................ The role of gold in Russia’s reserve management Vladimir Sokolov ........................................................................ The role of gold in Kazakhstan’s reserve management Batyrbek Alzhanov ...................................................................... Questions ................................................................................ 31 32 38 43 46

The role of gold in the international monetary system
Introduction by Dick Ware ............................................................ The future of the euro, the dollar and gold Robert Mundell .......................................................................... The BIS and gold Giacomo Panizzutti ..................................................................... External reserves in the IMF’s quota formulae Michael Kuhn ............................................................................ Questions ................................................................................ 51 53 62 69 75

Gold in the 21st century
Introduction by Benedikt Koehler ................................................... 79 Gold - an industry insider’s view Rex McLennan ........................................................................... 80 Why everybody should own gold Robert Weinberg ........................................................................ 87

Closing remarks
Robert Pringle ........................................................................... 97



On the eve of the introduction of euro notes and coins on 1 January 2002, the World Gold Council held a conference in the Palais am Festungsgraben in Berlin on 16th November 2001 entitled Challenges for Europe: the euro, the dollar and gold. This was the third in the series of conferences devoted to public policy issues surrounding gold as a reserve and monetary asset - the previous conferences having been held in Paris in 1999 and Rome in 2000. The conference addressed some of the important issues surrounding the future of the euro and the continuing role that gold could play in the international monetary system. In view of the impending enlargement of the European Union, the conference also discussed attitudes to gold as a monetary asset in eastern and central Europe. Krzysztof Majczuk, from Poland’s central bank, had no doubt gold had a future as a monetary asset. “Poland is especially attached to gold,” he said, adding that the name of its currency, zloty, means gold in Polish. Vladimir Sokolov of the Central Bank of Russia stressed the value of gold reserves in rehabilitating his country’s financial system, while Batyrbek Alzhanov, director of Monetary Operations department, National Bank of Kazakhstan spoke of how gold as a reserve asset offers protection from the vulnerabilities of holding the securities of foreign states. Former Bundesbank President Hans Tietmeyer and Nobel Laureate Robert Mundell spoke on role of reserve assets and currencies and the outlook for the international monetary system. Finally, Dr. Robert Weinberg of the World Gold Council introduced a new element, the role of gold in institutional investment. The management of gold holdings among professional investors in some ways mirrors the portfolio management of central bank assets. In raising interest in gold investment in the private sector the World Gold Council seeks to demonstrate the metal’s versatility in portfolio diversification and its role as the ultimate store of value. The World Gold Council is pleased to present all these speeches, among others given at the conference, in this volume. The World Gold Council would like to thank all speakers and participants for their contribution to the success of the conference.

Haruko Fukuda Chief Executive Officer



List of speakers
Batyrbek Alzhanov Batyrbek Alzhanov, born in 1964, has been the Director of the Treasury Department of the National Bank of Kazakhstan since 1997. He started his career with this institution as an economist at the Foreign Exchange Division. Having worked for the Turan Bank in the position of Deputy Chairman in 1996, Alzhanov returned to the National Bank of Kazakhstan in 1997.

Benedikt Koehler Benedikt Koehler is Manager, Official Sector Europe at the World Gold Council. His publications include a biography of the founder of the gold standard in Germany Ludwig Bamberger (Deutsche Verlags-Anstalt, 1999).

Krysztof Majczuk Born in 1951, Krysztof Majczuk has been Director of the Foreign Exchange Department and a member of the Board of the National Bank of Poland since 1997. Majczuk has graduated from the Nicolaus Copernicus University in Torun, where he received a master’s degree in law. He has been working for the National Bank of Poland for 25 years and has been involved in various areas of banking activity. Today he is responsible for managing the official reserves held by the National Bank.

Rex McLennan Rex McLennan was appointed Executive Vice-President of Placer Dome in 1998. Placer Dome, with its headquarters located in Vancouver, Canada, is one of the leading gold producers worldwide. McLennan is responsible for Placer Dome’s overall financial strategy and is in charge of various departments. After his MBA in Finance and Accounting in 1979 McLennan pursued a career with Imperial Oil (Exxon Corporation) for twelve years before he joined Placer Dome in 1991. 7

Robert Mundell Born in Canada, Robert Mundell is University Professor of Economics at Columbia University, New York. Besides his distinguished academic career, Mundell has been a consultant to the World Bank, the United Nations, the US Treasury and the Federal Reserve Board. Mundell has been the recipient of a number of awards and honarary doctoral degrees and is fellow of the American Academy of Arts and Sciences. Mundell received the Nobel Memorial Prize in Economics in 1999. Giacomo Panizzutti Born in 1946, Giacomo Panizzutti is global head of foreign exchange and gold with the Bank for International Settlements (BIS) in Basel. He is responsible for all marketing and trading activities with central and commercial banks worldwide. Panizzutti holds a diploma from the Swiss Commerce Academy. In 2000 he received the distinguished Leadership Award from the New York Mercantile Exchange for his outstanding contributions to the precious metals industry.

Robert Pringle Robert Pringle is Corporate Director for the Public Policy Centre of the World Gold Council. He has pursued a career as an economics editor, publisher, author and consultant specialising in international trade, banking and capital markets, and is the founder of Central Banking Publications, publishers of a range of journals and directories on international monetary subjects. He is the author of numerous publications on international monetary subjects and has served as a member of the World Gold Council’s Advisory Boards since 1991.

Mark Rachovides Mark Rachovides has been a Principal Banker at the European Bank for Reconstruction and Development (EBRD) in London since 1996. He is currently involved in the Natural Resources Team and is working on a variety of oil and gas mining projects in the former Soviet Union and in Eastern Europe. He leads the EBRD’s financing of two major gold projects, both syndicated to commercial banks. He has also written articles and made presentations on Russian gold mining. He has an MA from Oxford University and has 17 years’ experience in commercial banking. 8

Vladimir L Sokolov Vladimir Sokolov has been Director of the International Monetary Department at the Bank of Russia. He is responsible for developing and implementing the Bank of Russia’s policies in external reserves management and the Rouble exchange rate. Sokolov graduated from the Economics Department of Moscow University and joined the Bank of Russia as a dealer in the domestic currency unit.

Prof Dr Hans Tietmeyer Born in 1931, Hans Tietmeyer joined the German Federal Ministry of Economics after completing his dissertation. In 1973 he became Director of the Department of Economic Policy. In 1982 he joined the Ministry of Finance to become Secretary of State. From 1990 Tietmeyer was a board member, and from 1993 to 1999, President of the Deutsche Bundesbank. Since 2000 he has ben chairman of the initiative “New Social Market Economy”.

Dick Ware Dick Ware is manager of the Public Policy Centre of the World Gold Council. His primary responsibilities are in respect of official sector gold holdings. He also works with the Council’s regional offices to foster the deregulation of gold markets worldwide. Apart from a three-year spell at the National Westminster Bank as Director of Compliance, the majority of Dick Ware’s working life prior to joining the World Gold Council was spent at the Bank of England, where he specialised in international financial relations, with a secondment

Rob Weinberg Rob Weinberg is head of the global Institutional Investment programme of the World Gold Council. After gaining his doctorate in geology at Oxford University, Weinberg joined the Anglo American Corporation in South Africa. In 1985 he moved to London to join the international mining team at a firm of London stockbrokers, as a mining and gold analyst.



Challenges for Europe; the euro, the dollar
and gold
Introduction by Benedikt Koehler

Good morning, Ladies and Gentlemen. The World Gold Council is delighted to welcome you and I am looking forward to today’s speakers who will provide us with many new insights. Today’s conference sequels events the World Gold Council has held before in Paris and in Rome. When deliberating where we would hold this year’s conference we decided on Berlin for two important reasons. One is that we are only a few weeks away from the introduction of notes and coins in the Eurozone. Then, the world’s youngest currency will become tangible. We have noted this year the immense popularity of a gold coin issued to commemorate the Deutsche Mark, the legacy currency of this country. Subsequently we have heard the announcement by the German Ministry of Finance of the issuance of a golden coin next year to greet the advent of the world’s youngest currency. We thought it would be very fitting to build a bridge between the world’s youngest currency and the world’s oldest currency and where better to host this conference than in Berlin? The location of this conference matters. Here, today, we are convening in East Berlin, and by walking from the hotel to the conference centre, the Palais am Festungsgraben, we have been traversing what was formerly an area behind the Iron Curtain. It’s hard to imagine now, considering the reconstruction that has been taking place in the last ten years of Berlin’s building boom, but in 1945 this building was the only one in the immediate neighbourhood which had been undamaged by bombs. In view of the importance which East Germans ascribed to their friendship with Russians, this building was dedicated as the House of German/ Soviet Friendship. If you have the time to look around, you will see on the medallions painted on the ceiling portraits of the heroes of Soviet realism. The sculptures in this room are those of Maxim Gorky and of the great Jewish writer Heinrich Heine. In the last decade, things have changed once again. Now it is far easier to travel here than it was before. The important point is that Eastern Europe and Western Europe have grown together and today are very close. In today’s conference we have the benefit of hearing the views of our neighbours in the East and hear how they use gold as a reserve asset. This will be an important part of the conference. Our conference is divided into four sessions with ten speakers. The first session is about the euro as it is seen from within the Eurozone. A speaker from a neighbouring country, Poland, will give his outlook for the next few years following conclusion of monetary union in the Eurozone. Session Two then takes us further into Eastern Europe. Speakers from the European Bank for Reconstruction and Development, from Russia and from Kazakhstan, 11

will provide new information about gold in Eastern Europe. Later on we will hear about gold in the international monetary system. Finally, there will be a concluding session, which I’m sure everybody cannot help but be interested in: what does gold mean as an investment asset? Let me now turn to session one and introduce our first two speakers: Professor Tietmeyer and Krzysztof Majczuk. Many of us have travelled great distances to come here and we tend to think of Poland as a country which is very distant. This may be true from an economic point of view. Geographically, however, Mr Majczuk had to travel far less than many of us here today. The Polish border is only about 100 miles east from here. We’re delighted to hear Krzysztof Majczuk’s view on the introduction of the euro, and what it means for his own country. Before, we have Professor Tietmeyer, who I think needs no introduction; he is one of the architects of the European monetary reforms we are witnessing today. This building, before it became the House of German/Soviet Friendship, served as the Ministry of Finance of Prussia. One of the important Prussian reformers of finance was Freiherr vom Stein, commemorated today in a society named in his honour. The Freiherr vom Stein Society has as its President, Professor Tietmeyer, who is here to address us this morning. Herr Professor, we’re delighted to see you here.


Opening Address: The Outlook for the International Monetary System
Prof. Dr. Hans Tietmeyer Sometime President Deutsche Bundesbank

Thank you very much for that nice introduction. I can only tell you that I have taken over the Chairmanship for the Frei Herr von Stein Society from the Federal President Rau. He asked me to take it over so I’m his successor in this capacity. But today I would like to speak about the outlook for the international monetary system, and before I will go into the international monetary system, I would like to make some comments on the present situation of the world economy. I. The world economy is currently going through a difficult transitional period. The extremely strong growth in the United States during the nineties slackened markedly in the course of the past year. That slowdown was caused by the bursting of the bubble in the financial markets and the pronounced changes in the ratings of large parts of the so-called ‘new economy‘. The perceptible slackening of growth in the United States has meanwhile also impinged on most emerging economies in Latin America and Asia. Only China, India and, to some extent, Australia have apparently been relatively little affected, while, sadly, the major industrial country, Japan, is still suffering from its unresolved structural problems, and has been teetering on the brink of a recession for some while. However, Europe is likewise distinctly hard hit by the global slackening of growth – not only western Europe, but also most of the transition economies of central and eastern Europe. The distinct moderation of growth in the EU owes something not only to decelerating foreign trade, the extremely steep increase in oil prices at times, and the pronounced adjustments in the financial markets; especially in some of the larger euro-area countries, numerous unresolved structural problems are curbing the inherent momentum of their economies. This overall picture, which was becoming plainer and plainer in the first half of this year, has deteriorated even further since the terrorist attacks of September 11 in New York and Washington. Besides the direct effects on the financial markets (particularly insurance companies), airlines and tourism, additional uncertainties have arisen with regard to the response of the US consumers. It is to be hoped the


new uncertainties will not have any lasting effects and will not unduly delay the new upswing, especially in the United States, that was originally expected for this autumn. Any lengthy period of uncertainty might well increase the risk. At present, however, nobody can predict precisely when the turnaround expected in the next few years will start, and how strong it will be. At all events, convincing indicators of a new upswing are not visible so far, neither for the US economy nor for Europe, not to speak of Japan and the emerging economies. A new growth process at an early date would be highly desirable, it must be said. And yet – especially in Europe – it cannot be achieved by means of a short-lived policy of stimulation. What is possible, and makes good sense, in the United States on account of the flexibility of business activity there and the advanced state of budget consolidation might well turn out to be counterproductive in Euroland. New economic momentum in the euro-area calls primarily for new confidence in the future. And that can be built up, on a lasting basis, only by means of convincing reforms, especially in the larger euro-area nations. By contrast, major shortterm public spending programmes, like monetary policies that fail to take account of the need for stability, might jeopardise the requisite confidence in the future. The Japan fall into a liquidity trap should not be disregarded. Hence I don’t think there is any short-term ‘patent remedy’ – at least in Europe – for overcoming the current sluggishness of growth. In particular, our new currency, the euro, needs sustained confidence, and that implies a stability-oriented and reform-oriented policy geared to the longer term. II. At the beginning of 1999, eleven EU countries (twelve in fact, after the accession of Greece) joined together to form an economic and monetary union with the euro as its common currency. With the introduction of euro banknotes and coins at the beginning of next year, this process will become visible to all inhabitants of the euro-area countries and to the world at large. Then, the existing national currencies will forfeit their function of being legal tender. Along with the responsibility for monetary policy, the participating national central banks also transferred part of their former foreign exchange reserves, in the total amount of 39.46 million euros, to the European Central Bank – some 15 % of that sum in the form of gold, and approximately 85 % thereof mainly in US dollars. Thus, the greater part of the erstwhile foreign exchange reserves remained in the hands of the national central banks for the time being. Incidentally, those banks continue to manage the reserves transferred, albeit with the aid of joint 14

investment-policy principles and strategic benchmarks. In line with the Maastricht Treaty the ECB may call on the NCBs to transfer further foreign exchange reserves. This shows that the aggregate official foreign exchange reserves of the euro area – that means both those transferred to the ECB and those for the time being remaining in the hands of national central banks – are now in the area of responsibility of the Eurosystem (Article 105, section 2). Incidentally, a debate on the function of official foreign exchange reserves has been in progress ever since the global transition to the system of floating exchange rates. In my opinion, foreign exchange reserves play an important role, even for floating currencies. The chief factors affecting the markets’ assessment of a currency are, admittedly, a country’s economic performance, the policies influencing that performance and the monetary policies of central banks. But foreign exchange reserves may likewise have some bearing on the appraisal of a currency and thus also to the credibility of central banks. Consequently, not only the scale of the official reserves backing a currency but also their composition is important. In this connection, gold reserves may constitute a specifically confidence-inspiring element, because they are important for the confidence of the ordinary people and because in the event of a crisis, they can be used as collateral for loans that may be needed Two years ago, the Eurosystem (that is to say, the European Central Bank, along with the national central banks), together with other G-10 central banks, adopted an agreement on limiting gold sales, which, happily, has helped to stabilise the gold price in the meantime. That agreement demonstrates that the central banks of this group have no intention – at least, not in the foreseeable future – of engaging in heavy gold sales beyond those which have already been announced. However, I do not regard the pegging of currencies to gold – an issue regularly brought into the debate by certain commentators – as realistic or making sense, under the conditions prevailing today and tomorrow, either for the euro or for any other currency of international significance. Under present-day and likely future economic conditions, movements in the supply of, and the demand for, gold, as well as in gold prices, cannot in my view constitute a reference variable for the monetary policy pursued by the major central banks. III. The experience gained to date with the euro has on the whole been pretty favourable, in my opinion. Despite a short-lived steep rise in the inflation rate, the internal stability of the euro is largely assured. With the waning of the special trends in energy, farm and import prices, the inflation rate in the euro area is moving distinctly downwards again. 15

Moreover, in spite of divergent movements in growth and employment among the individual countries, there have to date been no serious political tensions. Throughout the euro area, conditions and interest rates in the money market are largely uniform today. In the capital markets, this far-reaching integration is, however, still incomplete. Unfortunately, diverse national statutory provisions still stand in the way of full integration. But here, too, some progress is discernible. The transition to the euro and the single monetary policy have made financial market competition in the euro area fiercer, and have meanwhile engendered a number of cooperative ventures, mergers and acquisitions among financial institutions. I am sure that this process will proceed further in the months ahead – especially across national borders. However, trends in the euro exchange rate in the first two years have posed some problems, notably relative to the US dollar. As you know, the euro has tended to be weak – particularly up the autumn of last year. That weakness mainly was due, on the one hand, to the temporarily inordinate strength of the dollar, but it also reflected, on the other hand, unresolved structural problems besetting a number of euro-area countries, as well as uncertainties affecting the further course of political integration in the euro area, and future participation in that monetary union. In the meantime, some of these factors, which are detrimental to the exchangerate movements, have been mitigated or remedied. Some of the major euro-area nations have taken initial steps towards reform, and at least a few countries are now pressing for clarification of the politicoinstitutional integration process in the EU. Moreover, the conditions for the accession, in the future, of new EU countries from central and eastern Europe to monetary union, and to the euro area, are now being spelled out more clearly than used to be the case in earlier times. Even so, in the estimation of the markets, a number of uncertainties apparently still remain. Further clarification is unquestionably required in those instances. With respect to the forthcoming EU enlargement, such issues also include the statement that membership of the EU is not synonymous with a right to membership of monetary union. The Maastricht Treaty rightly provides, for all the participants in monetary union, for a test period of no less than two years for complying with the convergence criteria specified in detail. During that test period, incidentally, not only the four often-mentioned convergence criteria, but also the reference variables expressly laid down in the Treaty (such as the integration of the markets, the development of the balances on current account


and the movement of unit-labour costs and other price indices) must be examined. The decision on membership of the three EU countries not so far participating in monetary union lies primarily in the hands of those countries. The United Kingdom and Denmark have hitherto exercised their right to ‘opt out’. In my opinion, it is hardly to be expected that those countries will avail themselves at very short notice of their right to join the eurozone. It is true that signals in that direction are to be heard from time to time from Tony Blair and some other people from the UK, but – on top of the threefold obstacle he has erected himself (decision “by the government, by Parliament and by the people”) – under the Maastricht Treaty, the United Kingdom would, first of all, have to participate in ERM II for two years “without devaluation”. That does not apply, incidentally, to Denmark, which has been pegging the Danish krone to the euro, via ERM II, for quite a while without encountering problems. Sweden is subject to the same obstacles as the UK – namely, prior two years participation in ERM II without devaluation. At least the Treaty is clear on this point. IV. But, no matter what those three countries ultimately decide to do, European monetary union and the euro have already changed the international monetary system to some extent. Nowadays, the euro is unquestionably the second most important currency after the US dollar. It represents an economic area, which, while not quite equal in potential to the United States (in terms of the gross national product), is already more closely integrated in the world economy (in terms of world trade) than is the United States. True, the international use of the US dollar is currently far greater than that of the euro. As a reserve currency, investment currency and settlements currency, the dollar is still distinctly ahead of the euro. But there is no mistaking the fact that the euro is now catching up in some market segments. It is ultimately the markets themselves that decide on a currency’s international role. In this connection, besides the size and performance of the economy and the policies behind that currency, the assessment of a currency’s future development is likewise of great significance. A new currency, such as the euro, can build up a reputation only gradually. But there is no denying that its potential is considerable. In the IMF’s special-drawing-rights basket, the euro already accounts for a share of 29%, behind the US dollar (at 45 %) and ahead of the yen and the pound sterling (at 15% and 11%, respectively). Although membership rights in the IMF continue to rest with the individual member states in the euro area, the repre-


sentatives of the Eurosystem are involved in the process of the regular surveillance of the various euro-area nations by the IMF. V. However, the launch of the euro in 1999 did not radically change the global monetary system. That applies particularly to the exchange-rate system. Within the euro area, of course, all mutual exchange rates ceased to exist. But that has not radically altered – at least not so far – the global system, in which floating exchange rates are the dominant feature. It is my belief that this system will not change in the foreseeable future. Since the collapse of the fixed-rate system of Bretton Woods, beginning in 1971 and concluded in 1973, there have repeatedly been proposals, and even sporadic initiatives, of enhanced exchange-rate cooperation among the major world currencies. I would recall only the target-zone concept advocated in the early eighties by Bergsten and Williamson. Some commentators have even mistakenly interpreted the exchange-rate cooperation schemes agreed, which were 1985 and 1987, under the so-called Plaza and Louvre Accords, as target-zone concepts. But the cooperation schemes actually agreed among the G-5 countries at the time, and I was involved in that, were far removed from a binding targetzone concept. They focused primarily on improved cooperation in the area of national economic and fiscal policy occasionally accompanied by some signal interventions in the foreign exchange markets. Since then, the idea of target zones between the major countries has been aired again quite frequently, for instance, in the period following the launch of the euro. And Bob Mundell, who will be here today, has meanwhile spoken out several times in favour of defining and defending target zones between the dollar, the euro and the yen. He is even going further; that should be only a step to binding the three currencies to a fixed rate system, and in the end, bringing them together into an international currency. But, given the reigning conditions in today’s foreign exchange markets, proposals for target zones do not have a realistic chance, in my view. Problematic though the volatility and, on occasion, the overreactions of the markets are, I regard any defence of exchange-rate target zones between the major world currencies, defined and announced in advance, as being utterly impracticable. At any rate, in view of the dimensions of the market, and the overriding importance of expectations, the risk of speculative counter-movements and exaggerations would be immense. The very announcement of target zones would be tantamount to an invitation to stage a speculative test. Hence the United States in the Eurosystem have rightly refused so far to define any target zones in public; and it is my conviction that they will continue to do so in future. However, the rejection of any formal system of target zones does not rule out the possibility of regular consultations or occasional signal interventions in the 18

foreign exchange markets. Judging by past experience, though, such signal interventions make sense only if, in a given case, they are carried out by both sides simultaneously, and if they are not unduly frequent. My experience has been that intervention signals are heeded only if they make it plain that both sides are agreed that the ruling exchange rate represents an unequivocal misalignment. After all, only concerted operations actually impress the markets, with the involvement of representatives of the stronger currencies being essential on one side, unilateral interventions from the weaker side can be counterproductive. So I’m not in favour of a formalised target zone system, but I’m in favour of co-operation, discussion, information and exchange of views. In case there is, in the view of both sides, a misalignment, then single interventions can play a role. But only if both sides are really doing it and showing it to the market. And let me say, the question is absolutely not the amount of that, it’s a question of signalling; that is precisely what is important. However, the question of the exchange-rate linkages of smaller currencies must be distinguished from that of the exchange-rate movements between the major world currencies: the euro and US dollar. That applies particularly to any linkages of those smaller currencies to one of the major currencies. Admittedly, there have been some changes in this respect, too, in the course of the past decade. While a number of countries have relinquished their earlier links to the US dollar of the yen (e.g. Mexico, Brazil, Thailand, Korea or Indonesia), others have actually intensified their links (e.g. Argentina or Hong Kong). Whether these ties can actually be maintained in the long run, however, still remains to be seen. The position adopted by many US economists – either complete flexibility or absolute fixing – has undoubtedly gained more acceptance in practice all over the world in recent years. European countries, however, have subscribed to this alternative only in part. In Europe, following the launch of the euro, ERM I, which had existed until then, was modified. The new system (ERM II) applies in principle only to non-euro-area countries, and incorporates more flexibility in some rules (e.g. wider fluctuation of margins and simpler realignments and so on). Of the present EU member states, however, only Denmark belongs to this system, which I mentioned. In the next few years, though, this ERM II could assume increasing importance, especially after the likely enlargement of the EU to include states in central and eastern Europe. After all, if the new EU countries subsequently want to become members of EMU as well, they will inter alia have to absolve an at least two-year test period in ERM II. In view of the manifest desire of many EU candidate countries to join the Eurosystem at an early date, ERM II will probably assume growing significance in Europe in the next few years. Viewed as a whole, however, such regional exchange-rate linkages in Europe will hardly durably alter the existing international system. The same thing applies, in my view, to other regions, too. 19

