The
news rocked the global gold market when an almost obscure line item in the back
of a 216 page document released by an equally obscure organization was
recently unearthed. Thrust into the unwanted glare of the spotlight, the
little publicized Bank of International Settlements (BIS) is discovered to
have accepted 349 metric tons of gold in a $14B swap. Why? With whom? For
what duration? How long has this been going on? This raises many questions
and as usual with all $617T of murky unregulated swaps, we are given zero
answers. It is none of our business!
Considering the US
taxpayer is bearing the burden of $13T in lending, spending and guarantees
for the financial crisis, and an additional $600B of swaps from the US
Federal Reserve to stem the European Sovereign Debt crisis, some feel that
more transparency is merited. It is particularly disconcerting, since the
crisis was a direct result of unsound banking practices and possibly even
felonious behavior. The arrogance and lack of public accountability of the
entire banking industry blatantly demonstrates why gold manipulation, which
came to the fore in recent CFTC hearings, has been able to operate so
effectively for so long. It operates above the law or more specifically above
sovereign law in the un-policed off-shore, off-balance sheet zone of
international waters.
Since President
Richard Nixon took the US off the Gold standard in 1971, transparency
regarding anything to do with gold sales, leasing, storage or swaps is as
tightly guarded by governments as the unaudited gold holdings of Fort Knox.
Before we delve into answering what this swap may be all about and what it
possibly means to gold investors, we need to start with the most obvious
question and one that few seem to ask. Who is this Bank of International
Settlements and who controls it?
BANK
OF INTERNATIONAL SETTLEMENTS (BIS)
The
history of the BIS reads with all the intrigue of a spy novel and comes with a very
checkered past. According to the BIS web
site, as a privately held bank, it decided in recent years to become wholly
owned and controlled by the Central Banks of the world - a highly unusual
decision for a private enterprise. Lengthy court cases in Le Hague were involved
by private members who objected. Something like this is usually called a buy
out or takeover, but there are no public records of any of the central banks
making such an acquisition - an extremely strange set of events with little
media coverage.
I am sure it can all
be explained very logically until we get to the size of the balance sheet. We
are talking close to a half trillion dollar balance sheet, or more
specifically 259 billion SDR’s, which is approximately $400B. Where did
the capital or deposits come from? The BIS goes out of its way to
specifically assert it only accepts deposits from member central banks,
though it does also state confusingly in the financial notes that there are
deposits from previous financial statements from recognized international
banks. Therefore, are we to conclude that the US Federal Reserve has huge
deposits at the BIS? Though I couldn’t find the assets on the
Fed’s balance sheet, I’m sure they are there in the small print
or on the New York Feds balance sheet somewhere. It would be a legal
requirement. It is a forensic accounting nightmare to find these items based
on public documents of the various private organizations. Apparently it is
just none of our business. For such a major element of the world’s
operating financial structure to have such poor visibility, it seems
preposterous until you actually do the research. It should be laid out so a
freshman Economics class could easily follow the ownership acquisition and
money flows. It isn’t and it appears to this researcher that it is
intentionally opaque.
Since the BIS goes out
of its way to ensure readers in its annual financial report that no private
funds are accepted, maybe all we really need to know is what the BIS
officially tells us. The BIS is owned and controlled by their member Central
Banks. Therefore if the BIS was to do a gold swap of the magnitude of 349
metric tonnes, then board member Ben Bernanke would have known of it in
advance and approved it. He would know exactly who the transaction was with and
why. If he didn’t then he is legally negligent in his fiduciary
responsibility as a BIS board member,
because of the size of the transaction and its material effect. Other board members
include: Mervyn King, Governor of the Bank of England, Jean-Claude Trichet,
President of the European Central Bank, Axel Weber, President of the Deutsche
Bundesbank and William C Dudley, President of the Federal Reserve Bank of New
York. You can’t have it both ways.
Though we can suspect
many things, there is no other conclusion we can reach than the swap is part
of an agreed upon plan or concurrence between these board members. So what is
the possible understanding or plan?
WHO
GAVE UP THE GOLD?
There are not a lot of
institutions who possess 349 metric tonnes of gold. So who needs $14B worth
of cash and has this amount of gold? That shouldn’t be too hard to
find.
