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Governments want a low gold price to make national
currencies look good. Gold is recognizable the world over as the "canary
in the coal mine" when it comes to money. A rising gold price blurts the
unpleasant truth that a national currency is being poorly managed and that
its purchasing power is being inflated.
This reality is made clear by former Federal Reserve
Chairman Paul Volcker. Commenting in his memoirs about the soaring gold price
in the years immediately following the end of the gold standard in 1971, he
notes: "Joint intervention in gold sales to prevent a steep rise in the
price of gold, however, was not undertaken. That was a mistake." It was
a "mistake" because a rising gold price undermines the thin reed
upon which all fiat currency rests -- confidence. But it was a mistake only
from the perspective of a central banker, which is of course at odds with
anyone who believes in free markets.
The U.S. government has learned from experience and
has taken Volcker's advice. Given the U.S. dollar's role as the world's
reserve currency, the U.S. government has the most to lose if the market
chooses gold over fiat currency and erodes the government's stranglehold on
the monopolistic privilege it has awarded to itself of creating
"money."
So the U.S. government intervenes in the gold market
to make the dollar look worthy of being the world's reserve currency when of
course it is not equal to the demands of that esteemed role. The U.S.
government does this by trying to keep the gold price low, but this is an
impossible task. In the end, gold always wins -- that is, its price
inevitably climbs higher as fiat currency is debased, which is a reality
understood and recognized by government policymakers.
So recognizing the futility of capping the gold
price, they instead compromise by letting the gold price rise somewhat, say,
15 percent per year. In fact, against the dollar, gold is actually up 16.3
percent per year on average for the last eight years. In battlefield terms,
the U.S. government is conducting a managed retreat for fiat currency in an
attempt to control gold's advance.
Though it has let the gold price rise, gold has
risen by less than it would in a free market because the purchasing power of
the dollar continues to be inflated and because gold remains so undervalued
notwithstanding its annual appreciation this decade.
These gains started from gold's historic low
valuation in 1999. Gold may not be as good a value as it was in 1999 but it
nevertheless remains extremely undervalued.
For example, until the end of the 19th century,
approximately 40 percent of the world's money supply consisted of gold, and
the remaining 60 percent was national currency. As governments began to usurp
the money-issuing privilege and intentionally diminish gold's role, fiat
currency's role expanded by the mid-20th century to approximately 90 percent.
The inflationary policies of the 1960s, particularly in the United States,
further eroded gold's role to 2 percent by the time the last remnants of the
gold standard were abandoned in 1971.
Gold's importance rebounded in the 1970s, which
caused Volcker to lament the so-called mistakes of policymakers. Its
percentage rose to nearly 10 percent by 1980. But gold's share of the world
money supply thereafter declined, reaching about 1 percent in 1999. Today it
still remains below 2 percent.
From this analysis it is reasonable to conclude that
gold should comprise at least 10 percent of the world's money supply. Because
it is nowhere near that level, gold is undervalued.
So given the ongoing dollar debasement being pursued
by U.S. policymakers, keeping gold from exploding upward to a true free-market
price is the first thing they gain from their interventions in the gold
market. The other thing they gain is time. The time they gain enables them to
keep their fiat scheme afloat so they can benefit from it, delaying until
some future administration the scheme's inevitable collapse.
So how does the U.S. government manage the gold
price?
They recruit Goldman Sachs, JP Morgan Chase, and
Deutsche Bank to do it, by executing trades to pursue the U.S. government's
aims. These banks are the gold cartel. I don't believe that there are any
other members of the cartel, with the possible exception of Citibank as a
junior member.
The cartel acts with the implicit backing of the
U.S. government, which absorbs all losses that may be taken by the cartel
members as they manage the gold price and which further provides whatever
physical metal is required to execute the cartel's trading strategy.
How did the gold cartel come about?
There was an abrupt change in government policy
around 1990. It was introduced by then-Federal Reserve Chairman Alan
Greenspan to bail out the banks back then, which, as now, were
insolvent. Taxpayers were already on the hook for hundreds of billions of
dollars to bail out the collapsed "savings and loan" industry, so
adding to this tax burden was untenable. Greenspan therefore came up with an
alternative.
Greenspan saw the free market as a golden goose with
essentially unlimited deep pockets, and more to the point, saw that these
pockets could be picked by the U.S. government using its tremendous weight,
namely, its financial resources for timed interventions in the free market,
combined with its propaganda power by using the news media. In short, it was
easier to bail out the insolvent banks back then by gouging ill-gained
profits from the free markets instead of raising taxes.
