All Bad Things Come to an End

The bane of our times is the widespread belief in human competence.

That's not of course to say that no one is competent - a great many people are and are capable of doing a great many things quite well - but even a shallow peek into history will show that most of the catastrophic financial problems of mankind were caused by people who should have known better and followed by flocks of soon-to-be-sheared sheep who presumed that because someone was on the contemporary equivalent of CNBC, that person was therefore competent. We believe in experts and that others "know what they are doing," and nowhere is that presumption more widespread and more dangerous than in the realm of central banking.

I'm going to cut a long story very short, just giving enough of the backstory for you to (probably mistakenly) assume I'm competent to talk about it. How's that for irony?

Central banks hold gold as a backing for their currencies. They have since central banks were established and they will forever, because as Alan Greenspan remarked to Dr. Paul in House testimony a few years back, in a financial emergency gold may be the only currency acceptable to settle accounts between nations. That's fact #1.

Fact #2 is that gold acts as a barometer of currency strength, and a rising price of gold in a nation's currency has long been recognized as a harbinger of economic troubles. Therefore it's no coincidence that the bottom of the gold market came precisely when the US dollar was at its strongest. 'Inversely proportional' sums it up. Gold has more than doubled in 4 short years since then.

Fact #3 is that central banks, paying heed to both fact #1 and fact #2, have a vested interest in making the price of gold low in their currencies if they want to project economic 'strength'. One way to do that is to sell gold, depressing the price. But because the gold they hold ostensibly belongs to the nation rather than the bank, they have no right to sell it. How then can they have their cake and eat it, too? How can they ensure the gold is sold, yet at the same time retain legal ownership of it?

One way is to 'lease' that gold out. By leasing it to a bullion bank (for a percentage return, usually 1% or 2%) they can keep it on their books while the bullion banks sells the gold into the market and invests the dollars in higher-returning vehicles, like t-bills. This excess supply of gold causes the price to fall, making the currency look stronger than it is. A falling gold price also ensures the bullion banks get a double return: an interest spread and a gain from the short sale. So long as no one knows, they can do it a long long time.

But it was a trap. The more gold that was sold, the lower the price fell, but bullion banks found that whenever the price of gold turned upward, they were suddenly trapped with literally millions of ounces in losing short positions. Buying those ounces back to cover their loans would raise the price more, wiping out their gains (oops, never thought about that, huh?) so the only way to preserve those gains was to suppress the price further by selling more and more gold.

But the longer the price was held down, the more cental bank gold was needed to supply a market that had a seemingly endless apetite for it. At last, in a trade that will go down in infamy, the Bank of England sold outright (after all but saying gold was worthless) several hundred million ounces of gold at the very bottom. Gold turned and began to rise. Fast. And as gold rose past the point where much of the dumping had occurred, it quickly became apparent that bullion banks if bullion banks had truly shorted thousands of tons, they could NEVER buy the gold back to cover what their borrowings - the best they could do was promise to pay that 1-2% interest in perpetuity and have everyone pretend all was well.

But all is not well. A group of gold bugs led by controversial analyst and former NFL tight end Bill Murphy created a group colled Gold Anti-Trust Action (GATA) and filed some lawsuits and started noising about the likely outcome of this massive shorting of gold. Someone was buying it and hauling it away (I think in a rickshaw, but that's just a guess) and the central banks denied they had leased the gold out, or at least they denied it was in the enormous amounts alleged. GATA has been steadfast, but has remained marginalized by a mainstream press for whom a PR on the Fed's letterhead might as well be penned by Moses.

Until now. As the price of gold continues to rise, and as companies like Barrick start to admit billions of dollars in investment losses via these schemes, other banks and brokerages are starting to take notice:

St. LOUIS - Cheuvreux, the equity brokerage house of the French bank Credit Agricole, distributed a 56-page report today endorsing the findings of the Gold Anti-Trust Action Committee (GATA) that the price of gold has been surreptitiously suppressed by Western central banks and that those banks do not have the gold they claim to have.

The report, written by Cheuvreux’s mining sector analyst in London, Paul Mylchreest, is titled "Remonetisation of Gold: Start Hoarding."

It repeatedly cites GATA by name and foresees an "unprecedented" rise in the gold price. But what is more, the report accuses central banks of “covert selling.”

According to the report, Cheuvreux has raised its mid-cycle gold price estimate to $900/oz from $750/oz, and sees the possibility of a spike to $2,000/oz, or higher.

Now all of that may be distilled into two things, and if you only take two things from all this noise, let these be they:

First, the central banks of the western world, in a dishonest attempt to show financial strength, set up a scheme in which they leased their gold, allowing it to remain on their books as an asset while simultaneously selling it in the market. That has ended, the gold is gone, and they are trapped. It was incompetence of the highest order, and will result in untold financial troubles across the western world. Gold is currently at a quarter-century high in part because of this.

Second, because the gold to be recovered must come from a market that is already supply short, the price will fly, far surpassing the old high set in 1981. Personally, I think the Dow and gold will meet at around 3000, like they met at 800 during the last gold bull (check a chart some time) until all the crooked, secret, and incompetent deals of the past two decades are unwound. It will be public and it will be bloody.

But no, there's a third thing, and it may be the most important of all. Everything I've said of gold above is also true of silver. In fact, it's doubly true for silver, becase while leased gold exists SOMEWHERE, leased silver is consumed. It's gone. And there is not enough silver in the world to return it all. If gold is going to the moon, silver is going to Alpha Centauri.

As is too often the case, those in government decided they knew better than the market what prices ought to be and they manipulated the markets to give a phony impression of strength. As always it worked for a while. As always perverse incentives trapped them. As always the entire economy will pay for their incompetence, and eventually we'll learn our lesson. Note the title of the French report once again.

We'll stumble through it, like our grandparents did. And then our grandkids will elect idiots to do the same thing, and they'll learn the same lesson again.

I started off with a strange statement, that it was a bane of humanity to believe in human competence. But how does one example a trend make? The answer is that this example - a combination of unforeseen effects, bad judgement, bad incentives, diversion, and secrecy - is repeated nearly every time the government intervenes in a market to make things better. Yet we continue to believe that wise men in Washington, elected or not, can work to make our lives better. They can give us a free ride that lasts forever. They can borrow and spend us all to prosperity.

But the one-way street that trapped the bullion banks and will result in billions (if not trillions) in derivatives losses is the same street that Washington is taking us on in regards to debt. It cannot rise forever; it can only rise until debt service costs meets income. And when they do, we will learn that we have consumed our future, just like the bullion banks consumed their future.

Yet we're sure they know what they're doing, and we're too busy paying our credit card debts to question it.