Saturday, January 29, 2011

Who is Draining GLD?

Actual GLD Vault

There seems to be a misunderstanding in the gold market that when you buy or sell shares of GLD you are putting pressure on the price of gold. That selling shares of GLD into the exchange is somehow analogous to selling physical into the marketplace. Or that buying shares of GLD is somehow, somewhere down the chain, removing physical gold from the marketplace.

We often look at apparent correlation and assume a certain cause and effect. GLD is designed to track the price of gold. It is not actively managed to track the price of gold. Instead, it does so through opportunities that arise whenever it doesn't. Imagine GLD as a big lump of gold just sitting there in Town Square. The price of gold is "discovered" elsewhere and shares in this big lump just trade based on that elsewhere-discovered price. If the share price is too high, then an opportunity exists to sell your share and buy "gold" elsewhere. Likewise, if it is too low, there is an opportunity to sell elsewhere and buy into this lump on display.

Occasionally, lately, someone comes along and shaves a chunk off of the lump, reducing its overall size. And financial reporters and analysts everywhere are struggling to correlate the price of gold and the GLD holdings with some semblance of cause and effect:
The Street – Alix Steel

Gold prices were breaking even after another double-digit selloff Tuesday as investors dumped their holdings. The SPDR Gold Shares exchange-traded fund dropped more than 30 tons of gold on Tuesday.

Traders in Asia reported strong physical gold buying, particularly from China, on Friday, but large bullion-backed exchange-traded funds continued to see outflows.
Reuters - Amanda Cooper and Jan Harvey

But investor sentiment towards gold has soured in the last few sessions, as evidenced by the largest one-day outflow in three months from the world’s biggest exchange-traded gold fund. Holdings in the SPDR Gold Trust fell 10.926 tonnes to 1,260.843 tonnes on Jan 24.
Funny. When we're talking about gold, an outflow to one person is an inflow to another, is it not? Randy Strauss at rightly responded to these silly reports with the truth [emphasis mine]:

RS View: Silly reporters. Instead of calling these “outflows” from the ETFs, it should be called what it is — a redemption of a basket of shares for physical gold by the Authorized Participants (e.g. bullion banks). Such share redemptions would actually be a bullish sign because it entails a reduction in the global supply of paper gold while at the same time signifying a preference by the redeeming party for having the metal over the ETF shares. That is, of course, unless the drawdown in physical gold merely represented the routine sales of the gold inventory that occur to cover the ETF’s administrative expenses.

RS View: I’ve said it before and I’ll say it again now, the reporters are getting it wrong when they equate outflows of gold from the ETFs with “sour” investor sentiment. What they need to work harder to understand is that these are NOT actively managed funds whose gold inventory is tweaked to ebb and flow based on public sentiment in the shares. Instead, the ETFs are more like a central coat-check room in which the various bullion banks have temporarily hung out their own inventories (i.e., meaning, their unallocated stock which they hold loosely on behalf of their depositors). And whereas the claim tickets (ETF shares) may freely circulate on the open market, any significant outflow of physical inventory is simply and primarily indicative of a bullion bank reclaiming the original inventory based on a heightened need or desire for physical metal in a tightening market — for example, to meet the demands emerging from Asia.

Here's another one. I found this to be an interesting post, even though the blogger is toeing the same line as the reporters above [emphasis mine]:

Gold Bubble?

Usually in a bubble, investors are holding a bag.

Investors have been net sellers of about 100 tonnes in the last 7 months. The IMF has disposed of another few hundred tonnes. Yet gold price is higher by around 10% in the same period.

To put this into context, since December 21st alone, 2.2M ounces have been sold from the ETF, basically a bit more than an entire quarter of production from Barrick gold (the world's largest producer). The normal run rate of global recycling plus mine production is approximately 2.95M ounces per month. So in the same period, assuming GLD was the only source of outflow, total global absorbed gold supply was 5.15M ounces. If outflows continued at the current rate, the GLD ETF (the largest investor depository of gold by far) would have no gold in 18 months.

Supply increased 75% in the short term to see price only fall 4.5%.

Someone else is doing the buying, clearly.

2.2M ounces is more than 68 tonnes... since December 21! Who is taking this stuff?

Now here's a bloodhound that might be on to a scent worth following. Lance Lewis, in his subscriber newsletter, follows what he calls "the GLD puke indicator" which tracks GLD physical gold regurgitations [emphasis mine]:

Just in case anyone missed it in last night’s letter, our GLD puke indicator that has nearly a flawless record at marking lows in gold triggered a buy signal yesterday after the ETF spit up 31 tonnes (and some blood) to trigger a 2.48% decline in its bullion holdings.

As we’ve noted before, one-day declines in the holdings of this ETF of over 1% have tended to be capitulatory in nature and have typically occurred near important lows in the gold price during gold’s secular bull market.

Consider that since the GLD ETF’s creation back in 2004, it has seen 1%+ one-day declines in its bullion holdings only 41 other times. When one goes back and looks at where these declines in bullion holdings have occurred, virtually all of them occurred “at” or were “clustered at” important lows in the gold price.

When we update this familiar (see above) chart for today’s 1%+ decline in bullion holdings, we can once again see where I have labeled the past eleven 1%+ declines in the ETF’s bullion holdings (plus today’s decline) with red dots and then placed a corresponding white dot below the price of GLD in order to show where that decline (or clusters of declines, as was the case in 2008) occurred relative to the price of the GLD, which is obviously tied to spot gold.

You will recall that we most recently used this indicator back on July 28th, 2010 in order to identify what was then the summer low in the gold price, and we used it again on October 7th, 2010 to recognize that a sudden 1 percent slide in gold from an all-time high was actually a just a one-day setback that led to new all-time highs being hit once again just a few days later.

The pattern you see emerge after today’s 1%+ puke, just as on those prior occasions, is that these “pukes” of bullion by the GLD ETF have always tended to occur at or very close to important lows in the gold price, and declines of over 2% have only occurred at MAJOR lows, such as the two major lows that were hit in 2008.

Note that one of those lows on September 9, 2008, which is the closest in size to today’s puke, also occurred just one day before a 5-day short squeeze/meltup of 30 percent in the gold price that kicked off on September 12, 2008. Perhaps the remaining shorts in the gold market will now pay a similar price for betting against a bull market?

Perhaps history will repeat and perhaps it won’t with respect to such a short squeeze, but given this indicator’s near flawless record at marking lows in gold, it's not to be ignored.

What we appear to have here is a severely tight noose around the supply of Bullion Bank deliverable physical gold at a time when the Giants are chomping it up! Bullion Banks have many means at their disposal to shuffle around a globally limited quantity of gold reserves and get it to where it needs to go. Especially when "important clients," like those in the East or Middle East, come calling for physical delivery or allocation.

Upon getting requests from unallocated depositors for either outright withdrawal, or more simply for transfer into allocated accounts, any Bullion Bank has options. Yes, it can seek to acquire (through borrowing or purchase) the requisite ETF shares for redemption of a "basket" in its special capacity as an Authorized Participant of GLD, or it can pursue alternate avenues such as buying gold on the open market or, better still, borrowing it from either its own unallocated pool of deposits or turning to other members in the BB fraternity to borrow the adequate quantity to cover the immediate needs. Whatever combo is deemed most efficient or cost-effective is what the bank will do.

But what if those other options are disappearing faster than a sack of currency left on the COMEX trading floor? If gold (in size) on the open market is scarce, the unallocated pool is spoken for (in other words, undergoing allocation) and the fraternity brothers are all suffering the same noose, what do you think becomes the most efficient and cost-effective option? Raiding the GLD reservoir perhaps?

Did you even know that you could take physical delivery from GLD? Apparently many didn't. I was just chatting (online) with one of my supporters yesterday, let's call him "Small Giant" (a term explained in my last post) because he is in that eight figure savings bracket that might find this information useful. On top of that, he makes his living assisting funds in their management of eleven figures.

So he says to me:

Small Giant [6:10 P.M.]: I think very very few people realize that you can convert GLD shares to actual physical
Small Giant [6:10 P.M.]: can't say I know of anyone who has ever done that

Okay, let me back up.

Small Giant [5:47 P.M.]: there is clearly panic in the ranks of the longs
FOFOA [5:47 P.M.]: The more it goes down, the bigger the pressure on physical. I think the draw down in GLD suggests other options for physical delivery in size are gone.
Small Giant [5:47 P.M.]: I agree
FOFOA [5:49 P.M.]: With $13 million, you could take possession of a basket of physical from GLD at a good price.
Small Giant [5:49 P.M.]: what is the minimum threshold?
FOFOA [5:50 P.M.]: 100,000 shares is a basket. Must be redeemed through an "Authorized Participant"...
Small Giant [5:50 P.M.]: wow this is getting very very interesting
FOFOA [5:50 P.M.]: Authorized Participants are: BMO Capital Markets Corp., CIBC World Markets Corp., Citigroup Global Markets Inc., Credit Suisse Securities (USA) LLC, Deutsche Bank Securities Inc., EWT, LLC, Goldman, Sachs & Co., Goldman Sachs Execution & Clearing, L.P., HSBC Securities (USA) Inc., J.P. Morgan Securities Inc., Merrill Lynch Professional Clearing Corp., Morgan Stanley & Co. Incorporated, Newedge USA LLC, RBC Capital Markets Corporation, Scotia Capital (USA) Inc., and UBS Securities LLC
Small Giant [5:51 P.M.]: so how would that work?
Small Giant [5:51 P.M.]: you buy 100K shares of GLD
Small Giant [5:51 P.M.]: then what?
FOFOA [5:53 P.M.]: You've got to go to one of those APs and have them create a basket for you. That gold is then transferred from the GLD allocated account into your broker's unallocated account. Then you redeem your basket and have your broker allocate the gold to you.
Small Giant [5:54 P.M.]: so it's really is that easy?
FOFOA [5:55 P.M.]: I'm working on a post tentatively called "Who is Draining GLD" using a lot of snips from the prospectus. The entire world of confused financial analysts is misinterpreting the GLD inventory reduction as if it is gold negative. But it is precisely the opposite. GLD doesn't buy gold when it's going up and sell when it's going down. Doesn't work that way. But that's what everyone thinks.
FOFOA [5:57 P.M.]: GLD might be the last reservoir for the giants to drink from. That's my Thought of the day. Because there should be easier ways to buy a tonne of gold.
Small Giant [5:58 P.M.]: u lost me
Small Giant [5:59 P.M.]: count me as a confused financial analyst

So after this chat I started thinking that I should write this post for other "small giants" out there that might be looking for tonnes of physical at a good, off-market price.

