The privateer provides a history of Gold Wars, the fight between governments and the price of gold.
The End Of the "Fixed" Dollar
Gold War I - The "London Gold Pool" - 1961 to 1968
By the beginning of the 1960s, the $US 35 = 1 oz. Gold ratio was becoming more and more difficult to sustain. Gold demand was rising and U.S. Gold reserves were falling, both as a result of the ever increasing trade deficits which the U.S. continued to run with the rest of the world. Shortly after President Kennedy was Inaugurated in January 1961, and to combat this situation, newly-appointed Undersecretary of the Treasury Robert Roosa suggested that the U.S. and Europe should pool their Gold resources to prevent the private market price for Gold from exceeding the mandated rate of $US 35 per ounce. Acting on this suggestion, the Central Banks of the U.S., Britain, West Germany, France, Switzerland, Italy, Belgium, the Netherlands, and Luxembourg set up the "London Gold Pool" in early 1961.
The Pool came unstuck when the French, under Charles de Gaulle, reneged and began to send the Dollars earned by exporting to the U.S. back and demanding Gold rather than Treasury debt paper in return. Under the terms of the Bretton Woods Agreement signed in 1944, France was legally entitled to do this. The drain on U.S. Gold became acute, and the London Gold Pool folded in April 1968. But the demand for U.S. Gold did not abate.
By the end of the 1960s, the U.S. faced the stark choice of eliminating their trade deficits or revaluing the Dollar downwards against Gold to reflect the actual situation. President Nixon decided to do neither. Instead, he repudiated the international obligation of the U.S. to redeem its Dollar in Gold just as President Roosevelt had repudiated the domestic obligation in 1933. On August 15, 1971, Mr Nixon closed the "Gold Window". The last link between Gold and the Dollar was gone. The result was inevitable. In February 1973, the world's currencies "floated". By the end of 1974, Gold had soared from $35 to $195 an ounce.
Gold War II - The IMF/U.S. Treasury Gold Auctions - 1975 to 1979
On January 1, 1975, after 42 years, it again became "legal" for individual Americans to own Gold. Anticipating the demand, the U.S. Treasury in particular and many other Central Banks sold large quantities of Gold, taking large paper profits in the process. This had two results. It depressed the price of Gold, which fell to $US 103 in eighteen months. More important by far, it "burned" large numbers of small individual investors.
But this "pre-emptive strike" against the Gold price did not solve the imbalances inherent in the floating currency regime. As the Gold price began to recover from its August 1976 low, the (US-controlled) IMF along with the Treasury itself, began a series of Gold auctions in an attempt to hold down the price through official means. But the problem of yet another free fall in the international value of the Dollar got in the way. Between January and October of 1978, the Dollar lost fully 25% of its value against a basket of the currencies of its major trading partners. By early 1979, due to this precipitous fall, the demand for Gold was overwhelming the amount that the IMF/Treasury dared supply, and the Gold auctions came to an end.
Gold regained its ($195) December 1974 level by July 1978. It then pressed on to new highs, hitting $250 in February 1979 and $300 in July. Also in July, Paul Volcker was appointed as Fed Chairman by a desperate Jimmy Carter. Gold continued to surge, hitting $400 in October. While this was happening, Mr Volcker was attending a conference in Belgrade. There the assessment was made that the global financial system was on the verge of collapse. When Mr Volcker returned to the U.S. from Belgrade, he took a momentous step. He announced that the Fed was swiching its policy from controlling interest rates to controlling the money supply.
This new Fed policy took some time to have effect. In the meantime, Gold soared from $381 on Nov. 1, 1979 to $850 on Jan. 21, 1980. The public, who had been burned in 1975, were late on the scene. The great burst of public Gold buying came in the four weeks between Christmas 1979 and the Jan 21, 1980 high. As in 1975, they were "burned" again.
The HIDDEN Gold Wars
In the early 1980s, when world stock markets boomed in tandem everywhere in the world, Gold reached the $500 level twice. The first time was in early 1983, just as the global boom was getting started. The second time was at the end of 1987, two months after the infamous crash of October 1987. From $499 in December 1987, Gold fell throughout 1988 and dipped below the $400 level in January 1989. Gold has only ever regained the $400 for four very short periods since then.
