The global gold market, similar to other key commodity markets, is
denominated
in fiat dollars or derivative currencies of the dollar, while global
labor
markets are denominated only in local fiat currencies. The Law of One
Price says
that identical goods should sell for the same price in different
markets after
adjusting for transaction costs such as transportation costs, tariffs
and taxes
applied in different markets and currency exchange rates. While the Law
of One
Price applies to gold and many other key commodities such as oil, it
does not
apply to the price of labor around the world.
Cross-border wage arbitrage is inversely linked to
cross-border price arbitrage in that producers seek maximize profit by
making
their goods in the lowest wage locations and selling their goods in the
highest
price markets. This is the structural incentive behind cross-border
outsourcing,
which does not seek to sell locally products produced locally at prices
adjusted
for purchasing power parity (PPP) between the currencies of the two
markets. PPP is a
theory of equilibrium in currency exchange rates as adjusted by
relative price
levels in local currencies in two economies. When comparing the GDP of
two
countries measured in one reserve currency, such as the dollar, the GDP
differential
as expressed in the reserved currency, converted at its exchange rate
to the
local currency, needs to be adjusted by the disparity in purchasing
power of the
local currency in its home market. If one exchange equivalent unit of
the local
currency buys four times as much in its local market as the dollar does
in the US,
say yielding a purchasing power disparity of 4 times, the nominal local
GDP
needs to be adjusted by a factor of four to achieve purchasing power
parity to
reflect its true size as compared to US GDP.
The purchasing power parity idea originated in the 16th
century from concepts rooted in the
intellectual and pedagogical work of Francisco de Vitoria (1492–1546),
a
French eductated Spanish Dominican theologian of Jewish converso
ancestry at
the School of Salamanca
in Spain,
in reponse to critical
challenge from Protestant
theologists of the Reformation to the oxthodox Catholic conception of
man’s
relationship to God in the context of an evolving secular world. The juridical
doctrine of the School of Salamanca put an end to medieval concepts of
law. It
accomplished that Herculean task with a vindication of personal liberty
that
had been suppressed in Medieval theology. The Salamanca juridical
doctrine resurrected
personal liberty as one of the God-endowed natural rights of man that
include
right to life as a corporeal being, economic rights as owner of
property and right
to freedom of thought and human dignity as a spiritual being after the
image of
God. The Salamanca
juridical doctrine distinguishes the natural (or civil) realm of power
from the
supernatural (or spiritual) realm of authority. This distinction sets
new limits
on both the conflated Medieval doctrines of the Divine Right of Kings
and of the
Temporal Powers of the Pope. A direct consequence of the separation of
realms
of secular power from spiritual authority is the proposition that there
are subscribed
limits to the legitimate powers of civil government and to the
spititual authority
of eclesiatical church. From this distinction
between secular power and spiritual authority spouts the theory of ius
gentium
(the rights of peoples). The common good of the Christian world is then
deemed categorically
superior to the individual good of each secular monarchial state in it.
The
extention of the theory means that relations between sovereign states
ought to be
conducted within the bounds of commonly recognized (i.e. Christian)
values and
deisputes ought to be settled not by force or the threat of force, but
by international
law and universal justice. Positive law
is man-made, through which a society bestows or denies specific civil
rights and
privileges and provides protection to individuals or groups to enjoy
such rights
and privileges or to impose penalties upon those who abuse the rights
and
privileges of others. In contrast, natural law safeguards inherent
human rights
and dignity, without the need for conferral by acts of civil
legislation. The concept of ius
gentium is further subdivided into ius inter gentes (law
between
peoples)from ius intra
gentes (law within peoples). Ius
inter gentes (which corresponds to international law) is something
common
to all subscribing countries, although being positive law and not
natural law, is
not necessarily universally observed. On the other hand, ius intra
gentes,
or civil law, is specific to each nation, and not to others. In his History
of Economic Analysis (1954), Joseph Schumpeter traces scholastic
doctrine
in general and Spanish scholastic doctrine in particular, to highlight
the sophisticated
level of economic thought in Spain in the 16th century. He argues that
the
School of Salamanca deserves to be credited as being among the founders
of
economics as a social science. Even though it did not elaborate a
complete general
theory of economics, the School of Salamanca did establish the first
modern economic
theories to address new secular problems that had emerged with the
evolution of
the Medieval spiritual socioeconomic order toward the Humanist material
socio-economic
order of the Renaissance. Francisco de
Vitoria, a younger contemporary of Erasmus (1466-1536), promoted
Scholasticism, a method of investigation developed by Thomas Aquinas
(1225-1274), which places strong emphasis on disciplined dialectical
reasoning
to extend knowledge and understanding by inference, and to resolve
conceptual contradictions
within a comprehensive truth. Scholastic thought is also known for its
rigorous
conceptual analysis and exacting precision in drawing distinctions.
