March 2008

By Peter Brimelow
Monday, March 31, 2008

NEW YORK — The gold bugs are coming out of their holes again.

When I last wrote on gold, the metal was challenging $1,000, a level which was passed that day.

After that, gold’s stumbled, down $70 at one point, although up $10.60 over this past week.

But two crucial factors have swung encouragingly, rallying the gold bugs.

The first: the price of gold in India, by far the world’s largest importer of the metal. India is a massive buyer of bullion for jewelry and cares little for the rest of the world’s concerns. If the Indians want to buy, they will.

India has a fairly high import duty on gold. If you subtract the duty from the world price, you find whether the domestic price makes importing profitable. It has been moved decisively into profitable territory for legal imports this week. This has not been the case for some time.

For reasons that mystify me, the only regular source of this Indian data is Bill Murphy’s Website, Le Metropole Cafe. Yet this is the key calculation for verifying Indian demand.

Over the weekend, Le Metropole posted this: “Indian ex-duty premiums — Friday: a.m.$1.85, p.m. $2.55, with world gold at $943.75 and $944.55. Ample for legal imports.”

Anyone familiar with the physical trade must find it hard to envisage much further price decline.

The second encouraging gold bugs: The lease rate for gold. This is the cost of borrowing gold.

Thirty years ago, this was a detail, but with the huge expansion of lending to gold mining companies in the 1980s it became a big deal. In particular it was an important part of the argument of outfits like Gold Anti-Trust Action Committee (GATA), which argued that secretive activity in the gold market by central banks was crucial to understanding what was happening with gold.

In the past few days a strange thing has happened. Australia’s The Privateer says, “the shorter term (one and two-month) rates have actually gone into negative territory this week.”

In other words, gold is being supplied to the market by the central banks. The Privateer goes on: “We do not recall a previous instance of this, and there certainly has not been one since the cold bull market began in 2001-02. …

“We have not — until now — seen a situation in which the central banks are actually paying the bullion banks, hedge funds, gold miners, et al. to borrow the stuff. And please don’t forget that, in this context, leasing gold is actually ‘shorting’ gold. Gold is not ‘leased’ to be hoarded; it is ‘leased’ to be sold for something that pays a far higher rate of interest. … The practice of ‘leasing gold — and silver’ by the central banks has been one of their best means of suppressing the prices of these precious metals for a long time.”

Interestingly The Privateer’s wonderful $US 5×3 Point and figure chart withstood this week’s slump. See chart:

Goldbug conclusion: Central banks, led surreptitiously by the Fed, are supplying physical gold to the market. And wise heads like the Indians are buying it.

* * *

Dear Friend of GATA and Gold:
The Federal Reserve’s ever-increasing “short-term” lending to major commercial and investment banks, described in the news report appended here, is starting to recall the boast of Barrick Gold a few years ago that its huge gold loans were “evergreen,” written for 15-year terms but always allowed to be extended for another year every year.

Barrick’s suggestion was that its gold loans never had to be repaid — that they were gold loans from central banks and that the central banks did not want their gold back, that the central banks wanted instead for the gold price to be suppressed. By contrast, demanding repayment of the gold loans would cause a short squeeze in the gold market and send the price soaring. That’s what central bank gold sales seem to be: not delivery of new gold into the market but cash settlement of old gold loans that can’t be repaid without causing that short squeeze.

For who else would want to “lend” gold on the virtually indefinite terms available to Barrick? Who else would even be able to lend gold this way? Who else would want to do so? And what purpose could such loans have other than to suppress the price?

Does the Fed want its burgeoning loans to the commercial and investment banks repaid? Probably not any time soon, for all these “short-term” billions can be deployed to rig a lot of markets — not just the mortgage derivatives markets that are the center of attention but very possibly the commodities markets as well. Thus these loans would become just like the funds in the Fed’s pool of repurchase agreements with the Fed’s primary dealers in New York, a pool of funds that now stands near $300 billion. These funds too are nominally “temporary” loans, but the pool never goes back to zero or even close. To the contrary, it is usually growing and has nearly doubled over the last six months — and its only purpose is market rigging.

News organizations and Congress have not yet realized the purposes to which infinite money may be put and so haven’t begun questioning all the money being flung around. But it’s not about free-market capitalism; it’s what’s called lemon socialism, wherein private interests take any profits and the public assumes any losses.

CHRIS POWELL, Secretary/Treasurer
Gold Anti-Trust Action Committee Inc.

* * *

Fed Offers $100 Billion More to Banks

By Martin Crutsinger
Associated Press
via Yahoo News
Friday, March 28, 2008

WASHINGTON — The Federal Reserve announced Friday it will auction an additional $100 billion in April to cash-strapped banks as it continues to combat the effects of a credit crisis.

The central bank said it would make $50 billion available at each of two auctions, on April 7 and April 21.

Through the end of March, the Fed has provided $260 billion in short-term loans to commercial banks through the innovative auction process. It also has employed Depression-era provisions to provide money to investment banks.

All the moves have been designed to cope with a serious financial crisis that has roiled U.S. and global markets and caused the near-collapse of Bear Stearns Cos., the nation’s fifth largest investment bank.

The Fed has been holding auctions every two weeks since December to provide short-term loans to commercial banks. It started with auctions of $20 billion, then pushed the level to $30 billion, and in early March raised the auction amount to $50 billion as the credit shortage grew more severe.

In announcing the move to $50 billion last month, the Fed said it would continue the auctions for at least the next six months, unless credit conditions show they are no longer needed.

The auctions are just one of a series of unorthodox steps the Fed has taken to battle the current crisis. The biggest of those moves was an announcement that it was allowing investment banks to borrow directly from the Fed. Previously, only commercial banks, which face tighter regulations, had that privilege.

The Fed also said it would make available $30 billion in financing to support the sale of troubled Bear Stearns to JP Morgan Chase & Co., hoping to prevent a bankruptcy that could have rocked Wall Street.

Private economists said the auctions were having a positive impact but that troubles still exist in many sectors of the credit markets because of multibillion-dollar losses many financial institutions have suffered as the result of soaring defaults on mortgage loans.

