# Silver is Money: The Four Horsemen - Part Three

By: Douglas V. Gnazzo | Sat, Jul 16, 2005

Silver Athenian Owl

This commentary was originally posted at www.financialsense.com on 12th May 2005.

Introduction

Now I saw when the Lamb opened one of the seven seals, and I heard one of the four living creatures say, as with a voice of thunder, "Come!" And I saw, and behold, a white horse, and its rider had a bow; and a crown was given to him, and he went out conquering and to conquer.

When he opened the second seal, I heard the second living creature say, "Come!" And out came another horse, bright red; its rider was permitted to take peace from the earth, so that men should slay one another; and he was given a great sword.

When he opened the third seal, I heard the third living creature say, "Come!" And I saw, and behold, a black horse, and its rider had a balance in his hand; and I heard what seemed to be a voice in the midst of the four living creatures saying, "A quart of wheat for a denarius, and three quarts of barley for a denarius; but do not harm oil and wine!"

When he opened the fourth seal, I heard the voice of the fourth living creature say, "Come!" And I saw, and behold, a pale horse, and its rider's name was Death, and Hades followed him; and they were given power over a fourth of the earth, to kill with sword and with famine and with pestilence and by wild beasts of the earth. [Revelations]

"Philosophy is written in this grand book - I mean the universe -
Which stands continually open to our gaze.
But it cannot be understood Unless one first learns to comprehend the language
And interpret the characters in which it is written.
It is written in the language of mathematics,
And its characters are triangles, circles, and other geometric figures,
Without which it is humanly impossible to understand a single word of it."

Galileo Galilei, Il Saggiatore (1623)

Linear Models & Predictability

Near the end of Part II of Silver Is Money the issue of linear and non-linear models was briefly discussed, including closed and open systems, and how the use of different models and or systems might effect the accuracy of any predictions made based on them. The questioning of these issues is nothing new, science is very aware of these issues, at least most scientists are.

Professor Antal Fekete is a world renowned economist, who has stated the importance of the difference between linear and non-linear models, noting that to ignore their differences can skew one's view and interpretations of observable data and information. In his paper Deflation or Runaway Inflation, he says:

"The explanation of the phenomenon of runaway inflation in terms of linear models is fallacious."

"The fact is that linear models are useless in studying runaway inflations. The phenomenon itself is non-linear in nature, as it is the culmination of a runaway vibration." [Fekete]

That is about as clear and succinct as it gets in explaining the fact that linear models are useless in explaining runaway inflation, which also goes by the name of hyperinflation.

Professor Fekete is one of the few economists who discusses this very important aspect of the inadequacy of linear models in the prediction of hyperinflation, which is non-linear in its expression. This is an extremely critical point of grave importance and will be revisited.

Hyperinflation is therefore - Impossible to accurately predict.

The above also ties in with chaos theory that was discussed in part II of Silver IS Money. As the collective work of Jonathan Mendelson and Elana Blumenthal states:

"Chaotic systems are mathematically deterministic but nearly impossible to predict."

As Barone, S.R., Kunhardt, E.E., Bentson, J., and Syljuasen, A. state in their work of 1993: "Newtonian Chaos + Heisenberg Uncertainty = Macroscopic Indeterminacy", American Journal of Physics, Vol 61, No. 5:

"The chaotic solutions of nonlinear differential equations are extremely sensitive to the numerical values of the initial conditions."

"Any set of differential equations represents a model of a system which incorporates some insights into the phenomena being studied and at the very least ignores numerous perturbations."

"The ignored small physical perturbations which might be modeled, for example, by additional 'forces' in the differential equations may totally change the behavior of the system in time intervals of interest."

"In this situation the behavior of the system is 'unpredictable' in the sense that it is not practical to include all perturbations which have a significant effect on the behavior of the system."

Professor Fekete has written rather extensively on the theory of linkage between the price level and the interest rate level. The 1947 work of Gilbert E. Jackson regarding such linkage has been referenced as follows:

"In 1947 the British-born Canadian economist Gilbert E. Jackson studied the behavior of just two economic indicators, that of the price level and the rate of interest. He found that the two are linked. Sometimes the price level leads and the rate of interest lags; at other times, the other way around."

