August 12, 2000. Guest Editorial: Letter to Central Bankers from Murray Pollitt

[Note: Murray H. Pollitt, P. Eng., is a Canadian broker and mining engineer long active in both the investment and operational sides of the gold mining industry. Recently he penned an open letter to the world's central bankers. So that the letter might be shared with a wider audience, Mr. Pollitt has given The Golden Sextant permission to publish it.]

The following is a message I would love to see conveyed to Central Bankers. Whether they like gold or don't like gold doesn't matter. Whether they care or don't care about the mining industry doesn't matter. Nor should it matter whether gold is still money, or just a commodity, or both. Nor should it matter whether bond traders, economists, bankers, policy makers and news services constantly quote the gold price. Chacun à son goût.

What does matter is that Central Bankers do not want a repeat of the 1970's and the runaway gold prices that characterized that decade. Whether they have a lot of gold, or no gold at all, Central Bankers do not want to see gold double or triple; it would convey a disconcerting message and it would have scary implications for any commercial banks which might be short the gold market.

Yet as a direct consequence of their activity in the gold market, some Central Banks have set the stage for another gold price explosion. For the past decade they have been selling and/or lending 20 million (or more) ounces a year. [All gold lent to commercial banks is then sold.] Enough to satisfy the gap between consumption and production, and enough to keep the gold price in a deflationary trajectory. This quantity of gold, when related to annual mine production of 80 million ounces, represents a 25% imbalance in the supply/demand equilibrium, a staggering number, and its impact has been visible and painful. But, importantly, the market has absorbed every last ounce.

The terrible gold price has crippled the gold mining industry. First, exploration activity has dried up, and now mine production is, finally, falling. One can only high-grade most mines for so long. Gold mines are currently chewing through 80 million ounces of reserves every year and, in our view, there is no way they are replacing even a quarter of this amount. The only way big companies get bigger is by way of acquisition. Real growth, such as Anglo American's project on Western Ultra Deep Levels, appears to be on hold, and Placer Dome's Las Christinas project (which represented a quarter of that company's reserves two years ago) has been written off. There are many other examples, and at the recent Financial Times Gold Conference, industry spokesmen made reference to the need to significantly revise (i.e. lower) ore reserves should the gold price remain mired at current levels.

In gold mining the leads and lags between cause and effect are lengthy, say five to ten years. In the decade of the 1970's global gold production actually fell 20% even while the gold price multiplied fifteen fold, a direct result of the debilitating economic conditions the industry experienced during the final years of the Gold Pool and the $35 era. And in the past two decades gold production more than doubled, a direct result of the price rise in the 1970's.

Once again, however, we are at a turning point and the debilitating conditions (costs, prices, margins if any) evident at the end of the $35 era have returned. The gold mining industry is sick and production in year 2000 will be down for the first time in many years. It won't be the last. Regardless of the price, annual production now appears destined to decline inexorably; it wouldn't surprise us to see it down by 10 million ounces (that's 12%) five years hence. Even more ominously, industry reserves are falling because of 1) the near cessation of exploration and 2) the reclassification (declassification?) of reserves brought on by the poor prices. Even with a sharp, sustained increase in the gold price, it would probably require at least five years to rekindle exploration and to begin to reverse the downtrend now under way. And without a sharp, sustained price increase, the gold mining industry will become progressively paralyzed.

Given this scenario, and given that there is a significant gap (20 million or more ounces annually) between mine production and physical consumption of gold, and given that this gap has been satisfied for more than a decade by ever increasing supplies from Central Banks (even while mine production was rising), what will happen as consumption continues to climb and production falls? Will the gap be 30 million ounces a year? Will it grow to 40 million? 50 million? Where will it be five years hence? Could the gap reach 60 million ounces? And where will the gold come from to meet the demand created by winding down mine hedge positions?

For how long will Central Bankers be willing, or able, to keep filling this gap? How much more can they, should they, provide? Contrary to popular propaganda, their reserves are not infinite; of total "official" reserves of a billion ounces, probably 200 million ounces have already been lent and at least 400 million ounces are supposed to be frozen. Gold may or may not still be money, but if one takes all the gold in all the Central Banks in all the world and multiplies by $280, the total is less than one year's US trade deficit. Western Central Banks are not going down to zero gold. Ideologically some Central Banks want to keep a lid on the gold price, and others are anxious to help some commercial banks "defend" their short positions, but inevitably the day will come when they will be unable to stop the market. Then what?

