HE WHO HAS THE GOLD MAKES THE RULES
There is an old adage which says, "He who owns the gold makes the rules." Specifically in the past eight years, I have written about (1) the value of the dollar, (2) the trade deficit, (3) interest rates and the Federal Reserve, (4) the stock market, and (5) gold. The problems which confront us at this time include: (1) the changing value of the dollar, (2) the burgeoning trade deficit, (3) the actions of the Federal Reserve to raise (or reduce) interest rates which not only affect the stock market but affect the amount of money in our banking system to either cause spending (economic boom as a result of low interest rates) or stop spending (economic bust as a result or raising interest rates). Interestingly enough all of our financial and economic problems can be traced back to gold--which brings us to the real reason for all of the above.
In the last several years, we have seen an interesting turnaround in the value of gold with its current price at a 22 year low. We are told this is as a result of: (1) the Asian crisis which began in 1997 with the loss in demand from that region, (2) the large sales of gold by a number of central banks, and (3) the proposed sale of IMF gold to help Highly Indebted Poor Countries (HIPC).
And just like the best suspense movie you have ever seen, there is another player: the $1Trillion surplus the government found- -or will come into over the next ten years. This "new find" has raised all kinds of questions as to how we will spend it. For the first time in our economic history--since we went off of the gold standard, it is being suggested that we pay down the federal debt. I find this very interesting since the interest we pay on the debt is paid to the Federal Reserve. Why do they want us to pay our debt down? Has the American economy reached a critical cross over point? Are there deeper structural economic problems which we are not aware of?
In order to find our answer which will then provide direction for investment decisions, we need to consider a number of things: (I) a brief History of Money and the Gold Standard, (II) our Current Economic Situation, (III) The Gold Market, and (IV) Conclusions.
I. History of Money and the Gold Standard
A. Introduction
In looking to determine what is really happening to the price of gold and then to analyze what it means, I felt that a refresher was needed on money and the evolution of gold and finances. To do this, I have primarily chosen the writings of Dr. Carroll Quigley who taught Humanities at Georgetown University and who was a mentor to Bill Clinton, a fact Clinton acknowledged in his first Inaugural Speech.
Dr. Carroll Quigley wrote an 1100 page account of history called Tragedy and Hope which was published in 1966. This is an incredible book for those who want to know how history has impacted our society today. I believe that what he wrote has great value in understanding not only today's monetary situation, but in understanding the new international order, set up in the 1920's which we are living under. He wrote, "Valiant efforts were made in the period 1919-1929 to build up an international political order quite different from that which had existed in the 19th century. On the basis of the old order of sovereignty and international law, men attempted, without complete conviction of purpose, to build a new international order of collective security" (Quigley, 315). (emphasis added)
Quigley wrote that society is divided into six aspects. Three of them are: military, political, and economic. He wrote that the military level is concerned with the organization of force, the political level is concerned with the organization of power, and the economic level is concerned with the organization of wealth. This newsletter is about the organization of wealth.
As we read from Carroll Quigley's book, we will see that the world financial infrastructure before 1910 had to be changed from a (gold) system of accountability where the amount of money a country had in circulation had to line up with the amount of gold in their coffers in order to maintain a stable currency, to a NEW paper system of no accountability so that the central bank could print paper money without any accountability such as is found in "balancing the books." In this present system, the imbalance is seen in the value of a country's currency which fluctuates according to the over-supply of paper money and trade deficits.
By converting to paper, the international/merchant/investment bankers (who are the rulers of the world's wealth) were able to completely dominate the financial system of the world and make it work in a manner that would make them money regardless of interest rates, the value of currency, or the amount of money in the system. What Quigley had to say about capitalism, gold, and paper money is prophetic to what is happening today. When we understand the changes made and the history of the goldless paper system which we are in, then we can make better financial decisions today.
B. The Economic Organization of Wealth - Types of Capitalism
The economic level can be divided up into four aspects: energy (how something is produced), materials [commodities or natural capital], organization [type of--corporate, national, supranational], and control (type of capitalism). Quigley said that capitalism has evolved from the manorial-agrarian system which was called commercial capitalism in 1050 to (1) industrial capitalism which was characterized by owner management through the single-proprietorship or the partnership in the 1770's, (2) financial capitalism which began about 1850 and was symbolized by the corporation or the holding company, and today's form of capitalism which is (3) monopoly capitalism or economic pluralism which is dominated by cartels and trade associations and began to appear in 1890. Quigley went on to develop mercantilism which has had, and continues to have, very strong influences on the world today. Later on in his descriptions Quigley writes the pluralistic system which began in 1934 and centers around lobbying groups.
1. Industrial Capitalism 1770-1850
Central Banking and Fractional Reserve Banking System
Although the world's trading system was based on the same gold and silver standards used by the traders in Ancient Chaldea and Babylon, it was the country of England, at the end of the 16th century, which was "smart" enough to discover the secret of credit.
Credit is the antithesis to monetary stability as found with the gold standard. According to Quigley, the founding of the Bank of England by William Patterson and his friends in 1694 is one of the great dates in world history. For generations men had sought to avoid the one drawback of gold which was its heaviness by using pieces of paper to represent specific pieces of gold. Today we call such pieces of paper gold certificates [paper money, i.e. dollars or "Federal Reserve Notes"] which [use to] entitle its bearer to exchange it for its pieces of gold on demand [this was outlawed by President Roosevelt in 1933]. Over a period of time it became clear that only a small percentage of gold needed to be on hand to cover the small number of certificates likely to be presented for payment. This idea was a natural evolution to advance trade from further distances around the Old World. By depositing gold in a central place, paper certificates or IOU's could be used to trade without carrying large amounts of gold [JV: It should be noted that most common people who put their savings in these banks did not use gold because they knew they could obtain gold on demand at any time].
The rest of the gold reserves on deposit could be used by the bank which found that they could charge an interest on the money loaned against the unneeded reserves. Over a period of time, as Patterson found, the bank could print more money than it had in gold and lend it out, thus earning more interest income. Patterson, on obtaining the charter for the Bank of England, a private corporation, in 1694 said, 'the Bank hath benefit of interest on all moneys which it creates out of nothing" (49). The simple fact was that the bank created paper money according to how much money they had a demand for--which meant that the more paper money they created, the smaller percentage of gold in reserve [You and I almost have that privilege. Our credit cards give us an opportunity to create money--additional purchasing power than what we have at the moment. However, the difference between us and our Federal Reserve or the Bank of England is that we have to pay back our debt where they do not!! They are the ones who make the rules since they have control of the monetary system in their respective country and world.]
2. Financial Capitalism -1850 - 1931
Quigley writes, "The second stage of capitalism is of such overwhelming significance in the history of the twentieth century and its ramifications and influences have been so subterrean and even occult, that we may be excused if we devote considerable attention to its organization and methods. Essentially what it did was to take the old disorganized and localized methods of handling money and credit and organize them into an integrated system, on an international basis, which worked with incredible and well-oiled facility for many decades. The center of that system was in London with major offshoots in New York and Paris. (Quigley, 51)
"London [was chosen] because of the (1) great volume of savings in England, (2) England's oligarchic social structure-- concentrated land ownership [feudalism] which provided a very inequitable distribution of incomes coming to the control of a small, energetic upper class, (3) the upper class while aristocratic was not noble, [allowing it] to recruit money and ability from the lower levels of society [less than aristocratic] and even from outside the country, (4) the significance in the skill in financial manipulation, especially on the international scene, which the small group of merchant bankers of London had acquired in the period of commercial and industrial capitalism. [I might make mention that London still plays a very major role in money today. The Bank of England conducts the largest gold market and the London Stock Exchange is in the making to become the center for the world stock exchange.]
"The merchant bankers of London already had [dominance and control] in 1810-1850 of the Stock Exchange, the Bank of England, and the London money market. In time they brought into their financial network the provincial banking centers, organized as commercial banks and savings banks, as well as insurance companies to form all these into a single financial system on an international scale which manipulated the quantity and flow of money so that they were able to influence, if not control, governments on one side and industries on the other (Quigley, 51).
International/Merchant/Investment bankers like Amschel Rothschild of Frankfort and his six sons established branches in Vienna, London, Naples, and Paris as well as Frankfort. They were cosmopolitan rather than nationalistic. Names of other banking families included Baring, Lazard, Erlanger, Warburg, Schroder, Seligman, the Speyers, Mirabaud, Mallet, Fould, and above all Rothschilds and Morgan (Quigley, 51-51). The Rothschilds and many of these same families continue to play a very central and key role in world economic affairs today.
