Chimps, Champs, and Chumps

By Aristotle
(10/18/2000; 7:24:11MT - usagold.com msg#: 39302)

I enjoyed the brief detour of the forum on Monday (and some previous days) into the realm of personality types -- with the Gold-related hypothesis that Gold advocates are most likely of the *NT* type. Dabbling with a linked on-line testing page revealed me to be distinctly a type INTP --for whatever that's worth to anyone keeping score.

Which brings me to my point. Any population can be divided and subdivided yet further based on the presence or absence of any given trait. In one rough cut we can focus on those who think independently about monetary affairs, and the remainder will be those who just go along with the flow. I call this latter group the "chimps" in this post because they see no evil, hear no evil, and speak no evil regarding the dollar, and are contentedly guided by the credo "Monkey see, monkey do." They follow the directions of their neighbors, whom at this point in time have been conditioned to consider Gold in low esteem. Obviously, this post is not written for the chimps--they aren't visitors to this forum.

Of the group of thinkers who see the problems with the dollar and the special merits to be found in Gold, we can divide them further into the physical "champs" and the paper "chumps." The champs are the ones who stand behind their thoughts by acquiring the Metal that they support in principle. This post isn't written for the champs, either -- they're already on the right track.

Hello, chumps. You guys comprise the sad group that is "so close and yet so far." Your good independent thinking has steered you toward the merits of Gold, yet you have undermined yourself in an attempt to capture additional paper through leverage based on the proclivity of me and my fellow champs to drive up Gold prices through our wise demand for Metal. Sorry. It doesn't work that way--as I (and many others here) have explained time and again, and most recently this past weekend.

What you chumps fail to recognize is that the Gold itself is the objective and desirable monetary wealth--as a safe and meaningful alternative to dollars which are subject to devaluation and collapse. And most importantly, you also fail to recognize the true role of your leveraged paper gold (futures) within the Gold market. The crux of this entire post is contained in the next two sentences, so open your mind and think objectively, setting aside briefly your indignance that words on a computer monitor have called you a chump.

Long positions in paper gold are NOT used, as you might like to think, as a "fire insurance policy" among institutions having vested interests in the status quo, whereby such a long derivative position would be expected (by you) to compensate them for rising Gold prices and weaker dollars. Instead, these institutions use the offering of paper gold (and its influence on price discovery) as a WET BLANKET to keep Gold from catching fire in the first place.(!)

By allowing yourself to miss the big picture, you are being played for a chump. The tragedy is not that you are throwing your paper currency away on paper gold, but rather that you approached so close to the brink of truth, and yet will likely have nothing material to show for your journey and efforts. It's not too late to stop beating your dead horse and take your place on the growing bandwagon headed down the Gold trail--that is, if you're not too consumed by your own pride and determination to stay with your horse until it regains its breath. My prediction is that the vultures will have your flesh too, because you'll let them.

Gold. Get you some. ---Aristotle
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Monkeynomics!



Laurie Santos studies primate psychology and monkeynomics -- testing problems in human psychology on primates, who (not so surprisingly) have many of the same predictable irrationalities we do.

Red Alert: Gold Backwardation!!!

Did I get your attention with the title? Good! It's a great headline, isn't it? Well, stick with me for a minute and I'll try to live up to my seemingly feigned hype.

And for you noobs that weren't attracted like moths to a freeway headlight by this title, you can get up to speed here, here and here.

First, let me ask you a question. Which of these two scenarios should be more instrumental in the transition to Freegold?

1.) A bottom-up shift in value perception as millions and even billions of small savers use their meager dollars all at once to bid up the price of gold.

2.) A top-down shift in risk perception as the very few physical gold holders of size in the world all at once withdraw their physical from the marketplace.

Just think about this question. That is its only purpose. And one more; Would either of these events be exclusive of the other?

One other item I would like to touch on before I get started is the distinction between loaning or leasing your gold to someone else versus putting your gold up as collateral for a fiat loan that you need, sometimes called a "swap".

In the former case you are handing over your gold to someone else in exchange for an income stream (the lease rate) as well as the promise that your gold will be returned at a predetermined time in the future. In the latter, you are handing over your gold to someone else in exchange for a lump sum of money, usually close to the full value of your gold, as well as the promise that you can buy your gold back for that same amount of money plus a fee (interest rate) at a predetermined time in the future.

In the former case, when leasing out your gold, you are generally said to be "deploying a 'dead' asset in pursuit of a yield." While in the latter case, putting up your gold asset as collateral for a loan, you are likely trying to keep other creditors at bay, paying them off with cash from this new loan rather than letting them take your gold. And, depending on who your new creditor is, you may be said to be "protecting your gold asset" from those other creditors who had intended to take it away for good.

I wanted to clarify this distinction because I read one article where the analyst seemed to view these two acts as one and the same, and in so doing, in my opinion, drew the wrong conclusion about the recent BIS gold swap.

The Gold Backwardation Story

Do any of you check the GOFO rate from time to time just to see if it is getting close to zero? GOFO is a relatively good proxy for the gold contango because it represents the cost basis a dealer calculates to take either side of a 'gold for currency swap' over a fixed length of time. It is also a good proxy for liquidity in the gold market. It should never turn negative because that would mean it costs more to borrow gold than to borrow dollars. (GOFO = $ interest rate - gold lease interest rate) In other words, if GOFO goes negative, the message is that gold is more precious than dollars.

As long as the GOFO rate is positive, the borrowing of dollars will cost you more "elbow grease" (debt service) than borrowing gold. So it can be said that there is a bid from gold for dollars as long as the GOFO is positive! When it turns negative, it can be said there is NO bid from gold for dollars.

Dollar forward mechanism - LBMA

I check the GOFO rate every few days, but more for amusement than analysis lately as it has been rising!

(A side note: Last week when I clicked my GOFO bookmark that I have been using for years, for the first time ever it asked me to log in, which apparently costs "an application fee of £1,000 (which is not refundable if the application is rejected for whatever reason) and an annual levy of £2,500." I'm sure this was just a normal LBMA site improvement though, because they put the new URL for free GOFO data in the small print down at the bottom. And they also improved the actual GOFO data by reducing the font size to tiny, compressing the columns, and reducing the contrast to light-gray on white background making it much easier on these tired old eyes.)

LBMA "website improvements" - Click image to view actual size

Looking at the 3 month GOFO rate for the calendar years of 2005, 2006 and 2007 (here) we see a steady gradual rise at an average annual clip of 34%, with a maximum of 79% in 2005 and a minimum of 1% in 2007. Yet so far this year we have a 221% rise from Jan. 29 through July 23 alone.

That 221% rate change in 6 months is pretty high volatility for this normally stable metric except in the remote instances of impending doom. But surprisingly, the rapid rate change this year has been in the direction of "nothing to see here, folks."

So here is the basic story of gold backwardation. On September 29, 1999 gold went into backwardation for the first time in modern history. The cause is commonly cited as the Washington Agreement on Gold that happened three days earlier in Washington, DC. This backwardation manifested itself in three common metrics. First, the price of gold shot up.


Second, the gold lease rate spiked. And third, the GOFO rate went negative in all five durations, from 1 month to 12 months.

What is important here is both the meaning of these anomalies and the message they send to the marketplace. The GOFO rate is basically a measure of unencumbered physical gold's desire to bid for dollars. And the lease rate is the banks' bid to borrow your gold so they can sell it and then do whatever it is that banks do with your money.

So the message of a high lease rate is "lease us your gold, PLEASE, and we'll pay you handsomely for it." Remember, a lease is where you "rent out" an asset to derive an income stream. And a swap (like GOFO) is where you need a loan, so you offer an asset as collateral and then YOU pay the income stream to someone else. Only with a negative GOFO rate, you retain control of the gold PLUS you receive the income stream coming in, so why would anyone LEASE their gold in this backwardation scenario?

For that matter, why would you even SWAP your gold in this scenario? Unless, perhaps, you were desperate for dollars and you were swapping your gold with someone you knew for a fact would hold it safe for you and do nothing else with it. Like a "rich uncle" perhaps?

I know this is complicated, but just take a look at the lease rate and GOFO charts from Sept. 29, 1999:



The point to take home here is that the spikes in these charts DO represent potentially imminent collapse of the dollar, but they are not the cause of the potential collapse, they are the system's response to it. In a way, these charts are to a collapse like a thermometer is to the temperature. Or like a body's immune response is to a bug.

They don't show the actual backwardation, they show the "immune system" response to it.

These images ARE what backwardation looks like. But in a strange way backwardation is kind of like AIDS to the fiat money system. Once it's in there, you can't get it out. And you can't actually see the HIV virus. All you can see are the antibodies that attack it. That's how you know it's in there, eating away at the system.

A few years after the Sept. 29, 1999 backwardation event the following conversation was revealed and can be found on many gold websites:

"In front of 3 witnesses, Bank of England Governor Eddie George spoke to Nicholas J. Morrell (CEO of Lonmin Plc) after the Washington Agreement gold price explosion in Sept/Oct 1999. Mr. George said "We looked into the abyss if the gold price rose further. A further rise would have taken down one or several trading houses, which might have taken down all the rest in their wake.

Therefore at any price, at any cost, the central banks had to quell the gold price, manage it. It was very difficult to get the gold price under control but we have now succeeded. The US Fed was very active in getting the gold price down. So was the U.K."

2008

Jump forward nine years to 2008. On Thursday, November 20, in the middle of the unfolding global financial crisis, the 1 and 2 month GOFO rates suddenly turned negative. By November 25 they were back to positive again. The lease rate also spiked as you can see in the chart above.

Four years earlier, in 2004, Antal E. Fekete had written a paper in which he explained what backwardation in the gold market actually means. Very simply, gold backwardation signals the permanent end of the current system and the beginning of dollar hyperinflation [FOFOA: and the beginning of Freegold?]. Here is his 2004 paper:

What Gold And Silver Analysts Overlook, May 1, 2004

SNIPS:
...As it is not set up to satisfy demand for delivery on 100 percent of the open interest, the gold futures market will default. Exchange officials will declare a “liquidation only” policy to offset long positions in gold. At that point all offers to sell cash gold will be withdrawn. Gold is not for sale at any price. The shorts are absolved of their failure to deliver on their gold futures contracts.

...Previous descriptions of hyperinflation purporting to explain the descent of a currency into the abyss of worthlessness do so in terms of the quantity theory of money. My explanation of the hyperinflation that is staring us in the face is very different. I dismiss the quantity theory of money as a linear model that is not applicable.