Does anyone remember the Jim Rickards comment I quoted in Open Letter to EMU Heads of State? Here it is:

"One point that does not get enough attention is the impact of size in the physical market. It’s one thing to say that COMEX is $1,100 per ounce and physical might be $1,200 per ounce for one metric tonne if you can find it. But what about 100 tonnes? 500 tonnes? Physical orders of that size are impossible to execute outside of official channels. Size of order is relevant in any market but I have never seen a market (short of a full blown manipulation or short squeeze) with as much price inelasticity as physical gold which is why the buy side overhang keep their intentions to themselves."

Now you are probably thinking, "why bother with GLD where a minimum "basket" is a whopping 100,000 shares (around 10,000 ounces) for $13 million dollars when you can take delivery of as little as a 400 ounce "LGD bar" from Eric Sprott's PHYS for just over a half million dollars?" If you thought that, then you are not thinking like a Giant. Read Jim Rickards' comment again. Giants like to keep their intentions to themselves. Why? Because they prefer to buy in off-market transactions – ones that do not influence the price of gold – in order to maximize the number of ounces they receive for their normally market-moving quantities of currency. They know that the size they want to convert would move the price, and then they would get less gold for their money.

Now let's compare PHYS with GLD and try to think like a real Giant for a minute.

The one day drain from GLD just the other day was larger than the entire PHYS ETF by more than 5 tonnes. So what would have completely emptied the Sprott warehouse was only 2.48% of GLD. The amount drained from GLD since Dec. 21st was 268% of Eric Sprott's PHYS. And what has it caused but barely a blip on the radar? Can you imagine the fuss (or price explosion!) if one single billionaire decided to clean out PHYS? That's right. PHYS represents maybe one real Giant. That's not exactly a "reservoir" for the giant class to drink from.

If you are a Giant, or even a Small Giant, you should know about this off-market opportunity to take giant amounts of physical into your possession at a good price. And you should know this before it is all gone. As my Small Giant friend wrote, "very very few people realize that you can convert GLD shares to actual physical." He didn't know until yesterday. But it's all there in the prospectus. It tells you how to do it, and who to contact to get it done. If one of the Authorized Participants refuses your business, just call the next one on the list. There are 16 of them!

I am reposting portions of the prospectus from the SPDR Gold Shares (GLD) website right here. It may seem like a lot to read, but trust me, this is a highly abbreviated version of the 46 page prospectus. This is actually from the reader-friendly "FAQ" section of the website, although some of it comes directly from the prospectus. This is all you really need to know!


8.Can you take physical possession of the gold?
The Trustee, Bank of New York, does not deal directly with the public. The trust handles creation and redemption orders for the shares with Authorized Participants, who deal in blocks of 100,000 shares. An individual investor wishing to exchange shares for physical gold would have to come to the appropriate arrangements with his or her broker.

14.How is the gold price set?
The spot price for gold is determined by market forces in the 24-hour global over-the-counter (OTC) market for gold. The OTC market accounts for most global gold trading, and prices quoted reflect the information available to the market at any given time. The spot price can be found on:

The London Bullion Market Association (LBMA) has about 70 full members, as well as many associate members. Twice daily during London trading hours the ten market making members of the LBMA fix a gold reference price for the day’s trading. These prices are based upon the actual buy and sell orders for gold in the global OTC market. A good analogy for the London fix versus OTC trading would be to consider the London fixes similar to opening/closing prices for stocks and to consider the spot price for gold as the continuous market price throughout the trading day.

The COMEX division of the New York Mercantile Exchange (NYMEX) is a futures and options exchange that acts as a marketplace to trade futures and options contracts on metals, including gold. Gold futures contracts typically trade at a premium to the spot price. Further discussion can be found in the prospectus.

15.What is the relationship between the GLD Net Asset Value, the GLD share price and the gold spot price?
The investment objective of the Trust is for the value of the shares to reflect the price of gold bullion, less the expenses of the Trust’s operations.

The Net Asset Value (NAV) of the Trust is determined by the Trustee each day that the NYSE Arca is open for regular trading. The NAV of the Trust is calculated based on the total ounces of gold owned by the Trust valued at the Gold London PM fix of that day plus any cash held by the Trust less accrued expenses. The NAV of each GLD share is the NAV of the Trust divided by the total number of shares outstanding.

The gold spot price is determined by market forces in the 24-hour global over-the-counter market for gold and reflects the information available to the market at any given time. The Indicative Intraday Value per GLD share published on the website is based on the mid-point of the bid/offer gold spot price adjusted for the Trust’s daily accrued expenses.

The NYSE Arca is an electronic exchange which displays orders simultaneously to both buyer and seller. Once orders are submitted, all trades are executed in the manner designated by the party entering the national best bid or offer. The buy and sell offers are posted on NYSE Arca in price order from best to worst and if the prices match up, they are ordered based on the time the buy order or sell order was posted (earliest to latest). These prices reflect the supply and demand for shares which is influenced by factors including the gold spot price and its impact on the NAV.

20.How is gold transferred to or withdrawn from the Trust?
The Bank of New York Mellon, as trustee of the Trust, or the Trustee, and the Custodian have entered into agreements which establish the Trust’s unallocated account and the Trust’s allocated account. The Trust’s unallocated account is principally used to facilitate the transfer of gold between Authorized Participants and the Trust in connection with the creation and redemption of Baskets (a “Basket” equals a block of 100,000 SPDR® Gold Shares). The Trust’s Authorized Participants are the only persons that may place orders to create and redeem Baskets and, in connection with the creation of Baskets, are solely responsible for the delivery of gold to the Trust. The Trust never purchases gold in connection with the creation or redemption of Baskets or for any other reason. All gold transferred in and out of, and held by, the Trust must comply with the rules, regulations, practices and customs of the LBMA, including “The Good Delivery Rules for Gold and Silver Bars.” The specifications of a London Good Delivery Bar are discussed below. The Trust’s unallocated account is also used to facilitate the monthly sales of gold made by the Trustee to pay the Trust’s expenses.

Except when gold is transferred in and out of the Trust or when a small amount of gold remains credited to the Trust’s unallocated account at the end of a business day (which the Custodian is directed to limit to no more than 430 ounces), the gold transferred to the Trust is held in the Trust’s allocated account in bar form. When Baskets are created or redeemed, the Custodian transfers gold in and out of the Trust through the unallocated accounts it maintains for each Authorized Participant and the unallocated and allocated gold accounts it maintains for the Trust. After gold has been first credited to an Authorized Participant’s unallocated account in connection with the creation of a Basket, the Custodian transfers the credited amount from the Authorized Participant’s unallocated account to the Trust’s unallocated account. The Custodian then allocates specific bars of gold from unallocated bars which the Custodian holds, or instructs a subcustodian to allocate specific bars of gold from unallocated bars held by or for the subcustodian, so that the total of the allocated gold bars represents the amount of gold credited to the Trust’s unallocated account to the extent such amount is representable by whole bars. The amount of gold represented by the allocated gold bars is debited from the Trust’s unallocated account and the allocated gold bars are credited to and held in the Trust’s allocated account. The process of withdrawing gold from the Trust for a redemption of a Basket follows the same general procedure as for transferring gold to the Trust for a creation of a Basket, only in reverse.

The Custodian updates its records at the end of each business day (London time) to identify the specific bars of gold allocated to the Trust and provides the Trustee with regular reports detailing the gold transfers in and out of the Trust’s unallocated account and the Trust’s allocated account. The Trust’s website includes a list of the gold bars held in the Trust’s allocated account. The list identifies each bar by bar number, brand, weight, fineness and fine weight and is updated once a week.

21.Who are the Trust’s Authorized Participants and what is their function?
Authorized Participants are the only persons that may place orders to create and redeem Baskets; the Trust does not deal directly with individual investors. Authorized Participants must be (1) registered broker-dealers or other securities market participants, such as banks and other financial institutions, which are not required to register as broker-dealers to engage in securities transactions and (2) Depository Trust Company (DTC) participants. Each Authorized Participant must establish an unallocated account with the Custodian in order to be able to process the gold transfers associated with creating and redeeming Baskets. Authorized Participants can place an order to create or redeem one or more Baskets on every day the NYSE Arca is open for trading. The Trust issues new Baskets to Authorized Participants in exchange for their delivery of gold to the Trust upon a creation and transfers gold to Authorized Participants in exchange for their delivery of Baskets to the Trust upon a redemption. In creating or redeeming Baskets, Authorized Participants may act for their own accounts or as agents for broker-dealers, custodians and other securities market participants that wish to create or redeem Baskets. An order for one or more Baskets may be placed by an Authorized Participant on behalf of multiple clients. A list of the Trust’s current Authorized Participants may be found in the Annual Report or Prospectus of the Trust most recently filed with the Securities and Exchange Commission.

22.What is an unallocated account?
An unallocated account is an account with a bullion dealer, which may also be a bank, to which a fine weight amount of gold is credited. Transfers to or from an unallocated account are made by crediting or debiting the number of ounces of gold being deposited or withdrawn. As gold held in an unallocated account is not segregated from the bullion dealer’s assets, credits to an unallocated account represent only the bullion dealer’s obligation to deliver gold and do not constitute ownership of any specific bars of gold. The account holder is entitled to direct the bullion dealer to deliver an amount of physical gold equal to the amount of gold standing to the credit of the account holder. When delivering gold, the bullion dealer allocates physical gold from its general stock to the account holder with a corresponding debit being made to the amount of gold credited to the unallocated account.

The Trust’s unallocated account is only used for the transfer of gold to and from the Trust’s allocated account.

