Regulators classify gold as zero-risk asset

In an Amphora Report last month, The Canary in the Gold Mine, I made the case that a key reason why gold has not been acting like a safe-haven asset in recent months is because banks are so capital impaired that they are scrambling to reduce their holdings of risky assets in favour of so-called ‘zero- risk-weighted’ assets, against which they needn’t set aside any regulatory capital. As it stands, gold has a 50% risk-weighting. But some government bonds, including US Treasuries, German Bunds and British gilts, are zero-risk-weighted.

However, in the report, I speculated that perhaps that would change in future, and that:

…if it happens, it will be an important step toward the re-monetisation of gold. Gold would be able to compete on a level playing field with government bonds. While the playing field could be levelled in this way, there would be a gross mismatch on the pitch. On the one hand, you have unbacked government bonds, issued by overindebted governments, yielding less than zero in inflation- adjusted terms. On the other, you have gold, the historical preserver of purchasing power par excellence. [1]

Well, on 4th June the Federal Reserve, OCC (Office of the Comptroller of the Currency) and FDIC (Federal Deposit Insurance Corporation) collectively circulated a memo asking for comment on their proposed changes to the regulatory capital risk- weighting framework. Section 11, ‘Other Assets’, specifies that a “zero risk weight” is to be applied to “gold bullion held in the banking organization’s own vaults, or held in another depository institution’s vaults on an allocated basis… [2]

Whoa. There you have it. As it stands now it would appear that, in the near future, banks will not have their regulatory capital ratios penalised for holding gold instead of government bonds as a safe- haven, zero-risk asset.

While the fundamental backdrop for gold is highly favourable and has been for some years, as the supply of money, credit and government bonds has grown dramatically, this technical aspect of the gold market is also clearly bullish. Indeed, as I wrote in The Canary in the Gold Mine, if gold is re-classified as a zero-risk-weighted asset, “the price is likely to soar to a new, all-time high.” I stand by that statement. In about six months we will know whether I am right, or whether I have misread this one.

Given the potential importance for gold, I’m surprised that this announcement has not been widely reported in the financial press, alternative or even mainstream. Perhaps this is due to the fact that, at this point, the re-classification of gold has only been proposed, not implemented. The change is not due to take effect until 1st January 2013.

With interest rates near zero, however, the opportunity cost of sitting on a non-interest-bearing gold position for six months is close to zero. Yes, gold may appear to be in a downtrend and, yes, it might have been unusually volatile of late, but unless the regulators backtrack, I see this as clearly bullish for gold, enabling much catch-up to Treasuries.

It remains to say something about why, perhaps, US regulators are poised to change bank regulatory risk weightings in favour of gold in this way. I do have some ideas about that. However, those will have to wait for a future Amphora Report.


[1] THE CANARY IN THE GOLD MINE, Amphora Report, Vol. 3, May 2012.

[2] The summary of the proposal, including a link to the complete version, including the explicit reference to gold, is here.

This article was previously published in The Amphora Report, Vol 3, 25 June 2012.

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One reply on “Regulators classify gold as zero-risk asset”
  1. says: Paul Marks

    Anything, including gold, carries the risk that demand for it will fall.

    The absurdity is the official position that government debt power is “risk free”.

    The only way that various governments (including the American and British government – and the German government as it has linked itself to the rotting corpse that is the Euro Zone) can pay their debts is by expanding the money supply.

    In old fashioned language by “printing” more money.

    So the official position really is “do not worry about government debt – the Federal Reserve, Bank of England and European Central Bank can always produce more money”.

    Not put this in terms of gold………

    If I had a magical gold producing machine that could produce as much as I wanted – and lots of other “authorities” had these machines also. And I (and they) said “do not worry about our gold obligations – we can produce any amount of gold we want at zero cost to us”.

    Would it really be sensible for you to hold gold? No it would not as (under these circumstances) gold would become worthless.

    The same is true for government fiat money (and government fiat money debts) – if governments can produce any amount of fiat money they want (and their whole fiscal and monetary position is based upon this doctrine) then holding government fiat money makes no sense – for it is going to become worthless.

    Lastly to people who hold government “inflation proof” debt paper (of various sorts).

    The governement has promised you that your bonds or securities (or whatever name is used) will be “protected against inflation” (the inflation the government produces).

    Please do not believe them. For they will have to “rethink” those contracts (and as was seen with the “Affordable Health Care Act”, Obamacare, courts tend to be desperate to avoid clashes with governments over vital issues – because they are vital issues, even years ago protected debt holders in General Motors suddenly found themselves not protected when the government took over, the United Auto Workers Union got the money instead in direct violation of centuries of contract law).

    First it will start with the rigging of inflation indexes – in the United States that has been going on for some time (although any index is a bit of a mess anyway – even if there is no dishonesty involved). But it will not stop there.

    Your “protected against inflation” government debt paper will NOT prove to be so.

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