Book Reviews

Paper Money Collapse 2nd edition teaser

One of the interesting things that happened at the End of the World Club on Monday evening, was a teaser of what’s new about Detlev Schlichter‘s Paper Money Collapse (2nd edition). We are promised some discussion about Bitcoin (which really got going about the time PMC first appeared on bookshelves).

Also promised is an update of Detlev’s views and he hopes to include discussions that have taken place in various forums (such as on his blog).

Further updates as we get them.
9781118877326.pdf

 

 

Economics

Madness!

“Central bankers control the price of money and therefore indirectly influence every market in the world. Given this immense power, the ideal central banker would be humble, cautious and deferential to market signals. Instead, modern central bankers are both bold and arrogant in their efforts to bend markets to their will. Top-down central planning, dictating resource allocation and industrial output based on supposedly superior knowledge of needs and wants, is an impulse that has infected political players throughout history. It is both ironic and tragic that Western central banks have embraced central planning with gusto in the early twenty-first century, not long after the Soviet Union and Communist China abandoned it in the late twentieth. The Soviet Union and Communist China engaged in extreme central planning over the world’s two largest countries and one-third of the world’s population for more than one hundred years combined. The result was a conspicuous and dismal failure. Today’s central planners, especially the Federal Reserve, will encounter the same failure in time. The open issues are, when and at what cost to society ?”

- James Rickards, ‘The death of money: the coming collapse of the international monetary system’, 2014. [Book review here]

“Sir, On the face of it stating that increasing the inheritance tax allowance to £1m would abolish the tax for “all except a very small number of very rich families” (April 5) sounds a very reasonable statement for the Institute for Fiscal Studies to make, but is £1m nowadays really what it used to be, bearing in mind that £10,000 was its equivalent 100 years ago ?

“A hypothetical “very rich” person today could have, for example, a house worth £600,000 and investments of £400,000. If living in London or the South East, the house would be relatively modest and the income from the investments, assuming a generous 4 per cent return, would give a gross income of £16,000 a year, significantly less than the average national wage.

“So whence comes the idea that nowadays such relatively modest wealth should be classified as making you “very rich” ? The middle-aged should perhaps wake up to the fact that our currency has been systematically debased, though it may be considered impolite to say so as it challenges the conventional political and economic wisdom. To be very rich today surely should mean you have assets that give you an income significantly higher than the national average wage ?”

– Letter to the editor of the Financial Times from Mr John Read, London NW11, 12 April 2014

“The former coach house in Camberwell, which has housed the local mayor’s car, was put on the market by Southwark council as a “redevelopment opportunity”. At nearly £1,000 per square foot, its sale value is comparable to that of some expensive London homes.”

– ‘London garage sells for £550,000’ by Kate Allen, The Financial Times, 12 April 2014.

“Just Eat, online takeaway service, slumped below its float price for the first time on Tuesday as investors dumped shares in a raft of recently floated web-based companies amid mounting concern about their high valuations..

“Just Eat stunned commentators last week when it achieved an eye-watering valuation of £1.47 billion, more than 100 times its underlying earnings of £14.1 million..

““They have fallen because the company was overvalued. Just Eat was priced at a premium to Dominos, an established franchise that delivers and makes the pizzas and has revenues of £269 million. Just Eat by comparison is a yellow pages for local takeaways where there is no quality control and no intellectual property and made significantly less revenues of £96.8 million. A quality restaurant does not need to pay 10 per cent commission to Just Eat to drive customers through the door,” Michael Hewson, chief market analyst at CMC Markets said.”

– ‘Investors lose taste for Just Eat as tech stocks slide’ by Ashley Armstrong and Ben Martin,

The Daily Telegraph, 8 April 2014.

Keep interest rates at zero, whilst printing trillions of dollars, pounds and yen out of thin air, and you can make investors do some pretty extraordinary things. Like buying shares in Just Eat, for example. But arguably more egregious was last week’s launch of a €3 billion five-year Eurobond for Greece, at a yield of just 4.95%. UK “investors” accounted for 47% of the deal, Greek domestic “investors” just 7%. Just in case anybody hasn’t been keeping up with current events, Greece, which is rated Caa3 by Moody’s, defaulted two years ago. In the words of the credit managers at Stratton Street Capital,

“The only way for private investors to justify continuing to throw money at Greece is if you believe that the €222 billion the EU has lent to Greece is entirely fictional, and will effectively be converted to 0% perpetual debt, or will be written off, or Greece will default on official debt while leaving private creditors untouched.”

In a characteristically hubris-rich article last week (‘Only the ignorant live in fear of hyperinflation’), Martin Wolf issued one of his tiresomely regular defences of quantitative easing and arguing for the direct state control of money. One respondent on the FT website made the following comments:

“The headline should read, ‘Only the EXPERIENCED fear hyperinflation’. Unlike Martin Wolf’s theorising, the Germans – and others – know only too well from first-hand experience exactly what hyperinflation is and how it can be triggered by a combination of unforeseen circumstances. The reality, not a hypothesis, almost destroyed Germany. The Bank of England and clever economists can say what they like from their ivory towers, but meanwhile down here in the real world, as anyone who has to live on a budget can tell you, every visit to the supermarket is more expensive than it was even a few weeks ago, gas and electricity prices have risen, transport costs have risen, rents have risen while at the same time incomes remain static and the little amounts put aside for a rainy day in the bank are losing value daily. Purchasing power is demonstrably being eroded and yet clever – well paid – people would have us believe that there is no inflation to speak of. It was following theories and forgetting reality that got us into this appalling financial mess in the first place. Somewhere, no doubt, there’s even an excel spreadsheet and a powerpoint presentation with umpteen graphs by economists proving how markets regulate themselves which was very convincing up to the point where the markets departed from the theory and reality took over. I’d rather trust the Germans with their firm grip on reality any day.”

As for what “inflation” means, the question hinges on semantics. As James Turk and John Rubino point out in the context of official US data, the inflation rate is massaged through hedonic quality modelling, substitution, geometric weighting and something called the Homeowners’ equivalent rent. “If new cars have airbags and new computers are faster, statisticians shave a bit from their actual prices to reflect the perception that they offer more for the money than previous versions.. If [the price of ] steak is rising, government statisticians replace it with chicken, on the assumption that this is how consumers operate in the real world.. rising price components are given less relative weight.. homeowners’ equivalent rent replaces what it actually costs to buy a house with an estimate of what homeowners would have to pay to rent their homes – adjusted hedonically for quality improvements.” In short, the official inflation rate – in the US, and elsewhere – can be manipulated to look like whatever the authorities want it to seem.

But people are not so easily fooled. Another angry respondent to Martin Wolf’s article cited the “young buck” earning £30K who wanted to buy a house in Barnet last year. Having saved for 12 months to amass a deposit for a studio flat priced at £140K, he goes into the estate agency and finds that the type of flat he wanted now costs £182K – a 30% price increase in a year. Now he needs to save for another 9 years, just to make up for last year’s gain in property prices.

So inflation is quiescent, other than in the prices of houses, shares, bonds, food, energy and a variety of other financial assets.

The business of rational investment and capital preservation becomes unimaginably difficult when central banks overextend their reach in financial markets and become captive to those same animal spirits. Just as economies and markets are playing a gigantic tug of war between the forces of debt deflation and monetary inflation, they are being pulled in opposite directions as they try desperately to anticipate whether and when central bank monetary stimulus will subside, stop or increase. Central bank ‘forward guidance’ has made the outlook less clear, not more. Doug Noland cites a recent paper by former IMF economist and Reserve Bank of India Governor Raghuram Rajan titled ‘Competitive Monetary Easing: Is It Yesterday Once More ?’ The paper addresses the threat of what looks disturbingly like a modern retread of the trade tariffs and import wars that worsened the 1930s Great Depression – only this time round, as exercised by competitive currency devaluations by the larger trading economies.

