Well, we had quite a week! Obama's State of the Arrogant speech confirmed that we will continue on with more of the same. More big projects, cool new bullet trains, and more big, expensive government. Helicopter Ben was confirmed for another four-year term, sure to be chock full of QE, both overt and covert. And Congress cleared the way for another $1.9tn in deficit spending. Quite a week indeed!
It almost seems like there is nothing at all that could stop these guys in Washington. With all the green lights, rainbows and good news, what could possibly go wrong?
It is this question that is most important to us savers and investors. What could go wrong?
Sometimes history repeats. The rest of the time it just rhymes.
Flashback: 1967
London: Nov. 19, 1967 - The new Labour government had inherited an £800m deficit from the Conservatives when it was elected just three years earlier.
Labour Prime Minister Harold Wilson proudly said the party had managed to reduce the deficit over the past three years. Nevertheless, the cost of hostilities in the Middle East, the closure of the Suez Canal and the disruption to exports through the dock strikes had put a tremendous strain on the pound sterling.
After weeks of evil speculators pounding the pound, the Bank of England had to, in one day, spend £200m worth of its gold and US dollar reserves buying back sterling in a futile effort to shore up its [f]ailing currency.
It was from this backdrop that Prime Minister Wilson announced the surprise devaluation of the pound.
"Our decision to devalue attacks our problem at the root and that is why the international monetary community have rallied round", said Mr. Wilson in a radio and television broadcast.
"From now the pound abroad is worth 14% or so less in terms of other currencies. It does not mean, of course, that the pound here in Britain, in your pocket or purse or in your bank, has been devalued.
"What it does mean is that we shall now be able to sell more goods abroad on a competitive basis."
The Conservative leader Edward Heath also appeared on television to reply to Mr Wilson's broadcast. He accused the Labour Government of failing in one of its foremost duties - to safeguard the value of the country's money.
Heath said, "Having denied 20 times in 37 months that they [Labour] would ever devalue the pound, they have devalued against all their own arguments."
But the only alternative, said the Prime Minister, was to borrow heavily from governments abroad. And the problem with this option was that the only loans being offered were short-term loans.
Prime Minister Wilson defended his decision to devalue the pound saying it would tackle the "root cause" of Britain's economic problems. He went on to say that he hoped a boost to British exports would lead to increased production and more jobs at home.
He said there would be cuts in defense spending and in some other capital expenditure programs.
Finally, he said that although there would likely be increases in the cost of some imported goods, such as food, he hoped this would not feed into excessive wage demands. [1]
A Banquet of Consequences
This relatively small (14%) devaluation of one single national, non-reserve currency in November of 1967 turned out to be quite a spark in the monetary powder keg of the Bretton Woods gold exchange system and the London Gold Pool. Within weeks of the devaluation the group of central bankers known as the London Gold Pool had to sell 1,000 tonnes of their own gold into the public market, 20 times the normal amount!
Then France under Charles de Gaulle withdrew from the gold pool and demanded US gold rather than Treasury debt in exchange for France's surplus dollars.
And less than four months after the British devaluation the outflow of official gold was so severe that Buckingham Palace had to declare a bank holiday, the London gold market closed for two weeks, and the London Gold Pool disbanded officially and permanently.
Three and a half years later the Bretton Woods system was done.
In 12 short years following the 14% surprise devaluation of the pound, the world saw the end of the London Gold Pool, the end of the gold standard, and a 2,400% rise in the price of gold. If gold rose 2,400% from "Brown's Bottom" like it did in the 70's we would see a price of $6,300 per ounce in 2011. If it went up 2,400% from today the price would be $26,000 per ounce, just to give you some perspective.
Of course my view is that we are not living a repeat of the 70's. My view is that something much more dramatic and fundamental is happening today. Even still, the London Gold Pool is a pretty good case study for understanding today's gold market.
The London Gold Pool
The London Gold Pool was a covert consortium of Western central banks, a 'gentleman's club' of sorts, that agreed to pool its physical gold resources at predetermined ratios in order to manipulate the London gold market. Their goal was to keep the London price of gold in a tight range between $35.00 and $35.20US.
