Is The Gold Market Manipulated? Part 2: From De-Pegging To De-Monetization

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 |  Includes: AGOL, DGL, DGLD, DGP, DGZ, DZZ, GLD, GLDI, GLL, IAU, PHYS, SGOL, TBAR, UBG, UGL, UGLD
by: Ben Kramer-Miller

In Part1 I introduced the reader to the concept of market manipulation. I exposed the nonsensical definition offered by the CFTC and proposed my own alternative as follows:

Manipulation occurs when:

A: A market participant buys and/or sells an asset or a derivative contract related to that asset in order to control its price.

B: The participant does so in order to achieve some agenda other than directly profiting from the aforementioned trading activity.

I then provided irrefutable evidence, given these conditions, of manipulation of the gold market from 1961 through 1968 by a consortium of eight central banks through what is called the London Gold Pool (LGP, here on). I provided the reader with statements from central bankers, most notably Arthur Coombs, that show that there was an intent to manipulate the gold price so that it remained at $35/ounce despite upward pressures, and that show that there was, in fact, market activity designed to maintain the $35/ounce price level.

In what follows I walk the reader through the relevant points pertaining to the gold market and its suppression from the collapse of the LGP through the 1970s bull market in gold.

There are two primary issues at hand during this era. The first is that gold was viewed as a vital tool for wielding political and economic power by top U.S. officials. The second is that there was an attempt to undermine this power through what is referred to as "de-monetization" of gold: i.e. the use of political force or gold price suppression, in order to make gold less appealing relative to other fiat currencies -- the U.S. dollar in particular. Ironically the latter policy can only be adopted by acknowledging gold's political and economic significance: de-monetization tactics, discussed below, only serve to reaffirm gold's importance and omnipresence on the monetary stage.

In this vein the manipulation that concerns us here is more qualitative than quantitative, although there is circumstantial evidence of the latter. Unlike with the LGP, the manipulation thesis for this time period isn't handed to us in straightforward language. Documentation suggestive of the manipulation thesis is typically found in fairly vague language that is open to interpretation -- that is, it doesn't explicitly provide us with evidence of a particular intent to manipulate; rather it expresses one of three things: openness to the idea, concern regarding the potential for a rising gold price, or a general admission of the political or economic significance of gold.

At best one can make an exceedingly strong circumstantial case. Thus my intent here is not to provide documentation that unequivocally proves that the gold market was manipulated in the 1970s: if such documentation exists then it is not in the public domain, at least to my knowledge. Rather the reader should walk away convinced that central bankers and politicians were concerned with the price of gold over this time period, and that there is a likely connection between these concerns and manipulative market activities.

De-pegging

About two weeks before the collapse of the LGP in March, 1968, the Department of State sent out a secret memo, now declassified, essentially discussing the rapid drains on the LGP and the threat this posed to the United States' political power. While the text blames the drains on gold market speculators we know from Part 1 that the demand for gold was rising given the rise in the supply of dollars and the fall in U.S. gold reserves (i.e. the value of the dollar was dropping) -- we saw that the U.S.'s gold reserves fell from about 25,000 tonnes in the late 1940s to just under 10,000 tonnes in 1968, and that the M2 money supply rose from just over $160 billion in 1948 (the Fed doesn't have data on M2 money supply prior to this) to over $520 billion at the end of March, 1968.

Towards the end of the document (p. 5 paragraph 13), the author suggests that the U.S. wants to remain the "masters of gold," presumably meaning that top U.S. officials wanted to control the price of gold and its role in the global monetary system. Aside from insinuating the political and economic significance of gold in the global monetary system, the author's statement clearly implies that there is a serious threat to the United States' control of the gold market, and that this is a pressing issue not just for monetary authorities, but for political authorities concerned with national security as well.

The political significance of gold is reified in another de-classified document, this one circulated by the CIA a few months later in December. The opening reads:

We lose influence in world affairs whenever:

  • The dollar is weak in exchange markets;
  • There is a major outflow of gold; and/or
  • We are obliged to pressure countries into holding dollars or giving us payments assistance.