Conclusion: The current non-system [a polite term for non-consensual, non-cooperative chaos] in international monetary policy [competitive currency devaluation] is, in my view, a source of substantial risk, both to sustainable growth as well as to the financial sector. It is not an industrial country problem, nor an emerging market problem, it is a problem of collective action. We are being pushed towards competitive monetary easing. If I use terminology reminiscent of the Depression era non-system, it is because I fear that in a world with weak aggregate demand, we may be engaged in a futile competition for a greater share of it. In the process, unlike Depression- era policies, we are also creating financial sector and cross-border risks that exhibit themselves when unconventional policies come to an end. There is no use saying that everyone should have anticipated the consequences. As the former BIS General Manager Andrew Crockett put it, ‘financial intermediaries are better at assessing relative risks at a point in time, than projecting the evolution of risk over the financial cycle.’ A first step to prescribing the right medicine is to recognize the cause of the sickness. Extreme monetary easing, in my view, is more cause than medicine. The sooner we recognize that, the more sustainable world growth we will have.

The Fed repeats its 2% inflation target mantra as if it were some kind of holy writ. 2% is an entirely arbitrary figure, subject to state distortion in any event, that merely allows the US government to live beyond its means for a little longer and meanwhile to depreciate the currency and the debt load in real terms. The same problem in essence holds for the UK, the euro zone and Japan. Savers are being boiled alive in the liquid hubris of neo-Keynesian economists explicitly in the service of the State.

Doug Noland again:

“While I don’t expect market volatility is going away anytime soon, I do see an unfolding backdrop conducive to one tough bear market. Everyone got silly bullish in the face of very serious domestic and global issues. Global securities markets are a problematic “crowded trade.” Marc Faber commented that a 2014 crash could be even worse than 1987. To be sure, today’s incredible backdrop with Trillions upon Trillions of hedge funds, ETFs, derivatives and the like make 1987 portfolio insurance look like itsy bitsy little peanuts. So there are at this point rather conspicuous reasons why Financial Stability has always been and must remain a central bank’s number one priority. Just how in the devil was this ever lost on contemporary central bankers?”

Book Reviews

‘The system has spun out of control’

Book Review: The Death of Money: The Coming Collapse of the International Monetary System by James Rickards

The_Death_of_Money_Cover_ArtThe title will no doubt give Cobden Centre readers a feeling of déjà vu, but James Rickards’ new book (The Death of Money: The Coming Collapse of the International Monetary System) deals with more than just the fate of paper money – and in particular, the US dollar. Terrorism, financial warfare and world government are discussed, as is the future of the European Union.

Though he quotes F.A. Hayek a few times, the Austrian School gets only one mildly disparaging mention in the entire book. This seems odd for an author who devotes a whole chapter to the benefits of the gold standard. His first bestselling book, Currency Wars, argues that currency wars are not just an economic or monetary concern, but a national security concern for the USA.

Rickards relies on emerging Chaos theories of economics and markets (1) to buttress his arguments in favour of sound money and prudent – limited – government. He uses the same insights, twinned with years of Wall Street experience, to explain why the “coming collapse of the dollar and the international monetary system is entirely foreseeable.”

One of Rickards’ key arguments is that exponential increases in the total size of credit markets mean exponential increases in risk. The gross size of derivative markets is the problem, irrespective of false assurances about netting, he claims. Politicians and central bankers have by and large learnt nothing from recent crises, and are still “in thrall to bank political contributions.”

He makes the case for the US federal government to reinstate Depression-era restrictions on banking activities and for most derivatives to be banned. As a former Federal Reserve Chairman, Paul Volcker, said in 2009, “the only useful thing banks have invented in 20 years is the ATM” – a sentiment Rickards would probably be sympathetic to.

The chapter dealing with the Fed’s hubris and what investment writer James Grant calls our “PhD Standard” of macroeconomic management will be familiar territory for readers of this site. The Fed is trapped between the rock of natural deflationary forces of excessive debt, an ageing population and cheap imports frustrating its efforts to generate a self-sustaining economic recovery and the hard place of annualised inflation of 2%. Rickards quotes extensively from eminent economist and Ben Bernanke mentor Frederic Mishkin, who noted in a 2013 paper titled Crunch Time: Fiscal Crises and the Role of Monetary Policy that “ultimately, the central bank is without power to avoid the consequences of an unsustainable fiscal policy.”

More interesting is the author’s attempt to map out what-happens-next scenarios. The chapter about the on-going transformation of the International Monetary Fund into the world’s central bank, and Special Drawing Rights (SDRs) into a global currency, is particularly insightful. Though Rickards doesn’t say it, Barack Obama’s former chief of staff (and current Mayor of Chicago) Rahm Emanuel’s dictum about never letting a crisis go to waste seems to apply here: hostile acts of financial warfare would lead to calls for more international regulation, and to more government intervention and monitoring of markets. Observers of the EU’s crab-like advance over the last half century will be familiar with the process.

Indeed, my only quibble with this book is Rickards’ starry-eyed take on the EU – soon to be “the world’s economic superpower” in his view. Though he makes a good argument – similar to Jesús Huerta de Soto’s – that relatively-tight European Central Bank monetary policy is forcing effective structural adjustments in the eurozone periphery, as well as in eastern states that wish to join the euro, his endorsement of other aspects of the EU seem too sweeping.

The author talks of the benefits of “efficiencies for the greater good” in supranational government, and how subsidiarity makes allowances for “local custom and practice”. But, as the regulatory débacle surrounding the Somerset floods has shown recently, EU rule frequently licenses bureaucratic idiocies that destroy effective, established national laws. Regulatory central planning for an entire continent is, I’d say, just as suspect as monetary central planning for one country.

The continent’s demographic problems are probably containable in the short-term, as Rickards says. But mass immigration is driving increasing numbers of white Europeans to far-right parties. And while there is consistently strong public support for the euro in the PIIGS (Portugal, Ireland, Italy, Greece and Spain), he’s silent on the broader question of the EU’s democratic legitimacy. No mention of those pesky ‘No’ votes in European Constitution, Maastricht and Lisbon Treaty referendums – or of the Commission’s own Eurobarometer polls, which show more and more Europeans losing faith in “the project”.

No matter I suppose: the eurocrats will rumble on regardless. But what was that quote about democracy being the worst form of government apart from all the others?

All in all though, this is a great book – even for someone like me who’s not exactly new to the economic doom ‘n’ gloom genre. As Rickards says at the end of his intro: “The system has spun out of control.”

References:
(1) For example Juárez, Fernando (2011). “Applying the theory of chaos and a complex model of health to establish relations among financial indicators”. Procedia Computer Science 3: 982–986.

Events

Bitcoin entrepreneurs meet in Paris this week

I’m open-minded about Bitcoin and digital currencies in general. Which is to say I want 10 million people to use it for 10 years before I consider it a store of value.

Events like Paris Bitcoin Startups On Wednesday 16th April reinforce my attentisme or ‘wait-and-see’ policy.

On the one hand, if the digital currency can overcome French bureaucratic hostility and prosper there, that speeds up my adoption date.

On the other hand, it looks a lot like venture capitalists playing with ‘out-of-the-box’ business ideas. Exciting, but not safe. For now, gold wins.

Economics

Renewed estimates of Chinese gold demand

Editor’s note: This article was previously published here at Goldmoney.com. It is republished with thanks.

Geopolitical and market background

I have been revisiting estimates of the quantities of gold being absorbed by China, and yet again I have had to revise them upwards. Analysis of the detail discovered in historic information in the context of China’s gold strategy has allowed me for the first time to make reasonable estimates of vaulted gold, comprised of gold accounts at commercial banks, mine output and scrap. There is also compelling evidence mine output and scrap are being accumulated by the government in its own vaults, and not being delivered to satisfy public demand.

The impact of these revelations on estimates of total identified demand and the drain on bullion stocks from outside China is likely to be dramatic, but confirms what some of us have suspected but been unable to prove. Western analysts have always lagged in their understanding of Chinese demand and there is now evidence China is deliberately concealing the scale of it from us. Instead, China is happy to let us accept the lower estimates of western analysts, which by identifying gold demand from the retail end of the supply chain give significantly lower figures.

Before 2012 the Shanghai Gold Exchange was keen to advertise its ambitions to become a major gold trading hub. This is no longer the case. The last SGE Annual Report in English was for 2010, and the last Gold Market Report was for 2011. 2013 was a watershed year. Following the Cyprus debacle, western central banks, seemingly unaware of latent Chinese demand embarked on a policy of supplying large quantities of bullion to break the bull market and suppress the price. The resulting expansion in both global and Chinese demand was so rapid that analysts in western capital markets have been caught unawares.

