Ron Paul on Gold

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Gold fever sets in

A prophetic and interesting analysis by Antal Fekete:

Gold fever sets in
By Antal E Fekete

A landmark in the saga of the collapsing international monetary system was signaled on December 2, when gold went to backwardation for the first time in history.

Backwardation is a market condition in which futures prices are lower in the distant delivery months than in the nearest delivery month. The facts are as follows: on December 2, at the Comex in New York, December gold futures (last delivery: December 31) were quoted at a 1.98% discount to spot, while February gold futures (last delivery: February 27, 2009) were quoted at 0.14% discount to spot. (All percentages annualized.) The condition got worse on December 3, when the corresponding figures were 2% and 0.29%.

This means that the gold basis [1] has turned negative. The backwardation continued and worsened on December 8, 9, and 10, as shown by the corresponding rates widening to 3.5% and 0.65%. It is nothing short of awesome.

Already there was a slight backwardation in gold at the expiry of a previous active contract month, but it never spilled over to the next active contract month, as it does now: backwardation in the December contract is spilling over to the February contract, which at last reading was 0.36%. Silver is also in backwardation, with the discount on silver futures being about twice that on gold futures.

This is a premonition of a coming gold fever of unprecedented dimensions that will overwhelm the world as soon as its significance is fully digested by the doubting Thomases. The worsening of backwardation must be viewed in the context of the gold price bouncing back from the lows of last week. It shows that the “gold bashing” on Friday was done in the December contract. It is quite revealing that the spot price bounced back more than the futures price. The bulls are on the warpath. They have unearthed the hatchet. They have stopped eating from the hands of the clearing members.

As I wrote on December 4 in my “Red Alert” note [2], the gold basis is a pristine, incorruptible measure of trust, or the lack of it in case it turns negative, in paper money. Of course, it is too early to say whether gold has gone to permanent backwardation, or whether the condition will rectify itself (it probably will). Be that as it may, it does not matter. The fact that it has happened is the coup de grace for the regime of irredeemable currency. It will bleed to death, maybe rather slowly, even if no other hits, blows or shocks are dealt to the system. Very few people realize what is going on and, of course, official sources and the news media won’t be helpful to them to explain the significance of all this. I am trying to be helpful to the discriminating reader.

Gold going to permanent backwardation means that gold is no longer for sale at any price, whether it is quoted in dollars, yen, euros or Swiss francs. The situation is exactly the same as it has been for years: gold is not for sale at any price quoted in Zimbabwe currency, however high the quote is. To put it differently, all offers to sell gold are being withdrawn, whether it concerns newly mined gold, scrap gold, bullion gold or coined gold. I dubbed this event that has cast its long shadow forward for many a year, the last contango in Washington – contango being the name for the condition opposite to backwardation (namely, that of a positive basis), and Washington being the city where the paper-mill of the Potomac, the Federal Reserve Board, is located.

This is a tongue-in-cheek way of saying that the jig in Washington is up. The music has stopped on the players of musical chairs. Those who have no gold in hand are out of luck. They won’t get it now through the regular channels. If they want it, they will have to go to the black market.

Mish Shedlock published a disdainful criticism of my theory on the worsening backwardation in gold (see note), calling it “nonsense” (see references below). A friend of his owns a seat on Nymex (a branch of Comex) who had this to say: “I have seen countless commodities go into backwardation for numerous reasons, the most frequent being a radical temporary divergence between immediate and overall demand. I have seen backwardations that have lasted years. The article is based on the assumption that a backwardation will necessarily lead to a breakdown of the delivery mechanism. But for every breakdown of the delivery mechanism there have been thousands of backwardations without a breakdown. Only if and when an actual breakdown occurred would the conclusions that the author drew make sense.”

Well, well, one can buy himself a seat on the Nymex for sure, and the price is hefty these days, but Nymex does not deliver the understanding of monetary science along with the seat. Nor does any university anywhere in the world.

Mish says that “there is nothing special about backwardation, period. OK, they are rare in gold. So what?” Here is what. There is a difference between “rare” and “non-existent”. Backwardation in gold has been non-existent, and for a very good reason, too, as I have explained in my articles. (I also pointed out that there have been “hiccups”, or short-lived instances of backwardation. They were temporary “logistical” bumps, always resolved within a day at most, and they never ever spilled over to the next actively traded delivery month.)

