Strange rumblings in Dollarstan


And now, we hear, JP Morgan is being investigated for evil deeds in the precious-metals markets—more or less confirming, or at least rendering plausible, the longstanding charges of GATA, Ted Butler, etc. Frankly, this doesn’t surprise me. But the converse would not have surprised me, either. These markets are extremely opaque.

When I first hypothesized the spontaneous remonetization of gold, way back in 2006, I remember clearly how wacky an idea it was. While not exactly conventional, these days it is not at all hard to find, not even in the official press. (I have no joke—I just like saying “the safest of all investments, gold.” I have been telling my mother this for quite some time, but I am still surprised to see it in the Times.) And the basic idea of remonetization was not at all unusual in those days, at least in the goldbug media. Completely unfiltered, this stream contains all good ideas about gold, and all bad ones too.


There is no Goldenstein today, but that doesn’t mean people can’t use gold as money—i.e., buy it now for the purpose of selling it later. (If there was a Goldenstein, and capital flight to gold meant capital flight to Goldenstein, all Goldenstein’s industries would disappear and its citizens would just be rich for a living, like Kuwaitis. But fortunately, there is no Goldenstein.)


But while this effect—perhaps best simply described as capital flight to gold, or CFG—now appears to be occurring to some extent, it is occurring much less than my evil theory would predict! And it has not yet devoured the entire financial universe. Although that’s certainly one of the things that could happen on Monday. But all this talk of gotterdammerungs does leave one a bit blase—does it not, Maurice?


Therefore, there was some unknown variable in my evil equations. Ha ha! I would have to try again. Egg again, on Dr. Lizardo’s face. But surely, any day now, the universe will end! (And it will come, to Dr. Lizardo it will come, and ask him to rule. Laugh while you can, monkey-boy.)


Since the price of all goods is set by supply and demand, the price of any good can be managed down by the creation of arbitrary supply. Who would buy artificial gold? Simple—someone who wanted to make a dollar when the price of gold went up a dollar. Who would sell it? Simple—anyone willing to lose a dollar when the price of gold went up a dollar.

In other words: to a gold investor, i.e., someone betting on the gold market, artificial gold is just as good as regular gold. Actually, this is not quite true. But at a crude level, it is true. And to all conventional financial analyses, it is true. Thus, you can expect there to be a fair amount of artificial gold (“paper gold”) around.

Even (perhaps especially) among the goldbugs, there is a considerable confusion between two kinds of artificial gold. Let’s call them virtual gold and synthetic gold. Moreover, the (now highly suspect) London gold market itself does not distinguish between these types of claim, considering both unallocated.

Virtual gold (VG) is artificial gold that’s backed, on the balance sheet of the issuer, by some kind of future gold receivable—e.g., a gold forward. This is typically maturity-transformed, a stupid and dangerous practice, but one that is conventional in both bullion and regular banking. So, for instance, Buns & Buns of London might have written a promise to deliver gold in 3 months, backed by a Barrick promise to deliver gold in 36 months.

Again, if this seems dangerous, that’s because it is dangerous. In a gold maturity crisis, as all holders of artificial gold demand allocated gold, gold interest rates spike—gold now is much more desirable than gold later.

But gold interest rates are tied by arbitrage to dollar interest rates. So what happens when this irresistible force meets that immovable object? Come on. In nature, what happens when an irresistible force meets an immovable object? What happens is a giant sucking financial death-vortex singularity, that’s what. Don’t ask these kind of things if you don’t want the answer.

And even if it wasn’t, that’s probably still what I’d predict! But that’s virtual gold—artificial gold backed by future gold production. Dangerous—but not lethal. At least, not especially lethal.




(The same is true of “clearinghouses.” The modern term “clearinghouse” is actually derived from the Old German klarenhaus, a bit of Hamburg wharf argot meaning “too big to fail.”)

Suppose you buy a CDS that pays you 1 euro if Greece defaults. Greece defaults. What do you have? A euro? No—a piece of paper, saying someone is supposed to pay you a euro. Who wrote this piece of paper? Who does it obligate? Do they even still exist? You didn’t used to have to worry about this stuff. You didn’t used to have to worry about Greece! Idiot. Or at least: if you mark this piece of paper at 1 euro on your balance sheet, you’re fooling either yourself or someone else. Its expected value may not be much less than 1 euro; it is certainly less.

The government, of course, could pay off on private credit-default swaps. Typically this is the implicit solution—better mathematical finance, through fiat currency! And it has been done before. But not so much again, I think. What saved the world, or purportedly saved the world, in 2008 was a lot of one-off tricks—emergency authorities that could not possibly become routine. This time, things will have to get worse. The old emergency powers are dissipating rapidly, as emergency powers do.



The real problem with synthetic gold is: gold is not wheat. Demand for gold is monetary demand, i.e., reservation demand. It is not consumption demand, as in wheat. Therefore, the creation of synthetic wheat by wheat traders should not have a substantial and predictable effect on wheat prices. This is not the case for gold.




