Numismatics

The liberty of a democracy is not safe if the people tolerate the growth of private power to a point where it becomes stronger than their democratic State itself. That, in its essence, is Fascism –- ownership of government by an individual, by a group, or any controlling private power.

For over two decades mobs of coin salesmen have been beating the dead horse of government gold confiscation. They hawk their wares – expensive numismatic coins with commissions upwards of 25%, usually US $20 gold pieces – by terrorising the ignorant public with the threat of confiscation. They claim that these coins are “exempt” from confiscation because they are “numismatic” (pron. noo-miz-MA-tick). Usually this is accompanied by the claim that the law defines “numismatic” as “costing more than 15% over its metal value.”

None of these claims have any basis in current statute or regulation, period. No statute or regulation “exempts” them. The law does not define pre-1934 gold coins as “numismatic,” but only certain coins the US mint issued since 1982 [sic. See 31 USC 5111(a)(3). Nowhere does any present regulation or statute define “numismatic” coins as those with a 15% premium. The only colourable basis for the “exemption” claim is slim precedent. When Roosevelt seized gold in 1934, he exempted “gold coins having a recognised special value to collectors of rare and unusual coins.” (Executive Order of 4/5/1933, § 2(b)). I have explained all this in the sidebar with this article, with citations to the regulations. Besides, the vast bulk of gold Roosevelt wanted to seize did not lie in the hands of private citizens, but on deposit in banks.

Congress passed the Gold Reserve Act of 1934 as an after the fact legal rationalisation for Roosevelt’s confiscation.[1] This act also criminalised gold ownership; those criminalising provisions were repealed in 1974, effective January 1, 1975. At the same time those provisions were repealed, all regulations relying on them automatically expired as well, since their underlying statutory authority had ceased to exist. There is at present no statutory or regulatory basis for confiscating gold, so there is no legal means for confiscation.

But what law does a thief need? Roosevelt lacked all authority whatsoever for the first call-in. After 65 years of increasing tyranny, would Bush & Co. gag at that? Not likely, but where’s their motive? Gold today forms no meaningful part of the world’s monetary system, according to the official story. In 1933, on the other hand, gold formed the reserve base of the entire monetary system. Why would the government today ever run the risk and unpleasantness of trying to call in gold? Wouldn’t that contradict the official story that “gold has been demonetised”? Wouldn’t that undermine their own fiat money?

Here you must follow the money, a twisted trail beginning with the gold carry trade. About 20 years ago central banks began loaning out their gold reserves, mostly to mining companies. After all, the reserves were just sitting there earning nothing. Why not put them to work? Miners could borrow gold at minuscule rates, one-half to one percent a year, sell the gold, use the proceeds to finance exploration and development, then repay the loans with newly mined gold. Borrow gold – pay back gold.

It worked so well that hedge funds began to wet their beaks -- not in mining gold, of course, but merely in borrowing gold at low rates, selling it, and investing the proceeds in government bonds paying 5 – 6%. Free money – just back up the truck. Beginning about 1996, the gold carry trade exploded.

Midwives to this trade were the bullion banks. Everybody would remain happy, wealthy, and wise as long as the price of gold didn’t rise above the price where they had sold it. Better yet, the further gold sank, the larger the “kicker profit” that borrowers reaped – the interest rate differential plus the profit from shorting gold.

Pretty soon the gold carry trade had attracted a fairly large flock of wet beaks – bullion banks, hedge funds, miners, and central banks – who didn’t want to see gold’s price rise at all. Not coincidentally, many of the wet beaks or their wetters were plugged into government positions such as the United States Treasury – positions powerful enough to influence the price of gold behind the curtains.

Even economists agree that the demand for free money is always fairly strong, so the number of trucks backing up to carry it off grew and grew. So did the short position over the gold market, today estimated at 5,000 tonnes (about 2 years’ mine production) to 15,000 tonnes (about 6 years’ mine production).

