Mr. Nixon, What is the 'Value' of a Dollar ?

By: Ed Bugos | Tue, Jun 6, 2000
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How the Continuing Repatriation of Global Gold Reserves Will Eventually Lead to a Remonetization of Gold

Last Friday's $9 gold rally came on the heels of a much weaker than expected US employment report, which has manifested itself in a growing consensus that the FED will soon have to stop raising interest rates. In fact, the weaker employment report follows a slew of other generally weaker economic statistics, from durable goods orders to new home sales to manufacturing activity over the past month. All because of a 1/2 point increase in the FED funds rate? Actually, there are a number of forces at work. The recent rise in US interest rates relative to the rest of the world may have over-inflated the Dollar "exchange rate," which would undoubtedly make the cost of US exports less competitive at some point. Perhaps this is a reason for the slowdown in manufacturing activity. The recent uncertainty clouding the guarantor status of certain GSE's, Freddie Mac and Fannie Mae, will no doubt contribute to the general availability of new mortgage funding, and the declining stock market has likely thrown the "wealth defect" into first or second gear. For as Mr. Noland, Author of "The Credit Bubble Bulletin" rightly contends, "the credit bubble has been pierced."

Now, financial "experts" are worried about weaker earnings. No shit Sherlock, especially if some of these earnings rely on the business of booking capital gains. On CNBC recently, the rumor about Canada wooing Microsoft was discussed, and it was pointed out that Microsoft employees were responsible for about $7 Billion of Seattle's economy last year, and "all of that" was from the exercise of "stock options." Let's see them do that again. It is strange though, that gold would rally with such news in the environment, which implies an economic slowdown at the very least. What really puzzled me was that there seemed to be no apparent concern at the speed with which the economy had seemed to decelerate. In fact, the bulls simply expect that interest rates will stop rising and therefore the stock market will resume its upward trajectory. That was good for a big 150-point something gain in the Dow. Big deal! Perhaps what should be of concern is the volatility not in the stock market, or the bond market, or in the currency markets, but in the economy. Up and down and all around, it must be making your head spin by now. Anyhow, all of this translated into an important sell off in the Dollar Index, a trade weighted average value of the Dollar relative to a basket of international currencies.

Obviously some selling was done by those interest rate players that have been bidding the Dollar higher in the expectation that global interest rate differentials, including the TED spread, would continue to favor the Dollar, but perhaps there was also some selling done by some who see this as the start of something completely different. For investors who understand the Balance of Payments issue, it seemed unlikely that this suddenly weaker trend in economic statistics will continue to attract the kind of stimulative foreign capital flows to US stock markets as has been the case thus far, and the kind that has kept the US payments deficit from having to be unwound. For them it also seemed unlikely that the Dollar would hold its "exchange rate" level without favorable interest rate differentials and with the risk of recession in sight. But do not worry. Technology bulls insist that investment spending on innovation and productivity enhancing technologies is real and is here to stay out of shear necessity that the show must go on, regardless of what happens to either the overall economy or the financial system. Get some perspective people. Even the lead bulls have taken cover.

Technically speaking, the fact that Gold prices have been able to hold on to support well above their all time lows, even while the trade weighted exchange rate of the Dollar, particularly against the Euro, has appreciated by roughly 10 percent this year (to its peak). This in light of the loud announcement of Swiss (SNB) gold sales, is something of a feat in light of the poor psychology in that market. The explosive rally in gold prices on Friday, therefore, came on the heels of Dollar devaluation, and that is the way it has always been. However, in this case, there is much more going on in the gold market today, but more on that later.

A Simple Perspective Will Do
The date is 2000-05-28. Don't you get tired of all the bad news bears reminding you of all these instabilities, excesses, and 'potential' tensions in the global economy? After all, hasn't it always been like that? Yes it has, but not in money it hasn't. Increasingly, investors find it harder to know where to put their savings. What about Government Bonds? Wrong. Their recent record of capital losses have wiped out your guaranteed yields, probably because the stock market keeps crowding them out, and this even in a strong dollar and low inflation environment. Furthermore, there is no reliable liquidity and potentially poor quality debt in the corporate sector. Foreign assets? Wrong. Most of the world's economies are riskier, have been under performing, and also, there is this thing called currency risk. Like how is the average person gonna cope with currency decisions. You can put your money in a Money Market Fund, or a Bank, for lower short term yields and little chance of capital loss, but then it is difficult to take, when your friends, colleagues, and news channels are all cheering on this thing about the technology sector that is making them richer than you. And, what happens if the US Dollar suddenly starts to under perform other currencies? You will have to worry about inflation potentially wiping out your negligible yield if not your capital.

