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An Educational Series on Gold and Money
by Bill Buckler / The Privateer
Money - An "Assay"
A History Of U.S. Paper Money
The Trading Range 1994-1996
A History Of U.S. Paper Money
(The notes depicted here are for illustrative purposes ONLY)
If you want to know why Gold is anathema to bankers and financial authorities, take a a good close look at these Notes. The history of the move away from Gold in the 20th century is printed right on them.
"Government is the only agency that can take a valuable commodity like paper, slap some ink on it, and make it totally worthless" Ludwig von Mises. For the ultimate illustration of the truth of this statement, we give you the German Reichsmark of the early 1920s.
The Early Gold Wars
That is precisely what the Congress did. In 1792, the Dollar was fixed by law at 24.75 grains or 0.05156 troy oz. of Gold. In 1837, the coinage was reworked and the Dollar was defined at 25.8 grains of Gold "nine-tenths fine". That gives 20.67 Dollars to one troy oz. of Gold. That was the Dollar's "fixed value" (see the quote above) for 96 years from 1837 to 1933.
War Declared - 1933-34
March 4, 1933
March 6, 1933
March 9, 1933
April 5, 1933
June 5, 1933
January 30, 1934
January 31, 1934
The new ratio of $US 35 was adopted at Bretton Woods in July 1944. The U.S. Dollar was made the world's Reserve Currency and the IMF and World Bank established in 1947. The now international ratio of 35 U.S. Dollars to one troy ounce of Gold lasted until August 15, 1971.
The End Of the "Fixed" Dollar
Gold War I - The "London Gold Pool" - 1961 to 1968
By the beginning of the 1960s, the $US 35 = 1 oz. Gold ratio was becoming more and more difficult to sustain. Gold demand was rising and U.S. Gold reserves were falling, both as a result of the ever increasing trade deficits which the U.S. continued to run with the rest of the world. Shortly after President Kennedy was Inaugurated in January 1961, and to combat this situation, newly-appointed Undersecretary of the Treasury Robert Roosa suggested that the U.S. and Europe should pool their Gold resources to prevent the private market price of Gold from exceeding the mandated rate of $US 35 per ounce. Acting on this suggestion, the Central Banks of the U.S., Britain, West Germany, France, Switzerland, Italy, Belgium, the Netherlands, and Luxembourg set up the "London Gold Pool" in early 1961.
The Pool came unstuck when the French, under Charles de Gaulle, reneged and began to send the Dollars earned by exporting to the U.S. back and demanding Gold rather than Treasury debt paper in return. Under the terms of the Bretton Woods Agreement signed in 1944, France was legally entitled to do this. The drain on U.S. Gold became acute, and the London Gold Pool folded in April 1968 [Ed. Note: mid-March, actually]. But the demand for U.S. Gold did not abate.
By the end of the 1960s, the U.S. faced the stark choice of eliminating their trade deficits or revaluing the Dollar downwards against Gold to reflect the actual situation. President Nixon decided to do neither. Instead, he repudiated the international obligation of the U.S. to redeem its Dollar in Gold just as President Roosevelt has repudiated the domestic obligation in 1933. On August 15, 1971, Mr Nixon closed the "Gold Window". The last link between Gold and the Dollar was gone. The result was inevitable. In February 1973, the world's currencies "floated". By the end of 1974, Gold had soared from $35 to $195 an ounce
Gold War II - The IMF/U.S. Treasury Gold Auctions - 1975 to 1979
On January 1, 1975, after 42 years, it again became "legal" for individual Americans to own Gold. Anticipating the demand, the U.S. Treasury in particular and many other Central Banks sold large quantities of Gold, taking large paper profits in the process. This had two results. It depressed the price of Gold, which fell to $US 103 in eighteen months. More important by far, it "burned" large numbers of small individual investors.
But this "pre-emptive strike" against the Gold price did not solve the imbalances inherent in the floating currency regime. As the Gold price began to recover from its August 1976 low, the (US-controlled) IMF along with the Treasury itself, began a series of Gold auctions in an attempt to hold down the price through official means. But the problem of yet another free fall in the international value of the Dollar got in the way. Between January and October of 1978, the Dollar lost fully 25% of its value against a basket of the currencies of its major trading partners. By early 1979, due to this precipitous fall, the demand for Gold was overwhelming the amount that the IMF/Treasury dared supply, and the Gold auctions came to an end.
Gold regained its ($195) December 1974 level by July 1978. It then pressed on to new highs, hitting $250 in February 1979 and $300 in July. Also in July, Paul Volcker was appointed as Fed Chairman by a desperate Jimmy Carter. Gold continued to surge, hitting $400 in October. While this was happening, Mr Volcker was attending a conference in Belgrade. There the assessment was made that the global financial system was on the verge of collapse. When Mr Volcker returned to the U.S. from Belgrade, he took a momentous step. He announced that the Fed was swiching its policy from controlling interest rates to controlling the money supply.
