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The topsy-turvy
world of central bank gold sales
Here is a passage from my 1998
book entitled Gold and Interest that will soon be released as an
e-book.
As these
pages are written (late 1997), chrysophobes make much of the weak
dollar-price of gold and of the fact that more central banks, including the
Swiss, join the company of those that have been dumping gold on the market.
In addition, self-styled experts on deflation submit that, while under an
inflationary spiral gold hoards may have been a reasonable investment, gold
is the worst possible place to be under a deflationary spiral.
It is undeniable that the gold market has been highly charged psychologically
for the past thirty years. This will likely continue into the 21st century.
It is also true that the great bull market in bonds that started in 1980 has
so far coincided with the great bear market in gold. From a high of $850 in
1980 gold went to a low of $ 285 in 1985 and is trading near the low end of
that range at the time of writing. However, it does not follow from this that
the gold bear must march hand-in-hand with the bond bull, or that they must
expire together. There are reasons to believe that the gold dumping is
orchestrated and is meant as a scarecrow tactic. A central bank advertising
its future gold sales stinks: it cannot be sincere about its real intentions.
As every student of the market well knows, selling at low and falling
prices is a sign of weakness ─ never a sign of strength. Central
bank selling of gold is no exception.
Hecatomb of
currencies
At this
juncture the gold market is a mere side-show. The main show is the foreign
exchange market where a clandestine trade war is being waged. Presumably
there will be a lot of casualties in the form of fallen currencies before it
is all over. The dollar, for the time being, is the obvious refuge for the
victims of the hecatomb of currencies. This makes it appear strong.
But the dollar has its own problems. First, it suffers from exactly
the same ills that are plaguing all falling currencies. Second, the American
political establishment has a very low tolerance for a strong dollar. Recall
that in 1985, under a conservative President, the dollar was diagnosed
’too strong’ and was subsequently scuttled ─ making the
price of gold rise from its lows. Rumors of the demise of gold are grossly
exaggerated. At the risk of belaboring the obvious I would like to make the
following points.
The only
financial asset that is nobody’s liability
The
volatility of the dollar-price of gold is not a reflection of the uncertainty
in the value of gold. It is in fact a reflection of the uncertainty in the
value of the dollar in which the gold price is quoted. A lower gold price
shows a momentary strength of the dollar; not a reluctance on the part of
people to hold gold. Nobody is suggesting that the world no longer needs a
financial asset that is nobody’s liability.
A currency immune
to debasement, default, and devaluation
The lower
gold price also reflects the reluctance of the people to put the central
bankers out of their misery. After all, they could call the bluffing of
central bankers at any time if they wanted to. For the time being they
don’t. Central bank gold dumping may or may not be good politics, but
it is certainly poor economics. Gold is the only sound asset in the balance
sheet. It is the only asset in the balance sheet that is not at the
same time a liability in the balance sheet of someone else. For this reason,
gold is immune to deliberate debasement, defaults or devaluations. By
contrast, dollars in the balance sheet represent irredeemable promises to
pay, with the obligor having a history of deliberate debasement, defaults and
devaluations. When a central bank discards a sound asset from its balance
sheet at a low price, and replaces it with a dubious one at a high price, it
makes its own currency weaker, not stronger. It is especially foolish to do
this at a time when the world is entering shark-infested waters where the
sharks are preying on paper currencies.
Central bankers
making themselves the laughing stock of the world
We must
distinguish between gold sales by a weak central bank from that by a strong
one. A weak central bank prefers to conduct its gold sales in perfect
secrecy. It does not want the world to know about the timing and the extent
of its selling program lest the market’s unfavorable reaction cause the
proceeds from the sale to suffer. Even so, the market has an uncanny way of
bringing down the gold price ahead of the sale just long enough to
accommodate the central bank eager to unload its gold, only to put the price
back up once the sale is completed. By contrast, a strong central bank wants
to show off that its gold is ’surplus’. All the same, the central
banks has to proceed carefully lest it become the laughing stock of the world
in selling its patrimony for a pittance. Embarrassing questions might be
asked such as this: „why is it that central bankers always sell at the
bottom, and never at the top?”
Hidden agenda?
Especially
suspicious is a central bank drumming up its proposed sales. It is the height
of incompetence and ineptitude to proceed this way ─ unless the central
bank has a hidden agenda. It may want to camouflage its intention to buy,
so it is bringing down the price to facilitate its purchasing program.
External demand
for dollars
The
strength of the dollar, such as it is, is entirely due to external demand.
This demand is, as it has been since 1971, subject to withdrawal without
notice. Internally, there is nothing to justify the strength of the dollar.