23.What is an allocated account?
An allocated account is an account with a bullion dealer, which may also be a bank, to which individually identified gold bars owned by the account holder are credited. The gold bars in an allocated account are specific to that account and are identified by a list which shows, for each gold bar, the refiner, assay or fineness, serial number and gross and fine weight. The account holder has full ownership of the gold bars.

The Trust’s allocated account is only used for holding the allocated gold bars of the Trust.

26.Is the Trust’s gold ever traded, leased or loaned?
Gold held in the Trust’s allocated account in bar form or credited to the Trust’s unallocated account is the property of the Trust and is not traded, leased or loaned under any circumstances.

And from the latest 10K filed with the SEC, here is the list of the current Authorized Participants [emphasis mine]:

Authorized Participants may act for their own accounts or as agents for broker-dealers, custodians and other securities market participants that wish to create or redeem Baskets. An order for one or more Baskets may be placed by an Authorized Participant on behalf of multiple clients. As of the date of this report:

BMO Capital Markets Corp.
CIBC World Markets Corp.
Citigroup Global Markets Inc.
Credit Suisse Securities (USA) LLC
Deutsche Bank Securities Inc.
Goldman, Sachs & Co.
Goldman Sachs Execution & Clearing, L.P.
HSBC Securities (USA) Inc.
J.P. Morgan Securities Inc.
Merrill Lynch Professional Clearing Corp.
Morgan Stanley & Co. Incorporated
Newedge USA LLC
RBC Capital Markets Corporation
Scotia Capital (USA) Inc.
UBS Securities LLC

…have each signed a Participant Agreement with the Trust and may create and redeem Baskets as described above. Persons interested in purchasing Baskets should contact the Sponsor or the Trustee to obtain the contact information for the Authorized Participants. Shareholders who are not Authorized Participants will only be able to redeem their Shares through an Authorized Participant.

So now I offer up a scenario, not as a statement of fact, but as fodder for thought and discussion. In this scenario I am not assuming that the drain on GLD to date has been the direct redemption of ETF shares by Giants. I presume it is simply redemptions by Bullion Banks in order to meet the delivery demands of "important clients," real Giants, perhaps from Asia and the Middle East. And because the BBs would normally have better options than plundering GLD, I am assuming those options are either gone or far more problematic than legalized looting.

Also, following Lance Lewis' "puke indicator," one could be forgiven for suspecting that the Bullion Banks have some way to temporarily "pound" the price of gold down on the COMEX in order to buy back ETF shares during a "good price window" with the intention of redeeming those shares into deliverable gold for clients that purchased it at a higher price. Perhaps it would take, what, a month or so to churn such a profit from a Giant delivery? Reminds me of that fella Jim Rickards spoke of on King World News:

Jim Rickards - Swiss Bank Client Denied His $40 Million in Gold

Jim: “Correct and upon request to move the gold...the bank demurred, the bank said, ‘Well, no, not so fast’ and he said, ‘What do you mean?’ Anyway, long story short I could see that taking a day or two...This took thirty days to complete delivery. Now if the gold is sitting there it shouldn’t take thirty days. Oh, and by the way I should add that the individual had to threaten to go public, in effect say I’ll call Reuters or I’ll call King World News or I’ll call Dow Jones and let them know that you don’t have the gold, you’re not good for it.”

Eric: "And he had his lawyers get involved?"

Jim: “Correct, and through all of that eventually the individual did get his gold, but this is something that should have taken two days, three days, a week at the most, although I would say even a week is a long time. But it took thirty days, and it took lawyers, it took threats of publicity, it took a lot of pressure to do that, which my inference is that that gold was not there. The bank had to scramble, go out and find it somewhere before they could make good delivery.”

I wonder when that was. And I wonder if GLD "puked" any "baskets" around that time.

Someone is draining GLD of its gold. Someone is taking in millions of ounces and tonnes of physical gold at off-market prices while the paper bug cheerleaders call it "dumping" or "offloading" the gold. Again, one man's "outflow" is another man's pickup truck (or dump truck as the case may be) backed right up to the loading dock at the GLD depository.

As of 2008, some analysts estimated there were still 15,000 tonnes of unallocated (un-spoken-for) gold floating around the Bullion Banking system. Of course some of that is still there, along with a decreasing supply from the mines and a scrap supply that, after rising since 2006, appears to have plateaued in 2010. You can continue to go after that diminishing flow "on market" by playing the paper game like Dan Shak. But one day soon, it will all be spoken for. And you don't want to be left holding only paper on that day. And if the BBs are raiding GLD like it seems, that 15,000 tonnes may be closer to 1,200 tonnes than you or I would be comfortable knowing about.

Jim Rickards wrote about 100 tonne and 500 tonne lots being impossible to come by "outside of official channels" meaning off-market prices. But from what I can tell, there are still twelve 100 tonne lots or two 500 tonne lots available through one of the 16 dealers listed above. The instructions are all there. This isn't like the private sector trying to buy gold from the public sector, like Sprott being turned down by the IMF. This is the reverse! Go for it, I say. Why not?

And for those of you GLD fans that think you will simply hold onto your shares until the bitter end, I have a warning for you. These Giants don't need to over-bid your shares away from you. They can always buy them at the price of paper gold trading in London and New York. And there will come a point when you are watching the premium on physical coins jump from 5% over GLD to 50% on its way to 500% over the paper gold price. How long are you going to stubbornly hold onto your precious paper before you finally relinquish it to that last Giant's delivery "basket?" Remember, unless you've got $13 million, you've only got paper.


Wednesday, January 19, 2011

Freegold Foundations

It has been fun to stumble across a number of sites where readers are attempting to explain my writings to others. It feels a little weird, yet pleasing. Some of you are amazingly apt at this difficult undertaking. While others I have seen fall a little short of the mark that I strive to hit. It's tough. Freegold is a deep subject with new angles each new way you look at it. I am constantly discovering this myself. And I know that a few of you know exactly what I'm talking about, while others are wondering whether old FOFOA has slipped off his rocker and scrambled his noodle.

So I thought it would be helpful to both me and you if we explore a few of the more fundamental angles (for lack of a better term) on Freegold. I am the originator of none of the conceptual perspectives I will present in this post. They all come from a few others, primarily FOA, but also Aristotle and others.

Someone wrote in the comments that I use "woolly language" (smile), meaning, I suppose, that I am unclear at times. I can only respond that I teach this thing just as I understand it. If it is not simple enough for you, then perhaps that's a reflection of your own special needs more than of the subject or presentation.

That said, in this post I will attempt to develop precise definitions where possible. But do not confuse precision with universality. If you find yourself emotionally in conflict with my words, I would point out that they are being delivered in a cold (whilst warm and inviting) calculated manner. Emotions – and/or pretentious moral judgment – have no place in this discussion. Check your ego and your dogma at the door, for none of these concepts carry a universal definition. My definitions offered here are for the purpose of this post, which is to help you understand Freegold. It could be said that my definitions are the proper ones for understanding what is actually unfolding right in front of us. If said, I would probably have to agree with that statement.

I will also tackle the term Freegold itself. What does the "free" in Freegold portend? This is an important question. More on it in a moment.


I'm not going to go into great detail on the concept of capital, other than to give you a mental exercise. Because the term "capital" can be quite confusing in our modern paper/electronic world, I want you to imagine a much simpler human civilization. Imagine an ancient Greek city. All the buildings made of stone and mud, the horse carts and agricultural tools, the linens and skins worn as clothing, the knowledge base passed down through generations; all these creations of man's intellect were the capital of the time.

Now imagine the destruction of capital. Imagine an earthquake or volcano that destroys the fruits of many generations. Or a plague or war, perhaps, that destroys the knowledge base. That's the loss of real wealth you are imagining. And it is this cycle of capital creation and destruction that tells the story of mankind throughout many civilizations.

In modern economics, the word "capital" accounts for many specific things. But I think it is helpful to consider this word in a more basic, fundamental way. Think of it in terms of capital creation, capital employment and capital consumption or destruction. Modern economics would not call consumables capital, which is why I am suggesting a different approach to the word. When we are productive, imagine we are creating this thing called capital. We may figure out a way to turn someone else's capital, combined with our own prowess, into more capital. This would be the employment of capital. And sometimes we simply consume it, or use it up.

If I build a house I have created capital. By owning and living in a home, I am consuming that capital slowly. If I were to buy a specialized tool and use it to make something new, then I have employed capital to create more capital. Is this view of "capital" clear, or woolly?


Savings are the result of one's production being greater than his consumption. Saving is the convention for deferring the fruits of capital creation—earned consumption—until later. Savings is also the way we hand off capital to the next person who will use it to create more capital. And when it is done right, saving results in the accumulation of capital throughout society at large. When it is done poorly, saving results in the aggregate destruction of capital through frivolous consumption and mal(bad)investment (the misguided employment of capital) resulting in unsustainable infrastructures built on unstable levered foundations.

Here's where it may get a bit counterintuitive. You might, if you were Charlie Munger, think that the best way to pass your earned capital on to another producer is through paper. If you save in paper notes then you are loaning your earned capital to the next producer in line, right? And if you buy gold Charlie says you're a jerk, even if it works, because he thinks you are pulling capital out of the system. But are you really? I bring this up (and please watch a minute or so of that video starting at 1:04:05) because it is the key to this discussion about savings.

We should think about the global economy in terms of production and consumption in the physical realm as opposed to the financial or monetary realm, what I like to call the physical plane versus the monetary plane. A "net producer" produces more capital than he consumes. Likewise, a "net consumer" consumes more than he produces. The global aggregate is generally net-neutral on this production-consumption continuum. I say "generally" because there are times of expansion and times of contraction, so taking time into account, we are "generally" net-neutral (or close to it) as a planet. At least that's the way it is under the global dollar reserve standard.

On the national scale, however, we are all both blessed and cursed by the presence of government. Governments are always net consumers, as it is their very job to redistribute part of our private savings into the infrastructure and secure environment that enables us to produce capital in the way that we do. Government's job is not to produce capital, but to enable and support the private production (and accumulation) of capital!

Being such that human society has evolved in this way, we private citizens must, in aggregate, be net producers so that government can net consume. And we become net producers by saving. Therefore we enable and support our own future net productivity by saving some of our past production of capital today, in the form of savings.

