The Fed's (Fictional) Intervention In The Gold Market, Part III: Faith And The Fed

Includes: GLD
by: Vince Martin

In Part II of this series, I criticized the evidence of a worldwide conspiracy of gold price suppression put forward by the Gold Anti-Trust Action Committee (better known as GATA). It's worth pointing out that I did not mean my criticism of GATA's conclusions as a personal attack. My choice of GATA as a target for the article stems from one simple fact: GATA, without question, is an authority on the history of government intervention in the gold market. Secretary/Treasurer Chris Powell has created an impressive resource for researchers; in fact, I owe Powell a debt of gratitude, as my research for this series has largely piggy-backed on his own work and his insistence on providing links to his sources and his emphasis on transparency.

In addition, I have corresponded with Powell via email on a number of occasions; despite my clear interest in contradicting his organization's claims, he has been nothing but polite and gracious. Furthermore, Powell is clearly under-compensated for his work (based on his claims, which are supported by GATA's government filings). I hope that readers -- no matter their opinion on the existence of a government-led conspiracy toward the suppression of gold prices -- will not mistake my disagreement with GATA and Powell as an impeachment of the integrity or honesty of either. There is not a shred of evidence that Powell is anything but a sincere, hard-working believer in his cause.

In fact, while I disagree with GATA and other advocates of a gold price suppression conspiracy, I can certainly understand their logic. The theory is simple: Western central banks -- including the U.S. Federal Reserve -- spent decades manipulating the market price of gold (and silver, too). This is unquestionably true; the U.S. dollar stayed on the gold standard until 1938, and the 1944 Bretton Woods agreement was predicated on using the U.S. dollar as a reserve currency, pegged to gold at a rate of $35 to the ounce. In an attempt to maintain this ratio without depleting national gold reserves, Western central banks intervened in the gold market, notably through the London Gold Pool.

After 1971 -- when President Richard Nixon closed the so-called "gold window" -- the Fed and other Western central banks are no longer legally charged with maintaining a constant, publicly disclosed reserve ratio between their currencies and gold. Yet they have, of course, retained the capability to manipulate the gold market and continue to operate largely in secrecy, with little accountability. (That may begin to change, as Ron Paul's, R-Texas, "Audit The Fed" bill passed the House of Representatives recently.) As GATA has noted, a 2009 Freedom of Information Act (FOIA) request was largely rejected on confidentiality grounds, though the Fed examiner in the case noted that there were documents relating to gold swaps among Fed files. "Why should the Fed be allowed to have any secrets about gold (emphasis in original)?" Powell has asked.

The logic, therefore, is simple: The Fed used to manipulate the gold market, it still can manipulate the gold market, and since it won't release details on its activities in the gold market, it must still be manipulating the gold market. Anyone who disagrees (such as this author) is hopelessly naive, and relies on sheer faith in the beneficence of the Fed, the Treasury, and the U.S. government.

But there are some holes in this logic. The biggest issue is that the legal mandate of the Fed and other Western central banks has completely changed. The price of gold is no longer of direct interest to the Federal Reserve. Fed actions in the gold market in the 1960s -- through the London Gold Pool and other mechanisms -- are of no more relevance to current Fed activities than U.S. activities toward the Soviet Union at the same time reveal anything about our foreign policy toward Russia today. The world has changed, and the presence of not only legal but Congressionally mandated activities in the 20th century are not proof that those activities continue illegally, and in secret, in the 21st century.

In response, conspiracy advocates argue that a rising gold price is a threat to the Fed, as it provides competition for sovereign debt. As Powell wrote in May:

[I]nvestors might be powerfully discouraged from buying such crappy bonds and thereby subsidizing profligate governments if, meanwhile, a rising gold price was trumpeting a rate of inflation substantially greater than the bond interest rates or if gold itself, via capital gains, was offering a substantially better return than those bonds.

But if the Fed really wanted to eliminate competition for Treasuries, why not also look to the equity markets, the more traditional competitor? Why not also execute downward manipulation in oil and other commodities? The gold market is far smaller than either oil or equities; why would it be the focus?

As for the argument that gold is an inflation barometer, it's not entirely clear that such a correlation exists. In fact, the more likely explanation is that Treasuries and gold are trading together at higher prices due to fears of worldwide upheaval (ranging from another Mideast war to a eurozone explosion). As one economist noted last year:

I think the reason people hold gold is as protection against what we call 'tail risk' -- really, really bad outcomes. To the extent that the last few years have made people more worried about the potential of a major crisis, then they have gold as a protection.