OK, so what about good old-fashioned Blue Chip Stocks that pay a dividend? Wrong. Corporations choosing to pay dividends rather than invest that money in the new economy have been punished by the market for doing so. Not much choice left, except to speculate in order to preserve. You have little choice but to accept risk! So what, hasn't it always been that way? Besides, it seems that the rewards offered in the electronic world of Nasdaq justify the additional marginal risk that everyone else is taking but me.

No, no, no. How is an economy full of people who constantly have a degree of financial stress, efficient? Remember, all this person wants to do is put his hard earned savings somewhere where he doesn't need to worry about guarding it from the vagaries of economic instability. Today, he needs to concentrate less on his traditional business activity, and more on managing his capital, which duty has become increasingly difficult, unless of course he has been speculating in the technology bull market of the day, whose premise itself is responsible for his financial stress. Only recently has this investor seen any kind of stress at all. Mr. Greenspan illuminates the Yin and the Yang of technology very well when he describes the wonderful forces of change on the one hand, and then the dangerous new macro forces on the other hand.

How about Real Estate? Low yields, but hard asset, which has been rising in value recently! The investment is not too liquid if the economy turns down though, and the form of general mortgage lending activity has come into public question recently. Still, it's a physical asset, which can only decline in price during a deflation or credit contraction. Even then, it only increases in value to the owner who doesn't have a callable lien against it to worry about. Of course, real estate will always have value, as will any needed or desired commodity that is fixed in supply, but that is not in question.

What is the Question Then
The fiat money of the day has a price, but it is only redeemable for other fiat money at the going rate. It has no anchor and its only value lies in its currently accepted role as a medium of exchange and in its "ability" to measure value (note that I've excluded "a store of value"). It is not fixed in supply, and political necessity has often created a volatile "price," which is why its ability to reliably measure value is in question. For the purpose of this essay, I will refer to the exchange rate as a price, in order to make a point. Anything that is infinite in quantity has no material price and no value, except in its use. Water is necessary for our survival so it has a value, yet where it is abundant, it is generally free to consume as one pleases. Where its marginal utility1 can decline to a theoretical zero, it has no price. In the case of money, it is useful, and maintains a constant marginal utility. I have yet to meet anyone who didn't need more of it. Therefore, it is always tempting to increase its quantity. The paper, which is used for the "legal tender," on the other hand, is useful as a medium of exchange, but it is not reliable to us beyond that. It is not valuable to us if it cannot preserve its price. It loses its value as a standard, and as a stable measure of value, it loses its value as a store of wealth, and it loses its value as a medium of exchange if it becomes less widely accepted because of its uncertain price. To be sure, these effects usually occur slowly over long periods of time, which is why we probably never seem to notice them. However, they may be rapidly approaching their climax.

Money has always been backed by gold to avoid just this. Today there is only an implicit, but not real, commitment by the Government to preserve the value of your savings. What this means is that when it becomes politically expedient to devalue your savings, the Government will not hesitate, the same way that every Government has chosen to debase the coin of the realm in favor of more prosperity. We don't clearly see this because the relative price of our money (the US dollar) has so far been rising, and we have been reaping and enjoying the benefits of a false perception of rising value. However, this has resulted in a number of global economic imbalances, which can only correct themselves if the price of the dollar properly reflects its relative abundance, or the FED corrects its relative abundance by raising interest rates to stabilize its price, and therefore value.

