The economist Harry Veryser sums up the situation:
It may be hard to imagine today, but only a hundred years ago the Western world had an economic system that was probably the best in history. Inflation was nonexistent, and there was free and open trading throughout the world. There was also price stability: for a full century the price of a loaf of bread remained about the same. At every level of society in America and Europe, people saw their standards of living ratchet up continually. People lived longer, diseases were wiped out, and literacy spread. These were years of monumental technological achievement, unprecedented economic growth, and extraordinary population growth.9
Then the government got involved in the game of trying to spur economic growth by tampering with the currency, which required it to seize gold. Few remember or even realize that from FDR’s administration until Nixon’s, it was illegal for Americans to own gold. “Of two men walking down Main Street, one with a gold coin in his pocket and the other carrying a bottle of booze, the first was now breaking the law and the second was an upstanding citizen,” writes Adrian Ash of Forbes. “FDR’s gold confiscation meant private owners were obliged to take their coins, bars or gold certificates to a bank, and exchange them for dollars at the prevailing rate of $20.67 per ounce. Over the next year, the president then raised his official gold price to $35 per ounce, effectively cutting 40% off the dollar in a bid to stoke inflation and spur the economy. . . . [S]eizing private gold and then devaluing the currency was in fact a 1930s version of quantitative easing.”10 This analysis is backed up by the Federal Reserve Bank of St. Louis.11
FDR knew he was removing the country from the gold standard. “We are now off the gold standard,” he told his advisors. Lewis Douglas, an aide, said that it would herald “the end of Western civilization.” Roosevelt then told reporters in his first press conference, “As long as nobody asks me whether we are off the gold standard or gold basis, that is all right. . . . [The United States will have a] managed currency [that] may expand one week and it may contract another week. That part is all off the record.”12
In order to accomplish this seizure of American wealth, Roosevelt had to ignore the limits on his constitutional power. As Thomas Woods explains, the Emergency Banking Act of 1933 gave Roosevelt powers far beyond anything the executive branch is granted under the Constitution. Congress expanded that power to the point that the president could arbitrarily set the value of cash each day:
For the next six months President Roosevelt pursued an erratic monetary course. Every day a new gold price was declared, on a basis no one could figure out. Private lending in effect came to a halt, with the value of the dollar in constant flux amid the prospect of ongoing devaluation. As Senator Carter Glass (D-Va.) put it, “No man outside of a lunatic asylum will loan his money today on a farm mortgage.” And thus the government could triumphantly announce that since the private sector was cruelly depriving Americans of credit, it would have to step in and provide relief.13
Did it work? Of course not. The Great Depression lasted all the way until World War II, and it was truly cured only by tremendous deregulation in the aftermath of the war and by the devastation in Europe, which required American goods and services in order to rebuild.
It is important to understand the confiscation of gold. Governments view gold as a policy tool to be exploited for their purposes. It cannot be viewed as an ultimate safe haven, therefore, as long as governments retain power. In the 1930s, FDR confiscated gold. Today, central banks can use their vast storehouses to drive down the price at will. Of course, over the really long term, gold has proved a storehouse of value (assuming the government doesn’t take it).
While FDR removed us from the gold standard as a practical matter, Richard Nixon made it official in 1971, about the time he embraced price and wage controls. Unionized labor was driving manufacturing costs up, so the United States’ import-export balance was moving in the wrong direction. Foreign governments began showing up demanding to exchange U.S. dollars for gold, and Nixon wanted to address those problems before his reelection campaign. In his history of modern capitalism, The Commanding Heights, Daniel Yergin describes how the decision was made: “The climax came on August 13–15, 1971, when Nixon and 15 advisors repaired to the presidential mountain retreat at Camp David. Out of this conclave came the New Economic Policy, which would temporarily—for a 90-day period—freeze wages and prices to check inflation. That would, it was thought, solve the inflation-employment dilemma, for such controls would allow the administration to pursue a more expansive fiscal policy—stimulating employment in time for the 1972 presidential election without stoking inflation. The gold window was to be closed.” The predictable result was an economy entirely at the behest of the federal government: on wages, on prices, and on currency valuation.14
Thanks to the public’s hunger for government action—a consistent failure of public understanding about economics that continually undermines the possibility of growth—gold came to be seen as Keynes’s “barbarous relic” rather than the underpinning of sound money. Even Ben Bernanke has admitted, “Nobody really understands gold prices and I don’t pretend to understand them either.”15 With that statement, the Fed chairman denies any real role for gold in backing currency—quite a departure from the early views of his predecessor Greenspan, let alone from those of the Founders.
Nevertheless, it was not that long ago that gold played a central role in thinking about currency. As recently as the creation of the euro in 1999, there were discussions of backing the currency with gold, at least in part. More recently, the “father” of the euro, Professor Robert Mundell, a Nobel laureate, even called for putting the currency on a gold standard.16 Steve Forbes agrees: “The American dollar was linked to gold from the time of George Washington until the early 1970s. If the world’s people are to realize their full economic potential, relinking the dollar to gold is essential. Without it we will experience more debilitating financial disasters and economic stagnation.”17
Since 1913, when the Federal Reserve System was established, the dollar has lost 96 percent of its purchasing power. It has suffered most of this decline since the gold standard was ditched in 1971. The dollar has lost 80 percent of its purchasing power since 1971.18 We’re not alone in destroying our own currency. From 1750 to 2002, the British pound lost more than 99 percent of its purchasing power.19
So Who Owns the Gold?
