Wednesday, May 30, 2012

How Tier 1 Capital Affects Gold

Gold had been on a steady rise for years but recently topped out in August of 2011. Many have wondered why, and what this may mean for the future price of gold. I've documented several times how central banks have an interest in managing gold's ascent and occasionally knocking its price down. But there is also another factor much less sinister and it has to do with what's called Tier 1 capital requirements required by the Bank of International Settlements (BIS).

The BIS is an intergovernmental organization of central banks that fosters international cooperation between central banks. When a bank is looking "shaky" or is otherwise distressed, the BIS may require commercial banks to raise "Tier 1" capital. This capital is usually AAA rated government bonds, US Treasuries being the best example. The BIS does not currently recognize gold as a Tier 1 asset. When commercial banks are distressed (Think Geek, Italian and Spanish banks) they are forced to sell gold and buy US Treasuries or German Bunds. Knowing this might explain where some of that 5,000 tons of gold came from.

The following video from RT and feature John Butler explains this well:

To recap the important points

  • BIS does not consider gold a Tier 1 asset.
  • Banks are being forced to sell gold to raise Tier 1 assets.
  • Gold is sold to buy Treasuries.
  • Demand for Treasuries keeps interest rates low (Bond prices and yields move in opposite directions.
  • Therefore central banks likely fight gold as a Tier 1 asset to keep price support of Bonds.
  • Commercial Banks such as JP Morgan already allow gold as collateral.
Tie this back to Ron Paul who wants gold & silver to become “money” once again as a competing currency with the dollar rather than a "collectible" that is taxed as ordinary income.

The second part of the video concerns China & Japan, two countries who have not exactly enjoyed good relations for centuries making a commitment to trade with each other in Yen & Yuan/Renminbi. The two countries are moving away from the US dollar. And lest you think this doesn't much matter, consider these two countries economies are the world's second and third largest economies! Our government's massive overspending and our Federal Reserve's printing is slowly but surely destroying the dollar's place as the world's reserve currency.

What does this mean in terms of wealth preservation (The purpose of this blog!)? It means America is becoming poorer, imports will become more expensive and interest rates will at some point have to increase making the government debt even more expensive and starting us towards a death spiral where higher rates mean we are less solvent which leads to even higher rates and less solvency.

Sound familiar? It should. That's Greece today.

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