Physical Gold Has a Centralization Problem

By John Banks

Physical gold has a centralization problem. It tends to gather in centralized places, and be guarded by centralized forces, under the strict administrative control of some centralized political authority. 

In regard to this topic, Ed Seykota, a legendary trend trader, made a spot-on observation in his late 1980s Market Wizards interview:

“Gold tends to be dug up, refined, and then buried again. The geographical entropy of all gold on the planet seems to decrease over time. A lot has been collected in vaults. I project the trend as one toward a central world gold stash.”

It’s a funny line. And yet, more than 30 years later, it has a striking ring of truth to it, as the country of Venezuela has painfully discovered.

The largest gold vault in the world belongs to the New York Federal Reserve. The second largest belongs to the Bank of England (BOE). The New York Fed and BOE don’t just hold gold for their own respective countries. They hold it for others, too, which explains why their vaults are outsized. 

A number of emerging and frontier market countries, for instance, choose to store their gold with the BOE, rather than keep it at home. This presumably avoids security and logistics headaches.

The question is: If someone else controls access to your gold, who truly owns it?

Or rather, if the old cliché is true that “possession is nine-tenths of the law,” does that mean the BOE is nine-tenths owner of the developing-world gold it sits on?

For Venezuela, this is a real and pressing issue.

Venezuela has more than $1 billion worth of physical gold on deposit with the Bank of England. Under severe strain from the pandemic, Venezuela wants the gold back to deploy funds for various purposes.

The BOE says no.

The situation is ugly and complicated. Venezuela is a failed state, with an economic system ravaged by inflationary collapse.

Meanwhile, Nicolas Maduro, the president of Venezuela, is considered by many to be a dictator, and not the legitimate leader of Venezuela’s government.

As a result of the ongoing economic, geopolitical, and humanitarian crisis in Venezuela —  and sanctions imposed by the U.S. and the U.K. — the Bank of England decided to freeze Venezuela’s gold holdings in January 2019.

There was no court proceeding or jury verdict in this decision. The BOE simply decided Venezuela should not have access to its gold reserves held on deposit and made the decision without comment.

The legitimacy of Maduro is a side issue for our purposes here. Whether or not Maduro is a dictator, a thug, or an illegitimate leader — all of which may be quite true — the precedent being set is fascinating.

A country deposits a sizable amount of gold with the Bank of England. Some bad things happen at home. The country wants its gold back — and yet the BOE refuses. It doesn’t even explain why. It just says no.

The core problem with centralization is that, if access to something is centralized, it means some central authority can take that access away from you.

Centralization also creates vulnerability one step removed. The existence of a steward, or a decision maker or some kind of governing body, becomes a point of leverage for authorities to exploit.

For example, let’s say the stewards of a particular asset are fine, upstanding people.

It is still possible that a government agency, or a political actor with no scruples, can decide to lean on those people, or even threaten them or blackmail them, to coerce a bad outcome.

For all we know, this might have been the case with the BOE and Venezuela’s gold.

The BOE might have had no desire at all to impound a country’s gold stash without comment, seeing it as uncouth and bad for business. And yet, the United States, or some other immensely powerful figure, might have demanded it — in which case the decision would be made to shrug and go along.

Again, we can’t know if that happened. But we can’t know it didn’t happen either, because the BOE has not explained its rationale at all.

This is what “possession is nine-tenths of the law” actually means in practice. If those who hold custody of an asset decide to cut the owner off and don’t explain why, well, then what? It ultimately becomes a matter of power, if not a matter of violence.

And yet, the Venezuelan gold ordeal speaks to one of Bitcoin’s deep strengths.

Bitcoin is decentralized in the most literal sense possible: Full copies of the Bitcoin ledger are distributed via computers all over the world.

Short of disabling the internet itself, there is no way to bring down the Bitcoin network — and the internet’s core infrastructure was designed to survive a nuclear war.

Just as importantly, Bitcoin has no central authority in the form of human individuals or a single known organization. If Bitcoin had a CEO, or a parent company, or a high council of advisers or something to that effect, the presence of centralized decision-makers would be an instant point of vulnerability.

The very existence of authority in a defined pair of hands would tell governments who to lean on and who to potentially threaten in their effort to attack Bitcoin or otherwise stop its inexorable rise. But no such vulnerability exists. Bitcoin submits to no centralization at all.

Henry Kissinger once asked: “Who do I call if I want to speak to Europe?”

The question was meant as a criticism, pointing out that Europe, as an entity, had no defined leader that spoke with authority and finality for the continent.

But with Bitcoin, the same question highlights a deep competitive advantage.

If one wanted to speak to “the person in charge of Bitcoin” or “the authority in charge of Bitcoin,” there would be nobody to call — and there never will be.

This effectively means that, not only is there no good way to stop Bitcoin, there is no way to apply political pressure to Bitcoin. One might as well pick a fight with electricity or gravity, or some other force of nature. The rules have been set, and now they replicate. That’s it.

Gold is like Bitcoin in the fact that gold is sovereign. But physical gold, to the extent it has to be domiciled, is vulnerable by dint of geographical location. It is hard to be truly, fully sovereign, while yet being vulnerable to confiscation, or blocked access.

If others store your gold, to some extent they also control it. You could remedy this by storing the gold yourself — but that decision comes with its own issues, as we explored via comparing gold to Bitcoin in an apocalypse. When it comes to centralization versus decentralization — and the challenges of a geographical physical asset presence exploitable by authorities versus an always-everywhere digital presence as ubiquitous as the internet itself — Bitcoin wins again.