Wednesday, December 31, 2008

Happy New Year!

Here's to 2009, "The Year of the Wheelbarrow"

"As broad money growth accelerates, inflation will increase. When heavy dollar selling… leads to dumping of dollar-based assets held by foreign investors, the Fed will… have to monetize accelerating Treasury debt… I am moving ahead in time the possible onset of hyperinflation into 2009."

John Williams

Friday, December 26, 2008

When Trust Runs Out

by Gary North

Every society and every institution rests heavily on trust. There is active trust, the result of "trust, but verify." I call this stage one trust. Then there is stage two trust, which I call default trust: "Trust, and assume that someone else has verified." Next, there is stage three trust, which I call blind trust: "Trust, because there is nothing else worth trusting." Then there stage four trust, which I call tooth fairy trust: "Trust, despite all evidence to the contrary." This form of trust is the foundation of all Ponzi schemes.

Bernard Madoff took advantage of this final form of trust. He ran what is said to be a Ponzi scheme of $50 billion. Or was it only $17 billion? The initial reports are sketchy.

The magnitude of these numbers boggles the imagination. How could anyone who is regulated by the Securities & Exchange Commission run up bogus numbers of $17 billion, let alone $50 billion?

More to the point, if Madoff could do this, of what value is the Securities & Exchange Commission? The SEC in this case has fostered the second form of trust: "Trust, and assume that someone else has verified." This form of trust is the most insidious, because it creates a widespread mentality of trustworthiness when such trust is not deserved. It reduces the investing public's suspicions.

Whenever widespread regulation by government agencies lulls investors to sleep, investors make investments that they would not otherwise make. Managers of what are called trust funds defer responsibility for doing the necessary due diligence. They can legally hide behind this excuse: "We invested our clients' money only in investments regarded as prudent."

Prudent is as prudent does. From October 2007 until today, prudent investments have taken a financial bath. All the way down, the well-funded investment advisors kept telling their clients, "Now is not the time to panic. Now is not the time to sell stocks. Use this as a buying opportunity. Buy on the dips. Maintain a well-balanced portfolio of stocks and high-grade corporate bonds. Hold Fannie Mae and Freddie Mac bonds. They are recognized worldwide."

The hypesters on Tout TV screamed: "This market is close to the bottom. Buy now!"

Government officials issued no warnings. They even denied what should have been obvious.

In a long, detailed, and devastating article in the New York Times, the authors savage the Bush Administration for its refusal to do something about Fannie and Freddie as early as February 2003. The article, in typical Times fashion, lays no blame on Congress, especially Barney Frank, who promoted home ownership for low-income constituents who could not possibly have afforded to buy homes under anything like normal, i.e., low-inflationary times.

The article tells the story of Armando Falcon, Jr., who ran the tiny and impotent Office of Federal Housing Enterprise Oversight. This was supposed to be an official verifier. Like virtually all government verifiers, it was expected never to call attention to problems with anything remotely connected to the Federal government. These organizations exist to foster stage two trust: "Trust, and assume that someone else has verified." The Times reports: "In February 2003, he was finishing a blockbuster report that warned the pillars could crumble."

Mr. Falcon's report outlined a worst-case situation in which Fannie and Freddie could default on debt, setting off "contagious illiquidity in the market" – in other words, a financial meltdown. He also raised red flags about the companies' soaring use of derivatives, the complex financial instruments that economic experts now blame for spreading the housing collapse.

Today, the White House cites that report – and its subsequent effort to better regulate Fannie and Freddie – as evidence that it foresaw the crisis and tried to avert it. Bush officials recently wrote up a talking points memo headlined "G.S.E.'s – We Told You So."

But the back story is more complicated. To begin with, on the day Mr. Falcon issued his report, the White House tried to fire him.

This was a typical government response. Whistle blowers are regarded as traitors in every organization. The government is no exception. Mr. Falcon was blowing the whistle on a pair of over-leveraged government-related but poorly regulated organizations. Falcon was the head of an organization set up to regulate these two massive swindles, but he was never supposed to blow the whistle. He therefore broke an unofficial rule. He was going to be taught a lesson.

Mr. Falcon survived, but resigned in 2005. He was replaced by James Lockhart, an old high school friend of President Bush. On his watch, Freddie and Fannie purchased $400 billion in sub-prime loans and alternative mortgages, marketing these packages to investors. By mid-March, 2007, both companies faced bankruptcy. But the Treasury Department did nothing. Treasury now ran policy. Its conclusion: no problem.

But Mr. Lockhart continued to offer reassurances. In a July appearance on CNBC, he declared that the companies were well managed and "worsts were not coming to worst." . . . .

Mr. Lockhart defended himself, insisting in an interview that he was aware of the companies' vulnerabilities, but did not want to rattle markets.

"A regulator," he said, "does not air dirty laundry in public."

This is the heart of the matter. It always has been. It always will be. Government regulatory agencies invariably become agents of the organizations that officially are being regulated. This is the heart of stage two trust: "Trust, and assume that someone else has verified." This trust is fostered by the government and by the agencies supposedly being regulated. The regulatory agencies' real economic function is to increase trust, where trust is not appropriate, in order to dupe the public.

At this stage, investors' trust moves to stage three: "Trust, because there is nothing else worth trusting." Investors bid up the assets' price. This is the bubble phase of the market.


Bernard Madoff was able, on paper – paper issued by his company – to generate 15% returns, year after year. It is not yet clear how he was able to fool accountants. That he did fool them points to the nature of the beast. We are living in an economy that is one gigantic Ponzi scheme.

The most famous one is Social Security. It is known to be a Ponzi scheme by anyone who examines its funding. This has been known for a generation. No one cares, least of all government accountants. Medicare is an even larger Ponzi scheme. Yet Warren Buffett assures us that the American economy can grow its way out of the looming unfunded liabilities of these two organizations. All it will take is a little prudence – an asset which retains its low price in Washington only because there is so little demand.

When the best and the brightest insist that there is no major problem with the two largest Ponzi schemes in history, the public has moved to stage four trust: "Trust, despite all evidence to the contrary."

Madoff took advantage of a mindset that is so widespread today that voters, investors, and politicians not only believe in tooth fairy economics, they take active steps to ridicule those who call attention to the evidence to the contrary.

Madoff also understood marketing. The late Mac Ross once told me this secret of marketing.

There are two ways to market something: the community college way and Harvard's way. The community college sells education on the basis of price. "It's the best deal around. Act now!"

Harvard sells a marginally superior form of education by telling people that they just don't qualify. "We aren't going to accept you, but if you really want to waste your time, you can mail in an application."

Madoff adopted the Harvard approach. Alexandra Penney, one of his victims, describes her dealings with his firm. She had become a millionaire author.

I suddenly had a lot of money. I was in my late 40s, and I felt that I was just too old to have it in a plain old bank account. But I was a creative person, not a savvy investor, so I asked around and talked to my smartest friends with Harvard and Wharton MBAs. There appeared to be a secret society of Madoff investors. A friend who was older, wealthier, and more established somehow got me in. I've always had good luck, and I thought it was another stroke of good fortune to be invested with the legendary Bernard Madoff.

Ah, yes: access to the inside track! There is a dream of every wanna-be investor. Find the next Warren Buffett and let him handle your money. Yes, Buffett's Berkshire Hathaway can be bought on the New York Stock Exchange. All it takes is about $100,000 a share. But that is not good enough for investors in dreams. She wrote: "There appeared to be a secret society of Madoff investors." Yes, yes, that's it! Get on the inside!

Every month I got detailed statements, and my money looked to be growing around 9 to 11 percent. It didn't seem greedy because I knew other people who were making 15 or 20 percent. I thought, "This is just a very smart investor."

On the contrary, he was just a very smart con man – a con man who plugged into stage four trust. But he did not do this on his own. He got a lot of help from the confidence industry's friends: government agencies that operate their own Ponzi schemes, creating widespread trust in impossible dreams.

The woman who was conned by Madoff thought she was rich. She no longer thinks so. She lived high on the hog. She no longer will. This scares her.

First, she always wanted to be an artist. She used her money to buy a studio in New York City. If she ever made a living with her art, she does not say. It's too late now. The recession has killed the art market.

The art market, as everyone pretty much knows, is dead. If I can't sell my work, I am going to have to find some way to make money.

Indeed, she is. Here is the former editor of Self magazine who is going to have to find herself in a competitive environment. This will not be easy. She must now make adjustments in her lifestyle.

I've lived a great and interesting life. I love beautiful things: high thread count sheets, old china, watches, jewelry, Hermes purses, and Louboutin shoes. I like expensive French milled soap, good wines, and white truffles. I have given extravagant gifts like diamond earrings. I traveled a lot. In this last year, I've been Laos, Cambodia, India, Russia, and Berlin for my first solo art show. Will I ever be able to explore exotic places again?

Frankly, Ms. Penney, the rest of us really don't care. We have problems of our own. She goes on.

