The Fed Still Manipulates Gold and the Markets 32 comments
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In a dynamic duo of articles published last weekend, I predicted the fall of the Dollar via a Gold-based perspective, and a US Treasury-based perspective. I want to round off and perhaps even reinforce my theory with a few more opinions and thoughts, which of course may be faulty as the major decisions are still at the mercy and discretion of the Fed, whom I have learned to never underestimate. To be a real "expert" in economics today requires one to be an "expert" in predicting government interventions, so it is all guesswork unless one is an insider. I am highly interested if there are any crucial facts I am missing by the way, please leave any counterarguments below.
I own some gold and if gold goes down I'll buy some more and if gold goes up I'll buy some more. Gold during the course of the bull market, which has several more years to go, will go much higher. – Jim Rogers, famed commodities trader, last week
I have written previously how the Fed creates and destroys money, but the example I used of open market operations (OMOs) has changed dramatically in 2008. The Fed is, on a daily basis, still altering its Treasury holdings, but more importantly propping up other assets by buying them, such as mortgage-based securities, Citigroup (C), AIG, etc. The Fed balance sheets have plunged from its historical levels of ~95% Treasury securities to less than 32% Treasuries, which hampers OMOs since the assets purchased will likely find no willing buyer on the market.
It may seem like the Fed is creating lots of money (and they are) but remember that $7.76 trillion, $8.5 trillion, WHATEVER the new number will be by the end of this week, pales in comparison to the amount of financial derivatives in existence, which per the BIS at last count (and just over-the-counter!) was $684 trillion. I am not sure if I ever wrote this phrase in this column before, but I’ve always viewed the financial crisis as a "Triple-D" crisis. Dollar. Debt. Derivatives.
There is another method of money destruction that I have not overlooked and want to mention. In an economic "disintegration" or a monster of a recession, money can also be destroyed by corporate, government and private bankruptcies.
In the debt-based world we live in, I think money destruction could be seen in shocking scales far exceeding the imaginations of the Keynesian-economics-based minds of the Fed and other central bankers. For instance, comparatively there has been much less noise in the commercial mortgage markets. However, if a lot of businesses fail, which has been known to happen in any recession, how do you suppose those mortgages will be repaid to the banks? In such a scenario, central bankers have just two options: create replacement money to re-inflate supply, or revalue the currency to an asset (very likely gold, after all central bankers do not hold at least some gold for their collective health, the yellow stuff is nice life insurance for fiat currency, ain't it?).
In this eye-popping December 4 essay by James Conrad, he reasons the central bankers will revalue to some sort of a gold standard to escape oblivion, and the price of gold will go from $750 per ounce to $7500-9000. [Remember the "price" is not REALLY going up, after all 1 ounce of gold is the same from day to day. What it really means is that all fiat currencies are going to be massively devalued as the worthless scraps of paper and electrons they really are!]
There is a legal requirement that, in every futures contract that promises to deliver a physical commodity, the short seller must be 90% covered by either a stockpile of the commodity or appropriate forward contracts with primary producers… Things, however, are changing fast. As previously stated, the first major mini-panic among COMEX gold short sellers happened last Friday. As of Wednesday morning, about 11,500 delivery demands for 100 ounce ingots were made at COMEX, which represents about 5% of the previous open interest. Another 2,000 contracts are still open, and a large percentage of those will probably demand delivery. These demands compare to the usual ½ to 1% of all contracts.
Time for Captain Calculator! On December 5, the open interest was 264,796 contracts (at 100 troy ounces per bar). This equates to 823 tonnes, a very significant amount equal to about 10% of the total gold reserves claimed by the United States, the world’s largest holder. There are 26.5 million ounces in contracts and only 2.9 million ounces in COMEX warehouses to cover deliveries as Dr. Fekete notes here. Over 40% of the warehouse totals will be delivered before January 1.
Where is the gold to cover the rest of the contracts? In the ground? In central bank vaults? At the GLD London vault? I do not know the answer, but I agree with Fekete’s comment on gold’s recent backwardation and Conrad, the traders requesting delivery are skeptical there is enough.
