|
|
Introduction. While
doing research in the Library of the University of Chicago in the early
1980’s I came across the unfinished manuscript of a book with the
title: The Dollar: An Agonizing Reappraisal. It was written in the
year 1965. It has never been published (although it has received private
circulation). The author, monetary scientist Melchior Palyi, a native of
Hungary, died before he could finish it. Monetary events started to spin out
of control in 1965, culminating in the default on the international gold
obligations of the United States of America six years later in August,1971.
Palyi had correctly prophesied that event which occurred after he died. He
had also correctly diagnosed the malady and prescribed the remedy that could
have arrested the train of events that would in all likelihood cause a crash
further down the road. As part of the offering of Gold Standard University, I
shall publish the manuscript serially in the form of excerpts, along with
with my commentary, concentrating on parts that are still timely.
That the title is more timely than
ever is a fact that nobody can deny.
Biographical
remark. Melchior Palyi (1892-1970), the internationally
recognized educator, author, and economist was born and got his early
education in Hungary. He was Professor Emeritus of the University of Berlin
and also taught at the Universities of Munich, Göttingen, and Kiel. He
was the chief economist of the Deutsche Bank of Berlin, the largest on the
European continent at the time, and was adviser to the Reichsbank, the
central bank of Germany, from 1931 to 1933. He was then guest of the Midland
Bank, Ltd., in London, and visiting lecturer of the University College of
Oxford.
Palyi moved to the United States in
1933. He was visiting professor and research economist at the University of
Chicago, Northwestern University, the University of Wisconsin, and the
University of Southern California. He was involved in broad literary and
lecture platform activities. The bibliography of his literary output is
extensive; let it suffice to mention the titles of some of his books: Compulsory
Medical Care and the Welfare State (1949; he is credited with the saying
„where the Welfare State is on the march, the Police State is not far
behind”), Managed Money at the Crossroads (1958), A Lesson in
French: Inflation (1959), and his swan song: The Twilight of Gold (1970).
Change of font to bold face type indicates quotations from the manuscript.
The Gold Paradox
Nineteen sixty five will be remembered in the modern history of money.
For the first time, private buyers absorbed almost the entire supply of new gold
coming on the market. „Newly mined gold plus Russian sales amounted to
approximately $1.9 billion”, reported the First National City Bank of
New York, but „only some $250 million worth is believed to have reached
officially recorded monetary stocks” (all quantities are stated in gold
dollars, reckoned at the gold price of $35 per Troy oz.) And none whatsoever
accrued to U.S. monetary reserves ─ which has actually declined by a
near record amount of $1.66 billion.
What is happening to all that disappearing gold? Why does it refuse to go
to official gold reserves? Why, in particular, is the U.S. Treasury on the
losing side year after year, with no sign of terminating this process? And,
above all, what does it say about the stability of the dollar, the economic
health of the nation, and the future prospects of the Western World?
The central problem is the actual maintenance of the parity. The U.S.
Treasury is under obligation, in effect, to assure that on the world’s
markets 35 dollar means the same value as one ounce of gold. Thereby the
value of the dollar is anchored to the solid rock of a fixed quantity of
gold. As long as this external convertibility of the dollar appears to be
guaranteed, world public opinion will not question the equivalence between
the currency unit and a set amount of the yellow metal. That is why to the
world at large the dollar is „as good as gold”. In the words of
President J. F. Kennedy, speaking in September, 1963, „We are
determined… to maintain the firm relationship of gold and the dollar at
the present price of $35 an ounce, and I can assure you we will do just
that.”
Gold Vanishing
Into Private Hoards
1950 is the watershed year marking the start of a new era in the
relationship between gold and paper money. In the twelve-year period ending
in 1964 the Western World’s gold mines and Russian gold sales (about $1
billion in 1963-64) combined, produced $16 billion worth of gold, but
official gold reserves have grown only by $7 billion. More than 50 percent,
on average, of the new gold bypassed official reserves and vanished in
private hoards. On the top of that the prime reserve currency, the U.S.
dollar (that is backing many other currencies) had lost close to one-half of
its gold reserves. By the end of 1965 our reserves have declined from a peak
of $24.7 billion in September, 1949, to less than $14 billion ─ of
which $835 million is a sight deposit of the International Monetary Fund. Not
only has the richest country failed to attract any part of the new gold
supply; it has actually lost more than $10 billion’s worth. If
continued, this process would herald the breakdown of the entire gold-based
monetary setup of the West, with incalculable consequences.
To have some idea of the order of
magnitude of gold vanishing into private hoards during the period from 1950
through 2007, let us recall some facts and figures.