Since this happened last Thursday, I have barely left my apartment, I haven't been out for dinner; haven't bought groceries. Can't remember the last time I ate a full meal. Food, which is one of my most favorite things in the world, has become meaningless.

The reality of Ponzi schemes eventually comes to this, whether the victims are rich or poor. Reality intrudes.

The entire Western world is trapped in a Ponzi scheme sold by politicians: free lunches in our golden years of retirement. Social Security will provide this. Socialized medicine will provide this.

I spoke with a health insurance agent last week. He had come at my request to discuss Medicare B. This is the physician-coverage section of Medicare. Medicare A covers hospitalization. This new Plan B will give me free prescriptions, which I don't take. It will give me access to any physician's office at $5 per visit. I will get partial dental care. All I will pay is about $1,000. In my previous location, northern Mississippi, my agent said in 2007 the average payment per enrollee per year was over $6,000. This is a region with a low cost of living.

This is a Ponzi scheme. As the population ages, there will be too many recipients and too few new entrants into the scam. We know what is going to happen. But the best and the brightest say we are wrong, that everything is covered, that experts have verified everything, that we will grow out way out of this.


The stock market in 2008 proved to 401(k) investors what I had told my readers in March 2000: the stock market is not going to provide positive returns any longer. The dreams of millions of investors have not been smashed – not yet. They will be, but not yet. The dreams have been called into question. There is real doubt that the stock market will recover fast enough to give investors their golden retirements.

The 401(k) programs are also Ponzi schemes. They depend, not on economic growth to provide wealth, but rather new investors in the stock market. Earnings are insufficient to provide the income required to provide a comfortable retirement. After deducting fund expenses, until 2008, earnings were zero or close to it. The dream of easy retirement always rested on the sale of shares to newcomers. This is Ponzi scheme financing.

American households are net dis-savers today. They have been for almost a decade. Who is going to buy the shares of retirees? Not the coming generation.

Trust in stocks as a way to wealth is fading. This is a good thing, because the trust was always misplaced.

What will replace this fading trust in stocks? Another problem: When people sell their shares in the final phase of the falling stock market, pushing stocks lower, who will buy them? Who will believe that, after nine years of losses, discounting for price inflation 2000–2009, that stocks will ever recover? In final sell-offs, pessimism is widespread. This pessimism will be justified. Where will the productivity come from in our new age of monetary base inflation, corporate bailouts, and trillion-dollar annual Federal deficits?

Who will buy a Chrysler today? Who will buy General Motors shares? Who will trust the hypesters on Tout TV, when they say to buy shares? Buy with what? Their viewers are down 40% or more, and the decline may not be over.


The American dream, as with any dream, is based on trust. But trust, to be maintained, must eventually be confirmed by reality. The economic reality today is stagnation, rising unemployment, falling home prices, and bankruptcy.

Reality is catching up with stage four trust.

December 24, 2008

Gary North [send him mail] is the author of Mises on Money. Visit He is also the author of a free 20-volume series, An Economic Commentary on the Bible.

Copyright © 2008

FOFOA: The bold destruction of trust is one small step for man, one giant leap toward FreeGold.

Wednesday, December 24, 2008

Monday, December 22, 2008

Deflation or Hyperinflation?

This post is for those who have been taken in by the deflationists recently, and who have begun to wonder and worry about what they thought they knew.

To think about this debate properly, let's look at what the Fed has in mind. The Fed fears deflation and would like to swing it back, in a linear fashion, to mild, controllable inflation. To do this it is using every trick in the book. One thing is certain, there are no physical limitation to how much the Fed can inflate the money supply. Money creation now comes with no physical costs (like paper, ink, and printing press grease).

Some say that any money created must be borrowed into existence and that this is a limitation. They are partly correct, because this is not a limitation. As the borrower of last resort, the Treasury of the United States has the power to borrow as much money as it wants to use for stimulus. This can take the form of rebate checks to taxpayers or spending on public works projects. In both cases, the money enters the economy efficiently.

So when Ben said in 2002 that "deflation is always reversible under a fiat money system", he was correct. Point in fact, if the US government issued Tbills, and the Fed bought them with printed money, and then the government used that money to refund everyone's income taxes for the last 10 years, it is likely that would be enough to reverse the current deflation. I use this example simply to show that it is within the power of central banks and governments to defeat deflation in a nominal way.

So now let's see what is the case if the Fed and the government do not take such drastic measures. Let's say they would never do something as Zimbabwe-crazy as that and let's say that the deflationary forces are now out of control. Well, the only thing that can mean is that the best investment to hold right now is fiat currency, or more specifically, US dollars. And if we accept that this runaway deflation will last for several years, that means the best thing you can do is hold dollars for all those years. Because as time passes, those dollars will always buy more and more goods, for as long as deflation persists.

So I ask you, does this pass the sniff test?

It is the only logical conclusion if you are going to accept what the deflationist's are telling you.

With US government bonds at a parabolic peak right now, this clearly does not pass the sniff test. If you buy this theory and act on it wholeheartedly, you are asking for big trouble in the coming months, both in the dollar and in the Tbills.

So, making a big jump here, I ask, is there any difference between a currency collapse and hyperinflation?

Let's ask a different question. What if the government decides to devalue the dollar against gold as many have suggested. This would solve a lot of problems for the government (and for us goldbugs, but that's for a different post). But it would create problems for other governments holding dollar reserves, like China. Well, there are a couple of remedies for this. Perhaps the US government would make a secret promise to China. But still, there are other's in the world that would be greatly hurt by a USD devaluation. So what would happen?

Governments don't always make rational moves. Sometimes they panic. So the likely response to a USD devaluation would be simultaneous devaluations across the board. Let's say there's no secret deal with China to replace it's reserves with a new currency at a favored rate. Well China would immediately devalue the Yuan against gold so that it would still be holding the same Yuan value of Tbills as it held before the USD devaluation.

If this happened across the board with all currencies (a fairly likely scenario), then all currencies in the world would drop roughly the same amount. In this case, the USDX value of the dollar could remain the same, say 81 like it is today, since that is simply a measurement against other fiat currencies. But the reality is that the dollar, and all other fiat money, would buy a whole lot less. You see, they can't devalue gold, they can only up-value gold. In order to devalue gold, they must do it surreptitiously through the COMEX or else outlaw it all together (which is not going to happen, but that's for another post).

This would literally be like overnight hyperinflation. If you bought your house for $300K in 2007, and this damn deflation has taken it's value down to $200K, and then the fiat moneys of the world devalue by 90% against gold, the very next day your house would be worth $2million.

From there, things would start to diverge. That first day, gold would be $9,000/ounce, and your house would be worth $2million. But because we are in a "deflationary environment", your house would likely continue dropping in price, maybe to $1.8million within the next year. And because gold is actually a hedge against failed confidence in fiat money, gold could rise from $9,000/ounce to $90,000/ounce in that same year.

Trust me, this would be a rough year. And there would be nothing linear or predictable in the TA (technical analysis) that would be tracking price movements.

You see, hyperinflation does not require a linear progression from deflation, to less deflation, to slight inflation, to inflation, to high inflation, to hyperinflation. Nope. As a monetary phenomenon, our money supply was already hyperinflated in the 90's. Counting dollars in the world is like counting stars in the sky. (The main difference being new stars are born at a much slower rate.) None of this recent housing bubble or derivatives monster bubble was even needed to create a currency crisis. In fact, these recent bubbles created their own additional credit inflation and also provided a place to put it, a place that has now collapsed to almost nothing. It sure feels like deflation right now. But that's just because of the collapse of the bubble. The money supply was already hyperinflated before this bubble. Even Another said so in 1997.

So why no price hyperinflation yet? That's because the rest of the world has been soaking up our hyperinflated currency through the trade deficit. No other currency in the world has had this privilege. That's why so many other currencies, when hyperinflated, were soon followed by price hyperinflation.

There is nothing playful and hippie-like about hyperinflation. I have seen it suggested that inflationary times are characterized by hippies and growth and good times, like the late 60's and early 70's. And that deflationary times are characterized by loss of control, social upheaval, war, and death, like the 30's. So the argument follows that we are obviously headed for the latter and not the former, therefore deflation. But I ask you, which is a better description of Zimbabwe? Obviously Zimbabwe compares more to our deflation of the 30's than to the inflation of the 70's, even though it is experiencing hyperinflation.

I think the point is that hyperinflation is a close cousin to deflation, and only a distant relative of inflation. So don't let the name fool you. Hyperinflation is most definitely not a hippie paradise.

I apologize if this post seems jumpy. It's just that there are so many different angles from which to view this debate. And there are so many people writing on both sides of the debate. I have given this much thought from all the angles I have come across, and I always come to the same conclusion.

