Dollar Better Than Gold? Ask Venezuela

Venezuela's recent experience is instructive. The Chavez regime had moved away from the fiat US dollar and had the bulk of its reserves in gold. Last month, Venezuela's reserves had been drawn down to about $19 bln, of which $14 bln was thought to be gold.  

Venezuela has found out the hard way that dollars are better than gold. At the end of last month, it swapped 1.4 mln troy ounces of gold for $1 bln with a large US bank. 

Venezuela's gold was discounted by a little more than 40% and it will pay interest on the dollars it receives. The swap is four years in duration, and at the end of it, Venezuela has the first right to buy the gold back. 

It is true that Venezuela has a relative extreme macro economic situation. The IMF expects the economy to contract 7% this year after 4% contraction in 2014.  Inflation is projected to be well over 100% and the fiscal deficit may be 20% of GDP. The black market rate for the bolivar has depreciated by nearly 50% so far this year. We suspect that when push comes to shove, and it will, Venezuela is more likely to officially devalue than default on its local debt. 

One of the advantages for Venezuela of the gold swap is that by some accounting it may still count the gold as part of its reserves. This underscores that central bank reserves many not always be what they seem. Central banks have used a number of ploys to hide the extent of their intervention, like operating in the forward market or conducting off-balance sheet operations, like Brazil's currency swaps. Similarly, Russia had included its sovereign wealth funds in its reserve calculations, but they are not liquid or available. 

The dollar's status as the primary reserve assets is partly a function the liquidity and depth of the US capital markets. Gold is not a particular liquid or deep market. Countries cannot service their debt with gold. To monetize it, Venezuela is paying a steep price--a 40% haircut plus interest on its dollar borrowings.  

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Nandkishore Korde 6 years ago Member's comment

Selling 1.4 m Ounces at current spot rate would have fetched $1.6 B. The discount is much steeper than 40%. Not a hair cut, full shave!! I wonder why the seller prefers a swap and not outright sale.

Ezra Johanes 6 years ago Member's comment

Either way, the power that be (PTB) will want to be in control. Never link central banks to US reserve groups. BRICS is avoiding all this hassle in an ingenius way.

Marc Bentin 6 years ago Member's comment

Gold is not "discounted" with the swap as if it would be sold 40% below its market price...that is misleading and disingenuous representation, I think. The 40% discount is a haircut indeed, enough to give some margin for error to the bullion bank in it its collateralized loan to Venezela in case its collateral would fall by more than 40%. "if" Venezuela does not get into more trouble with its currency or its debt situation, it should be in a position to get back all its gold at the swap maturity but it will indeed suffer a charge of interest which everybody else would face whenever taking a collateralized loan...Venezuela should also get its gold back "if" the bullion bank that has most likely sold the physical to china can get it back in a few years time from somebody else than the Chinese because the Chinese ain't going to sell that gold back...

Harry McNicholas 6 years ago Member's comment

Ah "if" Marc? I would say almost guaranteed.

Marcus David 6 years ago Member's comment

You can wax lyrical about paper money all you like - but I have no faith in it nor the governments that supply it - Gold is king in my world.

Harry McNicholas 6 years ago Member's comment

Marcus since you hate the U.S. dollar, I am going to help you. I will personally take all the dollars you do not want. Also, if you like Gold, well I just happen to have a hole in the ground, uh I mean Gold mine I will sell you for some of those terrible nasty dollars.

Dr. James Joy Safler 6 years ago Member's comment

Gold has nil future.It has only an assigned value,a value that is irrationally subjective to speculation and gambling.It has no inherent value.It has no scientific,industrial or household value of regular,constant use like an ordinary consumer durable.It cannot be easily stored,easily transportable or easily exchangeable.It consumes huge space to store,very difficul to protect and involves huge expenses to do so.It is absolutely aDull metal. It being so scares it is not economically or otherwise has the extent,flexibility and reach to cover the infinitely larger modern economies of the countries or the world before which it is a negligible pigmy.It was the common currency of dark ages and primitive times.Any currency tends to be and should always represent easily the economic,fundamental strength of a country which is the real wealth.Such wealth depends on manufacturing,industry,infrastructure,small and medium businesses,services like education,health,computer services and all other services,agriculture,human development,research and scientific capabilities,so on,but not on silly,downright irrational and illogicities and stupidities and inanities like gold,which needs to be dumped into the seas altogether.

Saul Smith 6 years ago Member's comment
Gold has many uses in STEM fields, namely the electronics used to power and run the very thing you are typing this on! It is a consumable in that field. Fiat currency will likely flop. I would rather buy Platinium group metals (Iridium, Ossmium etc) or silver and gold due to their physical, high electric conductivity properties, density and use in technology (ie: catalysts, chemical feedstock, metallurgy, catalytic converters in cars etc etc). I am in a state of shock as to think that a PHYSICAL OBJECT has less value than an I OWE YOU piece of paper printed by governments which may change in the next 100 years. If you were to dump all gold and other precious metals into the sea then you would not see another computer, camera, phone etc for a while. Like wise it is used elsewhere in astrophysics for mirrors, visors and such. source: en.wikipedia.org/wiki/Gold#Modern_applications
Harry McNicholas 6 years ago Member's comment

Saul. The number one use for industrial Gold are Gold jewelry.

Anders Leland 6 years ago Member's comment

sounds to me like this is a loan using gold as collateral.

Khanh Nguyen 6 years ago Member's comment

I share my exp from vietnam for many year.

If i am a Venezuela citizen, i will invest us dollar.

Arthur Amistoso 6 years ago Member's comment

Gold is still the best currency for more than 2000 years. It's present value is artificially lowered by the central banks of big economies to encourage countries to have confidence in the paper money which is only backed by the confidence in the government of the countries with large countries. Once this confidence is lost so with the value of the paper money, hence, the economies of these countries would soon collapse. Let'snot get into ourselves waking-up someday that we're holding to a lot of waste paper. Gold is gold eversince.

Khanh Nguyen 6 years ago Member's comment

if i Venezuela citizen, i would invest dollar. Sharing from Vietnam.

Harry McNicholas 6 years ago Member's comment

Hm, Khanh, have you considered moving to Switzerland?

Harry McNicholas 6 years ago Member's comment

The price of Gold is set every morning in London. It is based upon the buys and sells. You can also buy futures if you have a good working crystal ball.

Paul Fillion 6 years ago Member's comment

I calculate the value of the US gold reserves at closer to $300 billion than the $800 billion stated in the article.