by Jan Nieuwenhuijs, Gainesville Coins:
The Governor of the Dutch central bank stated the gold revaluation account ensures the solvency of his central bank in an interview on television about prospective losses. The significance of this statement is that if any European central bank will cover losses by using its gold revaluation account in full, the ECB has to put a floor under the gold price. And if more losses need to be covered than the current gold revaluation accounts of European central banks allow, the ECB will need to revalue gold.
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Introduction
A discussion has commenced in the Netherlands after Klaas Knot, Governor of the Dutch central bank (DNB), wrote a letter to Sigrid Kaag, Dutch Minister of Finance, on September 9, 2022. The letter is titled: “DNB foresees deterioration of capital position.” Knot warns Kaag of DNB losses due to interest rate hikes—decided by the European Central Bank (ECB) but applied by all National Central Banks (NCBs) of the Eurosystem. In recent years Quantitative Easing (QE) has made DNB, and all other NCBs, create an abundance in bank reserves to buy government bonds. Now the ECB is raising interest rates so DNB has to pay banks more and more interest over their excess reserves. These expenditures cause DNB to suffer losses to the detriment of its capital position (equity). Note, all NCBs in the Eurosystem face similar challenges.
For this year DNB expects a small loss but for the years 2023 through 2026 a loss of €9 billion euros is expected. Though, it could be more. DNB’s equity is currently €11.3 billion. If the losses exceed €11.3 billion, DNB’s equity will become negative. Although it’s possible for a central bank to operate under negative equity, it does hurt credibility—a central bank’s most valuable asset. And once credibility is lost people will dump the currency issued by said central bank.
For this reason, Knot wants to discuss with the Dutch state (DNB’s sole shareholder) the possibilities of funding a recapitalization of DNB. In other words, if taxpayers can bail-out their central bank.
The Gold Revaluation Account as a Solvency Backstop
A gold revaluation account (GRA) is basically an accounting item that records the unrealized gains of a central bank’s gold. Because most of Europe’s monetary gold was accumulated during Bretton Woods at $35 dollars an ounce, the respective GRAs are substantial. Monetary gold in the Eurosystem is marked to market and the gold price today is much higher than $35.
Below is a simplified balance sheet of a central bank. On the asset side there are international reserves (gold and foreign exchange), a bond portfolio, and discount loans to commercial banks. On the liability side there is the monetary base (reserves and currency), a deposit account for the government, a GRA, and equity.
Like commercial banks, the balance sheet of a central bank includes assets and liabilities.
Interestingly, there is no limit on a GRA because gold is the only international reserve asset that can’t be printed. Denominated in fiat currencies, which can and are printed, the gold price doesn’t have a ceiling and it can inflate balance sheets likewise.
The GRA can be seen as equity but technically it isn’t at this point because it’s prohibited from being used. The current laws in the E.U. dictate: “there shall be no netting of unrealized losses in any one security, or in any currency or in gold holdings against unrealized gains in other securities or currencies or gold.” At this stage the GRA just swells and shrinks in sync with the rise and fall of the price of gold. But all this might change.
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