America's Central Banks
When the United States was founded, there were great and serious debates over who should control the monetary system of our new country. While General Washington was chosen the first President by unanimous vote, he appointed a number of constitutional advisers. Thomas Jefferson, considered one of the most accomplished scholars in America who believed in the capacity of the common people for self-government, was Secretary of State. Alexander Hamilton, an aristocrat by birth and breeding, who was well connected by marriage to a landed aristocratic family in New York which constituted the Tory element of the Revolution, was Secretary of the Treasury. These two men were at opposite ends of the political and philosophical spectrum. It was Hamilton who saw to it that the monetary system of our new country was controlled by a central bank [just like the Bank of England]. On February 25, 1791, Congress chartered the Bank of the United States. Washington accepted the views of Hamilton and signed the bill into law. (Walbert, 3)
When Congress refused to renew the Bank's charter in 1811, the War of 1812 ensued and in 1816 Congress re-charted the bank with a capital stock of $35 million. "From 1816 to 1828, it was the sole arbiter of the financial affairs of the nation, both public and private. Its power in politics was immense, and it swayed elections as well "(Walbert 11). When Andrew Jackson was elected to Congress in 1828 he announced in his first message to Congress that he would not renew its charter. By that time, the Bank had great accumulations of reserves. Jackson advocated the passage of a law distributing these surplus revenues back to the states. Senator Benton of Missouri thoroughly understood the means by which the bank had obtained its mastery over the commerce and industry of the nation, and at the session of Congress, presented a resolution in the Senate to the effect that the charter should not be renewed (Walbert 12). The bank [then] initiated a policy of expanding its loans to $71 million which were "judiciously placed among leading merchants and manufacturers, that, in the event of their being called in by the bank,` [would create] powerful pressure upon the President and Congress" (12). Senator Benton delivered the following speech to the Senate,
The government itself ceases to be independent, it ceases to be safe when the national currency
is at the will of a company [Bank of the United States]. The Government can undertake no great enterprise, neither war nor peace, without the consent and co-operation of that company; it
cannot count its revenues six months ahead without referring to the action of that company--its friendship or its enmity, its concurrence or opposition to see how far that company will permit money to be scarce or to be plentiful; how far it will let the money system go on regularly or throw it into disorder; how far it will suit the interest or policy of that company to create a tempest or suffer a calm in the money ocean. The people are not safe when such a company has such a power. The temptation is too great, the opportunity too easy, to put up or put down prices, to make and break fortunes; to bring the whole community upon its knees to the Neptunes who preside over the flux and reflux of paper. All property is at their mercy, the price of real estate, of every growing crop, of every staple article in the market, is at their command. Stocks are their playthings--their gambling theater, on which they gamble daily with as little secrecy and as little morality and far more mischief to fortunes than common gamblers carry on their operations (Walbert 14). (emphasis added)
Congress did pass a law to re-charter the Bank, but it was vetoed by Jackson who conveyed the following points: " a central bank created a monopoly under the authority of the general Government, and therefore, it increased the value of its stock far above its par value, which operated as a gift of many millions to its stock holders." He laid down the fundamental principle, that a monopoly should only be granted when it returned a fair equivalent to the people. The President advocated the sale of the stock to the highest bidder and that the premium received from it be paid to the national Treasury to lighten the burdens of taxation in lieu of its bestowal upon a few wealthy citizens. He stated that $8 million of the stock was held by foreigners, chiefly in England; that this was the most dangerous feature of the plan; that a majority of the shares of its stock might fall into those alien hands and in that event, the United States would be involved in war with that nation, thus holding a large amount of the stock of this great bank monopoly, its influence would be thrown against the United States" (Walbert 17).
While it took a number of years, the bank was not re-chartered and it eventually, after numerous political fights in the Congress, went out of business. Its demise was exacerbated when it was revealed that the president of the bank had expended hundreds of thousands of dollars in influencing elections, subsidizing the press, and bribing members of Congress. (Walbert, 24)
The Federal Reserve Act of 1913
Needless to say, the move to re-establish control over the economy of the United States did not abate. Between 1840 and 1913, there was much done to try to re-establish a private corporation to control our monetary system.
By using secretive methods, a number of people in key positions assisted with the set up and passage of the Federal Reserve Act which created a new private corporation to control the monetary system of the United States. They included: Sen. Nelson Aldrich (grandfather of David Rockefeller), Jacob Schiff and Paul Warburg of Kuhn, Loeb and Company, an international banking house, Piatt Andrew, Assistant Secretary of the Treasury, Henry P. Davidson, Senior Partner of J.P. Morgan & Company, Charles D. Norton and Frank Vanderlip, President of National City Bank which today is CitiGroup. It should be noted that the passage of this Act was done under clandestine circumstances. If it wasn't, the Act would not have been passed.
Those in the Senate who favored the Federal Reserve Act did not go home with the other Senators for Christmas break, but waited to vote in a special session convened of a quorum at 11:45 p.m. on December 24, 1913.
With the passage of the Federal Reserve Act, our monetary system changed back to one of control by a private corporation and not the United States Treasury. Our currency no longer states, "Redeemable in gold (for gold certificates or silver for silver certificates) on demand at the United States Treasury or in gold or lawful money at any Federal Reserve Bank," but it was changed to "This note is legal tender for all debts, public and private" and was issued not on paper which said "Gold Certificate" or "National Currency of the United States" but which said "Federal Reserve Note." The words of Senator Benton still ring in the halls of our Congress.
Earlier in the day on December 24, 1913, Congressman Charles A. Lindberg, Jr., stated from the floor of the House: "This Act establishes the most gigantic trust on earth. When the President signs this bill, the invisible government by the Monetary Power will be legalized....The worst legislative crime of the ages is perpetrated by this banking bill."
Since 1913, the Federal Reserve Act has been amended over 195 times. One of those amendments, Section 25 (a), set up the Edge Act. It is this bill that allows national banks to establish foreign branches in order to conduct "international or foreign banking" activities. Lastly, those who passed the original Act in 1913 would not recognize it today; its power and domain far surpass what was ever realized or intended.
Investment/Merchant/International Bankers
Quigley wrote about merchant bankers which evolved during the time period of financial capitalists who he said "were fanatical devotees of deflation (which they called 'sound money' from its close association with high interest rates and a high value of money) and the gold standard, which in their eyes symbolized and ensured these values; and they were almost equally devoted to secrecy and the secret use of financial influence in political life. These bankers came to be called 'private bankers' in France, and 'investment bankers' in the United States" (Quigley, 52).
The influence of financial capitalism and of the investment/merchant/international bankers who created it was exercised both on governments and on business, based on the assumption that politicians were too weak to be trusted with control of the monetary system. [This is why the Federal Reserve, a private corporation like the Bank of England, controls the monetary system of the United States and that is why you and I cannot forgive ourselves the interest on the debt which is paid to the Federal Reserve.] (Quigley, 53).
Who owns the central banks such as the Federal Reserve and the Bank of England? International/Merchant/Investment bankers plus private individuals who are not named!!!!
The international/merchant/investment bankers said that the soundness of money must be protected "by basing the value of money on gold and by allowing bankers to control the supply of money." "Bankers called the process of establishing a monetary system on gold "stabilization" and implied that this covered as a single consequence, stabilization of exchanges and stabilization of prices. Exchanges were stabilized on the gold standard because by law, in various countries, the monetary unit was made equal to a fixed quantity of gold and the two were made exchangeable at that legal ratio. A person in America could convert $20.67 to one fine ounce of pure gold (Quigley, 53-54)."
In 1914-1939, U.S. Federal Reserve Notes were covered by gold certificates to 40% of their value. This was reduced to 25% in 1945 and today is anywhere from 6% to 10%. "Throughout modern history, the influence of the gold standard has been deflationary because of the natural output of gold each year which has not kept pace with the increase in output of goods. Only new supplies of gold, or the suspension of the gold standard in wartime or the development of new kinds of money (like paper notes and checks) which economize the use of gold, have saved our civilization from steady price deflation over the last couple of centuries" (Quigley, 57).
As a result of the international/merchant/investment bankers who dominated both business and government through interlocking directorships, holding companies, and lesser banks, they were able to engineer amalgamations and reduce competition until by the early 20th century many activities were so monopolized that they could raise their noncompetitive prices above costs to obtain sufficient profits. "The power of these international bankers reached their peak in 1919-1931 when Montagu Norman [governor of the Bank of England] and J.P. Morgan dominated not only the financial world but international relations and other matters as well. On November 11, 1927, The Wall Street Journal called Mr. Norman 'the currency dictator of Europe'" (Quigley, 62).
