The Death of Money

by James Rickards

  I have a secret understanding in writing with the Bundesbank . . . that Germany will not buy gold, either from the market or from another government, at a price above the official price of $42.22 per ounce.

  Just three days after the Burns memorandum was written, President Ford sent a letter to German chancellor Helmut Schmidt incorporating the substance of Burns’s advice:

  THE WHITE HOUSE

  WASHINGTON

  * * *

  JUNE 6, 1975

  Dear Mr. Chancellor:

  . . . We . . . feel strongly that some safeguards are necessary to ensure that a tendency does not develop to place gold back in the center of the system. We must ensure that there is no opportunity for governments to begin active trading in gold among themselves with the purpose of creating a gold bloc or reinstating reliance on gold as the principal international monetary medium. In view of the world-wide inflation problem, we must also guard against any further large increase of international liquidity. If governments were entirely free to trade with one another at market-related prices, we would add to our own common inflation problem. . . .

  Sincerely,

  Gerald R. Ford

  Central bank gold market manipulation wasn’t unique to the 1970s but continued in the decades that followed. A Freedom of Information Act (FOIA) lawsuit against the Federal Reserve System filed by an advocacy group uncovered meeting notes of the secret Gold and Foreign Exchange Committee of G-10 central bank governors held at the Bank for International Settlements on April 7, 1997. That committee is the successor to the notorious 1960s London Gold Pool price-fixing scheme. The notes, prepared by Dino Kos of the Federal Reserve Bank of New York, include the following:

  In May 1996, the market traded the equivalent of $3 billion of gold daily. Swap deals accounted for 75 percent of the volume. . . . Gold had traditionally been a secretive market. . . .

  Gold leasing was also a prominent piece of the market, whose growth central banks were very much a part of. The central banks, in turn, had been responding to pressures that they turn a non-earning asset into one that generates at least some positive return. . . . Central banks mostly lent gold at maturities of 3–6 months. . . . Central banks had some responsibility for the gold leasing market since it was their activity which made that market possible to begin with. . . . Gold does have a role as a war chest and in the international monetary system. . . .

  BIS had not sold any gold in many years. The BIS did some leasing.

  [Peter] Fisher (United States) . . . noted that the price of gold . . . had historically not trended toward the cost of production. This seemed to suggest an ongoing supply/demand imbalance. . . . He had the sense that the gold leasing market was an important component in this puzzle. . . .

  Mainert (Germany) asked how a big sale would affect the market. What would happen if, say, the central banks sold 2,500 tonnes—equivalent to one year’s production. . . . Nobody took up Mainert’s challenge. . . .

  [Peter] Fisher explained that U.S. gold belongs to the Treasury. However, the Treasury had issued gold certificates to the Reserve Banks, and so gold . . . also appears on the Federal Reserve balance sheet. If there were to be a revaluation of gold, the certificates would also be revalued upwards; however [to prevent the Fed’s balance sheet from expanding] this would lead to sales of government securities.

  More recently, on September 17, 2009, former Federal Reserve Board governor Kevin Warsh sent a letter to a Virginia law firm denying an FOIA request for documentation of Fed gold swaps on the grounds that the Fed had an exemption for “information relating to swap arrangements with foreign banks on behalf of the Federal Reserve System.” While the FOIA request was denied, Warsh’s letter at least acknowledged that central bank swaps exist.

  On May 31, 2013, Eisuke Sakakibara, former vice minister of the Japanese Ministry of Finance, cheerfully recalled how Japan’s government had secretly acquired 300 tonnes of gold in the mid-1980s. This gold acquisition does not appear in the Bank of Japan’s reserve position reported by the World Gold Council, because it was executed by the Finance Ministry rather than by the central bank:

  We bought 300 tonnes of gold in the 1980s to strike a commemorative coin for the sixtieth anniversary of the reign of Emperor Hirohito. It was a very difficult operation. We worked through JPMorgan and Citibank. We could not disclose our actions because it was a very large quantity, and we did not want the price to go up that much. So we bought gold futures, which are very liquid, and then we surprised the market by standing for delivery! Some of the bars delivered were three-nines [99.90 percent pure], but we melted them down and refined them into four-nines [99.99 percent pure] because we could only use the finest gold for the Emperor.

