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XMFSinchiruna (27.96)

An Interesting Proposal to Remobilize Gold and End USD Price-Fixing



July 20, 2009 – Comments (14)

The following open letter to former FED Chairman and Obama advisor Paul Volcker comes to Fooldom courtesy of economist Antal Fekete.

My regular readers will recall Fekete's comprehensive explanation of the gold backwardation event that we saw early signs of back in December, or this gem excerpted from a MarketOracle post:

Thirty-five years ago gold, symbol of permanence, was chased out from the Monetary Garden of Eden , replaced by the floating irredeemable dollar as the pillar of the international monetary system. That's right: a floating pillar. The gold demonetization exercise was a farce. It was designed as a fig leaf to cover up the ugly default of the U.S. government on its gold-redeemable sight obligations to foreigners. The word ‘default' itself was put under taboo even though it punctured big holes in the balance sheet of every central bank of the world, as its dollar-denominated assets sank in value in terms of anything but the dollar itself. These banks were not even allowed to say ‘ouch' as they were looking at the damage to their balance sheets caused by the default. They just had to swallow the loss, obediently and dutifully join the singing of the Hallelujah Chorus of sycophants in Washington praising the irredeemable dollar and the Nirvana of synthetic credit.

Well, Professor Fekete is at it again, this time with an urgent message for his seasoned colleague: get the physical gold supply flowing or face unthinkable consequences as bondholders run from dollar exposure like the plague. It's an interesting premise, and one I had not considered before ... discussion has typically included some form of modified gold standard, but it's interesting to consider that the same outcome might be attainable without going that far. According to Professor Fekete, access to physical bullion is the key (and in referencing this he is of course alluding to the gross undersupply of physical bullion that supposedly backs COMEX and global futures markets). Anyway, this is my first exposure to this particular idea, and I wanted to toss it out there to get your perspective on its merits. I do agree with him that a sort of permanent (or very prolonged) backwarddation event could easily arise if risk aversion were to suddenly return to the broader market amis heightened concern about U.S. sovereign debt. Before I go writing a novel about my thoughts on the topic, though, let's just consider Fekete's letter to Paul Volcker and see what we all think:

Dear Paul,

In 35 years our paths have crossed for the second time. In 1974/75 you and I were Visiting
Fellows at Princeton University. Now, in 2009, both you and I are attending the Santa
Colomba Conference on the present debt crisis at the invitation of Bob Mundell.

In 1975 you conducted a seminar on the international monetary system and invited me to
contribute a paper on gold which I did. Those were halcyon days by comparison. The United
States, after the turbulence of 1971, successfully consolidated the international position of the
dollar and could confidently lift the 42-year old ban on the ownership and trading in gold. On
December 31, 1974, trading of gold futures contracts started in New York and Chicago. It
showed a robust contango at full carrying charge, that is to say, the gold basis (the spread
between the futures and the cash price) was at its peak. It indicated that monetary gold was
available in great abundance to meet any demand for any reason. It showed that the gold
futures markets could serve as the fulcrum in seeking out the equilibrium between the supply
of and demand for gold. They could act as a safety valve, releasing occasional pressures that,
in the absence of paper gold, may be a threat to the monetary system. It looked as if the gold
problem has been solved for once and all.

But as I feared, and as the intervening 35 years have proved, rather than moving towards
equilibrium we have been constantly moving ever farther away from it, as measured by the
gold basis. The secular vanishing of the gold basis is a most ominous danger signal. It
indicates that monetary gold is increasingly unavailable, and in case of a crisis it can no
longer be relied upon to come to the rescue. Basis started out at 100 percent of the prevailing
interest rate, but has been steadily eroding all the way to zero percent today. Permanent gold
backwardation (negative gold basis) is staring us in the face. The gold basis is trying to tell
you something. It heralds the greatest monetary crisis of all times. It warns about the possible
collapse of the international monetary and payments system.

Let me explain. Gold is the only ultimate extinguisher of debt. Other extinguishers do, of
course, exist but they are not ultimate in that they have a counterpart in the liability column of
the balance sheet of someone else. Gold has no such liability attached to it. Gold is where the
buck stops. It is this property that makes gold unique as a financial asset. Historically, gold
discharged its function as the ultimate extinguisher of debt through the gold clauses written
into the bonds of the U.S. government before 1933. Gold could also discharge this function,
albeit rather imperfectly, under the gold exchange standard of 1934 with gold redeemability
limited to foreign holders. Still more imperfect was the system of fluctuating gold prices introduced in 1971, thanks to the availability of paper gold. Imperfect as though these
stratagems were, they served as a pacifier to the bond market. But as the threat of permanent
backwardation indicates, all offers to put monetary gold at the disposal of the international
monetary system could be abruptly withdrawn. In that event there would be no ultimate
extinguisher of debt. The world is totally unprepared for such a momentous development. I
ask you: are there contingency plans in the U.S. Treasury and in the Federal Reserve what to
do if backwardation makes monetary gold unavailable for the indirect retirement of debt?