Raising interest rates, as I believe we are about to see, however, can induce a severe credit contraction that will affect the wealth and currencies of foreign economies, if that isn't underway already. Initially, it has favored the price of the dollar, but at the expense of foreign liquidity. Furthermore, a recession in the United States would drag down foreigner's US dependent prospects for growth. The price of their dollar denominated assets would contract, which will likely drag down with it, their perceptions of the value of the dollar more rapidly than its price at first. This unsustainable divergence should create a global incentive to quickly repatriate overpriced dollars. If the incentive becomes reality, and Friday's action is perhaps an indication, the dollar price of gold should rise, initially revealing the divergence, and ultimately forcing it to rise towards its true value. If such an event accelerates, and inhibits a general confidence in the dollar's ability to function as a medium of exchange, the actual value of gold may start to rise as well, initiating a reinforcing loop between price and value, which would likely escalate. Once this process is set into motion, there is not a damn thing the Government can do about it.

"There is no institutional mechanism by which we could ever duplicate the kind of financial system we have, under a system that relied almost entirely upon gold. Of course, you could always have a system that used a lot of paper that was in some sense convertible into gold. You could always find a price of gold that you could convert that paper theoretically into gold. But I don't think anyone has thought in terms of the enormous price of gold that would be required in order to achieve that." -- Robert Mundell, 1999 Nobel Laureate in economics (sponsored by the Swedish Central Bank)

I have thought about it, though I'm sure in reality I would be very wrong. Well, at least some people had better hope so. Remember the Dow 36,000 prophecies? Coincidentally that was close to the number that showed up on the back of a napkin as I tried to estimate the value of the global money supply today, and divide it by 120,000 tons, etc.

Why Did Warren Buffett Buy all of that Silver Anyway?
The Stock Market & Dollar Bulls today, would have you believe that Warren is too smart to buy his silver for any old time traditional belief about money, gold, or silver, rather that he must know of some wonderful new technology that will arrive, and which will require plenty of silver in its applications. This may be true, but an aggressive move like that would contradict his decidedly more conservative modus operandi, and besides, it would make more sense that he corner the palladium market then. Let's consider that Mr. Buffett has always tried to stay away from timing the market, on the premise that he is not a market timer or speculator, but rather, an investor. His recent withdrawal from the stock market coupled with no real reported change in his silver holding then, remains a conundrum. On the surface, it would seem too risky to buy into such an outdated argument for the accumulation of tangibles. If you can keep your mind open, however, consider the more plausible argument for his silver purchases.

His father was a United States Congressman from Nebraska, The Honorable Mr. Howard Buffett. It was an accident that I recently stumbled upon a lecture that he had given to Congress in 1948,2 reprinted from "The Commercial and Financial Chronicle," on May 6th, 1948. The title was "Human Freedom Rests on Gold Redeemable Money", and after reading it, it became clear that Warren Buffett comes from a long line of financial people who understand the concept of monetary "value." That Warren Buffett has an unequaled grasp of value cannot be disputed by anyone except for maybe Larry Kudlow, now the chief economist/promoter for ING Barings. Recently, I have found it exceedingly difficult to comprehend why most investors see the price and value of a currency, as being the same. I have spent up to 30 minutes trying to illuminate the difference to otherwise intelligent people. The problem is that the subject of money has always been a difficult one for most people to understand. If you can accept that, consider that Mr. Buffett perhaps understands this better than we do. Why not? He's richer than you or I are. If nothing else, accept that premise. In any case, it is more plausible to me, in light of his family's historic predisposition to the invisible concept of value, that he believes his silver purchases to be a conservative decision that perhaps somehow regard monetary value. It sounds more plausible to me because for Mr. Buffett to hoard a sum of tangibles, in "anticipation" of some wonderful application for them, is either an outright speculation or an act of insider trading. It is more plausible to me now more than ever, after announcing his exit from the stock market and using words like massive wealth transfers, etc. Thank you, I'll think that his move will predict a trend toward the accumulation of tangibles at some point in the near future. In fact, his father says this in his 1948 lecture:

"For a long time shrewd people have been quietly hoarding tangibles in one way or another. Eventually this individual movement into tangibles will become a general stampede unless corrective action comes soon. "--The Honorable Mr. Howard Buffett, May 6, 1948.

He was right. That trend occurred, and accelerated, but over a long, long period of time. By 1973, however, he was about to be right in a big way. His reasoning was correct, in the end. But instead of applying the proper, disciplinary, solution, the decision was made to do away with the gold standard all together, unleashing the potential for another long reign for the paper money system, technically known as a "Fiat Monetary System," but today, known as the status quo, if only it could be harnessed.

