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... And God created gold...
And God saw that gold was
good, and he ordained it as primordial money. The gold coin was to be the
savers’ guardian angel and the producers’ patron saint, they
being the pillars of society. It was also meant to be the protector of the
wage-earners, the most vulnerable protagonists of the drama of Human Action.
The role of gold in the economy is that of regulator of the quantity and
quality of debt. Gold has continued to be money as well as obstruction to the
Debt Tower of Babel for over five thousand years. Until man in his infinite
conceitedness wanted to be wiser than God. He sought to overthrow the
monetary rule ordained by God. He set out to build the Debt Tower of Babel
that was to reach to Heaven. Pilfering savers and plundering producers was
the inevitable result of the activation of the fast-breeder of debt triggered
by the elimination of gold money.
Seven gaunt cows devouring seven fat ones
Not only did man overthrow
what he called “the yoke of gold”; he also sought to obliterate
whatever wisdom previous generations have accumulated through painstaking
research and careful experimentation with the sharp instrument of credit, the
cutting edge of progress but which can also hurt its careless wielder. The
monetary system of the Brave New World has feet of clay planted in a pile of
rotting paper. It is animated by a false doctrine, the Quantity Theory of
Money, a.k.a. monetarism, preaching that gold can safely be overthrown
provided that it is substituted by a “quantity rule”. The fundamental
error in this is the assumption that gold is there in the first place to
limit the quantity of money. Yet the role of gold is to regulate the
quantity, not so much of money, but of debt. In falsifying science man has
frustrated the only hope to rectify the error. This brings to mind the old
adage that “if God wanted to punish someone, He would make him mad
first”.
In
previous essays of this series I have discussed how speculation and
warehousing combine to meet the ever-present challenge of the fickleness and
niggardliness of nature. Warehousemen must ration scarce storage space among
competing uses. According to the Genesis the first warehouseman,
Joseph of Egypt, provided for the seven lean years by storing the grain
surpluses of the seven fat years, following his interpretation of the
Pharaoh’s dream: seven gaunt cows devouring seven fat ones.
Supply-shocks
Briefly stated, man is in a
continual struggle with supply-shocks in the market. They come in two varieties:
bumper crops and crop failures. The former is the Nemesis of producers, the
latter that of consumers. Either way, the whole society suffers. However,
supply-shocks can be mitigated through foresight, organized speculation, and
intelligent warehousing. The fulcrum is the activity of warehousemen who,
following the example of Joseph, allocate scarce storage space in a most
efficient manner in order to provide for future contingencies.
Their
talisman, enabling them to perform this job successfully, is the basis.
It is a seismographically most sensitive instrument
to provide information in a most concentrated form. It makes for an early
warning system exposing potential supply shocks threatening society.
Moreover, the basis also digests information such as the producers’
estimate of what is a good price for their product, comparing it with the
speculators’. The basis picks up all signals, including
producers’ forward sales and speculators’ purchases of futures
contracts, bringing the two into balance. The question arises how this can be
accomplished. After all, the basis is the spread between the nearby (rather
than distant) futures price and the cash price. The answer is: through
arbitrage. Floor traders hedge their sales and purchases of distant futures
as they simultaneously do the opposite transaction in nearby futures. The
basis registers and harmonizes all signals coming from all markets trading
that particular commodity. One cannot help but admire this fine communication
system through which potential supply-shocks, ever present due to risks
inherent in nature, are mitigated by the “invisible hand”as
directed by the basis.
Speculation versus gambling
But there are false
prophets, in economics no less than anywhere else. They preach that in exactly
the same way as speculation can counter the untoward effects of
supply-shocks, it can also meet the challenge of demand-shocks. Just as
speculation can face risks inherent in nature, it can also face risks
artificially created by man. However, in God’s own dictionary a fine
distinction is made between speculation and
gambling. When man meets risks artificially created by other men
(including the government), it is not speculation. It is gambling. It
is akin to bets placed by the gambler on future events which may appear to be
random but aren’t: they are rigged artificially by the casino owner for
his own benefit. The false prophets, being apologists for government-induced
gambling, are anxious to blot out this distinction.
