Gunning for Gold
Q: What links Turkey, India and Vietnam? A: Weak currencies, trade deficits - and a suspicion that gold is to blame...
Here's the scenario: a falling currency, a widening trade deficit, and a population buying more and more gold. What's the result? Well, it tends to be an unhappy government - followed by a policy response.
We've seen it Vietnam, where central bankers continue to make noises about "mobilizing" the country's privately held gold, having last year handed an effective monopoly to a single refiner (later "administratively acquired" by the central bank).
We're seeing it in India, where the government has quadrupled import duties since the start of the year.
And we may be about to see it in Turkey where, the Wall Street Journal reports, the government is to publish plans designed to encourage people to deposit their gold bullion with the country's banking sector. One proposal reportedly being considered would involve interest-paying gold deposit accounts, with depositors being offered the ability to withdraw gold bars from ATM machines.
It remains to be seen whether this will get off the ground, and whether it will be successful.
"The tradition of holding gold outside the system could be hard to shift," reckons Murat Ucer, economist at Istanbul-based research firm Global Source Partners.
If the scheme does go ahead, it will be the latest move by Turkey's authorities designed to inject a bit of gold into the nation's banking system. Last November, the country's central bank announced that banks could hold up to 10% of their reserves as gold.
The backdrop to all this is a falling currency, allied to a balance of payments problem. The Turkish Lira fell 23% against the Dollar in 2011. Turkish gold demand in the fourth quarter of last year meantime was up 128% year-on-year, according to the latest World Gold Council data.
Over the year as a whole, gold jewelry demand fell slightly, but demand for gold bars and coins, which people tend to buy primarily for investment purposes, rose 99% to 80.4 tonnes (indeed, Turkey was the world's largest producer of gold coins last year).
Almost all of that demand was matched by imports, with Turkey importing 79.7 tonnes of gold in 2011, according to data from the Istanbul Gold Exchange. This is not great news in country whose current account deficit is around 10% of GDP.
Here we have a clear case of cumulative causation: the Turkish Lira depreciates, people hedge by buying gold, the gold has to be imported thus putting further pressure on the exchange rate and widening the trade deficit.
It is not entirely 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 by association support the Lira.
Or perhaps the authorities think that by gathering together 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 and 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 into 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 finds itself now - a weak Lira, 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.
The history of gold deposit schemes does not bode well for Turkey's planners. India, another country which last year experienced a depreciating currency and a rising domestic gold price, launched a gold deposit bond scheme in 1999 through its largest commercial bank, the State Bank of India. It was not a roaring success, but that didn't stop the SBI re-launching the scheme in 2009.
Neither version of the gold bond scheme managed to prevent India's gold imports rising dramatically in recent years, with all the attendant effects on the exchange rate and balance of payments.
Indian policymakers have changed tack. This week, they moved to limit gold's value as collateral, with the central bank imposing a cap on the loan-to-value ratio gold financing companies can offer. Reducing the financial utility of owning gold may not have been the primary motivation for this move, but it is a side-effect that is unlikely to worry the authorities.
What most definitely is designed to curb gold demand is last week's announcement that India is doubling gold import duties for the second time this year, which sparked off a strike by Indian gold dealers. Finance minister Pranab Mukherjee specifically cited gold imports as "one of the primary drivers of the current account deficit" and a major cause of Rupee weakness.
As MineWeb reports, one side-effect of last week's move is the possibility that imports of jewelry routed through Thailand could now end up cheaper than those produced in India, since a free trade agreement between the two countries means imports from Thailand are currently subject to a much lower duty.
Domestic gold jewelry makers are understandably upset. This may well be an unintended side-effect rather than a deliberate policy, and one which the government may well iron out. The structure of gold import duties now seems designed to give an advantage to the domestic refining industry, with unrefined gold being subject to a lower duty than refined. It would seem perverse therefore to allow a situation to persist whereby domestic jewelers lose out while gold imports are barely stemmed.
Another country with direct experience of gold deposit accounts is Vietnam, which in recent years has also suffered from currency weakness and a current account deficit.
Vietnam's central bank is something of a pioneer when it comes to domestic gold market regulation. Last May saw the State Bank of Vietnam ban gold lending activities, at that time the latest in a series of interventions in the gold market.
What happened next is interesting. The authorities issued a decree to the effect that refiners of gold bullion should have a minimum of VND500 billion registered capital, as well as a domestic market share of at least 25%. They must have known that the market was dominated by a single refiner, Saigon Jewelry Co, whose market share was around 90%.
Having handed Saigon Jewelry a monopoly, the SBV announced in November that it had "administratively acquired" the refiner. Then a rather odd thing happened. The SBV's former governor, Cao Sy Kiem, said that the central bank should issue gold certificates as a way of mobilizing privately-hoarded bullion.
Then, in January this year, current SBV governor Nguyen Van Binh also spoke of "mobilizing" gold for the "socio-economic development" of the country, suggesting a role for credit institutions suspiciously similar to the one they were performing before the SBV shut them down.
In Vietnam, it would seem, gold should only be mobilized once the government is in a position to call the shots.
There would seem to be a deeper trend here. Vietnam, Turkey and India are all emerging economies whose governments, faced with currency and balance of payments problems, have identified gold as an area worthy of attention. So far Turkey is considering the carrot of paying interest on deposits and giving incentives to banks to hold gold. But the experiences of India and Vietnam suggest it may at some point choose to pick up a stick.
Another country whose authorities may now be paying closer attention to its citizens' appetite for gold is China. As BullionVault reported last month, some dealers are finding it now takes longer to import gold since importers need to get permission from the State Administration of Foreign Exchange as well as the People's Bank of China.
China saw its gold imports from Hong Kong triple last year. Are the authorities beginning to worry about the impact of gold on the country's trade position?
If emerging market policymakers continue to flex their regulatory muscles, this could have significant implications for global gold demand. Consumers in India and China accounted for one in every two ounces of gold bought last year. The growth in demand from these two countries - and from China in particular, which only de-regulated its gold market at the start of the last decade - has been a major driving force behind gold's bull market.
There is probably a limit to how far policymakers are willing to risk alienating populations who have demonstrated a desire to buy gold. In India, Mukherjee has said he does not intend to raise duties any further (time will tell if the government sticks to that). In Vietnam, for all the many decrees, leaders have been keen to pay lip service to private gold ownership and have said they will continue to permit it.
But we are yet to find out where that limit is. As Robert Kennedy said half a century ago (wrongly attributing it as an ancient Chinese curse): "Like it or not, we live in interesting times..."