Mish needs to educate himself on the fundamental difference between a monetary and a non-monetary commodity before he can grasp the idea that lasting backwardation in gold is tantamount to the realization that “gold is no longer for sale at any price”.

The bottom line is that there is no fever like gold fever. It is akin to St Vitus’ dance that swept through the Christian world just before the year 1,000 AD, affecting all the people who expected the end of the world to happen at the turn of the millennium. It was far worse than the mania that swept through the world affecting all the people a thousand years later who expected the 2K disaster to happen.

The coming gold fever must be distinguished from tulipomania in February 1637, when one single tulip fetched the equivalent of 20 times the annual income of a skilled worker. Gold fever is as different from a bubble as real gold is from fools’ gold. It is visceral. It has to do with one’s instinct for survival. It has no patience with logical arguments. It is highly contagious, ultimately affecting everybody. A bubble that never pops.

You may ridicule the idea that, during a prolonged backwardation, all offers to sell gold will be withdrawn. But a serious analyst must answer the question why hundreds of millions of people having gold coins under the mattress and in the cookie jar refuse to take the bait of “risk-free” profits offered by backwardation. Such a thing would never ever happen to a non-monetary commodity.

The only successful corners in history were gold corners, aka – hyperinflation. Keynesian and Friedmanite economists in the pay of the government thought that gold futures trading would permanently short-circuit the forces of gold backwardation, thus preventing hyperinflation from ever happening. They were wrong.

In an article “The Manipulation of Gold Prices” (see references), James Conrad, Professor Emeritus of Economics and former Dean of the School of Business Administration at the University of Indianapolis, argues that Bernanke is different. He understands that he needs a much higher gold price in order to increase the efficiency of his airdrops. There is no better way to distribute new money among prospective spenders than putting it into the pockets of the gold bugs. (Conrad admits that he is one.) This will induce a large spending spree, holding deflationary pressures back.

According to Conrad, Bernanke is well aware that the new money he is feverishly airdropping has not stopped and will probably not stop the bloodbath in the stock market. Further devastation of share prices will render pension funds insolvent. To prevent this, the dollar needs a massive devaluation, on the pattern of FD Roosevelt’s tinkering with the value of gold. I quote:

Anyone who reads the written works of our Fed Chairman will know that Bernanke’s long term plan involves devaluing the dollar against gold. This is the exact opposite of the position of most prior chairmen. He has overtly stated his intentions toward gold, many times, in various articles, speeches and treatises written before he became Fed Chairman. He often extols the virtues of F D Roosevelt’s gold revaluation/dollar devaluation back in 1934, and credits it with saving the nation from the Great Depression. According to Bernanke, devaluation of the dollar against gold was so effective in stimulating economic activity that the stock market rose sharply in 1934, immediately thereafter. That is something that the Fed wants to see happen again.”

It is only a matter of time before gold is allowed to rise to its natural level. Assuming that about one half of the recent increase in Federal Reserve credit is neutralized, the monetized value of gold should be allowed to rise to between $7,500 and $9,000 per ounce as the world goes back to some type of a gold standard. In the nearer term, gold will rise to about $2,000 per ounce as the Fed abandons its hopeless campaign to support Comex short sellers in favor of saving the other, more productive, functions of various banks and insurers.

Revaluation of gold, and a return to a gold standard, is the only way that hyperinflation can be avoided while large numbers of paper currency units are released into the economy. This is because most of the rise in prices can be filtered into gold. As the asset value of gold rises, it will soak up excess dollars, euros, pounds, etc, while the appearance of an increased number of currency units will stimulate investor psychology; and lending and economic output will increase all over the world. Ben Bernanke and the other members of the FOMC Committee must know this, because it is basic economics.

It is to be regretted that more of Conrad’s admirable paper cannot be quoted here because of lack of space. To summarize: Bernanke is prepared to throw the issuers of paper gold at the Comex to the wolves, as they have become useless, even a nuisance, by now. Besides, the wolves must be appeased lest they devour whatever remains of the US banking and insurance system.

My own position is somewhat different from Conrad’s. In my view we are facing a world-wide elemental grassroot movement: the flight into physical gold – witness the backwardation in gold. It is irresistible, and will ultimately overtake all other market forces. It will overwhelm official resistance.

