September 20, 1999 – “It is precisely when a free gold market is needed that most modern governments seek to suppress it. For it reflects and measures the extent of the lack of confidence in the domestic currency; and it exposes the fictitious quality of the ‘official rate’. And these are the very reasons why it is needed.” – Ludwig von Mises, Human Action, 1949.
A lot of things have changed since von Mises penned these words in 1949. The so-called ‘official rate’ at which the Dollar was ‘priced’ in terms of Gold has all but disappeared. Gone are many of the currencies that existed when von Mises’ insightful treatise on economics and money was first published, each of them destroyed by the ignorance and greed of governments more concerned about expanding their power than serving their constituency. Gone also is some 90% of the purchasing power of what von Mises back then knew to be a Dollar. But many things have also remained the same. Trust and confidence in national currencies unceasingly wax and wane, and governments still seek to suppress a free Gold market.
There are signs aplenty that governments have been battling Gold throughout this century. It began when Gold coins were taken out of circulation. Then to further remove Gold from the people, in the 1920’s the Gold Exchange Standard made it nearly impossible to exchange national currency for Gold, as only 400 ounce bars could be redeemed for paper. Then in perhaps what governments thought might be the crowning blow, in the 1930’s President Roosevelt confiscated the Gold of American citizens. Nevertheless, Gold prevailed. Only one-half of the Gold then circulating within the US was willingly turned in or captured by federal agents, so having failed again to break the trust people placed in Gold, governments continued with their campaign that was so obviously intended to destroy Gold.
After the Second World War, the Dollar – supplanting Gold’s historical and most valuable role – was made the center of the international monetary system by the Bretton Woods Agreement. When that doomed and relatively short-lived arrangement collapsed, Gold was dishoarded. In coordinated action, the US Treasury and other central banks, later joined by the IMF, attempted to drive the Gold price down by ‘flooding’ the market with supply previously thought to be permanently off the market. But it was not enough. Gold prevailed.
The Gold price continued to shine a light on the debasement of national currencies and the on-going erosion of their purchasing power. So a new strategy had to be devised by governments before Gold’s enduring qualities had a chance to lay bare for all to see the sham of fiat, national currencies. As a result, the so-called process of ‘leasing’ Gold was born in the mid-1980’s. Leasing is without doubt the most diabolical, fiendish scheme of the never ending attempts contrived by governments to hinder and impede the free Gold market.
Consider first the inherently fraudulent nature of leasing Gold. If you leased a car, and then tried to sell that car, you’d go to jail. But that same justice does not apply in the Gold market.
A bullion bank leases Gold from a central bank, but the bullion bank does not let this Gold sit in its vault. With the full knowledge – and usually even with the full cooperation – of the central bank that owns the metal, the leased Gold is sold into the market by the bullion bank. Are you shocked? Well, it is very understandable that you might be because the lessee is selling the asset of the lessor. It is a fraud, but the lessor condones this practice because the deception serves his purpose. As Alan Greenspan so clearly stated in testimony before Congress last year: “Central banks stand ready to lease gold in increasing quantities should the price rise.”
As bad as the fraud may be, there is even more dishonesty in this scheme – the double counting. Gold that is leased by a central bank shows up in two places. It is still reported as an asset of the central bank. But it is also an asset of the person that eventually buys the central bank’s Gold.
Recalling that under the scheme the lessee sells the Gold, the physical metal must always end up in someone’s hands. Typically, the standard good delivery 400-ounce bar ‘leased’ from the central bank is refined into metal of high purity, and then fabricated into small bars, coins and high-karat jewelry. This fabrication activity is then measured and reported by the World Gold Council and other advisory services that track physical metal, all of which continue to report record demand.
The double-counting trickery arises because the central bank’s balance sheet does not accurately reflect the reality that the physical metal is no longer in the central bank’s possession. The balance sheet does not distinguish or report any difference between assets of different risk – “Gold”, the physical metal, and “Gold Receivable”, an IOU for physical metal. This practice is known as fractional reserve banking, a corrupt process that has caused countless, repeated boom and bust cycles since it began when goldsmiths in Britain in the 1600’s issued more warehouse receipts for Gold than they actually held in their vault. As the French say, the more things change, the more they stay the same.
Fractional reserve banking and the unceasing, mindless drive by bankers to find ways to expand credit – the essence of banking for more than 300 years – explain what is happening to Gold and also to the Dollar. But there is a different result today because the Dollar is no longer on a fixed Gold Standard.
To explain the significance of this point, some basic monetary theory is needed, and an example made famous by Milton Friedman clearly provides it. If a helicopter flying one night over a community mysteriously dropped bundles of money that doubled the quantity of money in circulation, the community would not be twice as rich. Rather, prices double as the real wealth remains unchanged; only the money supply has doubled.
