Adrian Douglas: The second London Gold Pool is dying
By Adrian Douglas
What we are seeing in the gold market now is a rerun of the failure of the London Gold Pool.
The United States was on a gold exchange standard until 1971. The official price was $35 per ounce of gold. Because of the need to finance the Vietnam War, the United States was inflating the supply of paper dollars. As a result foreigners were returning dollars to the Federal Reserve's gold window and getting gold in return. The outflows were accelerating.
The United States and a group of seven European central banks agreed to set up the London Gold Pool in 1961 to defend the $35 per ounce price. They supplied gold to the market in concerted ways to bring down the price and bought the gold back on dips. (Do you recognize this behavior?) At first it worked well, but by 1968 it became impossible to hold down the price. Here is what James Dines wrote about the operation in the book "Invisible Crash":
"The gold pool was designed to dump gold on the market whenever it began to rise. This suppression of free-market price is not free enterprise. The United States provided 50 percent of the total net gold sales of the pool, which gives an indication of the geographical location of the true culprit (of monetary debasement)."
When the situation became untenable, France withdrew from the pool. In March 1968 the gold pool was closed and in a last-ditch effort to control the gold price a two-tiered pricing system was instigated -- one for "official transactions," which was $35 per ounce, and one for "open market transactions," which rose rapidly to more than $44 per ounce. The gold window was closed in 1971 and the gold bull market was launched.
On July 20, 2005, there was an exchange at a committee of the U.S. House of Representatives between U.S. Rep. Ron Paul and Federal Reserve Chairman Alan Greenspan. Greenspan said:
"So that the question is: Would there be any advantage, at this particular stage, in going back to the gold standard? And the answer is: I don't think so, because we're acting as though we were there.
"Would it have been a question at least open in 1981, as you put it? And the answer is yes. Remember, the gold price was $800 an ounce. We were dealing with extraordinary imbalances, interest rates were up sharply, the system looked to be highly unstable, and we needed to do something.
"Now, we did something. The United States -- Paul Volcker, as you may recall, in 1979 came into office and put a very severe clamp on the expansion of credit, and that led to a long sequence of events here, which we are benefiting from up to this date.
"So I think central banking, I believe, has learned the dangers of fiat money, and I think, as a consequence of that, we've behaved as though there are, indeed, real reserves underneath the system."
Now that I look at this again I realize that Greenspan was telling us that they are suppressing the gold price -- or, put differently, "behaving as if we were on a gold standard." That is to say they were trying to "fix" the gold-dollar price.
Remember Greenspan said that "central banks stand ready to lease gold in increasing quantities should the price rise." This is a description of the London Gold Pool except that they thought they were being smart by leasing it instead of selling it so in theory they can get the gold back, but in practice they cannot.
The other aspect of this has been the paper market. Greenspan said, "So I think central banking, I believe, has learned the dangers of fiat money, and, I think, as a consequence of that, we've behaved as though there are, indeed, real reserves underneath the system"
"Behaving as though there are, indeed, real reserves underneath the system"? That means that there are not real reserves under the system.
This is an indirect reference to the suppression of the gold price on the Comex and the OTC derivatives. Selling short makes it appear that they have real gold to back their intervention, but they don't. So they "behave" as if there are gold reserves under the system but there are not. This cannot be done without some real gold, so that is where the leasing and selling came in, but they were able to behave as if we were on a gold standard with less than 1 percent gold backing.
But such a scam cannot be maintained. We have now reached the "two-tier pricing" such that we have an "official price" on the COMEX but a higher, market price in the physical retail market. This is almost identical to the two'tier pricing that was the last-ditch attempt to control gold before the gold exchange standard was abandoned in 1971 and the price of gold exploded into a bull market that ended in 1980 at $850 per ounce. We have reached the same point again but under different and more extreme circumstances.
The World Gold Council's gold demand update for the third quarter of 2008 is telling us that physical demand is overwhelming the supply of gold. The game is all but over. The lesson that should have been learned in the 1960s should have been that you can't gold-back a currency if you issue more currency than the promised gold. Now the lesson is that you can't maintain a currency's purchasing power by behaving as if there were real reserves under the currency when they are not.
The obvious question is: What do you want to own -- the paper that is being managed as if there were real gold reserves under the system, or the real gold reserves themselves? The WGC's new report tells us the answer.
Adrian Douglas is a member of GATA's Board of Directors.
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