Dialectics is conducted through orderly dialogue between parties
who may hold differing views, yet wish to pursue truth by seeking
agreement based
on commonly accepted fundamentals. This is in contrast to debate, in
which parties
hold opposite views and wish to prevail by proving opposing views wrong
as judged
by a persuaded audience. Dialectics leads to evolutionary synthesis
while
debate leads to revolutionary displacement. Dialectics also contrasts
with
rhetoric, which takes the form of an extensive polemic conducted by a
single party,
a method of persuasion favored by Sophists. The Law of One Price
was developed in its modern form by Gustav Cassel (1866-1945) in 1918,
in a
series of post-World War I memoranda for the League of Nations on
currency exchange
rates and purchasing power parity. Cassel’s
contribution
is acknowledged by John Maynard Keynes in his Tract on Monetary
Reform
(1923).
The purchasing power parity concept is a prerequisite extension
of the Law of One Price which states that before adding both hard and
soft transaction
costs, identical goods will have the same price in different
interconnected markets.
The best-known and most-used benchmark to calculate currency purchasing
power
parity based on exchange rate is the Geary-Khamis dollar, proposed by
Roy C.
Geary in 1958 and developed by Salem Hana Kham between1970-72, known generally as the international
dollar, a hypothetical unit of currency that has the same purchasing
power that
the US dollar has in the United States at a given point in time. Data
expressed
in international dollars cannot be converted to another country’s
currency
using current market exchange rates; instead they must be converted
using the
country’s PPP adjustment in exchange rate. The Big Mac Index
An example of one measurement of PPP is the Big Mac Index
popularized by The Economist, which compare prices of a Big Mac
burger
in McDonald’s restaurants in different countries. The Big Mac Index is
pragmatically
useful because it is based on a modern-day well-known product whose
final
price, easily tracked in many countries, includes cost input from a
wide range
of sectors in the local economy, such as capital (exchange rate,
interest rate)
agricultural commodities (beef, bread, lettuce, cheese), labor
(productivity, service
and managerial), advertising, transportation, rent and real estate
value, etc.
In July 2010, the price of a Big Mac in the United
States of America was $3.73 and in
China RMB
13.2 yuan ($1.99 at concurrent exchange rate). The price difference
mostly reflects
wage differentials between China
and the US,
as
other cost factors of production, such as rent and energy, have been
converging
between urban centers in the two economies.
However, in many emerging economies, US
fast food meals represent an expensive niche product priced well above
equivalent
traditional meals. In emerging economies, the Big Mac is not a
mainstream
“cheap” meal as it is in the US
and other advanced economies, but a luxury fad import enjoyed by the
rising local
middle class. The price of RMB 13.2 yuan represents a high portion of
Chinese
hourly wage than $3.73 represents in US hourly wage. According to the 2009
China Statistical
Yearbook, Chinese wages in different fields and locations vary greatly.
Rural or
migrant manufacturing average hourly wage was only $0.40 an hour at
concureent
exchange rate. A Big Mac would cost a rural or migrant manufacturing
worker 5
hours’ earning in wages.
The middle fifth quintile of US
household in 2009 had an annual income of $34,738, which comes to $17.4
an hour
based on a 50-week, five-day, 40-hour work load. A Big Mack at $3.73
would cost
an US
worker 12
minutes’ earning in wages.
Chinese wages have been rising since 2008 as a result of
government policy. The US
national average wage index for 2009 is 40,711.61, dropping by 1.51%
from the
index for 2008.
For China,
despite the Global Financial Crisis in 2008, the pace of growth in
average wage
and living standards has remained positive, albeit at a slower rate.
According
to the 2009 China
Statistical Yearbook, the annual growth rate of the national average
wage
remains at 17.23% in 2008, similar to its pre-crisis level. Significant
growth
in the average salary level in the financial industry continues in
2008, with Beijing
leading with an impressive 37.19% increase compare to 2007. The top two
sectors
with the highest-paying salary and the fastest growth in China
are the Financial and the IT Sectors.
In 2008, Chinese national average annual salary for the financial
industry was $61,841
compare to $22,457 in 2003. Average salary in this category is still
increasing
by 22.46% per year. National average salary for the IT industry was
$56,642 in
2008 compare to $32,244 in 2003. Average salary in this category is
increasing
by 11.93% per year. Adjusted for PPP, $56,542 in China
commands the equivalent purchasing power of $226,568 in the US.
The fastest growing sector in China
is the security sector in the financial industry. In 2008, it was
$172,123,
compare to $42,582 in 2003. Average salary in this sub category is
increasing
at a rate of 32.23% per year.Adjusted
for PPP, $172,123 in China
commands the equivalent purchasing power of $688,492 in the US.
Price Deflation in
Emerging Economies Drives Up PPP Adjustment in GDP
PPP, as an adjustment index on comparative GDP as measured
in dollars, is closely monitored by economists concerned with
international macroeconomics.
PPP adjusts GDP measurements in dollars by taking into account the
difference
in prices of similar goods or substitutes denominated in local
currencies between
national economies, as calculated by currency exchange rates to the
dollar,
generally using the dollar as a benchmark. In other words, PPP
adjustments
reflect the real domestic purchasing power of an unit of national
currencies as
compared to the purchasing power of its exchange rate equivalent in
dollars in
the US.
