while its several heads were being chopped off one by one?
Antal E. Fekete - New Austrian School of Economics
I have never appealed to the so called conspiracy
theories in trying to explain the strange world of fluctuations in the price of
monetary metals. But neither have I ever said that the fiat money Hydra will
take it lying down when it comes to chopping off its several heads one by one.
Markets for the monetary metals under fiat money
Here are the relevant facts:
(1) The U.S. government defaulted on its obligation to
pay its short-term dollar debt to foreign governments and central banks in gold
at a fixed rate, as confirmed by several international treaties and by the
solemn pledges of several sitting presidents, on August 15, 1971. Subsequently
it has been bankrolling a chorus of servile academic cheer leaders and other
sycophants to shout from the roof top that the gold standard was a ‘barbarous relic’
anyway, quite ripe to be gotten rid of in an effort to cover up the shame of
fraudulent default (fraudulent because the U.S. did have the gold and could
have lived up to its international obligations).
(2) Thus the U.S. confiscated some of the gold
belonging to institutions outside its own jurisdiction, but could not
confiscate all of it. University economics departments and research
institutions have failed to investigate what gold at large will do in the long
run. They just assumed that it will be business as usual without
gold in eternity. Well, it didn’t quite turn out that way.
Speculators soon started
trading gold futures, first in Canada, then in 1975 in the U.S. as well. No
universities and think tanks showed an interest in studying gold futures
trading and its long run consequences. Why, gold has been reduced to the status
of frozen pork bellies. We know all that is to be known about trading frozen
pork bellies, don’t we? Supply and demand, right? And when push comes to shove,
it is easier to increase the supply of paper gold than that of frozen pork
bellies, isn’t it? (With due apologies to the late Fritz Machlup of Princeton
University for this interpretation of his theory of gold futures trading.) We
may bypass the question whether our institutions ignored problems connected
with futures trading of monetary metals on their own volition, or whether they
did so under duress. As it turned out two scores of years later, the failure to
study the consequences of the so called demonetization of gold (euphemism for
highway robbery) has caused an unprecedented world disaster: the disintegration
of the world’s payments system that is now unfolding before our very eyes.
(3) A scientific inquiry would have shown back in the
1970’s that the gold basis (defined as the difference between the nearby
futures price and the price for immediate delivery of gold) would be robust, in
fact, it would be at its maximum (equal to the carrying charge, or opportunity
cost of holding gold). But soon it would start its relentless decline all the
way to zero and beyond. A negative gold basis, a condition known as
backwardation of gold, would create an extremely unstable situation in
international finance because it meant risk free profits for holders of gold.
Knowledgeable market participants realize that persistently
falling basis means increasing scarcity which, in the case of gold, is not and
cannot be alleviated by current output from the mines. Output ultimately proves
no match for the mass movement of gold going into hiding, first gradually,
eventually reaching crescendo when the threat of permanent gold backwardation
starts looming large.
At that point all deliverable supplies of physical gold
would be gobbled up by gold hoarding. In case of monetary metals, in contrast
with all other commodities, high and increasing prices may not bring out new
supply. Rather, they might make supply shrink. Monetary metals are exempt from
the law of supply and demand. Under permanent backwardation, as no gold were
offered for sale at any price, the ‘price of gold’ would become a
vacuous concept. Gold, silver and, soon enough, all
other highly marketable goods would only be available through barter. In other
words, paper money as we know it would simply cease to function.
We cannot fathom how our complex world economy could
operate under such circumstances. One thing was certain, though: the world
economy would contract in a way that would make the contraction in the 1930’s
appear as a blip on the screen.
(4) All bubbles, all currency and financial crises of
the past forty years are direct or indirect consequences of the vanishing gold
basis whether we admit it or not. A few years ago Professor Robert Mundell of
Columbia University invited me to attend his annual seminar at Santa Colomba,
with most of the leading monetary scientist in attendance. I circulated a
statement warning of the danger of permanent gold backwardation and how it
would adversely affect the world economy. I argued that permanent backwardation
of gold would be a watershed event. As long as the gold futures markets are
open, U.S. Treasury debt is still gold convertible (albeit at a fluctuating
rate, never mind that the rate is minuscule).
