GOING FOR THE GOLD
IGNORED BY the stenographic media is the possibility
that the Enron scandal may be eclipsed by other
derivative-based disasters, most notably one involving
the shaky gold markets. It has been left to concerned gold traders
and market aficionados to blow the whistle on this crisis in the
making.
One exception in the press is Kelly Patricia O'Meara of
Insight Magazine who writes in the current issue:
"There are many in the world of high finance who aren't
buying the official line and warn that Enron is just the
first to fall from a shaky house of cards. Many analysts
believe that this problem is nowhere more evident than
at the nation's bullion banks, and particularly at the
House of Morgan (J.P. Morgan Chase). One of the world's
leading banking institutions and a major international bullion bank,
Morgan Chase has received heavy media attention
in recent weeks both for its financial relationships with bankrupts
Enron and Global Crossing Ltd. as well as the financial collapse of
Argentina . ..
"In recent years Morgan Chase has invested much of its
capital in derivatives, including gold and interest-rate
derivatives, about which very little information is
provided to shareholders. Among the information that
has been made available, however, is that as of June 2000,
J.P. Morgan reported nearly $30 billion of gold derivatives
and Chase Manhattan Corp., although merged with J.P. Morgan, still
reported separately in 2000 that it had $35 billion in gold
derivatives. Analysts agree that the derivatives have exploded at
this bank and that both positions are enormous relative to the
capital of the bank and the size of the gold market.
"It gets worse. J.P. Morgan's total derivatives position reportedly
now stands at nearly $29 trillion, or three
times the U.S. annual gross domestic product.
"Wall Street insiders speculate that if the gold market
were to rise, Morgan Chase could be in serious financial difficulty
because of its "short positions" in gold. In
other words, if the price of gold were to increase
substantially, Morgan Chase and other bullion banks that
are highly leveraged in gold would have trouble covering
their liabilities. One financial analyst, who asked not
to be identified, explained the situation this way: 'Gold is
borrowed by Morgan Chase from the Bank of England at 1
percent interest and then Morgan Chase sells the gold on
the open market, then reinvests the proceeds into interest-bearing
vehicles at maybe 6 percent. At some point, though, Morgan Chase
must return the borrowed gold to the Bank of England, and if the
price of gold were significantly to
increase during any point in this process, it would make
it prohibitive and potentially ruinous to repay the gold.'"
One reason no one knows for sure what is happening in
the gold market is because those that do know aren't saying.
For example: how has the Fed and the US government used
the gold market for their own purposes? The Gold
Anti-Trust Action group has dug up some tantalizing,
oblique references.
There is, for example, this comment from a former Fed
governor during a meeting of the Federal Open Market
Committee on March 26, 1991: "I would hesitate for us
to have foreign currency holdings that have swap puts that
just sit there, [which] is now becoming the case for
our gold."
At another FOMC meeting, in January 1995, then Federal
Reserve Governor Lawrence Lindsey asks about the legal
authority to engage in a Mexican financial rescue package
then under discussion. J. Virgil Mattingly, general
counsel of the Fed and FOMC, replied: "I don't think
there is a legal problem in terms of the authority. The
statute is very broadly worded in terms of words like
'credit' - it has covered things like the gold swaps -
and it confers broad authority."
Here is Fed Chairman Alan Greenspan before the House Banking
Committee and Senate Agricultural Committee in July 1998:
"Nor can private counter-parties restrict supplies of gold, another
commodity whose derivatives are often traded over-the-counter, where
central banks stand ready to lease gold in
increasing quantities should the price rise."
In January 2000, Greenspan wrote a letter to Senator
Lieberman attempting to explain his testimony: "This
observation simply describes the limited capacity of private parties
to influence the gold market by restricting the
supply of gold, given the observed willingness of some
foreign central banks - not the Federal Reserve - to lease
gold in response to price increases . . . The Federal Reserve owns
no gold and therefore could not sell or lease
gold to influence its price. Likewise, the Federal Reserve
does not engage in financial transactions related to gold,
such as trading in gold options or other derivatives.
Most importantly, the Federal Reserve is in complete
agreement with the proposition that any such transactions
on our part, aimed at manipulating the price of gold or otherwise
interfering in the free trade of gold, would
be wholly inappropriate."
But now consider a lawsuit in which Edward A. J. George, Governor of
the Bank of England and a director of the
Bank of International Settlements, is quoted as having written: "We
looked into the abyss if the gold price rose
further. A further rise would have taken down one or several trading
houses, which might have taken down all the rest in their wake.
Therefore at any price, at any cost, the central banks had to quell
the gold price, manage it. It was very difficult to get the gold
price under control but we have
now succeeded. The U.S. Fed was very active in getting
the gold price down. So was the U.K."
AS GATA would point out later, "The 'abyss' was the
problem of covering the short physical gold position
evidenced by a mountain of gold derivatives on the books
of the bullion banks."
It was none other than former Treasury Secretary and
now Harvard president Lawrence Summers, who in a 1988 paper
explained why a number of gold specialists are highly
skeptical of the banks' and government's role in gold
prices. Summers, then Nathaniel Ropes professor of
political economy at Harvard, co-authored with Robert B.
Barsky an article entitled "Gibson's Paradox and the Gold Standard."
A principal conclusion of the article is
that in a genuinely free gold market unaffected by
"government pegging operations," gold prices will move
inversely to real long-term interest rates, rising when real rates
fall, and falling when real rates rise.
Last August, the Golden Sextant web site offered this analysis:
"Gibson's paradox continued to operate for another decade after the
period covered by Barsky and Summers. But sometime around 1995, real
long-term interest rates and
inverted gold prices began a period of sharp and increasing
divergence that has continued to the present time. During
this period, as real rates have declined from the 4% level
to near 2%, gold prices have fallen from $400/oz. to
around $270 rather than rising toward the $500 level as
Gibson's paradox and the model of it constructed by
Barsky and Summers indicates they should have. The
historical evidence adduced by Barsky and Summers
leaves but one explanation for this breakdown in the
operation of Gibson's paradox: what they call 'government pegging
operations' working on the price of gold.
What is more, this same evidence also demonstrates that
absent this governmental interference in the free market
for gold, falling real rates would have led to rising
gold prices which, in today's world of unlimited
fiat money, would have been taken as a warning of future inflation
and likely triggered an early reversal of
the decline in real long-term rates."
GATA, which would like to see gold prices function freely, claims
that financial giants such as Goldman Sachs and
Morgan have conspired with the Treasury to keep gold
prices low. It sees this practice as risking a short
covering panic, endangering the US gold supply, and
helping countries such as Russia, China, and Japan who
are happily buying the cheap gold. And it notes that the
US Mint has included in its inventory some "deep storage
gold," which GATA suspects may be gold that is still to
be mined.
Banks have loaned gold, have shorted gold, and may have manipulated
gold prices with the help of the government.
If so, a marked rise in gold prices could cause a short
covering panic since the demand for gold would outstrip
the actual supply.
In one of the bizarre examples of what can happen, a
gold price rice in the recent past caused two mining
companies to belly up. Why? Well in part because they
had been convinced by their financial advisors to short
their own product. Even Marx had more respect for
capitalism than that.
The size of the derivatives gold and otherwise held by
Morgan is staggering and therein lies what could be a fatal problem;
as one analyst put it, "Morgan is too big to fail
and it's too big to bail."
MORE
goldensextant.com
196905 |