Let's take a look at what I call the Prophet angle. Where I think Peter Schiff got it wrong is that he thought the foreigners would abandon the USD Titanic either as it was approaching the iceberg, or soon after it hit the iceberg. But they didn't. They seem to be going down with the USD Titanic. However, they do have their own lifeboats. And at the last minute, before we disappear under the water, they will abandon us. Trust me. Peter was actually correct, only his timing was off, and to great cost to his clients at Europac. But his macro view of the way the world economy works is pretty spot-on.

Eric Janszen of iTulip correctly predicted this deflation years ago during the bubble inflation. He called his theory Ka-Poom. The Ka part is this deflationary cycle we are in, which he calls disinflation. The Poom is the massive inflation that will follow. So far he has been pretty correct.

Nouriel Roubini has been very correct about the collapse. And now he sees deflation. He and Mish both see this as continuing for a long time. But what I think they miss is the massive herd of black swans lurking in the bushes. The black swans are an analogy similar to the pins in Eric Janszen's book America's Bubble Economy. It says that the bubble (currently the TBill bubble) is floating through a maze of many many pins. And it only take one pin to pop the bubble. The odds are much higher for a pin prick than for the bubble to make it out of the house-of-pins in one piece.

Another related problem with Mish's and Roubini's view is that it relies too heavily on a linear analysis of the economy. I touched on this earlier. But I call this the TA angle. Part of the reason most mainstream economists did not see the collapse coming like Roubini did is that they relied too heavily on TA, which prescribes slow, linear movements. Roubini saw big troubles lurking, black swans, and rightly predicted a low probability (rare) yet high impact paradigm shift. But now it seems he is suffering the same blindness to black swans that inhibited the mainstreamers from 2006 to September 2008. He now thinks things will continue in a linear progression.

A good comparison for this TA angle is the POG (price of gold). There are some, like Jim Sinclair, Axstone and Stefanmo on GIM that track the POG using TA methodology. If you followed Stefanmo's thread, It's all in the dollar and his methodology, you'd have a hard time reconciling that POG with ANOTHER or FOA who spoke of a $30K POG back in the late 90's. This difference, a linear progression versus a gapping up due to a rare but high impact event, is analogous to the reason Mish and Roubini see deflation and I see hyperinflation in our future. Don't get me wrong, I too see their current deflation. But I also see a 95% probability that it will change to very high inflation, or hyperinflation, or a collapse of the dollar (mere semantic differences), within the next two years at the VERY LATEST.

There is also the Necessities vs. Luxuries angle. This is the way I see it most likely playing out. All "luxuries" are currently deflating. And in real terms (gold terms) this will continue for years. But when you look at necessities, the things we need to survive like food, we haven't seen much deflation at all. In fact, many prices have been going up (except gas) during this current "deflation". Mikal on USAGOLD listed out some of his bills which have INflated in the last two months:
Dentist bill
Grocery Bill
Heatlamp bulb
Car parts- do it yourself
Auto parts and service- garage
Car insurance
Precious Metals
UPS, Fedex and US postal shipping
Computer parts and repair

All you have to do is look at Zimbabwe. Necessities like clean water are as valuable as gold right now. Yet luxuries that we enjoy in the west have almost no market there. So even though their prices are now quoted in the quadrillions, their real values (in gold terms) are still dropping.

Hyperinflation need only hit the necessities. That is why it is so bad. The way I see this going down is that we'll see inflation start creeping into necessities in the next few months followed by shortages in those same necessities, and then a currency collapse which we could call "hyperinflation", because that's what it is. If we have hyperinflation is that not also a collapse of the currency? Yes. And the opposite is true as well.

The last angle I will discuss in this post is what I call the Manipulation angle. Remember that we had high "price inflation" in commodities including oil for the first half of this year. Note that I said "price inflation". This is a distinction from the Austrian "monetary inflation", which was already hyperinflated in the 90's (and which we are piling cash on top of now). Anyway, we had oil going up to $140/bbl in July. That ended July 15th, right after INDYMAC collapsed.

Many notable writers including Don Coxe and Jim Puplava have speculated that Paulson (and the PPT) engineered the commodity collapse simultaneously with the rally in financials and the ban on short sellers (in financials only) starting on July 16th. This commodity collapse, currently called deflation, continued through November. Now if I were to believe that Paulson started this "deflationary" collapse in commodities, must I now believe it is real? Should I believe it will continue once he is out of office? I don't know. But I think I know.

One thing I am fairly certain of is that gold is going up, way up, and relatively soon. Another thing that I'm sure of is that the dollar is not a safe investment. Even now. It can lose massive (like 90%) value overnight if the wrong thing happens. Don't get me wrong. I do have some dollars. But gold is no longer my hedge. Gold is now my wealth reserve, and the few dollars "under my mattress" are now my hedge. Since I don't know the timing of the future events I see coming, I still need to be prepared to pay my bills and to lose some value on those dollars if things happen as soon as I think they could.

One other thing I'm 95% certain of is that we will see what I am calling "hyperinflation" within the next 24 months. And I say 75% by next fall. 50% chance of it by summer. And 25% by spring. There are just too many black swans/pins in the room.

Once again, apologies for the jumpy post. But I have been reading too many things about "the big D" lately that I wanted to write a post. Don't get me wrong, the big D....epression is coming. And the big D.... flationary head-fake is happening right now. But take solace in the people that tell you gold will do well in both deflationary and hyperinflationary environments and don't worry about your gold. But as for the rest of your preparations, just be aware of the black swans.

The following article will show you the state of the money supply and the panic. Note that statistics can be interpreted in many ways, but this article highlights some of the most applicable statistics and graphs to what we are facing. It is by Rich Dad advisor, Michael Maloney.

The Greatest Wealth Transfer in the
History of Mankind Starts Now!

by Michael Maloney
December 19, 2008

Right now, the Treasury, the Federal Reserve, and the banking system seem to be gearing up for an event the likes of which has never been seen. I believe the crisis that will unfold over the next few years will add up to the biggest economic event in history. The scale of what is happening will dwarf all other economic events combined. The Tulip mania of 1637, John Law's "Mississippi Scheme" of 1720, and the dot-com / tech bubble of 1999 will pale by comparison. Even the hyperinflation in Weimar Germany in 1923 and the Great Depression will seem like a walk in the park compared to what is coming.

But wealth is never destroyed - It is merely transferred. Neither you, nor I, have the power to stop what is coming. But we do have the choice to either freeze in panic and be crushed under the wheels of the economic freight train that is bearing down upon us, or catch the ride of our lives on the road to immense wealth.

While speaking at a recent wealth conference in Florida, I showed the audience some charts to try to impress upon them the enormity of what is going on right now! The chart I call my Panic Meter is made up of LIBOR rates (the rate which banks lend to each other) divided by the 3-Month Treasury Bond yields. By dividing LIBOR rates by bond yields you get a measurement of just how panicked the banks and large investors really are. This chart is saying that something is really, really wrong.

Panic Meter (2006 - November, 2008) (Click charts to enlarge)

I then showed a chart of the monetary base (all paper dollars and coinage in existence). It took 200-years for the monetary base to go from $0 to $800 billion, but in just the past 3-months it has grown from around $800 billion to $1.5 trillion, and by the time you read this it will probably be surpassing $1.6 trillion. That's double the number of paper dollars in existence since last summer!

Base Money (1919 - November, 2008)

But here are a few charts that I didn't show at the conference...

The next chart is "Cash in Circulation". So far only a small amount of all that extra currency shown in the above chart has leaked out of the banking system and into circulation. But you can bet your assets... IT WILL. When it does, it means that prices must rise to soak up all that extra currency, like a sponge soaking up water. This is bad news for someone holding dollars, but cause for celebration for a precious metals investor.

Currency in Circulation (1919-November, 2008)

Here is a chart of how many dollars the banks have borrowed from the Federal Reserve through the end of last year (2007). Please note the spike that indicates the banks had to borrow $8 billion from the Federal Reserve during the Savings and Loan Crisis of the late 1980s.

Bank Borrowings from Federal Reserve (1919-2007)

Here is the same chart, but I've now taken it out through November of 2008. You can't even see the $8 billion S&L Crisis peak anymore! In fact, the banks are approaching $800 billion in borrowings. This means that the banks perceive this crisis as being 100 times larger than the S&L crisis.

Bank Borrowings from Federal Reserve (1919-Nov., 2008)

This next chart is Reserve Bank Credit. It is the total amount the Federal Reserve has loaned out of its bottomless checkbook. This chart includes all the rest of the bailouts (at least through November 2008). This chart also rises to roughly $800 billion by the end of 2007, but by November 2008, it has risen to $2.2 trillion. As Brent Harmes would say "It's climbing skyward like a homesick angel."

Reserve Bank Credit

Last, we have a chart of "Excess Bank Reserves". These are reserves in excess of the amount that the Federal Reserve requires the banks to have. It looks almost identical to the chart of Bank Borrowings, except for two small features; there is a tiny blip in 2001 and a small bump around 1941. Could it be that the banks perceive this crisis to be 50 times larger than 911 or even World War II?

