Wednesday, July 29, 2009

Green Shoots Open Forum


Hungry: Arizona decides to cannibalize self
Legislators are considering selling the House and Senate buildings where they've conducted state business for more than 50 years.

SP500 PE Ratio is Now at a Mind Blowing 723!
Previous all time high was 46.

5yr Treasury Auction Fails
That's right, FAILS. No, you didn't hear it reported this way and won't, but that's the math. Next try... 7yr tomorrow.

MOPE Spin: "Call it Lassie, this is a bow wow" - Rick Santelli

And just for fun...

Wednesday, July 22, 2009

Bondage or Freegold?

"When confronted with a situation that appears fragmented or impossible, step back, close your eyes, and envision perfection where you saw brokenness."
- Alan Cohen

"To visualize is to see what is not there, what is not real -- a dream. To visualize is, in fact, to make visual lies. Visual lies, however, have a way of coming true."
- Peter McWilliams

"What the mind can conceive and believe it can achieve."
- Napoleon Hill

Spend Currency, Save Gold

It is the concept of becoming a Super-Producer (producing more than you consume) that creates the need for savings. We all do this over the course of our lives if we plan to live a long time. It is a well-known fact that old people have a difficult time producing. There comes a time when we must retire on our Super-Producer fruits of yesteryear.

John Locke made the point in 1690 that metal money gives men something lasting to keep, that will not spoil, and does not infringe on anyone else's daily lives.

Today, while in our producing years, we transfer our excess value into bonds. That is, someone else's bondage to us. A SPECIFIC SOMEONE! We hold as wealth reserve a contract that says someone SPECIFIC will provide for us later when we can no longer provide for ourselves. These contracts are reputed to be better than gold! But are they?

This system on its surface is clearly a Ponzi scheme, requiring an ever-growing future army of laborers lured into debt in order to service the Super-Producers of yesteryear. But there are bigger problems than just the pyramid structure of the system.

Rather than staying balanced, the globe has divided into hemispheres where one side is producing more and the other is consuming more. The producing side is accumulating enormous amounts of contracts holding the consuming side in bondage well into the future. So it would seem that future generations in the West would be supporting an aging East (net-net) at some point in time.

The problem is that the trend is now visible to all. The West is shrinking while the East is growing, both in population and economically. Futurecrash is clear to anyone with eyes! So I ask again, are these contracts really better than gold?

If we hold gold as a wealth reserve instead of A SPECIFIC ENTITY'S bondage, we have exchanged SPECIFICITY for DIVERSITY. We now hold a claim on the future services of ANYONE IN THE WORLD who is willing to work for us (for gold)!! We eliminate the risk that our PERSONAL, SPECIFIC SERVANT may fail to perform for us in our time of need.

In the opaque world of paper investments we must CHOOSE which entity we want to service us in the future. Perhaps we choose a Vanguard Mutual Fund. Or a global company like General Electric. But how do we know they will perform for us when we need them.

With gold we have eliminated the risk of choosing the wrong entity. Instead, we have our own small share of a future claim on the entire workforce of the planet!

This simple difference between holding debt and holding gold is getting a lot of publicity right now, not through the media, but through the window of reality!

The journey through China

There was an interesting article in (I think) early '08 when the dollar was tumbling fast. It was about Chinese merchants dumping US dollars on their local banks as fast as they came in. In China, it was illegal to exchange dollars for yuan anywhere except the banks. And the banks were overwhelmed by the demand for renminbi. The PBOC was printing currency as fast as possible to keep up with the demand, but it was not fast enough. Long lines were forming at the local banks and some merchants were being turned away at the close of business, doomed to hold their depreciating US dollars for one more day.

I think it is helpful to consider the journey of a dollar in today's system.

If I am an importer of goods into the US, I simply pay foreigners with my home currency. But if I happen to be an importer elsewhere, there is a good chance I will have to first buy US dollars before I can pay for my shipment. If I am an exporter in China, I am prepared to receive both yuan and US dollars. But for my operating expenses I need only yuan. So I must go to the bank often to turn in my dollars.

My local Chinese bank then gives the dollars to the PBOC who prints new renminbi ("people's currency" in Chinese, denominated in "yuan and jiao" like "dollars and cents").

Sitting at the core of the Chinese economy of 1.3 billion Super-Producers, the PBOC ends up with an astounding amount of US dollars which it pays for with its printing press. This yuan inflation (printing) is a burden on the Chinese economy which must be offset by the central bank's investment of the accumulated US dollars in future usable wealth reserves.

Today, US Treasury debt is the primary option for such large hoards of greenbacks. No other entity offers as large of a future "debt service" as the US government. So the PBOC ships the accumulated dollars back to Washington DC who spends them back into the US economy. In exchange, China receives a contract stating that future US taxpayers will labor in service to China.

The problem is that our debt has grown so large that we are now servicing it Ponzi-style and with the printing press.

So the Chinese printing press (yuan) is backed by the US Fed printing press (dollars) which is backed by Chinese REAL labor (and goods) which is backed by the Chinese printing press (yuan) which is backed by the US Fed printing press... and on and on and on....

Jumping back to the Chinese merchant who needs yuan to pay his operating expenses, we must remember that he is also a Super-Producer, producing more than he consumes. So he has an inflow of EXTRA yuan to store for future retirement. His three choices are keep the paper yuan (not a good idea with inflation), buy a specific entity's future bondage, or buy a share of the entire future global workforce (gold). This third option has only recently been made available to Chinese citizens.

If our merchant chooses gold, he settles the world's debt to him for the time being, a debt which he can reactivate later by selling his gold in exchange for whatever paper medium is best at that future time for obtaining the goods and services he needs at that time.

It is helpful also to follow the path of the renminbi he exchanges for gold. His gold dealer will redeploy the majority of that renminbi in search of replacement gold, because that is his business. That is his operating cost. This path leads ultimately to either the public's gold, the CB gold, or new gold from the mines. This path of yuan seeking gold bids for the best value from each of these three sources. This yuan is now a heat-seeking missile aimed directly at Freegold. Multiply this effect over the entire globe and imagine the force of trillions of heat-seeking missiles all seeking the same thing! What do you think would be the result?

Note also that China recently offered its own bondage (backed by the printing press) as an option to help absorb some of this massive yuan monetary inflation, an offering that was basically rejected.

No Reserve? Yin and yang!

Let us now visualize what global trade would be like without a global reserve currency. Most people seem to believe that a global currency is necessary for global trade. That if the dollar were to lose reserve currency status because of mismanagement, it would have to be replaced with a One World Currency, or an SDR, or some other existing currency like the yuan, euro or dinar. But is this really true?

Importers from many countries other than the United States must already use currency exchanges in order to transact business. It is only the privileged importers that are allowed to skip this step. In many cases, the trade is done in US dollars even if the US is not involved in the transaction! This is because of the wide availability and convertibility of US dollars. But if the importer, instead of purchasing US dollars, purchased the local currency of his exporting country, the whole process would be simplified by one step. All exporters would receive payment in their local currency and would avoid the need to visit the bank so often!

The only transactions which would be complicated by this change would be those originating in the zone of the reserve currency. There the importers would have to do the currency exchange from dollars to yuan INSTEAD of the Chinese exporter!

This simplification of global trade would eliminate the journey the dollar makes back to the Washington DC spending machine. Each currency would only circulate between the public within its own zone, importers and exporters, the banks and the currency exchanges. And the exchange rate of all currencies would match the purchasing power parity (PPP) between countries based on the balance of trade! If the PPP got out of whack, then arbitrage would automatically step in to equal it out. How? Through the free trade of GOLD within each currency zone!

You see, with no global reserve currency in play, no single currency zone will have the wherewithal to manage the price of gold. It will float FREELY against all currencies within their own zones! And the only entities that will NOT benefit from this transition are the US Federal Reserve and the US Treasury! Yes, all other "evil powers that be" will benefit along with J6P! This is why there will not be resistance once the dollar goes!

If one country exports more than it imports, a shortage of its currency will develop on the currency exchange. This will drive up the price of that currency, also driving up its purchasing power relative to gold which trades in all currency zones. If exchange rates resist this gold PPP then gold will become underpriced within that surplus zone and the arbitrageurs will swoop in and bid it back up!

Thinking back to our Chinese merchant who buys gold with his extra yuan, under this new system, without a global reserve currency, his purchase of gold is one small piece of the global puzzle that both settles AND balances international trade!

Ender says it well

If you and I are allowed to buy gold with our currency, we have settled other's debts to us. On a personal level, acquiring gold allows you to settle other's debt to you. This act of settling others debt to me (as the case may be) does not destroy any currency nor relieve those that are still in debt to others of any burden. What it does offer is a means for me to buy a wealth reserve that stands on its own merit.

Doing a little calculus, if you sum an infinite number of little gold buying transactions you end up with a means of settlement for economies as all the little gold bugs enter the market and buy wealth reserve with their surplus currency. The currency remains in circulation and gold moves into its settlement role. 'Nations' and 'States' worth of people may be seen as settling, but the Nation and State still have the same amount of currency in circulation.

Independent of the nation state, those with surpluses that are currently held in currencies may find that the nation state is placed in a position to create MORE currency rather than less. That design in the system will always, over time, create a situation where more currency will be available to chase items that work as wealth reserve.

Now, back to the Freegold concept. Because gold is a wealth reserve, it will work just as well for a person as it will a nation state. In the marketplace, if gold is plentiful, its 'price' will be low. Likewise, if it is scarce its price will be high. If a nation state marks its gold to market and thins the gold market, it may find a high 'price' for all the nuggets the nation holds on reserve. This implies that if the nation state does NOT SELL gold in the open public market, all us little gold bugs (advocates) will be the ones that offer up our gold (in exchange for currency) that helps settle the imbalances that occur in global/national/local trade. If 60 billion needs to be settled every month and only a few ounces are available, those few ounces may absorb the imbalance.

In a Freegold system, the actual gold metal market determines the exchange rate of a currency. The nation state can liquidate/acquire less/more gold but the balance sheets will show the change allowing the businessman to determine where or not the currency is being managed respectably.

In a Freegold system, the incentive is for the nation state to create an environment where the gold price is continually falling in that local currency. If so, people will want to hold that currency knowing that they will be able to buy MORE gold tomorrow (or in the future). It will setup an environment where the businessman will WANT TO invest in that economy knowing that when the payoff comes - years from now - they will be able to convert it into wealth reserve.

Freegold is beneficial to everyone - except those that can print a currency out of thin air that can be used to buy goods anywhere in the world. You and I CANNOT print money. You and I can only go into debt for currency today (Committing future work for currency today). That going in debt subjects us to the political ramifications of the management of the currency. That may be good or bad depending on how it's managed.