In my opinion, there will continue to be exchange-rate links with the dollar, and also with the euro, in a number of instances (e.g., through Currency-Board systems). In specific cases, there may even be more far-reaching ties, in the form of dollarisation or euroisation. Furthermore, in some parts of the world (e.g. in Merosur or the Caribbean area) efforts are being made to enhance regional monetary cooperation. In my estimation, however, major and fundamental changes to the global exchange-rate system are unlikely in the foreseeable future. VI. But the further course of events in the international financial system is probably much more difficult to foresee. The progressive development of the financial markets will in my opinion persist in the next few years – notwithstanding all the new controls probably introduced in the context of combating terrorism. The pressure to include offshore territories in those international controls will presumably increase, but such enhanced anti-criminal activities will not obstruct the further development of the global financial markets. The crises that erupted during the nineties showed that expansionary and innovative trend in the financial markets give rise not only to great benefits – in the shape of an improved allocation of resources – and therefore to greater prosperity, but also to new risks. In particular, the proliferation of so called contagion effects generates risks not only to the institutions and countries directly involved; it may also engender and trigger serious systemic risks. In order to counteract such potential systemic risks, some major steps have been taken in the past few years and will be taken. • And, in combating crisis that have already broken out, the IMF now sometimes accentuates different aspects from what it used to. In order to prevent, as far as possible, bailout expectations from arising with respect to other countries, it has become more careful about gauging the scale of liquidity assistance. The new IMF management would apparently like to revert more to the original role of the IMF as a catalyst’ of crisis resolution, and to move away from the role of a lavishly operating development and insurance agent. • At least as important as these improvements in the operating practice of the IMF are its efforts to ensure enhanced cooperation among the various national and international institutions and organisations responsible for financial market oversight and systemic stability.


In 1999 the countries of G-7, acting on a proposal from myself, decided to set up an ‘International Stability Forum’ (ISF). That body, which is located in Basle, regularly brings representatives of the supervisory authorities (those for banks, insurance companies and also stock exchanges) in the major financial centres together with representatives of the IMF, World Bank, OECD and BIS at what is known as a round table. The purpose of these consultations is the regular review of the overall condition of the financial system, the identification of vulnerabilities and the institution of concrete measures to prevent the emergence of crises. This “quiet preventive work” has already ushered in may important initiatives, ranging from minimum supervision in the offshore centres and enhanced transparency in hedge funds activities to the definition of a core catalogue of minimum standards. Especially in the past few weeks, now that the anticipated new global upswing has failed to materialise, and that new dangerous uncertainties have arisen as a result of the terrorist attacks, the exchange of views and experience within that Forum has been greatly stepped up. Happily, the financial market infrastructure in the United States, which was in disarray for a while, has rapidly recovered. In addition, it has transpired that the contingency plans already existing in the financial institutions are proving their worth. So far, so good. But if the expected new upswing in the total global economic activity continues to be delayed (let alone if a short-lived recession supervenes), the national and international financial markets will demand special attention. Up to now, any losses accruing among the financial institutions have been cushioned above all by drawing on reserves, without exerting undue contagion effects or causing systemic difficulties. It is highly important that this should continue, even in the event of further losses. Hence all supervisory authorities must cooperate very closely under these conditions, and keep each other duly informed at all times. VII. Notwithstanding the difficult conditions ruling in the world economy, the global monetary and financial system has hitherto proved to be resilient. Even so, at the present time, particularly careful monitoring and, if need be, a rapid and effective response are required. Calls for a fundamentally new architecture of the monetary system, or mere demands for that evergreen, the Tobin Tax, do not get us any further. If anything, they divert attention away from the realistic improvement options, or even lead astray, because they only foster new distortions. With the advent of the euro, monetary conditions and the outlook for more stability as a foundation of economic growth have improved, at least in Europe.


Despite all the temporary difficulties, the ECB has so far kept the euro largely stable at home, and also free of conflicts. Compared with previous experience, that is a step forward for the euro-area countries. Furthermore, the exchange rate of the euro now seems to have stabilised at a lower level. That is an economic and political advantage, both for the global system and for the Eurosystem. I am convinced that the euro has an immense potential, both for integration in Europe and for the further development of the global monetary and financial system. Alongside the dollar, it can become a strong and globally recognised second world currency. In return, however, the euro-area countries must currently face up to the associated new challenges. They must make and keep their economies sufficiently dynamic, innovative and competitive. Along with the monetary policy of the ECB, they must conduct their fiscal policies in a credible and longer term stability-oriented way. And, now that first steps have been taken in the monetary sphere, they must likewise clarify and define the future course of integration in other political areas. A lastingly stable and strong euro will confer greater stability on the international system as well. To that extent, I think my outlook for the international monetary system – notwithstanding all the real economic uncertainties obtaining at the moment – is, on the whole, relatively optimistic. But, like every outlook, it depends in part on the fulfilment of the conditions I have specified in detail. Thank you very much.


The benefit of the euro for neighbouring countries
Krzysztof Majczuk Director, Foreign Exchange Department National Bank of Poland

Ladies and Gentlemen, it is a pleasure to address this Conference today. Let me present a brief overview of the current and potential impact of the euro upon the Polish economy. The euro is a symbol of successful economic and monetary integration within the EU. It strongly influences the international financial environment. The euro also contributes to fundamental social, political and economic reforms in Poland. I prepared to do a long speech. In view of the fact that our time is limited, I shall present you with some elements of the prepared text. Poland recognises that monetary union is fundamental to the integration of Europe. The key advantage of monetary union is nominal exchange rate certainty within the euro-area. This brings practical and material benefits: increased competition through greater transparency of prices and lower transactions costs, deeper and more liquid financial markets. This will help to complete the single market, limit price discrimination and other restrictive practices. Poland wishes to join the euro. This is both a political commitment and a matter of national economic interest. Poland continues to pursue macroeconomic, monetary and fiscal discipline in order to be eligible. The Government is committed to that course. I will begin by speaking about the issue of choosing the most appropriate exchange rate. Then, I shall discuss the impact of the euro on Poland’s economy. I shall continue with setting out the advantages of EU and EMU membership. And finally, let me touch on our level of preparedness for substituting EMU national currencies into euro. Relations between the EU and Poland show deepening economic integration. Just look at the negative impact of the general European slowdown on estimates and forecasts for Polish growth. Since early 2001 it has been revised several times, from 4.5% to 2%. International trade and investments are key to integration. According to the EUROSTAT, Poland was the fourth biggest market for EU products in 2000 after USA, Switzerland and Japan, and the seventh biggest exporter to the EU, after USA, Japan, China, Switzerland, Norway and Russia. For Poland the EU - as a single economic area - is the main partner for exports and imports. Poland’s leading partners are Germany (50% of exports and 40% of 23

imports), Italy and France, generally. 70% of Polish goods were exported in 2000 to the EU member states and over 61% of imported goods came from those countries. Despite this structure, the strong zloty/euro rate eased the external disequilibrium of the Polish economy in 2000. In contrary, opportunities in Poland’s main export markets increased markedly. In 2000 Polish exports to the EU amounted to EUR 23.9 billion. This is 14.6% higher than in 1999. This significant growth was attributable to the three factors: an 11% increase in the volume of the euro-area imports (including growth of 10.5% in German imports), the slowing of Polish domestic demand growth and depreciation of real zloty exchange rates against the US dollar. Another crucial factor is Poland’s cost competitiveness. During the same time Polish imports from the EU increased by only 0.4% in comparison with 1999 data and stood at EUR 32.3 billion. That rise in import volumes in 2000 resulted from a substantial decline in domestic demand growth, coupled with an acceleration of export growth. The structure of Polish trade is reflected in the share of payments made in euro. This shows the growing importance of the euro in foreign trade. This is an ongoing process. Since 1999 data, the use of the euro has gone up by approximately 8 percentage points. The average share of the euro in export payments in 2000 was 49%, and 48% in the case of import payments. This level exceeds the share of US dollar in international transactions, which were 36% in export and 35% in import payments. Share of the euro in export payments made in 1999 and 2000
60 50 40

Share of the euro in import payments made in 1999 and 2000
60 50 40 30 20 10 0 I II quarter III

20 10 0 I II










Export payments made in 2000 breakdown by main currencies
60 50 40

Import payments made in 2000 breakdown by main currencies
60 50 40

% 30

% 30




Systemic changes (including lifting trade barriers) as well as the prospect of EU membership have significantly raised the confidence of foreign investors in the Polish market. Foreign direct investments have an impact on the structural changes of the Polish economy and the dynamic of its growth (through knowhow, easier access to international outlets, development of the domestic market). Moreover, they finance the current account deficit. EU member states are the largest direct investors in Poland. According to the Polish Foreign Investments Agency, out of a total of EUR 53.3 billion invested in Poland between 1991 and 2000, almost EUR 33.5 billion came from the EU. The highest FDI inflows came from France (EUR 8.5 billion), Germany (EUR 6.4 billion), the Netherlands (EUR 4.5 billion), Italy (EUR 3.7 billion) and Great Britain (EUR 2.4 billion). The euro, since its launch on 1 January 1999, has strongly affected the terms of trade. Improving the cost and prices transparency as well as reducing transaction costs, the euro forces all business operators, including banks, to enhance their competitiveness. This pressure is noticeable on the macro- and microeconomic level. The euro is an important element of intra-bank competitiveness. Commercial banks in Poland offer a broad range of products denominated in euro. They will convert accounts kept in eurozone currencies into euro free of charge. At the end of the first quarter of 2001 the share of accounts held in euros by legal entities equalled those kept in US dollars and stood at 35.5% (compared with 60% of dollar and 15% of euro account in 1999). The introduction of the euro has caused a far-reaching convergence of conditions for banking products and services in Poland. This tendency was recognised in particular in cross-border credit transfers and international settlements. Since 1999 the average quarterly volume of cross-border payments made in euros has risen by around 10%. Polish commercial banks have seen an unexpected interest by corporate borrowers, especially corporate, in credits granted in euros. They were very popular in 2000 due to more favourable rates resulting from lower level of nominal and real interest rates compared with zlotys and the strong exchange rate of zloty against euro. Membership in the European Union and Economic and Monetary Union is the main strategic goal of Poland and one of the main challenges facing both Polish politics and economy. We are well advanced in preparing for participation in further stages of European integration and introduction of the single currency. Being outside the euro club, as an associated but still a third country, Poland is affected by the changes taking place inside the single economic area. Increased mutual trade, more investments, and greater interest in the euro as an international currency are not the only examples. This impact is expected to grow in future. Poland is willing to join the euro in the final stage of its economic integration with the EU. We are fully aware of the benefits of the single currency. Those include: elimination of foreign exchange risk, reduction of transaction costs,


more transparent and comparable prices, more dynamic trade and stronger competition, and optimum capital allocation. However, it is essential that we understand some practical challenges that arise, such as loss of national currency, loss of exchange rate adjustments and losing the sovereignty of national monetary policy to a single supranational monetary policy. In view of the above, it is perhaps much more important to realise that those challenges need to be regarded as a natural consequence of the monetary integration process, which lead to the benefits mentioned earlier. Polish positive attitudes towards the euro come from expectations regarding the long-term economic benefits of the single currency, such as: enhanced trade and increased efficiency of production, macro-economic stability and credibility gains as well as rapid economic growth that stimulate domestic savings. At this final point, I would present the currency composition of Polish reserves as it provides a clear evidence of the Euro share enlargement. For a long time there have been two currencies - Deutsche Mark and French Franc - comprising 35% of total foreign exchange reserves. On the very first day of the euro introduction those two currencies have been converted into euro. Then, a year later, the Swiss Franc was exchanged into euro. The share of euro increased to 40% of our total foreign exchange holdings. You may wish to know that Poland is especially attached to gold. The name of our currency - zloty – means gold in the Polish language. The origin can be traced through our millennium history; gold coins with Polish royalty’s effigies have been minted in medieval centuries and for a very long time have been used – beside the silver ones - as means of tender. As time passed the economic case for gold has changed. Almost the entire gold holdings of the National Bank of Poland came from the holdings of the central bank of Poland (Bank Polski – Bank of Poland) before World War II. During the Nazi regime this stock had been deposited in the Bank of England, the Federal Reserve Bank of New York, the Bank of Canada and a small share in the Bank of Romania. Gold returned after the war and for a couple of decades remained on a virtually unchanged level. In 1995-1998 there was a dynamic increase of foreign exchange reserves. Therefore, we decided to purchase additional amount of gold in 1998 when the reserves exceeded 24 billion US dollars. The first reason was its small share in reserves (over 1% before purchase) relative to other central banks standards, and the second reason was to improve diversification of foreign holdings. At present Polish foreign reserves consists of over 3% of gold (103 tonnes = 3.3 million ounces). This it is not too much, especially when the ECB reserves maintain 85% in foreign currencies and 15% in gold. For the time being, we cannot make any decision concerning gold share changes of our reserves as we have to take into consideration the issue related to our contribution to the European Central Bank, which will be further discussed and negotiated.


Questions: Challenges for Europe
Chair: Thank you to Professor Tietmeyer and Mr Majczuk. I was delighted to hear your comments, respectively with Professor Tietmeyer, about the role of how gold builds confidence in central banks… Professor Tietmeyer: (interrupts) It can build. Chair: It can build confidence in central banks and above asset diversification, from your point of view, Mr Majczuk. But I’d like to open the floor to your good selves to hear your questions. We have, ever the time watcher, until 10.25 for panel discussion. I’m sure you have a couple of questions. Yes, please. Questioner: Thank you very much Professor Tietmeyer and Mr Majczuk. It was a very interesting presentation. My name is Osa, I’m representative of the Bank of Japan in Frankfurt. And I have two questions; one for Professor Tietmeyer and one for Mr Majczuk. My first question is: Professor Tietmeyer mentioned some kind of international role of the euro. ECB has announced it is neutral in terms of the internationalisation of the euro. In other words, ECB neither promotes internationalisation of the euro, nor hinders the euro. But it seems to me that candidate countries, especially in Eastern Europe, have a kind of incentive to be a member of the euro area. That means internationalisation of the euro has a kind of self promoting mechanism inside, it seems to be at least so. What would be playing the major role as a self promoting motor in euro? I would like to hear the view from the hosting side of the euro from Professor Tietmeyer. My next question is for Mr Majczuk. You explained the merits of the euro as a neighbouring country, but I think there must be some disadvantages in terms of the euro as a neighbouring country. If any, what would they be? Chair: Thank you. Professor Tietmeyer? Professor Tietmeyer: I share the view that the international role of the euro cannot be directly promoted, and should not be directly promoted. But – the international role of a currency depends, first, whether this currency is really seen as a stable one, and secondly, whether this currency is representing, let me say, a bigger part of the world economy. As far as the first criterion is concerned, the stability, of course a new currency has a special difficulty to build up its credibility. An existing currency – like the dollar, like the Fed behind the dollar – they have already established, for some time, a reputation. And of course a newcomer like the euro, on the one hand, has the heritage of the other currencies which came in, and central banks which came in, but on its own it has to build up its value and its international role. But, as I said, you cannot decide, “I want to be an international currency”, it depends, first, whether the precondition of stability and credibility is there or not. Second point: of course, if this currency is used by a bigger part of the world in itself, that means, for example, 27

not only by the euro countries but also by the enlargement of the euro area, that means in itself, already, the role is to some extent international. But, I think there is no trade off, let me say that precisely, between the first and the second criteria. If a broader based currency is not seen as a stable one, over the time, then of course it will not play an international role to that extent which is possible. The question is, of course, what is an international role? Should it be the role as a reserve currency, investment currency, transaction currency, that means used for normal export and import in the real sector. And of course, it will not be easy, let me say, to compete with the dollar in the oil sector, or in some other raw material sectors, or in the air traffic also. But I’m not excluding that over time because there will be de facto competition, and that means, it could be the case, that even in such areas, the euro could play a role, and an increasing role but as I said, that cannot be done by a decision from the European Central Bank. That cannot be done by the decision of any official institution. It will be the reflection of the assessment of the markets for that currency. And the assessment of the market of that currency depends on the size, but not only on the size; it depends at the same time, of course, on how it is seen over time as value. You could already see that the DM, which represented only a relatively small area of the world economy played a much bigger international role, looking at the reserves, looking at the investment, That was a consequence, I think, that this currency built up its credibility. So, my conclusion is, that the ECB is right in saying that it is neutral because the international role is not dependent on what the ECB is saying, no, it is dependent on what is the assessment by the markets. Chair: Thank you very much. Mr Majczuk. Mr Majczuk: OK. For a transition country like Poland, the cost and benefit calculations show more opportunities than trades. The most important benefit arising from EMU is participation in the stable currency area. This cannot be overestimated in a country which experienced hyperinflation not a decade ago. Since inflation is a monetary phenomenon, and is attached to a currency, inflation disappears together with the currency. So this inflation cost with times of unemployment in Poland now huge, lower inflation and lower inflation vitality bring lower euro interest rates and boost investment. I think the biggest obstacle for Poland is to perform in a currency area in which current EMU countries can gain from labour markets. Significant instabilities in the market are at least partly to blame for high unemployment in Poland. Low labour flexibility has the effect caused by the structuring of the economy. The labour market has been guarded by labour unions. Necessary forms of the labour market, its circulation and institutional infrastructure, are a huge challenge for our new government. Trades for Poland arising from single monetary policy resemble fears expressed by EMU countries before forming the Union. They are described by an overpriced optimum currency area. It is not surprising that Poland and the EMU countries have not yet formed an optimal currency area. Even current EMU members have not yet formed such an area even after years of institutional and market convergence. We still need time to prepare ourselves, maybe.


