Don''t just discuss and argue; get out there and DO something


By Michael Kosares
August 18, 2001

Steve H. writes: "It seems that there is no end to the
confusion over Special Drawing Rights. Is it the
International Monetary Fund gold controlled or held by
the United States that is encumbered? Is it U.S. gold
that is encumbered? Or is it Exchange Stabilization
Fund gold, which is not part of the IMF or U.S. gold,
that is encumbered? Or is all the yellow stuff
encumbered? Plus, what risk specifically is Europe
taking with swapping SDRs, and why not the United

I believe that both the United States and Europe are at
risk. Here's why:

To keep it simple, let's say that you have 500 ounces of
gold and I'm a likely borrower. You lend me the gold. I
sign a loan agreement. You push the gold across the
table to me. I push the paper across the table to you. As
the "banker," you are hoping I will pay you back. You're
gold is now gone. I've got it. You've got a piece of
paper that says I will pay you back. But that does not
mean that I WILL pay you back. There are all sorts of
contingencies that could come into play to prevent
repayment, ranging from the run of the mill
(bankruptcy, refusal to pay, etc.) to the exotic (force
majeur, a gold squeeze, etc).

I use the word "hoping" because there is no collateral I
can offer you superior to what you just gave up. Why?

Because gold is the only internationally liquid financial
asset that is not contingent on someone else's ability to
perform. All other assets by definition are inferior in
terms of collateral to gold, because they do rely on
someone else's (a third party's) performance for final

This may seem a mundane consideration on the surface,
but it becomes ever so critical because the implications
to that assessment run so deep.

In fact, if you go back in the
archives, you will find that one of the first questions I
ever asked Another is: Wwhat collateral does a central
banker have once he makes a gold loan?

Why did I ask that question? Because I know that all
collateral is inferior to gold. There is no asset I can hand
over to you in the transaction outlined above that would
make you feel more comfortable than the gold you just
gave up.

This "gold-above-all-else" overarching socio-economic
contract is at the heart of why gold is so disparaged by
the the paperhangers.

Once again, let's reduce the concept to something very
fundamental: In a small kingdom at the foot of the
Himalayas hardly known to the outside world, there
once a lived a beautiful woman -- unattached -- who
was the attraction of every man and the envy of every
woman. Every woman believed the fidelity of her
husband to be at risk whenever this woman walked into
the room -- a modern Aspasia. One night at a grand
party, a small group of women, huddled away from the
rest, decided: We will cast this woman as a whore, as
unclean and unworthy, a lady of the night, and that way
we will protect our own homes from her devices. So it
was, and so the reputation of this Aspasia was
constantly under question and scrutiny. She was tagged
and branded, not because of what she was -- a good
woman who happened to be beautiful -- but because she
was truly feared by the other women in the kingdom.

And that's the way with gold. Cast unjustly as the
"barbarous relic," it is in reality the most beautiful lady
in the kingdom.

So who is in the better position in this transaction?

No one.

To bring it back to reality: Both the lending and the
borrowing countries have been diminished by the
transaction. The lender (let's say, the German
Bundesbank) no longer has its gold. The borrower (let's
say, the United States) has sold it and employed the
proceeds. The Bundesbank hopes that the United States
pays it back. The United States hope that it can pay the
Bundesbank back. At repayment time the United States
must repay in gold -- not in kind. It must then go out
and buy the gold to pay it back. (This is where
derivative contracts enter into the scenario, but I will
avoid this complication for now.)

And therein you can see where the problems begin:
What if the price is substantially higher? What if the
market is tight and there's not much gold around? What
if the United States in essence has declared bankruptcy?
(Remember, the Bundesbank has no collateral except a
piece of paper representing a claim to the U.S. gold

Obviously, Germany is at risk, and I find it difficult to
believe that someone on the board at Bundesbank
would not have pointed out these difficulties before the
the German gold reserve was let out the door.

I hope this example sheds some light on the situation,
because in the James Turk scenario this is precisely
what has happened with the complicated relationship
between various paper instruments being the only trail.

If the Turk scenario plays out, the U.S. gold reserve is
at risk and is encumbered, but as I hinted above, when
the day of reckoning comes, it is likely that the United
States will renege as it did in 1971/73. In other words,
Europe loses and loses big.

