GARY NORTH not only has skin but he also has his head in the monetary game. Read this informative article, and prepare yourselves for the likelihood of a continuation of global financial distress. In the meantime, you may want to subscribe to his newsletter.
Issue 847 April 10, 2009
THE GOLD WAR: Will You Lose It? If you own gold, you are in a war. You are under assault. You had better figure this out early. There is a full-scale war against you. The politicians and central bankers who are conducting this war against you are determined to see that you lose money on your investment.
I have written a detailed report on this: "The Gold Wars." You can download it free of charge here: The reason why you are under assault is because you have demonstrated by your purchase of gold or a gold-related investment that you do not trust the monetary policies of your nation's central bank. If you are an American, this means you do not trust the monetary policies of the Federal Reserve System. You have taken a step that confirms your lack of trust in the government and its central bank. If you think the government and the central bank will sit quietly, while millions of citizens buy gold as a way to hedge against government and central bank policies, you are terminally naive.
A PERPETUAL WAR
Governments and central banks for almost a century have done whatever they could to keep citizens from using gold as a way to hedge their economic futures against the taxation policies of the government and the inflation policies of central banks.
The war escalated a few days after the outbreak of World War I in August of 1914. At that time, central banks authorized commercial banks to cease redeeming paper money for gold at a fixed rate of exchange. For most of the world, that prohibition extended during the war, after the war, during the Great Depression, during World War II, up to today.
The United States government forbade American citizens from owning gold, beginning in 1933 and extending to the end of 1974.
Today, no government is restrained by a gold standard. No government, no central bank, and no commercial bank is required by law to redeem paper money or bank accounts for gold at a fixed rate of exchange.
This has freed governments and central banks from the limit which the traditional gold standard had imposed on them. When they inflated the currency, people who understood what was going on would go to their local bank and exchange paper money or bank account entries for gold or silver coins. They understood that the increased money supply would lead to a rise in prices, and that gold would flow out of the commercial banks and the central bank of the nation in question. They lined up early to get their gold, so they would not be stiffed by the commercial banking system and the central bank, which they knew would be the case if the central bank continued to inflate the currency.
People who own gold coins are skeptics regarding the fiscal and monetary policies of the government. There are people who buy gold as a temporary speculation, the same way that they would buy copper, but I am talking about people who buy gold coins and take delivery. These people are professional skeptics regarding governments and central banks. They are the sworn enemies of governments and central banks. The very fact that they would go to a coin store and purchase bullion gold coins testifies to their lack of trust in governments and central banks.
Politicians and central bankers regard such people as enemies of the state. They will do whatever is possible to impose losses on these people, so that others in the society will not perceive that those who are skeptics about government fiscal policies and central bank monetary policies are making money. The worst thing that can happen from the point of view of a government or central bank is the people who are completely skeptical about governments and central banks should get rich as a result of the policies of governments and central banks.
The goal of the politicians and central bankers to make certain that the public is anesthetized regarding the disastrous effects of severe monetary inflation on the wealth of individuals. A rising price of gold sends a signal to those members of society who trust the integrity and good judgment of politicians and central bankers. The signal says: "Skeptics are making money. You're losing money. Buy gold."
FROM JOHNSON TO OBAMA
The government of the United States has had a problem with gold-buying skeptics ever since the Vietnam War. Late in Johnson's administration, foreign central banks, especially the central bank of France, began cashing in dollars and demanding delivery of gold at $35 an ounce. This led to a gold run on the Treasury, which was in effect a gold run on the Federal Reserve System. This sent a signal to investors that central banks no longer fully trusted the United States government to be able to meet its contractual obligations to governments and foreign central banks.
Nixon closed the gold window on August 15, 1971. He broke contract with all foreign nations and central banks. He did exactly what the skeptics had predicted that the government would do: refuse to deliver gold at $35 an ounce.
That sent a signal to investors that the Nixon administration was going to require the Federal Reserve System to inflate the currency. This is exactly what the Nixon administration did. So did Carter's. The 1970s were the worst period of price inflation in peacetime American history.
By the end of the decade, January 1980, gold rose for one day above $800 an ounce. But the central bank under Paul Volcker had reversed policy in October of 1979. The Federal Reserve began to tighten money. This led to the collapse of gold and silver prices in January 1980, and also to the 1980 recession. That cost Jimmy Carter his presidency.
There is a legitimate way for central banks to fight gold and inflict losses. The way to do this is for central banks to stop increasing the money supply. That is a perfectly legitimate policy. That is what the traditional gold standard required of central banks. When central banks followed policies of monetary inflation, and the price of gold rose as a result, the run on gold would begin.
Paul Volcker fought gold investors from 1979 to 1982. The Federal Reserve reduced the increase of the money supply. This was what the traditional gold standard always did. It forced central banks to stop inflating. If they did not stop inflating, there would be a run on the supply of gold by a small minority of investors. They would bring in IOUs to gold and take their gold home.