Gold traded as high as $422 in December 1989 - January 1990.
It reached as high as $415 in the lead up to the Gulf war in August 1990.
It reached $408 in August 1993.
And finally, Gold reached a high close of $414 in February 1996.
But Gold's history in the years since the 1987 crash is that at all the actual crisis points, the Gold price has not risen, it has fallen. The best single example of this phenomenon remains Gold's performance on January 17, 1991, the day that the "air phase" of the Gulf war began. On that single day, Gold fell $30 from its previous close. In fact, it fell $40 from its intra-day high. Gold had been rising in the months leading up to the war. As soon as the war started, Gold plummeted.
The Gold price has failed to respond to the fact that Gold demand has exceeded newly-mined Gold supply in every year since 1988. It has, consistently done the opposite of what all of its previous history shows that it "should" do. Why has this happened?
From Overt To Covert
As we have documented in this series, in the 1960s and 1970s, governments fought Gold in the open. They announced what they were going to do before they did it. Of course, they failed miserably. But people in government, just like the rest of us, are quite capable of learning from their mistakes, The first thing they learned was that the best way to "fight" Gold was to go underground. They did so, with great success.
The plan adopted was to fight Gold on their own ground. In order to do this, they greatly expanded the ways in which Gold could be traded. More important, they introduced and developed an indirect market for Gold, they invented a Gold "derivatives" market.
The Paper Blizzard - "Derivatives"
Forward and futures markets were not, of course, an invention of the 1980s. What was an invention of the 1980s was the massive increase in paper trading instruments. These instruments, which became known as "derivatives", were first developed in the currency and debt markets. They then spread into the equity markets and into the Gold market.
The advantage of "derivatives" in the paper markets was twofold. First, they provided more and more leverage for more and more aggressive trading. Second, and far more important, they provided a method to hugely expand the amount of money in circulation without expanding the "money supply"! The traditional measures of money in circulation (M1, M2, M3, M...) expanded much more slowly. What did expand was the blizzard of "derivative paper" using paper money as its underlying "asset". This was one of the main reasons why "inflation" (defined as rising prices) slowed down.
The advantages of a Gold derivative market were similar. Governments learned in the 1960s and 1970s that it was impossible to meet an increased demand for Gold with physical Gold. They needed a paper substitute. Gold "derivatives" provided that substitute. With more tradeable alternatives to physical Gold, it became far easier to control the Gold price. But on top of the derivatives themselves, other specific mechanisms were developed to help control the price of Gold.
One of these methods was forward selling by Gold mining companies. This practice began with Gold's retreat from the $500 level in the wake of the 1987 crash. By the mid 1990s, Gold companies everywhere, but notably in Australia, were routinely forward selling years worth of their projected Gold production.
As the performance of Gold in the fifteen years between the market crash of 1987 and the start of the current $US Gold bull market in 2002 illustrates, these mechanisms worked very well indeed.
Forward Selling - By Gold Producers
For most of the past decade, Gold mining companies gradually changed the way they market their Gold. To an ever-increasing extent, they have "forward sold". The mechanism is quite simple. A Gold mining company with proven reserves in the ground wants to sell a portion of these reserves forward. The company representative goes to a bullion dealer who agrees to pay him, for example, $500 per ounce for Gold to be delivered two years from now. The Gold company has locked in a profit, and on top of that, has the money now for Gold which is still in the ground.
The Gold bullion dealer is exposed, however. He is exposed to a possible loss if the Gold price falls in the future. So, to hedge this position, the bullion dealer sells Gold - for immediate delivery. "Wait a minute" (you cry), where is the bullion dealer to get the Gold to provide for immediate delivery? The answer brings us directly to the second part of the mechanism for maintaining the $US 400 Gold "glass ceiling".
Gold "Leasing" - The Central Banks' Contribution
Our intrepid bullion dealer goes out and "borrows" the Gold. Where does he borrow it from? That's easy. From the formidable 36,000 Tonne hoard still owned by the world's Central Banks.
