The Gold Standard Did Not Cause The Great Depression, Part 2

As noted in my previous column, AEI’s James Pethokoukis and National Review‘s Ramesh Ponnuru — among many others — appear to have fallen victim to what I have called the “Eichengreen Fallacy.”  This refers to the demonstrably incorrect proposition that the gold standard caused the Great Depression.

Pethokoukis proves exactly right in observing that “Benko is a gold-standard advocate and apparently doesn’t much like the words ‘Hitler’ or ‘Nazi’ to be in the same area code of any discussion of once again linking the dollar to the shiny yellow metal.”  “Doesn’t much like” being falsely linked with Hitler?  Perhaps an apology is more in order than an apologia.

My objecting to a demonstrably false implication of the (true) gold standard in the rise of Nazism does not constitute a display of ill will but rather righteous indignation.  To give Pethokoukis due credit he thereupon generously devoted anAEIdea blog to reciting Peter Thiel’s praise for the gold standard, praise which triggered a hysterical reaction from the Washington Post‘s Matt O’Brien.

Pethokoukis’s earlier (and repeated) vilification of gold was followed by a column in the Washington Times by a director of the venerable Committee for Monetary Research and Education Daniel Oliver, Jr., Liberty and wealth require sound money. In it, Oliver states:

What if liberty and riches at times diverge, though? A shibboleth of mainstream economists, repeated recently in The National Review, of all places, is that countries recovered from the Great Depression in the order that they abandoned the gold standard. … No doubt, money printing — the modern equivalent of leaving the gold standard — can plug the holes in banks’ balance sheets when the demand deposits at the base of the credit structure are withdrawn. This is the policy recommended by National Review Senior Editor Ramesh Ponnuru and other “market monetarists” such as the American Enterprise Institute’s James Pethokoukis ….

I am not in complete accord with all of Oliver’s propositions therein. Ponnuru is on solid ground in contradicting Oliver’s imputation of sentiments to him he does not hold and does not believe.  Yet Ponnuru weakens his defense by citing, among other things, a

recent summary of the history of gold standards in the United States that George Selgin wrote for the Cato Institute. It is a very gold-friendly account, but it ‘concludes that the conditions that led to the gold standard’s original establishment and its successful performance are unlikely to be replicated in the future.’

“Unlikely to be replicated in the future?”  Prof Selgin is a brilliant economist, especially in the elite field of monetary economics.  Yet as Niels Bohr reportedly once said, “Prediction is very difficult, especially about the future.” This citation in no way advances Ponnuru’s self-defense.

Let it be noted that Cato Institute recently announced a stunning coup in recruiting Prof. Selgin to head its impressive new Center For Monetary and Financial Alternatives. As stated in its press release, “George Selgin, a Professor Emeritus of Economics at the University of Georgia and one of the foremost authorities on banking and monetary theory and history, gave up his academic tenure to join Cato as director of the new center.” Cato’s recruitment, from the Mercatus Institute, of a key former House subcommittee aide, the formidable Lydia Mashburn, to serve as the Center’s Manager also shows great sophistication and purpose.

Prof. Selgin hardly would give up a prestigious university post to engage in a quixotic enterprise.  I, among many, expect Selgin rapidly to emerge as a potent thought leader in changing the calculus of what is, or can be made, policy-likely.  Also notable are the Center’s sterling Council of Economic Advisors, including such luminaries as Charles Calomiris; its Executive Advisory Council; Senior Fellows; and Adjunct Scholars.  It is, as Prof. Selgin noted in a comment to the previous column, “a rather … diverse bunch.”

The Center presents as an array of talent metaphorically reminiscent of the 1927 Yankees. These columns do not imply Cato to be a uniform phalanx of gold standard advocates but rather a sophisticated group of thought leaders committed to monetary and financial alternatives, of which the classical gold standard is one, respectable, offering.  Prof. Selgin’s own position frankly acknowledging the past efficacy of the true gold standard represents argument from the highest degree of sophistication.

Ponnuru is on the weakest possible ground in citing the “commonplace observation that countries recovered from the Great Depression in the order they left gold.”  This is as misleading as it is commonplace. Ponnuru, too, would do well to break free of the Eichengreen Fallacy and assimilate the crucial fact that a defective simulacrum, not the true gold standard, led to and prolonged the Great Depression.

The perverse effects of the interwar “gold” standard led to a significant rise in commodities prices … and the ensuing wreckage of a world monetary system by the, under the circumstances, atavistic definition of the dollar at $20.67/oz of gold.  The breakdown of the system meticulously is documented in a narrative history by Liaquat Ahamed, Lords of Finance: The Bankers Who Broke The World, which received the Pulitzer Prize in history.  That road to Hell tidily was summed up in a recent piece in The Economist, Breaking the Rules: “The short-lived interwar gold standard … was a mess.”  As EPPC’s John Mueller recently observed, in, “the official reserve currencies which Keynes advocated fed the 1920s boom and 1930s deflationary bust in the stock market and commodity prices.”

The predicament — caused by the gold-exchange standard adopted in Genoa in 1922 — required a revaluation of the dollar to $35/oz, duly if eccentrically performed by FDR under the direction of commodities price expert economistGeorge Warren.  That revaluation led to a dramatic and rapid lifting of the Great Depression.  Thereafter, as Calomiris, et. al, observe in a publication by the Federal Reserve Bank of St. Louis, the Treasury sterilized gold inflows.  That sterilization, together with tax hikes, most likely played a major role in leading to the double dip back into Depression.

The classical gold standard — an early casualty of the First World War — was not, indeed could not have been, the culprit.  There is a subtle yet crucial distinction between the gold-exchange standard, which indeed precipitated the Great Depression, and the classical gold standard, which played no role.There is much to be said for the classical gold standard as a policy conducive to equitable prosperity.  It commands respect, even by good faith opponents.

For the discourse to proceed we first must lay to rest the Eichengreen Fallacy (and all that is attendant thereon). Once having dispelled that toxic fallacy let the games begin and let the best monetary policy prescription win.

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The Gold Standard Did Not Cause The Great Depression, Part 1

AEI’s James Pethokoukis and National Review’s Ramesh Ponnuru — among many others — appear to have fallen victim to what I have called “the Eichengreen Fallacy,” the demonstrably incorrect proposition that the gold standard caused the Great Depression.  This fallacy is at the root of much confusion in the discourse.

Both these conservatives find themselves, most incongruously, in the company of Professors Paul Krugman, Brad Delong, and Charles Postel; Nouriel Roubini; Thomas Frank; Think Progress’s Marie Diamond; the Roosevelt Institute’s Mike Konczal and other leading thinkers of the left pouring ridicule on the gold standard.  Most recently, Matt O’Brien, of the Washington Post, hyperbolically described the gold standard as “the worst possible case for the worst possible idea,” echoing a previous headline of a blog by Pethokoukis “The case for the gold standard is really pretty awful.”

