Currency Reserves

| 11/09/2009

The reason for the delay in commenting further is because I have been seeking clarification of certain matters raised by Mr Goelo. The views I am expressing are personal as I am no longer Chairman of the Monetary Authority.

In summary, the position is as follows: 

1. I have no objection to gold as a private investment or for many central banks (where there is no currency peg) as part of a prudent diversification programme. My point is that it is not appropriate for the Cayman Islands currency, certainly not as it is currently structured;

2. The CI dollar is tied to the US$ as this is the most logical given our revenue and expenditure. It would be risky to tie the currency to anything else (we can think about the SDR in the future). As a result, we enjoy the benefits and pains of the US dollar and US fiscal and monetary policy. When the US dollar is weak, it makes the Cayman Islands more attractive as a destination for tourists and financial services operating in stronger currencies. Commensurately, when the US dollar is strong, we are more expensive to those same persons.

3. As long as the CI dollar is tied to the US$ and the investments in the portfolio backing the currency are in US$ also, there is no exchange risk. And provided the investments are in top quality US dollar denominated government and corporate securities of one sort or another or on deposit with the Federal Reserve and relatively short term or held to maturity, there is no real risk of loss of capital. The decline in the currency reserve assets between December 2007 and June 2008, pointed out by Mr Goelo was not the result of losses in the portfolio (indeed the portfolio gained during the period!). Rather, the decline was due to the proper transfer of surplus in order to fund the Monetary Authority operations (and to reduce the amount required from Government). This is permitted by the Monetary Authority Law (MA Law).

4. The structure of thecurrency requires the Monetary Authority to be able to redeem in US$ every CI$ that is presented to it. So in theory, every holder of CI dollars (all $83.5 million) could present themselves and demand to be paid US dollars (there are very few currencies with the same structure today). Thus, the reserves need to be in US dollars and very liquid, even if the possibility of that level of redemptions being made is remote today. Thus, the MA Lawrequires the currency reserves to be invested only in very conservative short term top quality US dollar debt securities or top quality banks (including the Fed). Were the currency reserves to be held in other investments, even if hedged, the risks and costs are increased. Unhedged positions could be disastrous.

5. The IMF/World Bank guidelines for forex reserve management recognise that countries with a fixed exchange rate and that operate a currency board need reserves that provide confidence in the peg and deter speculation. Thus, they note these reserves “tend to be invested in a form that facilitates their ready availability”.

6.It is correct that Cayman may be losing a possible opportunity to make more profit on the currency reserves than the current rock solid and conservative returns, but I am not persuaded that the risks and costs are worth it. However, I do agree that the structure of the currency and the reserves should be kept under regular review.

This Viewpoint is in response to Diversification of Cayman Islands Reserves

See also Tim Ridley’s first response

and Currency Reserves and Gold – Part 3

Print Friendly, PDF & Email

Category: Viewpoint

About the Author ()

Comments (16)

Trackback URL | Comments RSS Feed

  1. Anonymous says:

    Mr. Ridley, while I hear your rationale for continuing with the US dollar as our vehicle currency.

    Fact:

    Gold was once the world currency for trade, one country demanded immediate payment from the then Superpower. The Superpower was unable to pay – there was a crisis- and wha-la a new currency of exchange established. We do not know when the rest of the world will demand payment from the US. We certainly, dont want to be unprepared and end up worthless (as our dollar is peg to a stable currency like the US dollar) as I understand this is the rationale behind it being so.

    Would it also not be wise to work start some research on a new vehicular currency. At least start to test another currency in our market maybe.  

    What amazes me is we have so many PROFESSIONALS for so may years hired on the Island being paid high salarys, etc and we get nothing no proposals, no research, to such an issue. It makes one wonder? Are they really qualified? What is the underlying reasoning behind coming here?