“The Fed has worked some positive magic,” said Mark Zandi, chief economist at Moody’s “At least the panic has subsided as the risk of another major failure has receded given that financial institutions now have access to a lot of cash through the various lending facilities the Fed has established.”

The Fed’s auctions have drawn criticism from some that the central bank, and ultimately U.S. taxpayers, could be financing a bailout for big Wall Street firms that had engaged in risky lending practices.

Fed Chairman Ben Bernanke will face questions about the Fed’s recent moves when he testifies on Wednesday before the congressional Joint Economic Committee.

* * *

In new commentary for Investor’s Digest of Canada, Sprott Asset Management’s chief investment strategist, John Embry, takes note of GATA’s full-page advertisement in The Wall Street Journal and urges precious metals investors to ride out the market’s short-term hairpin reversals. Embry’s commentary is headlined “Sit Tight — Don’t Let Gold’s Volatility Bother You” and you can find it at the Sprott site HERE
By Jeff Randall
The Telegraph, London
Wednesday, March 26, 2008
Bank customer: “What’s the difference between a recession and a depression?”
Bank manager: “In a recession, you lose your job. In a depression, I lose mine.”

Remarkable, isn’t it, just how quickly champions of laissez-faire solutions can become advocates for state intervention? All it takes is for their gravy train to break down.

When freedom to play with barely any restrictions was making them rich beyond imagination, big-shot financiers applauded “light-touch” regulation. The looser the rules, the louder they cheered.

Now, however, as credit is crunched, losses mount, and prospects for lucrative employment come under threat, many titans of unfettered enterprise are suddenly crying out for nanny.

Not for them the tough love of supply and demand. No, sir. These are desperate times, requiring generous measures of tender, loving care.

The essential plumbing of commerce, it is alleged, has become dysfunctional. Or, as Josef Ackerman, chief executive of Deutsche Bank, said: “I no longer believe in the market’s self-healing power.”

Whyever not? Nowhere on the tin does it say that markets will correct themselves without someone being hurt. Indeed, for markets to function properly, pain, somewhere along the chain, is inevitable.

Markets work because they create winners and losers, not jobs-for-life security. Financial Darwinism doesn’t just underpin the survival of the fittest; it ensures the extinction of pea-brained dinosaurs.

Corporations with too much fat and insufficient speed end up in evolution’s Room 101. This is often forgotten when the trees are full of fruit.

In his book, “The Final Crash,” Hugo Bouleau (the nom de plume of a City investment manager) predicts: “Reckless lending will come back to haunt many a greedy banker and catch up with those directors that set excessive sales targets, forcing bank employees to fund unsuitable projects, chase ever riskier clients, and sell inappropriate investment products.”

This process is already under way in London and New York. Had it occurred anywhere else, one could be sure that Wall Street and the City would be nodding their approval.

After all, job losses = cost reductions; company insolvencies = sector consolidation; falling prices = buying opportunities. Great value is often found on a rubbish tip.

“But hang on a minute,” the bankers yelp. “It’s happening in banking. Banking. That means us.”

Yes, boys, I’m afraid it does.

A smack by the invisible hand of market forces no longer seems such a good idea, does it? Far more appealing is the soft touch of Other People’s Money. Cue: chorus of calls for taxpayers’ funds to rescue distressed lenders.

We are told by the banks that they are too important to be allowed to fail, that their operations are so inextricably linked with the real economy we would be plunged into a 1930s-type calamity if a big one went under.

Forget moral hazard, we are urged; it’s in everyone’s interest to bail them out.

Those who got us into this mess are demanding that we get them out of it. They put a gun to our heads, insisting that, without immediate action, everyone will feel their pain. (Funny, I don’t recall feeling the joy of their jackpot bonuses.) Catharsis for a few will lead to nemesis for many.

Central banks seem to agree, so the Federal Reserve fixes a deal at Bear Stearns. This is no Northern Rock, a haven for small savers, but one of Wall Street’s most egregious examples of knock-’em-down-drag-em-out investment banking.

At a time when so many Americans are losing their homes, it’s hard to think of a company less deserving of state support.

Paul Krugman, professor of economics at Princeton University, forecasts: “As Bear goes, so will the rest of the financial system. And if history is any guide, the coming taxpayer-financed bailout will end up costing a lot of money.”

The banks have landed us in this bad place because, over many years they learnt how to wriggle out of regulation. Special investment vehicles were created to park risk. Derivatives were invented that became the financial equivalent of Frankenstein’s monster — they took on a life of their own. In short, there emerged a parallel system of Wild West behaviour.

The banks’ cocktail of greed and irresponsibility will, I’m sure, produce a wave of fresh regulation to clamp down on recent excesses.

Many of the new strictures will be counterproductive — they always are — in the same way that Sarbanes-Oxley legislation, after Enron and WorldCom, drove public share offerings out of New York and into London.

Never mind. For hyper-ventilating politicians — those who can think of nothing better than sticking their fingers into the free-enterprise pie — the sub-prime mortgage mess has turned into a two-inch tap-in. It’s an unmissable chance to justify far-reaching extensions of their activities.

Christopher Fildes, who graced these pages for many years, once warned that while bankers and investors are counting their losses, the next worst thing is “the spectacle of finance ministers … and their supporting cast of bag carriers and sherpas hurrying to meet each other and to think of something that they or their spokesmen can subsequently announce. They are tempted at such times to take initiatives.”

One dreads to think.

* * *

from Fund Strategy
by Vanessa Drucker

Where were the gold bugs in 2001, when the metal touched a low of $255 an ounce? Long snuggled deep in the mattress, they began to creep out as the metal price rose. It reached a plateau in 2004 in the $400 range, and then took off in earnest after July 2005.

The gold bugs refuse to concede that we could be in a speculative blow-off phase of frothy glitter. They point to the 1980 high watermark at $877 an ounce, and claim that price would convert to more than $2,000 (£1,000) today.

Notwithstanding, there are plenty of reasons to be cautious, or even downright bearish, at today’s lofty levels. A host of factors already signal a potential turn in the multiyear uptrend.