But I think we should all understand that what Turk is
talking about is THEORETICAL and remains to be

I will also say this. Chris Powell says that the
transaction outlined by Turk is no different from any
other gold loan in which the banks are already involved,
and he is absolutely right. The difference is the degree
of involvement.

A few hundred tonnes loaned by a central bank is not
going to raise any eyebrows, but when you get to
between 60 and 70 percent of the entire European
Union's gold holdings at risk via these swap
arrangements, this thing is taken to a level beyond
logical comprehension.

It would be hard for me to believe that even this group
of statist European central bankers is that foolish. I
would be surprised, for example, if even one ounce of
French gold has been loaned out in these schemes.

That consideration alone would move the percentage of
gold swapped out by the remaining members to
between at 70 and 80 percent, if we extrapolate the
reduction of SDR certificates to the U.S. reserve as a
call on its gold.

But there is more to it than that. This gold-lending
business goes way beyond what has been actually let
loose from the central banks.

Please understand that I mean Turk no disrespect and
the Gold Anti-Trust Action Committee no harm by my
hesitancy on this. In the end, they could very well be
absolutely right -- strange transactions have occurred in
international finance before in the name of saving the
system (though I cannot recall one as strange and
dangerous as what has been described).

Turk has made an enormous contribution to the work
available to gold advocates and owners on the possible
gold-rigging situation, and no one should make the
mistake of believing that my admiration for him has
diminished one bit. In fact, it is because Turk has
brought this situation to the forefront that it deserves to
be seriously considered. I am simply at a loss to agree
with him on this matter -- leaving aside how much I too
wish he had found the "golden key."

Turk's breakthrough work on the lender-of-last-resort
function and his famous phrase that "a central bank
cannot print gold" as it can print paper money plays a
critical role in my own analysis below. Beyond that, his
writings on driving a commodity, particularly gold, into
scarcity by keeping its price down were also an
important contribution. He taught us that such
management leads to a price explosion, and I, like him,
believe that such a breakout is inevitable. It is not a
question of "if" but "when." This is what I've called the
"market solution" to gold's dilemna.

But at the root I believe that the pestering anxiety to
find the source of the very large theoretical gold loan
numbers has led to a number of blind alleys, false leads,
and undeveloped theory -- though all of it is appreciated
as source material on the road to understanding the gold
market, including the SDR work.

Much of the discussion centers around trying to locate a
source for the very large amount of gold that has been
leased over the past nearly a decade -- some say near
15,000 tonnes. I believe that Another has pegged that
figure much higher (was it 25,000 tonnes?).

First of all, I have never seen a real justification for this
figure, or any gold loan figure for that matter, since
those statistics are not reported by the world's central
banks. Even the (approximate) 5,000-tonnes Gold
Fields Mineral Service figure bandied about as the
"conservative" estimate cannot be proven. It is in trying
to find the source for that gold in a 32,000-tonnes pool
that leads to all sorts of conjecture, and logic leads one
to believe that the U.S. government would have to be
that source.

This is where Turk has gone with this, and I can't blame
him for it. As Holmes says, when logic leads through a
process of elimination to only one probability, that
probability is necessarily the answer. (Onward,
Watson!) But we may not have reduced this convoluted
mess before us to the last probablility. Two remain --
drawing on the U.S. gold reserve and one other.

Statutorily, the U.S. gold reserve cannot be brought into
play without the blessing of the U.S. Congress. Are we
to believe that the U.S. Treasury Department
clandestinely brought the U.S. gold reserve into play,
circumventing Congress and/or the intent of Congress?

I think that moving in that direction might be a dead
end. Here's why:

First, my own belief is that central bank involvement in
the gold-lending business came about as an extension of
the "lender of last resort function" of the central banks.
Don't forget that this function was the primary reason
for the establishment of the Federal Reserve and the
other central banks in the first place. In the United
States, J.P. Morgan got fed up with repeatedly having
to engineer consortiums to save the banking system and
the U.S. economy just before and just after the turn of
the century. He believed that some permanent lender of
last resort needed to be put in place, and he was among
the group to push for a U.S. central bank for that

Ultimately, when you have a group of commercial
banks making gold loans and those loans go bad, the
central bank can become saddled with bailing the
commercial banks out. Since you cannot print gold, the
central bank called upon is left begging for options. One
of those options is the "sale" of gold from its own or the
government's coffers to meet the needs of the failing
national gold loan portfolio.