Output from
Western mines plus Russian gold sales before the
collapse of the Soviet Union (approximate quantities in gold dollars at
$35/Troy oz.):
1950-51: $ 2,000m; 1952-65: $ 21,000m; 1966-68: $ 3,400m; 1969-2006: $
77,500m.
Absorption into
private hoards from mine output, gold pool sales plus US/IMF/central bank
gold auctions (approximate quantities in gold dollars at $35/Troy
oz.):
1950-51: $ 100m; 1952-65: $ 9,000m; 1966-68: $ 3,200m; 1969-2006: $ 80,000m.
The crescendo of gold disappearing in
private hoards is crying out for an explanation. Gold absorption into private
hoards for the 20-year period from 1950 through 1970 was of the same order of
magnitude as the entire U.S. gold reserve at its peak in 1949, the largest
gold concentration ever in history: just short of $ 25 billion. It was
followed by the greatest dissipation of gold ever. This private absorption of
gold is unprecedented, both as to its magnitude and its speed. The total
amount of gold absorption for the entire 56-year period 1950-2007 was
approximately $ 90,000m, an amount greater than all the gold produced in
history before 1950.
Clearly, something ominous is
happening to the dollar. Vanishing gold is trying to tell us something, that
is, if we have ears for hearing. More remarkable still than these
extraordinary quantities of wealth shifted out of paper assets into phyisical
gold, worth about $ 1,8 trillion at today’s gold price, a process that
is still continuing at an accelerating rate, is the fact that mainstream
economists and their paymasters in government are not asking questions
about, nor offering explanations for this incredible movement of wealth going
into hiding. The apparent lack of interest about the identity and
intentions of the owners of this wealth on the part of the economists’
profession is in itself a worthy subject to investigate.
Put it differently, paper wealth in
the world is presently being destroyed at the rate greater than that of the
annual gold production, approx. $2.8 billion gold dollars (equivalent to
about $55 billion paper dollars at today’s gold price), but this
earthquake-style destruction is allowed to go unnoticed by academia and the
financial media. They are satisfied that paper wealth so destroyed will not
be missed. The U.S. Federal Reserve banks are dutifully replacing these real
assets, and more, by printing paper assets. „See no evil, hear no
evil.” „What you can’t see won’t hurt you.”
Nobody is pointing out that this newly created paper wealth facing, as it is,
an equivalent amount of wealth in solid gold, is quite hollow. Nobody asks
whether the large quantities of gold vanishing into private hoards could
cause a crisis when its size reaches and exceeds critical mass. Be that as it
may, thinking people ought to realize that, the official ’propaganda of
silence’ notwithstanding, the disappearance of such inordinate
quantities of gold cannot help but, in the fullness of time, have an untoward
effect on their lives, and on their children’s lives.
Fifty percent of all the gold in
existence has been produced since 1960. The same fifty percent has been
withdrawn from the public domain during the same period of time and
disappeared in private hoards. There is no way to account for this gold. We
do not know the location, the identity of owners, nor their intentions what
they wanted to do with it. This is a sea change portending a still greater
sea change to come. This is a situation comparable to the disappearance of
the gold and silver coinage of ancient Rome portending the fall of the
Empire. For this sea change the public is totally unprepared. It is left in
complete ignorance, due to the deep silence of the media and academia.
”The Most
Uneconomical Medium of Circulation”
At this point the reader may raise some pertinent questions. Why is gold
essential for a healthy monetary system? Why should anyone want to hoard it? Is
it not a useless gadget, good only for jewelry and dentistry? Why base the
currency on such an odd commodity, or on any commodity for that matter? We
have eliminated gold from hand-to-hand circulation; why not finish the job
and dethrone the „barbarous relic”, as Lord Keynes called it?
Indeed, we seem to be on the way to wipe all traces of gold out of the
monetary system. The first (1915) Annual Report of the New York Federal
Reserve bank argued that „gold is the most uneconomical medium of
hand-to-hand circulation since, when held in bank reserves, it will support a
volume of credit equal to four or five times its own volume”. (That was
an unintended admission of the inflationary bias indigenous to American
money-management.)
Twenty years later, in 1934, we proceeded to ’demonetize’
gold, forcibly taking it out of circulation. This was followed, in 1945, by
the reduction of the Federal Reserve banks’ gold reserve requirements
to 25 percent of total liabilities. By 1965 we had abolished gold as a mandatory
backing of the deposit liabilities of the Federal Reserve banks altogether.
Rationale of Gold
The first thing to know about gold is that there is no alternative to it.
