James Turk: A short history of the gold cartel

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By James Turk, Editor
Freemarket Gold & Money Report
http://www.fgmr.com/
Sunday, May 3, 2009
Copyright 2009 by James Turk. All rights reserved.

This week Bill Murphy and Chris Powell, co-founders of the Gold Anti-Trust Action Committee Inc. (www.gata.org), will be in London, England. Their trip is part of GATA's ongoing effort to raise awareness of the gold cartel and its surreptitious intervention in the gold market.

Bill and Chris will meet with the British news media to explain GATA's findings. They will also attend an important fund-raising event being held in support of GATA's work. Their trip is another important step by GATA aimed at creating a free market in gold, one which is unfettered by government intervention.

Governments want a low gold price to make national currencies look good. Gold is recognizable the world over as the "canary in the coal mine" when it comes to money. A rising gold price blurts the unpleasant truth that a national currency is being poorly managed and that its purchasing power is being inflated.

This reality is made clear by former Federal Reserve Chairman Paul Volcker. Commenting in his memoirs about the soaring gold price in the years immediately following the end of the gold standard in 1971, he notes: "Joint intervention in gold sales to prevent a steep rise in the price of gold, however, was not undertaken. That was a mistake." It was a "mistake" because a rising gold price undermines the thin reed upon which all fiat currency rests -- confidence. But it was a mistake only from the perspective of a central banker, which is of course at odds with anyone who believes in free markets.

The U.S. government has learned from experience and has taken Volcker's advice. Given the U.S. dollar's role as the world's reserve currency, the U.S. government has the most to lose if the market chooses gold over fiat currency and erodes the government's stranglehold on the monopolistic privilege it has awarded to itself of creating "money."

So the U.S. government intervenes in the gold market to make the dollar look worthy of being the world's reserve currency when of course it is not equal to the demands of that esteemed role. The U.S. government does this by trying to keep the gold price low, but this is an impossible task. In the end, gold always wins -- that is, its price inevitably climbs higher as fiat currency is debased, which is a reality understood and recognized by government policymakers.

So recognizing the futility of capping the gold price, they instead compromise by letting the gold price rise somewhat, say, 15 percent per year. In fact, against the dollar, gold is actually up 16.3 percent per year on average for the last eight years. In battlefield terms, the U.S. government is conducting a managed retreat for fiat currency in an attempt to control gold's advance.

Though it has let the gold price rise, gold has risen by less than it would in a free market because the purchasing power of the dollar continues to be inflated and because gold remains so undervalued notwithstanding its annual appreciation this decade.

These gains started from gold's historic low valuation in 1999. Gold may not be as good a value as it was in 1999 but it nevertheless remains extremely undervalued.

For example, until the end of the 19th century, approximately 40 percent of the world's money supply consisted of gold, and the remaining 60 percent was national currency. As governments began to usurp the money-issuing privilege and intentionally diminish gold's role, fiat currency's role expanded by the mid-20th century to approximately 90 percent. The inflationary policies of the 1960s, particularly in the United States, further eroded gold's role to 2 percent by the time the last remnants of the gold standard were abandoned in 1971.

Gold's importance rebounded in the 1970s, which caused Volcker to lament the so-called mistakes of policymakers. Its percentage rose to nearly 10 percent by 1980. But gold's share of the world money supply thereafter declined, reaching about 1 percent in 1999. Today it still remains below 2 percent.

From this analysis it is reasonable to conclude that gold should comprise at least 10 percent of the world's money supply. Because it is nowhere near that level, gold is undervalued.

So given the ongoing dollar debasement being pursued by U.S. policymakers, keeping gold from exploding upward to a true free-market price is the first thing they gain from their interventions in the gold market. The other thing they gain is time. The time they gain enables them to keep their fiat scheme afloat so they can benefit from it, delaying until some future administration the scheme's inevitable collapse.

So how does the U.S. government manage the gold price?

They recruit Goldman Sachs, JP Morgan Chase, and Deutsche Bank to do it, by executing trades to pursue the U.S. government's aims. These banks are the gold cartel. I don't believe that there are any other members of the cartel, with the possible exception of Citibank as a junior member.

The cartel acts with the implicit backing of the U.S. government, which absorbs all losses that may be taken by the cartel members as they manage the gold price and which further provides whatever physical metal is required to execute the cartel's trading strategy.

How did the gold cartel come about?

There was an abrupt change in government policy around 1990. It was introduced by then-Federal Reserve Chairman Alan Greenspan to bail out the banks back then, which, as now, were insolvent. Taxpayers were already on the hook for hundreds of billions of dollars to bail out the collapsed "savings and loan" industry, so adding to this tax burden was untenable. Greenspan therefore came up with an alternative.