"In the United States, Financial Capitalism was achieved when the structure of the financial controls created by Big Banking and Big Business were built with one corporation being built on top of the other. Quigley cites two financial powerhouses: J. P. Morgan (banking) in New York and the Rockefeller family (big business--Standard Oil) in Ohio. Between 1909 when there was only one billion dollar corporation, U.S. Steel, controlled by J. P. Morgan to 15 in 1930. By 1930, the 200 largest corporations held 49.2% of the assets of all 40,000 corporations in America or 22% of all the wealth in the country (Quigley, 72)!
Their influence was so great that the "Morgan and Rockefeller groups acting together, or even Morgan acting alone, could have wrecked the economic system of the country merely by throwing securities on the stock market for sale and, having precipitated a stock market panic, could have then bought back the securities they sold at a lower price" (Quigley, 72).
Has the possibility subsided of one or two major groups working together or alone who could wreck the economic system of the country? Unfortunately, no. If anything, these very same corporate giants have only gotten bigger and more powerful. How far do we have to look? The mergers and acquisitions which have been going strong in our economy since the beginning of the 1990's provide us with the proof. How many mom and pop hardware stores, gas stations, office supply, five and dime, etc., have gone out of business because they could not compete with the prices of Home Depots, Sams, WalMarts, Staples, etc.? The laws which originally were to guard against monopolies have fallen by the wayside with the recent merger of Mobil Oil and Exxon which is the reuniting of the Rockefeller oil empire broken apart in the 1910's by anti-monopoly legislation. Also, let us consider the buyout of Amoco by British Petroleum! Could it be that the British have a new weapon--mergers and acquisitions?
In addition, we are now seeing a merger between business and government through "public-private partnerships." These new partnerships, unfortunately, are the new cornerstone for Bill Clinton's "Reinventing Government" program which has been sold to the American people as a way of reducing expenses and saving taxpayers money but no one has explained that through a public-private partnership the representative government, as provided by our Forefathers in our Constitution, is bypassed. Furthermore, in a public-private partnership where corporations have all the money and governments all the debt, the power sharing can be skewed as a result of "who has the deepest pockets."
3. Economic Pluralism
According to Quigley, economic pluralism came about as a result of wartime control mechanisms which became the new basis for it. Pluralism operates from the "shifting alignments of a number of organized interest blocs such as labor, farmers, heavy industry, consumer, financial groups, and above all, government" (Quigley, 371). Who is swaying Congress? It is the lobbyists who are paid to bring to the attention of Congress the needs/agenda of specific interest groups.
He said that in a monopoly, the capitalist sought "profits from manipulation of the market to make the market price and the amount sold such that his profits would be maximized" (Quigley, 39). He went on to say that working people were "either directly or through cartels and trade associations in a position to exploit the majority of people" (Quigley, 40).
4. Mercantilism
Dr. Quigley weaves a very powerful and exact understanding of the economic powers that rule over the markets of the world, and you and I. He goes on to expound how financial capitalism evolved into MERCANTILISM. Dr. Quigley wrote, "the different stages of capitalism have sought to win profits by different kinds of economic activities. The original stage, which we call capitalism, sought profits by moving goods from one place to another. Commercial capitalism arose when merchants carrying goods from one area to another were able to sell these goods at their destination for a price which covered original costs, all costs of moving the goods, including the merchants expenses, and a profit. This development, which began as the movement of luxury goods, increased wealth because it led to specialization of activities both in crafts and in agriculture, which increased skills and output and brought into the market new commodities. [T]his stage of commercial capitalism became a restrictive system, sometimes called 'mercantilism,' in which merchants sought to gain profits, not from the movements of goods [alone] but from restricting the movements of goods" and subsequently the price (Quigley, 44). (emphasis added)
Quigley writes that by controlling BOTH the price and the movement of goods, the merchant could maintain his profits. Over time the merchant switched his attention to the monetary side of the exchange [banking] where he could then charge interest and [have the power to] control the value of money. (Quigley, 45) (emphasis added)
In order to control money, "bankers began to specialize in foreign trade and foreign-exchange transactions, soon becoming financiers and financial advisers of governments. They used their power and influence to do two things: (1) get all money and debts expressed in terms of a strictly limited commodity--gold; (2) get all monetary matters out of the control of governments and political authority on the ground that they would be handled better by private banking interests [central banks such as the Federal Reserve] in terms of such a stable value as gold" (Quigley, 47).
In this way, "the attitudes and interest of these new bankers became totally opposed to those of the merchants. Where the merchant had been eager for high prices and was increasingly eager for low interest rates, the banker was eager for a high value of money (low prices) and high interest rates)" (Quigley, 45).
"In the 1920's, Montague Norman and his devoted colleague Benjamin Strong, the first governor of the Federal Reserve Bank of New York, were determined to use the financial power of Britain and the United States to force all the major countries of the world to go on the gold standard and to operate it through central banks free from all political control, with all questions of international finance to be settled by agreements by such central banks without interference from governments (Quigley, 326)." This system was set up through the Bank for International Settlements in Basel Switzerland, in 1929.
The desire of both men to see the world continue on the gold standard did not last as the costs of World War I created problems for those European counties involved in the war to the point where they could not harmonize the amount of debt with their gold reserves. A different system was needed. Could it be that the war helped to bring this situation about?
In order to control the monetary system of the world, the international/merchant/investment bankers had to convert it from the accountability of the gold standard to a system which would allow them to inflate the value of money. In order to understand what they did, let us turn our attention to what money is and the gold standard.
C. Gold Standard
1. What is Money?
In the early days of the ancient Middle Eastern trading routes, before there was any kind of currency, traders used several different kinds of specie for money: clothing, food, animals and gold/silver, in addition to jewels. In the Old Testament there are many stories about gifts given and financial exchanges made using any one or all of the above. For money to last, it must have four components:
Medium of Exchange - Durable, portable, divisible,
homogenous (uniform structure)
Store of Value -- Stable in Value
Standard of Value - Incapable of being counterfeited
Standard of Deferred Payment -- The purchasing power
remains the same.
How does gold compare as a form of money?
Medium of Exchange Durable: Gold in a sunken ship is
still there and useable
Store of Value- It still has value after all these years
Standard of Value - Divisible - If you divide a four carat diamond into 1 carat sizes, you lose value. If you divide gold, it retains value
Standard of Deferred - No matter when you use your money, it retains purchasing Payment Power. It will
always buy the same amount of goods.
We can readily see that gold, over clothing, food, animals, and jewels, is the best form of currency as it retains all of the above values. Gold is not supposed to fluctuate like stock. It's value has been brought down by the massive central bank selling.
2. The Standard of Value of Gold
When the countries of the world were on the gold standard, it created a standard of value. Quigley wrote, "the value of a country's money will never go below the amount equal to the cost of shipping gold between the two countries. When a country exported more than it imported [today we call this a trade deficit], it affected the flow of gold between the two countries because then the country which imported more goods than it exported to a country, owed them more in gold. The amount of gold which a country had, in turn, increased the quantity of money [they printed money to equal the amount of gold in reserve], which then became inflationary, causing prices to rise (Quigley, 65).
"At the same time, the gold by flowing out of a country [to pay for imports] reduced the quantity of money, causing prices to fall in that country. The shifts in prices caused shifts in the flow of goods because of the fact that goods tended to flow to higher-priced areas and ceases to flow to lower-priced areas. (Quigley, 65).
"In other words, the gold standard would not have allowed countries to accumulate trade deficits like the ones they have today. Instead they would have been forced to buy only what they could pay for, based on the amount of gold their country had. The world had both stability of price and stable exchange when they were on the gold system of accountability. The ease of the paper of no accountability is what led countries to abandon the gold standard after 1931" (Quigley, 65).
Quigley wrote, "If government goes off the gold standard completely--that is--refuses to exchange certificates and notes for specie--the amount of notes and deposits can be increased indefinitely because there are no longer limited by amount of gold reserves " (Quigley, 60).
Let us make some parallels. In the early 1960's department stores started issuing credit cards which was a new innovation. Up until that time, people only bought what they could afford which was much less than what they are buying today. With the charge card came an increase in the income of the household because they were using credit to buy more than what they could afford. Today with easy credit extended by all banks to anyone with a social security number, people are receiving new credit cards in the mail almost every day. There are those who are in such financial straits because they have believed the advertisements about the "free vacation" and new car, that they are having trouble sleeping. Some are resorting to borrowing from one card to pay the minimum payments of all their other cards!!! This is a small parallel of the situation our Federal government is in. The difference is credit cards can charge up to 21%!