This new Fed policy took some time to have effect. In the meantime, Gold soared from $381 on Nov. 1, 1979 to $850 on Jan. 21, 1980. The public, who had been burned in 1975, were late on the scene. The great burst of public Gold buying came in the four weeks between Christmas 1979 and the Jan 21, 1980 high. As in 1975, they were "burned" again.
The Paper Era Begins
In early 1980, Mr Volcker's new Fed policy began to bite. U.S. interest rates began to skyrocket. As they rose, the Dollar first slowed it's descent, then stopped falling, and then began to rise. Both the public and the investment community which had stampeded into Gold was lured back into paper by this huge rise in interest rates - and by the prospect of a higher U.S. Dollar. The threat of financial meltdown was averted, but at a cost. The U.S. Prime rate hit 20% in April 1980 and stayed there (with a brief dive in mid-1980) until the end of 1981. There was a rush out of Gold and back to Dollars.
Once interest rates began to come down, in early/mid 1982, the choice of where to put the Dollars faced investors once more. The initial solution was just as it had been in the 1970s. The Dow took off - rising from 776 to almost 1100 between mid August 1982 and late January 1983. Gold started earlier and took off even harder - rising from $296 in late June 1982 to $510 at the end of January 1993.
That's where the similarity to the 1970s ended. Gold fell $105 in the last four trading days of February 1983. As it fell, the Dow broke above the 1100 point level for the first time. The long bull market in stocks, and the long stagnation of Gold, had begun.
Many facets went into this change in investment attitude, but one concrete change in the U.S. financial system was the most telling. Way back in March 1971, four months before Nixon closed the Gold window, the "permanent" U.S. debt ceiling had been frozen at $US 400 Billion. By late 1982, U.S. funded debt had tripled to about $US 1.25 TRILLION. But the "permanent" debt ceiling still stood at $US 400 Billion. All the debt ceiling rises since 1971 had been officially designated as "temporary(!?)". In late 1982, realising that this charade could not be continued, the U.S. Treasury eliminated the "difference" between the "temporary" and the "permanent" debt ceiling.
The way was cleared for the subsequent explosion in U.S. debt. With the U.S. being the world's "reserve currency", the way was in fact cleared for a debt explosion right around the world. It was also cleared for three of the biggest bull markets in history.
The global stock market boom of 1982-87
The HIDDEN Gold Wars
In the early 1980s, when world stock markets boomed in tandem everywhere in the world, Gold reached the $500 level twice. The first time was in early 1983, just as the global boom was getting started. The second time was at the end of 1987, two months after the infamous crash of October 1987. From $499 in December 1987, Gold fell throughout 1988 and dipped below the $400 level in January 1989. Gold has only ever regained the $400 for four very short periods since then.
Gold traded as high as $422 in December 1989 - January 1990.
But Gold's history in the years since the 1987 crash is that at all the actual crisis points, the Gold price has not risen, it has fallen. The best single example of this phenomenon remains Gold's performance on January 17, 1991, the day that the "air phase" of the Gulf war began. On that single day, Gold fell $30 from its previous close. In fact, it fell $40 from its intra-day high. Gold had been rising in the months leading up to the war. As soon as the war started, Gold plummeted.
The Gold price has failed to respond to the fact that Gold demand has exceeded newly-mined Gold supply in every year since 1988. It has, consistently done the opposite of what all of its previous history shows that it "should" do. Why has this happened?
From Overt To Covert
As we have documented in this series, in the 1960s and 1970s, governments fought Gold in the open. They announced what they were going to do before they did it. Of course, they failed miserably. But people in government, just like the rest of us, are quite capable of learning from their mistakes, The first thing they learned was that the best way to "fight" Gold was to go underground. They did so, with great success.
The plan adopted was to fight Gold on their own ground. In order to do this, they greatly expanded the ways in which Gold could be traded. More important, they introduced and developed an indirect market for Gold, they invented a Gold "derivatives" market.
The Paper Blizzard - "Derivatives"
Forward and futures markets were not, of course, an invention of the 1980s. What was an invention of the 1980s was the massive increase in paper trading instruments. These instruments, which became known as "derivatives", were first developed in the currency and debt markets. They then spread into the equity markets and into the Gold market.
The advantage of "derivatives" in the paper markets was twofold. First, they provided more and more leverage for more and more aggressive trading. Second, and far more important, they provided a method to hugely expand the amount of money in circulation without expanding the "money supply"! The traditional measures of money in circulation (M1, M2, M3, M...) expanded much more slowly. What did expand was the blizzard of "derivative paper" using paper money as its underlying "asset". This was one of the main reasons why "inflation" (defined as rising prices) slowed down.
The advantages of a Gold derivative market were similar. Governments learned in the 1960s and 1970s that it was impossible to meet an increased demand for Gold with physical Gold. They needed a paper substitute. Gold "derivatives" provided that substitute. With more tradeable alternatives to physical Gold, it became far easier to control the Gold price. But on top of the derivatives themselves, other specific mechanisms were developed to help control the price of Gold.