"While sometimes the price level leads and the rate of interest lags giving impetus to lenders to change the lending rate, at other times the rate of interest leads and the price level lags." [Fekete]

Note that Jackson believed that sometimes the price level leads and the rate of interest lags, at other times the rate of interest leads and the price level lags. The critical issue is whether one is the cause and the other the effect, and or at other times vice versa. Jackson had no explanation other than to say that they were linked. He even stated it might be do to chance or coincidence.

Also note the part of the quote that reads "interest lags giving impetus to lenders to change the lending rate", which appears to suggest causality, as well as implying that lenders have the power to effect changes in the lending rate, which they do have - most of the time, but perhaps not always. This is a very important point and will be revisited.

Causal Money Flows

In Causes and Consequences of Kondratiev's Long-Wave Cycle Professor Fekete offers a novel and most unconventional explanation of the genesis of the Causes of the Kondratiev Cycle. His tenor is both brilliant and unique.

Causes of the Kondratiev Cycle

"We can now present our own explanation for the linkage and, simultaneously, our own description of the genesis of Kondratiev's long-wave cycle. Frustrated savers sell their bonds and put the proceeds in marketable commodities. Thus rising commodity prices and falling bond prices are linked and they reinforce one another. The linkage is best described as a huge speculative money-flow. The money-tide begins to flow at the commodity market while ebbing at the bond market. This epitomizes the inflationary phase of Kondratiev's long-wave cycle."

"But falling bond prices are tantamount to rising rates of interest. Thus a rising price level and a rising interest-rate structure, if they do not march in lockstep, at least they are closely linked. The money-flow from the bond to the commodity market, while it can go on for decades, will not last indefinitely. Holders of commodities will find that it is not possible to finance ever increasing inventories at ever increasing rates of interest. At one point they will panic and sell."

"This means that the speculative money-flow has reversed itself. Now the money-tide begins to flow at the bond market while ebbing at the commodity market. Prices of commodities fall while bond prices rise. Again, rising bond prices are tantamount to falling interest rates. The falling price level and the falling interest-rate structure are linked and they reinforce one another. This reversed money-tide epitomizes the deflationary phase of the Kondratiev cycle." [Fekete]

Now to highlight what appears to be the most important points, at least in with regard to the present topics under discussion. They will be listed in two groups: the first group describes the genesis of the inflationary phase of Kondratiev's long-wave cycle theory; and the second group summarizes the genesis of the deflationary phase. All information was parsed from the above quoted work of Professor Fekete.

Inflationary Cycle

• Rising commodity prices and falling bond prices are linked and they reinforce one another
• The linkage is best described as a huge speculative money-flow
• The money-tide begins to flow at the commodity market while ebbing at the bond market
• This epitomizes the inflationary phase of Kondratiev's long-wave cycle

Deflationary Cycle

• Falling bond prices are tantamount to rising rates of interest
• A rising price level and a rising interest-rate structure, if they do not march in lockstep, at least they are closely linked
• This means that the speculative money-flow has reversed itself. Now the money-tide begins to flow at the bond market while ebbing at the commodity market
• Prices of commodities fall while bond prices rise
• Rising bond prices are tantamount to falling interest rates
• Falling price level and the falling interest-rate structure are linked and they reinforce one another

The critical issues now confronting us is whether linkage constitutes causality, or at least leads to it; and whether or not any such causality allows for reliable and valid predictions of the intended outcomes; and, whether there are other outcomes that can occur; and are they likely to occur, or are they only remotely possible and hence fairly improbable. Note that the above quotes were listed under the heading: "Causes of the Kondratiev Cycle", which suggest that they at least imply causality.

Professor Fekete's elucidation of the speculative nature of the money flows between these two markets and how it effects not only these markets, but others as well, is extremely informative. This is quite similar to the discussion in part II of Silver Is Money describing how large players in the bond market make a killing during deflationary episodes by taking advantage of the falling interest rate environment.

This also involves the critical issue of governmental intervention in the bond market, which ends up subsidizing the bond market by the continual lowering of the rate of interest. Although officially unspoken, this intervention is a tacit guarantee that such interest rate policy will remain in effect for the foreseeable future. This allows for what amounts to nothing more than a speculative orgy of gambling in the bond market. While the golden cat is away - the fiat mice come out to play.