A Paper Currency Impacts the Price of Currency
Quigley wrote, "When a currency is off the gold standard, fluctuation of exchange [which is then created], can go on indefinitely. The unbalance of international payments is worked out by a shift in exchange rates" (Quigley, 66). Quigley proivded an example of this new shift: "the new balance is seen in this example: If the value of the pound sterling falls to $4.00 or $3.00 from $5.00, Americans will buy in England because English prices are cheap for them, but Englishmen will buy in American only with reluctance because they have to pay so much for American money. Such a depreciation in the exchange rate will cause a rise in prices within the country as a result of the increase in demand for the goods of that country."
Today when you read in the newspapers or you listen to what the value of the dollar is against the yen or euro, the fluctuation is a result of the severe trade deficit America has at this point in history which is a result of leaving the gold standard. We are reaping today the consequences of our past spending spree. In addition, when the dollar is strong against the yen (which means if you and I travel, we get more yen for our dollar), Asians will not buy American goods because they become too expensive and will buy from other countries where they can receive a more favorable exchange rate. Conversely, when the dollar is weak, Asians obtain more dollars for their yen and will import more American goods.
Over the years I have noticed that whenever a country or region is having economic difficulties the dollar is strong or weak accordingly so that it is to their benefit and not ours. If we were on the gold standard, these games could not be played because it would not be possible.
Today our $5.5T deficit and our $200B trade imbalance is as a result of this "freedom" to print money. One of these days, it will catch up to us and we will "pay" all at once! The question is, "Are we there?"
The Depression
The U.S. stock market crashed in 1929. This was a separate occurrence from the depression which followed. The Crash came about as a result of (1) America reducing the gold content of the dollar by 40%, (2) speculation in the stock market, much of which was by credit, (3) foreign investor's selling their stocks, and (4) the Federal Reserve trying to reduce some of the stock market frenzy by calling upon member banks to reduce the number of loans they had made for purchases of stock on credit, instead of making money available in the banking system during a time of extreme unemployment. Demand for goods is created when money is available to borrow. The Federal Reserve withheld money from the banking system which meant there was no liquidity and no money available to create demand for goods and stimulate the economy to the point where people could be called back to work.
Removal from the Gold Standard
President Franklin Roosevelt was elected on his "New Deal for the American People" program. His first act as president on the day he was inaugurated, March 4, 1933, was to declare a national bank holiday beginning March 4 through March 12 in an effort to stem the tide of banks which had declared bank holidays of their own due to the number of people withdrawing their savings in gold.
On April 20, Roosevelt passed the Emergency Banking Act of 1933 which took America off of the gold standard. It ended the following: (1) convertibility of notes into gold was ended for Americans and only applied to countries holding our gold-backed dollar certificates, (2) private ownership of gold was made illegal but those owning rare or older gold coins were exempt because they were coin collectors. In essence, the American financial system was transferred from an accountability standard using gold to one in which there is no accountability because it is paper currency.
The Glass-Steagall Act
As a result of the 1929 banking crash, Congress instituted two laws, the McFadden Act of 1927 which prevented interstate banking and the Glass-Steagall Act in 1933. Several years ago the McFadden Act was torn down which now allows banks to cross state lines. It is the repeal of this law which set the stage for the bank buyouts and mergers which we have seen in the last five years.
Glass-Steagall adopted five key changes to the Federal Reserve Act: (1) It created the FDIC to protect bank depositors through insurance, (2) It restricts investment banking activities to acting only for its own account, (3) It prohibits the affiliation of any bank to engage principally in investment banking activities, (4) It makes it illegal for any depository institution to engage in investment banking and receive deposits at the same time, and (5) It prohibits interlocking directorates and certain other links between member banks and firms or individuals primarily engaged in investment banking. In short, it separated the functions of a bank from that of an investment firm which underwrote stocks and bonds.
For the past five years or so, there have been many, many mergers between banks and then between banks, insurance companies, and brokerage firms, thus tearing down the wall between commercial and investment banks. In 1998, the Glass- Steagall was effectively repealed by the action of the mega-merger between Citibank and Travellers which created a $700B giant. The path which was forged for this merger began in 1997 with Travelers Group who had acquired the brokerage firm Smith Barney and earlier purchased Salomon Brothers for $9B. In April 1998 Citicorp and Travelers Group struck a $82B deal that would create the world's largest financial services company and change the face of banking in the U.S. and abroad. The merger--which was twice the previous record of $387B, effectively challenged the Glass Steagall Act. John S. Reed, Citicorp's chairman, called this a "transforming merger" (Washington Post- WP, 4/7/98, A13). For the third year in a row, a banking "modernization" act has been introduced in Congress. Currently it has passed the Senate and the House and they are looking to agree on a final bill. I have no doubt that it will pass this year.
C. Control and Paper Money
It appears, from what we have seen so far that gold gets in the way of complete and absolute monetary control. It also appears that taking the world off of gold between 1914 and 1971 was the first step in instituting complete monetary control as the best mechanism for this control is a system of paper where there is no accountability and where the amount of money in the system creates either inflation or recession/depression.
England modifies the Gold Standard - First to Issue Treasury Notes--Paper IOUs
In order to understand subtlety of the change from gold to paper, we need to take a look at what the Bank of England did to introduce the issuance of paper IOU's in the form of treasury notes as a way of issuing debt. Up until 1914 when England was ready to enter World War I, instead of abandoning the gold standard, they suspended certain attributes of it and emphasized others which they tried to maintain. It was the idea of Sir John Bradbury (later Lord Bradbury) and Sir Frederick Atterbury to issue Treasury notespieces of paper called IOU's in place of gold. Quigley writes, "The decision to use Treasury notes to fulfill the bankers' liabilities was made as early as Saturday, July 25, 1914. The first Treasury notes were run off the presses on July 28. The usual bank Holiday at the beginning of August was extended to three days during which it was announced that the Treasury notes, instead of gold, would be used for bank payments" (Quigley, 317). This was the first step in removing the monetary system from gold. What we are witnessing today with the drop in the price of gold may be the final removal of the world from a gold system!!!
The Bank for International Settlements - Centralized Control of the World's Central Banks
As we have seen, Quigley points out that it is possible for one or two very powerful groups such as the Morgans and Rockefellers to completely control our country's monetary system. The follow-up question is, "If they could control the United States, think how easy it would be to control all of the countries of the world?" This system of centralized control in the hands of one mega-bank was realized in 1929 when the Bank for International Settlements was created.
Quigley wrote, "[T]he powers of financial capitalism had another far-reaching aim, nothing less than to create a world system of financial control in private hands able to dominate the political system of each country and the economy of the world as a whole. This system was to be controlled in a feudalist fashion by the central banks of the world acting in concert, by secret agreements arrived at in frequent private meetings and conferences. The apex of the system was to be the Bank for International Settlements in Basle Switzerland, a private bank owned and controlled by the world's central banks which were themselves private corporations.
"Each central bank, in the hands of men like Montagu Norman of the Bank of England, Benjamin Strong of the New York Federal Reserve Bank, Charles Rist of the Bank of France, and Hjalmar Schacht of the Reichsbank, sought to dominate its government by its ability to control Treasury loans, to manipulate foreign exchanges, to influence the level of economic activity in the country, and to influence cooperative politicians by subsequent economic rewards in the business world (Quigley, 324).
"In each country the power of the central bank rested largely on its control of credit and money supply. In the world as a whole the power of the central bankers rested very largely on their control of loans and of gold flows. In the final days of the system, these central bankers were able to mobilize resources to assist each other through the B.I.S., where payments between central banks could be made by bookkeeping adjustments between the accounts with the central banks of the world there. The B.I.S. as a private institution was owned by the seven chief central banks and operated by the heads of these, who together formed its governing board. Each of these kept a substantial deposit at the B.I.S. and periodically settled payments among themselves by booking in order to avoid shipments of gold (Quigley, 324).
"The B.I.S. is generally regarded as the apex of the structure of financial capitalism whose remote origins go back to the creation of the Bank of England in 1694 and the Bank of France in 1803. As a matter of fact, its establishment in 1929 was rather an indication that the centralized world financial system of 1914 was in decline. It was intended to be the world cartel of ever-growing national financial powers by assembling the nominal heads of these national financial centers (Quigley, 325).
"The commander in chief who controlled the world's banking system was the Governor of the Bank of England, Montagu Norman. In January 1924, Reginald McKenna, who had been chancellor of the Exchequer in 1915-1916 [and who had moved on to become] chairman of the board of the Midland Bank, told its shareholders, 'I am afraid the ordinary citizen will not like to be told that the banks can and do, create money...And they who control the credit of the nation, direct the policy of Governments and hold in the hollow of their hands, the destiny of the people'" (Quigley, 325).