Central bankers do not want to fight gold investors in this way. They want to continue to expand the money supply but not face the consequences in the arena of public opinion. They seek ways to force down the price of gold because the price of gold is an indicator of central bank monetary policy. Central bankers today have a number of anti-gold investor policies.
ANTI-GOLD INVESTOR POLICIES
The most common policy is to lease gold to a specialized group of insiders known as bullion banks. The central banks call this leasing, but it is operationally a form of gold sales.
The central bank leases gold at well under 1% per annum to bullion banks. Bullion banks then sell the gold into the private market, take the money, and invest it in government bonds or other investments that pay far more than 1% per year.
That gold is gone. To get the gold back, the central banks would have to demand payment in gold by the bullion banks. The bullion banks could not repay this gold without going into the gold market and purchasing it. This would drive up the price of gold. It would bankrupt the bullion banks.
So, central banks do not require the bullion banks to repay the gold which the bullion banks borrowed from the central banks. The central banks simply roll the loans over, year after year, and the bullion banks invest the money that they get from selling the gold. These central bank sales are not recorded as sales by the central banks. The public remains oblivious.
The central banks maintain the fiction that they still own the gold. They report their holdings of gold as not having changed. But, from an economic standpoint, the gold is gone, and there is no possibility of central banks will ever get it back from the bullion banks.
Another way that central banks and governments battle investors in gold is to announce, from time to time, that the central bank is contemplating the sale of gold. This scares some gold investors, who sell their goal. Of course, other investors who know the name of the game buy the gold. By threatening to sell gold, central banks are attempting to push down the price of gold.
The latest example of this came at the G20 meeting on April 2. An announcement was made that the International Monetary Fund will make available special drawing rights (SDRs), which will serve as money for central banks. To raise some of this money, the IMF will sell some of its gold. That was the official announcement.
The IMF has been threatening to sell gold for several years. To do this takes a majority vote of the member nations of the IMF. It is clear that the member nations are willing to allow the IMF to do this. Previously, this was not clear.
The figure quoted by the press regarding the amount of gold be sold is 400 tonnes. World production of gold each year is in the range of 2500 tonnes. It is unlikely that the IMF will sell all of this gold at the same time. It is likely that these sales will be stretched out over at least a two-year period. So, the sales are likely to increase the supply of available gold by perhaps 8% for two years. In a time when central banks are increasing the monetary base by 100% per annum or more, this increase in the supply of gold available for purchase is not substantial.
There is another issue to consider. It is likely that most of this gold will be purchased by other central banks. If this should turn out to be the case, then the actual supply of gold coming into the public domain will not change. Nevertheless, the announcement was made that these sales will take place. This put downward pressure on the price of gold.
Why would a central bank or the IMF say in advance that it planned to sell a large portion of its gold holdings? When a large holder of commodities is going to sell the commodity into the open market, he does not announce this in advance. His goal is to maximize the amount of money he gains by the sale of the asset. If he warns the world in advance how much he plans to sell and over which time period, this will depress the price if the sale constitutes a significant quantity. It is economically irrational for a seller of commodity to say in advance how much she plans to sell. I say "economically irrational" on the assumption that the goal is to make a profit. But if the goal is not to make a profit, but rather to inflict economic harm on people who hold a particular commodity as an investment, the announcement makes eminently good sense.
The fact that the IMF sale was announced by the IMF for years preceding the G20 meeting, and the fact that it was announced at the G20 meeting, indicate the degree of the hostility of the IMF and the central bankers to people who invest in gold. They were willing to take a loss in terms of the amount of money they could have obtained for the gold by quiet, unannounced sales.
They are willing to take this loss because they believe that it is more important to create uncertainty in the gold market than it is to maximize the amount of fiat money gained by the sale of gold. So committed are these people to inflicting financial losses on gold investors that they are willing to suffer hundreds of millions of dollars of losses. After all, it's not their money.
The classic example of this was Gordon Brown's decision in the late 1990s to sell half of the gold reserves held by the Bank of England in trust for Great Britain. In terms of today's price of gold, his decision cost the government something in the range of $10 billion. He drove down the price of gold to a little under $260 an ounce in 2001. He inflicted damage on a tiny minority of investors in gold, and he inflicted enormous damage on economic reserves of his country. He did this as Chancellor of the Exchequer. Today, he is the Prime Minister. He is now pressuring the Bank of England to inflate at unprecedented rates in order to save the banking system.
Any suggestion that Gordon Brown understands economics is laughable. Any suggestion that Gordon Brown is envious against investors in gold seems to be substantiated by his public career. He is representative of virtually every national politician and every central banker. He hates the fact that investors in gold can drive up the price of gold, thereby embarrassing the government and the central bank.
The rising price of gold warns the general public that the government's tax policies and the central bank's monetary policies cannot be trusted. Worse, a rising price of gold transmits the availability of a profit opportunity: get rid of fiat money and purchase gold.
