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June 17, 2005

A Gold-Euro Bust!
by Alex Wallenwein

Does this title confuse you? I'll bet it does, because in the minds of most gold investors it seems backwards. To most, it should read: "A Euro-Gold Boom!" That signifies that gold is booming in euro terms. The title of this essay, on the other hand, states that the euro is losing ground against gold, and fast - a far more accurate representation of what's happening.

Going back to an analogy I used in a two year old essay, both the euro and the dollar (and all fiats) are really but hikers on the side of the mountain that represents gold. The mountain's height (i.e., value) never changes as the hikers climb up or down its side, but the good folks of the government/banking sector like to make us believe that does.

The bank/government controlled and managed 'indexes' price gold in terms of the fiat unit. They pretend that the hikers are the measure of value, not the gold, and they solidify that idea in our minds by always expressing the "price of gold" in terms of fiat rather than the other way around. And out of sheer long-standing habit and convenience, even us gold analysts follow their lead.

That grossly distorts the real picture.

This is an utterly ridiculous notion. It's a sad testimony to where we have gotten in society, as well as the state of mind of most gold investors and analysts, that we fell into this mind trap made of lies and baited with convenience, but here we are.

How did we get here?

To explain that, we need to go back ... way back ... back into time, when the only people that existed were cavemen. Neanderthal. Troglodytes! Baroom dap di dap, dap, baroom, bap di dap dap ... (Sorry. That's the opening line to an old seventies hit from the Jimmy Castor bunch called "Troglodytes." It just kind of fits right here.)

Anyway, we need to go back to the time when even barter was not yet invented as a widespread trading system. The whole thing is basically a question of how humans developed the ability to assign "value" to something in terms of something else, for that's all a so-called "value" really is (unless you want to get theological here, which I don't).

It's a relative concept of worth or usefulness (one bucket of wheat is more useful to me than a set of bow and arrows since I can make lots of bows and arrows but I have no land on which to grow wheat, and my wife is bugging me to get her some wheat so she can make bread, so I trade for the wheat with Farmer John). There is no official wheat/bow-and-arrow index or exchange. It's purely s subjective value judgment in my mind.

This system went on for a while until people figured out that some shiny yellow metal was equally desired by everyone because it was pretty and compact and didn't break, and you could turn it into many different other things, and women loved it because it made them look pretty, so they nagged their men all day long to get them some more of it, and so we men figured that, since everybody wanted it (since most other men either had a woman who wanted it - or were trying to get one) so why not trade for the metal itself instead of the other stuff we wanted and then use the metal to buy what we needed?

Naturally, the obvious male-chauvinist slant of this example is a representation of our cavemen past and bears no relationship whatsoever to my current state of mind.

As this became widespread, gold naturally took on as its primary function that of a trading medium, or a "medium of exchange" as pointy-headed economists like to call it today.

Now people started to value (price) the things they wanted in terms of quantities of gold. But gold was rare, and only powerful and wealthy men and women - usually Kings, Queens, and nobles who made a living by clubbing others over their heads to make them accept them as rulers - could afford it.

The upshot of that was, of course, that rulers claimed control over the metal and over how it was to be traded - and valued.

That's where the problem came in. Rulers started regulating the size and shape of the gold pieces for trading purposes and formed them into coins, and subjects accepted those coins because they were convenient and because the rulers had men working for them with bigger clubs who could swing those clubs better than anyone else. (Any actual or imagined resemblance to our far more civilized world today is unintentional and purely coincidental.)

So, the rulers in their vanity and megalomania started calling those coins something other than what they were - quantities of gold - to remind their subjects who was boss around there. That way, a one-ounce (or whatever weight unit) piece of gold of a certain size and weight with a certain symbol impressed on it was called a "bezant" (after the great city "Byzantium") or a "thaler," etc. People eventually associated the names of the coins with the coins themselves and used the names to distinguish among them. That's how sooner or later the names of the coins became the official "unit of account" (another pointy-headed economist word) with which we learned to associate all economic value.

And that's where all of the real trouble began.