...Moreover, previous episodes of hyperinflation affected isolated countries which had embraced the regime of irredeemable currency out of desperation, while the rest of the world stayed the course of monetary rectitude. In the present situation the entire world has been inflicted with irredeemable currency.

...My description of hyperinflation is not in terms of the quantity theory of money, but in terms of a model where the relentlessly declining gold basis leads to backwardation destroying the gold futures market.

The dollar and other irredeemable currencies will go the way of the assignat...

Backwardation in gold should therefore be considered the self-destroying mechanism for the regime of irredeemable currency that “only one man in a million may identify and understand” (my thanks to Keynes for the felicitous phrase). This is where supply/demand analysis is utterly useless. The huge stocks of monetary gold are still in existence, yet zero supply confronts infinite demand.

Fekete followed this paper up with several more in 2006 and 2007 on the subjects of the gold basis and backwardation:

The Rise And Fall Of The Gold Basis, June 23, 2006
Monetary Versus Non-Monetary Commodities, June 25, 2006
The Last Contango In Washington, June 30, 2006
Gold, Interest, Basis, Mar. 7, 2007
Gold Vanishing Into Private Hoards, May 31, 2007

Over the years he became well known as possibly the only person in the world ringing this particular warning bell. Then, on Dec. 5, 2008, Fekete published RED ALERT: GOLD BACKWARDATION!!!
(Yes, that's where I got the title.)

But Fekete wasn't watching the "reactive" GOFO and Lease rates, he was carefully analyzing the gold basis, looking at specific trading prices in the spot and gold futures markets. And on Dec. 5 he announced the beginning of gold backwardation as of Dec. 2.

Fekete not only believed that when backwardation finally turns permanent it will end the fiat dollar, but he also boldly proclaimed that the gold basis was the foolproof metric! That it could not be falsified!

When contango gives way to backwardation in all contract spreads, never again to return, it is a foolproof indication that no deliverable monetary [metal] exists. People with inside information have snapped it up in anticipation of an imminent monetary crisis.

What he meant was that the gold basis, the difference between the price of cash gold and contract futures of different maturities, could not be manipulated! And he not only proclaimed this loud and clear, but he also put his money where his mouth was, developing an investment fund that would profit from tracking the gold basis.

At this point, in late November/early December '08, everyone and his brother was on "backwardation watch". Backwardation quickly became associated with the expected COMEX default. (COMEX Default & Backwardation?) Fekete's articles were prolific, and everyone was eating them up, myself included. Remember this site? Vaporize COMEX countDOWN « Meltdown It was started on Nov. 29, 2008 and later abandoned.

Fekete followed that Dec. 5 piece with several more on the subject, and "backwardation watch" continued in earnest for at least the next quarter:

RED ALERT: GOLD BACKWARDATION!!!, Dec. 5, 2008
There Is No Fever Like Gold Fever, Dec. 10, 2008
Backwardation That Shook The World, Dec. 14, 2008
Backward Thinking On Backwardation, Dec. 18, 2008
Forward Thinking On Backwardation, Dec. 21, 2008
The Vanishing Of The Gold Basis and its implications for the international monetary system, June 23, 2009
More Dress Rehearsal For The Last Contango, Aug. 25, 2009

To this day I believe that Fekete was absolutely correct that backwardation is THE existential threat to the system that he said it was. Where he went wrong was in his assertion that the gold basis was the only metric that could not be rigged. He has since admitted as much.

The Gold Basis Is Dead -- Long Live The Gold Basis!, Oct. 17, 2009

A year ago I conducted a Seminar on the gold basis and backwardation in Canberra, Australia. I suggested to my audience that the gold basis (premium in the nearby futures on spot gold, with negative basis meaning backwardation) was a “pristine indicator that, unlike the gold price, cannot be manipulated or falsified by the banks or by the government. Thus it is a true measure of the perennial vanishing of spot gold from the market, never to return, at least not as long as the present fiat money system endures.”

That was then. Today we are one year older and that much more experienced. We now know that the banks and the government have in the meantime found a way or two to manipulate the gold basis as well. Next month I have another Seminar coming up in Canberra. I shall address the problem of gold basis, giving a full account of what we know about the efforts of the powers that be in trying to falsify this most important indicator, the guiding star of refugees who have entrusted their fate to a golden dinghy on a stormy sea. To the government, the gold basis is like the naughty child who blurts out unpleasant truths. He must be gagged and silenced at all hazards. Fool’s gold basis is even more important than fool’s gold in terms of the number of people victimized.

Goldman Sachs

I would now like to draw your attention to this March 25, 2009 research paper put out by Goldman Sachs:
Forecasting Gold as a Commodity

SNIPS:
The inventory-demand curve is quite stable and downward sloping, with less inventories of gold being held on the COMEX as gold lease rates increase. Following the onset of the current financial crisis in the second half of 2007, however, the gold lease rate began to climb to a much higher level than would have been expected, given the level of physical gold inventories...

The link between the current financial crisis and the increased demand for physical gold inventory can be seen explicitly by looking at the correlation between gold lease rates in the recent period and the TED spread or the difference in (one-year) interest rates between LIBOR and the US Treasury...

As the degree of counter-party risk increases, so too does the demand for physical gold… the gold lease rates are well explained by the TED-spread and the level of COMEX registered gold inventories.

...COMEX inventories and nominal interest rates drive the shape of the gold forward curve, specifically the price spread between near- and long-dated contracts. High inventory levels place downward pressure on near-dated prices relative to long-dated prices, as the market anticipates inventories returning to more normal levels over time.

...The gold lease rate is the interest that must be paid (in our case in US dollars) to lease, or borrow, physical gold for a specified period of time. Consequently, this can be viewed as the explicit cost of borrowing gold to hold for a period of time or the opportunity cost of holding one’s own gold and not lending it out to another.

Clearly, someone at Goldman Sachs was studying the gold basis, the related lease rates and the relationship of these metrics to the dwindling COMEX inventories in late 2008/early 2009. And, of course, why does Goldman Sachs study any market metric? I know you know the answer to this question.

Goldman Sachs studies market metrics to figure out HOW TO RIG THEM! Then they publish a paper about how their findings would work in a normal free market, and then they laugh all the way to the bank. Oh wait, they are the bank. So I guess they just spin in their chairs laughing, huh?

Lease Rates and COMEX Inventories

It is a curious observation that published gold lease rates have been decidedly negative ever since Goldman Sachs released that paper, isn't it?



And as Izabella Kaminska at ft.com/alphaville observes, "negative [lease] rates should suggest some pretty hefty Comex gold stocks," even by the logic in Goldman's own paper. But oh, so mysteriously, COMEX "registered gold" has diverged during this same timeframe from the overall picture painted by negative lease rates.

She also points out that COMEX registered stock hit a significant multi-year low in Dec. 2009 and then "magically" recovered. And I'll add that the GOFO rate hit very close to zero a month later and then also "magically" recovered.

Dollars Bidding for Gold? Or Gold Bidding for Dollars?

When you think about the message that the lease rate sends, it is directly tied to the liquidity the dollar desperately needs. On Sept. 29, 1999 the message was "lease us your gold, PLEASE, and we'll pay you handsomely for it." Today the message is "we don't need to borrow your gold, and if you insist on lending it to us, it'll cost you."

Now, if I am a liquidity creator for the dying $IMFS - a bullion bank - how do I create dollar liquidity? I take a piece of unencumbered physical gold (owned or borrowed) and I fractionalize it. I sell it off to the extent that the probability of a delivery demand is lower than my physical reserves. And in the process, I am creating DEMAND FOR DOLLARS because my "golden tickets" are bidding on dollars. Remember what ANOTHER said...

Date: Fri Jan 23 1998 19:01
ANOTHER (THOUGHTS!) ID#60253:

All modern digital currencies do not go into an investment, they move THRU it... There is an alternative. Gold! It is the only medium that currencies do not "move thru". It is the only Money that cannot be valued by currencies. It is gold that denominates currency. It is to say "gold moves thru paper currencies".

This is the key to EVERYTHING!!! It is not "gold liquidity" that the bullion banks create... it is DOLLAR LIQUIDITY. Dollars bidding on MSFT stock set the value of that stock. If dollars are frantically bidding on MSFT (high velocity), the stock skyrockets. If dollars stop bidding for MSFT all at once (low velocity), the price falls to zero. This is true for everything in the world except gold.

Gold bids for dollars. If gold stops bidding for dollars (low gold velocity), the price (in gold) of a dollar falls to zero. This is backwardation!

Fekete says backwardation is when "zero [gold] supply confronts infinite [dollar] demand." I am saying it is when "infinite supply of dollars confronts zero demand from real, physical gold... in the necessary VOLUME." So what's the difference? Viewed this way, can anyone show me how we are not there right now? And I'm not talking about your local gold dealer bidding on your $1,200 with his gold coin. I'm talking about Giant hoards of unencumbered physical gold the dollar NEEDS bids from.

Think about it. You can't make it cold in July by simply rigging the thermometer.

And in my - purely speculative - analysis, "the BIS gold swap" CONFIRMS this view!

What the bullion banks do is they take a piece of gold and they inflate it 1,000% and sometimes up to 10,000% so it appears to be a SUPER BID for dollars. And they prefer to do this by LEASING gold (borrowing your gold) rather than buying it outright. It's a lot cheaper that way.

But right now the signal going out to the marketplace is "we don't need to borrow your gold, and if you insist on us borrowing it from you, it'll cost you." It is a completely bogus signal, and has been for more than a year now!

And just as with all bogus signals that the government, the Fed and Goldman Sachs create, the response is the same. The marketplace withdraws from games with bogus signals. Volume dries up, and Goldman Sachs ends up playing against itself to create the show. Just like price controls create shortages... SAME EXACT CONCEPT.

So Goldman Sachs (the $IMFS) has rigged the GOFO as a big F-YOU to Antal Fekete.. but it shot itself in the foot in the process.

Just like unemployment isn't really 9%, I think it is possible that gold is actually in permanent backwardation at this very moment and may have been for a while now. You can't change the temperature by simply rigging the thermometer. But you can't know the exact temperature either.

The dollar NEEDS voluntary bids from private physical gold to survive. My guess is that pool of REAL bids of size is bone dry and cracking. And "dollar liquidity" is just a cheap façade at this point. This is why the dollar NEEDS a rising gold price. As the price (for selling, not borrowing gold) rises, weak little bits of gold here and there will bid for dollars.

Of course that won't be enough (dollar demand from gold) to float the dollar for long. Gold must EXPLODE to reach equilibrium. And the knock-on effects of that explosion will kill the ability to run perpetual deficits, which will kill the value of all outstanding dollar debt, and on and on and on. It's all connected.

