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The title is a
bow to Peter Schiff for his admirable article It’s
Not an Oil Crisis: It’s a Dollar Crisis.
Thirty-five years
ago gold, symbol of permanence, was chased out from the Monetary Garden of
Eden, replaced by the floating irredeemable dollar as the pillar of the
international monetary system. That’s right: a floating pillar. The
gold demonetization exercise was a farce. It was designed as a fig leaf to
cover up the ugly default of the U.S.
government on its gold-redeemable sight obligations to foreigners. The word
‘default’ itself was
put under taboo even though it punctured big holes in the balance sheet of
every central bank of the world, as its dollar-denominated assets sank in
value in terms of anything but the dollar itself. These banks were not even
allowed to say ‘ouch’ as they were looking at the damage to their
balance sheets caused by the default. They just had to swallow the loss,
obediently and dutifully join the singing of the Hallelujah Chorus of
sycophants in Washington
praising the irredeemable dollar and the Nirvana of synthetic credit.
For
a time it looked like a clever coup
as America
has benefited at the expense of the rest of the world. It could now buy all
the goods and services it wanted from foreign countries in exchange for
“little scraps of paper on which some ink has been sprinkled”.
More importantly, America
could establish military bases and start wars on foreign soil paying for them
with dollars created out of thin air. Foreigners had to put up and shut up. What used to be
“deficits without tears” before, has now
become “deficits with laughter”.
Few
people realized at the time that America,
far from giving itself a gift at the expense of foreigners, has fatally shot
itself in the foot. At first the wound from this self-inflicted gunshot did
not hurt and was quite invisible. Festering and pain came later. The long
time-lag makes the causal
relationship between the two events fade. Yet the connection exists creating
ever more mischief, misdiagnosis, monetary quackery and, ultimately, the
greatest credit collapse in history.
America
had to foster an anti-gold psychosis in the world to cover up default. Milton Friedman was the high priest of the
new paradigm with his monetarism, preaching the unmatched virtues of the
floating dollar. It was supposed to eliminate the American current account deficit.
It never did. Instead, it killed the healthy American trade surplus, as
American industry was pushed into an endless decline by the self-mutilation
of the dollar.
The
worst part of the anti-gold psychosis was its effect on the banking system.
American banks were deprived of a chance to hedge their assets, all of it
held in the form of irredeemable debt (irredeemable in the sense that at
maturity it was payable in irredeemable currency) by holding monetary metals,
gold and silver, as a reserve. Those foreign banks that did were made the laughing stock of the banking industry.
‘Progressive’ banks were free to heap debt upon debt in the asset
column of the balance sheet without any regard to reserve ratios, in a mad
chase of illusory paper profits. If the balance sheet was not big enough,
why, they could simply go ‘off balance sheet’ to add more debt.
Foreign banks chimed in: “Me too, me too!” It was truly an
incredible sight watching the Union Bank of Switzerland, a solid and
liquid bank before 1973, throwing all caution
to the winds in its zeal to embrace hare-brained securitization schemes, and
to put a lot of bad debt made in USA
on its balance sheet.
We
were also treated to another incredible sight: the Bank for International
Settlements (BIS), the only sane central bank left after the
gold-demonetization farce, committing hara-kiri.
Since its establishment the BIS carried
its books in Swiss gold francs. The
implication was clear: the BIS wanted to stay above the hurly-burly of
competitive currency devaluations which humiliated even the lofty Swiss franc
in 1936. The BIS continued to carry its books in Swiss gold francs, never
mind the vicious anti-gold agitation that started in 1973. Ultimately it
threw away all good banking sense and caved in. On March 10, 2003, BIS
abandoned the Swiss gold franc and embraced the SDR (Special Drawing Rights)
as its unit of account. The SDR has the dubious distinction among fiat
currencies that it does not even have
an obligor. It is an out-and-out make-believe currency. It does not arise
as an obligation. It arises as a free gift, manna from heaven, brought by
Santa Claus alias IMF. (This Santa has just announced that, in a move of
belt-tightening, he was selling gold to cover the cost of mending his bag).
In want of a definition of an accounting unit no bank is subject to any
meaningful accounting rules any more. The last central bank with the ability
to step into the breach, offering sound credit in case of a world-wide credit
collapse, has disappeared from the scene.
Because of the anti-gold psychosis the dollar went
into a downward spiral, never to come out of it. The question arises whether
gold is just an embellishment, a barbarous relic, a superstitious talisman,
or whether gold is a real mooring without which the banking systems cannot
safely manage risks in the long run.
To
answer this question we must understand the first principles of hedging. Gold
and silver, as monetary metals, are the two most important hedges banks can
have to offset risks to the asset column of their balance sheets. You cannot
hedge these risks through owning more debt ― the liability of someone
else. A hedge that is subject to exactly the same risks would not diminish
but magnify risks. It is a “Texas
hedge”. (The reference is to the rancher who, when it was pointed out
to him that his long contracts on live cattle can in no way hedge his herd on
the ranch, proudly answered: “me hedge is a Texas hedge”.)
For
a true hedge, you need and ultimate asset that is not the liability of
anyone. Such an asset is furnished by the monetary metals. It is foolish to
suggest that gold and silver have lost their value as hedges since their
prices fluctuate. The fluctuation of their price does not prove that the value
of gold and silver fluctuates. On the contrary, it is the value of the dollar
that does fluctuate in which gold and silver prices are quoted.
Because of this fluctuation it is inherently
treacherous to trade gold and silver on the variation of price. Proper
hedging replaces price risk with basis risk which is less erratic and
more predictable. The basis is the difference between the nearest futures
price and the cash price of the monetary metal, gold or silver. There is a
long-term trend for the basis to fall, and ultimately to go negative.