The amazing thing is that Central Bankers have an interest in monetary stability that should transcend their support for speculators. An out-of-control gold price is presumably not part of the agenda, yet to go on anchoring it at levels that ensure the destruction of much of the gold mining industry guarantees crazy prices later; the lessons of the Gold Pool era ought to be clear enough. If gold has to be anchored, let it be at a price that permits the industry to survive, since the only real long-term defense against runaway gold prices is a healthy, expanding mining industry. There is nothing secret about the numbers cited above; with the passage of time these realities will become an ever more open book. Surely the time has arrived for Central Bankers to review their gold lending policies while they still have some gold left. Even if they don't like the stuff now, they may need it later.

July 17, 2000. "Ici est tombé...." On Choosing to Fight

Dotting sides of buildings in Paris are many little plaques proclaiming: "Ici est tombé..." They mark spots where members of the resistance fell during the street fighting that preceded the liberation of Paris in August 1944. Close inspection of nearby wall areas often reveals bullet scars. Yet many French display a certain ambivalence toward these signs as much of this fighting was done by late arrivals to the resistance movement, which not surprisingly attracted a huge upsurge of support after the Allied landings in Normandy. Only a relative handful of French joined the fight early during the darkest days of occupation and Vichy, and they frequently met horrible fates outside of public view.

One of these, the historian Marc Bloch, is remembered by Eugen Weber in My France (Harvard, 1991), p. 244 ff. Bloch, a brilliant scholar born to privileged parents and married to a wealthy woman, fought for the full duration of World War I in the French infantry. Called up as a reservist in 1939, after the fall of France he became a full-time underground organizer and a leader of the Franc-Tireur group in Lyon, the resistance capital of France. Betrayed by a collaborator, he was arrested in March 1944 and tortured. In June, as the Germans prepared their withdrawal, he was put on a truck with 26 other prisoners and taken off to be shot. By some miracle, one young man in the group lived to tell the tale, including Bloch's effort to reassure him during the ride: "They're going to shoot us -- don't be afraid, it doesn't hurt. It will happen fast."

In an academic paper delivered in 1927 at a conference in Oslo, Bloch advocated the study of comparative history, noting: "Mais ces textes, il faut songer à aller les chercher." Weber, himself an academic aware of the practical requirements for conducting research, gives a translation and adds an important note (p. 247): "If documents are to be sought out, you not only have to think of going to look for them, you also have to have the means to do it [emphasis supplied]." Bloch did, and he traveled to the great libraries and universities of Europe to pursue his historical studies. Still, however fortunate his personal and professional circumstances, Bloch's life is testimony to strong feelings about right and wrong together with an equally strong sense of personal honor. He chose to fight on principle come what may rather than to await the first signs of victory.

His is an example with some relevance to present gold bugs. Of course, they do not face the same physical dangers. But their views rest very much on studies in comparative history, particularly of monetary systems in different places at different times. Their struggle in its broadest sense is for freedom, a worldwide economic freedom that is not possible without an international monetary system based on a permanent and shared standard of value. Gold bugs cannot be truly understood apart from the fundamental values to which they are committed: personal integrity and honest dealing. Today they are vastly outnumbered by public and private forces with far more resources and huge stakes in continuing the system of unlimited fiat money -- impermissible under the Constitution of the United States -- that they have erected largely for their own benefit.

Few give the gold bugs much chance for ultimate victory. Their ranks are thin as many of their natural allies, including gold mining companies and nations rich in gold resources, remain aloof from the fray. Worse still, governments in some gold mining nations, notably Canada and Australia, seem intent on replicating the dishonor of Vichy, not that this course has done much for their paper currencies. The Clinton administration pretends to concern about South Africa's many problems, but spares no effort in secret to undermine prices for gold, that nation's leading export. And everywhere central banks and international financial institutions, created to make the gold standard operate more effectively, work assiduously to prevent its return. These institutions, controlled by the major industrial nations, prefer for their own selfish reasons to impoverish developing countries rather than to allow their development under sound money regimes based on gold.

Tyranny spawns resistance, and the tyranny of the paper dollar is no exception. Organizations favoring some sort of return to sound money based on gold or silver exist all over the globe. Among these is GATA, a recent upstart that began as an effort to unmask price manipulation in the world gold market. Today it is a major internet hub through which gold bugs from all over the world communicate with each other to exchange lots of relevant ideas and information as well as market intelligence. What is more, GATA is a force for action, publicly warning of the dangers lurking in a gold market manipulated by huge volumes of paper gold derivatives, and pressing Congress, central banks and other public officials to take effective action against these abuses before they erupt in a financial Armageddon.

GATA is the brainchild of Bill Murphy and Chris Powell. Chris, a newspaper editor in Connecticut, writes a popular political column syndicated statewide. Bill is Le Patron and Midas at Le Metropole Cafe ( He started at wide receiver for the Boston Patriots in 1968. Now, as in his playing days, standing just over six feet and weighing under 190 pounds, Bill looks like a soccer player, but we are talking American football here. Bill is used to playing against much larger opponents, guys like Ernie Ladd (6'9", 290) and Hall of Fame players Buck Buchanan (6'7", 270), Bobby Bell (6'4", 228) and Willie Lanier (6'1", 245). Playing in Bill's same position a few years later against the Oakland Raiders, Darryl Stingley was paralyzed for life with a neck injury on a perfectly legal tackle by Jack Tatum, a/k/a "The Assassin."

