Published on February 21st 2013
Please, see important disclaimer/ note at the end of this article: Please, click here to read this article in pdf format: February 21 2013 This is the first of three articles I will post on the suppression of gold. What drives me to write about the topic? I am tired of seeing endless proof of suppression [...]
Please, see important disclaimer/ note at the end of this article:
Please, click here to read this article in pdf format: February 21 2013
This is the first of three articles I will post on the suppression of gold. What drives me to write about the topic? I am tired of seeing endless proof of suppression (i.e. the typical take downs in the price at either 8:20am ET or at 10am-11am ET, with impressive predictability) and at the same time, it is unfair that anyone who voices this suppression be called a conspiracy theorist. Therefore, these three letters will give a rigorous theoretical support to the claim.
The first letter will show that, under mainstream economic theory, the suppression of the gold market is not a conspiracy theory, but a logical necessity, a logical outcome. From the publication of this letter onwards, the onus to prove the contrary will fall upon mainstream economists. The conspiracy theory will actually be the opposite: To claim that suppressing gold is not necessary.
The second letter will show how that suppression takes place. For those familiar with the gold market, this letter will offer nothing new and perhaps, it will even be incomplete. But at the macro level, I will seek to offer an insight.
The third letter will examine the consequences of this suppression and rigorously, prove that the claim of the gold bugs, namely that physical gold will trade at a premium over fiat gold or gold paper is also not a conspiracy theory, but the logical outcome of the current paradigm.
Before I begin, I would like to say that I think proving the logical implication from mainstream economics that gold needs to be suppressed is perhaps comparable to Von Mises demonstration of the impossibility of economic calculation under socialism. Both are very intuitive, of consequence, and a necessary intellectual step. Without further ado, let’s start with the first thesis: The suppression of gold is a logical necessity, under mainstream economics.
Axioms of mainstream economics
1.-Policy makers believe that there exists a general level of prices, and it can be measured by a price index (Ludwig Von Mises absolutely demolished this notion, but this is outside the scope of this letter. What is relevant is that price indices are “measured” and published by every nation and the market trades on them).
2.-Policy makers believe that in the long term, growth in the supply of money is neutral (Even David Hume laughed at this notion back in 1752)
3.-Policy makers use the general-equilibrium framework introduced by Léon Walras
4.-There exists a gold market and within this market, there are investors who see gold as money, as gold has been money for thousands of year
5.-In global trade, there is no relevant single price index, but relative prices, affected by cross exchange rates.
If axioms 1-5 hold, both a global monetary coordination (as opposed to currency wars) as well as the suppression of the price of gold are required, for the global economic system to remain stable.
Between 1874 and 1877, the works of Léon Walras introduced the notion of general equilibrium in Economics. Considered by Schumpeter as “the greatest economist”, in 1874 Walras published “Éléments d’économie politique pure, ou théorie de la richesse sociale”, as he was teaching in Lausanne. His work examined the conditions necessary to reach equilibrium in an economic system, based on a system of simultaneous equations. To this day, mainstream economists, including those at the helm of central banks, rely on the framework of general equilibrium to work out the theses on which their policies are based.
For obvious reasons, I cannot be exhaustive and therefore fair to M. Walras in this short article. Briefly, general equilibrium in an economic system with (n+1) markets implies that if the first n markets are in equilibrium, the last market, n+1, must be in equilibrium as well. In the same fashion but at an aggregate level, if the n markets show an excess of demand (supply), the (n+1) market must have an excess of supply (demand) large enough to offset the sum of the excesses of the n markets. This conclusion is known as the Walras’ Law. It is important to note that it is not necessary that all markets be balanced (i.e. in equilibrium). That is only a particular case of the Walras’ Law, where if n markets show no excess of either demand or supply, the last one, market (n+1), is also balanced.
Applied to our context, if we think of the (n+1) market as the global money market and the same is oversupplied because every central bank is monetizing sovereign debt, it must hold that the rest of the markets, on aggregate, must be overdemanded for the world economy to be in equilibrium. That is exactly what policy makers believe they can achieve. To be precise, I shall call here the global money market to the aggregate of fiat currency markets.