Excess Bank Reserves (1930-November, 2008)

With the exception of the Panic Meter, all graphs in this article are taken directly from the Federal Reserve's website. Personally, I'm pretty sure that in a few years a chart of the price of gold will look similar to these charts, and a chart of the U.S. dollar will look like one of these charts flipped upside-down.

If you don't believe me, just take a look at this!

Bloomberg, Dec. 15 - Dollar Staggers as U.S. Unleashes Cash Flood:
"U.S. policy makers are flooding the world with an extra $8.5 trillion through 23 different plans designed to bail out the financial system and pump up the economy. The decline (of the dollar) shows that the increased supply of money may be overwhelming investors...."

In my book, "Rich Dad's Advisor's Guide to Investing in Gold & Silver," I show how virtually every time governments, and/or the banking system, abuse a currency enough to push it to a tipping point (such as in these charts), the free market and the will of the public revalue gold and silver to account for the excess currency that was created since the last time they were revalued. But this time, for history to repeat, and for gold to do what it did in 1980, 1934, and hundreds of times throughout the world going all the way back to Athens in 407 BC, it will require a gold price of over $10,000 per ounce... And that's if they turn off the printing presses today!

I believe this is the greatest opportunity ever offered to anyone in the history of mankind! Gold below $1,000 and silver in the $10 range is a gift from God. You can ignore this gift at your own risk, or graciously accept it and be on the road to great abundance. I don't know about you... but I'm buying lots of gold and silver.

Things I believe every investor should do:

Step 1: Get educated. Don't take my, or anyone else's, word on this. Read books and newsletters on the subject and decide for yourself.

Step 2: Buy physical gold and silver and take possession of it (or have it stored at a third party depository).

Step 3: Avoid "Fools gold" such as:
ETF's, pool accounts, futures contracts, leveraged accounts etc. Many of these are just "paper contracts" with little or no gold or silver behind them.
Collector coins with excessive premiums above the worth of their metal content. These are a better deal for the dealer than for you.

Step 4: Relax knowing you have protected your wealth and positioned yourself to profit greatly from what history tells us is inevitable.

By Michael Maloney

Michael Maloney is a precious metals expert, monetary historian, author of "Rich Dad's Advisor's Guide to Investing in Gold & Silver, and the founder of is an online precious metals dealer that specializes in delivering gold and silver to your door or securely storing it for you in a Brink's precious metals storage account.

To read the book that predicted the current financial crisis and what will happen next, check out Michael's book "
Rich Dad's Advisor's Guide to Investing in Gold and Silver". (Amazon $11.55)

Sunday, December 21, 2008

Weekend at Bernies

This is a riveting read if you've been following the Madoff news. All 19 pages of it.

It is a memorandum to the SEC written by Harry Markopolos in 2005.

While it does make me question some of my thoughts in Madoff's (COMPLETE) Madness, I'm still not convinced this was only a Ponzi scheme.

If Bernie Madoff was willing to do a Ponzi scheme, why would he not do other things which would make him much more money at the same time? Like front running or worse? I mean, he was controlling large sums. He had to be doing something with all that money. And do you really think he was just running a split-strike conversion strategy while lying about his crappy returns? Or was he running a more nefarious strategy with huge returns while the market was good?

Gary Weiss sees several possibilities:

1. Madoff commenced the scam in the hope that it could be terminated at some point and his investors made whole without their knowing anything had happened. Sort of like the bank teller who steals and then tries to put it back.

2. Madoff was a sociopath, who knew precisely what he was doing at all times and felt that he could get away with it indefinitely, and had that mindset from day one.

3. Madoff commenced in the hope that he could make his investors whole, but after a while realized that it was easy money and that he could get away with it indefinitely.

I agree, and I think there are many more possibilities as well. I think we are only seeing the tip of the iceberg right now. I wonder how deep it goes.

As Justin Fox says:
The distinction between the brokerage and the money management business is one that most everybody I've been hearing from about the now-famous video of me and Madoff and his employee Josh Stampfli misses. All that talk in the video about how Madoff makes money and what his dealings with the SEC are like relates to his brokerage business, which was a pillar of the Nasdaq system and was, as far as anybody knows at this point, on the up and up. I didn't have the faintest idea that the man also ran a $50 billion sort-of hedge fund in his spare time. If I had known that, I like to think I would have been suspicious. You don't see Lloyd Blankfein or John Mack or Chuck Schwab running $50 billion hedge funds out of their hip pockets, do you?

Here's the video of Justin, Josh and Bernie:

Forward Thinking On Backwardation

By Antal E. Fekete

In an earlier article Backward Thinking on Backwardation I explained that backwardation in gold is the flipside of the phenomenon of a drastic contraction of world trade and employment. This brings out the danger in denying the fact of gold backwardation or to belittle its significance, as most observers seem to be doing. I am reminded of the saying of the Swiss educator F.W. Foerster: "if you don't use your eyes for seeing, later you will use them for weeping." In this article I want to enumerate the reasons why I believe that permanent backwardation in gold would bring about the descent of our civilization into lawlessness similar to that following the collapse of the Western Roman Empire.

The consensus seems to be that, even if backwardation in gold occurred at one point, it would not be a significant event given the zero-interest environment. Forward thinking on backwardation shows that this is wrong.

Tom Szabo observes (see References below): "If somehow short-term interest rates were to go into significant backwardation, it should be no surprise that gold and silver may go into significant backwardation. THIS WOULD NOT BE A SIGN OF IMMINENT MONETARY COLLAPSE [his emphasis]. In fact, a pretty strong argument could be made for the opposite - that the negative interest rate is a sign of excessive monetary demand (in relation to demand for capital goods and investments). I've looked but have been unsuccessful in finding an historical example of a monetary collapse that occurred while money was actually in high demand. Of course, high demand for money could be extremely deflationary and the only known cure for this is to create a high supply of money, otherwise known as hyperinflation."

While I would disagree with the use of the word "imminent" in describing the coming monetary collapse, I must maintain my stand that a durable backwardation, such as we have experienced for two weeks earlier this month, is a premonition that there will be repeated episodes of the same kind, ever more frequent, ever deeper, ever longer, each episode significantly weakening the monetary system - regardless of the zero or negative short term interest rate. (Let us leave the question aside that zero or negative interest rates in and of themselves show an alarming pathology of the monetary system!)

I have argued that we must carefully distinguish between a fiat money regime with an undisturbed flow of gold to the futures market; and a fiat money regime where the flow of gold to the futures market has been blocked by an unprecedented surge in the demand for cash gold. In the first case confidence in fiat money is high; in the second, it is low and waning fast. In the first case paper gold is an effective substitute for physical gold in most applications; in the second, paper gold has been unmasked as a fraud, and discredited beyond repair. In the first case the economy works pretty well the same way as under a gold standard; in the second, all hell is turned loose as the exchange of goods and services is on the decline and autarky on the rise.

Tom says that "it is incorrect to claim that gold and silver could be in true backwardation without at least some inversion of the futures price curve where the nearer contracts are trading at a higher price than the further out contracts. Well, exactly that's what has happened at Tocom during the first two weeks of this month and is happening still. Tocom publishes its trading summary at the close of trading every day on the Internet: TOCOM LINK. I don't understand how Tom could miss it. Backwardation is jumping off the Internet page covering the standard kilobar contract, even as I write this, on December 19.

Tom is complaining that the spot price for gold is difficult to ascertain: "the spot price for gold is elusive… because they are third-party quotes that suffer from a variety of problems that can make them unreliable and imprecise." I disagree. I have asked my student, Mr. Sandeep Jaitly of Soditic, Ltd., London, U.K., who is tracking the gold basis for me, to explain. Here is what he had to say on December 15: "Tom Szabo comments that spot prices are difficult to obtain. Not true! They are not. You just have to be plugged into the right feeds. My spot price quotes include all the five price fixers at the LBMA, plus everybody else worthy of quoting… The spot gold price I use is the best or highest bid (and the best or lowest offer) from 300 banks world-wide [list attached, not reproduced here]. The data I use is directly from the exchange, and the prints I see for the carry available are super precise. I can get 90¢ per oz profit on the December contract versus my spot quotes that come from every bank on earth…" Sandeep goes on, dateline December 18: "Everybody of note is inferring that gold is in backwardation because of the zero interest. Let us explore that a little further. One can achieve 0.25% annualized by carrying gold for 190 days till June 26, 2009. 190 days in maturity is about equivalent to a 6-month T-bill with a current yield of 0.18%. The cost of carry for 190 days is 0.25 - 0.18 = 0.07%. If we compare this with the cost of carry for 11 days till December 27, 2008, and, again, for 69 days till February 27, 2009, [calculation included, not reproduced here], then we get that the cost of carrying gold is as follows (all percentages are annualized)

for 11 days: 1.005%
for 69 days: 0.9%
for 190 days: 0.07%

That is pathological without any need of further explanation! It costs more to carry gold for shorter periods of time than for a longer period - according to the futures market. That puts a hole in the zero interest-rate argument, and explodes the explanation that the extra-low contango or outright backwardation in gold is nothing more than "normal backwardation" of a non-monetary commodity!"