To get the Gold - or more accurately, to get a marketable claim to the Gold - our bullion dealer pays what is known as the Gold lease rate (an extremely low rate of interest). He then sells the Gold - or the claims to Gold, and invests the money. This is the way the difference between the spot and forward prices for Gold is determined. The forward price is the money interest rate which our bullion dealer receives for his investment minus the lease rate which he paid to borrow the Gold.
The point is that this entire fandango (that's "fandango" - not "contango") can be performed by lending physical Gold, or it can be performed by lending a paper claim to Gold. The miners' Gold is still in the ground. The Central Bank sometimes lends Gold, or it lends a claim to Gold. These are what our bullion dealer sells. And since most demand for Gold is not a demand for the physical metal but a demand for paper (forward, future, etc) claims to the metal, this mechanism can meet the demand without an undue strain upon the available supply of the physical metal, and the upward pressure on the price of Gold that would cause.
In any discussion of the future of Gold, or of the price of Gold, the first thing that must be realized is that Gold is a political metal. In the true meaning of the word, its price is "governed".
This is so for the very simple reason that Gold in its historical role as a currency is fundamentally incompatible with the modern worldwide financial system.
Up until August 15, 1971, there has never in history been an era when no paper currency was linked to Gold. The history of money is replete with instances of coin clipping, printing, debt defaults, and the other attendant ills of currency debasement. In all other eras of history, people could always escape to other currencies, whose Gold backing remained intact. But since 1971, there is no escape because no paper currency has any link to Gold.
All of the economic, monetary, and financial upheaval of the past 30 years is a direct result of this fact.
The global paper currency system is very young. It depends for its continued functioning on the belief that the debt upon which it is based will, someday, be repaid. The one thing, above all others, that could shake that faith, and therefore the foundations of the modern financial system itself, is a rise (especially a sharp rise) in the U.S. Dollar price of Gold.
Gold Commentary - November 14, 2008
We're Running Out Of "Safe Havens"
On Friday, November 21, in concert with a rebound on US stock markets and as the US Dollar continued to make new multi-year highs on its trade weighted USDX, Gold suddenly woke up with a vengeance. There was a bit of warning. Two days earlier on November 19 as the Dow was closing below the 8000 level for the first time in half a decade, Gold suddenly shot up in European and early US trading. On the day, Gold rose over $US 24 with the PM fix coming in at $US 762. But by the close of trading in New York on November 19, Gold (at least paper Gold) had been put firmly back in the "bottle" - closing at $US 736. Two days later it closed in New York at $US 791.80, up $US 43.10 on the day and the highest spot future close since October 16.
The Fed cut official interest rates twice in October. After holding official rates steady for more than five months, they cut by 0.50 percent on October 8 and by another 0.50 percent on October 29. In the process, they halved the Fed Funds rate from 2.00 percent to 1.00 percent, bringing it down to the low point of the Greenspan Fed rate cutting orgy between 2001 and 2003. That one blew up the last of the investment bubbles, the housing bubble. This one has had the exact opposite effect as actual price deflation has bitten in the US and in many other nations.
Of course, this Fed rate cutting action (not to mention all the cuts by other major global central banks) has merely accentuated the increasing desperation of the global monetary authorities. The last time that the ultimate "safe haven" - short term three-month US Treausury debt paper was yielding more than 1.00 percent was on October 22, a week before the Fed cut their Funds rate to 1.00 percent. The three-month Treasury yield dipped below 0.20% on November 12 and has remained there ever since. And on November 21, the day that Gold suddenly woke up and soared $US 50 in intraday trading, the three-month yield on US Treasuries got as low as an interest rate can get. It closed on the day at 0.01 percent!
On top of that fact, it must be duly noted that for the first time, it actually costs money to buy derivative insurance to protect buyers of US Treasuries against a US government default. Granted, these premiums are nowhere near the HUGE amounts it costs to guarantee against corporate and/or consumer debt default, but nonetheless, they now exist.