Conrad then proceeds to outline a very convincing (to me) proof that ends with:
It is only a matter of time before gold is allowed to rise to its natural level. Assuming that about half of the current increase in Fed credit is eventually neutralized, the monetized value of gold should be allowed to rise to between $7,500 and $9,000 per ounce as the world goes back to some type of gold standard. In the nearer term, gold will rise to about $2,000 per ounce, as the Fed abandons a hopeless campaign to support COMEX short sellers, in favor of saving the other, more productive, functions of the various banks and insurers.
Revaluation of gold, and a return to the gold standard, is the only way that hyperinflation can be avoided while large numbers of paper currency units are released into the economy. This is because most of the rise in prices can be filtered into gold. As the asset value of gold rises, it will soak up excess dollars, euros, pounds, etc., while the appearance of an increased number of currency units will stimulate investor psychology, and lending and economic output will increase, all over the world. Ben Bernanke and the other members of the FOMC Committee must know this, because it is basic economics.
Hyperinflation is nasty stuff. I first wrote about it in my July article "Calling All Wheelbarrows: Hyperinflation in America? (Part 2/2)" and a fellow Nolan Chart columnist, Republicae, with far more experience than I wrote "The Hyper-Inflationary Trigger."
Jim Sinclair, precious metals expert, comments here:
I recently completed the same mathematics that helped me so much in 1980 to determine the price that would be required to balance the international balance sheet of the US.
Balancing the international balance sheet is gold’s mission in times of crisis.
I recently did the math again and was sadly shocked to see what the price of gold would have to be to balance the international balance sheet of the USA today. That price for gold is more than twice Alf’s projected maximum gold price.
Alf Field’s maximum projection is $6,000 per troy ounce. Wow, guess Captain Calculator can take a vacation! On that note I would like to end with a reminder to the republican, Republican, and the third person who is reading this:
"We renew our allegiance to the principle of the gold standard and declare our confidence in the wisdom of the legislation of the Fifty-sixth Congress, by which the parity of all our money and the stability of our currency upon a gold basis has been secured."
– Republican National Platform, 1900
"We believe it to be the duty of the Republican Party to uphold the gold standard and the integrity and value of our national currency."
– Republican National Platform, 1904
"The Republican Party established and will continue to uphold the gold standard and will oppose any measure, which will undermine the government’s credit or impair the integrity of our national currency. Relief by currency inflation is unsound and dishonest in results."
– Republican National Platform, 1932 [Above are sourced from H.L. Mencken, A New Dictionary of Quotations on Historical Principles from Ancient and Modern Sources (1985, p. 471)
"We must make military medicine the gold standard for advances in prosthetics and the treatment of trauma and eye injuries."
– the only mention of gold in the Republican National Platform, 2008. Try searching for ‘gold’ or ‘dollar’ here.
Well, the Gold Standard ended in the US in 1914 when the first unbacked and "unsound" Federal Reserve Notes were printed. Ok, I hate the Fed, but fellow columnist Gene DeNardo phrased it best in his intriguing article "MV=PT A Classic Equation and Monetary Policy":
When the economy grows in a healthy way, we all share in the profit as our currency becomes stronger and is able to purchase more.
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An additional note about the second case above: The actual inflation occurs when the bank lends out the $10,000 with only $1,000 of equity. The bailout by the FED merely repairs the bank's balance sheet and replaces the lost equity it started with. In essence the FED has monetized the bank's loss.
Interestingly, the only way to actually deflate in that second scenario is to pay off the loan and extinguish the asset. Once the bank gets back the FRB money it created to loan out it will mark the loan as "Paid" and 'destroy' the money I pay back (keeping the interest, of course).
So the only true way to deflate the money supply is to pay off all the unbacked loans which created FRB money in the first place.
Or so it seems to me.
Or so it seems to me. "
Bingo! It is an honor dealing with someone who can learn. We are all right in one way or another but a man who can learn is awesome. May I also learn to learn from anyone, anywhere, anytime. But it is not easy.