Tom says that he does not see things evolving in the same catastrophic manner as I do. For example, he believes that "there will always be willing buyers and sellers of gold in some quantity if the price is right." Buyers - si, sellers - no! That's just the whole point. The lack of credibility of irredeemable currency will be such that no one in his right mind will accept it in exchange for gold, the ultimate liquidator of debt. Previously, people were willing to trade their gold because they could always replenish their supply from Comex warehouses. That means, in other words, that the irredeemable dollar could still be used as a liquidator of debt (i.e., gold still has a competitor). But let them close the Comex gold warehouses. This is a quantum jump; it means that the irredeemable dollar can no longer be used to liquidate debt, e.g., debt incurred by those holding short positions in gold futures. It is essential not to belittle the import of this observation.

Tom thinks that I am an alarmist in believing that the permanent closing of the gold window at the Comex will mean a cessation in gold mining, loss of segregated metal deposits, and institutionalized theft of ETF holdings.

To answer this I have to go back to the collapse of the Western Roman Empire after the abdication of the emperor Romulus Augustus on September 4, 476 A.D. It was followed by the Dark Ages when the rule of law, personal security, trade of goods against payment in gold and silver could no longer be taken for granted. Gold and silver went into hiding, never to re-emerge during the lifetime of the original holders. It is plausible to see a causal relationship between the fading of the rule of law and the complete disappearance of gold and silver from trade. Virtually all observers say that the first event caused the second.

I may be in a minority of one to say that causation goes in the opposite direction. The disappearance of gold and silver coins as a means of exchange was a long-drawn-out, cumulative event. In the end, no one was willing to exchange gold and silver coins for the debased coinage of the empire. At that point the empire was bankrupt; it could no longer pay the troops that defended its boundaries against the barbarians threatening with invasion. This is not to say that the empire did not have other weaknesses. It did, plenty of it. But the overriding weakness was the monetary weakness. Centuries after centuries the Mint of the empire could attract less and less gold and silver. Because of this, the empire was forced to debase its coinage and the deterioration continued until the bitter end, when the gold flow to the Mint completely dried up.

Compare this with the Eastern Roman Empire that lasted until the fall of Constantinople to the Ottoman Turks in 1453 A.D., or almost one thousand years longer than the Western half, and during most of this time it could keep its Mint open to gold, producing the gold bezant, which also became the coin of the Muslim world. Is this difference between the two empires trying to tell us something about the importance, from the point of view of political and economic survival, of keeping the Mint open to gold?

The history of the monetary system of the United States shows an ominous parallel to that of the Western Roman Empire. As long as gold and silver was still used in trade at least to some extent, the Western Roman Empire was limping along. The modern equivalent of the disappearance of gold and silver is epitomized by the progressive vanishing of the gold basis.

There is simply no continuous transition from the paper dollar cum contango to the paper dollar cum gold backwardation, Tom's prayer notwithstanding. The transition will necessarily involve a sudden and fatal weakening of the legal system. Remember, the legal system works only as long as most citizens are law-abiding. It breaks down as soon as the majority of the citizens find that the law protects thieves in high places, but offers next to no protection for the honest hard-working middle class. I am not going to elaborate here on the proposition that irredeemable currency is a system that protects thieves in high places, but robs the little guy by plundering his savings.

Tom notes that it may be technically possible to delay the collapse of the fiat money system by "allowing" gold to appreciate in a hyperinflationary scenario. That is precisely the phase that will end with the entrenchment of backwardation in gold. Thereafter one can no longer talk about an "appreciating gold price", or any gold price for that matter, as the pricing mechanism will have self-destructed, at least as far as the price of gold is concerned. As Tom himself observes in the same article, local prices in India, China, and in the jungles of Papua are not relevant. Only gold prices in New York and London are, and the arbitrage between the two.

I have nowhere said that the end of the fiat money system will follow the closing of the gold window at the Comex in a matter of days. Sure, finance ministers and central bankers will try to "muddle through". It is not possible to predict how long the death throes of fiat money will continue. Tom may be right in suggesting that it will take many years, and claims of an imminent monetary and economic collapse will again turn out to be wrong.

But where Tom is certainly mistaken is his suggestion that all this agony will take place while the Last Contango in Washington is still going on. You can't have contango and backwardation at the same time. Backwardation is like a black hole, once it grabs a currency, it will swallow it, and gold quoted in that currency will never return to contango.

I think Tom's greatest mistake is to interpret the move into backwardation, or gold to enter the 'fever phase', as "gold's regaining fully-recognized monetary status". Unfortunately, just the opposite is the case. Whether officially recognized or not, gold's monetary status was never in doubt. Gold has always been the monetary commodity par excellence, due to the fact that it has constant marginal utility (or, if you will, the fact that the marginal utility of no other commodity declines at a rate slower than that of gold).

What we are witnessing is a transition that deprives gold of its monetary qualities. Gold in hiding cannot and will not act as money. More to the point, absent gold, nothing else can or will. The disappearance of money, that can be trusted, fatally undermines the legal system, the sanctity of contracts, habeas corpus, any and all provisions of law and order that we take for granted. Under these conditions nobody can operate a gold mine, nobody can run a gold refinery, nobody can guarantee segregated gold deposits, and nobody can prevent the institutionalized theft of ETF holdings. Welcome to the Madoff economy! (See References below: Paul Krugman's column in The New York Times). Jail one Madoff, two others will jump into his shoes.

As a consequence of the permanent backwardation in gold, we shall have a world gone Madoff.


Tainted Research: Lysenkoism -- American Style, June 4, 2003

Monetary versus Non-monetary Commodities, April 25, 2006

The Last Contango in Washington, June 30, 2006

Red Alert: Gold Backwardation!!! December 4, 2008

Has the Curtain Fallen on the Last Contango in Washington? December 8, 2008

There Is No Fever Like Gold Fever, December 10, 2008

Backwardation That Shook the World, December 14, 2008

Backward Thinking on Backwardation, December 18, 2008

These and other articles of the author can be accessed at the website

Backwardation Update - Still No in Gold, but Maybe in Silver! by Tom Szabo,, December 12, 2008

The Madoff Economy by Paul Krugman,, December 19, 2008


The author wishes to express his thanks to Mr. Sandeep Jaitly of Soditic Ltd., London, England, (e-mail: for tracking the gold basis for him.

Monday, December 15, 2008

Madoff's (Complete) Madness

As I have been following this story over the past 4 days, I have had to hit the snooze button on my BS detector several times. I will explain.

First of all, let me say that this story is HUGE in my opinion. In fact, if it escalates like I think it could, this scandal could bring us FreeGold earlier than even Mother Nature intended.
This is "a fresh blow to financial confidence", according to one tycoon facing a $9bn loss.
This from an article today. I think this quote says it all. When you consider the elites who have been affected by this, you start to realize that this could be a catalyst for the changing of elite psychology toward our way of thinking.

I remember back... it was a personal loss of net worth that first turned me to the recognition of gold!

So why is my BS detector screaming? Virtually every article about the Madoff crime has used the term "Ponzi scheme". Because that's what Bernie himself called it. But after much deliberation, I believe that once the details come out, his crime will be far more shocking, and the fallout infinitely more widespread than a simple Ponzi scheme would have produced.

You see, Bernie's company was a "market maker" on the NASDAQ!

Follow these snippets:

[Billionaire Bernie] was charged with operating what he told employees was a long-running $50 billion Ponzi scheme...

“It’s all just one big lie,” Madoff told his employees on Dec. 10, according to the government. The firm, Madoff allegedly said to them, is “basically, a giant Ponzi scheme.”

His New York-based firm was the 23rd largest market maker on Nasdaq in October, handling a daily average of about 50 million shares a day, exchange data show. It specialized in handling orders from online brokers in some of the largest U.S. companies, including General Electric Co. and Citigroup Inc.

Madoff ran his investment advisory business from a separate floor of his firm’s office, keeping financial statements “under lock and key,” prosecutors said. Early in December, he told one employee that clients wanted to redeem about $7 billion and that he was struggling to free up the funds, the government said. After he told another staff member Dec. 9 that he wanted to pay annual bonuses before the year’s end, two months early, a pair of senior employees asked to speak with him, prosecutors said.

They had noticed he had been suffering from a “great deal of stress” and wanted to know what was happening, the U.S. said. When one of them challenged his explanations, Madoff invited them to his Manhattan apartment, saying he “wasn’t sure he would be able to hold it together” if they continued talking at the office, the government said.