I don't view gold backwardation as only its simple metric signals that can be falsified. I view it as the terminal disease behind the metrics that has been present in the system and periodically erupting since 1999. I don't need a working thermometer to notice that it's hot outside and I don't need an accurate blood test to see that the patient is already dead.

Sincerely,
FOFOA



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UPDATE - Fekete responds: Gold Basis Screwed

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FOA on Hyperinflation

Dear Ben,

The answer is yes, "deflation" is what we want. Because we realize that a "normal" level of inflation through credit expansion is impossible at this point and deflation is the shortest route to renewed prosperity. But we also know that you will not let it happen. You will not let the piper be paid by those that owe the piper. You will make sure that payment to the piper is spread as far and wide as possible. You said so in 2002 in Deflation: Making Sure "It" Doesn't Happen Here.

We know that aggregate demand for new debt is dead, making it oh, so hard to push on a string that has no one on the other end to take up the slack (except, of course, the USG). And yes, we do know that you have other options, as you told us in your speech. Just because we don't want to borrow more money from you doesn't mean we won't take your freshly printed cash when you offer to buy our garbage at crazy prices.

But don't worry, Ben. We know it's not all on you. Your hands are pretty much tied. This was baked into the cake long ago. We had the chance to pay the piper by letting the price of gold explode freely many times, 1961, 1968, 1971, 1980, 1999, 2008 (and a few others that never made the papers, but I'm sure you are aware of) and each time we pushed the true and necessary devaluation of the dollar off into the "great unknown" future.

Here, read this. It might make you feel better to see how powerless you really are. It was written two years before you were even in public service, two years before your famous speech, back while you were still teaching 'nomics in Jersey.

Sincerely,
FOFOA


Trail Guide (10/24/00; 10:58:56MT - usagold.com msg#: 39784)
comment

Hello Traveler,

Let's talk:

Your words first, then
====my words====more

--------------------------------------
The Traveler (10/24/2000; 0:25:21MT - usagold.com msg#: 39771)
Deflation Scenario II

Greetings and warm regards to all.

Tonight, I will address the inflation or deflation debate that was highlighted this weekend by the formidable and never to be dismissed Trail Guide. Forgive me as I tell you my view from 30,000 feet. Much closer and the details would get in the way of full understanding by many here.

First, I thank Trail Guide for referring to me as a smart hard money thinker. His companion comment that I and many others walk forward down the gold trail but are looking backwards is similar to saying generals always fight the last war during a current conflict or that you can't see the economic pot holes down the road if you are always looking in the rear view mirror. Fair enough.

I however reply with a well-known admonishment from Lord Acton. This Cambridge historian of the 19th century wrote that those who do not know history are doomed to repeat it. I have devoted a professional life and investing life to knowing "something" of economic history - both domestic and international history. My summary viewpoint as expressed @ 39423 is reproduced below.

$$$$$$$$$$$$$$$$$$$$$$$$$$$$$

The economic lesson is ... ... ... ... ... .

Deflation is everywhere and always a monetary phenomenon -- a lack of sufficient currency and CREDIT in the economy to support prices. When the growth in credit slows or turns negative due to higher interest rates and higher default rates, then the above illustration [about the collapse of real estate] plays out.

================Mr. Traveler: conversely: the "real" inflation I point to is largely a cash phenomenon, where all the past massively over-created credit instruments are bought up by the money making authorities and paid for with printed cash or allocations to the owners digital cash accounts. ================= more


Some wise ones here state inflation is the curse waiting for us over the horizon. I doubt it because we are already highly inflated. I point you to the NASDAQ's PE, home prices and auto prices for but three easy references.

================ Sir, your three examples are the beginning "price" results of our highly inflated financial credit structure. However, as I pointed out above, that structure today is in the form of "highly reproduced" (inflated) credit instruments. In addition add to that mix all the vast paper derivatives in place and we can see how very different our present money inflation has been. Even as it only begins to raise prices. =============more


For hyperinflation to occur, even more credit would have to flow from Mr. Pump.

============Not true, sir. As your own examples pointed out above, rising prices in your examples above indicate how we are already receiving the effects of a hyper inflated credit system. Again, these are only an advance example of price inflation that's beginning to reflect the "real" amount of "credit money" we have created over 20, 30, 40 years. ============more


But to whom? The consumer is over leveraged already. The consumer has binged on easy credit to the point that debt service now takes more than 90% of disposable income for 80% of consumers according to the St. Louis FED. See why the economy has soared. If the above illustration does play out, most consumers -- still anguished by their recent credit traumas - will avoid the credit trap and thus Mr. Pump will be "pushing against a string".

Remember, the consumer represents 65% or so of the GDP. As credit goes so goes the economy.

=================Good point! It's one we have used to explain why deflation in a credit inflation is always a real possibility. But, hyperinflation cannot happen in a credit society unless the credit starts being made into cash. Our (yours and mine) "pushing on the string" scenario is predicated on pumping more credit to those that don't need it.

However, in the real hyperinflation that's coming as it follows our current credit inflation phenomenon it's not the borrowing class that's liquefied, it's the lending class! Remember, out there in our vast dollar world, for every dollar a consumer has borrowed, some entity holds the other side of the credit instrument. Our classic deflation begins when these holders are no longer being paid, resulting in the write-down of their assets. Across the land, banks, credit unions, citizens with lend able funds and every other form of lender no longer own a credit instrument that's sellable at par. That's 100 cents on the dollar.

Hyperinflation begins when pushing on the string no longer is an option. As you pointed out; "the consumer is binged out"! But there is more (smile).

We would not embark into such an obvious currency destroying process if we could drag the rest of the world with us into a cleansing recession. Call it an "almost deflation" where we start the inflation / deflation circle over for one more credit cycle. This is our record from most the dollar's life.

No country ever hyper inflates for the pleasure of the ruling class, as many want to believe. They / We inflate to keep the domestic system in use and do so because it's the last resort. In other words you are forced into it! Today, the advent of the Euro has created a currency competition that will allow world investors to run from any deflationary, restrictive policy the US can offer. Our currency will be lowered to non reserve status no matter what route we take. Just as in many other historic examples and present examples around the world, nation states always choose hyperinflation when no other way out is offered. No nation on earth has ever cascaded themselves into deflation once they are off the gold money system.

Below Traveler addresses some of the very aspects I detail in the above.======================== More:


Our worthy Trail Guide declares in his fireside chat along the Gold Trail @ message 43 that it will be different this time. It may be but as Cavan Man, a Missouri resident, might say: "Show Me". In part, Trail Guide states:

The US cannot walk away from hiking our ""gold trail"" now. Because "this process" is one of the few tools available to them for keeping the dollar perception in a good light. In effect by slowing the currency transition process they are doing exactly what world dollar holders need them to do. They will inflate these derivatives until in effect; our modern gold market bankrupts itself as supply is exhausted. I say, good! (smile) But once we get to that stage, I expect that a super US economic downturn will ensue.[*] Then the fed will go wide open and cover everything in sight to keep us going! The ongoing price inflation will be driving everything from physical gold to real estate through the roof.

[And a paragraph later... ... .]

Yes, it eventually breaks everything! But this is nothing new for us gold history buffs and it's what has happen in countless modern national fiats around the world today. Nations that don't have a reserve currency to play with. We will do like their citizens do, continue to use dollars but carry in our pockets whatever new reserve is in fashion, as a backup! Be it gold or Euros or both. In addition, our entire financial structure (like in these other nations) will change to operating in an inflation economy. Money will be lost, big time and made big time, but things will still be financed, bought and sold. Houses will double, triple then double again in price, even as financing rates approach 35%, 40% or whatever. We will also follow the (then) prevailing world policy concerning physical gold, solely because it will make economic sense to our officials.

$$$$$$$$$$$$$$$$$$$$$$$$$$$$

Do read the complete message for a fuller context and more vivid understanding. Your wealth and your grandchildren demand this of you.

Perhaps the point of debate between us is: (A) Does severe deflation come next at [*] above followed sometime later by inflation and eventually hyperinflation, or (B) Does the US go directly to hyperinflation? This debate has many, many dimensions and is complicated to map. But let's give it a whirl.

ORO @ 39481 has stated that the FED will do the bidding of its owners (the banks) if events don't get too far beyond their control. I agree. Do banks and other holders of debt instruments (loans, mortgages, gov't and corporate bonds) want their wealth withered by hyperinflation? I don't believe for a moment that the creditor class is this egalitarian.

==============No Traveler, I doubt the creditor class as a group is seeking to remove the financial inequalities that separate people through this coming process of hyperinflation. Far from it. As I stated above, the credit hyperinflation has already occurred. It's there, in place as we speak.

What is now faced by this non egalitarian lending crown is the choice of: having their debt instruments defaulted on and losing everything,,,,, or playing 'let the fastest runner win the game!'

My friend this is the choice you get when the currency your assets are denominated in hits the end of its "timeline".

Human nature has followed this path for thousands of years. You know the old joke about outrunning the bear? Well, these lenders will influence our financial policy as such. They will try to get their debt securities liquefied first, spend the fiat and in this process outrun you and I. Leaving anyone they can beat to the mercy of the hyperinflation bear eating their remaining fiat assets.

Your point above about deflation and then inflation is still valid; if we cannot get the borrowers to borrow more and in doing so stop the economy from servicing "OUR DEBT SECURITIES",,,, ! But we cannot risk the markets, in this particular time and place to make that decision.

Here, we and the world would for the first time make a "judgment call"; ---can the "dollar fiat system" our wealth is stored in endure the deflation / recession that must follow?---

To date, everyone stayed with the only reserve currency available. Tomorrow they will not because they have a choice. ==================more


According to the IMF, foreign holders of dollars (including Central Banks) have a $6.5 trillion stake (roughly 60% in debt instruments) in protecting the value of their dollar holdings. Do they wish to see their purchasing power drop TO 25% or so under a hyperinflation adjustment

============Again, dollar holdings by foreign CBs are worthless anyway when the nation issuing them does and must run a constant trade deficit. The money can never go home, only build further on digital account.

This is the reason most Hard Money Advocates fall so short in evaluating our present gold values using only the commodity use of gold. They completely miss the fact that current dollar pricing of gold vastly understates its wealth asset value.

Especially to CBs if their dollar assets dissolve in bookkeeping form, the way they would do in a hyperinflation. No, the billions in assets they hold in dollar debt instruments would not disappear, only be transferred through a massive devaluation of the dollar against gold.
================== more


or increase TO 175% or so under a deflationary adjustment?

