Governor of Dutch Central Bank States Gold Revaluation Account Is Solvency Backstop
Dutch Central Bank States Gold Revaluation Account Is Solvency Backstop
Analysis of landmark statements on using gold reserves as central bank capital and implications for European monetary policy
The Governor of the Dutch central bank stated the gold revaluation account ensures the solvency of his central bank in an interview on television about prospective losses. The significance of this statement is that if any European central bank will cover losses by using its gold revaluation account in full, the ECB has to put a floor under the gold price. And if more losses need to be covered than the current gold revaluation accounts of European central banks allow, the ECB will need to revalue gold.
Analysis Overview
DNB's Financial Challenges
A discussion has commenced in the Netherlands after Klaas Knot, Governor of the Dutch central bank (DNB), wrote a letter to Sigrid Kaag, Dutch Minister of Finance, on September 9, 2022. The letter is titled: "DNB foresees deterioration of capital position."
Knot warns Kaag of DNB losses due to interest rate hikes—decided by the European Central Bank (ECB) but applied by all National Central Banks (NCBs) of the Eurosystem. In recent years Quantitative Easing (QE) has made DNB, and all other NCBs, create an abundance in bank reserves to buy government bonds. Now the ECB is raising interest rates DNB has to pay banks more and more interest over their excess reserves.
Financial Projections
- 2022: Small loss expected
- 2023-2026: €9 billion loss projected
- Current equity: €11.3 billion
- Risk of negative equity if losses exceed capital
Systemic Challenge
- All Eurosystem NCBs face similar issues
- QE policies created excess reserves
- Rising rates increase interest expenses
- Credibility at risk with negative equity
Credibility Crisis Risk
Although it's possible for a central bank to operate under negative equity, it does hurt credibility—a central bank's most valuable asset. And once credibility is lost people will dump the currency issued by said central bank. For this reason, Knot wants to discuss with the Dutch state the possibilities of funding a recapitalization of DNB.
Gold Revaluation Account Mechanics
A gold revaluation account (GRA) is basically an accounting item that records the unrealized gains of a central bank's gold. Because most of Europe's monetary gold was accumulated during Bretton Woods at $35 dollars an ounce, the respective GRAs are substantial. Monetary gold in the Eurosystem is marked to market and today's gold price is much higher than $35.
Simplified Central Bank Balance Sheet
Assets
- International reserves (gold and foreign exchange)
- Bond portfolio
- Discount loans to commercial banks
Liabilities
- Monetary base (reserves and currency)
- Government deposit account
- Gold Revaluation Account (GRA)
- Equity
Unique Properties of Gold
Interestingly, there is no limit on a GRA because gold is the only international reserve asset that can't be printed. Denominated in fiat currencies, which can and are printed, the gold price doesn't have a ceiling and it can inflate balance sheets likewise. This is why understanding gold price movements is crucial for central bank solvency analysis.
The GRA can be seen as equity but technically it isn't at this point because it's prohibited from being used. The current laws in the E.U. dictate: "there shall be no netting of unrealized losses in any one security, or in any currency or in gold holdings against unrealized gains in other securities or currencies or gold."
Governor Knot's Landmark Interview
On Sunday October 30, 2022, Knot was interviewed by Buitenhof about DNB's losses. When the solvency of DNB's balance sheet was questioned Knot brought up the GRA. This marks the first time since Bretton Woods that a central banker has openly discussed using gold revaluation accounts for solvency purposes.
Critical Insight
Using the GRA to cover losses doesn't require selling gold, it requires changing the accounting rules. The reason it's now prohibited from being used is because once fully run down a declining gold price will cause the GRA to become negative, eating into DNB's net worth. In the interview Knot thus appoints the GRA as a solvency backstop, but this implies putting a floor under the gold price.
European Monetary Implications
The implications of Knot's statements extend far beyond the Netherlands. If European central banks officially adopt gold revaluation as a solvency mechanism, it fundamentally alters the role of gold in the international monetary system.
Price Floor Mechanism
If any European central bank uses its gold revaluation account in full, the ECB must establish a floor under the gold price to prevent the account from going negative and damaging bank solvency.
This creates unprecedented support for gold as an investment asset, as central bank policy would directly support gold prices.
Gold Revaluation Scenario
If current gold revaluation accounts prove insufficient to cover losses, European central banks may need to officially revalue gold at higher prices, similar to 1930s precedents.
Such revaluation would dramatically impact both monetary gold holdings and private gold investments, making gold price monitoring essential.
European Gold Coordination
European central banks have equalized, proportionally to GDP, their gold reserves among each other in the past decades. This was done for all to enjoy the same relative gain in their GRAs when revaluing gold.
- Proportional gold holdings established
- Equal relative benefits from revaluation
- Coordinated monetary policy framework
Crisis Response Framework
According to analysis, revaluing gold will only be done in an insurmountable crisis. After gold revaluation:
- Sovereign debt could be cancelled
- Gold price would be stabilized
- Eurozone moves toward new gold standard
Historical Context and Precedents
In the 1930s GRAs had been used for several purposes. After devaluing against gold central banks eventually re-pegged their currencies to gold at a higher price, leaving GRAs to be used as they saw fit.
Historical Significance
As far as documented history shows, no central banker has openly discussed using a GRA—to cover its own losses or cancel sovereign bonds—since Bretton Woods. Remarkably, in the Buitenhof interview it wasn't the interviewer that brought up the GRA, it was Knot!
Investment Implications
The current trend is clear: financial challenges, caused by unconventional monetary policy, lead to more focus on gold's role in overcoming these challenges. For investors, this represents a fundamental shift in gold's monetary role.
Strategic Positioning
Central bank recognition of gold as a solvency backstop validates gold's monetary properties. Investors can position themselves alongside central banks by acquiring physical gold before potential revaluation events.
Market Monitoring
As these developments unfold, tracking both gold price movements and silver market dynamics becomes crucial for understanding broader precious metals implications of monetary policy shifts.
Disclaimer: This analysis is for educational purposes only and should not be considered financial advice. Central bank policies and gold revaluation scenarios involve significant uncertainty. Precious metal investments carry risk, including potential loss of principal. Always consult with qualified financial advisors before making investment decisions.