Gold stands separate of this mis-management.

And, as you may have already figured, the way the reserve-currency of the world has been managed, gold is extremely undervalued. We are going through the process of discovery - where those with paper riches figure out that it's really not real until it is settled. As the settlement process accelerates, so will the scarcity of gold.

Stand for Gold settlement. It is the honorable thing to do.

FOFOA (and Ender)

Monday, July 20, 2009

Stuttering Hank

Stuttering, also known as stammering, is a speech disorder in which the flow of speech is disrupted by involuntary repetitions of sounds, syllables, words or phrases. The disorder is variable, which means that in certain situations the stuttering might become more severe depending on the anxiety level connected with that activity.

More fun from the HOTseat!

Saturday, July 18, 2009

A Little Perspective

The primary purpose of money is to bid on the real goods and services produced in the real economy without the need for direct barter exchange. In a sound money system the value of the money increases as the economy grows new goods and services on which to bid. This function allows money to have the secondary purpose of being a store of value over time.

For many decades now, we have lived in a system of credit money, where the money supply was allowed to grow along with the economy. As producers took out loans to create new goods and services, new money was created from thin air to match the value added to the system by the producer. The balance, or control in the system in case the producer died or defaulted for some other reason before he finished adding value was that the bank that issued the credit money would have to take the loss, the deficit, or "fill the hole" left when the producer failed to complete his contractual obligation. The money created at the start of the loan still circulated, but the bank now had to lose an amount roughly equivalent to the amount of value the producer failed to produce.

This control kept the system of money versus economic real value roughly in balance for a long time. But on the margin of the system was the temptation to the government and the base money printing authority to abuse the system by creating new money not matched by value added to the economy (base money or monetary base). This kept the money supply growing slightly faster than the economy at all times.

This race between money and real goods and services, with money supply always in the lead, removed the secondary function of money as a store of value. So to keep the system going, financial products were created which promised a supposedly high probability of keeping up with the money supply growth.

Scrip Clearing

Scrip is a temporary substitute for money. Because of these two qualities, "temporary" and "substitute", it is not a good store of value. Instead, it is a way to facilitate the exchange of real goods and services without the need for direct barter exchange, and without the presence of money. Today California is issuing IOU's which are a form of scrip. During the depression, many localities issued scrip because money was in short supply. (Click here)

But today's banking system is actually a very large and complex scrip clearinghouse that acts as the lubricant in the economic machine. Base money is roughly 10% or less of the total money supply. So the banks issue their own scrip (checks) with which to keep trade flowing.

Imagine a carpenter, a plumber and a painter. The carpenter banks at Bank A, the plumber at Bank B, and the painter at Bank C. All in the same day the carpenter works on the plumber's home, the plumber works on the painter's home, and the painter paints the carpenter's home. The carpenter writes a $500 check to the painter, the painter writes a $500 check to the plumber and the plumber writes a $500 check to the carpenter. The next day they each deposit their checks and that night the banks pass them around and make book entries. By the next day all debts are settle, all payments made, and no money was needed at all. The banks performed their function as a giant, complex scrip clearinghouse.

In the real economy this happens every day. And it only continues to function because of faith in the banking system of fractional reserves. It functions because people trust checks. If everyone had to withdraw cash to complete transactions, the fractional reserve system would crash.

This system has been expanded even further through the use of credit cards, another system of scrip clearing.

Base money becomes important in the clearing of the scrip clearinghouses. At the end of the day, any imbalance in the scrip clearing game must be settled with base money. This function is overseen by the Federal Reserve which holds large reserves of base money for each bank and transfers the ownership of that money to balance the imbalances.

Global Clearing

This same clearinghouse function is also needed in the global arena. The BIS (Bank for International Settlements) is the central bank of central banks. It is the clearinghouse of all the central banks of the world. It balances all international imbalances by transferring ownership of physical gold bullion deposits. Oh wait. What? It doesn't? Actually, there is NO adequate clearing mechanism for global imbalances. At least not for the last 38 years.

The global imbalance clearing mechanism is rather messy right now. Global imbalances are basically first settled in US$ base money which is then given back to the US government to spend on US Medicare, Medicaid, Social Security, government pensions, field mouse habitats and the US military global "peacekeeping" presence. And in exchange, the US government hands out Treasury Bills and Bonds to the various central banks.

This is today's global clearinghouse in a nutshell!

Why It Was So Important To Save The Investment Banks

The abstruse notion of money has been so confused over the last hundred years that almost no one understands what it once was. Today, 99% of the world stores its monetary savings in investment vehicles that are not really money. The very idea of money has been so corrupted that even the most conservative individual savers look at their "fixed income" brokerage statements and think, "this is my money". The fact of the matter is that there is actually NO money represented in that statement, even if it claims to have 10% in "cash".

This complete divergence from reality has taken nearly 100 years to accomplish. And now it is complete.

The fact of the matter is that now there is more money in the world than there are things to buy at current prices. And what's worse is that the money supply continues to grow even while the real economy contracts. This SHOULD be creating massive inflation in everything EXCEPT financial investments (of which there is no shortage). But instead the opposite seems to be happening.

How can this be?

It is because new financial investments are constantly being created by the financial industry to soak up the extra money, to keep it from bidding on the real economy. This is true for individual's money, for institutional money (like pension funds), and even for sovereign money (like China's foreign currency surplus). The financial investment industry is the giant TRAP that lures in the extra money with the simple promise of paying out MORE money! This is why it HAD to be bailed out and subsequently GUARANTEED against default.

Risk pricing MUST remain rigged!

If the risks of these "investments" were properly priced, interest rates would be sky high and the investments would be as cheap as dirt. There would be NO profit for the bankers to take home!

Now that the financial industry has been bailed-out and guaranteed, the very NATURE of financial risk has changed into something so terrible it is almost never mentioned. In fact, from what I can tell, I am one of only a handful of people that are willing to write about the true nature of today's investment risk.

But just because no one talks about it does not mean the global market "organism" doesn't smell it. It does! And this is why risk pricing MUST remain rigged. The market movers, shakers, makers and owners have quite a casino racket going right now. It is complex and computerized in the extreme. It is understood by few and managed by even fewer. Yet somehow it still masquerades as our global, capitalist free market.

Amazing, isn't it?

The fact of the matter is that a certain - specific - percentage of the global aggregate of default risk (which was certainly bearable because it only hits here and there) has been transferred to a much more demonic currency risk (which is totally UNbearable because it destroys EVERYONE)! The only thing left for the global market organism to digest is the actual SIZE of this transfer, a monumental task in the face of risk price RIGGING by diabolic forces.


In my opinion, this is the fuse. Lit and burning fast!

If you or I were to guarantee a financial asset we would want to make darn sure we wouldn't have to exercise that guarantee. Because if we had to, we would either have to give up some of our own wealth or we would have to produce real value into the economy to cover the guarantee. An insurance company faces the same danger when making guarantees. This is why it has highly paid underwriters who calculate the probability and charge the insured party enough premium to cover all claims, plus a profit.

But when the US government and the Federal Reserve make guarantees, they have none of the worries we mortals have. They each have their own way of printing new base money to cover the guarantees. In the case of the Treasury, it simply issues new debt to be purchased by the Fed. Because of this unique ability, these two entities feel very comfortable about making many guarantees. And over the past year, implicit guarantees have been issued on everything from your Chevy Tahoe to the entire money supply (all credit money is now backed by the implicit guarantee of new base money) to money market financial investments, to large insurance companies, and even to the largest financial institutions, which indirectly guarantees a mountain of financial derivatives.

Additionally, the federal government guarantees its own debt. This guarantee is supposed to be backed by the production of value into the economy through taxation, but today it is actually backed by the ability to create new base money in order to service the debt.

And finally, in the same way it guarantees its own debt (through base money printing, not taxation), the federal government implicitly (in some cases explicitly) guarantees all of its future obligations of Medicare, Medicaid, Social Security, government pensions and a global military "peacekeeping" presence.

I propose to you right now that the US government alone has guaranteed through its ability to expand the US dollar monetary base, more than the entire global monetary base combined (around US$5T); more than the entire value of all stock markets in the world combined (global equity markets estimated value US$37T); more than the entire globe produces in a year (global GDP estimated at US$70T); and even more than all the debt issued, both public and private, in the entire world (global bond markets estimated value US$83T).

In fact, because the mountain of derivatives that the guaranteed Too-Big-To-Fail banks play with is so large (somewhere between US$600T and US$2Q), I propose that the US government, without even realizing it, has verbally implied guarantees of more value than even exists on this planet! All in the name of "saving the system"!

Now, of course they don't plan to exercise all these guarantees. But that is not the point. This system of credit money ONLY works because the money supply has the ability to ROUGHLY track the growth or contraction of the real economy. And with these guarantees in place, monetary contraction is no longer an option.

Zimbabwe Versus the Dollar

The housing price crash has been called deflation. But let us look at it another way. You and I have lost some perceived wealth because we can no longer sell our houses for what we once could. But the other side of this equation is that much of the debt we took out (and even some that we have defaulted on) has either been made whole or guaranteed. So what has really been lost?

What if... the housing bubble was actually acting the same as the sponge we call the financial industry to suck massive inflation away from consumer prices? Remember, the money that was created from thin air when we bought our house is still circulating. And the debt hole that was created when prices crashed has been filled with new base money through TARP and other various "facilities", bailouts and guarantees.

The housing market is (at least for) now a dead sponge. And the financial industry is a dying sponge. So where is all the money going to go?

Recently I have read two arguments, by writers I respect, why the dollar system will not go the way of Zimbabwe. These are certainly not the full spectrum of arguments, but I think they touch on a couple good points, even if they are wrong.

The first argument is that reserve currencies are political, not market-based. And therefore the dollar's demise will be "managed" in a controlled fashion that may take another 10 or 20 years, with no sudden crashes. The one exception, this writer says, is if a geopolitical "mishap" happens.

The other recent argument was that it will take the US longer to get to "Zimbabwe-style" inflation since real productive assets in the US are not being totally seized, as they stole all the white people's farms in Zimbabwe.

The biggest weakness in the first argument is the terms "political" and "managed". These both mean "manipulated". Clearly the dollar is market-based because it is used to pay for real good in markets all over the world. It is also traded openly on foreign currency exchange markets. A currency like the SDR would be more purely political, but not the dollar. The dollar is simply "managed", as Another explained to us many years ago. And a simple "truism" about manipulation is that it cannot defeat the primary market trend for very long. And often when it does, the correction can be brutal.