An intriguing case can be made, as is attempted by Conrad, that Bernanke is intelligent enough to realize all this thinking that he can harness, if not hijack, the grassroot movement for his own purposes. This is a wee bit more intelligence than I can give credit for to the chairman, who is a former academic himself. I find the thought surrealistic that Bernanke wants to use gold as the safety valve through which he can release steam from an overheating deflation one day, and from an overheating inflation the next.

Be that as it may, the Brave New World of irredeemable currency sans the paper gold factory at Comex will be an entirely different world from what we have been used to for the past 36 years. I highlight the differences as I see them. This should be helpful in the long run, even if this backwardation is temporary and gold futures trading will return to normal, since permanent backwardation is ultimately unavoidable.

Item 1: Barrick and other gold producers that still have an open hedge book will go bankrupt.
Item 2: Other gold miners will, one after another, stop selling gold altogether, and go into hibernation.
Item 3: Junior gold mines will put off starting production indefinitely. They will consider their gold ore reserves in the ground a safer store of value than paper money in an insolvent bank.
Item 4: The closing of the gold window at the Comex will furnish an excuse for other issuers of paper gold including the bullion banks to declare bankruptcy fraudulently.
Item 5: GLD and other joint depositories of gold will be under enormous pressure to default and let the owners of the ETF shares hold the bag. Let them sue for the gold. They won’t get it: their contracts give them no right to physical gold. They will get small change, in paper. The principals will cut up the gold pie among themselves. No crumbs will trickle down to shareholders.
Item 6: Even allocated and segregated metal account gold is not safe. The temptation on the account providers to default will be irresistible. They are not going to release the gold until expressly ordered by the courts, and will make sure that no gold will be left by then.
Item 7: Central banks forfeit their gold under leases due to backwardation, causing an uproar of citizens whose patrimony was sequestered and dissipated in such an ignominious manner.
Item 8: The only market for gold will be the fragmented black markets in various countries each charging a price whatever the traffic can bear. All legal protection of the ownership of and trade in gold will be suspended. The Dark Age will descend on the trading world, just as it did when the Roman Empire collapsed.

Our present experiment with irredeemable currency can last only as long as it is able to support futures markets in gold. The declining gold basis is the hour glass: when it runs out and the last grain of sand drops, gold fever will bleed the futures markets of cash gold, and the days of the regime of irredeemable currency are numbered.

Previous episodes of experimentation lasted no more than 18 years, or half as long as the present one, which has taken 36 years so far, a world record. Of course, none of the earlier episodes were supported by futures markets. Forewarned, forearmed. Get ready and move closer to the doors. When the curtain falls on the last contango in Washington, there will be panic and some people may get trampled to death at the exit.

Dear Mish, lower your gun. The topic of gold backwardation is not for you.

References:
Monetary versus Non-monetary Commodities, April 25, 2006
The Last Contango in Washington, June 30, 2006
Has the Curtain Fallen on the Last Contango in Washington? December 8, 2008
(These and other articles of the author can be accessed at the website www.professorfekete.com)
The Nonsense about Gold Backwardation, etc., by Mike (Mish) Shedwick, December 7, 2008, www.globaleconomicanalysis.blogspot.com
The Manipulation of Gold Prices, by James Conrad, December 4, 2008, www.seekingalpha.com
Gold in Backwardation? Not so fast … , by “Hard Asset Investor”, December 2, 2008, ibid.
The Battle against Contango, by Brad Zigler, November 20, 2008, www.hardassetsinvestor.com

Notes
1. This edited article includes elements from Professor Fekete‘s previous newsletter, Red Alert, which initially signalled the backwardation discussed here and includes a more detailed account of the gold basis, backwardation and contango.
2. See Red Alert at www.professorfekete.com

Antal E Fekete has since 2001 been consulting professor at Sapientia University, Cluj-Napoca, Romania. In 1996, Professor Fekete won the first prize in the International Currency Essay contest sponsored by Bank Lips Ltd of Switzerland.

(Copyright 2008 Antal E Fekete).

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Has Silver Bottomed?

This year the price of a silver ounce has fallen to less than 1/82 of a gold ounce. While gold pulled back by about 30% from $1,011 to around $704, siver has plummeted by 58% from $20.92 to $8.79.

With the money supply on the rise again, and the Federal Reserve policy obviously out of control, coupled with a very cheap ratio in terms of gold, it is certainly reasonable to start being bullish on silver again. Silver is, after gold, the best monetary metal. True, it derives a lot of its demand from industrial uses, but it has already taken its beating for it.

