The Mystery of the Disappearing SDR Certificates

August 13, 2001 – Here’s a mystery for you. It ranks high with any of the great thrillers solved by Sherlock Holmes, but this one is not fiction.

I have been arguing that the US Treasury and possibly the IMF have been selling gold, and that their actions have depressed the gold price. But if I am right, then why has the reported weight of the US Gold Reserve and the gold stock of the IMF remained unchanged?

The easiest answer to this question is also the most unlikely. This low probability answer is that the US Gold Reserve and the gold stock of the IMF are not being accurately reported.

I dismiss this answer, almost completely but maybe not entirely because one never knows what could be happening. A deliberately reported inaccurate weight of gold would mean fraud, and I don’t see that deception to be a highly probable outcome. No, I think there has to be another answer.

I touched upon the possible solution to this mystery earlier this year. I wrote (“Behind Closed Doors”) that the portion of the US Gold Reserve stored at the depository in West Point, New York had been swapped with gold owned by the Bundesbank, and that the gold in the German central bank had been sold. So far, nothing I have seen refutes this contention, and correspondence from the Bundesbank has wrapped much of its gold policy in a cloak of confidentiality, adding credence to my conclusion. After all, if my supposition weren’t true, why not just disclose the facts to convincingly refute it?

Be that as it may, there were some loose ends that in my mind needed to be tidied up in order to add more substance to my contention that much of the US Gold Reserve was swapped and then sold. And first among those loose ends was the accounting. How were all of these gold transactions being accounted for? How could all of this gold be put into play even while the reported weight of the US Gold Reserve and the gold stock of the IMF remained unchanged? And perhaps most importantly, why didn’t these transactions result in any apparent change on the balance sheet of the main perpetrators of this scheme, the Federal Reserve and the Exchange Stabilization Fund? There has to be some kind of accounting trail, doesn’t there?

I’ve thought long and hard about these questions, but have been unable to answer them to my satisfaction – until now. And in this regard, I would like to thank David Walker, a tireless researcher who has an uncanny ability to read between the lines of tedious and dull government reports to get at the truth. Dave’s terrific work provided me with the motivation to continue researching an area that until recently had been largely unfruitful for me. And what is that area? A monetary instrument emitted by the International Monetary Fund called the SDR, an acronym for Special Drawing Rights a.k.a. ‘paper gold’.

My intuitive sense for some time had been that SDR’s were the key necessary to unlock the door. By understanding the SDR, I expected that one could understand what was happening to the US Gold Reserve as well as put together a consistent accounting and the legal framework for the gold transactions that I contend have been taking place. But even though I thought SDR’s would provide the much sought after answer I was seeking, I was having trouble with a few things, mainly related to the accounting.

For example, SDRs are so-called “paper gold”, so this financial asset has to have a corresponding liability just like any other ‘paper’ money, right? But I couldn’t find who or what is actually liable for the SDRs.

After digging away in the IMF archives, I found the following in an IMF accounting manual called the Manual on Monetary and Financial Statistics, in a section entitled “Definition of Financial Assets”: www.imf.org.

“Monetary gold and SDRs issued by the IMF are financial assets for which there are no corresponding financial liabilities.”

How about that? No wonder I couldn’t reconcile the accounting. Here’s a purely financial asset with no corresponding liability!?! SDR’s issued by the IMF are accounted in the same way that the IMF accounts for its stock of gold. I thought that only tangible assets like gold, houses and land had no liabilities. I never dreamed that a financial asset would not have a corresponding liability, but after this realization, one thing led to another and everything slowly but surely started falling into place.

In “Behind Closed Doors” I included the following quote from the transcript of the January 31st, 1995 FOMC meeting:

MR. TRUMAN. The legislation governing the objectives of the ESF was changed, I think for the most part in the mid- to late-1970s. The changes included the language that the government of the United States and the International Monetary Fund have the obligation to promote orderly exchange rate arrangements leading to a stable system of exchange rates.

Since first reading this candid comment I have always been struck by it. Truman is relying upon this 1970’s legislation to provide the legal justification to use the ESF to bail-out Mexico. It therefore seemed clear to me that if I could figure out what was implemented in the 1970’s, I could then come to more precisely understand how the US Gold Reserve was being put into play.

I had been unsuccessful, however, in trying to figure out what was the legislation to which Truman was referring. Well, I now think that he was referring at least in part to what is called the Second Amendment of the IMF.