=======================Again Traveler:
My above explained why a deflation cannot be in the cards. But if so, foreigners holding even government guaranteed paper debt in a deflating currency is little more than bookkeeping wealth if the actual goods buying power of the currency is compromised.

Yes, our US would continue to print dollars to service its debt, making the accounts look good. But, in such a deflation situation, foreign exchange controls are a 100% guarantee. Foreign held dollar assets would not come home, at least not at the same exchange rate one needs to become financially whole!

When the world begins to abandon a currency at the end of its reserve timeline, deflationary gains on debt instruments are an illusion of bookkeeping. There would be no 175% real purchasing power gains allowed. ========================more


If those wise monetary strategists and Euro creators thought that the dollar would go "up in smoke", why do they continue to hold on to the US$ at an INCREASING rate of accumulation? The ECB holds nearly 80% of its assets in US Treasuries (with 15% more in gold and 5% more in Yen). Is this the position of a shrewd central banker or wealth builder who is nervous about the future purchasing power of the US dollar? Why have not foreign dollar holders transitioned more rapidly away from the dollar and into the Euro, gold and other vehicles that would protect their wealth from the confiscation of inflation and later hyperinflation. Given that it's "ShowTime", one would think that the transition would be more complete than still having $6.5 trillion "At Risk" of going up in smoke. (Actually, it is "ShowTime" but physical gold is a sideshow in the unfolding three-ring circus). I suspect all those foreign held dollars are still in the USA because of an explicit promise -- Your dollars will increase further in value as we deflate the debt bubble and you are able to buy hard assets for dimes on the dollar.

====================Traveler, I addressed this in the above. Still, their asset base is safe in any circumstance. Their gold sales are largely to each other and much of the very gold they are delivering to certain clients will return for Euros once a dollar transition begins. Indeed, there has been massive ongoing physical gold buys the world over. Who do you think has been buying all the gold non official "Paper Gold Advocates" have been divesting themselves of? The key to understanding the scope of this is in seeing through the dollar paper gold pricing system. Had the prices of paper gold been rising all these years, it would have indicated a continued support of the dollar based gold markets. As such, the world today expects this currency system to fail, taking its paper bullion markets with it!

These "shrewd central bankers" are no fool to the economic world nor the political world. The US is still a major military and political force and will continue to be for some time. Allowing the US to destroy our own system and offering an avenue of escape for investors worldwide is a master political play. Why dump your dollar reserves when such an action would make you the bad guy? Buy some gold quietly, yes. But, better to let your dollars dissolve and have your assets transformed by a dollar / physical gold devaluation. FreeGold will do just that! ======================more


To RossL, Nickel 62 and others, your question is thus answered. Those dollars sent overseas by the trade deficit have ALREADY returned to the USA in the form of capital flows into debt instruments (60% or $4 trillion) and to a lesser extent equities and other assets. This gleeful repatriation of dollars is historically unprecedented and has been done for a reason. Like those of "Giant" domestic wealth builders whose dollars are now sitting in debt instruments, these instruments will be converted - in the fullness of time - into currency to purchase hard assets ("old economy" companies with captive customers, positive operating cash flow, little debt and little remaining CAPEX, or trophy real estate or certain other proven factors of production) once the deflationary spiral has exhausted itself and driven the price of all these factors into the ground.

ORO stated that the banks want the gold mines and telecoms on the cheap. The above is the process for setting up the BUYS of the CENTURY. Perhaps a real time illustration would serve us well at this point.

================= Your presentation shows a lack of understanding about how exchange rate risk works during unsettled times. Failing nation states that have opted for a fully """""fiat currency"""""" (the US dollar) do not simply stand by and allow ownership of everything in the country to be transferred to foreigners. Or even local creditors for that matter.

Truly, the vast bulk of overall debt assets standing against US credit extending institutions dwarfs our ability to service with real goods. Even at vastly diminished prices. These debt structures are held for further fiat accumulation only. Truly a Western Thought concerning wealth. Once an economy begins to get into trouble, everyone flees these very instruments you stand by in your analysis. Truly, people understand political risk as it pertains to the fleecing of constituencies. It doesn't happen in powerful states and investors know it. ==============more


A Denver ========"Traveler's example"==== company at 40 cents.

In the late 80's and early 90's, some banks liquidated land at an average 24% of the then CURRENT appraised "Fair Market" value, incoming producing properties at 50% of replacement cost or about 60% of then CURRENT appraised value and residential homes at 81% of the then CURRENT appraised value. Less than a decade later, most properties had handsomely appreciated from the FED induced credit expansion. Boom then bust then boom is the age-old cycle of wealth transfer TO the plutocracy.

========= These cycles end when the currency timeline ends! ==========more


Next, ... ... ... ... ... .

Does the US Government want hyperinflation? A close call depending upon timing and how events unravel. It could silently default on its outstanding debt and contingent liabilities (such as EXIM and SBA loan guarantees, FDIC insurance, etc.) by passing out wheelbarrows of FRN ala Weimar Germany. On the other hand, so many middle class welfare programs (the Big 5 are about 48% of total outlays) are indexed to inflation. They could never be met from the current tax code which has indexed rate brackets -- Thank you Ronald Reagan!

===========This is exactly what many people see and are preparing for! ==========more


Many models have =======more of Traveler's examples of possibilities===== apostles of Jenny, Jerry and Ophra.

Physical Gold Advocates fear not. Gold historically has done ITS BEST during a deflation! Yes deflation. When all other assets were spiraling down in value because defaults soared and collateral sales pressured the prices of all hard assets, gold alone increased its value. It has no liabilities (no one to default) and is portable to destinations without domestic deflation. See Professor Roy Jastram's The Golden Constant (Wiley & Sons, 1978) for a 416 year history of gold under four major deflationary periods of the past. If you are a bit lazy or pressed for time, simply recall that gold in the 1930's went from $20 to $35 during that deflationary depression. One caveat: All four were under some form of the gold standard.

=============== OK, now you say: """"One caveat: All four were under some form of the gold standard.""""
Boy Traveler, that's some caveat! (smile)

Four hundred and sixteen years of history examples can be toppled by one little caveat. Truly, that little point is exactly "the point" for today's time!

Our modern dollar world has created a fiat debt structure money system of biblical proportions. Nothing like it has ever been produced in the annals of time. We got to this point because our money was gold in the beginning. Then we allowed our confidence in gold as wealth to grow into the abilities of mankind to continue such a money system without gold. The result is a massive debt against every thing except gold! Every asset that exists in the USA is fully covered by such debt several times over. Either directly or indirectly through various official government debts.

There is simply no historic example in the history of mankind that shows where everyone surrendered their assets to satisfy such debt. Yet, this is the process you Traveler, fully well expect from a deflation. A deflation, by the way, that no gold standard today says must happen?

Truly, had the dollar advocates allowed it to be devalued against gold long ago we would all know where we stand. Free trading Physical gold would have slowly risen in dollar prices in an ongoing process that would have taken gold prices into the heavens. But, it didn't happen and an imploding debt structure (caused by pushing on a string of consumer credit demand) will be "QUICKLY" countered with debt instrument purchases from the official level. The old 1980 monetary control act is already in place and allows our fed to buy everything down to your shoe laces in order to stop any debt defaults. ===========================more


Is not deflation the very outcome that the Austrian economist Mises predicts following periods of rampant credit excesses? Furthermore, if one has escaped indentured servitude (being a debtor)through hyperinflation, how likely is one to "re-up" by borrowing at floating rates of "35%, 40% or whatever". What could one invest in and reasonably hope to make a positive spread (return on investment) if this is your cost of capital?

============Well Traveler, if you go to just about any third world country today, there are many extreme examples of what "re-uping" is all about.

Further, deflations following the credit excesses Mises talked about only happen when people believe the currency system will last and opt to stay with it.--- OR -- They escape the bad credit risk inherent in remaining in such a deflating system by jumping to another system of younger stature. Still, it leaves the choice of hyperinflation as the only route after a fiat expansion.

When such processes unfold today, people look for security in a fiat. One that will back itself with gold valuations conducted in an ongoing nature. Something the US fought so very hard to avoid all these years! ===========more


With respect to Trail Guide's "living in many, many lands and have witnessed and used such inflating systems," I would point out these key differences in economic profiles.

Unless he was economically alert during the last time a reserve currency "fell from grace" (the pound sterling following WWI), then the experience of Mexico, Argentina, Russia and other commodity based economies are not on point.

==============Well, the pound opted to have the dollar back its "transitioned" currency so the effects are not the same. Further, their debt structure had not come anywhere close to what we currently have. So they muddled through. The same could be said for the dollar if it took the Euro as its reserve backer. However, comparing the debt levels of Britain then and the dollar now is like comparing a baseball to the universe! ===============more


Furthermore, hyperinflation is difficult to introduce when a country's government, businesses and citizens are already overly leveraged and are having trouble meeting debt service obligations ($2 trillion annually as recently posted by ORO). Total debt in America is often quoted in multiples of record high GDP. It is one thing for the FED to pump money vigorously into the economy. It is another matter altogether for the banks to find credit worthy or semi-credit worthy users of this fresh tidal wave of liquidity. By some estimates, corporate America has already leveraged up from a conservative ratio of 25% debt to 75% equity to a precarious 75% debt to 25% equity ratio. That is almost a 10 fold (1,000%) increase in debt!

============= Traveler, every time you bring another log to our "Gold Trail" fire, I pour gasoline on it and burn it before it becomes of use. But keep trying, sooner or later I'll run out of fuel. (smile)

Again, hyperinflation in our economy will (as I demonstrated in the beginning) begin with our government buying the debt from creditors and changing the terms of its payment for over leveraged citizens and businesses. Further, a rising price structure of an extreme nature, such as this, quickly raises all wages and income levels. Allowing everyone to service easily what seemed like a mountain of debt before. No different than looking back to when minimum wage was $1.00 and now is $5.00+/-. Only happening on a super accelerated scale. =======================more


In summary, he who has the gold makes the rules. The creditor class -- both the domestic plutocracy and their foreign cousins, has the gold -- both literally and in the form of debt claims. They would rather convert their paper claims into foreclosed hard assets following a deflation and at worst loose a billion or two from poor collateral valuations while reaping trillions in new purchasing power. That beats passively losing 20% - 40% - 60% of the value of the entire debt portfolio from hyperinflation.

