The Gold Standard The Gold Standard InstituteIssue #30 ● 15 June 2013 1The Gold StandardThe journal of The Gold Standard InstituteEditor Philip BartonRegular contributors Rudy FritschKeith WeinerOccasional contributors Ronald StoeferleSebastian YounanPubliusThe Gold Standard InstituteThe purpose of the Institute is to promote anunadulterated Gold Standardwww.goldstandardinstitute.netPresident Philip BartonPresident – Europe Thomas BachheimerPresident – USA Keith WeinerPresident – Australia Sebastian YounanEditor-in-Chief Rudy FritschWebmaster Jason KeysMembership LevelsAnnual Member US$100 per yearLifetime Member US$3,500Gold Member US$15,000Gold Knight US$350,000Annual Corporate Member US$2,000ContentsEditorial ........................................................................... 1News................................................................................. 2Gold is for the Rich… no?........................................... 2Freegold: An Analysis.................................................... 5Are Covert Operations Underway in the GlobalCurrency Wars ................................................................ 6Theory of Interest and Prices in Paper Currency PartIII (Credit).....................................................................11EditorialPhilip Barton asked me to kick off this issue of TheGold Standard. Bear with me as I review some grimrecent events. There is a positive message at the end.Impelled by their dollar-derived irredeemablecurrencies, every country in the world continues itsfeckless march towards the oblivion of bankruptcy.Cyprus gave us an instructive example of what thecentral banks desperately fought to postpone. Peoplethink that the government took the money fromdepositors, but the banks lost it the moment theybought Greek welfare state bonds. Bookkeepingcaught up later, followed by the run on the bank.The next phase is the death of the stock market. TheCyprus stock market is now down over 98%. Notonly that, but trading volume has totally evaporated.Meanwhile in Greece, it is the labor market that hasflat-lined. Total unemployment is near 30%, andnear 60% for those aged 15-24.Now, all eyes are turned to Japan. The central bankof the rising sun has been buying bonds for a longtime. So it is shocking to see how much it has had toincrease its purchases. In 90 days, they increasedtheir holdings from ¥91.4T yen to ¥104.9T, or 15%.Did I say they did this in one quarter? I suspect thatpurchases this quarter are even more breathtaking.They are desperately flailing in an attempt to staveoff what happened in Greece and Cyprus. Theyshould read about King Canute’s attempt to holdback the tide.Two news items recently came from India. First,they increased the tax to import gold for the secondtime in 6 months (more echoes of King Canute).Second, the World Gold Council announced that itis talking to the Reserve Bank of India aboutpromoting gold as a financial asset.While it’s not yet clear what India may do, they aretalking about a topic that the whole world needs todiscuss. The gold standard is inevitable. When thedollar collapses, no new irredeemable paper currencywill be acceptable to most of the world. Gold will bethe only thing that works.
The Gold Standard The Gold Standard InstituteIssue #30 ● 15 June 2013 2Every leader in every country has a choice. They candeny the problem until their country collapses, orthey can take the initiative. The first country to dothat will gain a huge and enduring competitiveadvantage. Honest money makes savings and capital.Contrary to the stale mercantilist propagandabombarding us today, sound money, savings, andcapital is good for a country, its economy, and itspeople.Supporters of the Gold Standard Institute have anopportunity to think about how they might bringthis message to people and to government. We mayjust be able to avert collapse. Never forget thatunless the world changes trajectory, this will be ourdestination.Keith WeinerNewsGoldCore: France prohibits sending currency,“Coins And Precious Metals” by mail.≈≈≈The Blade: Jeep suspension kit offered for 1 goldcoin.≈≈≈Fox News: US pushing to stop all gold sales to Iran -still.≈≈≈Signs of the Times: If paper money is not availablethen gold and silver will be. For many reasons, noteveryone chooses to have their transactionsrecorded. Nothing will more effectively cause thereturn of gold and silver than a society where papermoney has been eliminated – either by collapse or bygovernment withdrawal.≈≈≈MineWeb: China demand drives Asian gold barpremiums to record highs.≈≈≈WSJ: India increases import tax on gold.International Man: US government gold paranoiabecoming more severe.≈≈≈Nehanda Radio: “The world needs to and will mostcertainly move to a gold standard and Zimbabwemust lead the way.” Gideon Gono – governor of theReserve Bank of Zimbabwe. Hmmm – reads verymuch like a paper standard to me.≈≈≈Business Standard: US working to block gold sales toIran to undermine rial.≈≈≈BBC: Sachin Tendulkar unveils gold coin engravedwith his face (for cricket buffs only).≈≈≈Odd Spot… (Yahoo): Venezuelan police seize 2500toilet rolls – who was it said that everyone lovesocialism until they run out of toilet paper?Gold is for the Rich… no?Is Gold, and a ‘Gold Standard’ really for the benefitof the rich, or is Gold and a Gold Standard actuallyof benefit to the average person? The short answeris; remember the Golden Rule… no, not the GoldenRule that says ‘Do onto others as you wish others doonto you’… but the other Golden Rule, the one thatsays ‘He Who Has the Gold Makes the Rules’.Today, the American G’man and his top banksterboast over 8,000 Tons of Gold in their vaults. TheGerman bankster has over 3,000 tons, the Italiannear 3,000 T… and on and on. The final numbersare a bit vague, but the world’s central banksterscollectively ‘own’… or hoard, or control or whateveryou want to call it… tens of thousands of tons ofGold.In the meantime, average people have almost noGold (the world population is estimated to hold lessthan ½ OZ per capita) and the total amount of Goldin (legal) circulation is zero. Guess who makes therules?
