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A Short History of the Gold
Cartel

May 4,2009 - This week Bill Murphy and Chris Powell,
co-founders of the Gold Anti-Trust Action Committee (http://www.gata.org/), will be in
London, England. Their trip is part of GATA’s ongoing effort to
raise awareness of the gold cartel and its surreptitious
intervention in the gold market.

Bill and Chris will meet with the British media to
explain GATA’s findings. They will also attend an important fund
raising event being held in support of GATA’s work. Their trip is
another important step by GATA aimed at creating a free market in
gold, one which is unfettered by government intervention.

Governments want a low gold price to make national
currencies look good. Gold is recognizable the world over as the
‘canary in the coalmine’ when it comes to money. A rising gold price
blurts the unpleasant truth that a national currency is being poorly
managed and that its purchasing power is being inflated.

This reality is made clear by former Federal Reserve
chairman Paul Volcker. Commenting in his memoirs about the soaring
gold price in the years immediately following the end of the gold
standard in 1971, he notes: “Joint intervention in gold sales to
prevent a steep rise in the price of gold, however, was not
undertaken. That was a mistake.” It was a mistake because a
rising gold price undermines the thin reed upon which all fiat
currency rests – confidence. But it was a mistake only from the
perspective of a central banker, which is of course at odds with
anyone who believes in free markets.

The US government has learned from experience and
taken Volcker’s advice. Given the US dollar’s role as the world’s
reserve currency, the US government has the most to lose if the
market chooses gold over fiat currency and erodes the government’s
stranglehold on the monopolistic privilege that it has awarded to
itself of creating ‘money’.

So the US government intervenes in the gold market to
make the dollar look worthy of being the world’s reserve currency
when of course it is not equal to the demands of that esteemed role.
The US government does this by trying to keep the gold price low,
but this aim is an impossible task. In the end, gold always wins,
i.e., its price inevitably climbs higher as fiat currency is
debased, which is a reality understood and recognized by government
policymakers. So recognizing the futility of capping the gold price,
they instead compromise by letting the gold price rise somewhat,
say, 15% per annum. In fact, against the dollar, gold is actually up
16.3% p.a. on average for the last eight years. In battlefield
terms, the US government is conducting a managed retreat for fiat
currency in an attempt to control gold’s advance.

Though it has let the gold price rise, gold has risen
by less than it would in a free market because the purchasing power
of the dollar continues to be inflated and also because gold remains
so undervalued notwithstanding its annual appreciation this decade.
These gains started from gold’s historic low valuation in 1999. Gold
may not be as good a value as it was in 1999, but it nevertheless
remains extremely undervalued.

For example, until the end of the 19th century,
approximately 40% of the world’s money supply consisted of gold, and
the remaining 60% was national currency. As governments began to
usurp the money issuing privilege and intentionally diminish gold’s
role, fiat currency’s role expanded by the mid-20th century to
approximately 90%. The inflationary policies of the 1960s,
particularly in the US, further eroded gold’s role to 2% by the time
the last remnants of the gold standard were abandoned in 1971.
Gold’s importance rebounded in the 1970s, which caused Volcker to
lament the so-called mistakes of policymakers. Its percentage rose
to nearly 10% by 1980. But gold’s percent of the world money supply
thereafter declined, reaching about 1% in 1999. Today it still
remains below 2%.

From this analysis it is reasonable to conclude that
gold should comprise at least 10% of the world’s money supply.
Because it is nowhere near that level, gold is undervalued.

So given the ongoing dollar debasement being
pursued by US policymakers, keeping gold from exploding upward to a
true free-market price is the first thing they gain from their
interventions in the gold market. The other thing they gain is time.
The time they gain enables them to keep their fiat scheme afloat so
they can benefit from it, delaying until some future administration
the scheme's inevitable collapse.

So how does the US government manage the gold price?
They recruit Goldman Sachs, JP Morgan Chase and Deutsche Bank to do
it, by executing trades to pursue the US government’s aims. These
banks are the gold cartel. I don't believe that there are any other
members of the cartel, with the possible exception of Citibank as a
junior member. The cartel acts with the implicit backing of the US
government to absorb all losses that may be taken by the cartel
members as they manage the gold price and further, to provide
whatever physical metal is required to execute the cartel's trading
strategy. How did the gold cartel come about?

There was an abrupt change in government policy circa
1990. It was introduced by then Federal Reserve chairman Alan
Greenspan in order to bail out the banks back then, which like now
were insolvent. Taxpayers were already on the hook for hundreds of
billions to bail out the collapsed ‘savings & loan’ industry, so
adding to this tax burden was untenable. He therefore came up with
an alternative.

