Economics is tricky and tracing the consequences of policy decisions into future outcomes is fraught with whatifs.  Counterfactuals are hugely difficult.  So, if the Tories had won the 2001 election, would Britain’s fiscal position been in any better shape?  Spending would have been less, but we might have had huge tax cuts instead, a bigger housing boom…  Or, instead, if they had cut the deficit, would rates have been lower, the housing boom even more out of control?  And so on.  Only the truly idiotic would think that Brown bringing in the FSA somehow led to the financial crisis.  But you still read it from time to time.

However, one piece of counterfactual history is SO easy that the Right can seldom resist bringing it out against Brown, and that is the Decision to Sell the Gold.  Leading from this Times’ article , Tim Montgomerie at ConHome can barely contain his gloating on the subject (hat tip LeftOutside). But I think LO’s attempt at a defence – continued on LibCon – does not go far enough. Sure, the money was invested so the loss was smaller.  More important is to bear in mind the record of abject failure that Brown had inherited, and was trying to rectify when he ordered that decision*.

First, let us remind ourselves of a couple of points.  One: gold earns nothing.  In fact, storing it costs money, though I will leave that fact out for my calculations.  Two, since 1979 the price went downhill or sideways therefore losing money compared to any other assets during a great boom for all things from 1982 – 1998.

Three, gold is normally regarded as an inflation hedge.  It ‘keeps its value’ (caveat: see graph above!).   So when things look inflationary, or the value of nominal financial assets looks under pressure (see 2007-9) it rises in value.

Four: the point of central bank reserves is to have something you can sell that has external value.  It can’t be your domestic currency because you have as much of that as you need.   Liquid currency from trusted foreigners will do as well.  Like $s.

Five, in 1979, for the first time since the 1920s, there arrived a British government with an absolute intention to kill inflation if necessary by crunching unemployment, high rates and all that.  Really determined.  Therefore Geoffrey Howe could have known with great certainty that from Britain’s point of view gold was going to become less valuable.  He might have also thought: if I want to demonstrate my commitment to low inflation (because high inflation has so many temptations), then getting rid of any inflation hedges whatsoever would be a good idea.  It would show people I put my money where my mouth is. In fact, a bit like what Brown did.

So.  Why didn’t Howe sell?  And how much did it cost us that he didn’t?

I have done the calculations.  Really simplifying: the scenarios are (1) 650 tonnes of gold held from 1979 to 2008; (2) What happened: 650 tonnes held, then 400 of those tonnes sold and presumed to be invested in $s at T-bill rates; (3) If Howe had taken the action Brown did and sold 400 tonnes in 1979.

Here is the result I get:

to put the figures into context: at about $12bn, in 1979 the 650 tonnes of gold were worth about 3% of Britain’s GDP.   By 1998, they were worth $6bn or so, which would have been worth about 0.4% of GDP at the time ($1.6trn).   Had Howe sold 400 tonnes, they would have been worth $28bn, or about 1.75% of GDP.  That is a lot to foresake, because of fetish with gold.

Brown’s current mistake has cost perhaps $7bn by my calculations, to the end of 2008.   As someone who used to work in spreadbetting, I find hindsight trading hugely irritating, so taking it far beyond the years he sold it annoys me immensely.  Still, let’s round it up to $10bn to take the recent uprush into account.  By my estimations, that is about 0.4% of GDP.    There are far bigger mistakes to make.

I have no bone to pick with Howe. You might wonder if it fair to compare an act to an 0mission.  But just like the management of the fiscal position (where I amongst other berate Brown for his omissions ,with great justification), management of our assets must include both. If your fund manager bought and held Logica in 1999, would it be the purchase or the failure to sell that would have you wringing his neck?

I think holding onto 600 tonnes of expensive inflation-hedge while actively trying to kill inflation was a costly mistake of the Conservatives.   Brown’s error on the other hand looked good for 2-3 years, has cost far less, and at least had the virtue of reason on its side.  It is, after all, a barbarous relic – and a fixation with gold has cost mankind greatly at crucial times in the past.

*I had nothing to do with it.  I’m guessing what he was thinking.

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17 thoughts on “Brown, gold and mismanaging Britain’s Assets

  1. That is quite the phenomenal graph you have there!

    As to not going too far defending Brown, maybe I just don’t particularly want to defend him. I just really really like consistency, and this one topic that has always struck me where a lot of people throw all logic or thought out the window for some received wisdom on Brown’s incompetence.

    Have you thought about looking into the mass privatisations of the 1980s? (Or even the farming out of PFI contracts in the 00s?)

    1. I also don’t want to defend him too much (particularly in the light of what Rawnsley suggests he may be like….). I just think picking on this particular timing is a bit weaselly. I mean, if he had waited, he might have sold at $400, $450 – but, whatever, it is nothing compared to having the wrong policy on gold for a long time, is my basic point.