=============== Exactly who in the voting public do you think is going to sit still for this paper conversion? You,,,, me,,,, that man behind the tree? Ha! Ha! """NoONE""" leaves their debt claims laying around in a country where their citizens are being economically tortured by huge, all consuming debt claims! At least not without massive risk returns. That's why rates soar so high. You either run for it or take a big chance in staying,,,, most run if a stable medium exists. Providing that medium in either Euros or a Free Trading gold market is where the ECB / BIS can play the good guys ============more


Furthermore, if the word came out that hyperinflation was the policy of the USA, who would lend their funds for the prospect of receiving less purchasing power later? I for one would rather take my chips overseas to an economy that is stable and offered good returns for definable risks. Domestic usury laws can only be raised so high and bankruptcy laws tightened so tight before the great unwashed revolt.

===============My feelings exactly!===============more


The major risk to the scheme of the plutocracy is a revolt of the masses -- whether politically through election of populists who pass legislation such as foreclosure moratoriums or violently though protests, strikes, lynchings, pogroms and the like. Thus inflation followed by hyperinflation will be instituted by the FED at the instruction of its masters once the fear of loosing it all exceeds the greed of gaining another prized asset on the cheap.

================Very good!=================more


Lastly, consider this. Current wealth of creditors only increases during deflation as each dollar now held becomes more dear.

=============That used to be true before the volumes of debt securities began to dwarf the universe. Today, most asset holders are true to nature players of the trading mentality. If inflation becomes the risk, they will exit the door in an attempt to out-trade you and me (and that man behind the tree (smile))! Most of them will simply run up the inflation ladder seeking the next higher return. In the process marking the market down in existing holdings until the government must also buy those items at par. ===============more


Inflation is a wild card for everyone. For example, my one ounce Maple may be worth $20,000 or $30,000 once deflation is turned into hyperinflation (and former creditors have switched to being net debtors). But what is that $30,000 worth in today's purchasing power - $3,000 for a 10 to 1 return or $300 for a big waste of time and energy?

==============ALL:

This is one of the major flaws in Western Hard Money thinking. We tend to view the dollar price of gold in a static purchasing power light just because it's bookkeeping-priced through paper accounting deals.

Lost in our perception of all this is the fact that current bullion prices must rise into the thousands just to reflect the US credit inflation that existed 20+ years ago! Much less reflect its value relationship to the current trillions of debt.

Our modern dollar paper gold derivatives have masked the true gold values all this time. Start with a base of gold holding its international wealth value at $3,000 to $10,000. Then extrapolate that to handle any future money printing to buy our already hyper inflated debt! Now you have an idea why PGSs (Physical Gold Advocates) are so quiet as they buy bullion today.

The current marketplace has so understated its true dollar value, physical gold must rise far beyond any price inflation that's in our future. Only Western commodity traders using a thought process that says; """the dollar market price of anything is correct because the dollar price says so"""" think gold today is a "one - on - one to price inflation" proposition. Nothing could distort the picture more. ==============more


Truly, what waits for us economically just over the horizon will be calamitous and stunning for all but a few.

===="""We watch this new gold market together, yes?"""=====


Black Gold, Yellow Gold - the only wealth worth physically owning.

=======Absolutely, Sir Traveler, Absolutely!!!!=============

Thanks
Trail Guide
_________________________________________________________

Gold: The Ultimate Wealth Consolidator

Can you remember back to 2004, 2005 and 2006, when your home value (and equity) was at its all time high? Do you ever wish you had sold your house during those years? At that time did you consider the tremendous equity in your home to be your reserves? Do you sometimes wish you had consolidated those "reserves" before they vanished into thin air?

I had a house I bought in 2000. In 2005 I sold it for 233% of what I paid for it. But when I look at the actual cash I put down for that house, 5% down!, my down payment yielded a 2,500% tax-free gain! I consolidated my "reserves"!

Of course there were costs along the way, to defend my 5% leveraged "investment". I had to regularly pay the interest on my loan, and I had to maintain and secure the property. But boy was I lucky I decided to sell in 2005! I wish I could say that I made that brilliant decision out of economic foresight. But alas, I did not. And later I made a few not-so-great decisions.

Some are still clutching their bygone perceived reserves

Wouldn't it be exciting to have such an opportunity come along again? Only this time to be able to see it coming? How about if you could gain TWICE the "leverage" without the risk and expense of actual leverage (debt)? And what if you didn't have to worry about consolidating your reserves by timing the peak? What if this next opportunity was in buying THE ultimate wealth consolidator? Sound too good to be true?

In order to understand why this is absolutely true, no matter how good it sounds to the exceedingly small and paranoid segment of society we call the gold bugs, we need to clarify a few definitions. Reader Jeff comments, "FOFOA, I find your writing in 'plain english' highly readable, putting you head and shoulders above [those] who engage in foolish jargon. Don't change a thing."

Thank you Jeff. This is something I strive for, and I am pleased that you noticed. I don't believe it is fancy words that make for a high-level discussion. Instead it is deep thoughts, fully understood and clearly articulated. In fact, fancy words are often used to intentionally obfuscate the meaning (or lack of meaning) in what is being said. And sometimes words have different meanings to different people, hopelessly confusing any discussion.

So what I'd like to do here is to explore the definitions of a few relevant words in plain English. To do this I will utilize various online dictionaries, a few friends, and my own plain English. Fair enough? I had a list of six words I was going to tackle, but as you can see by how long this post turned out I had to cut it down to three: recapitalization, liquidity and reserves.

Recapitalization

This is an especially tricky word because it definitely means different things to different people. At its root is the word "capital" which has been redefined through 66 years of $IMFS rule. But redefined or not, the only definition that actually works in times of systemic transition hasn't changed. After all, "money" is just a temporary intermediate surrogate for "real capital".

Imagine a family unit that has found itself to be bankrupt. How would it undertake a recapitalization? Would it borrow more money, or take a large cash advance and consider itself "recapitalized"? Of course not. It would immediately stop unnecessary spending and start saving its income. The same process we call "austerity" when applied to countries like Greece.

Investorwords.com defines recapitalization as a change in the permanent long-term financing of a company, including long-term debt, stock, and retained earnings. It says recapitalization is often undertaken with the aim of making the company's capital structure more stable.

So in plain English, recapitalization means reorganizing your ways and means for long-term financial survival, sustainability and stability. And this applies on all scales, not just to companies, but also to individuals, sovereign nations and even the global economy.

I mentioned above that individuals and nations (that cannot print their own reserve currency) both recapitalize by decreasing spending and increasing saving. This goes for most private corporations as well. But in a recent ECB press conference, Jean-Claude Trichet stressed the need for commercial banks to recapitalize themselves through other means. He did mention "retaining earnings" (saving), but he also encouraged banks to "use the markets" and to "take full advantage of government support measures for recapitalisation."

Jean-Claude Trichet at a press conference

This made me wonder if the banking system defines
"recapitalization" the same way the rest of us do. So I went back to Investorwords.com and read more about "recapitalization":

"Recapitalization is often undertaken with the aim of making the company's capital structure more stable, and sometimes to boost the company's stock price (for example, by issuing bonds and buying stock). Companies that do not want to become hostile takeover targets might undergo a recapitalization by taking on a very large amount of debt, and issuing substantial dividends to their shareholders (this makes the stock riskier, but the high dividends may still make them attractive to shareholders)."

Hmm... Does this sounded familiar? Borrow lots of money at almost 0% and then use it to buy (pump) your own stock? Interesting concept. Especially since I found it in the definition of "recapitalization" on a $IMFS financial website. Not exactly a "long-term", sustainable or stable recapitalization. But what the heck do I know?

In another article I read recently, titled funny enough, Cash Is Now King, Worthless Or Not, So Buy Dollars, John Taylor, Chairman and CEO of FX Concepts (Foreign Exchange Concepts), "one of the world's oldest and most established independent currency managers", explained that the entire world is now in the process of recapitalization. Everyone is doing the "austerity two-step"; cut spending, start saving. Everyone is saving their income (rather than spending every penny they earn plus more through debt). Everyone is hoarding dollars. And you should too.

John R. Taylor, Jr.

Taylor correctly points to the difference between macro and micro views of the economy in explaining misleading GDP data. The micro view looks only at individual entities, each recapitalizing, saving and repairing their balance sheets in one way or another, while ignoring the fact that when everyone is forced to do this all at once it lubricates the real economy like C&H pure cane sugar lubricates a Formula 1 engine. He goes on to quote Keynes in this regard:

"Keynes famously noted that there was a savings paradox. As I would paraphrase it, if one family saves, it is good for the family, but if all families save, the economy will be ruined. This is happening everywhere. The S&P 500 companies are all saving, by cutting costs – and building giant worthless cash mountains (like they did in the 1930’s) – but this is shrinking nominal GDP as their saved costs are others’ lost earnings. The global economies are all trying to grow by increasing exports, which is the same as saving. If there are no countries stimulating consumption, the world economy will shrink. If all countries try to balance their fiscal books, they are clearly saving. The Eurozone, the UK, and the American states are dramatic examples of this. And if consumers build up their savings, we know what happens to retail sales and the GDP."

Remember that unlike gold, which can simply be mined (dug up) from the ground by anyone, cash cannot. Dollars are not so easily gathered in nature. Only one person (Ben Bernanke) can produce real dollars, while ANYONE can dig up more gold. And Taylor says that everyone is hoarding dollars today, meaning the velocity of the buck stops here. So you should hoard them too. Greenbacks will be very hard to come by, especially for the debtors who will most likely have to default, while the whole world recapitalizes itself on scarce (even though they're worthless) dollars.

In other words, even if paper money completely ceases to perform its primary role - medium of exchange - it can still be counted on to gain value in its secondary role - store of value - "worthless or not."

Remember at the top of this section I said that the definition of "capital" had been rewritten over the past 66 years? And I also said that only the OLD definition would work in times of transition? If you are consolidating your wealth today, or even if you're doing the bankrupt-debtor-version of consolidation - recapitalizing your long-term financial prospects - how far down this pyramid do you think you should go for safety and/or return? And if the dollar is failing profoundly in its primary transactional function (to lubricate the real economy through new debt creation) then how long do you think it can possibly hold its value (GLOBALLY) being ONLY a "worthless" store of value?


Liquidity

Liquidity is another one of those hard-to-define words. Investorwords.com says it is "The ability of an asset to be converted into cash quickly and without any price discount."

In the above press conference Trichet said, "...we are in a situation of liquidity withdrawal. But it was the will of the banks [not the ECB], because they had an unlimited supply of liquidity [from us]... I would say that we [the ECB] are still in a mode of unlimited supply of liquidity."

BusinessDictionary.com says liquidity is the measure of the extent to which an entity has cash to meet immediate and short-term obligations, or the ability of current assets to meet current liabilities.