Ooops! I was hasty. Forgive me, please. Actually, the only thing needed to cause deflation is for the rate of new FRB loans to be less than the repayment of old FRB loans.
On Dec 10 05:26 PM moonbat1775 wrote:
> Drat! Slow down moonbat! The repayment of old FRB loans faster
> than the creation of new FRB loans IS deflation.
Smarty Pant's comments leave out a point made by James Conrad in his Dec 4th article: accumulated capital represents past work. When that is lost, the value of work is lowered. Having the Fed replace the capital with paper that doesn't represent work doesn't restore the value of past work.
The simple fact that Dec. 31 COMEX delivery notifications are running 5 to 10 times normal should make everyone VERY nervous. I am very worried and feel time is running out. The arguments for a revalution of the $ are compelling. Gold is the only commodity NOT going down.
If you add up all the anecdotal evidence, it points to something big happening soon.
Don't take my word for it:
en.wikipedia.org/wiki/...
en.wikipedia.org/wiki/...
Furthermore, as that relates to this article, let's put some common sense around this. Does anyone really believe that the price of gold would go from $750 to $9,000/oz (as it's in the process of getting re-monetized), YOU (private joe citizen) will get to go along for the ride on the way up? I THINK NOT! and history tells us so.
We've seen this before. In the first great depression they outlawed gold punishable by 10 years in prison... they forced everyone to trade it for $20/oz, soon after they devalued the dollar by 50%, several years later they doubled the price of gold to $43/oz (a double whammy to the people)... Any law obiding citizen got double screwed, they didn't get to ride the upside... the only problem for the Fed back then was they had no way of knowing who "got da gold"... Guess what??? in 2004 the patriot act was signed by the grandson of Prescot Bush which tracks and traces gold exchanges... by chance do you think they might have an idea who's got da gold these days? Do you think they might outlaw it again before it gets re-monetized and price shoots up, or do you think they'll wait until it's $9,000/oz before making it illegal? If I wanted to extract as much value as I could before I confiscated your gold what would I do?? hmmm... Well I guess I'd drive the price down to $400/oz or lower before outlawing it (if I had the power... oh wait, they do. using the method described by "user 317170"). You know the answer. Get ready for gold to get hammered down to a low level beyond belief just before they re-enact the confiscation act and take YOUR gold before the value skyrockets. Don't try and hide it either, just give it up because Barrack will have his 10,000 man militia in place soon (otherwise known as secret police back in the heyday of Communist Russia). Chew on that, then get yourelf a tube of petrolium jelly
On Dec 10 09:20 PM User 317170 wrote:
> There's definitely reasonable points to gold getting to $2k, I don't
> think anyone disagrees there. The big problem I have is that all
> the gold bugs seems to forget the G7 controls about 90% of the world's
> gold. All any of them have to do is decide to sell a couple percent
> of their gold reserve and gold prices would plunge. Oh, and the international
> agreement that sets a limit how much each gold each country can put
> on the market in a given time period? Yeah, that expires in Sept
> 2009. Point being, the price of gold is whatever the US Congress
> and Fed wants it to be (IMF transactions have to be approved by congress).
>
>
> Don't take my word for it:
>
> en.wikipedia.org/wiki/...
>
> en.wikipedia.org/wiki/...
>
In his latest article "There is no fever like gold fever" Professor Fekete states " In my view we are facing a world-wide elemental grass-root movement: the flight into physical gold ? witness the backwardation in gold. It is irresistible, and will ultimately overtake all other market forces. It will overwhelm official resistance."
If you haven't read it you can find it here...www.gold-eagle.com/gol...
Spot gold reflects the current fear factor, future gold no longer reflects inflationary expectations. I prefer Contango and do not believe Gold Futures have Ever been in Backwardization since the Gold Standard died in 1971.
If anyone knows different, please post. Gold in futures backwardization scares me. IMHO
On Dec 10 09:13 PM pslater wrote:
> Smarty Pant's comments leave out a point made by James Conrad in
> his Dec 4th article: accumulated capital represents past work. When
> that is lost, the value of work is lowered. Having the Fed replace
> the capital with paper that doesn't represent work doesn't restore
> the value of past work.