There was an absolute refusal to talk about money at all, let alone any form of monetary "reform", in the communique which was issued by the G-20 Heads of State summit in Washington last weekend. There has been an absolute refusal, at least in public, to contemplate any other means of "combatting" the now present spectre of actual deflation than by throwing more money at it by means of ever lower interest rates, burgeoning government deficits and bailout packages of all sizes, descriptions and degrees of futility. In (you should pardon the expression) short, nobody wants to address ANY of the all too REAL problems.
Instead, the political, monetary and financial "powers that be" continue with their "orthodox" measures and increasingly alarmed paper investors stampede into that last resort of "safety" - government debt paper. On the short maturity end, that stampede has now gone as far as it can go in the US with the three-month yield having effectively disappeared. Ironically enough, with the US government now reporting a FALL in consumer prices of 1.0 percent for October, even a zero yield is still "positive". Even so, it can't go any lower. Even the Japanese have not yet come up with a negative (nominal) interest rate.
As you know, we have in recent issues of The Privateer been talking about "second stage deflation", a situation in which the lenders stare impending bankruptcy in the face. A glance at the horrendous falls in the stock prices of the big New York money centre banks this week should dispel any lingering doubts that this situation now exists. We have also mentioned "third stage deflation", a situation in which GOVERNMENTS go broke and/or (what amounts to the same thing) repudiate their debt.
There are lots of precedents for this, of course. The IMF has been bailing out nations on every continent ever since their formation in the wake of Bretton Woods. But there has never been a situation in which almost every nation on earth was facing the same potential implosion. And not since 1931 has there been a situation in which the nation which supplies the world with a "reserve currency" is the prime candidate for "foreclosure". The US became a net debtor nation nearly a quarter of a century ago in March 1985. From that day to this, the chances of the US EVER actually making good on its government debt has been dwindling. But any prospect at all was blown away 9/11 - not by the event itself - but by the reaction of the Bush Administration and the US Establishment to 9/11.
By the time Mr Obama becomes President next January, Mr Bush will have all but DOUBLED the US Treasury's funded debt in his eight years of office. It is clear that this profligacy, above all other causes, has irreparably damaged the US position in the world. It is equally clear that the US Dollar cannot go on much further as the world's reserve currency. And when that happens, the US will have to service and repay debt by producing real economic goods, not merely by printing more swathes of US Dollars and US Treasury debt instruments.
But none of this seems to matter to all those stampeding into Treasuries. For their entire lives, this is the "quality" they have been taught to fly towards when all else fails. There has seldom, if ever, been a flight to US Treasuries like the one which has taken place over the past month. And now it has climaxed as the short-end of the Treasury yield curve reaches ZERO.
Small wonder that Gold woke up on November 21. When paper gets this close to the end of the line, REAL money can no longer be ignored. And, of course, Gold is not being ignored. Global demand for the PHYSICAL METAL is at (proportional) highs not even exceeded by the Gold panic of late 1979-early 1980. Increasingly, the supply is simply not there at all. But now, the paper Gold markets have taken a BIG jolt. The situation has suddenly become very much more interesting.
My reaction: I have been asked many times why a breakout in gold would be bad for the dollar. Hopefully this article on "gold wars" helps answer that question. Here is a summary of the noteworthy points in the text above:
1) Gold's historic role as a currency is a threat to the modern, paper-based financial system. For example, if foreigners started demanding the US pay its debts in gold instead of worthless dollars, our government would lose control of its finances and face a funding crisis.
2) Government interventions to suppress the price of gold aren't myths or conspiracy theories, they are fact. the London Gold Pool is a real, indisputable example of such government actions.
3) How Gold "Leasing" and derivatives ("futures") help central banks control the price of gold.
4) "In all other eras of history, people could always escape to other currencies, whose Gold backing remained intact. But since 1971, there is no escape because no paper currency has any link to Gold." What this means is that, since there are no gold-backed currencies anymore, the only safe asset is physical gold itself.
5) The rush into treasury is insane. Investors have been taught their whole lives that treasuries are a "risk-free" investment. They are about to learn that they are NOT.
6) Physical gold is the only form of money you can trust. Demand for physical gold is growing with every bailout. Once backwardation shuts down the COMEX, physical gold for sale will disappear, and those holding paper dollars will panic, paying any price to get the smallest ounce of gold.