What is not generally noticed is that price deflation in an emerging
economy increases the purchasing power of its currency, in that the
same local
currency buys more goods after price deflation, provided that there is
enough
money available to buy goods. Thus, price deflation in the local
economy drives
up the PPP adjustment needed in its GDP to achieve purchasing power
parity between
the local currency in the local economy and the
dollar in the US.A positive PPP adjustment between the local
currencies and the dollar enlarges the local GDP as measured in dollars at concurrent exchange rates.
However, price deflation is generally the result of a
decrease in the quantity and/or velocity of money in the economy,
causing a
market condition of less available money chasing after a given amount
of goods
to drive market prices down. Yet a decrease in the supply and/or
velocity of
money is generally accompanied by dampened economic activities that
will lead
to a rise in unemployment and to a fall in wages. Thus, workers in
emerging
economies may not benefit from price deflation even when the local
currency
buys more goods to adjust nominal GDP figures upwards, if unemployment
rises and
wages fall from a decrease in economic activities to yield a lower real
GDP.
Uner such conditions, a rise in GDP may cause a fall in wages.
Furthermore, for a number of complex reasons, including
market inefficiency, consumer confidence, political intervention and
cultural
fixations, the cross-border Law of One Price applies only to certain
commodities,
such as oil, and not to many other goods with less universal
characteristics
and market accessibility.
Thus for China with a PPP adjustment of four times on its
GDP as measured against the purchasing power of the dollar in the US,
meaning
that a given amount of Chinese RMB as defined by current exchange rate
between
the yuan and the dollar, buys four times more in China than its dollar
equivalent
does in the US. A rise in oil world prices denominated in dollars will
cost the
Chinese economy four times the equivalent in other goods not affected
by the
Law of One Price, or in lost purchasing power of Chinese wages for oil
than equivalent
dollar wages in the US
economy.
Should the Chinese economy be hit with deflation-driven falling
wages because of a slow down of the export sector, the PPP adjusted GDP
of
China may rise while Chinese wages shrink with rising unemployment. The
larger
the PPP differential between a local currency and the dollar benchmark,
the
more severe is the tyranny of dollar hegemony in widening purchasing
power disparity
between dollar wages in the US
economy and yuan wages in the Chinese economy, both nominally and in
purchasing
power for dollar denominated commodities. PPP Adjusted Chinese
Economy Larger than US Economy by 2012
The Conference Board, a US-based global, independent
business membership and research association founded in 1916 to work in
the
public interest, in a report published on November 10, 2010, projects
that China
could have a larger economy in GDP terms than the US by 2012 when
adjusted by purchasing-power
parity, which takes into account the goods and services a country’s
currency
actually buys at home at current exchange rates. This trend may be
accelerated
if China
yields
to US political pressure to let the yuan rise in exchange value against
the
dollar.
The Conference Board report sees the US
economy slowing by almost 1.5 percentage points from 2.7% in 2010 to
1.2% in
2011 due to slower spending by consumers, companies and state and local
governments.
At only 1.2%, US
growth rate would be lower than those of both Japan
and Western Europe, which are expected to grow
by 1.5%
in 2011. However, strong growth in emerging economies like China
and India
at
near double-digit will pushed growth in the global economy to 4.2% in
2011.
Looking further ahead, the Conference Board Report projects China
as accounting for almost 25% of the global economy by 2020, as compared
to 15%
for the US
and
13% for Western Europe of the 15 original
European Union
countries that include Germany
and France.
India
is expected to account for 8% of the world’s output by 2020.
The Conference Board Report hedges its projections with the
caveat that China’s
fast-growing economy may be hit by uncontrolled inflation or asset
bubble bursts.
However, the baseline scenario is that China
and India
together will account for half of global growth from 2010 to 2020. Over
the
next decade, growth in emerging economies is expected to be more than
three
times faster than growth in advanced economies. The Law of One Price
Applies to Gold, Not Labor
Throughout history, gold has been regarded as fungible and
undestructible. The Law of One Price applies to the global gold market
denominated
in dollars because financial market deregulation has removed capital
control and
allowed free flow of gold between most national borders. However, the
Law of
One Price does
not apply to the global labor markets denominated in local currencies
because
of there is no accompanying deregulation of immigration policies by any
trading
governments in the globalized market.Because
of the politically induced restriction on cross-border mobility of
labor, globalized
trade has been primarily driven by cross-border wage arbitrage and
financial
carry trade.
In recent decades, global labor markets as expressed in
wages paid in local fiat currencies have been de-linked from the global
gold
market denominated in fiat dollars, or other fiat currencies as
derivatives of
the fiat dollar. The one-price gold market is a true reflection of
falling
values of all fiat currencies, (exchange rates fluctuation being merely
expressions ofdifferent rates of fall in
value in different fiat currencies), while the local labor markets as
expressed
in wages denominated in local fiat currencies collectively reflect a
global
decline of worker/consumer purchasing power, albeit at different rates.
While full-blown currency wars may be avoided through international
cooperation, exchange rate volatility will not. Driving
foreign-exchange
volatility in the short term will be continuing fluctuations in market
sentiment
and central bank-imposed interest rates differentials. In the medium
term,
current account imbalances from trade will fuel market pressure on
volatility and
movements in exchange rates. In the long term, domestic inflation and
productivity and central bank monetary responses are the main factors
that will
likely exacerbate exchange rate volatility.
