Good as gold?

Thaddeus Best examines the decision of Venezuela's maverick president to demand back his nation's currency reserves

On September, Venezuelan President Hugo Chávez shocked the international markets with an unprecedented announcement that he was making plans to repatriate $11 billion of gold as well as transferring his entire country's paper reserves, $6 billion worth, from European and US banks and move them to banks in Russia, China and Brazil, sending alarm bells ringing across the world.

Buried treasure

The decision prompted waves of speculation over Chávez's intentions, and triggered a significant loss of confidence in the country - Venezuelan sovereign debt yields spiked sharply, gaining around 200 basis points by mid-September. But why did this announcement provoke such a response?

It is extremely unusual to repatriate a nation's gold reserves. Gold is rarely ever moved; the vast majority of gold sits in the same bank vaults around the world for decades. Even when that gold is sold to another country, it's unlikely it would be physically be transferred anywhere beyond the vault. But why not?

Firstly, it's a logistical nightmare to transport billions of dollars worth of gold bars halfway across the world. These ones would have weighed roughly 211 tonnes, making transporting them a slow, complex and expensive process. Traders estimate that it could take around 40 shipments to move the gold back to Caracas. Furthermore, the cost of insuring the gold, if a suitable party could even be found to take on such a liability, could be prohibitively expensive given that the value of the cargo easily reaches into the hundreds of millions. Given the publicity surrounding the announcement, it's not too farfetched to say that theft by pirates under these circumstances is a genuine risk.

Secondly, logistical reasons aside, there are other good reasons why gold rarely leaves the vault. If gold is removed from reputable banks such as the United States Bullion Depository, it's much harder to sell. It's no longer part of the international financial markets, so much of its utility as an asset is gone. Gold held in Venezuelan vaults is understandably particularly unattractive to potential investors, given the lack of transparency surrounding the nation's finances, and third party inspections would be likely to have to be carried out before each sale.

Under orders

No one would deny that Chávez has a history of making unexpected decisions, but given the significant difficulties of transporting gold and the disincentives to do so, what could be prompting him to make such an apparently counterintuitive move? There is increasing speculation that Chávez is worried about the outcome of several ongoing international court cases over his nationalisation of a string of Venezuelan industries during the past decade. Venezuela has at least 18 claims filed against it at the Court of International Settlements by American and European countries for illegally seizing their properties, their value totalling more than $14 billion. If the claims are successful but Chávez refuses to pay, it's possible that court orders could be made for the seizure of Venezuelan gold. These risks could also help to explain why Chávez is keen to transfer his country's paper wealth to countries such as China, with whom he maintains more cordial relations.

There are also suggestions that Chávez's hand has been forced. China and Russia have both made substantial investments in Venezuela, relying on the country's large oil reserves to obtain energy security. However, with Venezuela's finances looking increasingly dire, it's possible that the country's creditors have demanded collateral in the form of Venezuelan reserves, especially given that output from state oil company PDVSA appears to be in terminal decline, with most of its revenue siphoned off into murky organisations and expansive social projects.

Solid gold

The issue has brought broader questions to light, such as the role of gold reserves in the modern financial system. Since the termination in 1971 of the Bretton Woods system of monetary management, which tied paper money to the value of gold, and the rise of fiat currency (money which has government-ascribed, rather than intrinsic, value), the role of gold reserves in sovereign finances has become far less pronounced. Gordon Brown drew condemnation for selling over half of the UK's gold reserves between 1999 and 2002 at a time when prices were at a 20 year low - now widely regarded as one of his worst decisions during his time at the Treasury.

However, with doubts increasing over the future of the US dollar as the world's reserve currency of choice and increasing pessimism over the state of the global economy, gold has regained its lustre, reaching historic highs of $1,900 an ounce in August. Successive rounds of quantitative easing by the US Federal Reserve have driven the value of the dollar down, and the prospect of further dilution of the greenback is reducing its desirability in the eyes of governments seeking to build reserves for international settlement or capital buffers. Increasingly, countries are stockpiling gold rather than US dollars, fearful that the US debt issue will see the value of their reserves decimated in the future.

One thing is for sure. Chávez's decision has shaken what little confidence remained in Venezuela in the financial markets, and further widened the rift between the West and this firebrand president. Despite its significant gold reserves, Venezuela's credentials in the eyes of potential creditors are being reduced by Chávez's heavy-handed attempts to manipulate its economic standing. Bizarre plans to move hundreds of tonnes of gold around the world will do little to reassure them.

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