A confluence of disparate drivers has always buoyed or buffeted gold. Since about 2004, the mix of these drivers has shifted, with implications for the price action. Today, the critical factors are: the dollar; economic uncertainty; supply/demand forces; and the new-found popularity of the exchange traded funds. A look at how these factors are evolving may shed some light on where the gold price is heading next.

“We remain wedded to the view that the US dollar is the principal, longer-term driver of the gold price,” says James Steele, chief commodities analyst at HSBC. He expects the relationship to continue as long as the dollar remains the world’s reserve currency.

Gold, widely regarded as a hedge against a falling greenback, has performed an intimate inverse dance with the dollar over the past 40 years. Turning points coincided in 1976, 1982, 1988, 1994 and 2000. While the correlation remains high at 0.91, the two asset classes do not move exactly in lockstep. “If they did, we could do without precious metals traders,” Steele says. “We could just trade foreign exchange.”

Dan Smith, gold analyst at Standard Chartered, notes that a less linear relationship has developed over the past six months. Incremental dollar weakening keeps boosting the gold price, while dollar rallies barely affect the metal.

“It may show that people are steadily building long-term gold positions as they piggyback on dollar weakness,” suggests Smith.

Interest rate cuts by America’s Federal Reserve, instituted to boost a sagging economy, highlight the gold/dollar linkage. For example, on January 22, 2008, the Fed surprised markets with its announcement of a dramatic three-quarter point cut. That news rapidly depressed the dollar, as gold soared through $900.

“Real interest rates and the dollar are two sides of the same story. When people refer to inflation shocks, they are also describing a drop in real interest rate environments,” says Michael Lewis, global head of commodities research at Deutsche Bank. He points out that as long as real rates run 2.5% or lower, as they did in the 1970s, gold performs well. At the moment, inflation appears poised to climb, while the dollar loses real interest rate support.

Yet the role of inflation is not straightforward. To the extent that gold remains denominated in dollars, yes, it embodies an inflation hedge. At the same time, the perceived correlation between gold and inflation is probably a carryover from memories of the 1970s and 1980s. When we examine more recent patterns of American inflation, we observe that core inflation fell from 3.38% in 2000 to 2.83% in 2001, and then down to 1.59% in 2002, according to monthly rates published by the Bureau of Labor Statistics.

Gold barrelled up and up during those years. From 2005 to 2007, inflation skidded from 3.3% to 2.85%. Gold kept ascending, at an even more feverish pace.

Political and economic risk and instability of all stripes is another prime driver. In its long-standing role as a safe haven asset, gold can react to any type of turmoil that strikes on the world stage. “It is not even the type of risk that matters, but rather the severity,” Steele comments. When the credit markets seized up last August, why should gold then have fallen initially? The reason, it transpired, was that many investors, who needed liquidity, were selling their gold. Once again, the metal was duly performing its function.

Looking back, from 2001 through 2005, financial and political deterioration was building on all sides. At the same time, many investors still regarded the environment as a temporary blip that would soon readjust. It did not. By 2007, the economic uncertainty dwarfed that of the previous six years, as the subprime crisis, real estate weakness and financial illiquidity came together in a perfect storm.

Compared with economic dramas, reverberations from geopolitical incidents barely qualify as second order events.

“The idea that events such as terrorist attacks provide much catalyst has largely been discredited,” says Andrea Hotter at Dow Jones Newswires. She points to the London underground bombings, and even the 9/11 terrorist attacks, as examples of incidents that produced fleeting reactions in the gold price.

Other fears prompt hoarding. It is worth noting that certain Middle Eastern investors, as well as central banks of countries that may be suspicious of American policies, have also been storing gold. “In the post 9/11 environment, some of them fear having their US accounts frozen, if there is a link to terrorist activity. So they invest in gold and other alternative assets,” says David Thurtell, metals analyst at BNP Paribas. Similar behaviour occurred in the aftermath of the American hostage drama in Tehran in 1979.

Like all commodities, supply and demand must balance to clear the gold price. From the supply side, consider the case for “peak gold”. Until it was overtaken by China, South Africa was the world’s largest producer, providing more than 1,000 tonnes a year in the 1970s. Its output has contracted to 248 tonnes a year because of ageing mines, which are deeper and harder to access, and new legislation.

“Before, mine owners had the right to exploit their holdings easily, but now they need to obtain licences and agree to create jobs, undergo environmental audits and build schools and hospitals,” says Ross Norman, director of

Supply constraints got worse this January, when Eskom, a South African state utility, declared wide-ranging power cuts, forcing mines to close their operations for safety reasons. Many of the mines extend five kilometres below ground and rely on lifts and electricity. If Eskom cannot ensure uninterrupted power supplies, the mines cannot take the chance their workers might be trapped underground.

Mark Bristow, president of Randgold Resources, focuses on attracting first world capital to reinvest in African mining projects in Ivory Coast, Mali and Tanzania. He describes how cost and risk profiles have changed as “across the board, miners constantly run into first world intervention”. Resistance from green movements has made mining more challenging in places such as Canada, America and Australia, and shifted the focus to emerging markets.

Production is also falling in Australia and Canada. “Even in China,” says Norman, “where they are going for the richer grades, they may have exhausted their mines by about 2014.”

Also affecting production are a dire shortage of mining equipment, inadequate infrastructure and a dearth of professional skilled labour at all stages of the production process. Steele says the global commodities boom has strained the supply chain and compelled the gold industry to compete with coal, base metals and other precious metals for “scarce human and material resources”.

In another ongoing trend, the larger gold miners have been buying back their hedge books. Smaller operations may still be hedging to obtain finance, since banks are not necessarily willing to lend if they fear the commodity’s price might collapse.

The miners have undergone a massive mindset change since the late 1990s. “In the past, they used to sell forward into every rally and kill it, and the price would sink. Now they let the price levitate higher as it goes from elastic to inelastic,” says Norman.

The real sea change is the conduit forged between the gold markets and the investment world. The physical gold market itself is small, “but the derivatives traded on its back are huge”, Bristow points out.

“Despite the dehedging programmes, about 39m ounces of gold are still hedged in paper, and that must be delivered.”

