Alhambra Investment Partners CIO Jeffrey Snider returned to Erik Townsend's MacroVoices podcast this week to discuss one of his favorite topics: How central banks' use gold lending to manipulate their balance sheets, and also to manipulate the broader market for precious metals by sheer dint of their size, and willingness to buy and sell without any consideration for the price.
Their conversation begins with Snider explaining the history of "gold swaps" between central banks that helped birth the concept of fractional reserve lending.
The first "gold swap" conducted between the Federal Reserve and the Bank of England: The Fed handed the BOE $200 million in bullion through the New York Fed; in exchange, the BOE gave the Fed a "gold receivables" in the same amount. This is essentially an IOU that could (in theory, at least) be cashed in for gold, but allowed the Fed to keep the gold deep in its vaults. As Townsend explains, the gold is being taken out of the accounting for the balance sheet, but it's not being removed from the accounting.
Again, in theory, one could argue that these gold receivables were, in fact, "as good as gold" because the default risk from a counter party central bank is, effectively, zero.
Essentially, what happened was the Federal Reserve Bank of New York on behalf of the Federal Reserve system made $200 million of gold bullion available to the Bank of England for its disposal in whatever transactions it might take in defending sterling at that pre-war parity price. What's important about that is that it aids both sides of the equation.
Because the way a gold swap works is that, essentially, the central bank agent that is providing the gold exchanges it for what's called a gold receivable.
If you look at Slide 5, for example, I've sketched out roughly what this gold swap meant. $200 million in gold was made available to the Bank of England, which it would then sell in the market for sterling at the price that it wished to defend. They put the sterling currency into an account in London on behalf of the Federal Reserve Bank of New York.
So what really happened was gold disappeared from New York and ended up as cash in the UK denomination in London. But, for accounting purposes, the Federal Reserve Bank of New York showed a gold receivable where gold used to be.