Strange Things Are Happening With Gold
Last week featured two unusual stories on gold — one strange and the other truly weird.
These stories explain why gold is not just money but is the most politicised form of money.
They show that while politicians publicly disparage gold, they quietly pay close attention to it.
The first strange gold story involves Germany…
The Deutsche Bundesbank, the central bank of Germany, announced that it had completed the repatriation of gold to Frankfurt from foreign vaults.
The German story is the completion of a process that began in 2013. That’s when the Deutsche Bundesbank first requested a return of some of the German gold from vaults in Paris, in London and at the Federal Reserve Bank of New York.
Those gold transfers have now been completed.
This is a topic I first raised in the introduction to Currency Wars in 2011.
I suggested that in extremis, the US might freeze or confiscate foreign gold stored on US soil using powers under the International Emergency Economic Powers Act, the Trading with the Enemy Act or the USA Patriot Act.
This then became a political issue in Europe with agitation for repatriation in the Netherlands, Germany and Austria.
Europeans wanted to get gold out of the US and safely back to their own national vaults. The German transfer was completed ahead of schedule; the original completion date was 2020.
But the German central bank does not actually want the gold back because there is no well-developed gold-leasing market in Frankfurt and no experience leasing gold under German law.
German gold in New York or London was available for leasing under New York or UK law as part of global price-manipulation schemes.
Moving gold to Frankfurt reduces the floating supply available for leasing, making it more difficult to keep the manipulation going.
Why did Germany do it?
The driving force both in 2013 (date of announcement) and 2017 (date of completion) is that both years are election years in Germany.
Angela Merkel’s position as chancellor of Germany is up for a vote on 24 September 2017. She may need a coalition to stay in power, and there’s a small nationalist party in Germany that agitates for gold repatriation.
Merkel stage-managed this gold repatriation with the Deutsche Bundesbank both in 2013, and this week to appease that small nationalist party and keep them in the coalition.
That’s why the repatriation was completed three years early. She needs the votes now.
But the truly weird gold story comes from the United States…
A top level visit to Fort Knox
Secretary of the Treasury Steve Mnuchin and Senate Majority Leader Mitch McConnell just paid a visit to Fort Knox to see the US gold supply.
Mnuchin is only the third Treasury secretary in history ever to visit Fort Knox and this was the first official visit from Washington, DC, since 1974.
The US government likes to ignore gold and not draw attention to it. Official visits to Fort Knox give gold some monetary credence that central banks would prefer it does not have.
Why an impromptu visit by Mnuchin and McConnell?
And why now?
Borrowing money without adding to the debt
The answer may lie in the fact that the Treasury is running out of cash and could be broke by 29 September if Congress does not increase the debt ceiling again by then.
But the Treasury could get US$355 billion in cash from thin air without increasing the debt simply by revaluing US gold to a market price. (US gold is currently officially valued at US$42.22 per ounce on the Treasury’s books versus a market price of US$1,285 per ounce.)
Once the Treasury revalues the gold, the Treasury can issue new “gold certificates” to the Fed and demand newly printed money in the Treasury’s account under the Gold Reserve Act of 1934.
Since this money comes from gold revaluation, it does not increase the national debt and no debt ceiling legislation is required.
This would be a way around the debt ceiling if Congress cannot increase it in a timely way.
This weird gold trick was actually done by the Eisenhower administration in 1953.
Maybe Mnuchin and McConnell just wanted to make sure the gold was there before they revalue it and issue new certificates.
Whatever the reason, this much official attention to gold is just one more psychological lift to the price along with Fed ease, scarce supply and continued voracious buying by Russia and China.
How Central Banks could Cause Massive Inflation in Just 15 Minutes
One of the conundrums of monetary policy over the past eight years is the Federal Reserve’s failure to cause inflation.
This sounds strange to most.
People associate inflation with misguided monetary policy by central banks.
So-called “money printing” is seen as a certain path to inflation.
The US Fed, for example, has printed almost $4 trillion since 2008.
Yet inflation (at least as measured by official statistics) is barely noticeable.
With so much money around, where’s the inflation?
This conundrum has several answers.
The first is that the Fed has been printing money, but few loaned it or spent it.
The banks haven’t wanted to make loans, and consumers haven’t wanted to borrow.
In fact, the private sector on the whole was deleveraging — selling off assets and paying off debt — even as public debt expanded. The speed at which consumers spend money (technically called velocity) hasn’t accelerated.
From 1996-2008, it increased at a steady pace, exactly as Milton Friedman and other monetarists had recommended since the 1970s.
Beginning in 2008, the money supply “went vertical” with three successive quantitative easing (QE) programs of money printing. These were QE1, QE2 and QE3.
But there was declining velocity over the same period.
In effect, the money printing from 2008-2015 was cancelled out by the declining velocity over the same period.
The result was practically no inflation.
All the tricks have failed
Increased money supply alone does not cause inflation. The money must be borrowed and spent. The absence of lending and spending (declining velocity) is one reason disinflation and deflation have been more prevalent than inflation.
