Arctic Goldfinger

J’Accuse: The large Central Banks, with the complicity of their governments and some major investment banks, have been engaged in a conspiracy to systematically depress the price of gold by both open and covert means.

There is evidence to support this charge, but I can’t prove it as if I were in a court of law. There are no minutes of meetings at which such a conspiracy was agreed to. It has to be inferred from the conduct of those involved and from certain economic events that cannot otherwise be explained.

So who are these Central Banks? They are institutions (like the Federal Reserve) that claim to be independent of their respective governments (yeah, right!) and who have control of their country’s money supply. In the case of the Euro there is one Central Bank for multiple countries.

As I said, one of any Central Bank’s main jobs, and the source of its main problem, is to create paper (or, nowadays, electronic) money. There is no theoretical limit on how much it can create and everyone knows that the more it creates the less it will be worth. Therefore, as with any money, its supply has to appear to be limited in order for the public to accept it.

So how does gold fit into this scheme? It doesn’t. It is, in fact, the Central Banks’ worst nightmare. Gold doesn’t have to do a thing to be money; it just is. As it has been for 5000 years. Its claim to fame from a monetary point of view (it has other virtues) is that there will never be much more of it. It is still dug out of the ground, but the world’s stock of gold increases at a snail’s pace. And you could take all the gold on earth and fill a space about equal to the bottom third of the Washington Monument. You definitely can’t print it or conjure it into being with a computer key stroke.

Gold does not require anyone’s Good Housekeeping Seal of Approval to be money. No pictures of Presidents or Queens are necessary. You can take a one ounce gold coin and go practically anywhere on the face of the earth and you will have little trouble finding someone who is willing to give you something in exchange for it, including a blow to the head.

Without any effort on its part, gold is now, as always, the touchstone for the value of paper currencies. And if the price of gold is steadily rising it arouses suspicions (well-founded) about the soundness of paper money. The fact that every single paper currency from history is now worth zip (except as a collectible on E-Bay) certainly fuels that belief.

From the standpoint of the Central Banks, it would be peachy keen if every gold molecule on earth were beamed into outer space. They even have trouble figuring out how to talk about it. The gold owned by the Central Bank is called “reserves,” but they won’t tell you for what since their money does not purport to be “backed” by gold — or anything.

Gold is the the silent witness to the inflationary schemes of the Central Banks. Therefore, the Central Banks have a compelling motive to suppress its price. The most blatant of the gold suppression schemes will be discussed in the next post.

P.S. In case anyone is wondering, I am not a conspiracy buff. I do not believe that J.F.K. was assassinated by Fidel Castro. I do not believe that aliens have visited the earth. I do not believe that the Commies are trying to pollute our Precious Bodily Fluids. The Central Bank gold conspiracy is my only one. I can promise you that I will not be veering off to discuss fluoridation of drinking water or the Protocols of the Elders of Zion.

I know this is supposed to be a gold blog, but I am going to write once more about a broader economic issue. I promise that the next post will not only be about gold, but will lay the groundwork for describing a conspiracy against gold by the evil Central Banks. (Boo! Hiss!)

First, though, a little more about inflation and, this time, interest rates. Everyone knows, of course, about interest rates. Sometimes they seem low (if you are a saver) or high (if you are a borrower). Either way, it is a number that represents how much you pay or are paid for the use of money. However few people outside the world of economics are familiar with the term “real interest rate.”

It is easily defined. The “real interest rate” is any interest rate minus the inflation rate. The important part is choosing the correct number for the inflation rate. My post about the Consumer Price Index argued that what the government calls the inflation rate is not a scientific fact, like the atomic weight of iron, but rather a politically motivated manipulation. In other words, a lie.

Referring again to my post about the CPI, I cited the work of economist John Williams (shadowstats.com) who contends that if the Consumer Price Index were calculated now, as it was traditionally, the correct inflation rate would be 10%. There are those would argue with that, but for the sake of this discussion let’s take Williams to be correct (since he is).