Crafty money changers and gold warehousers (known as bankers today) figured out that the receipts they issued to depositors began to be traded among people as gold-substitutes, so there was no necessity for going to the warehouse and taking the gold out to give it to someone else who would then only put the gold right back into storage.

For one, this gave the moneychangers the ability to issue more receipts than there was gold. Such was the birth of modern-day "inflation."On the other hand, this got people over time to associate the name and amount of the prevalent gold coins with the words and symbols scribbled on the warehouse receipts. The receipts took on the personality of the gold they represented and began to be called the same thing. A dollar. Ten francs. Whatever.

That's when the banking class figured out they could pull the ultimate heist by completely disconnecting the paper bills from the underlying gold. In people's minds, the paper was called the same thing as the gold, bought the same thing (in practice at least), and was easier to carry, so - hey, why not?

You know the rest of the story.

It's all just a mindgame we are playing on ourselves. The banking class figured out how to play this mind game better than us, and to their advantage, by pulling the wool over our eyes.

And we let them!

So here we are. Today, the price-value of gold is figured in terms of some arbitrary name choice like "dollar" or whatever and, ironically, that in which gold is quoted (fiat) no longer has any relation to gold at all in that its value or quantity are no longer limited or determined by the amount of gold in existence.

The final step in this process now lay in creating - in addition to the fiat creation mechanism that was not limited by the amount of gold in existence - even a fiat pricing mechanism for gold itself that was no longer determined by the supply/demand dynamics of gold.

In other words, in order to perpetuate and cement the fiat creators' control over human economic endeavors, there had to be brought into existence a pricing mechanism for gold itself that was no longer subject to ordinary free market demand-and-supply considerations. That final "achievement" was realized in the creation and the bringing to prevalence of the gold derivatives markets during the 1980s. In other words, gold futures contracts and gold options contracts as well as far more exotic derivatives took the place of gold itself in determining a phony "supply and demand" picture. For some reason - probably because of the lack of a viable alternative - gold investors keep forgetting that the COMEX gold price has, at most, a ten percent relation to the supply-demand picture of physical gold.

Bottom line: What we call "the price of gold" is at best a two-stage illusion. First, that which we price it in (fiat) is disconnected from gold,and hence an illusion. Second, that which we trade in order to determine that "price" is not gold itself but paper claims to gold, of which only about 10 percent are ever settled in gold (and hence about 90% inflated). And the New York COMEX price is the price the entire world looks to in figuring their own gold price, even the "bullion" exchanges like London. Go figure!

For the past several years, gold investors were all happy that the gold price of the dollar was falling (i.e., the dollar-price of gold was rising). But we were dismayed by the fact that the gold price of the euro remained relatively high and wasn't falling. (Confusing to look at it that way, isn't it?)

The reason for this was that the euro still enjoyed higher respectability than the dollar, which began to fall out of favor with the world's CBs and investors. Thanks to the recent French and Dutch 'no' votes on the EU constitution, this is now beginning to change. Confidence in the EU economic bloc has plummeted as a result of its political and economic woes.

The euro is a derivative of its twelve member countries' economies combined. It is also a derivative of people's value-comparison between it and the dollar and other currencies. Neither of those currencies are gold-derivatives anymore in the proper sense, but neither can escape the public's currently scathing value-comparison with gold.

For as long as the gold price of the euro remained largely stable over time (though extremely erratic within its wide trading band), rising gold did not really prose a threat to the dollar, at least since the time the euro entered the world as a full fledged cash currency in 2002. During that time span, a rising euro was more of a threat (and also a blessing in this schizophrenic world, as noted in previous articles).

But now the euro is falling by the wayside, and the euro-fleeing public is not sufficiently piling into the dollar as the much-vaunted "safe haven." Some are, to be sure, and that's why the dollar is rising against the euro - but gold is now rising against both of them, with roughly equal speed. That means people are looking for an alternative to both the euro and the dollar. In our mountain analogy, it looks like the "winner" between these two descending currencies will be the one that hits the ground last. It is by no means guaranteed that the winner will take the spoils, though. This time, the title may have to be awarded posthumously.

