first majestic silver

Seven Golden Threads of the Global Quilt

June 4, 1997

This paper represents a contemplation on the golden threads that emerge from the wealth of gold analysis found on Gold Eagle. Although I am a novice gold bug, my insights come from my experience as an economist and analyst of complex macro-economic issues. The "seven gold threads" are pieces of evidence, thoughts, and insights about gold, global economics, and monetary policy. I believe these threads are interconnected in both a random and intentional pattern that are part of a global market quilt. While information in the market is neither complete nor transparent, golden threads sometimes emerge. Identifying these threads and understanding their consequences to the market quilt is a study of game theory itself. The quilt is like a giant chess game where information is incomplete, indicators manipulated, key players shadowy, and where the rules and desired outcomes of the game are not always clear. As in chess, the more we contemplate the threads on the quilt, the more we may observe a pattern that allows us to practice the art of intrinsic valuation, as Warren Buffet does. I caution you; some threads may be pure gold; others may be fools gold. I leave that to your discretion and contemplation.

Thread #1: Manipulated economic indicators

Allegations (see Martin Armstrong, Princeton Economics Institute article) about the cosmetic manipulation of official macro-economic statistics by the Clinton Administration through the Department of Commerce are disturbing. Donald McAlvany's article on Gold Eagle suggests the Clinton Administration dramatically understates unemployment rates. At the same time inflation is understated and GDP is overstated. Economists have long known that key economic indicators such as inflation (CPI), unemployment, and GDP are flawed in what they fail to measure. So why have politicians chosen this point in history to exercise "aesthetic interventions" of leading indicators at this point in history? To what end and for whose benefit? My hypothesis is such aesthetic tinkering provides a smoke screen leaving investors and analysts uncertain about the true state of the economy. Without clear evidence, there is no reason to discontinue the market game, despite the sentiment that it has become unsustainable and irrational.

Ironically the market itself now exhibits its own inflationary behaviour, a force that is largely out of the control of Central Bankers. This momentum of the "lemming pack" makes CBs nervous. Even the market's own inflation indices such as price to earnings ratios that suggest an overvalued and irrational market are seemingly ignored. What are we to make of this situation? Because we are unable to confirm or refute the validity of the key economic indicators, we are left believing that the game can continue even if our intuition tells us otherwise. Astute investors like gold bugs who have studied the fundamentals of the game understand the inherent flaws. We know that the truth about the true state of the economy will eventually percolate to the top. We are either still in the game, into gold or have one foot on the dance floor and one out the door. And so we wait; patiently. When the music stops a crisis of confidence unparalleled in history will result. There is, however, a nagging question: who is benefiting from the manipulation of indicators and how it benefits those who knowing the truth remain silent?

Thread #2: Political Wrongdoing by the Clinton Administration

The revelations in the Wall Street Underground and others about the unethical practices by the Clintons seems to be the stuff of fiction, fairy tales, or soap operas. Allegations of campaign funds flowing from China and other Asian nations, Whitewater and other preposterous scenarios are disturbing and provide further evidence that market turbulence lies ahead. Perhaps the most interesting of these allegations is the receipt of campaign funds by Clinton from China, Taiwan and other Asian countries through various channels, including through their respective U.S. embassies. One wonders what deals were made for such short-sighted objectives? Most favoured trading nation status, other trade deals, relaxation of copyright and patent laws in exchange of campaign funds, or the taking on of more U.S. debt? Confirming such allegations will be difficult, however, in time the truth will be exposed through the scrutiny of the media or the court of law. When they begin to stick, the tremors in the market will make the impact of Nixon's impeachment seem like a picnic. Such truths will send shock waves around the world dealing a death blow to the U.S. dollar and stock markets. Can gold bugs be patient?

Thread #3: Gold loans to gold companies

Butler's recent letter to Mr. Greenspan posted on Gold Eagle alleges that mining companies and other firms have been receiving gold bullion loans from U.S. and European central banks since the early 1980s. You don't have to be an economist to understand the ramifications this will have on the price and "perceived" supply of gold. More disturbing is that the central bankers may have no expectation of recouping the original bullion that was lent. Firms have simply sold the bullion to finance operations and exploration. The banks would presumably, however, show no change to their supply of gold reserves or show the amount as an outstanding receivable on their books. This financing amounts to an effective loan of 1-2%. This practice makes a gold novice wonder just how "free" the market is operating or whether we are playing with a "stacked" deck. Is there evidence of such loans? Maybe. An examination of Barrick's 1996 annual report reveals a reference in the notes to the financial statements of certain gold bullion loans received from unspecified sources. These loans do not, however appear on their books as a "bullion payable."

Another interesting aside is that Barrick is hedging its 1997 production at prices of roughly $415 per ounce. Barrick is certainly not alone. While I am not qualified to comment on the appropriateness of such loans, they presumably distort the dynamics of supply, demand, and price of gold in the market. But who expects to gain from such practices and to what end? Were these senior gold companies convinced to accept gold loans in exchange for other favours? Could it be that recipient companies would benefit whether or not the suppressed price of gold makes its long awaited vault skyward?