One recalls the frantic search for gold by Britain's
chancellor of the exchequer, Gordon Brown, including
extraordinary pressure on the International Monetary
Fund to sell gold just before the Bank of England sale
was announced. One is led to believe that the Bank of
England's gold sale was a "lender of last resort"
operation undertaken when all else failed.

This could be what happened in Switzerland as well --
though we have no way of knowing that this was the
motivation in either case.

The same set of circumstances could also prevail in the
United States if some of the Wall Street banking firms
are in as deep as GATA and others believe, but I don't
think that has happened yet, and it may not happen,
given the negative reaction of Congress to the sale of
IMF gold when Brown was making his pitch. This
negative reaction we can trace back to pressure on
Congress from gold advocates and gold owners all over
the United States, as well as the political left, which
saw IMF gold sales as undermining Third World

Second, as outlined by Turk in his analysis of SDR
certificates (which he sees as essentially a claim on the
U.S. Treasury's gold, covering potentially 87 percent of
reserves), this would have put nearly two-thirds of the
European gold reserve -- or 7,000 tones, if 12,500
tonnes is the correct total -- at risk through swap

Why would the Europeans do this when they were
introducing their own currency and attempting to
buttress its acceptability with a strong gold component
in the reserve system? Swapping out Europe's gold to
defend the U.S. dollar seems like a rash act that only
jeopardizes Europe's own reserve position. Where is the
reward for all that risk?

Third, I do not buy the argument that gold needs be sold to
defend the dollar. I believe that gold is sold because it
HAS to be sold -- as a final act of reconciliation. It is a
last resort. For better or worse, so far we have come
short of that to a place where the dollar is defended --
let's say, the dollar is held -- because those who hold it
fear that if they don't continue to hold it, their huge U.S.
export market will evaporate along with the dollar and
their economies will greatly suffer as a result.

That's the great flaw in the Bretton Woods/dollar-based
international system: It depends on Americans
remaining the world's great consumers -- the engine of
the world economy -- and going into ever-greater debt
and creating ever-greater trade imbalances to do it.

That "positioning" is a greater defense of the dollar than
selling gold could ever be.

The selling of the gold comes when that relationship
finally breaks down, and perhaps Friend of Another is
right when he says it comes at a very high gold price.

In a backhanded way, that could be the best solution
for the American economy, and if a few commercial
banks have to suck it up as result, then that's the price
we pay, far better that than losing the U.S. gold reserve
at giveaway prices. In my view, at the accelerated
prices, gold reserves within the United States could be
mined to defend the currency a la a Mudellian type of
reserve construct wherein the gold is constantly marked
to free-market prices.

So I believe the U.S. reserve is still intact (at some
level), but I believe it is threatened. I believe that the
large gold loan figures have come from operations
involving the Third World banks depositing their gold
with bullion banks. The bullion banks have in turn
loaned that gold out to the mining companies and some
hedge funds. As Randy Strauss has pointed out to me in
private conversation, gold quite often can be
redeposited by a new owner and loaned out again in
what amounts to a fractional reserve gold lending
operation. Essentially, the bullion banker acts as a hub
in gold loans/transactions. The gold garnered by a
bullion banker from a central bank is loaned to, say, a
mining company. At that time the bullion bank can
offer to sell the metal for the mining company.

Let's say that a Gulf-based sheik is a standing buyer.
The gold is sold to him. At the same time the bullion
bank offers to take the metal back on deposit, and the
funds are forwarded to the mining company, and the
wheel turns from there.

This creates an illusion of a larger pool of physical
metal being loaned than really exists.

As this balloon was blown up, the percentage of
depositors wanting their gold back remained the same,
but the pool grew, thus pressuring lease rates and the
ability of these commercial banks to repay the central
banks from which they borrowed the gold.

