Here’s an oldie but goodie from FOFOA that explains why gold confiscation will not be in the cards following a failure of the dollar and an attempt at a reboot of old gold standard. This has always been a concern of mine that the best laid plans could be undone by a government intent on defaulting for a 3rd time.
Our government would subject itself to significant risk by attempting to put gold back into play and that could be enough prevent it. Linking the dollar to gold means convertibility for someone at some price. Who in their right mind would not trade their paper that has been defaulted on twice before for real physical ounces? Fool me once, fool me twice,… fool me three times? There would either be an immediate run on gold or there would be a depletion over time as too many claims for gold would be created.
Friday, August 21, 2009
Confiscation Anatomy – A Different View
Please do not take this post as a definitive, final statement on this very complex topic. This is only one view of many that explains why confiscation will not happen. Once you understand the dynamics of a completely demonetized, free, non-fractional, physical-only gold market (freegold), it will become clear that this is where the river of time is taking us. This particular post is meant only to encourage a focused discussion on this “concern”, for the benefit of us all. In fact, think of this post as a primer or introduction if you will. Or if you prefer, think of it as a dose of ocular Xanax for your “gold-angst”.
Anatomy of a Straw Man
This tired old topic of gold confiscation seems to surface far too often within the online gold community. In the spirit of colorful analogies I’ll liken it to a noxious vial of fox urine strategically placed to scare hungry little bunnies away from the delicious golden strawberry patch. Fox urine seems more appropriate than a simple scarecrow. But as we all know, a scarecrow is not really alive, and urine does not really eat bunnies.
The most important thing to keep in mind during this discussion is the macro, or global economy. The US is but one global player among many. This is not a simple story about stupid US politicians versus helpless US citizens. Instead, it is a grand story of giants. It is a story about the US government versus the rest of the world. And it is not just about this present crisis. It is a story that covers many crises and 96 years in the life of a single paper contract called the US dollar. In this global macro view, that a 1933 confiscation happened at all means that a 21st century one will not. That option has already been fully exhausted!
Anatomy of a Dollar Collapse
The dollar is going down, and there are a couple of ways this could play out, but one is more likely than the other. To understand why this will not lead to the confiscation of our gold, we must first understand the corner the dollar has painted itself into, and what its future options really are.
As I have explained many times, freegold and hyperinflation are separate events. Freegold is the establishment of a physical gold market after the paper gold market is arrested through default, breaking the dollar’s grip on gold, and also breaking the dollar’s international settlement function.
The first way this collapse could play out is a quick devaluation of the dollar, say, over a couple weeks, followed by the emergence of freegold. Think of it as the riverbed at the bottom of the waterfall.
The second and more likely way this will play out is with hyperinflation thrown in, perhaps lasting many months or years after the initial plunge/devaluation. The overwhelming evidence that this will be our path is the political control the Executive Branch is exercising over dollar monetary policy. Jim Sinclair believes this is a serious threat:
China wishes the annihilation of the Fed policy of “Quantitative Easing.”
The Fed wishes to accommodate China.
The US Treasury is absolutely opposed to any such consideration as it would cement the present Administration into a one term wonder.
The US Treasury must win this battle because the boss of this opposition has the power to appoint the new Chairman of the Fed, either Summers or Geithner.
Political control of the US Fed and therefore of monetary policy is in the cards…
…political control of monetary policy is CERTAIN as the Fed cannot win this contest against the Administration in the form of the US Treasury.
Bernanke becomes a team player or a team player will replace him.
The latter is becoming a probability as it is hard to trust a prior adversary. (Link)
I suppose you could picture this one as a waterfall with no riverbed at the bottom. Instead, the water falls all the way to the fiery pit of Zimbabwe hell where it burns into nothing but a curiosity for future historians and possibly a cheap eBay collectable, “The $11 trillion bundle – Now even YOU can pay off the US national debt”.
