Letter to Alan Greenspan

April 14, 1997

April 8, 1997

The Honorable Alan Greenspan
Chairman of the Board of Governors
Federal Reserve Board

The Honorable Robert E. Rubin
Secretary of the Treasury
Washington, DC

Dear Chairman Greenspan and Secretary Rubin:

As the highest monetary officials of our country, I beseech you to investigate and terminate what has been a fifteen year fraud in two of the world's most important markets. As incredible as my allegations may sound at first, I am confident that you will find this fraud and resultant manipulation relatively easy to understand and document. Unfortunately, due to the level of prominence of the perpetrators, which include leading investment firms and central banks, and the long term existence of the fraud, the path to rectification will be met with self-indulgent pleadings for the status quo. That alternative, however, of allowing it to continue unfettered, will certainly prove more damaging to the American people and innocent citizens of the world. For the record, because I am certain there has been no involvement by U.S. government officials in this fraud and manipulation, and because full disclosure is the only sure way to terminate it, I intend to make copies of this letter available to other officials and interested parties.

The fraud in question is the lending of precious metals (gold and silver) by central banks, principally to mining companies, but also to users and speculators. One of the principle characteristics of these precious metal loans is that because there is supposedly no currency or inflation risk (actual metal is loaned and repayment is to be by actual metal), the interest rate is well below loans denominated in currency (ex Japan). In fact, current gold loan rates are between 1-2% per annum. These metal loans, which began to appear around 1982, have proved enormously popular with all the participants involved, and the total market issuance is reported to exceed a value of $50 billion.

It is no wonder that the lenders (central banks), the borrowers (mining companies, commercial users, and speculators) and the middlemen (investment banking firms) are all in love with these loans. They seem to be a great deal for everybody involved. The central banks are receiving, for the first time in history, income on what had been sterile assets, their vast holdings of precious metals. The borrowers are given cash up front at what is the equivalent of a below market secured rate when, in actuality, there is no collateral involved. And the investment bankers are raking in fees from various angles for concocting this scheme. It seems to be a true win/win/win situation. So what's wrong?

What's wrong is this - if you step back from the soothing reassurances from the "sophisticated" players in this scheme and view these loans with the perspective that is unique to your office, you will reach two startling and unavoidable conclusions. First, there is no possible way these loans can be collectively paid back without a complete abandonment of the terms and conditions under which the loans were originated. This is where the fraud comes in - if it is obvious before hand that a class of loans can't possibly be repaid as scheduled, such loans would have to be considered fraudulent instruments. Second, the huge volumes of these fraudulent loans has unquestionably manipulated the price of gold and silver to uneconomically depressed levels for the past 15 years.

Why can't these loans be collectively repaid without a wholesale revamping of their covenants? The answer is simple - because there isn't enough available metal in the world to allow them to be repaid as scheduled. These are metal loans - actual metal is loaned out and actual metal is to be paid back. That is why they are called gold or silver loans and is why 50 billion dollars worth of them are outstanding and accruing interest at the below market rate of less than 2% annually. If these loans were denominated in currency there wouldn't be any apparent conflict with the ever increasing outstanding volumes of issuance, aside from normal credit considerations. That is because total currency supply almost always increases. However, it is a much different equation for a tangible commodity. The total amount of a tangible commodity in existence can only increase if there is a surplus of production over consumption. And therein lies the first big problem with these metal loans - the supply of gold and silver is shrinking. It is common knowledge that the real gold and silver physical markets are operating under growing deficit consumption patterns, which by definition means that there is less total stock either in existence or available (some would argue that jewelry consumption doesn't count because the commodity isn't destroyed, but I'm sure you'll find that argument to be unfounded). And to those who would point to the vast stocks of metal held by the central banks, so what - they are the ones making the loans. While the total amount of gold and silver loans outstanding is growing alarmingly {meaning a growing metal repayment requirement), the total world available stock of metal is being reduced. It is not possible for such an unnatural situation to persist indefinitely, as I'm sure you will concur.

...there is no possible way
these loans can be
collectively paid back
without a complete
abandonment of the terms
and conditions under which
the loans were originated.

