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An open letter to
Paul Volcker, Chairman of the Board of Governors of the Federal Reserve,
1979-1987; Chairman of President Obama’s Economic Recovery Advisory
Board, presented to him, in person, last year
Antal E. Fekete
E-mail: aefekete@hotmail.com
Dear Paul:
In 35 years our paths have crossed for the second time. In 1974/75 you
and I were Visiting Fellows at Princeton
University. Now, in
2009, both you and I are attending the Santa Colomba
Conference on the present debt crisis at the invitation of Bob Mundell.
In 1975 you conducted a seminar on the international monetary system
and invited me to contribute a paper on gold which I did. Those were halcyon
days by comparison. The United
States, after the turbulence of 1971,
successfully consolidated the international position of the dollar and could
confidently lift the 42-year old ban on the ownership and trading in gold. On
December 31, 1974, trading of gold futures contracts started in New
York and Chicago.
It showed a robust contango at full carrying
charge, that is to say, the gold basis (the spread between the futures and
the cash price) was at its peak. It indicated that monetary gold was
available in great abundance to meet any demand for any reason. It showed
that the gold futures markets could serve as the fulcrum in seeking out the
equilibrium between the supply of and demand for gold. They could act as a
safety valve, releasing occasional pressures that, in the absence of paper
gold, may be a threat to the monetary system. It looked as if the gold
problem has been solved for once and all.
But as I feared, and as the intervening 35 years have proved, rather
than moving towards equilibrium we have been constantly moving ever farther
away from it, as measured by the gold basis. The secular vanishing of the
gold basis is a most ominous danger signal. It indicates that monetary gold
is increasingly unavailable, and in case of a crisis it can no longer be
relied upon to come to the rescue. Basis started out at 100 percent of the
prevailing interest rate, but has been steadily eroding all the way to zero percent
today. Permanent gold backwardation (negative gold basis) is staring us in
the face. The gold basis is trying to tell us something. It heralds the
greatest monetary crisis of all times. It warns about the possible collapse
of the international monetary and payments system.
Let me explain. Gold is the only ultimate
extinguisher of debt. Other extinguishers do, of course, exist but they are
not ultimate in that they have a counterpart in the liability column of the
balance sheet of someone else. Gold has no such liability attached. Gold is
where the buck stops. It is this property that makes gold unique as a
financial asset. Historically, gold discharged its function as the ultimate
extinguisher of debt through the gold clauses written into the bonds of the U.S.
government before 1933. Gold could also discharge this function, albeit
rather imperfectly, under the gold exchange standard of 1934 with gold redeemability limited to foreign holders. It could still
work under the system of fluctuating gold price introduced in 1971, thanks to
the availability of paper gold. Imperfect as though these stratagems were,
they served as a pacifier to the bond market. But as the threat of permanent
backwardation indicates, all offers to put monetary gold at the disposal of
the international monetary system could be abruptly withdrawn. In that event there would be no ultimate
extinguisher of debt. The world is totally unprepared for such a momentuous development. I ask: are there contingency
plans in the U.S. Treasury and in the Federal Reserve what to do if
backwardation makes monetary gold unavailable for the indirect retirement of
debt?
The message to debt holders would be: suave qui peut. There would be a rush
to the exit doors and people would trample one another to death in trying to
get out. The debt crisis of 2008 was a dress rehearsal. It gave the world a
foretaste. This crisis is a gold crisis.
It is a crisis indicating the threat of a shortage of the ultimate
extinguisher of debt, without which our runaway debt tower is doomed. When it
topples, it will bury the world economy under the rubble, as the Twin
Towers buried the
people working inside in 2001.
All kinds of ad hoc
explanations have been offered for the debt crisis. But the real explanation
is that under the threat of gold backwardation creditors are scrambling for
liquidity. There will be no recovery
unless provision is made for the orderly retirement of debt through a
mechanism using gold as the ultimate extinguisher. The alternative is a
Great Depression worse than that of the 1930’s. To understand this we
have only to contemplate the shock to the world if it was all of a sudden
revealed that the debt of the U.S.
government was in fact irredeemable. The Emperor is naked. As long as bonds
carry a gold clause, or the bond market is supported by the trading of paper
gold, bonds are deemed redeemable. But once permanent backwardation makes
monetary gold unavailable, debt becomes irredeemable in the eyes of the
bondholders. Paying U.S.
bonds at maturity in F.R. notes does not establish redeemability.