Politicians and central bankers are frantic today to keep the general public from being aware of the enormous increase this taken place in the monetary base of every Western industrial nation. They do not want the public to perceive that the central banks are in panic mode because of the disaster has taken place in commercial bank balance sheets. Large commercial banks around the Western world are bordering on bankruptcy. Central banks and governments are intervening frantically to keep the banks' doors open, in order to keep the public confused about the implications of the worldwide economic recession that has come as a result of worldwide monetary expansion by central banks from the year 2000 until 2004.
PRICES CONVEY INFORMATION
Prices convey information about economic conditions. The price of gold conveys information about the likelihood of future price inflation. This information governments and central banks want to distort. They do this by manipulating the price of gold through leases that are actually sales and sales that are announced in advance.
When an individual invests in gold, he is making a statement. He is saying that he does not trust the powers that be. The powers that be deeply resent this. So, an individual who actively takes steps to increase the price of gold, which he does by buying it, should be aware in advance that he and people like him will be the targets of deception, envy, and ridicule. Buying gold is not the same as buying other commodities. Other commodities are not perceived as touchstones of central bank monetary policy. The price of gold is, even though most of the gold in private hands winds up as jewelry to be used in dowries in India. Far more than central banks, Indian fathers set the price of gold. At the margin, however, central banks do affect the price of gold.
With the rising productivity of India, the gold market has received a long-term increase in demand. This can be offset by the worldwide recession, which is now in progress. When Indian fathers decide that times are getting better, they will start buying gold again. Today's policies of monetary expansion, which lower real wages and therefore get people back to work, will begin to affect the worldwide labor markets. This will increase the demand of gold in India.
It is unlikely that a tradition governing marriage that has prevailed for thousands of years is likely to change just because a relatively small fraction of the Indian population has moved into modern urban capitalism. On the contrary, there is likely to be increased demand for gold, because fathers will be enabled to purchase more gold for their daughters than before because they are making more money than ever before.
This is why the attempt of governments and central banks to lower the price of gold will backfire. Eventually, governments will run out of gold to sell, and so will the IMF. They will run out of gold to lease. While I do not think the politicians will ever catch on to the fact that their nations' gold is gone, leaving only IOUs for gold written by bullion banks that are on the verge of bankruptcy anyway, I do think that at some point the central banks will stop leasing gold. They will stop leasing it because they will not have enough to lease to substantially affect the price of gold.
I do not think the central banks will ever demand repayment of their gold by the bullion banks. The bullion banks would simply declare bankruptcy, and be done with it. That would publicly expose the central bankers as economic idiots, which happens to be the case, and the idiots don't want the bad publicity. So, the gold is gone, and the public will not find out that the gold is gone. The gold is nevertheless gone. Gone in the sense of outside of control by central banks. It is inside the dowries of women in India and a small handful of goldbug investors.
At some point, the number of investors who figure out that they had better buy gold is going to go from less than 1% of the public to 5%. When that happens, the supply of gold will not increase, and the price of gold will skyrocket. If as many as 10% of the investing public tries to put 10% of their assets in gold, I suspect the price of gold would go to $10,000 an ounce. The gold market is so marginal in the overall commodities market that the attempted 10% of investors to increase their holdings of gold to 10% of their assets would make today's holders of gold very rich and very happy. I think at some point this is going to happen, but I think it is going to happen in a time of price inflation so bad that the purchasing power of the currencies will decline so fast and so far that the fact that you can get rich in fiat money by selling your gold will not persuade you to sell your gold.
Who is going to win the gold wars? Holders of gold. The big winners will be Indian wives whose fathers gave them a lot of gold as a dowry. The rest of us gold bugs will also do well. The general public will never catch on in time, and by the time that it occurs to even 10% or 20% of investors that they’d better buy gold, it will cost them so much to get into the market that they will not make the kinds of profits that today's gold investors are going to make.
Governments and central banks can continue to fight the gold war by means of gold leasing, outright gold sales, and threats of gold sales, but for as long as they inflate the money supply to obfuscate the price of economic depression, they will be running out of ammunition. They are in a war in which ordinance is in fixed supply. They cannot go into the gold market and replenish the supply of gold without driving up price of gold.
Central banks are expanding the money supply, which is providing ammunition for those of us who want to fight the gold war by buying more gold. In contrast, central banks are not expanding their holdings of gold, but rather depleting them, and so they will not be able to fight this fight indefinitely.
They may be able to fight it for as long as the threat of recession hangs over the world economy. But when the recession ends, or appears to end, as a result of the massive monetary inflation and massive deficits that the governments of the world are running, there will be a new market for gold that is unprecedented in its intensity.
This does not mean that everybody is going to buy gold. It probably does not mean that even 20% of investors will buy gold. All it will take is about 10% of investors to decide to put 10% of their holdings in gold. Governments and central banks are going to lose the war on gold because they refuse to fight gold by the one technique that can give them victory: stop printing money.
As you may well perceive, there is much more to say on this vital topic. Read more here.