Mssrs. Pethokoukis and Ponnuru appear to have been misled by an ambient fallacy (reprised recently by Bloomberg View‘s Barry Ritholtz) that there is an inherent deflationary/recessionary propensity of the gold standard. Thus they are being lured into opposition to such respected center-right thought leaders as Lewis E. Lehrman (whose Institute’s monetary policy website I professionally edit); Steve Forbes, Chairman of Forbes Media; Sean Fieler, chairman of American Principles in Action (for which I serve as senior advisor, economics) and the Honorable Steve Lonegan, APIA’s monetary policy director.

They also put themselves sideways with Cato Institute president John Allison; Professors Richard Timberlake, Lawrence White, George Selgin and Brian Domitrovic; Atlas Economic Research Foundation’s Dr. Judy Shelton; Ethics and Public Policy Center’s John Mueller; public figures such as Dr. Ben Carson and, perhaps, Peter Thiel; journalists such as George Melloan and James Grant; and commentators John Tamny, Nathan Lewis, Peter Ferrara, and Jerry Bowyer, among others.

At odds, too, with such esteemed international figures as former Indian RBI deputy governor S.S. Tarapore; former El Salvadoran finance minister Manuel Hinds; and Mexican business titan Hugo Salinas Price. And, at least by way of open-mindedness and perhaps even outright sympathy, The Weekly Standard editor-in-chief William Kristol; Cato’s Dr. James Dorn; Heritage Foundation’s Dr. Norbert Michel; the UK’s Honorable Kwasi Kwarteng and Steve Baker … among many other respected contemporary figures.   Not to mention libertarian lions such as the Honorable Ron Paul.

Gold advocates and sympathizers from the deep past include Copernicus and Newton, George Washington, Alexander Hamilton, Thomas Jefferson, John Witherspoon, John Marshall and Tom Paine, among many other American founders; and, from the less distant past, such important thinkers as Carl Menger, Ludwig von Mises and Jacques Rueff, as well as revered political leaders such as Ronald Reagan and Jack Kemp.

Alan Greenspan recently, in Foreign Affairs, while not discerning gold on the horizon, recently celebrated the “universal acceptability of gold” while raising a quizzical avuncular eyebrow, or two, at what he describes as “fiat” currency.

Let not pass unnoticed the recent statement by Herr Jens Wiedmann, president of the Bundesbank,

Concrete objects have served as money for most of human history; we may therefore speak of commodity money. A great deal of trust was placed in particular in precious and rare metals – gold first and foremost – due to their assumed intrinsic value. In its function as a medium of exchange, medium of payment and store of value, gold is thus, in a sense, a timeless classic.

Nor let pass unnoticed the Bank of England’s 2011 Financial Stability Paper No. 13 assessing the long term performance of the Federal Reserve Note standard and assessing its real outcomes — in every category reviewed, including job creation, economic growth, and inflation — to have proven itself, over 40 years, as deeply inferior in practice to the gold and even gold-exchange standards.

Seems a puzzling mésalliance on the part of Mssrs. Pethokoukis and Ponnuru.The Eichengreen Fallacy — that the gold standard caused and protracted the Great Depression — has led the discourse severely astray. It is imperative to set matters straight.  As I previously have written:

Prof. Eichengreen, author of Golden Fetters, was and remains non-cognizant of a subtle but crucial aspect of world monetary history — and, apparently, of the works of Profs. Jacques Rueff and Robert Triffin elucidating the implications.  Eichengreen blundered by attributing the Great Depression to the gold standard.  This, demonstrably, is untrue.

As Lehrman puts it, the true gold standard repeatedly has proven, in practice, the least imperfect of monetary regimes tried. Robust data actually recommend the gold standard as a powerful force for equitable prosperity.

Just perhaps it can be bettered.  So let the games begin. That said, proposing alternatives to the gold standard is very different from denigrating it.

Pethokoukis (whose writings I regularly follow and with appreciation) recently presented, at AEIdeas, The gold standard is fool’s gold for Republicans. This was a riposte to my here calling him to task for insinuating a connection between the gold standard and the rise of the Nazis and Hitler.  And to task for making statements in another of his AEIdea blogs taking Professors Beckworth and Tyler Cowen out of context.  He also therein conflated the “weight of the evidence” with “weight of opinion.”  It appears that he has fallen prey to the Eichengreen Fallacy.

In self-defense Pethokoukis cites scholarly materials which tend to prove the innocence of the gold standard rather than his insinuation.  For example: he cites Prof. Beckworth’s statement that “the flawed interwar gold standard … probably … led to the Great Depression which, in turn, guaranteed the rise of the Nazis….”

Prof. Beckworth’s characterization “flawed” is entirely consistent with the characterization by the great French monetary official and savant Jacques Rueff, whose work informs my own, of the gold-exchange standard as “a grotesque caricature” of the gold standard.

Similarly, his reference to Prof. Sumner overlooks the obvious fact that Prof. Sumner would appear fully to grasp the key distinction.  Sumner, as quoted by Pethokoukis:

The gold standard got a bad reputation after the Great Depression, when it was seen as contributing to worldwide deflation.  Kurt Schuler points out that the interwar gold standard didn’t follow the rules of the game, which is true.

Pethokoukis speculates,

Perhaps advocates are so sensitive to charges that the gold standard played a key role in the Great Depression, that nuance gets lost in their knee-jerk counterattacks. After all, many gold bugs think their moment is approaching once again. As Ron Paul wrote in his 2009 book “End the Fed”: ” … we should be prepared for hyperinflation and a great deal of poverty with a depression and possibly street violence as well.”  And when the stuff hits the fan, nations will again return to the gold standard for stability. Or so goes the theory over at Forbes.

Notwithstanding my high regard for Dr. Ron Paul I have not shared in prognostications of hyperinflation, poverty, and possible street violence.  If such sentiments have occurred at, whose columnists trend to the classical liberal rather than Austrian model preferred by Dr. Paul, they are vanishingly rare.  To indict by imputing Dr. Paul’s views here suggests a lack of familiarity with these publications.  There are some crucial distinctions to which his attention hereby is invited.

There are some civil disputes amongst various camps of gold standard proponents.  They are far less material than the demonstrably incorrect fallacy that the authentic gold standard has deflationary tendencies which precipitated the Great Depression.  Once this fallacy is dispelled, James Pethokoukis and Ramesh Ponnuru may find it congenial to adopt a different posture in the — steadily rising — debate over the gold standard.  They, as do Profs. Beckworth and Sumner, might find themselves arguing for their version of a better policy rather than denigrating the case for gold standard as, in Pethokoukis’s words, “pretty awful.”

To be continued.

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Road to nowhere

Spring 2010: A gradual recovery
Autumn 2010: A gradual and uneven recovery
Spring 2011: European recovery maintains momentum amid new risks
Autumn 2011: A recovery in distress
Spring 2012: Towards a slow recovery
Autumn 2012: Sailing through rough waters
Winter 2012: Gradually overcoming headwinds
Spring 2013: Adjustment continues
Autumn 2013: Gradual recovery, external risks
Winter 2013: Recovery gaining ground
Spring 2014: Growth becoming broader-based
Autumn 2014: Slow recovery with very low inflation.. ”

European Commission economic headlines, as highlighted by Jason Karaian of Quartz, in ‘How to talk about a European recovery that never arrives’.