  2. Excellent stuff.

    Why the blip in 1998? And is that date wrong – sales began in mid-1999?

    There perhaps is a case for running this chart in sterilng – which given the pound has slightly fallen against the dollar over the years would presumably help Geoffrey out. And also I doubt he could have sold 400t in one year without hurting the price – so maybe spread it over four years from 1979-1983 (again as it when up then down perhaps not too big a difference)

  3. Giles: “why did he sell gold at the bottom”

    Actually, a more pertinent question: Why did Brown trumpet to all and sundry that he would be selling gold at a particular point in time, thereby assuring that the price he could obtain would be depressed in anticipation of his cack handed sale.

    From your link: “Gold earns nothing”.

    For a substantial holder of gold reserves, this is not true. Gold like any other security can be loaned out and return quite a nice little income if you are so inclined, often there is no need to move the gold either, if you are credit worthy and having gold to loan suggests you are, a certificate of loan is sufficient.

    from your link: “storing [gold] costs money”

    An organization that owns the bank of England and real estate in the city of London is hardly likely to worry about the cost of storing any gold it might own, but even if it did, it could offset that cost against the income from loaning out its gold holding.

    from your link: “Three, gold is normally regarded as an inflation hedge”

    That that assertion is true or not is open to debate, I would rather think of gold as a hedge against risk.

    At the begining of the period you cite, risk was dropping, largely because a responsible government had just taken over from its previous and as usual reckless Labour predecessor. Well, what do you know, while the new Labour government adhere to the Tory spending proposals the gold price stabilizes, then look what happens. The price of gold rockets and as we now know so does systemic risk.

    Well done Gordon Brown!

    Finally, from your link:

    “He might have also thought: if I want to demonstrate my commitment to low inflation [snip], then getting rid of any inflation hedges whatsoever would be a good idea. ”

    Why would he need to think that or indeed to demonstrate that by selling gold? His demonstration of his intent to get inflation under control would be that he was taking measures that would get inflation under control.

    And Brown did not ‘put his money where his mouth’ was! He put your money and my money where his mouth was. I suggest there is a not too subtle difference.

    “So. Why didn’t Howe sell? And how much did it cost us that he didn’t?”

    You might just as well ask, why didn’t Cripps or Gaitskill or Jenkins or Healey? The fact is they didn’t, that all these Labour chancellors didn’t sell of Gold and Brown did speaks volumes of Brown.

    1. The loan point is a red-herring: the Bank can already make loans. It is a bank …. it can make loans whatever the composition of its reserves. When considering the return on an asset, you don’t add in the value you might get lending it out, which presumably involves credit risks and other stuff.

      How much of Britain’s assets do you think SHOULD be held in an inert asset? Was 3% of GDP about right for you?

      As for the earlier Chancellors ….. Bretton Woods? The rules were different. And given their inability to control inflation, it was not such a terrible investment.

      I think Chancellors reordering their risks so that the Treasury does not benefit from unexpected inflation IS a powerful signal. Hence I like the idea of greater issuance of index-linked debt, for example.

      I have no quarrel with your view that he handled the actual sale badly. I don’t doubt it. I am no Brownite. But I think this sort of discussion requires fuller historical background, not just sniping hindsight trading.

    2. All of your example Labour chancellors operated under Bretton Woods and/or the sterling area, when we couldn’t sell gold even if we wanted to.

  4. Basically, this is all the folly of imagining you can hit the top of the market, isn’t it? I’d have sold in ’79! Sure you would. I’d have gone long in ’97! Sure you would.

    Strangely, I’m not aware of any well-known Tory publicists who made their fortunes trading gold. The nearest examples are Alan Duncan – but he traded oil – and Michael Spencer, whose business is all about huge volume on a matched book.

  5. FTE: “The loan point is a red-herring: the Bank can already make loans. It is a bank …. it can make loans whatever the composition of its reserves”

    It answered your criticism that gold cannot generate income. I pointed out, an organization that has a substantial holding of Gold – 400Tonns would be more than sufficient, can loan the gold and earn fees from so doing. QED gold can generate income.

    By the way, and I expect you know, any other asset can be used in the same manner too, stock lending for example, is quite profitable.

    FTE: “It is a bank …. it can make loans whatever the composition of its reserves.”

    Yes, so what? I wasn’t addressing a point you hadn’t made – ‘banks don’t make loans’, I was addressing your incorrect in my estimation, assertion that gold cannot not generate income.

    Had you or I bought the however many tonnes Brown sold, which as it happened turned out to be the bottom of the market, you could have obtained a nice little income lending your gold, at the same time as seeing in excess of 300% + increase in the capital value of your holding. I think that would compare very well in terms of asset appreciation and generated income. Particularly during a period of artificially low interest rates.

