Examination of Witnesses (Questions 120-140)
MONDAY 5 FEBRUARY 2001
120. Can I take you on finally to the assets
you hold. How much do you hold in cash? You have to intervene
in the market every so often, so presumably you have to do that
in cash terms?
(Mr O'Donnell) No.
121. Do you hold cash in any significant quantities?
(Mr O'Donnell) No.
122. So you are given time to realise your assets?
(Mr O'Donnell) We can intervene, given the expertise
of the Bank who would do it for us, very quickly. It is possible
to generate funds which can be used for intervention very quickly,
given the funds we hold which are not cash but interest-bearing.
123. I wanted to come back to this 40:40:20,
which I understand is long-term and that seems sensible in terms
of Government policy. How often would you review that position
in relation to the changing fortunes of the economies involved
in each of those currencies? We know Japan had and continues to
go through some difficulties. The American economy may be going
into difficulties. The European economy may be coming out of difficulties,
we do not know. How would you balance those judgments and how
often do you review the overall proportions of the percentages
you hold in each currency?
(Mr O'Donnell) We certainly are in continuous touch
with the Bank in terms of what is happening to the overall foreign
exchange account. We publish monthly what is happening, there
are monthly meetings between the Bank and the Treasury, and in
particular we have six monthly meetings where we look at more
long-term strategic issues.
124. I have a couple of questions following
on, very much from the point of view of the layman. I want to
take you back to this question of significance, because I recall
some months ago if one had listened to some commentators one would
imagine the sale of gold would have led to the economic roof falling
in, and actually the NAO Report demonstrates this clearly is not
the case. If you look at Figure 16 on page 20, and you look at
the price which would have been attained using the London Gold
Fix compared to the auction price, the significance is something
like 1.6 per cent. Not only is that not statistically significant,
it is not really significant at all, is it?
(Mr O'Donnell) No, I agree. The point being, it is
very useful we have a benchmark here we can look at. It is one
of the best benchmarks one can have but we know we are auctioning
at the same time they are doing a Fix, so we can look at the differences
between the two. That is what the NAO have done and those are
the numbers. I would have been surprised if they had shown big
125. Similarly, something else which has come
up quite a lot this afternoon, what has happened to the money
which was gained from the gold sales40 per cent into dollars,
40 per cent into euros, 20 per cent into yen? If one takes a longer-term
view of that, that is not significant either, is it? I may be
naive in this but if money is going away from the dollar, it is
going into something else, probably into euros or probably into
yen, so actually it is not going to do us very much harm wherever
the money is going, unless something fundamental happens.
(Mr O'Donnell) Two points I would make about that.
One is that is precisely why we diversify the portfolio, so we
are not putting all our eggs in one basket. If it was all in dollars
and the dollar went into long-term decline, we would have a problem.
The second point to note, of course, is that the one thing we
are doing is moving out of an asset which basically has an interest
rate of around half a per cent into interest-bearing assets in
the old currencies.
126. That is the third point I wanted to raise
with you. Looking at Figure 1, the really significant thing is
what has happened to the price of gold over a period of 20 years,
and if one was looking for good value for taxpayers one would
have to say that as those 20 years have progressed better value
was found outside gold as opposed to holding large amounts of
gold. Is that broadly true?
(Mr O'Donnell) With hindsight that is true. The question
is, could you have predicted that in advance.
127. But you used the phrase earlier, I think,
that it was a good bet, and history has demonstratedand
again hindsight is a wonderful thing with regard to historythat
gold has not really been a very good bet over the last 20 years
or so, has it?
(Mr O'Donnell) Its price has fallen substantially
from that peak, but if you look back to the 1970s you would find
a period of gold price rises. So you have to be careful about
which periods you choose.
128. We have heard a great deal this afternoon
about transparency and fairness and the idea that the UK has been
leading the way on this. What, in your view, has been the downside
of that? What has been the cost of being so transparent and going
out of our way to be fair? Has there been a cost?