Greenspan saw the free market as a golden goose with essentially unlimited deep pockets, and more to the point, saw that these pockets could be picked by the U.S. government using its tremendous weight, namely, its financial resources for timed interventions in the free market, combined with its propaganda power by using the news media. In short, it was easier to bail out the insolvent banks back then by gouging ill-gained profits from the free markets instead of raising taxes.

Banks generated these profits through the Federal Reserve's steepening of the yield curve, which kept long-term interest rates relatively high while lowering short-term rates. To earn this wide spread, banks leveraged themselves to borrow short-term and use the proceeds to buy long-term paper. This mismatch of assets and liabilities became known as the carry trade.

The Japanese yen was a particular favorite to borrow. The Japanese stock market had crashed in 1990 and the Bank of Japan was pursuing a zero-interest-rate policy to try reviving the Japanese economy. A U.S. bank could borrow Japanese yen for 0.2 percent and buy U.S. T-notes yielding more than 8 percent, pocketing the spread, which did wonders for bank profits and rebuilding the bank capital base.

Gold also became a favorite vehicle to borrow because of its low interest rate. This gold came from central bank coffers, but central banks refused to disclose how much gold they were lending, making the gold market opaque and ripe for intervention by central bankers making decisions behind closed doors. The amount lent by central banks has been reliably estimated in various analyses published by GATA as between 12,000 and 15,000 tonnes, nearly half of total central bank gold holdings and four to six times annual gold mine production of 2,500 tonnes. The banks clearly jumped feet first into the gold carry trade.

The carry trade was a gift to the banks from the Federal Reserve, and all was well provided that the yen and gold did not rise against the dollar, because this mismatch of dollar assets and yen or gold liabilities was not hedged. Alas, both gold and the yen began to strengthen, which, if allowed to rise high enough, would force marked-to-market losses on those carry-trade positions in the banks. It was a major problem because the losses of the banks could be considerable, given the magnitude of the carry trade.

So the gold cartel was created to manage the gold price, and all went well at first, given the help it received from the Bank of England in 1999 to sell half of its gold holdings. Gold was driven to historic lows, as noted above, but this low gold price created its own problem. Gold became so unbelievably cheap that value hunters around the world recognized the exceptional opportunity it offered and demand for physical gold began to climb.

As demand rose, another more intractable and unforeseen problem arose for the gold cartel.

The gold borrowed from the central banks had been melted down and turned into coins, small bars, and monetary jewelry that were acquired by countless individuals around the world. This gold was now in "strong hands," and these gold owners would part with it only at a much higher price. So where would the gold come from to repay the central banks?

While the yen is a fiat currency and can be created out of thin air by the Bank of Japan, gold is a tangible asset. How could the banks repay all the gold they borrowed without causing the gold price to soar, worsening the marked-to-market losses on their remaining positions?

In short, the banks were in a predicament. The Federal Reserve's policies were debasing the dollar, and the "canary in the coal mine" was warning of the loss of purchasing power. So Greenspan's policy of using interventions in the market to bail out banks morphed yet again.

The gold borrowed from central banks would not be repaid after all, because obtaining the physical gold to repay the loans would cause the gold price to soar. So beginning this decade, the gold cartel would conduct the government's managed retreat, allowing the gold price to move generally higher in the hope that, basically, people wouldn't notice. Given gold's "canary in a coal mine" function, a rising gold price creates demand for gold, and a rapidly rising gold price would worsen the marked-to-market losses of the gold cartel.

So the objective is to allow the gold price to rise around 15 percent per year while enabling the gold cartel members to intervene in the gold market with implicit government backing in order to earn profits to offset the growing losses on their gold liabilities. The gold cartel's trading strategy to accomplish this task is clear. The gold cartel reverse-engineers the black-box trend-following trading models.

Just look at the losses taken by some of the major commodity trading managers on their gold trading over the last decade. It is hundreds of millions of dollars of client money lost, and the same amount gained for the gold cartel to help offset their losses from the gold carry trade -- all to make the dollar look good by keeping the gold price lower than it should be and would be if it were allowed to trade in a market unfettered by government intervention.

As I see it there are only two outcomes. Either the gold cartel will fail or the U.S. government will have destroyed what remains of the free market in America. I hope it is the former, but the flow of events from Washington and the actions of policymakers suggest it could be the latter.

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James Turk is founder and chairman of GoldMoney.com, editor of the Freemarket Gold & Money Report, co-author of "The Coming Collapse of the Dollar," which was recently updated in a new edition as "The Collapse of the Dollar" (www.dollarcollapse.com), and a consultant to the Gold Anti-Trust Action Committee Inc.


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