Not long ago in his hometown of Dallas, someone stole Bill's car and a few days later thugs attacked him on the street. Some evidence suggests that these were efforts at intimidation. If so, the perpetrators misjudged their target, who with jaw bruised if not broken quickly rose from the pavement to return to his work for GATA. Lui, il est tombé, mais il s'est levé aussi. GATA's May 10 meeting with the Speaker of the House of Representives and other officials in Washington, its subsequent publication and distribution of the Gold Derivative Banking Crisis, and its June mission to the FT World Gold Conference in Paris all followed. I was privileged to participate in all these endeavors.

What's next on GATA's agenda? This decision is for Bill Murphy and Chris Powell to make, subject to the contraints imposed by GATA's limited resources. One idea on the table is to engage me as a consultant, again depending on available funds. The proposed compensation, covering out-of-pocket expenses plus a modest stipend for time and effort, would give me more time and resources to pursue gold-related subjects of mutual interest. What is more, it would make The Golden Sextant mildly profitable, enhancing its content and extending its life as a free service unencumbered by advertising, cookies or other revenue raising gimmicks.

Once derided as a two-man army, GATA now counts many successful business and professional people among its growing band of supporters. More than a few hold (or held prior to retirement) important positions in finance or mining. Working to expose gold market manipulation, GATA is fighting for a true free market in gold. The original focus has broadened with its growth to include other investment issues relating to gold as well. Nor does GATA ignore gold's monetary role, for it recognizes that most gold bugs are interested not just in making money from gold, but also in making gold money for the benefit of all, as the framers of the Constitution intended.

There is a sequel to stories like Marc Bloch's. He and others like him kept the flame of the French republic burning, later to be fanned by those who joined the resistance movement as the tide of the war turned. Thus when General de Gaulle made his triumphal address at the Hôtel de Ville in Paris on August 25, 1944, he could claim that the French people had freed themselves, starting the myth upon which a unified France escaped Allied military occupation and rebuilt herself after the war. The Vichy regime became an aberration, null and void, never recognized as a legal government of France.

Working to restore gold to its rightful place both at the center of the international payments system and in the American constitutional order, gold bugs are soldiers for economic freedom, which in the end is an essential component of political freedom too. They keep alive concepts, ideas and values that have fallen out of fashion, that are no longer taught in schools and colleges, but that nevertheless embody the wisdom of the ages. Without the gold bugs, the collapse of today's worldwide system of unlimited fiat money is likely to lead to dark times indeed. With them, if they do their job well now, the collapse can instead be turned into a springboard from which to restore principles of sound money and public integrity long absent from the world and national stages.

Whether to contribute to GATA is something people must decide for themselves. My possible economic interest in the matter is declared. All I ask is that those who enjoy my commentaries think about making a contribution to this organization which has already done so much for gold and gold bugs. General Patton liked to suggest that wars are best fought not by dying for your cause, but by making the other guy die for his. Assisting GATA is the best way that I know to try to put an "Ici est tombé l'ESF" on the side of the U.S. Treasury Building in Washington, D.C., or to achieve the ultimate victory of justice over greed, an "Ici est tombé Goldman Sachs" at 85 Broad Street, New York, N.Y.

July 11, 2000. "Ah! tenez, vous êtes de la merde dans un bas de soie."

With this much quoted insult Napoleon concluded his famous tirade against Talleyrand in 1809, an outburst of anger that most expected would end with the grand chamberlain hanging from a gate of the Tuileries. Instead, he was merely dismissed. Talleyrand himself would later suggest that Napoleon's clemency signified weakness, "le commencement de la fin," an end that Talleyrand in his enforced leisure secretly worked to hasten.

More than once at the FT World Gold Conference in Paris, I found myself thinking how well Napoleon's coarse description of Talleyrand fit certain bullion bankers, and wondering whether they would prove as adept as the great French diplomat at retaining money and power through changing governments and international alliances.

The new "consensus" figure on the net short physical gold position seems to be about 5000 tonnes, although where this figure comes from or how it is derived is far from clear. No matter, it is a figure that everyone can live with, giving the longs hope but not scaring too much the shorts. However, no one knows what the actual figure is, and most seem to prefer this state of uncertainty, along with an absence of discussion about the possibility that gold prices are being manipulated by a cabal of bullion bankers acting in league with certain government officials. The bear case for gold of a year ago has been replaced by predictions of stable to modestly rising prices, just the right climate for the shorts slowly to wind down their positions. Under the surface, the great fear in the bullion bank camp is another upward spike like that witnessed last fall in the wake of the Washington Agreement. Much anecdotal evidence continues to support the hypothesis of severe tightness in the physical market.

