Gold Appears Quiescent

Gold news has not received much media coverage lately. That's not because what's been happening is unimportant. Rather it has been eclipsed by sensational stories of the latest school shooting, the eruption of a Hawaiian volcano, the on-again-off-again summit plans with North Korea, tariffs on steel and aluminum, Italian political problems, the price of bitcoin, the latest on who's been raped or suffered other sexual abuse.

Thus few people know that central banks have been huge buyers of gold. In the 4^th quarter 2017, central bank reserves increased by 73.1 metric tons, bringing the total for the year to 372t. The pattern of central bank purchases in 2017 continued in the 1^st quarter 2018, when Central Bank gold purchases increased a whopping 42%. Do the central banks know something that others don't? In contrast to the central bank buying, sales of gold bars and coins to non-bank customers have been tepid.

Who has been buying? 2017 was the eleventh consecutive year of growth in Russia's official gold holding. For several years Russia was buying about 100t per year, but each of the last three years show gains of over 200t.

Another notable buyer of gold recently was Turkey. Beginning in May 2017, it averaged 11t of gold per month, increasing its reserves by 86t by the end of the year.

China does not disclose its purchases on a regular basis. So we must do with estimates. The best of these are calculated by Koos Jansen of Bullionstar, which we print above with his courtesy. Note that Aggregate Net Imports are the fastest growing category.

India just eliminated 86 % of the nation's cash by withdrawing from circulation its 500 and 1000 rupee notes. How can that be when India has run on cash? According to Bloomberg, “India has among the highest usage of cash across global economies,” accounting for up to 98%. So what will the people of India now do for money? What chaos and mischief will now occur there? And how about the U.S., where it has already been suggested that the U.S. $100 bills and even the $50 bills should be taken out of circulation. Replaced by what? A new fiat currency, a new digital one, or a national credit card that the government will issue to everyone? --and by which the government could know—and tax—every transaction of anyone in the country? And micro-manage every detail of the nation's economy, in the excuse of “the public interest” or “national security"?

Will gold have a role in the future of money? Is that why central banks have been buying gold? Since the formation of the European Union in the 1990s, there has been a concerted political effort to phase out gold in the international monetary system and replace it with a fiat currency, the euro. The euro experience has shown that an unlimited ability to print money with no backing cannot replace the effectiveness of a tangible monetary asset, gold. Central bank buying of gold now may be recognition of that. In this regard it may be useful to look at the history of the EU's agreements on gold.

The first Central Bank Gold Agreement took place in 1999.  At that time, central banks held nearly a quarter of all gold held above ground, about 33,000 tones.  The second gold agreement (CBA2) took place in 2004. CBA3 followed in 2009 and CBA4 followed in 2014. The first clause in each of these four agreements began: “Gold will remain an important element of global monetary reserves.” In one of its first pronouncements, the ECB governing council decided the capital subscriptions of euro-zone members would be paid 15% in gold and 85% in dollars or Japanese yen. (The capital subscriptions were based on population and GDP of the members.)

The national debt now $21 trillion keeps on growing.  It will never be paid off because it is growing faster than the economy.  And it is obvious to everyone that this cannot continue forever, because  credit cannot be expanding forever.  At some point, the whole system will break down because somewhere there will be a default that cannot be covered, leading to a cascade of interrelated debt defaults. Then we shall see a crash comparable to the Great Depression of the 1930s or the more recent Great Recession, only worse.  

Since 1971 when President Nixon severed the last link between the dollar and gold, the world has seen the longest period of money with no link to gold or silver.  Eventually there will be a need to connect supply and demand factors for gold with other supply and demand factors in the economy. This will mean an adjustment of the price of gold in relation to the realities of other market factors. Nixon cut the link between gold and the dollar because U.S. debt--from excessive government spending--made it impossible to maintain convertibility of the dollar at $35 per ounce. Since our national debt is now $21 trillion, making the dollar again convertible for gold will require a far, far higher price for gold. Either that or we shall see gold made convertible to a different currency, if not in the U.S. then somewhere else on the planet. There have been some 3,400 fiat currencies; they all became worthless.  It remains to be seen whether the U.S. will add to that list or return to a gold-backed currency.

