CENTRAL BANKERS ARE NO LONGER ABLE TO BEHAVE AS IF THEY ARE ON A GOLD STANDARD

By Adrian Douglas

Today I was pondering the relationship between the US dollar and gold. My study led me to produce some graphs which are extremely enlightening which I will share with you. In order to set the stage I want to reference an exchange between Ron Paul and Alan Greenspan before Congress, July 20, 2005. I have reproduced the entire exchange because I think it is critical in understanding the discussion that will follow.

QUOTE

Before the House Financial Affairs Committee, July 20, 2005

RON PAUL: If, indeed, this is your last appearance before our committee, Mr. Greenspan, I would have to say that, in the future, I’m sure I’ll find these hearings a lot less interesting.

But I do have a couple of parting questions for you. Keynes, when he wrote his general theory, made the point that he has tremendous faith in central bank credit creation because it would stimulate productivity.

But along with this, he also recognized that it would push prices and labor costs up. But he saw this as a convenience, not a disadvantage, because he realized that, in the corrective phase of the economic business cycle, that wages had to go down – which people wouldn’t accept, a nominal decrease in wages, but if they were decreased in real terms, it would serve the economic benefit.

Likewise, I think this same principle can be applied to our debt. To me, this system that we have today is a convenient way to default on our debt – to liquidate our debt after the inflationary scheme.

Even you, in the 1960s, described the paper system as a scheme for the confiscation of wealth.

And, in many ways, I think this is exactly what has happened. We have learned to adapt to deficit financing. But in many ways, the total debt is not that bad because it goes down in real terms.

As bad as it is, in real terms, it’s not nearly as high.

But, since we went on a total paper standard in 1971, we have increased our money supply essentially 12-fold. Debt in this country, federal debt, has gone up 19-fold – but that is in nominal dollars, not in real dollars.

So my question is this: Is it not true that the paper system that we work with today is actually a scheme to default on our debt? And is it not true that, for this reason, that’s a good argument for people not – eventually, at some day – wanting to buy Treasury bills because they will be paid back with cheaper dollars?

And, indeed, in our lifetime, we certainly experienced this in the late 1970s – that interest rates had to go up pretty high and that this paper system serves the interests of big government and deficit financing because it’s a sneaky way of paying for it.

At the same time, it hurts the people who are retired and put their money in savings.

And aligned with this question, I would like to ask something to dealing exactly with gold, is that: If paper money – today it seems to be working rather well – but if the paper system doesn’t work, when will the time come? What will the signs be that we should reconsider gold?

Even in 1981, when you came before the Gold Commission, people were frightened about what was happening – and that’s not too many years ago. And you testified that it might not be a bad idea to back our government bonds with gold in order to bring down interest rates.

So what are the conditions that might exist for the central bankers of the world to reconsider gold?

We do know that they haven’t given up on gold. They haven’t gotten rid of their gold. They’re holding it there for some reason.

So what’s the purpose of the gold if it isn’t with the idea that some day they might need it? They don’t hold lead or pork bellies. They hold gold.

So what are the conditions that you might anticipate when the world may reconsider gold?

MR. GREENSPAN: Well, you say central banks own gold – or monetary authorities own gold. The United States is a large gold holder. And you have to ask yourself: Why do we hold gold?

And the answer is essentially, implicitly, the one that you’ve raised – namely that, over the generations, when fiat monies arose and, indeed, created the type of problems – which I think you correctly identify – of the 1970s, although the implication that it was some scheme or conspiracy gives it a much more conscious focus than actually, as I recall, it was occurring. It was more inadvertence that created the basic problems.

But as I’ve testified here before to a similar question, central bankers began to realize in the late 1970s how deleterious a factor the inflation was.

And, indeed, since the late ’70s, central bankers generally have behaved as though we were on the gold standard.

And, indeed, the extent of liquidity contraction that has occurred as a consequence of the various different efforts on the part of monetary authorities is a clear indication that we recognize that excessive creation of liquidity creates inflation which, in turn, undermines economic growth.

So that the question is: Would there be any advantage, at this particular stage, in going back to the gold standard?

And the answer is: I don’t think so, because we’re acting as though we were there.

Would it have been a question at least open in 1981, as you put it? And the answer is yes.

Remember, the gold price was $800 an ounce. We were dealing with extraordinary imbalances, interest rates were up sharply, the system looked to be highly unstable – and we needed to do something.

Now, we did something. The United States – Paul Volcker, as you may recall, in 1979 came into office and put a very severe clamp on the expansion of credit, and that led to a long sequence of events here, which we are benefiting from up to this date.