The message to debt holders would be: suave qui peut. There would be a rush to the exit doors
and people would trample one another to death in trying to get out. The debt crisis of 2008
was a dress rehearsal. It gave the world a foretaste. This crisis is a gold crisis. It is a crisis
indicating the threat of a shortage of the ultimate extinguisher of debt, without which our
runaway debt tower is doomed. When it topples, it will bury the world economy under the
rubble, as the Twin Towers buried the people working inside in 2001.

All kinds of ad hoc explanations have been offered for the debt crisis. But the real explanation
is that under the threat of gold backwardation creditors are scrambling for liquidity. There will
be no recovery unless provision is made for the orderly retirement of debt through a
mechanism using gold as the ultimate extinguisher. The alternative is a Great Depression
worse than that of the 1930’s. To understand this we have only to contemplate the shock to
the world if it was revealed that the debt of the U.S. government was in fact irredeemable.
The Emperor is naked. As long as bonds carry a gold clause, or the bond market is supported
by the trading of paper gold, bonds are deemed redeemable. But once permanent
backwardation makes gold unavailable, debt becomes irredeemable in the eyes of the
bondholders. Paying U.S. bonds at maturity in F.R. notes does not establish redeemability.
The latter is just evidence of debt secured by the former as collateral revealing that bonds are
not really redeemable at all. An interest-bearing bond is replaced by a non-interest-bearing
bond, that is, by an inferior instrument. All you do is shuffle various forms of irredeemable
debt. When the world wakes up to this prestidigitation, the international monetary system will
not be able to survive the shock-waves. The chaos that will engulf the world is appalling.

The solution is relatively simple. The world’s monetary gold should be remobilized. This can
be accomplished by opening the U.S. Mint to the free and unlimited coinage of gold. There
should be no attempt to fix, cap, or otherwise control the dollar price of gold. The gold coins
of the United States ought to be made available to bondholders in order to provide for an
orderly retirement of debt, if that is what the bondholders want. When they become convinced
that this avenue is open to them through the unlimited availability of gold coins of the realm,
the scrambling for liquidity will peter out and stability return. If other great nations wanted to
join opening their Mints to the free and unlimited coinage of gold, so much the better. It
should not be beyond the power and the wit of the U.S. government to rein in this crisis and
make a decisive move in the direction of full recovery through opening the U.S. Mint to gold,
as demanded by the Constitution.

Gold is a great world resource. It would be foolish if, for parochial or ideological reasons, we
failed to enlist it in the cause of economic development — even in the absence of a great
crisis. But given the present crisis situation, remobilization of gold is imperative.


Thoughts? Reactions? Counter-proposals? Thanks in advance. :)





14 Comments – Post Your Own

#1) On July 20, 2009 at 8:20 AM, XMFSinchiruna (27.96) wrote:


Here is a link to Fekete's letter

This is the gold backwardation post from December 2008

And here's the MarketOracle post from which the first quote was excerpted.

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#2) On July 20, 2009 at 8:29 AM, portefeuille (99.55) wrote:


my first reaction: I like the URL

now back to reading that stuff ...

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#3) On July 20, 2009 at 10:13 AM, kaskoosek (91.39) wrote:


Great post.


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#4) On July 20, 2009 at 10:21 AM, jesusfreakinco (29.12) wrote:

Great theory.  Can't see it happening.  It would send gold through the roof likely with interest rates along with it.


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#5) On July 20, 2009 at 10:50 AM, silverminer (31.34) wrote:


Right, but is it the lesser of all evils? In other words, if it doesn't happen, gold prices and interest rates are still bound to rise commensurately ... just perhaps at a slightly later date but with far more abrupt collateral damage.

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#6) On July 20, 2009 at 11:06 AM, galtline (31.28) wrote:


Gold isn't the only commodity though...surely there are other commodities that our country has that is worth money... 

I own both AUY and SLW (largely thanks to your articles covering both of them), but I still wrestle with why we're expected to think of gold as a currency.  I understand it in historical terms...

I think a new trade currency is unquestionably in the cards, but I wonder what form that will take.  If it is backed up by something, why not a range of commodities?  Why just gold? 

Am I missing the point? 

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#7) On July 20, 2009 at 11:48 AM, silverminer (31.34) wrote:


To be considered money, it MUST be something that doesn not have excessive demand for other types of uses. Oil is not money because people have to burn it. Wheat is not money because people have to eat it. Industrial applications for gold and silver exist, to be sure, but their demand pull for those applications is not sufficient to hinder their monetary roles. 

