Gold Reserves Watch

NW8_SW1_EC3
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#1
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I'm a bit bored and was just wondering, what is the purpose of gold reserves? I think back in the day all the currency in a country was backed up by gold, but these days there is far too much currency and the gold reserves are no where near close enough to backing up the amount of currency in the UK. Also I remember Brown sold alot of the UK's reserves a few years (with the price of gold rocketing a year or two later :rolleyes: )
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President_Ben
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And had the price of fold plummeted, you'd be calling him a hero right? Plus, it was the Treasury, not like Gordon was sitting on his trader set up selling some physical delivery contracts on the CME or LME.

Reserves in general - FX included, give governments the ability to do short, single shot interventions if necessary. In the face of the full market beast, governments are pussy cats and lambs to slaughter if they try to intervene.
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jjbristol
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the purpose of any reserve is either as an investment or as a safety measure. The treasury would have probably intended to sell it at the highest price. However reserves can also be used to manipulate financial markets, for instance if at some point the pound were to fall sharply against the euro, assuming this were not desirable for our economy and opinions do differ, then the govt could sell the gold reserves in exchange for pounds which would probably cause the value of the pound to rise again. For example china holds huge precious metal reserves but uses them to keep the value of their currency low as they are an exporting nation
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NW8_SW1_EC3
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Yeah I remember reading in a textbook Japan once done this, I didn't think it happens alot though.
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President_Ben
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(Original post by NW8_SW1_EC3)
Yeah I remember reading in a textbook Japan once done this, I didn't think it happens alot though.
Japan intervenes in the FX market regularly but in small size.

The last major FX intervention was for the Euro, shortly after introduction, when it had depreciated quite significantly.

The next major FX intervention is probably on the US dollar for depreciating quite significantly.

And even though it's the next most likely one. It's still highly improbable. Comments on it have come from the US treasury secretary but it's not like he'd go to the press with a 'Weak Dollar Policy is good for the USA' headline in the news.

Anyway...
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Drogue
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(Original post by NW8_SW1_EC3)
I'm a bit bored and was just wondering, what is the purpose of gold reserves? I think back in the day all the currency in a country was backed up by gold, but these days there is far too much currency and the gold reserves are no where near close enough to backing up the amount of currency in the UK. Also I remember Brown sold alot of the UK's reserves a few years (with the price of gold rocketing a year or two later :rolleyes: )
The same reason banks have capital. Fiat (paper) money is itself worthless. The only reason it has value is because people believe it has value. If they don't, it becomes a house of cards. Banks have capital to ensure that they can endure minor shocks and keep solvent if they lose small amounts of money. Thus people have faith that banks will be able to repay their debt, and so price it accordingly. If people lose faith, there becomes a run on the bank and it uses up it's capital, failing if it doesn't have enough.

Similarly, governments keep gold. If there is a run on a currency, the government can use gold to prop it up (or prop up other country's currencies, a la China and the US in the last few years). So the more gold you have, the greater ability you have to support your currency, and thus the less likely people will think your currency will fall and so stopping runs on the currency.

Gold itself isn't needed, it's just handy for the purpose. You could use anything that's liquid, easy to store and keeps its value, and gold does all three very well. Oil could also be used, but it's a lot bigger thus harder to store. It also tends to be more volatile.

A long time ago, currencies had to be backed by gold. That meant even with a run on a currency, it could be kept propped up (so long as gold kept its value). However that much gold isn't needed, all that is needed is enough to give the currency credibility. The same way banks used to back the money they lent in gold, whereas down they need only a percentage of that money backed by assets (IIRC it's 4% tier one (high grade) and 8% total tier 1 and 2 asserts, though most banks hold a little more than that).

Indeed, the same principle works with mortgages. Your house is the asset backing your mortgage. The more your house is worth, compared to the amount borrowed on it, the safer an investment it is thus the cheaper your mortgage is.
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