-- Published: Monday, 29 February 2016 | Print | Disqus
By Richard (Rick) Mills
Ahead of the Herd
As a general rule, the most successful man in life is the man who has the best information
In July 1944, as allied troops were racing across Normandy to liberate Paris, delegates from 44 nations met at Bretton Woods, New Hampshire - the United Nations Monetary and Financial Conference - and agreed to “peg” their currencies to the U.S. dollar, the only currency strong enough to meet the rising demands for international currency transactions.
“At the closing banquet, the assembled delegates rose and sang “For He’s a Jolly Good Fellow.” The fellow in question was John Maynard Keynes, leader of the British delegation and intellectual inspiration of the Bretton Woods design.” Robert Kuttner, Bretton Woods Revisited
What made the dollar so attractive to use as an international currency, the world’s reserve currency, was each U.S. dollar was based on 1/35th of an ounce of gold (35.20 US dollars an ounce), and the gold was to held in the U.S. Treasury.
There’s a lesson not learned that reverberates throughout monetary history; when government, any government, comes under financial pressure they cannot resist printing money and debasing their currency to pay for debts.
London Gold Pool
The U.S. began to send larger and larger amounts of dollars overseas to fund their increasing trade deficits. The glut of U.S. dollars held abroad began to threaten U.S. gold reserves – remember U.S. dollars were redeemable for gold – and worldwide demand for gold was soaring. By the late 1950’s U.S. gold reserves had began to dwindle rapidly.
“Nineteen fifty-eight marked the first year in which foreign central banks exercised their convertibility rights in significant amounts and returned their dollars for gold. US gold reserves fell 10% from 20,312 metric tons to 18,290 that year, another 5% in 1959, and 9% in 1960.” John Paul Koning, Mises.org, The Losing Battle to Fix Gold at $35
In October of 1960 panic buying caused gold’s price to rise to over US$40 per oz – a night time emergency call was made by the US Federal Reserve, the Bank of England was to immediately flood the gold market with enough supply to reduce and stabilize the price of gold.
The U.S. made it abundantly clear stopping the drain of its gold reserves, and the depreciation of its currency against gold, was a huge priority.
The U.S., the Bank of England and the central banks of West Germany, France, Switzerland, Italy, Belgium, the Netherlands, and Luxembourg then set up a gold sales consortium to prevent the market price of gold rising above US$35.20 per oz.
This consortium was known as the London Gold Pool. Member banks were to provide a quota of gold into a central pool, the U.S. Federal Reserve would match their combined contributions ounce to ounce. This meant that the dollar would now be backed not only by the gold in Fort Knox but all the other Pool members gold as well.
By early 1962, the Bank of England, the consortium’s buy/sell agent, through the London Gold Exchange, was buying gold on the dips and selling on the rise to cap its price. Until 1968 nearly 80 percent of newly mined gold passed through the London Gold Exchange, London being the world’s premier gold market. The London Gold Fix had been a daily morning ritual since September 1919 - the 3pm Gold Fix was introduced in 1968 to coincide with the opening of the US markets.
Despite the Cuban Crisis and escalating tensions between Moscow and the U.S. gold prices remained fairly stable, the London Gold Pool was a success.
The Beginning of the End
With the Gulf of Tonkin incident in late 1964 and the acceleration of the Vietnam war in 1965, U.S. military spending exploded. This was compounded by President Lyndon B. Johnson's Great Society project spending and not raising taxes.
By 1965 the London Gold Pool was selling more gold suppressing the rise than it was buying back on the increasingly fewer, and shallower, dips.
Britain devalued the pound sterling in late 1967.
The ramping up, in early 1968, of the Vietnam war – because of the Tet offensive and U.S. President Lyndon B. Johnson’s agreeing to General Westmoreland’s proposed troop surge - brought renewed pressure on the dollar.