That economist, of course, was Fed Chairman Ben Bernanke, making the case for the very asset he has been accused of manipulating. In fact, neither Bernanke nor his predecessor Alan Greenspan have shown much interest in the price of gold. In the quarter of a century the two men have run the Fed, their public pronouncements have been limited at best. Beyond Greenspan's notorious statement during Fed testimony that "central banks stand ready to lease gold in increasing quantities should the price rise" -- whose context I covered in Part I -- and Bernanke's public disdain of the gold standard -- a belief that comes from his research as a student decades ago -- the Fed has shown little public interest in the price of gold. Even in Federal Open Market Committee minutes, discussion of gold has been minimal through the years.

Conspiracy advocates point to the relative quiet of the Fed on gold as evidence that it is conducting a sinister plot behind closed doors. But it's far more likely that the Fed just isn't all that concerned with gold. The Fed is concerned with monetary policy, and as Bernanke told Dr. Paul in Congressional testimony, he does not believe that gold is money.

He may be proven wrong on that as he may be proven wrong on the value of a gold standard; his stewardship of the Fed may go down as the most disastrous of all time. But his beliefs are in no way proof of his interest in manipulating the price of gold; they are, in fact, evidence that Bernanke sees gold as being relatively immaterial to his duties as Fed chairman. Without a legal charge to peg the U.S. dollar to the price of gold, and no belief that gold is a major influence on a monetary policy, there is no known reason why Bernanke would even make the effort to affect gold prices.

Indeed, as I noted in Part I, Bernanke's actions have been, almost without exception, likely to lead to an increase in gold prices. The expansion of the money supply, Operation Twist, and ZIRP (zero interest-rate policy) are all bullish for gold. And the metal has reacted strongly; it has nearly tripled under Bernanke's stewardship, continuing a bull run that lasted over a decade:

Gold 1985-2012


What better explains this chart: A commodity whose value as a buffer against "tail risk" has soared amid a weaker dollar and economic and political turmoil, or a commodity whose decades-long manipulation has now been turned into a "controlled retreat" during which gold rose by a factor of seven?

The other major issue with the conspiracy advocates is the nature of the alleged act. If true, it is literally a multidecade, multitrillion, multinational plot with the knowledge of thousands of people. It would be the greatest scandal, and the greatest fraud, in history as even conspiracy proponents point out. Several commenters on Parts I and II of this series pointed to the recent LIBOR scandal or the London Gold Pool as evidence that the alleged gold manipulation plot could exist. But the difference between those actions and the alleged gold plot is not of degree, but of kind.

More importantly, the fact that such manipulation could exist is not proof that it does exist. And there is no direct proof, despite the protestations to the contrary. There have been no whistle-blowers, no deathbed confessions, and no direct, primary source evidence of manipulation after 1980 ever produced. There are discussions of the price of gold across various government agencies; there are statements which appear (or can be construed to appear) as incriminating. But there is not a single piece of hard evidence that details the persons involved in the plot, not a single document anywhere that shows central bank trading activity, or the existence of a secret committee charged with gold price manipulation. There is no direct testimony in Congress or anywhere else of persons who claim to have knowledge of this gold price suppression conspiracy and wish to see that knowledge released to the public.

So, my response to the charges that I am somehow naive is simple: Why? Why does the movement in gold over the last quarter-century, which seems relatively sensible given the tumult in world markets and the vast expansion of the monetary supply in the West, require a massive conspiracy to explain it? Why would central bankers suppress the price of gold for decades to prevent its signaling of "true" inflation only to initiate a "managed retreat" when the damage that signal would do was maximized by the financial and fiscal crises of the last five to six years? And why would central bankers, relieved of their legal responsibility for the dollar-weighted value of gold, choose to manipulate that market instead of other larger, more followed and more influential asset classes?

In short, it seems to me that a belief in a conspiracy theory requires far more faith than simply taking the Fed at its word that it is (relatively) unconcerned with gold prices. The belief in a conspiracy requires faith in government competence rarely, if ever, seen. It requires faith in the conspirators' ability to keep quiet, which, again, is rare at best. And it requires faith in a theory that is far more convoluted and far less reasonable than the conventional wisdom. That conventional wisdom says that gold has risen as of late because of, not despite, Federal Reserve actions. And what evidence exists largely supports that claim. Indeed, faith has little to do with it.

In Part IV (my apologies -- this discussion was originally intended for Part III), I'll discuss the errors in GATA's understanding of the market for gold and (in particular) gold derivatives, and how those errors have led to a belief in many circles that gold is due for an exponential bull run.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Disclaimer: My household owns a small amount of physical gold in the form of jewelry, weighing substantially less than one troy ounce.