Anatomy of a Gold Run
In the 1920’s, if you had a dollar you held a contract for 1/20th of an ounce of gold. In essence, you had loaned your gold to the US Treasury and the dollar was your note on that loan. You could walk into the bank and present your note and it was the bank’s job to provide you with gold or to die trying.
The problem was that the Federal Reserve system issued more notes than it had gold. So the whole “fractional reserve system” relied solely on the confidence that you COULD receive your gold, knowing full well that all people could NEVER receive all their gold.
By taking a look at the modern paper gold market, a striking similarity should start to emerge.
COMEX is primarily a betting operation that pairs up long bettors with short bettors. Only a very small percentage of these bettors actually take the physical gold. So the COMEX relies on the market’s confidence that you COULD receive your gold, knowing full well that all the bettors could NEVER receive all of their gold at the same time (or ever for that matter).
So COMEX is essentially existing the same as the banks during the Roaring 20’s.
In the crisis of the early 1930’s, too many people went into the banks to withdraw their gold. And fulfilling their duty to provide gold or die trying, many banks died. This is the fate the COMEX has to look forward to.
Imagine if one favored entity, say Goldman Sachs, decides to take delivery on futures contracts that amount to perhaps 3% of the total open interest. Then imagine that all the short sellers exit the market through a cash deal with an offsetting long position. Where does the Goldman gold come from? Let’s say for convenience that the entire registered stock of COMEX gold is eligible to meet Goldman’s delivery. Great! The bank (COMEX) was able to cash Goldman’s check! But what happens when the other 97% open interest sees this action and wants delivery too? Or even just part of it?
In any bank run, the first few people in line do get their cash. But ultimately, it is the flood that ensues that kills the bank. An innocent bystander might hear a rumor that the bank is about to fail. When he arrives at the bank he sees the long line and starts to panic. But then he sees a few customers coming out with their cash, so he calms down and gets in line. But will he make it through the doors before the bank closes for the “holiday”?
Anatomy of a Gold Default
In its role as the global reserve currency, the dollar must have two vital things: value and function. It is indisputable to rational minds that gold is true money. The universal way fiat currencies are measured for value is by how much gold they can be exchanged for. So the dollar has value on the global stage because of its ability at any given moment to buy gold. For function, the dollar is needed to repay all dollar-denominated loans and contracts around the world. But a dollar will always be able to pay one unit of any dollar-denominated loan, no matter what the value of that dollar is. So a failure of the dollar would be defined as a failure of value, not function. A dollar collapse would be defined by its inability to be exchanged for true money, gold, at any reasonable price.
What does it mean for a bullion bank to fail? Just as a regular bank would fail from a massive withdrawal of deposits beyond its ability to pay, we could say that a bullion bank has failed if it can’t supply the gold necessary to honor its obligations. You can be sure it will first exhaust itself by trying to obtain whatever gold can be obtained on the spot market to fill its obligations prior to failure as an institution. But this is where the price would race away on the spot market paving the way for a complete run on all physical gold, permanent backwardation in the forward gold market, the withdrawal of all offers to sell physical gold, and a complete failure of the spot market to exchange gold for dollars at any reasonable price. And so, we would have the official failure of the dollar as well.
This is how a failure of the paper gold market, a DEFAULT on paper gold, will mean the collapse of the dollar. You will have the dollar on one side, gold on the other, and COMEX contracts in between the two of them. This will essentially pit gold and the dollar against each other, forcing them to arrive at a settlement in a dollar-rich/gold-starved arena. Could the dollar ever deliver on its physical gold contract obligations? No way. Which do you think will be left standing?
Back in 1933, the dollar DID default on its contractual gold obligations. In essence, the US government kept the gold that its citizens had loaned it and told the citizens to eat the loss. The government told them to simply keep the paper promissory note and pretend it was still “as good as gold”.
At the time, the Bretton Woods agreement was more than a decade away, but there were still a whole lot of dollars floating around the international arena. So in order keep international trade goods flowing into the US, the US government said that dollars that worked their way into the international central bank clearing system could still be exchanged for physical gold.