By now the game has grown so colossal and the players so big and numerous that a rising gold price can inspire numerous powerful central bankers and bureaucrats to check their deodorant. Bullion banks, for one, didn’t just loan out gold they had borrowed from central banks. They wrote lots and lots of derivatives as well on gold they didn’t have. That meant lots more free money, if you could be sure your government and central bank friends would keep the price from rising by evermore selling gold into the market, as Greenspan’s July 1998 speech seemed to promise.[2]

Today the bullion bank with the largest published position in gold derivatives, J.P. Morgan Chase, has sold $41 billion notional value[3] gold derivatives,[4] 65% of all reported outstanding US gold derivatives ($63.4 billion). Citibank, the only other bank reporting a position in gold derivatives, has $7.8 billion or 12% of the total.

Yet gold derivatives are peanuts, nay, mustard seed or fungal spores compared to the market for interest rate derivatives. Interest rate derivatives are financial contracts whose value changes with changes in interest rates. They are in effect bets on which way interest rates will move.

On December 31, 2001 all banks’ exposure to interest rate derivatives was $28.6 trillion with a “T”. JPM, Bank of America, and Citibank control 91% of all interest rate derivatives reported by US banks. In September, 2001 Adam Hamilton of Zeal Intelligence wrote, “JPM has at least $20,701 billion notional value exposure to interest rate derivatives contracts. This is 484 times JPM’s total shareholder’s equity.”[5] (For Fourth Quarter 2001 JPM Chase’s position had shrunk to only $16.5 trillion, but what’s a few trillion among friends?)

The size of the entire derivatives market among US banks is simply staggering with $45.4 trillion reported to the US Comptroller of the Currency in Fourth Quarter 2001. To put that gargantuan number into perspective, the US Gross Domestic Product runs about $10 trillion a year. Of the 369 banks reporting, the top nine control 97% of the market. The top three – JP Morgan Chase Bank, Bank of America, and Citibank – control 94% of the entire market.

Of course, everybody -- bullion banks and borrowers -- stood to make zillions in the gold carry trade. But as time went on, a much larger and even more profitable motive to suppress the gold price emerged: suppressing long term interest rates.

Why would that bring fabulously greater profits? Because an obscure, abstruse relationship exists between gold prices and long term interest rates. Gold and real (as opposed to nominal) interest rates are inversely related. In other words, the higher real) interest rates rise, the more interest income you must forgo to hold gold, and vice versa. The higher interest rates rise, the more interest you must give up to hold gold. Turned around, low gold prices imply high long term rates, and high gold prices imply lower long term rates.[6]

If you could use the gold price to jimmy interest rate expectations, then the opportunity to skim might be measured in trillions rather than mere billions. It would enable you to control or confidently predict a huge market – interest rates – using a tiny lever – gold As Adam Hamilton explains in “The JPM Derivatives Monster,”

“If JPM top management was participating in any US efforts to cap gold, they had full knowledge that a de facto fixed gold price regime had been stealthily established and they would have had carte blanche to massively balloon … highly lucrative interest rate derivatives exposure. After all, if JPM was convinced gold was under control, and that gold prices were a prime driver of real interest rates, then what better time to become the king of the interest rate derivatives world than when gold was being quietly hammered down through massive sales of official sector gold from Western central banks’ coffers?”[7]

Rising gold prices also blow the whistle on depreciating fiat currency values. Hence numerous central banks, as issuers of fiat currencies, might also have a motive to suppress the gold price.

As always when dealing with fallen mankind, the problem at this point is that success begets excess. With all that free money lying on the dock at the bullion banks, plenty of trucks were bound to show up. Now the crowd has grown so large and diverse that size and entangling cross defaults become a danger to the biggest players. America’s (and the world’s) biggest banks are involved. A dropping domino in the gold market (rising gold) might topple not only the huge short position born out of the gold carry trade, but also the huge interest rate derivatives position and the value of the heavily-inflated-but-not-yet-falling US dollar.

