The Death of Money (37 page)

The motivation for central bank gold market manipulation is as subtle as the methods
used. Central banks want inflation to reduce the real value of government debt and
to transfer wealth from savers to banks. But central banks also work to suppress the
price of gold. These twin goals seem difficult to reconcile. If central banks want
inflation, and if a rising gold price is inflationary, why would central banks suppress
the gold price?

The answer is that central banks, principally the Federal Reserve,
do
want inflation, but they want it to be
orderly
rather than disorderly. They want the inflation to come in small doses so that it
goes unnoticed. Gold is highly volatile, and when it spikes up sharply, it raises
inflationary expectations. The Federal Reserve and the BIS suppress gold prices not
to keep them down forever, but rather to keep the increases orderly so that savers
do not notice inflation. Central banks act like a nine-year-old-boy who sees fifty
dollars in his mom’s wallet and steals one dollar thinking she won’t notice. The boy
knows that if he takes twenty, Mom
will
notice, and he will be punished. Inflation of 3 percent per year is barely
noticed, but if it persists for twenty years, it cuts the value of the national debt
almost in half. This kind of slow, steady inflation is the central banks’ goal. Managing
inflation expectations by manipulating gold prices downward was the rationale given
by Fed chairman Arthur Burns to President Gerald Ford in the secret 1975 memo. That
hasn’t changed.

Since then, however, an even more ominous motive for central bank gold price manipulation
has emerged. The gold price must be kept low until gold holdings are rebalanced among
the major economic powers, and the rebalancing must be completed before the collapse
of the international monetary system. When the world returns to a gold standard, either
by choice to create inflation, or of necessity to restore confidence, it will be crucial
to have support from all the world’s major economic centers. A major economy that
does not have sufficient gold will either be relegated to the periphery of any new
Bretton Woods–style conference, or refuse to participate because it cannot benefit
from gold’s revaluation. As in a poker game, the United States possessed all the chips
at Bretton Woods and used them aggressively to dictate the outcome. Were Bretton Woods
to happen again, nations such as Russia and China would not permit the United States
to impose its will; they would prefer to go their own way rather than be subordinate
to U.S. financial hegemony. A more equal starting place would be required to engender
a cooperative process for reforming the system.

Is there a preferred metric for rebalancing reserves? Many analysts look at the statistics
for gold as a percentage of reserves. The United States has 73.3 percent of its reserves
in gold; the comparable figure for China is 1.3 percent. But this metric is misleading.
Most countries have reserves consisting of a combination of gold and hard currencies.
But since the United States can print dollars, it has no need for large foreign currency
reserves, and as a result, the U.S. reserve position is dominated by gold. China,
on the other hand, has little gold but approximately $3 trillion of hard-currency
reserves. Those reserves are valuable in the short run even if they are vulnerable
to inflation in the future. For these reasons, the 73 percent U.S. ratio overstates
U.S. strength, and the 1.3 percent ratio overstates China’s weakness.

A better measure of gold’s role as a monetary reserve is to divide gold’s nominal
market value by nominal GDP (gold-to-GDP ratio). Nominal
GDP is the total value of goods and services that an economy produces. Gold is the
true monetary base, the implicit reserve asset behind the Fed’s base money called
M-Zero (M0). Gold is M-Subzero. The gold-to-GDP ratio reveals the true money available
to support the economy and presages the relative power of a nation if a gold standard
resumes. Here are recent data for a select group of economies that together comprise
over 75 percent of global GDP:

Table 2. Gold-to-GDP Ratio for Selected Economies

The global gold-to-GDP ratio of 2.2 percent reveals that the global economy is leveraged
to real money at a 45-to-1 ratio but with a significant skew in favor of the United
States, the Eurozone, and Russia. Those three economies have ratios above the global
average; the Eurozone’s ratio at 4.6 percent is more than double the global average.
The United States and Russia are in strategic gold parity, the result of Russia’s
65 percent increase in its gold reserves since 2009. This dynamic is an eerie echo
of the early 1960s “missile gap,” from a time when Russia and the
United States competed for supremacy in nuclear weapons. That competition was deemed
unstable and resulted in strategic arms limitations agreements in the 1970s, which
have maintained nuclear stability in the forty years since. Russia has now closed
the “gold gap” and stands on a par with the United States.

The conspicuous weak links are China, the U.K., and Japan, each with a 0.7 percent
ratio, less than one-third the U.S.-Russia ratio and far smaller than that of the
Eurozone. Other major economies, such as Brazil and Australia, stand even lower, while
Canada’s gold hoard is trivial compared to the size of its economy.

If gold is not money, these ratios are unimportant. If, however, there were a collapse
of confidence in fiat money and a return to gold-backed money, either by design or
on an emergency basis, these ratios would determine who would have the most influence
in IMF or G20 negotiations to reform the international monetary system. On current
form, Russia, Germany, and the United States would dominate those discussions.

■
China’s Gold Deception

Once again we find ourselves looking at China. It seems absurd to posit that the international
monetary system could be reformed without major participation by China, the world’s
second-largest economy (third if the Eurozone is viewed as a single entity). It is
known, but not publicly disclosed, that China has far greater gold reserves than it
states officially. If Table 2 is restated to show China with an estimated—but more
accurate—4,200 tonnes of gold, then the change in ratios is dramatic.

