Development Through Wage-Led Growth
Henry C.K. Liu
Part I: Stagnant Worker Income Leads to Overcapacity
Part II: Gold Keeps Rising as Other Commodities Fall
Part III: Labor Markets de-linked from the Gold Market

This article appeared in AToL on December 3, 2010


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 between  1970-72, 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 of  different 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 Morgan Chase 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 than the 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.

In a 2008 article: History of Monetary Imperialism, I wrote:
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