But no sooner had gold futures trading stopped after
the advent of permanent backwardation than gold was no longer to be had in
exchange for U.S. Treasury debt. The entire outstanding debt of the U.S. was
worth not one ounce of gold. Not one gram of it. It is insane to pretend that
this would make no difference in world trade, as pretended by official doctrine.
This event would
mark the transition from monetary economy to barter
economy.
My missive did not provoke a single rejoinder.
It was simply ignored.
All the same, I have reasons to believe that people in
the U.S. Treasury and the
Federal Reserve started to listen and they took a
crash course on the problem of vanishing gold basis and the threat of permanent
gold backwardation.
(5) To summarize, in forcing the world off the gold
standard in 1971 the U.S. government created a many headed Hydra. The problem
was compounded by the apparent gag order, muzzling research on the gold basis as
a face saving exercise to cover up the fact of default. Gold is not the same as
frozen pork bellies after all in waking up too late that there was a problem after
gold futures markets have been flirting with backwardation for a year or so, officialdom
was forced to act.
Act it did in a typically haphazard fashion.
A few days ago, on April 12 and 15 the paper gold
market was demoralized by a ferocious attack on the lofty gold price. This in and
of itself is proof that Bernanke is fully aware that permanent gold
backwardation is imminent, and that it will create and unmanageable situation. It’s
got to be stopped in its track at all hazards.
Well, well, well.
Gold is not the same as frozen pork bellies after all.
The
Hydra is not taking it lying down. The kid gloves have
finally come off.
Bernanke is trying to stop gold backwardation by
selling unlimited amount of gold futures contracts through his stooges, the
bullion banks. He is underwriting losses they are certain to suffer in due
course. We can take it for granted that they haven’t got the gold to make
delivery on their contracts. In fact, delivery of gold will be suspended under
the force majeure clause. Short positions will have to be settled in cash, to
be made available by the Fed’s printing presses.
Gold futures trading will be a thing of the past.
Bernanke and columnist Paul Krugman, formerly his
subaltern colleague at Princeton don’t understand that the issue is not the
price of gold. The issue is backwardation or contango. In trying to wrestle the
gold price to the ground the Fed makes “the last contango in Washington” *an
accomplished fact.
From the frying pan into the fire Ostensibly a lower
gold price would solve the problem Bernanke has. Demoralized gold bugs would be
forced out of their holdings through margin calls. Disillusioned investors would
shun gold.
This would make physical gold available to rescue the
strapped gold futures market.
In fact, however, a lower gold price is making the
problem more intractable, not less. The Fed is diving from the frying pan into
the fire. This is the point missed by almost all observers and market analysts.They
ignore the underlying flight into physical gold that continues unabated, in
spite of (or, better still, because of) the panic in the paper gold market.
The Fed’s intervention in bankrolling short interest is
going to backfire, for the following simple reason. The Fed’s strategy is
inherently contradictory.
A lower price for paper gold makes it easier, not
harder, to demand delivery on maturing futures contracts. The more paper gold
Bernanke sells, the lower the cost of acquiring physical gold in exchange for
paper gold becomes. The price of the nearby futures contract will drop to hitherto
unimaginable depths, relative to the cash price, making backwardation worse,
not better. Ultimately this will make backwardation irreversible.
Welcome to the world of permanent gold backwardation.
From what hole does the evil deflationary wind blow? Academia
and the financial press have
utterly failed to recognize the relevance of gold backwardation
as regards deflation. They might fret about hyperinflation as a result of
unbridled money-printing (euphemism for the monetization of government debt).
Yet the real danger is not on the inflationary but on the deflationary front as
realized even by Krugman – while he is perfectly clueless on the question from what
hole the evil deflationary wind blows (other than conservative wishful
thinking). Well, I can pinpoint the location of the hole to within yards for
the benefit of Krugman. It is on Constitution Avenue, in Washington, D.C. The
evil deflationary wind is blowing from the building of Federal Reserve Board.
If Bernanke thought that his attacks on the gold price
would stem deflation, well, his efforts were counter-productive, to put it
mildly. They have, in fact, made the flight into physical gold accelerate.
Permanent backwardation of gold, and its concomitant, the re-invention of
barter the ultimate in deflation will be the result. There is no reason to fear
that the Fed is pushing the world into hyper-inflation. In fighting the gold
price the Fed unwittingly pushes the world into hyper-deflation. All the same,
it is destroying the dollar and the international monetary and payments system.
No comments:
Post a Comment