Chair: OK, thank you. I see another question here. Questioner: I’m Peter Hambro, and I’m a gold miner. I think we should all be very grateful to Professor Tietmeyer for instituting the International Financial Stability Forum, and I’m very glad that it’s been so helpful to us in the recent turbulence. I’d like to ask the Professor whether the involvement of International Financial Stability, as far as the gold market is concerned, is limited to the nature of the Washington Agreement, or whether there is a broader involvement of the Central Banks in the gold price. If that is indeed the case, what steps the Professor thinks that the international forum should take to have the dialogue that he so eloquently called for in the foreign exchange price convergence between large holders of gold like the Central Banks, and the producers of gold, like myself and my other producer friends here today. Thank you. Professor Tietmeyer: I think one has to be realistic on that point. First, it’s clearly the case that gold is not playing a role as a basis for the currency. All the ideas to link the currencies to the gold, and gold backed, even gold based… I think that is unrealistic, one has to be clear on that point. The second point is, as I said, the gold reserves are still existent in the reserves of the central banks – and reserves are playing some role. One should be careful; you cannot substitute a lack of credibility only by building up reserves. But, in my view, reserves are playing a role, especially for small and emerging countries. Not so much for the bigger areas, but especially for the smaller countries. So my feeling is that the reserves are playing a role. And gold could be for those countries, especially being available, as collateral in critical times. I’ve seen that many times, looking back in the last 50 years, that gold was used as collateral, and on that basis you can arrange in a short time a credit for the country. Besides that, let me say, gold is for the people, still an important point. Not only for the market but also for the ordinary people, who see as gold as a value that goes over all the difficult times. At least one should not underestimate this emotional element of gold. Now coming to the bigger countries, the last point can also play a role for the bigger countries. But I think, looking from a pure monetary policy, you could say, “Why could the central banks not sell the gold?”. For the bigger gold holders, the central banks there is common interest; that means value of the gold. If one would sell to a bigger extent, that would undermine the gold price. Let me say, the most important element for the Washington agreement was this: the common interest to hold the value of the gold at the appropriate level which should not be negatively affected by the fact or intention, that one country is selling gold and making money out of that, because that would then harm the others. So it is the common interest of the big gold holders to stick to a big part of their gold holdings, and that was the reason why there was a 5-year agreement. Whether this 5-year agreement will, in the end, be prolonged, I don’t know. But I can imagine that there is the common interest to, in the future. But you should not expect that the central banks do it only for the credibility of the


monetary policy. That is, at least for the big gold holders, not the crucial point. I think central banks are interested in having their reserves valued at appropriate prices. And that is a very important interest and should not be underestimated in future times because if some are going ahead in selling, it would have a disadvantage for the others. Besides this value interest – as I said, I see a reserve role especially for the emerging countries and I see the emotional side inside the big countries, for the people. For example, if all the European central banks would decide to sell their gold, I’m not sure whether that would, at least in Germany, improve the assessment of the euro; it could have a negative effect. One has to be very careful in assessing. On the other hand, one should not overdo it, and expect too much from the central banks because there will be no way back to a gold based monetary system. Some in the United States are arguing in favour of that but I don’t see that they will have any majority in the foreseeable future. What happens in next centuries, I don’t know, but my forecasts are not going so far. Chair: Thank you very much. You refer to the agreement struck in 1999, and later on we’ll be hearing more about that, but let’s wait for that particular contribution. Professor Tietmeyer: (interrupts) The only thing I can tell you, is that I negotiated that to a big extent. Chair: Yes, thank you very much. One more questioner, please. Questioner: Mike Lawrence, Moscow Norodny. It’s a short question for Professor Tietmeyer. Does the Professor know of any statistics on the monthly numbers of German workers emigrating to Ireland, to take advantage of the better economic prospects of Ireland, which seems to me to be a fundamental prerequisite for the “one size fits all” euro system? Professor Tietmeyer: (Laughs) I have no statistics about that. But I’m pretty sure that Ireland is an open country; that means everybody is invited to come to Ireland as every European is invited to come to Germany, so it’s up to the people to decide where they want to live, and in which part of the euro area - Ireland is a very nice euro area no doubt about that, but I know some other very nice places too. So it’s really up to the people. I have no statistics about that, but I know that a lot of Irish people are working on the continent and making money there. Chair: Thank you very much, Professor Tietmeyer. Making money is a nice chord to strike to finish our first panel. Thank you very much Professor Tietmeyer and Mr Krzysztof Majczuk.


Gold in Eastern Europe
Introduction by Benedikt Koehler

Well, we know the world is moving closer together, and few places can be more apposite for making that point than being here, in Berlin. The Brandenburg Gate is often seen by us as the gateway to the East. To some of the guests here today, I’m sure they would see it as the gateway to the West. Here we are, and we’re delighted to be greeting three experts from their respective fields who will be telling us about gold in Eastern Europe. Gold in Eastern Europe matters a lot to the World Gold Council, as it does to the gold miners’ community, and we have, just this week, published a study called “The Golden Road”, available to all of yourselves who wish to have it, which gives detailed statistics of gold sourcing in eastern Europe, in Russia and in the former CIS states. Let me welcome Mark Rachovides, whose institution, the European Bank for Reconstruction and Development, is one of the world’s great joint ventures. He will tell us about gold mining and opportunities in Eastern Europe, followed by Mr Sokolov, from Russia and Mr Alzhanov, from Kazakhstan, from their respective central banks, to talk about the use of gold in reserve management there. Welcome, Gentlemen


The contribution of EBRD to mining in Eastern Europe
Mark Rachovides Principal Banker EBRD

Mr Chairman, Ladies and Gentlemen, thank you very much. It’s nice, first of all, to see so many familiar faces here. It’s a very opportune time for the EBRD to be speaking at this gathering; it’s the EBRD’s tenth anniversary. I will speak today on our contribution to gold mining in Eastern Europe. I’ll divide my presentation today into three parts. Firstly, I’ll give a brief overview of the EBRD, for those that are not acquainted with my organisation. Secondly, I’ll speak a little bit about our activities in the CIS and Eastern Europe. Finally, I’ll offer you some thoughts as to the situation today, and possibly the way forward.

Shareholding of the EBRD
USA 10% Others 14.58% Japan 8.52% CEE & CIS 11.78%

EU 55.12%

As I’ve mentioned, the EBRD was founded ten years ago. It’s a multilateral entity. It exists to foster the transition towards open market economies in central and eastern Europe. As you can see, we’re majority owned by the European Union, and have shareholdings now of, I believe, 60 countries and institutions. Why do we exist? As I say, to promote the transition to a free market based economy, to improve the general investment climate for most of you here, to improve corporate governance and to provide improvements in standards in both environmental aspects and throughout. We seek to promote development in all respects; be it in terms of transparency, technical progress, environmental progress and, to a degree, social progress. I’m a member of the Natural Resources Team at EBRD. We cover oil, gas and mining, and we largely deal with private sector projects; we distinguish ourselves from the World Bank particularly in that respect. We provide a significant


volume to the EBRD’s business. We are one of the larger teams and certainly in terms of revenue, one of the most significant. Our activities in gold mining have started with the inception of the Bank. One of our first, and largest, projects was our Zarafshan-Newmont project in Uzbekistan. These figures give you an indication of our current portfolio. What they don’t really tell you is the amount we’ve actually invested so far. In gold mining, we are the largest single financial investor in the CIS and we’ve actually invested, so far, close to 400 million dollars. That may sound impressive, but if you compare it to our oil sector investments, those are touching 2 billion dollars at this stage. I’ll come back to that later, but it merely gives you an indication of the slow progress by comparison to other industries that gold mining has made.

Sector distribution in millions of Euros
Metal Ore Mining Oil and Gas Extraction


Petroleum Refineries Pipeline Transportation




A brief indicator of where we do our business: Russia is by far our largest area of business, and indeed, that’s reflected in our gold portfolio particularly. To an extent, these figures also reflect opportunities in our region. What I would like to say is that there are a number of countries in central and eastern Europe that haven’t received much, if anything, in the way of foreign investment. Armenia, for example, has substantial gold reserves as does Kazakhstan. Both are fairly

Natural Resource Projects per Country
700 600 500

Euros (Million) 300









Hung ary


Slovak Republic





good examples of failure in gold mining. To an extent, I’m a strong believer that that reflects the depressed gold price environment that the EBRD has seen for most of its existence. I can’t help but say, that were the gold price to improve, opportunities in our region would follow. Just to give you an idea of how we do our business: we are self-insuring. We won’t ask you to go out and purchase political risk insurance if you are an investor. We will take on project financings of political risk largely ourselves. We will take equity risk, be it formally or through a project financing structure. But we will ask all projects to meet normal commercial criteria: they must be viable, they must meet the standards applicable anywhere else in the world. We’ll expect gold mining companies to have competent, stable management and have the ability to assume operational, technical, environmental and other risks. We’re not in the business of running gold mines; we’re in the business of helping people like Mr Hambro to do that. How do we offer our financing? Very simply, we don’t offer a broad range of sophisticated products. We, as I say, are concentrating on project finance. Generally, that takes the form of debt. We will take equity and we will support projects with derivative transactions. We have made gold loans, we have provided hedging programmes. We have provided pre-production financing, even down to artesmal mining companies in Russia. We have some fairly straightforward foundations for the way we do things. I’ll explain in a little more detail, but essentially: transactions have to make sense. We really have to lead the market - that’s what we mean by using this strange word, additional. Thirdly, we really must see some demonstration or transition impact in any of our projects. As I mentioned, sound banking principles essentially mean that the transactions must make sense. In gold mining, this really does mean extensive and careful due diligence. In Russia particularly, it would mean extensive legal due diligence. In many cases we find that multilateral institutions will actually develop, and to an extent, improve regulatory and legal frameworks in countries of operation. We’ve undertaken work in Bulgaria, Uzbekistan, Kazakhstan, for example, in providing a more condign legal and regulatory environment for potential investors. We would seek to obviously obtain a fair balance of risk and reward for all parties. That might sound a very grand and romantic statement, but we believe it is achievable through sensible project negotiation and conditionality. We seek to ensure that investors will obtain suitable risk-adjusted returns. Essentially, we realise that investing in eastern Europe is, by comparison to alternative investments, often difficult. Whilst even in a good gold price environment returns may seem attractive, political risks have, in general, seemed daunting to many investors. I think if I’m correct, if we looked at the amount of mining companies interested in Russia, for example, when the Bank was started in 1991, you could count them between 30 and 40. At least 20 of them were quoted on the London Stock Exchange in some way. Today, I would say that there are probably no more than 6.


As I said, we would never seek to compete with commercial banks. I hope that comes as some relief to some of my competitors here! We would seek to lead the market. We would seek to develop financial structures that are appropriate to countries; in many situations that entails really making it up. We really have to structure transactions for the first time in many countries. That often leads to an extensive preparation period for regulators, for counter-parties, and with steeper learning curves that does mean that projects can take time. As I say, that means that the boundaries of transactions are extended, we do break new ground. Our maturities of transactions tend to reflect that, but we like to think that we would try to open doors for potential investors. We’d like to think that our transactions lead to follow on developments. As I mentioned, our primary existence is to ensure transition to market economies; I think the slide speaks for itself.

Ensuring impact on transition
EBRD’s projects should enhance: Creation, expansion and improvement of free and competitive markets, including private ownership Establishment and strengthening of institutions, laws and policies supportive of the market Adoption of market-oriented, good corporate behaviour and skills

To talk a little bit about what we’ve actually done in gold mining: I think we have a pretty successful gold mining portfolio. In Russia, the largest operational gold mine is the Kubaka mine, which is part of the Omolon Gold Mining Company. That project cost approximately 300 million dollars. It produces approximately 13 tonnes of gold a year. We provided financing, in co-operation with OPEC, of 62.5 million dollars, and it’s now operated by Kinross Gold of Canada. It’s the largest and most modern mine in Russia. It’s led the way in terms of technical innovation; it’s brought technology from the Arctic oil industry of Canada and the United States, and seen it applied in permafrost conditions in Russia. It’s totally transparent; it has western operating and accounting standards. Indeed, its environmental and health and safety performance compares with any mine in the world. You can do business in Russia, I must tell you this. With perseverance, with commitment and quite a lot of faith, you can do business in Russia. There are a number of companies that are doing so successfully today, but I really must say that there are a lot of misconceptions about the gold business in Russia today. Our largest investment, however, has been in Uzbekistan. As I mentioned, it was our first investment. It’s the Zarafshan-Newmont project. This is a large heatleaching operation; in other words, it’s a secondary mining operation. Uzbekistan


is currently, I think, ninth in the world in its gold production. Were ongoing projects to be developed and new projects to come on stream, I think Uzbekistan could probably rise to fourth or fifth; its potential is enormous. The Muruntau mine, for example, that feeds the Zarafshan project is absolutely gigantic; it produces something like 2 million ounces of gold per year. Newmont have been there now for approximately ten years; the mine has been in operation since 1993. And, as I say, again, another world-class operating performance. A different type of project is the Buryatzoloto mine. It gives you some evidence of the variety of our portfolio. The Buryatzoloto is a smaller producer. We’ve provided both debt and equity and a hedging programme. High River Gold is an active shareholder in this project but is not the mine operator. This is essentially a Russian project and doesn’t have a western sponsor putting its balance sheet behind it. However, it’s a successful mine; it’s exemplary, again leading the way in terms of technical and financial performance. Our largest production mine is now in Kyrgyzstan. The Cameco-led Kumtor Mine is now producing 700, 000 ounces a year. It’s doing well: has had a degree of adverse publicity due to environmental incidents, but is now back on-stream in a very difficult environment. I think we all know that Russia, and the whole CIS, has enormous mineral potential. It’s very well studied geologically. There haven’t been, I would say, enough foreign investors. I was privileged enough to read a book over the summer holiday called “In Search of Soviet Gold” by an American mining engineer called John Littlepage. He was active in Russia in the 1920s and 30s. If anybody’s interested in the history of Russian gold mining and the potential of the area, I strongly recommend it to you; find it in a second hand book shop. Gold mining has been active in Russia with foreign investment since Tsarist days. It’s remarkable that EBRD – and you notice that I speak with some hesitation – are the largest single investor in the Russian gold mining industry from a foreign perspective. It says, perhaps, a lot. As I say, there are some good examples. There is one new project, the Julietta mine in Magadan in the far east of Russia that’s coming on, showing good potential. It’s a difficult part of the world to do business with. The rouble is more stable than it was but high hard currency contents can prove problematic in construction periods. Again, to re-emphasise the points I’ve made: financing has been difficult. And as I’ve mentioned before, political risk has proven to be perhaps the major obstacle. I mentioned before that the oil and gas industry has been the beneficiary of much greater investment from EBRD and throughout the commercial banking world. One of the reasons for that is that it has become increasingly competitive, apart from the obvious economic realities. But it’s a relevant comparison, I think, to say that the mining and the gold industry in general in Russia hasn’t really experienced the same sort of international scrutiny and the pressure to reform that the oil sector has. Environmental issues are, I think, common throughout the world and I’ll not dwell on that. And of course there is the currency control issue. I think the slide will speak for itself.


Regulatory environment
Regulatory framework has not yet experienced the international scrutiny and pressure to reform that the Russian oil and gas industry has seen Environmental problems pose particular risks Laws and regulations are designed to stem the outflow of wealth

Difficulties that have been the best known have surrounded the Dukat Silver Project, where Pan-American Silver unsuccessfully attempted to develop a large silver mine in the far east of Russia. Sukhoi Log is the name of a project that I think is well acquainted to many of you, and has, I think, sadly become emblematic of the difficulties associated with Russia, and privatisation particularly. As I mentioned before, detailed legal due diligence is extremely necessary. A way forward might be to examine production sharing agreements, and if anybody would like to ask me about that, I’ll happily talk about that later. As I said, in conclusion, Russia and Eastern Europe have enormous natural resources. The risks associated with gold mining are common throughout the world. In Eastern Europe and the CIS there are all the normal difficulties, plus some more. It’s an evolving environment but we have clear evidence that you can succeed. Major gold mining companies have succeeded, are producing, are profitable, are leading the way. Smaller gold mining companies are also there. I’ve mentioned Peter Hambro already; he and Kevin Foo of Celtic Resources are two British entrepreneurs working in Russia. High River Gold of Canada, for example, in Buryatzoloto. Thank you very much, Ladies and Gentlemen.

How to contact us
Mark Rachovides Principal Banker Natural Resources Tel: + 44 207 338 7047

Kevin Bortz Director Natural Resources Tel: + 44 207 338 7119


The role of gold in Russia’s reserve management

Vladimir Sokolov Director, International Department Central Bank of Russia

It is only a short time ago that the issue of the role of gold in international reserves has become relevant for the Bank of Russia. Before that the proportion of gold in our reserves was determined by historical factors. It can be seen from Chart 1 that up until recently the share of gold in the official reserves of the Russian Federation has been primarily dependent on the dynamics of the currency component of the reserves, which in its turn has been determined by the nature of the exchange rate policy being pursued and in general by the macroeconomic conditions in our country. It was only in 1997 that the Bank of Russia started dealing in gold assets in the external market. It is evident from Chart 2 that over the past few years the share of gold in our international reserves has been fluctuating between 10 and 40 per cent. This ratio reached its peak of approximately 40 per cent following the financial crisis of 1998, when a substantial part of the currency reserves was spent on supporting the value of the rouble and government debt payments. When the Russian economy began recovering and the external trade conditions improved, the international reserves of the country started to grow rapidly. The main source for their growth was represented by foreign currency revenues from exports – the trade balance reached its all-time high of 60 billion US dollars in 2000. Consequently, the proportion of gold in reserves started to go down. As of November 1, 2001 the official reserves of the Russian Federation amounted to 38 billion US dollars, and the share of gold in that figure stood at the level of 10.5 per cent. According to the resolutions of the Bank of Russia’s Board the primary objectives of the reserve management activity are safety, liquidity and profitability of the reserves. In this regard, it is appropriate to consider the question, whether gold as a bank asset meets the requirements implied by the above mentioned objectives. Here one can observe a significant diversity of opinions. We at the Bank of Russia tend to support the conservative standpoint on the issue, given Russia’s historical experience, which has more than once demonstrated a crucial role of gold in rehabilitating the country’s financial system. Within this context we should recall the monetary reform conducted by Sergei Vitte, who successfully established the gold standard in Russia in late 19th century, as well as the introduction of gold-backed banknotes (“tschervonets”) that helped combat hyperinflation in the 1920s. At a later stage of our history the development of gold mining in the country allowed the government to accumulate a large stock of official gold reserves, which was viewed by the Soviet Union as an important attribute of state might.


USD (millions) 40000

Chart 1. Official Gold & FX Reserves of the Russian Federation (end of i d)








0 1996 1997 1998 foreign exchange 1999 gold 2000 01 Nov 2001

Chart 2. Official Gold & FX Reserves of the Russian Federation (end of period)
100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 1996 1997 1998 foreign exchange 1999 gold 2000 01 Nov 2001

Nevertheless, the Bank of Russia attaches the most importance to the following feathers of gold as a reserve asset: Gold stored in the vault is not exposed to credit risk with regard to the counterparties of a central bank. In contrast to foreign currency assets, gold does not represent any issuer’s debt obligations and its value is not dependent on any obligor’s financial condition. Against the background of the recent manifestations of instability in the world financial markets gold assets might serve as a “safe haven”. 39

The gold price trend is normally in a counterphase to the dynamics of the US dollar exchange rate. As long as the dollar performs the role of the primary reserve currency, holding substantial gold reserves might serve as an automatic compensatory mechanism for keeping the aggregate value of reserves steady. Therefore, gold fully meets the first criteria applicable to reserve assets – that of safety. As a rule, liquidity of gold assets falls short of that of foreign currency assets. However, in case of a substantial instability in the world financial markets, liquidity of the bullion market and the value of gold go up, while the same parameters of some foreign exchange assets might drop quite dramatically. Returns from active trade in gold are usually lower than those for similar foreign exchange transactions. That said, in certain periods gold lease rates might rise sharply, as can be seen from Chart 3. During the current year, due to the consecutive rate cuts by the US Federal Reserve, there has been a trend for convergence of US dollar money market rates with gold lease rates. Bullion deposits with top-rated overseas counterparties are the primary tools used by the Bank of Russia for managing its gold assets. In order to enhance the returns from these transactions; during the last few years the Bank of Russia has started placing gold deposits with embedded call options. It is common knowledge that such yield enhancement features may improve returns quite significantly. Overall, according to the Bank of Russia’s experience, the profits from bullion operations exceed by a considerable margin not only the respective transaction costs but also the aggregate outlays for the maintenance of the gold stock. Alongside the external economic reasons, the Bank of Russia has some domestic economic reasons for holding substantial amounts of gold. Given the fact that Russia is one of the largest producers of gold in the world, the present stage of the transformation from the centrally planned economy to a market-based one implies that the Bank of Russia has to facilitate the development of market mechanisms in the gold mining industry, particularly by providing liquidity to the gold market. The last few years have seen the creation of the legal basis for an active participation of commercial banks in financing gold mining and in trading gold. As a result, after a prolonged period of recession in early to mid-1990s, during a more recent period the production of gold in Russia has been picking up quite noticeably without any major allocations of centralized resources. Thus, the amount of gold production in 2000 exceeded the levels achieved in the early 1990s and reached 143 tonnes as compared to 125 tonnes in 1999. At the same time, a reliable mechanism for the accumulation of the official reserves has been created in the Russian Federation. For the purposes of further development of the precious metals market the Bank of Russia is planning to begin granting bullion loans to commercial banks in the


Chart 3. 3-Month Gold Loan Interest Rate and Gold Spot Price
7 350





USD per ounce

4 %








0 1998

0 1999 3-month rate 2000 spot price 2001

Chart 4. World Official Gold Holdings (October 2001)

United States Germany IMF France Italy Switzerland Netherlands ECB Japan Portugal Spain Taiwan China Russia United Kingdom 0 1000 2000 3000 4000 tonnes 5000 6000 7000 8000 9000

nearest future. In addition to that, the gold market will take important guidance from the plans declared by the Government of the Russian Federation to abolish tariffs on gold exports. Today several West European central banks pursue policies aimed at gradual reduction of their gold holdings, transferring their funds into more profitable investments. On the other hand, as seen from Chart 4, practically all the leading nations of the world have large official gold holdings at their disposal. The share of gold is similarly high in the aggregate official reserves of these countries. The amount of gold reserves of the Russian Federation lags behind the levels ob-


served for the majority of leading industrial countries, while the proportion of gold in the reserves is close to that of the European Central Bank (14 per cent) or the United Kingdom (11 per cent). It is noticeably lower than the ratio for the reserves of the United States (57 per cent), but it’s several times higher than the same indicator for the so called “emerging” economies of China and SouthEastern Asia (within 3 per cent). For the reasons described above, the Bank of Russia attaches a lot of importance to gold in the context of diversification of its reserve assets for the purposes of lowering the respective investment risks. We are not planning to pursue the policy of targeted reductions in the gold component of our official reserves.