     

    • Frank says:

      Very good points…

      Our professionals stick to what has worked well in the past, not paying attention to the new paradigm shift which is occurring before their very eyes and, as a result, not taking any forward looking action…

      The constant pressure pushing the Gold price, which recently reached $1,024.00 – not a brief spike, like the $850.00 reached briefly in 1980 – should be an eye opener to what’s coming…

      Here are some of the facts that should be taken into consideration:

      – Gold can’t be printed

      – Gold has no debt attached to it

      – Gold has represented real money for 5,000 years whilst no paper currency has ever survived in tact throughout history

      – Gold has limited supply – Gold production is declining and demand increasing

      – Total annual mine production of gold is only $75 billion per annum which is 0.05% of world financial assets

      – Total increase in debt in 2009 in the US alone will probably be in excess of $5 trillion against an increase in gold of $75 billion – a 66 to 1 ratio

      – Central banks which have been net sellers are becoming net buyers of gold

      – China and Russia are major buyers of gold and only declare increases in holdings with long delays

      – Retail demand of gold in China and India is very high – These are nations who understand the virtue of gold as savings

      With world debt probably increasing by as much as $7.5 trillion in 2009, there will be at least 100 times more paper money created than new gold produced. It can’t be difficult to forecast which money is likely to appreciate the most in the next few years – paper money with an unlimited supply or real money, GOLD, with very limited supply.

      But, I don’t expect miracles here, so look after your own fortunes and let the chips fall where they may…

       

       

  2. relaxx... says:

    I do think Frank’s points are founded to some degree but I disagree with Gold for obvious reason as the liquidity issue and stable value are concerned.  I think that the US is bound to collaspe, the Roman Empire, and I think it will be sooner than we like to think…Well I don’t hope for the US demise and in the past one would be wrong to place a bet against the Americans I think we need to take a new approach towards the handling of our currency.  We need to ensure that it is near it current rate for the near term but has the abiltiy to maintain it value while the US continues to plunge.  I envision a Cayman with a future that has regional trading partners such as Cuba and Jamaica etc playing a larger role as the lifestyle that we are currently living decreases on the fate of the US.  I predict the rise of asia as a new center for global prosperity and wealth and that will have little impact on economies this side of the world except where raw materials are concerned..i.e. nickle, bauxite and copper…..While the agriculture role of the US will still be vital the support it currently receives will be negated by the inability of the federal government to support it and hence the current cheap food will cease to exists.  This combined with a greater demand globally!  Furthermore, the health implications of the food currently produced in the US unless changed will be recognized and further decrease the preceived value of US agri Goods.  Furthermore, more emphasis will be placed on the durabiltiy of goods and not the strict pricing of goods and hence a tendancy for greater value to be placed on solid wood products i.e. doors and furniture from Honduras, Jamaica and Cuba and more concrete construction as opposed to gypsum board as we will be more aware that we no longer have money to pay insurance premiums and need items to last despite being waterlogged.  So the era of US products made in China and imported to CI will come to a close as surley as the chip board chips in your formica desk that currently hold your computer.  Mind you, your appliances (T.Vs ,Stoves) will still come from a US company manufactured in its Mexican plants however, many of these US Companies will be owned by Chinese firms that used their USD reserves to buy back US hard assets…Please google Chinese to buy $300 billion of the ppip program real estate assets.  You see the truth is that the chinese what is happening; that the model is broken but they unlike the Cayman Islands they cannot liquidate position as it would lead to a collaspe of the system US Bonds so they are being forced to buy hard assets..gold is one..oil stockpiles is another basically anything that is denominated in USD for the moment to help them get ride of their USD reserves that are constantly building off the bak of Wal-mart…You see they are buying Hummer (GM) and they want Volvo which is owned by (Ford?)…  The USA won’t fall for now as they have alot of hard assets to sell  (companies) but they are being slowly bought out and when they have noting left of value then the show is over…In fact, if you ask me the show is already over but we just need to wait a few years for global incomes to re-align themselves as predicted by the IMF.  Anybody have any comments on this theory..hey and I did’nt proof read so all you English majors find another article to comment on I am strictly speaking to the Economics here….

    John Ebanks

    • Frank says:

      Gold is very stable…

      It’s all the fiat currencies that are goind down fast agaisnt Gold, as clearly shown in this link:

      http://www.marketoracle.co.uk/Article8100.html

      For additional proof, the US Dollar has lost 96.5% of its value since 1971 when Nixon removed the 1 ounce of Gold = $35.00 peg: now 1 ounce of Gold = $1000.00…

      Gold in the amounts discussed, ie around $33 million, is totally liquid and can be sold for cash at spot price in a matter of minutes…

      It’s a lot easier and more compact to store than oil, or anything else for that matter and this why it’s been viewed as the best store of value for several thousand years…