London had become the world's marketplace for gold. For more than a half century nearly 80% of the world's gold production flowed through London. The "London Gold Fix" daily price fixing began in 1919 and only happened once a day until the London Gold Pool collapsed in 1968 and an "afternoon fix" was added to coincide with opening of the New York markets.
In 1944 the Bretton Woods accord pegged foreign currencies to the US dollar and the dollar to gold at the exchange rate of $35.20 per ounce. At that time gold was not traded inside the US, but in London it continued to trade between $35 and $35.20, rarely moving more than a penny or two in a day.
Through the first decade of the Bretton Woods system there was generally a shortage of US dollars overseas which lent automatic support to the fixed gold peg. But the US was running a large trade deficit with the rest of the world and by the late 1950's there was a glut of dollars on the international market which began draining the US Treasury of its gold.
Then, in one day in October 1960, the London gold price, which would normally have made headlines with only a 2 cent rise, rose from $35 to over $40 per ounce! The Kennedy election was just around the corner and in Europe it was believed that Kennedy would likely increase the US trade deficit and dollar printing.
That October night, in an emergency phone call between the Fed and the Bank of England, it was agreed that England would use its official gold to satiate the markets and bring the price back under control. Then, during Kennedy's first year in office the US Treasury Secretary, the Fed and the BOE organized the London Gold Pool consisting of the above plus Germany, France, Switzerland, Italy, Belgium, the Netherlands, and Luxembourg.
The goal of the pool was to hold the price of gold in the range of $35 - $35.20 per ounce so that it would be cheaper for the world to purchase gold through London from non-official sources than to take it out of the US Treasury. At an exchange rate of $35.20, it would cost around $35.40 per ounce to ship it from the US to Europe. So the target range on the London markets acted as a shield against the US official gold which had dwindled substantially over several years.
The way the pool was to work was that the Bank of England would supply physical gold as needed into the public marketplace whenever the price started to rise. The BOE would then be reimbursed its gold from the pool according to each countries agreed percentage. If the price of gold fell below $35 an ounce, the pool would buy gold, increasing the size of the pool and each member's stake accordingly. The stakes and contributions were:
50% - United States of America with $135 million, or 120 metric tons
11% - Germany with $30 million, or 27 metric tons
9% - England with $25 million, or 22 metric tons
9% - Italy with $25 million, or 22 metric tons
9% - France with $25 million, or 22 metric tons
4% - Switzerland with $10 million, or 9 metric tons
4% - Netherlands with $10 million, or 9 metric tons
4% - Belgium with $10 million, or 9 metric tons
And since they, as a group, were doing this in secret, it turned out that they were able to make a substantial profit in the first few years of the pool. Since they were buying low and selling high within a fixed trading range that only they knew was fixed, they reaped substantial profits and even increased their reserves as much as FIVE-FOLD by 1965!
But with the cost of US involvement in Vietnam rising substantially from 1965 through 1968, this trend reversed and the dollar came under extreme pressure. From 1965 through late 1967 the gold pool was expending more and more of its own gold just to keep the price in its range. Seeing this, France (who was one of the insiders and knew of the price fixing operation) began demanding more and more gold from the US Treasury for its dollars.
And as this trend progressed, the world was flooded with more and more dollars that were backed by less and less gold, creating an extremely volatile situation. Public demand for gold was rising, the war was escalating, the pound was devalued, France backed out of the gold pool, and in one day, Friday March 8, 1968, 100 tonnes of gold were sold in London, twenty times the normal 5 tonne day.
The following Sunday the US Fed chairman announced that the US would defend the $35 per ounce gold price "down to the last ingot"! Immediately, the US airlifted several planeloads of its gold to London to meet demand. On Wednesday of that week London sold 175 tonnes of gold. Then on Thursday, public demand reached 225 tonnes! That night they declared Friday a "bank holiday" and closed the gold market for two weeks, "upon the request of the United States". (So much for "the last ingot", eh?)