So I think central banking, I believe, has learned the dangers of fiat money, and I think, as a consequence of that, we’ve behaved as though there are, indeed, real reserves underneath the system.

END

(I would like to acknowledge www.lewrockwell.com/paul/paul267.html as the source of this transcript)

In order to test Greenspan’s hypothesis that the Fed has been acting as if it were on a pseudo-gold standard I took the daily price of gold and the USDX from January 2001 (roughly when the current gold bull started) up to his appearance before Congress on July 20, 2005. I then cross-plotted the USDX against the POG.

The result is quite astonishing. It shows an almost perfect linear relationship between the USDX and the price of gold. This is the manifestation of the “Strong Dollar Policy”; the manipulation of the price of gold to maintain the relative value of the dollar. If the dollar were to fall the central banks mobilized some of their gold which they leased out to be sold. The dollar increased in relative value as the gold price fell in accordance with this linear relationship. Presumably, if the USDX were to rise too much then gold could be purchased or more dollars issued. Greenspan denied in writing that the FED was trading gold. That may have been true in the most generous interpretation, but clearly someone was acting on their behalf for such a perfect relationship to have been forged between the USDX and the POG.

What a wonderful system! The Fed was able to regulate the value of the dollar without having the imposition of the strict discipline of a real gold standard. In addition by loaning out their gold they were able to regulate the dollar value AND still, in theory, maintain ownership of their gold. Wait a minute! That’s sounds very much like the “perpetual motion machine” that eluded the most intelligent scientists in all of human history. There must be a flaw. Yes, there is a flaw and it is revealed in my second graph.

In my second graph I have included all the data up to the present day. This graph shows that the relationship is broken. The USDX no longer moves in lock step with the gold price. The relationship broke down when gold was around $450/oz which was early September 2005. That coincides with the GATA Gold Rush 21 Conference in August of 2005.

The graph shows quite clearly that the Central Banks have LOST CONTROL of the gold market. The pseudo-gold standard of which Greenspan was so proud has failed. In my opinion, that is simply because they have run out of enough physical gold to continue the scheme. The latest attack on gold is an attempt to slow the ascent of gold, but that is all they can hope to achieve: slowing the ascent. It can not be stopped. They must have had to scrape together odd ingots and coin melt and gold dust to stage their latest assault!

In recognition of their inability to suppress the gold price, the Central Banks have switched into a different mode. The Central banks are now colluding to make their currencies have stable cross-rates while they all lose purchasing power with respect to gold at the same rate. This gives an impression of a semblance of stability. The USDX is an index of the USD against a basket of other currencies. The Central Banks are doing a good job of maintaining the USDX stable at around 85, but gold is revealing its true colors as real money. Who wants to be in a boat that is sinking at the same rate as everyone else’s boat when you can be on dry land?

The rhetoric of politicians, and echoed parrot fashion by the Press, is that gold is going higher due to geo-political concerns. It is not because of the obscenely promiscuous production of fiat dollars at a torrid rate that might even have made John Law blush! The fact that M3 numbers are no longer published it is likely that some Fed Governors are blushing too!

In closing I would like to examine in detail part of Greenspan’s statement. In replying to Ron Paul about owning gold he said:

QUOTE

Well, you say central banks own gold – or monetary authorities own gold. The United States is a large gold holder. And you have to ask yourself: Why do we hold gold?

END

The question from Ron Paul was about “owning gold” and Greenspan duly notes that in his response but then says “United States is a large gold holder”. This would suggest that the US doesn’t own any gold any more it only “holds” gold. It also fits with stories about Fort Knox being empty and the guard being reduced to a skeleton presence. It fits with a re-classification of the gold in WestPoint as “custodial gold”. One could argue that I am being pedantic, but given the mastery of Greenspan to choose every single word that he spoke with utmost precision, I believe it is very significant that in the same sentence he deliberately switched from “own” to “hold”. This would also explain why the Bank of England was required to come to the rescue of the US Dollar and the commodity traders this month. It also explains why the IMF debt relief plan was heavily pushed. In my opinion the Central Banks who are involved in the Cartel to support the dollar and fiat currency regimes have almost run out of physical gold. Gold has severed its relationship to the USDX. Real money is back! The Cartel knows it. This is why they are bringing in the Head of the Knights’ Templar into the Treasury to try to protect the secrets of the inner sanctum…

Central bankers are no longer able to behave as if they are on a gold standard, because they do not have enough gold to do so.

Adrian Douglas

June 2006