Paper vs Metal, Chapter 2

March 22, 1999 – In the last Letter I wrote that it is the physical market that drives the price of Gold, not the other way around. The paper market for Gold, namely, futures, options, etc., is not the most important factor determining the Gold price for the simple reason that the longs can ask for physical delivery.

In contrast to national currencies, all of which can be created by bookkeeping entries, Gold cannot be created out of thin air by any accounting technique. Consequently, in theory the longs (i.e., those who own Gold or own a contract that calls for the delivery of Gold) always have the upper hand. I sayin theory, because as we can see at the moment given the battering the Gold price is receiving, the much humbled longs may believe that they are very far from holding the upper hand. But they do, and a few key observations here may bring some cheer to the beleaguered longs.

Presently the markets are abuzz with the notion that the IMF does not really own Gold. Rather, the Gold supposedly held by the IMF (103 million ounces) is merely pledged to it by the member nations. By this line of thinking, the Gold remains in the vaults of the member nations, and the upshot is that the Gold is double-counted. First, the member nation reports the Gold as its reserve, and then the IMF also reports the same weight of Gold as its reserve. Sound preposterous? Well, it may not be.

I’ve been around long enough to know better than to laugh at anything. In short, I’ve seen some very strange things in my day, particularly when it comes to government accounting, so my first reaction when I heard this news was ‘it could be true; it wouldn’t surprise me‘. I know, for example, that plenty of accounting legerdemain is used by governments for reporting their so-called “capital contributions” to the World Bank, so why couldn’t these governments use the same sleight of hand with the IMF Gold?

In any case, I decided to do a little research. I did not think it likely that the IMF nor any of its member governments would provide the truth to any inquiry, but to be open about this, I would not feel comfortable accepting any of their answers anyway, knowing the level of deception governments have demonstrated this century when it comes to Gold. So I therefore decided to research this idea of the double-counting of the Gold in a different way. I went back to the IMF’s original records, specifically reviewing the thinking of the men who formed it.

The IMF was the outcome of several key people, and John Maynard Keynes of Great Britain and Harry Dexter White of the United States were the two most prominent figures. Each of their proposals, which had more in common than they differed, are now a matter of public record. White had this to say about Gold: “Earmarked gold [i.e., Gold supposedly owned but not in your possession, and we all know that possession is the ultimate proof of ownership]could be given a special status so that countries could unhesitatingly earmark large amounts with the [IMF] and still record such gold as part of their own reserve.”

If not actual double-counting, it sure sounds to me that the IMF’s founders were not too concerned about allowing Gold to perform its most important role, namely, to be a monetary asset of certainty. Mr. White does not seem to allow for the distinction between Gold you own and possess (i.e., physical metal) versus Gold you supposedly own but don’t possess (i.e., someone’s promise on paper to deliver the Gold when you ask for it). If this kind of thinking was proposed by the individual who is considered to be the ‘father’ of the IMF, then who knows what harebrained scheme the bureaucrats may have come up with to account for the Gold the IMF supposedly owns?

Interestingly, before the latest pronouncements last week of the IMF’s proposed Gold sales, I had already begun researching another matter concerning the Gold the IMF supposedly owns. As I understand it, the IMF a number of years ago requested that the Gold holdings the IMF reports on its balance sheet (i.e., the 103 million ounces) be audited. Because this Gold is ‘earmarked’, none is stored in the IMF’s own vault. Instead it is stored in the vault of the central bank and/or the treasury of its individual members, and being prudent, the IMF’s auditors recommended that the Gold supposedly owned by the IMF but stored in the different central banks/treasuries be audited. The US did not comply with this request. Why not?

I don’t know, but it does make me think about a matter I wrote about in Letter #143 published on April 25, 1994. It may also explain why the US government is working so hard to jawbone down the Gold price.

I’ve posted the entire article from Letter #143 ‘Thinking the Unthinkable’, but the gist of it is quite simple. A very knowledgeable and influential person told me a very interesting story explaining how most of the US Gold reserve was surreptitiously dishoarded in early 1968, in a diabolical scheme pursued by President Johnson. When the price of Gold did not collapse as Johnson expected, the two-tiered Gold price was then launched in March 1968, with a freemarket price and a lower so-called ‘official’ price for central bank dealings.

Because he realized that he had been duped by his advisors,President Johnson shocked the public in April 1968 with his announcement that he would not run for a second term. But this decision to step down from the pinnacle of power was not made because of his conduct of the Viet Nam War, as the media led everyone to believe, but rather, because he secretly dishoarded the substantial part of the US Gold reserve and failed to drive down the Gold price below $35 per ounce. Each subsequent administration has willingly participated in this 30-year old cover-up, recognizing that its power base would be threatened by a collapse in the Dollar if the truth ever became known.

In the 1970’s, several prominent citizens, of which Edward Durrell was the most vocal, spent considerable time and money to lobby for an audit of the Gold reserve, but to no avail. Consequently, the US Gold reserve has not been audited since President Eisenhower was in the White House. Does the US government have something to hide? Does that explain the concerted effort to drive down the price of Gold?

Again, more answers than questions, but this uncertainty makes clear the difference between paper versus metal, between national currencies and Gold. This fundamental difference is measured by my Fear Index, now at its record low, indicating Gold has never before been such good value. So confidence in the Dollar remains high, but for how much longer?

National currencies are in the end based upon the promises of politicians and also confidence in the monetary and banking system. Gold is based on its value in the freemarket. I’ll take Gold any day for one very good reason.

Although governments can manipulate the price of Gold, they cannot alter the truth, of which one reality is of greatest importance when it comes to money. Gold is the only money that is no one’s liability (when you possess the metal) so it is not subject to the unfulfilled promises of politicians nor the vagaries of the banking system (as is the case if you are holding paper).