Sovereign governments
have historically created their wealth by invading other countries to pillage
their treasuries which held gold, silver and the crown jewels. The winning
and seizure of more land allowed the sovereign to give it to the nobles who
used it to tax and tithe the feudal tenets. Recurring wealth flowed upward to
the sovereign treasury.
Considering
today’s EU membership, where sovereign countries can no longer print
their own currency (the politicians first weapon of choice), there are three
channels (other than the very politically unpopular increase in taxes and fees)
open in modern times to raising money for the treasury:
1- The public sale of debt offerings instruments such as Bills,
Notes and Bonds
2- The more recent and stealthy approach of selling assets,
including revenue streams from such things as taxes, fees, licensing etc..
These are sold into the securitization market through complex derivative
structures such as Interest Rate and Currency Swaps contracts. This approach,
as recently discovered, has
been rampant throughout Europe even prior to the creation of the EU.
3- When you exhaust all of the above, you then sell the family
jewels – the sovereign treasury of gold holdings.
The BIS was very quick
to respond to public speculation about the massive gold swap when they
immediately clarified that the gold swap was with a commercial bank.
Since by its own statements, as I mentioned above, it doesn’t accept
deposits from non member banks, this seems confusing on the surface. Does it
or doesn’t it accept private deposits? It would be respectful to
assume that the BIS is telling the truth and that they did in fact conduct
the transaction with a private bank who was transacting the swap on behalf of
a central bank or sovereign treasury. This would sort of make everything
work. For the BIS to be telling the truth in all their statements, the
transaction must be with a member central bank with the involvement of an
intermediary commercial bank. But something still isn’t right here.
When you work through
the details you quickly arrive at an astounding coincidence. Portugal shows
it has 348 tonnes of sovereign gold. The swap was for 346. Portugal is a
member bank, though does not sit on the Board, but attends the General
Meeting as an observer only. Portugal, as a member of the PIIGS, only
days after the unearthing of the swap, was again downgraded by Moody’s,
thereby making its lending costs even higher than the already elevated levels
being demanded by the financial markets. There is a very strong possibility
that the swap is with Portugal. Though who the swap is with is important to
those trading debt and credit derivatives it isn’t quite as important
to those interested in the gold market.
Ben Davies the CEO of
Hinde Capital in London and a player in the gold market suspects (12:40) we may have a
modified form of swap emerging. There is the possibility that the commercial
bank is in fact a major gold bullion bank. Some of the bullion banks have
major short positions on gold that far outstrip the annual physical
production of gold. The disconnect between physical and paper gold along with
rising gold prices is likely causing serious strains on their balance sheet.
As Davies points out the gold may be
transacted from a central bank to the BIS through a bullion bank while the
gold physically remains with the originating central bank; is classified as
‘unallocated’ at the BIS but in fact remains on the books of the
bullion bank. It effectively is double accounted for. The increase in gold
would allow gold prices to be pushed lower, which in fact is what has been
happening. A careful reading of the BIS financial statements shows more
clearly the accounting for such a transaction.
The March 31 2010
Financial Statement of the BIS shows 43.0B SDR’s of gold or 16.6%
of total assets. According to note #4 to the BIS Financial Statements:
“ Included in ’Gold bars held at central banks” is SDR
8,160.1 million (346 tonnes) (2009: nil) of gold, which the Bank held in
connection with gold swap operations, under which the Bank exchanges
currencies for physical gold. The Bank has an obligation to return the gold
at the end of the contract.” It is very important to appreciate
this note is pertaining specifically to BIS ‘assets’ which in the
case of banks are what the reader would consider ‘loans’. Under
Financial Policy notes #5 to the Financial Statement the BIS is clear that
under banking portfolios “all gold financial assets in these portfolios
are designated as loans and receivables”. Separately, but very
interestingly the BIS additionally states “ the remainder of the Banks
equity is held in gold. The Bank’s own gold holdings are designated as
available for sale”.
There can be little
doubt that the Gold Swap is with a central bank where the physical gold
remains. The transaction is considered a deposit at the BIS (liability) but
has been lent to a commercial bank (likely a bullion bank) as a loan (asset).
The question is only why a bullion bank needs to borrow this quantity of
gold, remembering it never gets the physical gold because it remains at the
originating central bank. The reader is encouraged to read the Financial
Policy notes #4,5, 6, 13, 14, 15, 16, 17
and 19 within the BIS Financial Statement for a clearer understanding along
with Notes to the Financial Statements #4 and #11.