Summed up briefly, my principal impressions from the conference were: (1) the ECB and its 11 member central banks do not have a common policy on gold, which remains almost entirely subject to national control by the individual member states; (2) while a few central banks are making noises about a greater monetary role for gold in the future, there is as yet little real movement in this direction, either with respect to gold support for the euro or as regards the monetary use of gold by less developed countries; (3) the gold policy of Germany and the Bundesbank is a mystery with potentially explosive ramifications; (4) no one wants to talk publicly about the recent increases in the notional amounts of gold derivatives on the books of the bullion banks, but at least some bullion bankers evince concern that these numbers, despite acknowledged difficulties of interpretation, may indicate rising systemic risk; (5) some large gold mining companies are beginning to show more sensitivity to investors' concerns, including the dangers of hedging, the often misleading use of "cash cost" figures, and the importance of the "option value" of their shares on rising gold prices, thereby creating a widening chasm between companies that do not hedge (or hedge only minimally) and those that do; and (6) outside of investors, but especially among bullion bankers, there is great reluctance to credit or even to discuss seriously the mounting circumstantial evidence of an international conspiracy to control gold prices.

No Common Gold Policy in the Euro Area. Perhaps the most striking fact to emerge on the first day of the conference was the lack not only of a common gold policy within the Euro Area but also of any officially reported information on gold lending or gold derivatives activities by EA central banks. Speakers from the Banque de France and the Oesterreichische Nationalbank ("OeNB" or Austrian National Bank), both of which are EA member banks, described the gold policies of their banks without once mentioning any constraint imposed by EA membership or the ECB other than the Washington Agreement. While both hailed the agreement as an example of cooperation among European central banks, the substance of their remarks made clear that it was in large part necessary precisely because the EA central banks do not have a coordinated gold policy administered by the ECB.

For the French, Hervé Ferhani suggested: (1) gold lending is risky because gold lent out is not the same thing as gold in the vault; (2) the return on gold lending is low; (3) gold lending tends to push gold prices lower, adversely affecting the balance sheets of central banks that regularly mark their gold reserves to market, which the ECB and all EA central banks do; (4) central banks with large gold holdings tend to lose more due to revaluations at lower gold prices than they gain from returns on gold lending; and (5) in light of these considerations, the Banque de France, which has gold reserves in excess of 3000 tonnes, does little or no gold lending.

Mr. Ferhani also noted the possibility that if major reserve currency governments continue to reduce debt, a shortage of "risk-free" assets might cause central banks to add more gold to their portfolios to offset rising credit risk in other assets. Although he did not say so, it is also possible that if these governments revert to their former ways, their additional debt might not be viewed as still so risk-free and more gold in central bank portfolios in that case would make sense as well.

Dr. Peter Zoellner for the Austrians gave quite a different view, emphasizing: (1) the lesser role of gold as a safe haven in light of the central banks' success in controlling inflation; and (2) the ability of central banks through gold lending and other gold derivatives activities to earn a modest return on an otherwise sterile asset. Austria has reduced its gold reserves from over 650 tonnes in 1988 to under 400 tonnes today, with a target of 320 tonnes in 2004. Much of this reduction represents sales to the Austrian Mint for its popular "Philharmonic" gold bullion coins.

During the question period, Mr. Ferhani tried to explain the difference in the French and Austrian positions on gold lending with reference to the difference in the size of their respective gold reserves. But admitting that the right gold policy for a nation with 3000 tonnes might not be the same as that for a nation with only 400 tonnes, no effort was made to explain why two countries which are members of a common currency area having combined total gold reserves of over 12,000 tonnes should not follow a common gold policy based on their combined reserves.

In conversation after his talk, Dr. Zoellner told me that the OeNB limited its gold lending and derivatives activities to not more than 5% of any particular market or market segment. I asked if that meant, assuming total gold loans were 5000 tonnes, the OeNB would be prepared to lend up to 250 tonnes. He answered in the affirmative, and when I expressed surprise at the idea of a central bank lending up to 62.5% of its total gold reserves, he reconfirmed his answer. In any event, the policy of the OeNB is not that of a central bank which expects gold to return to the center of the international payments system at much higher prices anytime soon.

After that same session of the conference, I had two other revealing conversations. In one, a representative from the Banca d'Italia told me that Italy takes very much the same position as France with respect to gold lending, and then added that the Bundesbank holds a similar view. Since there are well-founded reports that the Bundesbank may have loaned out as much as 10% of its gold reserves, I pressed him on this point, but he insisted that his contacts at the Bundesbank report that Germany does little or no gold lending.