Why
is speculation successful in reducing risks inherent in nature, but a
miserable failure when used to reduce risks artificially created by men? Why
is it that when the government wants the speculative markets to reduce the
fluctuation of foreign exchange and interest rates, or that of gold and
silver prices -- all caused by foolish policies of the self-same governments
-- the result is always contrary to purpose?
To
answer this question we need to consider that in the case of risks inherent
in nature all speculators start off with an equal chance to be successful. No
“inside information” is available to anyone. The playing field is
level. Not so in the case of risks artificially created by government in
deliberately destabilizing foreign exchange and interest rates. Here
speculators pit their wits against that of central bankers. The latter think
they can manipulate the former. A closed group of men tries to
outsmart an open group. But the closed group consists of paid hands who don’t have to face the music of accumulating
losses. All losses have been underwritten in advance by the government and
are covered from the public purse. The open group on the other hand consists
of speculators who risk their own capital which, if lost, will force them to
quit. Their role is taken over by others with better mental equipment to
outsmart the same central bankers. This is how George Soros
could single-handedly bust the Bank of England while it was trying to uphold
the value of the British pound. The Soros incident
was not the first episode of devaluation in the wake of speculative
onslaught, following solemn government pledges that the pound would never
be devalued. Major landmarks are: 1931, 1948, 1968.
Before 1931 a
paper pound fetched exactly one gold sovereign. Seventy-five years later, in
2006, it took one hundred paper pounds to buy the same sovereign.
Apparently, Mr. Soros knows something that Mr.
Brown, the Secretary of the Exchequer, does not.
The rise of the gold basis
When in the early 1970's
governments in their wisdom discarded gold from the international monetary
system, not only did they cut adrift foreign exchange and interest rates.
They also let the genie of the gold basis out of the bottle. Treasury
officials were confident that they could control it by giving speculators the
run of the house. The fundamental feature of the gold market is contango. When threatened to go into backwardation, the
falling gold basis would create powerful incentives for people to accept the
futures market’s offer to absorb all carrying charges and, on the top
of it, to pay a handsome bonus. Surely speculators would fall over themselves
in trying not to miss this bonanza in gold. In the event Treasury officials
have misinterpreted market behavior so completely as only economists imbued with government omnipotence
could. The genie has its own agenda. It will at one point refuse to take
orders from Aladdin Greenspan or Helicopter Ben (or whoever is put in the
Chair at the Federal Reserve Board). The rise of the gold basis will be
followed by its fall, bringing about the downfall of the Establishment.
God
created basis. He wanted to help men fend off blows from the prodigality or
frugality of nature. Like the creatures of Prometheus they would perish
without fire. The basis, in the case of agricultural commodities, is just
that mythological fire stolen from heaven. It is the Creator’s gift to
his creatures to help them survive devastating supply-shocks.
Demand-shocks
By contrast, the gold basis
is not a gift of God. It is a scourge of God to punish conceited governments
pretending to be omnipotent and omniscient. Powerful men want to manipulate
their neighbors inducing them to behave in a way
prejudicial to their own welfare. They want to enslave them by taking away
their ability to protect themselves and to provide for their own happiness
and survival, especially in view of the eventuality of disasters caused by
foolish government policy. They hire economists who parrot the line that
demand-shocks can be met in the same way as supply-shocks: through organized
speculation.
Therein
lies a great error. The gold basis has risen, but
its rise is to be followed by a fall and, later, by the downfall of
governments trying to play God as they gamble with the welfare of their
subjects. The fall of the gold basis tells us that God’s gold cannot be
drowned in a sea of paper gold. The price of the former will tend to infinity
while that of the latter will keep falling to zero. The genie of the gold
basis will crush the government through demand-shocks waiting in the wings of
the gold market.