The financial system is really just the monetary plane's record-keeper of this vital process that actually takes place on the physical plane. In its modern incarnation, the global financial system has allowed for a strange international balancing act whereby (literally) one whole side of the planet's net production has allowed the other side to net-consume for decades on end. But this is an unsustainable anomaly, and it is beside the point of this discussion. So please push this giant, global imbalance-elephant in the room over to the corner while we continue this discussion about savings.

The question we must answer here is: Is Charlie Munger right? Are you a good person only if you put your savings into paper where it can be easily redistributed, and a jerk if you buy gold, depriving the paper whores of your savings? Is this the way it works in reality? Or is this simply the sales pitch of one with great bets riding on the continued popularity of paper savings?

The government confiscates a portion of the physical capital created in the private sector through several means. Taxation is one way, forcing you to keep a portion of your earnings in paper so that it can be easily transferred to the government and then used to buy up capital from the marketplace. This forces you to leave some of your production in the marketplace to be taken by the government, preventing you from consuming an amount equal to your productive output.

Printing money, or its modern equivalent, quantitative easing, is another way the government can confiscate real capital from the marketplace without first producing a commensurate amount. This method inflicts what we call "the inflation tax." The "victims" of this confiscation are anyone and everyone holding (and saving) the currency or any paper asset fixed to it, and the damages are relative to the amount of currency each "victim" is holding. Because this form of confiscation is spread so wide and thin, it is mostly not even noticed by the private sector.

The last way the government confiscates capital is by borrowing it directly from the net producers in the private sector. When you buy US bonds, it is you that are loaning your earned claims on capital to the government. So we can see that the government has plenty of ways to create its own claims on capital in the marketplace without first producing a commensurate market contribution (because governments are always net consumers).

In fact, the modern financial system has bestowed these same powers, creating market claims without contribution, upon the private sector as well. I'm not talking about private banks loaning money into existence, for this process has no market contribution from which to feed. It is directly price inflationary until the debtor makes a market contribution to work it off.

What I'm talking about is the private sector's ability to sell unlimited amounts of this debt to the savers, funding the marketplace claims to consumers/debtors with real marketplace capital (contributed by the savers). Private banks that would normally be constrained by their balance sheets for their own survival can now offload that constraint onto the net producers, making themselves—the banks—totally unconstrained.

The banking system sells all kinds of packaged debt to net producers, the savers. It creates this stuff at will to meet demand. And if necessary, it drums up new debtors one way or another to keep this stuff financially funded. Even corporations can dilute their paper shares to take in new claims from the savers without giving up a commensurate marketplace contribution.

This is the process of paper savings hyperinflation. It is a self-feeding, self-fulfilling, self-sustaining, self-propelling system that will ultimately lead to real price hyperinflation. When you produce capital and decide to leave it in the marketplace, postponing your earned consumption until later, and you do so in any paper investment, you are feeding this process of capital destruction through paper savings hyperinflation.

If you buy government debt you are feeding, enabling the growth of government beyond its most basic mandate, providing the infrastructure and secure environment that enables us to produce capital. And if you think an expanding government is good, just beware that all governments are stupid!

"The institution of government was invented to escape the burden of being smart. Its fundamental purpose is to take money by force to evade the market's guidance to have the privilege of being stupid." Richard Maybury goes on (in the linked video) to say that private organizations that petition government for special protections, subsidies and incentives are asking for the same privilege. They want to be relieved of the burden of being smart.

(Not since the Agriculture Adjustment Act of 1933 that paid farmers to destroy crops during the Great Depression in an attempt to raise the price of crops, has there been a more obvious example of government's propensity for destroying real world capital than the 2009 "Cash for Clunkers" program, whereby government literally paid private car dealerships to pour sugar into running car engines ensuring their permanent destruction.)

This is why, when you save in government paper, you are enabling malinvestment and the destruction of capital that goes along with it. And it's the destruction of the capital that you just contributed to the marketplace that you are feeding. The same goes for the private sector. When you save in private paper you are enabling the expansion of frivolous consumption (beyond natural market constraint) and the destruction of your capital contribution to the marketplace that goes along with it.

So what's the alternative? If both public and private paper savings contribute to the expansion of malinvestment, net-consumption and systemic capital destruction, what is a net producer to do? If one wants to produce more capital than he consumes—for the good of the economy—yet he doesn't want to work for free, what is he to do? Or if one wants to produce more than she consumes—for the good of her retirement years and her family's future—what is she to do?

The monetary plane, the modern dollar-based global financial system, has failed these individuals. So what is left? The physical plane? If these individuals trade their earned marketplace credits in for physical capital without employing that capital in productive enterprise, then they are either consuming that capital (capital destruction) or denying other producers the use of it (hoarding, also destructive to the capital creation process). This is not only detrimental to society at large, but also to the future value of your savings that depends on new capital being plentiful in the marketplace when you deploy your savings in the future.

But of course there is one item, one physical asset, that stands out above all the rest. And this isn't some new discovery by FOFOA. Man discovered that this was gold's highest and best use thousands of years ago. Once you've produced capital for the marketplace, whatever asset class you choose to deploy your earned credits into will feel the economic pressure to rise in price. If the monetary plane was volume-fixed (or even constrained), it too would rise in price as real capital is added to the economy. But it has become a system that expands in volume rather than rising in price.

This is hyperinflation: quantitative expansion of savings! If the pool of savings rose only in value and not quantity, then each new net producer would have to bid "savings" away from an old net producer, and "savings" would retain their proper relationship to the pool of real marketplace capital available for purchase.

If you choose to deploy your credits into the everyday physical plane, the tangible goods plane, prices will rise. If all the savers chose oil for example, we'd all pay very high prices at the gas pump. Or choose agriculture for your savings and we'll all have to work an extra hour to feed ourselves. No, you want to choose something that both rises in price (rather than expanding in volume) and also something that does not infringe on others or economically impede the capital creation process that feeds value to your savings. And as an added bonus, if everyone chooses the same thing, it works extra well. This is called the focal point.

But for gold to fulfill this vital function in the capital creation process, it needs to trade in a fixed (or at least constrained) quantity that will allow its price to rise every time a new capital net-increase is contributed to the marketplace. And, unfortunately, paper gold and fractional reserve bullion banking doesn't allow this process to work properly. In fact, it makes paper appear generally competitive, even to gold.

So what about Charlie Munger? Is he right? Are you a jerk if you buy gold? Well, yes and no. If he's talking about paper gold, then yes! But likewise, it seems you are a jerk if you buy Charlie's paper as well! And you're an even bigger jerk if you buy physical commodities and tangible goods without the intention of employing them in real economic activity. It seems—and correct me if I'm wrong here—that physical gold (along with a few other discreet collectible items like real estate, fine art, antique furniture, ancient artifacts, fine gemstones, fine jewelry and rare classic cars) may be the only true wealth holdings in which you are not a jerk. What do you think?

The Money Concept

Use of the term "money" in these discussions seems to be the root of most of the confusion we encounter. Especially for those of us who have spent our entire lives immersed in the last several decades of monetary confusion and change. And that would be all of us. I think it is therefore perfectly rational to define money as a concept rather than a physical thing.

So if money is a concept, then by definition it is an abstract idea or a mental symbol, sometimes defined as a "unit of knowledge," built from other units which act as its characteristics or elements. Currency is but one element of this concept. And the main characteristic of money is that it is a shared idea that enables economic activity and commerce.

Some of you like to imagine a utopian world without money (presumably to get rid of the bankers), where people freely exchange their goods and services with others and everyone sings cumbaya. I see this a lot. A beautiful, peaceful barter world! But what you are imagining is actually a world without currency, not one without money.

In this fantasy paradise you might exchange a service for a good, right? Or perhaps you would part with a good in exchange for a service from someone else. But how do you think the relative value would be determined in this world without currency? Of course "prices" would be abstract ideas or mental symbols, but surely you wouldn't pay someone for a car wash with the title to your car. So what would determine the relative value of a car wash versus a car in this Xanadu?

The answer is the concept of money. This is the ability, unique to humans, to use numbers, mental constructs, to relatively value the goods and services of barter in a way that enables economic activity and commerce. It is the enabler of economic activity and commerce. It is a primeval instinct.

FOA: So, you think we have come a long way from the ancient barter system; where uneducated peoples simply traded different items of value for what they thought they were worth? Crude, slow and demanding, these forms of commerce would never work today because we are just too busy?

Think again.

Lean back and think of all the items you can remember the dollar price for. Quite a few, yes? Now, run through your mind every item in your house; wall pictures, clothes, pots and pans, furniture, TVs, etc. Mechanics can think about all the things in the garage: tools, oil, mowers. If one thinks hard enough they can remember quite well what they paid for each of these. Even think of things you used at work. Now try harder; think of every item you can remember and try to guess the dollar value of it within, say, 30%. Wow, that is a bunch to remember, but we do do it!

I have seen studies where, on average, a person can associate the value of over 1,000 items between unlike kinds by simply equating the dollar price per unit. Some people could even do two or three thousand items. The very best were some construction cost estimators that could reach 10,000 or more price associations!

Still think we have come a long way from trading a gallon of milk for two loaves of bread? In function, yes; in thought no! Aside from the saving / investing aspects of money, our process of buying and selling daily use items hasn't changed all that much. You use the currency as a unit to value-associate the worth of everything. Not far from rating everything between a value of one to ten; only our currency numbers are infinite. Now, those numbers between one and ten have no value, do they? That's right, the value is in your association abilities. This is the money concept, my friends.

This is the concept of money. It is our shared, primeval ability to associate relative values of barter able goods and services. It cannot be destroyed by eliminating currency any more successfully than it can be bottled up and sold. It is an abstract unit of shared knowledge, not a thing. You can dispute this section based on your favorite writer's opinion about the term "money" or "honest money" all you want, but this is the proper way to view the concept of money in its original context and in order to understand Freegold.


So the "thing" in our modern monetary and financial system that is closest to the concept of "money," the holistic (largely mental and lately derivatized) concept, is the system of institutional bookkeeping accounts of credits and debts. The currency element, alternatively, provides you the "in your hand," "on the run," "money to go" element, so that discrete (and discreet!) "amounts" ("amount" being a truly strange concept as applied to such a non-dimensional item) of said money-system can be transferred among individuals conveniently while operating temporarily outside of the institutional monetary ledgers. (I realize I'm getting a little woolly here, but bear with me.)