Gold is not a commodity, gold is money. :)

Fool on!


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#8) On July 20, 2009 at 11:53 AM, kaskoosek (91.39) wrote:


Let me tell you why it shouldn't be a range of commodities.


Because it becomes a derivative. There is no such thing as a range of commodities. You need to back the currency or note, by a tangable thing and not hot air.


One commodity will ultimately be deemed as money all the others will not be. Pricing should be in one currency and not multiple, otherwise it makes trading even more complex.


You price using one benchmark and not multiple. 

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#9) On July 20, 2009 at 12:04 PM, silverminer (31.34) wrote:


Not necessarily, my friend. Bi-metallic standards incorporating gold and silver at a fixed ratio have worked well in the past. But the gist of your statement is correct. :)

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#10) On July 20, 2009 at 12:27 PM, galtline (31.28) wrote:

Interesting.  So, in order for a commodity (which technically, by definition, both gold and silver are) to be considered as money, they must have a limited supply but not excessive demand?  By introducing a gold standard, aren't you creating an artificial (and excessive) demand?  

I know that there are arguments against perishable commodities being considered, but I would think that other commodities (even if there is excessive industrial demand) could fill that role (oil, for example).

If I understand you correctly, gold is money because gold can be hoarded, whereas oil can be hoarded, but it is more likely to eventually be spent (since there is a huge industrial demand), on the other hand, has very little demand other than to be considered a currency.

I admit...I find the whole topic to be a little heady, and beyond my (current) understanding of the topic.

Currency is just a convenient means of exchange - to say that 1 unit is equal to a certain amount of usable  or valued goods.  It feels strange to just peg it on something pulled out of mines in only certain countries.  

I know it is easier said than done, but it seems as though we should be able to establish a worldwide currency (where governments can't print them into worthlessness).   


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#11) On July 20, 2009 at 12:43 PM, XMFSinchiruna (27.96) wrote:


Gold and silver may fulfill the technical definition of commodities, that is true, but their monetary roles far outweigh in relevance the extent to which they resemble commodities. The reason why I assert that they are not commodities is not because they don't share certain key characteristics, but because calling them commodities causes people to grossly misunderstand how these two metal behave in relation to paper currencies (particularly the USD). Oil's correlation to currency moves, while visible, has been nowhere to the extent of gold and silver ... as well it should be. Gold and silver are utterly uniqu, and for that reason lumping them in under the generic title 'commodities' is counterproductive to understanding how they function in a currency crisis like the one we're experiencing.

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#12) On July 20, 2009 at 1:02 PM, kaskoosek (91.39) wrote:


"Currency is just a convenient means of exchange - to say that 1 unit is equal to a certain amount ofusable  or valued goods.  It feels strange to just peg it on something pulled out of mines in only certain countries. "


It is not strange at all.


Money has to originate from some thing that has objective value. Otherwise why would anyone want it.


The reason why silver or gold became money is because they were the most marketable forms of goods.

If I am selling loafs of bread I would try to acquire a good that I can easily trade later on to other goods.


The fact that these goods can be stored and divisable makes them that much more attractive.


Yes later on these goods would no longer posess just the inherent value of the good itself, but also value that it has also become the acceptable medium of exchange.


Fiat currency is theft. It means that anytime you are in debt you can easily print money to forgo your obligations. 




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#13) On July 20, 2009 at 1:39 PM, galtline (31.28) wrote:


If I understand you correctly, the reasons why silver and gold should be considered as currency are:  It has value.  It can be stored.


As to your earlier post...yes, I guess I am talking about the extent that I'm talking about hedging (in a way) and holding a commodity.  It's sole purpose being not to take risk, but mitigate it...find equalibrium on the price of goods.  I was thinking more of a managed currency comprised of commodities (and perhaps other currencies), and the sole purpose of the fund is to maintain a stability (so, it can't be linked to one governement and printed to worthlessness).

My inexperience might be showing here... ;)


I understand. You avoid calling it a commodity...not because it isn't one, but because it needs to be viewed as money instead (given our strange economic times).

In the article that you quoted above, he states concerns that the governments debt is irredeemable, and that the only way to solve the crisis is through a gold standard (if I'm understanding it correctly).  Why wouldn't other commodities be considered as a way to "redeem" debt?





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#14) On July 20, 2009 at 1:47 PM, galtline (31.28) wrote:

Thanks in advance.  Good discussion.

Also...Sinch, if you wouldn't mind, check Speedy's blog.  I was hoping that you could reply to my post.   I'd like to hear your thoughts.

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