Traditionally the basis has been positive. The condition that holds when the
futures price exceeds the cash price is called contango. Permanent contango is a characteristic of the monetary metals
indicating large above-ground stores relative to the annual output of the
mines. But fiat currencies keep losing value through monetary debasement. It
makes the basis of gold and silver fall, and contango
disappear. The opposite condition, obtaining when the futures price goes to a
discount against the cash price, is called backwardation. It is equivalent to a negative basis. It is an
indication of the fact that the monetary metals are going into hiding.
The
international monetary system is inevitably drifting towards the black hole
of backwardation, and will ultimately succumb to its pull. Governments and
central banks tell you that they are combating inflation. They do in the
forlorn hope that they can escape the pull of the backwardation of monetary
metals. But they cannot, because
that pull is the global manifestation of countless individuals’ seeking
shelter against deliberate monetary debasement in the ownership of monetary
metals.
The
point is that the only way to measure the more or less slow deterioration in
the collective value of irredeemable currencies is the gold and silver basis.
It is precisely the change in the basis that provides clues for hedging
against the risk of monetary debasement. The outstanding fact is that the
basis can be traded with greatly reduced risk, as compared with trading the
price.
It
should be clear that some banks in
the world are doing just that. They are trading the gold and silver basis (as
opposed to trading the gold and silver price) continuously. This means that
they are buying hedged metal when the basis is high, and selling it when the
basis is low. This enables them to earn a steady income on their gold and
silver reserves in gold and silver. The proof that they indeed engage in this
activity is furnished by the inordinate size of the short interest in the
gold and silver futures market. It is altogether erroneous to attribute this
short interest to the activities Jurassic Park
creatures, and to that of the bogeyman of ‘naked’ silver
commercials. The inordinate size of short interest in gold and silver is just
the visible side of the hedges of bullion banks and others, the invisible
side of which is their metallic reserves.
Gold Standard University
Live is the only organization that advocates paying attention to features
such as silver and gold contango, backwardation,
basis, and short squeeze. The vocabulary of analysts and other observers of
the passing scene doesn’t even include these
market terms. They follow statistics of production and off-take, the
commitments of traders in the futures market, and are trying to divine coming
moves in the gold and silver price through supply and demand equilibrium
analysis. Theirs is a wrong-headed approach. Supply and demand equilibrium
analysis is inapplicable to the monetary metals, both the supply of and the
demand for which tend to be unlimited. That’s just what makes gold and
silver a monetary metal. Nevertheless, the threat of a
short squeeze or, if the worse comes to the worst, that of a corner,
is very real. Corner in precious metals also goes by the other name hyperinflation. Reams and reams of
supply/demand statistics and all the COT reports in the world will not
predict when it will hit. Only the basis will. It provides an early-warning
system indicating, with the precision of a seismograph, the escalating
shortages in silver and gold. And only Gold Standard University Live is
willing, “without fear or favor”, to publish the results of
research which tell you how to read basis signals.
In
summary, the present crisis is far from over. Far from being an oil crisis,
it is not even a dollar crisis. It is a
gold crisis. It is preying on American and other banks, punishing them
for their failure to hedge paper assets with gold. The U.S.
government is trying to bail out large multinational banks by stuffing them
with more paper assets to bursting. In a recent move the Federal Reserve has
made history when it swapped U.S. Treasury bonds for the so-called
asset-backed securities held by brain-dead banks for which the market refuses
to put in a bid. The trick won’t work. And it is doubtful that the only
meaningful bail-out that would work, namely, opening the U.S. Mint to gold
and silver as advocated by presidential candidate Dr. Ron Paul, is in the cards. To be sure, opening the Mint
to the monetary metals should work. It would make U.S. Treasury gold
available to American banks, to save them from insolvency. What they need is
not augmentation of capital in the
form of more paper credits. What they need is metallic hedges to prop up the
value of paper assets. Opening the Mint would mobilize the world’s
metallic reserves, presently in hiding, and put them back into the public
domain to assume their traditional role as the foundation of the
world’s credit system.
References
Peter Schiff, It’s
Not an Oil Crisis, It’s a Gold Crisis, May 23, 2008
A. E. Fekete, What the Gold and Silver Analysts Overlook,
May 1, 2004, www.professorfekete.com
A. E.
Fekete, The Last Contango in
Washington, June, 2006, www.professorfekete.com
GOLD STANDARD
UNIVERSITY LIVE
Session Four is to take
place in Szombathely, Hungary (at Martineum Academy where the first two sessions
were held). The subject of the 13-lecture course is The Bond Market and the Market Process Determining the Rate of
Interest (Monetary Economics 201). It will be followed by a panel
discussion on the topic: The Silver
Basis and the Present Banking Crisis: Phony Bond Insurance Schemes and the
Lack of Hedging Irredeemable Dollar Debt with Monetary Metals.
The date is: July 3-6. For
more information please see www.professorfekete.com/gsul.asp
or contact GSUL@t-online.hu.
Registration can be made by e-mail upon payment of the pre-registration fee.
The remainder of the registration fee is due 3 weeks prior to the session.
Space is limited; first come, first served.
Preliminary
announcement: Gold Standard
University Live is planning to have
its Session Five in Canberra,
Australia, in
November, 2008. This Session will include a Primer on the gold and silver
basis, prerequisite for a Workshop on the basis offered at Session Six
(planned to take place in the Spring, 2009).
Antal E. Fekete
www.professorfekete.com
Professor, Intermountain Institute of
Science and Applied Mathematics
Missoula,
MT 59806, U.S.A.
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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