      I agree with you that the US economy will eventually suffer some serious damage as a result of the US Dollar ongoing devaluation, loss of status as a world reserve currency and its unmanageable debt load. The US citizens standard of living will be cut by at least 30% and the US will become a second tier country sooner or later…

      All countries still tied to the US Dollar, including the Cayman Islands will also suffer a similar fate and this is why I suggested hedging the reserves with a Gold holding to mitigate the damage…

      China is overtaking Japan as the second largest world economy and will be in adominant position within 15 to 20 years…

       

       

  3. Chris Randall says:

    I have heard this sort of twaddle before.  In the 70s there were pundits telling everyone to put half of their portfolio into silver; look what happened to the Hunt clan.  Gold rose to over $800 an ounce in the 70s too; anyone buying then looked rather silly a few years later.

    There are no dividends on investments in metals or comodities: the only return is by way of sale following an increase in value.  This entails constant monitoring and relies upon a belief that such an increase will occur.  If it does not, the investor loses.  The argument only makes sense to a bullion dealer; for anyone else, it is not worth discussing.

  4. Query says:

    Ahead of any wire tax, what is the best and quickest place to move money from Cayman to a tax free long-term account?  I am not having my nest egg eaten up to pay for this mess. 

    There is no way I will invest it here while the 60% rule is in place.

  5. Tim Ridley says:

    CURRENCY RESERVES AND GOLD – PART III

    I will give it one last shot to the best of my ability, although there are indeed very much more pressing issues for the Cayman Islands than a somewhat arcane debate over gold:

    1. On the subject of the MBS securities held within the CIMA portfolio, I will simply say that these were not the toxic type and, as far as I am aware, did not default or lose value. They were sold as a matter of prudence, given the financial climate at the time;
    2. There is presently no currency risk for the CI dollar, CIMA or the Cayman Islands Government. We operate under a strict traditional currency board structure. Under the Monetary Authority Law (MA Law) all that a holder of CI dollars can claim on redemption is US1.20 for every CI$1.00. That liability is more than matched by the (unhedged) US dollar denominated securities that CIMA holds in the currency reserves. Any currency risk rests with the holder of the CI dollars in exactly the same way as if he/she held US dollars. So if the US dollar/CI dollar depreciates against the yen, euro or remimbi (yuan), it is the holder’s risk, not the risk of CIMA or the Cayman Islands Government (as far as the currency is concerned). If the holder of the CI dollar is worried about that risk, then it is up to them to hedge the risk (which they can certainly do, indeed possibly by holding gold, as Mr. Guelo recommends). There is no compelling reason for CIMA or the Cayman Islands Government to do so;
    3. The current position also reduces the risk of any pressure in the forex markets on the CI dollar and pretty well eliminates any disruption by traders speculating for or against the CI dollar (they can do that against the US dollar as much as they like);
    4. Given the above analysis, it does not much matter for Cayman if the US$ ceases to be the world’s reserve currency while the US is our main trading partner and our revenue and expenditures (private and public sector) are US dollar denominated. If it becomes apparent that our trading patterns and trading currencies are changing, then it may be appropriate to reconsider. At that point, if we change the peg or go to a floating exchange rate, time enough to consider changing the structure and make up of the reserves.
    5. I reiterate that Mr Guelo’s case for gold is actually one of missing the potential opportunity to make a profit, not one for hedging. And commensurately with his case goes the risk of making a loss, if gold retreats. Under the MA Law and usual practice, CIMA distributes to Government its net surplus annually, after meeting its statutory requirements with respect to the currency reserve and its general reserve. Were CIMA to have invested in gold, fortuitously got its timing right and generated a profit/gain (even an unrealized one), it would be required to pay the net annual  profits/gains to our Government each year and/or to use it for its own operating expenses (so the currency reserves would not increase). Were CIMA to get its timing wrong, and gold were to go down in value (even if no loss was realized), breaching the statutory requirement that the CI dollar is 100% backed by the reserves, the Government is required under the MA law to make up the deficit to bring the reserves back to 100%. That could be very painful indeed.
    6. So I respectfully submit that relying on the right timing to make a profit (or avoiding a loss) on gold is not what the currency reserves are all about. We are not China or Switzerland and our currency arrangements and reserves are very different. I would need a lot more persuading that the risk of loss of capital (and the carrying costs and loss of income generation) could be prudently and cost effectively hedged and that the value of the other risk free assets in the reserves were equal to the outstanding currency liability before going down this road.  
    • Frank says:

      Let’s agree to disagree, Mr. Ridley and thank you for the time you spent making enquiries with CIMA and writing your comments…

      Clearly, CIMA has done a commendable job managing the country’s Reserves, so far, but times are achanging and new forward thinking may be required to keep up with past performance…

      Only time will tell whether my suggestions would have benefited the country’s finances, had they been taken into consideration and I plan to keep tabs on this issue for a few years…

      In the meantime, I’d like to share with you a very interesting article reviewing the various fiat currencies that have emerged throughout history and their demise due to over-issuance and the (hyper) inflation that followed:

      http://www.marketoracle.co.uk/Article8100.html

      Frank Goelo

       

       

  6. Caymanian to the bone says:

    Question to the editors – who is this Frank Goelo person?

    CNS: I don’t know. He seems to have got into trouble with the United States Securities & Exchange Commission at one time – see here http://www.sec.gov/litigation/complaints/comp18088.htm. And here is his explanation.

  7. Frank says:

    Those who suckle at the teat of Mother USA too long will soon get famished, when the milk runs dry as the purchasing power of the US Dollar collapses…

    That’s in a nutshell why there is a dire need for diversification into Gold, which to the ignorant may appear as a commodity, except that it’s not consumed like copper or oil, as 95% of all Gold ever mined still exist as the safest store of value ever devised for millennia…

    As Mr. Ridley implied, we in Cayman prosper or sink according to the vagaries of the US economy and fiscal policies. The problem is that all the prospering has now been done and all that remains is the sinking along with the US economy and its dysfunctional financial system…

    When the value of the US Dollar finally takes the plunge, as large holders of US debt like China and Japan are doing their best to diversify out of it, the value of Cayman’s portfolio invested in US debt will also plunge, along with the sacrosanct Treasuries, that were supposed to be foolproof investments, just like the MBS…

    To say that Treasuries are guaranteed by the US government won’t help when the guarantor is finally broke, as other countries shy from it worthless currency…

    The Bretton Woods system established the US Dollar as the reserve currency of the world, which made sense in 1944, as there was a constant parity between the US Dollar and Gold, which prevented the abusive printing of currency. Nixon removed the 1 ounce of Gold = $35.00 peg in 1971, resulting today in a 96.5% devaluation of the US Dollar, where now 1 ounce of Gold = $1000.00…

    After 1971, the US was free to print all the extra Dollars (also created  out of thin air with simple book entries) it needed, which were then exchanged for valuable goods, such as oil. As the world was bankrolling its extravagant expenditures, the US could engage in expensive and useless wars that only benefited US contractors supplying the needs of its Army. Manufacturing facilities were exported to Asia to take advantage of the low labour cost and soon the US transformed itself from a manufacturing nation to one that mostly consumes (71% of the GDP is now consumption related) with an economy based on services, dubious financial products and consecutive bubbles…

    It has now been clear to many economists that the US can NEVER repay its debt – in fact it can barely repay interests by borrowing $2 TRILLION a year at present – so why invest all Cayman’s reserves in debt that is absolutely certain to go bad… like the MBS?…

    The latest figures on the total US debt obligations, including unfunded liabilities have now reached a staggering $79 TRILLION Dollars, far exceeding total World GDP of $60 trillion and representing $263,000.00 for each man, woman and child living in the US, where 70% of the population lives from paycheck to paycheck…

    The unfunded liabilities, such as social security, pensions, medicare, etc… will most certainly be defaulted on, the US standard of living will be curtailed by at least 30% and before long, the US will become a second tier nation and so will those who have hanged on too long without hedging their bets with some Gold…  

     

  8. Anonymous says:

    Tim’s rationale is completely sound.

    The notion that Cayman should even consider speculating in any commodities is absurd. I sincerely hope that Frank’s brand of post-hoc selective "what if" nonsense will be ignored by everyone. If there is anyone out there that wants to speculate I hear that there is still plenty of swampland in Florida and plenty of people that it will sell it to the gullible.  