Hitherto, trading had been focused on the Comex in New York, the Tocom in Tokyo and the London spot interbank market. Now, exchanges are racing to open their doors to gold trading across a much broader jurisdiction. In January 2008, a new futures market was added to the two spot exchanges in China, along with new platforms in Dubai, India, Singapore and Vietnam.

The chief catalyst of demand is the development of the various new exchange traded gold funds, beginning in March 2003. ETFs, which must back the shares they issue with bullion, now command at least 10% of world demand, which is a quite a sprint from nothing, in five short years. Hotter explains that they are attractive to both institutions and individuals because they are so easy to invest in, with “no storage to arrange and no punt on the futures market.”

Lyxor Gold Bullion Securities, Europe’s largest gold exchange traded commodity, now holds 108 tonnes, with a value of about $3,186m. Overall holdings from all the gold ETFs constitute about 630 tonnes, which ranks them up there among the top 10 central bank holders, according to Jon Nadler, senior analyst at Kitco Bullion Dealers in Montreal.

In January 2006, David Davis, an analyst at Andisa Securities, famously described ETFs as the new “people’s central bank – a force to be reckoned with”. So far, the ETF money has tended to be sticky, apportioned 70% among individuals and 30% among institutions. “While central banks have been dumping gold, individuals have been quietly buying it and, even more amazingly, holding on to it,” comments Owen Rees, head of business development, Europe, at Exchange Traded Gold, the World Gold Council’s marketing arm for various ETFs.

Rees points out that the ETFs exhibit a volatility pattern similar to the S&Ps, compared with open interest on Comex, which “swings wildly”. In mid-2006, when the gold sector corrected, the entire ETF franchise only lost about 3% of its assets, and then regained that value in about a month.

Those are the elements of the brew that has been simmering to keep the gold price soaring.

Is it ready to bubble over any time soon? That is the actionable question investors need to know. A quick survey of the drivers themselves – the dollar, the economic instability and supply and demand, especially investment demand – may reveal some clues as to why the price could head south.

If the fate of the dollar is the key determinant, much depends on its direction. While it has been in a long term downtrend, it is worth remembering that most dollar cycles last about seven years and this one is getting long in the tooth. “The dollar may continue to weaken against the euro to $1.60,” suggests Lewis, “which could provide a last boost with overshooting and extreme misalignment.” Every past cycle has ended with central banks coming to the rescue.

The currency team at HSBC holds a similar view. Based on purchasing power parity (how much it costs to buy the same items in different countries), it regards the euro as overbought already. It attributes much of the recent rally to capital inflows for the purchase of European equities, which are now quite expensive. Dollar bulls are beginning to emerge from the woodwork, though most agree that the Asian currencies will continue to pose formidable competition.

Next, look beyond the storm clouds gathered on the horizon. Imagine if the economic malaise began to clear up. At some point, the banks will finally write down the bulk of the subprime mortgages and leveraged loans that have triggered the credit contraction. Suppose that liquidity flows again in normalised patterns.

“When the credit markets settle, they will remove a supporting plank from gold,” Steele predicts.

Even on the geopolitical front, there is some hope that military operations will wind down. Nadler believes we are now well into a speculative stage for gold – a last hurrah built on the post 9/11 anxiety premium. He says: “It began when the US invaded countries in the name of the war on terror, setting up an epic battle of religions, of good and evil. It snowballed over the past two years. Deficits mounted, with the haemorrhage of war expenditures. The panic may have peaked about the time Benazir Bhutto was shot.”

Alternative asset classes have been commanding an increasing share of investors’ portfolios as a method to boost risk-adjusted returns. At the same time, emerging markets, supported by the decoupling thesis, have been gaining popularity.

Part of the reason is that success breeds success, and those classes have generally outperformed. Yet commodities are no one-way street. Despite the ravenous appetite of emerging markets across the gamut, commodities remain volatile by nature. Nickel and zinc have fallen 50% from their 2007 highs. Copper has tumbled sharply and white sugar has declined from about 22 cents a pound in early 2006 to 14 cents this year.

How will the supply equation weigh up against the demand for gold? In a nutshell, jewellery fabrication demand is down, scrap sales are up, overall central bank sales are flat to sideways and investment demand is up – hugely so.

According to World Gold Council statistics, in the fourth quarter of 2007 the high price had a major impact on fabrication demand – most significantly in India, where identifiable tonnage demand fell by 17% from the year before.

Steele, who sailed with the Merchant Marines, uses a nautical metaphor. At sea, the first visible current is only 100 feet deep, moving on top of a massive subcurrent below. The shallow current is like investment demand – a driver for the gold price on any given day. The fabrication demand – the real bedrock – is like the current that flows beneath.

The supply story could also be ready to turn around. The mining community has spent more than $24 billion on exploration during the bull cycle, according to Nadler, and is now in a position to launch significant output. Between now and 2012, he foresees an increase of 25% a year. Whereas we are already seeing 2,200 tonnes of fresh mining output each year, by the end of that time-frame, expect a further 450 tonnes of additional supply. “Investors had better be willing to buy,” Nadler warns.

Prospective buyers are not hailing from the central banks. Since the Washington Agreement established in 1999 that central banks could each sell 500 tonnes a year, many of the European institutions have been divesting their holdings. Many central bankers, newly minted MBAs, are keen to improve their investment returns, relying on equities and bonds instead. Their lending lease rates for gold are so low (about 0.35 for 12 months) that they have stopped lending it out altogether.

Only Russia, South Africa and Argentina are increasing reserves. The International Monetary Fund, whose 103m ounces of gold is second in quantity only to that of America and Germany, has announced plans to divest some of it soon.

Even the valiant ETFs may not be able to keep the party alive, but they helped to goose the price on the way up. They could add to selling pressure just as easily in the other direction. On January 16, the StreetTracks gold ETF dropped 21.5 tonnes in a record swoon.

Rees is not rattled. “It is the wrong question to ask, whether or not gold has gone too high,” he insists. One should, of course, not always expect the price to go up, but should instead focus on assembling the right assets for protection, regardless of the economic environment. Studies from the World Gold Council demonstrate that gold is a more reliable diversifier than other commodities, and together with platinum exhibits the least volatility.