The latter is just evidence of debt secured by the former as collateral. This
reveals that bonds are not really redeemable at all. At maturity, an
interest-bearing bond is replaced by non-interest-bearing debt, that is, by
an inferior instrument. All you do is shuffle various forms of irredeemable
debt. When the world wakes up to this prestidigitation, the international
monetary system will not be able to survive the shock-waves. The chaos that
will engulf the world is appalling.
The solution is evident. The world’s monetary gold should be
remobilized. This can be accomplished by opening the U.S. Mint to the free
and unlimited coinage of gold. There should be no attempt to fix, cap, or
otherwise control the dollar price of gold. The gold coins of the United
States ought to be made available to
bondholders in order to provide for an orderly retirement of debt, if that is
what the bondholders want. When they become convinced that this avenue is
open to them through the unlimited availability of gold coins of the realm,
the scrambling for liquidity will peter out and stability return. If other
great nations wanted to join, and open their Mints to the free and unlimited
coinage of gold, so much the better. It should not be beyond the power and
the wit of the U.S.
government to rein in this crisis and make a decisive move in the direction
of full recovery through opening the U.S. Mint to gold, as demanded by the
Constitution.
Gold is a great world resource. It would be foolish if, for parochial
or ideological reasons we failed to enlist it in the cause of economic
development and stabilization — even in the absence of a great crisis.
But given the present unprecedented crisis, remobilization of gold is
imperative.
Yours very sincerely,
Antal E. Fekete
Santa Colomba,
July 10, 2009.
Volcker: “The financial system is
broken.” In a bleak
assessment delivered on September 23, 2010, he also said, among other things,
that the financial system is as broken today as it was in 2008. The real
economy was in disequilibrium, and that’s why it is so difficult to get
out of this recession. He was chastising banks and CEO’s,
he trashed regulators and inept business schools. He had a broadside on the
Fed; he bombed money market funds.
In fact, Volcker spared no one in his broad critique — except
himself. He was present at the Camp David meeting, as the Undersecretary of
the U.S. Treasury for Monetary Affairs that, where the decision was made to
default on the international gold obligations of the United States, as
announced by president Nixon on August 15, 1971, almost forty years ago.
Volcker still does not see the connection between that fateful
decision and the present crisis. Once you remove gold from the international
monetary system and prevent its rehabilitation, as the U.S.
has been doing it through chicanery, duplicity, and arm-twisting, you have in
fact removed confidence, and prevented its return, to international
relations. It started as a slow process as it was turning the granite at the
foundations into putty. It took forty years, but it has happened. Volcker
still does not see that, and he still could not bring himself to uttering a
word about gold in his assessment of the crisis at the 13th annual
International Banking Conference.
Volcker: “The financial system is still at
risk!” Yes, indeed, and only
bringing gold back as the ultimate extinguisher of debt into the
international financial system will change that.
If the United
States government hasn’t got the moral
fiber to admit its past mistakes, and make the necessary changes to correct
them, then other countries will bypass it, as will history. Then the United
States can join the Club of Disgraced Empires, and the
U.S. dollar can join the garbage heap of worthless fiat currencies of
history, right next to the Zimbabwe
dollar.
September 24, 2010.
Antal E. Fekete
DISCLAIMER
AND CONFLICTS
THE PUBLICATION OF THIS LETTER IS FOR YOUR INFORMATION AND AMUSEMENT ONLY.
THE AUTHOR IS NOT SOLICITING ANY ACTION BASED UPON IT, NOR IS HE SUGGESTING
THAT IT REPRESENTS, UNDER ANY CIRCUMSTANCES, A RECOMMENDATION TO BUY OR SELL
ANY SECURITY. THE CONTENT OF THIS LETTER IS DERIVED FROM INFORMATION AND
SOURCES BELIEVED TO BE RELIABLE, BUT THE AUTHOR MAKES NO REPRESENTATION THAT
IT IS COMPLETE OR ERROR-FREE, AND IT SHOULD NOT BE RELIED UPON AS SUCH. IT IS
TO BE TAKEN AS THE AUTHORS OPINION AS SHAPED BY HIS EXPERIENCE, RATHER THAN A
STATEMENT OF FACTS. THE AUTHOR MAY HAVE INVESTMENT POSITIONS, LONG OR SHORT,
IN ANY SECURITIES MENTIONED, WHICH MAY BE CHANGED AT ANY TIME FOR ANY REASON.
Copyright
© 2002-2008 by Antal E. Fekete
- All rights reserved
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