Safra had strong connections to gold


11:55p EST Thursday, December 2, 1999

Dear Friend of GATA and Gold:

Our old friend Reginald H. Howe, the Harvard-trained
lawyer and former mining company executive, sounds more
like GATA than GATA itself in another brilliant essay
he has posted at his web site, I
think that Reg may get closer to anyone else to what is
really happening behind government doors on both sides
of the Atlantic.

Please post this as seems useful.

Gold Anti-Trust Action Committee Inc.

* * *

Fed Options: The Plot Thickens

By Reginald H. Howe
December 1, 1999

My commentary of September 20 suggested the possibility
that the Bank of England's gold sales were triggered by
a plea from Washington aimed at rescuing the Fed from
potential big losses on the writing of gold call options.
Nothing that has happened since is inconsistent with this
suggestion, and what new evidence there is supports it.

But to go back, an initial question -- on which I accepted
the opinion of others -- was whether the Fed has statutory
authority to write (sell) call options on gold. In my opinion,
it clearly does. What is now codified as 12 U.S.C. Section
354 provides in relevant part:

"Every Federal reserve bank shall have power to deal in
gold coin and bullion at home or abroad, to make loans
thereon, exchange federal reserve notes for gold, gold
coin, or gold certificates, and to contract for loans
of gold coin or bullion, giving therefor, when
necessary, acceptable security...."

This provision, included in the original Federal
Reserve Act (Dec. 23, 1913, c. 6, s. 14(a), 38 Stat.
264), has remained unchanged and in force ever since.
While it does not specifically mention writing call
options, the broad grant of authority "to deal" in gold
and to make or receive gold loans can readily be
construed to include writing or purchasing options.

This authority, it should be noted, addresses only what
the Fed can do for its own account. It has nothing
whatever to do with buying, selling, or otherwise
dealing with the official gold reserves of the United
States, which are under the control of the secretary of
the treasury acting with the approval of the president
(31 U.S.C. ss. 5116-5118). Whether the Fed's authority
to deal in gold for its own account may in some
respects be limited by other statutes is a question
that I will leave to others, but under Section 6a(d) of
the Commodity Futures Trading Act, any transactions for
its account are expressly exempt from trading or
position limits.

Testifying in July 1998 before the House Banking
Committee looking into the regulation of over-the-
counter derivatives, Fed Chairman Alan Greenspan
distinguished financial derivatives from agricultural
derivatives, saying that it would be impossible to
corner a market in financial futures where the
underlying asset (e.g., a paper currency) is of
unlimited supply. The same point, he continued, also
applied to certain commodity derivatives where the
supply was also very large, such as oil.

Greenspan further volunteered: "Nor can private
counterparties restrict supplies of gold, another
commodity whose derivatives are often traded over-the-
counter, where central banks stand ready to lease gold
in increasing quantities should the price rise."

In other words, the Fed Chairman opposed any action by
Congress aimed at greater regulation of over-the-
counter derivatives, specifically including gold
derivatives. One reason -- left unstated -- for this
opposition may well have been concern that any new
legislation might interfere with the Fed's own
activities in the derivatives markets, particularly in
the gold area.

Why might the Fed have engaged in writing call options
on gold?

The Fed's immediate purpose and effect would be to
facilitate gold leasing by enabling the bullion banks
to hedge more easily short positions resulting from the
sale of leased gold. Indeed, as the so-called gold
carry trade grew, demand for this sort of hedging by
bullion banks likely strengthened, since here, unlike
in mining finance, their customers were not themselves
producers of gold. More generally, by thus exercising
control over the amount of leasing and resulting short
sales, the Fed could have achieved considerable
influence over the gold price.

Indeed, perhaps it was just this kind of activity that
led a former Fed governor to claim on CNN's "Moneyline"
in October 1998: "The Fed has precise control over the
price of gold and therefore over commodities such as
crude oil. No inflation, therefore no need to raise

A recent analysis by Ted Butler faults the Commodities
Futures Trading Commission for not taking action
against certain bullion bankers over the option
strategies foisted on certain mining companies. The
basic strategy to which Butler refers is the sale by
mining companies of long-dated call options to finance
the purchase of relatively short-dated put options --
that is, the strategy that crippled Ashanti and
Cambior. In all that has been written or disclosed
about this strategy in recent weeks, two facts stand

First, the risks were not fully or widely understood.

Second, the strategy experienced a surge in use right
after announcement of the Bank of England's gold sales

No doubt, as many have suggested, this sudden spurt of
options hedging reflected the gloom that descended over
the gold market in the wake of the Band of England's
announcement. But to the extent that the bullion banks
actively pushed the strategy onto their mining
customers, it may also have represented an effort by
them to replace Fed call options that were in process
of drying up.