The role of gold in Kazakhstan’s reserve management
Batyrbek Alzhanov Director, Monetary Operations Department National Bank of Kazakhstan

The central banks use gold as a reserve and the particularity of gold is that it is a quality of financial funds and also is, in general, a commodity that comes under the rules of supply and demand. The reserves that are formed by securities of foreign countries, and the measures of such countries such as the freezing of reserves, are very vulnerable; gold is by far better and can always be used. And although monetary, gold as the reserve asset is reduced in value, but the gold reserves of the National Bank of Kazakhstan are not exposed to many fluctuations and are 15-18% of all reserves we have. The significance of gold means that prices fall, but compared to the fluctuations of other currencies, it is still a reliable thing which can be easily used as a commodity by various central banks. The present strategy, and the gold reserves of the National Bank of Kazakhstan, is directed at increasing the active role by gold reserves, both internationally and nationally, in terms of carrying a number of products. The entire quantity of gold as reserves is the equivalent of more than 500 million US dollars; that is round about 50 tonnes and 73%. Abroad, the rest of the gold is used as deposits for various periods, and different operations are carried out. Also, the National Bank of Kazakhstan is carrying out operations to buy gold, and also gold is produced. As far as the production of gold is concerned, after the collapse of the Soviet Union, Kazakhstan has produced 28 tonnes of gold. We process the ores, and Kazakhstan mines have also exported gold to beyond the borders of Russia, after the collapse of the Soviet Union and after establishing our own economic ties with other countries. After the economic significance, the production of gold in Kazakhstan has reduced from 29 tonnes in 1998 to 2.5 tonnes. The state actually shut down the gold mining industry, and after the crisis in mining in July 1995, the President of Kazakhstan signed a decree on the state regulating precious metals and precious stones. This was the first step to liberalise the precious metals in Kazakhstan. A government programme with regard to mining gold, and increasing it to 50 tonnes in 2000, is one of our priority tasks [sic]. The provisional regulations have shown that gold will still be found. We have additional deposits but it costs a lot of money, and we want to get the money by attracting foreign investors. We feel that we have to increase the production to be attractive to foreign investors with the participation of Kazakhstan and foreign capital. It is known that Kazakhstan is one of the leaders in gold reserves; we are position number 5 in the world. We are in the fourth position with regard to the gold content in the tonne of ores. In the CIS countries, Kazakhstan is in 43

position number 3, after Uzbekistan. The precious metal trade in Kazakhstan is a very prospective trade and that is why, in 1998, new legislation was enacted so that changes were made regarding the controlling of precious metals and precious stones. Changes were also made by an order in Council with regard to taxation. The volume of gold and precious stones mined is important and our own banks are included in this. In spite of the drop of the gold price in international markets, gold mining in Kazakhstan is fairly cheap compared to other markets. In the market of precious stones and gold, we are also in a favourable position concerning the other CIS countries. Other legislation is aimed at attracting commercial banks and foreign capital to boost the mining of gold and to step up the operation with precious metals. New technologies should also be introduced in gold mining. At present, the investments of our own commercial banks are the bulk of the investments. The share of foreign companies in developing the gold mining industry is around 40% of the entire investments. With the participation of our own companies and foreign companies we also have to modernise our own processing companies. In Kazakhstan, we also established our own production, processing and upgrading of precious metals to be present in the international precious metal market. I would also like to state that at the end of 1991, the National Bank established favourable conditions for credit and loan granting, also for other important raw materials. In January 1992, we established a gold reserve and in 1993, the national currency tenges, is well, a hard currency and guarantees the sovereignty of our country. The gold mining industry in Kazakhstan lays the accent on exports. The producers of gold and precious metals have set the following typologies: the possibility to sell gold to the Kazakhstan banks. The producers get an additional saving due to the fact that banks actually pay for the customs and for the transport. Products can be more quickly delivered; two days after the delivery the gold is in place. They get additional money, and this in turn makes it possible for us to mine more of our precious metals. The producers have enough floating assets to keep prices stable and we get credit from banks for the floating assets. The production can be guaranteed in the future and stepped up. The commercial banks have now become the main credit organisations for the producers of precious metals. For mining, these banks enable us to be increasingly present in the world gold market. We also use all the general banking instruments and all sorts of operations that are customary, if possible. And that’s why Kazakhstan gets all the hard currency it needs to better develop its gold deposits. Apart from all these positive trends in the gold mining or processing industry, there are certain shortcomings as well, let’s face it. Above all, we have high prices for processing the ores and the metalworking industry is still too expensive in our Republic. The general trend of the fall of world price of gold and the insufficient credit taken of commercial banks for the gold mining and gold processing industries is also a certain minus. But in principle, what has also attracted the foreigners is that at present we continue to liberalise our market and in principle there are very positive prospects to further develop the gold mining


industry in Kazakhstan. It is known that the basis of the ores and gold mining industry in Kazakhstan are the deposits. (Three gold deposit locations are listed.) This is where the deposits are located and this is what we want to make use of further. We have a confirmed programme to develop the gold mining industry; this plan is up to 2003. It should increase by 20,000 tonnes the amount of gold in Kazakhstan. We used to have a different programme by 1995 but the National Bank of the Republic of Kazakhstan, the initiator and active participant in the Kazakhstan market, has asked us to do the trade with precious metals. The National Bank has also attracted various other Kazakhstan commercial banks, and together they fund the development of the mining companies. The objective is to increase the gold reserves of the Central Bank. These are 15-18%, they are kept the same and the quantity is reserved but the Central Bank also buys the gold in our internal market. Based on this, they also carry out operations in international markets. In the conclusion of my paper, I should like to stress that since we have established a gold reserve we have had very positive trends in legislation as it concerns all the operations of gold mining. We have witnessed a complete liberalisation of the gold trade, so we have very favourable conditions in Kazakhstan to attract foreign investment based on the work of commercial banks and to increase activities. Small businesses also get a chance to take advantage of minor deposits.


Questions: Gold in Eastern Europe

Chair: Thank you very much. I’m sure there’s lots of interest. We’ve seen different perspectives on the use of gold, where it comes from, who’s financing it and who’s using it in Eastern Europe. Open to the floor – any questions please. Questioner: My question is to Mark Rachovides. Could you tell me more about a little bit more about production sharings and developments in Eastern Europe? (This is an approximation made from the answer. The questioner was off mic.) Mark Rachovides: Thank you, Gerry. Production sharings are a technique that have been employed in several countries, I think most successfully in the oil sector in Russia. They are operated in the gold sector in Indonesia, for example. They are essentially an arrangement that vary from the traditional joint/venture style partnership, whereby production rather than dividends are shared. Production sharing agreements tend to be cast in bespoke taxation arrangements. The idea of that is that they provide certainty in cash flow and in terms of expectation of fiscal costs. Bankers like this sort of thing because they are easier to finance. For gold mining companies, they tend to represent a decision because, of course, the fiscal environment could get better rather than the present environment. You could find yourself disadvantaged. We’ve financed a very large PSA arrangement in the oil sector of Sachaleen Island, which has proven to be very successful. As yet in the former Soviet Union, there are no operating PSAs. There are several that are quite well known, we’re certainly following their progress actively. In respect to Uzbekistan, as I mentioned in my presentation, the largest foreign investment is by Newmont Mining Corporation in Zarafshan-Newmont. The largest mine, however, is run by the state owned Navoye Kombinat, which is the Muruntau open pit. That does not have any foreign investment but is one of the largest, and arguably the largest, open pit gold mine in the world. There are developments that have been relatively well publicised – some of you may have read articles, for example, in the Wall Street Journal last week on potential for further investment in Uzbekistan. Most well known is the recent development by Oxis Mining of the UK of the Amuntetau Heat Leach Project. Further, Newmont are exploring a new project in the Angren region, close to Tashkent, potentially a very large mine. And the Australian company, Multiplex Mining, are looking at the very large Zamitan deposit, close to Samarkand. Potentially we hope that one of the spin-offs of the current conflict will be that there will be greater attention to supporting foreign investments by the United States, I’ll be entirely honest about it. We believe that Uzbekistan has a proven track record of delivery; gold can be exported without hindrance. It is, of course, a difficult place to work but we believe, as I said in my speech, that it has tremendous potential.


Chair: Thank you very much for that extensive answer and response to the query. Any other queries, please? Questioner: Robert Guy, wanting to ask about the role of the commercial banks. Mr Alzhanov talked about the liberalisation of the market and the increasing involvement of the commercial banks. Mr Sokolov also talked about (not on tape)…the gold loans to commercial banks to help them assist their business. If either of the gentlemen would like to expand on the role of commercial banks, I would find that interesting. And I’d also find Mr Rachovides’ comments interesting on this because in talking about the investment of the EBRD, this has all been, principally as I understood it, in various gold mining projects. What I’m asking is: does the EBRD envisage a more active role vis-à-vis those commercial banks who themselves are specialising in gold mining? Mr Rachovides: EBRD does have some experience of supporting commercial banks in Russia. Immediately following the 1998 financial crisis, EBRD intervened to provide some gold financing, principally for alluvial miners. It’s a small scale operation but we do have some experience of it. In terms of more forward looking schemes, areas we’ve looked at basically amount to credit enhancement. Could EBRD or another multinational, for example, intervene to mitigate the credit risk or the political risk that may confront a commercial bank, particularly an old bank, in dealing with a Russian or a CIS counterpart? Indeed, it is something we are exploring. It does, I think, require from our perspective considerable co-operation with institutions such as those represented by these gentlemen. And also, indeed, considerable legal due diligence but it’s an area we are certainly exploring our interest in pursuing. Chair: Thank you, Mark. Vladimir, would you like to respond? Mr Sokolov: As I mentioned, the Bank of Russia is planning to grant bullion loans to the commercial banks and then we hope that they will invest their loans to the gold producers. As a central bank, we see our role as not being active on a daily basis in the precious metals market, but we should do everything to support our internal producers during our transition period in our economy. That is why we decided to issue this legal document, which is providing the opportunity for granting loans to the commercial banks. Thank you. Chair: Thank you. Mr Alzhanov. Mr Alzhanov: As I already said, the Kazakhstan market is completely liberalised. The National Central Bank of Kazakhstan supports the commercial banks and it makes their job more active with regard to funding the gold mining industry. At present, we have some 10 banks in Kazakhstan that have a licence to carry out operations with precious metals. As I said, the Central Bank wants to make this market of commercial banks more active and to act as a role model. And they also participate in certain projects, together with commercial banks in Kazakhstan, to fund the gold mining industry. Another thing is; that the Central


Bank cannot constantly co-fund these operations because our Central Bank has got a different function. Basically, we want to support our national currency. But to render support and as a role model, the Central Bank participates in some operations. In the long run, after two years I think, we will have large Kazakhstan investors, among them our own commercial banks. Chair: Thank you very much, Mr Alzhanov. Further questions. Yes, here. Questioner: Alexander Shorov, National Bank of Ukraine. I’ve got questions for each of the panellists if possible. First of all for Mr Rachovides: in your speech, you mentioned a lot of Eastern European countries like Uzbekistan, Kyrgyzstan and so on. Ukraine is East European, or rather a Central European country, or in any case, a country of operation. We’ve got some gold deposits in our land as well, estimated in hundred tonnes. My question is: does the EBRD have some analysis, a due diligence report, about Ukrainian gold mining prospects and if so, what do you think about these prospects? Second question, for Mr Sokolov: does the Central Bank of Russia make intervention in your domestic gold market, and if so, what is your official price, compared with gold fixing, for example? And one question for Mr Alzahnov: if you do not mind, I want to ask again, you said your market is liberalised and you spoke about the role of your commercial banks. But the banks actively participate in the gold mining as such? I did not quite understand it, although I know your market a little bit. Do you also have a gold stock exchange, only for the internal market or also internationally? Can others also buy some there? Chair: Mr Alzahnov is not the only person here who will be speaking in Russian! Thank you very much for the three questions, and let’s take them in that order, please. Mr Rachovides: Certainly. I acknowledge the gold mining potential of the Ukraine. We do have proven reserves, and as I mentioned in my speech, as part of the former Soviet Union, it’s a very well explored catalogue and we have an excellent tradition of engineering. We have not financed any projects in gold mining in the Ukraine, and there is certainly no prohibition to us doing so. We would welcome a dialogue on that subject. In terms of any available information, not specific to the gold industry, I would recommend you the forthcoming World Gold Council publication, “The Golden Road”, which does have a competence section on Ukraine. In terms of our own literature, obviously EBRD has a wealth of country data, but no, we have not undertaken an EBRD funded study of gold in Ukraine. Chair: OK, thank you. Mr Sokolov. Mr Sokolov: I can answer that the aim of Bank of Russia is to create liquidity in internal precious metal markets. Since the last two years, we are not so active in providing operations in the internal market. For this year, for example, the volume of operations, I mean the buying and selling, is less than 10% of the volume of our internal market. When we quote the gold price in our internal


market, we use the London fixing rate. In correspondence with the size of the export tariffs for gold in Russia, it’s 5%, plus export costs. That’s why we usually quote the purchase price as gold fixing, minus 5.5%. Thank you. Chair: Professor. Mr Alzhanov: As regards your question, let me more narrowly define it again. Until 1995, that is until the liberalisation of Kazakhstan took place and when we actually established a stock exchange, anybody was more or less allowed to get some gold. But this gold was basically bought by the National Bank, and if the National Bank did not want to buy gold, only then could the commercial banks and other buyers buy the gold. But beginning from 1998, the market was liberalised again. It’s now completely liberalised; now we haven’t got such a sort of stock exchange. Before, we had this system of priorities and we had this sort of stock exchange, but it makes it more difficult for the producers to attract investors and the Central Bank in Kazakhstan bought the gold at fixed prices in keeping with what I said. Now, the gold market is totally liberalised, the commercial banks also fund the gold mining and gold is then the property of the bank. The gold obtained by the commercial banks is basically exported; it is not sold by the commercial banks on our home market, like I said. We also pursue a number of projects where the Central Bank of Kazakhstan is one of the participants in carrying out those projects. In such a case, then the National Bank has the obligation, and the gold producers are obliged to sell the mined gold to the National Bank at world market prices. But basically all the gold produced is exported. Chair: Thank you, Mr Alzhanov. And thank you for those questions. Further questions? Yes. Questioner: Thank you. My name is Murray Pollock, from Toronto. I have a question regarding your bank, Mr Rachovides. You made reference to loaning only if it made economic sense, and then you also made reference to new projects. Are there many new projects that make economic sense in view of the current low gold price? And that would apply to the whole region. Thank you. Mr Rachovides: There are some extraordinary advantages to doing business in Eastern Europe and the CIS. As several people have found, there is a wealth of human resource, as well as mineral resource, which renders the cost base appreciably lower and provides better value than many alternative locations. As a counter to that, politically there are risks that can translate into fiscal costs. So if you like, the equation of, “When does a project make sense?” is slightly different in the CIS. Yes, I agree entirely, the low gold price has subdued the number of viable projects. We are, of course, examining projects everyday, and I do believe that there are a number of new projects that show good potential in the CIS. I haven’t mentioned, for example, countries like Bulgaria and Romania previously, and we do follow developments there closely. We’re certainly excited by the recent developments of mineralization in Bulgaria, for example. Yes, we believe potentially, and I would say, with the assistance of a slightly improved


gold price, that there are a number of new projects throughout our region that show potential. Chair: Thank you, Mark. I think our two central bankers don’t need to respond to this particular question. Further questions? Fine. Well, thank you Ladies and Gentlemen.


The role of gold in the international monetary system
Introduction by Dick Ware

I’d just like to outline very briefly the next session. This morning we had some practical messages as to how some central banks in this part of the world deal with their external assets. This session will deal with perhaps somewhat more theoretical concepts. First, Professor Mundell will give his views on the ever-evolving international monetary system. Might there be some sort of competition among the main currencies to be held in central bank portfolios or are there more fundamental factors involved in central banks’ decisions? Where, if anywhere, might gold fit in? Next comes Giacomo Panizzutti, who is extremely well-placed to give his views in this field since the BIS acts as agent for a large number of central banks. And, last but not least, is Michael Kuhn from the IMF. The issue of IMF quotas has always been contentious as it defines rights and duties in the Fund. The formulas deriving quotas are complicated. But there are thoughts that they might be changed. In the context of this conference, which is dealing with the system and with reserve assets, the importance of reserve assets in quota formulas is, obviously, vital. Although it may appear an esoteric subject, it is in fact one of very practical significance to every IMF member and the IMF has 183 members, virtually every country in the world. Finally, a few thoughts of my own before I give the podium to Bob. The international monetary system as it exists at the moment is paper-based. Reserve asset managers have a basic choice between dollars, euros, yen, sterling and Swiss francs. Can anyone forecast the future to the extent that they can choose the correct mix among these currencies? (I am of course assuming that there is no credit risk with such AAA currencies; but that would be a wrong assumption, I think; and we have already seen how Japan is no longer AAA. I am sure that you know the arguments already – and my colleague Rob Weinberg will expand on them in the next session – but gold has a negative correlation with virtually any other asset and a percentage should therefore be held. This is a fact which is true not only for the official but also the private sector. But I would like to go further.


Given that it is important that countries hold an element of gold in their overall reserve portfolios, which is something that was confirmed by Hans Tietmeyer this morning, there may be another way in which gold could benefit certain countries via their exchange rate arrangements. I have spoken about this on several occasions in the past, and I won’t bore you in great detail. But the point is that, for certain gold exporting countries – those for whom gold represents a significant proportion of their exports – it might make sense for their currency arrangements to reflect the importance of gold to their economy. In South Africa, the US, Australia and Canada it goes without saying that gold is important in its own right. But as part of such countries’ overall economies it may not register terribly highly. But for smaller countries the situation may be different. The current IMF Articles prevent a country pegging its exchange rate to gold and even, it appears to a basket including gold, though there are some arguments against that supposition. World Gold Council research will soon be forthcoming with good reasons as to why IMF Article IV2(b) should be amended. The inclusion of gold in a basket which anchors an exchange rate may not be appropriate for many countries. But for those countries where it suits, there should certainly be no prohibition against applying it. Here endeth the lesson. I now give the podium to Bob Mundell.