“Well we know where we’re going
But we don’t know where we’ve been
And we know what we’re knowing
But we can’t say what we’ve seen
And we’re not little children
And we know what we want
And the future is certain
Give us time to work it out
We’re on a road to nowhere..”

‘Road to nowhere’ by Talking Heads.

In 1975, Charles Ellis, the founder of Greenwich Associates, wrote one of the most powerful and memorable metaphors in the history of finance. Simon Ramo had previously studied the strategy of one particular sport in ‘Extraordinary tennis for the ordinary tennis player’. Ellis went on to adapt Ramo’s study to describe the practical business of investing. His essay is titled ‘The loser’s game’, which in his view is what the ‘sport’ of investing had become by the time he wrote it. His thesis runs as follows. Whereas the game of tennis is won by professionals, the game of investing is ‘lost’ by professionals and amateurs alike. Whereas professional sportspeople win their matches through natural talent honed by long practice, investors tend to lose (in relative, if not necessarily absolute terms) through unforced errors. Success in investing, in other words, comes not from over-reach, in straining to make the winning shot, but simply through the avoidance of easy errors.
Ellis was making another point. As far back as the 1970s, investment managers were not beating the market; rather, the market was beating them. This was a mathematical inevitability given the over-crowded nature of the institutional fund marketplace, the fact that every buyer requires a seller, and the impact of management fees on returns from an index. Ben W. Heineman, Jr. and Stephen Davis for the Yale School of Management asked in their report of October 2011, ‘Are institutional investors part of the problem or part of the solution ?’ By their analysis, in 1987, some 12 years after Ellis’ earlier piece, institutional investors accounted for the ownership of 46.6% of the top 1000 listed companies in the US. By 2009 that figure had risen to 73%. That percentage is itself likely understated because it takes no account of the role of hedge funds. Also by 2009 the US institutional landscape contained more than 700,000 pension funds; 8,600 mutual funds (almost all of whom were not mutual funds in the strict sense of the term, but rather for-profit entities); 7,900 insurance companies; and 6,800 hedge funds.

Perhaps the most pernicious characteristic of active fund management is the tendency towards benchmarking (whether closet or overt). Being assessed relative to the performance of an equity or bond benchmark effectively guarantees (post the impact of fees) the institutional manager’s inability to outperform that benchmark – but does ensure that in bear markets, index-benchmarked funds are more or less guaranteed to lose money for their investors. In equity fund management the malign impact of benchmarking is bad enough; in bond fund management the malign impact of ‘market capitalisation’ benchmarking is disastrous from the get-go. Since a capitalisation benchmark assigns the heaviest weightings in a bond index to the largest bond markets by asset size, and since the largest bond markets by asset size represent the most heavily indebted issuers – whether sovereign or corporate – a bond-indexed manager is compelled to have the highest exposure to the most heavily indebted issuers. All things equal, therefore, it is likely that the bond index-tracking manager is by definition heavily exposed to objectively poor quality (because most heavily indebted) credits.

There is now a grave risk that an overzealous commitment to benchmarking is about to lead hundreds of billions of dollars of invested capital off a cliff. Why ? To begin with, trillions of dollars’ worth of equities and bonds now sport prices that can no longer be trusted in any way, having been roundly boosted, squeezed, coaxed and manipulated for the dubious ends of quantitative easing. The most important characteristic of any investment is the price at which it is bought, which will ultimately determine whether that investment falls into the camp of ‘success’ or ‘failure’. At some point, enough elephantine funds will come to appreciate that the assets they have been so blithely accumulating may end up being vulnerable to the last bid – or lack thereof – on an exchange. When a sufficient number of elephants start charging inelegantly towards the door, not all of them will make it through unscathed. Corporate bonds, in particular, thanks to heightened regulatory oversight, are not so much a wonderland of infinite liquidity, but an accident in the secondary market waiting to happen. We recall words we last heard in the dark days of 2008:

“When you’re a distressed seller of an illiquid asset in a market panic, it’s not even like being in a crowded theatre that’s on fire. It’s like being in a crowded theatre that’s on fire and the only way you can get out is by persuading somebody outside to swap places with you.”

The second reason we may soon see a true bonfire of inanities is that benchmarked government bond investors have chosen collectively to lose their minds (or the capital of their end investors). They have stampeded into an asset class historically and euphemistically referred to as “risk free” which is actually fraught with rising credit risk and systemic inflation risk – inflation, perversely, being the only solution to the debt mountain that will enable the debt culture to persist in any form. (Sufficient economic growth for ongoing debt service we now consider impossible, certainly within the context of the euro zone; any major act of default or debt repudiation, in a debt-based monetary system, is the equivalent of Armageddon.) As Japan has just demonstrated, whatever deflationary tendencies are experienced in the indebted western economies will be met with ever greater inflationary impulses. The beatings will continue until morale improves – and until bondholders have been largely destroyed. When will the elephants start thinking about banking profits and shuffling nervously towards the door ?

Meanwhile, central bankers continue to waltz effetely in the policy vacuum left by politicians. As Paul Singer of Elliott Management recently wrote,

“Either out of ideology or incompetence, all major developed governments have given up (did they ever really try?) attempting to use solid, fundamental policies to create sustainable, strong growth in output, incomes, innovation, entrepreneurship and good jobs. The policies that are needed (in the areas of tax, regulatory, labour, education and training, energy, rule of law, and trade) are not unknown, nor are they too complicated for even the most simple-minded politician to understand. But in most developed countries, there is and has been complete policy paralysis on the growth-generation side, as elected officials have delegated the entirety of the task to central bankers.”

And as Singer fairly points out, whether as workers, consumers or investors, we inhabit a world of “fake growth, fake money, fake jobs, fake stability, fake inflation numbers”.

Top down macro-economic analysis is all well and good, but in an investment world beset by such profound fakery, only bottom-up analysis can offer anything approaching tangible value. In the words of one Asian fund manager,

“The owner of a[n Asian] biscuit company doesn’t sit fretting about Portuguese debt but worries about selling more biscuits than the guy down the road.”

So there is hope of a sort for the survival of true capitalism, albeit from Asian biscuit makers. Perhaps even from the shares of biscuit makers in Europe – at the right price.


Means-ends and consumer choices

A major problem with the mainstream framework of thinking is that people are presented as if a scale of preferences were hard-wired in their heads.
Regardless of anything else this scale remains the same all the time.
Valuations however, do not exist by themselves regardless of the things to be valued. On this Rothbard wrote,

There can be no valuation without things to be valued.1

Valuation is the outcome of the mind valuing things. It is a relation between the mind and things.
Purposeful action implies that people assess or evaluate various means at their disposal against their ends.

An individual’s ends set the standard for human valuations and thus choices. By choosing a particular end an individual also sets a standard of evaluating various means.
For instance, if my end is to provide a good education for my child, then I will explore various educational institutions and will grade them in accordance with my information regarding the quality of education that these institutions are providing.

Observe that the standard of grading these institutions is my end, which is to provide my child with a good education.
Or, for instance, if my intention is to buy a car then there is all sorts of cars available in the market, so I have to specify to myself the specific ends that the car will help me achieve.
I need to establish whether I plan to drive long distances or just a short distance from my home to the train station and then catch the train.