Make no mistake, I am not the least bit concerned with, nor am I referring to, bona fide sales of metal by central banks. Whatever market effect such sales might have, so be it. If you own something, you should be allowed to sell it. That does not constitute fraud or market manipulation. However, entering into a transaction that any reasonable person could see was flawed at its core, just might constitute fraud, and if that transaction artificially interfered with the basic functioning of the free market it could certainly constitute manipulation.

Allow me to expand on these transactions and why they are inherently flawed. A lease or loan of physical property is rooted in some basic principles. If you lease a car, or a house, or a piece of equipment you are expected to use, maintain and return the item in accordance with agreed upon conditions and considerations. Even if the item leased is scheduled to have zero value (in the case of some equipment leases) at the conclusion of the lease, the lease payments will reflect that condition. This is the essence of a tangible property loan or lease. During the term of the lease, ownership is retained by the lender and the lessee is entitled to agreed upon usage. Under no conditions, in any loan or lease, is the collateral allowed to be transferred by the lessee to a third party for the lessee's benefit. The tenant can't sell the house he's renting and pocket the proceeds. Yet, that is precisely what takes place in a metal loan. The central banks physically release their gold or silver to a dealer, mining company or speculator for a below market interest rate and a paper promise of the physical return of the metal at some future date. Then, in violation of every known concept of lending, the metal is sold for the lessee's benefit. The collateral is instantly converted to cash by being sold on the world markets and the proceeds are pocketed by the borrower, who has promised to return the physical metal later to the central bank. This is the fallacy of metal loans. They are just plain stupid. Who could imagine a tenant renting a house at a below market rate and being able to sell it and keep the money, as long as he promised to physically returned the house to the real owner in the future? To be sure, the players involved in these transactions will scoff at this example and point out that as a mining company they could earmark future production for physical return, or well financed speculators can just buy gold or silver in the open market at any time to return to the central banks. If there was a limited amount of these unsound loans in existence, perhaps the players would be able to buy back or earmark production. But consider this, with upwards of 100 million ounces of gold loans alone outstanding {equivalent to almost two years total world mine production} and with the market in an obvious supply shortfall, how is it possible for these loans to be collectively paid back? Can anyone seriously expect, for instance, that when the mining companies decide to return the two years worth of total world gold mine production they have borrowed with earmarked production, that the world will conveniently suspend total demand for a couple of years to accommodate them?

Under no conditions, in any
loan or lease, is the
collateral allowed to be
transferred by the lessee
to a third party for the
lessee's benefit.

In a nutshell, the flaw at the core of these metal loans is that there is no practical way for a lessee to "use" the gold and silver being loaned, aside from selling it immediately and using the cash proceeds. (Although a certain small amount of these loans go to metal fabricators for actual use, all that really amounts to is free inventory up front or a cash equivalent.) The players' greed to create transactions that clash with immutable laws of common sense is what's at the heart of the problem. Metals don't pay interest, period. The central banks are not being paid 1-2% interest on their gold and silver, they are being paid 1-2% on an unsecured paper promise of getting back assets that a third party has already sold and converted to cash. The collateral is gone. And it is precisely because the central banks are being so totally wacky in just giving their gold and silver away for free (except for 1 or 2% interest), that the borrowers have lined up in such a big way - it's money for practically nothing.

It is the appearance of legitimate business activity and the irresistible terms afforded the borrower that has allowed these loans to multiply and fly under the regulators' radar. That, coupled with the inherent secrecy associated with these transactions, has prevented normally astute market observers from considering the profound implications of these "loans". Mining companies could hardly be faulted, on the surface, for hedging future production from adverse pricing movements. But the desire to hedge is not what explains why there is an astounding two full years of total world gold mine production pre-sold by mining companies. Why don't we have equivalent amounts hedged in any other commodity, why just gold and silver? It's obviously not because the price of gold and silver is so high. No, it's because the mining companies were given an offer that they couldn't refuse and it has nothing to do with hedging. Where else in the world of commerce could a company get prepaid for what it might produce in the future? The mining companies might actually believe that their motivation is to hedge, but they are just succumbing to the lure of cash on the barrel head. Stated differently, would the gold and silver mining companies be "hedging" to the current extent if they didn't get cash up front? Some are actually hedging at less than their production costs according to the earnings statements that I've read. These aren't hedges, these are bribes. No legitimate mining company would lock in current prices in such massive quantities without cash up front from the central banks. That's why you won't find such ridiculous levels of hedging in any other metal or any other commodity, just gold and silver. Since the central banks don't own stockpiles of oil or soybeans, they can't entice the producers of those commodities to "hedge" by giving them the cash up front. The lure of easy cash from the central banks has subverted common sense and prudent business practices for many gold and silver mining companies. Sadly and ironically, the next metal bull market will put many out of business. That's just the beginning of the problem - it gets much worse.