If 10 percent of a 3,000-tonne loan pool is reclaimed by
depositors, then 300 tonnes would have to come out of
the market. Now if 10 percent of a 10,000-tonne loan
pool is reclaimed, then 1,000 tonnes would have to be
found in the market. If we go with Another's figure,
2,500 tonnes would have to be reclaimed.

Keep in mind that roughly 2,500 tonnes of gold are
mined per year worldwide.

If you want to know why lease rates spike from time to
time, it is likely because some bullion bank is out trying
to locate gold for a depositor who wants his deposit
back. Once again, I allude to the wild scramble by
Gordon Brown just prior to the Bank of England's gold
sale announcement. It was when the European central
banks realized that this was what was going on that they
decided to put an end to it in 1999 through the
Washington Agreement.

Now we are in the workout stage of this lending
operation and I believe that we will come to an
outstanding gold loan loss position internationally that
the banks can live with. It is their fondest hope that the
gold price will stay down for as long as is required to
get these gold loan portfolios reduced and the gold paid
back, but the market may not co-operate, particularly if
the dollar goes into a 1970s slide and gold demand rises
proportionally worldwide.

So Turk's belief that gold might go to $380 by year end
is perfectly justified. I believe that the
Barrick/Homestake merger was also part of this
workout, wherein a hedger was hooked up with a
non-heger to reduce the timeline on gold repayment. If
this theory is correct, the more mergers along these
lines, the better for physical gold, because the carry
trade is being reined in and the day approaches when
gold is set free.

So let Reg Howe's lawsuit be heard. Whether or not the
allegations of collusion to restrain the gold price are
true, my hope is that the suit will create awareness in
the financial community that will lead to steps to
protect the U.S. gold reserve and not let it be sacrificed
at disastrously low prices as the British reserve has
been. (The last British auction went out at $267, and
gold is now $280 and straining at the leash to go

I can say from the circumstantial evidence, including
full recognition of the large outstanding gold loan
position that would be threatened by a higher price,
coupled with the tight range gold has traded in for a
number of years, that something has been going on in
the gold market. I'll leave it to Messrs. Howe, Murphy,
Turk et al. to make their case and raise awareness in the
proper circles. I would have to say that, if nothing else,
Turk's published concerns about the U.S. gold reserve
have made great progress to that end.

At this time I believe, for the reasons cited here, that the
U.S. gold reserve has not played a role in these affairs.
But our mutual goal as Americans should be to make
sure that the remaining reserve (whatever it might be)
continues intact. We've sold much of our gold in the
past to no avail. Let's not make that mistake again. It
seems that governments around the world are moving
toward a more organic role for gold. The United States
will need our reserve to get into the game.

I would ask all not to let this disagreement with Turk on
the U.S. gold reserve take away from the rest of his
work. My recommendation for his newsletter stands. I
may be proven wrong on my assessment of the U.S.
gold reserve position. It too unfortunately resides in the
murky world of theory. I hope I'm not wrong (for the
sake of the monetary order and all of us), but if I am
wrong and Turk is right, we will owe him a debt of
gratitude for uncovering the SDR certificate movements
and pointing out their relevance.

I believe that the scenario I've described is about as
bullish a case for gold as can be conceived. It implies
that the loans will have to be covered, and when that
happens, the price will soar for physical owners. Paper
holders (options and futures) might be left with paper
settlement and possible default. Unhedged gold mining
stocks will prevail in that sector, but the question is:
Which will remain standing when that day comes?

I invite Turk to join in the conversation here (even if it's
through our friend, Chris Powell) and shed more light
on the scenario in which he finds himself occupied. The
many questions beg answers.

I am ready to incorporate the SDR thinking in my own.
Ultimately, we can only hope that the Howe case goes
to discovery and we can get some of this on the public
record through the deposition process and find out how
the puzzle fits together.

History is replete with examples of heroism in defense
of a principle -- the American Revolution is one, the
Dreyfus case another. Let's hope that there will be one
more profile in courage to be published someday
featuring a federal judge in Boston who wanted to get to
the bottom of what was happening in the gold market.

The deposition process should lead to a course of action
as the facts are revealed, and perhaps then we will know
what role, if any, the U.S. gold reserve has played in
this process.