The future of the euro, the dollar and gold

Prof Robert Mundell, Nobel Laureate

Great pleasure to be here again and to talk about the international monetary system. In the background of the system are a number of trends, forces that are part of the landscape in which that system acts. The “new economy” is going ahead, despite the recession we’ll come out of the slowdown with a new level of productivity and growth. With globalisation a factor around, we’ve got the US economy, which for the past two decades has been the motor of growth in the world economy, now entering a period of slowdown. And then we have China’s economy, which has come into the forefront, and only in the recent few days from Doha we have China’s entry into the WTO system, and also Taiwan’s entry a day later into this system. And then in the background of all that, we have the advent of the euro and the fortunes of the euro. The euro becomes an important player in the system. So with that landscape, we look at what is sometimes called, rather optimistically, the international monetary system. It’s not really a system; it’s really the absence of a system. We had a system before 1971 and even for a couple of years from 1971-3 there was an international system, but the movement to flexible exchange rates ended the system; there’s no system. There’s now an arrangement of national currencies, maybe 200/190 national currencies collected together in groups and currency areas, and other currencies floating or at different stages of control. But within that, we look for strong cases and uniformities, and we find of course the dollar, euro and yen areas. You measure the importance of currency areas by monetary mass and monetary mass is more or less proportionate to GDP. The GDP of the United States is 10 trillion dollars, that of the euro area is 7 trillion dollars and that of the yen area in 4.5 trillion dollars. Go next down the list to the next largest currency area, you come to the pound sterling, 1.5 trillion dollars of GDP and then Russia fits in somewhere, I’m not quite sure where, but anyway China comes in at, recently, 1 trillion dollars. So the dominant forces in the world are clearly these three large currency areas: 10 trillion, 7 trillion and 4.5 trillion, and anything that occurs, any major reform or change in what we might optimistically call the architecture of the system, whatever that term means in this context, has to do with the exchange rates among those three areas. Well, everything moves over time and evolves, and the law of growth of economies and currencies is change. We can see the euro area expanding; we could imagine in 2 or 3 years time Britain, Sweden and Denmark in the euro area. We could imagine in ten years time another 10 or 12 countries, accession countries, in the euro area. So that in a dozen years, the euro area would comprise countries, maybe 27/28 countries with 500 million people and a GDP potential of 53

about 20 or 30 or 40% higher than the dollar area. So the significance of the euro is that, when it was created it became the number two currency in the world and it has the potential for changing the power configuration in the system. You have to look upon the international monetary system partly as a kind of oligopoly; if you think of the money industry, you have one big firm and some groups of smaller firms that are still large but combine together to contest the leadership of the first, and then a lot of other smaller firms in it. That element of oligopoly characterises the international monetary system too. With the creation of the euro, you get another big zone of monetary stability. And it is stable; the dollar area is stable and the yen area is stable to some extent. Although the yen area might be too stable, there’s too much control of inflation, prices are going down there, there’s too much deflation in Japan. But nevertheless, there’s no inflation in any of these three areas and the addition of the euro area helps by creating an alternative to the dollar, creating another area of potential stability. However, the big problem is the instability of exchange rates between these areas and this is the source of a great deal of difficulty. Question: should Britain join the euro area? Well, if you could imagine that the dollar/euro rate was going to be as unstable in the next 4 or 5 years as the DM/dollar rate has been over the past 25 years, you’d have to say “absolutely no”. Because 25 years ago the dollar was 3.5 DM, 5 years later it was half that, 1.7, 5 years later in 1985 it was 3.4 DM and 7 years later in 1992 it was 1.34 DM below that, and now it’s 2.2 DM. You just see that big movement of instability and if anyone said that the dollar/euro rate was going to be anything like that, how could an economist ever say that Britain, which is sandwiched in between these areas, should join the euro area or the dollar area? You’d have to sort out; what’s the cause of this gross instability especially between currency areas that, at least currently, have about the same rates of inflation. Why do you have huge changes and swings in the exchange rates between these areas? Well, if you find out the cause of the instability is that one area is always unstable; if the dollar area is always unstable, Britain, if it joined anything, should join the euro area. If the euro area’s unstable, Britain should join the dollar area. Or if both areas are unstable, or they’re mixed, it should stay apart. So that’s the way I would answer the question about Britain. Yet I believe that Britain really belongs to Europe and it would be better if Britain would come into Europe. And I do believe that the dollar/euro rate in the future is not going to be as unstable as it has been in the past. It’s turned out to be a blessing for Europe that the euro is now ninety cents rather than a dollar eighteen. It’s help to sustain European growth over this period. I think if the euro had been again a dollar fifteen, Europe would have gone into the recession a lot earlier and quicker than the United States even. But the depreciation of the euro has really been a blessing in disguise. Currency integration has turned out to be a great blessing for Europe. I think every country in the euro area now has a better monetary policy than they had before. Every person in the euro area has a more important currency than they


had before, they’ve got the number two currency in the world with the brand name recognition it will have when it’s created in a few months all over the world. You no longer have wage pressure against currencies that way you had before when the exchange rate was always a hostage for wage expansion. And you have the transparency of pricing and those things that exist. And for those countries that have histories of monetary instability in the south of Europe; Spain, Italy, Portugal and Greece, that had ten years ago interest rates of 1015%, now have interest rates below 5%. An enormous saving on the interest payments on the public that, and a big reduction on the costs of capital. All those countries now have a unified capital market in Europe. So these are enormous blessings that have come about for Europe. Europe is a great experiment. Even for Germany; I say that Germany has a better monetary policy than it had before not because the Bundesbank was poorer than the European Central Bank but because of the isolation of the German currency, it became a kind of trophy currency, an investment currency. It always created the tendency for it to be overvalued rather than undervalued. It was only by linking up with its neighbours that it could get its currency down and would make German industry much more competitive than before. Now we’re in this period of slowdown and the recession has started in the United States. The US has had a remarkable swing; since 1982 the US has been in continued expansion up to the first half of the current year, except for 9 months of recession 1990-1, three quarters of recession. Since 1982, the US economy has been continued expansion. Over that period it has created 41/42 million new jobs, more than the entire labour force of the complete German economy. So this is a remarkable change. That’s come about in large part because of the supply side revolution in the 1980s, which brought tax rates down in the 1980s from a top rate of 70% at the federal level alone, down to 28%. And a corporate tax rate from 48% to 34%. And a capital gains tax rate, which was in the 1970s something like 48% is now down at 20%. So the US economy has become much more efficient. There was some backsliding on these supply side majors under the first Bush and Clinton administrations but the top marginal tax rate is still 39.6%, no longer 70%. The US economy achieved the benefits of this; they also deregulated labour markets, they deregulated a whole range of processes. They had a genuine supply side revolution, which is about maybe one third of all the things they should have done, but that one third was enough to make it among the most efficient economies in the world. Meanwhile in Europe and Japan; these economies had been the star performers of the 1950s and ‘60s with zero unemployment rates, or two or three percent unemployment rates, and rapid growth rates and strong trade balance surpluses over this period. The United States was withering under excessive unemployment, sluggish growth and some creeping inflationary pressure and the balance of payments deficit, and was the almost basket case. It was, of course, the richest country and the other countries were catching up. You have a complete reversal of fortune in the last two decades with the US as star performers and the European and Japanese economies in the background. Europe has to have a


supply side revolution; I think that’s the path that Europe has to take – freeing up its labour markets, getting rid of that tax system that taxes labour at almost 60%. In Italy, labour is taxed at 59% automatically so that if an employer pays 100 units to a worker, 59 of those go to the government and only 41 is left over for the worker. This creates the underground economy and the malaise that exists in the European economies now. It’s not just a slowdown for Europe, it’s the need to recreate and reform and regenerate the youthful economy that countries like Germany, Austria and even Italy had in the 1950s and ‘60s. It’s hard to do that though because in the 1950s and ‘60s, government spending in Europe was something like 25-30% of GDP and now it’s over 50% of GDP You’ve . got so much government in the system, and so many social programmes that are hard to sustain and were put on when there were 4 or 5 workers for every pensioner. Now, as we move with the demographic revolution, there are to two or three, or even in the future maybe 1.5 workers for every pensioner; an unsustainable system. It’s no longer going to be possible to have, as you do in Italy, people retiring at the age of 55 when they live to be 85 in that rather healthy country. You have to change those fundamental things and it’s not a matter of a quick fix. It’s a matter of long run, hard work, more liberal policies in the European sense and getting back to free market policies. What about macroeconomic policies? Well, Europe created so much debt in the 1980s and ‘90s that the debt/GDP ratio in Europe went over 70% for the European Union as a whole. Remember when Maastricht was negotiated in 1991, the debt/GDP ratio was 60% and that was the target for each country. But by the time the euro came into being, it was 72/73% so that’s a major problem for Europe. The implication of that, which was not really thought of much then, is that there is no possibility of any kind of macroeconomic fiscal policy in Europe. Even if you had a Secretary of State that could manage European fiscal policies, there’s no conceivable Keynesian type policies that would have any benefit at all because every increase in government spending or tax cut that was involved would have to be matched by an issue of bonds to finance that. So any stimulus you’ve got in one direction would be taken away in another direction. The multiplier, in short, in Europe is zero. It’s a little bit the same also in the United States; its tax reductions that it’s undertaken will have some supply side effects and it will have a modest effect on the economy. The programmes that are being talked about for giving money away, a rebate to everybody, some people will keep up their spending with it but a lot of people will just repay debt with it and it won’t go into the spending stream, and it’ll increase the deficit or decrease the surplus and there won’t be much benefit to that. We’ve got to a stage where we have monetary policy but in the case of fiscal policies; if fiscal stimulus ever was a remedy, the remedy has disappeared. There isn’t much to be said in that respect. Even in monetary policy now, interest rates have come down in the United States from 6% down to 2%, an absolutely astonishing reduction in interest rates and that’s certainly helped to sustain the housing market and some things like that, but it hasn’t prevented the economy from going into recession. And the additional scope for further movements in that


direction is quickly disappearing. In Europe, the interest rates started 1.5/2% points lower than in the United States, and Europe was therefore slower in reacting and getting its interest rates down. It’s inhibited from doing so because it just cannot afford, under its current mandate, to let interest rates get too low and let the euro tumble below 85 cents and awaken inflationary pressure somewhere down the line. The tools really have gone out. If we look ahead, along the future, we see the US current recession. The most optimistic prediction I’ve seen of it is that it’ll hit bottom by the second quarter of next year and the third quarter will see positive growth again. This current quarter, the third quarter, was negative growth and if the next quarter is negative growth and the first two quarters of next year are negative growth, that’s a full year of negative growth, which makes it a steeper recession than that very demoralising recession of 1990 and 1991. That recession was very demoralising; it was the first computer recession. The computer replaced one whole tier of middle management and it was a depressing recession because it hit educated white collar workers that always thought of themselves as being protected before. This one could be, therefore, worse. The IMF yesterday came out with a forecast for growth for the United States of 0.7 or 0.4%, something like that, anyway less than one percent for next year, which is a very depressing phenomenon, especially coming off the highs of growth of 5% on the average from 19952000. Remember, suddenly in 1995, the fruits of the computer/IT revolution combined clicked in and productivity jumped, growth jumped, from 2.5% to 5%. That was a wonderful kind of growth because it was connected with very low inflation and with a decreasing deficit and a rising surplus over time. So everything that looked rosier then doesn’t look rosy any more. The fact is that at a certain point, the US and Europe, there isn’t much they can do individually to cope with this slowdown recession next year if it turns out much worse than people expect (and that’s a definite possibility). Is there much they could do together? Directly not; it’s hard to see them sitting down and agreeing either on fiscal policy majors or joint monetary policy majors that would really going to do much good. Europe is going to be worried too much about pushing too hard on the monetary string without that weakening the euro further. My own view is that what we need is now a joint policy; we’re missing a tool in the whole apparatus of the world economic structure, a tool that we had when we had an international monetary system. Whenever there is an international monetary system, there is always a concern about global liquidity. And the IMF in the 1950s and ‘60s would come out with reports of global liquidity and there was a provision every five years, a quinquennial review, of quotas. A world currency was created with the SDR; the SDR was a gold substitute because the SDR as it was created was defined in terms of the 1944 gold dollar, one thirty fifth of an ounce of gold. When the prices rose as they did in the 1970s, oil prices went up and the gold prices shot way up, what did the IMF do, what did the members of the IMF do? Well, they stripped away the gold guarantee from the SDR and they made the SDR powerless, they killed it, they killed the SDR as a reserve asset. I think it was a mistake, I also think it was illegal because it was a


treaty and it was never repudiated in a sense. It might be a matter of dispute whether the second amendment made it legal or not. But when it was done it was an illegal act. What I would do, would be to have an issue of some unit of purchasing power, and I would call them as I did in a plan I had for world currency in 1948, that I gave to Congress, the “intor”, using the French word for gold for the last part of it. And define that as the 1944 gold dollar. What I would propose then is an issue of “intors” that are the original SDR as defined by the first amendment of the articles of agreement as one-thirty-fifth of an ounce of gold and have an issue of let’s say for a start, 50 billion intors. That would be a big amount in the world economy. It would be something like 400 or 500 billion dollars of purchasing power. With that instrument delivered into the system, you’d then have the basis on which countries would feel much more comfortable with expansion in a wide range of different things. It would create the opportunity for countries to all have increases in exports at the same time. So that would be the way in which I would go. Thank you. Chair: Thank you very much, Bob, for a very useful survey, I think, of the current economic scene. As I said earlier, if people would like to ask a question or two of Bob at this stage, we will have general questions at the end and I’m sure Bob will still be around if you’ve thought of something between now and then, but if one or two of you would like to ask a question now, please do. Questioner: I’m from the Bank of Japan. I’d like to raise one simple question: Professor Mundell, do you think there should be a single currency like the euro in Asia? Professor Mundell: That is a very important question, and I wish I could give a short answer to it! The answer is “yes” to the question of the need for a currency in Asia, but probably no to a single currency. Asia has a far lower degree of political integration than Europe and some degree of political integration is absolutely essential before moving toward a single currency. I don’t think that there is anything like the degree of institutional development or political integration necessary to have countries scrap their own currencies and replace it with a single currency. At the minimum, you would have to establish Asia as a security area, i.e., a zone in which war is absolutely ruled out. Europe has a higher degree of political integration than Asia and is even contemplating working together on defence and foreign policy arrangements, and that makes it possible for the European countries to achieve a single currency. It imposes to a certain degree some irrevocability and irreversibility. Nevertheless I do believe Asia desperately needs a common currency in order to defend itself against the instability imported from large fluctuations in the dol-


lar, euro and yen exchange rates. By a common currency, I mean just that, a parallel currency that the countries used in common, but does not involve going to the almost irrevocable step of scrapping their national currencies. Each of the national currencies in Asia could be linked or even locked to a common Asian currency and the size of Asian trade would be such as to make that an important element in the world monetary system. I am aware of course of the difficulties of finding the leadership in Asia that would enable the creation even of a parallel currency. A natural start in this connection might be the so-called “APT” group, the now-ten ASEAN countries, plus three—Japan, South Korea and China. That group could in principle be the framework for creating the common currency. But even APT has great problems. Frankly, the issue turns partly on relations between the two superpowers, Japan and China. Could they consent to the high degree of cooperation needed without worrying about the issues of control, dominance and future security. Yet you could hardly have an “Asian” currency area without including China and Japan. I have recently come to a little change of mind on this subject. I think it might be better to start with a different framework, even larger than APT. I was last month invited to speak at the APEC CEO meeting in Shanghai, and I had the great advantage in being “positioned” to speak just after President George W. Bush, and so I had a great audience! I talked about the possibility of an APEC (Asian Pacific Economic Cooperation) currency. To be sure monetary cooperation is not strictly on the APEC agenda, but I nevertheless introduced it. APEC seems like a very large area because APEC would count not just the APT countries, but also Taiwan, Russia, Canada, the United States, Mexico and other coastal Latin American countries. The more I thought about an APEC parallel currency the more I liked it! It would finesse the political problem of APT and because it could include the dollar and the ruble and the peso as well as the yen and the yuan, it would be much more multinational. It would also help to solve the problem of Russia, a country which, at least for the time being, is excluded from the euro area. The natural currency leader in the APEC currency area would be the dollar. Now I am not suggesting an APEC dollar forever. We have to be aware of the potential difficulties of fixing to a floating dollar. But the only feasible way to get the system going in the near future would be to base it on the dollar. The dollar itself is (or was!) the “ghost of gold” and an APEC currency, should there prove to be sufficient political demand for it, would be the “ghost of the dollar.” An alternative would be a basket of the dollar and yen (or the dollar, yen and euro, or the dollar, yen, euro and yuan), but I do not believe that would be negotiable given the present state of the Japanese economy. I should make clear that, except in one case, I am not advocating dollarization. Each country keeps its own currency but uses the ASEAN currency for international purposes, and it keeps its own currency fixed to the ASEAN currency which, for the first phase, will be the US dollar, just as Hong Kong, China and Malaysia keep their currencies fixed to the dollar at the present time.


I am not an advocate of dollarization in general as a means to monetary stability. Monetary stability implies a whole range of policies that are essential, and dollarization, without those other policies being instituted, would not work. I know that many economists think that dollarization will bring about or force monetary and fiscal discipline. But if the political will for monetary and fiscal stability is not there, even dollarization will break down. If the political authorities insist on spending measures that cannot be sustained by the tax system, the buildup of debt will eventually lead to a choice between default or abandoning dollarization and as often as not the latter will be chosen. I am not saying that dollarization will not be successful in some cases, but only that it is not a panacea where the underlying political will to balance the budget is lacking. Having said that, however, there is one exception I would make. In countries that have demonstrated that they have the political will to achieve fiscal balance and monetary balance, dollarization might provide the “icing on the cake” that is otherwise lacking. Countries that have been successful in maintaining currency board systems, for example, and have at the same time kept fiscal discipline and not allowed debt levels relative to GDP to soar, might very well gain from the extra security and confidence that dollarization could provide. This would be most apparent in the case of small countries where the seignorage cost is unlikely to be excessive. An excellent case in point is Hong Kong. If you dollarised Hong Kong, you’d suddenly have in Asia a rock-solid currency in Asia that would be a reference point for New York interest rates, and it would greatly assist in furthering the goal of a future APEC currency. A currency area that included the United States, Japan, China, Russia and perhaps Canada, Australian New Zealand, the ASEAN countries and several Latin American countries would be by far the largest currency area in the world and would account for well over half of world output. It would not only be of great assistance to Asia and North America but it would contribute to the stability of the world monetary system. It was remarkable to witness, at this APEC meeting in Shanghai in October 19-20, 2001, a continuation of the love affair between Bush and Putin, and China’s remarkable stress on cooperation with the United States in matters of economics, finance and politics, as well as Japan’s continued interest in furthering openness in trade and financial cooperation.. It could not have been predicted before the September 11 attacks, and it represents a whole new ballpark for global cooperation. To summarize my long answer to your very important question, I should say that the most feasible route to creating an Asian currency lies in first establishing a currency area of fixed exchange rates among the major APEC countries with the dollar as the pivot for convergence of their economies. In the process of creating that convergence, an APEC Monetary Fund devoted to support of the fixed exchange rate systems would be possible and desirable, modelled, perhaps, partly on the basis of the Bretton Woods arrangements established in 1944. After con-


vergence is established, alternatives could be considered that would, if judged necessary, generalize the dollar anchor to include other relevant currencies that would provide protection against the possibility—perhaps remote at the present time—that the dollar would become unstable. I know all this sounds radical if not utopian today. But once one considers the real benefits for Japan and the rest of the world that would result from stabilizing the yen-dollar exchange rate, the approach starts to sound practical. If the yen-dollar rate were fixed, joining China, Hong Kong and Malaysia, much of the battle would already be won. The advantages to Russia and Mexico of entering this stable currency area would become apparent, once their economies had been brought into the fold of monetary stability. In my opinion, we will hear more about this issue at the next APEC meeting, which will be held next November in Baha California under the auspices of APEC’s new presidency, which is Mexico. Chair: Thank you very much, Bob.


The BIS and gold
Giacomo Panizzutti Head of Foreign Exchange and Gold Bank for International Settlements This document represents exclusively the views of the author and should not be interpreted as reflecting those of the Bank for International Settlements or the official sector.

Mr Chairman, Ladies and Gentlemen. It is a great pleasure to be with you at this conference and I am grateful for the opportunity to offer some thoughts about the gold markets. The World Gold Council suggested that I talk about the BIS and Gold. On reflection I felt that I should expand my presentation and talk about a couple of subjects which I hope are of interest to all of you. Today I would like to say a few words on: The outlook of gold as an Asset Class The 1999 Central Bank Gold Agreement The BIS and Gold The outlook of gold as an Asset Class When addressing the issue of Official Gold as an Asset Class the first question has to be: - should gold be judged by the same criteria as other reserves? If the answer is no, then the issue simply fades away and the central bank is only left to determine what the optimal percentage of gold might be and, possibly, whether they wish to make a return by investing a part or the whole of their gold holdings. If, on the contrary, gold should be treated in the same way as currency reserves then the question in which Asset Class it should be allocated is justified. Let me tell you straight away that, in my opinion, official gold reserves should be treated by central banks quite differently than currency reserves and they should therefore be allocated on an Asset Class on its own. Some of you may not be very familiar with the gold lease markets. Therefore, before explaining why I believe that gold need to be treated differently than currency reserves let me just spend a few minutes on the subject. Essentially there are three major and distinct participants in the gold deposit market:


Central banks looking for a return on their gold reserves by lending them, gold mining companies who need to borrow metal to use in accelerated supply programmes and, in the midst of these, the “bullion banks” which manage the credit risk between these sectors and often run mismatched tenor deposit books. Another minor class consists of participants taking some speculative short positions and consignment stock holders. Central banks add liquidity to the market either by gold deposits - where they take full risk on the commercial banks to which they typically lend – or in the form of swaps where central banks lend gold and in return receive an amount of currencies. In a gold deposit there is obviously a flow of principal from the lender to the borrower. At maturity the principal is returned to the lender along with the accrued interest, which is payable either in gold or in currency.


Gold Market Liquidity

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Back in the late seventies some of the more sophisticated central banks started to place, in a very low scale, gold on deposit. At that time producer hedging was very limited and the demand for gold loans was therefore small and mainly concentrated at the very short end. This was reflected in the interest rates, which, at that time, were fluctuating between ¼ to ½ per cent p.a.