Hence, gold was never "the money." It was only ever a barter item, or else a currency item. Similarly, the term "fiat money" seems somehow bogus. Money is a commercial and economic enterprise. It exists even in the absence of a functioning currency. The term "fiat" ought to apply only to the system of "currency" that the government has organized as a suitable non-dimensional yet unitized and standarized "on the go" representative hand(/wallet)-friendly form of "the money system."

"fiat money" = NO
"fiat currency" = YES

And for all the many reasons discussed on this blog, a worthless token fiat currency is a better systemic component than a precious gold currency. Gold is too precious to capital creation and accumulation in the savings function to be squandered in the currency role. And the CBs now know this too!

F A Hayek: I do believe that if today all the legal obstacles were removed… people would from their own experience be led to rush for the only thing they know and understand, and start using gold. But this very fact would after a while make it very doubtful whether gold was for the purpose of money really a good standard. It would turn out to be a very good investment, for the reason that because of the increased demand for gold the value of gold would go up; but that very fact would make it very unsuitable as money. You do not want to incur debts in terms of a unit which constantly goes up in value as it would in this case, so people would begin to look for another kind of money: if they were free to choose the money, in terms of which they kept their books, made their calculations, incurred debts or lent money, they would prefer a standard which remains stable in purchasing power.

I have not got time here to describe in detail what I mean by being stable in purchasing power, but briefly, I mean a kind of money in terms which it is equally likely that the price of any commodity picked out at random will rise as that it will fall. Such a stable standard reduces the risk of unforeseen changes in the prices of particular commodities to a minimum, because with such a standard it is just as likely that any one commodity will rise in price or will fall in price and the mistakes which people at large will make in their anticipations of future prices will just cancel each other because there will be as many mistakes in overestimating as in underestimating.

So, the point about currency is, and mainly for those of you that fret over a NWO currency, or "whatever currency," an Amero or SDR or euro-whatzit... chill TF out! Currency is no big deal. Currency is not the issue that matters here. What matters is what we, as a planet, choose to save.

RS Comment: So often in commentaries of this sort that propose a “solution”, the author is strangely obsessed with the notion of replacing the dollar (as a reserve currency unit) with simply another institutional emission of similar ilk (such as currencies of other nations, SDRs, bancors and whatnot). Their avoidance of any meaningful discussion of the most obvious remedy is almost pathological in the extreme. To be sure, we don’t need to invent any manner of universal reserve currency to fill the role of a unit of account because that role is already served in a fully functional capacity for any given country by its own monetary unit.

What IS desperately needed, however, is a universally respected reserve asset capable of filling our current void with a reliable presence that serves as a store of value. And far from needing to be conjured or created by complex international committees, that asset is already in existence and held in goodly store by central bankers and prudent individuals around the world — it’s known as gold. From amid the ruins of a chaotic financial crisis that was brought about by its own complexity, a degree of sanity will prevail, and gold as a freely floating asset will arise in stature as THE important element of global monetary reserves. The floating aspect is the vital evolutionary improvement over all previous structural monetary failures which tried to use a gold standard at a fixed price (i.e., unit of account) perversely joined to the very elastic money supply of any given country’s banking system.


Gold as a Barter Item

Hard money advocates, or as FOA and Aristotle dubbed them in jest, "Hard Money Socialists," will readily explain to you how gold naturally emerged as money in antiquity. But as FOA argued—in great detail—this is not really the case.

In antiquity, gold was merely a barter item, a physical good for trade. In some cases it was the best, most efficient barter item and in others it was not. For instance, within the locality of one's home, oil might be a more common barter item. Gold was reserved for "on the road" trade, because it carried the most exchange value in a portable item. But at home, you'd be more inclined to perform the labor required to create some of your own capital for trade rather than to part with some of your precious gold.

Eventually gold emerged as a common unit of account. But the physical stuff still wasn't money, or even currency. It was still just a (somewhat standardized) barter item and a physical store of value, an "asset," a "tradable wealth item." It is this role that gold is returning to today, believe it or not.

FOA: We were first alerted to the "gold is money" flaw years ago. When considering the many references to gold being money, in ancient texts, several things stood out. We began to suspect that those translations were somewhat slanted. I saw many areas, in old text, where gold was actually more in a context of; his money was in account of gold or; the money account was gold or; traded his money in gold. The more one searches the more one finds that in ancient times gold was simply one item that could account for your money values. To expand the reality of the thought; everything we trade is in account of associated money values; nothing we trade is money!

The original actual term of money was often in a different concept. In those times barter, and their crude accounts of the same, were marked down or remembered as so many pots, furs, corn, tools traded. Gold became the best accepted tradable wealth of the lot and soon many accountings used gold more than other items to denominate those trades. Still, money was the account, the rating system for value, the worth association in your head. Gold, itself, became the main wealth object used in that bookkeeping.

This all worked well for hundreds and perhaps thousands of years as fiat was never so well used or considered. Over time, society became accustomed to speaking of gold in the context of money accounting. Translations became all the more relaxed as gold and money accounting terms were mingled as one in the same. It was a subtle difference, then, but has become a major conflict in the money affairs of modern mankind; as gold receipts became fiat gold and bankers combined fiat money accounting with gold backing.

(Read more of FOA's historical account starting with "The Gold Of Troy!" found on Gold Trail III – The Scenic Overview.)

Gold as Currency

At some point along the evolutionary trail of the money concept, gold was employed by the power of government fiat and stamped into currency. As I have written before, this was done for the purpose of profit (for the government). The official stamp on these coins designated the overvaluing of the underlying metal. Otherwise there would be no profit in it. And sooner or later, that profit ran out and the gold content had to be debased.

These gold coins were the first fiat currency! Not fiat money; such a thing doesn't exist. The money concept is the creation of private enterprise and finance. Government can only create currency, the portable "on the go" element of the concept.

In the more recent past, while gold shared the currency role along with many national paper fiats, and before we had a globally integrated, computerized, efficient and trusted system of payments (notice I said "payments" and not store of value) gold was the go-to currency for certain payments, especially among less trusting trading partners. And among these, certain "super-producers" accumulated quite a lot of this gold currency.

Do you realize that somewhere out there, there is perhaps four billion (with a b) ounces of gold in private hands (in many forms, including coins, bars and jewelry)? A lot of this gold was accumulated by families over many generations. It is only in modern times (and in the West) that we think of our "nest egg" as something that should be deployed into the marketplace in search of a yield. That we must trust it to a "manager" who we pay to churn us an ROI. This is a very modern and Western view. The rest of the world (the rest of time for that matter) views wealth a little differently.

ANOTHER: This brings us back full circle, to the problem of "digital currencies" and the "mind set" of much of the simple ( and rich ) third world persons. To many of these people, wealth is the surplus of life's work that you pass on after death. Currency is something you, spend, trade or hold for a few years. It isn't wealth.

When Another spoke of "rich third world persons" and "old world giants," what quantities of gold do you think he was talking about? Mr. Gresham asked him once:

Mr. Gresham: "We who read here generally buy the coins, one ounce and less. The "Giants" you speak of are usually buying the large bars (100 ounce?), yes?"

ANOTHER: "I ask you, how many of your bars in tonne? This is the small purchase size."

Good question. How many 100 ounce bars are in a tonne? The answer is 321 and a half. Or 32,150 ounces. And this is a "small" giant! 4 billion ounces in private hands. Let's take just half of that and wonder how many of these "small giants" there might be in the world. 2 billion divided by 32,150 = 62,208. So I'm going to go out on a limb and say, conservatively, that there are probably "tens of thousands" of these so-called "giants" in the world. That 4 billion ounces is out there somewhere, in private hands, and that kind of family wealth doesn't necessarily show up on things like the Forbes list.

So what is my point? My point is that today is not just the sum of the last 10, 20 or 30 years, like it probably seems to most Westerners. To the giants, to the world outside of the West, today is the net sum of centuries of production minus consumption.

Some in the West might argue that the overweight value of Western "paper capital" is justified by the overweight capital contribution from the West for the last half century, reflected in the high development of the developed world, the West. But Another observer might point to that same high level of development and call it capital consumption from the effort to use debt to rebuild the West following WWII. And he might point to Wall Street and suggest that the accumulation of "paper capital" represents real capital consumption, destruction and malinvestment.

The West believes it has much wealth stored in paper promises of never ending debt service, but it hasn't actually been paid yet. The West is hoping to be paid someday. But there is a whole other world out there that, for centuries, has already been paid in full, in gold.

Gold in Modern Bullion Banking

In the not-so-distant past, gold shared the currency role with various national fiats. Gold was a currency, more or less, right alongside this paper. And because the two traded at a fixed parity within the banking system, there was no such distinction as a Bullion Bank.

Modern bullion banking is a carryover from this past. When Nixon abruptly took the dollar off the gold standard in 1971, the billions of ounces in private ownership didn't just disappear. They weren't cast into the streets in disgust. And these giants with 100,000 ounces or more didn't take those tonnes home to the basement. No, they stayed right there in the bank vaults and literally JUMPED in value.

In fact, the banking system never really stopped "banking" with all that gold, even though Nixon demonetized it. While gold was currency, deposits of gold generally went into unallocated accounts just like your deposits of physical dollars do today. Putting gold in an allocated account in the past would be akin to putting cash in a safety deposit box today. Sure, it happens, but it is not common because it has a cost associated with it.

And what is it that banks do with unallocated accounts? They make loans to generate income for the bank, and they use fractional reserve accounting to juggle the deposits and (hopefully) keep everyone happy. And in the rare situation where they come up short on reserves, the Central Bank stands ready to backstop their fractional reserves with a loan of extra reserves.

Even today, a few of the biggest banks still have bullion departments where they can take deposits in physical gold. These banks are what we now call the Bullion Banks. This bullion banking practice seems very foreign to us shrimps with a little gold in the family safe. But yes, just like the billions of ounces that existed during the gold standard era, this practice of bullion banking still exists.