The fall of the gold basis
As a mental experiment let
us arrange all goods in a linear order starting with agricultural commodities
exposed to supply-shocks to the greatest extent, reflecting the fickleness of
nature. Next in line are base metals and other minerals, as well as
energy-carriers which are exposed to supply-shocks to a lesser extent.
Finally at the far end of the spectrum we put the monetary commodities
virtually immune to supply-shocks. Gold, in particular, has a stocks-to-flows ratio which is a high multiple variously
estimated between 50 and 80. An increase in the flows, however large, would
hardly cause a ripple, considering the size of stocks. To state the case
differently, suppose new gold fields were discovered more prodigious than
those of Witwatersrand. Or suppose that
processes were developed whereby gold molecules suspended in the infinite
oceans could be distilled and gathered economically. Such events could in no
wise have an untoward effect on the value of gold, so huge are existing
stocks relative to incremental flows. This fact alone shows that it was sheer
madness to discard gold from the monetary system. The monetary commodity must
be immune to both supply and demand-shocks. God has kept His side of the
covenant by helping man control supply-shocks. Governments haven’t:
they have artificially magnified demand-shocks through foolish monetary
policies.
The
upshot is that the basis risk is much higher for gold than for non-monetary
commodities. The fall in the gold basis, whenever it comes, will have nothing
to do with assumed supply-shocks. Even if governments threatened to dump all
their remaining monetary gold, the result (after the news wore thin) would be
counter-productive. The dumped gold, and more, would be readily absorbed.
People would not allow the government to trick them out of their golden
life-saver. Rather, they would behave as predicted by the ancient Greek
monetary scientist Xenophon. In his treatise entitled The Revenues of
Athens he wrote that, after people had satisfied all their artistic and
industrial needs for it, they would derive just as much pleasure in digging a
hole in their own backyard and burying their surplus gold there, rather than
entrusting it to public warehouses or, heavens forbid, to government
treasuries.
It
has always been that way. It will be that way in the future, too. Whenever
the government wants to trick people out of their possession of gold, the
basis turns negative. It then falls into a pit and no one will hear it to hit
bottom. The number of instances of this happening strains the counting
ability of monetary historians. Every episode of a hyperinflation in which
paper currency has self-immolated furnishes such an example.
Putative gold basis
“Hey, wait a
minute”, you may interject. “Is this not an anachronism? How
could you talk about gold basis under a gold standard?” Well, you are
right. Gold basis is a new concoction, barely 35 years old. There was no gold
basis before 1970, as there were no futures markets in gold. The
world’s first gold futures market opened in the Winnipeg Commodity
Exchange in 1970. The contract called for the delivery of the 400 oz. (12.5 kg) international
‘good-delivery’ gold bar, the one central banks of the world have
been using to settle international imbalances with one another in the good
old days. I meant the putative gold basis in the previous paragraph,
that is, whatever the gold basis would have been if there had been a gold
futures market at the time of hyperinflation.
In
1971 I went to Winnipeg
to be witness to history. I purchased a seat on the exchange. I was
interested in studying the variation of the gold basis on the floor first
hand. At that time gold ownership and trading was still a crime in the United States
pursuant to a Presidential Proclamation dating from 1933. F. D. Roosevelt
nationalized (read: confiscated) monetary gold. In Canada gold ownership and trading
has always been legal. Canada
was chosen as testing grounds by the U.S. Treasury to see how the market
would react, in preparation for the legalization of gold ownership in the U.S. four
years later. The gold futures market in Winnipeg
was a robust carrying-charge market. Its wide basis reflected the popularity
of gold futures with gold investors. Buy orders came in a steady stream from
all corners of the world. In the absence of gold futures this demand would
have shown up as demand for cash gold, the greatest threat to the value of
the U.S. dollar. The U.S.