The second argument is interesting because it deals with the economic side of the equation. It is true that Zimbabwe's slide into the depths of hell began in early 2000, when Mugabe tried to change the Zimbabwe constitution to give himself the dictatorial powers of additional terms in office, immunity from prosecution for all his friends in government, and the authorized government seizure of all white-owned land. When his referendum to change the constitution was defeated, he assumed those powers through force and violence.

Zimbabwe's economy began shrinking in 2000 and has continued to shrink ever since. It has been plagued by political turmoil, capital flight, monetary mismanagement and high inflation. The core underpinnings of the economy, agriculture and industry, have virtually disappeared since 2000.

From 2000 to 2002, the annual rate of inflation in Zimbabwe quadrupled. By 2006 the value of the Zimbabwe dollar had fallen by a factor of a million. In August of 2006 they introduced a new currency at an exchange rate of 1 new Zdollar for 1000 old Zdollars. This new Zdollar, at its inception, was only worth about a tenth of a US penny (Z$10=One penny). From there it fell even faster as the government funded EVERYTHING, including a LAVISH lifestyle for its leaders, with the printing press.

In less than two years the annual inflation rate rose from 1,000% to 231,000,000% by July of 2008.

I ask you: Is this history so different from the US? Look at the 8 year chart. Much of the core underpinnings of our economy were shipped overseas during the last 15 years. What is left is an economy driven by consumerism to the tune of 70%! Now even that is fading.

Shrinking economy! Monetary mismanagement! Government funding itself with the printing press! Lavish plans, one - after - another, coming out of Washington!

What if we are now living the above chart, and we are still in the first two years of the chart? Relatively flat, huh?

The last issue I want to discuss is the nature of Zimbabwe's money supply during the last years of its life. Credit had disappeared. Government debt disappeared. There was no interest rate high enough to lure in real capital. The entire money supply, M1, M2, M3 etc... was replaced with BASE MONEY! In hyperinflation, it is only BASE MONEY that matters! This is because hyperinflation IS currency collapse!

What if all of our government guarantees are used? Every "perceived" dollar becomes a real base dollar! When future liabilities are funded by the printing press, this is all BASE MONEY flowing into the system. When the Fed buys government debt, this is BASE MONEY the government is spending. And when a bank is bailed out by either TARP or the Fed, it is BASE MONEY being exchanged for bad debt that should have SHRUNK the money supply.

And what if... the mere GUARANTEE of all this debt actually changes its core NATURE to that of base money? I'm just saying what if. If this is the case then it is up to the markets, the producers of REAL ECONOMIC GOODS to determine the meaning. A monumental task in the face of risk-price rigging by diabolical forces, but not impossible.

In my view, the only hope they have to avoid this terrible fate (other than blind hope alone) is a FREE gold revaluation to preempt the market revaluation of everything. But I'm afraid they may mistakenly take matters into their own (incapable) hands and attempt a controlled devaluation through devious means (like a bank holiday). In any case, the dollar's immediate future is grim.

Monetary theory is FAR from being a settled science. We should not rest comfortably on untested, possibly false assumptions. Preparation for the worst while hoping for the best is the only sane course of action. Please be well.


Thursday, July 16, 2009

Tuesday, July 14, 2009

Thursday, July 9, 2009

Call Me Contrarian

In the years leading up to mid-2007 keen observers noted dangerous leverage in the US debt markets and some predicted that the bubble would pop. Predictions like this were contrarian while the market was rising, and they were ridiculed. But then when the bubble did pop, those same contrarians became nearly household names as network TV invited them on to explain their predictions.

From mid-2007 though the end of 2008 a great deal of pressure on the system from the dangerous leverage was relieved. Many pundits switched sides to join the pre-2007 contrarians, and the spotlight widened. By late 2008 through March 2009 a few optimistic analysts telling investors to buy back into the markets became the new contrarians.

In 2009 we have witnessed a shift from a pseudo-free market overloaded with debt and leverage to a more controlled market driven by public sector stimulus money. This publicly supported market includes the big Wall Street banks as well as some in Europe. Stimulus money and quantitative easing has shifted much of the pressure from the debt bubble onto the public at large.

Through the process of watching this slow-motion train wreck (still ongoing), the consensus opinion about danger in the system has shifted from an imminent threat to a long-term threat. Before 2007, a few "doomers" were contrary to the consensus, and for the most part they were right. Late in 2008 and early 2009, a few optimists were contrarian and for the medium term, they have been right. There were some excellent bargains during that time that have paid off very well.

The point is that during times of transition, surprises are always the order of the day. Look to the consensus on both sides, optimistic consensus and pessimistic consensus, and expect a surprise different from that consensus, depending on which direction we go.
One of the few things we are confident about is, some very improbable things will happen. Surprises will occur so often they will become routine... I am sure this was only the beginning of a parade of shockers.

-Richard Maybury 06/09

This is true because the market CANNOT reward the majority for long. A zero sum game, the market must reward a minority. If too many people pile into one line of thinking, the market is primed for surprise.

Because of the slow-motion train wreck we are all passengers on, we have reached a unique dichotomy of opinions. This divergence can be boiled down to the inflation-deflation debate, with a few variations. On the inflation side we have both optimists and pessimists, who view the coming inflation as either good or bad. And on the deflation side we have mainly pessimists who see continued downward pressure on the stock market, the housing market and consumer prices as well.

Running parallel to these general impressions, we have a crazy-out-of-control government that has given in to the temptation of printing its way out of this mess. The deflationists view this as an exercise in futility, while the inflationists say that you cannot print these amounts of dollars without it affecting the markets sooner or later.

A few cunning analysts are hedging their bets saying we will see another deflationary collapse first, followed by a bout of high inflation. But nearly all of the pundits who are still predicting "doom" have lengthened their horizon to several years to make way for the slow speed at which this train is tumbling down the tracks.

Frankly, I'm not buying it.

Call me contrarian, but I say that when the rubber band breaks this time it will snap back with a speed and fury that will make your head spin.

In fact, I think that the longer this drags out (and I'm only talking weeks and months now), the more abrupt the correction will be. While at one time it may have happened over a month, it could now happen overnight! The laws of economics can only be violated for a limited time frame. So far that time frame is four months and counting. Or viewed another way, 15 years and counting. Viewed yet another way, 38 years and counting. And viewed one more way, 96 years and counting. These are four waves of economic violation that are converging right in front of us.

What kind of correction are we looking at?

I think we will have a correction of ALL FOUR waves of economic and monetary violation... all at once!

To see this, you must view the imbalance that has developed during each of these time frames. On the medium scale we have the imbalance of debt in the West with surplus in the East. This imbalance is an ongoing flow that has not only gone parabolic, but is projected to continue through at least 2025 (BIS study)! How can a trend that has gone parabolic in only 15 years continue for another 15 years?

In the shortest time frame, the imbalance is between market technical patterns, managed through media spin and "other means", and long term (secular) market fundamentals. This imbalance is most obvious in the divergence of the public sector and the private sector. The public sector has been bailed out by the private sector without its consent. In fact, against its wishes. This has created an imbalance of fairness that is boiling under the surface tension of the green shoots media hype.

Both the 38 year timeline and the 96 year timeline have created an imbalance in the fractional reserve system that has also gone parabolic in the last decade. I am talking about gold. No, the price of gold has not gone parabolic, but the ratio of available gold to outstanding paper currency HAS gone parabolic.

The central banks of the world are well aware of this. It is why they have slowly, inconspicuously changed from net sellers into net buyers. This gradual shift is extremely significant, because as net sellers they were supporting their own fiat regime. But now as net buyers, they, as a group, are stressing it. Why would they do this unless they knew it was about to reset?

This fractional gold reserve imbalance is the one imbalance the media and governments do not want you to know about. This is the one that will RESET the entire system. This imbalance, once corrected, will make central bank fiat currencies sustainable once again. This is why they are net buyers! Here at FOFOA, we like to call it FREEGOLD!

Do I think this magnitude of a reset could happen overnight? Yes, I do. Why? Because that is the way you get the most "bang for your buck". Surprise is the order of the day! "Devaluations always happen by complete surprise as to exert maximum leverage effect."

It matters not one iota how well you do in the stock and bond markets leading up to the reset. Neither does it matter what the "gold market" does between now and then. The ONLY thing that matters is how you are positioned on that one - fateful - day! Everything will be reset and surprises will abound.

Some of the entities that you think most deserve to be wiped out will turn out to be the BIGGEST beneficiaries of this "overnight" transfer of wealth. And others who thought they were fully hedged will be wiped out. These are the kinds of surprises I expect. I am truly in the mode of "expecting the unexpected" with a timeline shorter than a normal TV season. ;)

Call me contrarian. But please don't call me a "doomer". I do not view this as doom. I realize the difference between the monetary system and the real economy. I recognize the difference between real capital and illusory wealth. The current monetary system is like a virtual grid, an electronic parasite overlaid on the real world. It can completely vanish and leave the real world totally intact. I look forward to a new beginning for the entire system. A healthy start like we have not seen in generations.

This reset is not something I am pushing for. It is not something I even wanted a mere year and a half ago. Instead, it is what I see as inevitable. Yes, many will be hurt and I will mourn their losses as some of my own loved ones are not well prepared. But what can I do more than I am already doing? We cannot fight the inevitable. We can only prepare.

Some have said that I am only viewing the forest and not the trees. That I do not care for the individual trees that will be engulfed by the forest fire. I do care, and this is why I blog.

There is NO SOLUTION that will save everyone's dollars. There are simply too many of them. There is NO SOCIALIST PARADISE. There is only reality and, living in it as we do, we must each walk our own Trail into the future.

Perhaps I am wrong and this fateful day will come later than I expect. I hope I am wrong. More people will make it to the safe harbor in the meantime. But do I venture out into the open sea while I wait? No, I remain moored to my anchor.

So call me contrarian, but follow the consensus voices out into the choppy waters at your own peril.

Supplemental reading:

What did the top central bankers of the world know and when? This is an excellent forensic examination of our monetary leaders. One has to wonder, if this much was known at the top level of central banking, shared, published and ignored by those with the most power, what preparations were made by the central bankers that did not ignore the warnings?
The Man Nobody Wanted to Hear

What do you give the leaders of the free world in a gift bag? What if they are sitting around talking about money? Why... gold coins of course!
G-8 Leaders To Receive Gold Coins

United Future World Currency

The above is presented for entertainment purposes only and in no way constitutes financial advice. Please consult with a REAL financial advisor before making any rash decisions. They will probably direct you to some of the new and improved securitized investment vehicles. Yes, they will pay you interest, until they default and you lose your principle or until the whole darn thing is toilet paper. But then again, I am not a financial advisor so I probably don't know what I am talking about. Remember what they say, "gold is not a financial investment because analysts cannot value it because it does not pay interest". I couldn't agree more!


