"I am sure nostalgia for the relative automaticity of the gold standard will rise among those of us engaged to replace it."
- Alan Greenspan, April 14, 2000.On April 19th the Commerce Department announced that the US February trade deficit had reached a record $29.24 billion. That's with services thrown in. By the old measure of measurement on a strictly goods basis the deficit was $35.95 billion. However one wants to look at it the current account imbalance is running at $400 billion per annum or over 4% of gross domestic product.
In the April 24th edition of Barron's an anonymous Fed official was quoted as saying, "The current-account problem is a bigger one than inflation. If prices heat up, we can work with that. But if tons of capital are pulled out of the U.S. then it's a systemic risk."
The bright side of this trade picture is that the US is exporting more gold. In February exports of non-monetary gold were $921 million vs. $727 in January. That's about 3.2 million ounces, not bad for a country that produces $11.5 million ounces per year. For the year to date that is $1648 million vs. $448 million last year. Interestingly, the increase in gold exports started last September, is this part of the Duisenberg Deal?
We ran this by the old professor Frank Veneroso and he explained that it was not nonmonetary gold, rather it was monetary gold being transferred from the New York. Fed. If this was the case, why, we asked, was it reported in the Commerce Department figures? There are often cases of other commodities being brought into the US and put in bonded store. When they are re-exported the commodity does not become part of the trade data. His answer was that it was a mistake on the Government's part. Assuming he is correct the Commerce Department is misleading the financial community by counting as exports a "commodity" that is already owned by a foreign entity, and we have to add another $921 million to the trade deficit for February.
Gold exported from the Fed would be in the form of unworked bars. The dollar value for Jan and Feb unworked gold exports was $1,151 million dollars. The balance was bullion coins, gold dust, numismatic coins, gold powder and gold dross. We say appears because nowhere is the actual currency stated but we assume it must be dollars. Neither is the unit of measurement which was 122,384,749. However it appears this is grams as it works out to $9.4 per unit and there are 31.1 grams in the troy ounce which would put the price at $292 per ounce.
Of these shipments the largest importer was Switzerland at $948 million, followed by the UK at $202.5 million and finally Germany $108,000.
This would support Frank Veneroso's contention that the major importers of gold for retail demand would be India and the Far East. It would suggest that official gold is being mobilized so that demand is not seen in the open market and the perma-bears can continue their perennial diatribe about "lack of demand." (Hello, Andy)
It is also interesting to note the increase in Off Balance Sheet Derivative Contracts. In the fourth quarter report released by the Comptroller of the Currency the notional amount of contracts held by Morgan Guaranty was $38 billion up from $16.7 billion in December 1998. For Chase Manhattan it was $22.0 billion down from $24 billion the previous year. For Citibank it was $11.7 billion up from $6.6 billion the previous year. These three bank gold derivatives total $71.9 billion. The other 409 banks with gold derivative contracts hold $15.7 billion. Of the total $87.6 billion, 46.5 billion mature within one year, $24 billion in 1-5 years and $12.9 billion in over five years.
Now compared to the size of the total derivative market these are small numbers. The size of the gold derivative market is dwarfed by the total of outstanding derivatives. For the top seven banks gold derivative totaled $72.9 billion. (The report states that Bank of America, Bank One, First Union and Bankers Trust have zero gold derivative contracts.) The notional amount of all derivatives held by these seven banks is $32.6 trillion against total assets of $1.8 trillion.
From the above we can deduct that two thirds of the exports of gold leaving the US in the first two months of this year went to Switzerland. Second that there has been a significant increase in the size of off balance sheet derivative contracts.
These two facts may go a long way towards explaining the curious behavior of the gold market. Any moderately astute observer will have noticed the pattern of price rises in the Far East and Indian market, followed by a pause in London and then a break prior to the New York opening. The pattern of rallies halting at precisely defined chart points and the handful of operators who contain them are too much of a pattern to ignore.
The war on gold is certainly not new. In his 1972 book, "The Monetary Sin of the West" the French economist Jacques Rueff wrote "In this way, the gold-exchange standard brought about an immense revolution and produced the secret of a deficit without tears. It allowed the countries in possession of a currency benefiting from international prestige to give without taking, to lend without borrowing and to acquire without paying."
"This message was not lost on the French central bank and between November 1967 and March 1968, the US lost a staggering $3.2 billion from its gold stocks," wrote Anthony C Sutton in 1977 in his seminal book, The War on Gold. "By this time the other European central banks followed the French example and told the United States that further defense of the dollar would require US gold; none of theirs would be available. The end came on March 14, 1968, the day the Gold Pool lost 400 tons of gold to private buyers. The loss of 20 percent of US gold stocks within five months finally galvanized the Treasury into action. At the request of the Federal Reserve Bank and the US Treasury, President Lyndon Johnson asked the Bank of England to close the Gold Pool operation." This is not historical trivia. In the Gold Pool scramble the offtake of gold was 2,500 tons in two years. Today official sector gold loans total 4500 tons according to GFMS (Gold fields Mineral Service) or 7000 tons according to Dinsa Mehta, chief bullion trader at Chase Manhattan. It is interesting the Chase's gold derivative book actually dropped year on year. The fact is the gold loans can't be paid back under the current deficit situation. It is the magnitude of the situation that demands a universal propaganda effort to destroy any belief in gold as money. The size of the dollar debt pyramid is so awe inspiring that any attempt to predict the upside potential for gold is meaningless. How many rupiah does it take to buy an ounce? For that matter how many 1923 German marks?
So Mr. Greenspan may well have nostalgia for the days of a gold standard. Certainly he has presided over the greatest credit explosion of all time while maintaining the poker face and somber demeanor so necessary to cultivate his image. But then Mr. Greenspan has been observing the economy since 1948 when he worked for the National Industrial Conference Board and has shown himself to be most adept at self-preservation. This was the man who wrote "that capitalism holds integrity and trustworthiness as cardinal virtues and makes them pay off in the market place, thus demanding that men survive by means of virtues, not of vices. It is this superlative moral system that the welfare statists propose to improve upon by means of preventative law, snooping bureaucrats and the chronic goad of fear." Somewhere along the line, perhaps exposed to Potomac fever, he was subsequently described as "not very ideological" by Alice Rivlin and, "He is not doctrinaire," by Andrea Mitchell. She should know she's married to him.
Maybe Ayn Rand had it right in the first place when she asked, "Do you think Alan might basically be a social climber?" (Quoted from The Fountainhead. Alan Greenspan Faces the Biggest Challenge of His Career. By John Cassidy, New Yorker Apl 24 and May 1. Must reading.)
Strong circumstantial evidence thus points to an explosive and unprecedented mixture. The central bank of the world's reserve currency seems unwilling or unable to contain an out of control credit expansion. This has led to another "gold pool" situation where a serious trade balance problem is being solved by dissipation of official gold. This loss of gold will ultimately threaten confidence in all major currencies. The clandestine nature of the current gold pool operation appears to have put major money center banks in a huge and dangerous short position. The bubble is not confined to Wall Street: At its center is the dollar itself and our very means of economic calculation.
Greg Pickup
April 25, 2000Greg Pickup hedges risk for commercial agricultural firms and speculates for investors. He can be reached at 312-902-6720, or email him at gpickup@ix.netcom.com. He posts a daily overview of the grain markets at http://www.chicagoperspective.com
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