While meeting the pair at his home yesterday, Madoff conceded that he was “finished,” that his advisory business is “all just one big lie” and “basically, a giant Ponzi scheme,” the government said. The business had been insolvent for years with losses of about $50 billion, he told the employees, according to the criminal and SEC complaints.

Madoff said he had about $200 million to $300 million left and planned to distribute money to select employees, family and friends before surrendering to authorities in about a week, the government said.

The Madoff firm had about $17.1 billion in assets under management as of Nov. 17, according to NASD records.

Okay, so he had his market-maker business, then he had his secretive $17bn investment "advisory". So if it was a straight Ponzi scheme, the losses should not exceed $17 billion, assuming he spent the whole nut. And that's a lot of spending!!
Mr Madoff confessed last week that his business was "all one great big lie". The investment returns were fake, and he had been paying old clients with money from new ones. In its conception, the scam is a classic. In its size, it is breathtaking, eclipsing anything seen before. He personally estimated the losses at $50bn

The feds are now confirming that his estimate of $50bn will probably hold up. So where did the other $33bn come from?

From the NASDAQ!

The way a market maker works is that it takes your bets, on Scottrade, E-trade or whatever, and guarantees your return. It doesn't run down to the floor to sell 25 shares just because you clicked a button. It waits and makes bulk trades to clear the books. But in Bernie's case, my guess is that he thought he knew better than you. So he would guarantee your bet on the books, but take your money and place his own bets.

He probably placed these bets with other people's money, (not money they had entrusted him to bet) on "high return" investments like OTC derivatives of some exotic kind. My guess is that he has been doing this for years with both his Investment Advisory $17bn as well as untold sums from his sons' market maker business. And any return he made above and beyond your bet on, say, Microsoft, he would keep. Then his computers would credit your account for whatever your bet on Microsoft paid.

And because he mixed the money in this way, he generated a very good (11%), but imaginary, return for his IA clients. Then, when the market turned really bad in mid-September, the jig was up. He took huge losses. Perhaps his losses started a year earlier even. Whatever. At that point his crime, his fraud, became a Ponzi Scheme.

He kept both businesses going as long as he had fresh money flowing in. And I have a hard time imagining that he kept this going for 15 months, so I think he probably "hit the wall" this past September.

Of course his market maker redemptions took preference. He wasn't even ALLOWED to touch that money. But once his IA redemptions hit a certain level, he had to give up. He realized this over Thanksgiving weekend. That's probably when he told his sons. Then he told them again in December with a witness present.

So...... this means that money was lost that was invested through OTHER BROKERS, and was traded fairly on the NASDAQ! These losses will be the first that the SIPC will have to cover. And $33bn will clean out the SIPC.

So that's why I say we have only yet seen the tip of the iceberg. And even the tip is pretTy bad!!
They have poured billions of dollars into Mr Madoff's too-good-to-be-true investment fund, which appeared to post double-digit annual returns come rain or shine.

nothing left of the money Mr Madoff had pretended to be investing for many years.

Mort Zuckerman, the owner of the New York Daily News and one of the 200 richest Americans, said "I think we have another break in whatever level confidence needs to exist in money markets."

And from the public comments on one of the article:
Now they're talking about bailing these people out. If they bail out the rich folks and holier-than-thou "charities" who dealt with this thieving bum you can forget about the rule of law. There will be riots.

Well, I think the fallout could actually be WORSE than riots. It could be a complete loss of confidence in all paper investments. I mean, if you can't even trust your online broker, or your safe bank, who can you trust?

Gold! That was the conclusion I came to after the pain of coming to terms with great loss. Loss makes you think in new ways, and it makes you search. I think we must add this (THOUGHT) to the already unfolding FreeGold and realize that the Madoff scandal adds some serious fuel to the fire.

As ANOTHER said, "All paper will burn!"


Postscript: For clarity's sake (my wife says I should be more clear)... I think BB (Billion Bernie, soon-to-be Bighouse Bernie) was definitely engaged in a long term fraud. But I don't think that fraud was a Ponzi scheme. I think it only BECAME a Ponzi scheme recently, when his returns went massively negative. And I think that there is a high probability that this kind of fraud is widespread, whereas, if it were strictly a Ponzi scheme (which is kinda stupid if you think about it), he might be the only one. So that's why I think this is a HUGE story (in the making). It's not about a Ponzi scheme, it's about a money "trustee" trying to earn a higher return (on the sly) so he can pocket the difference. And the only reason BB busted himself was to try and spare his sons.

Sunday, December 14, 2008

Backwardation That Shook The World

By Antal E. Fekete

On Friday, December 12, backwardation on gold was still in force at an annualized discount rate hovering around 2% in the December contract, and 0.3% in February contract. Many readers have asked me how it is that so many other observers fail to see the backwardation. The discrepancy is due to differences in methodology. Most analysts calculate the basis as the difference between February and December futures prices which gives them a positive reading. They use the December futures price as proxy for the spot price. This is clearly wrong. The December futures price is not the same as the spot price, even though we are in December.

My methodology is to calculate the basis as the difference between the asked price for the December futures and the bid price for spot gold. The logic behind this is that if you wanted to transfer your costs of carrying gold to the futures market, then you would have to sell physical at the bid price of spot gold and buy it back at the asked price of the December futures.

The opportunity cost of carrying physical gold is known as the carrying charge. It covers interest, insurance, cost of storage, and all other incidental costs including taxes and fees, if any. The carrying charge is the upper bound of the range within which the gold basis can vary. Holders of gold would never allow the basis to exceed the carrying charge. If it did, they would keep selling cash gold and replace it with gold futures until their arbitrage would eliminate excess contango.

Exactly the same theoretical argument can be used to prove that the basis cannot go negative. And, indeed, it never has for more than a few hours that it takes to send out a wake-up call to alert sleeping arbitrageurs.

That is to say, the gold basis has never gone negative -- until December 2, 2008. On that ill-starred day gold went to backwardation for the first time ever in history, and got stuck there. This gave rise to a controversy that is still raging. What is the significance of this event? The majority of observers shrugged: so what? Others, including the present writer, warned of the extremely serious consequences threatening the international monetary system and the world economy because of the highly corrosive nature of the backwardation in gold.

Why is it that the same theoretical argument is foolproof in the case of full contango, but it is fallacious in the case of backwardation? The reason is that full contango in gold (maximum reading on the gold basis) implies full public confidence in fiat money; backwardation (minimum reading on the gold basis) implies the collapse of public confidence in fiat money.

Let us put this into context. We have had a strange and ominous phenomenon lasting well over three decades which mainstream economists have been utterly unable (unwilling?) to explain. When gold futures started trading in the United States in 1975, the gold basis was close to full contango. Since that time it has shown a stubborn falling tendency, steadily increasing its deviation from the carrying charge.

This is as if, after a brief honeymoon in 1975, holders of physical gold started to go on strike in ever greater numbers, refusing to take the ever increasing wage offers on the bargaining table. They would rather go without any wages at all.

Of course, strikes are not out of the ordinary, so the phenomenon of the vanishing gold basis could be, and was, swept under the rug. Mainstream economists could still lull themselves in the belief that the gold basis would never go negative. Come to think of it, if it ever did, it would be the equivalent of employers offering to take over from the unions the responsibility of making strike-pay available to workers on the picket line. Now, there, such a thing would truly be unheard-of!

Yet, surprise, surprise, it has now happened, although not in industrial but in monetary relations. Holders of physical gold, now on fully-fledged strike, are offered a strike-pay by the futures market, and the offer is left on the bargaining table, but the strikers still won't budge. There it is: the gold basis went negative, gold has been in backwardation for over a week, and physical gold is still not coming out of hiding.

In spite of all the propaganda aimed at discrediting me and my theory of gold backwardation, what we are hearing is the shrill sound of the fire-alarm indicating that the house of the international monetary system is on fire. For many a year I have been warning all those who cared to listen that such a fire-alarm was coming sooner or later, and the consequences of ignoring it would be disastrous. Well, it is sounding loud and clear now, and guess what. Fire-fighters brazenly ignore it. Yet you can ignore it at your own peril.

What does it all mean? Not only does it mean that the market is willing to pay all your carrying charges involved in holding physical gold, but it is also willing to pay you (allegedly) risk-free profits for the privilege of relieving you from carrying the burden! "Let me take over your yoke just for a few days; I shall pay you handsomely for the honor" - so the clearing members of Comex plead.

It is as if the bank was paying all your utility bills without charging it to your account. Nay, the bank is actually offering you a bonus for you allowing it to do you the favor. Suppose, for the sake of argument, that all the banks in the world offered all their account holders to take over responsibility for paying their utility bills. Would it not evoke some searching questions about the hidden agenda of the banks? Wouldn't people become extremely suspicious of the preposterous offer? Yet here we go, the futures market in gold, the world's residual source of cash gold, is making the same preposterous offer, and nobody is asking questions. Timeo Danaos et dona ferentes (I fear my enemies most when they bring me gifts, Virgil, Aeneid, II. 49.)