Treasury was satisfied that paper gold would do nicely, thank you very much,
and gold futures trading in the U.S. was duly allowed to commence
in January, 1976.
Bribe money
I have always felt that the
gold basis was an anomaly. It certainly did not belong to the same category
as the basis of agricultural commodities. It was not a bonus rewarding good
husbandry. It was more like the Trojan Horse planted by a bankrupt government
that wanted to take through deception what it couldn’t by force. I
always looked at contango as bribe money, to induce
people to take the promise instead of the real thing. It is remarkable and
important that under the gold standard there was no need for bribes. People
were happy to accept the promise at face value. The credibility of central
bankers has in the meantime been reduced to a zero. They are the spinmasters of the “greatest fool” game. The
greatest fool is the player who will hold the bag of worthless banknotes when
the music stops. Gold futures trading has been
introduced in order to make people believe that the possibility of
hyperinflation has been eliminated for good.
We
may grant that gold futures trading has materially
added to the longevity of the regime of irredeemable currency. But while the
central bankers are buying time, sand in the hour-glass of the gold basis
keeps trickling down. When it runs out, the trickle of cash gold from
warehouses will have become an avalanche that could no longer be stopped. The
gold futures market will be bankrupt, along with the regime of irredeemable
currency. Treasury officials will cry “foul play”and
will scurry around looking for “rogue traders” everywhere. That
is, everywhere except in the Treasury and in the White House where the real
culprits hide. When the present unconstitutional monetary regime of the U.S. comes
unstuck, the responsibility for the disaster will have to be assigned to the
President and the Secretary of the Treasury. They have betrayed their oath to
uphold the Constitution of the United States of America, as far
as its monetary provisions are concerned.
I
have never ever wavered in my conviction that such will be the denouement of
the drama unfolding before our eyes. Any other outcome, however widely
prophesied, whether the inflationary or deflationary variety, appears
unlikely to me.
Fools treat promises with greater respect than the issuer himself
I reject the Quantity
Theory of Money. It is an essentially linear theory trying to explain an
essentially non-linear phenomenon. Consequently, I do not believe that there
is a causal relationship between the central bank’s inflating the money
supply and an increasing price level. No doubt, the newly created money could
go into commodities; but it could, and would, also go into bonds, equities,
and real estate. It is true that paper currency will ultimately
self-immolate. An irredeemable promise to pay, it has been gushing forth in
the aftermath of the break of the dam, the 1933 reneging on the promise to
redeem the dollar in gold at the rate of slightly over 1/20 oz. It does not
matter that hardly anybody alive today has any direct memory of that event.
What does matter is that the central bank has neither the intention nor the
means to meet this obligation. It simply refuses to give anything of
value in exchange for its own notes. It should not come as a surprise then
that these notes will, at one point, be unacceptable to the producers in
exchange for real goods and real services. This is plain logic. There has
never been an exception to the truism: if the issuer treats his own promises with
disdain, then it is only a matter of time before the public will do likewise.
Nor does the truth of this syllogism depend on the quantity of promises issued, or on the rate of increase in their issuance. It
is still valid even if the rate of increase in the issuance of new promises
is declining, or if no new promises are issued. It follows that a quantum
increase in prices is not a necessary condition for the imminent
self-destruction of the monetary system. Nor can the increase in prices be
relied upon to predict the timing of such an event. Then what can?
I
am suggesting it to you that the gold basis can.
Aladdin Greenspan whistling in the black hole
Expect the regime of irredeemable
currency to put up a desperate and vicious fight for survival. There may be
times when the gold basis bounces back. But its decline, on the average, is
relentless. The dead-cat-bounce is still to come. I have been a student of
the gold basis for 35 years. In the early 1990's I made the pilgrimage to the
World Trade
Center in New York City to meet
the Director of Research at Comex. I asked him what
explanation he had for the vanishing contango and
for the relentless fall of the gold basis. He cited a couple of ad hoc
reasons, having to do with the low and falling interest-rate structure, and
its effect on the declining carrying charge. But he had to admit that he knew
of no theoretical explanation for the phenomenon of continuing erosion even
in the face of rising interest rates and increasing carrying charges.