"On September 26, 1921, The Financial Times wrote, 'Half a dozen men at the top of the Big Five Banks could upset the whole fabric of government finance by refraining from renewing Treasury bills'" (Quigley, 325). Quigley called them investment bankers, international bankers or merchant bankers and wrote, they "remain largely behind the scenes in their own unincorporated private banks. These formed a system of international cooperation and national dominance which was more private, more powerful and more secret than that of their agents in the central banks" (Quigley, 326).
As a result of this power, these men had "control over the flows of credit and investment funds in their own countries and throughout the world. They could dominate the financial and industrial systems of their own countries by their influence over the flow of current funds through bank loans, the discount rate, and the rediscounting of commercial debts, they could dominate governments by their control over current government loans and the play of the international exchanges" (Quigley, 327).
The Financial Crisis of the 1920's Spreads
In 1928, Britain did not have enough gold to exchange the Bank of France's request of foreign currency to gold. The financial crisis which began in Central Europe in 1931 reached London by the end of that year and spread to the United States in 1932 bringing the United States to the acute stage in 1933 (Quigley, 345).
As a result of the British crisis, the gold countries of Europe sought to modify their financial basis by downgrading their gold system again, this time to a gold bullion standard which meant gold coins still circulated.
Roosevelt Outlaws the Ownership of Gold
At the same time that Roosevelt took America off of the gold standard, he adopted the economic philosophy of British socialist John Maynard Keynes who said that a country could spend its way out of a recession/depression by using credit. The New Deal created the following programs, all of which were paid for by credit:
The Federal Emergency Relief Administration - for state relief agencies
Civilian Conservation Corp - Reforestation and flood-control work
Reconstruction Finance Corporation - Loans to small/large businesses
Agricultural Adjustment Administration - Loans to Farmers
Public Works Administration/Works Progress Administration - Help the unemployed
National Industrial Recovery Act - Public Works
Social Security Act and Fair Labor Standards Act (minimum wage)
D. Summary
To summarize, we have seen that in history, military power and economic control is the name of the game. Has gold lost its shine? No, it never will. It only appears to have lost its shine because those who want control needed to change the monetary system from one of accountability using the gold standard to a "New international system" which has no accountability as it uses paper currency. The international/merchant/investment bankers who rose to power between 1770-1850, the industrial capitalist stage, found the secret to making and controlling money and nations: credit. It was the Central Bank of England, a private corporation which first understood how they could take control of the monetary system of the country they not only understood credit but were the first to issue Treasury notes which provided them with capital and created debt. Over the years, private corporations or central banks have been established in every country of the world. The top seven central bank governors--England, United States, Canada, Japan, Germany, Italy and France manage the Bank for International Settlements, the central bank's bank. There, the governors meet monthly to determine the financial and economic policy of the world-- interest rates, currency values, determining which countries will benefit and which will not.
The gold system was discarded piece by piece after World War I because of the high debts which countries incurred as a result of the war. They could not reconcile their debt with the gold reserves which they had. A series of circumstances prevailed in the United States. President Franklin Roosevelt took the opportunity to outlaw the ownership of gold by private individuals in 1933 and to only make foreign country holdings of our gold certificates redeemable in gold. By 1971, Richard Nixon, as a result of new presentments by the government of France to convert U.S. paper gold certificates into gold, severed all ties. By 1973, the U.S. dollar was allowed to float, the rest of the world followed.
The result of a monetary system not backed by gold was that the price of its currency would fluctuate. Today the dollar has dropped in value against the yen and Deutsche mark by 69% and 50% respectively. The dollar and the euro which will replace the Deutsche mark is within 2% of being equal. America has a $5.5 Trillion national debt, of which $3.7T is held by banks, businesses, pension funds and people in the form of U.S. Treasury bonds. Our trade deficit is projected to hit $200B this year. This is as a result of massive imports. The interest on our debt is $239,299B which is 2.8% of the Gross Domestic Product. The stock market appears to be in a sideways up-down market, and the price of gold is at a 22-year low (1978 levels). The euro was birthed in January 1999 and the Asian miracle became the Asian crisis in 1997 when Korea, Thailand, Malaysia and Japan refused to go along with the World Trade Organization Financial Services Agreement . Currently these economies appear to be rebounding.
IT IS CLEAR THAT THE FIRST STEP IN CONTROLLING THE WORLD'S MONETARY SYSTEM WAS TO (1) CONSOLIDATE GOLD IN THE HANDS OF CENTRAL BANKS BY (2) SIMULTANEOUSLY REPLACING GOLD WITH A PAPER SYSTEM COMPRISED OF TREASURY NOTES. THE QUESTION TO BE ASKED NOW IS, ARE WE AT A NEW POINT IN THE SEVENTY YEAR OLD PAPER SCHEME WHICH WILL BRING US INTO A "CASHLESS MONETARY SYSTEM?"
Why would the central banks want to destroy the value of gold? Is it too abundant? The answer to that is cartels--like the ones created for DeBeers Diamonds. Has it lost its shine? If gold no longer has value then that means that the governments and central banks of the world along with the International Monetary Fund and major gold purchasers have lost a tremendous amount of value and are no longer as rich as they thought....If that is so, then we need to ask them if they are having financial difficulties and need to sell their best and prime assets?
PERHAPS WHAT WE NEED TO ASK IS IF GOLD IS BEING REPLACED BY THE COMING "ELECTRONIC MONEY" OR "E-MONEY"? Are the central banks trying to convince you and I who are "Joe Average" that gold has no value so we will sell and they will buy or are they creating a transfer of wealth situation?
II. Current Economic Situation
A. Introduction
Who can argue with what the stock market has done? The nine-year bull--with all of its snorts (several "adjustments") and steam has continued to amaze all. The economic expansion of America appears to have strength of its own--apart from the Internet stocks--with the technology, communications stocks, and S&P 500 reflecting this strength. While mergers and acquisitions have pumped up the market, it still is the small investor who has continued to shift monies from Treasury bills and 2 1/2% savings accounts that has kept this market up.
That does not mean that we are home free, without concerns. It is these same concerns, interestingly enough, which have been addressed in this newsletter since I started writing it fourteen years ago. The difference is that the numbers are higher. You have just read part of the history of money and capitalism by Carroll Quigley. He could not have stated more accurately the systemic problems which America is facing as a result of changed monetary system which began in 1913. In an article published August 19 in the Los Angeles Times, Jonathan Peterson writes,
In recent years, the trade gap has been evidence of the nation's economic strength because
it reflected a U.S. appetite for goods from all over the globe. But now, as the rest of the world
begins to grow, the deficit stands to drive down the value of the dollar and drive up interest rates and the price of imports. The reason: The trade deficit has oversupplied the world with dollars and now that other nations' currencies are attracting buyers, those dollars have begun to lose their value. So far this year, for example, the greenback has shed about 20% of its value against the Japanese yen; on Wednesday it hit a six-month low as more capital rushed to Japan.
What we are experiencing is the fullness of the new international order set up in the 1920's. Is there more to our current economic situation? Is the banking system signaling that our federal deficit is too high after all these years? Are we at some kind of crucial "cross over" point? Are we entering a second phase with regard to the value of gold? Are we being moved from a paper currency system to an electronic one?
Let us take another look at these concerns:
The article above illustrates the end result of an economy free to float without any consideration to whether they can pay. This imbalance is seen in the value of the dollar.
1. Dollar
Quigley wrote, "When a currency is off the gold standard, fluctuation of exchange [which is then created] can go on indefinitely. The unbalance of international payments is worked out by a shift in exchange rates" (Quigley, 66). What we are seeing is the end result of the paper system of un-accountability. This imbalance is seen in the value of the dollar against the euro and the yen. Earlier this year, the euro dropped in value from its issue price of 1.17 euros to the dollar to about 1.02. The Deutsche mark has strengthened (which means the dollar has weakened), moving up about 20 basis points from the 165 range to the 185 range and the yen has weakened against the dollar from 130 to its current price of 111.
The dollar is having a rough time as a result of our high national and trade debt. It is interesting to note that without American spending, none of the currencies would be as strong as they currently are because it is American spending which has increased the demand for their products. This is what has contributed to our high trade deficit! We are creating demand for foreign products which is now going to be the rod that punishes us as a result of the new international order. If the American people stopped spending the world would sink!
The only way we will be impacted is when foreigners sell their Treasury bills, notes, and bonds. As long as they hold, the trade deficit is manageable but when they start selling as they have been for the past two years --- America will face and is facing a serious liquidity problem.
How is this liquidity problem being dealt with? In two ways: (1) paying down the debt of the U.S. Treasury and (2) "dollarizing" the Latin American countries which means they would use our dollar as their currency (see Veon Financial economic newsletter dated 12/98). Both of these will help eliminate the liquidity problem because by paying down the debt it relieves the liquidity problem and by shifting other countries to the dollar, it reduces the liquidity problem.