The Gold Standard The Gold Standard InstituteIssue #30 ● 15 June 2013 3One example of ‘making rules’ is setting the rate ofinterest. Mr. Bankster has decreed that he will set a‘ZIRP’ policy… that is, a Zero Interest RatePolicy… supposedly to ‘stimulate the economy’…and to bring about ‘full employment’. By theexpedient of buying bonds with newly created Fiatpaper, Mr. Bankster keeps the price of bondsartificially, fraudulently high… which is the same askeeping interest rates artificially, fraudulently low.Explaining exactly how and why high bond pricesequal low interest rates is beyond the scope of thisarticle. If you are interested, Google ‘bond equation’and you will see the answer for yourself.Getting on with it, the claim that ‘low interest ratesstimulate the economy’ is a Big Lie. Really? Let’s askour average persons, like our retired couples wholive off their life’s savings, does ZIRP benefit their‘economy’? With their hard earned cash bringing aminiscule income, far less than the ongoingdestruction of purchasing power, so called ‘inflation’,having to live off their rapidly disappearing capital…ZIRP is hardly of benefit to them, is it?How about our middle aged couples, saving to payfor their children’s education… does ZIRP helptheir economy? With their savings earning negativereal income, with their accumulated wealth beingrobbed by monetary depreciation… when pricesgrow far faster than whatever their savings earn…and their wages never even match the rate ofmonetary depreciation? Hardly. ZIRP is destroyingtheir ‘economy’ as well.But surely, the young graduate about to embark onhis career, who has borrowed a bunch of money topay for his education… surely HE must benefit?What? He says “no, man… I borrowed a bunch ofmoney for my schooling, and I can’t possibly pay theloan back. I am doomed to live as a debt slave…I can’t get a job in my field of studies the best I cando is flip hamburgers part time for a pittance. I amnot even allowed to declare bankruptcy… I amDoomed.”But didn’t Mr. Bankster tell us that he wasintroducing a ZIRP to ‘stimulate the economy’? Ifthis were true, if the economy were really‘stimulated’, how come our new grad can’t find ajob? If even he doesn’t benefit, then who does?Maybe a businessman? That is another claim by theG’man. That the ZIRP will stimulate businessinvestment, by making ‘money cheap’… and surelymore business investment will reduceunemployment? Just another Big Lie, I am afraid.I ran a business, manufacturing metal formingmachinery in Canada, for over thirty years… still runthe business in fact, but now the work is all beingdone in China… and the prevailing rate of interestnever had a noticeable effect on our business. Theonly thing that moved our business, either up ordown, was demand for our products.Demand depends on the financial health of ourcustomers, and of the economy. If ZIRPimpoverishes most people, it does not do anythingbut destroy the economy… and this destructiontakes most business with it. Believe me, I know…ZIRP took my business into bankruptcy!Does anyone benefit from ZIRP… fraudulently lowinterest rates? Come on, it’s obvious… big timedebtors benefit big time. Can you guess who is thebiggest ‘big time’ debtor of all? Why, surprisesurprise… it’s the G’man. Uncle Sam owes… wait, Iwill check usdebtclock.org… geez, hard to read, thenumbers keep flashing higher and higher… everysecond the G’man’s debt grows…but as I write this,the official US debt is over $16,800,000,000.Savor that number for a second or two; it is beyondastronomical… 16 trillion, 800 billion Dollars. Mindnumbing. No human mind can imagine even atrillion, never mind multiple trillions… but there itis. The truth is out; Uncle Sam can’t afford higherinterest rates, so he tells his bedfellow bankster topush interest rates down… regardless of theeconomic destruction this causes. This is the truereason behind ZIRP… ignore the Big Lie… and justfollow the money; Cui Bono… to whose benefit…The G’man is the big beneficiary of ZIRP.Thus dies the Fiat world economy… but a GoldStandard economy goes in exactly the otherdirection; not towards death, but towards prosperity.Remember the Golden Rule; he who has the Goldmakes the Rules…
The Gold Standard The Gold Standard InstituteIssue #30 ● 15 June 2013 4During the nineteenth century, the heyday of theClassical Gold Standard… and of the BritishEmpire… England ruled nearly 85 percent of the‘civilized’ world… and the Bank of England ran thewhole show under the graces of Gold. Care to guesshow much Gold the Bank of England had in itsvaults during the nineteenth century? During the‘peacable days’? It was not the 8,000 Tons that UncleSam has… not the 3,000 Tons that Germany has…no, it was an incredibly tiny 150 to 250 Tons…This number is in the public records of the Bank ofEngland… if you doubt me, check it your self. Thecommerce of practically the whole world was wellconducted on the basis of a few hundred Tons ofgold. Where was the rest of the Gold? Where werethe thousands of Tons that were in existence? Why,in the hands of average people; Gold was incirculation as money. Guess Who Made the Rules?It was every man who made the rules, not a handfulof banksters and G’men. But how… how couldhundreds of millions of men, nay billions of menmake any rules? The answer is laughably simple,once you see the truth. The rule for setting interestrates works like this;When I earn money, there are only three things I cando with it; spend it, hoard it, or put it to work toearn more money… somehow. There is no otherpossibility… if you concede that giving money awayas a gift is spending. Some spending is mandatory…as I need to buy food, fuel, shelter, clothing… theessentials. Hoarding and ‘saving’ are optional.Hoarding has some less unpleasant connotations; weare constantly being told that hoarding is somehowwrong, anti-social, ‘primitive’… like a Gold standardis called ‘primitive’… but even squirrels have enoughbrains to hoard, saving food in balmy summer daysto last them through the tough winter days to come.Are humans as smart as squirrels?As far as putting money to work, only entrepreneursand businessmen truly put their money to work.Average, ordinary people are far too busy earning aliving to go into business for themselves. Instead,they look for ‘yield’ with ‘safety’.This is impossible under Fiat paper… as we alreadysaw. There are no real returns possible without all-out gambling, er speculation. Under Gold, the storyis very different. After all, simply hoarding Gold isprofitable. The purchasing power of a Gold hoardincreases as prices decline. Any earnings fromlending money at interest are a bonus.I would not lend my Gold money, unless I wasabsolutely certain of getting it back, and was offeredsufficient interest income. If you get Gold money,would you not think the same way? Spend some,hoard some, but only lend some if the interest beingoffered was sufficient to make it worth your while?I believe you think the same way, although what youconsider ‘worth your