Greenspan saw the free market as a golden goose with
essentially unlimited deep pockets, and more to the point, that
these pockets could be picked by the US government using its
tremendous weight, namely, its financial resources for timed
interventions in the free market combined with its propaganda power
by using the media. In short, it was easier to bail out the
insolvent banks back then by gouging ill-gained profits from the
free markets instead of raising taxes.

Banks generated these profits by the Federal Reserve’s
steepening of the yield curve, which kept long-term interest rates
relatively high while lowering short-term rates. To earn this wide
spread, banks leveraged themselves to borrow short-term and use the
proceeds to buy long-term paper. This mismatch of assets and
liabilities became known as the carry-trade.

The Japanese yen was a particular favorite to borrow.
The Japanese stock market had crashed in 1990, and the Bank of Japan
was pursuing a zero interest rate policy to try reviving the
Japanese economy. A US bank could borrow Japanese yen for 0.2% and
buy US T-notes yielding more than 8%, pocketing the spread, which
did wonders for bank profits and rebuilding their capital base.

Gold also became a favorite vehicle to borrow because
of its low interest rate. This gold came from central bank coffers,
but they refused to disclose how much gold they were lending, making
the gold market opaque and ripe for intervention by central bankers
making decisions behind closed doors. The amount lent by central
banks has been reliably estimated in various analyses published by
GATA to be 12,000 to 15,000 tonnes, nearly one-half of central banks
total holdings and 4-to-6 times annual new mine production of 2500
tonnes. The banks clearly jumped feet first into the gold
carry-trade.

The carry-trade was a gift to the banks from the
Federal Reserve, and all was well provided the yen and gold did not
rise against the dollar because this mismatch of dollar assets and
yen or gold liabilities was not hedged. Alas, both gold and the yen
began to strengthen, which if allowed to rise high enough would
force marked-to-market losses on those carry-trade positions in the
banks. It was a major problem because the losses of the banks could
be considerable, given the magnitude of the carry-trade.

So the gold cartel was created to manage the gold
price, and all went well at first, given the help it received from
the Bank of England in 1999 to sell one-half of its gold holdings.
Gold was driven to historic lows, as noted above, but this low gold
price created its own problem. Gold became so unbelievably cheap
that value hunters around the world recognized the exceptional
opportunity it offered, and demand for physical gold began to climb.
As demand rose, another more intractable and unforeseen problem
arose for the gold cartel.

The gold borrowed from the central banks had been
melted down and turned into coins, small bars and monetary jewelry
that were acquired by countless individuals around the world. This
gold was now in ‘strong hands’, and these gold owners would only
part with it at a much higher price. Therefore, where would the gold
come from to repay the central banks?

While yen is a fiat currency and can be created out of
thin air by the Bank of Japan, gold in contrast is a tangible asset.
How could the banks repay all the gold they borrowed without causing
the gold price to soar, further worsening the marked-to-market
losses on their remaining positions?

In short, the banks were in a predicament. The Federal
Reserve’s policies were debasing the dollar, and the ‘canary in the
coalmine’ was warning of the loss of purchasing power. So
Greenspan's policy of using interventions in the market to bail-out
banks morphed yet again.

The gold borrowed from central banks would not be
repaid because obtaining the physical gold to repay these loans
would cause the gold price to soar. So beginning this decade, the
gold cartel would conduct the government’s managed retreat, allowing
the gold price to move generally higher in the hope that, basically,
people wouldn’t notice. Given its ‘canary in a coalmine’ function, a
rising gold price creates demand for gold, and a rapidly rising gold
price would worsen the marked-to-market losses of the gold
cartel.

So the objective is to allow the gold price to rise
around 15% p.a., while at the same time enable the cartel members to
intervene in the gold market with implicit government backing in
order to earn profits to offset the growing losses on its gold
liabilities. Its trading strategy to accomplish this task is clear.
The gold cartel reverse engineers the black-box trend-following
trading models.

Just look at the losses taken by some of the major
commodity trading managers on their gold trading over the last
decade. It is hundreds of millions of dollars of client money lost,
and gained for the gold cartel to help offset their losses from the
gold carry-trade. All to make the dollar look good by keeping the
gold price lower than it should be and would be if it were allowed
to trade in a market unfettered by government intervention.

There are only two outcomes as I see it. Either the
gold cartel will fail in the end, or the US government will have
destroyed what remains of the free market in America. I hope it is
the former, but the continuing flow of events from Washington, D.C.
and the actions of policymakers suggest it could be the latter.

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