Sunday, July 5, 2009

How The Dollar Made It This Far

Duality of value is a funny thing.

If you have a gun pointed at me and I have an identical gun pointed at you, they (the guns) are worth the same. Yet, if I am wearing a bullet-proof vest, my gun has more worth. Not much, just a little more. Strategic location! In 1933 dollars outside the US were worth their weight in gold. Yet, inside the US they were not. The same dollar had a dual value dependent on location.

Oil, gold, minerals and one's bank account can all have dual values based on their strategic location. Another form of duality exists for most things. Gold has a jewelry value and a monetary value. Its price is reflected in the degree of total demand generated from each value. In fact everything we own has our personal sentimental worth and a "monetary" value. After 1980, oil also reflected this different duality.

In the late 60's and early 70's some US strategic leaders were beginning to understand the "monetary value" of oil. It was becoming clear that local oil reserves, not gold was the real backing behind the robust US economic engine. Like gold today, oil back then was worth a whole lot more than the amount we were paying for it.

It was recognized that even though the old (gold) money system of the 60's had priced oil favorably for the US, its (US) oil reserves were running out at that price. We needed a higher price for oil in order to build local reserves. At the very least, we needed higher prices to discover higher cost reserves located in the "Strategic Americas" (both north and south).

The potential (indeed, it was reality at that time) for the Middle East to continue producing reasonably priced oil for gold (dollars) stood in the way these needed higher prices. In order to resolve this, we moved off the gold standard (1971) and onto the oil standard. Again, in hindsight it was a masterful play. You see, in duality, oil in the Middle east was worth more than other oil if it could back the dollar in world settlement.

The US had already placed it's currency on an oil standard years before (in practice anyway). They were expanding the money supply directly in relation with the increased production of goods that modern oil use was providing. Of course they ran away with the process as is always the case. Gunning the debt money supply and justifying it by extrapolating growth at ever increasing rates. Dollar creation overran the ability of the gold exchange standard to balance it. Still, in all fairness, the old system was built on a much slower creation of production efficiencies and couldn't accommodate this modern surge of wealth (and debt). Let's face it, the world has no precedent for the last 30 years of growth.

After 1971, the value of the gold backing lost, was found in oil. In reality, the value of oil to the world economy was increasing much faster than value of gold lost from dollar default. Even at the higher prices per barrel the need and demand for oil proved to be a far superior "monetary backing" for the dollar than gold. As long as the majority of oil producers agreed to receive dollars for oil, the stage was set for a renewed surge in growth the world over.

During the '70's, dollar price inflation was bad, but by no means did we see the "runaway price inflation" that should have come from a reserve currency without gold backing.

In practical theory, oil now backed the dollar as world oil payments were settled in dollars. In return, gold now backed oil from a US guarantee of an open market for the metal. Over time, a portion of oil dollars could be replaced with real gold through actual physical purchases or in participation with evolving world gold banking (paper gold). Even though the dollar gold price had surged, the higher oil prices were allowing a percentage of those dollars to be converted back into gold at the old gold/oil rate. [Note: After the gold window closed, dollars surrendered for gold REMAINED in circulation!]

Slowly, the old dollar holdings (prior to 71) were effectively being used to reclaim gold. The expansion of the world dollar money supply was seen as reflecting the more modern importance (value) of oil in the economy. As long as growth in the production of economic goods outstripped dollar price inflation, the dollar could be expanded to match the unrealized value held in oil.

Again, "strategic location" of the world's major oil reserves was the backbone behind this "duality" in oil's value. Gold in Fort Knox could not back the dollar anymore, because the US had shown that they could just withdraw it from backing. In fact, the entire validity of backing ANY currency with a fixed gold amount was in question with this new age of "super nation blocks". For it to work again, gold and the reserve currency backed by it would have to reside in different "power blocks" to guarantee delivery. That wasn't going to happen. Indeed, with supply of the world's major oil reserves being controlled outside the US, the dollar was now backed more effectively by a commodity that could be used to devalue it (through the oil price) should the money supply run wild.

[See The Judgement of Value. This is key. If I print dollars, the judgement of value of those dollars belongs to whomever I offer them to. Under the gold standard, the value of the dollar was set by the printer himself. An unstable and unsustainable system!]

This system [of EXTERNAL backing] came into balance, as the value received from oil by the goods producing world outran the loss from price inflation initially created from rising oil prices.

Today, the situation is changing in a much more dramatic way.

Throughout the 80's and 90's, an increasing dollar reserve base impacted the economies of foreign nations as the US dollar trade deficit and the debt that represented it expanded without relief. After over three decades of non-stop foreign dollar inflation, the dollar float has become so large that any transition from dollar settlement into "Other" settlement will permanently remove it from reserve status. These events we will witness and document will be the "Facts" of a dollar fall from grace.

The strong US economic success [is best expressed] in our SOL (Standard Of Living). Dollar exchange rates, interest on dollars, stock market values, home values all represent what an American "can buy" if they decide to spend their wealth. Not what they presently have as owned wealth, paid up 100% [or liquidated 100%]. This leveraging of dollars created an "illusion of savings" that in effect allowed a high SOL.

In other words, we lived high on the hog because our equity values and savings don't really exist. Time has transformed the entire dollar system into a giant "futures contract" that only represents the wealth we could obtain in partial "future purchases". Just like the gold market, we mostly trade paper wealth and call it real. Yet, if a large percentage demand for delivery ever happened, the contracts would fail. Yes, our wealth and economy status is really based on us cashing in and buying just a little at a time. If we didn't, the illusion would be exposed.

Our present dollar economy is "super leveraged" not just into the future of US goods production, but it also completely depends on future foreign fulfillment to produce those real goods. Truly, most of our present sizeable financial wealth is little more than a function of the "acceptance of dollars overseas" by others.

In reality, if this foreign reserves chart was ever forced into reverse, no amount of real US goods production could be bought using present dollar price rates.

Foreigners could never spend their dollars at a rate that matches our SOL values. Indeed, some of the biggest players now know it! It's all an illusion that has spanned 35+ years from the loss of the gold standard and it's about to be tested.

Indeed, even now the paper gold market expressed a major "duality" in real value depending on the strategic location of it's contracts. Some leveraged gold banking backed with Euroland guarantees is today far superior after the Euro success. [See Deutsche Bank and the ECB] (I think this concept is hard on most people. Still, it will look much different after the train wreck that is coming.)

Going further into the duality of values, Oil prices today are on the rise and doing so in total conflict to perceived marketplace function. It's no mistake as to why this dollar price rise is happening now. Just as a high gold price would expose the dollar by presenting it's true past inflation (world dollar money supply growth), a rising oil price exposes the US economy to the super leverage it contains. Especially if one can grasp how that economy was built on oil backing through dollar settlement. Once the threat of a dollar crash is made possible by high oil, expect big oil to run elsewhere for settlement for international trade. Perhaps run is not a good word? Let's just say a transition will begin that shows the world the trail ahead.

But the market has yet to fully grasp the impact of these events and still bids contract gold at par.

Our [FOA and ANOTHER] stance is and always has been that the world will be using paper digital currencies for the rest of our lifetime. I for one, have never heard any official voice his stance that we will move back into a gold standard. Their direction has always been to keep a reserve currency system and strengthen it with a free physical gold market trading in the background. In none of our meetings have we heard where a fear was expressed that the governments will lose control of digital currencies and give it (control) back to gold. That is simply not going to happen, no matter how severe a down turn the loss of the American dollar system creates. Believe it.

The dollar system is failing as we move into another stronger (relative to fiat currencies) money system. The future will see us all using digital currencies, for better or worse. Therefore, by logical extension if I must use a reserve currency of account, I move into one that has the best strategic ability to survive and denominate my assets. In addition, the Euro's creators are restructuring the gold market to the physical bullion holders advantage. This is the only reason I "Walk In The Footsteps Of Giants". They created this bullion path and the world will follow in due time. Therefore, my position of Euro assets and physical gold. Mostly (because I am American), I lean to gold for this transition.

One can take the radical position that the world financial system is going to end without the dollar. You can also say that the Euro will fail as this process evolves. One can buy gold for these reasons only and still prosper, whether your grasp of politics leads you to this conclusion or not. Our sole reason for writing is a private commission to share official directions and perceptions with the average citizen of the world. Nothing else.

Still, stand alone logic and history promote that the world will lose the present system to paper inflation and move into another as it has done before. With this, gold will bankrupt the outgoing system as hyperinflation runs through it. In a broader view, all total dollar dependent economies (Canada, Mexico, Japan, etc.) will share this fate.

This view gives you no facts only our perceptions from the builders of the future. We offer only the events as they occur for our proof. Indeed, strong events are ahead on this gold trail we all walk.

- FOA paraphrased by FOFOA

Friday, July 3, 2009

Gold, Oil and Money in the Free Market

This article provides some answers to questions that have come up in the open forums...

GOLD & MONEY: More Than Meets the Eye
By Aristotle
Written in 1999
Reposted from here.

Thanks in advance to Aragorn III for his direct input and valuable insights for what I am embarking on here. Much of this I hope will help to illuminate many of the developments and ideas that have been valiantly offered by ANOTHER and FOA over many preceding months.

Part 1 --- Stormclouds Gather...

The estimable economist Milton Friedman stated his forgettable opinion in 1974 that OPEC would collapse and oil would never get up to $10 per barrel. In all fairness to Professor Friedman, we must recognize his position as coming from a staunch monetarist, emphasizing money supply as the "true religion" for the Federal Reserve to keep the US Dollar as good as Gold. At times, he half-seriously argued for the abolition of the Federal Reserve in light of the simple monetary policy guidelines that could serve in its stead, with the economy returning to a state of self-regulation. (In the past sound-money days, economic hardships were far from unnatural, and they were not necessarily attributable to acts of government. However, modern attempts to centrally manage the economy ensures that any blame for systemic difficulties today may be clearly laid at government's feet.)

Milton's mistake was two-fold. First was his knowledge that Arabian oil could be produced for one dime of real money, and that inevitable competition among OPEC members would surely keep the price close to cost of production. Second, and most importantly, Milton failed to account for the possibility that the government would abandon such reasonable monetary management to keep the dollar nearly as good as Gold. This fact was NOT lost, however, on the oil producing countries. Ask yourself, what would YOU do if your business or trading partners suddenly started offering you payment with Monopoly money instead of "real" money? Would you shun real money as though it were the plague, and embrace Monopoly money as the greatest thing since sliced bread? If you would, then I have got a job for you!! Bring your shovel and some work-clothes, you have been hired for life...