Distribution of global gold holdings

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During the subsequent years demand by producers expanded very rapidly. As a consequence official sector liquidity increased from 900 tonnes in 1990 to 2,100 tonnes in 1995 to reach 4,700 tonnes in 2001 – an increase of more than 500% over a period of ten years. It is estimated that a further 500 tonnes of gold is lent from private stockpiles. Not only has there been a growing tendency for central banks to lend gold but tenors have been increasing over time as well. Traditionally, central banks have, and to a lesser extent still are, lending some of their gold for relatively short periods - often not exceeding 12 months. Over the past couple of years there has been a growing tendency for central banks to lengthen their maturity profile to take advantage of the pick-up in yield. It is believed that the 1999 Central Bank Gold Agreement may have resulted in a fundamental change in the management of gold reserves. It should be noted that the 15 signatories of the agreement now hold approximately 15,300 tonnes of gold or 47% of official holdings; the other two large holders being the United States and the IMF. As mentioned above, prior to the Agreement there had been some interest to lend beyond one year – but by no means a trend. However, in the last couple of years we have seen a remarkable transformation with trades up to 3 years or even longer becoming more common. The process has been two-fold. Firstly the poor returns on short-term gold deposits have led the official sector to look for higher yield – and a move along the curve has been the simplest way to achieve this. Secondly, this trend to the longer maturities has been very much led by the European central banks. Since the fate of their gold holdings are effectively determined until the expiry in September 2004 of the Agreement there are few issues about maintaining short-dated liquidity in case of a sale and therefore 64

little hesitation about locking up gold balances for longer periods. Credit issues have been largely negated by the growing use of collateral agreements. Some 80 out of 190 central banks globally are now providing the liquidity needed by the market. It is believed that ten to fifteen central banks are active in the derivatives markets, this number has been bigger, but declined in the past years. But let me get back to my initial point. Central banks now make a distinction between liquidity portfolio and their investment portfolio. Over the years, central banks’ portfolio managers have reached a level of sophistication that is often comparable to that of their peers in the private sector. A rise in reserves often allows central banks to extend, for at least a part of their currency reserves, the duration and, as a result, to increase the return on their investments. However, despite these revolutions, one aspect has not changed and that is liquidity. While central banks are now increasingly prepared to extend the duration of their investment portfolio, often as far out as ten years or even longer, they remain nevertheless limited in investing in very liquid instruments, such as Government papers, Agencies or BIS securities. This brings me back to my initial remark that gold needs to be treated as an Asset Class on its own. How liquid are gold placements and how could central banks become more active in gold reserve management?. The ability to efficiently mobilise any reserves without undue market impact is an essential condition for sound reserve management. A liquid market environment is also essential for portfolio managers to be able to take advantage of any expected interest rate fluctuations. In my opinion, gold should not be treated in the same way as currency reserves as long as it does not offer adequate liquidity. Having said this, it is not my intention to suggest that central banks should not place part of their gold on deposit. A clear distinction should be made between central banks having large reserves, both in currency and gold, and these central banks with relatively small currency and gold reserves. Large official gold holders could probably afford to place part of their gold on deposit, even for longer periods, as they may have no imminent need for their gold and therefore be less concerned about the liquidity aspect. On the contrary, smaller and less reserve rich holders may need to consider very carefully the issue of liquidity as they may need to mobilise their gold at short notice. The 1999 Central Bank Gold Agreement Let me now turn to my second item, the future of the Central Bank Gold Agreement. Since September 1999, I have been asked on several occasions if and when the Agreement will be extended. The answer is – I do not know. I can only repeat what has been said in the original statement. The Agreement will be reviewed 65

Bank for international settlements

The 1999 European Central Bank Gold Agreement
The European Central Bank and the central banks of Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal, Spain, Sweden, Switzerland and England announced that: • • • Gold will remain an important element of global monetary reserves The signatories will not enter the market as sellers, with the exception of already decided sales The gold sales already decided will be achieved through a concerted programme of sales over the next five years. Annual sales will not exceed approximately 400 tons and total sales over this period will not exceed 2,000 tons The signatories of this agreement have agreed not to expand their gold leasings and their use of gold futures and options over the period This agreement will be reviewed after five years

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after 5 years. I personally believe that the Agreement will, in one form or another, be extended. As I mentioned on previous occasions the signatories may consider various scenarios when they discuss the future of the Agreement. I would envisage the following three possibilities: - the Agreement is not extended, - it is extended in exactly the same form as at present, - or it is extended but in a modified version.

Gold after 2004
Possible scenarios before or at the expiry of the CBGA
• CBGA is not extended • CBGA is extended in its present form • CBGA is extended but in a modified version
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If the Agreement were not extended in any form, the market would certainly find that disappointing. Should the Agreement be extended in its present form, it would be positive – as long as both supply and demand for gold has not changed substantially in the meantime. I believe that the most likely scenario is that the Agreement is extended in some modified version. This could have both positive and negative implications for the market. On the positive side: a reduction in the amount of gold to be sold would provide some longer-term support for the gold price. An increase in the number of signatories might also be considered in a positive manner. 66

A reduction in the lending activity of the signatories would also tend to support the price, but as I realise that the market would not appreciate such a reduction, I would exclude such a possibility. Among the possible negative outcomes: Should one of the existing signatories drop out, that could be damaging. Any increase in the size of sales or lending activity would be seen as negative unless it had been prompted by a lasting sharp increase in demand or by a substantial reduction in supply. The BIS and Gold Finally, let me spend a few minutes on the BIS and on its involvement in gold. The BIS is the oldest but at the same time least well known of the international institutions. It is owned by some 50 central banks, including the central banks of all the major industrial countries and a number of emerging market countries as well. As the focal point for central bank meetings, negotiations and co-ordination, some of the mystery that has in the past surrounded central banking has also surrounded the BIS. The BIS is best described as the central bankers’ bank. Of course, unlike its members and customers, the central banks themselves, the BIS does not have the power to create money. Instead the BIS provides a forum for central bank meetings, co-operation and co-ordination. It also provides commercial banking

BIS and Gold
• Security - A claim on the BIS is seen as comparable a top-rated insutrial country • Liquidity - The BIS maintains a highly liquid enabling it to mobilise large amounts within • Confidentiality - Central banks are able to operate discreetly through the BIS when they do not wish activities to be read - or misread - by the
©2 00 1 Ba nk for Int ern ati on al

services to the central banks. In particular, the BIS takes foreign exchange reserves from the central banks and places them back into the market. This classic financial intermediation role originated with the founding of the BIS in 1930. At that time, the BIS was established to manage and re-invest in Germany the postWorld War I reparation claims of the victorious powers. These functions soon faded into insignificance when reparation payments ended with the Great Depression and the coming to power of the Nazi Government in Germany. But by that time, the BIS role as a financial intermediary between the central banks and the market had been established. The BIS has continued to play this role ever since. 67

Why have the central banks over the past 71 years continued to place funds with the BIS in ever-increasing volumes reaching over $150 billion at the latest count? The main reasons are the following: Security - A claim on the BIS is seen as comparable to a claim on a top-rated industrial country government, given our capital strength and the backing of our central bank ownership. Liquidity - The BIS maintains a highly liquid book enabling it to mobilise several billions within hours. Confidentiality - Central banks are able to operate discreetly through the BIS when they do not wish their activities to be read - or misread - by the markets. But let me now turn to gold. Gold plays two roles in the BIS balance sheet. First, a symbolic role in that we continue to denominate our own accounts in Gold Francs. When the BIS started in 1930, it adopted the Swiss Gold Franc - Switzerland’s currency at that time. A few years later Switzerland, following most other currencies, broke its link with gold, but the BIS did not, continuing to denominate its accounts in Gold Francs. Today we still maintain this practice. We present our accounts in Gold Francs - a unit defined as 0.29032258… grammes of gold. This is mostly symbolic. Since we fix the price of gold at $208 an ounce, one Gold Franc is fixed at $1.94, so our balance sheet is in reality denominated in US dollars. Secondly, and more importantly, gold plays a real role in our asset holdings. We own 192 tonnes, which we value in our balance sheet at $208 an ounce or approx. $1.3 billion. In addition, we hold a much larger amount of gold for our central bank customers. This can be seen from the balance in our latest annual report. In addition to owning gold for its own account as part of its overall investment strategy, the BIS also provides a wide range of gold services to its customer central banks. These services include financial intermediation, buying and selling of gold for spot and forward delivery, providing technical advice on hedging, and arranging location swaps to facilitate central bank management of physical gold. I am not giving away any secrets by saying that we have over the past years carried out substantial buying and selling programmes for various central bank customers. The aspect of confidentiality mentioned before has certainly played an important role in selecting the BIS to carry out such transactions. The BIS has attached the highest importance in executing such transactions in the best interest of the customer without causing any negative impact to the market. So far we have been successful.


External reserves in the IMF’s quota formulae
Michael Kuhn Deputy Treasurer International Monetary Fund

It is a pleasure to be here today at the annual World Gold Council Conference. I am particularly pleased to participate in this distinguished panel on the international monetary system, a topic that has been at the core of the IMF’s work since its Articles of Agreement were negotiated over 50 years ago at Bretton Woods. The international financial system has changed nearly beyond recognition during the past decades, especially after the collapse of the postwar system based on fixed exchange rates and a direct link to gold. But the basic multilateral framework created at Bretton Woods has lost none of its relevance, with the IMF as the central cooperative forum for managing international interdependence in a way that takes account of the interests of all countries, large and small. My remarks will focus on the IMF as a cooperative institution and, in a look behind the scenes, on the current debate whether the financial and governing structure of the IMF remains fully representative in today’s world. This debate has centred on the role and relative size of IMF quotas. At the conclusion, and in response to the questions of many of you, I will briefly touch upon the current, and much diminished, role of gold in the IMF. The IMF today The IMF is probably best known to you as the financial institution that helps countries in balance of payments difficulties, put together policy programs, and financial rescue packages. This role of crisis manager and lead agent in supporting countries that are in economic and financial trouble remains critically important for the stability of the global financial system. However, the IMF is more than a lender and financial crisis manager. Equally important, if not of greater significance, is the Fund’s role in promoting good policies—sound money, prudent fiscal policy, strong financial sectors, and open markets—and thus helping to prevent crises before they happen. Crisis prevention has become a much more important aspect of international cooperation, and recent developments demonstrated the need for strengthened bilateral and multilateral surveillance—the key responsibility of the IMF. Among the many recent IMF initiatives for reform of the international financial system, the decision to become much more open and transparent stands out as nearly revolutionary for an institution that used to be very secretive. Indeed,


without this move to greater openness, my remarks here today would not have been possible. Some years ago, the Fund published only a few background papers. On surveillance, the only publicly available information was a very brief summary in the Fund’s Annual Report, and details of Fund programs were considered highly confidential. Today, the Fund publishes a wealth of information about its policy advice, lending arrangements, policies and assessments on key topics, as well as all its financial activities. This information, including the papers and summaries of discussions in the IMF Executive Board referred to later, is all available on the IMF website. However, one important aspect of the IMF, its financial and governing structure, has remained essentially unchanged since its inception. This has raised questions whether the Fund’s internal structure and decision-making process are still adequate for a truly global institution, which has grown from the original 29 members to 183 members at a time that tests its cooperative spirit with difficult and wide-ranging decisions. Concerns about the internal structure of the Fund have centred on the distribution of quotas in the IMF. The role of IMF quotas Quotas play a central role in the IMF. Each member country has a quota, which serves several financial and organizational functions: the provision of financing to the Fund, access to loans from the Fund, and voting power in the Fund. Most important for the Fund as a financial institution, members have to pay their quotas in full, with one quarter typically paid in usable foreign exchange and the remainder in domestic currency. Prior to the breakdown of the Bretton Woods system, the foreign exchange portion was paid in gold, and these payments in gold were the main source for the Fund’s gold holdings. Quotas are broadly determined by members’ relative economic positions. The distribution of quotas is therefore heavily weighted towards the advanced industrial countries. Together, these countries account for some 62 percent of Fund quotas and thus of the voting power in the Fund. The United States holds over 17 percent of the quotas and votes, followed by Japan and Germany with slightly over 6 percent each, and France and the United Kingdom with 5 percent each. The European Union countries together hold some 30 percent. Quota shares in the IMF have not changed much in recent years. This has given rise to concerns that the current distribution of quotas gives a disproportionate weight to the economic powers of the past at the expense of countries that have experienced recent rapid economic growth. The distribution is seen by many as no longer representative of the current economic system in which the Asian countries in particular, and emerging markets more generally, play a significant role. Indeed, anomalies have emerged as some countries have grown relatively rapidly and are able, willing, even anxious, to assume greater responsibility in an increased role in the global financial system.


Quota formulas The central role of quotas has led to considerable interest in and debate about how quotas are determined. To guide the process of quota determination, the Fund has developed quantitative criteria, or formulas, to “calculate quotas”. These formulas have been refined, revised, and expanded to take account of the growing number of countries that have joined the Fund over the past decades. Today, there are four variables designed to take account of the principal financial functions of quotas. These are combined in a variety of ways to reflect the economic structures of particular groups of members. The variables include (i) GDP as the broadest measure of capacity to provide resources; (ii) openness, as reflected in current account flows, to measure integration in the world economy; (iii) vulnerability to external shocks based on the variability of current receipts; and (iv) reserves, including gold valued at the historic price of SDR 35 per fine troy ounce (about US $45 at current exchange rates). The formulas were last updated some 20 years ago. As a first step in addressing the concerns that quotas no longer reflect members’ relative economic positions, the Fund embarked on a revision of the quota formulas. A panel of outside experts was commissioned in 1999 to provide an independent view on possible reforms. The report of the experts emphasized the need for greater simplicity and inclusion of a variable that would take account of the growing role of international capital flows. Specifically, the experts recommended a major simplification involving a single formula with just two variables, GDP and variability of current receipts and long-term capital flows. When the IMF’s Executive Board considered the experts’ report last year, broad agreement emerged on the need for simplification and updating of the formulas. However, concern was expressed that the formula recommended by the experts, once quantified, showed an increase in the concentration of quotas in the largest members, which ran counter to the objective of a more balanced distribution. This outcome is perhaps not surprising, given the predominant share of the largest countries in world GDP. Building on the work of the experts, the Fund staff analysed various economic criteria and alternative formulas in a recent paper, which was discussed by the Executive Board last month. A broad consensus is now emerging that the traditional economic variables should continue to be used but modernized to take account of the growing role of international capital flows. One open issue is whether foreign reserves remain a useful measure of capacity to provide financing to the IMF, especially for countries with access to international capital markets. In this context, the question whether gold holdings should be valued at market prices rather than historic cost will also need to be addressed. While a number of countries use market prices, the IMF Articles of Agreement prohibit the Fund from taking measures that could result in an offi-


cial price for gold. Use of market prices could also artificially inflate some countries reserves since it is unlikely that current prices could be realized in the event of large market sales. The debate on quota formulas is continuing. Clearly, formulas can only be fully specified once the distribution of overall quotas, at least among broad country groups, has been decided. And this is essentially a political decision. But it is highly unlikely that any formula with economically meaningful variables would result in a significant reduction of the calculated quota shares of the advanced economies, given that these countries continue to be the largest participants in the global economy. Changes in actual quotas Agreement on revised quota formulas is a necessary condition for adjusting actual quota shares. But it is not sufficient. In particular, it would be difficult to adjust actual quota shares in the absence of an overall increase in quotas. This is due to the fact that no member can be required to accept a reduction in the size of its quota. Since all shares must, by definition, add up to 100 percent before and after a quota alignment, an increase in the shares of some must be offset by an equivalent reduction in the shares of others. As countries that would experience a decline in their quota share cannot be forced to accept a decline in the size of their quota, the only way to effect the decline in quota share is to increase the size of the quota of other countries, and thus increase the size of Fund quotas as a whole. General quota increases normally take place as the result of the five-yearly general reviews of IMF quotas. Since its inception, the Fund has conducted eleven general quota reviews, and quota increases were agreed in nine of these reviews, including the last review, which was completed in early 1998. The next general review of quotas is scheduled to commence in January of next year. In the absence of a general increase, an alternative, and much more limited, approach could be considered in which a very few countries are given selective increases in their quotas. Any changes in quota shares, if and when they are agreed, are not likely to alter the IMF quickly or dramatically. Nor would a large change be desirable. For the IMF as a financial institution, the provision of financing remains of paramount importance, and the major industrial countries will remain the largest members and principal creditors of the Fund, given their weight in the world economy. In terms of access to Fund resources, quotas have become less important as the Fund’s policy has become more flexible over the years. Under the original Articles of Agreement, the maximum amount of a loan was set at 100 percent of a member’s quota, in order to balance the obligation to provide resources with the right to obtain financing. Under current policies, a member may borrow up to 100 percent of quota annually, provided outstanding loans do not


exceed 300 percent of quotas. These limits can be and are exceeded in exceptional circumstances. In light of members’ evolving balance of payments needs, the Fund has also introduced special policies for situations requiring very large commitments which have no stated limits, but shorter maturities and higher interest charges to encourage early repayment. Since the Mexican financial crisis in 1994/95, and particularly following the Asian crisis in 1997, the size of IMF loans has increased significantly reflecting the much larger financing needs that emerged. At present, the bulk of financing is provided under programs involving exceptional access to IMF resources. Finally, while quotas also serve as determinants of voting power, the IMF has a long tradition of making decisions by consensus rather than by counting votes. In this tradition of consensus, and with 12 of the 24 seats on the Executive Board, the developing and transition countries have had notable success in ensuring that their interests are recognized and their concerns addressed. Gold in the IMF Responding to the questions many of you have posed, I would like to conclude with a few comments about the current role of gold in the IMF. The slightly over 100 million fine ounces of gold owned by the IMF make it the third largest official holder of gold, after the United States and Germany. While the role of gold in the IMF has diminished greatly over the years, the Fund has a continuing interest in gold market developments. Gold occupied a central role in the postwar international monetary system and, therefore, in the IMF as the institution intended to oversee the operation of that system. The collapse of that system in the 1970s led to a fundamental change in the role of gold in the IMF. The change was incorporated in the Second Amendment of the IMF Articles of Agreement, which became effective in 1978. Today, the role of gold in the IMF is largely as a safety net. Gold remains a valued asset but is not used in the Fund’s regular activities. The IMF no longer has the authority to buy gold and may only accept gold in payments from members on the basis of a specific decision requiring an 85 percent majority vote. The IMF may decide to sell gold at market prices or to “restitute” gold (i.e., sell gold at the old official price to countries that were members in 1975) by the same high majority vote. Finally, the IMF may not engage in many of the standard transaction that occur in the modern gold market, including loans, leases, swaps or gold collateral for loans, and must avoid managing the gold price or establishing a fixed price in the market. The IMF has adopted broad principles governing its gold policies. These principles acknowledge that gold provides fundamental strength, operational flexibility, and additional credibility to the Fund’s precautionary balances. Therefore,


any gold mobilization should avoid weakening the Fund’s overall financial position. They also recognize that retention of relatively large gold holdings would enable the Fund to meet unforeseen contingencies, and that the Fund has a systemic responsibility as a large gold holder to ensure that any gold mobilization avoids causing market disruption that could have adverse effects on gold holders, producers or the market. Finally, any sale of gold should not weaken, and preferably should strengthen the Fund’s financial position, by retaining any capital profits and utilizing only the income derived from the investment of those profits. Consistent with these principles, the IMF undertook off-market transactions involving 12.9 million ounces of gold in 1999/2000 to help finance Fund participation in the international effort to reduce the debts of the heavily indebted poor countries (HIPC). The initial proposal was to sell the gold in the market and use the income from the investment of the profits to provide grants to eligible poor countries which would be used to repay IMF loans. However, concerns expressed by gold producers and others about the possible market effects led to a change in approach, even though the amount of gold to be sold was modest. In the event, the gold was sold to Mexico and Brazil in an off-market transaction at market prices and the same amount of gold was accepted at the same price from these countries in repayment of IMF loans. The profits from the sales have been invested and the income is being provided to a special Trust Fund and will be disbursed to HIPC participants as needed. The IMF’s effort to be responsive and responsible involved substantial cost to the institution in terms of liquidity and income at a time when other official holders were supplying much larger amounts of gold to the market. Moreover, the Fund transactions were fully publicized in sharp contrast to the lack of transparency that occurs in other cases of gold sales by official holders. This demonstrates the Fund intends to be a constructive market participant and that any future mobilization of gold would be undertaken in a manner to avoid market disruption.