In the other conversation, a representative from the ECB confirmed that it does not publish any figures on gold lending or other gold derivatives activities by EA central banks. He also confirmed that unlike Swiss National Bank, none of the EA central banks issues an annual (or other) report detailing its gold lending. Indeed, it appears that the ECB itself does not have these figures, which continue to be guarded at the national level much as they were before the euro was launched. Accordingly, it appears that there is absolutely no way to police the Washington Agreement, particularly as it relates to the signatories' commitment not to increase gold lending or gold derivatives from the levels that existed on the date of the agreement.

The German Mystery. The gold policy of the Bundesbank is rapidly emerging as a major issue with potentially huge ramifications.

Many believe that if the Bundesbank is in the gold market, the bulk of its business is being channeled through Deutsche Bank, Germany's biggest bank. In an earlier commentary, I detailed the extraordinary increases in the notional amounts of Deutsche Bank's gold derivatives during the last half of 1999, all as shown in its most recent annual report. At the conference I learned from a reliable source that its former chief gold trader left the bank a couple of years ago, apparently forced out in a dispute over new and more aggressive trading strategies.

At the conference, Jonathan Spall, Head of Central Bank Marketing at Deutsche Bank, gave -- as did others -- a current estimate of 5000 tonnes of central bank lending, attributing 1700 tonnes to the European signatories to the Washington Agreement and noting that both the Bundesbank and the Swiss National Bank had confirmed lending "a small proportion of their gold." In the Swiss case, officially reported figures show leased gold at the end of 1999 amounting to almost 320 tonnes, or over 12% of total reserves. If the Germans lend in the same proportion, total gold lending by the Bundesbank would amount to around 420 tonnes of its nearly 3500 tonnes of reserves.

However, excluding the gold reserves of France and Italy since these countries do little or no gold lending, and even without adjustments for recent gold sales, total gold reserves available for lending by the signatories to the Washington Agreement are less than 10,400 tonnes, which multiplied by 12% yields about 1250 tonnes of gold lending. Thus to arrive at a figure of 1700 tonnes of total gold lending by this group, both more aggressive lending by some of the smaller central banks and German lending at least equal to Switzerland's as a percentage of reserves appears required. In other words, if Mr. Spall is close to correct, the Italian view of the Bundesbank's gold lending activity is almost certainly mistaken.

Other interesting figures in Mr. Spall's talk: (1) his estimate that "realistically the available balance for expansion" of central bank gold lending worldwide is not more than 1000 to 1500 tonnes; (2) of the some 70 central banks that are involved in the gold market, the great majority lend gold via deposits of maturities under one year; and (3) only 10 to 15 central banks trade in options and perhaps no more than 5 or 6 engage in lease rate swaps. Although there have been rumors that the Bundesbank is among the central banks writing call options, Mr. Spall unfortunately provided no information on this point.

The day before announcement of the British gold sales, GATA's Bill Murphy reported online that Deutsche Bank had notified its clients that "the gold market is stopping at $290." Deutsche Bank was notable but not alone in reporting exploding notional amounts of gold derivatives in the last half of 1999. The same phenomenon occurred at Morgan Guaranty Trust and Citibank, but not at UBS, the market leader, or Credit Suisse. Indeed, at the big Swiss banks during this time period, the total notional amounts of gold derivatives were flat to down. What is more, Morgan by all accounts is the bank that sold Barrick its calls, a strange transaction smelling of manipulation.

Deutsche Bank, which acquired Banker's Trust in mid-1999, clearly aspires to be a major force in the dollar area as well as in the EA, where it now faces greater competition from large banks outside Germany. The transition to the euro has deprived the big German commercial banks of the home currency advantage they enjoyed when the mark was the dominant currency of Europe. Financings in euros can as easily be done by French, Italian and other EA banks as by German banks.

An even bigger loser to the euro is the Bundesbank, which has yielded its former position as the pre-eminent financial institution in Europe to the ECB. There are many who think that former French President Mitterand and the Italians outsmarted Helmut Kohl in negotiating the Maastricht Treaty. In any event, the French and Italians who used to have to follow the Bundesbank's lead on monetary policy and interest rates now have some significant input through the ECB, while the Bundesbank is reduced to just another EA central bank, albeit one with memories of glory and a surfeit of formerly important officials.

Under these circumstances, it is not inconceivable that the German bankers might cooperate at some level with an Anglo-American scheme to control gold prices. For the Americans, the goal would be to protect and extend the international dominance of the dollar, rebuffing any challenge from gold or a gold-backed euro. For the British, the purpose would more likely focus on undermining the euro. Its success will almost guarantee the demise of the pound as a major international currency, forcing the British to choose between the euro or the dollar. It is a choice that the British do not want to make and upon which they cannot agree. If the euro fails, the British can muddle on with their own currency and monetary policy.