So, to me, liquidity seems to mean our day-to-day ability to meet our day-to-day needs. Fair enough?

But in the $IMFS-ruled banking world liquidity seems only to mean the availability of credit (debt), waiting to be lent (borrowed), at an interest rate that is advantagious to borrowers (not savers). Trichet's statement (above) was in response to a question about the rising interbank interest rates. The question was:

"Do you think that the current interbank borrowing costs are appropriate? And do you expect them to rise further? And were you happy with the recent increase? In the same context, if you are not happy with the market developments, what options does the ECB have to steer interbank market rates in the future?"

So from this, I think we can make a few observations about how "liquidity" really works in the $IMFS.

The first is that rising interest rates correlate with "liquidity withdrawal" -- or let's just say "lack of liquidity". Causation is unclear within this observation alone. Did the withdrawal of "liquidity" cause interest rates to rise? Or did rising interest rates cause the withdrawal of the "liquidity"? Which came first, the chicken or the egg?

The second observation helps us answer the above causality question. And this is that "an unlimited supply of liquidity" does not create liquidity. As Trichet himself said, the ECB is providing an "unlimited supply of liquidity" yet the banking system is in a "situation of liquidity withdrawal." Does this sound like it might violate some universal principle, say, Aristotle's Principle of Non-contradiction?

Aristotle

He who examines the most general features of existence, must investigate also the principles of reasoning. For he who gets the best grasp of his respective subject will be most able to discuss its basic principles. So that he who gets the best grasp of existing things qua existing must be able to discuss the basic principles of all existence; and he is the philosopher. And the most certain principle of all is that about which it is impossible to be mistaken... It is clear, then, that such a principle is the most certain of all and we can state it thus: "It is impossible for the same thing at the same time to belong and not belong to the same thing at the same time and in the same respect."

-Aristotle, Metaphysics, 1005b12-20
Formulation for the Law of Non-contradiction
http://www.non-contradiction.com/

In plain English, it is impossible to be (unlimited liquidity) and not to be (the opposite - a situation of liquidity withdrawal) at the same time and in the same respect.

Our third observation (closely tied to the second) is that it is not the lender (supply) that creates "liquidity", but the borrower (demand). If systemic liquidity is being "withdrawn" (in reality it is disappearing into thin air, withdrawn is the causally-wrong way to look at it) at the same time "unlimited liquidity" is being offered, this is the only conclusion we can draw. That demand for more debt creates $IMFS liquidity, not supply. And perhaps demand is dead?

Stepping back from the banking world's "ledge of risk and doom" and onto the solid ground of the real world, liquidity seems to mean something entirely different. ANOTHER gave us a clue back in 1998:

Date: Fri Jan 23 1998 19:01
ANOTHER (THOUGHTS!) ID#60253:

Do you really hold dollars?

It is important to understand that few persons or governments hold US dollars! Look at any investment portfolio and what you will find are "assets denominated in US$". This sounds simple, but it is not. You have heard the phrase, "money is moving into real estate, land, oil, stocks or bonds". It is a bad meaning, as it does not what it says.

All modern digital currencies do not go into an investment, they move THRU it. The US unit is only an exchange medium to acquire assets valued in dollars. US government bonds are the usual holding. No CB holds any currency! They hold the bonds of that currency. The major problem today, is that digital currencies have erased the currency denominations of all government/nation debt holdings! Even though a debt is marked as DM, USA, YEN, they are in "real time" / "marked to the market" and cross valued in all currencies! No currency asset, held by CBs today are valued in the light of a single issuing country, rather "all currencies are locked together". To lose one large national currency, is to lose the entire structure as we know it!

There is an alternative. Gold! It is the only medium that currencies do not "move thru". It is the only Money that cannot be valued by currencies. It is gold that denominates currency. It is to say "gold moves thru paper currencies". Gold can be used to revalue any asset, and not be destroyed in the process!

Viewed this way, liquidity can be pictured as the ability to traverse my dual pyramid introduced in Gold is Wealth, level by level, and from the top to the bottom. The top pyramid is "the monetary plane" or "matrix" and the bottom is "the physical plane".


Here are a few more very relevant Thoughts on liquidity and gold from FOA and friends. These are not in The Gold Trail. They are from the regular forum archives prior to The Gold Trail, so many of you may not have seen these posts before now. Enjoy!

Friend of Another (10/29/98; 10:28:53MDT - Msg ID:845)

Even in today's engineered society, it is the interaction of human wants and desires that make the world turn. In the simplest of terms, modern fiat currencies are created through borrowing (the creation of debts as assets) by individuals. When enough debt is created that all assets have been borrowed against, the borrowing, on a net basis, no longer expands the currency. With the currency no longer functioning as an economic expansion tool, its most useful reason for existence is lost. In this stage, the federal treasuries and CBs no longer have the power to control their money. The
government response concerning local money takes on the function of only lowering interest rates to protect the economy / banking system.

Friend of Another (10/13/98; 10:51:03MDT - Msg ID:556)

The central purpose behind the Yen Carry trade and the Gold Carry trade is to place liquidity into the world financial structure. This action was made necessary by the failure of the US dollar to function any further as a money creation vehicle. In these last days of the dollar, worldwide debt as denominated in dollars has ceased to expand and is indeed contracting. This is a natural event that occurs in the latter time cycle of un-backed paper currencies. This contraction was expected to complete the fiat money cycle back in the late 1980s. It has been the Central Banks, lead by the BIS that created ingenious ways to expand liquidity until another currency system could be introduced. In these 1990s, the Yen / Gold Carry was one of those ways.

Much of the Gold lending dealings is more a function of paper contracts than actual gold sales. Using my "water flow" point above, if that much gold was actually sold out into the industry, we would have seen major reductions from the gold asset side of the Central Banks. The true purpose of the leasing (not all of it , just most of it) was to create cheap money that could flow into other aspects of the economy and help perpetuate a boom, worldwide. As seen in the LTCM debacle, a little money in the right hands can be multiplied into billions of new found liquidity. Now consider that some have stated that the gold loan contracts amount to 8,000 tonnes or more! Another has said that they, if actually closed out as gold deliveries would amount to over 14,000 tonnes! Suddenly we see where the money has come from to gun the world asset markets. A market of
trillions!

So, why are they called gold loans if the gold isn't used? The point is the gold is used. It is the final commitment or backup if the deals fail. When a hedge fund (or mine) cannot repay the "cash equivalent" of the gold or "the gold itself", then the Central Bank, as the originator of the deal must deliver Real Gold or PAY IN A HARD CURRENCY!

One of the things that Another has been guiding us to for over a year is that the current gold deals amount to an all out corner on the CB gold supply. The major people that are on the other side of these Gold Loans (lets call them what they really are: currency loans on a worldwide scope that is backed, ultimately with much of the CB gold) will call for this gold that was already paid for over many years! The intent of the Euro Group CBs was to have these loans self liquidate in a normal fashion. If they did not them they would pay the equivalent of the gold owed in Euros! A function, in actuality, of issuing Euros for already sold gold! Furthering a pending proposition between the ECB and its EMCBs.

Now, my friends, you understand why a Euro price for gold of $6,000+ (current rate), if in effect a year or so after that currency debuts will create a reserve currency of tremendious debth and holdings worldwide. It will be a welcome development. With the dollar falling from reserve status and the total default of dollar based gold contracts, physical gold will be an "investment for a lifetime" as Another has said! The demand for gold as a currency reserve by governments and as a currency alternative by citizens, will amount to more metal than exists.

I credit Another with most of this input. It is his wish that these thoughts be discussed by all, for all to see.
Thanks FOA

Aragorn III (10/29/98; 15:37:25MDT - Msg ID:848)

As the banks still hold the gold that was promised on paper as a result of the short sale/forward sale/gold loan (call it whatever you like), rather than give up the gold, they will settle the short seller's default with CASH--euro cash, not the gold. This will add new euro liquidity into the world that is effectively backed by gold...100% in terms of THAT cash amount. The gold stays in the bank, and the world has a new pricing mechanism for gold...euros. A lot of 'em! Non-inflationary liquidity! What started as a means to prolong USDollar liquidity (and remove gold from investor psyche through falling prices -- remember, the euro has been in the works for years) becomes a natural (and brilliant) means to generate a non-inflationary world supply of euros sufficient to fill non-european national vaults as the new world reserve currency."

FOA (4/25/99; 17:40:44MDT - Msg ID:5145)
GOLD?

As I mentioned in an earlier post a few days ago, the IMF / dollar engine is shutting down. Just look at M3 money supply GROWTH, straight down!

The IMF must quickly find liquidity through government gold sales to support dollar debt reserves held in other countries. If not, the dollar will be destroyed in a nuclear currency event. By selling gold receipts, they can leverage the those assets ten times plus, using derivatives. That money will be used as loan collateral. Ever wonder why we never see the physical trail of the real gold assets? It's because they never move the gold, just free it up to write derivatives against it in the OTC market.

Who will gain from this? Anyone that has leveraged dollar reserves into gold derivatives reserves that will be bailed out using Euros! Not to mention that gold will soar into the thousands. I wonder what entities would have purchased so much gold?

FOA

FOA (4/26/99; 10:10:31MDT - Msg ID:5183)
M3 money supply!

This is why they want to free up and leverage the IMF gold. The other world CBs are not selling so the only way to force it out, for paper liquidity creation is through an existing IMF structure! The game continues. FOA

Aristotle (4/28/99; 0:05:40MDT - Msg ID:5258)
"Camdessus Says IMF 'Will Certainly' Sell Some Gold to Fund Debt Relief"

America essentially has veto power with 17.5% of the IMF Board vote--85% needed to approve the sale. As we've seen from a recent post from Aragorn, the 11 unified EMU nations would effectively have veto power also (with 22.4%) if this sale were seen as a legitimate threat to their cause. So, from the IMF Director characterizing these Gold sales as a done deal, may we conclude that this has already been worked out behind the scenes, and is ultimately (somehow) in the best interest of all?

These international institutions clearly don't hold their Gold as future inventory for jewelers. It is NOT being demonitized, and for that reason, I think the characterization of this coming IMF Gold 'redistribution' as a SALE is misleading, at best. But frankly, as one who is thrilled to acquire Gold month after month at these prices, I welcome their choice of words and the accompanying rhetoric. I know it must be hell on the mining companies and people acting on short time horizons, but much evidence points to the end of this incredible span of time in economic history. Looking back, I will surely take comfort in knowing that I acquired as much as my means allowed me to, and even at that, I will surely be saddened by the smallish box that accomodates the total. So be it. Such is the high value of this rarest and most important monetary asset on Earth.