while’ may not be the same aswhat I consider ‘worth my while’. Nevertheless, thisis the crux of the matter; this is where the rubbermeets the road.If hundreds of millions of people think the sameway… that is, choose NOT to lend their moneyunless they believe it ‘worth their while’… thenanyone who wants to borrow must offer moreinterest. The ones who hold the Gold make therules. Borrowers must follow the rules set by theGold holders, or they luck out.With paper this does not work; the ‘powers that be’will simply print up more paper, and force ratesdown… regardless of what I, or what you, or what ahundred million others wish for.This is why only a true Gold Coin standard canwork; actual Gold must be in circulation, in thehands of all… else the teeth are not there. Nomonetary system with Gold ‘backed’ (paper) moneycan ever work. If fraudulent paper is in circulation,and if fraudulent paper is accepted as money, morefraudulent paper will be printed… regardless ofpromises of ‘backing’ Indeed, Mr. Bankster mayopen the door to his vault, show us the Gold sittingthere ‘backing’ our paper… and then print as muchpaper as he wishes… but he cannot print Gold.Rudy J. FritschEditor in Chief
The Gold Standard The Gold Standard InstituteIssue #30 ● 15 June 2013 5Freegold: An AnalysisWikipedia describes freegold as “a monetaryenvironment where gold is set free, and has no function asmoney. Gold is demonetized, and has one function only: astore of value. The function of legal tender changes onlyslightly: it is a medium of exchange and unit of account, butstripped of the store of value function. In this environment,currency and freegold will coexist to supplement each other,without interacting with each other.” (Link accessed May12, 2013).One of the several functions of money is a store ofvalue. Thus, under freegold, gold contains at leastone monetary function. Many other commoditiesalso store value. Later the article describes gold beingused as a medium of exchange, another function ofmoney, under freegold. Although the article claimsthat freegold frees gold from its monetary functions,freegold as described in the article seems to fail toachieve this goal.Today’s legal tender, which continues to be legaltender under freegold, is credit money, i.e., paper fiatdebt money and its electronic equivalent. Suchmoney can be and is used as a medium of exchangeand a unit of accounts. However, it makes a poorunit of accounts because it makes long-rangeplanning extremely difficult. Because fiat moneycontinues to lose value, i.e., purchasing power, at avarying rate, long-term planning becomes almostimpossible. Money needs to able to store value, i.e.,retain purchasing power over time, to make long-term planning practicably. Moreover, under thecurrent fiat monetary system, interest rates are highlyvariable. Such variability in interest rates greatlyhinders long-range planning. Under the goldstandard, interest rates are stable and the value ofmoney varies little over the long-term; therefore,long-range planning is feasible.The article lists several implications of freegold.Eight of them follow. The reviewer’s comments arein parentheses and italics.1. Savings accounts at banks would decline. Peoplewould convert their excess money into gold insteadof depositing it into savings accounts. (People can dothis today under the current system. However, in manyjurisdictions the current system penalizes them with sales taxesif they convert their legal tender money to gold and with capitalgains or income taxes if they convert their gold to legal tendermoney.) A reduction in savings could affect thebanking system and fractional-reserve banking.2. Interest rates would reflect expected futurepurchasing power of the currency. (Why the governmentand its central bank would not try to keep interest ratesartificially low as they do now is unclear. As governments andbanks are the largest borrowers, governments and their centralbanks have an incentive to keep interest rate low. Low interestrates reduce their cost of borrowing.)3. Monetary policy would no longer affect the poolof savings. (To the extent people save in the form of gold,that may be true. However, converting gold into legal tendermoney is often a taxable event and thus a loss to the saver.Moreover, people who save with gold do not appear to earn anyinterest under freegold on their gold savings. The article doesadmit that people who keep their savings in the form of thelegal tender money risk losing purchasing power. However, thearticle seems to blame the loss more on freegold than on thenatural deterioration of fiat money.)4. Freegold would remove the need for countries todevalue their currency to make exports cheaper.(Most countries still adhere to the mercantile idea that exportsare good and imports are bad. Consequently, most will stillseek to gain an export advantage by destroying their currency.The only solution that the article provides for changing thismind-set is that gold would flow into countries with strongcurrencies and from countries with weak currencies. Thissolution works only if the political power of owners of goldexceeds that of the export industry.)5. Countries could choose to be paid in currency orgold. (Is this not using gold as money, a medium of exchange?Freegold is supposed to eliminate all monetary functions of goldexcept as a store of value. Here it can be used as a medium ofexchange.)6. Freegold would shift power from those whocontrol the money, where it is today, to the workers,and the owners of capital (gold) and naturalresources. (The unadulterated gold standard does the samething.)7. Freegold would slow the expansion of today’sdebt-based money because money would be used
The Gold Standard The Gold Standard InstituteIssue #30 ● 15 June 2013 6only for short -term transactions. (If long-term loanscease under freegold, financial institutions will no longer makeloans for real estate as most of those loans range from 10 to30 years. Freegold appears to devastate the real estate,construction, and related industries. As these industries arepolitically much more powerful than gold owners will ever be,freegold is dead before it starts. Moreover, what central bankis going to refuse to buy 30-year bonds of the government thatcreated it and can abolish it? If freegold really does eliminatelong-term transactions with the legal tender money, then goldwill reenter the monetary system through the backdoor of long-term loans and thus end freegold as gold again becomes part ofthe monetary environment.)8. Freegold would better support Islamic bankingand Islamic countries that want to return to a goldstandard. (This seems to contradict the concept of freegold,which seeks to liberate gold from all monetary functions beyondserving as a store of value.)The article correctly claims that governments have tosuppress the price of gold to mask the U.S. dollar’sdecline in value. Also, the article claims that freegoldremoves the need for governments to suppress theprice of gold. Why