The Gold War Explained
A interesting gold war flared up in recent days… namely between what I’ll call gold insiders (Jeffrey Christian of CPM Group, a metals consultancy), and those on the outside GATA (Gold Anti-Trust Action Committee). You can see this war of words here: http://www.gata.org/node/8581
I find it amazing that people can argue forever without getting to the crux of the issue. And in this case the core disagreement is blindingly simple. GATA says banks have sold gold that doesn’t exist, creating “paper” gold, and that this action is fraudulent. Insiders acknowledge this but say there is nothing wrong with it. This is the core issue – that banks have treated gold like paper money and loaned it out on a fractional basis. Just about everything else is secondary or builds on this concept.
Is this wrong? After all banks have been loaning money on a fractional basis for hundreds of years and it is legally accepted. But there is an immense difference between cash and gold. Gold is a physical asset that is no one else’s liability while paper money is a liability of a central bank. People own gold specifically because they don’t want to own paper money. Conflating the two items is flat out wrong. However, that’s what banks and the regulatory system do.
Imagine it this way. You want to buy a diamond as an investment and store it at your your bank. The bank says sure, but because it has to create space to store the diamond, it will cost 1.5% per year to store it. But the bank offers you another option. It has a bunch of identical diamonds in a big room and it can sell you one of them, but not a specific one. Since they are all together, this reduces its storage fees. At any time you can ask for your diamond back. OK, that’s a much better deal you say.
The catch is that bank has sold more diamonds than it has in inventory. When the bank takes your money it records a liability, but doesn’t go out and buy another diamond, it loans your money out and earns interest. This interest is what enables storage costs to be lower.
In effect, you are told you own a diamond, but you really don’t, you own 1/10 of a diamond. This is because the bank has sold that diamond ten times over.
This fractional system is widely accepted in checking accounts but you can see how the logic melts away when you consider physical objects. People own gold, diamonds, or whatever to have that specific, physical asset. That’s the whole point. Of course, the benefit of not getting your own specific one is lower fees, but that is completely superficial and overwhelmed by the fact that you have claim on far less of a diamond than you think you do. The gold people think they own doesn’t actually exist.
But this doesn’t matter, say the insiders. For every customer liability (someone that owns a gold claim from the bank), there is an asset. If people ask for their diamonds, the bank can convert some of those assets into cash and buy enough diamonds to give them to their owners. The problem is the price of diamonds will go through the roof, affecting the ability to deliver the physical good. It’s similar to a bank run.
The fundamental difference between the two parties is that Christian does not see anything wrong with a fractional gold banking system but GATA does. GATA thinks the fractional gold system is flat out wrong on many levels and the banks are in essence perpetrating fraud.
My view is that it’s shocking that insiders like Christian cannot comprehend the difference between gold and paper. I can sort of see how he might support the fractional banking system because it is so ingrained in our society, but how he justifies a fractional gold system is beyond me.
It’s an open and shut case that banks are committing fraud. When you tell clients they own gold and they don’t it is fraud. There’s nothing more to be said. In many cases, banks have hedged themselves with their language, but in some cases, it is blatant fraud.
Where it gets more interesting (and exciting for the gold owners!) is when you consider what could happen if the situation unravels. I’ll tackle that issue in a future post.