My final end will dictate how I will evaluate various cars. Perhaps I will conclude that for a short distance a second hand car will do the trick.
Since an individual’s ends determine the valuations of means and thus his choices, it follows that the same good will be valued differently by an individual as a result of changes in his ends.
At any point in time, people have an abundance of ends that they would like to achieve. What limits the attainment of various ends is the scarcity of means.
Hence, once more means become available, a greater number of ends, or goals, can be accommodated—i.e., people’s living standards will increase.

Another limitation on attaining various goals is the availability of suitable means.
Thus to quell my thirst in the desert, I require water. Any diamonds in my possession will be of no help in this regard.

1. Murray N. Rothbard, Towards a Reconstruction of Utility and Welfare Economics.


Deflation comes knocking at the door

There is little doubt that deflationary risks have increased in recent weeks, if only because the dollar has risen sharply against other currencies.

Understanding what this risk actually is, as opposed to what the talking heads say it is, will be central to financial survival, particularly for those with an interest in precious metals.
The economic establishment associates deflation, or falling prices, with lack of demand. From this it follows that if it is allowed to continue, deflation will lead to business failures and ultimately bank insolvencies due to contraction of bank credit. Therefore, the reasoning goes, demand and consumer confidence must be stimulated to ensure this doesn’t happen.

We must bear this in mind when we judge the response to current events. For the moment, we have signs that must be worrying the central banks: the Japanese economy is imploding despite aggressive monetary stimulation, and the Eurozone shows the same developing symptoms. The UK is heavily dependent on trade with the Eurozone and there is a feeling its strong performance is cooling. The chart below shows how all this has translated into their respective currencies since August.

Major CCYs vs USD 07112014

Particularly alarming has been the slide in these currencies since mid-October, with the yen falling especially heavily. Given the anticipated effect on US price inflation, we can be sure that if these major currencies weaken further the Fed will act.

Central to understanding the scale of the problem is grasping the enormity of the capital flows involved. The illustration below shows the relationship between non-USD currencies and the USD itself.

Total World Money 07112014

The relationship between the dollar’s monetary base and global broad money is leverage of over forty times. As Japan and the Eurozone face a deepening recession, capital flows will naturally reverse back into the dollar, which is what appears to be happening today. Economists, who are still expecting economic growth for the US, appear to have been slow to recognise the wider implications for the US economy and the dollar itself.

The Fed, bearing the burden of responsibility for the world’s reserve currency, will be under pressure to ease the situation by weakening the dollar. So far, the Fed’s debasement of the dollar appears to have been remarkably unsuccessful at the consumer price level, which may encourage it to act more aggressively. But it better be careful: this is not a matter susceptible to fine-tuning.

For the moment capital markets appear to be adapting to deflation piece-meal. Analysts are revising their growth expectations lower for Japan, the Eurozone and China, and suggesting we sell commodities. They have yet to apply the logic to equities and assess the effect on government finances: when they do we can expect government bond yields to rise and equities to fall.

The fall in the gold price is equally detached from economic reality. While it is superficially easy to link a strong dollar to a weak gold price, this line of argument ignores the inevitable systemic and currency risks that arise from an economic slump. The apparent mispricing of gold, equities, bonds and even currencies indicate they are all are ripe for a simultaneous correction, driven by what the economic establishment terms deflation, but more correctly is termed a slump.


Antisemitism and Banking

[Editor’s Note: this piece, by Ivo Mosley, first appeared at]


A good deal of today’s nationalist and right-wing antisemitism rests upon the fantasy that “the Jews” control the world through finance and banking. Nor is the same fantasy entirely absent from left-wing antisemitism, which currently tends to concentrate itself on criticism of Israel.

The fact that some Jews are very good at banking is, apparently, enough to justify race-hate in the antisemite’s mind. Of course, a number of Jews are also prominent as scientists, civil rights activists, generals, hairdressers, actors, musicians, historians, etcetera, without anyone blaming science, civil rights, theatre, hairdressing, war, music, history, etcetera on “the Jews.”  This highlights one of the traditional functions of antisemitism: if something is obviously bad, “the Jews” can be reached for as a scapegoat.

The object of this article is twofold: first, to analyze what is rotten in the world of capitalism and finance; second, to show that while it has nothing to do with “the Jews” as a people or as a tradition, it has everything to do with a tradition that for centuries excluded “the Jews.”

Capitalism and Predatory Capitalism

There are two stories about how capitalism is financed. One is commonly believed and accepted, but not true. The other is true, but hidden under veils of obscurity.

The familiar story is that citizens save up bits of money: banks gather up those bits of money and lend them to capitalists, who put them to good use for the benefit of all. This, however, is not what banks do – nor is it necessarily what capitalists do.

The unfamiliar, but true, story is that banks create money out of nothing when they lend to capitalists, who use the new money to purchase assets and/or labor, from which they expect to make a profit.

The first story needs no elaboration: as well as being untrue, it is simple and widely understood. The second needs to be explained, however, because though it is not so very complicated, it is unfamiliar to most people.

Economists generally avoid mentioning the fact that banks create money, but central bankers are happy to state it and even on occasion to try to explain it. The Bank of England website states simply: “Most money in the modern economy is in the form of bank deposits, which are created by commercial banks themselves.” And again: “The majority of money in the modern economy is created by commercial banks making loans.” The same article explains that this fact is not recognized by most economists: “rather than banks lending out deposits that are placed with them, the act of lending creates deposits — the reverse of the sequence typically described in textbooks.” (Quotes from the Bank of England Quarterly Bulletin, 2014/1.)

The way bankers create money today requires two things: a “magic trick” by which a small quantity of money held by the banker becomes a great deal of money in circulation; and laws which make the “’magic trick” not just legal, but binding on all citizens.

The “Magic Trick” of Banking

“A banker may accommodate his friends without the payment of money merely by writing a brief entry of credit; and can satisfy his own desires for fine furniture and jewels by merely writing two lines in his books,” wrote Tommaso Contarini, Venetian Banker and Senator in 1584.

The Encyclopedia Britannica of 1950 states firmly and definitively, “A bank does not lend money.” So just what does it do, when we think it is lending money? The answer is: it writes two numbers into a ledger, just as Tommaso Contarini did in 1584. Those numbers represent two equal-and-opposite claims, with a time lapse in between. The borrower gets a claim on cash belonging to the bank, which it can exercise immediately. The bank gets a delayed claim against the borrower, which it may exercise when the loan is due for repayment. In the meantime, the bank charges the borrower interest. When both claims have been exercised, the bank’s creation – the loan – disappears.

The claim which the bank creates for the borrower is called “credit.” “Credit” means “believes,” meaning whoever owns the claim believes they can get cash from the bank when they want it. This is where the “magic trick of banking”’ begins.  If people believe they can get cash from a claim, they are happy to receive a claim in payment, so long as they too can use the claim to get cash from the bank. Joseph Schumpeter observes: “There is no other case in which a claim to a thing can, within limits to be sure, serve the same purpose as the thing itself: you cannot ride a claim to a horse, but you can pay with a claim to money.”