Gold is the one and only commodity that has no marketing problem. There is no
sales resistance and no competition to overcome. A gold reserve is as
important for the nation as a bank account for the firm or individual. You
keep part of your funds in idle bank balances in order to be
’liquid’ ─ to be able to pay your bills. Gold is the
ultimate and unquestioned world-wide ’liquidity’. It is accepted
in payment of claims. Hence it is imperative that a country should possess
gold, or to have access to gold, in order to take care of an unfavorable
balance of foreign payments that arises when it has to purchase abroad more
goods, services, and assets than other countries buy from it. This has been
the chronic case for the United States in the post-World War II era,
resulting in gold losses and in a huge volume of short-term debt to foreigners.
The gold reserve inspires confidence in the currency at home and abroad.
„Even the most prejudiced managed-money advocate cannot deny that no
form of paper or arrangement can ever command the confidence and trust
inspired by gold, a store of value in itself” (The Statist,
London, December 25, 1964.)
In addition to the monetary there is also a non-monetary demand for gold.
The very promising metallurgical and medical applications of gold are still in
their infancy. Its use in the arts is ancient history. In any case, the
non-monetary demand provides a substantial part of the value of the yellow
metal, and is the root-cause of its use as the Number One store of value.
This function loses its importance when the national currency is safely
anchored in gold. But it is promptly revived and expanded whenever
convertibility comes under a cloud.
Paper money can be multiplied sine fine, virtually at no cost.
Gold is available only in limited quantity and at a substantial cost of
production. This fact is not a negative but a highly positive factor for
determining gold’s monetary fitness. Gold derives further strength from
another circumstance. The annual new production is a very small part of the
accumulated total supply, hardly ever more than 3 percent at any given time.
In 1965, for example, the $1.9 billion new gold reaching the market was less
than 3 percent of the total supply of over $60 billion accumulated in the
central banks of the West and in private hoards. (The latter has been
’guesstimated’ at $17 billion.)
No commodity known to man combines as gold does the qualities of
durability, unlimited marketability, portability, homogeneity, steady demand,
stability of supply growth, fitness for being stored, low cost of storage per
unit of value and, last but not least, independence from authoritarian
manipulation of the total supply. This is why totalitarians (and their
dedicated or subconscious fellow-travellers) are violently opposed to its
private ownership that provides the citizen with a large measure of freedom.
By having gold he can hedge against arbitrary policies of the Omnipotent
State, or even slip out from its clutches.
Explanation of the
Gold Paradox
The paradox of a chronic flight into gold, and out of the U.S. dollar
which is tied to gold, is the outstanding symptom of the present critical
situation. The pat explanation for the paradox is to blame the recurrent runs
on the ’speculators’. This is a characteristic throwback to
medieval economics, confusing symptom and cause. In truth, responsibility
belongs to the authorities who create opportunities to induce speculators to
go short on the dollar or to buy gold on margin. A far more important factor
may be the maneuvering of the cautious who do the exact opposite of
’speculating’: they are trying to protect their assets and
incomes by hedging against a possible devaluation…
Another pat explanation relegates the problem to the fringes of the
global economy. In areas where political, legal, or monetary insecurity
prevails, there is a compulsive instinct to seek security in hoarding gold.
No country can beat India in this regard. The hidden gold of her population
has been estimated by India’s Reserve Bank at some $6.4 billion (!), built
up over a period of 100 years or longer.
But the less developed economies are altogether too poor to absorb each
year the huge amount of vanishing gold. And why would they not hoard
convertible currencies instead of gold, as they did in the past? Actually, an
appreciable fraction of foreign aid dollars has been used by the recipients
to acquire gold ─ another vote of no-confidence for the dollar, as well
as for the respective local governments.
Even more significant is the fact that leading European central banks
display definite signs of impatience with the dollar. Given the $13.7 billion
holdings of dollar claims by monetary authorities, not counting some $6
billion held by international organizations, the danger this implies for the
American gold reserve and the maintenance of the dollar’s
convertibility can scarcely be overestimated.
It is more than a problem in monetary management. Our very prosperity,
and the integrity of our economic system is at stake!
Explanation, Forty
Years Later
In forthcoming parts of this series I
shall take the analysis of the gold paradox beyond the point to which Palyi
has taken it. I shall ask the question who the hoarders are and what
motivates their gold hoarding. My thesis is that gold hoarding is a win-win
strategy, the only valid one as such. (All other win-win strategies are Ponzi
schemes.) However, there is a strict condition, one that disqualifies most
would-be beneficiaries. The gold hoarder must be prepared to, and mentally
capable of, using gold exclusively as his numeraire in calculating
asset values as well as pofit and loss. He must understand that profit/loss
accounting in terms of the paper dollar is tantamount to trying to measure
length with an elastic measuring-tape. The obvious result is a cover-up for
the deficiency of length, akin to the cover-up for the deficiency of wealth
and to making losses parade as profit. Watch for the day when people wake up
from their delusion.