Near the end of the paper Causes and Consequences of Kondratiev's Long-Wave Cycle some profound ideas are expressed by the Hungarian philosopher Béla Hamvas:

"Their thinking had one great advantage: they were not afraid to warn of the day when the weather would turn from fair to foul. They dared to think mutations. They dared to think catastrophes. While they were aware that dull times called for dull theories, they believed that critical times called for theories altogether alien to and different from those dull theories. In critical times you must think deeper, you must be wiser and more imaginative." [Fekete]

A study was once performed to look into the traits of very successful people, to see if there were certain traits that they had in common. What the study found was that there was one trait that seemed to separate the very successful from the rest of the population: whenever they entered a business deal or any other endeavor, they were not as concerned or interested in want might go right, as they were with what could or might go wrong, and whether they had a plan in place to deal with it. If they didn't, they wouldn't undertake the endeavor. The risk to reward ratio was too high or unknown.

In the above quote by Bela Hamvas a similar philosophy is being expressed. They "were not afraid to warn of the day when the weather would turn from fair to foul", "they dared to think mutations." In part one of Silver Is Money this exact topic of mutations was mentioned. In other words, what might possibly go wrong that would throw a monkey wrench into the system resulting in chaos? And, how likely or probable was just such an event?

The Precious Metals

Now we can finally discuss the precious metals of silver and gold. Both silver and gold are real honest money, the original money of the Constitution, and the hard money coinage system of the Coinage Act of 1792. We know that since a constitutional amendment has not been ratified to change the Constitution - the Silver Standard still is.

In today's world of derivatives, and other financial weapons of wealth transference and mass destruction, gold and silver are heavily traded in the future's and options markets.

Often times, even the precious metal "experts" myopically focus on the trading that takes place at the Comex, and review the commitment of traders (COT) report on such trading as if it was the Holy Grail, which perhaps it is, but for some reasons I have my doubts, specifically - two such doubts: the first goes by the name of the over the counter market (OTC), and the second is called the overnight access market,

If your a big player in the futures market, and you want to keep your trading unknown, these two markets are just what the doctor ordered, as neither the over the counter market nor the overnight access market have any disclosure whatsoever. No one knows who is doing what to what degree. This raises derivatives to a whole different level: now it is unknown and secretive, as well as extremely risky, and potentially explosive. Does this sound like a recipe for progress - or disaster? And on whose watch? See The Derivative Conundrum by James Sinclair.

Tick Tock Goes The Clock

The trading of futures or options in the precious metals is referred to as derivatives because they are paper obligations based on or derived from the underlying asset: physical silver and gold. The paper futures and options market in silver and gold now account for several times the amount of actual physical silver and gold traded. These are the critters that Warren Buffett refers to as time bombs.

Not to worry say da boyz down at the comex, and the bigger boys at the commodity future trading commission (CFTC), which supposedly regulates all commodity trading - we have plenty of silver and gold on deposit to meet redemptions, as in to fulfill all futures contracts. Now we can all sleep better at night, at least so they hope we believe, and have faith in - such babble.

A little tidbit of interest: in one day of trading on the NYMEX and COMEX, 972 cubic feet of paper is swept off of the floors. This is enough paper to fill 10 full length New York City subway trains over one years time of trading. Now we know what they're good at producing - garbage.

What's Wrong With This Picture?

So could Mr. Buffett be right, might derivatives be a time bomb just ticking away, waiting to go off? And more specifically, could the derivative positions in the precious metals of silver and gold constitute a potentially devastating event all on their own?

The reason why we ask this about the derivative positions within the silver and gold market is because, as we have discovered, silver and gold are real honest money, the money mandated by the Constitution.

If there is the potential for a devastating event to occur in the paper futures markets that is based or derived on the underlying physical silver and gold - then shouldn't We The People be told about it? That is what full disclosure means - doesn't it?

Shouldn't the CFTC be doing something about it - as in fixing it? Isn't that their job - to oversee and protect the integrity of the markets under their jurisdiction?

Out of Sight - Out of Mind

In another of his many outstanding papers, "What Gold and Silver Analysts Overlook", Professor Fekete examines the derivative futures market in gold and silver in meticulous detail. Consequently, we are going to review the most critical issues, as they are extremely apropos to the topic at hand - Silver Is Money.