I started following China’s gold strategy over two years ago and was more or less on my own, having been tipped off by a contact that the Chinese government had already accumulated large amounts of gold before actively promoting gold ownership for private individuals. I took the view that the Chinese government acted for good reasons and that it is a mistake to ignore their actions, particularly when gold is involved.

Since then, Koos Jansen of ingoldwetrust.ch has taken a specialised interest in the SGE and Hong Kong’s trade statistics, and his dedication to the issue has helped spread interest and knowledge in the subject. He has been particularly successful in broadcasting market statistics published in Chinese to a western audience, overcoming the lack of information available in English.

I believe that China is well on the way to having gained control of the international gold market, thanks to western central banks suppression of the gold price, which accelerated last year. The basic reasons behind China’s policy are entirely logical:

  • China knew at the outset that gold is the west’s weak spot, with actual monetary reserves massively overstated. For all I know their intelligence services may have had an accurate assessment of how much gold there is left in western vaults, and if they had not, their allies, the Russians, probably did. Representatives of the People’s Bank of China will have attended meetings at the Bank for International Settlements where these issues are presumably openly discussed by central bankers.
  • China has significant currency surpluses under US control. By controlling the gold market China can flip value from US Treasuries into gold as and when it wishes. This gives China ultimate financial leverage over the west if required.
  • By encouraging its population to invest in gold China reduces the need to acquire dollars to control the renminbi/dollar rate. Put another way, gold purchases by the public have helped absorb her trade surplus. Furthermore gold ownership insulates her middle classes from external currency instability which has become an increasing concern since the Lehman crisis.

For its geopolitical strategy to work China must accumulate large quantities of bullion. To this end China has encouraged mine production, making the country the largest producer in the world. It must also have control over the global market for physical gold, and by rapidly developing the SGE and its sister the Shanghai Gold Futures Exchange the groundwork has been completed. If western markets, starved of physical metal, are forced at a future date to declare force majeure when settlements fail, the SGE and SGFE will be in a position to become the world’s market for gold. Interestingly, Arab holders have recently been recasting some of their old gold holdings from the LBMA’s 400 ounce 995 standard into the Chinese one kilo 9999 standard, which insures them against this potential risk.

China appears in a few years to have achieved dominance of the physical gold market. Since January 2008 turnover on the SGE has increased from a quarterly average of 362 tonnes per month to 1,100 tonnes, and deliveries from 44 tonnes per month to 212 tonnes. It is noticeable how activity increased rapidly from April 2013, in the wake of the dramatic fall in the gold price. From January 2008, the SGE has delivered from its vaults into public hands a total of 6,776 tonnes. This is illustrated in the chart below.

This is only part of the story, the part that is in the public domain. In addition there is gold imported through Hong Kong and fabricated for the Chinese retail market bypassing the SGE, changes of stock levels within the SGE’s network of vaults, the destination of domestic mine output and scrap, government purchases of gold in London and elsewhere, and purchases stored abroad by the wealthy. Furthermore the Chinese diaspora throughout South East Asia competes with China for global gold stocks, and its demand is in addition to that of China’s Mainland and Hong Kong.

The Shanghai Gold Exchange (SGE)

The SGE, which is the government-owned and controlled gold exchange monopoly, runs a vaulting system with which westerners will be familiar. Gold in the vaults is fungible, but when it leaves the SGE’s vaults it is no longer so, and in order to re-enter them it is treated as scrap and recast. In 2011 there were 49 vaults in the SGE’s system, and bars and ingots are supplied to SGE specifications by a number of foreign and Chinese refiners. Besides commercial banks, SGE members include refiners, jewellery manufacturers, mines, and investment companies. The SGE’s 2010 Annual Report, the last published in English, states there were 25 commercial banks included in 163 members of the exchange, 6,751 institutional clients accounting for 81% of gold traded, and 1,778,500 clients of the commercial banks with gold accounts. The 2011 Gold Report, the most recent available, stated that the number of commercial bank members had increased to 29 with 2,353,600 clients, and given the rapid expansion of demand since, the number of gold account holders is likely to be considerably greater today.

About 75% of the SGE’s gold turnover is for forward settlement and the balance is for spot delivery. Standard bars are Au99.95 3 kilos (roughly 100 ounces), Au99.99 1 kilo, Au100g and Au50g. The institutional standard has become Au99.99 1 kilo bars, most of which are sourced from Swiss refiners, with the old Au99.95 standard less than 15% of turnover today compared with 65% five years ago. The smaller 100g and 50g bars are generally for retail demand and a very small proportion of the total traded. Public demand for smaller bars is satisfied mainly through branded products provided by commercial banks and other retail entities instead of from SGE-authorised refiners.

Overall volumes on the SGE are a tiny fraction of those recorded in London, and the market is relatively illiquid, so much so that opportunities for price arbitrage are often apparent rather than real. The obvious difference between the two markets is the large amounts of gold delivered to China’s public. This has fuelled the rapid growth of the Chinese market leading to a parallel increase in vaulted bullion stocks, which for 2013 is likely to have been substantial.

By way of contrast the LBMA is not a regulated market but is overseen by the Bank of England, while the SGE is both controlled and regulated by the People’s Bank of China. The PBOC is also a member of both its own exchange and of the LBMA, and deals actively in non-monetary gold. While the LBMA is at arm’s length from the BoE, the SGE is effectively a department of the PBOC. This allows the Chinese government to control the gold market for its own strategic objectives.

Quantifying demand

Identifiable demand is the sum of deliveries to the public withdrawn from SGE vaults, plus the residual gold left in Hong Kong, being the net balance between imports and exports. To this total must be added an estimate of changes in vaulted bullion stocks.

SGE gold deliveries

Gold deliveries from SGE vaults to the general public are listed both weekly and monthly in Chinese. The following chart shows how they have grown on a monthly basis.

Growth in public demand for physical gold is a reflection of the increased wealth and savings of Chinese citizens, and also reflects advertising campaigns that have encouraged ordinary people to invest in gold. Advertising the attractions of gold investment is consistent with a deliberate government policy of absorbing as much gold as possible from western vaults, including those of central banks.

Hong Kong

Hong Kong provides import, export and re-export figures for gold. All gold is imported, exports refer to gold that has been materially altered in form, and re-exports are of gold transited more or less unaltered. Thus, exports refer mainly to jewellery which in China’s case is sold directly into the Mainland without going through the SGE, and re-exports refer to gold in bar form which we can assume is delivered to the SGE. Some imported gold remains on the island, and some is re-exported from China back to Hong Kong. This gold is either vaulted in Hong Kong or alternatively turned into jewellery and sold mostly to visitors from the Mainland buying tax-free gold.

The mainstream media has reported on the large quantities of gold flowing from Switzerland to Hong Kong, but this is only part of the story. In 2013, Hong Kong imported 916 tonnes from Switzerland, 190 tonnes from the US, 176 tonnes from Australia and 150 tonnes from South Africa as well as significant tonnages from eight other countries, including the UK. She also imported 337 tonnes from Mainland China and exported 211 tonnes of it back to China as fabricated gold.

Hong Kong is not the sole entry port for gold destined for the Mainland. The table below illustrates how Hong Kong’s gold trade with China has grown, and its purpose is to identify gold additional to that supplied via Hong Kong to the SGE. Included in the bottom line, but not separately itemised, is fabricated gold trade with China (both ways), as well as the balance of all imports and exports accruing to Hong Kong.

The bottom line, “Additional supply from HK” should be added to SGE deliveries and changes in SGE vaulted gold to create known demand for China and Hong Kong.

SGE vaulted gold

The increase in SGE vaulted gold in recent years can only be estimated. However, it was reported in earlier SGE Annual Reports to amount to 519.55 tonnes in 2008, 582.6 tonnes in 2009, and 841.8 tonnes in 2010. There have been no reported vault figures since.