Richard Nixon made this decision, when he officially did away with the Bretton Woods system of money, incorrectly perceived as a gold standard. Of course, legalizing the ownership of gold was an important element in harnessing and extending the life of this paper money system. The government essentially gave people a choice, whether to own the Dollar or whether to own gold. As you will see, however, this was quickly followed by a campaign to demoralize that choice. When Paul Volcker came in to stabilize the global financial system, he threw the Global economy into a deep recession with double digit interest rate increases. The demand for new money came to an abrupt halt, and people saw that the US government had the wherewithal and resolve to restore confidence in the Dollar. This is an age-old battle. It (the battle) hasn't stopped there; it has, however become less relevant (read less understood) than the initiative, and desire to finance the new economy has become, today. In this context, with all the excitement about the next big technology billionaire maker, with the delusion of a "lender of last resort" (which is really, you and I) and the familiarity with the status quo, it is easy to understand why most people today find this subject of money, an old and boring debate not worth talking about, if only for the moment. Nevertheless, a nadir has been reached in the psychology of gold, and some new facts and conclusions have become inescapably clear.

The New Order
Perhaps out of ignorance, I am not against a system of free floating exchange rates, but I believe that for them to function efficiently, the abstract notion of monetary value has got to become both more transparent, and as well, more generally comprehended. Sadly, the true reason that the United States has been able to resist the same destiny as other less influential (I mean less developed) economies is not because they've discovered the Internet, or because they know something the other countries do not. It is because, rather fortunately, they have been able to put themselves in a position where the world has become increasingly dependent upon their prosperity. By virtue of the world's vested interest in the United States economy/dollar, the United States has been empowered and assigned an immense amount of financial clout with which to defend global financial markets, including and especially, the Dollar. Welcome to the new economy, and as someone once said, the "New Order." However, allow me to demonstrate how large the speculative forces have grown out of check, and therefore, why that clout has dramatically diminished today. I will then demonstrate to you, why I believe that Mr. Buffett, Mr. Soros, and a large list of "smart money," have completely withdrawn from the stock markets, and why this group may lead a stampede into tangible assets, namely Gold.

The Honorable Mr. Howard Buffett once proclaimed,"because of our economic strength, the paper money disease here may take many years to run its course. But we can be approaching the critical stage. When that day arrives, our political rulers will probably find that foreign war and ruthless regimentation is the cunning alternative to domestic strife. That was the way out for the paper-money economy of Hitler and others. "

Perhaps, his son believes that the day has almost arrived. I certainly do. Here is why.

It's Too Big Not to Fail
Granted, the stock market has been in record breaking mode since about 1996, but in 1998, only a few years ago, the stock market blew through century old barriers like a Ginsu knife through Margarine, restrained only by the upwardly biased flexibility in the financial system, yet few choose to question the quality of the move. That is because the market punishes anyone who questions it, forcing investors to believe in the dogma of efficient market hypotheses. How can millions of investors be wrong, especially in today's "information age?" If all of these investors constantly question and thoroughly analyze each fundamental as it shows up, I would agree, but the speed with which markets pump and dump any particular stock prevents that kind of analysis. The online community has become one big herd that momentum players have been leading around the market for the past two years, with irresistible chart patterns and lots of hype. This is not an efficient market any longer, for if it were, this kind of volatility could not show up so randomly in so many different stocks. In fact, the stock market has become so random, that even in hindsight it is difficult to understand (with any kind of sensible analysis) why a particular stock first went up tenfold, and then declined 50% or more, all within a month or two…and no, it hasn't always been that way. Perspective people.

The quality of the bull market has been bubble like in nature and has deteriorated markedly since 1998, in terms of breadth, in terms of a cogent justification of valuation, and in terms of time tested perspective. Finally, these things appear to be catching up with it. Yet, growth in the economy has become increasingly sensitive to the nearly spent stock market, leaving the potential for an asymmetric outcome wide open. In my experience, the further markets overshoot, the harder they reverse. Still, investors choose to question the implications of the conspicuously exploding macro distortions that have developed and are of historic proportion in the global economy/monetary system, and which either were caused by, or caused, the unprecedented inflation of asset prices.