Upon the 1971 declaration by the United States that redemption of dollars for Gold would be terminated, the entities in receipt of dollars for balance of trade settlements had no difficulty recognizing this as an outright default on payment contracts. The scramble was on to make sense of this new payment system in which the dollar was no longer a THING of value (a small amount of Gold), but was now reduced to a CONCEPT of value; an undefined unit with which the world would denominate the amount of value in contracts for goods and services. The problem ever since has been in coming to terms with the meaning of value for this shifting and undefined unit, and its vulnerability for mismanagement and abuse.

Jelle Zijlstra, who became head of the Bank for International Settlements, said while with the Bank of the Netherlands in regard to the 1971 severing of Gold from the dollar, "When we left the pound, we could go to the dollar. But where could we go from the dollar? To the moon?"

As I continue this tale, I hope it becomes clear that not only have we gone to the moon, but that Gold is going there also.

Part 2 --- A Transition: Things Are what they Are...

Do you see the world as it is? Or, do you see the world as you are? A tough obstacle, to be sure, as our experiences weigh heavily on our perceptions, and many people have no practical earthly experience with real money. There is hope..."the Truth is out there!" as a popular show is quick to proclaim. Albert Einstein puts an interesting slant on this theme: "My religion consists of a humble admiration of the illimitable superior spirit who reveals himself in the slight details we are able to perceive with our frail and feeble mind."

So with a ready admission our minds are frail and feeble, let's prepare to tackle something so ponderous it must hopelessly remain an abstraction to us mere mortals. I refer to the U.S. national debt, expressed in dollars, that stands at 5.6 trillion. Wow! What does that really mean? To put it in some perspective, we will revisit the 1970's, and try to get our arms (and feeble minds) around some much smaller numbers, and yet numbers that themselves are large enough to be abstractions. Let's examine the incredible and overwhelming wealth and economics of oil.

Imagine having claim to a sandy and barren land that reaches 120 degrees Fahrenheit in Summer, making your living through the ages on goats, dates and Pilgrims to Mecca. Not a posh existence when compared to America in the Roaring 1920's, but the passage of time reveals the fortunate few that were in the right place at the right time. When the Standard Oil Company of California was granted an exploration concession for Saudi Arabia in 1928, the 35,000 Gold sovereigns paid by Socal were reportedly counted by Sheik Abdullah Sulaiman himself. Wispy shades of things to come! This can be thought of similarly to how you might view a collection of skinny stock investors who found themselves heavily invested in penny internet stocks when the technology market exploded in the 1990, making them all millionaires. Except this: Oil is much, much bigger! We will soon examine what it means to be in the right place at the right time.

I will talk about pricing and balance of trade in the next part...stay tuned for the biggest transfer of wealth the world has ever seen. The key-currency gets debased in 1971, and Gresham's Law rules the land.

Part 3 --- It's Only (a mountain of) "Money"...

Having purchased this Saudi Arabian concession, in subsequent drilling Socal's Damman Number 7 struck oil in 1937 (I believe old Number Seven is still flowing.) Socal partnered with Exxon, Mobil, and Texaco to form the Arabian-American Oil Company. Over a thirty year period, Aramco discovered petroleum reserves in Saudi Arabia in excess of 180 billion barrels...a quarter of the known reserves of the planet at that time. And as the world aged and changed, the amount of oil consumed daily in world trade climbed dramatically, from 3.7 million barrels per day in 1950, to 9.0 mbpd in 1960, to 25.6 mbpd in 1970, to 34.2 million barrels per day in 1973 during the first Oil Crisis.

Consider this for better perspective: the average yield per well at the end of the 70's in the United States was 17 barrels per day per well, in Venezuela (one of the co-founders of OPEC) it was 186 barrels per day per well, and in Saudi Arabia (the other OPEC co-founder) it was 12,405 barrels each day per well. Wow! Just imagine if the internet companies today issued new, additional shares each day at this same rate as oil consumption...the stock price would plummet! But unlike internet stocks, because this oil is consumed, it must be replaced (and paid for) every single day.

But before I can move into the fascinating region of this miniseries that sheds light on how and why the Gold market is as it is today, this background is vital, so please bear with me, and I shall thank you for your patience. Oftentimes, understanding is its own reward, but in this case it may well prove essential for wealth preservation at a minimum. To begin, we must look at life in these United States (and in the process we will see a compelling reason that import barriers must be fought tooth and nail)...

What does the Texas Railroad Commission have to do with this story? Plenty. So much oil was being produced in Texas in the 1930's that engineers were concerned about depletion and wastage, and the owners would fret over the effects of oversupply that would at times bring the price per barrel down to ten cents. Tiny independent producers were often drilling side by side with the majors, but when the price slumped their profitability suffered more because they didn't have income from the downstream processes like the majors did. Because some of the individuals operating these independent companies happened to be multimillionaires, their complaining voices were heard thanks to their political contributions.

The state government responded by giving the Texas Railroad commission the power to regulate drilling. And while they didn't have the authority to set prices, they could regulate production levels. By setting an appropriate rate of production, oil would be conserved and this restricted supply would achieve price levels high enough to keep the independents in gravy. This Texas price became the American price, and also the world price (in the 1950's the U.S. was producing half of the world's oil.) This meant pure profit for the major companies with overseas production that cost only ten cents per barrel. To keep the price of oil up, what started as a gentlemen's agreement among the American oil companies to limit the imports of cheaper oil later became enforced by the U.S. government--known as the "invisible dike" against the outside world of cheap oil. Throughout the 1960's, the Persian Gulf offered the world oil at $1.80, while inside the "invisible dike" oil was being sold to the nation at the Texas price of $3.45 per barrel by the end of the decade.

The great irony is that a Venezuelan lawyer (and oil minister) named Juan Pablo Perez Alfonso studied and used the Texas Railroad Commission as his model for OPEC, which he co-founded with the Saudi Arabian director of the Office of Petroleum Affairs, Abdullah Tariki, in 1960. OPEC from the beginning maintained that oil was a depleting asset, and it had to be replaced by other assets to balance national budgets and fund developments.

Now that we know a bit about the producers and the price and cost of oil during the era of "real money," let us take a look at the dollar itself. The dollar and the world was pegged to Gold via the post-WWII Bretton Woods agreement in which $35 was convertible to one ounce--but for foreigners only, not U.S. citizens. The rate for international currency exchange was coordinated through the International Monetary Fund (IMF), with each currency pegged to each other through the dollar and Gold. The U.S. economy steamed along nicely in the 1950's, producing half of the world's oil as I've already stated, and half of the cars that burned up this oil. By the arrival of the 1960's, American industry was buying foreign factories, equipment and raw materials. In addition, the government was spending for its foreign bases and troops, and Vietnam was funded largely in the red.

An overhang of dollars was developing overseas--and while at first the foreigners were reassured that the Gold guarantee of the dollar was solid, as ever more dollars piled up, ever more of them cashed in the dollars for Gold. General de Gaulle summed up the sentiment, saying that America had "an exorbitant privilege" in ownership of the key-currency. By that he meant that the dollars America was able to issue via simple printing carried the same value in trade as the dollars that had to be earned by other nations through meaningful productivity. It quickly became clear that too many claims had been issued on the limited Gold, and President Nixon was prompted to close the Gold exchange window in the face of a certain run on the Treasury.

In a quick repeat from Part 1: " Upon the 1971 declaration by the United States that redemption of dollars for Gold would be terminated, the entities in receipt of dollars for balance of trade settlements had no difficulty recognizing this as an outright default on payment contracts. The scramble was on to make sense of this new payment system in which the dollar was no longer a THING of value (a small amount of Gold), but was now reduced to a CONCEPT of value; an undefined unit with which the world would denominate the amount of value in contracts for goods and services. The problem ever since has been in coming to terms with the meaning of value for this shifting and undefined unit, and its vulnerability for mismanagement and abuse."

With OPEC in place, and the dollar now rendered meaningless by traditional standards, the stage is adequately set to describe what followed. With OPEC now united and able to conserve, and threaten to cut back in the grand tradition of the Texas Railroad Commission, they were able to name their terms of payment, and decide essentially what value the dollar would have in oil terms. That is important enough to repeat: They were able to name their terms of payment, and decide essentially what value the dollar would have in oil terms. The increased world demand for oil ensured that the price would be met (Texas was pumping around the clock and still coming up short), and the printing presses essentially ensured that there would be no lack of dollars, so to speak.

It is important here to realize the attitude of OPEC, and notably the Middle East. In the mid 1970's, the finance ministers of both Kuwait and Saudi Arabia stressed that their needs were only to provide for the welfare of their citizens, and that oil in the ground is better than paper money. Who from the West can argue with that? They called our money's bluff, fair and square. So in 1971, while the Texas price of oil was $3.45, OPEC re-priced their Middle Eastern oil up from $1.80 to $2.20 (such audacity, don't you think?) only to see the market price due to demand in 1973 overtake the official posted price, at which point OPEC saw the writing on the wall, and in October raised the price per barrel to $5.12 while curbing production. By December, the Shah of Iran called a press conference to announce the official price would now be $11.65. Well, why not? It's only paper to you if you are not in NEED of this currency through a debt to someone else. And so began the First Oil Crisis of the 1970's.

Just as America had been issuing claim checks on the national Gold throughout the 1960's, its spending habits didn't change with the advent of the all-paper dollar. As a consequence, the world's greatest transfer of wealth was underway. Watching the rising cost of real estate became a national pastime in the 1970's--an odd distraction from the gas lines and cost of fuel. By raising the price of oil $10, from $1.80 to $11.65, at those current production levels OPEC raised its annual revenues by approximately 100 billion dollars. Now recall from Part 2 where I promised you we would tackle some large numbers, though nowhere near as incomprehensible as the $5.6 trillion U.S. debt. Here we go...

How much IS 100 billion dollars per year? It can't be much, because we all know the Middle East is heavily in debt with struggling economies even now at the end of the 1990's. Right? Well, I invite you to follow along, and judge for yourself. Let's try to spend that $100 billion, and is 1974. And let's not waste time on small stuff, we'll go right for the big ticket toys.

How about some F-14's? Fully equipped (minus missiles because we are a peaceful bunch) they are ours for $9 million each. Grumman on Long Island assembles 80 each year. Hell, let's take 'em all for $720 million. How about some F-15's too? At $12 million each, we conclude our visit to McDonnell Douglas with 100 under our arm for a cool $1.2 billion. Let's take home the biggest brute the U.S. has to offer--a top of the line nuclear-powered aircraft carrier for $1.4 billion. Better yet, make that two carriers. Throw in some destroyers, some submarines...let's see... We've spent a total of $2 billion on a kicking air force and a little more than that on a fine little navy. How much money is left in round figures? About $100 billion. And this amount comes in not only this year, but the next, and the next, and the next... [a side thanks to Mr. Goodman for these historical prices.] $100 billion is a large annual paycheck, and we haven't even touched the $30 and $40 dollar prices brought about in the Second Oil Crisis. Now consider again that America has written future claims on $5.6 trillion dollars. Can you imagine how such a figure might be settled? Ouch.