The closest and most logical relationship for vaulted gold is with actual deliveries. After all, public demand is likely to be split between clients maintaining gold accounts at member banks, and clients taking physical possession. The ratios of delivered to vaulted gold were remarkably stable at 1.05, 1.03, and 0.99 for 2008, 2009 and 2010 respectively. On this basis it seems reasonable to assume that vaulted gold has continued to increase at approximately the same amount as delivered gold on a one-to-one basis. The estimated annual increase in vaulted gold is shown in the table below.

The benefits of vault storage, ranging from security from theft to the ability to use it as collateral, seem certain to encourage gold account holders to continue to accumulate vaulted metal rather than take personal possession.

Supply

Supply consists of scrap, domestically mined and imported gold

Scrap

Scrap is almost entirely gold bars, originally delivered from the SGE’s vaults into public hands, and subsequently sold and resubmitted for refining. Consequently scrap supplies tend to increase when gold can be profitably sold by individuals in a rising market, and they decrease on falling prices. There is very little old jewellery scrap and industrial recycling is not relatively significant. Official scrap figures are only available for 2009-2011: 244.5, 256.3 and 405.8 tonnes respectively. I shall therefore assume scrap supplies for 2012 at 430 tonnes and 2013 at 350 tonnes, reflecting gold price movements during those two years.

Scrap is refined entirely by Chinese refiners, and as stated in the discussion concerning mine supply below, the absence of SGE standard kilo bars in Hong Kong is strong evidence that they are withheld from circulation. It is therefore reasonable to assume that scrap should be regarded as vaulted, probably held separately on behalf of the government or its agencies.

Mine supply

China mines more gold than any other nation and it is generally assumed mine supply is sold through the SGE. That is what one would expect, and it is worth noting that a number of mines are members of the SGE and do indeed trade on it. They act as both buyers and sellers, which suggests they frequently use the market for hedging purposes, if nothing else.

Typically, a mine will produce doré which has to be assessed and paid for before it is forwarded to a refinery. Only when it is refined and cast into standard bars can gold be delivered to the market. Broadly, one of the following procedures between doré and the sale of gold bars will occur:

  • The refiner acts on commission from the mine, and the mine sells the finished product on the market. This is inefficient management of cash-flow, though footnotes in the accounts of some mine companies suggest this happens.
  • The refiner buys doré from the mine, refines it and sells it through the SGE. This is inefficient for the refiner, which has to find the capital to buy the doré.
  • A commercial bank, being a member of the SGE, finances the mine from doré to the sale of deliverable gold, paying the mine up-front. This is the way the global mining industry often works.
  • The government, which ultimately directs the mines, refiners and the SGE, buys the mine output at pre-agreed prices and may or may not put the transaction through the market.

I believe the government acquires all mine output, because it is consistent with the geopolitical strategy outlined at the beginning of this article. Furthermore, two of my contacts, one a Swiss refiner with facilities in Hong Kong and the other a vault operator in Hong Kong, tell me they have never seen a Chinese-refined one kilo bar. Admittedly, most one kilo bars in existence bear the stamp of Swiss and other foreign refiners, but nonetheless there must be over two million Chinese-refined kilo bars in existence. Either Chinese customs are completely successful in stopping all ex-vault Chinese-refined one kilo bars leaving the Mainland, or the government takes all domestically refined production for itself, with the exception perhaps of some 100 and 50 gram bars. Logic suggests the latter is true rather than the former.

Since the SGE is effectively a department of the PBOC, it must be at the government’s discretion if domestic mine production is put through the market by the PBOC. Whether or not Chinese mine supply is put through the market is impossible to establish from the available statistics, and is unimportant: no bars end up in circulation because they all remain vaulted. It is material however to the overall supply and demand picture, because global mine supply last year drops to about 2,490 tonnes assuming Chinese production is not available to the market.

Geopolitics suggests that China acquires most, if not all of its own mine and scrap production, which accumulates in the vaulting system. This throws the emphasis back on the figures for vaulted gold, which I have estimated at one-for-one with delivered gold due to gold account holder demand. To this estimate we should now add both Chinese scrap and mine supply. This would explain why vaulted gold is no longer reported, and it would underwrite my estimates of vaulted gold from 2011 onwards.

Further comments on vaulted gold

From the above it can be seen there are three elements to vaulted gold: gold held on behalf of accountholders with the commercial banks, scrap gold and mine supply. The absence of Chinese one kilo bars in circulation leads us to suppose scrap and mine supply accumulate, inflating SGE vault figures, but a moment’s reflection shows this is too simplistic. If it was included in total vaulted gold, then the quantity of gold held by accountholders with the commercial banks, as reported in 2009-11, would have fallen substantially to compensate. This cannot have been the case, as the number of accountholders increased substantially over the period, as did interest in gold investment.

Therefore, scrap and mined gold must be allocated into other vaults not included in the SGE network, and these vaults can only be under the control of the government. It will have been from these vaults that China’s sudden increase in monetary gold of 444 tonnes in the first quarter of 2009 was drawn, which explains why the total recorded in SGE vaults was obviously unaffected. So for the purpose of determining the quantity of vaulted gold, scrap and mined gold must be added to the gold recorded in SGE vaults.

Though it is beyond the scope of this analysis, the existence of government vaults not in the SGE network should be noted, and given cumulative mine production over the last thirty years, scrap supply and possibly other purchases of gold from abroad, the bullion stocks in these government vaults are likely to be very substantial.

Western gold flows to China

We are now in a position to estimate Chinese demand and supply factors in a global context. The result is summarised in the table below.

Chinese demand before 2013 had arrived at a plateau, admittedly higher than generally realised, before expanding dramatically following last April’s price drop. Taking the WGC’s figures for the Rest of the World gives us new global demand figures, which throw up a shortfall amounting to 9,461 tonnes since the Lehman crisis, satisfied from existing above-ground stocks.

This figure, though shocking to those unaware of these stock flows, could well be conservative, because we have only been able to address SGE deliveries, vaulted gold and Hong Kong net flows. Missing from our calculations is Chinese government purchases in London, demand from the ultra-rich not routed through the SGE, and gold held by Chinese nationals abroad. It is also likely that demand from the Chinese diaspora in SE Asia and Asian is also underestimated by western analysts.

There are assumptions in this analysis that should be clear to all. But if it only serves to expose the futility of attempts in western capital markets to manage the gold price, the exercise has been worthwhile. For much of 2013 commentators routinely stated that Asian demand was satisfied from ETF redemptions. But as can be seen, ETF sales totalling 881 tonnes covered only one quarter of the west’s shortfall against China, the rest coming mostly from central bank vaults. Anecdotal evidence from Switzerland is that the four major refiners have been working round-the-clock turning LBMA 400 ounce bars into one kilo 9999 bars for China. They are even working with gold bars that are battered and dusty, which suggests the west is not only digging into deep storage to satisfy Chinese demand at current prices, but digging a hole for itself as well.

Economics

Speech to the Brazilian Chamber of Commerce in London

Last week I spoke to a small group in London about the current monetary situation and the outlook for gold. The speech lasts about 20 minutes and the video can be found here:

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Economics

There is too little gold in the West

Western central banks have tried to shake off the constraints of gold for a long time, which has created enormous difficulties for them. They have generally succeeded in managing opinion in the developed nations but been demonstrably unsuccessful in the lesser-developed world, particularly in Asia. It is the growing wealth earned by these nations that has fuelled demand for gold since the late 1960s. There is precious little bullion left in the West today to supply rapidly increasing Asian demand. It is important to understand how little there is and the dangers this poses for financial stability.

An examination of the facts shows that central banks have been on the back foot with respect to Asian gold demand since the emergence of the petrodollar. In the late 1960s, demand for oil began to expand rapidly, with oil pegged at $1.80 per barrel. By 1971, the average price had increased to $2.24, and there is little doubt that the appetite for gold from Middle-Eastern oil exporters was growing. It should have been clear to President Nixon’s advisers in 1971 that this was a developing problem when he decided to halt the run on the United States’ gold reserves by suspending the last vestiges of gold convertibility.

After all, the new arrangement was: America issued the petrodollars to pay for the oil, which were then recycled to Latin America and other countries in the West’s sphere of influence through the American banks. The Arabs knew exactly what was happening; gold was simply their escape route from this dodgy deal.