Since Johnson refused to raise taxes to pay for A. the social welfare reforms undertaken earlier and B. the war in Vietnam, the U.S. was now running massive balance of payment deficits with the world.
In a little over a month London sold close to 20 times its usual amount of gold, over a 1000 tons.
France dropped out of the pool to send it’s dollars back to the U.S. - for gold rather than Treasury debt.
Gold demand was skyrocketing. London sold 100 ton of gold in one day, up 20 times the average.
The consortium said "the London Gold Pool re-affirm their determination to support the pool at a fixed price of $35 per oz".
Fed chairman William McChesney-Martin said the US would defend the US$35 per oz gold price "down to the last ingot".
Several planeloads of gold were emergency airlifted from the U.S. to London. Gold demand continued to escalate with the London Gold Pool selling 175 tons one day and the very next day selling an additional 225 tons.
This broke the back of the London Gold Pool, members were tired of draining their countries gold reserves to pay for the U.S.’s Vietnam war and social reform policies.
At the request of London Gold Pool members the Queen of England declared Friday, March the 15th a bank holiday - the London gold market remained closed for two weeks and the London Gold Pool was disbanded.
Johnson was forced to reverse his decision to send hundreds of thousands more U.S. troops to crush the Vietnamese resistance - instead he opened up peace talks.
An official "two-tiered" price for gold was announced to the world - the official price of US$35.20 would remain for central banks dealings, the free market could find its own price.
"...there came the March 1968 run on gold, which led to the collapse of the London Gold Pool. The U.S. government and Federal Reserve System, seeking to stave off the complete collapse of the dollar-gold exchange standard, felt obliged to take deflationary measures. The fed funds rate, which on October 25, 1967, had fallen to as low as 2.00 percent, rose to 5.13 percent on March 15, 1968, the day the gold pool collapsed.
As the Federal Reserve System’s deflationary measures took effect, the fed funds rate rose to as high as 10.50 percent during the summer of 1969. Long-term interest rose too, if to a lesser extent. On September 6, 1967, the rate on U.S. government 10-year bonds fell to 5.20, still well above the level of around 4 percent that prevailed during the first half of the 1960s...
On December 29, 1969, the yield on the long-term government bond hit 8.05 percent. With interest rates, both long term and short term, at such high levels, the demand for gold bullion was finally broken, and the dollar price of gold fell to around $35 an ounce by 1970. For the moment, the dollar-gold exchange standard had been saved." The Industrial Cycle and the Collapse of the Gold Pool in March 1968, critiqueofcrisistheory.wordpress.com
In February of 1970 the closing dollar price of gold on the London market averaged US$34.99.
On August 15, 1971, U.S. President Nixon ended the convertibility of the dollar into gold. With gold finally demonetized the U.S. Federal Reserve (Fed) and the world’s central banks were now free from having to defend their gold reserves and a fixed dollar price of gold.
In the Federal Reserve Act Congress established three key objectives for monetary policy:
- Maximum employment
- Stable prices
- Moderate long-term interest rates
The first two objectives are often referred to as the Federal Reserve's dual mandate.
The Fed could finally concentrate on achieving its mandate - full employment with stable prices - by employing targeted levels of inflation. The great experiment had begun – the objective being a leveling out of the business cycle by keeping the economy in a state of permanent boom - gold's "chains of fiscal discipline" had been removed.
By the end of August 1971, the dollar price of gold exceeded US$42 and was rising.
“The financial system used by all national economies worldwide is actually founded upon debt. To be direct and precise, modern money is created in parallel with debt…
The creation and supply of money is now left almost entirely to banks and other lending institutions. Most people imagine that if they borrow from a bank, they are borrowing other people's money. In fact, when banks and building societies make any loan, they create new money. Money loaned by a bank is not a loan of pre-existent money; money loaned by a bank is additional money created. The stream of money generated by people, businesses and governments constantly borrowing from banks and other lending institutions is relied upon to supply the economy as a whole. Thus the supply of money depends upon people going into debt, and the level of debt within an economy is no more than a measure of the amount of money that has been created.” Michael Rowbotham, ‘The Grip of Death’
The effort by the London Gold Pool to cap the price of gold was as unsuccessful as central bank efforts were the years preceding 2009. Why were the world’s most powerful central banks so spectacularly unsuccessful, not once but twice, in capping gold’s price rise? The answer is definitely something you’ll want on your radar.
