Rome's Attack on Italy's Gold

Which part of "No" don't Italian politicians understand...?

THERE ARE ONLY so many ways you can say "No" in Italian (just the one, in fact, that we know of here at BullionVault), and the Bank of Italy has worn them all out in defending its gold hoard so far this decade.

Little love's lost, in short, between the Banca and the Treasury in Rome. But somehow, things just took a turn for the worse.

"We always knew they didn't get on," as Stefano Sansonetti wrote at Italia Oggi back in late June. In fact, finance minister Giuli Tremonti and Banca d'Italia governor Mario Draghi make the UK's Alistair Darling and Mervyn King look like the best of pals. (Though they might seem more chummy than ex-US chief Hank Paulson and Fed chair Ben Bernanke before too long...)

"Nor is it news," Sansonetti went on, "that the finance ministry has had its eye on the Banca d'Italia's gold for some time. There have been plenty of attempts to make use of these resources."

But now "It really looks like Tremonti is playing games with Draghi" – a game costing €251 million...or perhaps €206m...if not €300m, the latest proposal issued on Monday by the Italian government.

Either way, this game aims to force the Bank to break its gold-hoarding habit of a decade and more. And since Draghi is widely seen as the next president of the European Central Bank (ECB) – and with the current Central Bank Gold Agreement to cap sales at 500 tonnes per year less than 10 weeks away from expiring with no new deal in place – what happens in Rome might just matter to gold investors.

Given the state of Italy's public finances, it might matter to anyone holding Euros, too. But first, the story so far...

On June 29th the Treasury on Via XX Settembre tried to throw a net around the Gold Bullion stored beneath Rome's Palazzo Koch. It stands at 2,451.8 tonnes – the third largest central bank hoard in the world. And there it's stood – unchanged at 2,451.8 tonnes – for the last 11 years or more.

That makes Italy the only Eurozone nation not to sell any of its gold reserves since 1998. It's also the only signatory to the Central Bank Gold Agreements of 1999 and 2004 not to sell any gold either. Which makes you wonder why it bothered to take out its pen.

Despite agreeing to the CBGA's 400-tonne per year limit in 1999 and then signing the renewal – with its new 500-tonne ceiling – five years later, the Banca d'Italia failed to sell one single gram, let alone an ounce or a tonne. Not at any price. Not at €250 an ounce a decade ago. Not at €500 an ounce in spring 2006. Not at €750 an ounce in Feb. 2009.

Italy's fellow CBGA signatories, in contrast, have shrunk their gold reserves by more than one quarter on average.

Even the Bundesbank in Germany, which has twice restated gold's "confidence and stability-building function" against political calls to sell part of its hoard in the last 12 months, has sold over 50 tonnes since 1999, albeit for casting coins and medals for the collectors' market.

Whereas the last concerted attempt to "mobilize" Italy's central-bank gold – that ultimate crisis insurance – failed to get through parliament, stymied by Italy's absurd political horse-trading as well as the fact it's pretty much illegal to force the Banca to do anything with its gold or foreign currency reserves.

Since then, however, the public-debt crisis of 2007 has become the public deficit crisis of 2009, with spending set to out-run tax receipts by 5% of the annual economy. A 'primary deficit' of new debt even before interest payments is also set to strike for the first time in 19 years.

Time for the ultimate crisis insurance to pay up, right?

"Imposed on the capital gain in non-industrial gold of societies and institutions," says Article 14 of the Berlusconi government's new Anti-Crisis Intervention, "a tax of 6%."

If that sounds like a rough and clumsy translation, you should see the original in Italian. Jewelers, metals dealers and their advisors spent all of 5 minutes studying the proposed law, scratching their heads and trying to guess if it meant them. Those we called here at BullionVault then simply rolled their eyes and got back to work. Because the clause clearly wasn't intended to tax their gold – not yet, at least. (And if it was, then bully for them. Because as a superseding tax rate, rather than an addition, it would replace any previous charge. And corporation tax for Italy's bullion firms is nearer 30-35% per year.)

Private investors can also breathe easy (for now, at least), since they're clearly excluded. The decree's tortuous diction would seem to avoid hitting investment and pension funds, too. All told, it makes the un-named target quite clear. This new tax is meant solely for the central bank alone.

But the Banca d'Italia isn't alone. It's got the European Central Bank on its side. Yaa-boo!

"The ECB's competence to deliver an opinion is based on Article 105(4) of the Treaty establishing the European Community and the third indent of Article 2(1) of Council Decision 98/415/EC of 29 June 1998 on the consultation of the European Central Bank by national authorities regarding draft legislative provisions, as the draft article relates to the Banca d'Italia..."

In short? Listen up, cretino...

"The draft article needs to be reconsidered to address...concerns relating in particular to central bank independence and the prohibition on monetary financing. The ECB expects to be consulted on any revised draft legislative provisions in this matter."

Meaning non, nein und nimmer, as they say in Frankfurt. Using three "furthermores" and five "moreovers", the ECB's letter to the finance ministry lays out its view like a pitbull chewing a wasp. Most especially, "The draft article is not clear" with regards to scope, time-period or even subject (which of course the finance ministry intended), but it does clearly seek to break two key planks of the entire Eurozone system, now a little more than 10 years old.