Where did all of this money come from? It would seem that America found an efficient means to issue claims on the country in exchange for something that goes up in smoke. Would OPEC own America lock, stock, and barrel? What would OPEC do with all of that cash? And would there be any end to it? How are the poorer countries that must EARN their dollars, as General de Gaulle indicated, going to fund their own oil needs? Banks are the answer. Buy banks, fill banks, and recycle the petrodollars. Oh, and let's not forget Gold. Straight from two ministers of finance, "We would rather keep the oil than have the paper money." We thank you for that insight.

Now that I have properly set the stage, in the next part I shall relate the really good stuff of Aragorn's tale suggesting where this money went, and how the system survived 20 years after the end was nigh, bringing cheap Gold crumbs for anyone mindful enough to pick them up. To quote that good knight, "With a payday reaching that magnitude, the question of destiny begs no answer. You set your own, and hope for nice weather."

Part 4 --- A 1970's History Lesson (without the disco)

One Oil Crisis down, one to go. We looked at some pretty incredible figures in Part 3. Where did this money go, and maybe more importantly, where does it come from? For the sake of brevity I will assume the reader is well acquainted with the process of money creation via modern banking. If not, then you have some important questions to ask and research to do. For now, accept on faith that new money is created (as a simple ledger entry at a bank) through the process of borrowing. A loan creates new money, and banks collectively may create money far in excess of what they hold on deposit. As a contract, the loan is quite real, but the dollar is not. A dollar is an undefined concept--an undefined unit of measurement for value, so to speak. You can see how such an arrangement favors those in a position to name their price.

As you can well imagine, for a country such as Saudi Arabia that had been subsisting on simple agriculture and the business of Pilgrims, a sudden infusion of such a magnitude of money can be seen as pure profit, and a fine opportunity for capital improvements to national infrastructure. Much of this money flowed back to the rest of the world to pay for international contractors and materials. But clearly, much more money was coming in than could possibly be spent. Vast sums of it found its way into the world's largest international banks--the five largest American, three largest Swiss, three biggest German, two biggest British, and then on to the next tier... Suddenly there were over one hundred banks that set up shop in tiny Bahrain: Citicorp, Chase Manhattan, Barclays, and Bank of Tokyo among them; all competing for surplus oil profit deposits. Paris suddenly found itself host to over 30 new Arab banks.

So much money flowed in, and so much was lent in turn to the poor countries that could scarcely afford to buy oil with their meager exports, that the financial system became a large game of musical chairs, and the biggest risk was that the music might stop. There were no chairs to sit on! To protect themselves from the unthinkable--that the Arabs might pull their deposits out of an individual bank--the banks developed a system. This system provided for the relatively smooth inter-lending of funds. Because even though a bank can create new money "out of thin air," they have to have deposits in the bank as a starting point. If these funds were to be withdrawn, the bank must locate other deposits to cover their outstanding loans. If the money were pulled, say from a British bank, it had to go somewhere; the amount of money was too great to "hide" for long. This British bank could call around, and arrange to borrow the funds back from a Swiss bank, or German bank, by paying a nominal interest rate on this inter-bank loan. The important concept to grasp here is this: as long as the petrodollars stayed in the banking system, the banking system would survive.

In fact, that is how the world weathered the storm of the First Oil Crisis. Such a grand scheme of inter-reliance was formalized by several central banks in a meeting in Switzerland to handle any event should money come up short in one area or another--the Basel Concordat. Have you ever heard of the LIBOR in any of your financial reading? Some credit card issuers make use of the LIBOR instead of the US. prime rate in their contracts. It is the London Inter-bank Offered Rate, and functions as the international bank borrowing rate, and it is the tie that binds the group together into a nearly seamless global financial System.

When the First Oil Crisis caused a global tightening of belts, only America, as the issuer of the key-currency, could shamelessly create new money with ease to pay its bills. Other countries had to balance their own books with productive output, or else turn to the banks to borrow the needed funds. And borrow they did! Let there be no doubt that these petrodollars were recycled through the banking system. Throughout the Oil Crisis and the distractions of the Nixon Watergate scandal, the former Secretary of Defense under the Johnson administration, and then president of the World Bank, Robert McNamara, was focused on one thing only--maintaining the good graces of OPEC. McNamara had to ensure continued access to OPEC's funds. During 1974, the World Bank had drawn on OPEC for $2.2 billion, for a total at the time of $3 billion--one quarter of all World Bank debt. For Euroland banks, business was booming because lending was their business. And the IMF had its hands full trying to hold together the international currency exchange system.

Some of the countries that quickly found themselves behind the eight-ball: Brazil, Korea, Yugoslavia, the Philippines, Thailand, Kenya. (You can easily imagine that there aren't enough coffee drinkers in Saudi Arabia to achieve a meaningful balance of trade of coffee beans for oil for a country like Kenya.) So in a move driven more by politics than banking to ease the financial squeeze upon a nation's citizens and industry, the governments would turn to their central banks and to the international and multinational banks to secure the needed money. And the banks couldn't stop lending, because many countries relied on new loans to pay off the old loans in addition to their continued need for oil. Loans in default were simply rescheduled. There were no chairs, and the music could not be allowed to stop.

If a bank were to fail, what would the Arabs do with their remaining deposits, now clearly in jeopardy? Further, the inflationary impact of all of this borrowing was also a fact not lost on the OPEC nations. Many of the OPEC members' advisors and ministers held Ph.D.'s from prominent American colleges. They did not have their heads in the sand. The inflation would lead to a new price of oil just to recapture the value that was lost, and the cycle would intensify in the next round. OPEC knew the western currencies were depreciating faster they were compensating with price hikes. They were getting less "real" money as a result. Hopeless.

Remember Jelle Zijlstra with the "moon" comment earlier? As head of the BIS in 1980, he confidently predicted that the Second Oil Crisis could be worked through, slowly, but that the System (international financial system) could not survive a Third Oil Crisis--the inflation would make it impossible to recycle the petrodollars to the oil importing countries with any hope of repayment, trade would crumble, and the System would be brought to its knees. On that grim note, we need to take a quick look at how the world reacted to the Second Oil Crisis. It opens the door to everything that follows.

By now you are patiently awaiting mention of Gold. There it is. Now back to the story... No, seriously, pay attention here, and things will start to fall into place. I hope you have noticed the few references to oil prices throughout this series. In most cases, the oil was made available at a posted price. In the 1960's, OPEC's posted price was $1.80 (though sometimes the producers would undercut that to gain an advantage through additional volume), then it was $2.20, then $5.12, and within weeks it had been changed again to $11.65 (in late 1973). By May 14 of 1979 the posted OPEC price was $13.34 per barrel, but life was about to change. The key element to keep in mind is that oil was not priced directly by the market. It was mostly sold under long-term contracts at posted prices that were set by the producers after careful analysis of what the market could bear under self-determined production levels.

When the Ayatollah Khomeini's revolution deposed the Shah, Iran's 6 million barrel per day production fell off dramatically, and the resulting shortage sent the downstream processes scrambling for sources of oil anywhere to feed their refineries. Many turned to Rotterdam for oil, to fill their empty tanks. The deepwater port at Rotterdam was the principle harbor where huge tankers could be found to deliver oil on the spot, and hence the spot market for oil was often referred to as the Rotterdam market--but in truth, the spot market was available worldwide. This spot market was never meant to determine the price for oil, but was only supposed to supply day-to-day purchases.

Due to the stresses of low supply, the Rotterdam price sailed above the $13.34 posted OPEC price on Tuesday, May 15,1979 to $28, and two days later it reached $34. Iran immediately took what little production remained and sold on the Rotterdam market. OPEC then set a ceiling price for oil at $23.50 per barrel, but that was soon broken by Libya and Algeria. Obviously, Rotterdam was the place to sell oil at the best price, so many tankers with long-term contracts for oil stood empty waiting for delivery while ever more of OPEC-member production was diverted through Rotterdam. Countries and many companies looked at the low levels in their storage tanks, and soon they were rushing to support the Rotterdam market with their business. The "spot" price reached $40 per barrel as uncertainty about the future brought forth every empty tank or dilapidated tanker out of retirement to be filled.

Gresham's law can help explain this phenomenon-- bad money is spent and good money is saved. Oil was being bought and saved as a store of value, while paper money was spent. The flames of this Rotterdam inferno were eventually cooled as the last available storage tank was filled to capacity. This display of the spot value for oil reinforced OPEC's concept of value, and they had no qualms about raising the posted price to the spot value. Please recall, "We would rather keep the oil than have the paper money." Any student of history will also recall that the explosion in Gold prices also occurred in 1979 to early 1980, showing us Gold priced at $850 per ounce.

So what exactly has changed in the world since 1980? There haven't been any similar blowups in the pricing of important how was this wild tiger tamed? Is the money better than it once was? Or are the OPEC nations now suddenly and truly beggars upon the West's doorstep? What happened? Are the multinational banks (once scrambling to hold together the System) now calling the shots with nary a care in the world?

In Part 5, I put an end to this tale, and answer the biggest mysteries about Gold in the easiest of terms. The road will seem so straight and fair to travel, you will kick yourself for struggling through the brambles for so long, and wonder at your neighbors who STILL can't see the path, though it is truly a freeway.

Part 5 --- Gold, Money, and the Free Market

Before I conclude this commentary, let me first express my gratitude to USAGOLD for hosting this illuminating site, and for the tolerance I've been extended by so many here for my four long posts that up until this moment probably didn't seem germane to the topic of Gold.

On any journey, the first few steps are the most important, and in this case they were also the most difficult--to include enough for context without drifting off-topic. This last part is easy. The task at hand is to provide an explanation of Gold's pre-eminence as a monetary asset. Gold is, in fact, Money, while the dollar and others are merely currencies--an importance difference!

I am not claiming to be offering new findings of my own. The inspiration for this tale originated from many sources, comments Aragorn III offered to a small group last month, a knowledge of history, and keen perception. I have been challenged to render this tale into the clearest of terms suitable even for those not acquainted with Gold and worldly economics. If I have succeeded in my challenge, at the conclusion of this final part you will fully grasp how the free market has managed to provide a sophisticated asset (Gold) at a laughably minute fraction of its relative value. You will know that Gold is Money, and will gain new respect for its "price." Although this information isn't new, it might be new to you, and hopefully this explanation of financial operations with Gold, together with the background information of the 1970's Oil Crises, will help you anticipate and conclude for yourself an outlook for events ahead, and will also help you to better understand and evaluate the important messages being presented by ANOTHER and FOA, in addition to the other worthy knights of this Table round. Knowledge is power, and with it your destiny shall be yours to decide.