There is no end in sight to U.S. trade deficits. All the optimistic
predictions about eliminating the U.S. budget deficit that have been made in
the past turned out to be ill-founded. It remains to be seen whether the
latest optimistic prediction is better founded. If the deflationary cancer
metastasizes across the Pacific, as appears likely, then the present falling
trend in the U.S. budget deficit could make a nasty U-turn. The U.S. is still
the greatest debtor in the world and in history. And it is still true that
nothing comes from nothing.
Misunderstanding
economics and mismanaging public resources
The current
rush of central banks to sell their shrinking gold assets in the face of
their burgeoning liabilities is just another case of misunderstanding
economics and mismanaging public resources as completely as only government
bureaucrats can misunderstand and mismanage them.
35 years of
Keynesian and Friedmanite agitation for confetti money
The folly of central bankers and
Treasury officials managing the patrimony of their countries in the face of
gathering storm is unprecedented. This is the result of 35 years of Keynesian
and Friedmanite agitation in favor of irredeemable currency, and the
systematic badmouthing of sound economics, finance, and debt-management. I am
grateful to Dr. Theo Megalli of Germany for translating into English a paper
of the late Hungarian monetary economist Melchior Palyi with the title Gold
Standard and Economic Order that appeared in the book Geld, Kapital
und Kredit ─ Festschrift for the seventieth birthday of
Heinrich Rittershausen (Stuttgart, 1968) from which the following quotations
are taken.
The Gold Standard
and economic order
The gold
standard was sacrosanct to generations brought up on Adam Smith’s ideal
of the free market, free, that is, from arbitrary and discriminatory
intervention by the powers that be. Indeed, it was an essential instrument of
economic freedom. It protected the individual against arbitrary government
measures by offering a convenient hedge against confiscatory taxation as well
as against currency depreciation and devaluation. Gold provided essential mobility
of funds beyond national boundaries. Above all it raised a mighty barrier to
authoritarian interference with the economic process. In the words of Adam
Smith: ”That insidious and crafty animal calling himself
’statesman’ whose councils are guided by the momentary
fluctuations of affairs” was forced to keep the national budget
in good order. Authoritarians of all denominations had to control their
inflationary propensities and to refrain from excessive taxation in order to
forestall the loss of confidence in the currency on the part of the people.
The public purse had to be held tight. The business community had to learn to
live with the salutary threat that illiquidity caused by short-sighted
over-investment and irrational speculation could be penalized by loss of gold
and an automatic tightening of the money-supply.
The gold standard in the classical sense was part and parcel of an economic
order. It was the corner-stone of the system of public law, social customs
and institutions that Marx pejoratively called ”capitalism”
─ a system that rested on nearly unlimited freedom of consumer choice,
of enterprise, and of markets…
Unity of the
economic world
The
meaning of the gold standard ─ with unrestrained and uncontrolled
private ownership of gold ─ cannot be appreciated in isolation from the
institutional and psychological background that characterized the civilized
world in the decades before 1914. The outstanding feature of that period was
the unity of the economic world as it has not been achieved before or
thereafter.
Quoting from Oscar Morgenstern’s International
Financial Transactions and Business Cycles, New York,1957, pp 17-19:
”There was freedom of travel without passports, freedom of migration,
no exchange controls or other monetary restrictions. Citizenship was freely
granted to immigrants… capital could move unsupervised in any
direction, and these movements could take any form… International trade
had to overcome tariffs, yes, but… tariffs were exceedingly low. There
were hardly any qualitative restrictions on international trade (quotas,
import prohibitions, etc.)… It was a world of which recently
many… would have been inclined to assert that it could not be created
because it would never work…”
It was a world of low wages and lower still prices. Taxes were almost
nominal. It was a world in which virtual freedom of enterprise,
’workable’ competition and highly flexible wage-price structures
prevailed in which private property and contracts were held inviolable.
Defaulting governments had to face boycott or worse.
It was a world, by and large, of balanced national budgets. Public debt had
to be amortized as a matter of course, just as private debts had to be
repaid. Fiat money was anathema. Emergency public expenditures were financed
by long-term bonds. There was no monetization of public debt.
A world
of steady real growth
Above
all, it was a world of steady real growth ─ at an average annual
rate of 5 percent during the six decades before 1914 ─ of steadily
rising living standards for the masses, with ’social security’
provided by the automatic protection of savings…
The role of the gold standard in unifying the civilized world can scarcely be
overestimated. It was the sine qua non opening up the world for
economic progress, for the diffusion of modern civilisation. Capital flows
that were instrumental could allow the gold standard to operate with a
minimum of actual gold transfer and with relatively modest gold reserves. The
gold standard presupposed a high degree of freedom in foreign trade helping
the debtor nations in liquidating their debt through exports to the
creditor…
Throughout the 19th century most major central banks remained privately owned
commercial institutions and were supposed to conduct themselves as financial
enterprises ─ to earn profits. They were to ”suffer” the
impact of gold flows, rather than influencing them…
Real Bills
─ the safest earning asset
In
Britain, the Banking School argued that no authoritarian control or
discretionary power was needed to sustain the balance between the production
of marketable goods and the creation of currency. Enlightened
self-interest would compel the central bank to maintain the liquidity of its
earning assets that were to consist of ”real bills”, that is,
short-term self-liquidating commercial paper growing out of the actual sale
of goods.
