The Central Bank’s Gold Reserves: Present, Past, and Future - Does the Gold Reserve alleviate the financial crisis?

Opinion Analysis by Yara Dally, Contributor

August 2nd, 2021

History of Gold Purchase:

By the late 19th Century, most of the world economies, including Lebanon, adopted the gold standard. The gold standard is a monetary system where the government links the value of its paper money to a stock of gold reserves at a set price per ounce. Under the gold standard, the government defines the dollar to be a specific weight of gold, and a dollar bill is defined as a paper object that is made redeemable at a specific dollar weight of gold.  

Pre-war Lebanon had a budgetary surplus that was used for gold purchases and investing in several ventures.

The first purchase of gold in Lebanon dates back to 1948 when 1.5 tons of gold were bought. The implementation of the first monetary law in 1949 played a major role in increasing the gold reserves, especially after setting conditions for lira issuance provided that 50% of the value of the currency in circulation is covered in gold and hard currencies, and 50% of it is covered by various government papers. In 1954, the rate of gold coverage of cash in circulation exceeded the rate set by law and reached 90%.

With rising inflation figures and a gold run looming in the United States of America in 1971, President Richard Nixon ended the dollar convertibility to gold. Foreign governments were no longer able to swap their dollars for gold, effectively transforming the international monetary system into a fiat system. At that point in time, Lebanon had stopped purchasing Gold.

Gold Reserves:

According to Riad Salameh, Governor of the BDL, gold reserves stood at $18 billion at the end of 2020. However, by the first half of 2021, its value depreciated to approximately $15 billion not due to withdrawal or liquidation but rather to a drop in gold prices globally from an average of $2,000 to $1,800 per ounce.

World Gold Council’s latest report shows that Lebanon ranks 20th globally and 2nd regionally in terms of gold holdings in the MENA region with 286.8 tons of gold reserves. After calculating the per capita share of gold reserves, the Lebanese citizen appears to be ahead of his Arab counterpart in this index at 1.35 ounces of gold (the weight of an ounce of gold = 31.10 grams).  

Due to political instabilities and security concerns, BDL shifted a major portion of its gold reserves to Fort Knox in the US in the mid-1970s and early-1980s, while thousands of gold bars are kept underground in steel vaults at the Banque du Liban which require three keys to unlock, one of which is kept by the government commissioner at the Banque du Liban, and two with the Central Bank's competent departments.

Past vs. Present:

In Lebanon, history is repeating itself. Many voices requested the sale of the central bank's gold holdings in 1986 amidst the civil war and its devastating effects on the Lebanese economy.

Edmond Naïm, the governor of the Banque du Liban at the time, raised the proposition of selling gold as an available solution after the continuous depletion of the BDL foreign currency assets which had weakened its capability to face the ongoing crisis at that time.  However, these arguments did not convince many politicians and parliamentarians, and it was reported that a group of businessmen and politicians involved in corruption scandals were behind this proposal to put their hands on the gold. Thus, law No. 42 of 1986 was implemented, which states the following; “Prohibiting the sale of all Bank of Lebanon gold reserve, only by a legislative text of the Parliament.” with the aim of protecting the gold reserves.

Today, Lebanon is engulfed in a political, financial, and economic crisis that started in 2019. The devaluation of the local currency has already resulted in triple-digit inflation and a surge in poverty rates. Without a functioning executive authority, the country is attempting to form its fourth government since the crisis with no positive insights. The country's failure to establish a government has hampered progress in fixing its economic challenges. The Beirut port explosion, as well as the lockdowns enacted to prevent the spread of COVID-19, have exacerbated this fractured state's profound financial crisis.

After the depletion of foreign currency assets at the Banque du Liban, will the gold reserves be our last resort to alleviate the financial crisis?

To find an answer to that question, The Phoenix Daily Interviewed Dr. Henri J. Chaoul on July 21th, 2021.  Dr. Chaoul is the Managing Partner of Levantine Partners, former advisor of the Minister of Finance from February 2020 to June 2020 before resigning due to the absence of willingness to do any reforms, in addition to being a member of the official delegation representing Lebanon in the negotiations with the IMF.

That gold should be used:

“The gold has to be used for the revival of the economy and for no other reason. So, I am against the use of the gold if it is to finance depositors that have lost their money or to finance bank shareholders to remain on their two feet, or to finance the current consumption without any vision, but rather to build the economy of the future. This all means by definition, that it cannot be touched in the presence of this political governance system that we have in this country. The losses we have today in the financial systems have to be ring-fenced so that the Gold is not touched in order to accommodate or finance these losses.” Explained Dr. Henri.

“People who led to the crisis, people who literally raped the country, are not people fit to take us in that direction nor to have suggestions on how to use the gold.” He further stressed.

Indeed, different ways of gold usage could be seen: let’s take for example the gold swap; the central bank exchanges gold for foreign currency with the understanding that the transaction will be unwound at a predetermined price at a later date. It carries little credit risk because it is a collateralized transaction­ - the use of a valuable asset to secure the repayment, in this case, the collateral is the gold. Implementing such measures could never be efficient with the presence of an incompetent ruling class. We may default on repurchasing them back, as money could be spent on buying more time suchlike spending them on financing ratio cards scheme and not investing the money for long-run solutions.

Digging Deeper

The impact of gold liquidation within this same ruling class for 30 years without any reforms or vision for the future was brought to discussion. Chaoul tells The Phoenix Daily that every day without solutions being implemented is another day where we face significant additional losses, not only financially but humanely, environmentally, economically, socially, and so on...  The so-called leaders of the country have been specialists at buying time and kicking the can down the road, he added.

Henri believes that there are no conceptual differences between foreign currency assets and gold holdings at the Banque Du Liban. “I am of the opinion that both should be treated the same, in other words, the remaining cash and FC assets we still have are strategic assets,” he mentioned.

“Whatever money we have in the meantime - and it’s not a lot - if we put our act together today, within nine months we can have a plan together and we can stabilize the situation,” Chaoul affirms.

Trust Issues and the availability of the Gold

“How can we trust any statement or announcement made on behalf of the Banque Du Liban, if the data issued by BDL is continuously subject to guessing, analysis and lack of transparency?” Questioned Henri.

“The question that stands out here is that is the gold pawned or used in any way, although it’s forbidden by law? The only way to find out is by executing a forensic audit.” He also highlighted. 

Lebanon defaulted on a $1.2 billion Eurobond on March 9th, 2020, the first sovereign default in the country's history, which had left the country facing potential lawsuits that could be filed against the government with the intention of seizing Banque du Liban’s foreign assets: its gold and foreign currency reserves.

“Central banks assets are immune under the US law, and till today seizing Central Banks’ foreign assets has been rejected in court over and over again” Claimed Chaoul.

Corrupt Lebanese politicians are specialists at buying time and using a Band-Aid approach rather than implementing reforms for the long run. Nothing is optimistic about the future of Lebanon if it’s still in the hand of the same ruling class.