---Aristotle

FOA (4/28/99; 7:04:43MDT - Msg ID:5261)
IMF

Aristotle,
I think the IMF gold sale has been worked out already. Any further public statements are just political posturing. The term "sales" is indeed misleading and true words like "leveraging assets to provide further loan guarantees" will never be used. Aristotle, gold is now the last asset and the US / IMF factions are going to have to make it rise to provide liquidity. As I said before, the BIS and its European / other allies have (for the past year or so) blocked any further lowering of the gold price. If the US wants to protect its remaining dollar reserve viability, (by maintaining all foreign dollar reserve debt) it now must allow it to depreciate against gold to provide liquidity.

That, my friend is the only avenue left for them! This will, as Another has pointed out, drive assets to the other new reserve system. As I mentioned to Christine, national entities will have a choice as will you and I and Christine. That being, stay with a falling dollar or move into Euros and gold.

Free choice is what it's all about, not conspiracy. FOA

SteveH (07/24/99; 14:20:29MDT - Msg ID:9584)

PS. FOA, the first paragraph above seems to describe what a Gold contract for oil is. Did I get it right?

Central Banks guarantee or deliver gold to a bullion bank for a small fee of 1 or 2%. Most probably only guarantee gold backing in the event a bullion bank defaults. A bullion bank cuts a deal with a miner for physical gold in return for money to operate. The mine pays back the loan over time with gold plus gold interest. One or more oil countries buy the contract from the Bullion Bank for the repaid gold from the mine with dollars from oil production. The oil country now receives the gold that the mine repays. The bullion bank's guarantee from the CB goes with the contract to the oil country. So, if a mining company defaults on a repayment, the Bullion Bank will guarantee the oil country payment against the default. It may actually have to go to a CB for the gold to repay the default. This is what I believe is happening in the Bank of England Auction.

FOA (07/24/99; 15:37:27MDT - Msg ID:9588)
Reply

Steve,
It's right in that that is one of many ways. When one reads "Aristotle's Work", it's so easy to see the purpose behind it all. The maintenance of a world fiat currency system requires a constant expansion of liquidity (more money) to keep it working. In the old days, when a borrower defaulted on a "gold loan" (that was what a dollar loan was back then) the entity that held that debt paper lost his buying power. Be it the bank or an individual, the loan security became worthless and was written off. The write-off was certain because no one could (or would) come up with the gold to pay off the loan. Eventually, the US did issue more "gold loans" in the form of the dollar ("a gold contract currency") than it had gold to honor the $35 contract. Just a plain old fraud of creating new money so someone of importance didn't have to fail (lose some of their wealth).

Today, all kinds of loan guarantees are used to back modern fiat dollar loans. If they default, someone (a national treasury) prints the money to buy the loan so no one loses anything. Usually, if the loan is guaranteed, the lending institution just lends more money to try and keep the business going. However, in real life, a fiat reserve system, just as in a gold money system, is always in a natural state of deflation as bad loans appear. So, in time, a paper money system always swells large enough to pass the point that it can create more liquidity (money).

That's what happened with the dollar reserve world. Every US treasury obligation held as a Central Bank reserve was used to create its maximum amount of liquidity. Sometime in the 80s or so they had to start borrowing against gold as debt defaults were destroying wealth faster than the dollar system could supply replacements.

We all worry so much about CBs lending gold reserves, my friend, every other reserve they hold is in the form of lent assets! I won't find any crisp, unlent dollar bills in any of their reserve hoards. The gold represented the last asset for the expansion of the world money supply. It's lent because they can fractionalise it just like a fiat currency. One ounce sold creates only one ounce of liquidity. One ounce lent, can create 90 ounces of paper gold and the dollar liquidity that provides. When they do actually sell it, most of it goes to other CBs. A "fact" supported by the WGC that no one wants to factor, because it destroys their argument about the CBs supplying physical to fill the deficit. Check it out, 300 tones or so over ten years is the net out reduction of gold reserves.

All of this bears out why this entire "new gold market" is SO important to the present dollar / IMF system. It's entirely a paper gold arena that really trades CB vault gold "as guarantees". Crash this Arena and the dollar is history as we know it.

thanks steve, I'm here for a while. More later FOA

International Liquidity

There is one type of liquidity that is of absolute importance. And that is "international liquidity". It is the kind of liquidity that lubricates the cross-border flow of real, essential goods like heating oil, food and medicine. It is the very existence of this imperative for sufficient international liquidity that puts the greatest strain on a fiat currency system at the very end of its timeline while it desperately tries to push out "unlimited liquidity", but fails to do more than push on a string.

In 1969, shortly after the collapse of the London Gold Pool and the devaluation of the pound sterling, while the Bretton Woods gold exchange standard was imploding, Alexandre Lamfalussy gave a speech at the IMF titled The Role Of Monetary Gold Over The Next Ten Years. In it he addressed the fact that gold, being of relatively fixed supply, when also fixed at a specified par (price) with the inflating currency, automatically disappears as a source of new international liquidity. Here is a short excerpt:

The striking fact apparent from this Table is that over the last ten years, gold has practically no longer contributed to the growth of international liquidity. In ten years, total foreign reserves rose by nearly 19 billion dollars; the greater part of this increase -- some 14 billion -- was due to increased holdings in foreign currencies, whereas the increase in the reserve positions with the International Monetary Fund was about 4 billion. The increase in gold stocks was less than one billion; in fact, there was a decline between 1963 and 1968 [thanks to the London Gold Pool]. Consequently, the share of gold holdings in total reserves, which was 66 per cent at the end of 1958, fell, to 51 per cent at the end of 1968.


It is therefore right to say that over the last ten years and in particular since 1963-64, we have witnessed a gradual decline in the role of gold as a means of reserve and its complete disappearance as a source of new international liquidity. At the same time, the mechanics of the gold-exchange standard have ceased to function: the creation of reserves by the spontaneous holding of dollars or Sterling has come to a halt and has been replaced by the creation of negotiated reserves.

Alexandre Lamfalussy speaks at the Bank of Greece in 2006 on Monetary Policy and Systemic Risk Prevention - Challenges ahead for Central Banks

I would like to draw your attention to the almost interchangeable way Lamfalussy used the terms "international liquidity" and "reserves". It seems that gold's share (percentage) of total reserves has something to do with that most important type of liquidity, "international liquidity". That's because, when properly defined, they are ONE AND THE SAME!

Reserves

Reserves is another tough word that means different things to different people. Investorwords.com offers two seemingly relevant definitions:

1. In asset-based lending, the difference between the value of the collateral and the amount lent.

2. Funds set aside for emergencies or other future needs.

But the definition I will be focusing in on is closest to #2, because that is how central bankers define reserves and it is how we as individuals should as well. It is also the definition most closely related to the aforementioned and most critically vital "international liquidity".

In your monthly bank statement you probably have two accounts, a checking and a savings account. Well, maybe not you, per se, dear FOFOA readers, but most people do. In addition to these two accounts you probably also work for an income, unlike some bloggers I know. ;) And as your paychecks come in you probably put most of that money into your checking account for your day-to-day needs and hopefully you put your excess money into your savings account (or some other savings "vessel").

My point is to demonstrate that we all differentiate between our normal assets set aside for everyday trading needs (income and checking account) and our reserves (savings account/reserve assets) which are set aside specifically "for a rainy day". Central banks are no different. As I said earlier, the principles discussed in this post work on all scales, personal, corporate, national and international.

So let's take a look at a central bank's balance sheet. How about the latest Eurosystem ConFinStat (Consolidated financial statement) released on July 7, 2010? It is published by the ECB but it is called "consolidated" because it covers the entire Eurosystem.


You can click on the image to see it full-size or the link above will take you to it on the ECB website. Now, you will notice the left side is a list of assets and the right side is a list of liabilities, just like anyone's financial statement, even yours! So how can we tell the "everyday assets" from the reserves?

Well central bankers have a very quick and easy way to tell the difference between their normal, everyday assets and their reserves. The regular assets are all claims denominated in their own currency... and the reserves are not. One is internal (domestic) and the other is very decidedly foreign/external (international).

With the key exception being gold, credit is at the very core of the phenomenon we call "money". And insofar as credit on any balance sheet is concerned, a liability is when another entity has a claim on you, and an asset is where you have a claim on another entity.

Those credits can be denominated in various currency units, and it is the goal of the balance sheet to help a bank keep score on itself to ensure that it doesn't overextend itself by emitting more liabilities (claims against itself) than it can balance against its own assets (its claims upon others).

At the central banking level, like the ECB, institutional liabilities largely take the form of issuance of currency and deposits held at the CB on behalf of commercial banks (such as those to meet reserve requirements and to facilitate check-clearing between institutions). These liabilities are denominated in its own domestic monetary unit (i.e., the euro.)

The assets to balance against these liabilities are largely in form of euro-denominated claims on commercial credit/banking institutions. As these claims are often collateralized by government bonds, at the very end of the rope it is fair to say a large portion of assets held by the central bank take the form of government bonds even though they were (largely) acquired indirectly through typical financing operations to extend credit (liquidity) to the commercial banks.

Euro-denominated claims (assets) are suitable for offsetting euro-denominated liabilities, but they do NOTHING in regard to your rare "rainy day" when it is found necessary to defend the euro's stature against its foreign peers. For that purpose a central bank needs to have either gold (which is a universal asset) and/or a net (positive) position in foreign currency assets, IMF SDR's and other assets denominated in "reserve currency" units, meaning mostly the US dollar, the pound, the yen, and (outside the Eurozone) the euro. It is this combination of gold and net foreign currency assets that constitute the official "reserves" of any central bank.

The proportion of RESERVE assets among the central bank's TOTAL assets is usually a judgement call. Generally, the more unstable or insecure a central bank deems its national government and economy to be on the world stage, the larger the proportion of assets it will hold in the form of reserves. (Recall the expansion of reserves among Asian countries following the 1997 Asian Contagion crisis.)

And regarding the make-up of the reserve assets specifically, it is ultimately a central bank's own internal management decision that determines what proportion of reserves are in the form of gold versus foreign currency. Of course, there is often a political component as well, such as "good will" or crude attempts at bilateral exchange rate intervention -- akin to playing pick-up-sticks while wearing oven mitts.