>
Therefore, the FED and central banks have simply opted to manage the price. That was possible until the math behind the fiat indicated an unpayable debt, as it does now.
I don't think that anyone knows for sure when or how high gold will go, but in order for the US to have a payable debt, and since fiat money is debt, a currency revaluation on the order of 10:1 is in order for the debt to again become payable.
Needless to say, for a 10:1 fiat revaluation in a vacuum, just add another zero to the current price of gold (as well as all other real assets).
Of course, they will probably just try to issue a new currency, which values gold at the same price in "new dollars", however your old dollars exchange at 10:1 for new dollars which has the same net effect.
On Dec 11 09:07 AM nononameo wrote:
> Gold is the competition for fiat currency. It anchors the fiat. Therefore,
> if the price of gold is allowed to rise it represents a defacto devaluation
> of fiat vis a vis real things.It is also a defacto indicator of confidence
> in the fiat, and conversely the most widely watched indicator of
> panic and a flight out of fiat for the safety of real intrinsic value.
>
>
> Therefore, the FED and central banks have simply opted to manage
> the price. That was possible until the math behind the fiat indicated
> an unpayable debt, as it does now.
>
> I don't think that anyone knows for sure when or how high gold will
> go, but in order for the US to have a payable debt, and since fiat
> money is debt, a currency revaluation on the order of 10:1 is in
> order for the debt to again become payable.
>
> Needless to say, for a 10:1 fiat revaluation in a vacuum, just add
> another zero to the current price of gold (as well as all other real
> assets).
>
> Of course, they will probably just try to issue a new currency, which
> values gold at the same price in "new dollars", however your old
> dollars exchange at 10:1 for new dollars which has the same net effect.
The article which discusses gold backwardation:
www.kitco.com/ind/feke...
"real capital is saved work, and you can't print it. Capital destruction means genuine value has been destroyed, not mere paper. Printing paper and trying to use it as "Capital" dilutes all presently-existing capital." - SWRichmond
I agree, real capital is saved work and ink on paper is not. Your conclusion doesn't seem to be specific enough, perhaps it's a definition issue. To me 'real capital' would be a tangible item like a bulldozer or a truck, whereas the 'printed capital' wouldn't qualify as such. (In times past, when paper money was exchangable for gold, the paper represented real capital as the gold itself is 'real capital')
Given those concepts, printing more FRNs would dilute the value of 'printed capital' but not the value of tangible capital. A bulldozer is still a bulldozer and has the same worth to its owner.
It was the disassociation of paper with a tangible item (gold or silver) that rendered the 'printed capital' of lower value. Today's paper money is really saved work on a changing scale. The scale changes over time as they print more and so dilute the value of the 'saved work'. This doesn't really change the value of the work saved as tangible capital however. The 'price' of the used bulldozer will rise as more paper is printed reflecting that the bulldozer's worth is more nearly constant and it is the value of the printed capital that is declining.
I think that's the point SWRichmond is trying to make, it's just a difficult concept to convey in a short sentence without including cases that don't fit neatly.
"Smarty Pant's comments leave out a point made by James Conrad in his Dec 4th article: accumulated capital represents past work. When that is lost, the value of work is lowered." - pslater
I'm not sure I agree with this comment, but perhaps I misunderstand what it is trying to say.
IMO, it depends on the form of the past work. For tangible wealth like the bulldozer, the value of the remaining stock increases as more of it is lost.
Assume your business relies on using 20 bulldozers and there are a total of 100 bulldozers in existence. A mysterious bulldozer epidemic strikes and irreperably destroys 65 bulldozers, including 8 of yours.
When a working, used bulldozer is auctioned off do you think the final price will be higher or lower than what it would have been before the epidemic? I would guess higher. Every business that relies on bulldozers would be bidding to get it, including you. The price would go up as a result until only one person could afford the purchase.