That was the end of the London Gold Pool. The public price of gold quickly rose to $44 an ounce and a new "two tiered" gold price was unveiled; one price for central banks, and a different price for the rest of us. Even today official US gold is still marked to only $42.22 per ounce, $2 LESS than the market price in 1968! [2] [3]
A highly recommended read is the Fed minutes from its December 12, 1967 FOMC meeting, one month after the devaluation of the pound sterling. It can be found on the Fed's own website, and is an amazing, priceless window into the final days of the London Gold Pool. Here is a small excerpt:
...the announcement on Thursday, December 7, of a $475 million drop in the Treasury's gold stock seemed to have been accepted by the markets as about in line with prior expectations of the costs of the gold rush following sterling's devaluation. What the market did not know, of course, was that only a $250 million purchase of gold from the United Kingdom saved the United States from a still larger loss in the face of some foreign central bank buying, notably the $150 million purchase by Algeria. The actual pool settlement for November took place last Thursday and Friday, December 7 and 8; the U.S. share of the $836 million total was $495 million. The logistical acrobatics of providing sufficient gold in London were performed with a minimum of mishaps, although the accounting niceties were still being ironed out.
Of greater concern, however, was the fact that the drain on the pool was accelerating again, Mr. MacLaury observed. Last week there was a small net surplus, but yesterday the loss was $56 million and today $95 million; for December to date, the pool was in deficit by $183 million. Some of the demand shortly after devaluation apparently represented large individual purchases by Eastern European countries, Communist China, and possibly Middle Eastern countries, although demand was more general in the last two days.
On the whole, it was Mr. MacLaury's impression that the measures taken by the Swiss commercial banks and by some other continental banks to impede private demand for gold worked quite well, although it was clear from the start that such measures could serve only as a stop-gap until some fundamental change was agreed upon. Persistent newspaper leaks--mainly from Paris--about current discussions on this subject and their reflection in gold market activity Monday and today pointed up the need for speed in reaching a decision. Mr. Hayes was in Basle this past weekend and might want to say a few words about recent developments. So far as the prospect for further declines in the gold stock were concerned, the Stabilization Fund now had on hand about $100 million. He knew of no firm purchase orders at the moment, although there was a distinct possibility that Italy might want to buy $100 million before the end of the year to recoup its losses through the pool. No one could say, of course, how many orders might be received from other quarters, but it would be surprising if there were not some. [4]
Of course the London Gold Pool was just one in a long chain of wars declared on the gold price by our modern central banks. [5] The current war on gold, led by the US Fed and Treasury, that we have been living under for at least 15 years now, is being documented - with sweeping precision - by no one other than GATA. Go GATA! [6]
Repeat of the 70's?
As I said earlier we are not reliving the 1970's. In the 70's we lost the gold standard but not the reserve currency. Today we are not only going to lose the reserve currency, but perhaps (and I say most certainly) the very idea of a reserve currency. Can you imagine a reserve that is not a currency? Can you imagine a transactional currency that is not a reserve? How about on a global scale? A global reserve? A global currency? How about a global reserve and a bunch of local or regional currencies? So many options to consider!
In the 1970's the gold market was a lot more "physical" than it is today. So while the flow of funds that went into gold was more directly reflected in gold's price, there also was not a paper gold derivative market like there is today that could swell along with demand and then rupture all at once.
Another difference was that in the 1970's the Dow was cheap compared to the decades of "passive" monetary inflation that preceded it. The Dow was the "virtual wealth" (as FOA says) of the 70's that had the great potential to explode upwards as wayward global dollars finally found their footing. Please read carefully FOA's description of this important distinction between then and now...
FOA (2001): Back in the mid to late 70s Sir John Templeton always drove his point home for investors watching Luis Rukiser's show. (how does one spell his name,,,,, we always called him Lou Baby (smile))
Sir John, living here on Layford Cay, kept saying that the Dow of the 70s was very under priced and would soar. He was the most absolutely correct person stating that then! But more into the mechanics of his perception: he knew that anyone buying the Dow and waiting a decade or more, would gain way beyond mere price inflation. Monetary inflation would eventually drive the perceived virtual wealth of US stocks ever higher. So high, in fact, that their percentage gains over price inflationary gains would be incredible. They were!
