WHAT U.S. AND FOREIGN OFFICIALS HAVE SAID ABOUT
THE FED'S ACTIVITIES IN THE GOLD MARKET
From the transcript of the minutes of the Federal Open Market
Committee on March 26, 1991 (www.federalreserve.gov/fomc/transcripts/1991/910326Meeting.pdf):
Near the end of a lengthy discussion (pp. 8-21) of U.S. foreign
exchange reserves, which are held in approximately equal portions
by the Fed and the Exchange Stabilization Fund, former Fed governor
Wayne Angell added (p. 19):
There's one slight addendum to this discussion: ... [I]f you
mark our gold to the $358 price, we end up with something like
$170 billion [in total foreign exchange and gold reserves]. There
are opportunity costs because we don't get interest on that gold
as we do on our foreign exchange [holdings]. That cost is out
there also. I would hesitate for us to have foreign currency
holdings that have swap puts that just sit there, [which] is
now becoming the case for our gold. [Emphasis supplied.]
From the transcript of the Federal Open Market Committee meeting
on January 31, 1995 (www.federalreserve.gov/fomc/transcripts/1995/950201Meeting.pdf):
Responding to a question raised by then Federal Reserve Board
Governor Lawrence Lindsey about the legal authority of the ESF
to engage in the financial rescue package for Mexico then under
discussion, J. Virgil Mattingly, general counsel of the Fed and
FOMC, stated (p. 69):
It's pretty clear that these ESF operations are authorized.
I don't think there is a legal problem in terms of the authority.
The statute [31 U.S.C. s. 5302] is very broadly worded in terms
of words like 'credit' -- it has covered things like the
gold swaps -- and it confers broad authority. Counsel
at the White House called the Treasury's General Counsel today
and asked "Are you sure?" And the Treasury's General
Counsel said "I am sure." Everyone is satisfied that
a legal issue is not involved, if that helps. [Emphasis supplied.]
Note: As described by the FOMC (www.federalreserve.gov/fomc/transcripts),
transcripts of its meetings in 1995 were prepared "shortly
after each meeting from an audio recording" and "[m]eeting
participants were then given an opportunity within the next several
weeks to review the transcript for accuracy." Nevertheless,
in a memorandum dated June 8, 2001, to Chairman Greenspan (and
later released by him to Senator Jim Bunning, Kentucky) (http://groups.yahoo.com/group/gata/message/827),
Mr. Mattingly disclaims his 1995 statement about gold swaps,
stating in relevant part:
Given the passage of time, some six years,
I have no clear recollection of exactly what I said that day
but I can confirm that I have no knowledge of any "gold
swaps" by either the Federal Reserve or the ESF. I believe
that my remarks, which were intended as a general description
of the authority possessed by the Secretary of the Treasury to
utilize the ESF, were transcribed inaccurately or otherwise became
garbled.
From U.S. Treasury Directive TD 27-04 (www.ustreas.gov/regs/td27-04.htm),
dated November 17, 1996, describing the functions of the Office
of Under Secretary (International Affairs) and the duties of the
Deputy Assistant Secretary (International Monetary and Financial
Policy) (part 5.h):
Provides direction to the Federal Reserve Bank of New York
concerning Exchange Stabilization Fund (ESF) operations under
the authority of the Secretary of the Treasury and other Treasury
officials who are delegated such authority to assure that
operations of the Federal Reserve System concerning the ESF are
coordinated. In this regard, the incumbent intensively
monitors foreign exchange markets and maintains continuing
monitoring of gold markets and related developments.
[Emphasis supplied.]
Note: This directive, which expired November
17, 1999, appears in virtually identical form as a current directive
under the Assistant Secretary (International Affairs) (www.ustreas.gov/org/dasimfp.htm).
From testimony of Fed Chairman Alan Greenspan before the House
Banking Committee and Senate Agricultural Committee in July 1998
(http://agriculture.senate.gov/Hearings/Hearings_1998/gspan.htm):
Nor can private counterparties restrict supplies of gold,
another commodity whose derivatives are often traded over-the-counter,
where central banks stand ready to lease gold in increasing
quantities should the price rise. [Emphasis supplied.]