Whenever the supply of anything is decreased the value of the remaining supply increases (microeconomics says lower supply = higher price for given demand). That would have to include capital (ie. saved work).
Don't confuse that with SWRichmond's "printed capital" which has no actual worth other than to trade for things that do have actual worth, if you can find someone willing to make the trade.
IMHO
Thanks to all for their insights.
MM
Yes, you're right, it's hard to explain without examples. My point is this: to the extent that capital is something you can borrow and use to build a productive facility, capital can be money; however, money isn't necessarily capital. Your ideas about convertible money ("In times past, when paper money was exchangable for gold, the paper represented real capital as the gold itself is 'real capital'") are spot on. Under those circumstances (convertibility) then money IS capital.
When convertibility ends, then the term "capital" becomes bastardized and we have monetarists talking about doing "capital injections" using newly-printed money. At any given moment under non-convertibility, all the existing "money" can be though to have a capital component, left over from the times when convertibility still existed. Printing more of this "money" dilutes the capital component.
My basic point is this: you can't lie about math. If genuine capital (value) could be printed, we'd all be wealthy and retired on the beach. But we're not, and we can't be. This, IMO, means that any act of printing must, MUST, have a capital dilutive affect, if our system uses money as capital, which it does.
Thanks a lot for your insight. In your loan example, I also see no flaw in its reasoning.
What I am referring to is that I run a business. I consume electricity. The power plant paid $$ for its raw materials and labor to give me the electricity. They give me a bill. I can't pay it back and go bankrupt.... hold on... crap! you are still right. I need to reread my Hazlitt "broken window" fallacy :)
Ok. The bank gives me $1000. I spend it all and go bankrupt. However, the bank only ever had $100 to back it up. The other $900 was just created out of thin air (and given to other third parties). Now the bank will need to call in other loans, resulting in more losses for the bank..... hmmm... I guess you have a real point here, it is the banks that lose money.. Eventually it will consume the banks deposits though.
I will have to think about it some more. Thanks a lot! FYI I finished my series at my website, not posted to seeking alpha yet.
Jake
HOW THE FED WORKS
www.nolanchart.com/art...
On Dec 10 10:59 AM Smarty_Pants wrote:
> "There is another method of money destruction that I have not overlooked
> and want to mention. In an economic "disintegration&am... or a
> monster of a recession, money can also be destroyed by corporate,
> government and private bankruptcies."
>
> I am not so sure this is the case. Let's consider a simple example:
>
>
> Bank A has a capital base of $1,000.00 (owner's starting equity).
> I borrow $100 to start a business. Bank now has $900 in equity and
> a $100 asset (my loan), I have $100 in cash.
>
> Instead of running my business I gamble at the horse track, losing
> the entire $100. I file for business bankruptcy.
>
> My business has no assets so the bank is forced to write off the
> entire $100 loan as a loss.
>
> Let's examine the money supply changes as a result of my bankruptcy:
>
>
> I have nothing. The bank lost $100 of equity (their asset was revalued
> to $0 in my bankruptcy). The horse track has an extra $100.
>
> Did the money supply deflate? No. That $100 is still out there
> in the hands of the track owners.
>
> The net result of a business bankruptcy is to transfer bank equity
> into the hands of the public.
>
> The money does NOT disappear.
>
> Now let's extend our example a bit to more closely resemble today's
> circumstances.
>
> What happens if the bank had loaned me $10,000 instead and I lost
> all that?
>
> Again. I have nothing. The track has an extra $10,000. The Bank
> now has equity of -$9,000 (they are insolvent and technically bankrupt).
>
>
> So, since Bank A is "too big to fail", the FED injects $10,000 into
> the bank. Bank A now has reserves of $1000 and a FED IOU for $10,000.
> Technically they now meet the reserve requirements.
>
> End result?
>
> The circulating money supply has been increased by $10,000 as a result
> of my bankruptcy and the FED injection to prop up Bank A.
>
> I'm no expert at this, but I cannot see any flaw in that line of
> reasoning. I welcome any suggestions or comments regarding possible
> errors.