The second bit of the magic trick is for the banker to create many claims on the same bit of money – or, to put it another way, to create claims on money that isn’t there. Banks, naturally enough, want to maximize their profits, so they create as many claims as they think they can get away with, bearing in mind the regulators and people’s demand for cash. By creating fictitious claims a bank turns a billion, say, of cash into sixty billion, say, of credit.

The magic trick may seem somewhat technical in nature, but it has enabled bankers, with the active connivance of governments and capitalists, to replace money we can own with money we must rent off governments and banks. The effects of this substitution are immense, incalculable, far-reaching, all-pervasive (more on this later).

The Legal Underpinnings and Authority for Bank-Money

For a claim to pass from hand to hand as money, completing the “magic trick of banking,” one more thing is needed: the law must recognize it as a valid claim.

Normally, people are not allowed to create claims on property they don’t have. You can’t, for instance, create a claim on Buckingham Palace – unless you happen to own it. Nor can you mortgage your house sixty times over, and spend the money. Banks alone may do this kind of thing. Only banks (and “other depository institutions”) are authorized in law to create claims on property they do not have.

For centuries, banks operated in a legal grey area. Their activities were restricted to merchants, who understood the risks involved, and to what might be called the “higher criminal class” of rulers and potentates. Lending to princes often carried an interest rate of 100% — but still, most bank-crashes occurred when monarchs defaulted on their debts.

The watershed in banking history came during the decades on either side of 1700, when the English House of Commons, newly-all-powerful and consisting of rich men voted in by other rich men, wanted to exploit the fruits of bank-credit for their own devices of war and profit.

The Lord Chief Justice of the time, Sir John Holt, was supporting the traditional legal position that a claim on property was valid only if the claim was on a specific piece of property. Parliament passed an Act of Parliament (the Promissory Notes Act of 1704) to overrule him. Over the next three centuries, other countries followed the English example and “credit-creation” — creating claims on assets that don’t exist — is now authorized for bankers all across the world.

The Two Traditions: Money-Lending and Banking

Within the European tradition, Jews were long known as money-lenders. The relatively straightforward nature of money-lending, as a freely-negotiated contract between lender and borrower, was complicated by moral and social issues.

Usury (lending money at interest) was deplored in the Judeo-Christian tradition, but Jews were allowed (by their own religious laws and by self-interested Christian monarchs) to lend to non-Jews. A pattern was established: monarchs licensed Jewish money-lenders to lend to their subjects; agents of the monarch helped them collect their debts, then the monarch would rob the money-lenders of much of their profits. Throughout much of Europe, discriminatory laws forbade Jews to earn a living any other way. Although money-lending was a despised and hated occupation, it could make people very rich.

Meanwhile, banking — the creation of credit — was developing in an entirely separate tradition via the activities of merchants, exchange-dealers and civic banks. The tradition was Christian, protective of its own, and often openly antisemitic. When these early bankers “lent” money they were not lending hard cash, they were lending claims written into ledgers.

Failure to distinguish between banking and money-lending, and the superior social status of bankers (who being in close collusion with the State are liable to pick up honors as well as great wealth) have led many writers to claim that Jewish money-lenders were bankers, i.e. creators of credit. This in turn has fed the delusions of antisemitic pseudo-historians. In reaction to this false history, most serious historians of banking have found themselves making statements similar to this from Raymond de Roover: “Unlike the Christian moralists, the rabbis paid little attention to exchange dealings or cambium, because, as Yehiel da Pisa explains, this business was not practiced by Jews. This is further evidence that the latter confined their activities to money-lending on a small scale and that the leading international bankers, such as the Medici or the Fuggers, were all Christians. There is, therefore, nothing to support Sombart’s thesis according to which the Jews were the originators of international finance and the founders of modern capitalism.”

All this, of course, was a long time ago, and nowadays bankers are Anglo-Saxon, Chinese, African, Indian, Jewish, Christian, Islamic or whatever: assorted individuals who have no more consuming interest than to make lots of money.

What is Wrong With Creating Money as Fictitious Credit?

Bank-credit — money created as credit on assets that don’t exist — has many features that may be viewed as negative. It replaces money owned outright with money rented out, and is therefore (in the words of John Taylor of Virginia, 1753-1824) a “machine for transferring property from the people to capitalists.” Along the same lines, it allocates new money to borrowers on the mere promise of profit: as a result, much of it goes to inflating asset prices, again increasing inequality. It enables governments to borrow with little accountability, and to charge interest and repayment to “the people”: these charges make domestic labor more expensive, and therefore less competitive. It is created in large quantities during booms, and disappears during busts as loans are retired or “go bad,” thereby exacerbating business cycles. It encourages the production of arms and war by providing unaccountable finance to both governments and arms manufacturers, at the expense of their peoples. It encourages large concentrations of power in government, corporations, and individual “oligarchs,” reducing independence among citizens. It has an endogenous (inbuilt) insatiability: money drifts to the ownership of capitalists and only economic growth, state hand-outs and war (when governments create new money for working people rather than for banks) can supply consumer-money to the poor. The effects of this insatiability on the environment are literally devastating. It gives vast wealth to an elite who care only for making more money: the tastes of this elite have corrupted human culture. Lastly, because the process is not widely understood and is conducted largely in secret, it makes Western claims to political “democracy” dubious at best.

Given all this, it might be a good idea to contemplate reform, which would have to include (i) the replacement of credit money with digital money owned outright and (ii) withdrawal of the license allowed banks, to create claims on assets they don’t have.


Most people familiar with the reality of bank-credit also profit from it. Reason gives way to self-interest in human affairs, so enlightenment and reform are hardly to be expected from among the powers-that-be. As for antisemitism, mental disease is also resistant to reason, so the targets of criticism in this essay are unlikely to be affected by the contents of this article. However, the majority of humanity have strong reasons to desire both financial reform and less racial hate and I hope this essay has made a small contribution to those ends by shedding light on a topic that is not at present widely understood.


The Future of Bitcoin

Later today, I will be speaking at this year’s Cato Annual Monetary Conference in Washington, DC. The theme of this year’s conference is positively eye-watering for proponents of private money: “Alternatives to Central Banking: Toward Free-Market Money.” I will be speaking on the first session, “The Bitcoin Revolution”. So will I be expanding on how bitcoin will revolutionise money and change the world as we know it? Well, not exactly. My topic is: Bitcoin will bite the dust. Bitcoin will collapse, and probably soon.

The core of the argument is simple. To work as intended, the Bitcoin system requires atomistic competition on the part of the ‘miners’ who validate transactions blocks in their search for newly minted bitcoins. However, the mining industry is characterized by large economies of scale. In fact, these economies of scale are so large that the industry is a natural monopoly. The problem is that atomistic competition and a natural monopoly are inconsistent: the inbuilt centralization tendencies of the natural monopoly mean that mining firms will become bigger and bigger – and eventually produce an actual monopoly unless the system collapses before then. The implication is that the Bitcoin system is not sustainable. Since what cannot go on will stop, one must conclude that the Bitcoin system will inevitably collapse. The only question is when.