How might everything unravel? Gold might rise through 300, then through 315, which (according to the best expert I have heard) is probably where the short position breaks even. Panic seizes the short sellers, who try to reverse their position by buying. Their buying drives the price farther up, in a self-feeding cycle. The rising gold price implies the US dollar’s value will drop. The implied rise in inflation sends long term nominal interest rates up, choking off the US economy.

What do we see then? Although gold has been demonetised for all purposes other than central bank official reserves, its price still most strongly and narrowly influences the whole financial world. Farfetched as it may otherwise be, a gold confiscation just might fit into this picture. What would relieve the pressure of a rising gold price? More supply. Where might that come from? The co-operating or co-opted central banks of the world have most likely already been looted. Why not loot the public now? Why not steal their gold?

Whoa! Hold on a minute! I am most emphatically not, repeat, not predicting a government gold grab. However, the topic recently cropped up because of an article in the February 17 Washington Post. I had a hard time forcing myself to write this article, fearing that if I did, I might contribute to that false fear, but better that than let the Chicken Littles run wild.

What does that article signify? The Washington Post and the New York Times are the fountains of the incestuous stream of “news” that moulds and shapes public opinion in the USA. That becomes especially clear when you read the Times regularly while also reading Time, Newsweek, and local newspapers. Any subject in the Times this week will appear in Time and Newsweek next week, and virtually verbatim in your local newspaper. The selectivity of this incestuous news stream glares even more blindlingly when you read the foreign press.

When the ruling Establishment wants to install some policy, they soften up the enemy’s positions not with an artillery but a propaganda barrage. The Washington Times article presented gold as a vicious tool of terrorists. That could be construed as the opening shot in a campaign to demonise gold.

Now whether this was only the first in a series of such attacks remains to be seen, but the technique is well-worn. We have seen it over and over with manufactured crisis after manufactured crisis, from money laundering to handguns to health care to spotted owls to the War on Drugs. . Normally the Washington Post or New York Times begins the demonisation, and then the lesser branches downstream take up the hue & cry. After sufficient hueing and crying a "crisis" erupts, whereupon Congress volunteers to "fix" things. "Fix" means "outlaw & criminalise", usually.

The article was entitled “Al Qaeda's Road Paved With Gold -- Secret Shipments Traced Through a Lax System In United Arab Emirates.” It appeared under Doug Farah’s byline in the Sunday, February 17, 2001 Washington Post on page A01. He identified gold as a chief means al Quaeda and other terrorist groups use to transfer and hide their wealth. “The interviews offered a tantalising glimpse into the critical yet mysterious role played in the finances of al Qaeda, both before and after the September 11 attacks. Gold has allowed the Taliban and bin Laden to largely preserve their financial resources, despite the military attack that bettered their forces in Afghanistan … [G]old played a uniquely important role in the group’s financial structure … because it is a global currency.” Along with gold he targeted the network of Arab “halawas, the informal money transfer system widely used across the Middle East, North Africa, and Asia that … often serves as the only money transfer system.” Halawa transactions take place between each other and once completed, transaction records are destroyed.” In sum the article presents the equation, “Gold = Terrorists = Osama bin Laden.”

How does all this fit together? First of all, it is unlikely that this truly marks the beginning of a gold demonising campaign, so don’t panic. However, it also raises a motivation wholly different from that of the 1933-34 crisis, but plausible nonetheless. The most influential Establishment banks in the country (and the world) have their necks on the line in gold and interest rate derivatives. What happens when gold passes through US$305, then US$315? Will they survive or crumble? Will the government bail them out? Answer: they and their government cronies would shoot their mothers in front of a cop to hold onto their power.

But remember the line of least resistance. Any attempt to confiscate gold would hit one of the most obstreperous and least co-operative groups in the country, gold owners. Why kick up all that fuss when there’s an easier way out? Simply impose cash rather than in kind settlement on all gold contracts. That bails out the banks, avoids the messy fight of confiscation, and might even tame the market.

