Central
Banks and Our Dysfunctional Gold Markets byMarcia Christoff-Kurapovna
Mises.org | July 24, 2015
Many investors still view
gold as a safe-haven investment, but there remains much
confusion regarding the extent to which the gold market
is vulnerable to manipulation through short-term rigged
market trades, and long-arm central bank interventions.
First, much of the gold that is being sold as shares, in
certificates, or for physical hoarding in dubious “vaults”
just isn’t there. Second, paper gold can be printed into
infinity just like regular currency. Third, new electronic
gold pricing — replacing, as of this past February, the
traditional five-bank phone-call of the London Gold Fix
in place since 1919 — has not necessarily proved a more
trustworthy model. Fourth, there looms the specter of the
central bank, particularly in the form of volume trading
discounts that commodity exchanges offer them.
The Complex World
of Gold Investments
The question of rigging
has been brought to media attention in the past few months
when ten banks came under investigation by the US Commodity
Futures Trading Commission (CFTC) and the US Department
of Justice in price-manipulation probes. Also around that
time, the Swiss regulator FINMA settled a currency manipulation
case in which UBS was accused of trading ahead of silver-fix
orders. Then, the UK Financial Conduct Authority, which
regulates derivatives, ordered Barclays to pay close to
$45 million in fines against a trader who artificially suppressed
the price of gold in 2012 to avoid payouts to clients. Such
manipulations are not limited to the precious-metals market:
in November of last year, major banks had to pay several
billion dollars in fines related to the rigging of foreign-exchange
benchmarks, including LIBOR and other interest-rate benchmarks.
These cases followed on the heels of a set
of lawsuits in May 2014 filed in New York City in which
twenty-five plaintiffs consisting of hedge funds, private
citizens, and public investors (such as pension funds) sued
HSBC, Barclays, Deutsche Bank, Bank Scotia, and Société
Génerale (the five traditional banks of the former London
Gold Fix) on charges of rigging the precious-metals and
foreign-exchange markets. “A lot of conspiracy theories
have turned out to be conspiracy fact,” said Kevin Maher,
a former gold trader in New York who filed one of the lawsuits
that May, told The New York Times.
Central Banks at the Center of Gold
Markets
The lawsuits were given more prominence
with the introduction of the London Bullion Market Association
(LBMA) on February 20, 2015. The new price-fixing body was
established with seven banks: Goldman Sachs, J.P. Morgan,
UBS, HSBC, Barclays, Bank Scotia and Société Génerale. (On
June 16, the Bank of China announced, after months of speculation,
that it would join.)
While some economists have deemed the new
electronic fix a good move in contrast to behind-closed-door,
phoned-in price-fixing, others beg to differ. Last year,
the commodities exchange CME Group came under scrutiny for
allowing volume trading discounts to central banks, raising
the question of how “open” electronic pricing really is.
Then, too, the LBMA is itself not a commodities exchange
but an Over-The-Counter (OTC) market, and does not publish
— does not have to publish — comprehensive data as to the
amount of metal that is traded in the London market.
According to Ms. Ruth Crowell, the chairman
of LBMA, writing in a report to that group: “Post-trade
reporting is the material barrier preventing greater transparency
on the bullion market.” In the same report, Crowell states:
“It is worth noting that the role of the central banks in
the bullion market may preclude ‘total’ transparency, at
least at the public level.” To its credit, the secretive
London Gold Fix (1919–2015) featured on its website tracking
data of the daily net volume of bars traded and the history
of gold trades, unlike current available information from
the LBMA as one may see here (please scroll down for charts).
The Problem with Paper Gold
There is further the problem of what is
being sold as “paper” gold. At first glance, that option
seems a good one. Gold exchange-traded funds (ETFs), registered
with The New York Stock Exchange, have done very well over
the past decade and many cite this as proof that paper gold,
rather than bars in hand, is just as sure an investment.
The dollar price of gold rose more than 15.4 percent a year
between 1999 and December 2012 and during that time, gold
ETFs generated an annual return of 14 percent (while equities
registered a loss).