Rees adds: “We want people to invest responsibly, and we believe we can offer a sensible way to use a low-cost product.”

Why gold?

King Midas learned the hard way. In India, people still eat it as a blood cleanser and use it as an aphrodisiac. John Maynard Keynes dismissed it as a barbaric relic. Many are curious as to how gold maintains its significance in a world driven by fiat currencies. Whatever the reasons, Joseph Schumpeter, the economist, acknowledged its predictive function as a barometer: “The modern mind dislikes gold because it blurts out unpleasant truths.”

  • Jon Nadler, senior analyst at Kitco Bullion Dealers in Montreal: “It is portable money and universally acceptable. At the end of the day, it is a liability-free asset. No-one can print it at will so it is limited in quantity – unlike paper money.”
  • Dan Smith, gold analyst at Standard Chartered: “Across the metals complex, some – like zinc and copper – are leveraged to construction. But gold is not driven by fundamentals.”
  • Ross Norman, director of “Gold is a bellwether of economic activity and goes both ways. It can tell you that things are very good or very bad.”
  • Axel Merk, manager of Hard Currency fund, California: “It’s so dense, you can store a lot in a small space – unlike, say, silver. Another feature of gold is its lack of industrial applications. That makes it far less subject to the business cycle and a pure reference point for money. Gold cannot go to zero, but fiat money can.”
  • Michael Lewis, head of commodities research at Deutsche Bank: “It’s indestructible, imperishable and can be stored. It is driven more by financial than by physical supply and demand. If you closed all the gold mines, you would run out in 45 years. If you closed every oil well, you would see power cuts in a couple of weeks.”
  • James Steele, chief commodities analyst at HSBC: “Other hard assets, like timber or property, can’t be sold in such a hurry. And they are not fungible. Every parcel of land is different from every other one. The same goes for diamonds or rare coins.”
  • What the Price of Gold Is Telling Us
    by Ron Paul
    The financial press, and even the network news shows, have begun reporting the price of gold regularly. For twenty years, between 1980 and 2000, the price of gold was rarely mentioned. There was little interest, and the price was either falling or remaining steady.Since 2001 however, interest in gold has soared along with its price. With the price now over $1000 an ounce, a lot more people are becoming interested in gold as an investment and an economic indicator. Much can be learned by understanding what the rising dollar price of gold means.The rise in gold prices from $250 per ounce in 2001 to over $1000 today has drawn investors and speculators into the precious metals market. Though many already have made handsome profits, buying gold per se should not be touted as a good investment. After all, gold earns no interest and its quality never changes. It’s static, and does not grow as sound investments should.It’s more accurate to say that one might invest in a gold or silver mining company, where management, labor costs, and the nature of new discoveries all play a vital role in determining the quality of the investment and the profits made.

    Buying gold and holding it is somewhat analogous to converting one’s savings into one hundred dollar bills and hiding them under the mattress – yet not exactly the same. Both gold and dollars are considered money, and holding money does not qualify as an investment. There’s a big difference between the two however, since by holding paper money one loses purchasing power. The purchasing power of commodity money, i.e. gold, however, goes up if the government devalues the circulating fiat currency.

    Holding gold is protection or insurance against government’s proclivity to debase its currency. The purchasing power of gold goes up not because it’s a so-called good investment; it goes up in value only because the paper currency goes down in value. In our current situation, that means the dollar.

    One of the characteristics of commodity money – one that originated naturally in the marketplace – is that it must serve as a store of value. Gold and silver meet that test – paper does not. Because of this profound difference, the incentive and wisdom of holding emergency funds in the form of gold becomes attractive when the official currency is being devalued. It’s more attractive than trying to save wealth in the form of a fiat currency, even when earning some nominal interest. The lack of earned interest on gold is not a problem once people realize the purchasing power of their currency is declining faster than the interest rates they might earn. The purchasing power of gold can rise even faster than increases in the cost of living.

    The point is that most who buy gold do so to protect against a depreciating currency rather than as an investment in the classical sense. Americans understand this less than citizens of other countries; some nations have suffered from severe monetary inflation that literally led to the destruction of their national currency. Though our inflation – i.e., the depreciation of the U.S. dollar – has been insidious, average Americans are unaware of how this occurs. For instance, few Americans know nor seem concerned that the 1913 pre-Federal Reserve dollar is now worth only four cents. Officially, our central bankers and our politicians express no fear that the course on which we are set is fraught with great danger to our economy and our political system. The belief that money created out of thin air can work economic miracles, if only properly “managed,” is pervasive in D.C.

    In many ways we shouldn’t be surprised about this trust in such an unsound system. For at least four generations our government-run universities have systematically preached a monetary doctrine justifying the so-called wisdom of paper money over the “foolishness” of sound money. Not only that, paper money has worked surprisingly well in the past 35 years – the years the world has accepted pure paper money as currency. Alan Greenspan bragged that central bankers in these several decades have gained the knowledge necessary to make paper money respond as if it were gold. This removes the problem of obtaining gold to back currency, and hence frees politicians from the rigid discipline a gold standard imposes.

    Many central bankers in the last 15 years became so confident they had achieved this milestone that they sold off large hoards of their gold reserves. At other times they tried to prove that paper works better than gold by artificially propping up the dollar by suppressing market gold prices. This recent deception failed just as it did in the 1960s, when our government tried to hold gold artificially low at $35 an ounce. But since they could not truly repeal the economic laws regarding money, just as many central bankers sold, others bought. It’s fascinating that the European central banks sold gold while Asian central banks bought it over the last several years.

    Since gold has proven to be the real money of the ages, we see once again a shift in wealth from the West to the East, just as we saw a loss of our industrial base in the same direction. Though Treasury officials deny any U.S. sales or loans of our official gold holdings, no audits are permitted so no one can be certain.

    The special nature of the dollar as the reserve currency of the world has allowed this game to last longer than it would have otherwise. But the fact that gold has gone from $252 per ounce to over $1000 means there is concern about the future of the dollar. The higher the price for gold, the greater the concern for the dollar. Instead of dwelling on the dollar price of gold, we should be talking about the depreciation of the dollar. In 1934 a dollar was worth 1/20th of an ounce of gold; $20 bought an ounce of gold. Today a dollar is worth 1/1000th of an ounce of gold, meaning it takes $1000 to buy one ounce of gold.