I find it interesting that the timing of the euro and the Free Trade Areas of the Americas which was officially set up in April 1998 have come within six months of each other. Countries selling the dollar for the euro while Latin American countries want to buy the dollar and sell pesos! Do you get the feeling sometimes that the world is actually a giant Monopoly game?
2. Debt
The national debt is $5.6T and has been accumulated since the mid 1860's and it includes spending by Roosevelt and his Great Deal programs, World War II and the Korean War, the space program, defense, Johnson's Great Society, the Vietnam War, Reagan's tax cuts, and everything else since then. It also includes money the government owes itself when it borrows from the social security account. The amount held by banks, businesses, pensions funds and investors in the form of U.S. Treasury bonds totals $3.7T.
In addition to the national debt, the number of companies defaulting on their debts is rising sharply and credit quality is reaching its lowest point in a decade. There were 61 defaults in the first seven months of the year versus 65 in 1995. According to Diana Vazza, head of fixed-income research at Standard and Poor: "Clearly we are heading into a credit trough in which a number of industry subsectors are under pressure" (Financial Times-FT, 7/20/99, 22).
3. Interest Rates and the Federal Reserve
Last year this time when our stock market dropped 1800 points as a result of weakness in demand and the fallout from Yeltsin's threat to resign and the ruble dropping in value, the Federal Reserve lowered interest rates twice because they were concerned. As a result of their second 1/4 point increase on October 20, the stock market gained 15% in less than two weeks! In an economy as large as ours, I am amazed that a year later, our economy is now being told it is in the process of overheating and they need to put the lid on inflation. Interest rates were raised 1/4 of one percentage point on August 24 to 5.25% following a similar quarter-point increase at the end of June. Prime rate is currently at 8.25%.
The stock market, in anticipation of this increase, advanced 199 points to close at 11,299.76, surpassing its July 16 record close of 11,209.84. So far this year, the Dow is up 23%. Interestingly enough on the day the rate increase was announced, the U.S. trade deficit hit a new high with the dollar dropping against the Japanese yen slightly. This is what perhaps prompted Alan Greenspan to say that the Federal Reserve needs to pay closer attention to what happens on Wall Street since Americans reaping the rewards of the high-flying stock market are using those paper profits to justify spending and other financial decisions.
Interestingly enough there has been a debate in economic circles over whether financial markets should be taken into consideration when the Fed sets interest rate policy. In light of the fact that 44% of household wealth is created by investment instead of savings, Greenspan indicated that "the central bank needs to watch financial markets more carefully" (Washington Times-WT, 8/28/99, C7). In response, the market dropped 108 points closing at 11,090.
While all of this sounds plausible, when you have a liquidity problem, one way to solve it is to cut off demand for loans by raising interest rates. Depending on how high they go will determine if they cut off consumer demand for everything else.
4. Foreigners not purchasing our Treasuries
In March 1998 I wrote about the coming economic conversion of the currencies of 11 countries which would comprise a new revised Roman Empire in Europe. I said that the dollar would suffer as a result of (1) European countries switching from the dollar to support the euro, (2) other countries switching a portion of their savings out of the dollar to the euro, and (3) corporations who do business overseas and other transnational/multinational corporations switching some of their positions from the dollar to the Euro. In January the Euro was birthed. While there were no major problems and although it has been slow to take off, the fact that eleven currencies "came together" is extremely historic and monumental.
I wrote, "A massive shift from dollars to euros will fundamentally change the balance of the world's financial system. The euro may be where the buck stops. A strong euro means European exports to the U.S. will be more expensive and U.S. exports to Europe will be cheaper. This is good for U.S. manufacturers but it also means higher inflation in the U.S. because of the higher cost of European goods (Washington Post-WP, 4/1/98,1). Currently the dollar comprises 60% of the reserves of the central banks of the world. The dollar is used in at least 80% of the world's financial transactions and accounts for 27% of the world's production (WP, 4/1/98,.1)."
The dollar is being sold not only as a result of the shift from dollars to euros, but to shore up the yen. In April 1998 it was reported that the Federal Reserve had sent out an unusual electronic message asking traders for bids on the biggest block of U.S. Treasury bills ever sold at one time on behalf of an unnamed customer. The amount was $12.1B and many traders agreed that it was probably the Bank of Japan which had been aggressively buying yen in international currency markets to support it against the U.S. dollar. The yen closed at 129.60. (WP, 4/14/98, C1)
In July 1998 James Cooper and Kathleen Madigan from Business Week wrote that as the pall from the Asian crisis lifts, currency traders would be looking at the U.S. trade deficit to determine if they should sell dollars (for euros) which would raise interest rates and push up inflation. Furthermore, they cautioned that until Japan enacted REAL economic reform, the U.S. dollar would continue to be the global choice of currency. They speculated (and appear to be right on the money today) that our current account deficit, which is a kind of cash flow statement of U.S. international business (and which is comprised of trade, net investment income and foreign transfers) is headed toward 3%, the highest of any G-7 countries. They wrote that at this level currency markets begin to speculate about a country's ability to continue to finance its international obligations (Business Week-BW, 7/6/98, 21).
According to the Securities Industry Association, the worldwide appetite for Treasuries was largely sated between 1995 and 1996. By last year, net foreign purchases of U.S. government bonds were only a fifth of the peak year of 1996. In the first quarter of 1999, foreigners dumped a net $17.3B of Treasuries. David Hale, chief economist at Zurich Investments in Chicago said, "I wouldn't call it a crisis, but we're seeing the first signs of what could happen next year" (FT, 8/3/99). If foreigners are not buying our national debt, then who is? If no one is, then America has a severe liquidity problem and the only way to curb it would be to raise interest rates to (1) attract foreign money into our market and (2) curtail loans.
5. Liquidity
Recently the Administration announced that it was looking to change its issuance of government debt in order to maintain LIQUIDITY in the U.S. Treasury market. Proposals included (1) further reductions in the number of debt issues and (2) a move to buy back some of the publically held debt. Citing the first surplus in 30 years in 1998, it was felt that this would have a profound effect on U.S. treasuries since the amount of debt held privately had declined from $3,100B two years ago to $2,760B. In 1998, the Treasury eliminated the 3 year note and reduced the frequency of the 5 year auction to quarterly from monthly (FT, 5/28/99, 15). It is interesting to note that the Clinton Administration announced this on May 28 and didn't find any surpluses until JUNE 28!!!
With regard to liquidity and "possible computer failures related to the century date change", the Federal Reserve strongly supported adoption of HR 1094 which passed in July. This law amended the Federal Reserve Act to broaden the range of discount window loans that could be used as collateral for Federal Reserve Notes. Section 16 of the Federal Reserve Act required the Federal Reserve to collateralize Federal Reserve notes when they are issued [what this means is that every time your local bank goes to the Federal Reserve for money to use at its bank to make loans--commercial or personal, that bank has to put up something of value for collateral. In other words, your local bank has to give the Federal Reserve the pledge of some asset. This is just like you going to your bank and obtaining an auto loan--the bank wants the title to the car until you pay the loan off.]
The Fed is required to hold certain kinds of assets in an amount at least equal to the amount of currency in the hands of the public. These assets eligible for collateral include: Treasury and federal agency securities, gold certificates, Special Drawing Rights [that's what the IMF gives the Federal Reserve], foreign currencies, and discount window loans made under Section 13 of the Federal Reserve Act.
In order to harmonize the Federal Reserve Act with the collateral allowed under Section 13, Section 16 needed to be changed. In an interview I had with David Skidmore of the Federal Reserve on April 22, 1999, he told me that this change had to do only with making discount window loans that "do not conflict with reserves and do not interfere with monetary policy." In essence, in addition to the above list of assets eligible for collateral, the Federal Reserve wanted to add discount window loans to the list of available assets.
Discount window loans are where a bank (your bank) borrows from the Federal Reserve to help boost its reserves or provide liquidity in order to handle increased demand for dollars by the public. In a speech before Congress, Alan Greenspan said that the public did not need to hold additional dollars for the Year 2000 but that the Federal Reserve was making provision by printing an additional $50B to have on hand.
This was being done, according to testimony of Federal Reserve Governor Edward M. Gramlich before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate on March 25, 1999, "so that the Federal Reserve would not have to chose between two of its most important fundamental policy objectives--protecting the value of the currency and preserving financial stability. The legislation in Section 1013 would authorize the Federal Reserve to collateralize the currency with all types of discount window loans, not just those made under Section 13. By permitting all discount window loans to back the currency, the Federal Reserve would be able to collateralize currency fully--as the original frames of the Federal Reserve Act saw fit to require."