I warn the world again that the futures market would not go to backwardation in gold if the house of paper money were not on fire. There is just no prima facie reason for a shortage in physical gold. A very large part of all the gold produced throughout history still exists in monetary form, sitting in vaults doing nothing. (Under the gold standard it used to be doing heavy-duty work in financing production and world trade.) Unlike all other commodities with the exception of silver, for gold the stocks-to-flows ratio is a high multiple (by contrast, the stocks-to-flows ratio of copper is a small fraction). And, on the top of privately held gold, there is central bank gold amounting to one quarter of all the gold ever produced since the dawn of history. Why are central banks unwilling to take advantage of risk-free profits by releasing gold? Could it be that, in possession of inside information, they have reason to be afraid that the regime of irredeemable currency may soon collapse and, with their gold gone, they don't want to be left holding the bag? Could it be that the Babeldom of the debt tower is already crumbling, but the fact is being covered up?

There is simply no explanation for the backwardation in gold, absent monetary science. And since monetary science has been exiled from the world's universities for the past fifty years (this is what I call "Lysenkoism -- American style", see References below), people are dumbfounded. They don't understand the phenomenon of holders of gold passing up the opportunity to earn risk-free profits.

Monetary science gives a clear and unambiguous explanation. Here it is, and please remember that you have heard it here first. We are facing a pathology of the international monetary system based, as it is, on irredeemable promises to pay. People are enjoined through 'legal tender' legislation to use these irredeemable promises as if they were the ultimate means of payment, even though they are not, and the world would rather use gold and silver as the natural and ultimate extinguisher of debt. But gold and silver have been coercively eliminated from monetary circulation for the competition they offered to synthetic debt-liquidating devices. Mainstream economics pretends that the issue has been settled for once and all. It asserts that liquidation of debt through the coercively maintained payments system has no threat to the national and world economy. Yet what is happening is that the government keeps kicking the toxic garbage upstairs which keeps accumulating unobtrusively in the attic, only to come crashing down in its own good time to cause untold amount of social damage.

In the real world it is natural law, rather than man-made coercive laws, that prevail. The pathology of the regime of irredeemable currency has not been attended to, and the day of reckoning has dawned. Our pathological monetary system has allowed the burgeoning of debt beyond all rhyme and reason. It has no mechanism to extinguish debt. It pretends that transferring debt to the banks, and ultimately to the government, is tantamount to extinguishing it. However, the truth of the matter is that only gold circulation is able to extinguish debt. When it is stopped in its tracks, as it is under conditions of backwardation, debt explodes.

The debt tower is toppling. Central banks work overtime printing money to plug the holes in the leaky foundation, but their traction that they could once take for granted is gone. The money they print goes into either gold hoarding or into government bonds. The monetary system has short-circuited and is in the process of burning out. Practically no money is going into the production of goods and services. The bloated economy is contracting fast. Great Depression II is upon us. The monetary system is past the point of repair. This is the story that the backwardation of gold is trying to tell those of us who have ears for hearing and brains for comprehending.

Backwardation in gold is the sweet siren song that is trying to tempt Odysseus to his doom. But Odysseus was smart enough to have himself tied, fist and foot, to the mast and had the ears of his oarsmen be plugged with wax. His ship is sailing through the dangerous waters without unloading gold.

Backwardation also gives a signal to those who are not so fortunate as to have some of the precious yellow in hand. It tells them to be prepared for a thunderous collapse of the international payments system, worse than the collapse of the twin towers of the World Trade Center. Backwardation means the inevitable contraction of the world economy, the beginning of an era of diminishing enterprise and employment, an era of snowballing business failures and poverty. Printing more irredeemable promises to pay will make this condition worse, not better.

* * *

It can be seen that the $80 rise in the spot price from $740 to $820 during the week that just ended has not been able to compel holders of spot gold to exchange their holdings for a promise to deliver gold a mere 18 days later, the bait of 'risk-free' profit notwithstanding, in spite of the unprecedented discount on gold futures. To tell the truth, the promised profits are not risk free. The risk is that the gold will never be returned and those who have listened to the siren song will be left holding the bag.

Events of last week show the heroic resistance of the bulls: they have so far refused to listen to the sweet siren song of the clearing members. They unearthed the golden hatchet and have not let themselves be led astray from the warpath. On Thursday, December 11, 12,588 contracts in the December futures month (an increase of 139 contracts from the previous day) stood in line waiting for delivery. This is equivalent to 43% of registered gold in the warehouses! As is known, the clearing members have till December 31 to deliver; otherwise they have to declare "liquidation only", effectively closing the gold window. If that happens, it would be a historical first, likely to cause a much bigger stir than the appearance of backwardation on December 2, which caused a yawn. The world would be shaken out of its lethargy. This backwardation would break the grip of the regime of irredeemable currency on the world.

The clearing members have used the carrot to no avail. Will they now use the stick, increasing margins on long positions to exceed the value of the underlying contract? We don't know, but obviously they are hesitant to make a rash decision. Such a move could easily backfire. It would betray their desperation, which could provoke even more notices demanding delivery of physical gold.

Who is going to blink, the good guys or the bad? It is too early to say. At any rate, even if the good guys blink, they will be back in force in February for a showdown to face a much-weakened opponent.

* * *

Mike (Mish) Shedlock published a rejoinder to my There Is No Fever Like Gold Fever (see References below). According to him I have stated that "gold is not for sale at any price", here and now. What I have said was that if Comex declared "liquidation only", in effect closing the gold window, and backwardation became a permanent fixture of gold futures trading, then it would be tantamount to "gold is not for sale at any price". Mish also puts words into my mouth suggesting that I considered this an equivalent of the gold price shooting up to infinity, a kind of initial salvo to mark the beginning of hyperinflation in the United States.

I have been very careful to avoid any prognostication that backwardation in gold would trigger backwardation or price rises in other commodities. I am not even talking about a price rise of gold itself. The truth is that my own position on deflation in the United States is, and has been, very close to that of Mish. Backwardation in gold has nothing to do with the opening salvo for hyperinflation. "Gold is not for sale at any price" is not the same thing as a runaway gold price. Rather, it is an indication that it has dawned on people how foolish it is to accept irredeemable promises to pay in exchange for gold, the ultimate means of payment.

What Mish seems to be missing is that it is not unthinkable that gold futures trading stops altogether for want of deliverable material, while the price of oil, grains, and other highly marketable commodities keep falling along with the rate of interest -- symptoms of deflation. This is precisely the problem that needs to be researched, but no university or government think-tank is doing it.

Mish says that the United States is not Zimbabwe. Who said it was? However, the United States dollar and the Zimbabwe dollar are no different in principle, if not yet in practice. They are both an irredeemable currency. Managers of the U.S. dollar are just making the first tentative steps to join the managers of the Zimbabwe dollar in Dante's Inferno. The eighth of the nine circles in Hell is reserved for perpetrators of fraud and false pretenses, among others, the managers of irredeemable currencies. As Dante describes it, their punishment is to be kept submerged in a cesspit full of excrement. Honestly, they don't deserve to be washed clean by Mish or anybody else.

Rumors that there may be a failure of delivery in the December contract turned out to be surprisingly accurate. Mish is premature in doubting that such a failure is in the cards. Backwardation-deniers must not jump the gun. A titanic struggle is taking place right now, out of earshot and out of sight: the bull fight at Comex. In this bull ring it is not always the toreador who kills the bull. Sometimes the bull kills the toreador. The fight takes place on weekdays from 8:15 a.m. to 3 p.m. EST. While it is not carried on TV, it is carried by the wire services. The last fight is scheduled on December 31 -- unless the toreador resigns beforehand and the bulls win by default.

Mish says that actually he hopes that there will be a failure of delivery in December gold. Be careful what you wish for, you may just get it! Especially if you have not made a study of what backwardation of a monetary commodity means, because you don't know what you are wishing for. It is no picnic. It is more like a monetary earthquake measuring ten on the Greenspan scale. Hyperinflation is not the only hell on earth! Hyper-deflation ushered in by backwardation in gold could well be worse.

* * *

I have received the following letter from a reader.

Mr Fekete:

I always read your articles as part of an effort to educate myself about the gold market. Thanks for sharing your expertise and I look forward to your future articles.
In your most recent articles you harp on Mr Sprott for no longer supporting your University.
I don't know Mr. Sprott personally but I have to say he has every right to support or not support whatever endeavours he choses.
Your constant negative referral to him diminishes your credibility, imo.
Give it a break!