And today the bullion banks still operate with fractionally reserved unallocated gold. Some reports put the remaining amount of unallocated gold being juggled within the banking system at about half a billion ounces, or 15,000 tonnes. But so far, this is apparently enough to support the meager delivery demands on the spot gold trade as well as the allocation needs of the bullion bank-operated ETFs. (More on this in a moment.)

Things have changed in the last decade. The Bullion Banks no longer have the same income-producing uses for this unallocated gold on deposit that they did in the 80s and 90s. Back then they lent it out to hedge funds and mining operations. For mines, a gold loan made great sense because it carried a lower interest rate than a dollar loan and could be paid back with just what they pulled out of the ground. For hedge funds, it also made sense with the low gold interest rate. Funds would just sell the gold into the market for cash and buy it back later, called the gold carry trade. But today, with the rising price of gold, gold loans no longer make sense for anyone. And in 1999 the WAG ended the CB backstop for this Bullion Bank lending practice.

So guess what income-producing activity the banks found to do with some of this unallocated gold today? As the mutually reinforcing factors of rising prices and termination of mine company hedging and waning carry trade activities in the wake of the 1999 CBGA left bullion banks with their full store of unallocated gold deposits but a shrinking base of usual customers for their gold lending services, the ETF mechanism provided the ideal means to relatively safely put these deposits back into play. By delivering them into an allocated account with the ETF in exchange for ETF shares that could be lent or sold for cash, these same Bullion Banks found a new path to dollars that could then be used to churn an income.

I don't think the issue is whether or not the gold in the ETFs actually exists, but rather, how many claims exist on that gold and who (of the claimants) has an actual pathway to take possession of it?

Where do you think the 40 million ounces allocated to GLD came from? Were they purchased on the spot market? And who can withdraw actual physical from the ETF? Here's a hint: Authorized Participants can exchange shares for physical. And who are these "authorized participants?" You guessed it, other Bullion Banks that allocated gold to the ETF.

And it seems that some of these authorized participants are doing just that…

Jan 14th, 2011 08:27
"… large bullion-backed exchange-traded funds continued to see outflows."


RS View: Silly reporters. Instead of calling these “outflows” from the ETFs, it should be called what it is — a redemption of a basket of shares for physical gold by the Authorized Participants (e.g. bullion banks). Such share redemptions would actually be a bullish sign because it entails a reduction in the global supply of paper gold while at the same time signifying a preference by the redeeming party for having the metal over the ETF shares. That is, of course, unless the drawdown in physical gold merely represented the routine sales of the gold inventory that occur to cover the ETF’s administrative expenses.

And why do they do this? Because more and more of those "small giants" are converting their unallocated accounts into allocated accounts. This very act stretches the Bullion Bank's fractional reserves ever thinner. So there is a sort of tug-of-war on those scarce gold bars in the Bullion Bank's vault, between the unallocated account holders and the ETF shareholders. And the unallocated accounts outnumber the shareholders by a large margin. Furthermore, they have an actual pathway to physical redemption while the shareholders do not.

And as this fractional reserve rubber band is stretched thinner and thinner, how confident are you that all of the "authorized participants" are following the rules to a T? And since you have no recourse to the actual physical, as an ETF shareholder, how sure are you of the ETF denouement come Freegold, which will be a physical-only market for gold? Will shares still trade at par with physical when that comes? I don't know, but it is a valid question.

Bullion banking is no different than regular banking. They do what all banks do. They take unallocated deposits and loan them out for profit. Then they juggle their fractional reserves to keep everyone happy. And if they ever get in trouble, the central bank comes to the rescue. But no longer for physical gold. Only for fiat currency. That will likely be the denouement of this fractional reserve conundrum, and it is what Another and FOA both predicted. You will ultimately be settled out in cash and told to source your own physical in the physical marketplace.

And for those of you that think all bankers, by nature, are anti-gold, guess again. A better way to view banking versus gold is that "the past" was anti-gold, but "the future" is pro-gold. The first Central Bank Gold Agreement in 1999 (the CBGA, aka the WAG) signaled this change.

The Washington Agreement is most well-known for its cap on central bank gold sales. But much more important than the sales cap was the cap on gold lending! From the Joint statement on gold (the Washington Agreement):
1.Gold will remain an important element of global monetary reserves.

2.The undersigned institutions will not enter the market as sellers, with the exception of already decided sales.

3.The gold sales already decided will be achieved through a concerted programme of sales over the next five years. Annual sales will not exceed approximately 400 tons and total sales over this period will not exceed 2,000 tons.

4.The signatories to this agreement have agreed not to expand their gold leasings and their use of gold futures and options over this period.

5.This agreement will be reviewed after five years.

And from ANOTHER:

Date: Sun Nov 16 1997 10:20

In today's time the CBs do not sell physical gold with a purpose to drive the price down. They sell to cover open orders to buy what cannot be filled from existing stocks. Look to the US treasury sales in the late 70s. They sold 1 million a month using open bid proposals with much fanfare. If the CBs wanted physical sales to drive the price they would sell in the same way.

The sales today are done quietly with purpose. The gold must go to the correct location. That is why these sales do not impact price as they occur, there is a waiting buyer on the other side…

Banks do lend gold with a reason to control price.


Date: Sun Apr 19 1998 15:49

If they sell gold, a way is clear to "bring gold back" for the nation! Canada has local mines, Australia has local mines, Belgium has South African mines! If they lease gold, it is for a purpose…

This is the real significance of the Washington Agreement! The end of the CB's backing (through lending reserves to the BBs) of the fractional reserve gold practices of the Bullion Banks.

Paper Gold

My purpose here is not to pick on the gold ETFs. Admittedly, all gold ETFs are not created equally. But they are all a reasonable current example of "paper gold" in that they are (for the most part) just claims on gold held by Bullion Banks, not gold itself. The paper markets exist because the public believes gold is a commodity like any other. And I say, paper markets schmaper markets, it's not really about the paper markets, it's about gold being a fractional reserve in the banks.

It is much less important to Freegold that the investing public believes gold is a commodity. Those that really matter already know it's not. And the paper markets and the public's misunderstanding of gold simply help the banks manage their fractional reserves to keep everyone happy.

Yes, the paper markets by their very nature, and only because gold has the highest stock to flow ratio, automatically act in harmony to suppress the price of the actual product. And yes, they do provide a means for the banks to occasionally control the price of paper gold in an effort to manage where their fractional reserves of the real thing actually go.

But the actual physical portion of the paper markets is tiny compared to global gold. COMEX does not project its price discovery globally because it is so powerful. That price is accepted, not projected, because the Bullion Banks choose to use it in their fractional reserve gold banking. The paper markets are markets for claims on gold held by the BBs, not for gold itself.

To put it another way, if the Bullion Banks and their fractional reserve gold banking is a dog, then the COMEX (or "the paper markets") is its tail, not its heart. And the tail doesn't wag the dog. Paper markets will be the price discovery mechanism for gold as long as fractional reserve gold banking exists. Simple as that. Will beating on the tail of a dying dog kill it faster? I don't know the answer to that question. Never tried it.

Also, I'm not here to ask you to avoid "paper gold" on moral grounds. Buy paper gold or ETFs if that's what works for you, by all means. I'm only saying that when you hold "paper gold" you are the same as those that held (external) dollars from 1970 right through until 1972. Dollars were once paper gold too.

There may be a very high price to be paid in the future for the high liquidity of paper claims on gold held by the Bullion Banks today.

FOA: Somehow, the BIS and the major private gold holders know the total claims, as does Another. The Euro group is going to force those claims into real bids instead of just claims!

From this...

into this...

(The illustrations are from my post Relativity: What is Physical Gold REALLY Worth?)

The Gold in Freegold

One question I see over and over and over and over again is this, presented in its most recent email incarnation:
Another has stated, as have you, that behind the scene, gold trades between the giants for many times what the posted price is. If this is so, then when the phase change comes, and gold is used to recapitalize the central banks and to redress trade imbalances, could it not continue to be used for those purposes behind the scene at inflated values, with the “posted price” remaining at much lower prices?

The Central Bankers NEED gold to be precious in the hands of the people, fiat currency NEEDS Freegold, just as much as gold needs fiat currency in order to be set free from the fractional reserve practices of the bullion bankers, a carryover from the gold standard. Let the bankers play their fractional reserve games with fiat currency, backed by the CBs as their fiat lenders of last resort, just not with precious gold, and certainly not with the backing of the most precious CB asset.

This isn't about anyone financially screwing anyone else. That stuff happens regardless. This is about the emergence of a stable foundation on which the global economy (and central banks) can operate. To date, there isn't one, only the U.S. dollar.

The same thing that has given the dollar exorbitant privilege all these years is now bringing it down. And that thing is the self-referential foundation on which it is built. It is the mountain of debt, highlighted by China's pile of Treasuries, but also including every dollar denominated savings in the world. That pile of "implied dollars" no longer has a recoverable relation to reality. Freegold provides this base, this stable foundation, for the fiat currency system of the future.

Gold trading behind the scenes at a much higher price was never the CBs way of excluding us from the fun. It was their way of protecting their assets from what is inevitably coming. For the CBs to redistribute their gold among themselves in preparation, it made sense that gold's value (future price) was more than its present price. What Another described was never a parallel trading universe. It was merely preparation for what is coming to everyone.

Nothing is gained for the masters of fiat (the CBs) by having gold trade at a suppressed price, fractionally reserved by bullion bankers, except systemic instability. This is why Another told us that in the future your government will ENCOURAGE you to save in gold. That's because this will bring monetary stability back to a world that has just experienced (past tense used for a future event) the worst INSTABILITY ever.

It's not a gold standard. It is saving your earned credits by buying a physical asset, outside of the currency. Buying a currency asset provides a temporary privilege to the currency issuer, but it ends in collapse. Buying a physical item transfers that purchasing power to the physical plane by exerting upward pressure on physical things and downward pressure on the currency. Buying gold isolates, contains and focuses that pressure on one point for the benefit of all.

The Free in Freegold

Okay, here it is. What you've been waiting for patiently, I presume. This is what gold will be freed from: The fractional reserve banking practice, which is a carryover from the gold standard.

This is the free in Freegold.