The phony pricing mechanism that conceals the nature of the gold mountain and the currency hiker's true relationship to it will begin to lose its blinding power when the currencies descend to a certain level versus gold. What level that is remains to be seen, but it will be that level at which it becomes apparent to the rest of the world that no official recuse action can prolong the euro's and dollar's so far unquestioned dominance in the currency arena.

It is revealing to note that the dollar, in order to survive as "the" alternative to gold, absolutely needs a viable euro that can rise against the dollar as the dollar falls and simultaneously remain stable against gold.

That means in essence that the euro must be able to hang on to the side of the mountain as the dollar falls off. These two are literally tied together like a rock climbing party is tied together by their life saving rope. One can fall and survive as long as the other is still "hanging on." Right now, the euro can safely fall off as long as the dollar maintains its footing on the gold mountain (i.e., remains stable against gold). But if the dollar should lose its foothold too, well ...

It's amazing how closely this analogy tracks the real life euro vs dollar situation, isn't it?

Now, what happens to the entire Comex paper-pricing mechanism when this occurs? Will it retain any kind of validity and relevance?

If the current gold-dollar price interaction continues, the dollar is already discredited by the world's failure to pile into it as it flees the euro. The Comex paper-gold/dollar pricing mechanism was instituted to give the falling dollar a sort of "safety cushion." Through it, the dollar's illusory value could be upheld by artificially inflating the "supply"of gold by throwing gold-derived paper contracts into the balance on the dollar's side of the scales, which makes the dollar appear to pull more weight.

When a rising forex value of the dollar can no longer hide the true value comparison with gold (i.e., the retreat of the dollar against gold), even with the help of the phony paper-pricing mechanism for gold, then what good is that pricing mechanism anymore? It retains its value only for as long as people are paying attention to it.

More likely than not, this paper-screen that was developed to obscure the true action of gold versus the dollar will atrophy from lack of use. Less and less people will pay it any regard, and it will be forgotten and replaced by a more accurate and open system (either that, or we all get "tagged" and are forced to buy and sell via RFID chip only).

The paper contracts that make up the Comex will be settled in dollar cash, most likely at vastly discounted prices after plenty of litigation ensues when the longs finally figure out that the gold they thought they were contracting for was never there to begin with (in sufficient quantities to satisfy all demands, at least) - not even at the price at which they originally contracted.

Just imagine you have "gone long" on thirty-day gold, betting that the price will be $500 per ounce then. The price actually rises to $2,000 in that time span (purely theoretical; of course, this could never happen, could it?) You try to get your gold so you can sell it for your expected $1,500-plus profit per ounce. What will you get out of this?

You'll get the option of accepting $500 in cash per ounce contracted, or file a lawsuit, or shut the hell up if you decide that neither option suits you.

So the question arises why "they" (supporters of the Comex system) could not throw more and ever more paper contracts at the longs to continue to obscure the true price action and dilute it into eternity. The answer is: they already are, and it ain't workin' no more.

Technically they could, yes, but not in reality as we have seen in the example above. When people, even institutional investors, find out that they can never get the advantage they are betting for, then why bet?? If you know the casino you play in refuses to cash in the chips you win, why play?

That will be the day the Comex system dies. It will simply cease to exist.

What will replace it?

Either a pure gold settlement system where actual ounces are required to be on hand to satisfy all demands, or a worldwide dairy farm where human cattle are tagged, tracked as inventory, regularly milked, and then led to the slaughtering pen with a far more ruthless efficiency than we have endured during the past seventy-some years.

Got gold?

Got guts?

It takes a sufficient number of people who have both to prevent such a world from ever coming about. And, we're very, very close as it is!

Alex Wallenwein
Editor, Publisher
The Euro vs Dollar Monitor

Just like driving your car, investing only makes sense if you can see where you are going. The Euro vs Dollar Monitor is your golden windshield wiper that removes the media's greasy film of financial misinformation from your investment outlook. Don't drive your investment vehicle without it!

Copyright © 2003-2008 Alex Wallenwein

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