Examples include the Balance of Payments deficit, which reveals a consumption outflow of $30 Billion per month, compared to only $1 Billion per month in 1990. What this means is that if the United States doesn't borrow, or otherwise lure, that much money from foreign investors, each month, the dollar will have to rapidly adjust downwards.

The National Savings Rate has declined to nearly zero. The average United States consumer has always saved less than most people in the rest of the world, but the amount he has saved has always varied from 5% to 12% of his income, at least over the last half of the century. In fact, this rate was still near 5% in 1995, just before the stock market was to go on a five-year double-digit annual run. These unprecedented returns have clearly caused the wealth effect to go into overdrive, and the consumer to become ever more dependent on foreign capital inflows for his wealth and purchasing power to keep on rising. In light of this, I would be surprised if his balance sheet has not materially worsened, and would be concerned about what it will look like if his stock market wealth was to be sliced in half.

Record High Real Interest Rates reflect some of these excesses, and the quality of government Tax Revenues is temporary at best. Nearly all of the improvement in the "adjusted" surplus has come from tax receipts on capital gains, also fueled by this paper inflation. Yet, as always, the Government hesitates not in extrapolating their currently flush revenues well into the future. That would be tolerable if it didn't result in manipulating long-term bond yields in the moment, on such a flaky premise.

Credit Market Illiquidity and widening spreads across the entire spectrum of debt reflect debt saturation and investor distrust for anything that is not in the most liquid form. Mr. Greenspan notes that this behavior in the credit markets is unprecedented in the post World War II era, and that investor's preference for the most liquid assets in times of uncertainty reflect a willingness to attach an unprecedented premium to investments that have the option to be immediately reversed. Perhaps investors have caught on to the ponzi-like nature of credit excess in the Unites States, as Mr. Noland correctly points out in a recent article.

Let's not forget to mention the sheer size of the Stock Market in relation to the economy, and the, arguably, one-sided leverage in the financial system towards Dollar denominated financial assets - to the point that they don't look comfortably reversible. The value of the entire stock market has outgrown the economy now by nearly twice, an immense feat in light of the fact that throughout the century it has fluctuated in size from roughly 25% of the size of the economy to 85%, at its peaks. Yes, this massive paper inflation is an imbalance, which will need to normalize one day, maybe soon. Yikes!

The largest of speculative forces, however, lie in the Derivatives Markets, which even Alan Greenspan admits to some level of ignorance about. These markets have increasingly grown out of the necessity to hedge volatility, but have also been used to manipulate and speculate with. The size of the derivatives market, however, makes the US stock market, worth about $15 Trillion itself, look like a golf ball way across the green, and most of it is leverage. It is conceivable that the application of chaos theory to today's financial environment would generate high disaster probabilities, and even a cursory look at Government bourses today will reveal how little they can really do to defend you against such an outcome, short of changing the rules. In today's highly complex financial markets, it is of course difficult to tell which link will break first, but it is easy to assess which is the largest and heaviest link - the Dollar denomination of the US stock market, which appears heavier by the day.

In fiat monetary systems, it is easy to inflate irredeemable paper and postpone consequences for a later date, but when the credit cycle, upon which all of these wonderful economic statistics are built, is pierced, the process of deleveraging such an economy has always been a mite painful. When this process kicks into gear, it is impossible to stop. I am reminded of a well-known quote:

"Lenin is said to have declared that the best way to destroy the Capitalistic System was to debauch the currency… Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all of the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million can diagnose." -- John Maynard Keynes.

A Final Discourse on the Subject of Floating Exchange Rates
The confidence behind floating exchange rates generally stems from the clearly successful application of free market principals in other commodities and markets, especially relative to the experience of trying to regulate, fix, or manage those markets. However, the 28-year experience with free-floating exchange rates has been as equally unsuccessful in preventing massive economic distortions from building up. Actually, it seems that they have helped the process along. Perhaps Mr. Birnbaum is right, that free market systems need stable money in order to properly function, because this floating system of fiat money seems only to have increased the burden of regulation on stabilizing the free market mechanisms within an economy. Arthur Burns, FED chairman in 1973, apparently said that he thought that "floating rates would surely bring misery to mankind, and that once begun, it would be hard to end and could last anywhere from a few years to a century." Hard to end - could he mean with respect to the irreversible imbalances they might engender? Anyhow, Mr. Birnbaum contends that a fixed par value of the dollar is not just a price, but also a sovereign commitment.