As I have repeatedly said, I am not predicting gold confiscation. However, I recognise it as a remote possibility. What does that mean for you and for me? That we ought to think out in advance what our course will be. If it comes down to a choice – your family’s ability to eat and survive versus a wicked government order – you had best make your choice in advance.

The liberty of a democracy is not safe if the people tolerate the growth of private power to a point where it becomes stronger than their democratic State itself. That, in its essence, is Fascism –- ownership

Click on either chart to download Excel spreadsheet

[1] In fact, Roosevelt declared an “emergency” equivalent to war and then usurped powers under the 1917 Trading with the Enemy Act” to seize the gold. Really, ‘seize” or “confiscate’ constitutes a misnomer. By the Gold Reserve Act of 1934 congress after the fact more or less ratified what he had done. Carefully distinguish what the government did. They forced the holders of US government-minted legal tender gold coin (and bullion in banks) to turn in their gold money for the equivalent in US government legal tender paper money. So if you had a $20 gold piece, you received in exchange a $20 bill. (Let us leave unexamined for a moment Roosevelt’s already-hatched perfidious plans to raise the price of gold from $20.6718 per ounce to $35.00 per ounce or a 41% devaluation.) In law, at least, the gold was not “seized” or “confiscated,” only called in. However, the Gold Reserve Act of 1934 later restricted gold ownership to jewellers and those in the trade. Those provisions were repealed in 1974, effective January 1, 1975. How the government might handle today foreign coins is another question. The 1933 ruse wouldn’t work when your are forced to swap a South African Krugerrand for US paper money..

[2] Testifying before the House Banking committee in July 1998, Greenspan assured the committee, “[N]or can private counterparties restrict [the] supply of gold, another commodity whose derivatives are often traded over the counter, where central banks stand ready to lease gold in increasing quantities should the price rise.” Ringing in the ears of the gold carry trade and bullion banks, this translated as, “Back those trucks up to the dock! Not only is the boss not watching, the boss is in on the deal, too!” If it wasn’t an announcement that central banks were controlling and intended to keep on controlling the gold price, it’s pretty hard to imagine what it did mean.

[3] Think of “notional value” as “face value,” not current market value. If you hold a December 2003 call option for gold with a strike price of $400, the “notional value” is $40,000 ($400 an ounce times 100 ounces). However, with spot gold at $293.50 that Dec. ‘03/$400 strike option will only bring $370. Hence notional value is the roughest possible approximation of the position’s level of risk. To determine the risk accurately, the derivatives must be evaluated against current market. How you would do this with a twenty trillion dollar position is anybody’s guess.

[4] The Office of the Comptroller of the Currency defines “derivative” as “a financial contract whose value is derived from the performance of assets, interest rates, currency exchange rates, or indexes. Derivative transactions include a wide assortment of financial contracts . . .” Rather than delve into the wonders of swaps, caps, floors, collars, etc, just think of derivatives as futures and options contracts.

[5] These figures and others in this article are updated from the Office of the Comptroller of the Currency, Administrator of National Banks “ OCC Bank Derivatives Report Fourth Quarter 2001. I first found this connection presented by Adam Hamilton in “The JPM Derivatives Monster,” September 7, 2001, www.zealllc.com/commentary/monster.htm and “JPM Derivatives Monster Grows,” January 4, 2002, http://www.zealllc.com/2002/jpmgrows.htm. I strongly recommend you subscribe to Adam Hamilton’s superb and lively Zeal Intelligence newsletter at his website. To thoroughly understand my short article here, you need to read Mr. Hamilton’s deeper pieces cited above and “Real Rates & Gold,” 7/20/2001, www.zealllc.com/commentary/realgold.htm.

[6] On this point see Reg Howe’s “Gibson’s Paradox Revisited: Professor Summers Analyzes Gold Prices,” August 13, 2001, www.goldenstxtant.com/commentary18html.

[7] Hamilton, “The JPM Derivatives Monster,” page 14.