Efforts at market manipulation almost always come to a
bad end because ultimately market fundamentals will
assert themselves. Central bankers tend to have a
better appreciation of this than politicians, which is
almost certainly why the Bank of England's gold sales
program was ordered by the British government over the
objection of bank officials. If the BOE's gold sales
were originally intended to rescue the Fed from a
losing options position as gold threatened to move over
$300/oz. last May, it has probably largely achieved
that narrow goal by now. But the cost has been
enormous, not only in British gold but also in
undermining continued central bank control of the gold

Neither the BOE nor its political masters foresaw that
their attack on gold would trigger the Washington
Agreement, announced Sept. 26, 1999, which overnight
caused an almost complete reversal in negative
attitudes toward gold created by several years of
highly publicized central bank sales and huge increases
in their gold leasing activities.

The resulting spikes in the gold price and in already
high lease rates effectively killed the gold carry
trade and forced far more prudent use of hedging by
mining companies. While the troubles of certain mining
companies caught wrong-footed have been widely noted,
the damage to the bullion banks themselves, not to
mention certain hedge funds, has yet to be fully

The Bank of England's reputation for prudent oversight
of the international gold market, long based in London,
is badly tarnished. Kuwait's release of its entire
official gold reserves for loan through the BOE has
only underscored the parlous condition into which that
market has fallen.

The BOE itself now appears locked into a gold sales
program that amounts to a fire sale of British gold, so
much so that two of the world's largest mining
companies have successfully used the last two auctions
to cover some of their own forward sales. Whether
wholly unsubstantiated or floated as a trial balloon,
the mere rumor -- quickly denied -- that the BOE might
cancel future planned gold sales caused an almost
immediate $10/oz. spike in the gold price a couple of
weeks ago. Charges fly that the BOE's sales are part of
a government plot to join the European Monetary Union.
If so, it's a pretty dumb plot.

By not joining the first round of the EMU, Britain
regained possession of 173 metric tons of gold
previously deposited with the EMI (predecessor to the
EMU) and increased its total gold reserves to 715 tons,
which its gold sales program when completed will reduce
to around 300 tons. Should Britain join the EMU, it
will probably have to allocate about 140 tons to the
European Central Bank, leaving national gold reserves
of around 160 tons. Britain would thus be the only
major EMU member without substantial gold reserves, and
thus the only one not to benefit from any future upward
revaluation of gold.

Beyond these direct consequences, some believe that the
Fed responded to the October gold banking crisis and
presumed problems of the bullion banks by adding
liquidity to the banking system, thus providing much of
the fuel for the November stock market rally. In this
connection, it is worth noting that the bullion banks
with apparently the greatest exposure to Ashanti's
problems are among those most often associated with
suspected Fed activities in the gold market.

So too the question of whether and to what extent short
gold positions may have played a role in last year's
Long-Term Capital Management affair remains shrouded in

What does appear, however, is that the Fed is very
reluctant to allow the U.S. stock market to progress
from a correction into a true bear market, adding
credence to the growing belief that the stock market,
however overvalued, is too big and too important to be
allowed to fail.

There is a certain irony in the fact that since Alan
Greenspan assured Congress in July 1998 that over-the-
counter financial and gold derivatives required no
further regulation, these very same derivatives have
twice presented the Fed with an opportunity to allow a
stock market correction to turn into a bear market for
which it could escape much of the blame. In each case
the Fed may properly have been concerned that the
decline might cascade into a disorderly rout. But by
intervening to head off these stock market declines,
the Fed may also have undercut the credibility of its
own interest rate weapon. Searching for a way to freeze
the bubble or at least to let the air out slowly, and
unwilling to let market forces have their way, the Fed
has steered the whole American economy into uncharted

The Fed was founded to stabilize the gold value of the
dollar on the theory that central banking could achieve
this goal better than free banking. Having utterly
botched that mission, it has accepted a new one:
guardian of the American economy's paper wealth.

The Fed has never had nor will it ever have "precise
control" over the gold price. The question now is
whether its control over the stock market will prove
equally illusory. No doubt, should its traditional
monetary tools or suspected derivatives activities
appear inadequate to the task, the Fed will unveil some
new weapon. But if the Bank of England ever announces a
plan to achieve greater diversification of its dollar
assets by investing proceeds from its gold sales in
U.S. blue chip stocks, beware. For if the first rule of
investing is "don't fight the Fed," the second is "bet
against the Bank of England."