(Mr O'Donnell) I do not think there is a cost in being
transparent. I think what transparency does is enhance your reputation,
for us as big operators potentially in the market, big owners
of large foreign exchange reserves, markets know we will operate
in an open, transparent and predictable fashion, and that reputational
gain spills over into other areas. It means, for example, we can
borrow money from the markets, if you go out to 20 or 30 years,
more cheaply than any other country, as far as I know, with the
possible exception of Japan which is a special case, I have to
say, and maybe Switzerland. Compared to, say, Germany, the United
States, France, we can borrow money more cheaply, so our reputation
matters a lot to us and openness and transparency, although you
cannot pick it up in any one particular area, generally feeds
through and enhances the reputation of the authorities, and I
think that is useful.
129. I am sure there are many people wanting
to bend your ear at the outset with very good advice, but paragraph
3.23 says that over half the members of the London Bullion Market
Association were concerned that their experience was not sufficiently
used in the route that was taken. Should we read anything into
that or would they have said that anyway?
(Mr O'Donnell) We went down the route which was basically
auctions, where the Government is selling it, so in a sense I
am not completely surprised by that statement. But it is important
for us to listen to the markets and there are at the moment on-going
consultations with the LBMA about reviewing our processes, so
we talk to them a lot.
130. In Figure 15 I am interested in the idea
of game playing, the idea that the volume of gold trading might
be reduced prior to an auction. Is there evidence, from what you
have seen now of ten auctions, of prices being artificially depressed
before an auction?
(Mr O'Donnell) Interestingly not. We can compare what
happens in the gold market with what happens when we auction bonds,
which we do very regularly, and one can see the differences in
the market shorting position before an auction and what happens
in the auction price. Paul might be able to give you the numbers
(Dr Mills) Coming at it from my experience of the
gilt market where you generally see some cheapening up of the
bond before the auction because you have to attract buyers and
market makers are pre-selling it forward, you do expect the price
to fall somewhat because effectively that is the equivalent of
your underwriting fee. You are asking the market to take the supply
and they essentially require a small incentive to do that. This
does not seem, as yet, to have occurred that much in the gold
market and on the whole the losses on the swings are outweighed
by the gains on the roundabouts and there does not seem to be
a clear-cut pattern that gold necessarily cheapens up just before
an auction. Sometimes it does and sometimes it does not. We have
a wide variety of auction results just from the ten. There does
not seem to be a clear-cut pattern. To me that is as good as we
can expect if not better than we anticipated. I would have thought
that auctions would have under-performed the Fix because to sell
this amount of gold you would expect the price to cheapen up a
little bit before the auction relative to the average Fix price,
and that does not seem systematically to happen. If we were to
be selling through the Fix, of course, the Fix price is likely
to be the same or lower and it would only be the same if all the
demand that came through auctions went through the Fix. As that
may not have occurred you would have expected the Fix price to
be lower anyway if we had not auctioned. I am quite surprised
how well it has gone.
131. My final question is on figure 13 which
is on page 18. I am not sure whether you have been asked this
and answered it before, which is the significance of the bid cover
ratios for future auctions. First of all, is there any significance
in that figure and what would happen in the future if not all
the bids were fully covered?
(Mr O'Donnell) On your first point bid cover ratios
is something you would normally put out after an auction to give
an idea you were selling X tonnes but there was five X number
of bids. It gives you an idea of how much demand there is. You
have to be careful about that because some of the bids could be
ridiculous bids and that is why there is a potential for this
ratio to be manipulated. If, for example, you are a player in
the system and you wanted to give the impression that there was
enormous demand for this auction you could put in a really big
bid but at a ridiculously low price. You would not get any gold
but the cover ratio would not show that up. In fact, that has
not happened and that is not the way things have operated. The
bid cover ratio has been a reasonably good guide and it shows
there has been fairly clear demand.
132. What would happen if all the bids were
not fully covered?
(Mr O'Donnell) That is one of the things we would
have to consider in the light of our operating. We retain certain
options. What have we precisely said?