Historically, official reserves were ONLY gold. But through the Bretton Woods experiment we evolved into what we have today. Wikipedia describes this transition succinctly:

Official international reserves, the means of official international payments, formerly consisted only of gold, and occasionally silver. But under the Bretton Woods system, the US dollar functioned as a reserve currency, so it too became part of a nation's official international reserve assets. From 1944-1968, the US dollar was convertible into gold through the Federal Reserve System, but after 1968 only central banks could convert dollars into gold from official gold reserves, and after 1973 no individual or institution could convert US dollars into gold from official gold reserves. Since 1973, no major currencies have been convertible into gold from official gold reserves. Individuals and institutions must now buy gold in private markets, just like other commodities. Even though US dollars and other currencies are no longer convertible into gold from official gold reserves, they still can function as official international reserves.

In a flexible exchange rate system, official international reserve assets allow a central bank to purchase the domestic currency, which is considered a liability for the central bank (since it prints the money or fiat currency as IOUs). This action can stabilize the value of the domestic currency.

Central banks throughout the world have sometimes cooperated in buying and selling official international reserves to attempt to influence exchange rates.

Excess reserves

Foreign exchange reserves are important indicators of ability to repay foreign debt and for currency defense, and are used to determine credit ratings of nations, however, other government funds that are counted as liquid assets that can be applied to liabilities in times of crisis include stabilization funds, otherwise known as sovereign wealth funds. If those were included, Norway and Persian Gulf States would rank higher on these lists, and UAE's $1.3 trillion Abu Dhabi Investment Authority would be second after China. Singapore also has significant government funds including Temasek Holdings and GIC. India is also planning to create its own investment firm from its foreign exchange reserves.

Recall Lamfalussy's 1969 speech above. In the decade from 1958-1968, the gold proportion of the make-up of all international reserves DECLINED from 66% --> 51%. Remember? And there was another interesting thing Lamfalussy said about reserves that matches what wikipedia says (above):

Wikipedia: Foreign exchange reserves are important indicators of ability to repay foreign debt...

Lamfalussy (1969) at the IMF: "The IMF definition [of "international liquidity"] has the additional merit of limiting the concept of international liquidity to the amount of reserves over which the monetary authorities of a country have unconditional and immediate command. This is not without importance in a era dominated by vast and swift movements of capital, when speculative attitudes are strongly influenced by the confidence (or lack of confidence) one can have in the ability of the national authorities to settle their debts immediately and unconditionally. On this point I published a recent article in the December 1968 number of the “Recherche 5 Economiques de Louvain”."

So now that we understand how central banks define their reserves, similar to "2. Funds set aside for emergencies or other future needs", also "international liquidity", lets take a look at the actual make-up of the Eurosystem's present official reserves.


On the asset side of the statement, lines 1 and 2 are the reserves. So we have:

1. Gold - €352,092,000,000
2. Foreign currency claims outside the Eurozone - €232,639,000,000

Adding them we see that the Eurosystem has total reserves of €584,731,000,000 as of July 2, 2010. Considering that €352 billion of that is gold, we can say that the gold proportion of the Eurosystem's reserves is presently 60% (60.21% to be more precise).

Next, let's do the same calculation on the Eurosystems FIRST ConFinStat and compare the two.


Assets (as at January 1, 1999):

1. Gold - €99,598,000,000
2. Foreign currency claims outside the Eurozone - €230,342,000,000

Total reserves at ECB MTM concept innauguration - €329,940,000,000
Gold proportion of the Eurosystem's reserves on Jan. 1, 1999 - 30% (30.19% if you insist).

Conclusion (And isn't it an interesting one?): During the last decade of the Bretton Woods "experiment", 1958-1968, gold failed to produce new international liquidity and fell from 66% --> 51% as a proportion of international reserves. But during the FIRST decade of the Freegold (ECB MTM FLOATING gold price) "experiment", gold has risen from 30% --> 60% of the Eurosystem's (international liquidity) reserves!

Think on this one for a while. It deserves at least that.

1958-1968 - 66% --> 51%
1999-2010 - 30% --> 60%

And where do you think it might be going?

1999-->2010-->201_ - 30% --> 60% --> 9_%?

To be fair, we should also look at that same gold evolution from a weight perspective (the opposite of the ECB MTM Freegold floating gold price perspective).

The official gold used in Lamfalussy's statistics totalled 33,769 metric tonnes in 1958 and 34,569 tonnes in 1968. And the Eurosystem's total official gold was 12,576 tonnes on Jan. 1, 1999, and today it is 10,833 tonnes. Note that these weights are not from the WGC or Wikipedia. They are directly from official financial statements.

So we can now see that, measured by weight alone, gold reserves ROSE by 800 tonnes from 1958 to 1968, while, at the same time, falling as a proportion of total reserves. Also, measured by weight alone, the Eurosystem's gold reserves actually FELL by 1,743 tonnes from 1999 to 2010, while, at the same time, RISING as a proportion of total reserves.

Again, please think about this for a while.

1958-1968 - UP 800 m/t; DOWN in relevance 66% --> 51%
1999-2010 - DOWN 1,743 m/t; UP in relevance 30% --> 60%

(Of course these weight changes are "net" over the entire decade. In the case of 1958-68 the official gold hoard actually spiked to 35,725 tonnes in 1963, up 1,956 tonnes, and then plunged 1,156 tonnes from '63 to '68 thanks to the misguided "interventions" of the London Gold Pool. Likewise, the Eurosystem actually sold more than 1,743 tonnes during the last decade, but this was offset by the small gold additions to the consolidated statement as the newer group of euro-member nations came on board as part of the Eurosystem. So 1,743 was the net change.)

And while we are on the subject of "gold sales", I'd like to briefly comment on the recent "hot topic" of the BIS gold swap. I have read myriad speculation on this gold swap with the BIS. But the one I give the most credence to belongs to Randal Strauss over at USAGold.com: "News & Views", as it relates directly to this post. Randy says,

"...throughout this entire crisis it has been the commercial banks which are highly stressed and in need of liquidity, NOT the central banks. (The CBs already have ample fire-power to create domestic liquidity at will or to access forex liquidity through preexisting bilateral loan agreements with their peers.)

...the more rational conclusion to the slender body of evidence is simply the continuing need/desire for forex liquidity on the part of the profoundly stressed commercial banks. In an effort to make the most out of the unallocated gold deposits managed by their various bullion banking departments, it takes no stretch of the imagination to see these employed in every manner of conceivable derivative utilization, with swaps ranking high among them in this current economic environment. But with so many of their commercial peers swimming in the same soup, it does not take terribly deep thinking to fathom how or why the BIS would emerge as a principle counterparty.

As the bullion banks are casting derivatives of their unallocated gold deposits time and again into the thusly-polluted waters of the market (note to self: never commit your physical gold to an unallocated account at a bank!) the central banks of the world who adhere to mark-to-market accounting principles can become understandably dismayed that the commercial banks, poised along the shoreline with their garbage, are creating a superficial blight upon the market’s perception of and confidence in this most important of all reserve assets — gold. It is no surprise, therefore, that the BIS would emerge — as a sort of vacuum sweeper — to suck up a goodly quantity of these filthy commercial derivatives and thereby working to clean up the gold market by taking the corresponding tonnage out of commercial circulation (even if only a temporary step), removing it for the time being from risk of any further derivatization and fractionalization.

As a bit of corroborating evidence, I would again point out that the European’s quarterly MTM revaluations on June 30 took place in a distinctly favorable environment — with gold prices residing near record high levels, thus allowing the gold portion of the European central banks’ reserves to strengthen the books at this critical juncture with a chart-topping €65.4 billion quarterly gain. Subsequently, the July 1st price drop was of no account — a nice physical buying opportunity for the rest of us ahead of future quarterly advances in the status and value of gold."

The only thing I would add to Randy's excellent analysis is that, to me, it doesn't really matter who or why. What is obvious is that THE most important kind of liquidity, "international liquidity", foreign liquidity, external liquidity, the hardest "liquidity" to round up, was desperately needed by someone. So they swapped one reserve for another, with the promise of getting it back, placing their gold in probably the safest hands in the world when considering a future dramatic Freegold revaluation. To me, this is evidence that the transition is near.

Reserves, wealth, "that which you cannot print", "that which is tradable outside your zone", "that which is hard, not easy, to get"... this is exactly what the system needs right now in VOLUME!!! And the CB's can no longer provide it. They are pushing on strings! So someone went to the ultimate bank with the ultimate asset, gold, and got themselves some of the ultimate liquidity, "international liquidity". And because debt is collapsing, CB printing is failing to provide this ultimate liquidity. The BIS gold swap is FRESH EVIDENCE that only gold can provide what the global system desperately needs today!

Summary

I started this long post stating that there is a new and unique opportunity directly in front of us, greater than any before. And that it is there for all with eyes to see. And then I went on to explore the seemingly amorphous definitions of three words that are key to understanding why this opportunity is as real, and as big, as ANOTHER said it was. So I guess now that you are probably as tired of reading as I am of writing, I should wrap this post up by using these words in a sentence (or three) so that we can flex our new, deeper understanding.

What the world needs now, other than love sweet love, is recapitalization through true, international liquidity. The kind that can only come from the MTM revaluation of true reserves. And when I say needs, I am talking about the kind of need that is a constant, not a variable. In other words, it is a fixed need that all other variables must, will and do conform to, one way or another, manipulated or not.

Today we can observe, as the ZH Taylor piece above does, that the real world is undergoing recapitalization through austerity and savings, the old fashioned way. And the commercial banking system is recapitalizing the newfangled way, by taking on unlimited debt liquidity and leveraging it to look good on the surface. And the central banks are prepared for whatever comes. As their dollar foreign reserves go up in smoke, their gold reserves will more than replace any lost value. And as this happens, that gold percentage will rise from 30% to 65% to 90+%.

Any time during 2004, 2005 or 2006 would have been a financially beneficial time to consolidate your perceived reserves held in home equity. But if you happened to sell your house and become a renter in late 2006 or early 2007, you got really lucky! Well, it's now "2007" for paper wealth. Time to consolidate that percieved value, before it goes the way of your old home equity. And for those of you that think a better time is yet to come, just look at any 10-year gold chart.

Now obviously I haven't connected ALL the dots for you in this post. But they are there... and self-discovery is a wonderful feeling. Recapitalization, international liquidity and reserves all relate very closely to gold when properly defined. Herein lies an epiphany worth discovering.

As ANOTHER and FOA taught us, a time of systemic transition is completely wrong for trading on technicals. Instead, it is the PERFECT time to consolidate on fundamentals, then sit back and wait. The reward, as ANOTHER put it, will be enough for one's lifetime. And what is gold? Oh yeah, it's the ultimate wealth consolidator.

Sincerely,
FOFOA