Later on, in 1949, another economist, Don Patinkin published a work titled “The Indeterminacy of Absolute Prices in Classical Economic Theory“, on Econometrica. Patinkin decisively demonstrated that under the Walrasian analysis, the absolute level of prices cannot be determined and that markets clear (i.e. supply meets demand) driven by relative prices. Indeed, the whole notion of a price index is flawed. As Rothbard pointed out:
“…After one commodity, say gold, is chosen to be the medium for all exchanges, every other good except gold will enjoy a unitary price, so that we know that the price of eggs is one dollar a dozen; the price of a hat is ten dollars, and so on. But while every good and service except gold now has a single price in terms of money, money itself has a virtually infinite array of individual prices in terms of every other good and service. To put it another way, the price of any good is the same thing as its purchasing power in terms of other goods and services…(…) In short, the price, or purchasing power, of the money unit will be an array of the quantities of alternative goods and services that can be purchased for a dollar. Since the array is heterogeneous and specific, it cannot be summed up in some unitary price- level figure…” The Austrian Theory of Money, 1976
In other words, agents do not bother about a price index, because they only look at relative prices. At this point, one has to make the following observations:
a) We cannot blame Walras. When he wrote, the world was a different place. There was sound money and in 1879, the gold standard would fully blossom. Indeed, with commodity-based money and no aggregate leverage or re-hypothecation the sorts of which we suffer today, imbalances were less pronounced and relative prices were all what mattered (It is necessary to clarify here that the gold standard of 1879 did not enforce a 100% reserve requirement. These two conditions, as far as I know, where only met during the golden time of the Bank of Amsterdam).
b) In the world of fiat money that Patinkin was familiar with, the illusion of the existence of a level of prices was relevant. It was a world of relatively closed economies, that ended with the birth of the likes of Wal-Mart. More than half its population lived under communism, there was relatively little outsourcing, no internet, no Euro zone, no NAFTA or other free-trade blocks.
But if axiom 5 is correct, in a fiat world with the integration which we still enjoy, Walras’ implied condition that markets can operate based on relative prices only, namely cross fx rates, should hold. Mainstream economists after all could not point to a global price index which does not exist. Most if not all goods are made with components/inputs produced in different currency zones with different local price levels, as measured by mainstream economists. There is no global consumer price index, unless one (like me) measures everything in ounces of gold.
In such a context, it is conceivable and necessary to look at the global economic system as a set of (n+1) markets where the last one, the (n+1) market is the global fiat money market. As long as this market remains balanced, the rest of the markets should not be impacted by global monetary policy.
To obtain the global money market in balance, there must be global monetary policy coordination. Currency wars should be clearly discouraged. Under mainstream economics, there is a benefit in achieving balance at an aggregate level, where the excess of demand in a currency is offset by an excess of supply in another currency. This is what we have observed between the US dollar and Euro currency zones. This is a direct implication of axioms 1-5…But what about the manipulation of the gold market?
When we consider gold as an additional currency, it is clear that its imbalance, for instance, an excess in the demand of it, has to be offset by the opposite imbalance in fiat currencies, if the global money market is to remain in equilibrium. If gold is demanded more than is supplied, fiat currencies will have to be supplied more than demanded. In similar fashion, if there is global coordination to maintain the global fiat money markets balanced at an aggregate level, gold must be also balanced.
But balance is not what policy makers (i.e. central bankers) are looking for these days. They see an imbalance in the n markets for goods and seek to address it with another imbalance in the global fiat money market. They want to induce an excess of demand on the real side of the economic system through an excess of supply in the global fiat money market. But as money is simply another necessary good, people need sound money; a sound asset as a medium of indirect exchange. If the idea of central bankers is to weaken the liabilities of the banks they lead, people will simply switch to gold. This, of course, is unacceptable to the existing rulers. Therefore, it is hereby demonstrated that to either keep the status quo (i.e. global fiat money market balanced) or to boost an excess demand in real assets, it is a logical necessity to manipulate the gold market; either to leave it balanced or oversupplied.
Having demonstrated that if axioms 1-5 are true, the manipulation of the gold market is a logical outcome, I want to make a final observation. If global coordination of currencies would leave the global fiat money market balanced, the balance in the rest of the markets would entirely depend of fiscal policy.