By way of background, when the gold crisis in the 1960’s was in full swing, the original IMF articles were amended. This First Amendment to the IMF created SDRs. Then here’s what the Second Amendment did. (www.imf.org)

What changed under the Second Amendment to the Articles of Agreement of the IMF? The Second Amendment to the Articles of Agreement of the IMF, which came into effect in April 1978, eliminated the use of gold as the common denominator of the par value system and as the basis of the value of the SDR. The Amendment also abolished the official price of gold and abrogated the obligatory uses of gold in transactions between the IMF and its members… Under the Amendment, members undertook to collaborate with the IMF and other members with respect to reserve assets to promote better international surveillance of international liquidity.

I draw your attention to the last sentence. I think this statement explains what Ted Truman was referring to. The term “international liquidity” is a euphemism I think that gives a carte blanche to do whatever the various IMF members want to do, using assets that are at hand or whatever assets that they create out of thin air, to intervene and manipulate any market anyway they want under the guise of “international liquidity” – which really means to let the banks create credit out of thin air for no other purpose but to keep the present system afloat so they can preserve their position of privilege and keep lining their pockets.

The following quote is from the “User’s Guide to the SDR” published by the IMF. (www.imf.org)

3. Improvements in the SDR after the Second Amendment:
One of the major objectives of the Second Amendment of the Fund’s Articles of Agreement, which became effective on April 1, 1978, is to make the SDR the principal reserve asset of the international monetary system. To this end, the Fund’s Executive Board has taken a number of decisions to improve the yield on the SDR and its liquidity and usability. At the same time, certain obligations arising from participation have been eliminated.

“Improvements” to you and me may sound innocuous, but in reality these ‘improvements’ have only one objective – to keep the present system afloat by providing more power to governments working hand-in-hand with the banking cartel. So far I’m not sure of all the ways the SDR became more usable, nor have I yet discovered all the obligations that were eliminated when the Second Amendment “improved” the SDR. But I have learned enough about the SDR to conclude why the accounting of the US Gold Reserve does not appear to have changed. This mystery can be solved by first solving a second mystery, the case of the disappearing SDR Certificates.

To begin, it is necessary to provide some background information gleaned from more hours of studying arcane IMF accounting than I care to admit, but I’ll keep it simple. And the way to do that is to show how ‘real gold’ and Gold Certificates are accounted, because I have learned that ‘paper gold’ and SDR Certificates are accounted essentially the same way.

The US Gold Reserve does double-duty. It sits in the vaults at Fort Knox and the other depositories, but the US Treasury has issued Gold Certificates against it. The Federal Reserve owns these Gold Certificates, giving the Fed a claim to the 261.6 million ounces in the US Gold Reserve. Simple enough, and the same transaction is used for ‘paper gold’ – the SDR’s – with just one small difference. The US Treasury has transferred its SDR’s to the ESF, so the ESF and not the US Treasury issued the SDR Certificates now owned by the Federal Reserve.

Importantly, these SDR Certificates are being accounted for much the same way as the Gold Certificates. Both are carried at book value, which is much less than their market value. The Gold Certificates are carried on the Federal Reserve’s books at $11,046 million, which doesn’t sound like much. However, when you consider that these Gold Certificates are being valued at only $42.22 per ounce, this asset represents the entire 261.6 million ounces in the US Gold Reserve. And the SDR Certificates are being valued at – well, here is where it starts to get interesting. And here is where the mystery of the disappearing SDR Certificates comes into play. Look at the decline in the SDR Certificates in the accompanying table.

The above table presents the SDR assets and liabilities of the ESF and the Fed. Though recent figures for the ESF are not available, as of August 9th the Fed still owns only 2,200 million of SDR Certificates, so presumably the SDR entries on the ESF balance sheet have not changed much since December 2000. To understand why the SDR Certificates are disappearing as well as where they are going, more background information is necessary.

The US, like each IMF Member, owns SDR’s but is also responsible for the value of the SDR. Note #4 of the ESF’s financial statement for 1999 explains it thus: “Its [the SDR’s] value as a reserve asset derives, essentially, from the commitments of participants to hold and accept SDR’s and to honor various obligations connected with its proper functioning as a reserve asset.”

As of December 1998, the ESF owned 10,603 million SDR’s, but it had a liability for 6,899 million SDR’s. What does this liability represent? Here’s what Schedule B of the Articles of Agreement of the IMF says: “…0.888671 gram of fine gold shall be equivalent to one special drawing right.” That means 35 SDR’s equals one ounce of gold. So the US has the potential obligation as of December 2000 – if required to make good on SDR’s issued – to pay to the IMF or its members 182.4 million ounces of gold, some 69.7% of the US Gold Reserve.