At the same time, wage disparity between economies, while
narrowing, will not close fast enough to moderate trade imbalance
caused by
cross-border wage arbitrage. Furthermore, the cross-border wage
disparity is
being narrowed with all wages falling, and high wages falling faster
rather
than the low wages rising. The value of all fiat currencies will
decline
continue to when measured against gold, albeit at difference rates of
decline,
with an appreciation bias in favor generally of emerging economy
currencies and
specifically the Chinese RMB. As wages are paid in currencies,
nominally rising
wages will also decline against gold. Gold Took 28 Years to
Recover its Historical High set in 1980
On January 21, 1980,
gold hit its then historical high up to that time at $850 per ounce.
Before
that time, gold had been far below that historical peak price since
1974 when
President Gerald Ford restored the legal right of US citizens to own
and hold
gold bullions. In addition, gold had been below that high peak since
1980, for
28 years, before reaching $865.35 on January
3, 2008. Those who bought gold or went long on gold in that
28-year
period had all seen their money gone down the drain. I personally knew
quite a
few of them.
From $865.35 on January 2, 2008,
gold rose steadily to $1,421 on November 8, 2010 over a 34-month period. Those
who shorted gold in that period also lost money. I also know some of
them.
Gold as Hedging
Instrument
Gold Forward Rate Agreement (GOFRA) is a hedging instrument used by
producers
who, having drawn down gold loans, can lock in forward gold interest
rate exposure
to both US dollars and gold borrowing rates with settlement in dollars.
GOFRA
hedges against the combined effect of market moves in both US dollars
and gold leasing
rates with settlement in dollars.
Gold Leasing Forward Rate Agreement (GOLFRA) restricts itself to gold
leasing
rates with settlement in gold, as expressed by the gold spot rate in
dollars.
The increased activity of central banks in lending gold to the market
means
that central banks also have exposure to gold spot rate volatility.
Gold Deposit Forward Rate Agreement
(GODFRA) is tailored particularly
to track central bank activities.
Gold Offered Forward Rate (GOFO) is the rate at which dealers will lend
gold
against US dollars. Since July 1989, twelve market makers of the London
Bullion
Market Association (LBMA) have contributed to the GOFO page on Reuters
their
rates for lending gold against US dollars; and at 10 a.m. every business day, a mean is calculated
automatically giving
the market, in effect, a gold LABOR (London Interbank Offered Rate).
The gold
lease rate is LABOR minus GOFO rate.
In 1997, a second GOFO page was added that provides logical data, which
allows
the user to apply the rates to other applications, such as spreadsheets
and
charts. Reuters LBMA 07 gives a full list of contributor codes. Gold Anti-Trust
Action Committee (GATA)
Gold trades in the most opaque
of all markets. Gold
traders live in a precarious arena of incomplete and unreliable
information,
more than in the treacherous market pits for other commodities. Most
official
data about gold held by national accounts offer only incomplete
information, if
not outright disinformation. In response, a Gold Anti-Trust
Action
Committee (GATA) was organized in January 1999 in the US
to advocate and undertake litigation against illegal collusion among
central
banks to control the price and supply of gold and related financial
securities.
GATA underwrote an anti-trust lawsuit filed by its
consultant, Reginald H. Howe, in Howe vs.
Bank for International Settlements et al., in US District Court in Boston
from 2000 to 2002. Class Action Lawsuit
against Barrick and JP Morgan Chase
While the Howe suit was dismissed on a jurisdictional
technicality, it became the model for the anti-trust lawsuit by New
Orleans-based
Blanchard Coin and Bullion, one of the oldest and most respected gold bullion and numismatics dealers in the US,
against
Barrick Gold Corporation and JP Morgan Chase & Co. That suit was
filed in
US District Court in New Orleans
in
2002 and caused Barrick Gold to agree to stop selling gold in advance
as a
hedge for 10 years.
By 2001 Barrick,
working with JP Morgan Chase had amassed off-balance-sheet assets that
were
worth more than the market capitalization of the next five biggest gold-mining companies in the world
combined. Barrick made $2.3
billion on its short sales of gold
and made a profit on those short sales for 62 consecutive quarters.
Over a period of five years, JP Morgan Chase loaned gold to
Barrick at approximately 1.5%; sold the gold into the market and
invested the
dollar proceeds at approximately 6.5%; then paid both the proceeds from
the
sales and the 5% interest differential to Barrick whenever it repaid
any of the
borrowed gold. During a period when the price of gold dropped by more
than 25%,
Barrick’s annual operating cash flow increased by more than 400%. Blanchard’s class-action lawsuit charged that JP MorganChase provided Barrick
with so much borrowed gold --
presumably obtained from central banks -- on such favorable terms that Barrick could overwhelm the market and
move prices up or down at will and not have to repay the borrowed gold for many years if at all. Blanchard
maintained that in some
years, Barrick was able to
supply to the market more gold
than was supplied by all the bullion banks combined. According
to the World Gold Council, bullion banks are investment banks that
function as
wholesale suppliers dealing in large quantities of gold. All bullion
banks are
members of the London Bullion Market Association.