  • Central bank independence from politics – beginning and ending with central-bank discretion over what happens to central-bank profits and assets, provided they're shared with the mother bank, the ECB itself, in the agreed proportions;
  • Absolutely no monetization of government debt. Repeat, zero purchases of government bonds direct from the government, and thus no budget financing to come from the central-bank either. What is it in the "monetary financing prohibition" that Rome doesn't understand?

The finance ministry's not done yet, however. And why should it quit now?

Playing by these central-bank rules must seem a mere formality when the Eurozone's key fiscal rule – capping budget deficits at 3% of GDP max – has been so routinely ignored by each of its fellow member states. Germany will run a 4% deficit on its public spending this year, with 6% penciled in for 2010. France is already budgeted for a deficit worth 7.5% of GDP this year and next. Spain's on course for a near-10% drag. Greece fiddled its figures to hit the 3% limit even before joining the Euro, and Italy itself has run an annual deficit below that ceiling only once in the last seven years.

So cue the horse-trading, Italian-style.

First the finance ministry offered to cut the 6% gold tax to just 1%. But parliament said it couldn't amend the Anti-Crisis decree just like that, and the 6% rate had to stay. So this week Tremonti wrote to the speaker of the lower house, offering to apply the tax only to fiscal-year 2008 and announcing a €300 million cap to boot. That would "safeguard" the Banca's "institutional and financial independence," he claimed. Which is divertente like a night out with Silvio Berlusconi.

At the full 6%, back-of-the-envelope numbers say the Banca d'Italia would have incurred a bill of only €251 million on the capital appreciation of its gold during 2008. Allowing for that 18% of its gold hoard which the Banca d'Italia must pledge to the ECB under the terms of the single currency treaty, says Sansonetti at Italia Oggi, the bill would fall to €206m. But that's still money which the central bank could only raise by selling gold. And capping the bill at €300m is just raising the finger in the gesto dell'ombrello.

What next? Italian politics are famously messy, and never more so than when the Banca d'Italia fights with the Treasury. But now the European Central Bank is involved. The scrum could threaten to crash into the crowd.

"If you don't go away, I'll have you roughed up a bit," was how finance minister Tremonti "joked" with reporters when he took the job in 2005, repeating a threat made to the press by then-central bank governor Antonio Fazio. Draghi's predecessor had refused to quit despite being caught on a wire-tap apparently breaking European merger and takeover rules, favoring Banca Popolare Italiana over Dutch competitor ABN Amro for control of the domestic Antonveneta lender.

Fazio went in the end...and Draghi took over. But there was no love lost between the Banca and the Treasury. Nor was any of the Bank's gold used as a sticking-plaster for the Italian state's yawning debts. Now in 2009, Treasury bond issuance this year alone is set to top €260 billion...a huge increase in Europe's second-deepest sovereign debt market and ten times the sum it's trying to tease out of Italy's gold. That suggests the Anti-Crisis gold tax is symbolic, as well as desperate, nevermind being illegal under the Eurozone treaty.

The timing bears notice, too. Because Western Europe's 5-year Central Bank Gold Agreement is set to expire in just nine weeks' time, on Friday 26th September. The 2004 renewal was long since signed by this point in the summer (March, in fact). Yet here in 2009, the US Congress just gave its approval to a 400-tonne sale by the International Monetary Fund, which in turn has vowed to make any such disposal within the CBGA framework.

How can it if the CBGA doesn't exist? And what's the point of the 16 existing signatories renewing the treaty's 500-tonne annual limit when their 2004 Agreement has seen less than 150 tonnes sold so far in this, its fifth and final year?

"One does not have to be an amateur investor to sell low," as the late Peter Bernstein noted in his classic history, The Power of Gold. "The lower the Gold Price fell [in the early 1980s], the greater became the prospect of official sales. As the price rose from $375 in 1982 to nearly $500 after the stock-market crash of 1987, few central bank sales were executed."

Selling high, on the other hand, only grows more difficult when rising gold prices – up three-fold since the Euro was launched – point to a deeper malaise in finance and the economy. Neil Mellor at Bank of New York Mellon isn't alone in thinking Italy's fast-swelling debt could threaten wider Euro-region investment. Now nearing 120% of GDP, and the second-largest in the world at twice the currency zone's agreed limit, Italy's outstanding sovereign debt has pushed the interest rate demanded by bond investors almost 1% above the rate paid on German Bunds.

Hardly a unified interest rate, is it? And it's hardly a unified union when politicians from the Eurozone's third-largest economy – its second-biggest debt issuer – take their horse-trading public, arguing the toss over what monetary union actually means in law with the European Central Bank. So far, it means not selling any of Italy's gold. But if monetary union frays any further, holding onto it – or Buying Gold as crisis insurance – might become still better advised.

All Rome is asking, after all, is for the same "monetary financing" enjoyed by its non-single currency partners in Washington and London, with the same scope for "independent" national action that the Fed and Bank of England have taken – together! – in cutting interest rates below the ECB's stand-out rate of 1%.

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Adrian Ash runs the research desk at BullionVault, the physical gold and silver market for private investors online. Formerly head of editorial at London's top publisher of private-investment advice, he was City correspondent for The Daily Reckoning from 2003 to 2008, and is now a regular contributor to many leading analysis sites including Forbes and a regular guest on BBC national and international radio and television news. Adrian's views on the gold market have been sought by the Financial Times and Economist magazine in London; CNBC, Bloomberg and TheStreet.com in New York; Germany's Der Stern and FT Deutschland; Italy's Il Sole 24 Ore, and many other respected finance publications.

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