Thread #4: Gold demand outstrips supply

Evidence from the World Gold Council, shows the enormous imbalance in the supply and demand for gold. Record quarterly demand was recorded in the first quarter of 1997. Demand in India is up 38%, up 9% in the U.S. and up 44% in Saudi Arabia. India and the U.S. remain the largest consumers of gold. Of particular interest is falling gold demand in China (down 7%), Japan (down 8%) and Taiwan (down 21%). Did the U.S. prevent or dissuade China and Japan from buying gold? Where is the evidence, in terms of gold reserves, of allegations that China was buying gold when it reached $350 per ounce or less? Were they convinced instead to buy U.S. debt? If so, did this U.S. policy essentially hamstring Japan's or China's potential international clout? The Gold Council evidence shows that the imbalance between price and demand is now close to its lowest point since Q1 1993 when price made a significant rally. Yet gold prices continue to languish despite what economics would tell us should happen. Why? Is there just a lag effect or is the game somehow manipulated?

Robert Pringle of the World Gold Council shows that despite the talk about the effects of EU gold selling, there has been virtually no net change in the reported global gold reserves. Official world gold holdings (primarily central banks) has fallen less than 5% since 1989. What is happening? Pringle notes that informed sources believe the net reduction in official holdings has been acquired by government agencies and other institutions in Singapore and Hong Kong. Official statistics, however, show no significant purchases in the last 10 years by Asian developing countries (including Japan) who collectively hold about 9% of total global gold reserves and 41% of foreign currency reserves (this latter point is worth another thread). What we may be seeing is a slight-of-hand by the European and American CBs; a lot of posturing but with no "official" net movement in reserves.

While the Chinese and Japanese have made attempts to buy gold as a hedge they may have been dissuaded. But why? The truth remains a mystery. Gold bugs might still have reason to feel confident that market forces of supply and demand will prevail even if CBs are colluding in stacking the deck. Exogenous forces outside of the CB's control, including rising demand for jewelry in India, China and the Middle East plus an end to European CB gold "sales", will continue to apply pressure on gold. How long must we wait?

Thread #5: Purchasing power of gold versus the U.S. dollar

One of the most profound threads I have come across is a study by Deutsche Morgan Grenfell (DMG) that examined the relative purchasing power of gold in relation to the U.S. Dollar. DMG's occasional paper is titled "Breaking the taboo: using gold as a financial markets indicator." The paper examines the behaviour of gold as a measure of purchasing power and shows that gold has maintained if not increased its purchasing power in the U.S. since 1792 when the U.S. dollar was conceived. A chart by Richard Salsman shows the purchasing power of gold and of the U.S. dollar between 1792 and 1994 with 1792 equal to an index of 1.0, the point when the U.S. dollar was the equivalent of 24.75 grains of gold. During the period 1792 to 1935 the U.S. dollar follows gold in virtual lock step in the range of 0.500 to 1.300 (compared to the benchmark of 1792=1.000). However, after 1935 the dollar's purchasing power begins to fall, then plunges after 1974 when the U.S. dollar is decoupled from gold. By 1994 the purchasing power of gold stood at almost 2.000 while the U.S. dollar's relative power stood between 0.075 and 0.100; a massive spread of roughly 1.900 basis points or a margin of 1900%. The largest spread ever occurred in the early 1980s, when gold hit an index of 4.000 while the dollar stood just above 0.100. Other gold bug authors have revealed similar evidence about the strength of gold over time.

Paper or fiat currencies, unlike gold, have continued to lose their purchasing power. Part of the strength of gold is its relative scarcity combined with increasing demand as a hoardable asset and annual additional supplies of 1.7%. Paper currencies are inherently weak since they can be manipulated by monetary authorities (central banks). Their relative value is subject to the sentiments of currency traders and are affected dramatically by expectations of future supply of currency and expectations of a nation's economy.

The DMG evidence reveals just how vulnerable the U.S. dollar, U.S. stock market and other international stock markets are. This shows that gold is an excellent reference point for measuring the changes in the value of commodities What is disturbing is the confidence international players have in the U.S. dollar as a store of value. The DMG analysis may reveal how the leveraging of the U.S. economy and stock market (and other stock markets) was possible by decoupling gold from the fiat currency. Also, this provided the means to create easy credit and maximize the money multiplier effect by private banks (which some economists and central bankers now deny exists). Is it any wonder we have an irrational bull market? The evidence reveals what leveraging power was made available to achieve the stupendous stock market performance by taking gold (a limited and hoardable asset) out of the equation. Gold, the only reality check because of its scarcity, was removed from the chess board and silenced. Without the gold chaperone the wild party continues. Despite such evidence gold bugs should be confident that gold will have its day. Just one tremor in the deck of debt cards, one political crisis, or threat of Middle East war will send thousands to again hoard the ancient store of value: gold.