Comments by Dave Morgan, a leading professional on the silver market will also be provided. Although this section all comes under the one heading above, sub-headings will also be used to highlight points of importance.

Quotations from Professor Fekete's paper will be used extensively in this section, as the tenor employed would be most difficult to emulate. All quotes are from his paper What Gold and Silver Analysts Overlook unless otherwise noted.

Supply and Demand

" ... other analysts, chose the supply of and the demand for gold and silver. This is a mistake. Under the regime of an irredeemable currency the supply and demand of a monetary metal are indeterminate. In other words, they cannot be quantified in any meaningful sense of the word"

"It is a mistake to assume that the dealers are committed to the short and the tech-funds to the long side. Such commitments, to the extent they exist, are subject to many an overriding consideration such as profit-taking, stop-loss, to say nothing of herd-instinct that may induce a massive stampede from one side of the market to the other based on nothing more substantial than a rumor." [Fekete]

The point that supply and demand cannot be quantified is true, especially when the OTC market and the Overnight Access Market are included, as they contain no disclosure at all. We will revisit this topic shortly, in the above context, but also later on in a somewhat different context that may provide important implications and ramifications.

Demonetization

Further on we read the following concerning demonetization of the precious metals:

"It is not up to the governments to monetize or demonetize a commodity. It is the prerogative of the market. In picking a monetary commodity the market will make its marginal utility decline at a rate more slowly than that of any other. There is always such a commodity, no matter what the government says. It can be recognized by the fact that its above-the-ground supply is a large multiple of annual output, whereas that for a non-monetary commodity is a small fraction." [Fekete]

This is the very same point that was made in part two of Silver Is Money. Only a free market of We The People can choose to legitimately demonetize a monetary commodity. The stocks to flow ratio that makes precious metals so precious was also mentioned, now it will be discussed in more detail.

Stocks To Flow Ratios

The stocks to flow ratio for silver is approximately 2 to 1, meaning it would take approximately 2 years to mine the existing above ground stock of silver according to the yearly supply of silver that is presently mined in one year.

This is based on the above ground supply of silver bullion being approximately 500 million ounces, and the above ground supply of silver coins and medallions of approximately another 500 million ounces.

This does not include all of the "plate silver" that is quite considerable as well. The present yearly rate of mining production of silver is approximately 560 million ounces.

The stocks to flow ratio for gold is 50 to 1, meaning it would take 50 years to mine the existing above ground stock of gold according to the yearly production supply of gold presently mined in one year.

This is why the bankers are scared of gold and silver - because of the inherent discipline it brings to the supply of money, it cannot just be created out of thin air at their whim. This involves not just the quantity of money, but the more important aspect of the quality of money - its purchasing power.

Silver and gold does not obey their beck and call. It marches to the beat of a different drummer - the beat of the hearts of the men who perform the hard, dangerous and honest labor of exacting it out from the bowels of the earth; not by clicking a computer key that adds billions of paper fiat dollars to the system instantaneously without any honest labor being exerted to earn it.

Risks Out of Balance

"It is patently false to suggest that symmetry prevails in trading derivatives. The risks taken by the longs and shorts fail to be symmetric. In case of commodities the risk of the longs is limited while that of the shorts is unlimited. Nor is it hard to see why. The risk of the longs is that the price will fall. But fall as though it may, it will definitely not fall below zero. This limits the exposure of the longs. Compare this with the risk of the shorts, which is that the price may rise. As there is no obvious limit above which the price may not be allowed to rise, the risk of the shorts is unlimited." [Fekete]

Now we are getting down to the bone. In any market, the risk of the longs is always limited by zero, yet the risk of the shorts has no such limitation, the risk is basically unlimited. This is a crucial point to remember, as it shows a very unbalanced and unstable system, one that is exposed to stress and chaos. The bifurcation point awaits.

"Examples of the bond-bears cornering the bond-bulls are provided by the various historic episodes of hyperinflation." [Fekete]

No comment is offered at this time and in this context, as the statement is self-explanatory and stands on its own merits quite soundly. Once again, we will revisit this extremely important point in part four.