These statements clearly evidence that top U.S. government officials believed that there was a political need to control gold in order to retain political power: in essence these two documents give credence to the "golden rule": he who has the gold makes the rules. Of course there is a corollary to this rule: if you don't have the gold and you want to make the rules, then undermine the golden rule. The United States, and to a lesser extent those nations involved in the LGP attempted to do this by suppressing the price of gold so that the U.S. dollar would appear to be as good as, or better than gold.

But with the LGP out of business the United States and other interested parties played upon another corollary of the golden rule: if you don't have the gold then control who does: South Africa. South Africa produced roughly 3/4 of the world's gold in the late 1960s, and by controlling South Africa's gold sales the United States was able to maintain something akin to the price suppression scheme that was the LGP. This is a matter that I touched on in part one, and which is discussed in the above-cited CIA document. The United States tried to force the South African government to sell gold only on the London market in order to suppress that price, and to suppress the potential arbitrage trade whereby central banks could purchase gold in the United States for $35/ounce and sell it in London for a quick and (essentially) risk-free profit. As the following chart illustrates the arbitrage opportunity was rather substantial for much of the time-period from 1968 -- when the LGP collapsed -- to 1971 -- when the Bretton Woods agreement and the $35/ounce peg collapsed.

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South Africa stood pat despite the fact that it was losing revenues by withholding its largest export, and this is almost certainly due to the fact that the government of South Africa knew that the attempts to suppress the gold price were temporary.

The United States lost this game of chicken and in August, 1971 Richard Nixon closed the gold window. While he stated that this was a temporary measure never again would the United States trade its gold for U.S. dollars.

De-monetization

U.S. gold reserves were safe from foreign central banks, although they were heavily depleted having fallen from 25,000 tonnes in the late 1940s to just over 8,000 tonnes in 1971. However the United States still had major issues on which the two aforementioned documents shed light: holding gold was still crucial to maintaining political power, and a rising gold price would shed light on the diminishing value of the U.S. dollar, and by extension the diminishing dominance of the United States as a political power on the world stage.

These documents also allow us to properly contextualize future attempts to de-monetize gold, or to reduce its significance on the global monetary stage. Shortly after Nixon closed the gold window the gold price was trading at a multiple of the $35/ounce peg.

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As the gold price was rising we find that its political significance remained intact. Furthermore, the desire amongst monetary officials to suppress the price of gold did not dissipate, as is evidenced by Paul Volker's memoirs, in which he maintains that it was a mistake not to intervene in the gold market in order to mask the declining value of the dollar. I should note that this decline was not just in terms of gold, but in terms of other fiat currencies, as this chart of the Dollar Index in the 1970s illustrates.

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The decline of the dollar's value is more pronounced when measured in terms of specific currencies such as:

The German Mark

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The Japanese Yen

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The Swiss Franc (note that the chart is the U.S. dollar in terms of the Swiss Franc). Click to enlarge

The shallow dip in the Dollar Index by comparison was mostly the result of a weak British Pound and a neutral French Franc.

Ultimately the world was entering a new economic era -- post-Bretton Woods -- in which the U.S. dollar's role on the world stage began to wane.

The United States would not let this happen without a fight.

The first threat came as the European Community began talks towards forming a different monetary system. While these talks didn't amount to anything top U.S. officials certainly felt threatened, as evidenced in a discussion between Kissinger and Enders on April 25, 1974. True to previous statements we have seen regarding the importance of gold in the global monetary system, Thomas Enders -- Kissinger's economic expert at the time -- reveals this importance to Mr. Kissinger as they discuss the best way to approach the potential for European monetary action independent of the United States:

It's against our interest to have gold in the system because for it to remain there it would result in it being evaluated periodically. Although we have still some substantial gold holdings-about 11 billion-a larger part of the official gold in the world is concentrated in Western Europe. This gives them the dominant position in world reserves and the dominant means of creating reserves. We've been trying to get away from that into a system in which we can control-

What this boils down to is that the "golden rule" was the political reality, and the United States didn't have the gold, and so in order to continue making the rules, the U.S. had to undermine the "golden rule." This would mean de-monetizing gold. There are three ways of doing this, and we have already touched on the first two. The first is through political force, which is what then Fed Chairman Arthur Burns would suggest to President Lynden Johnson a year later. Burns points to a rift between the Federal Reserve and the Treasury. The latter accepted a free market approach to gold, while the former wanted to strictly limit the amount of gold that central banks were allowed to hold. Burns argues that the Fed's position is the correct one.