Thread #6: Monetary Policy and the Bank of International Settlements

Few citizens know of the Bank of International Settlements (BIS); the "central bankers bank"; a shadowy group of central bankers and international financiers primarily from the G-7 nations. Decisions made by the BIS affect virtually every aspect of our economic existence from interest rates, money supply, employment policies, currencies and possibly even the price of gold. Yet, this shadowy group of players operates outside of their respective national boundaries and are unaccountable to a nation's citizens. The BIS is stuff of folklore. Located in Basel, Switzerland the BIS has existed for decades perhaps centuries as a secretive club of central bankers who meet to set global monetary policy. The BIS was to have been dismantled under the Bretton Woods Agreement after revelations that Nazi Germany had used its services to fund Germany's war effort. It never was. It continues to yield enormous influence on monetary policy throughout the world. This secretive group can essentially conspire to design the rules of the monetary policy game which will result in the outcome they desire. What is their game plan and desired outcome?

If you combine these policies with the removal of the U.S. dollar from the gold standard in the 1970s, enormous leveraging by both private and public financial institutions was made possible.

One of the most influential and perverse policy positions of the BIS has been the relaxation of the reserve requirements of private banks with central banks. Many central banks, including the Bank of Canada, have virtually eliminated the requirement of private banks to hold funds in reserve with the central bank as a safety valve against potential collapse. Some economists, including the Committee on Monetary and Economic Reform (COMER) in the U.S./Canada have, to no avail, raised the red flag on this ruinous policy. COMER and others are calling for a return to the prudent monetary policies of yesteryear when central banks were born in times of post-financial calamities. Sadly, their calls remain unheeded and even belittled by economists, politicians, and the popular media. There is evidence that these policies in combination with the money multiplier effect (which many central bankers suggest no longer exists) has goosed the creation of easy credit, the ballooning of debt, the huge profits of private banks, and the fueling of the market Phoenix bird to the point of global monetary collapse. National treasuries are exposed and extremely vulnerable. The BIS position that declares government debt as risk free and business debt with an 8% risk premium has resulted in the unprecedented loading up on government debt by private banks. If you combine these policies with the removal of the U.S. dollar from the gold standard in the 1970s, enormous leveraging by dollar from the gold standard in the 1970s, enormous leveraging by both private and public financial institutions was made possible. Easy money was available to flood the stock market. Easy money has goosed the economy to irrational and unsustainable levels. Sadly, this artificial economic development has also goosed the depletion and ruin of our environmental assets.

While fiat money may be artificially created out of virtual thin air, the accumulated debt is real and must be repaid. The question remains as to whom and who will be the first to call an end to the music of this musical chairs game? An article in the Economist several years ago suggested that if the G-7 debt game stops, it may be China left alone on the sidelines of the dance floor.

China may indeed stand on the sidelines of the game. China has enormous economic power, a virtually self-sustaining economy, the largest standing army in the world, has provided enormous debt financing to the U.S., and has reportedly been loading up on gold. When the music stops, will China rule?

Thread #7: One-World Currency

My seventh and final thread is the most controversial and pushes the envelope to the realm of fiction or is it virtual reality. You may discard this thread as you wish. If the implications of the first six golden threads suggest a conspiring of a few shadowy players to establish their own rules of the game, then what is their Holy Grail or desired outcome? It may be as simple as power and dominion; control over the most important lever of the global economy - the medium of exchange. A single world currency? Electronic currency that would replace fiat money and even gold? The servants of those few in control (perhaps the BIS) may include the presidents of nations or other senior public officials. To contemplate such a scenario of power and control seems almost preposterous. But is it? Consider for a moment the events that would usher in a single world currency in an electronic medium. These might include: financial and stock market chaos; the collapse of the U.S. dollar, Yen or the stillbirth of the Euro; war in the Middle East; or other global unrest.

Consider the following and contemplate whether there is a correlation or is it pure coincidence. Electronic currency (debit cards) and electronic transactions have already made significant inroads into our economic lives at a pace that has astounded me. The use of paper currency is discouraged and may soon be removed from the market system. Multilateral agreements for the free flow of investment are being secretively negotiated amongst the OECD. Gold remains out of favor and even discredited. Was the Bre-X fiasco orchestrated to discredit gold? What about those gold loans? Is the so-called selling of gold by European CBs a slight of hand? How exactly is the London gold price set twice a day? Does gold really behave according to the economic laws of supply and demand? Is the timing of these events pure coincidence or are there those in power who have enough influence to design the rules of the game that meet their desired outcome of power and control? If I were a game theory designer, I might consider adopting these chess moves to achieve my goal of winning.


You may have good reason to discard or refute these golden threads as the stuff of fiction. Only time and studious contemplation will reveal the truth. In the meantime we continue to play the game on the global market quilt. The rules may be set by others and thus the game stacked against gold bugs. Yet, we continue to play in hopeful anticipation that the powers of supply and demand will prevail for gold. I leave you with the nagging thought as whether or not gold will be allowed to have its day. I welcome your comments and further golden threads!

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