The
BIS is known as the central bank to the central bankers.
The
BIS may equally be referred to as the Central Gold Bullion Bank to the Gold
Bullion Banks.
SPECIAL
DRAWING RIGHT (SDR)
If problems get worse
for Portugal, as possibly the global economic climate worsens, then the gold
may never legally belong to Portugal. The contracted swap terms at some point
may simply reclassify it a net zero sale, if Portugal fails to return the
cash portion of the swap. The BIS would have 346 tonnes of gold and Portugal
the $14B of Euros it has long since spent to solve a 2010 problem. By then
Portugal likely would need even more loans in whatever currency would replace
a crumpling or possibly extinct Euro.
Up until 2004 the BIS
denominated its financial statements in Gold Francs. It now has made a major
shift to denominating itself into Special Drawing Rights (SDRs). The
calculation is exactly the same as used for the IMF. The
SDR is operating as a defacto currency.
It takes a little
arithmetic (which is not done in the financial statements) to be able to get
values in any currency that can give the reader a perspective of the scope of
the activities at the BIS. The SDR reporting obscures the BIS’s
significant size and scope.
FUNDING
For those who followed
the European Sovereign Debt Crisis and the negotiations with Greece, you know
that the IMF was an unwelcomed intruder into EU financial affairs. Greece on
more than one occasion held the IMF as a negotiating ploy and as a funding
alternative to the EU’s procrastination and lack of decisiveness.
The IMF’s
willingness to interfere created a lot of bad feelings within the EMU and
Germany specifically. As Ambrose Evans-Prichard reported: “The ECB is
barely on speaking terms with the IMF – the "Inflation Maximizing
Fund" as it was dubbed in a Bundesbank memo - - The IMF has not
caught up to the reality in Europe said ECB über-hawk Jürgen Stark
on July 9th” The final EU bailout in fact heavily involved
the IMF participation. The very busy IMF is the dominant crisis lender of
last resort throughout all Central & Eastern European current financial
problems.
What
we are seeing is the emergence of another funding structure based on the SDR
- SDR’s that have a degree of gold backing. The BIS now has a total of
12.4% of its deposits (32B SDR) in the form gold deposits. Note #11 to the
BIS financial statements states: “Gold deposits placed with the Bank
originate entirely from Central Banks. They are all designated as financial
liabilities measured as amortized cost”.
ARE
WE SETTING THE PINS UP FOR AN ALTERNATIVE RESERVE CURRENCY?
Are we moving towards
the BIS and IMF being fractional reserve banks that will create money &
credit - a reserve currency that will satisfy Russia and China with an
element of Gold backing? A bank such as the BIS could easily assume this role
(if it hasn’t already) as could the IMF with possible banking charter
adjustments.
The chances are high
that this is the roadmap we will find ourselves taking. Like all banking that
started as Gold backed you could expect that in this case the little gold
backing that starts the process is quickly diminished so a limitless money
machine could begin functioning. The gold backing would likely be an initial
requirement by Russia and China. The partial gold backing would lend
credibility to the acceptance and a possible reserve currency alternative and
eventual establishment as the global reserve currency.
SHADOW
BANKING REPLACEMENT
The collapse of the
Shadow Banking system and its attendant SIV / CDO structures were at
the root of the financial crisis. That structure which is
representative of a huge amount of the credit growth since the dotcom bubble
burst isn’t coming back soon, if ever. The world needs more liquidity
than the central banks or sovereign treasuries can currently deliver politically. The central bankers, huddled in
their bimonthly board meeting at the BIS in Basel, Switzerland, know this
better than anyone. Their discussions in the very halls of the BIS must
resonate with them to use all the tools available at their disposal -
quickly.
Paul McCulley and
Richard Clarida at Pacific Investment Management Co. (PIMCO) have written extensively about the Shadow Banking
System and its growth. An extensive slide presentation on the Shadow Banking
System can be found on my web site at TIPPING POINTS. I
won’t go into the detail here, but suffice it to say that the shadow
banking system collapse has created a massive hole in credit creation that
central bankers can’t fill in the manner in which they presently appear
to be approaching the problem. Of course appearances can be deceiving
The problem has now
reached crisis proportions and the central bankers know they must urgently
act in a coordinated manner. Deflation now has a firm hand on the global
economy and this must be reversed. I have been calling for a US Quantitative
Easing QE II of $5T in my writings for some time. This amount is required for
the US alone. The entire global requirement is three to four times this
amount.
