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Global Governments Play the Gold Game

It's worth a look at how Vietnam, India, and Turkey have fared in managing their nations' gold activity

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It’s not clear how gold deposit accounts are supposed to break this cycle. Perhaps the government hopes that if banks have gold on their balance sheets, this will boost confidence in the financial system, diminish the propensity to buy gold and in effect support the lira.

Or perhaps the authorities think that by gathering a “liquidity pool” of gold, banks will be able to meet spikes in domestic demand without the country needing to rely as heavily on imports. In effect, banks would lend out depositors’ gold, much as they already do their cash, holding a proportion in reserve from which to satisfy any withdrawals.

If this is what Turkey is considering, it would involve the obvious risk that banks could be subject to a run. Gold depositors, one suspects, would be most likely to try to take their gold back when (a) financial or economic stress has created a need for them to realize its value. and (b) they fear the bank with which they’ve deposited the gold may be about to go under.

Both such scenarios have in recent times tended to occur together. Furthermore, they are often (though not always) associated with a rising gold price as investors run to perceived safe havens.

A run on gold deposits is arguably more likely than a run on cash. Government deposit guarantees are one way of maintaining confidence and avoiding a run, but these are more credible for cash deposits than they would be for bullion. Unlike domestic currency cash deposits, gold deposits cannot be guaranteed by a government unless that government has large gold reserves it is prepared to see diminished, or it is willing and able to buy gold then and there on the international market.

Neither move could be expected to promote confidence in the currency, bringing us right back to the situation in which Turkey now finds itself  — a weak lira, a weak current-account position and a population fleeing to gold. The other option, of course, is that a government could shift the goalposts, denying depositors access to their gold.

Article printed from InvestorPlace Media,

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