As paper claims on trusts that hold gold
in bank vaults, ETFs are for many, preferable to physical
gold. Gold coins, for instance, can be easily faked, will
lose value when scratched, and dealers take high premiums
on their sale. The assaying of gold bars, meanwhile, with
transport and delivery costs, is easy for banking institutions
to handle, but less so for individuals. Many see them as
trustworthy: ETF Securities, for example, one of the largest
operators of commodity ETFs with $21 billion in assets,
stores their gold in Zurich, rather than in London or Toronto.
These last two cities, according to one official from that
company, “could not be trusted not to go along with a confiscation
order like that by Roosevelt in 1933.”
Furthermore, shares in these entities represent
only an indirect claim on a pile of gold. “Unless you are
a big brokerage firm,” writes economist William Baldwin,
“you cannot take shares to a teller and get metal in exchange.”
ETF custodians usually consist of the likes of J.P. Morgan
and UBS who are players on the wholesale market, says Baldwin,
thus implying a possible conflict of interest.
Government and Gold After 1944:
A Love-Hate Relationship
Still more complicated is the love-hate
relationship between governments and gold. As independent
gold analyst Christopher Powell put it in an address to
a symposium on that metal in Sydney, October 2013: “It is
because gold is a competitive national currency that, if
allowed to function in a free market, will determine the
value of other currencies, the level of interest rates and
the value of government bonds.” He continued: “Hence, central
banks fight gold to defend their currencies and their bonds.”
It is a relationship that has had a turbulent
history since the foundation of the Bretton Woods system
in 1944 and up through August 1971, when President Nixon
declared the convertibility of the dollar to gold suspended.
During those intervening decades, gold lived a kind of strange
dual existence as a half state-controlled, half free market-driven
money-commodity, a situation that Nobel Prize economist
Milton Friedman called a “real versus pseudo gold standard.”
The origin of this cumbersome duality was
the post-war two-tiered system of gold pricing. On the one
hand, there was a new monetary system that fixed gold at
$35 an ounce. On the other, there was still a free market
for gold. The $35 official price was ridiculously low compared
to its free market variant, resulting in a situation in
which IMF rules against dealing in gold at “free” prices
were circumvented by banks that surreptitiously purchased
gold from the London market.
The artificial gold price held steady until
the end of the sixties, when the metal’s price started to
“deny compliance” with the dollar. Still, monetary doctrine
sought to keep the price fixed and, at the same time, to
influence pricing on the free market. These attempts were
failures. Finally, in March 1968, the US lost more than
half its reserves, falling from 25,000 to 8,100 tons. The
price of other precious metals was allowed to move freely.
Gold Retreats Into the Shadows
Meawhile, private hoarding of gold was underway.
According to The Financial Times of May 21, 1966, gold production
was rising, but it was not going to official gold stocks.
This situation, in turn, fundamentally affected the gold
clauses of the IMF concerning repayments in currency only
in equal value to the gold value of such at the time of
borrowing. This led to a rise in “paper gold planning” as
a substitution for further increases in IMF quotas. (Please
see “The Paper Gold Planners — Alchemists or Conjurers?”
in The Financial Analysts Journal, Nov–Dec 1966.)
By the late 1960s, Vietnam, poverty, the
rise in crime and inflation were piling high atop one another.
The Fed got to work doing what it does best: “Since April
[1969],” wrote lawyer and economist C. Austin Barker in
a January 1969 article, “The US Money Crisis,” “the Fed
has continually created new money at an unusually rapid
rate.” Economists implored the IMF to allow for a free market
for gold but also to set the official price to at least
$70 an ounce. What was the upshot of this silly system?
That by 1969 Americans were paying for both higher taxes
and inflation. The rest, as they might say, is the history
of the present.
Today, there is no “official” price for
gold, nor any “gold-exchange standard” competing with a
semi-underground free gold market. There is, however, a
material legacy of “real versus pseudo” gold that remains
a terrible menace. Buyer beware of the pivotal difference
between the two.