That huge liability is pretty scary, but it is only a potential liability. Who knows whether the US will ever be required to make good on it, or if it does, whether the US will default just like it defaulted in 1933 on its obligation to pay US government bonds in gold and in 1971 on its obligation to redeem 35 dollars for one ounce of gold. Those are problems to worry about in the future. Of more immediate concern is the decline in the SDR Certificates. What is that all about? To answer this question and to solve this mystery of the disappearing SDR Certificates, we have to once again go back to basics.

Why are the SDR Certificates declining? The basic answer is quite simple. The SDR Certificates MUST BE reduced if the ESF intends to use its SDR’s for any purpose, such as market intervention or swaps. In other words, the SDR Certificates are a claim against the SDR’s, so the SDR Certificate must be cancelled to remove any claims on the SDR before the SDR can be used by the ESF. But the amount of SDR’s owned by the ESF hasn’t changed except briefly in early 1999, so it seems that the SDR’s are not being used for any purpose.

So what I think has happened is that the SDR Certificates are themselves being used by the ESF. Here’s what the IMF says about the use of SDR’s in swaps: “In accordance with Article XIX, Section 2(c), the Fund prescribes that…a participant, by agreement with another participant, may engage in an operation by which (a) one of the parties transfers [i.e., swaps] to the other party SDRs in exchange for an equivalent amount of currency or another monetary asset, other than gold.”

Thus, SDR’s cannot be swapped for gold, but there is no IMF regulation that prohibits the swapping of SDR Certificates for gold. So let’s take this observation to its logical conclusion, namely, that the ESF and/or the Federal Reserve has been swapping SDR Certificates issued by the ESF for gold owned by the Bundesbank, and presumably other central banks as well because we noted above that the Second Amendment states that “members undertook to collaborate with the IMF and other members” for the sake of international liquidity. So presumably, all IMF members are committed to undertake any scheme that the US government may hatch.

This interpretation may also explain the strange response to Alan Greenspan by the Fed’s General Counsel, Virgil Mattingly, who has “no clear recollection of exactly” what he said during the January 31st, 1995 FOMC meeting, even though it seems most likely that the transcript accurately records him as saying “gold swaps”. In his June 8, 2001 note to Greenspan, Mattingly states: “I can confirm that I have no knowledge of any ‘gold swaps’ by either the Federal Reserve or the ESF.” Is Mattingly being truthful? Yes, I think so, at least in regard to the precise choice of terms used in his note.

Remember President Clinton’s exegesis on the definition of the word is? Lawyer Mattingly I think is playing the same game. By this line of thinking, neither the Federal Reserve nor the ESF do ‘gold swaps’. Instead, these transactions are probably called “SDR Certificate Swaps” or some other similar term, although the FOMC participants may use the unofficial term “gold swaps” as a short-hand moniker that is not only easier to say than the official name of the transaction, but also has the added advantage of clearly communicating the net result of the transaction.

There is another important piece of corroborating evidence that SDR Certificates are being used by the ESF to hide its gold transactions. When several months ago I first read the audited financial statement of the ESF, I was struck by a peculiar phrase in footnote #4, which in addition to considerable explanatory text also provided a table of SDR purchases and sales during the year. The text stated that these purchases and sales were “equivalent of SDR’s”. Therefore, I concluded that if they were “equivalent of SDR’s”, SDR’s were not actually being used in the transaction. But I wondered, if they weren’t SDR’s, then what were they? We don’t know for sure what they are, but they are probably SDR Certificate transactions – not SDR’s, but only their “equivalent”.

Let’s put the size of these transactions into perspective. As of December 2000, the ESF owned 10,539 million SDR’s, against which it has issued 2,200 million SDR Certificates. Therefore, 8,338 million SDR’s are potentially ‘in play’, but we can refine this number given that it is the SDR Certificates and not the SDR’s that are important.

The ESF by law cannot issue more SDR Certificates than it has SDR’s. The largest amount of SDR Certificates outstanding was 10,168 million in December 1995, a significant date because I have contended all along that government actions that have depressed the gold price began in 1996, which is the same year that the SDR Certificates began to decline. From this peak to the present, the SDR Certificates have been reduced by 7,968 million. Given that there are 35 SDR per ounce of gold, this reduction in the SDR Certificate account equates to 227.7 million ounces, or 87% of the US Gold Reserve. Does this mean that 87% of the US Gold Reserve has already been swapped? I don’t have the answer to that question, but I would like to make four important observations that do in fact suggest that substantially all of the US Gold Reserve has been put into play.

First, note on the accompanying table the dates when the SDR Certificates began to decline rapidly. From 10,168 million in December 1995, the SDR Certificate account declined to 8,200 million by June 1999, or 19% over 3½ years. Now look at the decline beginning in the third quarter of 1999, which corresponds with the Washington Agreement signed in September of that year. In only 18 months the SDR Certificate account declined by 73%. Was there a panic to get gold into the market after the Washington Agreement to keep the gold price from rising? This evidence sure does support that conclusion.