One of these methods was forward selling by Gold mining companies. This practice began with Gold's retreat from the $500 level in the wake of the 1987 crash. By the mid 1990s, Gold companies everywhere, but notably in Australia, were routinely forward selling years worth of their projected Gold production.
As the performance of Gold in the more than a decade since the market crash of 1987 illustrate, these mechanisms have worked very well indeed.
For as long as Gold has been prized, there have been men who have tried to create it. For hundreds, if not thousands of years, the Alchemists strove to transmute base metals into Gold, without success. But even after its introduction to the West and the invention of the printing press by Gutenberg at the end of the Thirteenth century, no-one had the idea of trying to turn paper into Gold. In past centuries, those who would control money contented themselves with substituting paper for Gold, with limited success.
It took some true "visionaries", and the end result of a long process of economic wishful thinking, to seriously propose "paper gold". The notion goes back about 30 years, to the period just before the dawn of the "floating currencies" era. When the U.S. closed the the "Gold Window" in August 1971, the Dollar promptly dived against all its major trading partners. By February 1973, it had become impossible to pretend that any fixed ratio still existed between currencies, and the era of "floating currencies" began.
The IMF actually invented what became referred to as "Paper Gold" in 1971 [Ed. note: SDRs were first allocated in January 1970] - months before the U.S. severed the tie between the Dollar and Gold. The IMF knew this step was coming, and so it invented the "SDR" (Special Drawing Right). It was touted as a Reserve "Currency" that would replace both the U.S. Dollar and Gold in the basements of the world's Central Banks.
While these SDRs still exist, they have not done much over the past three decades or so except gather dust. Their prime purpose, to provide a substitute for Gold, was not fulfilled. The SDR was the last major attempt to provide a "substitute" for Gold. For at least the past two decades, the approach has been that no substitute for Gold is necessary. And to "prove it", Gold has been progressively debunked as either a money or even a viable investment option. The price has been forced down, then held down, then forced even lower.
If You Can't Replace It - Dilute It
The price of Gold cannot be held down by selling the physical metal. The decade between 1970 and 1980 proved that conclusively. Hundreds of years of history have proven conclusively that nothing can be sold as a "substitute" for Gold. In the years since the 1987 crash - when the $US 400 "glass ceiling" on Gold has been put and kept in place, Central Banks have continued to sell Gold, but only in emergencies. The real mechanism for holding down the price has been different.
Forward Selling - By Gold Producers
For most of the past decade, Gold mining companies gradually changed the way they market their Gold. To an ever-increasing extent, they have "forward sold". The mechanism is quite simple. A Gold mining company with proven reserves in the ground wants to sell a portion of these reserves forward. The company representative goes to a bullion dealer who agrees to pay him, for example, $500 per ounce for Gold to be delivered two years from now. The Gold company has locked in a profit, and on top of that, has the money now for Gold which is still in the ground.
The Gold bullion dealer is exposed, however. He is exposed to a possible loss if the Gold price falls in the future. So, to hedge this position, the bullion dealer sells Gold - for immediate delivery. "Wait a minute" (you cry), where is the bullion dealer to get the Gold to provide for immediate delivery? The answer brings us directly to the second part of the mechanism for maintaining the $US 400 Gold "glass ceiling".
Gold "Leasing" - The Central Banks' Contribution
Our intrepid bullion dealer goes out and "borrows" the Gold. Where does he borrow it from? That's easy. From the formidable 36,000 Tonne hoard still owned by the world's Central Banks.
To get the Gold - or more accurately, to get a marketable claim to the Gold - our bullion dealer pays what is known as the Gold lease rate (an extremely low rate of interest). He then sells the Gold - or the claims to Gold, and invests the money. This is the way the difference between the spot and forward prices for Gold is determined. The forward price is the money interest rate which our bullion dealer receives for his investment minus the lease rate which he paid to borrow the Gold.
The point is that this entire fandango (that's "fandango" - not "contango") can be performed by lending physical Gold, or it can be performed by lending a paper claim to Gold. The miners' Gold is still in the ground. The Central Bank sometimes lends Gold, or it lends a claim to Gold. These are what our bullion dealer sells. And since most demand for Gold is not a demand for the physical metal but a demand for paper (forward, future, etc) claims to the metal, this mechanism can meet the demand without an undue strain upon the available supply of the physical metal, and the upward pressure on the price of Gold that would cause.
by Bill Buckler / The Privateer -- The Private Market Letter for the Individual Capitalist
The Privateer market letter
This overview series was excerpted from The Privateer's Gold Pages.
Copyright ©2001 The Privateer Market Letter. All Rights Reserved.
Reprinted by USAGOLD with permission of The Privateer and Bill Buckler. No further reproduction without permission.