Admittedly, very few people are able
to adapt their thinking to the demand that the dollar be discarded as numeraire
of wealth. The dollar is far too deeply ingrained in their psyche for
that. As a result, very few people see the fragility of wealth under the
regime of irredeemable currency. Those who can are not tempted by the
spectacular profit opportunities in stock, bond, and real estate speculation.
They know full well that yielding to the temptation would be tantamount to be
seated in the middle of a crowded auditorium just before the fire alarm was
ready to sound. Their chance to reach the fire exit alive would be
practically nil.
Apparently, more and more people do
accept gold as a valid numeraire replacing the dollar, since they have
seen the writing on the wall warning about the dollar: „Mene tekel,
upharsin” (you have been weighed and found wanting).
We can understand the little
guy’s agonizing watch on a hesitant gold price to go up. He is
conditioned by a host of cheerleaders of get-rich-quick schemes. However, the
more enlightened hoarders of gold (whom in another paper I have called
’bulls in bear skin’) ─ admittedly a tiny minority ─
are in no hurry to see the dollar to bite the dust, or the price of gold to
go to outer space. They do have the philosopher’s stone, gold, well in
hand. More importantly they also have the matching wisdom, without which gold
is just another dead asset. They know that the most productive use of gold is
not to sit on it waiting for the miracle of a gold price in five digits to spring
upon the world. They want to derive maximum advantage from their possession
of the metal. In particular, they know how to make gold beget gold, something
even Aristotle believed was impossible. Most importantly, they need not
release control over their gold while deriving an income from it. Mark that,
in all other cases, deriving income from an asset involves putting the latter
to risk. The fact that gold income is an exception to that rule, in that it
can be harvested risk free even while the gold is locked up in one’s
own vault, is due to the idiosyncrasies of irredeemable currency. It is the
paradox that, while the irredeemable dollar is gold’s sworn enemy, it
lends gold the unbeatable advantage whereby it can generate an income risk
free.
The ’enlightened hoarders of
gold’ prefer the security of a gold income, that they can enjoy in
relative peace, to the insecurity of an exploding gold price. They understand
that they could not enjoy their exploding wealth once the gold price escaped
from the earth’s gravitation, because blood would flow in the streets
where the ’have-nots’ gave battle to the ’haves’ over
the only bone of contention that mattered: gold.
The common perception is that
commercial traders are selling gold short naked in order to drive down
the gold price where they can cover their short positions at a huge profit.
In this view the bears are sucking the blood of the bulls. This, of course,
is a myth. It is a simplistic explanation for a complex puzzle, the gold
paradox. In reality commercial traders are mere agents. If they trade for
their own account, the amounts are paltry in comparison. Commercial traders
act on behalf of principals who do hold the gold and are set upon deriving an
income from their holdings. It is understandable that these principals wish
to stay anonymous and, in an unexpected reversal of Andersen’s tale The
Emperor’s Clothes, they foster the misperception that they are
naked!
Historical
Precedence: Vanishing Gold in Ancient Rome
The last time in history when huge
quantities of gold were going into hiding occured during the twilight of the
Roman Empire. It was an ominous portent of bad tidings. People were
withdrawing gold coins from circulation. They declined to spend them hoping
that saner and safer times would come. As a rule people do not spend their
gold coins unless they see that they will be able to get them back on the
same terms. As saner and safer times did never come, these ancient hoards
were forgotten and remained buried in the ground throughout the Dark Ages.
Present day archeologists still keep finding them fifteen hundred years
later.
The owners of those ancient gold
hoards were helpless. They could not enjoy their gold as they were unable to
retard the coming of the evil day when the Roman monetary unit would become
worthless, and the Empire would fall. In this respect latter day gold
hoarders appear to be better off. They seem to be able to retard the fall of
the dollar towards worthlessness and, in the meantime, they could enjoy a
gold income in relative security. Of course, this will not ward off the
ultimate collapse of the American Empire, although it may materially postpone
it. The fortunes of empires tend to be predicated by the fortunes of their
currencies.
The present episode of gold vanishing
into private hoards is no less ominous than the previous one that was
followed by the collapse of the Roman Empire, and the lights going out in the
civilized world.
As this „agonizing
reappraisal” shows, the days of the dollar are numbered. Whether it be
a large number or small, the coming Dark Age looms large on the horizon.
Antal E. Fekete
San Francisco School of
Economics
aefekete@hotmail.com
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
|
|