The second is to suppress the price: if the price of gold is falling against fiat currencies such as the U.S. dollar, then the latter gains legitimacy as money. This suggestion actually comes out directly later in the conversation, where Enders tells Kissinger that they should consider "raiding" the gold market.

The third way is to treat gold as a commodity rather than a currency. This was carried out as is evidenced by the fact that by the end of 1974, citizens who were once barred from owning gold, were once again allowed to own it. While there is no documentation to back this up to my knowledge, I suspect that a reason for this decision was that if Americans are allowed to own gold it is on equal footing with other commodities that American's are allowed to own. If they are barred from owning it, the implication is that gold is "special" for some reason or another. True or not, gold needed to be just another commodity. Furthermore, at the same time, gold futures contracts began trading on the COMEX. Nowadays stock indexes, bonds, currencies, and other non-commodity assets have futures contracts, but 40 years ago futures contracts were for commodities.

(*As a side note I should point out that precisely when gold took on this commodity status (literally the last day of 1974), its price hit a crucial peak of about $200/ounce, and it underwent a correction that dragged the price down nearly 50% over a nearly 2-year period, and the price did not exceed $200 again until 1978.

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While there is no evidence of manipulation, I find it extremely difficult to believe that there is a pure coincidence here, especially given Enders' aforementioned statement. Further reason for suspicion lies in the fact that suppression-thesis advocates often claim that the paper futures market is an integral tool used to suppress the price.)

Ultimately the effort to de-monetize gold was successful, but only insofar as the effort led to the largest holders of gold divesting some of their gold reserves: most notably Germany, France, Italy, Belgium, and the Netherlands. I should note that all of these divestitures took place in 1978 -- the year in which the gold price breached its 1974 peak (begging the question of how high gold might have soared had these divestitures not taken place). The IMF also divested a third of its gold from 1976 through 1980, and it even uses some of the language found in the above-cited Burns letter to Ford on its website today, viz. it was reducing the role of gold in the international monetary system.

De-monetization failed in that the market was not convinced that gold's role was diminished. This is clearly evidenced in the enormous price appreciation gold experienced in the 1970s despite the aforementioned (coordinated?) sales into the market in 1978. In fact the price would peak at roughly $850/ounce in 1980, although since we are not smart enough to sell at the exact peak, those who owned gold and who saw the bubble forming had plenty of time to sell at least $600/ounce, representing a 17-fold increase from the $35/ounce fixed price.

Conclusion

Looking at this last chart it is difficult to come out with cries of manipulation: how can an asset that has climbed at least 17-fold in value be suppressed?

Two points must be made, and these will come into play during my discussion of the supposed ongoing suppression scheme. First, as I argue in Part 1, where I discuss my definition of manipulation, I make it clear that the manipulation does not have to be successful. We only have to show intent, which we get from comments from Elders, and market activity, which we see in the seemingly coordinated sales of five European nations and the IMF. Second, price suppression doesn't necessarily have lower prices as a goal. Proponents of the ongoing manipulation argue that what we have now is a "managed retreat," which means that the goal of intervention in the market is to make sure that the price doesn't rise too quickly or generate too much enthusiasm amongst investors. Of course these same proponents suggest that the managed retreat is a way for manipulators to unwind existing positions, which were initially meant to suppress the price of gold. In the 1970s the six market participants that sold gold into the market were not unwinding positions that were initially put on to suppress the gold price.

One might also argue that what we saw in the 1970s was not price suppression, and that the sales were motivated by a desire to de-monetize gold. While we can infer that such a desire entails that the participants want to see a lower gold price there is nothing definite about this inference. In fact the only documentation to this effect is Ender's seemingly capricious comment about raiding the gold market.

Ultimately, as I suggest above, there is no definitive case to be made for gold price suppression the way that there was when the LGP operated. It is more important that the reader is able to see a continuity of the attitudes of political and monetary authorities between the LGP period -- when gold clearly was manipulated -- and the era of de-pegging and de-monetization, which I discuss here. The price action and market activities of central bankers differ markedly, but in both periods there is clearly a political and economic motivation to undermine gold's monetary role, especially relative to the U.S. dollar.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. I own gold coins and shares in select gold miners.