Let's Dance

The precious metals futures market is just that - a market of paper contracts that represent future prices and obligations of silver and gold. The "normal" or most usual state of such future contracts is that the farther one goes out in time the higher the price, and the closer the delivery date or maturity date the lower is the price. This is referred to as contango.

It is also possible for the futures market to exhibit a state or condition whereby the price of the closer delivery or maturity dates is higher than the farther out or more distant dates of the paper contracts. This is called backwardation.

"Contrary to the teachings of Keynes, the normal condition of the futures markets is one of contango, not backwardation. The proper way to view the futures markets is a place where warehousing services are traded. Contango is the premium from which the warehouseman derives the fee for his services. If there is no contango, no warehousing is possible. Accordingly, it takes not two but three to contango: the producer, the speculator, and the warehouseman." [Fekete]

Some Definitions

The following is from the New York Mercantile Exchange (NYMEX) glossary of terms, but first - who are these guys?

On August 3, 1994, the New York Mercantile Exchange and the Commodity Exchange merged to form the world's largest physical commodity futures exchange.

Trading is executed by two divisions, the NYMEX Division on which crude oil, heating oil, gasoline, natural gas, propane, coal, electricity, platinum, and palladium trade; and the COMEX Division where gold, silver, copper and aluminum trade.

Actuals

Physical cash commodity as opposed to future contracts.

Back Months

Contract months that are further out in time are collectively referred to as back months. See front months for comparison.

Backwardation

Market situation in which futures prices are lower in each succeeding delivery month. Also known as an inverted market. The opposite of contango.

Basis

The differential that exists at any time between the cash, or spot, price of the nearest future contract for the same or related commodity. Basis may reflect different time periods, product forms, qualities, or locations. Cash minus futures equals basis.

Basis Risk

The uncertainty as to whether the cash-futures spread will widen or narrow between the time a hedge position is implemented and liquidated.

Carrying Charge

The total cost of storing a physical commodity over a period of time. Includes storage charges, insurance, interest, and opportunity costs.

Contango

A market situation in which prices are higher in succeeding delivery months than in the nearest delivery month. Also known as a carry market, it is the opposite of backwardation.

Current Delivery Month

The futures contract which ceases trading and becomes deliverable during the present month or the month closest to delivery. Also called the spot month.

Daily Limit

The maximum futures contract price advance or decline from the previous day's settlement price permitted during one trading session, as fixed by the rules of the exchange.

Delivery Month

The month specified in a given futures contract for the actual delivery physical spot or cash commodity.

Exchange of Futures For Physical

A futures contract provision involving an agreement for delivery of physical product that does not necessarily conform to contract specifications in all terms from one market participant to another and a concomitant assumption of equal and opposite futures positions by the same participants at the time of agreement.

Force Majeure

A standard clause which indemnifies either or both parties to a transaction whenever events which the Exchange declares to be reasonably beyond the control of either party occur to prevent fulfillment of the terms of the contract.

Hedger

A trader who enters the market with the specific intent of protecting an existing or anticipated physical market exposure from unexpected or adverse price fluctuations.

Inverted Market

A futures market is said to be inverted when distant contract months are selling at a discount to nearby contract months; also known as backwardation.

The final trading day for a particular delivery months futures contract or options contract. Any futures contracts left open following this session must be settled by delivery.

Legal Tender

Coins that have been authorized by Congress. This includes circulating coins and all commemorative coins legislated by Congress.

Over The Counter (OTC)

A term referring to derivatives transactions that are conducted outside the realm of regulated exchanges

Short Selling

Selling a contract with the idea of delivering or of buying to offset it at a later date.

Short -The - Basis

A person or firm that has a commitment to sell in the cash or spot markets and hedges through the purchase of futures is said to be short-the-basis.

Swap

A custom-tailored, individually negotiated transaction designed to manage financial risk, usually over a period of one to 12 years. Swaps can be conducted directly by two counterparties, or through a third party such as a bank or brokerage house. The writer of the swap, such as a bank or brokerage house, may elect to assume the risk itself, or manage its own market exposure on an exchange.

