| ... And God created
gold...
And God saw that gold was good, and
he ordained it as primordial money. The gold coin
was to be the savers’ guardian angel and the
producers’ patron saint, they being the pillars
of society. It was also meant to be the protector
of the wage-earners, the most vulnerable protagonists
of the drama of Human Action. The role of gold in
the economy is that of regulator of the quantity and
quality of debt. Gold has continued to be money as
well as obstruction to the Debt Tower of Babel for
over five thousand years. Until man in his infinite
conceitedness wanted to be wiser than God. He sought
to overthrow the monetary rule ordained by God. He
set out to build the Debt Tower of Babel that was
to reach to Heaven. Pilfering savers and plundering
producers was the inevitable result of the activation
of the fast-breeder of debt triggered by the elimination
of gold money.
Seven gaunt
cows devouring seven fat ones
Not only did man overthrow what he called
“the yoke of gold”; he also sought to
obliterate whatever wisdom previous generations have
accumulated through painstaking research and careful
experimentation with the sharp instrument of credit,
the cutting edge of progress but which can also hurt
its careless wielder. The monetary system of the Brave
New World has feet of clay planted in a pile of rotting
paper. It is animated by a false doctrine, the Quantity
Theory of Money, a.k.a. monetarism, preaching that
gold can safely be overthrown provided that it is
substituted by a “quantity rule”. The
fundamental error in this is the assumption that gold
is there in the first place to limit the quantity
of money. Yet the role of gold is to regulate the
quantity, not so much of money, but of debt. In falsifying
science man has frustrated the only hope to rectify
the error. This brings to mind the old adage that
“if God wanted to punish someone, He would make
him mad first”.
In previous essays of this series I
have discussed how speculation and warehousing combine
to meet the ever-present challenge of the fickleness
and niggardliness of nature. Warehousemen must ration
scarce storage space among competing uses. According
to the Genesis the first warehouseman, Joseph of Egypt,
provided for the seven lean years by storing the grain
surpluses of the seven fat years, following his interpretation
of the Pharaoh’s dream: seven gaunt cows devouring
seven fat ones.
Supply-shocks
Briefly stated, man is in a continual
struggle with supply-shocks in the market. They come
in two varieties: bumper crops and crop failures.
The former is the Nemesis of producers, the latter
that of consumers. Either way, the whole society suffers.
However, supply-shocks can be mitigated through foresight,
organized speculation, and intelligent warehousing.
The fulcrum is the activity of warehousemen who, following
the example of Joseph, allocate scarce storage space
in a most efficient manner in order to provide for
future contingencies.
Their talisman, enabling them to perform
this job successfully, is the basis. It is a seismographically
most sensitive instrument to provide information in
a most concentrated form. It makes for an early warning
system exposing potential supply shocks threatening
society. Moreover, the basis also digests information
such as the producers’ estimate of what is a
good price for their product, comparing it with the
speculators’. The basis picks up all signals,
including producers’ forward sales and speculators’
purchases of futures contracts, bringing the two into
balance. The question arises how this can be accomplished.
After all, the basis is the spread between the nearby
(rather than distant) futures price and the cash price.
The answer is: through arbitrage. Floor traders hedge
their sales and purchases of distant futures as they
simultaneously do the opposite transaction in nearby
futures. The basis registers and harmonizes all signals
coming from all markets trading that particular commodity.
One cannot help but admire this fine communication
system through which potential supply-shocks, ever
present due to risks inherent in nature, are mitigated
by the “invisible hand”as directed by
the basis.
Speculation versus gambling
But there are false prophets, in economics
no less than anywhere else. They preach that in exactly
the same way as speculation can counter the untoward
effects of supply-shocks, it can also meet the challenge
of demand-shocks. Just as speculation can face risks
inherent in nature, it can also face risks artificially
created by man. However, in God’s own dictionary
a fine distinction is made between speculation and
gambling. When man meets risks artificially created
by other men (including the government), it is not
speculation. It is gambling. It is akin to bets placed
by the gambler on future events which may appear to
be random but aren’t: they are rigged artificially
by the casino owner for his own benefit. The false
prophets, being apologists for government-induced
gambling, are anxious to blot out this distinction.
Why is speculation successful in reducing
risks inherent in nature, but a miserable failure
when used to reduce risks artificially created by
men? Why is it that when the government wants the
speculative markets to reduce the fluctuation of foreign
exchange and interest rates, or that of gold and silver
prices -- all caused by foolish policies of the self-same
governments -- the result is always contrary to purpose?
To answer this question we need to consider that in
the case of risks inherent in nature all speculators
start off with an equal chance to be successful. No
“inside information” is available to anyone.
The playing field is level. Not so in the case of
risks artificially created by government in deliberately
destabilizing foreign exchange and interest rates.