Where else in the
world of commerce
could a company
get prepaid for what
it might produce
in the future?

As unsound as the hedging activities of many gold and silver mining companies will prove be to their shareholders in the next precious metals bull market, the political and social repercussions to the lending central banks promise to be more severe. After all, these central banks are undoubtedly carrying the metal that they have loaned out as still on their books. These weren't sales - they were loans, they'll say. In fact, these transactions were neither, because unlike a real loan they don't stand a chance of being repaid as scheduled. And, unlike a sale, they did not receive the proceeds. It's like a hybrid with only the bad features of each. Of course, there will have to be some monetary settlement for the central banks to compensate for metal they will not be receiving - but that's just the point, that these metal loans, in spite of the preferential low interest rate, can't be repaid as issued. It will be interesting to hear the explanations of the lending central bankers as to why they entered these transactions in the first place and what happened to their national treasure.

But the problems of the central banks, as well as the over-hedged mining companies, are overshadowed by the implications to the world markets of the cumulative effects of 15 years of fraudulent metal loans. That gold and silver prices have been artificially depressed for such a long period of time is a relatively straight-forward position to prove. Both markets have been and are in a pronounced and escalating physical deficit. In each, the world physically consumes more than it produces each year, with the resultant shortfall satisfied by inventory depletion. That inventories could be liquidated for years with declining nominal and inflation adjusted prices would appear to invalidate the law of supply and demand. After all, how do you bid away inventory of existing stock from owners with lower, not higher prices? You shouldn't be able to do that for days, let alone years, for world market commodities. There would have to be an obvious extraordinary supply source being released to effect such a condition. That supply source would have to be incredibly price-insensitive, that is, the sellers wouldn't or couldn't care less what price they received for their property. The central banks that are lending gold and silver receive no price for their metal (as in zero), save 1 or 2% a year interest and an empty promise of repayment. You can't get more price-insensitive than that. If this isn't dumping and manipulation, then those things just don't exist. Just to put some numbers on how absurd the uneconomic release of central bank metal has become, the consumption of gold and silver exceeds total world production by a factor of between 30 to 40%, with central bank lending providing the vast majority of the shortfall. A reasonable person would have to conclude that an amount of dumping of such proportions would have to have a significant impact on price and that the circumstance of how the central banks' gold and silver is being dumped on the market was uneconomic at best, and most probably manipulative to prices.

As if the total uneconomic dominance, distortion and manipulation of the real gold and silver markets weren't enough for the lenders, borrowers and the middlemen, there is another massive and ugly angle to the fraud. Millions upon hundreds of millions of troy ounces of gold and silver equivalents of derivatives, options, futures, swaps and any possible kind of paper that could be concocted by the rocket scientists of Wall Street have been sold to anyone who was attracted to the spectacularly bullish fundamentals of a precious metal in a deficit supply/demand equation. First, you absolutely crush two of the world's oldest and most important markets, then you clean up to the tune of billions and billions of dollars by issuing paper you know will be worthless because the markets are fixed. It has to be the all-time ultimate rip off. That leading U.S. financial institutions, including banks and insurance companies, appear to be heavily involved in all aspects of this fraud is most troubling.

I urge you to use the full power of your offices to immediately forbid the facilitation, issuance or solicitation of any future gold or silver loan involving any U.S. commercial or investment bank or financial institution under your jurisdiction, and to punish the perpetrators of this scam. While there is no way the lending central banks can collectively be repaid with metal on loans already outstanding, you must not allow the fraud and manipulation to escalate.

Respectfully yours,

Theodore J. Butler

78 percent of the yearly gold supply is made into jewelry.

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