Govts hard at work to keep gold prices low
Vivek KaulTuesday, April 28, 2009 3:32 IST
Mumbai: "For all your bullishness on gold, its price hasn't gone anywhere in the last few months, hovering more or less around $900 an ounce (one troy ounce equals 31.1 gram) since the beginning of this year," she said, sipping coffee as we sat watching the sunset.
"One reason the price of gold has not gone up, despite the United States and other governments going on a currency printing spree, is the International Monetary Fund's decision to sell its gold holdings. On April 2, 2009, the national heads of the Group of Twenty nations approved up to 400 tonnes of IMF gold being sold. When you take into account the fact that world production of gold is around 2,500 tonnes a year, the amount of gold being sold is not huge. Also, the fact that this gold will not be sold in the open market, over the counter, but is most likely to be picked up by central banks across the world. Despite all this, the fact that the world's most powerful nations have approved the sale is significant," I said.
"What do you mean?" she asked.
"That governments across the world do not want the price of gold to go up, to put it simply."
"Isn't that an outlandish statement to make?"
"I don't think so. If you want to sell something, would you announce to the whole world how much you plan to sell? No sane person who wants to maximise his price would do that. He will gradually sell gold and hope to get a good price for it, unless of course the idea is to depress the price of gold by giving out information in advance."
"I am still not convinced," she said.
"Okay. Let me get into a little more detail. Central banks across the world have been dumping their gold reserves on the open market. The way it worked, central banks leased their gold to a major private bank(s), known as a bullion bank, which typically paid an interest of 1% to the central bank and then sold the gold in the open market, depressing prices or at least ensuring that gold prices did not continue to rise. The money they got was then invested at a market rate of interest of around 7%. The stock of gold in the reserves of central banks did not go down, because technically they had leased the gold out to bullion banks and could call it back at any point of time. Estimates made by James Turk, a major gold bull and the co-author of the book The Collapse of the Dollar and How to Profit from It - Make a Fortune By Investing in Gold and Other Hard Assets suggest that at the end of 2007, central banks owned around 32,000 tonnes of gold. Of this, nearly 14,000 tonnes had been lent by central banks to bullion banks," I said.
"Interesting, even though it sounds outlandish," she said.
"You know, if central banks ever call this gold back, the bullion banks will have a tough time. Estimates by Gary North, who has been writing on gold for a very long time, suggest that if gold prices are over $800 an ounce, these bullion banks will not be in a position to buy back the gold. This is primarily because they have sold the gold in the open market, when its prices were around $800 an ounce. If they try to buy it back at the current prices of around $900 an ounce, the bullion banks will face huge losses. Going by Turk, if and when these bullion banks try to buy back this gold to return it to the central banks, there will be a classic short squeeze, where all these banks will want to buy at once, sending the price of gold through the roof."
"That still doesn't explain why governments do not want the price of gold to go up," she said.
"You know what, till a hundred years back, gold was money. Till July 1914, all the major economies of the world were on what is known as the gold standard. Central banks around the world had gold in their coffers, which was essentially used to back the paper currency being issued. In the US, the value of one ounce of gold was fixed at $20. This meant citizens essentially held gold as money and at any point of time could convert their paper currency into gold. It worked the same way in Europe. It also ensured that governments could only print a fixed amount of currency, depending on the amount of gold they had in their coffers, unless of course they managed to dig up new gold. So the government increasing money supply just like that, as is the case these days, was not possible. In the second half of 1914, the First World War started, and banks in Europe suspended the conversion of paper money into gold. The US government confiscated the gold held by its citizens in 1933. It forbade its citizens from owning gold till the end of 1974. On August 15, 1971, Richard Nixon, the then President of United States, decided to do away with the last prevailing gold standard."
"Stop your speech. Where are we headed?" she interrupted.
"Over the years, various governments have killed the gold standard. So the status of gold as money has ended. Today governments and central banks across the world do not need to back their paper currency with gold reserves. This gives them the freedom to print any amount of money they want to, which is what they are currently doing. But when an item is available in abundance, its value tends to go down and vice versa. All this printing of currencies will lead to the purchasing power of currencies continuing to come down. Given this, concerned investors the world over would want to move their investments into gold, leading to the price of gold going up. But the governments do not want that. As Gary North wrote in a recent report, "Gold's price is a test of political legitimacy: the value of a national currency. A rising gold price is a vote of reduced confidence in the state's money. This is why governments since World War I have done everything they could to remove gold coins from circulation. This is why governments sell gold. It de-legitimises gold and legitimises government currency.""
"Hmmm. I get it now. More coffee?"
The example is hypothetical
References: The Gold Wars, an ebook that can be freely downloaded from www.garynorth.com/GoldWars.pdf; Why Gold Owners Are Targets of the Government, Gary North, April 25,2009, www.garynorth.com; Empire of Debt - The Rise of an Epic Financial Crisis, Bill Bonner and Addison Wiggin, John Wiley and Sons, 2006.