"Without an earnest political commitment (to a stable money), market confidence in the stability of a national currency cannot be sustained. Without that confidence, technical policy manipulations lose force - they are swept away." -- Eugene Birnbaum, 19963

Our current floating exchange rate regime was born of at least two important misconceptions. One of the misconceptions comes from a misinterpretation of Milton Friedman's discovery of the causal relationship between money supply and economic growth, and the other comes from a misinterpretation of the economic characteristics of fiat money. With regard to the former, changes in the money supply don't absolutely and directly stimulate anything, though they can restrict almost everything. However, changes in demand for anything that requires capital, can affect changes in money supply. Some economists, with whom I agree, even contend that rising prices themselves beget inflation in the money supply, as opposed to the more commonly accepted reverse of that.

The latter misconception assumes that money shares the economic characteristics of a simple commodity, where prices themselves typically reverse a price trend. In other words, an abundantly cheap commodity stimulates extra demand while restraining supply, thus setting the stage for a price reversal at some point. Likewise, a dear commodity stimulates production and restrains demand, ceteris paribus. So, in both cases, prices themselves, do much of the work to naturally set into motion the forces of reversing an oversupply or a shortage of the commodity, by giving participants the right signals. Fiat Money, on the other hand, works quite differently, because while demand is still influenced by the domestic cost of the money (the general interest rate), its supply is mostly dictated by demand and not by price. In so far as the general cost of money rises and exerts an upward influence on its "exchange rate," external demand for the currency might rise also.

So, the structure of the current system is set up to provide all the liquidity that the economy demands at any given interest rate. Therefore, cheaper money can (theoretically) infinitely increase the demand for money, but will not discourage the supply of it as long as it can still be produced (printed) at a profit. Therefore, some kind of system is necessary to ensure this process is checked. In the same regard, dearer money may restrict demand for money (credit), but cannot encourage any more supply if no one is willing to borrow at that rate. So, the free market mechanism when applied to fiat money is not self-correcting in the way that it is with the average commodity. It is self-perpetuating. "Anchored" money, on the other hand, is self-correcting, which is probably why politicians avoid it. This, however, is clearly an assault on our eventual monetary freedom. The data is in, and the verdict shall soon follow.

"You have to choose (as a voter) between trusting to the natural stability of gold and the natural stability of the honesty and intelligence of the members of the Government. And with due respect for these gentlemen, I advise you, as long as the Capitalist system lasts, to vote for gold." -- George Bernard Shaw.

Our experience with floating exchange rate systems shows that they tend to destabilize confidence; and as Mr. Robert Mundell asserts, this has translated into an otherwise completely unnecessary derivatives industry. As well, they play havoc with our wealth, the economy's invisible hand, and our psychology in so far as long-range business plans are discouraged in favor of encouraging speculation and goods arbitrage. Mr. Birnbaum easily proves that traditional business activity has been in relative decline along with the average worker's wages over the twenty-five years prior to 1996. Granted, wages at least appear to be on the mend, but I would argue that some of the underlying imbalances that have grown, have influenced many of these statistics if only through the, arguably, temporary inflation of US dollar denominated assets.

What Is the Difference Between Price and Value?
It is my contention then, that floating fiat exchange rate systems simply cannot function as both, an economic price, and as a measure of value, without being anchored to some standard measure of value. If their prices are only relative to each other, their volatilities will be larger than if their price in relation to each other is compared to, and contained by, a standard and stable measure of value, such as gold. The reason is that under a gold standard of some kind, the value of the currency is transparent and its price gives policymakers the right signals.

However, for such a system to work properly, both the gold market needs to trade freely and transparently so that governments and individuals may trust the market's signals, and the individual must have the freedom to choose between it and any paper currency of his choice. The ownership of gold must not be restricted, but most important of all; the individual needs to be informed about his choice. He needs to understand that there is in fact a difference between price and value, even with respect to money. This is the basis of money under which capitalism was originally designed, and it is the only basis of money that can guarantee our economic freedom, but it has been discredited, hasn't it?