  The gold was transported to Japan by Brinks in the upper deck of two Boeing 747s configured for cargo use. Two shipments were used not because of weight but to spread the risk. Brinks had two couriers on each flight so that the gold could be watched at all times even as one courier slept.

  The foregoing documentary record is just the tip of the iceberg in terms of official gold market manipulation by central banks, finance ministries, and their respective bank agents. Still, it establishes beyond dispute that governments use a combination of gold purchases, sales, leases, swaps, futures, and political pressure to manipulate gold prices in order to achieve policy objectives, and they have done so for decades, since the end of Bretton Woods. Official gold sales that depressed gold prices were practiced extensively by Western central banks from 1975 to 2009 but came to an abrupt end in 2010, as gold prices skyrocketed and citizens questioned the wisdom of selling such a valuable asset.

  The most notorious and heavily criticized case involved the sale of 395 tonnes of U.K. gold by chancellor of the exchequer Gordon Brown in a series of auctions from July 1999 to March 2002. The average price received by the U.K. was about $275 per ounce. Using $1,500 per ounce as a reference price, losses to U.K. citizens from Brown’s blunder exceed $17 billion. More damaging than the lost wealth was the U.K.’s diminished standing among the ranks of global gold powers. Recently, outright gold sales by central banks as a form of price manipulation have lost their appeal as gold reserves have been depleted, prices have surged, and the United States has conspicuously refused to sell any gold of its own.

  The more powerful price manipulation techniques by central banks and their private bank agents involve swaps, forwards, and futures or leases. These “paper gold” transactions permit massive leverage and exert downward pressure on gold prices, while the physical gold seldom leaves the central bank vaults.

  A gold swap is typically conducted between two central banks as an exchange of gold for currency, with a promise to reverse the transaction in the future. In the meantime, the party receiving the currency can invest it for a return over the life of the swap.

  Gold forward and gold futures transactions are conducted either between private banks and counterparties or on exchanges. These are contracts that promise gold delivery at a future date; the difference between a forward and a future is that the forward is traded over the counter with a known counterparty, while a future is traded anonymously on an exchange. Parties earn a profit or incur a loss depending on whether the gold price rises or falls between the contract date and the future delivery date.

  In a lease arrangement, one central bank leases its gold to a private bank that sells it on a forward basis. The central bank collects a fee for the lease, like rent. When a central bank leases gold, it gives the private banks the title needed to conduct forward sales. The forward sales market is then amplified by the practice of selling unallocated gold. When a bank sells unallocated gold to a customer, the customer does not own specific gold bars. This allows the banks to sell multiple contracts to multiple parties using the same gold. In allocated transactions, the client has direct title to specific numbered bars in the vault.

  These a
rrangements have one thing in common, which is that physical gold is rarely moved, and the same gold can be pledged many times to support multiple contracts. If the Federal Reserve Bank of New York leases 100 tonnes to JPMorgan in London, JPMorgan then takes legal possession under the lease, but the gold remains in the Fed’s New York vault. With legal title in hand, JPMorgan can then sell the same gold ten times to different customers on an unallocated basis.

  Similarly, a bank like HSBC can enter the futures market and sell 100 tonnes of gold to a buyer for delivery in three months but needs no physical gold to do so. The seller needs only to meet margin requirements in cash, which are a small fraction of the gold’s value. These leveraged paper gold transactions are far more effective in manipulating market prices than outright sales, because the gold does not have to leave the central bank vaults; therefore the amount of selling power is many times greater than the gold on hand.