Here speculators pit their wits against that of central
bankers. The latter think they can manipulate the
former. A closed group of men tries to outsmart an
open group. But the closed group consists of paid
hands who don’t have to face the music of accumulating
losses. All losses have been underwritten in advance
by the government and are covered from the public
purse. The open group on the other hand consists of
speculators who risk their own capital which, if lost,
will force them to quit. Their role is taken over
by others with better mental equipment to outsmart
the same central bankers. This is how George Soros
could single-handedly bust the Bank of England while
it was trying to uphold the value of the British pound.
The Soros incident was not the first episode of devaluation
in the wake of speculative onslaught, following solemn
government pledges that the pound would never be devalued.
Major landmarks are: 1931, 1948, 1968. Before 1931
a paper pound fetched exactly one gold sovereign.
Seventy-five years later, in 2006, it took one hundred
paper pounds to buy the same sovereign. Apparently,
Mr. Soros knows something that Mr. Brown, the Secretary
of the Exchequer, does not.
The rise of the gold basis
When in the early 1970's governments
in their wisdom discarded gold from the international
monetary system, not only did they cut adrift foreign
exchange and interest rates. They also let the genie
of the gold basis out of the bottle. Treasury officials
were confident that they could control it by giving
speculators the run of the house. The fundamental
feature of the gold market is contango. When threatened
to go into backwardation, the falling gold basis would
create powerful incentives for people to accept the
futures market’s offer to absorb all carrying
charges and, on the top of it, to pay a handsome bonus.
Surely speculators would fall over themselves in trying
not to miss this bonanza in gold. In the event Treasury
officials have misinterpreted market behavior so completely
as only economists imbued with government omnipotence
could. The genie has its own agenda. It will at one
point refuse to take orders from Aladdin Greenspan
or Helicopter Ben (or whoever is put in the Chair
at the Federal Reserve Board). The rise of the gold
basis will be followed by its fall, bringing about
the downfall of the Establishment.
God created basis. He wanted to help
men fend off blows from the prodigality or frugality
of nature. Like the creatures of Prometheus they would
perish without fire. The basis, in the case of agricultural
commodities, is just that mythological fire stolen
from heaven. It is the Creator’s gift to his
creatures to help them survive devastating supply-shocks.
Demand-shocks
By contrast, the gold basis is not a
gift of God. It is a scourge of God to punish conceited
governments pretending to be omnipotent and omniscient.
Powerful men want to manipulate their neighbors inducing
them to behave in a way prejudicial to their own welfare.
They want to enslave them by taking away their ability
to protect themselves and to provide for their own
happiness and survival, especially in view of the
eventuality of disasters caused by foolish government
policy. They hire economists who parrot the line that
demand-shocks can be met in the same way as supply-shocks:
through organized speculation.
Therein lies a great error. The gold
basis has risen, but its rise is to be followed by
a fall and, later, by the downfall of governments
trying to play God as they gamble with the welfare
of their subjects. The fall of the gold basis tells
us that God’s gold cannot be drowned in a sea
of paper gold. The price of the former will tend to
infinity while that of the latter will keep falling
to zero. The genie of the gold basis will crush the
government through demand-shocks waiting in the wings
of the gold market.
The fall of the gold basis
As a mental experiment let us arrange
all goods in a linear order starting with agricultural
commodities exposed to supply-shocks to the greatest
extent, reflecting the fickleness of nature. Next
in line are base metals and other minerals, as well
as energy-carriers which are exposed to supply-shocks
to a lesser extent. Finally at the far end of the
spectrum we put the monetary commodities virtually
immune to supply-shocks. Gold, in particular, has
a stocks-to-flows ratio which is a high multiple variously
estimated between 50 and 80. An increase in the flows,
however large, would hardly cause a ripple, considering
the size of stocks. To state the case differently,
suppose new gold fields were discovered more prodigious
than those of Witwatersrand. Or suppose that processes
were developed whereby gold molecules suspended in
the infinite oceans could be distilled and gathered
economically. Such events could in no wise have an
untoward effect on the value of gold, so huge are
existing stocks relative to incremental flows. This
fact alone shows that it was sheer madness to discard
gold from the monetary system. The monetary commodity
must be immune to both supply and demand-shocks. God
has kept His side of the covenant by helping man control
supply-shocks. Governments haven’t: they have
artificially magnified demand-shocks through foolish
monetary policies.
The upshot is that the basis risk is
much higher for gold than for non-monetary commodities.
The fall in the gold basis, whenever it comes, will
have nothing to do with assumed supply-shocks. Even
if governments threatened to dump all their remaining
monetary gold, the result (after the news wore thin)
would be counter-productive. The dumped gold, and
more, would be readily absorbed. People would not
allow the government to trick them out of their golden
life-saver. Rather, they would behave as predicted
by the ancient Greek monetary scientist Xenophon.