Going back to the definition of “real interest rate,” and assuming, for example, that a bank CD would now pay you let’s say 4.5%, the the real interest rate on your money would be negative 5.5% (some would would express it as “minus 5.5%”) Therefore, if you bought the CD, your money would lose 5.5% of its value over the course of a year.

There has been a great deal in the press about America’s “low savings rate.” In fact, it is at its lowest level since the depths of the Great Depression when people literally had no money to save. Commentators have called Americans selfish, shortsighted and dedicated to near term pleasures rather than to saving for their future and their childrens’ future.

To me the low savings rate proves something very different. It shows that Americans aren’t stupid. Thanks to the Fed and its out-of-control money creation machine, it is foolish to save. The smarter course is to either spend the money before it is worth even less, or try to put it into something, like real estate, which seems to be increasing in value faster than even John Williams’ figure for inflation. And, similarly, to borrow your butt off in the expectation that you will able to pay the loan back with cheaper money than you borrowed.

I could proceed forward from this point and expound at great length about the current state of the real estate market and related credit market issues. But I promised to get back to gold and the Central Banks, so that is what will be coming next.

Monetary inflation has now become the explicit policy of the U.S. Government. Of course, based on the historical record, you would think that inflation has always been government policy. But, at the official level, monetary stability has always been given lip service as the government’s avowed goal. After years and years of inflation, however, those pronouncements have had about as much credibility as a drunk staggering out of a bar and telling you that sobriety is his avowed goal.

Up until the appointment of Ben Bernanke as Chairman of the Fed, every one of his predecessors, to and including Alan Greenspan, pronounced the elimination of inflation as one of the Fed’s primary goals. All of this, of course, while the value of the dollars in our pockets was steadily depreciating thanks to the flood of paper money being created by the Fed and the banking system day after day and year after year.

When he came onboard as Fed Chairman, Ben Bernanke, to his credit, abandoned the pretense of trying to achieve zero inflation. Instead, he proposed “inflation targeting,” that is, attempting to hold inflation down to a low level, say two percent, rather than trying to eliminate it entirely. So what they call “tame” inflation has now become official policy.

The obvious question of course is why? According to mainstream economists, it is because the economy cannot grow without steady increases in the money supply. Therefore, they say, the choice is between either a little bit of inflation or recession/depression. Putting aside whether or not that is true (hint: it’s not), the problem is that we rarely have a little bit of inflation.

In the last post I talked about the joke known as the Consumer Price Index. Unfortunately it’s not really funny. The CPI is the basis on which cost of living adjustments for social security recipients are calculated. Because it understates inflation on a year over year basis, those who can least afford the effects of inflation are being further impoverished by it. But on the plus side, from the government’s point of view, it saves large amounts of money that can be spent on farm subsidies, stupid wars and other things that are more important than food and housing for the poor.

But I do admire Bernanke for abandoning the pretense of achieving zero inflation. Under our current funny money system that can never happen and I give him credit for admitting it.

When you talk about gold you have to talk about inflation and when you talk about inflation, at least in the United States, you have to talk about the Consumer Price Index (CPI), which is the government’s official report of inflation at the retail level. The CPI is reported every month by the Bureau of Labor Statistics (BLS).

The CPI in recent months has been showing a “core” inflation rate in the neighborhood of 2% per annum. This allows Ben Bernanke to tell Congress that inflation has been “contained” and therefore that the Fed is doing a splendid job. And the newspapers report the 2% inflation figure without a hint of irony.

It is not disputed that this “core” inflation number excludes food and energy, but that is rationalized by describing these prices as “volatile” and therefore misleading. And for anyone who doesn’t eat or drive a car that makes perfect sense. But for those who lead normal lives, however, the “core” CPI, right off the bat, is a joke.

