Greetings!
If I were to tell you that people in positions of power and influence have a habit of lying to the public, you most likely would not blink an eye or alter your daily habits in any way, even if that person was Alan Greenspan. During his tenure as Chairman of the Fed Mr. Greenspan was an icon who moved markets with every utterance. He was what E.F. Hutton wished he could be in those 1980's commercials. Now, after the sub-prime mess people have directly blamed him for doing nothing to raise interest rates to stem the tide of sub-prime mortgage lending.
This week we had news that after years of denial about using gold swaps, the FED acknowledged that Mr. Greenspan failed to disclose the truth about using gold swaps. The FED made the disclosure in response to a Freedom of Information act submittal.
This revelation comes at a bad time. The U.S. dollar is showing unprecedented weakness and gold is showing unprecedented strength. The issue with gold is that governments, and not just the U.S. Government, want a low gold price to make their national currency look good. The basis by which all currencies are valued is confidence and trust. When people trust the dollar they do not mind holding dollars and so the value goes up. However, when people get nervous about the dollar, they look to gold to offset their fears and so the price of Gold rises. A rising gold price screams out for all to hear the unpleasant truth that a national currency is being poorly managed and that its purchasing power is being inflated. Former Federal Reserve Chairman Paul Volcker once said it very succinctly, "...a rising gold price undermines the thin reed upon which all fiat currency rests -- confidence."
If we are to correctly assume that the U.S. dollar's role as the world's reserve currency is still in tact for now, then we must also conclude that the U.S. government has the most to lose if the market chooses gold over the dollar. If that were to happen, then this significantly erodes the ability of the U.S. government to print money. It goes without saying that printing money when the dollar is strong has less of an effect on the value of the dollar then doing so when people are opting for Gold instead of the dollar. After all, the ability to print money is a privilege afforded every government, but one that must be managed carefully.
Therefore we now have the truth that the U.S. government does in fact intervene in the gold market for the purpose of making the dollar more worthy of continuing as the world's reserve currency. The concern is that this may be too little too late to stem the deterioration the dollar has suffered in confidence level. Unfortunately, the tidal wave of change is proving that in the end, gold always wins, as proven by the fact that today gold is nearing $1,000 an ounce, and the dollar having difficulties keeping up.
Now, given the devaluation of the dollar being pursued by U.S. policymakers as they continue to print money, albeit a policy fostered originally to lower the value of toxic sub-prime assets on the books of big banks, and also trying to keep gold from exploding in price to its free-market level is the first thing the government gains from interventions in the gold market. The second is time; time that allows policymakers to keep their economic policies afloat while delaying until some future administration the scheme's inevitable collapse.
So, you might ask, how is this little dance orchestrated? The U.S. government cannot act directly but instead uses accomplices like Goldman Sachs, JP Morgan Chase, Deutsche Bank, and to some extent Citibank to handle the transactions by executing trades to pursue the U.S. government's aims. These banks are referred to in some circles as "the gold cartel." These large institutional banks act with the backing of the U.S. government which agrees to absorb any losses suffered by cartel members as they manage the gold price, and by also providing whatever physical gold bullion is required to execute a particular trading strategy. This is beginning to sound like an Ian Fleming James Bond novel.
Now back to Mr. Greenspan. Strangely enough, the banks were having difficulty remaining solvent in the late 80's, much as they are having problems today. Around 1990, a policy was introduced by then-Federal Reserve Chairman Alan Greenspan to bail out the banks. At the time, taxpayers were already on the hook for billions of dollars to bail out the collapsed savings and loan industry. Remember the likes of Michael Milken and Charles Keating? So the thinking was that adding to this tax burden was not an attractive solution, and so Mr. Greenspan got creative.
Mr. Greenspan's view of the free market system was that it was an available resource of essentially an unlimited supply of money in the hands of wealthy segments of society that could occasionally be tapped at a time of need by the U.S. government. The Government can then use its tremendous financial resources for timed interventions in the free market, combined with its ability to manage the news media to keep things hush hush. In short, it was easier to bail out the insolvent banks back then by gouging ill-gained profits from the free markets instead of raising taxes. So the Fed under Greenspan manipulated short and long term interest rates which in turn allowed Banks to take advantage of the wide spread between them; namely, high long-term interest rates and lower short-term rates. Banks in turn leveraged themselves to borrow short-term from the Fed and use the proceeds to buy long-term paper. This mismatch of assets and liabilities became known as the "carry trade."
For example, around 1990 the Japanese stock market had crashed and the Bank of Japan was pursuing a zero-interest-rate policy in an attempt to revive the Japanese economy. This sounds too familiar! U.S. banks could borrow Japanese yen for 0.2 percent and buy U.S. treasury notes yielding more than 8 percent, thus achieving significant profits and helping banks rebuild their capital base. It's déjà vu all over again with Mr. Bernanke and Mr. Geithner!
Gold also became a favorite vehicle to borrow because of its low interest rate. This gold came from central bank coffers, but central banks did not disclose how much gold they were lending. This in turn made the gold market less than transparent and very ripe for intervention by central bankers making decisions behind closed doors. Enter Mr. Greenspan with his friends the bank executives. Billions of dollars were put to work.
Problems arose as both gold and the yen began to strengthen, which, if allowed to rise high enough, would produce major losses on those carry-trade positions. So the gold cartel was created to manage the gold price, and all went well at first. This manipulation not only managed the price of Gold, it also managed to drive the price too low. Gold became cheap. Value investors caught on and recognized the exceptional opportunity Gold offered and thus demand for physical gold began to climb. As demand rose, the question for banks now was where would the gold come from to repay the central banks, since the gold borrowed the gold borrowed from the central banks had since been melted down and turned into coins and bars?
While the yen and the dollar are currencies that can be printed by the Bank of Japan or the U.S. Treasury, gold is a tangible asset; a commodity. How could the banks repay all the gold they borrowed without causing the gold price to soar, which in turn exacerbated the losses on their remaining positions? In short, the banks were in a predicament, and Mr. Greenspan had essentially traded one problem for another. The Federal Reserve's policies were devaluing the dollar, so Greenspan's policy of using interventions in the market to bail out banks morphed yet again. The question one has to ask is, when will policymakers realize that saving banks is not in the best interest of American Citizens.
All this sounds peculiarly familiar when viewed in light of the sub-prime mortgage fiasco and the high leveraging used by these same banks when they bought and sold mortgage derivatives. By the way, it was in 2000 when George Bush took office and Congress was safely in the hand of Republicans that these derivatives were de-regulated as part of the overall economic policy of letting businessmen do their thing. After all, the profit motive was good for the country and it creates jobs.
Have a nice weekend!
