The Tiger and the Tightrope

By: Alex Wallenwein | Thu, Oct 11, 2007
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After years of official denials and ridiculing so-called 'conspiracy theorists', Citigroup now openly admits to gold price manipulation among central banks. Adrian Ash at the Daily Reckoning lays it out perfectly.

It's not like mainstream financial manipulators, analysts, reporters and news outlets don't know what's really going on in world finance. It's not like they have no clue that Austrian or free-market economics is really the most accurate and true to life perspective on economic interaction. The real problem is that it is not usually in their best interest to admit these things.

So why are they admitting them now?

The Tightrope

Because, in full view of the house of cards finally tumbling, wide open for everyone to see, they will lose all credibility - and therefore readership - if they still pretended not to see.

They are riding a tiger across a tightrope, and there is no net or safety harness. Tiger's weren't made for tightropes. Both they and the tiger (the unprepared general public with no gold holdings) will go down, but on the way down the tiger will 'rip them a new one', as they say.

If anyone who reads this still believes that US government treasury notes and bonds are their investments' 'safe haven', they have a thing or two or three coming. It would be the equivalent of trying to shore up the house you've built on sand by injecting massive amounts of water into the sand below - turning it into quicksand.

Once you realize that the dollar is indeed diluted to the point of effective nonexistence, adding more 'water' doesn't help.

The initiated know that inflation is a monetary phenomenon, not a demand phenomenon. Prices rise across the board mainly because there is too much worthless fiat currency floating around chasing things to buy, bidding up their fiat price.

Once you understand that, and once you know that fiat currency is created by either printing or borrowing, and that the rate of borrowing is determined by how cheap it is to borrow (how low the interest rates are), you understand immediately that the entire current world financial structure is set to self-destruct. It cannot avoid its eventual demise. It can only delay it.

So far, the system's power to delay the inevitable has appeared endless to many. Prognostications of financial doom have always turned out to be poorly timed. In the mid-to-late 1970s, many predicted the fall of the dollar because it was finally decoupled from international gold convertibility. They were wrong only because Paul Vocker had the ability to raise interest rates so high that the cost of owning and holding gold in terms of a forgone potential interest rate bonanza was perceived as too high - for the time being.

So the price of fiat in terms of gold rose again. Gold became cheaper and fiat more expensive in terms of how much gold it would take to buy a dollar. That process continued until 2001, when fiat topped and gold bottomed.

If the (unjustifiably revered) Paul Vocker was Fed chairman today, his policies would be indistinguishable form those of 'Bernie' Bernanke. There's just no way in hell any Fed chief could raise interest rates to 18 and 19% today without immediately collapsing the entire world financial structure.

This market, this economy, will not bear high interest rates. All financial activity (which is based on borrowing and spending) would come to a halt. If that was not so, the (relatively tiny) credit crunch we have experienced so far would not have occurred at all.

The Credit Crunch

Suddenly, investors who used to gladly endure daily beatings with the 'stupid-stick' rediscovered their formerly instinctive risk aversion. When risk only meant higher returns, they were all for it and threw caution into the whirlwind - but now that risk means loss of capital, they bolted in record numbers.

The Fed and other world central banks, because of how they are set up to operate, have very few policy options. By their very existence they have condemned themselves to fighting the kind of fire weare now experiencing with gasoline. All they can do is lower their policy rates to try and reassure the public that it will never run out of liquidity.

Economic Crack-Whores

If you have paid attention, though, you already know that too much liquidity is the real problem. Collectively, the financial world is hooked on economic crack cocaine - easy credit - and the only place it can go to for 'relief' is the crack-pusher who got it hooked in the first place.

We all know that more crack is not the answer to the crack-whore's woes. Only withdrawal is - but that is painful and politically unpopular.

The problem is, however, that more expensive credit is not the equivalent of the needed withdrawal. More expensive credit is only the equivalent of making crack more expensive and therefore hard to get to. It does not cure the underlying ill - the addiction itself.

As an economic entity, as long as you cycle fiat-crack through your system, you condemn yourself to the ultimate fate of all crack whores: You condemn yourself to eventual collapse and death.

Crack is addictive because it artificially, deceptively, stimulates the brain's pleasure centers, giving them only an illusion of stimulation. Fiat does the same thing. It stimulates economic 'growth' because it creates the illusion of never-ending money supply to finance what will soon turn out to be equally illusory wealth creation.

There is only one cure, and that is to kick the fiat habit, period. Naturally, the financial world (of which you and I are a part) does not have the financial and political will to kick this habit. It will therefore die, sooner or later.

Note, though, that the "financial world" is not the same thing s the world. Humanity itself won't die. The planet will not cease to exist. There will still be air to breathe and food to eat and water to drink - but economic pain will be inevitable.

How do we cure this crack addiction, then?

Kicking the Fiat-Habit

To cure a disease you need to properly diagnose it and then prescribe the proper medical remedy.

Let's diagnose, then. Following is the pathogenesis of the fiat world:

The dollar (as were most currencies in the 1800s) was once tied to gold. The law said that X amount of gold was worth Y amount of dollars, and that banks had to exchange Y dollars for X gold on demand, at any time;

The law allowed bankers to print more paper-dollars than there was gold to back them, calling this "fractional reserve banking" (banks only needed to keep a fraction or percentage of the total amount of dollars outstanding in forms of gold on reserve);

Banks inevitably printed too many dollars, and depositors got nervous, demanding their gold back. Banks got into hot water.

The then recently created (in 1913) 'lender of last resort' (the Fed) only had one option to save the illiquid banks: Create (print) more dollars. Naturally, it was unable to create more gold.