  9. Frank says:

    Frankly, I am amazed that CIMA would buy Mortgage Back Securities (MBS) as a ‘secure investment’, while shunning Gold as an hedge against the ongoing devaluation of the US Dollar compared to most other currencies…

    When the real estate market in the US went into a tailspin, the MBS tanked hard and brought many banks into bankruptcy. Bear Sterns was one of the victims of the MBS fiasco and its remaining assets had to be ‘fire’ sold in a matter of a couple days to prevent total collapse…

    I could hardly think of a riskier asset to buy in the Reserves portfolio of the Cayman Islands and I shudder to imagine what would have happened if these MBS were not sold in 2007…

    Gold on the other hand has provided ample proof of its worth against the US Dollar’s propensity to lose its value over the years:

    === In 1971, Gold was worth $35.00 an ounce when its peg with the Dollar was ended by Nixon: in 38 years, it has risen 2,857% to $1000.00 in relation to the Dollar, which has lost 96.5% of its value in the same time frame. ===

    While I agree that, for the sake of avoiding exchange risks, a substantial portion of the reserves should be US Dollar denominated, I see absolutely no reason why Gold could not represent 33% of the total reserves value, as an HEDGE against the Dollar ongoing devaluation…

    – It’s a fact that had, CIMA bought $100 million worth of Gold in 2001 at $255.00 an ounce, when the unsavvy UK Central Bank was dumping its stash, it would now have $400 million in the kitty and the UK would be begging to borrow from us….

    – If CIMA had invested only $10 million in Gold in 1971 at $35.00 an ounce, it would now be sitting on a $286 million nestegg…

    This actually illustrates more the weakness of the US Dollar – which also applies to most other fiat currencies being quickly debased – than the strength of Gold, which I picture as an immutable rock buffeted by tides and currents of waning and waxing fiat currencies.

    Gold is the ultimate store of value and the benchmark against which all fiat currencies ultimately fail, due to debasing through over-printing: one hundred years ago, an ounce of Gold bought you about  the same quality suit and pair of shoes than it does today, but the corresponding amount of US Dollars would barely buy you a bier today…

    How could I possibly make the argument any clearer?…

    In the last 2 years, the M1 money supply in the US and elsewhere has been  spiralling out of control, while the production of Gold continues to dwindle since 2001, in spite of a quadrupling of gold prices: this points out to an acceleration of the price of Gold denominated in US Dollars, as per the study posted here:

    http://centos6-httpd22-php56-mysql55.installer.magneticone.com/o_belozerov/31115drupal622/viewpoint/2009/09/09/diversification-cayman-islands-reserves

    Let’s analyse your objections:

    – Currency peg: the Yuan was pegged to the US Dollar for the longest time and this did not stop the Bank of China to double its Gold reserve to 1,054 tons and diversify rapidly into the Euro…

    – We’re tied to the US dollar: I am not suggesting it should be any different, since the components in the Reserve portfolio have little to do with day to day business in the Cayman Islands. 66% of the Reserves would still be in US Dollars and Gold is a lot more liquid than MBS: any quantity can be sold in a matter of minutes for cash…

    – Exchange risk: over the longer term in the example provided, it’s clear that not only there was no exchange risks, but there is a large exchange benefit…

    – Confidence in Reserves: I would wager that the IMF would have a lot more confidence in Gold than MBS in the CI reserve portfolio, since most of the IMF assets happen to also be in Gold…  

    Here are some points I would like you to address at your leisure:

    + If CIMA doesn’t hedge its currency risk now with a substantial Gold holding, when the US Dollar ceases to be the reserve currency of the world and is replaced by SDR’s or a basket of currencies including the Euro and Yuan, our currently unhedged Reserve portfolio will be at a great disadvantage…

    + If/when the US Dollar loses another 20% or more against the Euro and/or a basket of alternative currencies, which seems likely, as a result of a loss of confidence by the large holders of US securities, such as China and Japan, how will the value of the Treasuries in CIMA’s portfolio be affected?…

    + The Swiss have done very well for themselves and until recently, their entire money supply was 100% backed by Gold: so what’s really wrong with suggesting that CIMA should hedge its Dollar position with a 33% holding in Gold?…

     

     

    • Frank says:

      Addendum to response…

      CIMA has not yet published its June 2008 – June 2009 report and the 2007-2008 report was lacking the ususal financial statements. On August 6, 2009, I sent CIMA an e-mail requesting clarification about the drop in the Reserves from $110.15 million in December 2007 to $99.8 million in June 2008: I am still waiting for an answer to this and other questions, so the matter has now been referred to the FOI…