Through a combination of market manipulation and a 1992
transaction that Interior Secretary Manuel Lujan, Jr. described as “the
biggest
gold heist since the days of Butch Cassidy,” Barrick amassed
off-balance sheet
assets that were worth more thanthe
combined market capitalizations of the next five biggest gold mining
companies
in the world. Barrick
submitted a motion arguing that in borrowing gold
and selling it into the market, the company was acting as the
agent of central banks and carrying out their policies in the gold market and thus should share
their immunity from lawsuits. US
District Judge Helen Berrigan rejected the Barrick
motion and sent the case on for discovery and trial. Soon
after that ruling, in November 2005, Barrick settled the Blanchard
lawsuit out
of court. While the settlement was sealed, Barrick simultaneously
announced
that it would stop hedging gold. In the market, a steady rise in the
price of
gold ensued.
On January 20, 2006,
Barrick acquired a majority share of Placer Dome. The production of the
combined organization moved Barrick to its current position as the
largest gold
producer, ahead of Newmont Mining Corporation.
In 2008, it produced 7.7 million ounces of gold at a cash
cost of US $443 per ounce. As of December 31, 2008, its proven and probable gold
mineral reserves stand at
138.5 million ounces.
In 2009, Barrick produced 7.42 million ounces of gold at
total cash costs of $466 per ounce or net cash costs of $363 per ounce
and 393
million pounds of copper at total cash costs of $1.17 per pound. The
profit margin over net cash cost was overt $1,000 per ounce when gold
was prices at its historical high in November 8, 2010. The 2009
production of 7.42 million ounces of gold has a profit margin of $7.43
billion.
Today, Barrick is the largest pure gold mining company in
the world, with its headquarters in Toronto,
Ontario, Canada;
and four regional
business units (RBU's) located in Australia,
Africa, North
America and South America. Barrick
is currently undertaking mining and exploration
projects in Papua New Guinea,
the United States,
Canada,
Dominican Republic,
Australia,
Peru,
Chile,
Russia,
South Africa,
Pakistan,
Colombia,
Argentina
and Tanzania.
Barrick Gold Corporation is the gold industry leader, with
25 operating mines and a pipeline of large, long-life projects located
across
five continents, in addition to large land positions on some of the
most
prolific mineral districts. Barrick offers investors exceptional
leverage to
higher gold prices with the industry’s largest production profile,
largest
reserves of 139.8 million ounces of gold, in addition to 6.1 billion
pounds of
copper reserves and 1.06 billion ounces of contained silver within gold
reserves
as at December 31, 2009.
IMF
Gold Accounting
GATA, in its continuing effort to expose and oppose secret
collusion against a free market for gold, other precious metals,
currencies,
and related securities, disclosed that the
International
Monetary Fund (IMF), in compiling official gold reserve data, allows
its member
nation governments to count gold they have leased out - gold that has
physically
left their vaults - as if it were still in their vaults for accounting
purposes. This selective accounting may
give the gold
market an accurate picture of the amount of gold reserves owned by the
central
banks, but not the total amount of gold controlled by member
governments at any
one time.
In April 2009, China informed the IMF that its gold reserves had
increased from the 600
tonnes it had reported consistently in the previous six years to 1,054
tonnes,
a 65% increase. Market participants thought China’s sudden increase in gold reserves was largely
caused by
increased gold production by state-owned gold mining industry in China.
In June 2010, the World Gold Council (WGC, a
gold mining
trade association headquartered in London
with operations in the key gold demand centers of India,
China,
the Middle East and United States.) reported that Saudi Arabia’s gold reserves had increased by 126%, from 143 to
323 tonnes since
2008. The Saudi government’s new preference for gold was viewed by
market
participants as a sign of its falling confidence in the fiat dollar in
which global
oil trade is denominated. A few weeks
later, Saudi Monetary
Authority President Muhammad al Jasser told the press that the new gold
reserves were not new purchases, but merely transfers from existing
non-reserve
accounts.
A new WGC Report issued on November
17, 2010 puts Q3 global demand for gold at 922
tonnes, a 12% increase over Q3 2009. China
announced its 2009 demand for gold as 423 tonnes, a 15% increase over
2008.
Estimated Chinese demand for 2010 will increase by over 20% with
increases
projected for the next decade. Gold is projected to possibly reach
$1600 per
ounce in 2011. China
will continue to be the world’s biggest gold producer with a production
of over
320 tonnes in 2010, suggesting that China
will import 100 tonnes of gold every year to meet its consumer needs.
IMF only requires member nations to report their gold reserves, not
their total
gold holding not assigned to reserve accounts. Countries
such as China and Saudi Arabia are
thought to be holding more gold than indicated in their IMF reports on
gold
reserves. China accumulates gold in recent years to hedge its huge
dollar
foreign exchange reserves, and Saudi Arabia to hedge both its oil dollar surplus and the
depletion of its
oil reserves. Countries such as China and Saudi Arabia do not
release their total gold holdings because they want to avoid the
information’s adverse
market impacts on the value of their large dollar holdings.