  The easiest way for central banks to disguise their actions in the gold markets is to use bank intermediaries such as JPMorgan. The granddaddy of all bank intermediaries is the Bank for International Settlements, based in Basel, Switzerland. That the BIS acts for the central bank clients in the gold markets is not surprising; in fact, it was one reason the BIS was created in 1930. The BIS denominates its financial books and records in SDRs, as does the IMF. The BIS website states plainly, “Around 90% of customer placements are denominated in currencies, with the remainder in gold. . . . Gold deposits amounted to SDR 17.6 billion [about $27 billion] at 31 March 2013. . . . The Bank owned 115 tonnes of fine gold at 31 March 2013.”

  The BIS’s eighty-third annual report, for the period ending March 31, 2013, states:

  The Bank transacts . . . gold on behalf of its customers, thereby providing access to a large liquidity base in the context of, for example, regular rebalancing of reserve portfolios or major changes in reserve currency allocations. . . . In addition, the Bank provides gold services such as buying and selling, sight accounts, fixed-term deposits, earmarked accounts, upgrading and refining and location exchanges.

  Sight accounts in gold are unallocated, and earmarked accounts in gold are allocated. In finance, sight is an old legal term meaning “payable on demand or presentment,” although there is no requirement to have the gold on hand until such demand is actually made. The BIS achieves the same leverage employed by its private bank peers using leasing, forwards, and futures.

  Notably, footnote 15 of the accounting policies in the 2010 BIS annual report stated, “Gold loans comprise fixed-term gold loans to commercial banks.” In the 2013 report, the same footnote stated, “Gold loans comprise fixed-term gold loans.” Apparently by 2013 the BIS considered it wise to hide the fact that the BIS deals with private commercial banks. This deletion makes sense because the BIS is one of the main transmission channels for gold market manipulation. Central banks deposit gold with the BIS, which then leases the gold to commercial banks. Those commercial banks sell the gold on an unallocated basis, which allows ten dollars of sales or more for every one dollar of gold deposited at the BIS. Massive downward pressure is exerted on the gold market, but no physical gold ever changes hands. It is a well-honed system for gold price suppression.

  While the presence of central banks in gold markets is undoubted, the exact times and places of their manipulation are not disclosed. But intriguing inferences can be made. For example, on September 18, 2009, the IMF authorized the sale of 403.3 tonnes of gold. Of that amount, 212 tonnes were sold, during October and November 2009, to the central banks of India, Mauritius, and Sri Lanka. An additional 10 tonnes were sold to the Central Bank of Bangladesh in September 2010. These sales were done by prearrangement to avoid disrupting the market. Sales of the remaining 181.3 tonnes commenced on February 17, 2010, but the buyers have never been disclosed. The IMF claimed the other sales were “on market” but also said that “initiation of on-market sales did not preclude further off-market gold sales directly to interested central banks or other official holders.” In other words, the 181.3 tonnes could easily have gone to China or the BIS.

  At the same time as the IMF gold sales were announced and conducted, the BIS reported a sharp spike in its own gold holdings. BIS gold increased from 154 tonnes at the end of 2009 to over 500 tonnes at the end of 2010. It is possible that the IMF transferred part of the unaccounted-for 181.3 tonnes to the BIS, and that the BIS Banking Department, controlled at the time by Günter Pleines, a former central banker from Germany, sold the gold to China. It is also possible that the large gold influx was attributable to gold swaps from desperate European banks trying to raise cash to meet obligations as their asset values imploded during the sovereign debt crisis. The answer is undisclosed, but either way the BIS stood ready to facilitate such nontransparent gold market activity as it had done for the Nazis and others since 1930.