    The number of dollars created by the Federal Reserve, and through the fractional reserve banking system, is crucial in determining how the market assesses the relationship of the dollar and gold. Though there’s a strong correlation, it’s not instantaneous or perfectly predictable. There are many variables to consider, but in the long term the dollar price of gold represents past inflation of the money supply. Equally important, it represents the anticipation of how much new money will be created in the future. This introduces the factor of trust and confidence in our monetary authorities and our politicians. And these days the American people are casting a vote of “no confidence” in this regard, and for good reasons.

    The incentive for central bankers to create new money out of thin air is twofold. One is to practice central economic planning through the manipulation of interest rates. The second is to monetize the escalating federal debt politicians create and thrive on.

    Today no one in Washington believes for a minute that runaway deficits are going to be curtailed. In March alone, the federal government created an historic $85 billion deficit. The current supplemental bill going through Congress has grown from $92 billion to over $106 billion, and everyone knows it will not draw President Bush’s first veto. Most knowledgeable people therefore assume that inflation of the money supply is not only going to continue, but accelerate. This anticipation, plus the fact that many new dollars have been created over the past 15 years that have not yet been fully discounted, guarantees the further depreciation of the dollar in terms of gold.

    There’s no single measurement that reveals what the Fed has done in the recent past or tells us exactly what it’s about to do in the future. Forget about the lip service given to transparency by new Fed Chairman Bernanke. Not only is this administration one of the most secretive across the board in our history, the current Fed firmly supports denying the most important measurement of current monetary policy to Congress, the financial community, and the American public. Because of a lack of interest and poor understanding of monetary policy, Congress has expressed essentially no concern about the significant change in reporting statistics on the money supply.

    Beginning in March, though planned before Bernanke arrived at the Fed, the central bank discontinued compiling and reporting the monetary aggregate known as M3. M3 is the best description of how quickly the Fed is creating new money and credit. Common sense tells us that a government central bank creating new money out of thin air depreciates the value of each dollar in circulation. Yet this report is no longer available to us and Congress makes no demands to receive it.

    Though M3 is the most helpful statistic to track Fed activity, it by no means tells us everything we need to know about trends in monetary policy. Total bank credit, still available to us, gives us indirect information reflecting the Fed’s inflationary policies. But ultimately the markets will figure out exactly what the Fed is up to, and then individuals, financial institutions, governments, and other central bankers will act accordingly. The fact that our money supply is rising significantly cannot be hidden from the markets.

    The response in time will drive the dollar down, while driving interest rates and commodity prices up. Already we see this trend developing, which surely will accelerate in the not too distant future. Part of this reaction will be from those who seek a haven to protect their wealth – not invest – by treating gold and silver as universal and historic money. This means holding fewer dollars that are decreasing in value while holding gold as it increases in value.

    A soaring gold price is a vote of “no confidence” in the central bank and the dollar. This certainly was the case in 1979 and 1980. Today, gold prices reflect a growing restlessness with the increasing money supply, our budgetary and trade deficits, our unfunded liabilities, and the inability of Congress and the administration to rein in runaway spending.

    Denying us statistical information, manipulating interest rates, and artificially trying to keep gold prices in check won’t help in the long run. If the markets are fooled short term, it only means the adjustments will be much more dramatic later on. And in the meantime, other market imbalances develop.

    The Fed tries to keep the consumer spending spree going, not through hard work and savings, but by creating artificial wealth in stock markets bubbles and housing bubbles. When these distortions run their course and are discovered, the corrections will be quite painful.

    Likewise, a fiat monetary system encourages speculation and unsound borrowing. As problems develop, scapegoats are sought and frequently found in foreign nations. This prompts many to demand altering exchange rates and protectionist measures. The sentiment for this type of solution is growing each day.

    Though everyone decries inflation, trade imbalances, economic downturns, and federal deficits, few attempt a closer study of our monetary system and how these events are interrelated. Even if it were recognized that a gold standard without monetary inflation would be advantageous, few in Washington would accept the political disadvantages of living with the discipline of gold – since it serves as a check on government size and power. This is a sad commentary on the politics of today. The best analogy to our affinity for government spending, borrowing, and inflating is that of a drug addict who knows if he doesn’t quit he’ll die; yet he can’t quit because of the heavy price required to overcome the dependency. The right choice is very difficult, but remaining addicted to drugs guarantees the death of the patient, while our addiction to deficit spending, debt, and inflation guarantees the collapse of our economy.

    Special interest groups, who vigorously compete for federal dollars, want to perpetuate the system rather than admit to a dangerous addiction. Those who champion welfare for the poor, entitlements for the middle class, or war contracts for the military industrial corporations, all agree on the so-called benefits bestowed by the Fed’s power to counterfeit fiat money. Bankers, who benefit from our fractional reserve system, likewise never criticize the Fed, especially since it’s the lender of last resort that bails out financial institutions when crises arise. And it’s true, special interests and bankers do benefit from the Fed, and may well get bailed out – just as we saw with the Long-Term Capital Management fund crisis a few years ago. In the past, companies like Lockheed and Chrysler benefited as well. But what the Fed cannot do is guarantee the market will maintain trust in the worthiness of the dollar. Current policy guarantees that the integrity of the dollar will be undermined. Exactly when this will occur, and the extent of the resulting damage to the financial system, cannot be known for sure – but it is coming. There are plenty of indications already on the horizon.

    Foreign policy plays a significant role in the economy and the value of the dollar. A foreign policy of militarism and empire building cannot be supported through direct taxation. The American people would never tolerate the taxes required to pay immediately for overseas wars, under the discipline of a gold standard. Borrowing and creating new money is much more politically palatable. It hides and delays the real costs of war, and the people are lulled into complacency – especially since the wars we fight are couched in terms of patriotism, spreading the ideas of freedom, and stamping out terrorism. Unnecessary wars and fiat currencies go hand-in-hand, while a gold standard encourages a sensible foreign policy.