Swap transactions include interest rate swaps, currency swaps, and price swaps for commodities, including energy and metals. In a typical commodity or price swap, parties exchange payments based on changes in the price of a commodity or a market index, while fixing the price they effectively pay for the physical commodity. The transaction enables each party to manage exposure to commodity prices or index values. Settlements are usually made in cash.

Out To Lunch - Return Time Unknown

In his outstanding article Let's Get Physical Dave Morgan discusses the following question:

"If a retail dealer were to stand for 1000 contracts of silver (approximately 5 million ounces) every month, would this cause a problem with the CFTC?" [Morgan]

What Dave is asking involves what would happen if the buyer wanted to take physical delivery of the silver as opposed to cash settlement in the future's paper market. I strongly suggest reading the article to get a more detailed discussion of the question.

The answer appears to be that the physical delivery of a significant amount of silver could very well create problems for the CFTC, to the extent that it could cause a halt or even a shut down of the market.

The following emergency actions pertaining to the halting and or termination of trading indicate that such action has been determined to be a distinct possibility under several different scenarios or events.

U.S. Code
Title 7 > Chapter 1 > § 7

7. Designation of boards of trade as contract markets

(6) Emergency authority

The board of trade shall adopt rules to provide for the exercise of emergency authority, in consultation or cooperation with the Commission, where necessary and appropriate, including the authority to -

(A) liquidate or transfer open positions in any contract;

(B) suspend or curtail trading in any contract; and

(C) require market participants in any contract to meet special margin requirements

Then there is the following which goes into a bit more detail:

402.C. Emergency Actions

1. The BCC is authorized to determine whether an emergency exists and whether emergency action is warranted. The following events and/or conditions may constitute emergencies:

a. Any actual, attempted, or threatened market manipulation;

b. Any actual, attempted, or threatened corner, squeeze, congestion, or undue concentration of positions;

c. Any action taken by the United States or any foreign government or any state or local government body, any other contract market, board of trade, or any other exchange or trade association (foreign or domestic), which may have a direct impact on trading on the Exchange;

d. The actual or threatened bankruptcy or insolvency of any Member or the imposition of any injunction or other restraint by any government agency, self regulatory organization, court or arbitrator upon a Member which may affect the ability of that Member to perform on its contracts;

e. Any circumstance in which it appears that a Member or any other person or entity has failed to perform contracts or is in such financial or operational condition or is conducting business in such a manner that such person or entity cannot be permitted to continue in business without jeopardizing the safety of customer funds, Members, or the Exchange; and/or

f. Any other unforeseeable or adverse circumstance with respect to which it is not practicable for the Exchange to submit, in a timely fashion, a rule to the CFTC for prior review under the Commodity Exchange Act.

2. In the event that the BCC determines, in the good faith exercise of its sole discretion, that an emergency exists, it may take any of the following emergency actions or any other action that may be appropriate to respond to the emergency:

b. Limit trading to liquidation of contracts only;

c. Impose or modify position limits and/or order liquidation of all or a portion of a Member's proprietary and/or customers' accounts;

d. Order liquidation of positions as to which the holder is unable or unwilling to make or take delivery;

e. Confine trading to a specific price range;

f. Modify price limits;

g. Modify the trading days or hours;

h. Modify conditions of delivery;

i. Establish the settlement price at which contracts are to be liquidated; and/or

j. Require additional performance bond to be deposited with the Clearing House.

All actions taken pursuant to this subsection shall be by a majority vote of the Panel members present. A Member directly affected by the action taken shall be notified in writing of such action. As soon as practicable, the Board and the CFTC shall be notified of the emergency action in accordance with CFTC regulations. Any action taken pursuant to this subsection may not extend beyond the duration of the emergency, and shall not continue beyond 30 days following the imposition of the action without express CFTC authorization. In no event shall action taken pursuant to this Rule remain in effect for more than 90 days following its imposition. Nothing in this section shall in any way limit the authority of the Board, other committees, or other appropriate officials to act in an emergency situation as defined by these rules.

The Four Horsemen

So it does appear that emergency events can occur, as they do appear to have contingency plans in effect to deal with them, or at least to halt trading and to shut down the market.

Now let's take a look at a possible scenario that could cause the halting of trading and the shutting down of the market, not from any outside force or cause, but due to its inherent structure from within.