    At any rate, my criticism of Brown [on this specific issue] is not so much that he sold the gold, rather that he sabotaged the sale by trumpeting the fact before hand.

    FTE: “How much of Britain’s assets do you think SHOULD be held in an inert asset? Was 3% of GDP about right for you?”

    I don’t have an opinion, it would depend on the economic environment. Talking of ‘inert assets’ would you consider selling Wales? By many accounts as an asset it represents red ink on the P&L of UK Plc. How about Northern Ireland? Definitely a loser, perhaps we could sell it to Gerry Adams? 🙂

    FTE: “not just sniping hindsight trading.”

    If I had purchased 100T Au from Brown, I may now be considering selling it. It is an asset and it looks like we agree that the price of assets fluctuate. It may be a good time to sell gold.

    FTE: “Bretton Woods? The rules were different.”

    And it seems the rules may have been ignored:

    http://www.zerohedge.com/article/exclusive-bank-england-engaged-flagrant-gold-manipulation-interwar-period-new-york-fed-does-

    Regards

    yorksranter: ” we couldn’t sell gold even if we wanted to.”

    Didn’t Bretton Woods just fix the price of a currency in relation to Gold? There may have been circumstances where Brittan may have had to sell gold, no?

    1. I think neither of us think the lending against gold issue is the point. What I am saying is: whatever your core liquid assets L, you can make loans against them as a central bank of x * L. But in one case, the assets also has the US treasury obligingly sending you interest payments. So the comparison between the two has that case more lucrative.

      I agree his timing and execution were cackhanded. Perhaps that cost 10-30$ per oz. But that should be the extent to which he be berated, not all the subsequent $700 of hindsight action.

    2. There could have been circumstances when we wanted to – but ever since the first world war, we were hugely short of it and the yanks hugely long, and therefore, the world was generally short of gold. BW was meant to allow for crawling pegs against the dollar, which was on gold, but it didn’t happen in practice. Those non-US countries that had advantageous BW rates – like France – refused to crawl and instead hoarded gold and dollars, cranking up the pressure on everyone else. A little like the Chinese today.

  6. FTE: “I think neither of us think the lending against gold issue is the point.”

    Agreed, I’m not talking about lending against gold at all.

    Now I must be being extremely obtuse and if so, then I apologize this discussion seems a little sterile as we do not seem to be communicating very well, I will not bother to comment on this thread again. But …

    If you hold 100T of gold in your vault, and you are thinking ‘this gold is a liability, I have to build a strong room to store it, pay guards to guard it, and I get nothing in return’.

    Instead of just selling, I am suggesting you loan your physical gold to another individual who may need gold, or the certificated representation of gold, for his own financial activities – that individual will pay you a fee for allowing him/her to borrow your gold.

    In this way, you can make your gold work for you, rather in a similar manner to loaning cash to a bank in return for interest. You expect your principle and the interest to be paid back at the end of the agreement, likewise when you loan out your gold or its certificated representation, you expect the gold and your fee back at the end of the loan term.

    I don’t know how we got around to lending against gold, since if I am going to lend you cash, you would have to give me collateral not the other way around.

    But there you go, the wonders of the Internet.

    Bye

    1. I see your distinction. But I am not sure that a central bank that is using that gold to back up its ability to fulfil all sorts of other operations is able to do this. “We need gold, now” – “Sorry, I loaned it out for 4%, I’ll get it back soon” – “off whom”?

      The idea is to have something that is good to make payments there and then, and has no credit risk attached to it. If I lend it to X in the private sector, does it have that property?

      But, anyway, while this is interesting, I think neither of us believe it actually settles the issue.

  7. At the end of the day, Brown took half a loss making asset (which the US had sold a lot of a decade earlier knowing they were in a huge bond boom) and diversified it into bonds, likely doubling it’s new value at the very least and more if they still have them.

    And no, govts shouldn’t be selling assets on the quiet. Totally wrong. they should be transparent.

    I also believe they sold it over a period of time, not that the gold price was fluctuating hugely, but if I remember, he announced it at about $250 and sold at average $275 having been told not to sell it all at once.

    And why would you loan it out for a return when you’re running low inflation policies which means it would likely lose value? Now would be a good time to do that, but again is that the role of the govt ‘reserves’? No.

    I’ve read that 6 years forwards from the sales the price increase of gold was a 4.5% compounded. So it’s certain the diversified bonds did just aswell at least.

    The gold price has followed the american’s sudden expansion of debt in the last decade, when the govt debt ceiling has been raised so many times people have lost count.

    In short Bush added $6trillion to US debt in boom years which allowed/caused our problems.

    Now investigating that and it’s relationship with the banks is what is really interesting.

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