The Big Reset

This is part two of a Q&A with Willem Middelkoop about his new book The Big Reset. In his book a chapter on the ‘War on Gold’ takes a prominent position. Willem has been writing about the manipulation of the gold pricesince 2002 based on information collected by GATA since the late 1990’s. So part two of our interview will focus on this topic.

The War On Gold

Why does the US fight gold?

The US wants its dollar system to prevail for as long as possible. It therefore has every interest in preventing a ‘rush out of dollars into gold’. By selling (paper) gold, bankers have been trying in the last few decades to keep the price of gold under control. This war on gold has been going on for almost one hundred years, but it gained traction in the 1960's with the forming of the London Gold Pool. Just like the London Gold Pool failed in 1969, the current manipulation scheme of gold (and silver prices) cannot be maintained for much longer.

What is the essence of the war on gold?

The survival of our current financial system depends on people preferring fiat money over gold. After the dollar was taken of the gold standard in 1971, bankers have tried to demonetize gold. One of the arguments they use to deter investors from buying gold and silver is that these metals do not deliver a direct return such as interest or dividends. But interest and dividend are payments to compensate for counterparty risk – the risk that your counterparty is unable to live up to its obligations. Gold doesn’t carry that risk. The war on gold is, in essence, an endeavor to support the dollar. But this is certainly not the only reason. According to a number of studies, the level of the gold price and the general public’s expectations of inflation are highly correlated. Central bankers work hard to influence inflation expectations. A 1988 study by Summers and Barsky confirmed that the price of gold and interest rates are highly correlated, as well with a lower gold price leading to lower interest rates.

When did the war on gold start?

The first evidence of US meddling in the gold market can be found as early as 1925 when the Fed falsified information regarding the Bank of England’s possession of gold in order to influence interest rate levels. However, the war on gold only really took off in the 1960's when trust in the dollar started to fray. Geopolitical conflicts such as the building of the Berlin Wall, the Cuban Missile Crisis and the escalation of violence in Vietnam led to increasing military spending by the US, which in turn resulted in growing US budget deficits. A memorandum from 1961 entitled ‘US Foreign Exchange Operations: Needs and Methods’ described a detailed plan to manipulate the currency and gold markets via structural interventions in order to support the dollar and maintain the gold price at $ 35 per ounce. It was vital for the US to ‘manage’ the gold market; otherwise countries could exchange their surplus dollars for gold and then sell these ounces on the free gold market for a higher price.

How was the gold price managed in the 1960’s?

During meetings of the central bank presidents at the BIS in 1961, it was agreed that a pool of $ 270 million in gold would be made available by the eight participating (western) countries. This so-called ‘London Gold Pool’ was focused on preventing the gold price from rising above $ 35 per ounce by selling official gold holdings from the central banks gold vaults. The idea was that if investors attempted to flee to the safe haven of gold, the London Gold Pool would dump gold onto the market in order to keep the gold price from rising. During the Cuban Missile Crisis in 1962, for instance, at least $ 60 million in gold was sold between 22 and 24 October. The IMF provided extra gold to be sold on the market when needed. In 2010, a number of previously secret US telex reports from 1968 were made public by Wikileaks. These messages describe what had to be done in order to keep the gold price under control. The aim was to convince investors that it was completely pointless to speculate on a rise in the price of gold. One of the reports mentions a propaganda campaign to convince the public that the central banks would remain ‘the masters of gold’. Despite these efforts, in March 1968, the London Gold Pool was disbanded because France would no longer cooperate. The London gold market remained closed for two weeks. In other gold markets around the world, gold immediately rose 25% in value. This can happen again when the COMEX will default.

More evidence about this manipulation?

From the transcript of a March 1978 Fed-meeting, we know that the manipulation of the gold price was a point of discussion at that time. During the meeting Fed Chairman Miller pointed out that it was not even necessary to sell gold in order to bring the price down. According to him, it was enough to bring out a statement that the Fed was intending to sell gold.

Because the US Treasury is not legally allowed to sell its gold reserves, the Fed decided in 1995 to examine whether it was possible to set up a special construction whereby so-called ‘gold swaps’ could bring in gold from the gold reserves of Western central banks. In this construction, the gold would be ‘swapped’ with the Fed, which would then be sold by Wall Street banks in order to keep prices down. Because of the ‘swap agreement’, the gold is officially only lent out, so Western central banks could keep it on their balance sheets as ‘gold receivables’. The Fed started to informing foreign central bankers that they expected that the gold price to decline further, and large quantities of central banks’ gold became be available to sell in the open market. Logistically this was an easy operation, since the New York Fed vaults had the largest collection of foreign gold holdings. Since the 1930's, many Western countries had chosen to store their gold safely in the US out of fears of a German or Soviet invasion.

