Gold: the answer to Europe’s problems

As the European crisis deepens, the EU’s top economic official Olli Rehn has tried to sell the concept of a new bond issued by the collective 17 Euro nations dubbed a “Stability Bond”. In essence, the bond seeks to leverage the higher quality of better performing Euro nations in the north to support the weaker ones in the south.

A case of ‘united we stand, divided we fall’. The effect, it has been supposed, would be to reduce the overall borrowing costs of all. Under the proposal, debts in excess of the equivalent of 60% of GDP would be transferred to a fund with joint liability, which would be paid off over 20-25 years, but the EU countries involved would need to pledge part of their foreign exchange holdings or gold reserves as security. The structure proposed by Rehn probably does not in itself go far enough.

The proposal has, however, been killed by Angela Merkel – at least for now. However, the idea does have some merit and here’s why.

Between them the EU nations own approximately 10,800 tonnes of gold worth, at current market valuations, about $583bn or €435bn, sufficient to provide collateral for a loan of say €2trn on a coverage basis of about 20% to 25%. While €2trn would not resolve all of Europe’s debt issues, it would bring them down to a very manageable level.

The second issue is the natural hedge embedded in the deal. If the European crisis deepens and it appears they are unable to pay down their debts then this would be gold-positive and increase the appeal of the collateral held by investors in the Eurobond. Conversely, if Europe gets its act together then this would presumably diminish gold prices and the quality of the collateral and yet the risk of it being called by investors is commensurately less.

At the end of the day the crisis is as much one of mathematics as one simply of confidence. The EU appears incapable of producing a set of realistic policies that have even the slightest chance of getting popular support from nation-states. Even the US suffers from this problem, as the failure of their Super Committee suggests.

We are not huge fans of greater European political and economic integration but it would appear that we have the worst of all possibilities and that is the half-way house. Euro nations need to either find solidarity and consensus – even if that means putting 10,000 tonnes of gold on a ship bound for Asia – or to separate quickly.

Ask yourself – as a prospective investor would you be tempted to buy European debt as things stand even at the high rates on offer? I thought not, and yet we expect foreign investors to queue up to buy our debt. Desperate times require drastic measures and it is time we pledged arguably our most valuable asset if we are to have any chance of succeeding. 

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