For the Germans, if the euro fails, there is hope for the restoration of their beloved deutschemark, and the privileges, advantages, power and prestige that go with managing Europe's leading currency. All these considerations hint at possible hidden motives for the Anglo-American push for military action in Kosovo during the euro's first year, as well as Germany's willingness to support that action by sending its forces to fight on foreign European soil for the first time since World War II.

Notional Amounts of Gold Derivatives. Since these numbers first surfaced publicly, there has been surprisingly little public discussion or even acknowledgement of them. The bullion banks with the largest increases have refused to discuss or explain them. Others have sought to play down the significance of notional values. At the conference, in response to a question from GATA's Bill Murphy, Kevin Crisp, formerly at Morgan and now at Credit Suisse, refused to discuss the increases in Morgan's gold derivatives on the ground that he was no longer there, and asserted wrongly that his new employer did not have to report similar figures, a mistake that was caught by his competitors at UBS. Another speaker mistakenly tried to compare notional amounts of gold derivatives to turnover figures for the LBMA.

However, several bullion bankers approached Bill Murphy and me specifically to discuss the figures on gold derivatives. Although they made some good points particularly about the difficulties of interpreting notional amounts, none could explain why certain large bullion banks had huge increases in the notional amounts of their gold derivatives during the last half of 1999 while others experienced no growth or even slight declines. A couple of the bankers also confessed to having difficulties reconciling total gold borrowing with total gold deposits, i.e., their inside observations suggest a lot more borrowing by the bullion banks than there are readily identifiable gold deposits by central banks (and others) to support.

Within a single large bullion bank, there are often multiple trading operations frequently located in different countries. A couple of bankers said that even they did not know their own bank's total gold deposits. Since the conference, another analyst has told me that this problem is further complicated by the fact that bullion banks not only accept gold deposits from central banks but also borrow gold from them. The deposits typically fund trading operations, but the gold loans are more often part of the bank's general funding under the supervision of its treasury department. In any event, it appears that some bullion bankers are beginning to reach the same conclusion as Frank Veneroso, GATA and others: there is a large, undisclosed source of physical gold entering the market.

Synthesizing the bullion bankers' comments on gold derivatives, several points merit mention. Both the sharp price collapse that followed the British announcement of gold sales and the even sharper rally triggered by the Washington Agreement naturally stirred up a lot of hedging and derivatives activity. Basically, the third quarter was characterized by heavy demand from miners and others to put on new short positions, and the fourth quarter brought equally heavy demand to cover these short positions or go long. Had the fourth quarter demand been satisfied mostly in the physical market, notional amounts logically would have come down from end of third quarter levels. However if this demand were met mostly by derivatives, and particularly by derivatives of different types which are not as susceptible to netting, they would likely be cumulative and add to the third quarter notional amounts.

For example, suppose a mining company entered into forward sales contracts with bullion banks in the third quarter for delivery of a million ounces two years out. In the fourth quarter, it covered part of this position. If it did so by buying back some of its forward contracts or buying offsetting forward contracts, the bullion banks would show lower notional amounts. If it covered by purchasing physical bullion, the notional amounts reported by the bullion banks would not rise but probably would not fall either. But if it covered by purchasing calls, both the forward contracts and the offsetting calls would be reported in the bullion banks' notional totals at the end of the fourth quarter. Being different types of instruments, they likely would not qualify for netting, particularly if the precise terms of the calls did not exactly match the forward contracts.

This example is hardly farfetched. Recent information suggests that Barrick's calls are European style, cash settlement only, with maturity dates of December 31, 2000, and December 31, 2001. Most of Barrick's forward contracts are spot-deferreds. Thus the obligation to deliver physical gold at a specified date (or another date further out) is being covered by a cash obligation that comes due on one of two specified dates at the prices prevailing on those dates, which almost certainly do not coincide with the delivery dates of more than a few, if any, of the forward contracts. Clearly these different sets of obligations are not appropriate for netting.

However, while this example shows how notional amounts could grow even as the size of a short position is reduced, it also points at two other risks: (1) a real or threatened shortage of physical gold; and (2) ever longer daisy chains of derivatives with increasingly complex links. Indeed, as previously discussed in my commentary on Barrick's calls, this kind of transaction seems almost purposely designed to avoid triggering a sharp covering rally in a market short of physical gold, but of course it does nothing to deal with the underlying problems of too little supply and too low prices.