The run on U.S. gold reserves leading up to the Nixon Shock in August 1971 is blamed by monetary historians on France. But note this important passage from Ferdinand Lips’ book GoldWars:

Because Arabs did not understand bonds and stocks they invested their surplus funds in either real estate and/or gold. Since Biblical times, gold has been the best means to keep wealth and to transfer it from generation to generation. Gold therefore was the ideal vehicle for them. Furthermore after their oil reserves are exhausted in the distant future, they would still own gold. And gold, contrary to oil, could never be wasted.

According to Lips, Swiss private bankers, to whom many of the newly-enriched Arabs turned, recommended that a minimum of 10% and even as much as 40% should be held in gold bullion. This advice was wholly in tune with Arab thinking, creating extra demand for America’s gold reserves, some of which were auctioned off in the following years. Furthermore, Arab investors were unlikely to have been deterred by high dollar interest rates in the early eighties, because high interest rates simply compounded their rapidly-growing exposure to dollars.

Using numbers from BP’s Statistical Review and contemporary U.S. Treasury 10-year bond yields to gauge dollar returns, we can estimate gross Arab petrodollar income, including interest from 1965 to 2000, to total about $4.5 trillion. Taking average annual gold prices over that period, ten percent of this would equate to about 50,500 tonnes, which compares with total mine production during those years of 62,750 tonnes, over 90% of which went into jewellery.

This is not to say that 50,000 tonnes were bought by the Arabs; it could only be partly accommodated even if the central banks supplied them gold in very large quantities, of which there is some evidence that they did. Instead, it is to ram the point home that the Arabs, awash with printed-for-export petrodollars, had good reason to buy all available gold. And importantly, it also gives substance to Frank Veneroso’s conclusion in 2002that official intervention – i.e., undeclared sales of significant quantities of government-owned gold  was effectively being used to manage the price in the face of persistent demand for physical gold as late as the 1990s.

Transition from Arab demand

Arabs trying to invest a portion of their petrodollars would have left very little investment gold for the advanced economies. As it happened, U.S. citizens had been banned from holding bullion until 1974, and British citizens were banned until 1971. Instead, they invested mainly in mining shares and Krugerrands, continuing this tradition by using derivatives and unbacked unallocated accounts with bullion banks in preference to bullion itself. This meant that, until the mid-seventies, investment in physical gold in the West was minimal, almost all gold being held in illiquid jewellery form. Western bullion investors were restricted to mainly Germans, French, and Italians, mostly through Swiss banks. The 1970s bull market was therefore an Arab affair, and they continued to absorb gold through the subsequent bear market.

By the late-nineties, a new generation of Swiss investment managers, schooled in modern portfolio theory and less keen on gold, persuaded many of their European clients to reduce and even eliminate bullion holdings. At the same time, a younger generation of Western-educated Arabs began to replace more conservative patriarchs, so it is reasonable to assume that Arab demand for gold waned somewhat, as infrastructure spending and investment in equity markets began to provide portfolio diversification. This was therefore a period of transition for bullion, driven by declining Western investment sentiment and changing social structures in the Arab world.

It also marked the beginning of accelerating demand in emerging economies, notably India, but also in other countries such as Turkey and those in Southeast Asia, which were rapidly industrialising. In 1990, the Indian Government freed up the gold market by abolishing the Gold Control Act of 1968, paving the way for Indians to become the largest officially-recognised importers of gold until overtaken by China last year.

Lower prices in the 1990s stimulated demand for jewellery in the advanced economies, with Italy becoming the largest European manufacturing centre. At the same time, gold leasing by central banks increased substantially, as bullion banks exploited the differential between gold lease rates and the yield on short-term government debt. This leased gold satisfied jewellery demand as well continuing Asian demand for gold bars.

So, despite the fall in prices between 1997-2000, all supply was absorbed into firm hands. When gold prices bottomed out, Western central banks almost certainly had less gold than publicly stated, the result of managing the price until 1985, and through leasing thereafter. This was the background to the London Bullion Market Association, which was founded in 1987.

The LBMA

In 1987, the unallocated account system became formalized under London Bullion Market Association (LBMA) rules, allowing the bullion banks to issue gold IOUs to their customers, making efficient use of the bullion available. The ability to expand customer business in the gold market without having to acquire physical bullion is the chief characteristic of the LBMA to this day. Futures markets in the U.S. also expanded, and so derivatives and unallocated accounts became central to Western investment in gold. Today the only significant bullion held by Western investors is likely to be a small European residual plus exchange-traded fund (ETF) holdings. In total (including ETFs), this probably amounts to no more than a few thousand tonnes.

The LBMA was established in 1987 in the wake of the Financial Services Act in 1986. Prior to that date, the twice-daily gold fix had become the standard pricing mechanism for international dealers, whose ranks grew on the back of the 1970s bull market. This meant that international banks established their bullion dealing activities in London in preference to Zurich, which was the investment centre for physical bullion. The establishment of the LBMA was the formalization of an existing gold market based on the 400-ounce “good delivery” standard and the operation of both allocated and unallocated accounts.

During the twenty-year bear market, attitudes to gold diverged, with capital markets increasingly taking the view that the inflation dragon had been slain and gold’s bull market with it. At the same time, Asian demand  initially from the Arab oil exporters but increasingly from other nations led by Turkey, India, and Iran – ensured that there were buyers for all the physical gold available. Mine supply, which benefited from the introduction of heap-leaching techniques, had increased from 1,314 tonnes in 1980 to 2,137 tonnes in 1990 and 2,625 tonnes by 2000. Together with scrap supply, London was in a strong position to intermediate between a substantial increase in gold flows to Asian buyers, and it was from this that central bank leasing naturally developed.

Gold backed by these physical flows was the ideal asset for the carry trade. A bullion bank would lease gold from a central bank, sell the gold, and invest the proceeds in short-term government debt. It was profitable for the bullion bank, governments were happy to have the finance, and the lessor was happy to see an idle asset work up some extra income. However, leasing only works so long as the bullion bank can hedge by accessing future supply so that the lease can eventually be terminated.

Before 2000, this was a growing activity, fuelled further by Swiss portfolio disinvestment in the late 1990s. As is usual in markets with a long-term behavioral trend, competition for this business extended the risks beyond being dangerous. This culminated in a crisis in September 1999, when a 30% jump in the price threatened to bankrupt some of the bullion banks who were in the habit of running short positions.

Post-2000

Bull markets always start with very little mainstream and public involvement, and so it has proved with gold since the start of this century. So let us recap where all the gold was at that time:

  • Total above-ground gold stocks were about 129,000 tonnes, of which 31,800 tonnes were officially monetary gold. Of the balance, approximately 85-90% was turned into jewellery or other wrought forms, leaving only 10-15,000 tonnes invested in bar and coins and allocated for industrial use.
  • Out of a maximum of 15,000 tonnes, coins (mostly Krugerrands) accounted for about 1,500 tonnes and other uses (non-recovered industrial and dental), say, 1,000 tonnes. This leaves a maximum of 12,500 tonnes and possibly as little as 7,500 tonnes of investment gold worldwide at that time.
  • After Swiss fund managers disposed of most of the bullion held in portfolios for their clients in the late 1990s, there was very little investment gold left in European and American ownership.
  • Frank Veneroso in 2002 concluded, after diligent research, that central banks had by then supplied between 10-15,000 tonnes of monetary gold into the market. Much of this would have gone into jewellery, particularly in Asia, but some would have gone to the Middle East. This explains how extra investment gold may have been supplied to satisfy Middle Eastern demand.
  • Middle Eastern countries must have been the largest holders of non-monetary gold in bar form at this time. We can see that 10% of petrodollars invested in gold would have totalled over 50,000 tonnes, yet there can only have been between 7,500-12,500 tonnes available in bar form for all investor categories world-wide. This may have been increased somewhat by the addition of monetary gold leased by central banks and acquired through the market.

It was at this point that the second gold bull market commenced against a background of very little liquidity. Investment bullion was tightly held, the central banks were badly short of their declared holdings of monetary gold, and from about 2004 onwards, ETFs were to grow to over 1,500 tonnes. Asian demand continued to grow (led by India), and China began actively promoting private ownership of gold at about the same time.