To facilitate this convertibility in a time of dire crisis, it took three more drastic steps. First the government defaulted on 41% of its outstanding international gold obligations by devaluing the dollar 70%. (The world DID take notice of this 41% default!) Second, it called in the local gold to establish a fresh hoard for backing the international dollar. And third, it made gold ownership illegal in the US, a capital control move to prevent capital flow out of paper and into physical gold on the open market.
Then, in 1971 the US did it again, this time defaulting on 100% of its gold obligations to the rest of the world. Something to think about: The US did this while it still had a lot of gold. Why was that? If it was going to take the world off the gold standard, why not do it when the gold ran out? At least then it doesn’t make you look like a cheat. As Another liked to say, “think long and hard on that one”!
Gold is off the table
The US gold hoard is now off the table. Think of a poker cheat who pockets his winnings yet still wants to play. When he loses he writes paper IOU’s to the other players. Can he ever pull his money back out of his pocket without having it taken away? Think of an individual who declares his own insolvency and defaults on his obligations to pay, only to resurface later with a windfall inheritance. What problems will he face?
In 1971 the US refused to ship any more gold. It defaulted on its international obligations. It took its golden chips off the table but continued to play in the game. But the dollar didn’t change. It still remained an international contract for gold. Watch the announcement:
Nixon Closes the Gold Window
As a politician, the President did not want to interrupt television viewers watching the tremendously popular TV series Bonanza, not wishing to potentially alienate those voters who fanatically followed the cowboy series. He was advised that the practical decision was to make an announcement before the stock markets opened on Monday (and just when Asian markets also were opening trading for the day). On 15 August 1971, that speech and the price-control plans proved very popular and raised the public’s spirit. The President was credited with finally rescuing the American public from price-gougers, and from a foreign-caused exchange crisis.
This was cheating, plain and simple. The international financial system and the global market place run on procedure protocols that are not binding. They are not binding, but without them, international trade would stop altogether. Just because a rule is not binding does not mean it is not important. And just because a non binding rule is broken, does not mean it disappears.
Why do you think the US gold hoard was never publicly audited after this? And why do you think the book value of that gold was left frozen at $42 per ounce, never marked to market bringing it “back into play”?
There are two international bodies that facilitate the international financial and monetary system, the IMF and the BIS. These two bodies are in opposite camps. The IMF is in the dollar camp. Its sole purpose is to ensure that third world countries can pay their dollar-denominated debts in order to keep the dollar alive. If that debt from third world countries could no longer be serviced, it could no longer be held as an asset within the financial system. Therefore, the IMF issues highly leveraged dollar loans to these countries to make sure that payments continue. In exchange, it locks up real world capital as collateral for the loans. This is NOT a system that supports third world economies. It is a system that supports the dollar’s reserve function at the EXPENSE of third world economies. If the IMF stopped functioning, so would the dollar. And the US government would lose its external funding.
The BIS, on the other hand, coordinates central bank transfers to facilitate international trade balance. If the BIS stopped functioning, so would international trade. This clearing system is fractal in that imbalances are first cleared locally, then regionally, then nationally, then internationally. If the BIS didn’t deliver, food would not arrive at your local store, at least until a local production, distribution and clearing system was set up.
This leaves us with a one-sided dependence dynamic in which the BIS and the rest of the world could, if they wanted to, stop supporting the IMF and let the dollar die. But on the other side, the dollar cannot survive without the BIS. But why does this matter? What could make the dollar even think about abandoning the BIS?
Well, if the US ever put gold back on the table through another confiscation of its citizens’ gold, the BIS would call in all of its outstanding claims in gold at the rate of $42 per ounce. And the BIS would not be alone. Other entities would have legal claims for gold at $20.67 per ounce, and others at $35 per ounce. How much gold was either confiscated or defaulted on without due process of law? Claims of perpetual entities never go away. If the US government ever exposed its own gold (or its citizens’ gold through confiscation) to the light of day, it would expose itself to all kinds of claims and an international legal mess. Under international law, the US is still an OUTLAW when it comes to gold!