I could go on at length about how this centralizing tendency will eventually destroy every single component of the Bitcoin value proposition, knocking them down like a row of dominos: the first domino to fall will be distributed trust, Bitcoin’s most notable attraction; instead, the system will come to depend on trust in the dominant player not to abuse its power. This player will become a point of failure for the system as whole, so the ‘no single point of failure’ feature of the system will also disappear. Then anonymity will go, as the dominant player will be forced to impose the usual anti-anonymity regulations justified as means to stop money laundering and such like, but in reality intended to destroy financial privacy. Even the Bitcoin protocol, the constitution of the system, will eventually be subverted. Every component of the Bitcoin value proposition will be destroyed. For bitcoin users and investors, there will be no reason to stay with the system. Plus the large mining pools, or at least one of them, are already a major threat to the system and the system has no effective way of dealing with this threat.

The whole thing is a house of cards: there will be nothing left within the system to maintain confidence in the system. If you have money invested in Bitcoin, best get out now before it collapses, because collapse it will.

Before going further, let me stress that I have not changed my support for private money one jot: researching and promoting private money has been my life’s work. Am I against Bitcoin? No. I just don’t think it is unsustainable. Am I against the alt currencies, the blockchain etc? Not at all. For the record: I support all experimentation in the private money space. My point is that some experiments will fail, and Bitcoin will be one of them.

Informal feedback on my and Martin Hutchinson’s paper on which the presentation is based leaves me in no doubt that our message will provoke outrage amongst the more extreme Bitcoiners: indeed, it already has. We have no axe to grind against Bitcoin and no desire to offend the Bitcoin lunatic fringe. However, one has to follow the logic of one’s argument as one sees it: Hier stehe ich, ich kann nicht anders. If others disagree, well, that’s just the way it is.

I would ask everyone involved in this controversy to note that Martin and I are making a prediction, made before the event: Bitcoin will bite the dust. The more extreme Bitcoiners say it won’t: they say that Bitcoin will reach the moon. They are welcome to their views, but only one side of this argument is going to be proven right. So let’s wait and see who is right and who gets egg on their face. If we have to eat humble pie afterwards, then so be it, but we don’t think so.

Our best guess is that we are facing a mass extinction in the cryptocurrency ecosystem. However, the competition for market share will continue and we expect that that ecosystem will soon repopulate. If the experience of life on earth offers any guide, we could expect to see such cycles of proliferation and extinction occurring again and again. For all we know, cryptocurrencies might still be in their Ediacaran Period, when a wonderful diversity of multicellular life had first colonized the seas, but many of these organisms are about to become extinct. No, correction: many of the alts have already bitten the dust – the mass extinction is well under way.

The undeniable achievement of Bitcoin is that it demonstrates the practical possibility of fully decentralized monetary systems based on the principle of distributed trust rather than central authority: it shows that they can fly, but the problem is that it does not demonstrate that they can stay in the air for too long. Where Bitcoin falls short is that its model is not sustainable thanks to the contradiction between the decentralization on which it depends to work properly and its inbuilt tendencies toward centralization. I therefore regard Bitcoin as an instructive creative failure, but I am hopeful that the lessons to be drawn from its impending demise will lead to superior cryptocurrencies that are free of its major design flaws. Designing such systems would be a challenge worthy of a new Satoshi Nakamoto – or possibly the old one if he is still out there somewhere and looking to complete the project that he didn’t quite get right the first time.

Pity about the conference date though. Had the conference been yesterday, I could have gone dressed as Guy Fawkes or a Catherine wheel.


Into the unknown

“Sir, Your headline “Fed’s grand experiment draws to a close” (, October 29) combines ignorance of what quantitative easing is with insouciance as to its potential effects – both of these mistakes being perennial features of FT coverage of QE. The “experiment”, as you call it, is not at an end; it is, with the purchases now ending, at its height. Only when the Fed starts selling the securities it has purchased back into the market will the US’s QE begin its withdrawal from that height; only when the last purchased security has been sold back into the market, or allowed to expire with consequent permanent expansion of the money supply, will the “grand experiment” (I would prefer that you called it “reckless gamble”) be at its end.

“Only at that point will we even start to see the results – on interest rates, on securities prices, on the economy. The outcome, as has so often been the case with such Keynesian experiments, is unlikely to be pretty.”

  • Letter to the FT from Jon Moynihan, London SW3.

The other potential cause of a sell-off in markets is through a central bank mistake. Some think the liquidity created by QE will eventually leak into higher inflation, but there is no sign of this as yet. More likely is a decline into deflation which would lead to financial distress as debts become more difficult to repay.

“If that does show signs of happening, then we may indeed get to see QE4 rolled out. Daddy might have let go of the market’s hand for the moment but he’s still close by.”

Strange things are happening in the bond market. Few of them are stranger than the reports that a French fund management colleague of Bill Gross (formerly of Pimco) took such exception to public excoriation from his stamp-collecting associate that he quit the business to sell croques monsieur from a food truck. According to the Wall Street Journal, Gross told Jeremie Banet in front of Pimco’s entire investment committee that, “I never understand what you’re saying. Ever.” With those credentials, M. Banet is clearly supremely qualified to become the next chairman of the Federal Reserve. As it is, he elected to return to his job managing an inflation-linked bond portfolio.

He has his work cut out. Consider the sort of volatility that the 10 year US Treasury bond – the closest thing the financial world has to a “risk-free rate” – experienced on 15th October (below).

Intra-day yield, 10 year US Treasury bond, 15th October 2014

10 day Treasury Bond Yield

Source: Bloomberg LLP

Having begun the day sporting a 2.2% yield, the 10 year note during the trading session experienced an extraordinary surge in price that took its yield down briefly towards 1.85%. Later in the same session the buying abated, and the bond closed with a yield of roughly 2.14%. During the same trading session, equity markets sold off aggressively (the UK’s FTSE 100 index, for example, closed down almost 3% on the day). What accounts for such melodrama ?

Analyst Russell Napier takes up the story:

“There it was — a real market come and gone in half an hour, like a pregnant panda at Edinburgh zoo. What did it mean and what should you do? You should pay attention to what happens to the direction of prices when volumes surge and markets work. When the veil is lifted, pay attention to what you see beneath. Last Wednesday, in the space of half an hour of active trading, the Treasury market had one of its most rapid rises ever recorded and equities fell sharply.

“There is a very simple lesson that when the markets finally break through the manipulation they move to price in deflation and not inflation. This is key because it means financial repression has failed. Such repression requires the artificial depression of interest rates but, crucially, it must be paired with boosting inflation above such rates. On October 15th 2014, if only for a few short minutes, market forces broke out and the failure of central bankers was briefly evident.”

These days, you don’t tend to hear the words ‘failure’ and ‘central bankers’ in the same sentence (unless the topic happens to be Zimbabwe). But perhaps the omniscience and omnipotence of central bankers is somewhat overstated. On October 29th, the US Federal Reserve followed a long-rehearsed script and announced that it had “decided to conclude its asset purchase program [also known as QE] this month.”

So now stock and bond markets will have to look after themselves, so to speak. The Economist’s Buttonwood columnist described it as “Letting go of Daddy’s hand”. That coinage nicely speaks to the juvenilisation to which markets have been reduced during six long years of financial repression, unprecedented central bank asset purchases, and the official manipulation of interest rates. Only the asset purchases have abated (for now): the financial repression, one way or another, will go on.

