WORLD GOLD COUNCIL: Bonds backed by gold, a solution for cutting the borrowing costs in the Eurozone

The member states of the Eurozone which were hit the hardest by the sovereign debt crisis could use part of their gold reserves as collateral for the bonds they issue, according to a report quoted by the World Gold Council (CMA).

Such an initiative would represent a temporary measure which would stimulate the economic recovery in those countries, because it would allow them to borrow at lower costs, considers professor Ansgar Belke, monetary expert with the Economic and Monetary Affairs Council of the European Parliament, the author of the report called "A more efficient monetary policy in the Eurozone - sovereign bonds backed by gold".

"The use of gold as collateral for new bond issues would reduce the short term pressure (ed. note: when it comes to financing) and would facilitate the return to economic growth", he said, stating that bonds backed by gold have numerous benefits compared to other unconventional monetary instruments which the ECB has introduced to fight the sovereign debt crisis in the Eurozone. "The balance sheet of the ECB would be, for the most part, unaffected by this measure, because the gold held in the reserves of the central banks would be more than enough to cover those bonds. The decision would increase the yields of the sovereign bonds without increasing inflation, and would provide some of the most indebted countries in the Eurozone the additional time needed to achieve reform and economic recovery", Ansgar Belke also said.

The report shows that not all countries which borrow at high costs have enough gold to use as collateral for their sovereign bond to make this a viable idea. Countries which fall under that category are Greece, Ireland and Italy. On the other hand, Italy and Portugal have gold reserves which cover 24%, namely 30% of their financing needs for the next two years, which allows this measure to be used. In the case of Portugal, government bonds would have a lower yield than if they were not backed by gold, because the gold reserve represents one third of the collateral, the study says.

However, Ansgar Belke states that the use of gold as a collateral for sovereign bonds would be hard to implement without a political consensus. The need for refinancing in the Eurozone would have to become overwhelming for countries in Southern Europe to support the idea. "Obviously, one condition for obtaining the support of the public for using gold to back the government bonds would be unsustainable financing costs: the prospect of high inflation, which limits the ability of the central banks to conduct quantitative easing, excessive yields required by the financial markets and unsustainable debt to GDP ratio", he said. What is more difficult than the legal aspects involved by this measure is the ability to convince the central banks to adopt such a decision, Ansgar Belke concluded.

"Even though there are political and legal aspects which must clearly be addressed, throughout time, gold has been used by countries such as Portugal, Italy and India, to obtain loans, and it would provide a partial solution to the problems which currently exist, in Europe, and an alternative to the austerity measures", said Natalie Dempster, head of government affairs at the World Gold Council.