Banks generated these profits through the Federal
Reserve's steepening of the yield curve, which kept long-term interest rates
relatively high while lowering short-term rates. To earn this wide spread,
banks leveraged themselves to borrow short-term and use the proceeds to buy
long-term paper. This mismatch of assets and liabilities became known as the
carry trade.
The Japanese yen was a particular favorite to borrow. The Japanese stock market had crashed
in 1990 and the Bank of Japan was pursuing a zero-interest-rate policy to try
reviving the Japanese economy. A U.S. bank could borrow Japanese yen for 0.2
percent and buy U.S. T-notes yielding more than 8 percent, pocketing the
spread, which did wonders for bank profits and rebuilding the bank capital
base.
Gold also became a favorite
vehicle to borrow because of its low interest rate. This gold came from
central bank coffers, but central banks refused to disclose how much gold
they were lending, making the gold market opaque and ripe for intervention by
central bankers making decisions behind closed doors. The amount lent by
central banks has been reliably estimated in various analyses published by
GATA as between 12,000 and 15,000 tonnes, nearly half of total central bank
gold holdings and four to six times annual gold mine production of 2,500
tonnes. The banks clearly jumped feet first into the gold carry trade.
The carry trade was a gift to the banks from the
Federal Reserve, and all was well provided that the yen and gold did not rise
against the dollar, because this mismatch of dollar assets and yen or gold
liabilities was not hedged. Alas, both gold and the yen began to strengthen,
which, if allowed to rise high enough, would force marked-to-market losses on
those carry-trade positions in the banks. It was a major problem because the
losses of the banks could be considerable, given the magnitude of the carry
trade.
So the gold cartel was created to manage the gold
price, and all went well at first, given the help it received from the Bank
of England in 1999 to sell half of its gold holdings. Gold was driven to
historic lows, as noted above, but this low gold price created its own
problem. Gold became so unbelievably cheap that value hunters around the
world recognized the exceptional opportunity it offered and demand for
physical gold began to climb.
As demand rose, another more intractable and
unforeseen problem arose for the gold cartel.
The gold borrowed from the central banks had been
melted down and turned into coins, small bars, and monetary jewelry that were acquired by countless individuals
around the world. This gold was now in "strong hands," and these
gold owners would part with it only at a much higher price. So where would
the gold come from to repay the central banks?
While the yen is a fiat currency and can be created
out of thin air by the Bank of Japan, gold is a tangible asset. How could the
banks repay all the gold they borrowed without causing the gold price to
soar, worsening the marked-to-market losses on their remaining positions?
In short, the banks were in a predicament. The
Federal Reserve's policies were debasing the dollar, and the "canary in
the coal mine" was warning of the loss of purchasing power. So
Greenspan's policy of using interventions in the market to bail out banks
morphed yet again.
The gold borrowed from central banks would not be
repaid after all, because obtaining the physical gold to repay the loans
would cause the gold price to soar. So beginning this decade, the gold cartel
would conduct the government's managed retreat,
allowing the gold price to move generally higher in the hope that, basically,
people wouldn't notice. Given gold's "canary in a coal mine"
function, a rising gold price creates demand for gold, and a rapidly rising
gold price would worsen the marked-to-market losses of the gold cartel.
So the objective is to allow the gold price to rise
around 15 percent per year while enabling the gold cartel members to
intervene in the gold market with implicit government backing in order to
earn profits to offset the growing losses on their gold liabilities. The gold
cartel's trading strategy to accomplish this task is clear. The gold cartel
reverse-engineers the black-box trend-following trading models.
Just look at the losses taken by some of the major
commodity trading managers on their gold trading over the last decade. It is
hundreds of millions of dollars of client money lost, and the same amount
gained for the gold cartel to help offset their losses from the gold carry trade
-- all to make the dollar look good by keeping the gold price lower than it
should be and would be if it were allowed to trade in a market unfettered by
government intervention.
As I see it there are only two outcomes. Either the
gold cartel will fail or the U.S. government will have destroyed what remains
of the free market in America. I hope it is the former, but the flow of
events from Washington and the actions of policymakers suggest it could be
the latter.
James Turk
Goldmoney.com
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James
Turk is the founder of GoldMoney
(www.goldmoney.com) and the co-author of The Coming Collapse of the Dollar (www.dollarcollapse.com).
Copyright © 2007 by
James Turk. All rights reserved.
Published by GoldMoney
Copyright © 2008. All rights reserved.
Edited by James Turk, alert@goldmoney.com
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