would governments stop trying toconceal the loss of purchasing power of theircurrencies under freegold? They have as muchincentive to hide the poor quality of their currencyunder freegold as they do under the current system— perhaps even more.Freegold does end valuing gold held by thegovernment and its central bank at some fictitiouslow price as is done in the United States. Under thecurrent monetary system, maintaining such fiction isabsurd.Does freegold require governments and centralbanks to sell their hoards of gold? Apparently itwould. With its discussion of the euro and theEuropean Central Bank, the article implies that theydo not. Although their notes are inconvertible,central banks use gold as part of the backing fortheir notes. If gold is to be set free from themonetary environment, then central banks have tosell all their gold. Moreover, at least in the UnitedStates where the central bank’s notes are obligationsof the U.S. government, the government needs tosell all its gold to free gold from the monetaryenvironment.For freegold to work, governments would have toend all sales taxes, value added taxes, capital gainstaxes, and other taxes on gold and converting legaltender currency into gold (buying gold) and gold intolegal tender currency (selling gold). Thus, the taxsystem has to treat gold differently from othercommodities. In essence it has to treat gold asthough it is part of the monetary system.With one exception, the unadulterated gold standardaccompanied by the real bills doctrine does asuperior job of achieving the goals of freegold thandoes freegold itself. The one exception is thatfreegold allows governments and their central banksto continue to manipulate the monetary system.Freegold seems to depoliticize gold more thandemonetize it. Depoliticization of gold is a step inthe right direction. Freegold should be considerednot as an end in itself, but as a step towardestablishing the unadulterated gold standardaccompanied by the real bills doctrine.Thomas AllenAre Covert Operations Underway inthe Global Currency WarsNote: this article is adapted from Vol 4 (May 2013) of theAmphora Report investment newsletter. Anyone interested insubscribing to the AR should email the author firstname.lastname@example.orgIn an age of economic policy activism, including widespreadquantitative easing and associated purchases of bonds andother assets, it is perhaps easy to forget that foreign exchangeintervention has always been and remains an importanteconomic policy tool. Recently, for example, Japan,Switzerland and New Zealand have openly intervened toweaken their currencies and several other countries haveexpressed a desire for some degree of currency weakness. In thisreport, I consider the goals and methods of foreign exchangeintervention and place today’s policies in their historicalcontext. Also, I examine the evidence of where covertintervention—quite common historically—might possibly betaking place: Perhaps where you would least expect it.Another Tool in the ToolkitOver two decades ago, when I was a graduatestudent of international economics in the US, I had
The Gold Standard The Gold Standard InstituteIssue #30 ● 15 June 2013 7the good fortune to take a course in internationaleconomic policy from a former US Treasury officialwho had worked in the International Affairs divisionduring the 1980s.Some readers might recall that the 1980s were thedecade of the Plaza and Louvre Accords, so namedafter their respective locations, as the Bretton-Woods arrangements had also so been. This formerofficial had thus been involved in negotiating thesehistoric currency agreements to first weaken andthen support the US dollar, respectively. Oneevening in 1991, while preparing for our final examin his course, some fellow students and I hosted himfor dinner.Although the primary goal of the wine-laden dinnerwas to try and glean from our esteemed guest cluesas to the questions on the exam, once we collectivelyrelented in that unsuccessful effort, the discussionturned to his experiences at the New York Plazahotel in 1985 and subsequently at the Paris Louvre in1987. This became one of the more eye-openingconversations of my life as a student and practitionerof international finance. What follows is my besteffort to recall and to paraphrase:As the conversation turned toward the professor’s experiencesat Treasury, one student asked, “How did the Plaza andLouvre interventions take place? Is there an optimal way inwhich countries can intervene in the FX markets?”“Well it is certainly optimal from the policymakers’ perspectiveif countries on both sides of an exchange rate can agree tocooperate,” the professor answered. “This was the case withboth Plaza and Louvre, at least initially. With both sidespublicly cooperating, and executing their intervention incoordinated fashion, it is the rare, brave, one might sayfoolhardly speculator who will dare to take the other side.“More difficult is when a country intervenes unilaterally,especially if they are trying to defend their currency fromspeculative attack. That is ultimately futile, although if youhave some accumulated FX reserves and are clever how you goabout it you can nevertheless accomplish quite a bit.”“But reserves are limited, are they not? Once markets sensethat a country is running out of ammo, don’t they becomeemboldened to attack more aggressively, forcing the issue?” thestudent pressed.“Oh of course there is a limit. We have seen this countlesstimes throughout history. Reserves dwindle, the attackintensifies and all of a sudden in some midnight meeting thegovernment in question gives up and just devalues, either all inone go or in a handful of stages. In my view, once youdetermine the dam is breaking it is best just to let it break,face the consequences and move on. But that is just my opinionand I suppose if I were facing such pressures myself I don’treally know exactly how I would act.“But I will tell you this: If you are going to intervene from aposition of weakness, you had better do everything in yourpower to burn the speculators. That is what buys you time andthat’s precisely what you need to defend against the attack:time. When you go into the market, you go in big. You go inwhen liquidity is low. You go in when people don’t expect it.And the moment they come back to attack anew, you go ineven bigger. You force the price hard over a short time,ensuring that distinctive chart patterns emerge and on highvolume. Speculators will read those charts, assume the trendhas reversed, and you will win some of them over to your side,at least for a period of time. That is the way to do it.”“But if the speculators know that is the game plan, will theytake the charts seriously?” asked another. “Won’t they seethat it is all artificial price action, not indicative of anythingother than a desperate government exhausting its scarcereserves?”“Well, you must…” The professor paused for a moment. Youcould tell he wanted to say something but was unsure how bestto say it. Then he continued: “As a good poker player, youmust be careful to play your cards close to the vest. Don’t showthe speculators your hand if you can help it. In fact, considerkeeping the intervention secret if you can. Some might figureout what is going on but many won’t and they will just assumethat the trend is reversing due to natural market causes. Ithelps if you have friends at the major dealers who owe you afavour or two or at a minimum understand and support thereasons behind the policy.”“Are you saying that covert intervention occurs frequently?”asked another student in astonishment.“I have no privileged information to that effect. Certainly whenI was at Treasury we did no such thing. But then we had noreason to because we had our allies on side and we desired toshow our intentions to the markets to get them to do our workfor us. But I suspect other countries in a more difficult positionhave operated in this covert way on occasion and perhaps the