The futures market is structured in the same way that our paper fiat monetary system is. Both systems employ irredeemable obligations based on fractional reserves.

Fractional reserves means just what it says, there are only a fraction of the reserves on deposit to meet all possible redemptions; be it the currency of Federal Reserve Notes that are said to be redeemable in lawful money in the U.S. Code, or be it all paper futures obligations in silver and gold that could be held to maturity and hence need to be physically filled and delivered.

We will once again look to Professor Fekete for a most concise explanation of the issue in his article What Gold and Silver Analysts Overlook:

"It appears to be a theoretical impossibility for the gold and silver market to be in backwardation for any extended period of time. Such a situation would guarantee unlimited and riskless profits for all those holding gold and silver. They could replace their cash holdings with futures at a lower price. When their futures contract matured, they could take delivery and repeat the procedure. The mere possibility of unlimited and riskless profits suggests that there is an error in the calculation. And indeed, there is. The profits are not riskless. As the ancient adage says: "A bird in hand is worth a dozen in the bush". [Fekete]

When cash gold or silver is replaced with futures, a risk is created, namely, the risk that it may not be possible to convert the futures contracts back into cash gold or silver at maturity. There is the risk of default in the futures markets. Of course, exchange officials, bullion bankers, and government watchdog agencies vehemently deny the existence of such a risk. But the fact remains that under the regime of irredeemable currency it is possible to corner a monetary metal.

It is true that cornering a monetary metal goes by another name: that of hyperinflation. There have been any number of hyperinflationary episodes ever since paper was invented by the Chinese. What people don't generally realize is that every one of these episodes was a corner in gold or silver." [Fekete]

This is essentially the same scenario that Dave Morgan was discussing in his article Let's Get Physical as was Jason Hommel in his letter which can be reviewed at CFTC Response to Silver Problem.

Is there an amount of silver or gold futures that would not be able to be filled by the exchange for a customer who wanted to take possession of the silver and gold by having it physically delivered, as opposed to settling the futures in cash, for the total amount that his future contracts represented?

This would seem to be a very legitimate question, as there is a limit to the amount of silver and gold on supply at the exchange, unless of course they can just materialize the stuff out of thin air like paper fiat money by prestidigitation. Perhaps that trick is in the works for a later date in the future - let's hope and pray it isn't.

As is well known by any seasoned market player, a short position carries unlimited risk, and a long position carries a limited risk, as the price can only drop to zero.

When dealing in futures markets one gets the queasy feeling that they are watching a horror movie that goes by the name of The Four Horsemen of the Apocalypse.

The first horse's name is irredeemable paper fiat; the second horse is known as inherent inflation; the third horse is the deflation that can occur; and the fourth beast is hyperinflation and the destruction of the monetary system that can likewise occur. A most unpalatable choice of menu and venue.

Riskless or Unlimited Risk

So who is exposed to the most risk in the futures market? Officialdom, as the last syllable of the word suggests, doesn't have a clue, as their contention is that no one is at grave risk - that's the whole point of the futures market - to control and manage risk.

I find this to be wishful thinking and a bit hard to swallow. I keep thinking back to some of the definitions by the NYMEX at the beginning of the paper and it just makes you wonder about - not so wonderful things.

For instance, do some of the following definitions seem to imply risk, sometimes unknown, sometimes so unquantifiable that it can cause trading to terminate?

And why would anyone worry about indemnity if there wasn't any risk involved or loss possible - doesn't one have to loose something to be made whole or to be indemnified?

• Basis Risk - The uncertainty as to whether the cash-futures spread will widen or narrow between the time a hedge position is implemented and liquidated.
• Backwardation - Market situation in which futures prices are lower in each succeeding delivery month. Also known as an inverted market. The opposite of contango.
• Daily Limit - The maximum futures contract price advance or decline from the previous day's settlement price permitted during one trading session, as fixed by the rules of the exchange.
• Force Majeure - A standard clause which indemnifies either or both parties to a transaction whenever events which the Exchange declares to be reasonably beyond the control of either party occur to prevent fulfillment of the terms of the contract.
• Over The Counter (OTC) - A term referring to derivatives transactions that are conducted outside the realm of regulated exchanges.
• Swap - A custom-tailored, individually negotiated transaction designed to manage financial risk, usually over a period of one to 12 years. Swaps can be conducted directly by two counterparties, or through a third party such as a bank or brokerage house. The writer of the swap, such as a bank or brokerage house, may elect to assume the risk itself, or manage its own market exposure on an exchange.
• Emergency authority - to suspend or halt trading in any contract

Pop Goes The Bubble

I have commented many times before that the mother of all existent bubbles is the bubble in the paper fiat dollar debt system and the loss of purchasing power or quality that such has engendered. Recall the chart of the purchasing power shown in part two of Silver Is Money, which showed a 95% loss to date.