I think most people understand “volatile” to mean that a price goes up and then goes down. Applying that to the real world, you would then have to say that the price of crude oil went up to $40 a barrel, then down to $50, then up to $60, then down to $70 and finally up to $80. As for food, the prices of wheat, corn and dairy products are at or approaching all time highs. In fact, if you haven’t been getting sticker shock at the grocery store you are lot richer than I am.

But that’s not all. Most people, I believe, assume that the CPI, from month to month, looks at the actual prices of a constant basket of items and then reports the change. And, in fact, prior to the Clinton administration, the BLS calculated the CPI exactly that way.

But Clinton didn’t like seeing the CPI go up and told the BLS to do something about it — and they did. They started introducing “adjustments” intended, they claimed, to make the CPI more accurate (i.e., lower). If the price of something in the index was going up too fast they would replace it with something more to their liking.

As if that weren’t enough, they began to make what they called “hedonic” adjustments. (“Hedonic” means relating to pleasure). So, for example, if the price of a computer went up they would look at that and if, in their judgment, you got more for your money (more memory, faster, etc.) they would treat it as if the price of the computer had stayed the same, or even gone down. And the Bush administration, of course, has told the BLS to keep up the good work. Who wants higher inflation?

My source for this analysis is the work of an economist named John Williams who compiles what he calls “Shadow Government Statistics.” He has taken the CPI, gone back to the pre-Clinton era methodology and added back food and energy. By Williams’ calculation, the true CPI, calculated in this manner, is running at about 10% per year. That’s right — 10%

I don’t think anyone reading this (other than a Buddhist Monk) will be the least bit surprised. So you can now stop believing the 2% BS from the BLS. Also, in case you are wondering, Williams says that the rest of the government’s statistics are just as phony and that we are, right now, already in a recession.

If you go to the Blogroll on this page you will see a new link to “Money As Debt.” It is a 47 minute long film (actually a cartoon) with a terrific explanation of how money and debt are created in the modern world. I kind of generally knew the stuff it talks about, but it really brought it home in a very enjoyable (albeit scary) way. It will be well worth your while to set aside the time to watch it.

If my link doesn’t work for you for some reason, find “Money as Debt” somewhere. You will not be sorry. My only quarrel with the film is what it has to say about the future. When it talks about the past and the present, though, it is literally and figuratively right on the money.

When you live in today’s world, you can reach only one conclusion as to where money comes from: governments. Sometimes it is one government, as with the U.S. Dollar or the Mexican Peso, or several governments, as with the Euro. Sometimes one country uses another country’s currency as its own, e.g. Panama and Ecuador, which both use the U.S. Dollar. But always, somewhere at the center of things, lies a government or, its alter ego, a Central Bank. (Boo!Hiss!)

If you go back through history, however, the picture is quite different. There is no question that the invention of money predates the creation of governments as we know them today. As far back as we know, money, in some form, was adopted spontaneously as the only solution to the immense difficulty of relying entirely on barter.

In order to fill this desperate need, each society adopted some form of money that worked for that society. For something to be money, the only constant was an understanding throughout society that it would be used and accepted as money. Additional requirements were few. First and foremost, it had to be something in limited supply. It wouldn’t do for it to be something that anyone could pick up off the street. In other words, it had to be either relatively rare or valuable in its own right. It needed to be reasonably portable so that it could be given to someone in exchange for what you were buying. Finally, it had to be something that was not too perishable. Grain would work, but bananas would not.

The historical record is replete with examples of a variety of things being used as money. What they all had in common is that they more or less satisfied the above criteria and worked for that particular society. Some forms of money, such as cattle, had problems that we don’t have to deal with today. Whatever else you may say about the dollar, it doesn’t have to be fed and won’t die on you (except perhaps metaphorically). The point is that if people consider something money and use it as money then it is money. This remains true today where, for example, in prisons cigarettes are used as money.

