The Great Incredible Gold Subsidy
“Every individual is a potential gold buyer, although he may not need the gold. It may be added to the store of personal wealth, and passed from generation to generation as an object of family wealth. There is no other economic good as marketable as gold.” Hans F. Sennholz (Austrian School economist and editor of the 1975 book, Gold is Money).
I was amused by this week’s headline on Bloomberg, “The 500 Tons of Gold That Show Global Rise in Investor Angst.” According to that article, global gold holdings have risen by:
“more than 500 metric tons since bottoming in January in a signal of investors’ rising concern about slowing growth, a Federal Reserve that’s probably on hold and the ructions caused by Britain’s vote to quit the European Union.”
Gold in exchange traded funds rose 6.6 tonnes on Friday to 1,959.1 tonnes, up from 1,458.1 tonnes on January 5th, 2016. Again according to Bloomberg:
“Bullion prices climbed to the highest level in more than two years in June as investors absorbed the implications of the U.K. result, adding to a rally that’s been driven by the Fed’s hesitation in raising borrowing costs and the spread of negative rates in Europe and Japan.”
Well, I suppose after an hysterical, four month-long “Project Fear” campaign mounted by British Prime Minister David Cameron and the Remain side in the United Kingdom referendum on European Union membership — a campaign aided and abetted by leaders from all around the planet — the majority vote for Brexit would likely generate some nervousness, and even more investor “angst”. Still, the gold Exchange-Traded Funds have some way still to go to regain their peak in 2012 of 2,632.5 tonnes.
But all of this misses the point.
In 1971, President Nixon was forced to abandon the dollar’s convertibility link to gold at the then official price of $42 per troy ounce. In theory, all the west’s currencies had a fixed link to the dollar with the greenback being convertible into gold for the west’s central banks at the official rate. A two-tiered gold market had existed since 1968, with an official rate used by the central banks and a free market rate used by everyone else. Needless to say, the free market price went higher than the official price.
By agreement, central banks were not allowed to buy gold in the free market, though by late 1974 they could sell their gold reserves there if they wished. Few wished to sell gold at all, although some chronically mismanaged countries like Italy raised loans against their gold holdings, in Italy’s case from the then West Germany. In the event of an actual physical gold transfer between debtor and creditor, the International Monetary Fund insisted the transfer take place using the official lower price. It was, and has been since 1971, a recipe for today’s fiat money disaster.
At a stroke, and without consultation, the dollar and all the lesser currencies, became “fiat” currencies, exactly the same as with the communist currencies. The last systemic link to order, i.e. gold, was lost, and disorder took its place, lately in spades. Politicians and central bankers everywhere became profligate money spenders and money issuers. The free lunch had arrived, deficits didn’t matter anymore.
Of course it was a Great Big Error and money supply ballooned everywhere, and has never stopped ballooning since. Instead of devaluing the dollar against gold in 1971 and keeping discipline, the world took off like a rocket on forever-devaluing fiat currency.
Now comes the really interesting bit, how gold has reached getting a subsidy of $67,000/oz by some measure, $47,600/oz by another measure, and $3,982/oz by the narrowest measure (the one I have chosen). I’ve opted to use the USA’s figures, but the global fiat money problem is obviously much larger.
In August 1971 when America went off the gold link, M1 money supply (narrow money) according to the Federal Reserve was $226.5 billion, the currency component part of M1 was $51.3 billion. America held gold reserves totalling $262 million ounces. Each ounce of gold covered $195.80. At the official price of $42, each ounce had a deficit of $153.80.
Fast forward through wars, bubbles and busts to June 20, 2016. The M1 currency component has ballooned to $1.3839 trillion. The gold position, we are told, is still 262 million ounces, though it has never been audited since the 1950s (and then only partially). Each ounce of gold now covers an impressive $5,282. With the gold price itself suppressed to $1,300/oz this means that, when the whole system crashes, each ounce of gold is carrying a subsidy of $3,982. Not too shabby considering the state of the world.
But by other monetary measures it gets even better. Though the Fed dropped M3, their widest monetary measure, back in 2006, privately-assembled M3 measures are available for use. At the end of December 2015, M3 was estimated at about $18 trillion. Each ounce of gold now covered by $68,702; deduct the present price of the metal and each ounce is carrying a gold subsidy of an incredible $67,402.
The central bankers seem to think that this state of affairs can go on forever, growing like Topsy to the sky. I think the whole system blows up long before then, releasing the gold subsidy — an interesting long term investment, I think. Gold flows from west to Asia’s east in anticipation that the subsidy will one day get released.
To finish, a couple of other apposite quotations:
“It was a confusion of ideas between him and one of the lions he was hunting in Kenya that had caused A. B. Spottsworth to make the obituary column. He thought the lion was dead, and the lion thought it wasn’t.” P. G. Wodehouse.
“If we went back on the gold standard and we adhered to the actual structure of the gold standard as it existed prior to 1913, we’d be fine. Remember that the period 1870 to 1913 was one of the most aggressive periods economically that we’ve had in the United States, and that was a golden period of the gold standard. I’m known as a gold bug and everyone laughs at me, but why do central banks own gold now?” Alan Greenspan. June 28, 2016.
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