Second, readers will recall how the US Treasury changed in September 2000 the classification of that portion of the US Gold Reserve in West Point to “Custodial Gold”. It is interesting and probably meaningful to note that this change occurred in the fiscal year ending September 30th in which there was a substantial decline in the SDR Certificates.

In “Behind Closed Doors” I speculated that the reason for this reclassification was that the Mint’s accountants or its new director realized that it was misleading to continue calling this swapped metal as “Gold Bullion Reserve”. This logic may also explain why more recently, the entire US Gold Reserve was reclassified as “Deep Storage Gold”. If 87% of the US Gold Reserve has indeed been swapped, it may have been too obvious an admission by the US Treasury to reclassify nearly the entire US Gold Reserve as “Custodial Gold”. Therefore, to give some semblance of proper accounting while not totally divulging the truth, the Treasury came up with the half-baked term “Deep Storage Gold”. Further, it was my thinking that the Treasury, taking a lesson from lawyers Clinton and Mattingly, probably defined this term in some obscure Treasury accounting manual.

What was a speculation on my part is now supported by a letter dated August 7, 2001, to Richard May from John P. Mitchell, Deputy Director of the US Mint. Mitchell states: “The gold in West Point was not reclassified – it was renamed to better conform to our audited financial statements.” Despite providing five pages of supporting material with his letter, Mitchell does not explain how this ‘renaming’ enables the Treasury to “better conform to [its] audited financial statements.” The logical conclusion is that this better conformation arises because the strict application of prudent accounting principles no longer allows the Treasury to use the term “US Gold Reserves” because more than half – and possibly 87% of it – has been swapped. Given that the Treasury does not want to use the more accurate but alarming term “Custodial Gold”, the US Gold Reserve has therefore instead become “Deep Storage Gold”, allowing the Treasury to remain within the letter if not the spirit of the principle of full disclosure.

The third observation takes the above changes and explains them in weights of gold. The 6,000 million drop in SDR Certificates from June 1999 to December 2000 represents 171.4 million ounces, or 28.6 million ounces (888.7 tonnes) per quarter. That’s a supply of about 3500 tonnes per year, which added to 2500 tonnes new mine production implies an annual demand of 6000 tonnes for the period of time after the Washington Agreement. Is this number reasonable?

In my opinion it is reasonable. Noted gold analyst Frank Veneroso contends that annual gold demand has been running about 5000 tonnes, but this number reflects normal market conditions. After the Washington Agreement and the price spike, the market was anything but normal. Even though fabrication demand fell during that period, investment and monetary demand for gold soared. So it is not unreasonable to expect that more than 1000 tonnes of newly supplied gold from government dishoarding was needed in the months after the Washington Agreement to turn the price back from the +$320 level reached at that time.

The fourth and final observation relates to a point I made in the last newsletter. I noted how earmarked gold has been shipped from the Federal Reserve Bank of New York at a rate of at least 40 tonnes per month beginning in September 2000, while also stating this new “dishoarding from the NY Fed smacks of desperation”. The above table confirms this conclusion.

The SDR Certificate account has not changed since the 4th quarter of 2000. With only 2,200 million remaining, the SDR Certificate account, while not depleted, is near rock bottom and one must ask how much more gold the US government is willing to throw at the market? I don’t think the answer to that question is “all of it”, so essentially there is no more US gold available for swapping. Consequently, with these SDR Certificate swaps eliminated as a source of supply, another source of gold had to be located to fill the gap between supply and demand.

In the last newsletter I suggested that the IMF is this new source. That’s just a supposition on my part, but it seems logical that IMF gold is being shipped out of the FRB of NY. The quantities being shipped are so large, the gold must be coming from a large hoard, and the IMF has, on paper at least, one of the world’s largest. But regardless of whose it is, this gold is being shipped at a rate greater than gold is being mined each month in South Africa, the world’s largest producer. That volume of shipments smacks of desperation to get gold into the market, and the reason is clear. Because the SDR Certificate swaps have ended, a new source of gold supply is needed to keep the gold price from exploding upward.

In conclusion, it is becoming very obvious that the US government has put itself in an incredible pickle. But we’ve seen this happen before.

In the 1960’s the US government dishoarded over 9000 tonnes of gold rather than admit that the dollar had been debased and was no longer worth only $35 per ounce. Now it appears that perhaps as much as 7,000 tonnes (227.7 million ounces) has been swapped for essentially the same purpose – to intervene in the market to fight the truth, rather than admit that the dollar has again become very debased relative to gold.