But there is an inconsistency here, because the flow and stock of fiat money in most if not all currency zones today are governed by fiscal policy (i.e. by the monetization of fiscal deficits). Therefore, to enforce a balance in the global fiat money market via coordination of central banks is impossible. What may be feasible is to coordinate the expansion in the supply of global fiat money. But if that is the case, we fall back to my proposition: that the manipulation of the gold market to leave it oversupplied is the logical outcome. To pretend it is not…is a conspiracy theory! The onus is on mainstream economists, to prove me wrong.
Note: In a recent post published by Mr. Chris Powell on Gata.org on March 22, 2013, a few inferences on me are published that are false. I have no control on such inferences and was not contacted by Mr. Powell nor GATA with regards to any of my posts on this blog. Had I been contacted, I would have strongly denied such inferences, which I completely disavow.
First, I am not a high executive in a big investment firm, as Mr. Powell has portrayed me. I am an employee with very limited responsibilities, completely outside the precious metals markets or mining.
Second, I do not work in investments nor invest for anyone or work in the area of investment banking or trading and, with respect to this particular article, I do not have any previous working experience or inside knowledge in the precious metals markets or mining. This should be clear from reading the “About the contributor” tab in this blog.
Third, as the disclaimer on this blog duly notes, the comments expressed in this website and daily letters are my own personal opinions only and do not necessarily reflect the positions or opinions of my employer or its affiliates. I maintain this personal and independent blog outside my working hours and absolutely all of my posts are based on nothing else but public information and my own analysis/reading/interpretation of that information.
In particular, I completely disavow the inferences made by Mr. Powell’s post with respect to bullion banks and the mining industry. They are 100% his responsibility. The paragraph on the involvement of miners in the futures market of my (third) post of this topic is nothing else than my personal interpretation of articles in the public domain on the subject and only seeks to explain a certain dynamics affecting the gold forward rate. As my disclaimer also notes, the information contained herein is not necessarily complete and its accuracy is not guaranteed. In other words, I can be wrong.
Unfortunately, my name and comments have been subject to incorrect inferences. I am not responsible for them.
Published on August 6th 2012
Click here to read this article in pdf format: August 6 2012 Today is a holiday in Canada and our letter is published later than usual. We will make a few comments on what we believe were the most relevant events impacting capital markets (do these still exist, by the way?) last week: No news [...]
Click here to read this article in pdf format: August 6 2012
Today is a holiday in Canada and our letter is published later than usual. We will make a few comments on what we believe were the most relevant events impacting capital markets (do these still exist, by the way?) last week:
No news on monetary policy
During the past week, both the Fed and the European Central Bank had the opportunity to execute on new policies, be it price or volume driven. As we anticipated in our last letter, these banks decided to past on such an opportunity. There is really nothing else they can effectively do, except explicitly monetize sovereign debt. If they opt for unconventional policies, the medicine will have a worse effect than the sickness, although we want to make this clear: Monetizing sovereign debt is also not the solution. However, it buys time and is the less distorting of all available measures. Having said this, if we are right, the rally we saw in the Euro was only short-covering and soon, we will have to enter a new downward leg.
Relevering of corporate balance sheets: Rich shareholders, poor corporations
A few months ago, we warned that: “…in the past 10 years, you have seen the S&P500 index fluctuate, nominally, without making any “improvement”. This has huge ramifications and one of them is that businessmen who would want to monetize the fruit of their labour would not be able to do so, on average, because if they are lucky, they only break even when they sell their businesses. If you were one of them, what would you do in the face of the recent monetary expansion?
I for one would leverage my company with cheap credit lines and distribute (or increase the distribution of) dividends, to cash out. And this is precisely what we are seeing and will continue to see: Leverage seems to have bottomed and now is reverting in corporates. This is not positive for growth and hence, we don’t want to own shares. We don’t want to own mining companies. We understand that the recent rally was fully driven by the expansion of the Fed (via swaps) and the European Central Bank (via Long-Term Refinancing Operations). We are simple investors and are humble enough to know that we will not be able to call the exact day in which the reversal in stocks takes place…”
This trend is increasingly becoming more evident, as new multi-billion shares-buyback programs and dividend raises are announced every week. Who’s financing this? Banks mostly and they will be sorry for it by the time interest rates (i.e. real interest rates go up). In the meantime, let’s enjoy the party!