Whether the asset purchases have really disappeared, or merely been suspended, will be a function of how risk markets behave over the coming months and years. We would not be in the least surprised to see petulant markets rewarded with yet more infusions of sweets.

Yet some still associate QE with success. The Telegraph’s Ambrose Evans-Pritchard, or his sub-editor, reckon that central bankers deserve a medal for saving society. He dismisses any scepticism as “hard money bluster”. Economist David Howden, on the other hand, can see somewhat further than the end of his own nose:

“One of the true marks of a great economist is an ability to see past the obvious outcomes and into the veiled results of policies. Friedrich Bastiat’s great essay on “that which is seen, and that which is not seen” provides a cautionary parable that disastrous analyses result when people don’t bother looking further than the immediate results of an action.

“Nowhere is this lesson more instructive than with the Fed’s QE policies of the past 6 years.

“Consider the Austrian business cycle theory. The nub of the theory is that changes in the money market have broader results on the greater economy. In its most succinct form, when a central bank pushes interest rates lower than they should be (by buying assets, for example), the greater economy gets distorted. Some of these distortions are immediately apparent, as consumers buy more goods and everyone takes on more debt as a result of lower interest rates. Some of the distortions are not immediately apparent. The investment decision of firms gets skewed as interest rates no longer reflect savings preferences, and the whole economy becomes fragile over time as erroneous investments add up (what Mises coined “malinvestments”).

“When a financial crisis or economic recession hits, it’s almost never because of some event that apparently happened at the same time. The crisis of 2008 did not occur because of the collapse of Lehman Brothers. It happened because the whole financial system and greater economy were fragile following years of cheap credit at the hands of the Greenspan Fed. If anything, Lehman was a result of this and a great (if unfortunate) example of the type of bad business decisions firms are lured into by loose money. It wasn’t the cause of the troubles but a result of them. And if Lehman didn’t go under to spark the credit crunch, some other fragile financial institution would have.

“The Great Depression is a similar case in point. It wasn’t the stock market crash in 1929 that “created” the Great Depression. It was a decade of loose money policies by the Fed that created a shaky economy. Again, if anything the stock market crash was the result of stock prices being too buoyant and in need of a repricing to reflect economic fundamentals. Just like today, stocks rose to such storied heights as a result of cheap credit, not because of the seemingly “great” investments funded by it.

“The Fed has lowered interest rates since July 2006. We have just come off the period with the most rapid and extreme increase in the money supply ever recorded in American history. The seeds of the next Austrian business cycle have been sown. In fact, they are probably especially fertile seeds when one considers that the monetary policy has been so loose by historical standards. Just as cheap credit of the 1920s beget the Great Depression, that of the 1990s beget the dot-com bust and that of the mid-2000s beget the crisis of 2008, this most recent period will also give birth to a financial crisis.”

Although our crystal ball is no more polished than anyone else’s, our fundamental views are clear. Bonds are already grotesquely expensive, yet may get more so (we’re not investing in “the usual suspects” so we don’t much care). Most stock markets are pricey – but in a world beset by QE (and prospects for more, in Europe and Asia) which prices can we really trust ? By a process of logic, elimination and deduction, out of the major asset classes, only quality listed businesses trading at or ideally well below a fair assessment of their intrinsic worth offer any semblance of value or attractiveness. Pretty much everything else amounts to nothing more than paper, prone to arbitrary gusts from some very powerful, and very windy, bureaucrats. We note also that former Fed chairman Alan Greenspan, no doubt looking to polish his legacy, managed to front-run the Fed’s QE announcement by pointing to the merits of gold within a government-controlled, fiat currency system. Strange days indeed.


Macro economic data: an instrument for government intervention

It is generally held that for an economist to be able to assess the state of the economy he requires macro-economic indicators which will tell him what is going on. The question that arises is why is it necessary to know about the state of the overall economy? What purpose can such types of information serve?

Careful examination of these issues shows that in a free market environment it doesn’t make much sense to measure and publish various macro-economic indicators. This type of information is of little use to entrepreneurs. The only indicator that any entrepreneur pays attention to is whether he makes profit. The higher the profit, the more benefits a particular business activity bestows upon consumers.

Paying attention to consumers wishes means that entrepreneurs have to organise the most suitable production structure for that purpose. Following various macro-economic indicators will be of little assistance in this endeavour.

What possible use can an entrepreneur make out of information about the rate of growth in gross domestic product (GDP)? How can the information that GDP rose by 4% help an entrepreneur make a profit? Or what possible use can be made out of data showing that the national balance of payments has moved into a deficit? Or what use can an entrepreneur make out of information about the level of employment or the general price level?

What an entrepreneur requires is not general macro-information but rather specific information about consumers demands for a product or a range of products. Government lumped macro-indicators will not be of much help to entrepreneurs. The entrepreneur himself will have to establish his own network of information concerning a particular venture. Only an entrepreneur will know what type of information he requires in order to succeed in the venture. In this regard no one can replace the entrepreneur.

Thus if a businessman assessment of consumers demand is correct then he will make profits. Wrong assessment will result in a loss. The profit and loss framework penalizes, so to speak, those businesses that have misjudged consumer priorities and rewards those who have exercised a correct appraisal. The profit and loss framework makes sure that resources are withdrawn from those entrepreneurs who do not pay attention to consumer priorities to those who do.

In a free market environment free of government interference the “economy” doesn’t exist as such. A free market environment is populated by individuals, who are engaged in the production of goods and services required to sustain their life and well being i.e. the production of real wealth. Also, in a free market economy every producer is also a consumer. For convenience sake we can label the interaction between producers and consumers (to be more precise between producers) as the economy. However, it must be realised that at no stage does the so called “economy” have a life of its own or have independence from individuals.

While in a free market environment the “economy” is just a metaphor and doesn’t exist as such, all of a sudden the government gives birth to a creature called the “economy” via its constant statistical reference to it, for example using language such as the “economy” grew by such and such percentage, or the widening in the trade deficit threatens the “economy”. The “economy” is presented as a living entity apart from individuals.

According to the mainstream way of thinking one must differentiate between the activities of individuals and the economy as a whole, i.e. between micro and macro-economics. It is also held that what is good for individuals might not be good for the economy and vice-versa. Within this framework of thinking the “economy” is assigned a paramount importance while individuals are barely mentioned.

In fact one gets the impression that it is the “economy” that produces goods and services. Once the output is produced by the “economy” what is then required is its distribution among individuals in the fairest way. Also, the “economy” is expected to follow the growth path outlined by government planners. Thus whenever the rate of growth slips below the outlined growth path, the government is expected to give the “economy” a suitable push.

In order to validate the success or failure of government interference various statistical indicators have been devised. A strong indicator is interpreted as a success while a weak indicator a failure. Periodically though, government officials also warn people that the “economy” has become overheated i.e. it is “growing” too fast.

At other times officials warn that the “economy” has weakened. Thus whenever the “economy” is growing too fast government officials declare that it is the role of the government and the central bank to prevent inflation. Alternatively, when the “economy” appears to be weak the same officials declare that it is the duty of the government and central bank to maintain a high level of employment.