Now carrying this example to the days of the Gold Standard, the quantity of paper money – payable in Gold at the demand of the holder – doubles, and prices rise. The boom is underway, but it is illusory because the real wealth of the community has not increased. What’s more, as the excesses of the boom grow, holders of Dollars (which, remember, under the Gold Standard are IOU’s for Gold) eventually begin doubting the capacity of the banks to fulfill their liabilities to pay Gold. When the rush by people to redeem their money substitutes (paper currency and bank deposits) for real money (Gold) began, so too did the bust, as surely as night follows day. But today there is a twist.
The Dollar is no longer linked to Gold under a fixed standard. Therefore, the shape of credit expansions today is somewhat different. Dollar and Gold credit expansions are no longer tied to one another.
The Dollar can be expanded on its own, and we know that its credit expansion is ongoing. The continued growth of M3 and the other monetary aggregates is proof that the bankers are pursuing their unceasing, mindless drive to expand credit. Consequently, the prices of goods and services continue to rise when measured in Dollar terms. In short, inflation is still very much with us today.
Because there is no formal link to the Dollar, Gold can also be expanded independently on its own, without any direct impact on the Dollar. And this credit expansion of Gold explains what is happening in the Gold market today.
Gold supposedly in central bank vaults is being double counted. It has been refined and fabricated into small bars, coins and high-karat jewelry, all of which have been scooped up at bargain basement prices all over the world. The quantity of Gold, measuring here both the physical metal and the countless IOU’s for physical metal, has been artificially expanded by credit. Central banks that have ‘leased’ Gold hold the IOU’s, and the metal underlying these IOU’s has been absorbed by the market, as evidenced by record demand for Gold in India, middle-eastern souks and even American Eagle coins, all of which has led to a predictable result. Gold too is experiencing ‘inflation’ like the Dollar.
Unfortunately, Gold’s inflation is not widely understood. We don’t normally measure this inflation because we have become accustomed to performing economic calculation (i.e., measuring the relative value and the prices of goods and services) in terms of Dollars rather than Gold, so some explanation about how Gold is being inflated is necessary.
Inflation is the loss of purchasing power. The Dollar’s inflation is measured by rising prices of goods and services. The Dollar in other words is losing purchasing power because it takes an ever increasing quantity of Dollars to purchase the same Consumer Price Index basket of goods and services. Gold is also losing purchasing power. Because the price of Gold in Dollar terms is declining, the price of goods and services if measured in terms of ounces of Gold is also rising. Gold is being inflated.
For example, in January of this year, crude oil was $11 per barrel when Gold was $290 per ounce. Today an ounce of Gold is $255, and a barrel of oil is $24. In other words, the price of crude oil has risen in Gold terms from .038-ths of an ounce to .094-ths of an ounce, an increase of nearly 2½-times. The same result arises when measuring the price of other goods and services, although the degree of inflation will of course vary. Gold is losing purchasing power because of inflation. This observation leads to an important conclusion.
Gold is not being demonetized. Rather, Gold is being inflated from credit expansion. The prices of goods and services are rising when measured in terms of Gold ounces.
Expanding credit through fractional reserve banking is a process that works like a game of musical chairs. When the music stops (the so-called ‘bust’), there are more liabilities to pay Gold than there are ounces in the bank vaults. Like musical chairs, those ending up without a place to sit (i.e., no physical Gold) are out of the game. For this reason, when the game ends, the price of Gold will soar to a more normal level. What’s normal? It’s beyond the scope of this article to answer this question, but one observation is useful. Using the government’s own CPI from the January 1934 date at which the $35 ‘official rate’ was established, Gold today should equal $422 just to keep even with the rate of inflation.
In the 1960’s the central banks dishoarded their Gold reserve under the name of redemption. Beginning in the 1970’s and continuing to this day, some central banks still dishoard their reserves by exchanging them for national currencies under the name of sales. But in the mid-1980’s a new form of dishoarding began. Under the name of leasing, central banks have been dumping Gold on to the market, but there is a big difference between this last method and the other two.
When Gold was redeemed or sold, it was removed as an asset from the balance sheet of the central bank. It was obvious that the Gold was gone, replaced on the balance sheet by some national currency for which it was exchanged. With leasing, however, the Gold asset still remains on the balance sheet of the central bank, even though it is long gone. This reality explains the inherent fraud of leasing. It also explains why the so-called ‘official rate’ has been replaced by what might appropriately be called the manipulated rate.
There is an irony to this dishoarding by government. We know that Gold at $255 an ounce is even better value today than the former $35 ‘official rate’. After all, adjusted by the CPI, in terms of the old official rate Gold today is only $21. The irony is that governments today are no brighter than they were in the 1960’s when so much valuable Gold was dishoarded at the bargain basement price of $35 per ounce. But what’s worse, governments today are far more dishonest.
Long before Orwell wrote of ‘newspeak’, that changing the meaning of words does not change something’s nature, Shakespeare made the same conclusion. To paraphrase Shakespeare’s celebrated observation about the nature of a rose: What’s in a name? that which we call a fraud By any other name would smell as foul.