The Currency School on the other hand doubted that stability could be
guaranteed by asset liquidity rules which, notoriously, could be violated
when most needed ─ at times of business upturn and rising prices.
Adherents of this school believed that the money-creating power of the
central bank was the crux of the situation and insisted on curtailing this
power by requiring 100 percent gold reserve for the note issue. The idea was
that the automatism of the gold standard was to be preserved by putting the
central bank into a strait-jacket. The volume of the outstanding note issue
was to expand and contract in exact proportion with the inflow and outflow of
gold.
The Currency School won a Pyrrhic victory in 1844. By the Peel Act the Bank
of England was obliged at all times to maintain 100 percent gold reserve
behind its note issue beyond a modest amount… But the necessity to
suspend limitation on the note issue in the monetary panics of 1846, 1858 and
1867 taught that tying the Bank of England to a formula was a senseless
undertaking. Not only did the Peel Act fail to extend the 100 percent reserve
requirement to the central bank’s deposit liabilities, which grew
faster than the note liability, but the tying of the bank’s hands
behind its back, as it were, left the problems of monetary policy unresolved.
The flame of
liberty
Before World War I economic
considerations dominated political agenda, not the other way around. Wars
could not be waged to the bitter end, bankrupting vanquished and victors
alike. Peace following war was genuine, rather than a continuation of
hostilities through other, economic means. The vanquished were allowed to
recover through hard work and hard saving, thanks to the operation of the
gold standard.
All this was to change with the outbreak of World War I. Economic
considerations were sacrificed on the altar of political expediency. A new
regime, one of prepetual and total war was inaugurated. When the gold
standard refused to play along, it was given a bad name, and a dishonorable
discharge. People were not consulted. Through a series of confidence tricks
they had been weaned from the gold coin. The Warfare State went all out to
bribe the electorate with the newly-invented Welfare State. The golden thorn
in the flesh of the establishment remains. The Constitution of the United
States of America, primarily because of its monetary provisions, was thrown
to the winds. The powers that be wanted to unshackle themselves in
preparation of enslaving the American people. Confiscation of the gold coin
of the people was the necessary first step. Trying to bribe people with an
avalanche of confetti money was the second.
If the flame of liberty is to flare up again from the ember barely glowing
underneath layers of ashes left behind by a century of total war, it will be
thanks to the indelible mark that the gold standard, once the epitomy of
unity of the entire civilized world, has left on human affairs as no
religion, ideology, literary or scientific movement ever did.
Gold Standard
University
Session Two is scheduled for
August 15-29, 2007, in Szombathely, Hungary. It will include a blue-ribbon
panel discussion under the title The Last Contango: the First Sign of
Disintegration of the International Monetary System, on the gold/silver
basis as a most sensitive market indicator that is being developed by a team
of researchers. For further information please contact: GSUL@t-online.hu.
Antal
E. Fekete
San Francisco School
of Economics
aefekete@hotmail.com
Read
all the other articles written by Antal E. Fekete
DISCLAIMER AND CONFLICTS
THE PUBLICATION OF THIS LETTER IS FOR YOUR INFORMATION AND AMUSEMENT ONLY.
THE AUTHOR IS NOT SOLICITING ANY ACTION BASED UPON IT, NOR IS HE SUGGESTING
THAT IT REPRESENTS, UNDER ANY CIRCUMSTANCES, A RECOMMENDATION TO BUY OR SELL
ANY SECURITY. THE CONTENT OF THIS LETTER IS DERIVED FROM INFORMATION AND
SOURCES BELIEVED TO BE RELIABLE, BUT THE AUTHOR MAKES NO REPRESENTATION THAT
IT IS COMPLETE OR ERROR-FREE, AND IT SHOULD NOT BE RELIED UPON AS SUCH. IT IS
TO BE TAKEN AS THE AUTHORS OPINION AS SHAPED BY HIS EXPERIENCE, RATHER THAN A
STATEMENT OF FACTS. THE AUTHOR MAY HAVE INVESTMENT POSITIONS, LONG OR SHORT,
IN ANY SECURITIES MENTIONED, WHICH MAY BE CHANGED AT ANY TIME FOR ANY REASON.
Copyright © 2002-2008 by Antal E. Fekete - All rights reserved
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