In this revised alignment, the global ratio increases slightly from 2.2 percent to
2.5 percent, putting global gold leverage at 40 to 1. More important, China would
now join the “gold club” with a 2.7 percent ratio, equivalent to Russia and the United
States and comfortably above the global average.

Table 3. Impact of Chinese Stealth Acquisition on Gold-to-GDP Ratios

Although it is rarely discussed publicly by monetary elites, the increase of China’s
gold ratio from 0.7 percent toward 2.7 percent, as shown in the comparison of Table
2 and Table 3, has actually been occurring in recent years. When this gold rebalancing
is complete, the international monetary system could move to a new equilibrium gold
price without China being left behind with only paper money. The increase in China’s
gold reserves is designed to give China gold parity with Russia, the United States,
and the Eurozone and to rebalance global gold reserves.

This rebalancing paves the way for either global inflation or gold’s emergency use
as a reserve currency, but the path has been complicated for China. When Europe and
Japan emerged from the ashes of the Second World War, they were able to acquire gold
by redeeming their dollar trade surpluses, since the dollar was freely convertible
at a fixed price. U.S. gold reserves declined by 11,000 tonnes from 1950 to 1970 as
Europe and Japan redeemed dollars for gold. Thirty years later China was the dominant
trading nation, earning large dollar surpluses. But the gold window had been closed
since 1971, and China could not swap
dollars for U.S. gold at a fixed price. As a result, China was forced to acquire its
gold reserves on the open market and through its domestic mines.

This market-based gold acquisition posed three dangers for China and the world. The
first was that the market impact of such huge purchases meant that gold’s price might
skyrocket before China could complete the rebalancing. The second was that China’s
economy was growing so quickly that the amount of gold needed to reach strategic parity
was a moving target. The third was that China could not dump its dollar reserves to
buy gold because it would burden the United States with higher interest rates, which
would hurt China’s economy if U.S. consumers stopped buying Chinese goods in response.

The greatest risk to China in the near future is that inflation will emerge in the
United States before China obtains all the gold it needs. In that case, the combination
of China’s faster growth and higher gold prices will make it costly to maintain its
gold-to-GDP ratio. However, once China does acquire sufficient bullion, it will have
a hedged position because whatever is lost to inflation will be gained in higher gold
prices. At that point, China can give a green light to U.S. inflation. This move toward
evenly distributed gold reserves also explains central bank efforts at price manipulation,
as the United States and China have a shared interest in keeping the gold price low
until China acquires its gold. The solution is for the United States and China to
coordinate gold price suppression through swaps, leases, and futures. Once the rebalancing
is complete, probably in 2015, there will be less reason to suppress gold’s price
because China will not be disadvantaged in the event of a price spike.

Evidence that the United States is accommodating China’s gold reserve acquisition
is not difficult to find. The most intriguing comment comes from Min Zhu, the IMF’s
deputy managing director. In response to a recent question concerning China’s gold
acquisition, he replied, “
China’s acquisition of gold makes sense because most global reserves have some credit
element to them; they’re paper money. It’s a good idea to have part of your reserves
in something real.” The use of the term
credit
to describe reserves is consistent with the reality that all paper money is a central
bank liability and therefore a form of debt. Treasury bonds purchased with paper money
are likewise a form of debt. Min Zhu’s distinction
between
credit
reserves and
real
reserves highlights precisely the role of gold as true base money, or M-Subzero.

The reaction within the U.S. national security community to China’s gold rebalancing
is nonchalance. When asked about Chinese gold acquisitions, one of the highest-ranking
U.S. intelligence officials shrugged and said, “
Somebody’s got to own it,” as if gold reserves were part of a global garage sale.
A senior official in the office of the secretary of defense expressed concern about
the strategic implications of China’s gold rebalancing but then went on to say, “The
Treasury really doesn’t like it when we talk about the dollar.”

The Pentagon and CIA routinely defer to the Fed and the U.S. Treasury when the subject
turns to gold and dollars, while Congress is mostly in the dark on this subject. Congressman
James Himes, one of only four members of either party with a seat on both the House
Financial Services Committee and the House Permanent Select Committee on Intelligence,
said, “
I never hear any discussion of gold reserve acquisition.” With the military, intelligence
agencies, and Congress all unconcerned or uninformed about China’s acquisition of
gold, the Treasury and Fed have a free hand to help the Chinese until the rebalancing
is a fait accompli.

Despite the discreet and delicate handling of the global gold rebalancing, there are
increasing signs that the international monetary system may collapse before a transition
to gold or SDRs is complete. In the argot of chaos theorists, the system is going
wobbly. Almost every “paper gold” contract has the capacity to be turned into a physical
delivery through a notice and conversion provision. The vast majority of all futures
contracts are rolled over into more distant settlement periods, or are closed out
through an offsetting contract. But buyers of gold futures contracts have the right
to request physical delivery of metal by providing notice and arranging to take delivery
from designated warehouses. A gold lease can be terminated by the lessor at the end
of its term. So-called unallocated gold can be turned into allocated bars, typically
by paying additional fees, and the allocated gold can then be delivered to the owner
on demand. Certain large gold exchange-traded fund (ETF) holders can convert to physical
gold by redeeming the shares and taking gold from the ETF warehouse.