Instead of protecting depositors and punishing the profligate banks, 'the law' (US government) helped the guilty bankers and punished innocent depositors instead (see, FDR's gold confiscation in 1933);

American citizens got screwed, but international central banks could still exchange their traded-for dollars for gold from the US treasury. Like Americans, central bankers weren't stupid and demanded their gold when they saw that the Fed and US banking system had printed and loaned too many dollars into existence that began to float around the world, so Nixon did internationally what FDR did domestically: He closed the gold window.

Now, international central banks (or actually the countries they represented) were the ones who got screwed. They could have rejected the dollar at that time and given the US the finger, but they chose not to. They themselves wanted "in" on the money-creation scheme;

Fiat and Oil

The US made a deal with the Saudis that they would always protect the Saudis in return for the Saudis' promise to only accept US dollars for their oil. This became the standard among oil-producing countries, and dollar-demand was secured for decades to come, in sufficient amounts to keep its lack of real value (and its oversupply) hidden from ordinary observers and investors.

As a result, the market (representing the collective wisdom of all its participants in spite to the stupidity of most of its individual members) sensed there were too many dollars (and other fiats) and started to bid up the fiat-price of gold.

Central banks tried to suppress gold by selling it outright, but they soon began to run out. In the late 1970s, Paul Volcker, crack-pimp extraordinaire, saw his chance to make dollar-crack more expensive by raising interest rates, thus reducing the value of holding gold as explained above. The situation eased - for a while;

In the mid-1990s, gold prices pulled up again. World central crack-bankers agreed to "sell" gold to each other and to the Chinese in order to create the illusion of oversupply in the market. This time, they used gold options, futures, and other related contracts to magnify the appearance of oversupply. The resulting price-drought forced gold miners to sell gold not yet produced 'forward' to lock in higher prices in what appeared to be an ever-declining market.

The Gold Carry Trade

In addition, central crack-bankers worldwide agreed to lease gold at ridiculously low prices to banks (deceptively referred to as "bullion banks") so these banks could sell the gold short, turn the proceeds into cash, invest the cash in higher yielding government treasuries, and pocket the difference. Thus, the gold carry-trade was born.

This (like the current credit crisis) occurred in typical crack-dealer fashion: make your product cheap so as to drive up demand and get more poeple hooked on it.

This carry trade supported low interest rates in the general economy by driving up demand for treasuries, which ultimately led to the recent housing boom in the US and UK; however, the market, however, dutifully absorbed all of the gold thus made available;

Meanwhile, central bank crack-pimps realized that their main source of crack - the dollar - may one day dry up, so they created a new source of fiat-crack: The European Common Currency, aka the 'euro', a synthetic, designer-made fiat drug not unlike what today is known as 'ecstasy.'

The US, having exported way too many dollars in its fiat-lifetime, began building record trade deficits. Other countries became nervous and welcomed the euro with open arms. As oil producers followed suit, the dollar's oil-backing deteriorated and started to crumble;

At the same time all of those easy-credit crack-dollars had to go somewhere so as not to drive up prices of goods and services in the general economy where high prices are considered "bad" - so Greenspan became a bubble-wizard of sorts, creating one financial asset-bubble after another (where high prices are considered "good") to absorb all those excess dollars floating around: First stocks, then real estate; now, we're back in stocks again.That's where we are now. (Soon, the bubble will shift back into tech stocks, i.e., NASDAQ.)

A Different Kind of Animal

The real estate bubble was a different animal from the stock-bubble, though. Stocks are generally bought with money earned, not loaned. But real estate is almost exclusively bought with money loaned, not earned.

The big mistake of the crack-wizards of Oz (US) was that in recent years they began repackaging loans (which are contractual rights to the future income of the borrowers) to sell them to investors at a discount. That way, loans (debt) became "assets." Those 'assets' were then used to back up "commercial paper" by which big corporations borrow short-term money from investors to finance their operations. This commercial paper is usually "rolled over" into new loans as it matures.

When the debt (mortgages) that was 'backing' other debt (commercial paper) began to fall into default as borrowers were reneging on their obligations to repay it, investors who used to loan corporations the money they need to fund operations began to pull back. Big businesses could no longer finance its operations. The result: no operations > no business > no income > no profits > lower share prices.

That's what happened on August 19th. It was the public tiger's first wobble on the financial fiat tightrope. There will be others, and they will come with increasing frequency and mounting severity.

Eventually, the ability of big business to do business will be severely hampered. Share prices will drop. People will lose their jobs. They will then default on their mortgages. The vicious cycle will deepen and will descend like a funnel cloud on the world's financial landscape. Traditional 'safe haven' investments like government debt obligations that used to appear set in stone will go airborne.

Ha! Now we can see the crux of the coming catastrophe.

The Sink-Hole

By dropping the federal funds rate half a percentage point, the Fed has "injected liquidity" into this cycle again - but at the tremendous cost of further undermining the already undermined dollar.

A huge sinkhole is opening up before our eyes, our out-of control, fiat-fueled, economic bubble-machine is reeling towards it - just as we discover that the brakes are shot as we hold the broken-off steering wheel in our hands!

This time, there will be no soft landing.

As the debt-pushers are making a spectacle of themselves while riding the public tiger across - and off - the tightrope of a fast-decaying world fiat system, gold and silver owners will watch them hit rock-bottom from the safest of all vantage points: with both of their financial feet already firmly on the ground

Got gold?



Author: Alex Wallenwein

Alex Wallenwein
Editor, Publisher
The Euro vs Dollar Monitor

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