The second reason for the absence of inflation is that the world has been confronting powerful deflationary headwinds, principally demographics and technology. The rate of increase of global population peaked in 1995.
Today populations are in decline in Japan, Russia and Europe. They are also stagnant elsewhere outside of Africa and the Middle East.
Fewer people means less aggregate demand for goods and services. Improved technology and efficiencies from predictive analytics have lowered the cost of everything from inventories to transportation.
This combination of less demand and greater efficiency results in lower prices.
The final reason is globalisation.
The ability of global corporations to locate factories and obtain resources anywhere in the world has expanded the pool of available labour.
Global supply chains and advanced logistics mean that products like smartphones are created with US technology, German screens, Korean semiconductors and Chinese assembly.
The phones are then sold from India to Iceland and beyond. Yet many of the workers are paid little for their value-added in these global supply chains.
These deflationary tendencies create a major policy problem for the Fed.
Governments need to cause inflation in order to reduce the real value of government debt. Inflation also increases nominal (if not real) incomes. These nominal increases can be taxed.
Persistent deflation will increase the value of debt and decrease tax revenues in ways that can cause governments to go bankrupt. Governments are therefore champions of inflation and rely on central banks to cause it.
In the past eight years, the Fed has tried every trick in the book to cause inflation.
They have lowered rates, printed money, engaged in currency wars, used “forward guidance” (promises not to raise rates in the future), implemented “Operation Twist” and used nominal GDP targets.
All of these methods have failed.
The Fed then shot itself in the foot by tapering asset purchases, removing forward guidance and raising rates.
These tightening moves made the dollar stronger and increased deflationary forces even as the Fed claimed it wanted more inflation.
Now it plans to start shrinking its massive balance sheet next month.
This tightening episode is proof (not that any was needed) that the Fed does not understand the dynamic deflationary forces it is now confronting.
My expectation is that the Fed will soon reverse course and return to some form of easing.
A central bank’s worst nightmare is when they want inflation and can’t get it.
The Fed’s tricks have all failed. Is there another rabbit in the hat?
Massive price inflation in 15 minutes
The Fed can cause massive inflation in 15 minutes.
They can call a board meeting, vote on a new policy, walk outside and announce to the world that effective immediately, the price of gold is $5,000 per ounce.
The Fed can make that new price stick by using the Treasury’s gold in Fort Knox and the major US bank gold dealers to conduct “open market operations” in gold.
They will be a buyer if the price hits $4,950 per ounce or less and a seller if the price hits $5,050 per ounce or higher.
They will print money when they buy and reduce the money supply when they sell via the banks. This is exactly what the Fed does today in the bond market when they pursue QE. The Fed would simply substitute gold for bonds in their dealings. The Fed would target the gold price rather than interest rates.
Of course, the point of $5,000 gold is not to reward gold investors.
The point is to cause a generalised increase in the price level.
A rise in the price of gold from $1,000 per ounce to $5,000 per ounce is really an 80% devaluation of the dollar when measured in the quantity of gold that one dollar can buy.
This 80% devaluation of the dollar against gold will cause all other dollar prices to rise also.
Oil would be $400 per barrel, gas would be $10.00 per gallon at the pump and so on.
There it is — massive inflation in 15 minutes: the time it takes to vote on the new policy.
Don’t think this is possible?
It has happened in the US twice in the past 80 years…
You may even know some people who observed both episodes from down under.
The first time was in 1933 when President Franklin Roosevelt ordered an increase in the gold price from $20.67 per ounce to $35.00 per ounce, nearly a 75% rise in the dollar price of gold.
He did this to break the deflation of the Great Depression, and it worked. The economy grew strongly from 1934-36.
The second time was in the 1970s when President Richard Nixon ended the conversion of dollars into gold by US trading partners.
Nixon did not want inflation, but he got it!
Gold went from $35 per ounce to $800 per ounce in less than nine years, a 2,200% increase.
US dollar inflation was over 50% from 1977-1981. The value of the dollar was cut in half in those five years.
A proven way to trigger huge inflation
History shows that raising the dollar price of gold is the quickest way to cause general inflation.
If the markets don’t do it, the government can. It works every time.
History also shows that gold not only goes up in inflation (the 1970s), but it also goes up in deflation (the 1930s).
When deflation runs out of control, as it did in the 1930s and may again, the government will raise the price of gold to break the back of deflation. They have to — otherwise, deflation will bankrupt the country.
Do I expect deflation to run out of control soon?
Deflation is a strong force now, but I expect that eventually the Fed will get the inflation they want — probably through forward guidance, currency wars and negative interest rates.
When that happens, gold should go up.
Still, if deflation does get the upper hand, gold should also go up if the Fed raises the price of gold to devalue the dollar when all else fails.
This makes gold the ultimate “all weather” asset class.
Gold goes up in extreme inflation and extreme deflation. Very few asset classes work well in both states of the world.
Since both inflation and deflation are possibilities today, gold belongs in every portfolio as protection against these extremes.
For more detail on sidestepping the coming monetary crisis, click here.
For The Daily Reckoning Australia