Though our great economic minds inform us regularly that gold is passé, central banks are the largest official holders of gold, with almost thirty-two thousand tons in their vaults. That’s almost 20 percent of all the gold in the world, which is estimated at a little over 171,000 tons.20
The largest official holder of gold is the United States, with over 8,133 tons. Next in line is Germany, with 3,391 tons. Outside of official holdings, most gold is used for jewelry, which accounts for 78 percent of annual consumption. China led the world in gold production as of 2011. Australia was second, the United States third, Russia fourth, and South Africa fifth.21
It should be understood that since central banks control almost 20 percent of the world’s gold supply, they are in a position to move prices in any direction they desire. Since those same central banks also control the value of paper money, they have an incentive to keep gold prices, well, reasonable. A rapid run-up in gold prices would indicate a failure of confidence, which central banks want to avoid. That’s why in July 2013, when the Indian rupee dropped, Indian government officials told citizens not to buy gold. Jewelers actually pulled gold coins and bars after the Indian finance minister asked people to resist “temptation.”22
There are many who believe that the central banks’ claims about their holdings of gold are a sham. The gold vault of the Federal Reserve, for example, has not been the subject of a full-scale audit. It is not only individuals who are questioning the official accounts of how much gold is in the vault. Foreign countries store some of their gold in the vaults of the Bank of England a
nd the Federal Reserve, and Mexico and Germany have expressed concern about how accurately their reserves are accounted for: “In the case of Mexico, questions have been raised about the country’s off-shore storage of precious metals and its ability to take possession if necessary. These concerns have been magnified by Germany’s experience. Germany’s Bundesbank intends to repatriate a large portion of gold reserves abroad and by 2020 seeks to have at least 50 percent of its total gold reserves at home.”23
Germany’s demand for the return of its gold reserves is a sign of growing distrust among central banks.24 The Mexican government also appears distrustful, requiring an internal audit of that country’s gold holdings:
The Government Audit Office has concluded that 95% of the gold reserves of the Bank of Mexico are stored abroad and 99% of this gold is stored with the Bank of England. However, the Mexican central bank has never inspected the gold it bought, has not performed purity tests on it and doesn’t even have a list of all the gold bars stored in London. In their current state, Mexico’s gold reserves are no more than “paper gold” in the meaning that the Bank of Mexico doesn’t have any physical gold, but mere “claims” on a certain amount of gold supposedly held by the Bank of England.
Bill Gross, the Chief Investment Officer of PIMCO (the world’s largest bond fund) has recently said that “Central banks distrust each other.” The pending audit of the Mexican gold reserves is not a singular case of actions that show a high level of mutual distrust among central banks. The latest move of the Bundesbank, which demanded the repatriation of its gold holding from Bank of New York, Bank of England and Banque de France, is another sign of distrust in the world’s financial system. It is quite probable that after the audit, Mexico will decide to repatriate its gold holdings, possibly prompting other countries to follow suit.25
The real concern is that while the central banks lay claim to a huge supply of gold, they may have loaned it out or even sold claims on it. This concern grew when the Federal Reserve indicated that it would take years to return the Germans’ gold deposits to them: “A particularly interesting aspect of the announcement that has been largely ignored is the extraordinarily lengthy seven year time period in which the Germans expect to receive back their gold. The 300 tons they’re repatriating from the New York Fed reflects just five percent of the more than 6,700 tons held there. It strikes many as unusual that the Fed would need so much time to deliver what should be a manageable withdrawal.”26
If people discovered that central banks do not have the gold they say they have, or have loaned it out or sold rights to it, the price of gold would soar.