A Final Word

As you can probably tell from this post, I believe that understanding Freegold requires a slight shift in your perspective. It is not sufficient for me to simply describe it in terms as they exist within our present financial and monetary paradigm. I know that some of you think I should be presenting a simple, fully articulated scenario. But I have tried this before. It does not work. It doesn't do a lick of good. It's not an easy task to explain something that requires a totally different point of view (before it actually happens; after it happens, of course, everyone gets it… but too late to act on it). My grandfather once taught me that anything in life that is really worthwhile will not be easy. This applies to Freegold.

Some of you have wondered why I am the only one talking about this. Why are none of the other well-known gold analysts acknowledging Freegold? Well, the reason should be self-evident. I am anonymously trying to share that which is easily ridiculed from within the current paradigm. But I will share with you this. Some big names in the gold analyst community have let me know (indirectly) that they are fans of this blog. Take that for what it is worth. But if I told you the names, you'd probably say, "no way!" Way.

Others of you are here looking for "concrete, actionable advice." Fine. Here it is: Buy. Physical. Gold. Now. Simple is as simple does.


Thursday, January 13, 2011

Friday, January 7, 2011

Reference Point: Gold - Update #1

The system we have today is actually broken, only we haven't quite recognized it yet. And so we need a new one, and this is the time to do it, while the markets haven't quite figured it out yet.

The preceding were the words of a billionaire more than a year ago. The following are the words of a Federal Reserve Bank president from just a couple days ago (emphasis mine)… Should the debate that is happening privately remain hidden from the public eye…? Is the nation somehow better served by giving the public the impression that the entire [Fed] is in agreement…? A gold standard that forces countries to back their currency reserves with bullion is a legitimate monetary system.

This being the "year of the RPG" here at FOFOA, I thought it would be a good idea to keep an eye on how gold is acting as "a key reference point to allow people to assess the relations between different currencies" (to quote the head of the World Bank) throughout the coming year.

In order for the limited and stable quantity of above-ground physical gold to perform this important international function effectively, it will ultimately trade independent from the current network of bookkeeping derivatives that assume gold ownership through a counterparty's gold liability (receivables, futures, options, forwards, ETF shares, etc.). Such contractual obligations do not represent a stable and credible quantity like the physical gold itself does, and therefore they make a poor and distorted pricing benchmark.

More than 10 years ago FOA blew the whistle on the inevitable failure and subsequent dénouement of this distorted benchmark. From my post 100:1:

FOA (05/06/00; 16:45:21MT - msg#20)
For Your Eyes Only!

By holding physical gold you are owning a super leveraged "derivative" that will be exchangeable against the value of real things at a par level lost to the minds of most investors. Today, physical gold purchased in dollar values is discounting its worth by perhaps 100 times. For us PGAs (physical gold advocates), that is a leverage worth "playing the physical game for"! (smile)

… Throw in the fact that the earth will not give up all its gold any time soon, present world gold holdings in reserve currency today must rise in value at least 100 times to match what assets now exist. On top of that add in the fact that dollar gold will go sky high just to equal past dollar creation (as the dollar fails) and one can see where physical gold is "the play" in modern times. Forget stocks, business valuations, land or currencies: physical gold is the wealth for the next generation.

FOA (10/9/01; 10:05:48MT - msg#117)

Lost in all the confusion is the distinction between investing in the price of gold and investing in gold itself. Perhaps 90% of all the investing in today's worldwide, dollar settled, gold market is done in this first way mentioned. Yes, the market is structured, contractually, to settle in gold. However, in practice, in norm, and in past legal precedent, it is accepted that paper gold trading is meant to only capture the price movements in gold while ceding, what could be, controlling physical trades and their price setting function to other market areas.

Obviously, this is the way it all started, years ago, with the physical trading and its fundamentals dominating the lesser paper trading. But the market evolved with the paper contractual trading becoming 100 or more times the size of the physical side. But everyone already knows all this, right?

From a Friend

Ref: "In other words, the current price of gold means that you are buying a slice of the world’s gold supply with a proportionately smaller slice of the world’s money. You can currently buy x% of the world’s gold with y% of the world’s money, where x is much bigger than y. When gold will become the unit of account of the world’s wealth, you will find yourself able to claim a much bigger slice of that wealth than you would have been able to do with fiat money before the collapse."

This means that CBs and gold-clearinghouse BIS must attach a much higher VALUE to the gold they exchange (redistribute) than the public (visible) goldprice(s).

Note the difference between Value and price. The price is for bookkeeping purposes. The Value is for wealth reserve purposes.

That's why a private person cannot buy goldmetal directly from any CB (or BIS/IMF) ! We are not allowed to know how CB gold " flows " (and is valued in the inner circle). We have no idea how bullion banks intermediaries let goldmetal circulate from goldmine to state and private entities.

We are not allowed to know how the CB/IMF gold auctions really happen. How can we possibly verify the goldprices that are publicised ? Who are the receivers of the WAG gold redistribution ?

So much CB gold-Action and so little transparency. WHY !?
Because of Big difference between price and Value !?


Of course today this is not yet the case. When we say "the gold market" today we mean all of the above paper contracts plus the gold itself. But that doesn't mean that everyone in the world views gold in this same way. They don't. It is really only us in the West, encouraged by the cheerleaders on CNBC, that carry this laughably optimistic view of counterparty trustworthiness when it comes to gold. Other more "giant" and less "Western thinking" entities around the world have quietly taken steps to prepare for the future.

Certain "giant entities" are, and have been for more than a decade, marking their physical-only gold assets to the market price of "paper gold" the whole time it has been rising from its low of around $250 per ounce. This doesn't seem like a very big deal to the Western mindset that can't see the difference between "counterparty gold" and "counterparty-free gold," but it is actually quite significant given the history of metal used as currency.

In the past, whenever any metal has been used in a monetary function during the presence of a government or monetary authority, the metal itself has endured a trade-value distortion that is always in conflict with the market forces present at that time. This market distortion is what has melded metal into money during these past systems. Not its free market floating value, but just the opposite; the suppression of free market forces on that specific monetary metal.

For example, you can stamp a metal into coins and declare that your coin form of the metal is of higher value than uncoined metal in payments you make and those made back to you. This is a way to overvalue a portion of a commodity metal's above-ground supply to your advantage. You are marking your specially stamped metal above the rest of the market metal, or "marking it to your model."

But over time, this method of monetizing a metal has always run into the same problem. The market for uncoined commodity metal always seems to catch up and overtake the face value of your coined metal and you are forced to dilute your currency into ultimate collapse, occasionally on a civilizational scale.

So then you might declare that all of a certain metal, coined or uncoined, is the monetary base or standardized unit of another money that you can print very easily. This method becomes more of a confidence trick because you are attempting to undervalue that metal (the entire quantity of it) out in the free market, relative to the easy money that you can print.

In order to support this confidence trick you must become both the buyer and seller of last resort of both your metal and your easy money. You must buy your easy money back with your metal and vice versa. This trick can last until you run out of one or the other. Of course, you need never run out of the easy money you can print, so that's not the real danger in this con.

In a sense, or perhaps in essence, today's paper gold market is not very different from this second monetary scheme. The banks that create paper contracts for "counterparty gold" by simply writing them become the buyer and seller of last resort for both their own paper promises and real physical gold. This can continue until one or the other runs out. But again, you are marking a metal to your model of a marketplace that includes both the metal and your paper creation, be it dollars or "counterparty gold."

There are many variations of these schemes in which the value of various metals had to be distorted by authorities in order for them to fulfill any useful monetary function. And there are also many examples where monetary authorities were forced to adjust or abandon their preferred money to avoid drowning in the unstoppable tide that is the market force. Like France in the 1870s abandoning its planned return to bimetallism in order to avoid having to spend its gold buying up all the excess silver in the world. [1] Or Sweden's successful move in 1916, closing its mint to the previously free coinage of all gold in order to levitate the value of Sweden's coined gold back above the market price of uncoined gold. [2]

All of these market/monetary shenanigans of the past stand in stark contrast to what is being performed today in broad daylight, once every three months, on the Consolidated Financial Statement of the youngest major monetary authority in the world. Once per quarter, the ECB openly marks the Eurosystem's monetary reserve assets, including the physical gold asset, to the last market price of the previous quarter. This is marked to market (MTM) monetary authority gold in the specific role of reserve asset, aka store of value. And while the implications of this 180 degree shift in any major monetary authority's regard for gold is not widely discussed, it is immensely significant. (See: FOFOA)

So without further ado, let's get to the latest Eurosystem reserve revaluation, just released Wednesday, and see how our RPG (Reference Point Gold) is holding up. First, I will show you how you can follow this on your own, or even go back and check past statements for analysis, or just for fun.

If you click on the following link to the ECB website you will see a description of the "Weekly financial statements" they publish every week:

It reads: "As a general rule, the consolidated weekly financial statements of the Eurosystem are published on a Tuesday, and they relate to the preceding Friday. There are two exceptions to this general rule.

"Firstly, the publication day for the first financial statement of each quarter will normally be a Wednesday (instead of Tuesday) in order to allow more time to complete the quarterly revaluation of assets and liabilities, which is reflected in these statements."

Note the use of the word "consolidated." This means that every line on the statement relates to the entire Eurosystem, not just the ECB. So the gold listed on this form is the consolidated total of the official gold reserves of all its member states. Same for other itemized assets and liabilities. Also note that they only perform the market-based revaluation of assets on every 13th statement (once a quarter). And for these, they allow an extra day, publishing on Wednesday instead of Tuesday. And this being the first week in January, we got the new numbers on Wednesday.

Below the description you'll see a list of the actual publication dates for the quarterly revaluations this year:

To the left you can click on any year going back to the launch of the ECB on Jan. 1, 1999 and review the weekly and quarterly reports from each year:

And down at the bottom, you can click on the language of your choice for today's quarterly statement, "en" for English:

So let's click "en" for English and check out the latest ECB press release, the "Consolidated financial statement of the Eurosystem as at 31 December 2010" or ConFinStat for short. If we scroll down a little we'll come to the actual balance sheet. This lists out all of the Eurosystem's official assets and liabilities, listed in their euro value, the official unit of account in Euroland.