Reconsidering our last comments on the repo market: Why we may be proven wrong
At the end of our letter on June 25th, we brought up what we thought was a sharp comment from Murray Rothbard, in his book “America’s Great Depression”. In its Chapter 12, under the section titled: “The attack on property rights: The final currency failure”, Rothbard told us that: “…despite the gigantic efforts of the Fed, during early 1933, to inflate the money supply, the people took matters into their own hands, and insisted upon a rigorous deflation (gauged by the increase of money in circulation)— and a rigorous testing of the country’s banking system in which they had placed their trust…”
We concluded therefore that this crisis has to end with a rigorous deflation or liquidation of liabilities, which must be expressed in terms of a new standard. In the ‘30s, the US dollar was still backed by gold and gold was the Fed’s asset. Today, the US dollar is backed by US Treasuries. Therefore, we concluded, “to insist upon a rigorous deflation” is to repudiate the US Treasury notes. On July 2nd, we made the case that such a repudiation was going to take the form of lower volumes in the repo market. By that, we meant illiquidity in the repo market. The same was going to make harder to short commodities naked, brining eventually one net short position in the futures markets to bankruptcy. In the process, counterparty risk would rise exponentially endangering the respective clearinghouse and forcing the Fed to intervene. The key conclusion here was that from that point on, spot prices of commodities were no longer going to be manipulated, given the broken futures markets, opening the door to high inflation.
As the title of this paragraph suggests, we may be wrong in this analysis. What makes us think so? New information: Namely, the potential massive use of floating rate notes (FRNs) by the US Treasury, starting 2013. We want clarify this: The introduction of FRNs will not suppress the process described above. It will only delay it and make the fall even more catastrophic.
The new information came to us upon reflection, based on a series of anonymous articles published on Zerohedge.com, regarding the upcoming change in the funding policy of the US Treasury. Please, find the links to these articles below. Give yourselves some time to read them carefully. They are worth it. We present them in chronological order:
Floating Rate Notes are variable rate notes. If you hold them and rates increase, for instance, you don’t suffer a capital loss. Since the beginning of the crisis, the US Treasury has basically issued fixed rate debt. The long term portion of it, courtesy of Operation Twist, is being massively bought by the Fed. The short end, is accumulating in the balance sheets of the primary dealers. If interest rates were to rise, these dealers would suffer untold capital losses, and it would be politically difficult to bail them out. Therefore, the same dealers are pushing the US Treasury to slowly start refinancing this short-term fixed rate notes in their inventory with floating rate notes. That way, by the time interest rates rise, the problem will have already been transferred to the US taxpayer, who will be in a deeper hole.
What does all this have to do with our previous analysis of the repo market? Well, if floating rate notes are issued, they will have a strong bid from money market funds and liquidity will be enhanced in the repo market, which would continue funding the commodity futures markets.
However, with the US Treasury facing a higher fiscal cliff, the Fed would be forced to intervene buying not only the long-term, but the also short-term debt, to ensure that inflation transforms these higher nominal short-term rates into lower “real” rates. The Fed would not do this only to save the US Treasury, but also the private sector. Why? As short-term liquidity shifts from commercial paper to government-issued floating rate notes, levered companies (and we just said companies are pushing leverage) would have a hard time finding short-term working capital funding. Potentially, and only years ahead, this could well end in situations seen in Latin America, where banks offered weekly or weekend guaranteed investment certificates at high rates. Gold, again, would end up being “the” store of value. But this, this is years ahead and in the making.
The consequences of high frequency trading and the myth that it is needed to bring liquidity to markets
High frequency trading was brought back to light in the past week, after the tremendous losses suffered by the Knight Capital Group. We don’t have much time but want to simply say this: The whole idea that high frequency trading brings liquidity to markets is born out of a misconception of liquidity. And here, we go with the Austrian school: Liquidity is not and should never be intrinsic to an asset, but is the result of preference by acting men.