An example from ancient China is particularly instructive on how money can go from the concrete to the abstract. At one point people began using farm implements as money. That proved unwieldy, of course, and over time the actual farm implements were replaced by small metal tokens that were stylized representations of farm implements.

No one knows exactly when gold began being used as money, but it was clearly before the dawn of recorded history. Gold’s qualifications for that role are impeccable. It is rare. It is virtually indestructible. It neither rusts nor tarnishes nor evaporates. It is easily divided into units of any size or melted down and combined into larger units.

With the advent of governments, it was apparent that controlling money is a huge benefit for anyone exercising sovereign power. So emperors and kings began minting coins out of gold and silver with their picture on them in order to proclaim their power and glorify themselves. And almost as soon as coinage began, so did monetary debasement.

Monetary debasement stems from a human desire that ranks up there with food and sex — getting something for nothing. If you can turn one hundred coins into two hundred coins by replacing the precious metal component with something cheaper, then you have created money out of thin air and can buy twice as much as before.

That is until people catch on and then you have inflation. That is a topic that will be revisited time and time again in future posts.

If my last post hasn’t scared potential gold investors to death, I will describe the three ways to invest in the gold market — physical gold, a gold ETF and gold mining stocks. There are arguments pro and con for each.

Physical gold is just what it sounds like. You can buy gold bars or you can buy “bullion coins,” such as Krugerrands and Maple Leafs. These must be distinguished from numismatic coins that trade at a premium to the gold price because of their relative rarity. There is nothing wrong with them, but I avoid them because they involve factors I am not familiar with. The bullion coins are sold at a small premium to the gold price, but they have the advantage of liquidity. They are easy to sell and don’t need to be assayed for weight and purity as would physical gold in other forms.

One disadvantage of physical gold is that you need to keep it in a secure place such as a safe deposit box. For something that supposedly isn’t important any more, there are a surprising number of people who would be happy to relieve you of them. On the other hand, physical gold has the advantage of being just plain beautiful. There is something satisfying about holding an ounce of pure gold in your hand.

I need to say one last word about physical gold. There are gold proponents who say that physical gold is the only safe way to own it. Not safe from burglars, but safe from the government. They point out that during the Great Depression the ownership of gold was made illegal and that the best way to guard against that is have it in physical form and ignore any order that requires you to give it up. I personally don’t worry about that much, but paranoids aren’t always wrong.

The second way to invest in gold is to buy shares in a gold ETF, which is short for Exchange Traded Fund. These shares mirror the market value of gold. There are other gold ETF’s, but the most popular one is called StreetTracks Gold Trust and trades on the New York Stock Exchange under the ticker symbol GLD.

Each share of GLD represents the value of one-tenth of an ounce of gold, although not with mathematical precision. So if gold is selling for $650 an ounce a share of GLD will cost you $65, give or take. A hundred shares would then cost you around $6500 and be the equivalent of owning ten ounces of gold.

As shares of the Trust are purchased, the Trust buys physical gold that is held in vaults in London. You should be aware, though, that you have no direct claim on that gold. Your shares in GLD are basically a bet on the gold price. Also, profits are taxed at a higher rate than the usual capital gains rate because of some arcane provision in the Internal Revenue Code. That is not true for gold mining shares, which I will discuss next.

The third way to invest in gold is to buy shares in gold mining companies. You can buy shares in individual companies or in mutual funds that invest in gold mining companies. Mining shares more or less track changes in the gold price, but not with the mechanical precision of GLD. Gold mining is a business and involves enterprise issues that are not related to the price of gold as such. Sometimes those differences work in your favor and sometimes they don’t.

So there you have it. The easiest route is to buy GLD and/or a gold mining mutual fund. A few bullion coins, however, will give you the tangible feeling that you really own some gold.

I received a very complimentary e-mail from a friend who said that she enjoys this blog and finds my arguments well stated. I appreciate that, but think the time has come for me to throw a little cold water on the proceedings by introducing the guys on the other side — the Central Banks.