From Chairman Greenspan's letter to Senator Joseph I. Lieberman,
Connecticut, dated January 19, 2000, elaborating upon the foregoing
testimony (http://groups.yahoo.com/group/gata/message/346):
This observation simply describes the limited capacity of
private parties to influence the gold market by restricting the
supply of gold, given the observed willingness of some
foreign central banks -- not the Federal Reserve -- to lease
gold in response to price increases. [Emphasis supplied.]
From the same letter by Chairman Greenspan:
The Federal Reserve owns no gold and therefore could not sell
or lease gold to influence its price. Likewise, the Federal Reserve
does not engage in financial transactions related to gold, such
as trading in gold options or other derivatives.
Most importantly, the Federal Reserve is in complete agreement
with the proposition that any such transactions on our part,
aimed at manipulating the price of gold or otherwise interfering
in the free trade of gold, would be wholly inappropriate.
From the Complaint in Howe v. Bank for International Settlements,
et al., United States District Court for Massachusetts, No.
CV-00-12485-RCL (www.goldensextant.com/Complaint.html#anchor3130):
The reaction of the Fed and other central banks to the sharp rally
in gold prices triggered by announcement of the so-called "Washington
Agreement on Gold" in September 1999, as described by Edward
A. J. George, Governor of the Bank of England and a director of
the BIS, to Nicholas J. Morrell, then Chief Executive of Lonmin
Plc, a principal shareholder in Ashanti Goldfields Ltd. (paragraph
55):
We looked into the abyss if the gold price rose further.
A further rise would have taken down one or several trading houses,
which might have taken down all the rest in their wake. Therefore
at any price, at any cost, the central banks had to quell the
gold price, manage it. It was very difficult to get the gold
price under control but we have now succeeded. The U.S.
Fed was very active in getting the gold price down. So
was the U.K. [Emphasis supplied.]
LOOKING INTO THE ABYSS: GOLD AND
INTEREST RATE DERIVATIVES
The "abyss" was the problem of covering the short
physical gold position evidenced by a mountain of gold derivatives
on the books of the bullion banks.
Central banks put physical gold from their vaults into the
market by outright sales or by leasing, which may include not
only gold loans but also gold deposits or swaps with major bullion
banks. Technically different but functionally the same, gold on
lease, deposit or swap is reported by most central banks as part
of their gold reserves. However, the physical gold itself is ordinarily
sold into the market by the bullion banks receiving it, resulting
in a short physical position, meaning that the gold ultimately
required for repayment must be purchased in the market or obtained
from new mine production. The bullion banks are intermediaries,
they borrow central bank gold at low rates [1-2%], sell it at
spot for cash, put the cash into financial assets earning higher
returns [e.g., 5%], and generally hedge their short position
by going long in the forward market. Leading U.S. bullion banks
include J.P. Morgan Chase, Citibank and Goldman Sachs; leading
overseas bullion banks include Deutsche Bank and UBS.
When bullion banks go long, someone else in the forward market
must go short because all contracts in that market have two sides,
buyer and seller. This hedging produces gold derivatives, e.g.,
forward contracts, options. Who goes short in the forward market?
Gold producers hedging future production; jewelers hedging inventory;
speculators. Shorts in the forward market typically also earn
a contango, which is almost but not quite equal to the spread
earned by the bullion bank. The bullion bank has a hedged position
on which it earns a small margin [0.5%]. Shorts in the forward
markets are the ultimate gold borrowers, but the bullion banks
are the ultimate guarantors of gold repayments to the central
banks.
Pursuant to rules promulgated by the IMF (http://groups.yahoo.com/group/gata/message/904),
central banks are not required to report gold in the vault separately
from gold receivables on account of gold loans, deposits or swaps.