In his treatise entitled The Revenues of Athens he
wrote that, after people had satisfied all their artistic
and industrial needs for it, they would derive just
as much pleasure in digging a hole in their own backyard
and burying their surplus gold there, rather than
entrusting it to public warehouses or, heavens forbid,
to government treasuries.
It has always been that way. It will
be that way in the future, too. Whenever the government
wants to trick people out of their possession of gold,
the basis turns negative. It then falls into a pit
and no one will hear it to hit bottom. The number
of instances of this happening strains the counting
ability of monetary historians. Every episode of a
hyperinflation in which paper currency has self-immolated
furnishes such an example.
Putative gold basis
“Hey, wait a minute”, you
may interject. “Is this not an anachronism?
How could you talk about gold basis under a gold standard?”
Well, you are right. Gold basis is a new concoction,
barely 35 years old. There was no gold basis before
1970, as there were no futures markets in gold. The
world’s first gold futures market opened in
the Winnipeg Commodity Exchange in 1970. The contract
called for the delivery of the 400 oz. (12.5 kg) international
‘good-delivery’ gold bar, the one central
banks of the world have been using to settle international
imbalances with one another in the good old days.
I meant the putative gold basis in the previous paragraph,
that is, whatever the gold basis would have been if
there had been a gold futures market at the time of
hyperinflation.
In 1971 I went to Winnipeg to
be witness to history. I purchased a seat on the exchange.
I was interested in studying the variation of the
gold basis on the floor first hand. At that time gold
ownership and trading was still a crime in the United
States pursuant to a Presidential Proclamation dating
from 1933. F. D. Roosevelt nationalized (read: confiscated)
monetary gold. In Canada gold ownership and trading
has always been legal. Canada was chosen as testing
grounds by the U.S. Treasury to see how the market
would react, in preparation for the legalization of
gold ownership in the U.S. four years later. The gold
futures market in Winnipeg was a robust carrying-charge
market. Its wide basis reflected the popularity of
gold futures with gold investors. Buy orders came
in a steady stream from all corners of the world.
In the absence of gold futures this demand would have
shown up as demand for cash gold, the greatest threat
to the value of the U.S. dollar. The U.S. Treasury
was satisfied that paper gold would do nicely, thank
you very much, and gold futures trading in the U.S.
was duly allowed to commence in January, 1976.
Bribe money
I have always felt that the gold basis
was an anomaly. It certainly did not belong to the
same category as the basis of agricultural commodities.
It was not a bonus rewarding good husbandry. It was
more like the Trojan Horse planted by a bankrupt government
that wanted to take through deception what it couldn’t
by force. I always looked at contango as bribe money,
to induce people to take the promise instead of the
real thing. It is remarkable and important that under
the gold standard there was no need for bribes. People
were happy to accept the promise at face value. The
credibility of central bankers has in the meantime
been reduced to a zero. They are the spinmasters of
the “greatest fool” game. The greatest
fool is the player who will hold the bag of worthless
banknotes when the music stops. Gold futures trading
has been introduced in order to make people believe
that the possibility of hyperinflation has been eliminated
for good.
We may grant that gold futures trading
has materially added to the longevity of the regime
of irredeemable currency. But while the central bankers
are buying time, sand in the hour-glass of the gold
basis keeps trickling down. When it runs out, the
trickle of cash gold from warehouses will have become
an avalanche that could no longer be stopped. The
gold futures market will be bankrupt, along with the
regime of irredeemable currency. Treasury officials
will cry “foul play”and will scurry around
looking for “rogue traders” everywhere.
That is, everywhere except in the Treasury and in
the White House where the real culprits hide. When
the present unconstitutional monetary regime of the
U.S. comes unstuck, the responsibility for the disaster
will have to be assigned to the President and the
Secretary of the Treasury. They have betrayed their
oath to uphold the Constitution of the United States
of America, as far as its monetary provisions are
concerned.
I have never ever wavered in my conviction
that such will be the denouement of the drama unfolding
before our eyes. Any other outcome, however widely
prophesied, whether the inflationary or deflationary
variety, appears unlikely to me.
Fools treat promises with greater
respect than the issuer himself
I reject the Quantity Theory
of Money. It is an essentially linear theory trying
to explain an essentially non-linear phenomenon. Consequently,
I do not believe that there is a causal relationship
between the central bank’s inflating the money
supply and an increasing price level. No doubt, the
newly created money could go into commodities; but
it could, and would, also go into bonds, equities,
and real estate. It is true that paper currency will
ultimately self-immolate. An irredeemable promise
to pay, it has been gushing forth in the aftermath
of the break of the dam, the 1933 reneging on the
promise to redeem the dollar in gold at the rate of
slightly over 1/20 oz. It does not matter that hardly
anybody alive today has any direct memory of that
event. What does matter is that the central bank has
neither the intention nor the means to meet this obligation.