6. The "Phantom" Budget Surplus
We didn't buy a lotto ticket but yet we won--or so we are told! Somehow when we went to balance our books, we did something wrong and now we are in the gravy--not just up to our knees but up to our eyeballs! WooooWhee!!
How did we come into $1T without doing one thing? On June 28, the Office of Management & Budget issued new estimates that showed stronger growth--2.5% vs. the previously predicted 2.3% which COULD boost the surplus by $3 Trillion over 15 years (instead of the previously predicted $2T). (I might add that I play similar games when I go shopping. For example I might find something for $200 in one store but look around before I purchase it. By golly, two stores later, it's on sale for $150. I justify my purchase because I just "saved" $50 or 25%. Sound familiar? When you and I do it, it's okay--because we know how much we can handle, but when Uncle Sam does it, perhaps we should "wake up and smell the coffee because we are doing it with pennies and he's doing it with billions and trillions.") I call this "phantom" budget surplus because it is dependent on the status quo in the budget for the next ten years. What is the probability that that will happen? I would think very small.
In the proposed congressional House Resolution 2488, it states, "the national debt of the United States held by the public is $3.619 trillion as of fiscal year 1999, the Federal budget is projected to produce a surplus each year in the next 10 fiscal years; and refunding taxes and reducing the national debt held by the public will assure continued economic growth and financial freedom for future generations. It is the sense of the Congress that the national debt held by the public shall be reduced to a level below $1.61 trillion by fiscal year 2009."
Greenspan in testimony before the House Banking and Financial Services Committee said, "[T]he first priority, in my judgment, should be getting the debt down, letting the surpluses run and putting in contingency plans." Greenspan also stated that in the past, the predictions of the government should not be used for more than 18 months into the future (WT, 7/23/99,A1).
Paying down the debt is not a simple transaction. Treasury wouldn't use excess revenues to buy back bonds and retire paper. Instead, Social Security and Medicare trust funds would use the $3T surplus to buy the bonds (BW, 8/9/99, 32).
In the July 12 edition of Business Week they write, "Suddenly, Washington seems ready to shift trillions in general revenue dollars to Social Security [which has a $3T public debt] and Medicare, ensuring paper solvency well into the next century. Clinton wants to "buy back Treasury securities [which] would save the government $100 billion a year in INTEREST COSTS with those "savings" going to shore up Social Security. Their plans are to pump some $790B into Medicare while $600 billion would be shifted to Social Security."
Buying Back
According to the August 5 USA Today, Clinton said he "wanted to use some of the budget surplus to buy back government debt. He likened the proposed buy backs to a homeowner refinancing his mortgage and portrayed this as a step toward eventual elimination of the government's debt. 'In the past seven years, we've balanced Washington's books. We've cut its credit card balance (by eliminating the budget deficit). Now let's refinance our nation's mortgage and then wipe the ledger clean,' said Clinton."
The aim of buying back debt at reverse auctions would be to retire higher-yielding, more costly debt and improve the working of the Treasury bond market. Until now the Treasury has used the budget surplus to reduce the amount of securities it sells in the market." This action by the Clinton Administration does not require congressional approval.
While most economists think that paying down the debt will shrink the economy, there are problems, we are told by Business Week, in paying down the debt. "Without government borrowing, there would be no Treasury bond market and the Federal Reserve would lose a vital monetary tool: buying and selling Treasuries to adjust liquidity."
In an editorial by George Hager in The Washington Post, he points out: (1) that although the government predicts a huge surplus, private economists say 10-year forecasts are notoriously flaky and (2) of the $3T, $2T would come from the excess payroll taxes being collected to fund baby boomer's Social Security benefits in the next century.
However, he points out something very important--all of this (phantom) income is dependent on how well the economy has been and is doing and that budget cuts and spending are as deep as they have been. Much of the cut has come from defense which has fallen by 26% (WP 8,5/99, A21). Also, the above is predicated on a tax cut. Recently a bill was introduced by Rep. Nick Smith to condition the gradual 10% cut in income tax rates on whether the annual interest expense on the debt is going down. Greenspan has endorsed this idea (WP 8/5/99, A21).
B. Summary
Americans have had a "free ride" since 1944 when the dollar was declared the reserve currency of the world. In other words, the dollar was considered the "global medium of exchange". For over 50 years, all oil contacts worldwide have been denominated in dollars. Can you imagine the cost to Japan to convert yen to dollars to buy oil/gas? Now with the birth of the euro, it is in the process of being replaced as the Japanese, multinational and transnational corporations switch assets out of dollars to euros. This is having a tremendous effect on our dollar as it exacerbates the hard truth about our debts.
For the first time since the Federal Reserve was set up in 1913, our government is looking to pay down the debt with future "phantom" income from future budgets.
What is our problem? LIQUIDITY--WE HAVE HIGH DEBT AND NO RESERVES--NO LIQUIDITY. WE ARE AT A TURNING POINT. JUST LIKE THE INDIVIDUAL WHO REALIZES HE CANNOT PAY HIS DEBTS AND HAS NO OTHER SAVINGS OR RESERVES, HIS ONLY ALTERNATIVE IS TO DECLARE BANKRUPTCY. AMERICA IS AT THE SAME TURNING POINT. BUT IT IS NOT ONLY AMERICA BUT THE REST OF THE WORLD AND THAT IS WHY GOLD PLAYS A VERY STRATEGIC ROLE.
III. THE GOLD MARKET
A. Introduction
To again repeat the old adage, "He who owns the gold makes the rules." Along with wealthy individuals, oil sheiks, and the aristocracy like kings, queens, princes, and dukes, it is the central banks of the world along with the International Monetary Fund which have amassed great amounts of gold.
Surprisingly enough, these major entities are all in the process of selling a good portion of their gold reserves. It is because they are in dire financial straits that they need to sell their prize investments? Or could it be that this is a major and massive transfer of wealth? Is it because they are signaling the end to gold as a medium of exchange, store and standard of value, and standard of deferred payment? I have concluded that it is all three of them. I believe that they are inter-connected in what the effect will be. Let us take a look at the validity of these assumptions.
The price
In 1997, gold was at a 12-year low. Because of the Asian turmoil, US gold mutual funds were heavy sellers of gold stocks. The US funds sold again after Switzerland's central bank sold 1,400 tons of its gold reserves. As a result, gold hit $309 an ounce. With Britain announcing that it would sell 50% or 415 tons of its gold reserves in 1999-2000, the metal fell 27% to a 22-year low, a rock bottom price at around $258. In order to understand the repercussions of what is happening with gold, we need to take a look at South Africa.
B. Third World Debt
As a result of World Bank lending policies, it appears that they have helped to create a situation in the world in which there are over 60 "Heavily Indebted Poor Countries" (HIPCs). Many of these countries are in dire straights as a result of taking World Bank advice over the years as to how to increase their revenues. They borrowed heavily to finance grandiose plans for future income only to have many of them become white elephants leaving the country strapped with huge World Bank debts which are still in the process of being repaid. As a result, many of these countries cannot breathe as they do not have sufficient income from the sale of their own resources--gold, cattle, diamonds, etc.--to erect the proper infrastructure in their countries such as hospitals, roads, schools, clean water plants, and electricity. It should be noted that many mutual funds now have new sector funds dealing with the infrastructure of countries. [I might add that many Americans are in the same boat. They earn so much a month and spend 95% of what they earn paying their auto, mortgage, and credit card loans. They too believed what they were told about "having it all."]
1. Poor Gold Producers
The World Gold Council has identified half of the 60 highly indebted poor countries as being gold producers. In the countries of Ghana, Guyana, and Mali, gold accounts for at least 5% of export revenues. In sub-Saharan Africa, gold accounts for 7.8% of exports or 2.5% if South Africa is excluded.
To provide you with an understanding of their dire situation, the following is based on information provided by the World Gold Council:
Country Debt (Billions)
% of GNP Gold Mined Tons
Gold as % Debt
Ghana
6.4
95%
55.7T
97.0%
Mali
3
116
22
272.4
South Africa
24.3
19
473.8
N/A
Zimbabwe
5.1
60
27.1
45.2
Let's take a look at Ghana. They are the second largest gold producer in South Africa and yet their debt is 95% of the Gross National Product. The gold they mine accounts for 97% of their debt. In other words, if you destroy their right to mine gold, they will not only be able to not produce gold but they will have to sell their gold mines to create liquidity in order to stay alive a little while longer. Do you think, even with a gift of debt forgiveness from the Group of Eight (which includes Russia), that the G8 will not want "something in return" for this great gift of forgiveness?