Other than through physically-backed ETFs, Western investors were encouraged to satisfy their demand for bullion through derivatives and unallocated accounts at the bullion banks. There are no publicly available records detailing the extent of these unallocated accounts, but the point is that Western demand has not resulted in increased holdings of bullion except through securitised ETFs. Instead, the liabilities faced by the bullion banks on uncovered accounts will have increased to accommodate growth in demand. Therefore, the vested interests of the bullion banks and the central banks overseeing the gold market call for continued suppression of the gold price, so as to avoid a repeat of the crisis faced in September 1999 when the price increased by 30% in only two weeks.

Where are the sellers?

Price suppression can only be a temporary stop-gap, and there has never been sufficient supply to allow the central banks to retrieve their leased gold from the bullion banks. Therefore, Frank Veneroso’s conclusion in 2002 that there had to be existing leases totalling 10-15,000 tonnes is a starting point from which leases and loans have increased. There are two events which will almost certainly have increased this figure dramatically:

  1. When the price rose to $1900 in September 2011, there was a concerted attempt to suppress the price from further rises. The lesson from the 1999 crisis is that the bullion banks’ geared exposure to unallocated accounts was forcing a crisis upon them; if they had been forced to cash-settle these accounts, the gold price would almost certainly have risen further, risking a widespread monetary crisis.
  2. Through 2012, Asian demand, particularly from China, coinciding with continued investor demand for ETFs, was already proving impossible to contain. In February this year, the Cyprus bail-in banking crisis warned depositors in the Eurozone that all bank deposits over the insured limit risked being confiscated in the event of a wider Eurozone banking crisis. This drove many unallocated account holders to seek delivery of physical gold from their banks, forcing ABN-AMRO and Rabobank to suspend all gold deliveries from their unallocated accounts. This was followed by a concerted central- and bullion-bank bear raid on the market in early April, driving the price down to trigger stop-loss sales in derivative markets and subsequent liquidation of ETF holdings.

It is widely assumed that the unexpected rise in demand for bullion that resulted from the April take-down was satisfied through ETF sales, but an examination of the quantities involved shows they were insufficient. The table below includes officially reported demand for China and India alone, not taking into account escalating demand from the Chinese diaspora in the Far East and from elsewhere in Asia:

gold-demand-chart1

These figures do not include Chinese and Indian purchases of gold in foreign markets and stored abroad, typically carried out by the rich and very rich. Nor do they include foreign purchases by the Chinese Government and its agencies. Despite these omissions, in 2012, recorded demand from these two countries left the world in a supply deficit of 131 tonnes. Furthermore, ahead of the April smash-down in the first quarter of this year, the deficit had jumped to 88 tons, or an annualised rate of 352 tonnes.

Demands for delivery by panicking Europeans in the wake of the Cyprus fiasco could only provoke one reaction. On Friday 12th April, 400 tonnes of paper gold were dumped on the market in two orders, triggering stop-loss sales and turning market sentiment bearish in the extreme. Western investors started to think about cutting their losses, and they sold down ETF holdings to the tune of 325 tonnes in 2013 by the end of May. However, this triggered record demand among those who looked on gold as insurance against currency and systemic risks.

Later that year, in July, Ben Bernanke told the Senate Banking Committee he didn’t understand gold. That was probably a reference to the April gold price smash orchestrated by the central banks and how it unleashed record levels of demand. It was an admission that he thought everyone would follow the new trend by acting like portfolio investors, forgetting that if you lower the price of a commodity, you merely unleash demand. It was also an important admission of policy failure.

Since those events in April, someone has been supplying the market with significant quantities of gold to keep the price down. We know it is not Arab gold, because I have discovered through interviewing a director of a major Swiss refiner that Arab gold is being recast from LBMA specification bars into one-kilo .9999 bars, which has become the new Asian standard. Arab gold does not appear to be being sold, only recast, and anyway, it is only a small part of their overall wealth. We also know from our long-term analysis that any European gold bullion is relatively small in quantity and tightly held. There can only be one source for this gold, and that is the central banks.

I discovered that there was a discrepancy in the Bank of England’s custodial gold of up to 1,300 tonnes between the date of its last Annual Report (28th February) and mid-June, when a lower figure was given out to the public on the Bank’s website. This fits in well with the additional amount of gold needed to manage the price between those months. Furthermore, the Finnish Central Bank recently admitted that all its gold held at the Bank of England was “invested”  i.e., sold  and further added that the practice “was common for central banks.”

Bearing in mind Veneroso’s conclusion in 2002 that there must be 10,000-15,000 tonnes out on lease and loan from the central banks at that time, one could imagine that this figure has increased significantly. Officially, the signatories of the Central Bank Gold Agreement, plus the U.S. and U.K. own 20,393 tonnes. A number of other central banks are likely to have been persuaded to “invest” their gold, but this is bound to exclude Russia, China, the Central Asian states, Iran, and Venezuela. Taking these holders out (amounting to about 3,000 tonnes) leaves a balance of 8,401 tonnes for all the rest. If we further assume that half of that has been deposited in London, New York, or Zurich and leased out, that means the total gold leased and available for leasing since 2002 is about 12,000 tonnes. And once that has gone, there is no monetary gold left for the purpose of price suppression.

Could this have disappeared since 2002 at an average rate of 1,000 tonnes per annum? Quite possibly, in which case, the central banks are very close to losing all control over the gold price.

This article was previously published at PeakProsperity.com.

Peace

Remember

An article by Cobden Centre fellow David Howden for Mises.ca.

Today many of us are wearing a poppy on our lapels in a show of remembrance. What exactly are we remembering?

The Great War from 1914-18 saw many changes to the world. Many of them were bad, though as we shall see some good did come from one of, if not the worst war of all time.

Over 64,000 Canadians lost their lives fighting in Europe, almost 1% of her population. A further 150,000 were injured. The comparable statistics today, updated for population growth, would be nearly 315,000 dead soldiers and almost 700,000 wounded. Remember that these are just Canadian soldiers. The final global death toll was 17 million (including the civilian deaths in the neutral countries of Scandinavia) and over 21 million wounded.

In fact, in this regard one could argue that Canadians came away relatively unscathed. Romania lost 10% of its population, Serbia 16%, and the great Ottoman Empire almost 14%. This latter figure excludes the additional 100,000 Turks who died fighting the subsequent Turkish War of Independence following the signing of the Armistice in 1918.

The First World War was not only the first war to be waged on a truly global scale, it was the first to inflict the magnitude of destruction it did. Soldiers of previous battles were felled by disease more often than in direct combat. Advances in technology changed that, and even though the 1918 outbreak of Spanish influenza killed many more (current estimates place the deaths from the flu at 50-100 million), the Great War killed more people in four short years than most of the previous European wars combined.

In remembering the Great War it is easy to focus on the deaths of those who sacrificed their lives, but it is also important to reflect on what caused the War and what it achieved.

It’s true that advances in modern warfare and logistics made the War able to be fought on a wider scale than ever before. It is also true that a series of alliances – both formal and informal – agreed upon prior to the War brought belligerents into the melee with only tangential interest in it. Canada’s allegiance to Great Britain at the time might be thought of in this way, as could any number of the other Dominions and Colonies including Australia, India, New Zealand and Newfoundland.

Some simple economics also played an important role. Prior to the War most countries of the world had a monetary system linked to the gold standard. Government deficit spending was curtailed under this system as borrowing would be limited by the extent of a country’s gold reserves. The expression “to have a war chest” has its origins in the necessity of a sovereign to carry a chest of gold to war to pay soldiers. Wars under the gold standard were quite limited affairs, curtailed by the supply of gold available to keep soldiers paid (and motivated).

The War brought with it the breakdown of the gold standard as all belligerents resorted to monetary inflation to finance the growing expenses. This one simple fact goes far in explaining why the scope of the War and the resources driven into it were so great. The lack of a spending anchor under a fiat money regime allowed countries to print money and run deficits in order to finance the increasingly expensive battles, expensive both in money and lives. While governments could print money to paper over the cost of the War, soldiers were much less reproducible. As we shall see, the use of conscription was the counterpart to inflation and allowed the War to continue being waged once volunteers ran out.