The Gold Standard The Gold Standard InstituteIssue #30 ● 15 June 2013 8US has done so as well in the past, for example to manage themarkets as Bretton-Woods was breaking down. I can onlyspeculate.I forget the remaining details of that evening, otherthan a humorous discussion of some of theprofessor’s misadventures when he was a youngForeign Service officer posted to various countries inthe 1970s. He certainly did have a good sense ofhumour and he was also remarkably forthcoming inhis discussion of US international economic policy.Recall that this conversation took place in 1991, theyear prior to the 1992 European Exchange RateMechanism (ERM) crises that rocked the foreignexchange world and threatened the process ofEuropean integration, by then already longunderway. Another, less-severe ERM crisis would hitin 1995. A rash of Asian currency crises arrived in1997, followed by a near-collapse of the Russianrouble in 1998, precipitating a US financial crisis viathe now-notorious hedge fund Long-Term CapitalManagement (LTCM). In all cases, policymakerswere active in trying to prevent, manage and clean upafter the respective crises. In some cases their actionswere out in the open; in others, less so. In stillothers, their specific actions and interventionsbehind the scenes probably remain secret to this day.A Curious Paper on Covert InterventionBack in 2001, some prominent economists wrote apaper, published in the American EconomicAssociation’s prestigious Journal of EconomicLiterature, titled “Official Intervention in theForeign Exchange Market.” In this paper, theauthors discuss the efficacy of foreign exchangeintervention and, perhaps surprisingly, they include abrief section on covert intervention specifically, ofwhich the following is an excerpt:Most actual intervention operations in theforeign exchange market have been—and stillare—largely secret, not publicly announced bymonetary authorities…The traditional relevant literature identifies three types ofarguments in favor of secrecy of official intervention: argumentsbased on the central bank’s desire to minimize the effects of anunwanted intervention operation (for example because thedecision has been taken outside the central bank, e.g. by theTreasury), arguments based on the perceived risk and volatilityin the foreign exchange market which might be exacerbated byan announcement of official intervention, and portfolioadjustment arguments. A further explanation may be thatalthough monetary authorities intervene in orderto target the value of a foreign currency, sincethe fundamentals of the foreign currency are notnecessarily equal to this objective, the monetaryauthorities do not have an incentive to revealtheir intervention operations as noannouncement on their activities will be credible… [S]ecrecy of intervention may be an attemptto affect the exchange rate … without triggeringa self-fulfilling attack on the currency. (Emphasisadded.)1Now it is not exactly common for publishedacademic journals to contain a discussion of covertactivities. How did the authors conduct theirresearch? Who were their sources? Why did theeditors allow such opaque, unsubstantiated materialto be published without appropriate verification?Small clues are provided in the authors’ respectivebackgrounds and also in the articleacknowledgements: Both authors studied at theUniversity of Warwick in Britain. At time of writing,one worked at the US Federal Reserve and one forthe World Bank in Washington DC. Theacknowledgements thank a number of prominentfellow academics for their assistance but alsomention three anonymous referees.It is therefore not much of a stretch to surmise thatsitting economic policymakers, perhaps on bothsides of the Atlantic, provided the source materialfor the section on covert FX intervention discussedabove. As for exactly who they might have been, theshort list would certainly include those officialsworking at the time at the US Treasury’sInternational Affairs Division or at the US FederalReserve on the one side; and at one or moreEuropean finance ministries or central banks on theother.1 Sarno, Lucio and Taylor, Mark P., “Official Intervention in theForeign Exchange Market,” Journal of Economic Literature vol.39 (September 2001). The link is here.
The Gold Standard The Gold Standard InstituteIssue #30 ● 15 June 2013 9Foreign Exchange Intervention and the GlobalFinancial CrisisReturning now to our discussion of the history offoreign exchange intervention, as it happened, theEuropeans managed to hold integration togetherthrough the 1990s. In 1999, against the expectationsof many, the euro currency was launched and theleaders of the time hoped that, stronger togetherthan apart, European financial crises would becomea thing of the past.Of course we now know that financial crises are nota thing of the past but the present, and not only inEurope. All major developed economies have beenembroiled in protracted financial crises since 2008.Yes, there have been tentative signs of a recovery attimes, including recently, and stock markets in theUS, Europe and Japan have all risen dramatically oflate. The fact remains, however, that policymakersare holding interest rates on the floor while runninghuge fiscal deficits in a blatant, neo-Keynesian effortto stimulate aggregate demand in the hope that thiswill lead to an economic normalisation in time.Well good luck with that. Readers of this report willknow that I don’t believe that financial marketmanipulation of interest rates, currencies, stockmarkets, commodities or anything else for thatmatter diminishes the need for natural economicdeleveraging following a boom-bust cycle. Indeed,manipulations are ultimately counterproductive asthey misallocate resources. This misallocation maygo unseen for a sustained period but, as FredericBastiat explained so eloquently in the 19th century,that doesn’t make it any less real or harmful.As one tool among many, foreign exchangeintervention has continued to be publicly andactively used as a policy tool, most recently in