2. Selling the Prize Investments for Liquidity
The current low price of gold is as a result of central banks selling their gold reserves. Britain joins other central banks such as the Netherlands, Belgium, Argentina, Australia, and Canada who have all sold gold for cash. Also there are rumors that the Danish and Greek central banks have also been selling gold. Since gold generates no income, selling it and investing in treasury bonds is one way of creating liquidity and improving the return on reserves. Because of the increase in the number of central banks selling gold, the deputy governor of the South African Reserve Bank, James Cross, has suggested that an organization like the Bank for International Settlements conduct these sales (FT, 6/15/99, 34).
The question which needs to be asked is, "Who is buying all of this gold?" We have no answers. It has not been reported in any of the major financial newspapers to my knowledge. In a telephone call to the World Gold Council, they were unable to provide any information since gold is auctioned and many third parties buy on behalf of anonymous buyers.
What is Britain going to do with its newly acquired cash? It is reported that they are going to buy U.S. dollars, Japanese yen, and European euro to "create a more balanced cash reserve" (FT, 7/7/99, B7). What we see is that the central banks--the ones who created all of the debt, have created so much paper debt that they have put the world in a liquidity crisis--no cash. It appears that the world system needs liquidity. In this light, the sale of gold by central banks makes sense. What does not make sense is the sale of gold by the International Monetary Fund.
C. IMF Plan to Help HIPCs is a Transfer of Wealth
Interestingly enough at the G-8 meeting in Cologne Germany in June, the presidents and prime ministers agreed to sell 10% or 10 million troy ounces of gold held by the International Monetary Fund (IMF) which will bring an estimated $2.3B to be invested in government bonds--U.S., euro, and yen. If the proceeds were invested at 5%, they would bring an estimated income of $110 million a year. The G-8 said that they would then use some of that income to reduce the debt of HIPCs, provided they meet extremely stringent criteria. The criteria chosen by those with power usually has the effect of putting that debt-strapped country into a straitjacket--they can't protect themselves nor can they defend themselves!
The IMF uses a number of programs to lend to third world countries. By selling some of its gold reserves, it would be freeing up non-interest bearing assets for interest bearing assets. One of the programs which the IMF provides to heavily indebted countries to borrow from is the Enhance Structural Adjustment Facility (ESAF). Most poor countries dread this program because of the very fierce economic demands it imposes on borrowers. The sale of gold would make this program self- financing (FT, 7/9/99, 22).
The IMF holds about 3,000 tons of gold after it sold 1,500 tons between 1976 and 1980. The sale of IMF gold would have to be approved by Congress first since the United States has 17% of the votes on the IMF Executive Committee. Representative Jim Saxon, Vice Chairman of the Congressional Joint Economic Committee, introduced legislation that would prohibit the sale of IMF gold unless the profits were returned to member states (FT, 7/6/99, 4).
D. Transfer of Wealth
What is the effect of the low price of gold? A number of gold producers have announced that they are suspending gold production. South Africa is experiencing great problems as they cannot mine gold if the price drops below $260 an ounce. They project that more than 80,000 people will become unemployed, joining the 100,000 who have been laid off in the past three years, pushing up the current 30% unemployment. It has been estimated that the average mine worker has seven to eight dependents (FT, 7/8/99,5).
In South Africa when a miner loses a job, it means that there is a good change that he will never work in the formal sector. Some gold analysts believe that with the selling of gold by both the central banks and the International Monetary Fund that it is proof of an irrevocable change in sentiment about gold as a reserve asset and investment. For South Africa, gold as a share of total exports has declined in value from 50% in 1980 to 16% today.
One South African Cabinet member said, "this behavior and the decisions of other industrialized countries and the IMF on the public handling of gold sales is having the effect of defeating the very objective that they profess to pursue" (WP, 7/8/99, E1).
Earlier this year, South Africa announced plans to sell the rights to 332,000 hectares of commercial forest owned by the state for an estimated $240 million. Stella Sicgau, minister of public enterprises and Kader Asmal, minister of water affairs and forestry said, "This action represents the largest offering of its kind that has taken place anywhere in the world." The government says it expects approaches from companies in Europe, North America, and Asia. Most existing private plantations in South Africa are owned by Mondi, the paper producing arm of the Anglo American group or Sappi, the Johannesburg-based international paper company. Last year the government sold 20% of Airports Company South Africa to Aeroporti di Roma of Italy and is planning to sell 25% of South African Airways to a foreign buyer (FT, 3/5/99, 6). What South Africa does not understand is that it is selling its prized possessions. This should not be, given the amount of gold they mine.
Ashanti Goldfields in Ghana will be laying off 2,000 workers or one sixth of its workforce. Many junior producers of gold in Australia have been hammered by the collapse in the price of gold. Many of them find it impossible to raise cash and will be even harder pressed to stay in business. Historically the Australian gold industry has been funded by equity capital but now it is funded by debt underwritten by forward sales (FT, 7/13/99, 26). Only the big gold mining companies will survive the low prices of gold. The small and medium sized producers will be wiped out.
Lastly the World Gold Council estimates that the countries which mine and export gold have lost an estimated $150 million in annual export earnings. Unfortunately, none of them can afford this. The Group of Eight's gesture to "forgive debt" is really going to provide an opportunity for a transfer of wealth from the weak and poor to the strong and rich as the indebted countries try to stay alive by selling their only income producing asset--the gold mines!!!!
Global Bankruptcy Laws
Interestingly enough, there is a push by the Group of Eight and the Bank for International Settlements to pass new global bankruptcy laws in every country. The United States already has several new bankruptcy laws in the making, one is consumer, the other covers larger institutions and other situations (country). We are now living in a time when it is possible for a country to go bankrupt. Can you imagine the havoc it would create for a country to say, "We are bankrupt!" Can you imagine the vultures? To help, part of these laws require that a country, instead of borrowing from the IMF or World Bank, that they float global governmental bonds. What kind of interest rate would they have to promise to investors?
IV. CONCLUSIONS
In a letter to the Editor published by The Financial Times on July 8, 1999, Mr. Richard A. Werner, chief economist/managing director of te Profit Research Center in Tokyo Japan offered the following reasons:
"True Mr. Eddie George, the governor, and his colleagues at the Bank of England have claimed that the gold is being sold off because it does not yield a high return. But surely they are not serious. For if they were really running their central banks with the aim to maximize profits, they would have to be arrested for insider trading. Central banks are special, because making money is a piece of cake for them. Not only do they move markets, they issue the chips of the game. They know that, if they needed a quick buck, they just have to print the stuff. So why then have central banks been selling gold? Economic theory tells us that monopolists will strive to maintain their cartel-like control of a market. The same is true for central bankers. They hate gold, because it is unwelcome competition. It represents an alternative to their "product", paper money. Moreover, it is out of their control: they can control the supply, value and even allocation of new paper money. They have no such monopoly power over gold. So it is not surprising that they would go out of their way to destroy peoples faith in it. This is achieved by consistently driving down the bullion price. The 20-year fall of the gold price has already persuaded many individuals to switch into paper assets. Since the central banks still own enough gold to drive its price down further, it is too early to bet against them." (emphasis mine)
Interestingly enough this man understands exactly what Carroll Quigley wrote about in Tragedy and Hope. Furthermore, he sees what the effect is of the monopolists (or the mercantilists) is on the market. Lastly, he realizes and understands that gold is un-welcomed competition to paper because he understands "he who owns the gold makes the rules." But there is one more thing which Mr. Werner has not written about and that is electronic money, or e-money, otherwise known as a cashless society.
Everyone knows we are wired to one another, not only through the radio, television and Internet, but through the ATMs, which now allow you to obtain cash throughout the United States, and Visa/MasterCard and American Express which you can use worldwide.
Gold is not only a threat to a paper currency but electronic money as well. By destroying the value of gold, the Group of Eight will also destroy the gold foundations and resources of the African countries which have some of the largest and most profitable gold mines in the world. By selling gold, the central banks, which have tons of it, will bring the price down long enough to be able to purchase, for pennies on the dollar, major gold mines as these countries scramble to find assets to sell in order to keep their heads above water.
Since the central banks own vast quantities of gold, and the International Monetary Fund collects their dues in gold, do you think they are going to destroy their savings? No, they are not that foolish. They are creating the perfect situation which will allow them to accumulate more of the gold reserves of the world while at the same time, giving Joe Average the impression that it has no value!
Gold will only lose its real shine when diamonds lose theirs--and that, my friends will never happen. This is a time to buy low!!
Sources:
Tragedy and Hope by Carroll Quigley (available through Veon Financial Services, Inc., for $40.00 including shipping and handling)
The Coming Battle by M. W. Walbert (available through Walthaiz Research, 1-800-955-0116)