The Great War was supposed to be the war to end all wars. Unfortunately the signing of the Treaty of Versailles to officially settle it proved to be the peace to end all peace.

A not well-known 36-year old economist by the name of John Maynard Keynes found fame penning his The Economic Consequences of the Peace in 1919. Keynes had two profound criticisms of the Treaty. First, that Europe could not survive and prosper without an integrated economic system, something that the Treaty precluded. Second, that the Treaty violated many terms of the Armistice signed 95 years ago on the eleventh hour of the eleventh day of the eleventh month of 1918. The armistice included terms relating to war reparations, territorial adjustments and general even-handedness in economic matters.

Keynes presciently predicted that the Treaty of Versailles would be the cause of a future war, and 20 years later he was proven correct. Poor economic conditions in Germany as a result of war reparations and the loss of culturally and economically important territories set in motion a series of events that brought Adolph Hitler to power and resulted in the invasion of Poland by both Fascist Germany and Communist Russia in September 1939.

Six years and 50-85 million additional deaths later the world had a new Great War. This one necessitated a numbering system to distinguish the first Great War from the Second.

All of this death and destruction could easily be pegged on one person. The Bosnian Serb student Gavrilo Princip may have fired the shot that killed the heir to the Austo-Hungarian throne, the young Archduke Franz Ferdinand of Austria on June 28th, 1914. But Princip was not alone in his distaste for the ruling class of that Empire.

Indeed, general unease concerning many sovereigns and governance structures were warming like kindling, ready to ignite Europe at any time. Secession problems in the Austro-Hungarian Empire and brewing revolutions in both the Russian and Ottoman Empires were slowly creating the conditions for civil wars.

The British Empire under the rule of King George V was also going through its own coming of age problems, though nothing severe enough to spark bloody revolution. Indeed, the Great War ushered in an era that saw Britain’s Colonies and Dominions reorganise into a peaceful and voluntary structure. In few places was this push more apparent than in Canada.

A bloody Battle of the Somme resulted in Prime Minster Robert Borden’s pledge to send 500,000 soldiers to Europe by the end of 1916, despite a population in Canada of only 8 million at the time. Conscription was enacted to offset the dwindling supply of volunteers to join the War cause.

Almost all French Canadians opposed conscription, feeling no allegiance or duty to aid either England or France. The Conscription Crisis of 1917 was primarily a backlash of Francophone Canadians against the forced military service imposed by Ottawa to aid his Majesty’s war. Uneasiness about being Catholic soldiers under predominantly Protestant commanding officers also fuelled the flames.

The Conscription Crisis exposed Ottawa to many difficult questions. One problem was that by forcing labour, the Canadian government had no knowledge who would be the best soldier, toolmaker or farmer. Someone had to stay back and supply those who went to fight, but the government lacked any rational way to make this decision. More importantly, there was the apparent rights issue. Canada had never before enacted conscription, and the idea of forcing someone to fight in a war against their wishes is morally repugnant. More to the point, fighting a war in a distant land to aid a government which one never voted for created its own problems. The problem lives on today for pacifists around the globe, as well as those who choose to refrain from political participation.

Indeed, in a bid to garner support for conscription the Military Service Act of January 1st 1918 included exemptions to remove oneself from the forced call of duty. By autumn of that year these exemptions were removed, in a move that offended not only the French but also English-speaking Canadians. This move by Robert Borden not only shut the Conservative Party out of Quebec for over 50 years, but also caused them to lose the next general election in 1921 to the Liberal’s of William Lyon Mackenzie King.

At the very least, the Conscription Crisis put in motion a debate as to what role and duty, if any, the Dominions and their citizens had in regards to the United Kingdom. The culmination of these debates was the Statute of Westminster, signed into law by the Parliament of the United Kingdom in 1931 and passed on to all realms within the Commonwealth for ratification shortly thereafter. Amongst other things, the Statute legislated equality and self-governance for the Dominions that ratified it. (Not all colonies did so: Newfoundland Colony did not ratify the Statute, and remained a Dominion of the British Empire until joining Canada in 1949.)

The Commonwealth of Nations today survives as an organisation of 53 countries, most of which were territories of the British Empire. It represents a quarter of the world’s land mass, almost a third of its population and 15% of the globe’s GDP. It is a voluntary group which exists due to some loosely shared values paired with some established statutes.

Racial equality is a requirement for inclusion, and this was tested with the withdrawal of South Africa under apartheid, as well as its eventual readmission after its end. Not all member states recognise the Queen as the head of State, though some (like Canada) do. We have a shared history, heritage and traditions (like wearing a poppy on Remembrance Day). Chief among these is obedience to the common law, one of the greatest forces of civilisation in history. A dedication to peace, liberty and free trade are all points for inclusion, secured by the values of the 1971 Singapore Declaration.

There are no formal laws dictating that member countries must trade or associate with one another, but they do. The voluntary nature of this institution is apparent in the immigrants that flow between Commonwealth nations as well as the fact that Commonwealth members trade up to 50% more with other Commonwealth members than with non-members.

Inclusion in the Commonwealth does not yet instil by law the free movement of goods, people or money across borders, but it would be wise to do so. Some countries give preferential treatment to immigrants or investors from other Commonwealth countries, and the benefits are clear. Economic prosperity reigns when people, goods and money go to where they are treated best. Informal preferences within the Commonwealth promote this.

There is discussion of making the Commonwealth into a broader free trade union, as is the case with the European Union. This should be welcomed as it would solidify into law those benefits which heretofore are only informally recognised.

A word of caution is in order.  Should the Commonwealth choose to formalise its union it must do so in its own way and according to its founding principles. Liberty and freedom are among these, and the voluntary nature of the union must also be upheld. (This in distinction to the mandatory nature of the European Union which now results in ill feelings of coercion or otherwise being forced to behave in ways undesired by many citizens of the member states.) Infringements to freedom and liberty, such as those occurring in South Africa under apartheid must be met swiftly and surely with exclusion from the union.

United we stand, but only if you want. Countries can choose to break the rules that have promoted peace and prosperity for so long, but must do so of their own accord and separately of Commonwealth benefits.

There is historical precedent for this. South Africa was forced to withdraw from the Commonwealth in 1961 under growing opposition from other members to legislated discrimination based on race. The Commonwealth reopened its arms at the fall of apartheid, and South Africa was readmitted in 1994 (less than one year after the fall of apartheid).  More recently Zimbabwe was suspended for its human rights violations, ignoring the rule of law and suspension of its constitution, and the country’s government decided to formally withdraw in 2003.

Zimbabwe – when your government gets its act together and restores the conditions for peace and prosperity so cherished by the rest of us we will be waiting with open arms.

The Commonwealth has no positive obligation to set straight those countries that pursue different policies than us; who are we to decide? But not playing by our rules will not be tolerated and will be costly for belligerent countries. This is established by the final article of the Singapore Declaration, which states:

These relationships we intend to foster and extend, for we believe that our multi-national association can expand human understanding and understanding among nations, assist in the elimination of discrimination based on differences of race, colour or creed, maintain and strengthen personal liberty, contribute to the enrichment of life for all, and provide a powerful influence for peace among nations.

Coercion is rejected as a policy tool to enforce these values. Even though the Millbrook Commonwealth Action Programme does set out that Commonwealth Nations must concern themselves with other members’ internal situations, it limits repercussions to sanctions, suspensions and expulsions from the group as punishments for persistent violations to its core values.

The continued voluntary nature of the Commonwealth sets it apart from other groups, such as the European Union, and goes far in explaining why this very large and diverse grouping of countries has stood together for almost 65 years. Countries have been free to leave in that period as well as apply for admission, but the core values shared by these member states – freedom and liberty – have not been altered. We are the better for it.

And so today we remember, not just the evils and injustices of 95 years ago but of the benefits that we have today as a result. The freedom and liberty that Canadians enjoy are in no small part the result of the injustices suffered during the Great War.

Canada’s Conscription Crisis in particular was a critical albeit costly coming of age moment. The Statute of Westminster that it resulted in freed Canada and the other Dominions from forced service to a Crown it never voted for. In its place was formed a voluntary Commonwealth of Nations, joined by certain principles and rights but not irrevocably so. Countries can choose to not adhere to these principles, but the Commonwealth will have nothing to do with them if they choose this path. Despite being a stalemate for many years the Great War did accomplish much. The formation of the voluntary union of the Commonwealth might not have been so without it.