In August 2009, the
Bundesbank, Germany’s central bank, released a written statement that
much of Germany’s gold holdings are held outside Germany at “trading centers” at which the Bundesbank may
“conduct its
gold activities.” It is commonly known that the New York Fed holds gold
for some
60 nations and international organizations.
In September 2009, under a
freedom of information lawsuit in
US District Court for the District of Columbia, GATA
obtained a written admission from the New York Fed that it had engaged
in secret
gold swap arrangements with foreign banks and that these arrangements
needed to
be kept secret to avoid destabilizing the market. The United States officially has 8,200 tonnes of gold in its reserve.
However, US
gold reserve has not been audited in more than half a century, and the
last known
audit showed only incomplete data. Congressman Ron Paul, a conservative
openly
critical of the Federal Reserve, has repeatedly tried, without success,
to
introduce legislation requiring an audit of the US gold reserve,
including
specifically any encumbrances like swaps and leases.
Gold and Silver ETFs
Gold and silver exchange-traded funds (ETFs)
provide
retail investors convenient ways to invest in gold and silver. While
gold and
silver ETFs are required by regulation to report their metal holdings
regularly,
studies suggest that this data may not involve physical gold. ETFs are
not
required to disclose precisely where their metals are held, or if the
custodians
and sub-custodians actually have the gold the ETFs own as long as such
custodians are credit worthy. Major international banks who act as gold
custodians
often have large short positions in their own proprietary trading desks
on gold
and silver that give these custodian banks and other metal custodians
incentives
to suppress the rise in the market price of the metal. These
incentives, while
alleged separately by an internal firewall from those of clients,
conflict with
the interests of investors in general and clients in particular, whose
metal
these banks are holding and who want their gold assets to rise in
price.
The Physical Gold
Market
The biggest “physical” gold
market in the world is run by
the London Bullion Market Association (LBMA), which publishes
statistics on the
volume of gold and silver traded by its members. However, these
statistics show
spectacular trading volumes involving more metal than could possibly
exist. Of course,
much of the same metal could be sold and resold many times every day.
But Jeffrey
Christian of the CPM Group testified at a hearing of the US Commodity
Futures
Trading Commission, as he had already pointed out in a 2000 report,
that the London
bullion market is actually a fractional-reserve gold-banking system
built on
the presumption that most gold buyers would never take delivery of the
metal they
own, but rather would leave it on deposit with account s of the LBMA
members
from whom they had bought it.
The GATA study on LBMA statistics supports
estimates by Christian
that a good portion of the gold bought and sold by LBMA members does
not actually
exist, and that most gold sales by LBMA members are highly leveraged
based on
only a notional quantity of gold. LBMA does not disclose the level of
transactional
leverage or how much gold is due from LBMA members that does not
actually
exist. Like the Fed’s gold swap arrangements, the transactions are
based only on
market participant claims on gold supposedly held by custodians, but
those
claims are backed only by the credit worthiness of the custodians, and
not by
the amount of gold the claimants actually possesses. The gold market
then is as
vulnerable to panic runs, as the over-leveraged banking system if all
gold
market participants suddenly demand actual delivery of all the gold
they
supposed own.
Gold Not Good Hedge against
Inflation
Should gold owners suddenly demand physical delivery of the gold they
own, they will realize that even at its
historical high price of over
$1,400 per ounce, gold is not even close to keeping up with the
inflation
caused by fiat currency debasement of last decades.Gold is not a full hedge against inflation,
and
only a partially effective hedge against currency depreciation. The
Growth of Virtual Gold The gold market has figured
out how to
increase the supply of virtual gold by vast amounts without actually
digging gold
out of the ground or even discovering its unmined existence as
reserves. Gold
derivatives based on notional gold are more risky than “paper gold”
which at
least implies paper backed by sufficient amount of physical gold as
required by
fractional reserve banking rules. Gold derivatives are mostly naked
shorts on
gold, thus removing the price of gold, which is the expression of
market sentiment
on gold, from the law of supply and demand of physical gold. A number of big international
banks have built up huge and
unbalanced derivative positions on gold spot, futures and leasing rate.
These OTC
(over-the-counter) gold derivative positions are traded between
counterparties
and not traded on exchanges. The positions bet not on physical gold
supply/demand
ratios, but on the technical implication of gold price movement and
directions
as manipulated by central banks and speculators.
BIS Gold Swaps
The Bank for International
Settlements (BIS), the central
bank of the central banks, disclosed in a small footnote in its 2010
annual
report without explanation that it had undertaken a gold swap of
unprecedented
size - 346 tonnes. After GATA publicly challenged Reuters reporters for
not demanding
full explanation on gold from the BIS, Reuters reported: “The BIS said
the gold
in question was used for ‘pure swap operations with commercial banks’
but
declined to respond to further questions from Reuters on the
transaction.” The Federal Reserve also
does not announce its gold swap transactions. Gold
as Instrument of Monetary Imperialism
Gold and silver have been used as monetary metals throughout history,
with
copper used in pennies. While coins are less susceptible to devaluation than paper currency, the exchange values
of these
metals can be manipulated by fiat. Gold particularly has served as an
effective
instrument of monetary imperialism.