It is true that the quantity theory of money is inadequate in explaining a complete theory of money, as the quality aspect of money is as important, if not more important, than the quantity of money. The number of units (quantity) that one has is not as important as the purchasing power (quality) that the units of money have.

Real money does not only function as a medium of exchange, it also serves as a store of value or purchasing power over time into the future.

Professor Fekete once again hits the nail squarely on the head when he says:

"The explanation of hyperinflation in terms of the quantity theory of money is untenable. You cannot explain non-linear phenomena in terms of a linear model. The proper explanation must be sought in terms of a non-linear model. Such a model can be developed using the concepts of basis and backwardation."

"As the regime of irredeemable currency threatens to crumble under the weight of the inordinate debt tower of Babel, people increasingly take flight to gold. Supplies will get tight and the gold basis will fall. The gold futures market may even go to backwardation briefly at the triple-witching hour, i.e., the hour when gold futures, as well as call and put options on them expire together. Later, flirtation with backwardation may occur even more often, at the end of every month when gold futures expire. Gold will get caught up in a storm."

"Rather than bringing out deliverable supplies of gold, backwardation tends to remove them. The more the gold basis falls the less likely it becomes that owners will exchange their cash gold for futures. Please remember that you have seen it here first. This perversion of the gold basis constitutes the self-destroying mechanism of the regime of irredeemable currency. The longs tend to take delivery on their gold futures contracts in ever greater numbers, and refuse to recycle cash gold into futures, regardless how low the gold basis may go.

As it is not set up to satisfy demand for delivery on 100 percent of the open interest, the gold futures market will default. Exchange officials will declare a "liquidation only" policy to offset long positions in gold. At that point all offers to sell cash gold will be withdrawn. Gold is not for sale at any price. The shorts are absolved of their failure to deliver on their gold futures contracts." [Fekete - What Gold and Silver Analysts Overlook]

Gee, I wonder if this would constitute an emergency? If it does, then the monetary system that has been created, and those that have created it, have brought forth a creature that they cannot control. One is reminded of Dr. Frankenstein who had a similar problem - that didn't end all too well, for the creature, the Dr., and the people.

This is why we need to return to Honest Money of the Constitution - silver and gold coin, and to do away with the dishonest system of paper fiat debt obligations. We are at the edge, staring into the abyss. It is time to stop such foolishness.

Chaos Can Cause Havoc

Chaos caused and made by the hand of man can be most devastating, as man-made risks are not the same as natural risks of nature. Man lives within nature and throughout nature, but outside of nature as well. He knows not the power that his actions can have - on nature. Consequently, even Love can on occasion be ruthless.

Silver Zoroastrian Fire Altar Coins

"My name is Love, supreme my sway.
The greatest god and greatest pain, Air, earth, and seas, my power obey,
And gods themselves must drag my chain.

In every heart my throne I keep,
Fear ne'er could daunt my daring soul;
I fire the bosom of the deep,
And the profoundest hell control."

[Miguel de Cervantes, Don Quixote]

Part Four To Be Forthcoming - Behold A Pale Horse

Including Some Call It Manipulation & Gibson's Paradox Revisited

And Is Hyperinflation Likely To Occur?

## Author: Douglas V. Gnazzo

Douglas V. Gnazzo
Honest Money Gold & Silver Report

Douglas V. Gnazzo is the retired CEO of New England Renovation LLC, a historical restoration contractor that specialized in the restoration of older buildings and vintage historic landmarks. Mr. Gnazzo writes for numerous websites, and his work appears both here and abroad. Just recently, he was honored by being chosen as a Foundation Scholar for the Foundation of Monetary Education (FAME).