And for this, in addition to the thoughts of those who perished and their families, we remember.

Economics

Finland’s gold

On Wednesday Finland gave in to public pressure and revealed where she stores her gold reserves. The statement followed a press release by the Bank of Sweden on similar lines released on Monday.

The totals (in tonnes) for these two Scandinavian countries are as follows:

Location Sweden Finland
Bank of England 61.4 25.0
Swedish Riksbank 15.1 9.8
New York Fed 13.2 8.8
Swiss National Bank 2.8 3.4
Bank of Finland - 2.0
Bank of Canada 33.2 -
Total 125.7 49.0

So far, so good. But then the Head of Communications for the Bank of Finland added some more information in Finnish in a blog run on the Bank’s website. It is not available in English, so I asked her for a translation, but I am still waiting.

Instead, a Finnish reader of my own blog and a Finnish journalist who has been following this topic have independently given me an English translation of a highly relevant and interesting paragraph, three from the end. This is the journalist’s:

Maximum half of the gold has been within investment activity over the years. Gold has been invested among other things in deposits similar to money market deposits and using gold interest rate swaps. Gold investment activity is common for central banks. The risks associated with gold investments are controlled using limits, investment diversification and limitations concerning duration.

And my reader’s translation:

Throughout these years no more than half of the gold has been invested. Gold has been invested in for example deposits similar to money market deposits and gold interest rate swap agreements. Gold investment activities are common for central banks. Risks related to gold investments are controlled with limits, decentralising investments and limits regarding run times.

Half Finland’s gold is stored at the Bank of England, and “no more than half” is “invested”. If any “investment” is to take place it would be in London. It is not immediately clear what is meant by invested, but presumably this is a result of translation of what has happened from English into Finnish plus explanation for a non-specialist readership. However if it has been invested, then by definition it is no longer in the possession of the Bank of Finland, and will most probably have been sold into the market in return for a promise to redeliver at a later date. This follows the Austrian National Bank’s admission to a parliamentary committee a year ago that it had earned EUR300m by leasing its gold through London.

The evidence is mounting that Western central banks through the Bank of England have been feeding monetary gold into the market through leasing operations. Indeed, the Finnish blog says as much: “Gold investment activities are common for central banks”.

This explains in part how the voracious appetite for gold by China, India and South-East Asia is being satisfied, without the gold price rising to reflect this demand. It is also consistent with my disclosure earlier this year of the discrepancy of up to 1,300 tonnes between the gold in custody as recorded in the Bank of England’s Annual Report, dated 28th February 2013 and the amount recorded on the virtual tour on the Bank’s website the following June.

This article was previously published at GoldMoney.com.

Economics

Money printing: not what it was

There are lots of reasons why QE hasn’t yet created inflation in the rich West…

SO HEADLINE writers everywhere got to say money really does grow on trees today.

Gold, in fact, has been found in minute quantities in eucalyptus trees in Australia. Analyzing tree leaves and bark could now unearth gold deposits up to 30 metres below ground elsewhere in the world, geochemists say.

Good news perhaps for the mining sector. But unearthing that ore won’t be easy like picking a leaf. Making money is never cost-free. And not even money-printers are making as much profit as you might imagine right now. 

UK firm De La Rue today gave its second profits warning of the year. Weird as it sounds, there is over-capacity in note printing worldwide, it claims. That may seem hard to believe, what with quantitative easing still rolling ahead at record levels. But money printing isn’t what it used to be, even without the US Fed daring to taper its $85 billion per month. And De La Rue is lagging profit targets set back in 2010, when asset purchases with newly-minted central bank cash was hitting its stride.

De La Rue Plc is the world’s largest independent printer of banknotes. It has printed 150 different currencies over the last 5 years, and designed two-fifths of all new banknotes issued anywhere in the world since 2008. 

You might think that was (ahem) a license to print money. But volumes actually fell this year, De La Rue says, down 10% in the first half of 2013.

Surely quantitative easing means there’s more money around? Near-zero interest rates are also bringing more credit and spending to the economy, right? And what about the revival of real estate prices, most notably in UK housing but also worrying German politicians as even Berlin rents soar?

All that money, however, is electronic, not physical paper. Indeed, the central banks’ printing presses are today an “electronic equivalent” as current Fed chair Ben Bernanke put it way back in 2002. Urging the Japanese to debauch the Yen just as he’s since attacked the Dollar, Bernanke only used “printing” as analogy, however. Whereas it was paper money, not photons blinking on a bank-account balance, which fired inflation in the basket-case economy of Zimbabwe when Bernanke spoke a decade ago, and in Argentina today.

Digitized cash, in contrast, is now the real thing, as military strategist, historian and consultant Edward Luttwak noted this month in an aside on Italian gangsters. Starting in the 1990s, says Luttwak, the Calabrian family gangs pushing cocaine north into Europe as far as the new markets of the old Soviet states found their “Colombian [cocaine] suppliers refused to accept cash, because it was no good for investing in Miami real estate or local hotels or restaurants. The Calabrians needed real money: not bundles of paper but deposits in bank accounts that could be wired.”

Fact is, legitimate businesses cannot use cash. And worldwide, reckons Mastercard (with a vested interest, of course), business transactions now account for 89% of the value of payments. Consumers, meantime, are also moving away from cash (at least, outside the black economy they are; and those immoral earnings still need laundering into the “real money” of digitized bank databases in the end). As a proportion of retail transactions by number, cashless payments now make up 80% in the United States, 89% in the UK, and all but 7% in Belgium according to Mastercard. Even ignoring the plastic PR team, nearly half of UK consumer transactions are now done without cash, with currency payments sinking almost 10% by value in 2012 from the year before, according to the British Retail Consortium. The bulk of non-cash growth came from “alternative” methods, notably PayPal, with “new ways to pay and new ways to shop shaping the retail landscape like never before.”

Might this explain why consumer price inflation hasn’t taken off in the developed West? Yes, there’s lots more money around. Yes, people keep buying gold as protection. Because basic economics says this should push the general price level higher, as the value of each monetary unit is shrunk. But all this extra money sits on hard drives, servers and in the cloud, rather than in purses and wallets. That’s where money is transacted too, in intangible code. Lacking a physical presence, perhaps this wall of money loses its impact.

There are lots of other reasons you could give for why inflation hasn’t surged with the money supply. It’s all locked up in banking reserves, for instance, instead of reaching the “real” economy. Increased spending power since 2008 has gone almost entirely to the richest households, who use it to buy shares, property and fine art rather than Doritos and donuts. Or perhaps central bankers really have kept that credibility which they fought to attain after the 1970s’ inflation. Western households are now sure that the cost of living will never be let loose again.

But the birth of physical money back in ancient Greece changed our brains and our world. Coins made kings of anyone holding them, with the “universal equivalent” marking the beginning of the end of feudal society just as it created an independent yard-stick for all values – mercantile, religious and personal. This is what the myth of King Midas is about, after all.

The human brain and how it conceives of the world is being changed again by digitization today. Just ask a 20-year old (go on, ask them. Ask them anything, and see if they can answer without checking online. Ask a 45-year old come to that). Plenty of people worry that it’s all changing us for the worse, twiddling their fears about the internet by writing, of course, on the internet. Plenty of other idiots think the posthuman world will prove a new joy, with the internet’s jibber-jabber of lies, confusion and stupidity taking us back to some forgotten Eden where everyone’s views are equal. Like, y’know, in the way opinions were freely allowed to medieval peasants who couldn’t read? Today’s infotainment and readers’ comments let knowledge morph and shift just like knowledge was shared and communal pre-Gutenberg. Who needs the Enlightenment?!

Either way, perhaps our brave new digital world also revokes the iron law of money. Perhaps our flood of new cash will never end in higher living costs in the way it always has – always has – in the past. Because money we cannot touch cannot in turn touch prices as surely as paper or metal did.

Yeah right. And money really does grow on trees.

This article was previously published at BullionVault.com.