To start, I'm going to paraphrase some specific remarks made by Aragorn III that some people need to hear and think about, though most of the Forum posters are already in tune with this.
'The falling price of Gold has had various effects on people. The common person says, "Of course it is falling, because Gold has been demonetized." The Goldheart knows better, so the falling price has a more remarkable effect, bringing out insecurities and irrationalities of some. Though these people don't question that Gold is money, their insecurities start to question whether the world really needs money at all...that somehow this greatest device of mankind has been antiquated. Simply preposterous. If they knew the truth they would confidently buy today at triple the price and call it a bargain of a lifetime. People ask, "Why waste effort to dig up Gold from the ground, only to rebury it in vaults?" I say, "For the same reason the central banks toil to print millions of fancy notes that nobody reads. If you've read one, you've read them all." The effort is needed to prevent cheating, though we easily see the fancy cash does not stem the abusive tide of money from nothing. People also say, "Gold is a dead asset. It does not earn interest." What is the point of such a comment, to demonstrate their naiveté? Did banks not pay interest when coins were stamped from Gold?

You see, it is not the nature of money itself to earn interest, but rather, it is the investment risk that maybe earns a reward. A modern dollar in a shoebox is as a Gold coin beside it. No interest for either. You should know the interest paid by a bank savings account is not a product of the money itself, but instead it is the rewards on the risk the bank takes with the money you have provided for their investment use. Sometimes these banks choose poorly, and in those cases even the modern dollar earns no interest, and does not come back at all--lost with the closing of the bank doors. Money must be risked (invested) to expect a yield, and in this regard, the big players in the world risk Gold money as they do paper money (though often not as aggressively), while the small players are content with the shoebox yield. You are forced to be more aggressive (more risky) with paper because its value dies quickly, unlike Gold that stands forever even in a shoebox of no risk.'

With that, I will now conclude this tale that shows Gold functioning in its role as Money. And because preconceived notions of words often cloud a person's ability to see the case before them, I shall try to deliver this message with the slightest use of such terms as Gold loans, leases, shorts, etc. In fact, I will be so bold as to simply refer to Gold as Money (I will write it as "Money (Gold)" to ensure you know my meaning, but as you read, simply pronounce it as money). As far as what you might think is money (dollars, yen, pesos, etc.), I shall from this point forward not call them money, but refer to them by their given name (dollars, yen, pesos, etc.) or else will call them "fiat currency," or just "currency" for short. Fiat means "by decree, and fiat currency is currency because the government tells us it is.

Enough of the preamble. Let's pick up where we left off from Part 4. In days past, the oil exporters had been poor to modest countries scraping by when two things occurred. They discovered that they owned lots and lots of oil, and they also found that the rest of the world had developed a voracious appetite for oil. Think how different the world situation would be today if this supply of oil had simply never existed. We are certainly lucky to have its availability, and it is a reasonable expectation to pay fairly for all that we take. As bald as that statement is, it is necessary because some people have suggested (as Kissinger did in the 1970's) that warfare is a possible alternative to obtain what isn't ours. Such a world!

We've already discussed much of the turmoil that resulted from consumption that outpaced ability to pay. Payment in Money (Gold) was terminated, and many payment scenarios were developed in addition to the ever rising prices in paper currency. While it can be suggested that currency is a reasonable means in which to track balance of trade accounts (equating oil exports with similar value of imports such as infrastructure improvements), it should be readily admitted that paper currency is an unacceptable means in which to pocket one's profits. Book the trade balances with paper currency, but pocket the profits (savings) with Money (Gold). That's what I do every month, too!

Paper currency was falling fast in value when it was no longer tied to Money (Gold), and this was causing international settlement difficulties on many fronts in addition to oil. It is instructive to investigate some of the tools of the international financial System, because what worked for Money (Gold) and currency back then, certainly works for Money (Gold) today. (Please reread the paraphrasing of Aragorn's money comments if you have forgotten them already.)

Back in the 1960's when dollars were still tied to Money (Gold) under the Bretton Woods agreement, the American penchant to spend for goods abroad led Kennedy's Undersecretary for Monetary Affairs, Robert Roosa, to fear a mass "cashing in" of these dollars in international hands for Money (Gold)--a run on the Treasury. Roosa created a new financial device, referred to as a "Roosa bond," which was a special issue of Treasury bonds that were denominated in Swiss francs. As the bonds were sold to the world, they would sop up excess U.S. dollars with the terms that repayment at a future date would be in a given quantity of Swiss francs. (Notice I said quantity, and not value.) While these Roosa bonds stemmed the tide of a possible run on the Treasury, they ended up costing America more because the Swiss currency appreciated versus the dollar during the life of the bond.

In 1978, the U.S. issued 10 billion dollars worth of bonds denominated in foreign currencies (marks or yen) to milk extra life out of a dying dollar system, and the fix lasted until the 1979 Oil Crisis made mincemeat of it. It was an acknowledgment that some foreign investors wouldn't hold U.S. government obligations that would be repaid in dollars worth less than originally spent on the bond. Further, it was at this time that the U.S. promised to sell Money (Gold) from the Fort Knox stockpile to foreign central banks unwilling to hold dollars. (On his last day of office, March 31, 1978, Federal Reserve chairman Arthur Burns suggested that the entire $50 billion of the nation's Gold stock be sold for foreign currency in defense of the dollar, at which time the foreign reserves could be used to buy up the collapsed dollar in international markets. While this plan was originally rejected, within three weeks the Treasury Department was forced to announce it would auction Money (Gold) on a regular basis.)

Treasury Secretary Michael Blumenthal pledged in a meeting two days later with top-level Arab businessmen that the integrity of the dollar would be defended vigorously, and asked them to do their part to stabilize the global economy by keeping a price freeze on oil in place at least through 1978. (You should have no questions now about where the dollar found its value after the 1971 delinking with Money (Gold). The asking price by oil--influenced by many factors--is what established the dollar's value.)

It is also important to realize that not all international arrangements are conducted on the open market. For example, to avoid the German mark from being bid up in strength with a result of ever more people bringing them dollars for an exchange, Germany's Bundesbank issued bonds directly to the Middle Eastern buyers, avoiding the marketplace impact altogether. This was at the time Saudi Arabia was swimming in cash and spreading the excess among the world's largest banks (as mentioned in Part 4). My point is this (which I shall expand on soon): don't be surprised that banks are far more creative in their operations than revealed in your common experience through savings and checking accounts and home loans.

Eliyahu Kanovsky, an oil economist, won renown by many for accurately forecasting long-term oil production and pricing trends by OPEC where all others had gotten it wrong. In the 1970's he maintained that economics, not politics, were the determining forces behind the decisions of OPEC. In 1986 he wrote in response to the prevailing notion that OPEC would eventually own the world as a result of its oil wealth: "It is, by now, abundantly clear that these forecasters committed gross errors not only in terms of magnitude of change, but, far more important, in terms of direction of change. Instead of increased dependence on OPEC and especially Middle East oil, there has been a very sharp diminution. ... Oil prices have been weakening almost steadily since 1981 and there has been a collapse since the end of 1985. Instead of rising 'petrodollar' surpluses, most OPEC countries, and Saudi Arabia in particular, are incurring large current account deficits in their balances of payments, and are rapidly drawing down their financial reserves."

In the 1990's, Kanovsky maintains that OPEC has lost its ability to raise income through raising prices, and that oil below $20 is virtually assured. (This should remind you of Milton Friedman's poor prognostication from Part 1.) Kanovsky claims competition among producers ensures an end to price fixing. They can only pump it and sell it for whatever the market will provide. He contends (rightfully so) that Iraq can be counted on to "pump like mad" upon lifting of UN sanctions. He also contends that with the current account deficits of many OPEC members, notably the Saudis, they have no option themselves but to add to the oil glut with overproduction to raise revenue.

Since it has been brought to our attention by Kanovsky, let's take a look at the Saudi budget, and the toll taken on it in the aftermath of the Gulf War. IMF data reveals that the Saudi deficit climbed from $4.3 billion in 1990 to $25.7 billion in 1991. Oil had been selling at around $14 per barrel until June 1990 when Saddam Hussein pressured OPEC to raise the price to about $20 to help repair Iraq's national budget (which had been wiped out and sent into the red by their 1980-88 war on Iran). Iraq's subsequent invasion of Kuwait in August 1990 temporarily spiked the price higher.

Here I must ask you to pause for a moment to reflect on those huge oil trade surplus figures we toyed with in Part 3, and recall that they were from early 1970's oil demand at a price of $11.65 which caused the First Oil Crisis. What happened to the vast amounts of petrodollar revenue that was being pumped into international banks, and recycled as fast as the loans could be written to borrowers throughout the 1970's? Further, what happened to the earnings that were surely being generated on these deposits through the activities of the lending institutions? As I noted at the end of Part 4, the System miraculously survived the Second Oil Crisis of 1979, and concurrently the skyrocketing price of Gold promptly abated in 1980. Further, Kanovsky points out that oil prices started weakening in 1981, and then plunged in 1985. Force yourself to make the connections. You will be one step ahead of Kanovsky, who has identified the effect, but no doubt has missed the cause entirely. Let us now tie together everything we know, and fill in the remaining pieces.

Historically, the price of oil had been simply posted by the producers for contracted delivery until it was unleashed to respond to daily supply/demand forces on the "spot" Rotterdam market, at which time the price exploded in 1979-80. Although the dollar had been historically fixed to Money (Gold), after it was unpegged in 1971, the currency price of Money (Gold) was determined by the daily supply and demand, similar to Rotterdam. Gold auctions began in May of 1978 because the U.S. had trouble getting international entities to accept its dollar currency. After "booking" their trade balances with dollars, the House of Saud, among others, wanted to "pocket" their profits with Money (Gold), and therefore competed with everyone in the world for Gold on the spot market. As the price shot right through $700 it was clear that every ounce purchased made it that much more difficult to purchase the next ounce. There was little trouble raising the price of oil as needed, except the financial structure of the world was coming apart at the seams. Each dollar withdrawn from international banks to buy Money (Gold) made life ever more difficult for the banks to square their books against outstanding loans or to write new loans. There had to be a better way...the return of Money!

The high price of Gold brought mining companies out of the woodwork. The Earth was suddenly crawling with geologists looking for the next jackpot Gold deposit. The mining companies needed capital to finance the construction of these numerous new mines. It's not strange to you to accept that banks can lend currency. It should not be difficult for you to accept that banks can lend Money (Gold) also. Struggling with that thought? Don't. They lent Money (Gold) in the days prior to Roosevelt's 1933 confiscation of Money (Gold) in exchange for currency, and they can lend Money (Gold) today. In fact, they can even create Money (Gold) out of thin air, in a manner of speaking, and I'll walk you through it.