Central Banks have been selling gold and telling everybody that it is not a monetary asset any longer. Whether deliberately or not, they have destroyed this choice by psychologically, and financially, punishing those who desire to choose it. They have built a complicated pyramid structure of paper and leverage, supported only by a massive nontransparent derivatives market, and the people's full faith and belief in the bank's seemingly never ending ability to fulfill its role as "lender of last resort." All the while, fully accepting the people's trust, the government is busily and blatantly lying about its own budget, and god only knows what else. Meanwhile, the relentlessly depressing price of gold in relation to the irresistible lure of financial asset speculation, both caused directly by monetary policy, if nothing else, has quite forcefully persuaded the vast public majority to speculate in the paper currency that offers the best short term reward.

I believe that we are technically on a gold standard; only most people don't know it because they've been misinformed about the subject by their government. This misinformation campaign has resulted in confusion about monetary value, and where price is mistakenly perceived as value, has created enormous exchange rate volatilities over the past twenty years, which in turn, as already pointed out, has favored the growth of the derivatives and arbitrage industries at the expense of traditional business activity.4 It has created a trading society that specializes not in wealth creation, but in wealth transfer. It has predictably, created a financial casino of enormous proportions and an increasing ability to affect your lives. That, by the way, is a view shared by Warren Buffet, George Soros, Julian Robertson, and the long list of professionals that have recently exited this popular delusion. Not that their opinions really make a difference, hey?

Whither Gold…by Antal Fekete
Before I touch on the forces at work in the Gold market, I would like to briefly summarize and personally comment on some important points in an essay I recently read.5 Under a gold standard, the plunder of gold from public stocks or the public's hands has always resulted in rising prices and an apparent but temporary devaluation of the metal's monetary value, as its new acquirers spend the hoard to acquire scarce goods. Mr. Fekete illustrates this by relating large historical plunderings to the examples of inflation that occurred under previous gold standards. Early this century, however, central bankers who had initially abused the gold standard to build a pyramid of credit expansion have chosen to continue this plundering of the nation's gold reserves, with a subtle nod from their political allies in Washington, under the guise of growth. When that became irreversible without serious consequence, they began campaign after campaign to keep the party going, eventually switching over to a fiat monetary system and in due course, attempted to demonetize the metal by forcing down its price, which they hoped might ultimately result in a permanent demonetization. That is how the current era of monetary reform started in 1971/1973. The basis of today's monetary system is one of irredeemable currency. The partially successful attempt to demonetize Gold has been prodded along by the psychology inflicted upon gold owners who have faced a seemingly never-ending stream of Gold Dispersal from global bank vaults. However, the funny thing is that, as Mr. Fekete points out, periods of gold dispersal, historically, have been followed by a reconfirmation of gold's position as the paramount monetary asset of the world. This is because, ultimately, the markets decide on what should be used as money. Interestingly, looking through the history of money, it is apparent that a gold standard has often been claimed official only after the public has already declared a de facto gold standard by virtue of their cumulative market vote. The irony is that the Government's gold dispersal's are in fact the predecessor to a remonetization of the gold standard, and since most of this dispersal comes from outside of the United States, perhaps it is some kind of deliberate European ploy.

In 1996, only four years ago, Mr. Fekete said this, "Paradoxically, gold's importance is growing while its dispersal from official hoards and the mines continues apace. Dispersed gold represents latent power, far greater in scope than its nominal market value, as sound credit can be built only upon a gold base. When the dispersal of gold reaches a certain threshold (nobody knows where exactly this threshold is), a metamorphosis of money will take place. Gold will reclaim its throne as constitutional monarch in the monetary and credit system of the world."