  Some of the most compelling evidence for manipulation in gold markets comes from a study conducted by the research department of one of the largest global-macro hedge funds in the world. This study involved two hypothetical investment programs over a ten-year period, from 2003 to 2013. One program would buy gold futures at the New York COMEX opening price every day and sell at the close. The other program would buy gold at the beginning of after-hours trading and sell just before the COMEX open the following day. In effect, one program would own New York hours and the other program would own the after-hours. In a nonmanipulated market, these two programs should produce nearly identical results over time, albeit with daily variations. In fact, the New York program revealed catastrophic losses, while the after-hours program showed spectacular gains well in excess of the market gold price over the same period. The inescapable inference is that manipulators slam the New York close, which creates excess profit opportunities for the after-hours trader. Since the New York close is the most widely reported “price” of gold, the motivation is equally clear.

  The motivation for central bank gold market manipulation is as subtle as the methods used. Central banks want inflation to reduce the real value of government debt and to transfer wealth from savers to banks. But central banks also work to suppress the price of gold. These twin goals seem difficult to reconcile. If central banks want inflation, and if a rising gold price is inflationary, why would central banks suppress the gold price?

  The answer is that central banks, principally the Federal Reserve, do want inflation, but they want it to be orderly rather than disorderly. They want the inflation to come in small doses so that it goes unnoticed. Gold is highly volatile, and when it spikes up sharply, it raises inflationary expectations. The Federal Reserve and the BIS suppress gold prices not to keep them down forever, but rather to keep the increases orderly so that savers do not notice inflation. Central banks act like a nine-year-old-boy who sees fifty dollars in his mom’s wallet and steals one dollar thinking she won’t notice. The boy knows that if he takes twenty, Mom will notice, and he will be punished. Inflation of 3 percent per year is barely noticed, but if it persists for twenty years, it cuts the value of the national debt almost in half. This kind of slow, steady inflation is the central banks’ goal. Managing inflation expectations by manipulating gold prices downward was the rationale given by Fed chairman Arthur Burns to President Gerald Ford in the secret 1975 memo. That hasn’t changed.

  Since then, however, an even more ominous motive for central bank gold price manipulation has emerged. The gold price must be kept low until gold holdings are rebalanced among the major economic powers, and the rebalancing must be completed before the collapse of the international monetary system. When the world returns to a gold standard, either by choice to create inflation, or of necessity to restore confidence, it will be crucial to have support from all the world’s major economic centers. A major economy that does not have sufficient gold will either be relegated to the periphery of any new Bretton Woods–style conference, or refuse to participate because it cannot benefit from gold’s revaluation. As in a poker ga
me, the United States possessed all the chips at Bretton Woods and used them aggressively to dictate the outcome. Were Bretton Woods to happen again, nations such as Russia and China would not permit the United States to impose its will; they would prefer to go their own way rather than be subordinate to U.S. financial hegemony. A more equal starting place would be required to engender a cooperative process for reforming the system.

  Is there a preferred metric for rebalancing reserves? Many analysts look at the statistics for gold as a percentage of reserves. The United States has 73.3 percent of its reserves in gold; the comparable figure for China is 1.3 percent. But this metric is misleading. Most countries have reserves consisting of a combination of gold and hard currencies. But since the United States can print dollars, it has no need for large foreign currency reserves, and as a result, the U.S. reserve position is dominated by gold. China, on the other hand, has little gold but approximately $3 trillion of hard-currency reserves. Those reserves are valuable in the short run even if they are vulnerable to inflation in the future. For these reasons, the 73 percent U.S. ratio overstates U.S. strength, and the 1.3 percent ratio overstates China’s weakness.

  A better measure of gold’s role as a monetary reserve is to divide gold’s nominal market value by nominal GDP (gold-to-GDP ratio). Nominal GDP is the total value of goods and services that an economy produces. Gold is the true monetary base, the implicit reserve asset behind the Fed’s base money called M-Zero (M0). Gold is M-Subzero. The gold-to-GDP ratio reveals the true money available to support the economy and presages the relative power of a nation if a gold standard resumes. Here are recent data for a select group of economies that together comprise over 75 percent of global GDP:

  Table 2. Gold-to-GDP Ratio for Selected Economies