Subtitles:
- Intro
- The GRA
- What’s the Difference?
- Europe's Central Bank Risk Mgt is Brain Dead
- Nice Piggy Bank You Got There
- Gold is Responsible When You Can’t Be
- EURO Death Watch
1- Intro
Having read ZH's German Central Bank May Need Bailout this morning the following came to mind. This piece is intended to give readers some perspective on the effects of a GRA change and a basis for processing the event if it were to happen. At the margin: if it were to happen, risk of the EURO dying in its Fiat form would be on the table.The focus below is on the Gold Revaluation Account. What that really means is: if used, gold will recapitalize the EU. Gold will “invest” in the EURO if they do this.
2- The GRA
Over the last few months there has been chatter out of Europe centered on the possibility of revaluing their Gold reserves to offset losses incurred by central banks from their ill-advised NIRP buying frenzy. This is developing and the facts are good to know before an unlikely1 but possible disaster gets going.
The name Gold Revaluation Account (GRA) is not a “Gold Revaluation” event but it has the same effect as far as us mortals are concerned. Most of the difference is accounting terminology that obfuscates intent of behavior to those unfamiliar with that terminology.
The GRA account is not permitted to be netted into CB income statement due to it being non-realized and out of their jurisdictional control. Here’s the rule saying so.
The Central Bank accounting rulebook...
The following rules shall apply to income recognition:
(e) there shall be no netting of unrealised losses in any one security, or in any currency or in gold holdings against unrealised gains in other securities or currencies or gold. - pdf here2h/t Gainesville
3- What’s the Difference?
Gold held by the EU CB’ is marked-to-market regularly. There is no need for literal Gold revaluation. They know what it is worth by looking at price. They’ve done the math. However, because it is not an asset created by central banks, its price fluctuations cannot be used to increase equity from income on its actual balance sheet.
In accounting terms as a manifestation of practical risk mgt, they think of gold like a stock or off balance-sheet investment, an asset they have little direct control over and therefore are reticent to allow its potential income volatility into their math. It is not government created and therefore an instrument that can cause risk3 to sovereignty as unlikely as that is. More likely, as is the case now, it bails out the EURO
Therefore they mark their purchases to market regularly noting the (potential) profits or losses on all Gold holdings. But because of this accounting principle, they do not permit those profits/losses be netted into the CB income statement/balance sheet.
4- Europe's Central Bank Risk Mgt is Brain Dead
We used to call this accounting entry “Open Trade Equity” (OTE) in commodity trading. Essentially it is unbooked P&L.There are several good accounting reasons 4 for this. Two reasons we can all likely grasp is you don’t count your chickens pre-hatched, and adhering to this rule adds a modicum of financial discipline provided the risk managers do not mentally spend rainy day money in their day-to-day calculations. It’s like a piggy bank.
***Regarding OTE: How the Euro CB is viewing it is proof of incompetence. This part, we feel is indicative of the culture**
Depending on your clearing house (prime broker) relationship, you may or may not be able to withdraw cash against your OTE. Usually only responsible traders were permitted to do this. But even the responsible ones during volatile times had that revoked. The clearing firm rescinded OTE access to protect its own existence. This is the exact opposite of what Europe would to if they tapped Gold.
Put another way, as the beer fridge empties, real clearing house risk managers lock it. When a CB risk manager sense the fridge is emptying, he takes the last beer for himself. These types are disciplined when convenient, not by need.
5- Nice Piggy Bank You Got There
Well, you know what happens when times are tough.. that piggy bank you’d forgotten about starts to look tempting. At first, you don’t break it open.. NO!!!
Ignore the bank...
But you start mentally adding its value to offset your mounting losses. This helps you sleep at night. With a little luck, the rest of your portfolio will bounce and you can go back to not thinking out ripping that bank open.
Continues here