As far as my limited chart reading skills go, the SLV chart seems to reaffirm this belief:

Click on image to enlarge.

Has a floor formed? I do think so. Has the trendline been broken? Not quite yet, but it looks like we’re close to a trend reversal.

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Use Gold Money

A fiat money can only function when forced upon the people via aggression or threat thereof. As a tendency, a government, the bigger and more powerful it gets, will more and more take advantage of the system. The monopoly over money creation tempts those in charge to produce money and spend it for the government’s own projects.

In the United States this happens in the form of government bonds issued by the Department of Treasury. Those bonds are bought up by the Federal Reserve Bank. The government gets to spend the newly printed money first and hence gets to purchase goods before everyone else sees their prices rise. They hence benefit from the inflation and effectively impose a tax on those who get to use the money later, the workers who earn wages in businesses.

In 1971, $28 would buy one ounce of gold. Today $813 are needed. $29 are needed today for what $1 would have bought back then. This trend will continue. Inflation always causes misallocations, disturbs a smooth functioning of the market, and reduces prosperity below the level that could be achieved without it. It transfers wealth from those who receive the newly injected money later to those who get it earlier.

But as a certain amount of inflation becomes acceptable to a conditioned populace, the government will push the boundaries toward more inflation and debt with no end in sight. Those who run the state apparatus won’t owe money to anyone when they jump ship. They have no incentive to be prudent. It is the future taxpayer who will foot the bill. A hyperinflation will wipe out enormous sums of wealth for the common man, before the currency is finally destroyed completely. Those who understand the historical relevance of gold money, and act accordingly, will be the winners of this development.

Last Saturday, at the San Francisco “End the Fed” rally organized by the “Campaign for Liberty“, a man on the podium was holding up a Silver Dollar and an American Gold Eagle. To his left the mighty San Francisco Federal Reserve Bank, to his right the US Bank tower. “I hold here in my hand more money than these banks have ever owned … one Silver dollar buys me 2 popcorn, 2 sodas, and 2 movie tickets. My rent is $40 per month.” I presume he is self employed and demands payment in gold and silver Dollars from his customers as much as possible. He said he uses the money in grocery stores, cleaners, and restaurants who gladly accept sound money.

Now the incredible part: When he earns 50 Gold Dollars, he declares $50 on his income tax return for an asset that has a price of currently about $900. So long as he doesn’t cash it in he owes no income tax on its fair value. An American Gold/Silver coin is considered legal tender over the amount that is imprinted on it. This is, in fact, the law: After hearing him speak, I did my research:

Article 31 U.S.C. § 5112 outlines the details of the arrangement of minting American Eagle coins. The law makes them legal tender for all debts private and public.

As per wikipedia.org, another important decision was made by a court in 1877:

The case of Thompson v. Butler establishes that the law makes no legal distinction between the values of coin and paper money used as legal tender:

A coin dollar is worth no more for the purposes of tender in payment of an ordinary debt than a note dollar. The law has not made the note a standard of value any more than coin. It is true that in the market, as an article of merchandise, one is of greater value than the other; but as money, that is to say, as a medium of exchange, the law knows no difference between them.

I encourage everyone to read this:

It is an article about a Nevada businessman who applied the concept I explained above throughout the 1990s. The most notable sections:

…Kahre hadn’t committed a crime. He had upset the Internal Revenue Service by paying his workers based on the face value of gold and silver coins, versus the market value in the Federal Reserve system (the value of the coins in U.S. paper dollars)…

…The IRS expected Kahre to report his workers’ earnings based on the coins’ market value in the Federal Reserve system. Instead, he didn’t report or pay anything at all because the face value of the coins fell below the reporting threshold. The IRS alleged that Kahre and the other defendants paid at least $114 million (based on the Federal Reserve system) to workers. The use of these coins in trade is a direct challenge to the fiat money system now in place…

…In 1985, Ron Paul and other congressmen challenged our country’s currency system, which was monopolized by Federal Reserve Notes (FRNs) the familiar greenbacks in American wallets. The congressmen successfully pursued the Gold Bullion Coin Act, which required the U.S. government to mint and place gold coins in denominations of $50, $25, $10 and $5 into circulation based on demand. The coins are made of 91.67 percent pure gold….

