I thought it might be interesting to play a quick game of 'pass the bomb'... here are the rules of this game, as I see them:
- National Central Bank (NCB) holds mostly US$ in its international forex reserves, a little other currencies perhaps, and some amount of gold.
- NCB wishes to find a way to dispose of excessive holding of US$, without simplistic sell-US$/buy-own-currency trades on forex markets. Excessive strength in its own currency would kill its exports, helping to sink the local economy.
- European Central Bank (ECB) holds gold and some foreign currencies including US$. It issues its own currency, the euro, which is backed by these aforementioned reserves. The gold component percentage of the reserves expands as the market price of gold rises (and falls if the market price drops), as witnessed quarterly in its accounts on the website.
- ECB can issue new euros to buy gold from NCB. Euro supply is increased (euro value decreases), but there is an offsetting increase in ECB gold reserves to balance that dilution (euro value increases again). Confidence is fully maintained in the ECB's currency, in spite of the increased number of euros, through the also increased gold reserves.
- NCB has more euros in its reserves, lower percentage of currency reserves are in US$ now. But NCB's gold reserves are also lower... hmm... bummer!
- NCB is free to sell US$ and buy gold. Even lower percentage of currency reserves are in US$ now, and restored holding of gold in NCB reserves again. Yay!
- Eurozone total ECB+NCB's gold reserves net increased, exposure to US$ reserves net decreased. Euro retains valuation against gold.
- Supply/demand balance of US$/gold now out of whack, US$ valuation against gold declines as a result of this supply/demand dynamic. Ergo, $:€ exchange rate declines too. Euro is by this stage net stronger, against Dollar. NCB is net up on the deal.
- If NCB was able to obtain gold from the market OK, keep going back to (2), otherwise...
- Boom! Strong Dollar Policy game over. Freegold reset.
Please try our new blockbuster game, Strong Euro Policy.