This is why gold is off the table. This is why we can never go back to a gold backed dollar. It is also why they cannot call in gold AGAIN under the same dollar that they did in 1933. To call in gold at a specific exchange rate now, the US would first have to back the dollar with gold at that rate and then call it in. That would expose the US gold to international legal challenges for redemption. If they simply called in the gold without backing the dollar, the US government would be exposed to thousands of internal law suits. These law suits would rightfully demand a retroactive reversal of 1933 before any new confiscation could take place. They would demand that US official gold be distributed to all citizens at $20 per ounce BEFORE it could be turned back in to the government.
The US government will never take this risk! It will never expose itself to this legal nightmare! The US is already a golden outlaw!
If the coming dollar collapse takes the first waterfall route and hits the riverbed, how would an insane and illogical confiscation play out? Well, if the US dropped out of the BIS to secure sovereignty over its confiscated gold, the BIS would halt all international dollar traffic and probably try to use those dollars to buy gold on the international free market. The dollar would be instantly dead.
But what if the dollar falls all the way to the pits of Zimbabwe hell? What if the US simply declares the dollar dead, confiscates the gold, and then starts a new gold backed currency? Wouldn’t that work? I will tell you now that it would never be accepted on the international market as an exchange contract for gold! Even at $10,000 or $100,000 an ounce. The world is not that stupid. The US has defaulted on its gold obligations to the world TWICE now. The first default was 41% and the second was 100%. What will it be next time? No, the US will never be trusted to issue paper promises for gold again! Freegold is the only option!
The US government and the US dollar is caught up in this massive Catch-22 because of its own past cheating actions. This is why a future gold confiscation is simply not in the cards. This is why the Fed will appear more and more INSANE in its futile attempts to save the current system, all the way to the fiery bottom. And this is why freegold is the only possible end to this system.
Bottom Line: It takes AAA credibility to gain the confidence needed to run a fractional reserve paper gold scheme. The US government spent all of its credibility on a failed scheme long ago. And now the current COMEX scheme will face the same fate, thanks to the inflating of paper contract supply to meet demand, far in excess of physical supply, in the sole support of the US dollar printing authority that needed support since it had already defaulted TWICE!
And when the dollar finally collapses in value, a THIRD and final default will take place. The US government’s existing dollar-denominated debt of $11 trillion will become instantly worthless.
And once the printing press source of funding is gone, the US will be forced to settle its trade deficit with real money on a 1 to 1 basis, no more fractional reserve shenanigans. If this is done centrally, as it is now, then the government will face a whole world of claims saying the gold already belongs to them. For its past sins, the government cannot take this chance. The other way to settle an ongoing trade deficit is on the local level, through millions of small transactions.
This is freegold. And this will pit trader against foreign trader, rather than government against government, or central bank against central bank. It will allow for trade goods to flow across borders and keep the economy alive so that the government can continue to collect taxes. This system will become very clear, very fast. It may be hard to imagine right now, but once it is forced into action by necessity, it will be clear. Even to the US government.
Freegold is not about huge profits for owning gold. It is only about the protection of wealth for everyone in the world. The huge profit only happen once, during the waterfall. It is a one time event. After that gold becomes the only store of value that keeps up with inflation… automatically!
I had wanted to end with a recent comment on this subject which prompted this post. But rather than extend this already long post any further, I will end with a simple link. Here is Ender’s excellent explanation of why a freegold financial system is the only option left to a government that cornered itself long ago. Ender’s comment will give you a glimpse at how this new freegold system will actually benefit governments while gold confiscation would hurt them. Remember, the government already has a monstrous system of confiscation in place. It is called TAXES. And freegold will stimulate the exact activity that generates the most confiscation, er… taxes. That would be local business investment! So take a break and then come back and read Ender’s great two part post.