Accordingly, there are no authoritative reported numbers from
which to calculate the total short physical position. Credible
estimates run from around 5000 metric tonnes to over 15,000 tonnes
out of total reported central bank gold reserves of roughly 32,000
tonnes. Annual new mine production currently runs around 2500
tonnes. Annual demand is estimated at 4000 to 4700 tonnes, leaving
a deficit of 1500 to 2200 tonnes to be filled by scrap, official
sales, and gold leasing mostly by central banks.
In May 2000, five delegates from GATA (www.gata.org)
made a 45-minute presentation to House Speaker Dennis Hastert
on the dangers to the U.S. financial system posed by the exploding
quantities of gold derivatives on the books of the bullion banks
as a result of gold leasing by central banks. In this connection,
GATA published an advertisement (www.goldworld.net/rollcall.htm)
in Roll Call, the congressional newspaper, and delivered
an extensive written document, Gold Derivative Banking Crisis
(www.gata.org/test.html),
to every member of the House and Senate banking committees. Within
the next six months, more than 20,000 copies of Gold Derivative
Banking Crisis were downloaded from the GATA site.
Why do central banks loan gold? The reason most frequently
cited is a desire to earn a return, however paltry, on an otherwise
"sterile" asset. But as Chairman Greenspan suggested
to Congress in 1998, the real reason usually has much more to
do with suppressing gold prices. In 1988, Harvard president and
former U.S. treasury secretary Lawrence H. Summers, then Nathaniel
Ropes professor of political economy at Harvard, co-authored with
Robert B. Barsky an article entitled "Gibson's Paradox and
the Gold Standard" published in the Journal of Political
Economy (vol. 96, June 1988, pp. 528-550). A principal conclusion
of the article is that in a genuinely free gold market unaffected
by "government pegging operations," gold prices will
move inversely to real long-term interest rates, rising when real
rates fall, and falling when real rates rise.
A commentary on this article published in August 2001 at The
Golden Sextant (www.goldensextant.com/commentary18.html#anchor196905)
includes the chart reproduced below depicting real long-term interest
rates (30-year T-bond yield minus 12-mos. cumulative CPI) and
gold prices (inverted) since 1977. As the commentary points out:
"Gibson's paradox continued to operate for another decade
after the period covered by Barsky and Summers. But sometime around
1995, real long-term interest rates and inverted gold prices began
a period of sharp and increasing divergence that has continued
to the present time. During this period, as real rates have declined
from the 4% level to near 2%, gold prices have fallen from $400/oz.
to around $270 rather than rising toward the $500 level as Gibson's
paradox and the model of it constructed by Barsky and Summers
indicates they should have.
"The historical evidence adduced by Barsky and Summers
leaves but one explanation for this breakdown in the operation
of Gibson's paradox: what they call 'government pegging operations'
working on the price of gold. What is more, this same evidence
also demonstrates that absent this governmental interference in
the free market for gold, falling real rates would have led to
rising gold prices which, in today's world of unlimited fiat money,
would have been taken as a warning of future inflation and likely
triggered an early reversal of the decline in real long-term rates."
What new alchemy drove real long-term rates and gold prices
lower together after 1995? The next two charts, also from The
Golden Sextant (www.goldensextant.com/Charts.html#anchor161737),
depict the notional values of gold and interest rate derivatives
as reported quarterly to the Office of the Comptroller of the
Currency by U.S. commercial banks since 1995. Of particular note
are: (1) the sharp rise in Morgan's gold derivatives in the last
two quarters of 1999; (2) the sharp rise in Chase's gold derivatives
in the first two quarters of 2000; (3) the massive cumulative
totals for the new J.P. Morgan Chase, which as a result of the
merger approved by the Fed in December 2000 now holds almost two-thirds
of all gold and all interest rate derivatives on the books of
U.S. commercial banks; and (4) the sharp drop in the still separately
reported gold derivatives of Morgan in the third quarter of 2001
while those of Chase, Citibank and All Other remained static.
Reprint Permission courtesy of
http://www.goldensextant.com
http://www.gata.org
January 9, 2002
Printer Friendly Version
Email this Article