Truly, what John was referring to was the effects that simple "passive inflation" has on paper assets; especially in a "reserve currency's" domestic market. In this; real price inflation is mostly exported by importing "real goods". This happens as we export excess credit dollars to buy things. It also has another effect; some of that same exported printed money flows in a circle and joins native investor's buying of local paper assets. When this process first starts, "passive inflation", in the form of massive money creation that's far beyond real price inflation, allows one to gain "virtual paper wealth" even before the markets price out the gains. That is; the Dow stays cheap at first then eventually rises to absorb the money inflation! As long as [CPI] prices don't rise too much.
People that followed his advice, accumulated the Dow over a decade or more; buying "virtual wealth" before the fact! Stock investors made a killing by positioning their assets where this created "passive monetary inflation" would eventually end up. Even though hard money players laughed at them all thru out the 70s, 80s and early 90s! Look who is laughing now? Stocks tromped hard money plays hands down for over 20+ years! Even considering the latest fall on wall street.
My friends:
Today, this same "virtual wealth" effect has been created again and is located in physical gold bullion. I believe Sir John has already made part of my point but I will repeat it.
When a currency system comes to the end of its reserve use -- I'm speaking politically here -- its domestic market will come to a point where it can no longer export "real price inflation" in the form of; "shipping its excess currency outside its borders". This happens because internal money inflation, that is super currency printing, is increased so much that it overwhelms even its export flow. Worse, even that export flow later tumbles as the fiat falls on exchange markets.
The effect is that local "passive inflation", built up over decades and fully reflected in "Sir John's" paper assets, spreads out as "aggressive inflation" and hyper price rises begin. In this action, the very same wealth effect that was eventually priced into "John's" Dow stocks and other assets, begins a long march of being priced into real gold.
Anyone that has accumulated physical gold over this past long period was doing the exact same thing Dow buyers of the late 60s and early 70s were doing: saving "wealth" as unpriced "virtual wealth" stored up over that "passive inflation" period.
our old "virtual wealth" that is no longer in the form of "passive inflation" nor limited only to the currency, and is openly displayed in our vast sea of paper assets values including stocks & bonds
must now be defended in the open with official printed money flow.
The "virtual wealth" in gold, saved over years by patient investors, will also be priced to market in this process.
Never mind that during the Dow years the paper gold market could not work in parallel with all the other asset gains; it couldn't. Hard money players, trying to somehow play the Dow's game, never caught on to what was happening. Instead of buying "virtual wealth" by saving real gold; they brought leveraged bets that gold would be priced correctly during the "paper asset" years.
Obviously, this "trade" failed our hard money investors as the waves of profits from other paper gains and derivatives leverage were employed against every long bet on gold. Not only that; the "virtual wealth" in gold was never opened for them with the super price inflation they all thought was coming during that era!
Now that the paper game is about to stop for the Dow, it will also cut off the leverage of gold bets. Just as the real game begins.
The reason for this is that our massive, decades-long gains in our stock markets did not bankrupt the leverage in the money system. Where as any massive rise in physical gold values cannot be priced into "derivative gold" without crashing the system.
Remember; in political inflations, money is printed to save the assets as they are currently priced; not to create new loses by saving the leverage that's countering their play!
This paper gold market will be cashed out at prices far below real bullion trading so as to inflate further the books of the Bullion Banks,,,,,, not destroy them. At least this is how the US side will proceed.
In this perception USAGOLD has been guiding its clients, and now the world, in much the same way Sir John did decades ago.
"Buy what has value at the greatest discount and waits for the politics of money to price your new savings correctly"!
The politics of wealth today is centered around gold bullion and only gold bullion: that is where the wealth and power will be manifested: this is where the gains will be! To bet on the rest of the hard market, is to bet against the coming inflation making your asset whole!
Place as much of your wealth in physical gold as your understanding allows and save this "virtual wealth" of the ages today: waiting for it to become real wealth, priced correctly in the market place, tomorrow.