It's the Dollar, Stupid!
Yesterday's Dollar problems remain unresolved and have in fact become critical, forcing foreign countries to become net exporters of investment liquidity in order to keep the "Dollar system" functioning. When this inevitably breaks down, there are a few possible political outcomes:
1) Issuing more Treasury debt at higher interest rates in order to soak up excess dollar liquidity, even while asset prices contract. Naturally this will throw the economy into a recession at best.
2) Allowing the Dollar to fall, or devalue, has historically tended to be the most politically convenient way to solve this problem.
3) Capital controls preventing the withdrawal of foreign interests can cause political tension. Besides, Mr. Greenspan voices his opinion that such controls will not work in the technology era in which we live.
4) Dollarization of the entire global monetary system is a theoretical possibility that would allow this Ponzi scheme some respite but is culturally and politically impractical.
5) Implementation of a Fixed Exchange rate regime is plausible if the fixees don't notice that they are being taken advantage of.
6) Inventing a North American currency block. Whatever the outcome, it will be one, which will either postpone the consequences to this delusion or finally correct them. With every downturn that we have had since 1973, this dollar problem resurfaces, except this time; the forces are coiled to an unprecedented extreme, setting the stage for a big day of reckoning. Since most of these choices need to adopt an anchor, such as gold, in order to work properly, the outlook for gold prices looks better by the day.

A Coup For Anyone Who Seizes The Opportunity
The current balance of forces in the gold market is interesting. First of all, whom do central banks lease their gold to anyway; Secondly, producers and bullion dealers are caught net, net short, as supported by the recent stream of data from Reginald Howe and Frank Veneroso; Thirdly, the strength in the exchange rate of the Dollar over the past five years has forced aggressive selling incentives by offshore producers. Likewise, a falling Dollar exchange rate will demote this activity and has already initiated higher gold prices, but higher gold prices will beget even higher gold prices. This is because producers and dealers will have to move rapidly to unwind their shorts, while offshore producers will concurrently slow down their production if they are going to receive cheaper dollars for it. Any kind of financial trouble that creates an insolvent gold producer will only add to the pressure on gold prices as that production will likely go off line for even a short time. And if there is any truth to the gold carry trade, and I believe that there is, look out money center banks. They had better rein it in quickly.

Interestingly, while the anecdotal accounts of the Yen and Euro carry trades have not been questioned, the transparency in gold markets is conveniently much, much less. Yet, if these speculators are willing to borrow Yen or Euros at lower interest rates in order to make no money down profits in US financial markets, why wouldn't they borrow gold, if they could pay a measly 1% lease rate to put on such a trade for the very same reason?

The forces of speculative imbalances between the Dollar and Gold have never been greater, and have never been more irreversible than they are today. What rabbit will the government pull out of its hat this time? What were the real reasons that Mr. Greenspan had influenced the signing of the Washington deal in the fall of 1999?

Gold is really the FED's last line of defense, Checkmate. When this whole game finally starts to unravel, they might have to let it go just to give the speculating public something else to sink their teeth into other than policymakers and technology promoters (probably one in the same). Refer back to Howard Buffet's quote for other creative government distraction ideas…war, scandal, etc. I know that everyone disagrees with me on this one, but what if Watergate was the distraction, not the crime?

So perhaps we should ask Mr. Nixon himself, what he believes is the value of a Dollar!

1 The concept of marginal utilities is paraphrased from Antal Fekete's report, Whither Gold. It can be found at
2 This document can be found at the website for the Foundation of the Advancement of Monetary Education (FAME) @ This is an excellent website for anyone who wants to study the ideal basis for a gold-standard.
3 From his 1996 report on "Dollar Instability and World Economic Growth," prepared for the Joint Economic Committee in the United States.
4 According to Robert Mundell at his Pacific Canada lecture in Vancouver late May.
5 See Whither Gold, by Antal Fekete, of the Memorial University of Newfoundland and the 1996 winner of the international currency prize, awarded by Bank Lips

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Ed Bugos

Author: Ed Bugos

Edmond J. Bugos

Ed Bugos is a former stockbroker, founder of, one of the original contributing editors to and former editor of the Gold & Options Trader. He continues to publish commentary on market and economic trends; and provides gold, economic and mining research to private clients worldwide.

The editor is not a registered advisory and does not give investment advice. Our comments are an expression of opinion only and should not be construed in any manner whatsoever as recommendations to buy or sell a stock, option, future, bond, commodity or any other financial instrument at any time. While we believe our statements to be true, they always depend on the reliability of our own credible sources. We recommend that you consult with a qualified investment advisor, one licensed by appropriate regulatory agencies in your legal jurisdiction, before making any investment decisions, and barring that, we encourage you confirm the facts on your own before making important investment commitments.

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