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Central Banks Can Fail, Should Return To Gold Standard: Asset Manager

The Federal Reserve and other central banks are able to go bust and may yet do so, Urs Gmuer, an asset manager at Dolefin, a Swiss investment advisor, told CNBC Tuesday.

Instead of printing more money when needed, he said central banks should return to using gold to back their currencies.

Gmuer contacted CNBC in response to comments by ING senior economist Teunis Brosens, who said central banks are technically unable to go bust.

“If the central bank needs money, it just turns on the printing press to buy whatever it needs,” Brosens told CNBC. “When the [U.S. Federal Reserve] wanted to buy assets as part of its [quantitative easing] programs, it did not first have to borrow the funds to do so, as an ordinary individual or company would need to.”

However, Gmuer said the ability to print money does not in itself save a central bank from insolvency, as purchased assets still need to generate sufficient interest to counteract the bank’s liabilities.

“Printing money has a cost for a central bank,” said Gmuer. “With rates being extremely low, the seigniorage [the difference between the value of money and the cost to produce it] is very small.”

With base rates in many developed countries at historical lows, asset purchases are subject to significant interest-rate risk, when the value of investments is diminished by a later rise in absolute interest rates.

U.S. benchmark rates are currently at zero to 0.25 percent, while on Sept. 8 the European Central Bank announced it was holding rates at 1.5 percent. Base rates in Japan are 0.1 percent.

Gmuer said that for central banks with substantial amounts of risky assets on their balance sheets, such as the Federal Reserve, the Bank of England and the Swiss National Bank, getting out of the red could prove an impossible task.

“The U.S. Fed currently has risky assets — from a debt point of view — amounting to $1 trillion in mortgage-backed and fellow [government] agency-backed securities," he said.

“If out of $1 trillion assets, 10 percent go bust, that is $100 billion assets you need to replace. The Fed would need to increase its balance sheet by such a huge amount, the risk would become enormous. You would need to buy $350 billion 10-year treasury bonds at 2.5 percent to 3 percent,” he said.

While central banks can increase the real value of their assets by increasing the money supply, this risks overshooting inflation targets.

Instead, Gmuer advocated a return to the gold standard, with central banks backing their currencies with physical gold.

“The ultimate currency which has made the test of time is gold," he said. "In Victorian times there was complete price stability because of the gold standard.”

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