    The cost of war is enormously detrimental; it significantly contributes to the economic instability of the nation by boosting spending, deficits, and inflation. Funds used for war are funds that could have remained in the productive economy to raise the standard of living of Americans now unemployed, underemployed, or barely living on the margin.

    Yet even these costs may be preferable to paying for war with huge tax increases. This is because although fiat dollars are theoretically worthless, value is imbued by the trust placed in them by the world’s financial community. Subjective trust in a currency can override objective knowledge about government policies, but only for a limited time.

    Economic strength and military power contribute to the trust in a currency; in today’s world, trust in the U.S. dollar is not earned and therefore fragile. The history of the dollar, being as good as gold up until 1971, is helpful in maintaining an artificially higher value for the dollar than deserved.

    Foreign policy contributes to the crisis when the spending to maintain our worldwide military commitments becomes prohibitive, and inflationary pressures accelerate. But the real crisis hits when the world realizes the king has no clothes, in that the dollar has no backing, and we face a military setback even greater than we already are experiencing in Iraq. Our token friends may quickly transform into vocal enemies once the attack on the dollar begins.

    False trust placed in the dollar once was helpful to us, but panic and rejection of the dollar will develop into a real financial crisis. Then we will have no other option but to tighten our belts, go back to work, stop borrowing, start saving, and rebuild our industrial base, while adjusting to a lower standard of living for most Americans.

    Counterfeiting the nation’s money is a serious offense. The founders were especially adamant about avoiding the chaos, inflation, and destruction associated with the Continental dollar. That’s why the Constitution is clear that only gold and silver should be legal tender in the United States. In 1792 the Coinage Act authorized the death penalty for any private citizen who counterfeited the currency. Too bad they weren’t explicit that counterfeiting by government officials is just as detrimental to the economy and the value of the dollar.

    In wartime, many nations actually operated counterfeiting programs to undermine our dollar, but never to a disastrous level. The enemy knew how harmful excessive creation of new money could be to the dollar and our economy. But it seems we never learned the dangers of creating new money out of thin air. We don’t need an Arab nation or the Chinese to undermine our system with a counterfeiting operation. We do it ourselves, with all the disadvantages that would occur if others did it to us. Today we hear threats from some Arab, Muslim, and far Eastern countries about undermining the dollar system- not by dishonest counterfeiting, but by initiating an alternative monetary system based on gold. Wouldn’t that be ironic? Such an event theoretically could do great harm to us. This day may well come, not so much as a direct political attack on the dollar system but out of necessity to restore confidence in money once again.

    Historically, paper money never has lasted for long periods of time, while gold has survived thousands of years of attacks by political interests and big government. In time, the world once again will restore trust in the monetary system by making some currency as good as gold.

    Gold, or any acceptable market commodity money, is required to preserve liberty. Monopoly control by government of a system that creates fiat money out of thin air guarantees the loss of liberty. No matter how well-intended our militarism is portrayed, or how happily the promises of wonderful programs for the poor are promoted, inflating the money supply to pay these bills makes government bigger. Empires always fail, and expenses always exceed projections. Harmful unintended consequences are the rule, not the exception. Welfare for the poor is inefficient and wasteful. The beneficiaries are rarely the poor themselves, but instead the politicians, bureaucrats, or the wealthy. The same is true of all foreign aid – it’s nothing more than a program that steals from the poor in a rich country and gives to the rich leaders of a poor country. Whether it’s war or welfare payments, it always means higher taxes, inflation, and debt. Whether it’s the extraction of wealth from the productive economy, the distortion of the market by interest rate manipulation, or spending for war and welfare, it can’t happen without infringing upon personal liberty.

    At home the war on poverty, terrorism, drugs, or foreign rulers provides an opportunity for authoritarians to rise to power, individuals who think nothing of violating the people’s rights to privacy and freedom of speech. They believe their role is to protect the secrecy of government, rather than protect the privacy of citizens. Unfortunately, that is the atmosphere under which we live today, with essentially no respect for the Bill of Rights.

    Though great economic harm comes from a government monopoly fiat monetary system, the loss of liberty associated with it is equally troubling. Just as empires are self-limiting in terms of money and manpower, so too is a monetary system based on illusion and fraud. When the end comes we will be given an opportunity to choose once again between honest money and liberty on one hand; chaos, poverty, and authoritarianism on the other.

    The economic harm done by a fiat monetary system is pervasive, dangerous, and unfair. Though runaway inflation is injurious to almost everyone, it is more insidious for certain groups. Once inflation is recognized as a tax, it becomes clear the tax is regressive: penalizing the poor and middle class more than the rich and politically privileged. Price inflation, a consequence of inflating the money supply by the central bank, hits poor and marginal workers first and foremost. It especially penalizes savers, retirees, those on fixed incomes, and anyone who trusts government promises. Small businesses and individual enterprises suffer more than the financial elite, who borrow large sums before the money loses value. Those who are on the receiving end of government contracts – especially in the military industrial complex during wartime – receive undeserved benefits.

    It’s a mistake to blame high gasoline and oil prices on price gouging. If we impose new taxes or fix prices, while ignoring monetary inflation, corporate subsidies, and excessive regulations, shortages will result. The market is the only way to determine the best price for any commodity. The law of supply and demand cannot be repealed. The real problems arise when government planners give subsidies to energy companies and favor one form of energy over another.

    Energy prices are rising for many reasons: Inflation; increased demand from China and India; decreased supply resulting from our invasion of Iraq; anticipated disruption of supply as we push regime change in Iran; regulatory restrictions on gasoline production; government interference in the free market development of alternative fuels; and subsidies to big oil such as free leases and grants for research and development.

    Interestingly, the cost of oil and gas is actually much higher than we pay at the retail level. Much of the DOD budget is spent protecting “our” oil supplies, and if such spending is factored in, gasoline probably costs us more than $5 a gallon. The sad irony is that this military effort to secure cheap oil supplies inevitably backfires, and actually curtails supplies and boosts prices at the pump. The waste and fraud in issuing contracts to large corporations for work in Iraq only add to price increases.