Changes in Hedging Strategies. Another important point about the increases in notional amounts of gold derivatives reported by bullion banks relates to changes in hedging strategies by many mining companies, particularly in Australia where hedging has not fallen into as much disfavor as elsewhere. However, there are now many reports of Australian companies changing the mix of their hedging to reduce the role of forward contracts and increase that of purchased puts, still typically financed by written calls. Logically this practice should tend to inflate the notional amounts of gold derivatives reported by the bullion banks while leaving replacement values more or less flat, and thus is consistent with the most recent BIS statistics on the gold derivatives of the major bullion banks and dealers in the G-10 countries.

But again, this explanation also points to another area of increased risk. To bullion banks, forward contracts with mining companies represent a call on gold at favorable prices in a gold bull market. So do any purchased calls. But while written puts may provide gold to bullion banks in a bear market, in a bull market they merely permit the bank earn its premium without engaging in much delta hedging. Thus a significant move away from forward contracts toward options tends to reduce the amount of physical gold available to bullion banks at favorable prices in a bull market. Again, some examples may help.

Prior to the Washington Agreement, a mining company wanting to hedge a million ounces of future production might typically have sold forward 800,000 ounces and bought reasonably close to the money puts on 200,000 ounces, financed by writing calls further out of the money on 400,000 ounces. This activity would have resulted in a total notional amount of derivatives covering 1,400,000 ounces. In a big bull market, the company's maximum exposure would be to deliver 1,200,000 ounces to its bullion banks at below market prices.

Today a company wanting to hedge a million ounces might typically sell 200,000 ounces forward and buy puts on 800,000 ounces financed by written calls on an equal or lesser number of ounces. These transactions would create a total notional amount of derivatives covering up to 1,800,000 ounces. But the maximum delivery exposure to the company's bullion banks in a bull market would not exceed 1,000,000 ounces, and could be considerably less depending on the company's choice of strike prices and the premiums it could obtain for its written calls in the much more favorable climate for selling them since the Washington Agreement.

Alternatively, the company might reduce its hedge position to 800,000 ounces, with 200,000 ounces sold forward, and purchased puts on 600,000 ounces financed by written calls on another 600,000 ounces. The total notional amount of these derivatives would cover 1,400,000 ounces, the same as in the first example, but the company's maximum delivery exposure in a bull market would now be down to 800,000 ounces, or a one-third reduction from the 1,200,000 ounces in the first example.

Admittedly all these examples are a bit arbitrary, but the point is that the notional amounts of gold derivatives reported by the bullion banks can remain level or even increase while the maximum delivery exposures of mining companies to bullion banks in a strongly rising gold market actually decline.

More Evidence of Manipulation by the ESF. The June 2000 U.S. Treasury Bulletin ( contains the financial statements of the Exchange Stabilization Fund for the period ending December 31, 1999. It had a trading loss of $1.627 billion in the the last calendar quarter of 1999, or its first quarter of fiscal year 2000. This loss wiped out virtually its entire profit of $1.637 billion in fiscal 1999, of which $1.257 billion was earned in the last (July-September) fiscal quarter. An earlier commentary traces in detail a pattern over the past several years under the Clinton administration of ESF losses in quarters marked by strong gold prices and gains in quarters with weak gold prices.

This pattern could not be more unequivocal than in the last half of 1999, with large gains in the third calendar quarter during the price collapse caused by the May 7 announcement of British gold sales, and large losses in the last calendar quarter dominated by the sharp rally and complete reversal of sentiment brought about by the Washington Agreement of September 26. What is more, since the administration denies making any interventions in the currency markets during either quarter, and since there were no other crises appropriate for ESF intervention, nothing other than gold trading appears available to explain these odd results.

Another interesting aspect of the most recent ESF profit and loss statement is another mysterious entry for commission income of $39 million, the second time in the last three quarters that this new line item has appeared. The closest historical analogue in prior ESF statements to these "commissions" are "handling charges on gold" that appeared prior to 1978.

I didn't hear it, but Bill Murphy reports that James Riley of Goldman Sachs told a delegate to the Paris conference that Goldman would offer unlimited amounts of paper to keep buyers from pushing gold prices above $310 to $320. This remark does not make much sense unless Goldman Sachs, former Treasury Secretary Robert Rubin's old firm, has unlimited backing from some government entity. None is a more likely suspect than the secretive ESF, as to which Treasury Secretary Summers still has not responded to GATA's questions. Last I heard, he was reportedly "looking into" the matter.

"Talleyrand - Entre l'aigle et le lys." Under this title in Son et lumière, the series of summer evening spectacles in the Loire Valley, a cast dressed in period costumes at Valençay, Talleyrand's castle, celebrates his astonishing career. Because members of his family still live in the château, only a few rooms are open to the public, but there is an interesting automobile museum in the park. Talleyrand is buried at Valençay. He died in 1838 at his Paris townhouse on the rue de Rivoli. Today two plaques, one in English and the other in French, remind passers-by that his former home, now the Hôtel de Saint-Florentin, is where the Marshall Plan for Europe was signed into effect.