By lumping into one statistic many activities, government statisticians create a non-existent entity called the “economy” to which government and central bank officials react. (In reality however, goods and services are not produced in totality and supervised by one supremo. Every individual is pre-occupied with his own production of goods and services).

We can thus conclude that so called macro-economic indicators are fictitious devices that are used by governments to justify intervention with businesses. These indicators can tell us very little about wealth formation in the economy and thus individuals’ well-being.


China’s gold strategy

China first delegated the management of gold policy to the People’s Bank by regulations in 1983.

This development was central to China’s emergence as a free-market economy following the post-Mao reforms in 1979/82. At that time the west was doing its best to suppress gold to enhance confidence in paper currencies, releasing large quantities of bullion for others to buy. This is why the timing is important: it was an opportunity for China, a one-billion population country in the throes of rapid economic modernisation, to diversify growing trade surpluses from the dollar.

To my knowledge this subject has not been properly addressed by any private-sector analysts, which might explain why it is commonly thought that China’s gold policy is a more recent development, and why even industry specialists show so little understanding of the true position. But in the thirty-one years since China’s gold regulations were enacted, global mine production has increased above-ground stocks from an estimated 92,000 tonnes to 163,000 tonnes today, or 71,000 tonnes* ; and while the west was also reducing its stocks in a prolonged bear market all that gold was hoarded somewhere.

The period I shall focus on is between 1983 and 2002, when gold ownership in China was finally liberated and the Shanghai Gold Exchange was formed. The fact that the Chinese authorities permitted private ownership of gold suggests that they had by then acquired sufficient gold for monetary and strategic purposes, and were content to add to them from domestic mine production and Chinese scrap thereafter rather than through market purchases. This raises the question as to how much gold China might have secretly accumulated by the end of 2002 for this to be the case.

China’s 1983 gold regulations coincided with the start of a western bear market in gold, when Swiss private bankers managing the largest western depositories reduced their clients’ holdings over the following fifteen years ultimately to very low levels. In the mid-eighties the London bullion market developed to enable future mine and scrap supplies to be secured and sold for immediate delivery. The bullion delivered was leased or swapped from central banks to be replaced at later dates. A respected American analyst, Frank Veneroso, in a 2002 speech in Lima estimated total central bank leases and swaps to be between 10,000 and 16,000 tonnes at that time. This amount has to be subtracted from official reserves and added to the enormous increase in mine supply, along with western portfolio liquidation. No one actually knows how much gold was supplied through the markets, but this must not stop us making reasonable estimates.

Between 1983 and 2002, mine production, scrap supplies, portfolio sales and central bank leasing absorbed by new Asian and Middle Eastern buyers probably exceeded 75,000 tonnes. It is easy to be blasé about such large amounts, but at today’s prices this is the equivalent of $3 trillion. The Arabs had surplus dollars and Asia was rapidly industrialising. Both camps were not much influenced by western central bank propaganda aimed at side-lining gold in the new era of floating exchange rates, though Arab enthusiasm will have been diminished somewhat by the severe bear market as the 1980s progressed. The table below summarises the likely distribution of this gold.

Gold Supply 31102014.jpg

Today, many believe that India is the largest private sector market, but in the 12 years following the repeal of the Gold Control Act in 1990, an estimated 5,426 tonnes only were imported (Source: Indian Gold Book 2002), and between 1983 and 1990 perhaps a further 1,500 tonnes were smuggled into India, giving total Indian purchases of about 7,000 tonnes between 1983 and 2002. That leaves the rest of Asia including the Middle East, China, Turkey and South-East Asia. Of the latter two, Turkey probably took in about 4,000 tonnes, and we can pencil in 5,000 tonnes for South-East Asia, bearing in mind the tiger economies’ boom-and-bust in the 1990s. This leaves approximately 55,000 tonnes split between the Middle East and China, assuming 4,850 tonnes satisfied other unclassified demand.

The Middle East began to accumulate gold in the mid-1970s, storing much of it in the vaults of the Swiss private banks. Income from oil continued to rise, so despite the severe bear market in gold from 1980 onwards, Middle-Eastern investors continued to buy. In the 1990s, a new generation of Swiss portfolio managers less committed to gold was advising clients, including those in the Middle East, to sell. At the same time, discouraged by gold’s bear market, a western-educated generation of Arabs started to diversify into equities, infrastructure spending and other investment media. Gold stocks owned by Arab investors remain a well-kept secret to this day, but probably still represents the largest quantity of vaulted gold, given the scale of petro-dollar surpluses in the 1980s. However, because of the change in the Arabs’ financial culture, from the 1990s onwards the pace of their acquisition waned.

By elimination this leaves China as the only other significant buyer during that era. Given that Arab enthusiasm for gold diminished for over half the 1983-2002 period, the Chinese government being price-insensitive to a western-generated bear market could have easily accumulated in excess of 20,000 tonnes by the end of 2002.

China’s reasons for accumulating gold

We now know that China had the resources from its trade surpluses as well as the opportunity to buy bullion. Heap-leaching techniques boosted mine output and western investors sold down their bullion, so there was ample supply available; but what was China’s motive?

Initially China probably sought to diversify from US dollars, which was the only trade currency it received in the days before the euro. Furthermore, it would have seemed nonsensical to export goods in return for someone else’s paper specifically inflated to pay them, which is how it must have appeared to China at the time. It became obvious from European and American attitudes to China’s emergence as an economic power that these export markets could not be wholly relied upon in the long term. So following Russia’s recovery from its 1998 financial crisis, China set about developing an Asian trading bloc in partnership with Russia as an eventual replacement for western export markets, and in 2001 the Shanghai Cooperation Organisation was born. In the following year, her gold policy also changed radically, when Chinese citizens were allowed for the first time to buy gold and the Shanghai Gold Exchange was set up to satisfy anticipated demand.

The fact that China permitted its citizens to buy physical gold suggests that it had already acquired a satisfactory holding. Since 2002, it will have continued to add to gold through mine and scrap supplies, which is confirmed by the apparent absence of Chinese-refined 1 kilo bars in the global vaulting system. Furthermore China takes in gold doré from Asian and African mines, which it also refines and probably adds to government stockpiles.

Since 2002, the Chinese state has almost certainly acquired by these means a further 5,000 tonnes or more. Allowing the public to buy gold, as well as satisfying the public’s desire for owning it, also reduces the need for currency intervention to stop the renminbi rising. Therefore the Chinese state has probably accumulated between 20,000 and 30,000 tonnes since 1983, and has no need to acquire any more through market purchases given her own refineries are supplying over 500 tonnes per annum.

All other members of the Shanghai Cooperation Organisation** are gold-friendly or have increased their gold reserves. So the west having ditched gold for its own paper will now find that gold has a new role as Asia’s ultimate money for over 3 billion people, or over 4 billion if you include the South-East Asian and Pacific Rim countries for which the SCO will be the dominant trading partner.

*See GoldMoney’s estimates of the aboveground gold stock by James Turk and Juan Castaneda.
**Tajikistan, Kazakhstan, Kyrgyzstan, Uzbekistan, India, Iran, Pakistan, and Mongolia. Turkey and Afghanistan are to join in due course.