Questions: The role of gold in the international monetary system
Chair: First question, back there. Questioner (John Crow): Bob, you made a fairly categorical statement that the euro couldn’t stand going below 85 cents because of inflation. If Europe is entering into recession, could you explain why you are so categorical? Let me also note that the pass through from exchange rate change into inflation seems to have diminished substantially in recent years, including in Canada, by the way. Professor Mundell: Well, precise limits on exchange rates are arbitrary but when the euro went down below 85 and hit an all time low of 82, it began to have the immediate effect of raising the prices of international goods and starting up, down the line, wage increases and therefore the basis of core inflation. I know that the European Central Bank has a mandate to target inflation and not exchange rates. However, depreciation is one of the best forecasts of future inflation, and if a central bank ignores these signals it is making a big mistake. A few months down the line, exchange rate changes always affect future inflation. Now about the passthrough effects. It is not so much a question of them having declined. It is rather that the time period in which they are effected differ between economies partly because of the degree of openness and partly because of the direction of trade. Countries like Ireland and Spain, on the periphery of the continent, experience more immediate passthrough effects from the euro’s depreciation than countries in the core, like France and Germany. Further depreciation of the euro would be experienced first in those countries but the other countries will not in the final analysis escape. Chair: Can I just add a comment there? John said that he thought there was Canadian evidence that the pass through from exchange rate depreciation to inflation was less than it used to be. But my comment on the other side would be that the Monetary Policy Committee of the UK has made it quite clear in its pronouncements in recent months that it does think that there’s a pass through, and it’s concerned about the possible decline in sterling, perhaps to align itself with the euro before the UK joins, and it takes that into account very much in its monetary policy decisions. Sorry for that personal observation. Professor Mundell: Let me elaborate on this. You have to distinguish between different situations. Sometimes exchange rate changes have an effect upon inflation and sometimes they don’t. Consider the situation before and after the 1992 ERM crisis. First consider the British situation. On the eve of Britain’s entry into EMU in October 1990—the month of German unification—Britain had an inflation rate of


almost 10 per cent. It entered the ERM at a rate of 2.95 marks per pound. When it left the ERM on “Black Wednesday”—September 16, 1992—the inflation rate had been reduced to 4 per cent. This was a great demonstration of how a nominal anchor can be successful in reducing the inflation rate. But the excess of Britain’s inflation over Germany’s led to and aggravated the overvaluation of the pound. As a result, when Britain left that currency area, there was substantial room for depreciation without much additional inflation. There’s also the case of the Italians. In the spring of 1992 prices of real estate near Rome and other cities doubled, clearly anticipating a devaluation. When the Italians left the ERM in September 1992, the mark rose eventually from 800 lire to 1000 lire. Many people were astonished that the depreciation did not cause much inflation. The fact was that the inflation had preceded the devaluation when it was anticipated. The depreciation is the consequence of overvaluation and therefore does not have a pass-through effect. But it is a very different case if the exchange rate change occurs from a position of equilibrium, as is frequently the case during the phenomenon of overshooting. In that case an overshooting that leads to undervaluation leads to an increase in the prices first of traded goods, then wages and then domestic goods. The depreciation is a cause of undervaluation and therefore provokes the consequence of compensatory inflation. Let me mention now the case of Canada, a country that pioneered flexible exchange rates and has given economics some rich examples. In 1987 the Bank of Canada announced a policy goal of zero inflation at a time when the Canadian dollar was something like US$0.73. This was a formidable task for several reasons, not least because the American inflation rate was about 4 per cent and financial markets were closely connected. Theoretically, to arrive at an equilibrium with a 0 inflation rate in Canada and 4 per cent inflation in the United States would have required Canadian interest rates to be 4 percentage points below American rates and Canadian wage rates, with equal productivity growth rates would have to rise by 4 percentage points less than American wage rates. The Bank of Canada never made this clear to the rest of the country and the experiment, while fairly successful in getting the inflation rate lower, turned out to be the biggest fiasco in Canadian economic history since the Great Depression! To get the Canadian inflation rate down, the Bank of Canada increased interest rates, which had the effect of appreciating the Canadian dollar, which soared to over US$0.91 by 1990, killing export and real estate markets and driving unemployment into two-digit levels. Later, the Canadian dollar came back down to 73 cents, near its purchasing-power-parity equivalent. Recently the Canadian dollar has been falling against the American dollar, and it has reached a low of 62 US cents. This recent process has not involved any excess inflation in Canada and we have to look for a different explanation. In my opinion, the explanation lies in differential productivity growth between the


United States and Canada. The former country has experienced the IT revolution earlier and more strongly than has Canada, and it has resulted in higher productivity growth in the international industries. This means that the US real exchange rate has to appreciate against Canada’s and other countries. Had Canada fixed its currency to the US dollar it would mean that the inflation rate in Canada would have to be lower than that in the United States and perhaps even negative. This is my opinion also explains why countries with hard fixes to the US dollar have actually experienced some deflation—examples include Hong Kong, China, Argentina and some of the Gulf states. I want to also make a comment about Mexico’s situation today. To a certain extent Mexico is in a position of using an overvalued currency as an instrument to reduce inflation, just as Britain and Canada did in different ways. Mexico uses monetarism as a device for getting the inflation rate down after their long period of over-depreciation of the peso. The dollar was 11 pesos and then the Governor of the central bank started to use tight money to get the inflation rate down. He was successful in doing so but in the process, brought the dollar down to 9 pesos, overvaluing the peso. The end result was to bring the inflation rate down to its current level of 6%, which seems to be a great apparent success for the Fox government, and the plan is to bring it down to 4% in the next year. But when it does get down to 4%, the peso is going to be overvalued and there is going to be either a crisis or a quick movement down in the exchange rate. Having accomplished that job, of achieving the disinflation, you’ll have to move the exchange rate down to an equilibrium level again. Chair: Thank you, that was, I have to say, personally quite illuminating. Questioner: For Mr Kuhn. My name is Murray Pollack. You talked about IMF transparency and you pointed out the IMF doesn’t lend or do anything with its gold; it’s all one piece. Member countries of the IMF: any chance we’ll ever see some transparency regarding what they do with their gold, how much is in the vault, how much is on loan, how much is under swap? That would be an interesting number. Does the IMF publish those numbers? Thank you. Mr Kuhn: We do not publish the numbers directly on swaps or loans of gold by our member countries. We do have a new template for reserves that includes all potential activities on gold holdings. That is part of what we call the special data dissemination standard – you can find more information on that on our website. Most of the industrial countries adhere to this standard, which covers a wide range of statistics, and therefore should in adhering to this standard, disclose the activities in gold. Chair: Any more? Yes. Questioner: Kamal McCoy from McQuarry Bank. Professor Mundell, a question for you: you mentioned that a weaker euro has been a blessing for the European economy. Given that the world awaits for signs of recovery from the US, do you


think a weaker US dollar is something that should be encouraged to spur that recovery, or do you think that there are too many threats associated with that? Professor Mundell: I think that the strong US dollar and the weak euro have changed the ratio of the growth rate of the United States relative to the growth rate of Europe. Europe has delayed the onslaught of recession because of the cheap euro and the US recession came earlier, and maybe will go deeper, because of the strong dollar. And I do think that a change would partly reverse the situation. [Gap in recording, changing over tapes] I do think it would be in US interests to keep the euro from declining below, say 85 US cents. It would be easy for the United States to maintain a floor at that level and it couldn’t be seriously challenged. It might even be in US interests to put the floor at, say, 90 cents. But I don’t think it would be in Europe’s interest during this slowdown for the euro to be much about 90 cents. It would be easy to imagine circumstances in which the United States wanted to replay the Plaza Accord of 1985 all over again. There could develop protectionist pressure in the United States that would not suit US general interests or its commitments to WTO, and an attempt to get a weaker dollar might be looked upon as an alternative. The large debt position and huge current account deficit would help to support the US case for a lower dollar. At the present time the United States has not made that case—the knee-jerk reaction of US Treasury secretaries has been to say that a strong dollar is in US interests. But that may change, and prolonged weakness of the euro as the global recession unfolds might reignite a policy to achieve a lower dollar. For that reason alone it would not be in the euro area’s interest to let the dollar drop below 85 cents. Chair: I’d like to thank our speakers.


Gold in the 21st century
Introduction by Benedikt Koehler

Ladies and Gentlemen, it wasn’t a very long time ago, but it feels that way now, there were words coined by Alan Greenspan about “irrational exuberance” on the stock exchange. Apart from any other contributions to coining new terms, another observation from Alan Greenspan was that, over the last half century, weighted in tonnes, the US economy hadn’t grown. These were the years when we were speaking about the “weightless economy”, “virtual businesses”, the “new economy”, and investors were expecting instant gratification on the stock exchange. It seems like a long time ago already. Gold was not really in the limelight during those years. Gold is one of the world’s oldest economies and it’s certainly one of the world’s oldest global economies, connecting peoples at remote corners of the globe at all times. This year, equities in the gold sector, in gold mining, have produced one of the best performance results that any investor could have found. I think we’re very fortunate now that we’re coming to the concluding fourth session of today’s conference to hear two people tell us about gold as investment and gold as it’s seen by someone who’s producing it. First by Rex McLennan, Chief Financial Officer of Placer Dome, one of the world’s major multinational gold producers, and then followed by Rob Weinberg, who will compare gold as an investment asset to others. So in this way, once again, we see the same topic from two points of view; from the point of view of the producer, and the point of view of the user. Rex.


Gold - an industry insider’s view
Rex McLennan Chief Financial Officer Placer Dome

Well thank you, Benedikt, for those very kind words of introduction. I’m really delighted to be here in Berlin to be able to share the views of a senior gold producer in what’s turning out to be some very turbulent and uncertain times. With all the uncertainty following September 11, it’s prompted me to go back to reading a book by a Canadian born economist, John Kenneth Galbraith, called the “Age of Uncertainty”. It speaks to the 1970s, which was a period in which the world’s leading economists had a very difficult time trying to understand what was guiding the economy, and were even less able to prescribe cures. They were forced to revisit assumptions about the economic paradigm of the time. When I look back to those days, and John Kenneth Galbraith’s writings, it seems to me that we may well be entering another such “age of uncertainty”. So with that beginning, I’d like to start off with a brief overview of the topics that I’ll be covering in the next 20 minutes. First of all, I’d like to tell you a little bit about Placer Dome. I’ll talk about our strategy and the challenges we face in running our business. It’s not a commercial for Placer Dome, as what I really want to do is focus on producing industry issues but from our Placer Dome perspective. I’d also like to spend time to talk about how society benefits from gold mining. And then I’ll wrap it up with a few observations on what would help to improve the current state of our industry. For those of you who may not be familiar with Placer Dome, we’re a Canadian company focused primarily on gold mining, with additional interests in copper. We’re the third largest gold miner in North America, and we’re the fifth largest in the world. Our corporate headquarters are in Vancouver, Canada, but we’re a global company and we have 14 mines in 6 countries on 5 continents. Our mines are located in some of the most prolific mining districts on the globe and we employ 12,000 people worldwide. We run our business in US dollar terms, and our functional currency of reference is the US dollar. One of the attractions of investing in Placer Dome stock is our sheer size and liquidity; we’re listed on 5 international stock exchanges, although the vast majority of our trading occurs on the New York and Toronto exchange, where on any given day we have about 2 million shares trading hands, and it’s not unusual to see as many as 10 million shares bought and sold during heavy trading days at razor thin margins; sometimes as little as 5 cents. My view about this business is that as a single gold producer, our product isn’t simply gold. And our customers are not simply the banks, the jewellery fabrica-


tors or others who buy gold. What we’re really selling is a portfolio of high quality gold operations. Our principle customers, in this sense, are the company’s shareholders. That doesn’t mean that we should not be concerned about gold as a product and not help to promote it, but it’s important to know that our basic strategy is to find, develop and run our mines as efficiently as we can and more efficiently than anyone else in the industry in which we compete. So our mission is to successfully compete against other gold mining companies for shareholders, for capital and for mine development opportunities. What we do not want to be is in the business of competing in the official sector to meet gold demand, and I would say we simply don’t stand a chance of winning in that game; after all, we don’t exactly have the same cost base. For Placer Dome to be competitive, which means to attract capital and have the best assets, it requires that we must have the best people on our team and that we run the business to be profitable throughout price cycles. The key tools we use to achieve this are as follows: first, a balanced hedge programme that offers some protection from downside risk, while preserving the upside when the gold price rises. I’d say that our programme is probably one of the most effective in the business in achieving this desired balance. It has the highest per ounce value and the highest mark to market value, right now of approximately 450 million dollars. Secondly, we place a very strong emphasis on research and development initiatives, and these allow us to continually find ways to be innovative and more efficient in our business. As a result, we have one of the lowest cost structures in the industry and we generate about 400 million a year in cash flow from operations, even at today’s prices. But I would say that we prefer to be building mines, and not just building cash. So let’s talk a little bit about price risk: by far the biggest challenge we face in this business is managing price risk. In real terms, the gold price has declined for nearly 20 years, and this has been due in part to the fact that the official sector has been gradually privatising its holdings. But I think more broadly, it reflects the evolution of modern day monetary policy and the globalisation of capital markets, which are holding inflation in check and preserving or increasing the value of major currencies relative to gold. And of course now it has having a major impact on gold mining and new gold mining development. So our industry is finally getting serious about balancing the desire for top lying growth; that is growth in reserves and production, with bottom line expectations of operating profitably at sub-300 gold prices. That’s vitally important at this juncture because the total capitalisation of our industry has declined to about 35 billion dollars worldwide, and that’s a fraction of the size of the number of single companies trading on the New York stock exchange today. Throughout the 1990s, investors and producers were very focused on growing reserves and production on the expectation that the gold price would remain strong or rise further, and this would provide a decent profit margin. Unfortunately, this is no longer the case. Today, miners have to demonstrate that we can run a profitable business when prices are weak. So industry leaders have moved


from the pursuit of top lying growth in reserves and production, to the more mundane task of actually making money consistently, in good times and in bad times. And few are actually accomplishing this in these times. For the past few years leading up to September 11, we watched gold trade in a fairly tight band between 260 and 275 dollars an ounce. This was punctuated by some very interesting but short lived rallies, such as the one that we witnessed in the first few days and weeks after the September terrorist attacks. Traditionally, investors look to gold and gold equities as a safe haven during periods of political or economic unrest. But today gold has given up all of the gains it posted in response to September 11, and it is again hovering around 275 dollars. Most of the experts who predicted it would rise to the 300 dollar level in the near to mid term are beginning to shake their heads, wondering why the rally has been so unsustainable. But as producers, we have seen this type of volatility before, and experience has taught us that we must run our business at today’s spot price. So we’ll maintain our focus on the bottom line and we’ll stick to the hard task of making money at 275. While on the topic of price volatility, it’s important to recognise that it’s something our shareholders not only expect, but want. So while we use forward selling as a means to limit the impact of price volatility on the downside, we also offer gold investors exposure to high quality gold projects with good upside potential. Volatility is not something we shy away from, we just have to ensure that we deliver quality exposure to the gold price by investing only in the very best projects. More so than ever before, the operative word today is becoming “quality”. Like any extractive industry, we must go where the resources are. And the developed world is well explored and the most prolific gold deposits have already been found and developed. The frontier is the developing world; it offers gold miners the opportunity to build the world class mines of the future. At Placer Dome, nearly 70% of our production is generated in Canada, the US and Australia, with the remainder coming from lesser developed or emerging jurisdictions. For example, two of our mines are located in Papua New Guinea. We first invested there in the 1930s and we’ve operated successfully for more than 70 years. We also have a 50% stake in the South Deep project in South Africa, where we’re investing our capital and applying our technology to develop a trackless mechanised mine operation some 3000 metres below surface. Operating in these challenging jurisdictions is something that we at Placer Dome have become particularly adept at, and we’re very proud of our track record. I’d like now to talk about earning the cost of capital. Another challenge we face in this business is earning our cost of capital, and while that sounds very simple, the gold price environment has put pressure on industry to demonstrate that we can in fact do this. Simply put, gold miners have to make money consistently over the long run to attract capital. Not just from traditional gold investors but from the much larger base of generalist investors. As in other sectors, when an industry fails to earn its cost of capital, the outcome is very predictable: we lose


investors and with that we lose the opportunity to create value from our mine development opportunities. Well, the gold price responds to basic supply and demand fundamentals like other commodities; its allure is that is a rare, highly liquid financial asset. It doesn’t represent a liability to any government so it is in a sense the ultimate currency of last resort. Gold producers provide leverage to gold exposure. So the role that gold stocks play in portfolio diversification has enabled gold producers to access equity capital at a lower cost than other commodity sectors such as base metals or oil and gas. The flip side of this is that senior gold stocks have tended to trade at much higher multiples of cash flow per share and higher multiples of net asset value per share than other resource sectors. So in other words, the capital market has expected, and tolerated to some extent, a lower return on gold equities. But as this slide shows; the majority of gold equity returns have in fact been under water over the past 5 years. The argument can be made that this under performance reflects the cost of insurance protection that gold equities provide to investors. However, this only goes so far, and my personal view is that what is fine in theory, may ultimately fail in practise. Gold as an asset class has had a hard time competing against the high real returns offered in the US capital markets throughout the latter 1990s. It’s only been very recently that gold’s returns have in fact become very competitive. Central banks have done such a good job these past two decades of instilling confidence in major currencies, particularly the US dollar, and in controlling inflation that the demand for this kind of portfolio insurance has suffered. However, the fundamental role for gold and gold equities remains and there’s now clear evidence of increasing investment demand for gold. Relative to the broader markets, gold equity performance has actually been very good this past year. I would say this is more a result of the disastrous performance of other sectors, notably the technologies, rather than actual earnings or financial performance from the gold sector. In fact the majority of mining and minerals companies have not even earned their cost of capital over the past decade. And until quite recently, investor returns in the gold sector have been negative. We should ask the question, “Why is that?” Well, it has to do with the replacement cost of gold. For our industry to succeed in developing new mines around the world, we need to demonstrate that we can earn more than our cost of capital. And simply put, based on the current industry cost curve, we need higher than 300 dollar gold to consistently deliver a return in excess of our cost of capital. Assumptions from a sampling of industry sources suggest that an average quality gold deposit requires something like 40 dollars an ounce to find it, about 80 dollars per ounce of capital to build a project and 180 dollars per ounce to mine and process the ore. And, in fact, I believe the recent Gold Fields Mineral Services report has the average cash cost of producing gold at something like 191 or 192 dollars an ounce. Anyway, one assumes another 25 dollars per ounce to cover reclamation and overhead costs and to provide a margin of return to investors; this brings the gold price required up to about 325 dollars per ounce.


At Placer Dome, we’ve had the good fortune of owning a portfolio of gold assets that have a number of very high powered, low cost mines. And we also have the benefit of a significant hedge position, which enables us to generate strong cash flow, at least for the time being. However, as I mentioned earlier, we’d prefer to be building quality gold mines rather than building cash. For that to change, we will need a combination of higher gold prices, lower exploration finding costs and productivity improvements. So what lies ahead? In the absence of a higher gold price, the obvious conclusion is that the gold mining business is going to change from what it is today. Our industry is highly fragmented and it lacks the strong economic incentives to drive us towards major consolidation. The success of individual companies will be determined primarily by the strength of their existing assets and the ability to successfully find or acquire new reserves at prices low enough to earn more than their cost of capital. Regardless, the supply of gold from below the ground seems destined to stabilise and perhaps decline gradually from the current level of just over 25 hundred tonnes per year. It would appear that fabrication demand will become more reliant on supplies from existing stocks rather than from new primary mine supply. Of the world’s existing gold stocks, the single most important holder, the official sector in the developed world, continues to sell but more importantly is perceived to be a seller in future. And while perception and reality often differ, in the case of the gold price, at least the impact on the gold price, perception is the reality. This forces the producing industry to adopt a very cautious long term price view in their decision making, leading in turn to fewer projects. I expect there will also be more consolidation in the industry as high cost producers close down or are taken over by companies that have the technical ability to lower costs. I believe this will lead to the concentration of the quality gold assets in a small menu of tier one gold producers. We are seeing more evidence of this in announcements made earlier this week. However, Placer Dome is not going to be drawn into the game of pursuing growth of production and reserves when it is not accompanied by growth in cash flow and earnings per share. We will only pursue those opportunities that are accretive to our existing shareholders. High quality gold assets are very scarce. At today’s prices few deposits can be brought economically into production. Exploration budgets have been slashed and new projects are being put on hold or abandoned altogether. Many operating mines are having trouble eking out modest profits, and some are being closed ahead of schedule as capital projects are cancelled. Because of this, nearly 10 billion dollars of new projects have been postponed or cancelled over the past two years due to lowered price expectations of producers. Some key examples are on this table and they include Las Castinas in Venezuela, Pascuelama on the Chile/Argentinian border, Serra Cuesidas in Costa Rica and the Phoenix Project in Nevada. We’ve now concluded that further development of our own getchl property in Nevada would require a gold price well in excess of 300 dollars per ounce. So if the outlook for gold is so fraught with peril, why continue to mine it at all? We do so because we recognise that there’s an ongoing need in the world for 84

mining in metals, and because of the positive contributions that mining makes to host countries. Mining activity creates jobs, it generates taxes, it generates wealth, it stimulates economies and it creates infrastructure. It’s a vital industry in many developing nations. Foreign investment and the development of natural resources have the potential to make sustainable improvements in people’s lives. In that sense, the loss of mine development opportunities in developing countries, such of those I spoke of earlier, also represents a cost to the developed nations, who in the end, in one form or another, provide their safety nets. At the global level, mining companies have a role to play in social responsibility. Around the world, the quest for metals has fuelled community development, often in very remote areas. We’ve built schools and hospitals, we’ve brought electricity, education and health care to areas where the local governments did not have the capacity or the resources to do so. Perhaps more importantly, from a global perspective, mining helps redistribute wealth between the haves and the have-nots. Historically, the developed world has controlled the lion’s share of resources. As I heard last January, at the World Economic Forum in Davos, we’re not getting any closer to a more equitable distribution of wealth. The gap, in fact, threatens to get wider as we see the effects of what has been termed as the “digital divide”. Developing nations lack the infrastructure or even the tools that will allow their citizens to participate in the knowledge economy. Furthermore, they are unable to tap into the full intellectual capacity of their people to the extent that we can in the developed world. To me, this is the fundamental reason why mining is such an essential activity: it’s to make people’s lives better. We need metals, and so far as governments are concerned about rebalancing wealth around the world, the business of mining should be taken very seriously. Particularly in developing countries which rely primarily upon resource extractive industries to develop an industrial base and to foster social progress. Natural resources, including gold, are only of value to your community if they are extracted at a profit. At the outset, I mentioned that before I sat down, I’d share my thoughts on some changes that would help to sustain our industry. Gold miners are in the unfortunate position of being price takers, yet they are exposed to very long lead times before recovering their capital investments. We can only go so far in lowering production costs, as I mentioned earlier. The official sector influences the gold price, not just by their selling and lending activities, but more importantly through perceptions left as to their future intentions and attitudes towards gold. Thus, self imposed restraints on official sector gold sales, which might be triggered when the price dips below a predetermined level (and that might be the replacement cost of gold), would help to sustain and promote investment in gold mining. Further, the future of the European Central Bank’s agreement on gold weighs very heavily on our minds. The agreement removes much of the perceived threat of large scale European Bank sales, and supports gold’s continued role as a store of value. It’s now near the halfway point. We hope it will be followed by a 85

similar agreement and better yet, a moratorium on gold sales until the price rises to its full replacement cost on a sustained basis. Finally, I believe it is vital that more producers support the World Gold Council’s marketing initiators. As the gold mining industry’s leading trade association, the World Gold Council is ideally suited to promote gold both as a luxury item in the eyes of consumers and for investment purposes. Although our industry is fragmented, we’re finally coming together in a united way to create new demand for gold. We need to demonstrate success on this front, and I can assure you that Placer Dome will be there to do its part in this endeavour. Thank you for your time and attention. Chair: Thank you very much, Rex.