Japan,China, Brazil, Switzerland, New Zealand and ahandful of other countries. In all of these cases,however, it has been used to prevent or limitcurrency strength rather than to defend againstweakness.Based on the academic paper cited above, theauthorities in these countries have had no need toemploy covert intervention tactics as they have notsought to disguise eroding currency credibility andhave been seeking to weaken rather than strengthentheir currencies, accumulating rather than depletingtheir foreign reserves in the process.However, as all major economies seem to prefercurrency weakness to strength at present, the worldappears to be in the midst of a so-called ‘currencywar’. The term ‘war’ implies that countries are failingto cooperate with one another. This in turn suggeststhat there might indeed be a role for covertoperations of some sort at present to weakencurrencies without other countries noticing.Let’s consider the evidence. As the professorexplained in his comments, covert, non-coordinatedinterventions would probably leave a ‘footprint’, thatis, they would take place at times of low marketliquidity and tend to continue until an importantchart pattern has emerged that encouragesspeculators to reverse the previous market trend,thereby initiating a new one in line with theintervention’s objectives.Looking around various FX rates, there is someevidence that covert intervention has been takingplace in Asia. Occasional, sharp overnight moves onunusually high volume have taken place in theKorean won, Taiwan dollar, Indonesian rupiah,Malaysian ringitt and Vietnamese dong. This is ofcourse only circumstantial evidence but it would beodd were profit-maximising economic agents tobehave in this way. Given that the authorities inquestion have the means and quite possibly themotive, and the price action is suggestive, it isentirely reasonable to surmise that some covertintervention has been taking place in the region.The Future of Covert FX InterventionIf the currency wars continue to escalate as they haveof late, it seems reasonable to expect that covertinterventions will grow in size, scope and frequency.As it is impossible for all countries to devalue againstall others, however, this just raises the stakes in whatis, at best, a zero-sum game. At worst, as countriesbegin to accuse one another of covert currencymanipulation, the currency wars will morph intodamaging trade wars with tariffs, taxes, quotas,regulations and all manner of restrictive trade
The Gold Standard The Gold Standard InstituteIssue #30 ● 15 June 2013 10practices that, collectively, could slam the brakes onwhat little global economic momentum remains.There is one country in particular, however, that hasa particularly keen interest in avoiding this: theUnited States. As the issuer of the world’s reservecurrency and the world’s largest foreign-held publicdebt, the US wants to ensure that foreignerscontinue to absorb dollars as reserves. If theirpreferences were to change in favour of other assets,this would place upward pressure on US interestrates, greatly complicating the Fed’s efforts tostimulate domestic growth and reduceunemployment.Worse, if an outright trade war breaks out, the USwill quickly become mired in a severe stagflation, theresult of higher import costs, strangled global trade,far fewer dollars being absorbed abroad andassociated upward pressure on dollar interest rates.The US would have to make some tough choices.Many argue that, absent a trade war, foreigners’appetite for dollar assets will not diminish. Historysuggests otherwise. Central banks actively diversifiedreserves out of dollars in the 1970s, following the USdecision in 1971 to renege on the Bretton-Woodspromise to redeem foreign official dollar holdings ingold. By the early 1980s, the dollar share of reserveshad fallen dramatically as other currencies and goldtook a growing share.The same has happened in recent years and at anaccelerating rate. Central bank gold purchases rose toa post-Bretton-Woods record last year and arecontinuing at a rapid clip so far in 2013. Privateinvestors also continue to diversify out of dollars.The US Federal Reserve has been absorbing roughlyhalf of all new US Treasury bond issuance, whichhas held interest rates artificially low. Wereforeigners to dramatically accelerate theirdiversification out of dollars and into othercurrencies and gold, the US would face a dilemma:Allow interest rates to rise to stabilise the dollar,triggering a recession and a huge deterioration ingovernment finances; or continue to suppressinterest rates but watch the dollar fall sharply,triggering far higher inflation and general economicand possibly also political instability.2There is a third option, however. The US could tryto have its cake and eat it too. It could continue tosuppress interest rates through QE but it could alsocovertly intervene to support the dollar in theforeign exchange markets. To do so publicly wouldbe a short-lived, probably disastrous exercise as theUS possesses little in the way of foreign currencyreserves. Speculators would almost certainly see thisas a historic opportunity to force through a majordevaluation, reaping potentially huge profits in theprocess. Thus I consider this highly unlikely.But consider: the US may have little in the way ofFX reserves but it has a huge pile of gold reserves—the world’s largest in fact. If the US were to setabout covertly intervening to support the dollar amidartificially low interest rates, therefore, it would makefar more sense to do through covert intervention inthe gold market. Should they follow my formerprofessor’s advice, they would sell gold into themarket at relatively illiquid times for maximum priceeffect. They would do so repeatedly until certaintechnical chart patterns turned in favour of the dollarand against gold, establishing a new trend. And ifthey succeeded, no one need ever know.So do I think they will try it? Perhaps. Desperatepolicymakers sometimes do desperate things. Andhistory is sometimes stranger than fiction.John ButlerJohn Butler has 19 years experience in the global financial industry, havingworked for European and US investment banks in London, New Yorkand Germany. Prior to founding Amphora Capital he was ManagingDirector and Head of the Index Strategies Group at Deutsche Bank inLondon, where he was responsible for the development and marketing ofproprietary, quantitative strategies. Prior to joining DB in 2007, John wasManaging Director and Head of Interest Rate Strategy at Lehman Brothersin London, where he and his team were voted #1 in the InstitutionalInvestor research survey. He is the author of The Golden Revolution (JohnWiley and Sons, 2012), a regular contributor to various financialpublications and websites and also an occasional speaker at majorinvestment conferences.2 I wrote about this policy dilemma in much more detail back in2011. Please see IT’S THE END OF THE DOLLAR AS WEKNOW IT (DO WE FEEL FINE?), Amphora Report vol. 2(April 2011). Link here.