      This lack of transparency can only make one suspicious of the motives. You said that the $10+ million missing from the Reserves has been transferred to the government’s general account and this is indeed very good news: however, there is no official record of this transaction that I could find anywhere on CIMA’s Website…

      I fully understand your main concern: if CIMA bought Gold tomorrow as an hedge against the devaluation of the US Dollar and it went down, there would be consternation in financial circles…

      However, I am not suggesting that CIMA should put 33% of its reserves into Gold immediately, but rather that it makes the decision to do it over a period of time at the appropriate pricing and in several installments to use as a portfolio HEDGE against US Dollar weakness and its waning as a world reserve currency…

      Gold may or may not break through the $1010/1030 resistance band, in spite of a great deal of price pressure to the upside: if it does, the next targets will be $1,100.00 and then $1,300.00 with the resistance band becoming support on the downside…

      If the stock market collapses, Gold may retreat to strong support at $850.00, which would be a good opportunity to buy around one third of the total CIMA position with little downside risk in the current climate of all out monetary expansion…

      It may take 12 to 18 months to build up the full position to minimize downside risks but at least Cayman will then be in tune with progressive thinking countries such as China, which has recently doubled its gold reserves and Switzerland, which used to have its entire money supply 100% backed by Gold…

       

       

       

    • Anonymous says:

      – If CIMA had invested only $10 million in Gold in 1971 at $35.00 an ounce, it would now be sitting on a $286 million nestegg…

      In 1971 there was no CIMA, no CI dollar, and our entire national budget was probably less than $10 million per year. Land on the 7-mile beach was cheap, although it didn’t appear to be at the time, and very few crooks had found their way here to advise us on how to invest our money wisely.

  10. anon1 says:

    Tim, you need to stop giving Frank Guelo’s suggestions to teh Government  so much credence. If you keep answering him people will start to think he actually knows what he is talking about. The man is not even a heavyweight in the real estate develoupment industry locally, let alone in international monetary and financing polocy making.

    I do agree with the idea that we should reduce the spread between US$ and CI$ to 0.01% and that another 0.01% tax should be placed on ALL foreign currence transactions, which will more than cover Governments operational defecit.

    We would not run away any customers as the net gain to these customers would be a 0.01% savings on cash, instead of the banks pocketing the whole 0.04%. The banks would still enjoy an additional 0.01% on their cash transactions, but of course they will still cry foul.

    Perhaps we neeed to talk about this one day while sailing on the North Sound so that I don’t upset CNS with my postings anonomously.

    We just need a Government and monetary authority with the balls to just go ahead and do it.

    • Anonymous says:

      I agree with your thoughts on the penny stock pimp.

      Tim is also a good friend of mine and I have known him for many years. I am no banker and have never worked in the industry, but here are my thoughts.

      Anyone who already has a bank account in the Cayman Islands can open an account in US dollars. I have one and I use it to pay my credit card bills. If I wish to withdraw CI dollars from a US dollar account I receive them at the rate of 82 cents. So I can take my US dollar bills, deposit them into a US account and take them back out immediately, thus gaining 2 cents over 80 cents that I would have received if I had opted to have the bank exchange my US dollar bills for CI currenty.

      Purchasing US currency is a little more expensive because I have to pay 84 cents for a US dollar, but it is my understanding that many large businesses involved in the tourist trade who receive their paymentsin US dollars will actually "sell" those US dollars for 83 cents thus splitting the 2 cents evenly between buyer and seller.

      Is there anything that prevents one of the local banks from offering to sell US currency at 83 cents per dollar and thus cornering the market on US currency sales? I can’t see why there would be. I can only imagine the reason why no bank is doing it is that the volume of business does not make it worth their time.

      Now that I think about it, I could offer to purchase US dollars at 81 cents from the consumers, and then run them through my account and split the 2 cents between myself and the sellers.

      I’m not sure what kind of permit I would need for that, but my bank would probably give me a lot of "know your customer" questions if I suddenly have lots of US cash flowing into and out of my account.

      I’ll give Frank a call and see if he can IPO my business.I think I will call it the US Dollar Store.

      If I see anyone else advertising this on eCay prepare to be sued!