 The U.S. says it has 8,133.5 tonnes of gold, but questions have arisen over the years as to whether that is accurate.  Records of audits are sparse, incomplete and show a troubled history of government accounts. Recently Koos Jansen of Bullionstar.com has completed the most extensive research ever done on the U.S. government gold holdings. Through the use of the Freedom of Information Act, he has unearthed startling information never before available.  He encountered a wide range of problems that document the audits have been executed with an inadequate degree of integrity, including:

• Most physically verified and sealed vault compartments have been re-opened, for which the auditor can provide no valid explanation.
• Auditing personnel has proven to be utterly incompetent and did not follow the auditing policies and procedures.
• Repeatedly metal has been excluded from verifications.
• Many of the audit and assay documents have been destroyed.
• The US government goes to great lengths in withholding information and spreading false information.
  

"The protocol was designed to open, audit, close and seal all compartments once, in order to avoid the necessity to repeat these procedures. Despite these rules, my research points out nearly all compartments have been re-opened after being audited....This is a story about misconduct, deceit, inconsistencies, and loose ends. At risk is the safety of the gold meant to underpin the world reserve currency....

"Whilst the function of the audits was to prove the existence of the gold, what they’ve achieved is to make us doubt about the existence of the gold. Up to 200 million ounces are stored in compartments that either have been subjected to dubious re-audits or have been re-opened and/or re-sealed for a vast array of other suspicious reasons....

In response to a question from Ron Paul, a member of the committee hearing testimony, Thorsen, a member of the Office of Inspector General, replied, "It should be noted that most workpapers associated with our reports issued prior to 2004 have been destroyed in accordance with our records retention policy." Thus Jansen writes: "Stunningly, the US government has destroyed most documents drafted from 1974 until 2004 associated to the audits of its 261,498,926 ounces (8,134 tonnes) of gold that serve to underpin the world reserve currency....The OIG lost 10 audit reports from 1974 through 1986...."

"Factually, seals can survive for 32 years, but by 1981 the seal on Fort Knox compartment 1 had been replaced five times. Remember we have the audit reports of 1974, 1977, 1980 and 1981; these mention nothing about perpetual re-sealing of compartments. That’s suspicious."

Welcome to the 1930s

President Trump fired the opening salvo in a trade war—reminiscent of the 1930s trade war from the Smoot-Hawley Act, which prolonged the Great Depression—when he announced he will impose tariffs of 25% and 10% on imported steel and aluminum. Chinese officials quickly responded saying they would impose a 25% tariff on 106 U.S. products, including automobiles, pork, soybeans, fruit, nuts and other goods amounting to $50 billion on imports from the U.S. That roughly matched the scale of tariffs the U.S. government proposed on China the previous day. This is exactly how trade wars begin. Trump then hit back by threatening as much as $60 billion more in other tariffs and restrictions.

Trump tweeted, “Trade wars are good and easy to win.” Actually they are bad and impossible to win. When a trade—whether between individuals or countries—is freely made, it is a win-win situation, because both sides judge it to be in their interest. That is why countries with relatively free markets are more prosperous than those those without them. Government economic mandates are at best win-lose and often become lose-lose by victimizing not only one side to benefit the other but also by forcing a chain of secondary losses throughout the economy—as well as often victimizing the very people they are supposed to benefit.

For example, the tariffs on steel and aluminum are intended to benefit those industries and their workers but will also increase the cost of production for American firms that use those metals. So there will be lower production from U.S. manufacturing and less employment. The American steel industry employs 147,000 workers, while 6.3 million workers are directly employed in the steel-using industry. Thus about 16 times more workers are employed in steel-consuming industries than steel workers producing the metal. Economists Joseph Francois and Laura Baughman show that more workers (200,000) lost jobs because of George W. Bush's tariff on steel than were employed in the entire U.S. steel industry (187,500).