It is not yet clear who possesses how much gold in the murky world of central banking holdings. But as these issues are sorted through, the impacts on currency valuations will likely be significant. Issues of gold holdings and repatriation are interlinked with currency valuations, and both bear watching.27
The Role of Hedge Funds and the Potential for Manipulation
While the central banks have led us to believe that they have cornered the market on gold, large hedge funds like Soros Fund Management, which got involved in trading gold in the early part of the twenty-first century, also are able to move the market. As Amine Bouchentouf of Seeking Alpha reports, “While it’s difficult to quantify the amount that capital hedge funds account for in the gold markets, suffice it to say that gold has become such a prominent asset class for the industry that some of the world’s biggest hedge funds have launched dedicated gold funds specifically to trade the yellow metal.”28
Such concentrated holdings can lead to manipulation. In the 1970s the Hunt brothers proved that if you controlled enough of the supply, you could control the price of a commodity like silver. They began buying enormous quantities of silver, and the price soon doubled. Within four years, they controlled 9 percent of all the silver on the planet, and the price doubled again. With a little subterfuge and the help of the Saudi royal family, the Hunts kept amassing silver, and the price almost tripled again. Jason Tillberg tells how it ended: “The Hunts and their allies controlled 62% of all the silver in the COMEX warehouses and 26% of all the silver held by the Chicago Board of Trade, the CBOT, plus all the silver they held in Switzerland, the 40 million ounces they first bought in 1974.” Silver was selling for $1.50 an ounce when the Hunts started buying. By the end of 1979, the price was $34.45. The U.S. government eventually foiled the Hunts’ designs by limiting holdings of silver. When it became clear that the Hunts could go bankrupt, the government stepped in to bail them out. That’s how it works in the world of big government and manipulative finance.29
Silver is not the only commodity susceptible to manipulation. Dr. Paul Craig Roberts, considered the “father of Reaganomics,” believes that gold has been manipulated by the government in order to curb demand and prop up the dollar:
On Friday, April 12, 2013, short sales of gold hit the New York market in an amount estimated to have been somewhere between 124 and 400 tons of gold. This enormous and unprecedented sale implies an illegal conspiracy of sellers intent on rigging the market or action by the Federal Reserve through its agents, the [banks too big to fail] that are the bullion banks. The enormous sales of naked shorts drove down the gold price, triggering stop-loss orders and margin calls. The attack continued on Monday, April 15, and has continued since. . . . Who can be unconcerned with losing money in this way? Only a central bank that can print it.30
Roberts accuses the government of colluding with hedge funds in order to scare investors out of bullion: “Brokerage houses told their individual clients the word was out that hedge funds and institutional investors were going to be dumping gold and that they should get out in advance. Then, a couple of days ago, Goldman Sachs announced there would be further departures from gold. So what they are trying to do is scare the individual investor out of bullion.”31
Dr. Roberts may be right, or he may be wrong. But if he’s right, then it appears that the Fed is using just a fraction of its reported eight thousand tons of gold to send prices plummeting. It could even sell promises of gold, not backed by the metal itself, and have the same effect. What about the other countries with thousands of tons? In the second quarter of 2013, the price of gold fell 23 percent, more than any previous quarter in history.32
Now the point is this: The advice to put all your eggs in the gold basket should give you pause, because gold can be manipulated. It would be too easy to destroy wealth in the short term.
Dollar Failure?
This is not to say that gold has no place in your portfolio. It is very useful in many ways. First, it will always have some value. Over the long term, it is a remarkable hedge against a host of ills. But its short-term performance is spotty. The economist Mark Skousen writes that “stocks are a superior inflation hedge over the long run because they represent a growing economy. U.S. stock indexes have outperformed gold and silver by a long shot. . . . But precious metals traditionally have held their purchasing power over long periods of time.”33
So what are the pros and cons?
The fundamental advantage of gold is that it will never go to zero. In all of human history, gold has had a premium value of some sort. The same cannot be said about paper money.
Gold is universal. All societies have a reverence for gold. Therefore it is always liquid. As Greenspan said, gold is money.
Most important for investment purposes, gold is not correlated with other asset classes over longer periods—that is, it doesn’t perform the same as other major investments. Because it can rise in price while other things are falling, and vice versa, it is an ideal addition to portfolios for the purpose of diversification. As Fidelity says in its “pros’ guide to diversification”:
When you put assets together in a portfolio that have low correlations, you may be able to get more return while taking on the same level of risk, or the same returns with less risk. The less correlated the assets are in your portfolio, the more efficient the tradeoff between risk and return.
To build a diversified portfolio, an investor should look for assets whose returns haven’t historically moved in the same direction, and ideally, assets whose returns move in the opposite direction. That way, even if a portion of your portfolio is declining, the rest of your portfolio is designed to be growing. Thus, you can potentially dampen the impact of poor market performance on your overall portfolio.34
But it’s not all sunshine and rainbows with gold. There are important disadvantages. First, you can’t eat gold. For all those suggesting gold as the ultimate in survivalism, it’s going to hurt your teeth. Second, it costs money to store and keep gold. For investment purposes, far more importantly, it can be manipulated or confiscated, as I have pointed out. It doesn’t always perform as expected, since many people sell gold when things go bad as a way to get cash from a liquid asset.
In fact, the price of gold can go down for long stretches of time. Gold fell from $850 an ounce in January 1980 to below $300 in 1984. It traded at $251 an ounce in August 1999, a loss of 70 percent over two decades. Given the choice in January 1980 of gold at $850 an ounce or the Dow Jones Industrial Average at about 850, you would have fared better with the stock market. Over the next thirty-three years, gold went from $850 to over $1900 in 2011, falling to $1200 in 2013. By contrast, the Dow increased from 850 to over 15,000 in early 2013. Meanwhile, holding gold would have entailed insurance and storage fees, while stocks were paying dividends over and above the gains in the index.
On the other hand, when gold traded as low as $250 in 1999, the Dow was closer to 11,000. Over the next twelve years, gold increased almost eightfold, while the Dow was virtually flat. Even accounting for storage costs and dividends, gold trounced stocks in that period. As you can see, one of the problems with gold is that analysts have a poor track record in predicting price movements. For example, just as gold was peaking at $1,900 an ounce, many of the top analysts were predicting a move up to $5,000 or higher.
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