Didn’t the British help as well by unloading gold at the bottom of the market?

Between 1999 and 2002, the UK embarked on an aggressive selling of its gold reserves, when gold prices were at their lowest in 20 years. Prior to starting, the Chancellor of the Exchequer, Gordon Brown, announced that the UK would be selling more than half of its gold reserves in a series of auctions in order to diversify the assets of the UK’s reserves. The markets’ reaction was one of shock, because sales of gold reserves by governments had until then always taken place without any advance warning to investors. Brown was following the Fed’s strategy of inducing a fall in the gold price via an announcement of possible sales. Brown’s move was therefore not intended to receive the best price for its gold but rather to bring down the price of gold as low as possible. The UK eventually sold almost 400 tons of gold over 17 auctions in just three years, just as the gold market was bottoming out. Gordon Brown’s sale of the UK’s gold reserves probably came about following a request from the US. The US supported Brown ever since.

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How do they manipulate gold nowadays?

The transition from open outcry (where traders stand in a trading pit and shout out orders) to electronic trading gave new opportunities to control financial markets. Wall Street veteran lawyer Jim Rickards presented a paper in 2006 in which he explained how ‘derivatives could be used to manipulate underlying physical markets such as oil, copper and gold’. In his bestseller entitled Currency Wars, he explains how the prohibition of derivatives regulation in the Commodity Futures Modernization Act (2000) had ‘opened the door to exponentially greater size and variety in these instruments that are now hidden off the balance sheets of the major banks, making them almost impossible to monitor’. These changes made it much easier to manipulate financial markets, especially because prices for metals such as gold and silver are set by trading future contracts on the global markets. Because up to 99% of these transactions are conducted on behalf of speculators who do not aim for physical delivery and are content with paper profits, markets can be manipulated by selling large amounts of contracts in gold, silver or other commodities (on paper). The $200 crash of the gold price April 12 and 15, 2013 is a perfect example of this strategy. The crash after silver reached $50 on May 1, 2011 is another textbook example.

For how long can this paper-gold game continue?

As you have been reporting yourself we can witness several indications pointing towards great stress in the physical gold market. I would be very surprised when the current paper gold game can be continued for another two years. This system might even fall apart in 2014. A default in gold and/or silver futures on the COMEX is a real possibility. It happened to the potato market in 1976 when a potato-futures default happened on the NYMEX. An Idaho potato magnate went short potatoes in huge numbers, leaving a large amount of contracts unsettled at the expiration date, resulting in a large number of defaulted delivery contracts.  So it has happened before. In such a scenario futures contracts holders will be cash settled. So I expect the Comex will have to move to cash settlement rather than gold delivery at a certain point in the not too distant future. After such an event the price of gold will be set in Asian markets, like the Shanghai Gold Exchange. I expect gold to jump $1000 in a short period of time and silver prices could easily double overnight. That’s one of the reasons our Commodity Discovery Fund invests in undervalued precious metal companies with large gold/silver reserves. They all have huge up-side potential in the next few years when this scenario will play out.

In Gold We Trust

Synopsis of The Big Reset: Now five years after the near fatal collapse of world’s financial system we have to conclude central bankers and politicians have merely been buying time by trying to solve a credit crisis by creating even more debt. As a result worldwide central bank’s balance sheets expanded by $10 trillion. With this newly created money central banks have been buying up national bonds so long term interest rates and bond yields have collapsed. But ‘parking’ debt at national banks is no structural solution. The idea we can grow our way back out of this mountain of debt is a little naïve. In a recent working paper by the IMF titled ‘Financial and Sovereign Debt Crises: Some Lessons Learned and Those Forgotten’ the economist Reinhart and Rogoff point to this ‘denial problem’. According to them future economic growth will ‘not be sufficient to cope with the sheer magnitude of public and private debt overhangs. Rogoff and Reinhart conclude the size of the debt problems suggests that debt restructurings will be needed ‘far beyond anything discussed in public to this point.’ The endgame to the global financial crisis is likely to require restructuring of debt on a broad scale.

About the author: Willem Middelkoop (1962) is founder of the Commodity Discovery Fund and a bestselling Dutch author, who has been writing about the world’s financial system since the early 2000s. Between 2001 and 2008 he was a market commentator for RTL Television in the Netherlands and also appeared on CNBC. He predicted the credit crisis in his first bestseller in 2007.