Quantitative changes to this sheet are published every week, but qualitative changes, the line items signifying foreign currency assets and gold, are only revalued into the euro unit of account once per quarter. Just above the balance sheet you'll see the only section that differentiates this quarterly statement from any other weekly statement, the "Quarter-end revaluation of the Eurosystem’s assets and liabilities."

Notice the black arrow pointing to the following:

Gold: EUR 1055.418 per fine oz.

USD: 1.3362 per EUR

JPY: 108.65 per EUR

Special drawing rights: EUR 1.1572 per SDR

These four lines are the "market snapshot" that is taken once every three months, mentioned in my last post. It is a snapshot of the euro's market price as it floats against four different benchmarks or reference points. It is used to calculate the weight of those most valuable line items to any Central Banker, the reserves that cannot be printed and are therefore used to defend and evaluate that which can be printed. This snapshot will be used for the next 90 days.

For comparison, here's the last "snapshot" taken on Oct. 1, 2010:

Gold: EUR 960.580 per fine oz.

USD: 1.3648 per EUR

JPY: 113.68 per EUR

Special drawing rights: EUR 1.1399 per SDR

Right off the bat you should notice an interesting thing. Look at the percentage of the euro's change against the other fiat currencies. 2.1% change against the dollar. 4.6% against the yen. And only 1.5% against the SDR. They are all falling in tandem! Yet there's a 9.9% change against gold over the same time period. What you are witnessing here is the emergence of a true leader, the benchmark or Reference Point par excellence, from the rest of the pack of potential "reference point contenders."

Now let's take a look at the actual balance sheet to see how this Reference Point snapshot is applied. In the image below I have placed the asset side of the previous statement released on Dec. 28 side by side with Wednesday's release.

One distinction I want you to notice is the two columns on the quarterly statement, which I circled. Column "i" is for transactions or quantitative changes from the week before (this is the column that is reported every week), and column "ii" is for the "snapshot-based" adjustments or qualitative changes from the previous week/quarter.

You'll see from the previous statement that there was a net increase of approximately €1 million worth of gold (only around 1,000 ounces) to the Eurosystem stockpile during the week ending on Christmas Eve (possibly delivered by Santa). And in column "i" you'll also see that there was no change to quantity of gold during the week between Christmas and New Year. There was only a "qualitative" change (revaluation) which was reported in column "ii." And that change was +€33 billion for the Eurosystem's 348.1 million ounces (10,827 tonnes) of gold.

The other important thing to note on these ConFinStats is the gradually changing relationship between gold reserves and foreign currency reserves. These are both "hard money" reserves to the ECB because they must be acquired "the old fashioned way," or the "hard" way; they cannot be printed. This is what makes them valuable to any Central Bank. They are what is sometimes used to defend the value of the "easy money" that can be printed. And the qualitative relationship between these two fundamentally different kinds of reserves has been changing for the past 12 years!

As Randy Strauss of USAGold fame so eloquently points out here, "gold’s role has gained musculature from a mere 30.5% proportion to its current dominance now at 67.1%." That means that at the beginning, in 1999, Eurosystem reserves were made up of 69.5% foreign fiat paper and 30.5% gold. Today that has shifted qualitatively to a net foreign paper position of only 32.9% to gold's 67.1%, a virtual flip flop!

And what makes this so significant (and unique) for the euro is the way the ECB measures itself nakedly, transparently, against all competing benchmarks. The ECB valiantly reports ALL foreign holdings in its own unit of account, displaying itself confidently against any and all reference points. Second only to the ECB MTM concept, this is the revolutionary CB practice that other major CBs have yet to adopt. Most CBs still report their dollar holdings in Ben Bernanke's favorite benchmark, the dollar itself, master at the confidence art of self-reference.

Speaking of the dollar, it is difficult to maintain yourself as the global reference point if you are seen to be losing your youthful posture. So let's take a quick look at how an aged major monetary authority (preparing for its 100th birthday party in 2013) deals with this conundrum. It's not as pretty as the spry ECB statement, but here is the Fed's asset report from its latest release, "Factors Affecting Reserve Balances" (just released yesterday):

The salient point here (circled) is what Randy Strauss expounded on in his previously linked piece:

"Meanwhile, due to the woefully outdated paradigm established by the U.S. Congress for gold held by the Treasury Department, the gold reserves of the United States are effectively anemic and bedridden upon the books of The Federal Reserve System, where they exist only in certificate form — valued at a static $42.22/oz., forming a paltry $11 billion stake."

That's right! The Fed doesn't even have actual gold on its balance sheet that can be used as a reference point. It has "gold certificates" issued to it by the U.S. Treasury from the past monetization of U.S. Treasury gold at $42.22/oz. I suppose, technically, if the U.S. Treasury wanted to revalue its gold to the market price today, the proper yet antiquated process would be for the Fed to credit the Treasury's spending account with new dollars representing the difference in price. Today that would be about $355 billion fresh dollars for Congress to spend. Yet there would still be no existing mechanism to automatically account for the new and emerging Reference Point: Gold. Something technical is going to have to change!

But that's not really my concern. That is something for Congress, the Treasury and the Fed to collectively figure out. My concern is simply how this shifting, changing and adjusting international monetary system will affect my balance sheet. And that's why I have put myself on my own personal RPG. I have consolidated my assets. And in doing so, I have favored the genuine article over its lesser reproductions.

What makes me sad, though, is that some of the most studious and longstanding gold bugs, some of the most ardent "honest money" advocates, will apparently be slower to grasp this unfolding system of "RPG/Freegold" than the flocks of Sheeple, or even the Chartalists. Sometimes you've just got to "unlearn" a little past dogma in order to comprehend present reality.

The "silver lining" for them is that, at least, hopefully, they will have some physical gold in their immediate possession so as to participate in the RPG party train. If not, well, hopefully the commodities they invested in will at least rise with inflation and not succumb to the global economy resetting as it adjusts to its newfound lack of a 300 million-strong group of net consumers.

FOA (8/22/01; 05:18:54MT - msg#98)

The war between gold and the dollar has been over for a while now. The action, today, is between the dollar and the euro arena and this is what will break the price lock on gold.


FOA (07/27/01; 15:20:44MT - msg#85)
"The Wind Will Blow"

Circulating cash dollars, official metal coinage and other previous fiats, themselves thought of as a final hard payment, were never any more than a known tradable value. A trade credit owed to you as long as one held the money unit. Even with gold backing the dollar unit, money's value was always in its exchange for something else we wanted. Gold values behind these fiats was used to represent some fixed tradable value the money unit stood for; not to be the money unit itself.


The immovable past structure the dollar is built upon demands its values be defended with complete hyperinflation if necessary. Prior to EMU, there was no other reserve currency that the world could run to. Now, the dollar cannot deflate and take the rest of the world into deflation with it. The tables are turned; deflationary policy will not defend the dollar. Only inflationary policy will. Make no mistake, we are not calling for price inflation to end the dollar's reserve rein! We are calling for "inflationary policy" to dethrone it while said hyperinflation follows.


The next step will be an orderly exit from dollar use; a somewhat destruction of all dollar gold pricing; and a super price inflation for US dollar assets. We are not at the end my friends, we have just come to the beginning. For physical gold advocates that understand the difference between real wealth and leveraged real wealth, the time arrives when values are reflected with the speed of the wind. Truly, in our time, "The Wind Will Blow".


Having evolved a dollar reserve money system into a straight debt fiat currency, without gold involvement, the entire dollar function became locked into one basic premise: for the system to survive, its core reserves of debt values had to remain somewhat price stable as the currency inflated relative to GDP. Over the next 30+ years their dollar controllers, the fed and treasury, thought they had a fairly good handle on the system as they managed banking reserve requirements. To their amazement, it turns out today, that digital use demand was the best function that supported their efforts all the while; by increasing the world's use and need for currency. Had they understood this modern economic function early on, they could have somewhat printed the currency outright with almost the same result while arriving at today's destination. They could have let gold float, not to mention they could have skipped a large portion of the debt build up that will now end the dollars timeline.

Most, if not all, of this perspective is only now coming to light as the Euro builds pressure on the dollar. The better architecture of the Euro system is leaving little room to adjust as the US fed must singularly act to inflate their local currency in a historically new and unprecedented fashion. The actual debt machine that built much of America's lifestyle is now going into reverse as it destroys its own currency; one built upon a stable debt system with locked down gold prices.


Without an international floating gold reserve pricing, to balance against their devaluing debt reserve, the entire dollar banking system can only rely upon extreme dollar inflation to float its accounts. Price inflation will have to be ignored. To this end the group of dollar supporting countries, we refer to as the dollar faction, has locked itself into a box. It must find a way to float gold prices with a gold reserve that only drains away if world gold price rise.


How far will gold rise? At first blush, foreign dollar assets will not, in any way, return home! They will circulate offshore; either from lack of understanding of the issues, a thought that things will be worked out or from foreign exchange controls aimed at protecting the failing US economy!...


Exogenous (or exogeneous) (from the Greek words "exo" and "genis", meaning "outside" and "generated") refers to an action or object coming from outside a system. It is the opposite of endogenous, something generated from within the system.

In an economic model, an exogenous change is one that comes from outside the model and is unexplained by the model. For example, in the simple supply and demand model, a change in consumer tastes or preferences is unexplained by the model and also leads to endogenous changes in demand that lead to changes in the equilibrium price. Similarly, a change in the consumer's income is given outside the model. Put another way, an exogenous change involves an alteration of a variable that is autonomous, i.e., unaffected by the workings of the model.

...These reserves will circulate until their gross exchange value simulates a figure that can be reasonably expected to "buy something" within the US; ten cents on the dollar could be a guess? However, keep in mind that the fed will be printing like mad, local prices will be soaring and no one will be chasing dollars like they do today. I expect that physical gold trading, within the US, will follow far behind foreign trading for a time. Perhaps a $5,000 to $15,000 ratio will be a thought as dollars within the US will be worth more than outside. Still, the relative value of physical gold will eventually converge as a trading standard is reached.



[1] Mundell - The International Monetary System in the 21st Century: Could Gold Make a Comeback?
[2] Hayek - A Free-Market Monetary System