Make no mistake, the wealth is there "but only there in bullion"! Because a free bullion market cannot be denied or controlled when it stands between the opposite goals of political powers!
In this: it will separate from the politically crushing reality the current dollar based paper gold markets represents. The premium on bullion will soar!
The "Political will" of old world Europe is about to help make our investment real. For myself, a large percentage of my wealth is being saved by going with the evolution of paper moneys: not against!
This trend is visible now and based on the forward flow of human affairs, not the backward rules of money theory!
Our future is today; if not just around the trail!
What could go wrong?
What could go wrong is that the producers and savers of the world, those with the most to lose, might just decide that the US dollar under the governance of Obama, Geithner and Bernanke is no longer a safe store of wealth for any length of time. This includes both physical dollars and digital "electron" dollars as well as ALL non-physical "dreams" denominated in this symbolic unit of account, both debt and equity, stocks and bonds. If the dollar is deemed unsafe in the time dimension, then so is anything and everything else denominated in dollars that does not include the built-in safety hedge of also occupying the three physical dimensions!
The key here is time. The difference between the two primary functions of money (transactional medium and store of value) is time. It is the amount of time one is willing to hold onto a currency, or any paper proxy for physical goods denominated in that currency.
Of course time is a relative dimension. So the differentiation between a purely transactional currency and a wealth reserve is up for valid debate here in the theoretical realm. But in the real world we would expect to see a sign if the trend was heading in this direction.
I suppose you could say that a preference would emerge for shorter terms of holding versus the longer ones. As FOA said in 2001, "Are you worried that our 10 year bond, the new bench mark, will soar and squeeze off any recovery? Don't! We will just remove it from use and move to the 5 year,,,,,,,, to be replaced later by the 2 year,,,,,,,, to be replaced later by the 6 month,,,,,, 1 month,,,,,, 1 week,,,,, 1 day,,,,,, then,,,,,,,,,,,,,,,,, CASH!"
What FOA was talking about eight years ago was the government's "statistical efforts" to mask the market's evolving preference for shorter terms of holding dollars. In the ensuing eight years it has not played out exactly that way. But one would still expect to see some visible indication if global dollar preferences were heading to the short term. Or to put it another way, "to the here and now"!
For the really big money, "here and now" cash accounts in insolvent banks that are only guaranteed up to $250,000 are a poor option. But there is no such guarantee limitation on Treasury bills. So for the really big money we might expect to see a rush of funds into the shortest end of the yield curve, the 1 month Tbill. And with such a rush, we should expect to see the value of these bills soar as the yield falls to zero, or even possibly less than zero!
You see, for the really big money, it might be better to receive ALMOST all of your cash in 30 days if the system were to implode during that time, than to only receive $250,000 back from the FDIC. Of course you can always just keep rolling over your 1 month Tbills as long as the system doesn't implode. But as long as you, Mr. Really Big Money, see implosion as a possibility, it's best to keep your funds as close to the here and now as possible!
So what might we expect to see at the very end of this? How might it all end? As the pictures so graphically illustrate, it can't end well.
My friend and fellow blogger Sir Topaz has a few ideas...
The Stock Markets ...as expected, will be (are) the first skittle to fall here IMO. At approx 10% the size of the Bond arena, you'd expect this segment of the Market-place to be jettisoned first.
As the days (and weeks perhaps) wear on, we're likely to see the intensity of this "flight to the Here 'n Now" increase in magnitude.
The Precious Metals (price) will capitulate along with the rest of the general Market ...and this price capitulation will ultimately lead to a point where there's NO METAL on offer at the price.
An acquisition opportunity par excellence ...for those amongst us who fancy themselves as being uber-astute and ...."not one minute too late"
You see, when all this is done ...and the dust has settled, it WILL BE - all about the Metal!
Sincerely,
FOFOA
[1] 1967: Wilson defends 'pound in your pocket'
[2] Lessons From The London Gold Pool
[3] R.I.P. - The London Gold Pool, 1961-1968
[4] FOMC minutes 12/12/67
[5] The Early Gold Wars
[6] GATA.org
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