The Gold Standard The Gold Standard InstituteIssue #30 ● 15 June 2013 11Theory of Interest and Prices in PaperCurrency Part III (Credit)In Part I, we looked at the concepts of nonlinearity,dynamics, multivariate, state, and contiguity. Weshowed that whatever the relationship may bebetween prices and the money supply inirredeemable paper currency, it is not a simple matterof rising money supply rising prices.In Part II, we discussed the mechanics of theformation of the bid price and ask price, theconcepts of stocks and flows, and the centralconcept of arbitrage. We showed how arbitrage isthe key to the money supply in the gold standard;miners add to the aboveground stocks of gold whenthe cost of producing an ounce of gold is less thanthe value of one ounce.In this third part, we look at how credit comes intoexistence (via arbitrage, of course) with legitimateentrepreneur borrowers. We also look at thecounterfeit credit of the central banks (which is notarbitrage). We introduce the concept of speculation inmarkets for government promises, compared tolegitimate trading of commodities. We also discussthe prerequisite concepts. Marginal time preference andmarginal productivity are absolutely essential to thetheory of interest and prices. That leads to the lastnew concept resonance.In the gold standard, credit comes into existencewhen one party lends and another borrows. Thelender is a saver who prefers earning interest tohoarding his gold. The borrower is an arbitrager whosees an opportunity to earn a net profit greater thanthe rate of interest.As with all markets, there is a bid and an offer (alsocalled the “ask”) in the bond market. The bid andthe offer are placed by the saver and theentrepreneur, respectively. The saver prefers a higherrate of interest, which means a lower bond price(price and interest rate vary inversely). Theentrepreneur prefers a lower rate and a higher bondprice.Increased savings tends to cause the interest rate tofall, whereas increased entrepreneurial activity tendsto cause a rise. These are not symmetrical, however.If savings fall, then the interest rate must go up. Themechanism that denies credit to the marginalentrepreneur is the lower bond price. But, if savingsrise, interest does not necessarily go down much.Entrepreneurs can issue more bonds. Savings isalways finite, but the potential supply of bonds isunlimited.What is the bond seller—the entrepreneur—doingwith the money raised by selling the bond? He isbuying real estate, buildings, plant, equipment,trucks, etc. He is producing something that will makea profit that, net of all costs, is greater than theinterest he must pay. He is doing arbitrage betweenthe rate of interest and the rate of profit.It may seem an odd way to think of it, but considerthe entrepreneur to be long the interest rate andshort the profit rate. Looking from this perspectivewill help illustrate the principle that arbitrage alwayshas the effect of compressing the spread. Thearbitrager lifts the offer on his long leg and pressesthe bid on his short leg. The entrepreneur iselevating the rate of interest and depressing the rateof profit.Now let’s move our focus to the Fed and itsirredeemable dollar. The Fed exists to enable thegovernment and favored cronies to borrow more, atlower interest, and without responsibility toextinguish their debts.People often use the shorthand of saying that theFed “prints” dollars. It is more accurate to say that itborrows them into existence, though there is no(knowing) lender. The Fed has the sole discretion tocreate these dollars ex nihilo, unlike a normal bankthat must persuade a saver to deposit them. By thisreason alone, the Fed’s credit is counterfeit. The verypurpose of the Fed is to cause inflation, which Idefine as an expansion of counterfeit credit3.These borrowed dollars are the Fed’s liability. It usesthem to buy assets such as bonds or to otherwiselend. Those bonds or loans are its assets. While theFed can create its own funding, its own liabilities, itstill must heed its balance sheet. If the value of its3 http://keithweinereconomics.com/2012/01/06/inflation-an-expansion-of-counterfeit-credit/
The Gold Standard The Gold Standard InstituteIssue #30 ● 15 June 2013 12assets ever falls too far, the market will not accept itsliability. Gold owners will refuse to bid on the dollar.Through a process of arbitrage (of course), the dollarwill collapse.4What does the government get from this game? Itdiverts resources away from value-creating activitiesinto the government’s welfare programs, graft,regulatory agencies, and vast bureaucracy. Bysuppressing interest rates and enabling debts to beperpetually rolled, the Fed enables the governmentto consume much more than it could in a freemarket. Politicians are enabled to buy votes withoutraising taxes.Earlier, I said there is no knowing lender. Let’s lookat this mysterious unknowing lender. He isindustrious and frugal, consuming less than heproduces, keeping the difference as savings. He feedsthis savings, the product of his hard work, into thegovernment’s hungry maw. Unfortunately, the credithe extends is irredeemable. The paper promise heaccepts has a warning written in fine print: it willnever be honored. The lender is a self-sacrificialchump. Who is he?He is anyone who has demand for dollars.He is the trader who thinks that gold is “going up”(in terms of dollars). He is the businessman whouses the dollar as the unit of account on his incomestatement. He is the investor who measures his gainsor losses in dollars. He is every enabler who does notdistinguish between the dollar and money.People don’t think of their savings in this light, thatthey are freely offering it to the government toconsume. They don’t understand that savings isimpossible using counterfeit credit.Now we have covered the counterfeit credit of theFed, let’s move on to cover another prerequisitetopic: speculation. With arbitrage, I offered in Part II amuch broader definition than the one commonlyused. With speculation, I will now present a narrowerconcept than the usual definition. Let’s build up to itby looking at some examples.4 http://keithweinereconomics.com/2012/03/15/when-gold-backwardation-becomes-permanent/The first example is the case of agriculturalcommodities, such as wheat. Production is subject tounpredictable conditions imposed by nature, likeweather. If early rain reduces the wheat yield by 5%,then there could be a shortage. Think of thedislocations that would occur if the price of wheatremained low. Inventories from the prior crop wouldbe consumed too rapidly at the old price. Then,when the reduced new crop was harvested, it wouldbe too late for a small reduction in consumption.Grain consumers would suffer undue hardship.Futures traders perform a valuable economicfunction. Their profit comes from helping to driveprices up (in this example) as soon as possible, andthus discourage consumption, encourage moreproduction, and attract wheat to be shipped in fromunaffected regions. Good traders study andanticipate nature-made risks to valuable goods andearn their profits by providing price signals toproducers and consumers.Trading commodities futures is a legitimate activitythat helps people coordinate their activities. If suchtraders were removed, the result would be reducedcoordination (i.e. waste). Therefore my definition ofspeculation excludes commodities traders.There are two elephants in the room of theirredeemable currency regime: interest and foreignexchange rates. It is the profiteer in these games whoearns the dubious label of speculator.The price of each currency is constantly changing interms of all others. To any business that operatesacross borders, this creates unbearable risk. They areforced to hedge. The banks that provide suchhedging products must, themselves, hedge. Oneresult is volatile currency markets.The rate of interest presents the other big man-maderisk. Unlike in gold, interest in irredeemable paper isalways changing and is often quite volatile. Forexample, the interest rate on the 10-year Treasurybond has gone from 1.63% to 2.16% just during themonth of May. As with currencies, there is a bigneed to hedge this risk, and hence, a massivederivatives market.