Rising prices of American steel and aluminum will not only mean higher costs for cars in the U.S. but leave the U.S. Big Three less able to compete with foreign auto companies. This will be counter to the effort to sell more American cars overseas to reduce the trade deficit. Goldman Sachs estimates that the tariffs would cost both GM and Ford $1 billion. Harley-Davidson may have to lay off 1,200 steel workers because the company relies on a special Russian steel not available from U.S. manufacturers.

Steel is used in natural gas pipelines, railroads and bridges. The steel tariff will make it more costly to maintain and replace the nation's infrastructure. There are 126 million households in the U.S. that buy appliances such as refrigerators, freezers, and stoves that utilize large quantities of steel and will now be higher priced. And aluminum is widely used in dozens of common products, including even beer cans and soda cans, accounting for about half the cost of a can.

China is the second-biggest customer for U.S. agricultural exports, after Canada. Trump's proposed tariffs, leading to retaliatory measures by China, will worsen the U.S. farm economy's slump that has already pushed some farmers out of business and eroded profits from seed, chemical and equipment companies.

The government's corn ethanol mandate provided generous tax credits and subsidies to stimulate demand for ethanol and other biofuels. This soon diverted 40% of America's corn crop away from the food supply. This government “gift” to the ethanol advocates was paid for by a government-imposed shortage that boosted the long-term mean levels for corn from about $2 per bushel to more than $8 per bushel in 2012. This price surge produced a range of harmful responses. Farmers planted 17 million new acres of corn and reduced the acreages of soybeans, wheat, hay and cotton, driving their prices to new highs, too.

Cattle farmers, unable to afford corn for feed, reduced their herds to levels not seen in 60 years. In the five years 2007 to 2012, beef prices rose 60%, and the International Monetary Fund food price index increased 42 percent.

The country endured an enormous amount of economic disruption by trying to foist an uneconomic fuel on the public in place of an economic one—gasoline. The government's decision was not based on economics but on politics. The economic solution is always the free-market solution. A political solution is always uneconomic because it confers on some a benefit at the expense of others whose compliance must be forced—by the police power of government because it is counter to the interests (and rights) of others. So then it is necessary for a bureaucracy to administer the tax credits and subsidies, none of which are needed in a free market.

The bureaucracy also finds it necessary to ameliorate the effects of uneconomic political policy on friendly foreign governments. For example, Trump claims the tariffs on imported steel and aluminum are intended to improve the balance of trade with China. But steel imports from China account for only 3% of U.S. steel usage, and Canada provides 43% of our aluminum imports—more than twice as much as China and Russia combined. The four largest sources of our foreign steel imports are Canada, Brazil, South Korea and Mexico. Canada and Mexico are our good neighbors, and South Korea is a key alley in Asia. So our bureaucracy must carve out exceptions or waivers to protect these friendly governments from the worst effects of our tariffs. Again, this is a bureaucratic function that is unnecessary in free markets.

If President Trump does not understand the economic effects of tariffs we have just explained—and believes “trade wars are good and easy to win”—then we have a president who is economically illiterate (as well as oblivious to the Constitution). And he has learned nothing from our history under the Smoot-Hawley Act.

Finally, environmental concerns are not a valid reason for political decisions to override economic facts (or constitutional principles). A political decision here based on the threat of so-called global warming cannot be a rational solution because the the environmental effects are worse for the uneconomic solution. For example, among many similar studies, a 2010 Congressional Budget Office study of corn-based ethanol found it terribly inefficient, with government spending astronomically more—$754 per metric ton—for avoided carbon emissions, compared with other policies. And a 2008 study in the journal Science found that biofuel production can produce hundreds of times more carbon emissions than the biofuels themselves.