(Dr Mills) No government which auctions bonds or gold
says, "We are going to fill every bid that comes along even
if we do not get up to 25 tonnes." So we do not tell anyone
what it is but we have a reserve price, and we do not necessarily
then fill every bid that comes in if we do not get cover. The
point to note is that this is a uniform price auction. That means
that we will fill all the bids up to 25 tonnes and everyone pays
the same price. That means that the marginal bid sets the revenue
for the whole of the auction. If we do not get up to 25 tonnes
then the marginal bid could be very low and if we pre-committed
to taking every bid, our revenue could be very low. So, for instance,
we had one uncovered auction in index-linked gilts about two years
ago where we did not allocate all the bids because that would
have reduced total revenue if we had done so. If that happened
here it would depend on what the bidding pattern was. We might
take all the bids if they were reasonable. We might reject some
if they were too low.
133. I have one or two follow-up questions for
you. Firstly, I was interested in Mr Mills' comment about the
absence of game playing in the market prior to auctions. Could
we have a note on that? In that note can you pick up the apparent
propensity of the market to leap up shortly after the auction
on more than one occasion.
I can think of some tactics that might cause that. Secondly, you
would not believe the amount of free advice I have had about this
hearing from people with conspiracy theories in the back of their
mind. Can you let me have for the record the indication that the
only purpose of this exercise was to get a value-for-money improvement
in the risk profile and no other?
(Mr O'Donnell) Exactly.
134. Thank you very much. The third point is
the 40:40:20 basis, is that based on our world trade balance or
(Mr O'Donnell) We look at a whole range of possible
reasons for holding currencies, but one of the things we look
at is trade, yes. That is part of it.
135. Anything else?
(Mr O'Donnell) You would not want to hold a whole
range of currencies, because that just becomes messy. We do not,
for example, hold any roubles, as was suggested earlier, even
though we do have trade with Russia.
136. We would encourage that!
(Mr O'Donnell) We keep it to a small number which
can be highly liquid and transferred to different currencies if
we wanted to. Having said that, we look to roughly get in line
with trade patterns.
(Dr Mills) It would be worth adding that if you look
at the composition of the basket of the SDR, the Special Drawing
Right, that has got sterling in as well, but if you take sterling
out the composition of dollars, euros and yen is not too far away
137. The reason I ask is that I can imagine
circumstances whereand let us say that the trade weighting
is the primary drivertwo variables run away from you. If
one is that the American economy is very successful, and continues
to be successful for 20 years more than the other two you are
talking about, you would probably see that as an appreciation
in the dollar and a significant change in the trade weighting
at the same time. My question is a rather mathematical one really,
how would your risk minimisation deal with that? Could you write
the Committee a note on that because it is not a point which is
particularly easy to debate around the table.
Do you take the point?
(Mr O'Donnell) I do, yes.
138. The fourth one is a simple question, do
we have statistics on how much gold we bought or sold unannounced
in the pre-1999 years?
(Dr Mills) We have sold only gold coins
as far as I know in small quantities. We had roughly 715 tonnes
in the early 1970s, maybe a little more than that, and we have
sold some for investment purposes in gold coins.
139. Trifling sums really?
(Dr Mills) Yes.
140. The final point is something a member of
the Committee asked as well, and it relates to Figure 10 on page
16, when did Switzerland announce its very high level of sales
and what happened to the price of gold at that point? Was it the
same sort of 10 per cent drop we got when we announced our sale?
(Dr Mills) I think the early indications for Switzerland
were after our sales but they went through a more protracted process
because they had to have a referendum to clear the sale.
(Mr Plenderleith) It emerged in stages because there
have to be local referenda to approve it through their system.
The full realisation of the scale of the programme came shortly
after ours but the market was expecting that, and indeed part
of the reason the market softened after our announcement was the
recognition that there was this substantially larger Swiss sale
to come on top of it.
Chairman: I will not ask you to do an analysis
of the effect of referenda on it. Thank you very much for that.
It has been a very interesting session, the only disappointment
has been no free samples! Thank you.
4 Note: See Evidence, Appendix 1, page 18 (PAC
Note: See Evidence, Appendix 1, page 18 (PAC 00-01/107). Back
Note: See Evidence, Appendix
1, page 18 (PAC 00-01/187). Back