My
own explanation is that the shrinking contango and
the persistent fall in the gold basis is a measure of the vanishing of gold
into private hoards. Monetary gold together with the output of the gold mines
is disappearing. Aladdin Greenspan was whistling in the black hole when he
testified before a Congressional committee saying that central banks stood ready to
sell more gold to quash flare-ups in the gold price. The irrefutable fact is
that selling gold makes the central bank’s balance sheet weaker, not
stronger. The bank would replace its best assets for the worst.
It would exchange an asset that is the liability of no one for the liability
of devaluation-happy governments. Central bankers are helpless. They are in a
catch-22 situation. Selling gold into a rising market would be the
coup-de-grâce to their fiat money scheme.
They hope against hope that inundating the world with paper gold in the form
of gold futures, options, ETF’s and other
derivatives, existing or yet to be invented, will save their skin. It
won’t. Not forever, anyhow.
So
I advise my audience to ignore the siren song of the Quantity Theory of
Money. Focus attention on the falling gold basis. It is a foolproof indication
of the disappearance of monetary gold still available to the public as
insurance against economic disasters. The fact is that the vast majority of
the people lives in a fool’s paradise. They
haven’t given a thought to purchasing such insurance while they are
busily building their homes right on the financial fault line.
As
a further refinement I call attention to the silver basis which, if my
analysis is correct, will fall first. Not because monetary silver has been
“consumed”, as trumpeted by the cheerleaders of the
get-rich-quick crowd. It hasn’t. But, as the silver basis shows, silver
is going into hiding even faster than gold. Why? Basically because central
bankers have less scope for bluffing in the silver market. The cupboard is
bare and the kitty is empty when they are looking for more silver.
Sapere aude!
I will not go out on one
limb to make predictions about timing beyond repeating what I have already
said. The indication for the imminent collapse of the international monetary
system will be the “last contango in Washington”: the
fall of the silver basis. It will be followed by the fall of the gold basis.
These events will indicate that the irredeemable dollar has entered its death
throes -- regardless what the inflation numbers say. Woe to all fiat
currencies whose principal backing is the irredeemable dollar. Controlling
their quantity can and will do nothing to save them.
I
am fully aware that it is dangerous to question the validity of the
prevailing Quantity Theory of Money. I am willing to stake my professional
reputation, as Galilei has staked his when he saw
no wisdom in the prevailing geocentric cosmology.
I
close this series of essays on the basis with Horace: sapere
aude! (In English translation: dare to be wise; Epist.,
I. ii .42.)
References
A.E. Fekete, What Gold and
Silver Analysts Overlook
A.E. Fekete, Bull in Bear’s Skin?
A.E.
Fekete, Ultracrepidarian
Musings
A.E. Fekete, Monetary versus Non-monetary
commodities
A.E. Fekete, The Last Contango
in Washington
Tom
Szabo, The Silver Basis
Antal E. FEKETE
aefekete@hotmail.com
June
23, 2006.
_________________________________________________________
Antal E. Fekete is Director of of Research and Education at the Ferdinand Lips
Institute, Zurich, Switzerland. . Born and educated
in Hungary, he emigrated to Canada after the Hungarian
Revolution in 1956 and taught for 35 years in the field of mathematics. Over
the years, he has been a visiting professor or Fellow at Columbia University,
Princeton University,
and Trinity College
of Dublin. He
worked in the Washington office of Congressman W.E.
Dannemeyer on monetary and fiscal reform for five
years in the nineties; and in 1996, he won first prize in the prestigious
International Currency Essay contest sponsored by Bank Lips Ltd. of
Switzerland. He is the author of Gold and Interest and Monetary
Economics 101. In addition, his scholarly articles have appeared on
numerous Internet sites throughout America.
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