Sometimes a parallel familiarity assists comprehension. Consider the existence of Government-Sponsored Enterprises (G-SE's) such as the Federal National Mortgage Association (commonly known as Fannie Mae). Fannie Mae is in the business of creating financing for people to acquire a house. The government's involvement in this affair is that they underwrite the risk of a default on the repayment of the loan. Dollars are borrowed, dollars are lent, and dollars are repaid. It doesn't matter what happens to the exchange rate of the dollars versus other currencies. A certain amount of dollars are owed, plain and simple, under the terms of the loan contract. If a home mortgage loan is sold on the secondary market, the purchaser of the loan is effectively buying not the house that was financed by this loan, but rather the rights to receive the borrower's scheduled repayments over a span of time.

Think of a loan to a mining company in a similar fashion. Interest rates on Money (Gold) loans are often much less than on currency loans because the Money (Gold) holds its inherent value over time (despite its "price,) whereas the paper currency fails so fast you must return more for the lender to at least break even, not to mention show a profit for the risk. Because miners will be pulling Money (Gold) out of the ground, it makes the most sense to them to seek a loan of Money (Gold) rather than currency in order to finance their new mine construction. But because Caterpillar has its head in the sand, it requests dollar currency for the purchase of its mining equipment, so an exchange must be made for paper currency as an integral part of this Money (Gold) loan. These arrangements can take place in every conceivable fashion, but this following example will be representative.

As 1980 arrived, the Saudis naturally still wanted Money (Gold) for their oil, and the rest of the world was struggling with liquidity. Much currency "wealth had already been transferred to OPEC, leaving many countries toiling to service their own debts--much of their credit existing as recycled petrodollars. Let the lending continue! Bullion banks would facilitate these deals, and central banks (CB's) would act in the same capacity as with the G-SE Fannie Mae, guaranteeing ultimate repayment in the event of a borrower's default. In this simple example, the House of Saud could be looked at as the principle lender (although the borrower doesn't see this)...providing the currency equivalent of the Money (Gold) borrowed by the mining company to pay for Caterpillar's equipment to build the mine. Because this is contracted as a Money (Gold) loan, Money (Gold) must be repaid over time. In a sense, from the Saudis' viewpoint it is similar to the Roosa bonds where U.S. dollars are paid for the bond, with a fixed amount of another currency (in this case, Money (Gold)) expected to be returned upon maturity.

With the simple but vital central bank guarantee against the default of these Money (Gold) loans, the House of Saud, for example, would have no qualms about supplying the cash side, effectively buying not the Gold metal immediately, but rather the rights to receive the borrower's Gold repayments over a span of time. Just like buying a home loan on the secondary market. And the Money (Gold) of the central bank need not ever move or change ownership unless the borrower defaults on the loan, and the CB is obligated to deliver on its guarantee for the full repayment in Money(Gold).

There is nothing sinister in all of this. The price of Gold has fallen simply because anti-gold sentiment has been fostered throughout the common investment markets while the principle buyer at the Golden "Rotterdam market" had found another avenue in which to obtain the Money (Gold) desired in exchange for oil profits. This is very much like the off-market Bundesbank offerings that I mentioned about earlier. Please appreciate the patience in this approach, and the commitment it shows to Money (Gold), knowing full well that for many years it might be getting ever cheaper, while they would appear the fool for buying it from the top prices all the way down to the lowest. But the big payoff is in the end--which is near--and I'll get to that.

Now that you grasp the basics, let's take things up one level. So many Money (Gold) loans were written, that the House of Saud in our example spent down their past petrodollar surpluses. What now? It is time for banks to do what banks do best...create new money. This is the typical example I promised you earlier:

The miner approaches a bullion bank for a Money (Gold) loan. Let's assume the current dollar price of Money (Gold) is $400 per ounce, and the miner needs $20 million to pay Caterpillar for equipment. The bullion bank (such as can be found operating in the network of the London Bullion Market Association--LBMA) writes the Money (Gold) loan contract specifying the term of repayment of 50,000 ounces of Money (Gold) plus interest at 1% - 2%. The borrowing miner collateralizes this Money (Gold) loan with company stock, the deed to the mine, etc., and is sent down the road with $20 million in currency for Cat. Where did this cash come from? The bullion bank turned to the House of Saud, which is currently out of currency. However, using their oil in the ground as collateral, the bullion bank is able to write them a currency loan out of thin air (just like banks can do) with which the Saudis purchase the repayment rights on the Money (Gold) loan. They will be receiving future Gold for their future oil! As they sell oil, they will use their dollar revenue to repay their currency loans, and in the meanwhile, the miner's Gold loan repayments will be directed to the Saudis' account.

What does the bullion bank get for all this trouble? First, the central bank gets 1% - 2% for underwriting or guaranteeing the loan. (Just like the underwriting done with Fannie Mae.) The bullion bank had added on top of this low interest rate an applicable margin for its cost of funds to establish the final interest rate for the miner that borrowed the Money (Gold). This rate might run 3% - 5% (while currency loans would demand much more.) Each year the miner produces Gold, and after paying the required installment of Money (Gold) for the Loan, the remainder of his annual production can be sold on the spot market for currency used to meet business expenses.

There's one hitch. Because the biggest Gold buyer is no longer shopping on the spot market, the pricing pressure has come off, and prices could very well be expected to fall. To protect against this leading to the possible bankruptcy of the miner, and hence his default on the repayment of Gold, the terms of the Loan might also require that the miner lock-in a certain amount of future production at the current Gold prices at the hedging counter. (Economists first scrutinize the mining plan to ensure that it will in fact be viable at current prices before granting the Loan.)

As described so far, it should come as no surprise that the House of Saud would also step right up to purchase the delivery side of this hedged production. Enough must be hedged to ensure the mine will remain viable (even at lower prices) at least long enough to repay the Loan. Lets assume this mine is operating today with Money (Gold) at $260 per ounce, while their cost of production is actually $320. The current price of Money (Gold) is not a factor on the Loan repayment...they owe 50,000 (plus interest) ounces, regardless. Any additional production would be sold under the terms of their hedge, at $400 per ounce, and they can pay their bills comfortably and stay in business. Is the House of Saud a fool for paying $400 long ago for the Loaned ounces, and for paying $400 today to honor such hedged ounce agreements? You or I could pay $260 today for that same ounce on the spot market. Have you started to develop a new opinion of your currency, or at least a new opinion of Money(Gold)?

OK, so what else does the bullion bank get out of this, other than the applicable margin on the Money(Gold) loan mentioned above? It also collects the interest on the currency loan that was written to the Saudis using their oil as collateral. You can see how the mechanism that has brought us temporarily cheap Money (Gold) over the years has also given us cheap oil not subject to the same shocks witnessed in the Seventies. You can also see why the economists can look at the Saudi balance books and see tremendous currency debts and budget deficits where once there were surpluses that threatened to buy up the world. They have in fact bought up a significant portion of the Gold mined well into the future...through Loans and Hedges bought all the way down from the top. So who are we to question whether to exchange our currency for Gold now or tomorrow, and to gripe over a missed opportunity of $10? The equation is simple. If you have cash, buy Gold immediately, because the downward trend has become terribly unstable. Here's why...

The various financial Hedge Funds saw how easy it was for miners to raise low interest capital, and further appreciated the fact that even if they were not themselves a producer of Gold, the Gold itself needed for repayment could be purchased on the spot market at ever lower prices. The Hedge Funds could meanwhile invest the capital received through taking out this Loan and expect to have a double profit potential in the end. (The infamous Gold Carry Trade would invest the currency received through the 1-2% Gold Loan into U.S. bonds that yield over 5%.) And of course, with the proper central bank guarantees, the House of Saud would be there to buy up the repayment contracts expected on these Money (Gold) loans also.

The problem is that these speculating Hedge Funds have cumulatively driven the price so low (well beyond where mines would have long ago stopped seeking this type of Loan) that some unhedged mines are shutting down or going bankrupt. This aggravates the spot market with thin supplies of real metal reaching it (due to so much production already having delivery obligations) such that it becomes hypersensitive to any real effort to make substantial purchases there.

As a result, the Hedge Funds will be in for a rude awakening in their efforts to purchase the Gold needed to repay their Loans. And the bullion banks are sweating, because they stand next in line having facilitated the Money(Gold) loans and pledged to the CB's that they were credit worthy of the CB Gold guarantees. And the important Oil Producer sees that the big bucks paid long ago for future Gold delivery has actually purchased only uncertain arrival. And further, some miners, despite their hedges, have played fast and loose liquidating them for cash, and through general mismanagement have not been able to stay so viable as to ensure future operation and delivery of the repayment terms.

The CB's are fretting because their guarantees were used over and over again, and they are on the hook for a lot of Money (Gold) when the speculating Hedge Funds and bullion banks find it impossible to cover their Loan repayment obligations on the spot market as the price races away from them due to the hypersensitivity that low supply has caused. Shades of Rotterdam. Currently aggravating this spot market problem is the massive demand by individuals brought about by the low prices and concerns for Y2K. I hope this give you new perspective on the push lately by some CB's to free up some Money (Gold) from the vaults, whether it is Bank of England, IMF, or maybe even Swiss. It should also give you perspective on the anti-gold propaganda delivered regularly by the media. Consider that a skyrocketing price of Gold would not only be viewed by the masses as a viable investment avenue, it would also tend to shake the confidence in paper currencies, and threaten the banking system and Wall Street in general.

It is this same currency, borrowed against oil collateral for the purchase of Gold, that has added the massive liquidity to the world over the past decade and a half that many people have used in turn to fan the flames of the stock markets here and overseas. That's a lot of cash born unto Gold, and were it not for the prospects of receiving the real wealth of Gold metal, this supply of currency would have been stillborn, and oil would likely only come forth by way of brute force rather than by civil, economic means. I realize that I have left a lot out, but this should get you started along the clear road traveled by smart currency. Now, knowing what you know, what would you do with your dimes? Because this is really his tale, not mine, I'll leave you once again with perhaps my favorite statement made by Aragorn one evening last month among his old friends. "If I were given a dime for every time I cursed the market for providing easier gold, I'd have a dime...and that one was found on my way over here.

Everyone, your comments are welcome. And thanks again to MK for the USAGOLD forum and for the opportunity to obtain a world-class Money education and shiny yellow metal diplomas all at the same place!

Gold. Heading to the moon at a world near you. ---Aristotle


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