Secondly, High frequency trading does not even provide liquidity. It just plays the operational weaknesses of markets. In a casino, when the croupier says “rien ne va plus”, all the real bids are locked. In a stock exchange, it appears that this doesn’t happen, allowing high frequency traders to introduce false signals to trigger stop losses or profit taking. If that is liquidity, our markets are broken. It is another Ponzi scheme, with no real cash at the end, played within mili-seconds.
But the underlying point here is that we should not force liquidity into all stocks. If some are not liquid, it is for a reason and providing fake demand via high-frequency trading is an expensive mistake. If the world allows high frequency trading to continue, it will end, paradoxically, in illiquid markets. The real money will leave markets and flow to real assets, because if liquidity means being exposed to the manipulation of high frequency trading….why pay a premium to be liquid?
Austrian school,corporate leverage,deflation,dividends,Euro,European Central Bank,Fed,floating rate notes,high frequency trading,Knight Capital Group,liquidity,long-term debt,money market,money market funds,Murray Rothbard,repo market,share buybacks,short-term debt,US taxpayer,US Treasury,zerohedge.com
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Published on July 9th 2012
“… For all practical purposes, the European Central bank made sure that its liabilities, the Euro, will never be able to reach a global reserve status…”
Click here to read this article in pdf format: July 9 2012
Markets had a quiet week, with a holiday in Canada and another in the United States. We will therefore be brief today.
In our last letter, we presented how we think, the end of this crisis will be brought about: With the collapse of the futures markets. It is important that these markets really break because they are the ones used to manipulate commodity prices (not just gold) and as long as commodity prices can be controlled, the flight from fiat money to real assets will not be triggered and the global depression will stay with us. We know that, “they” know that and that’s why when that critical moment approaches, the repression to avoid it will be phenomenal, of a kind nobody in the developed world has ever witnessed. We leave it here…
Last week, the central bank of Argentina declared that at least 5% percent, we understand, of deposits held by local banks “must” be lent to businesses. Everyone laughed at this ridiculous measure. Everyone knows that it is useless and that the government of that country can do nothing to prevent their eventual fall. Last week too, the central bank of the European Union declared that it will pay nothing, (zero percent rate) on deposits from Euro zone banks. Yet nobody laughed at this measure and still… it is nothing else but a twisted version of what the Argentines did. It is as ridiculous and it will be met with the same answer: Less lending and more recession.
As we wrote months ago, in order to save their currency, the Euro zone destroyed its banks. And with this last measure, it will have ended its money market. For all practical purposes, the European Central bank made sure that its liabilities, the Euro, will never be able to reach a global reserve status. The damage these irresponsible central bankers are doing is immense because until now, Euro banks were not lending to each other for a genuine reason: Very high counterpart risk within a currency zone that is falling apart. They were taking heavy capital losses on the sovereign debt holdings they had been coerced to invest their funds in but, at least, they were able to earn 25bps on immobilized monies. Now, they won’t even have this “risk-free” income, a situation that actually enhances counterpart risk, as solvency is further crushed.
At the same time, if the banks cannot afford to have funds immobilized, they will discourage the growth of deposits in the Euro zone, precisely when they are most needed. The way markets welcomed this measure shows we are not alone with this view.
On another note, last week too, Robert Diamond, ex-CEO of Barclays was called a criminal during a testimony before the British Parliament. The reason? His former employer was accused of manipulating the London inter-bank offered rate (LIBOR). We can only ask this: Why are bankers called criminal when interacting in the market to get a price for their product, while central banks, who actually “set” the rates….are not? Who is the criminal? After all, would any other business not try to move a price to its benefit? If it is successful, it’s because the demand for that product is there. The point is: They were not, which is why Libor, after all, has become an irrelevant rate. Was that criminal? Did bankers really ever force other banks or businesses to borrow by way of bank debt, rather than bonds or raising equity? Yet, central banks do actually impose rates on the market, regardless of demand. Who is the criminal? Who is it?, we ask…
Lastly, in our letter of June 25th, we argued that it was now conceivable to see Germany leave the Euro zone first. We think that the latest actions, both by the central bank and the Euro Summit, make this outcome increasingly likely.
Bob Diamond,deposit rate,deposits,Euro,Euro Summit,Euro-zone,European Central Bank,Germany,global depression,LIBOR,money market
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