The above chart serves
as an illustration to simplify the essence of the Shadow Banking System . The
international bankers prefer to refer to the process as Capital Arbitrage. An
arms-length agreement allowed the banks to invest in a Structured Investment
Vehicle (SIV) as an affiliate investment. The large spread that an SIV
captured made it an excellent investment, but more importantly it allowed the
banks to use their fractional reserve (10X) money creation abilities to buy
risky securitization products without them appearing on their balance sheet.
The banks received huge multiplier leveraged returns from the high yielding
Collateralized Debt Obligations (CDOs) until the crisis imploded the game.
HOW
MUCH LEVERAGE WILL THE CENTRAL BANKER CHOOSE TO COMPOUND? =>
“x” times “y”
When the financial
crisis unfolded you may recall that then US Treasury Secretary Hank
Paulson’s (former Chairman and CEO of Goldman Sachs during the
explosion of Shadow Banking structures) first solution was to create a $100B
Super SIV. The SIV leverage thinking was so entrenched that this was the
first ‘go to’ solution to fight de-leveraging. If we were to jump
forward to today when we are further along in increasing and unprecedented
de-leveraging, what the central bankers need to replace the shadow banking
system is a vehicle that will deliver the previous scale of leverage PLUS an
order of magnitude more. The answer is the Bank of International Settlements.
The SIV model is used as illustrated ‘Shadow Central Banking
System’ above.
With
the use of the SDR ‘currency’, central bankers can compound
fractional reserve lending.
IT’S
ALREADY HAPPENING
It is my view this
process is already well along. The following Bloomberg global money supply
growth chart graphically shows this. As the circles indicate, once
again money is flowing into the pipeline or at least into global bank
reserves.
CONCLUSION
The advantage of this
approach is:
1. Leverage: Compounding money creation between banks
2. Partial gold backing: Present BIS levels of 12.4%
3. SDR: Offers a basket of currencies approach versus a single
currency dependency.
4. Former Communist bloc regime backing: China and Russia would
likely support this approach for a number of reasons, which they have already
expressed as short comings to the current global reserve situation.
5. Reserve Currency: The SDR approach offers a migration path from
today’s US$ reserve currency to an alternative bank reserve currency to
a future global reserve currency.
This may be the final
lever required to initiate a Minsky Melt-Up (see: EXTEND & PRETEND - Manufacturing a
Minsky Melt-Up) and the $5T in QE II (see:
EXTEND & PRETEND: A Guide to the Road
Ahead) I have been writing about for some time
now.
There are many
questions that are raised in the above discussion - many about the future
role and safety of gold. Time and space don’t allow for this here. I
hope to work through the answers in forthcoming articles.
If you would like to be notified as the articles are released,
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follow the ongoing daily developments at Tipping Points.
The following gave me
concern when I first read it many years ago and something for you to think
about:
"...the
powers of financial capitalism had another far-reaching aim, nothing less
than to create a world system of financial control in private hands able to
dominate the political system of each country and the economy of the world as
a whole. This system was to be controlled in a feudalist fashion by the
central banks of the world acting in concert, by secret agreements arrived at
in frequent private meetings and conferences. The apex of the system was to
be the Bank for International Settlements in Basel, Switzerland, a private
bank owned and controlled by the world's central banks which were themselves
private corporations."
Professor Carroll
Quigley
Tragedy
and Hope: A History of the World in Our Time (1966)
President Bill
Clinton’s Georgetown Professor
Sign Up for the next release in the Sultans of Swap
series: Commentary
Gordon T. Long
Tipping
Points
Mr. Long is a former senior group
executive with IBM & Motorola, a principle in a high tech public start-up
and founder of a private venture capital fund. He is presently involved in
private equity placements internationally along with proprietary trading
involving the development & application of Chaos Theory and Mandelbrot
Generator algorithms.
Gordon T Long is not a
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expression of opinion only and should not be construed in any manner whatsoever
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you are encouraged to confirm the facts on your own before making important
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© Copyright 2010 Gordon T Long. The information herein was
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