…[the] jurors delivered zero guilty verdicts. Three defendants, all workers, were acquitted as well as Kahre’s mother, who worked as a runner for her son’s businesses. Two other defendants were partly acquitted, the jury hung on one count each. The jury also hung on all counts faced by Kahre, Loglia and Kahre’s sister, resulting in mistrials…

…The outcome of this case is a magnificent victory for those of us who believe that the United States of America should have an honest monetary system.

I expect to see more cases like this in the near future. As the quality of the US Dollar diminishes people will be forced to look for a better money. What better option is there than using precious metals which the country’s highest federal legislator has made legal tender. The tax savings are a convenient side effect but the practice will certainly be legislated away and violently punished once the government becomes desperate. But at least it would be a means to put an end to the fraudulent Federal Reserve System that has been plaguing this country for 95 years, and once and for all do away with the inflation tax.

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History of Money

The history of money doesn’t need to be confined to one specific country or time period. It is rather expedient to outline the role money has played and the changes it has gone through in virtually all countries over time. Some events might have occurred earlier or later in one nation or another. However, the general trend to date has been the same. Understanding this trend is of major importance when it comes to understanding money today. This article describes the imaginary story of a country that went from no money at all to a fiat money, paper money. It is conceptually applicable to any country on earth.

The demand for money arose with the appearance of division of labor, when individuals began producing for others rather than for themselves. This was of course a direct outcome of the law of comparative advantage and the corresponding specialization of labor. If individual A transforms land and produces a good that individual B demands, but B has nothing to offer that A demands for consumption, A might still consider receiving a product M in exchange that he can then give to individual C. C happens to demand B’s product for consumption AND offers something that A also demands for consumption. In this case, from A’s point of view M is a medium of exchange, a money.

With division of labor spreading, different goods would be used as money, such as tea, coffee, beans, salt, or cattle. There are numerous accounts of the usage of these goods as money in history. However, there are goods that are better and goods that are worse than others for usage as a medium of exchange. A medium of exchange needs to fulfill criteria such as durability, divisibility, homogeneity, measurability, sufficient but limited availability and broad acceptance. The metals gold and silver emerged as goods that best fulfilled these criteria when used on the market.

Consumers, entrepreneurs, capitalists, landowners, and workers dug up and/or used gold and silver as money in exchange and credit transactions on the market. Decentralized, competing gold mines would channel gold into the market, part of which was used as money. For a fee, some entrepreneurs began offering the service of depositing money in warehouses, also known as deposit banks, so the owners of the money wouldn’t have to carry it with them. They would issue receipts for the money deposited. Soon the receipts themselves, rather than the deposited gold, would be used as money, hence gaining value as media of exchange.

Some of the gold would not be redeemed but rather stay in the warehouses. Thus the entrepreneurs issuing the receipts started offering their own receipts in exchange and credit transactions which were not backed by their own gold. However, they had to be careful not to issue too many uncovered receipts. Because as the price of their additional receipts would drop, their customers would begin redeeming them in exchange for gold again. If there were too many uncovered receipts issued, the warehouse would ultimately lose all its deposits and hence go out of business.

Thus in the long run those deposit banks who managed their deposits most prudently would be the most successful and profitable ones.

But some of the depositors had loaned receipts to the government and hence accumulated public debt. When they faced the threat of going out of business, due to a massive drain upon their gold reserves they sought help with the government.

The government used its police force in order to prevent the deposit banks from having to redeem their customers’ receipts for gold. It declared the receipts of the banks a legal tender, which means that they became a fiat money, a money that people are forced to accept or face government force if they don’t. The operations of different banks were consolidated within one central bank and numerous fractional reserve banks with the exclusive authority to produce fiat money. In addition, the government forcefully confiscated private gold holdings and declared private ownership of gold illegal.

This central bank was no longer under the constraints that the deposit banks used to face. It didn’t depend upon gold deposits and it could inflate the money supply at will. Without voluntary competition within the country, the result was that the quality of the money produced was low. Inflation became a common phenomenon.

Just as seen in the example of the production of cars in the Soviet Union, the more monopolized and centralized the production of a good, the less competition exists, and the less the consumer is given a choice, the lower the quality of the good produced will be from the point of view of those consuming the good.

Roughly, this has been the History of Money and Banking in the United States and the course of events that led to the establishment of the Federal Reserve Bank.

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