    When problems arise under conditions that exist today, it’s a serious error to blame the little bit of the free market that still functions. Last summer the market worked efficiently after Katrina – gas hit $3 a gallon, but soon supplies increased, usage went down, and the price returned to $2. In the 1980s, market forces took oil from $40 per barrel to $10 per barrel, and no one cried for the oil companies that went bankrupt. Today’s increases are for the reasons mentioned above. It’s natural for labor to seek its highest wage, and businesses to strive for the greatest profit. That’s the way the market works. When the free market is allowed to work, it’s the consumer who ultimately determines price and quality, with labor and business accommodating consumer choices. Once this process is distorted by government, prices rise excessively, labor costs and profits are negatively affected, and problems emerge. Instead of fixing the problem, politicians and demagogues respond by demanding windfall profits taxes and price controls, while never questioning how previous government interference caused the whole mess in the first place. Never let it be said that higher oil prices and profits cause inflation; inflation of the money supply causes higher prices!

    Since keeping interest rates below market levels is synonymous with new money creation by the Fed, the resulting business cycle, higher cost of living, and job losses all can be laid at the doorstep of the Fed. This burden hits the poor the most, making Fed taxation by inflation the worst of all regressive taxes. Statistics about revenues generated by the income tax are grossly misleading; in reality much harm is done by our welfare/warfare system supposedly designed to help the poor and tax the rich. Only sound money can rectify the blatant injustice of this destructive system.

    The Founders understood this great danger, and voted overwhelmingly to reject “emitting bills of credit,” the term they used for paper or fiat money. It’s too bad the knowledge and advice of our founders, and their mandate in the Constitution, are ignored today at our great peril. The current surge in gold prices – which reflects our dollar’s devaluation – is warning us to pay closer attention to our fiscal, monetary, entitlement, and foreign policy.

    Meaning of the Gold Price – Summation

    A recent headline in the financial press announced that gold prices surged over concern that confrontation with Iran will further push oil prices higher. This may well reflect the current situation, but higher gold prices mainly reflect monetary expansion by the Federal Reserve. Dwelling on current events and their effect on gold prices reflects concern for symptoms rather than an understanding of the actual cause of these price increases. Without an enormous increase in the money supply over the past 35 years and a worldwide paper monetary system, this increase in the price of gold would not have occurred.

    Certainly geo-political events in the Middle East under a gold standard would not alter its price, though they could affect the supply of oil and cause oil prices to rise. Only under conditions created by excessive paper money would one expect all or most prices to rise. This is a mere reflection of the devaluation of the dollar.

    Particular things to remember:

    * If one endorses small government and maximum liberty, one must support commodity money.

    * One of the strongest restraints against unnecessary war is a gold standard.

    * Deficit financing by government is severely restricted by sound money.

    * The harmful effects of the business cycle are virtually eliminated with an honest gold standard.

    * Saving and thrift are encouraged by a gold standard; and discouraged by paper money.

    * Price inflation, with generally rising price levels, is characteristic of paper money. Reports that the consumer price index and the producer price index are rising are distractions: the real cause of inflation is the Fed’s creation of new money.

    * Interest rate manipulation by central bank helps the rich, the banks, the government, and the politicians.

    * Paper money permits the regressive inflation tax to be passed off on the poor and the middle class.

    * Speculative financial bubbles are characteristic of paper money – not gold.

    * Paper money encourages economic and political chaos, which subsequently causes a search for scapegoats rather than blaming the central bank.

    * Dangerous protectionist measures frequently are implemented to compensate for the dislocations caused by fiat money.

    * Paper money, inflation, and the conditions they create contribute to the problems of illegal immigration.

    * The value of gold is remarkably stable.

    * The dollar price of gold reflects dollar depreciation.

    * Holding gold helps preserve and store wealth, but technically gold is not a true investment.

    * Since 2001 the dollar has been devalued by 60%.

    * In 1934 FDR devalued the dollar by 41%.

    * In 1971 Nixon devalued the dollar by 7.9%.

    * In 1973 Nixon devalued the dollar by 10%.

    These were momentous monetary events, and every knowledgeable person worldwide paid close attention. Major changes were endured in 1979 and 1980 to save the dollar from disintegration. This involved a severe recession, interest rates over 21%, and general price inflation of 15%.

    Today we face a 60% devaluation and counting, yet no one seems to care. It’s of greater significance than the three events mentioned above. And yet the one measurement that best reflects the degree of inflation, the Fed and our government deny us. Since March, M3 reporting has been discontinued. For starters, I’d like to see Congress demand that this report be resumed. I fully believe the American people and Congress are entitled to this information. Will we one day complain about false intelligence, as we have with the Iraq war? Will we complain about not having enough information to address monetary policy after it’s too late?

    If ever there was a time to get a handle on what sound money is and what it means, that time is today.

    Inflation, as exposed by high gold prices, transfers wealth from the middle class to the rich, as real wages decline while the salaries of CEOs, movie stars, and athletes skyrocket – along with the profits of the military industrial complex, the oil industry, and other special interests.

    A sharply rising gold price is a vote of “no confidence” in Congress’ ability to control the budget, the Fed’s ability to control the money supply, and the administration’s ability to bring stability to the Middle East.

    Ultimately, the gold price is a measurement of trust in the currency and the politicians who run the country. It’s been that way for a long time, and is not about to change.

    If we care about the financial system, the tax system, and the monumental debt we’re accumulating, we must start talking about the benefits and discipline that come only with a commodity standard of money – money the government and central banks absolutely cannot create out of thin air.

    Economic law dictates reform at some point. But should we wait until the dollar is 1/1,000 of an ounce of gold or 1/2,000 of an ounce of gold? The longer we wait, the more people suffer and the more difficult reforms become. Runaway inflation inevitably leads to political chaos, something numerous countries have suffered throughout the 20th century. The worst example of course was the German inflation of the 1920s that led to the rise of Hitler. Even the communist takeover of China was associated with runaway inflation brought on by Chinese Nationalists. The time for action is now, and it is up to the American people and the U.S. Congress to demand it.

    March 15, 2008
    Dr. Ron Paul is a Republican member of Congress from Texas.

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