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Adrian Douglas: Could U.S. government really be that stupid about gold?

Section: Daily Dispatches

By Adrian Douglas
Tuesday, October 26, 2010

On October 12, 2010, Edwin (Ted) Truman wrote an article for the Financial Times of London in which he suggested that the US Treasury should sell all of its gold reserves:

Ted Truman is not just anybody. He is a former Federal Reserve economist and is well connected. This means that we should not write off his comments as idle chatter. Although it seems highly unlikely that such a wholesale liquidation of the U.S. gold reserves could ever be approved, it is interesting to study the implications if it were to happen. I will show you why it would be the most stupid thing the government could ever do.

Let's first revisit what has been the evolution of the U.S. dollar. Until 1933 the United States was on a gold standard. Money was gold. Gold was deposited in banks for safekeeping and bank notes or Federal Reserve Notes (FRNs) were given in exchange. These notes were redeemable at any time for the gold on deposit at the rate of $20.67/oz (increased to $35/oz in 1933 by the Franklin Roosevelt administration).

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So the dollar was a deposit slip for gold. If you wanted to buy something, you could retrieve your gold from the bank by redeeming dollars and paying with gold. However, the seller of the item would probably deposit the gold in a bank and receive dollars in return. It was simpler to pay with dollars. So gold was the money while dollars were only a convenient proxy for the money; the dollar was the circulating currency but was not intrinsically worth anything except in being able to retrieve a gold deposit.

In 1933 the U.S. government confiscated privately held monetary gold. The dollar was still a proxy for gold but a citizen could not redeem his bank notes. Only foreign central banks could redeem dollars for gold. President Nixon suspended even that much convertibility in 1971.

The only change was in the redeemability of dollars. The dollar was not redefined. In fact Nixon "temporarily suspended" convertibility of dollars for gold; that temporary suspension is still in force today. This means that all dollars issued represent a claim against the U.S. gold reserve, but it is an irredeemable claim.

If you think that doesn't make sense, let's consider another example.

ExxonMobil issues shares in the company. The value of these shares is principally driven by the oil reserves the company owns. But the shares cannot be redeemed for oil or any other asset of the company; rather the shares are a claim against the assets of ExxonMobil. If the company were to sell its oil assets and liquidate the company, a shareholder would be paid a percentage share of the liquidation value based on his percentage ownership of the company.

To explain the dollar and its relationship to gold I have written a parody which is as follows:

In 1913 a company is established called the Federal Valet Parking Board (FVPB). FVPB establishes branches all over the country. You take your car to FVPB and you are given a valet parking ticket (VPT). At any time you can redeem your ticket and get your car back. FVPB brokers a special deal with the government that allows people to use their VPT as currency. A law obliges everyone to accept these VPT as payment. No one objects because the tickets can be redeemed for a car at any time. People find it convenient to spend their VPTs.

Unfortunately, the FVPB is corrupt and prints more Valet Parking Tickets without parking any more cars in the parking lot. People start to suspect a scam. They rush to redeem their VPTs and take back their cars. The first ones to redeem think they are lucky because they get their cars back, but latecomers are told there are no cars in the parking lot.

"How can this be?" the people demand. "I have a Valet Parking Ticket so I want my car back."

The FVPB is in trouble. The government steps in and makes it illegal to own a car. This promptly prevents anyone from asking for his car to be returned. Even the people who were lucky enough to get their cars back are told that they must return their cars to the FVPB or risk a fine or imprisonment. These hapless individuals dutifully cave in and return their cars and they are given VPTs in return. The people are still forced by law to accept VPTs as currency but the corrupt FVPB continues to print and issue more of them. As no one can retrieve a single car from the parking lot with a VPT, there is no restraint on how many VPTs the FVPB can issue.

In 2010 an economist who is also a car expert remarks that the FVPB has millions of cars gathering dust that are of no use. He proposes that the FVPB should sell them all. The government and the FVPB think this is a terrific idea. One fine day the parking lots are opened up and the people flock in to buy the cars. And what does the FVPB accept as payment for the cars?

Why, VPTs, of course! But due to the massive printing of VPTs that has gone on over the years that has increased the supply of VPTs while the stock of cars has remained constant, the FVPB insists that the people have to give 100 Valet Parking Tickets to be given a car instead of the one ticket originally issued for each car. At the end of the operation the people have the cars and the FVPB has all the tickets.

If the FVPB has only tickets and no cars, what do you think the street value of these VPTs is? Absolutely worthless.

The parallel with the U.S. gold reserves should be obvious. The gold reserve belongs to the people but the Treasury holds it and refuses to give it back. It instead issues Federal Reserve Notes using the gold reserve as collateral, but the FRNs are irredeemable in gold. If the government could truly be that stupid to adopt Ted Truman's proposal to sell the U.S. gold reserve in exchange for Federal Reserve notes, then for the first time since 1933 and only "while stocks last" the FRNs could be exchanged for gold. This would allow a lucky few to buy gold in exchange for the FRNs. The government would no doubt brag about what a great deal it has have made by getting billions of dollars for the gold but, just like the VPTs, with the underlying collateral having been disposed of, the FRNs would have zero value.

The government claims to have 261.5 million ounces of gold but this doesn't belong to the government; it belongs to the citizens. By being the custodian of the gold and refusing to give it to the holders of FRNs, the government appears to have a very valuable asset, but the truth is that this asset is offset by the corresponding liability of all the FRNs that have been issued against it. So in fact the government has no net assets, just like the FVPB had no net assets of its own.

If the asset is sold off for FRNs, then the FRNs will become worthless and with no collateral it would be impossible to issue a new currency that anyone would accept. The solution that would no doubt be top of the list would be to confiscate the gold back again.

This is why I ask: Could the government really be that stupid?

But I expect it is Ted Truman who thinks that gold investors are that stupid to think it would be gold and not the dollar that would suffer and that they could be intimidated to dishoard their gold in a panic by just suggesting in his article that the United States should sell its gold reserves.

Nice try, Mr. Truman, but no cigar.

What is revealed by this analysis is that if the U.S. gold reserve has already been sold off surreptitiously or partially or entirely encumbered in some way, then confirmation of that would be extremely detrimental to the dollar. Once you realize this you can grasp why an audit of the U.S. gold reserve is not an academic exercise and why the Federal Reserve is vigorously opposing GATA's Freedom of Information Act request to determine if the gold reserve has been subject to swap arrangements.


Adrian Douglas is publisher of the Market Force Analysis letter ( and a member of GATA's Board of Directors.

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