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Boosting Canada's gold reserves, the smart way

By Daniel M. Ryan
web posted April 18, 2011

According to a survey of thirty-nine central-bank reserve managers, gold is now seen as a safe asset for central-bank reserves. Comparing favourably to sovereign debt in their eyes, unsurprisingly given the debt turmoils that have engulfed Ireland, Portugal and Greece, that survey speaks to an intention of central banks as a whole to increase gold reserves this year. Those institutions, as a class, were net buyers of gold last year.

As is often the case, Canada lags behind that trend. According to the latest Bank of Canada statistics, its gold reserves total only US$160 million. Contrast this modest figure to its US$28.604 billion in U.S.-dollar-denominated reserves and US$19.055 billion in other foreign currencies. IMF reserves are more than twenty times gold reserves.

Given those intentions from other central banks, and given that gold is only 0.262% of the Bank of Canada's reserves, there's a good case to be made that gold is underserved. This relative paucity does not impel the Bank of Canada to back up the truck and shovel gold into the vault: not at these prices, which are on the high side. As I'll explain below, there is a way to boost Canada's gold reserves by using market forces to concentrate the accumulation when prices are on the low side. In a sentence, it involves letting Canadian corporations pay their federal income taxes in gold bullion.

With regard to selling the reserves it formerly had, the Bank of Canada has an enviable record. There was no "Brown bottom" when the Bank of Canada decided to offload its gold. Instead of blunderingly selling near the bottom, the Bank of Canada's reserve managers sold at the top. The original decision to offload the gold was made in 1980, when the 1970s gold bull market had started to crack. Had the Bank of Canada been a private investment institution, it would have eaten out on that sell call for the rest of the 1980s – perhaps for longer.

Given this track record, it makes sense to come up with a plan that would allow the Bank of Canada to join the growing central-bank movement towards gold in a manner that avoids blundering in at the top. The Government of Canada allowing corporations to pay federal corporate income taxes in gold, and then selling the gold to the Bank of Canada for newly-issued Canadian dollars, would push the Bank's reserves up from the minuscule amount now. It would also incentivize acquiring gold when low.

Why and Who? 

Although some firms in other industries might pay with gold on a lark, there's only one industry that would seriously consider paying taxes in gold as a business matter: gold miners. There are quite a few in Canada, gold mining having been an important part of Canada's economy since Canada's founding. Despite the stereotype of them being irresponsible "hewers of wood and drawers of water," the industry is actually better than standard stereotypes portray. Gold mining is not on the list of the three biggest polluting industries. Two of the three that are, are manufacturers.

So, the Government of Canada would not be dirtying its hands by allowing Canadian gold mines to pay their taxes out of product.

As for why gold miners would do so, it would be to conserve cash. When gold flies up, as it has, there's not much need for gold producers to conserve their cash. Thus, there would be a tendency for them to pay their income taxes in good old Canadian dollars when gold is high.

When gold turns down, though, they get strapped. The trough times are the times when a gold producer would most want to pay their taxes out of product. Granted that some gold miners wouldn't have any income taxes to pay, because they would generate losses, but some would still make profits because their costs would shrink along with their revenues. It's companies like those who would see an advantage to paying their taxes out of product. Since cash costs are going to be lower than revenue, they would save needed cash by doing so. As for the loss generators, Canada Customs and Revenue could offer them the option of forward-paying future taxes in gold in exchange for tax credits that would earn interest equal to three-month T-bills. The economic effect would be the same as they buying newly-issued Government of Canada bills as cash equivalents. Once they recover to profitability, they can apply the tax credits to their future taxes. Making the tax credits vendible at value would make their liquidity close to a cash equivalent too.

As for the mechanics, it would be fairly straightforward. Gold companies normally produce dore bars that are not pure gold. In the strict version of the plan, they would be responsible for smelting the bars into 99.9% pure gold certified good-delivery. In the more accommodative version, the companies take their dore bars to the Royal Canadian Mint which would credit them with the pure-gold value minus a smelting fee. The dollar value for tax purposes would be calculated the same way capital-gains taxes are calculated for gold investors: using the day's London gold fixing.

Since the greatest incentive to conserve cash would be when gold was low, barring exceptions like a producer who needs to conserve cash for a takeover of a successful explorer or junior producer, the Government of Canada would tend to get the gold at a bargain. So would the Bank of Canada, who would take possession of the gold in exchange for issuing Canadian currency.

Extension

Due to the tragic nature of investment markets, there's a surer way for the Bank of Canada get gold at a low price: allowing individuals to pay their income taxes in gold. The Royal Canadian Mint has the perfect product to facilitate this means: it's called a "Prestige Account." It allows the customer to buy gold stored at the Royal Canadian Mint. This vehicle, if allowed to pay income taxes with, would be a convenient way for the Government of Canada and the Bank of Canada to secure title to gold that's used to pay tax.  

Because of withholding, there would be little scope for paying taxes on employment income. Where it would come into its own, would be paying capital-gains taxes. Transferring gold to pay taxes would be a deemed sale, which would mean a tax loss for someone who gave up on gold in disgust. Because people tend to sell an investment late in a bear market, the Bank of Canada would tend to pick up more gold when it's cheap.

Not That Radical  

On the face of it, this proposal isn't radical at all. It could be described as a treat for the gold-mining industry, one that's more used to being whapped on the head for environmental misdeeds, but a fuller perspective shows it's a bargain of mutual advantage. By making the Bank of Canada's gold acquisition move with the rhythm of the marketplace, in a counter-cyclical way, it takes away the risk of an imprudent purchase at the top of the market. It also gives a convenience, and a cash-saver, to an industry that's very much part of the fabric of Canada. It could be described as a treat, but it could also be described as a kind of reward to an industry that has cleaned up its act. Insofar as the gold option is a treat, the individuals' variant is a treat for the long-taken-for-granted Mint.

There's another advantage…given what the Utah government has recently done, it's a way to leap ahead of Uncle Sam. ESR

Daniel M. Ryan is an occasional contributor to The Gold Standard Now, and currently watching the gold market. He can be reached at danielmryan@primus.ca.

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