That Central Banks hate gold can hardly be disputed. While they are spewing out their staggering piles of so-called money, gold just sits there, as it always has, immortal, immutable and, like the Central Banks’ opinion of gold, unprintable. While the quantity of their unbacked fiat paper crap (my words, not theirs) grows and grows, the amount of gold on this little blue planet stays pretty much the same.

The problem for gold bugs like me, however, is that whatever the Central Banks may think of gold, they own a lot of it. I mean a LOT of it. The six Central Banks with the largest holdings own over 20,000 metric tons of gold. Let’s say that a bit differently. They own over twenty million kilos of gold. Let’s do that one more time. They own over twelve billion ounces of gold (give or take).

That certainly gives one pause. One of the things they could do with it is sell it and that wouldn’t exactly drive the gold price up, to put it mildly. That “overhang,” as it is generally known, of Central Bank gold is scary for any gold bull. And it should be.

The topic of Central Bank gold sales has an interesting history some of which I will deal with in later posts. But for now, before anyone becomes too enthusiastic, be afraid. Be very afraid. The guys on the other side have plenty of ammunition.

I was trading e-mails with a friend when the subject of gold came up (which often happens when I’m part of the conversation). She allowed as how she owns some gold coins, but said “the fish in my freezer will be more useful come the end times.” Many people think the same way. They see an inherent Catch 22 in owning gold. If the social fabric falls apart your gold won’t do you any good. You will need a machine gun, not gold, to defend the food in your cupboard from your hungry torch-bearing neighbors.

I am certainly not about to declare the end times scenario impossible. But I think it is fair to consider it unlikely. This planet will always have its winners and losers, but the scenario in which everybody loses makes for great fiction (e.g. Mad Max), but seems like a longshot. (A compromise would be to have a gold machine gun, but then you would have to be James Bond.)

Profits in gold, however, don’t require a collapse of our current regime of fiat paper money much less the end of the world. They just requires a loss of confidence in the currency. And why would anybody lose confidence in it? Hmmm, how about:

1. The current 35 year experiment in floating unbacked paper money is unique in human history.

2. No one knows how much money is out there and who actually owns it.

3. The money is created out of thin air and, in the West at least, mostly exists in the forms of electronic bleeps and bloops.

There are other reasons, but if those don’t make you a little nervous about the contents of your bank account then you aren’t paying attention. It goes back to what I said in an earlier post: gold is money. Its value floats the same as that of all other money. There is one big difference, however. Governments can’t print it. The end of the world is therefore not required in order for gold, heavy as it is, to float to the top.

Ever since he was appointed Chairman of the Fed, Ben Bernanke has been trying to live down the nickname “Helicopter Ben.” It goes back to his academic days when he wrote a paper about the Great Depression which said, to make a long story short, that the Fed has the power to do whatever it takes to ward off a deflationary economic collapse including shoving money out of helicopters to keep prices from falling.

So what’s so bad about prices falling you may ask? The answer is complicated, but, to make another long story short, if people start to believe that prices tomorrow will be lower than they are today then they might save their money rather than spend it. That could cause the economy to decline because of decreasing demand and if such a downward spiral were to feed on itself you would have the makings of another Great Depression.

It shouldn’t be too hard, though, to imagine the consequences of the cure (the helicopter cash drop) that Bernanke mused about. People on the ground would figure out that the money falling to the ground is probably diluting the value of the money in their wallets and they would start spending it furiously. That would result in the opposite side of the coin from deflation — hyperinflation. And the result of would be the money eventually becoming worthless, as happened in Germany after WW1.

Because of the embarrassing nickname, Bernanke has, since day he was appointed Fed Chairman, claimed to be a stalwart inflation fighter. It is therefore surprising that the Fed yesterday cut interest rates like crazy. What it tells me is that the current economic mess is even worse than the insiders are saying and that inflation is considered the lesser of two evils if the alternative is a deflationary collapse.