Over the course
of
the 19th
century, enough gold was known to have been accumulated by Britain
to make it credible for the British Treasury to introduce paper
currency backed
by its gold holdings to force the demonetization of silver in Europe
as a strategy to advance British monetary imperialism.
Many historians inaccurately
ascribe 19th century mercantilism as the policy of
accumulating gold
for a country through export of merchandise. The fact is that gold
accumulation
can only be achieved by a purposeful policy of monetary imperialism.
Mercantilism under bimetallism gave a trade surplus country both silver
and
gold. Only monetary imperialism could cause an inflow of gold with an
outflow
of silver.
Demonetization
of
Silver turned Gold into a Fiat
Currency
In reality, Britain
earned gold in the 19th century not from export of
merchandise
because buyers of British goods had a choice of paying in silver or
gold under
bimetallism. In reality, Britain
accumulated gold by overvaluing gold monetarily all through the 19th
century. This allowed Britain to force the world to demonetized
silver
and to replace bimetallism with the gold standard after enough of the
world’s
gold had flowed into Britain to enable the pound sterling, a paper
currency
back by gold, but essentially a fiat current without bimetallism, to
act as a
reserve currency for world trade with which to finance Britain’s role
of sole
superpower after the fall of Napoleon. With the pound sterling as
reserve currency, British banks, operating
on a
fractional reserve system backed by the Bank of England, the central
bank, as
lender of last resort, could practice predatory lending all over the
world,
sucking up wealth with boom and bust business cycles instigated by her
predatory monetary policy of fiat paper currency. The strategy worked
for more
than a century until the end of World War I. Between 1800 and 1914, the
main
British export was financial capital denominated in fiat pound sterling
disguised by the gold standard to be as good as gold. The factor income
from
banking profits derived from pound sterling hegemony paid for the
wealth and
luxury that Britain
enjoyed as the world’s preeminent power in the century between the fall
of
Napoleon in 1815 and the start of First World War in 1914, for a whole
century.
The demonetization of silver stealthily turned the gold standard into a
fiat
paper money regime through the officially gold-backed pound sterling
because
the gold backing it was no longer priced in silver at a fixed rate, or
any
other metal of intrinsic value for that matter. Gold and only gold
became a
fiat unit of account set by the British Mint, a fact that made Britain
monetary hegemon of the age.
An asset that is priced by or in itself has no transactional meaning,
even if
it is gold. This is because a transaction must involve at least two
assets of
different value, expressed with different prices in exchangeable
currencies. In
addition, there must be an agreed upon exchange ratio at the time of
the
transaction to effectuate a transactional outcome. Even in barter, an
exchange
ratio between the two assets to be exchanged needs to be agreed upon.
For
example, an ounce of gold can be exchanged for 15 ounces of silver. An
ounce of
gold that can be exchanged for another ounce of gold carries no
information of
transactional value.
Thus the pound sterling, even when backed by gold, was in fact a fiat
paper
currency because the monetary value of gold was set by fiat in England,
devoid of any relationship to any other thing of intrinsic value beside
gold
itself.
Without bimetallism, specie money
cannot have any meaning of transactional worth. Currency backed by gold
turns
into a fiat currency if it can be redeemed at its face value only in
gold. The
monetary value of gold is not separate from the commercial value of
gold. Gold
then can fluctuate in purchasing power due to any number of factors,
including
government policy, but is not fixed to any other metal of intrinsic
value at an
universally agreed upon ratio.
That a pound sterling is worth another pound sterling is no different
than an
ounce of gold is worth another ounce of gold. In addition, the market
price of
gold can be manipulated by the government who is in possession of more
gold
than any other market participant. This means that any unwelcome
speculator can
be quickly ruined by the government. This is of course how central
banks
nowadays intervene in the foreign exchange market for fiat currencies.
Central
banks with sufficient dollar reserves, a fiat currency, can drive
speculators
against their national currencies toward bankruptcy.
Before silver was demonetized, the silver/gold ratio was set monetarily
at 15.5/1
in England
and
15/1 in France,
motivating speculators to buy silver with gold in England
and buy gold with silver in France
for an arbitrage profit of half an ounce of silver for each ounce of
gold so
transacted in the two countries. This caused a continuous flow of gold
to England
independent of international trade flows in other commodities. Even
when Britain
incurred a trade deficit, gold continues to flow into Britain
because of the monetary hegemony of the pound sterling.
After silver was
demonetized, gold could be exchanged at the British
Treasury
only for pound sterling notes at the rate of 21 shillings or
£1-1s per ounce of
gold fixed in 1717. The commercial price of gold in England
was set by the British Treasury on par with its monetary value because
gold
price was denominated in pound sterling. The commercial price of silver
or any
other commodity in England
was also denominated in pound sterling, which had a monetary value in
gold set,
by the British Treasury by fiat.