Real Interest Rates
The demand for gold moves inversely to interest rates - the higher the rate of interest the lower the demand for gold, the lower the rate of interest the higher the demand for gold.
The reason for this is simple, when real interest rates are low, at, or below zero, cash and bonds fall out of favor because the real return is lower than inflation - if your earning 1.6 percent on your money but inflation is running 2.7 percent the real rate you are earning is negative 1.1 percent - an investor is actually losing purchasing power. Gold is the most proven investment to offer a return greater than inflation (by its rising price) or at least not a loss of purchasing power.
Gold's price is tied to low/negative real interest rates which are essentially the by-product of inflation - when real rates are low, the price of gold can/will rise, of course when real rates are rising, gold can fall very quickly.
Dumping gold on the market, like the London Gold Pool, and until very recently modern central banks did, cannot dampen the demand for gold at low/negative real interest rates. They can temporarily be successful at capping or slowing gold’s price rise but as long as interest rates are low to negative the demand for gold will grow and soon strips supply from their vaults.
There’s a saying that “six percent interest can draw gold from the moon,” undoubtedly true, but real rates below two percent draw investors to gold.
Consumer prices in the United States went up 1.4 percent year-on-year in January of 2016, following a 0.7 percent increase in the previous month. The inflation rate accelerated for the fourth straight month, reaching the highest since October of 2014 and beating market expectations of a 1.3 percent gain.
The benchmark US 10-year note currently yields 1.76%. The latest inflation rate for the United States is 1.40% through the 12 months ended January 2016 as published by the U.S. government on February 19, 2016.
- Since 1913 the U.S. dollar has lost over 95% of its purchasing power while gold has gone from US$20 an ounce to currently over US$1600.00 per ounce in the same time frame
- When people catch onto the fact that all government statistics are so massaged as to be useless, and actually start to think about how much more they are paying today over yesterday for the necessary everyday items they need to get by, than they will start to understand why gold is so important to a sound monetary system
- Continuing low interest rates, combined with higher inflation rates will equal low to negative real rates of return causing continued demand for gold
- Consistent, sustained, large-scale bulk gold purchases on the dips by central banks and governments buying a large part of the annual supply of gold will keep a gradually rising floor under gold’s price
“Gold has special properties that no other currency, with the possible exception of silver, can claim. For more than two millennia, gold has had virtually unquestioned acceptance as payment. It has never required the credit guarantee of a third party. No questions are raised when gold or direct claims to gold are offered in payment of an obligation; it was the only form of payment, for example, that exporters to Germany would accept as World War II was drawing to a close. Today, the acceptance of fiat money -- currency not backed by an asset of intrinsic value -- rests on the credit guarantee of sovereign nations endowed with effective taxing power, a guarantee that in crisis conditions has not always matched the universal acceptability of gold.
If the dollar or any other fiat currency were universally acceptable at all times, central banks would see no need to hold any gold. The fact that they do indicates that such currencies are not a universal substitute.” Golden Rule, Alan Greenspan
Gold and silver, in this author’s opinion, are extremely undervalued financial instruments. A portion of every investors portfolio needs to be dedicated to holding gold and silver bullion.
But historically, and perhaps especially so today, the greatest leverage to rising precious metal prices has been owning the shares of junior resource companies focused on acquiring, discovering and developing precious metal deposits.
“When the time comes and the gold price is moving to the upside again, you’ve got to be in the shares because that’s where the leverage is.” John Embry, Mining.com