Kevin Southwest

I have sent this answer:
Dear Mr. Southwest:

Thank you for your kind words. I am delighted that you have found my writings of some value.
You are right in saying that Mr. Sprott can do with his money as he pleases. What you don't know is that I have not approached Mr. Sprott asking for money; he has approached me offering it. Under these circumstances I thought I could expect the courtesy of an advance notice of his decision to terminate the arrangement. Instead, he just cut me off and ignored my repeated inquiries. When I insisted on an answer, he sent me a letter with the insulting remark that "results do not justify the expense". For your information, the grand total of his "expense" was $22,500 Canadian.
I am sorry that you find my repeated reference to this humiliating incidence annoying. Please allow me to be the judge whether my procedure diminishes my credibility or not. After all, nobody is forcing you to read someone with impaired credibility.

Yours, etc.

Here is another letter:

Hi Antal,

This letter is to thank you for and congratulate you on your priceless contributions to the education of your fellow men. I have said this to you before, but now I repeat it: Your lasting legacy to history will be your work on the 'basis'. I am sure that a hundred years from now you will be quoted favourably by authors of financial articles and books. You have become a truly great financial intellectual power.
Constructive criticism: I do understand your disappointment at the cancelling of financial support for Gold Standard University Live by Eric Sprott. I am sure this was a business decision. If so, it was a bad one. Time will prove this.
But you are much too big and important of a person to let it drag you down. Get over it! Let it go! Move on! We all have great respect for you. Your written sideways slaps at Eric's bad decision do not hurt him but rather diminish you.
Give him credit for the assistance he did provide. Rise above the hurt feeling slipping into your writings.
I do hope you understand that this is sent to you by a friend who intends only the best for you.


I have answered this letter as follows:
Dear Frank,

Thank you for your kind words and encouragement. I can assure you that Eric's decision in no way drags me down. Nor have I ever had any intention of hurting him.
Every week my readership is increasing by hundreds of newcomers seeking knowledge which they could not get from any other source. I have the right to inform them about the reasons why Gold Standard University Live had to fold tent.
I have never doubted that you have but the best intentions towards me.

Your friend,


Tainted Research: Lysenkoism -- American Style, June 4, 2003

Monetary versus Non-monetary Commodities, April 25, 2006

The Last Contango in Washington, June 30, 2006

Red Alert: Gold Backwardation!!! December 4, 2008

Has the Curtain Fallen on the Last Contango in Washington? December 8, 2008

There Is No Fever Like Gold Fever, December 10, 2008

These and other articles of the author can be accessed at the website

The Nonsense about Gold Backwardation, etc., by Mike (Mish) Shedlock, December 7, 2008,

No Fever Like Gold Fever: Response, by Mike (Mish) Shedlock (ibid.)


The author wishes to express his thanks to Mr. Sandeep Jaitly of Soditic Ltd., London, England, (e-mail: for tracking the gold basis for him.

Calendar of events

Szombathely, Martineum Academy, Hungary, last weekend of March, 2009Encore Session of Gold Standard University Live.

Topics: When Will the Gold Standard Be Released from Quarantine?The Vaporization of the Derivatives TowerLabor and the Unfolding Great DepressionIs There Life after Backwardation?

San Francisco School of Economics, June-August, 2009
Money and Banking, a ten-week course based on the work of Professor Fekete. The Syllabus of this course is can be seen on the website:

December 14, 2008

Thursday, December 11, 2008

FOA - Quotes from The Trail

Below are some gems from FOA that I especially like and that seem very appropriate today. Enjoy!

Within every social order, people have conflicting factions that try to dominate the whole. But if one can understand and pinpoint the logic and reasoning of several dominant groups, we can get a grasp for the overall eventual flow. We have seen throughout history and in our modern life that the human spirit, most always reaches for and leans towards natural conclusions to ages old problems. There is something in us that makes mankind flow this way. (2/23/00)

Few investors can "grasp" that in reality, our dollar has already been hyper inflated, but without the higher price effects. Years of deficit spending, over borrowing, debt expansion have created an illusion that the dollar was immune to price inflation. This illusion is evident in our massive trade deficit as it carries on with no negative effects on dollar exchange rates. Clearly other investors, outside the Central Banks were helping in the dollar support process without knowing they were buying into a dying currency system.

The only thing that kept this process from showing up in the prices of everyday goods was the support other Central Banks showed for our currency through exchange intervention. As I pointed out in my other writings, this support was convoluted at best and done over 15 to 20 years. (3/17/00)

We will all look back on this and see that most of our trusted measuring sticks were useless to decipher the situation. If we truly do not know what a "dollar credit" (DC) is, how can we know what it is worth in purchasing power? We do not even know approximately how many DCs are out there, let alone their demand to satisfy debt service. What is really starting to spook the big world players is that no one now knows what kind of currency intervention is in the pipeline at any moment in time. This is having the effect of making one's real debt in international dollars an "unknown". The same thing goes for dollar assets?

You could owe one million in value today, then find that an evolving political agenda has changed that amount to 5 million in real value tomorrow. All of this was glossed over for many years by employing derivatives to hedge. Now that arena has grown so large that there is a real threat that the derivatives need hedging too! I laugh about it but it's a real event, happening in real time. It's scaring the hell out of a bunch of people and they are not taking if as being funny.

The camp fire is burning now and everyone is here:

Did you ever see the movie "Havana" with Robert Redford? It was a great tale about a card gambler that often went to the casinos in Cuba. It takes place just before the revolution when Havana was a real swinging place. I don't remember the exact lines in the show but he often made reference the the laws of probability. Saying "anything is possible, just not always probable". To that end he explained to his girlfriend why there was a lump in the skin in his forearm. It seems he had a diamond sewed under the skin, "just in case"!

It was an excellent example of human interaction with the laws of probability. It seems that inside all of us lies a fear that what the world is telling us (the marketplace) may not be real. Just like ORO said what if "there is no spoon" and our financial process is the trading of illusions! We all expect life itself to be chancy, and fully expect to lose some in the effort. But no one wants to be "busted out" because of a freak, once in a generation "revolution in the way wealth is counted".

In reality,,,, in the real world,,,, big players never tell their whole tale,,,, not like the persona of our little trader/gamblers talking their book on the Internet. In the big arena that really counts,,,,,, real players all keep most of the wealth "off the table" and "under the skin". So what does this have to do with the BIS?

Remembering back:

Something that Big Trader or Another said a long time ago about trading gold off market in the thousands. Trust me, it's there somewhere way back in the pre USAGOLD days. It seems that gold was then and is today traded between countries, CBs, special accounts,,,,,,, at not only contract prices but in the "perceived prices" that would exist in a non dollar world. Hard to believe? Don't be so quick to laugh. We are talking about gold traded in large amounts on the "possibility" of a no dollar reserve world,,,,,, gold moved from "under the skin" to "under the skin" so to speak.

In some cases more than a few people have "done the math" and come up with some startling probabilities and possibilities. In some perceptions, it's a political certainty!

Imagine, if you will that gold,,,,, tomorrow,,,,,, was "marked to the market" and slated for 30 day physical settlement. Most Western thinkers and investors would say that there is plenty of gold out there to cover all that paper. At worst it's price would go to,,,,, say,,,,, $700 in the squeeze. Well, that is assuming this event happens in a world like today where the dollar and our US economy is still running.

But these Western investors don't understand the real human world. Gold being marked to market would be the result of an economic revolution of sorts. A currency transition, if you will.

Most of the big talkers you hear in the bar,,,,,, saying they would sell at $1,000 and buy some land,,,,,,, would be the very last scared kittens to cut that diamond from under their skin! Believe it!

Under the circumstances,,,,,,, miners would do their best to "stop mining",,,,,,, dealers would mostly be making a market on the buy side only,,,,,,, and our bar room paper gold trading friend,,, with all his bravado would be telling everyone,,,,,, "Gee, I sold too early and wish I hadn't"!! All the while wearing a long sleeve shirt on a 90 degree night in Phoenix,,,,, just to cover the lump that's under his skin!

The night is getting very still:

Today, gold is worth far more than it's traded contract price,,,, and has been for some years. That's the reason some players have owned it while giving up any interest and stock gains they could have enjoyed.

Listen to this and listen closely: "the real value of gold today is based squarely on the probability of whether the US dollar can survive as a reserve currency"! No problem, you say? Well, you may think a little different in a few weeks or years.

Considering the trade deficit of the US, CB dollar reserves and the interest they earn,,,, are worth between $.50 and $0 in real good buying power.

Now, would you sell your gold into the BIS system for dollars,,,,,, at the market price today to have it returned in Euro gold credits reserves at the real price much later?
Just as TownCrier says in his daily commentary:

the IMF gold leaves at one price and returns at "Another" ,,,,,,,, it travels far but never moves,,,,, while the BIS holds the value for a later use in time.

It seems a neat "gray concept" to have just popped out of nowhere, no? Was that plan already "in process" somewhere ,,,,,, someplace,,,,,,,, think about it?

Then think about the dollar price of gold today? In fact, "think long and hard about it"?

Fires out

Thanks for hiking. (be on the forum later or tomorrow)

FOA/ your Trail Guide (4/15/2000)