Tweet
The Law of One Price applies to gold, not labor
Throughout history, gold has been regarded as fungible and indestructible. The Law of One Price applies to the global gold market denominated in US dollars because financial market deregulation has removed capital controls and 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 rate fluctuations 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 declining value of all fiat currencies when measured against gold will continue, albeit at difference rates, with an appreciation bias in favor generally of emerging economy currencies and specifically the yuan. As wages are paid in currencies, nominally rising wages will also decline against gold.
Gold - 28 years to recover its historical high
On January 21, 1980, gold hit its then historical high up to that time at $850 per ounce. Before then, 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 bullion. In addition, gold then remained below the 1980 peak for 28 years, to reach $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 know 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.
Various gold-related agreements are used in the trade. The 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.
The 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.
The Gold Deposit Forward Rate Agreement (GODFRA) is tailored particularly to central bank activities.
The Gold Offered Forward Rate (GOFO) is the rate at which dealers will lend gold against US dollars. Since July 1989, 12 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 am every business day, a mean is calculated automatically giving the market, in effect, a gold LIBOR (London Interbank Offered Rate). The gold lease rate is LIBOR minus the 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 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 the US District Court in Boston from 2000 to 2002.
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 Corp and JPMorgan 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 JPMorgan 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, JPMorgan Chase lent 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 JPMorgan 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 apparent 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 Corp.
In 2008, it produced 7.7 million ounces of gold at a cash cost of $443 per ounce. As of December 31, 2008, its proven and probable gold mineral reserves stood 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.
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) in Australia, Africa, North America and South America. It is 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.
The corporation has 25 operating mines and a pipeline of large, long-life projects 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 and the largest reserves 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 third-quarter 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 $1,600 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.
The 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 accumulated 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 were 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, the 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 such as 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 world's biggest "physical” gold market 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.
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 accounts 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.
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 the past 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 a full explanation 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 an 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.
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 demonetize 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 World War I in 1914.
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 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 continued 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 ฃ1-1s 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 per ounce of gold and Britain at ฃ3-17s-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, and so forth.
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 Franklin D 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 ฃ3-17s-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 four 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. For rest of article, part of the "China's dollar millstone" series, see History of monetary imperialism, Asia Times Online, September 26, 2008.)
Dollar hegemony
As the United States has been the issuer of the primary reserve currency for globalized international trade since the end of World War II, and as the dollar had become a fiat currency since president Richard 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.
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 resulting 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 highs.
Delegates polled at the London Bullion Market Association 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, the 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.
Next: Central banks and hold
Henry C K Liu is chairman of a New York-based private investment group. His website is at http://www.henryckliu.com.
http://www.atimes.com/atimes/Global_.../LL03Dj03.html
Throughout history, gold has been regarded as fungible and indestructible. The Law of One Price applies to the global gold market denominated in US dollars because financial market deregulation has removed capital controls and 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 rate fluctuations 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 declining value of all fiat currencies when measured against gold will continue, albeit at difference rates, with an appreciation bias in favor generally of emerging economy currencies and specifically the yuan. As wages are paid in currencies, nominally rising wages will also decline against gold.
Gold - 28 years to recover its historical high
On January 21, 1980, gold hit its then historical high up to that time at $850 per ounce. Before then, 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 bullion. In addition, gold then remained below the 1980 peak for 28 years, to reach $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 know 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.
Various gold-related agreements are used in the trade. The 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.
The 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.
The Gold Deposit Forward Rate Agreement (GODFRA) is tailored particularly to central bank activities.
The Gold Offered Forward Rate (GOFO) is the rate at which dealers will lend gold against US dollars. Since July 1989, 12 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 am every business day, a mean is calculated automatically giving the market, in effect, a gold LIBOR (London Interbank Offered Rate). The gold lease rate is LIBOR minus the 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 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 the US District Court in Boston from 2000 to 2002.
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 Corp and JPMorgan 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 JPMorgan 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, JPMorgan Chase lent 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 JPMorgan 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 apparent 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 Corp.
In 2008, it produced 7.7 million ounces of gold at a cash cost of $443 per ounce. As of December 31, 2008, its proven and probable gold mineral reserves stood 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.
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) in Australia, Africa, North America and South America. It is 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.
The corporation has 25 operating mines and a pipeline of large, long-life projects 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 and the largest reserves 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 third-quarter 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 $1,600 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.
The 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 accumulated 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 were 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, the 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 such as 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 world's biggest "physical” gold market 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.
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 accounts 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.
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 the past 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 a full explanation 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 an 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.
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 demonetize 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 World War I in 1914.
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 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 continued 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 ฃ1-1s 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 per ounce of gold and Britain at ฃ3-17s-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, and so forth.
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 Franklin D 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 ฃ3-17s-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 four 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. For rest of article, part of the "China's dollar millstone" series, see History of monetary imperialism, Asia Times Online, September 26, 2008.)
Dollar hegemony
As the United States has been the issuer of the primary reserve currency for globalized international trade since the end of World War II, and as the dollar had become a fiat currency since president Richard 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.
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 resulting 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 highs.
Delegates polled at the London Bullion Market Association 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, the 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.
Next: Central banks and hold
Henry C K Liu is chairman of a New York-based private investment group. His website is at http://www.henryckliu.com.
http://www.atimes.com/atimes/Global_.../LL03Dj03.html