After the demonetization of silver, no one knew how much silver
was worth
as money because it was no longer used as money anywhere. Thus, there
could not
be any discrepancy between the commercial price of silver and its
monetary
value because silver ceased to have a monetary value. Silver then
became a
commercial commodity like any other commercial commodity, while only
gold
remained a monetary unit of account accepted in the British Treasury
and in
other treasuries of countries which observed the gold standard.
Countries that
refused to join the gold standard saw their currency kept out of
international
trade and had to pay a penalty of higher interest rates on loans
denominated in
their non-gold-backed currency.
Further, the
Bank of
England could issue more pound sterling notes by
fiat
based on the fractional reserve principle in banking.
She only needed
to keep
enough gold to prevent a run on pound sterling notes for gold at the
Bank of
England. In addition, since England
was in possession of more gold than any other country at the time, Britain
under the gold standard became the monetary hegemon, with more money at
her
disposal than justified by the amount of gold she actually held.
Other
gold standard country had to maintain a much higher fractional reserve
in gold
than Britain
and therefore had less money with which to participate in international
capital
markets. The monetary hegemon could sustain a trade deficit with an
inflow of
gold cause by monetary policy.
Without a fixed
exchange rate regime, each nation could adopt a gold
standard
unrelated to other nations’ gold standard. For example, the US at
$20.67
dollars per ounce of gold and Britain at £3-17s-10.5d per ounce
of gold would
let the exchange rate between the dollar and the pound sterling work
itself out
mathematically. This is what a fiat currency regime does, except
instead of
being valued by a gold standard based on the amount of gold held by the
issuing
government, the exchange rate of the currency is valued by each
country’s
monetary policy implications and financial conditions, such as interest
rates,
balance of payments, domestic inflation rate, fiscal budgets, trade
deficits,
etc.
The United States, though formally on a bimetallic (gold and silver)
standard,
switched to gold de facto in 1834 and de jure in 1900.
In 1834,
the United States
fixed the price of gold at $20.67 per ounce, where it remained for a
century
until 1933, when President Roosevelt devalued the dollar to $35 per
ounce of
gold, but made it illegal for US citizens to own gold in amount more
than $100.
Before World War I, Britain had fixed the per ounce price of gold at
£3-17s-10.5d, three times the original price of gold set in 1717
which was at
one Guinea or 21 shillings. The exchange rate between dollars and
pounds
sterling, the “par exchange rate”, mathematically came to $4.867 per
pound
during the period between 1834 and 1914. Between 1914 and 1933, the
dollar/pound exchange rate mathematically rose to $2.214 per pound
sterling.
On August 25, 2008,
a
relatively uneventful trading day, the per-ounce market price for
silver was
$13.45 and that of gold was $829, yielding a silver/gold ratio of
61.6/1. This
was 4 times the historical British Mint ratio of 15.5/1. On that same
day, the
exchange rate between the dollar and the pound sterling, both
free-floating
fiat currencies, was $1.853 per pound sterling, determined by monetary
policies
of their respective central banks. The exchange rate between the dollar
and the
pound sterling on that day was less than one third of the “par exchange
rate”
from 1834 through 1914. The British pound had lost more than a third of
its
exchange value against the dollar in 94 years while the dollar itself
had also
fallen against gold by over 4,000%, from $20.67 to $829. The dollar had
not
become stronger, only the pound had become weaker against the dollar.
This is
because the pound, like all other fiat currencies in the world, has
become a
derivative currency of the dollar. (End of Excerpt)
Dollar
Hegemony
As the United States has been the issuer of the primary reserve currency
for globalized
international trade since the end of WWII, and as the dollar had become
a fiat
currency since President Nixon delinked it from gold in 1971, the United States has invaded all trading nations monetarily and
economically
without using military force, despite the fact that all trading
sovereign
nations continue to retain their sovereign right to issue national
currencies. All
national currencies of trading nations are in essence derivatives of
the
dollar. This is because all sovereign nations still must hold foreign
exchange
reserves primarily in dollars. The current global monetary regime is
dominated
by dollar hegemony. (Please see my article: Dollar Hegemony) Bull Market in Gold maintained
by Bear Market in Fiat Currencies
Since the global financial crisis that began in the US in
mid-2007, with the Federal Reserve pursuing an unprecedented loose
monetary
policy to try in vain to help the US economy to recover from the
serious impairment
resulted from a sudden burst of a gigantic debt bubble of the Federal
Reserve’s
own making, investor uncertainty over the grim outlook of global
markets and
the ruinous fate of the fiat dollar have driven gold price in dollars
to new record
highs.
Delegates polled at the London Bullion Market Association (LBMA)
2010 annual conference saw no end to the gold rally any time soon.
Conference delegates
submitted electronically their individual estimates on where the price
of gold
was likely to be in September 2010, giving a forecast of $1,406 an
ounce, with
32% expecting around $1,500. The forecast of $1,406 an ounce was
actually reached
on November 8, 2010.
In the 12 months before September 2010, gold price had risen
by 30% against a backdrop of volatile currencies, stocks and bonds and
market doubt
over the resilience of the global economy. With investors looking to
protection
against potential inflation, or even deflation, many analysts have also
said
that gold would be a viable investment for either scenario only if
central banks
stop manipulating its market price. November
25, 2010