The Gold Standard The Gold Standard InstituteIssue #30 ● 15 June 2013 13Naturally, volatility attracts traders, in this case thespeculators. Their gains are not profits fromanticipating natural risks to the production of realcommodities. They are not skilled in responding tonature. They are front-runners of the artificial riskscreated by the next move of the government orcentral bank. Worse still, they seek to influence thegovernment and central bank to act favorably totheir interests.Unlike the trader in commodities, the speculator inman-made irredeemable promises is a parasite. Thisis not a judgment of any particular speculator, butrather an indictment of the entire dollar regime. Itimposes risks, losses, and costs on productivebusinesses, while transferring enormous gains tospeculators.It is no coincidence that the financial sector (and thederivatives market) has grown as the productivesector has been shrinking. A good analogy is to call ita cancer that consumes the economic body, byfeeding on its capital. A free market does not offergains to those who add no value, much less toparasites who consume value and destroy wealth.The rise of the speculator is due entirely to theperverse incentives created by coercive governmentinterference.5In light of the context we’ve established, we are nowready to start looking at interest rates. In the goldstandard, the mechanism is fairly simple as I wrote in“The Unadulterated Gold Standard Part III(Features)”:This trade-off between hoarding the gold coin anddepositing it in the bank sets the floor under the rateof interest. Every depositor has his threshold. If therate falls (or credit risk rises) sufficiently, andenough depositors at the margin withdraw their gold,5 See my dissertation for an extensive discussion of governmentinterference: A Free Market for Goods, Services, and Moneythen the banking system is deprived of deposits,which drives down the price of the bond which forcesthe rate of interest up. This is one half of themechanism that acts to keep the rate of intereststable.The ceiling above the interest rate is set by themarginal business. No business can borrow at arate higher than its rate of profit. If the rate ticksabove this, the marginal business is the first to buyback its outstanding bonds and sell capital stock (orat least not sell a bond to expand). Ultimately, themarginal businessman may liquidate and put hismoney into the bonds of a more productiveenterprise.6To state this in more abstract and precise terms, therate of interest in the gold standard is always in anarrow range between marginal time preference andmarginal productivity.7The phenomena of time preference and productivitydo not go away when there are legal tender laws. Thegovernment attempts to disenfranchise savers, toremove their influence over the rate of interest andtheir power to contract banking system credit.In the gold standard, when one redeems a bankdeposit or sells a bond, one takes home gold coins.This pushes up the rate of interest and forces acontraction of banking system credit. The reason todo this is because one does not like the rate ofinterest, or one is uncomfortable with the risk. Itgoes almost without saying that holding one’ssavings in gold coins is preferable to lending withinsufficient interest or excessive risk.6 The Unadulterated Gold Standard Part III (Features)7 Interested readers are referred to the subsite on ProfessorAntal Fekete’s website where he presents his theory of interestand capital markets.Marginal ProductivityInterest RateMarginal Time Preference
The Gold Standard The Gold Standard InstituteIssue #30 ● 15 June 2013 14By contrast, in irredeemable currency, there is no realchoice. A dollar bill is a zero yield credit. If one isforced to take the credit risk, then one might as wellget some interest. Unlike gold, there is little reason tohoard dollar bills.The central planners may impose their will on themarket; it is within their power to distort the bondmarket. But they cannot repeal the law of gravity,increase the speed of light, or alter the nature ofman. The laws of economics operate even under badlegislative law. There are horrible consequences topushing the rate of interest below the marginal timepreference, which we will study later in this series. Thesaver is not entirely disenfranchised. He can’t avoidharm, but his attempt to protect himself sets quite adynamic in motion.It should also be mentioned that speculators affect andare affected by the market for government credit.Their behavior is not random, nor scattered.Speculators often act as a herd, not being driven byarbitrage but by government policy. They anticipateand respond to volatility. They can often race fromone side of a trade to the other, en masse. This is agood segue to our final prerequisite concept.The linear Quantity Theory of Money tempts us tothink that when the Fed pumps more dollars into theeconomy, this must cause prices to rise. If there werean analogous linear theory of airplane flight, it wouldpredict that pulling back on the yoke under anycircumstance would cause the plane to climb. Goodpilots know that if the plane is descending in a spiral,pulling back will tighten the spiral. Many aninexperienced pilot has crashed from making thiserror.The Fed adds another confounding factor: itspumping is not steady but pulsed. Both in the short-and the long-term, their dollar creation is not steadyand smooth. Short term, they buy bonds on somedays but not others. Long term, they sometimespause to assess the results; they know there are leadsand lags. They also provide verbal and non-verbalsignals to attempt to influence the markets.In a mechanical or electrical system, a periodic inputof energy can cause oscillation. Antal Fekete firstproposed that oscillation occurs in the monetarysystem. Here, he compares it to the collapse of aninfamous bridge:It is hyperdeflation [currently]. The Fed isdesperately trying to fight it, but all is in vain. Weare on a roller-coaster ride plunging the world intozero-velocity of money and into barter. In my lecturesat the New Austrian School of Economics I oftenpoint out the similarity with the collapse of theTacoma Bridge in 1941.8I will end with a few questions. What happens if thecentral bank pushes the rate of interest below themarginal time preference? Could this set in motion anon-linear oscillation? If so, will this oscillation bedamped via negative feedback akin to friction? Orwill periodic inputs of credit inject positive feedbackinto the system, causing resonance?In Part IV, we will answer these questions and, at last, divein to the theory of prices and interest rates.Dr. Keith WeinerDr. Keith Weiner is the president of the Gold Standard Institute USA,and CEO of Monetary Metals where he write on the basis and relatedtopics. Keith is a leading authority in the areas of gold, money, and creditand has made important contributions to the development of tradingtechniques founded upon the analysis of bid-ask spreads. Keith is a soughtafter speaker and regularly writes on economics. He is an Objectivist, andhas his PhD from the New Austrian School of Economics. He lives withhis wife near Phoenix, Arizona.8 Antal Fekete: Gold Backwardation and the Collapse of theTacoma Bridge with Anthony Wile