Why everybody should own gold
Robert Weinberg Head, Institutional Investment World Gold Council

Good afternoon, Ladies and Gentlemen. I see that in the programme, the title of my presentation is given as “Why Everybody Should Own Gold”. Now, of course, that is a sentiment with which I wholeheartedly agree. But I’m sorry, I shall disappoint you. Today, I shall be focusing on a much smaller area, and that is the area of professional investment. Just very briefly: What is a professional investor? – it is somebody who views the assets that he owns from a portfolio perspective. So that would include pension funds, insurance companies, ultra high net worth individuals, and so on.

Alternative investments compared
Potential Liquidity Diversifier returns Risk Income Holding costs

Private Equity – seed capital - buy ins/outs Hedge funds Gold Commodities Timber Collectibles
v.high high various low* volatile medium medium low low low high high low v.low high medium high v.high high high high v.high high various low high low medium various low low high high high low low high medium

medium medium high low

Source: Phillips & Drew * except in times of economic unrest

We’ve heard a great deal today about uncertainty so it cannot have escaped anybody that there is growing uncertainty about the future of mainstream asset classes. That is why alternative investments are such a hot topic at investment conferences. All sorts of alternative assets are being promoted as portfolio diversifiers and here you can see some of them. But buying diversifiers such as these is one thing, but selling them when one needs the cash is quite another. Gold’s liquidity is, of course, one of its critical investment attributes, and certainly in this particular space. Here you can see the ratio of market capitalisation to GDP of three major markets. Japan had an enormous asset bubble in the late 1980s; it’s still recovering. Now the rest of the world is going through its own deflation of what has been 87

described as the biggest stock market bubble ever. Who knows where it will all end and how long it will take.

Market cap to GDP ratio
(Ratio of market capitalisation to GDP, per cent)
180.0 160.0 140.0 120.0 100.0 80.0 60.0 40.0 20.0 0.0 Q2 73 Q2 74 Q2 75 Q2 76 Q2 77 Q2 78 Q2 79 Q2 80 Q2 81 Q2 82 Q2 83 Q2 84 Q2 85 Q2 86 Q2 87 Q2 88 Q2 89 Q2 90 Q2 91 Q2 92 Q2 93 Q2 94 Q2 95 Q2 96 Q2 97 Q2 98 Q2 99 Q2 00 Q2 01





The answer is unlikely to come from a consensus of even the most prominent financial and economic forecasters. Here are consensus forecasts for GDP growth in the year 2001. You can see there’s the US, there’s Europe, there’s Japan and there’s the UK. The first forecast on the left hand side is August last year, and

So much for forecasts
4 3.5 3 2.5 2 1.5 1 0.5 0 -0.5 -1






August November February May

September December March June

October January April July


here you go, month by month. So, it seems to me, that what these people do is simply follow existing trends. I mean, wouldn’t it have been nice, in August last year, to have been told “Mind yourselves, guys; growth is only going to turn out at 1%. Whoops! Even that’s wrong!” Rather than to be told it was going to be 3.5%, and set our portfolios accordingly. Martin Wolf, who is Chief Economics Writer at the Financial Times, said just the other day that we may be facing possibly the most serious recession for 50 years. Being ever the optimist, I very much hope that he’s wrong, no doubt we all do. But we shouldn’t ignore these kinds of possibilities.

The essence of portfolio diversification

Higher return, same risk

Same return, lower risk


Investors strive to reduce the volatility, that is to say, risk profile of their portfolios but to do so without diminishing their expected returns. The alternative is that they try to enhance returns without increasing risk and in order to do that

Gold - an effective diversifier
Jan 1991 to Dec 2000
US Stocks Gold T-Bills Intl Bonds Emerging Mkts Equity Long Term Bonds REITS -20 0 20 40 41 45 60 80 100 120 -13 1 5 55 100

Correlation with Equities x100 (1990 - 2000)


they seek poorly correlated asset classes which, because they are driven by different economic forces, tend not to move up and down together. This is the essence of portfolio diversification. The trouble is that traditional diversification often fails when you most need it. The correlation and volatility of most ostensibly poorly correlated assets tend to converge during financially unstable periods. Gold’s pre-eminent investment characteristic is its very low or, in this particular time period, negative correlation with other commonly held asset classes. And this correlation tends to fall further during periods of financial instability. This, of course, is what investors seeking effective diversification demand. With its specific investment attributes, gold, you could say, has been designed for portfolio risk management. Gold is as relevant today as it ever has been.

Gold - reduces the effects of “stress”
18 16

Designed for stress env ironment Non stress env ironment

Annualized Return %

14 12 10 8 6 4 2 0 0 1 2 3 4 5 6 7 8

Designed for nonstress env ironment Base Case

Stress env ironment W rong Env ironment Non-stress W rong Env ironment Stress

9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26

Annualized Standard Dev iation % Fiv e year Monte C arlo simulation w ith quarterly rebalancing

The investment environment, of course, is highly dynamic. It veers without warning between stable (non-stress) and unstable (stress) periods. Here we can see an aggressive portfolio designed for a stable climate. That’s going to perform poorly in stress periods. Here it is, designed for a non-stress environment and that’s what happens when you discover that the period has changed. And this is what happens, here, if you design your portfolio very conservatively; it’s designed for a stress environment. All of a sudden, you find that you’re not in a stress environment, and there are examples of pension funds that have suffered severely in the past year from having positioned their portfolios, apparently, wrongly. They have lost mandates and so on. Equally, conservative portfolios will underperform in a benign investment climate. What we can show, is that even a modest weighting of gold can improve the consistency of a wide range of portfolios. And so in gold, not surprisingly, that’s what happens if you’ve got a portfolio containing gold. In other words, portfo90

lios that contain gold are generally more robust than those that do not. They’re better able to cope with these sudden changes in investment climate. Now, please forgive me, a bit of statistics but it is important to understanding how these things work.

Normal and abnormal curves
Normal Leptokurtic

Leptokurtic, negatively skewed










Standard deviation from the mean

An underlying assumption of most asset-allocation studies is that the returns on individual assets in a portfolio are normally distributed. Normal distribution is often referred to as a bell curve and, in the world of the bell curve extreme outcomes are rare; 95 per cent of the time normally distributed returns will fall within two standard deviations of the mean. But in the real world of stock markets the returns of most asset classes are not normally distributed. There is a higher proportion of outliers, here you can see they go well out beyond the standard deviations. Such a distribution of returns is, for obvious reasons, described as “fat-tailed”. Skewness is also a problem as you can see here. Portfolios are skewed from the mean. During the 12 months to June 2001, the quarter preceding the tragedies in the United States, the S&P 500 index experienced four daily moves that traditional risk indicators suggest should occur no more than once every 120 years. Of course nobody believed that markets would be OK for the next 500 years, but that is what the numbers said and those are the sort of numbers on which portfolios are built. We have also looked at what happened to a number of different markets during the month just prior to 911 and the month following 911. These are the figures which show the percentage of days where there were excessively high returns or excessively low returns, in other words, less than two standard deviations. As 91

you can see, there weren’t many excessively high returns but even before 911, there were really quite a lot of excessively low returns. During the month following, here in the UK, we got up to 50% of the time the market was abnormal. So that lets me remind you that if returns were normally distributed daily moves of that magnitude should occur no more than 5 per cent of the time. Or indeed, if you look at these tails, no more than 2.5% of the time. So the combination of fat tails and negative skewness results in a disproportionate number of underperforming returns in the left-hand tail. The inclusion of gold in a portfolio serves to mitigate those results. And indeed, it does so more efficiently than T Bills.

Low volatility is important
Portfolio 1 (low volatility) Annual Value return % 10,000 9 11 9 11 9 11 10% 1.10% 9.996% 10,900 12,099 13,188 14,639 15,956 17,711 Portfolio 2 (high volatility) Annual Value return % 10,000 -5 25 -5 25 -5 25 10% 16.43% 8.972% 9,500 11,875 11,281 14,102 13,396 16,746

Initial value Year-end 1 2 3 4 5 6 Arithmetic av. return Std. deviation Compound return

It is not always appreciated that holding gold in a portfolio can enhance the overall rate of return. And the gold price does not have to go up for that to happen. The reason is that gold can reduce the overall level of volatility or risk of a portfolio, which means that you can benefit from the mathematical effect of compounding quite apart from being able to add higher yielding, riskier assets without increasing your target level of overall portfolio risk. Here, I’ve got a high volatility portfolio and a low one. The numbers are purely arbitrary. Both parts have the same arithmetic average. Clearly, the volatile one has a very much higher standard deviation. What gold can do is give the lower volatility portfolio a significantly higher compound return. At this stage you probably expect that every fund manager in the world already has a significant weighting of gold in his portfolio. If only that were the case! The majority of investment professionals are unaware of the role that gold can play as a portfolio diversifier. Bearing in mind the twenty-year downtrend in the dollar price of gold, it is difficult not to feel a degree of sympathy with that


view. Gold has closely tracked the decline in inflationary expectations as expressed in the yield on the US long bond. The US long bond has ceased to exist, or will do so very shortly. But if this sort of trend continues I wonder how long it will be before the spectre of deflation strikes in the US and elsewhere and indeed we heard the deflation word earlier today. On the other hand, as an economist might say, perhaps we are about to enter a period of rising inflation. I’ve heard it said that it may be the only way to get out of the economic mess that we now find ourselves in, particularly perhaps in Japan.

Gold and the US long bond
900 800



US $ per ounce

700 600 500 400 300 200

16 15 14 13 12 11 10 9 8 7 6 5

Yield per cent






The point is that the future is always uncertain. It is for that reason that gold should not be ignored. Of course investors should do their own due diligence and then decide for themselves whether to invest or not. But continuing to ignore gold I believe is imprudent; it could actually be an abrogation of their fiduciary responsibilities.

Gold and equity trends: 1970-2000
• This pattern has held over the past three decades • Since the early 90’s: – stock returns have diverged dramatically above their mean – while gold has done the opposite • Reversion to the mean?

700 600 500 400 300 200 100 0

Gold JANUARY 1970— December 31, 2000

1600 1400 1200 1000 800 600 400 200 0

65 67 69 70 72 74 75 77 79 80 82 84 85 87 89 90 92 94 95

65 67 69 70 72 74 75 77 79 80 82 84 85 87 89 90 92 94 95

S&P 500 JANUARY 1970— December 31, 2000


Gold has also suffered from the extraordinary strength of equities in the 1990s in particular. The lower chart shows how dramatically stock indices, in this example the S&P500, the period 1970 to December of last year. You can see how dramatically stocks have diverged from their long term mean. Even after the set backs of the past 18 months or so, many feel that valuations remain stretched. Reversion to trend has been threatening for some time. The recent past has done no more than accelerate what was already lurking there. Conversely, the upper chart is the gold price in US dollars and that shows you how far it has fallen beneath its long-term trend. And yet annual consumption outstrips mine production by nearly 50 per cent while production itself may be expected to fall in the medium term. It might be rational to expect both equities and gold to revert to their respective trends. In fact it appears that they may already be on the way to doing so. This chart shows the ratio of the Dow Jones industrial index to the gold price in dollars; basically, it means “How many ounces of gold do you need to buy one unit of the Dow?” And you can see, in 1928, you needed about 18, in 1965, you needed about 28, last year at the peak, you needed about 45, but by the year end it came down to 40. At the moment, it’s standing at around 34/35, or it was earlier this morning. I leave it you to work out what this could imply for the levels of the Dow Jones and of the gold price should it once again take only 10 ounces of gold to buy one unit of the Dow.

Gold vs. Equities
Ratio of Dow Jones Industrials to Gold
1895- 2000
2000 2000 1965 - 40 - 30 - 20 - 10 -0 1880 1900 1920 1940 1960 1980 2000


The majority of investors are unaware also of gold’s market fundamentals. Mr Panizzutti told us earlier today about the European Central Bank Agreement on gold. Even those investors who have heard, for example, of this Agreement have little understanding of its implications for the market. Prior to the agreement, clearly investors were led to fear an overwhelming tidal wave of central bank 94

selling swamping the market. I find that to a great extent they still do, even though, certainly in terms of the Agreement, that danger has receded dramatically. Some 85% of official sector gold holdings are either subject to the Central Bank Agreement or are in holdings where the holders have assured us that they are not going to sell. A major part of this balance, which is 15% and could be described as loosely held, although some part of it may be more tightly held than loose implies, has already been mobilised in the market and is no longer available for sale at least not at the moment.

Gold - Some market fundamentals
• European Central Bank Agreement on Gold caps sales and lending by central banks • Only 15% of official sector gold is “loosely held” • Dramatic downturn in gold exploration • Annual consumption outstrips production by more than 40% • Mine production could fall by 35% by 2005

Neither are many investors aware of the dramatic downturn in gold exploration expenditure, by more than 60 per cent from over the last four years, and what that implies for the future of newly mined gold supply. Some recent research suggested that, absent a significant upturn in the gold price, global production could fall by as much as 35 per cent over the next five years. Even if this is an extreme case, we should not ignore that. It seems to me that the logic of holding gold as a portfolio diversifier is increasingly compelling. If you want total independence of course you must buy gold bars and store them in your own vaults. But for many professional investors, that may not be practical, whom although they would like to allocate some portfolio weighting towards an asset with gold’s special investment attributes, find the concept of taking delivery of gold bars difficult to accept as indeed they would taking delivery of scrip. There are investment vehicles which can perhaps meet their needs. Depository schemes or metal accounts, some of which may come with a government guarantee also give a choice of holding gold on either an allocated, that is segregated, or an unallocated basis. In the latter case you can put it on interest bearing deposit although the security then becomes dependent on the security of the bank itself. 95

Ways of buying gold
• • • • • Depository schemes Metal accounts Accumulation plans Futures and options Bonds convertible into gold

A common criticism of gold is that it provides no income and this is particularly the case for pension funds. A gold linked convertible bond provides a securitised investment in gold and is backed by gold. It is a hybrid, combining most of the attributes of an investment in gold itself with all the advantages of a bond. An important benefit is that it enables an investor to buy gold with an income. And not only an income but also, if they want, capital protection. If you issue it at a premium it can be structured so as to carry a higher coupon. Or you can issue it at a discount and create a zero coupon. In short, the variables that can be built into such an instrument are such that it can be tailor made to meet the needs of practically any investor.

Gold -- identified professional purchases Gold identified professional purchases
Year 1997 1998 1999 2000 2001 (h1) Tonnes 50 57 60 91 45 303

During the past four years we have identified some 300 tonnes of institutional investment consumption of gold. Increasing numbers of professional investors are buying gold as a portfolio diversifier. I expect their ranks to grow as they learn how gold can address the main prob24 lems associated with traditional methods of asset allocation and products are created to meet their needs. They are coming to realise that gold is a credible and desirable alternative investment with which to diversify. Of course, as I said earlier, none of us wants too dramatic a reversion to the longterm mean price levels for either equities or gold. But it does seem that current market uncertainties or investment risks are perhaps greater than most of us have ever experienced. Gold can no longer be ignored, must no longer be ignored.


Challenges for Europe: the euro, the dollar and gold: Closing address
Robert Pringle Corporate Director, Public Policy & Research World Gold Council

Ladies and Gentlemen: it falls to me now to close this conference and to thank this panel of speakers and all of you. It is indeed an honour for us at the World Gold Council to have hosted the third in this series of annual economic conferences – we’ve had Paris, Rome and Berlin, and some of you have actually come to all three of these conferences, and thank you so much for doing that. The idea behind these conferences has been to look at gold in a broad economic and financial context. For central bankers, the key issue is always that of policy; policy not just in relation to gold itself but in relation to the markets, exchange rates, international monetary system. Gold brings in all these things, including the role of the International Monetary Fund, and many other things besides. We have heard today about all these subjects from some of the world’s leading authorities on them. On behalf of the World Gold Council, I would like to thank them all for their contributions. We will be sending the proceedings of this conference to all the participants here today. We would like to thank you for coming to Berlin. We’ve not yet settled on a city for next year’s conference, and anybody with a strong preference for one is welcome to make suggestions. I would like to thank all our panel of speakers and my colleague, Benedikt Koehler, for having chaired this day’s session. And with that, I call the conference closed. Thank you so much.



No. 1 Derivative Markets and the Demand for Gold by Terence Martell & Adam Gehr Jr April 1993 No. 2 The Changing Monetary Role of Gold by Robert Pringle, June 1993 No. 3 Utilizing Gold Backed Monetary and Financial Instruments to Assist Economic Reform in the Former Soviet Union by Richard W Rahn, July 1993 No. 4 The Changing Relationship Between Gold and the Money Supply by Michael Bordo & Anna Schwartz, January 1994 No. 5 The Gold Borrowing Market - A Decade of Growth by Ian Cox, March 1994 No. 6 Advantages of Liberalizing a Nation’s Gold Market by Prof Jeffrey A Frankel, May 1994 No.7 The Liberalization of Turkey’s Gold Market by Professor Ozer Ertuna, June 1994 No. 8 Prospects for the International Monetary System by Prof Robert Mundell, October 1994 No. 9 The Management of Reserve Assets Selected papers given at two conferences,1993 No. 10 Central Banking in the 1990s - Asset Management and the Role of Gold Selected papers given at a conference on November 1994 No. 11 Gold As a Commitment Mechanism: Past, Present and Future by Michael D Bordo, January 1996 No. 12 Globalisation and Risk Management Selected papers from the Fourth City of London Central Banking Conference, November 1995 No. 13. Trends in Reserve Asset Management by Diederik Goedhuys and Robert Pringle September 1996 No. 14 The Gold Borrowing Market: Recent Developments by Ian Cox, November 1996 No. 15 Central Banking and The World’s Financial System Collected papers from the Fifth City of London Central Banking Conference November 1996 No. 16 Capital Adequacy Rules for Commodities and Gold: New Market Constraint? by Helen Junz and Terrence Martell, September 1997 No. 17 An Overview of Regulatory Barriers to The World Gold Trade by Graham Bannock, Alan Doran and David Turnbull, November 1997 No. 18 Utilisation of Borrowed Gold by the Mining Industry; Development and Future Prospects by Ian Cox and Ian Emsley, May 1998 No. 19 Trends in Gold Banking by Alan Doran, June 1998 No. 20 The IMF and Gold by Dick Ware July 1998 No. 21 The Swiss National Bank and Proposed Gold Sales, October 1998 No. 22 Gold As A Store of Value by Stephen Harmston, November 1998 No. 23 Central Bank Gold Reserves: An historical perspective since 1845 by Timothy S Green November 1999 No. 24 Digital Money and Its Impact on Gold: Technical, Legal & Economic Issues by Ricahrd Rahn, Bruce MacQueen & Margaret Rogers November 2000 No. 25 Monetary Problems, Monetary Solutions & The Role of Gold by Forrest Capie and Geoffrey Wood, April 2001 No. 26 The IMF and Gold Revised Edition by Dick Ware, May 2001

Switzerland’s Gold, April 1999 A Glittering Future? Gold mining’s importance to sub-Saharan Africa and Heavily Indebted Poor Countries, June 1999 Proceedings of the Paris Conference “Gold and the International Monetary System in a New Era”, May 2000 Gold Derivatives: The Market View by Jessica Cross, August 2000 The New El Dorado: The Importance of Gold Mining to Latin America March 2001 Gold Derivatives: The Market Impact by Anthony Neuberger, May 2001 Burning Bright: The Importance of Gold Mining to the Asia-Pacific Region, Sept 2001 Proceedings of the Rome Conference “The Euro, The Dollar and Gold”, Oct 2001 The Golden Road: the Importance of Gold Mining in the CIS and Eastern Europe, Oct 2001

Available from Centre for Public Policy Studies, World Gold Council, 45 Pall Mall, London SW1Y 5JG, UK. Tel + 44.(0)20.7930.5171, Fax + 44.(0)20.7839.4314. E-mail:


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Conference on Gold:


The Euro, the Dollar and Gold, Berlin November 2001

Published by World Gold Council 45 Pall Mall London SW1Y 5JG Tel: +44 (0) 20 7930 5171 Fax: +44 (0) 20 7839 6561 e-mail: Website:

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