It simply refuses to give anything of value in exchange
for its own notes. It should not come as a surprise
then that these notes will, at one point, be unacceptable
to the producers in exchange for real goods and real
services. This is plain logic. There has never been
an exception to the truism: if the issuer treats his
own promises with disdain, then it is only a matter
of time before the public will do likewise. Nor does
the truth of this syllogism depend on the quantity
of promises issued, or on the rate of increase in
their issuance. It is still valid even if the rate
of increase in the issuance of new promises is declining,
or if no new promises are issued. It follows that
a quantum increase in prices is not a necessary condition
for the imminent self-destruction of the monetary
system. Nor can the increase in prices be relied upon
to predict the timing of such an event. Then what
can?
I am suggesting it to you that
the gold basis can.
Aladdin Greenspan whistling in
the black hole
Expect the regime of irredeemable currency
to put up a desperate and vicious fight for survival.
There may be times when the gold basis bounces back.
But its decline, on the average, is relentless. The
dead-cat-bounce is still to come. I have been a student
of the gold basis for 35 years. In the early 1990's
I made the pilgrimage to the World Trade Center in
New York City to meet the Director of Research at
Comex. I asked him what explanation he had for the
vanishing contango and for the relentless fall of
the gold basis. He cited a couple of ad hoc reasons,
having to do with the low and falling interest-rate
structure, and its effect on the declining carrying
charge. But he had to admit that he knew of no theoretical
explanation for the phenomenon of continuing erosion
even in the face of rising interest rates and increasing
carrying charges.
My own explanation is that the shrinking
contango and the persistent fall in the gold basis
is a measure of the vanishing of gold into private
hoards. Monetary gold together with the output of
the gold mines is disappearing. Aladdin Greenspan
was whistling in the black hole when he testified
before a Congressional committee saying that central
banks stood ready to sell more gold to quash flare-ups
in the gold price. The irrefutable fact is that selling
gold makes the central bank’s balance sheet
weaker, not stronger. The bank would replace its best
assets for the worst. It would exchange an asset that
is the liability of no one for the liability of devaluation-happy
governments. Central bankers are helpless. They are
in a catch-22 situation. Selling gold into a rising
market would be the coup-de-grâce to their fiat
money scheme. They hope against hope that inundating
the world with paper gold in the form of gold futures,
options, ETF’s and other derivatives, existing
or yet to be invented, will save their skin. It won’t.
Not forever, anyhow.
So I advise my audience to ignore the siren song of
the Quantity Theory of Money. Focus attention on the
falling gold basis. It is a foolproof indication of
the disappearance of monetary gold still available
to the public as insurance against economic disasters.
The fact is that the vast majority of the people lives
in a fool’s paradise. They haven’t given
a thought to purchasing such insurance while they
are busily building their homes right on the financial
fault line.
As a further refinement I call attention
to the silver basis which, if my analysis is correct,
will fall first. Not because monetary silver has been
“consumed”, as trumpeted by the cheerleaders
of the get-rich-quick crowd. It hasn’t. But,
as the silver basis shows, silver is going into hiding
even faster than gold. Why? Basically because central
bankers have less scope for bluffing in the silver
market. The cupboard is bare and the kitty is empty
when they are looking for more silver.
Sapere aude!
I will not go out on one limb to make
predictions about timing beyond repeating what I have
already said. The indication for the imminent collapse
of the international monetary system will be the “last
contango in Washington”: the fall of the silver
basis. It will be followed by the fall of the gold
basis. These events will indicate that the irredeemable
dollar has entered its death throes -- regardless
what the inflation numbers say. Woe to all fiat currencies
whose principal backing is the irredeemable dollar.
Controlling their quantity can and will do nothing
to save them.
I am fully aware that it is dangerous to question
the validity of the prevailing Quantity Theory of
Money. I am willing to stake my professional reputation,
as Galilei has staked his when he saw no wisdom in
the prevailing geocentric cosmology.
I close this series of essays on the basis with Horace:
sapere aude! (In English translation: dare to be wise;
Epist., I. ii .42.)
References
A.E. Fekete, What Gold and Silver
Analysts Overlook
www.gold-eagle.com/gold_digest_04/fekete050404pv.html
A.E. Fekete, Bull in Bear’s Skin?
www.financialsense.com/editorials/fekete/2006/0504.html
A.E. Fekete, Ultracrepidarian Musings
www.financialsense.com/editorials/fekete/2006/0525.html
A.E. Fekete, Monetary versus Non-monetary commodities
www.financialsense.com/editorials/fekete/2006/0625.html
A.E. Fekete, The Last Contango in Washington
www.financialsense.com/editorials/fekete/2006/0604.htlm
Tom Szabo, The Silver Basis
www.silveraxis.com/explain_basis.html
*****
Copyright ©
2006 by A. E. Fekete |