As Bishop of Autun under Louis XVI, Talleyrand anticipated the French Revolution. After moving to Paris, he helped draft the Declaration of the Rights of Man and became president of the National Assembly. Fleeing France for England and America during the worst excesses of the Revolution, he returned after the fall of Robespierre. Talleyrand both assisted in Napoleon's accession to power and managed his departure. At the Congress of Vienna in 1815, Talleyrand negotiated a favorable settlement for France under the restoration of Louis XVIII, whom he served as prime minister at the insistence of the European allies. With their departure from France, he was sacked, but later returned as advisor to Louis Philippe in the July Monarchy. Talleyrand ended his official career as ambassador to London in 1834 at the age of 80, having worked with equal success for France's advantage and his own through the most tumultuous half century in French history.

In 1800 as Napoleon's foreign minister, Talleyrand signed a commercial treaty with the U.S., and in the process forced the American minister, Robert Livingston, to pay a substantial bribe. In April 1803, Talleyrand arranged Napoleon's sale of Louisiana to the U.S. for $15 million. In his definitive and entertaining biography Talleyrand - ou le sphinix incompris (Flammarion, 1970), p. 397 (English translation, Talleryrand - The Art of Survival (Knopf, 1974), p. 281), Jean Orieux notes that France paid an unexplained 10% negotiating charge on the gross sales price, and hints that this "fee" may have facilitated Talleyrand's acquisition of Valençay the following month. Purchased at Napoleon's urging as a place to receive princes and foreign diplomats, Valençay, once under contract to John Law and among the last remaining great feudal estates of the Ancien Régime, fell by serendipity into Talleyrand's hands. Thus, as Orieux wryly observes (p. 298), "the shipwreck's most illustrious victim claimed the best of the wreckage."

A malicious rumor that Talleyrand counterfeited notes somewhere in the cellars at Valençay never gained traction. His preference for real money was too well-known. Acts of official thievery are one thing. Undermining the monetary system is quite another. With nothing but contempt for real money, today's manipulators of the gold price share Talleyrand's thirst for wealth and power, but they lack his ability to discern and effect the broadest national and international interests. His public legacy was relative stability merely tarnished by greed. Theirs will be chaos as the product of greed -- not the simple greed of individuals but that of great commercial nations seeking to capture much of the world's physical wealth by foisting their unlimited fiat currencies upon lesser states.

June 20, 2000. Paris: Un poilu pour l'or y va

Paris, the City of Light, where two centuries ago Napoleon assumed the reins of power amidst the appalling excesses of the worst paper money inflation that the world had yet known. Asked how he would meet the government's expenses, he announced: "I will pay cash or pay nothing." Within three months, he established the Banque de France on a sound gold footing. It celebrates its bicentennial this year.

Today Napoleon's remains, encased in six concentric coffins, lie under the sparkling gold dome of the church at Les Invalides. He is still honored by the French people in part because he remained true to his word, never resorting to irredeemable paper despite far more provocation to take this disastrous step than many who have. As a result, after Waterloo, France carried on with no great financial disruption.

On my last and only trip to Paris 36 years ago, I neither spoke any French nor stayed there long, making this current trip very much a voyage of discovery. Then, I was on my way for a year of study at the Bologna Center of the Johns Hopkins School of Advanced International Studies, where the two principal topics of debate were the growing U.S. military effort in Vietnam and the increasing strains on the Bretton Woods international monetary system. Both were difficult problems, and both would eventually be tackled by unconstitutional means.

Fortunately for me, my active military service was over and my reserve unit ignored when Vietnam finally spiraled out of control into full scale war without a formal declaration of war or its practical equivalent by the Congress. But if my situation and talents were unsuited for any useful action in connection with that problem, the same could not be said of the second.

I had studied international economics and worked in international finance during the decade prior to the closing of the gold window in August 1971. By that date, I had also finished law school and become a member of the Massachusetts bar. In all its essential particulars, the oath required to join any federal or state bar is the same as that required to join any branch of the U.S. military, or to hold any office or position of trust under the federal government or the government of a state. It is an oath, required by the Constitution itself, "to support this Constitution."

My view of this oath, and my respect for the wisdom of the nation's founders, has propelled me along an unusual professional route, through fruitless battles in the courts for a return to constitutional money, and then, with bridges severed, to virtual retirement from the law. Tomorrow my modest efforts for the same cause through a medium that barely existed five years ago put me aboard a plane to Paris for the FT World Gold Conference on June 26-27, carrying a spear for GATA's quixotic campaign to restore integrity to the world gold market. Perhaps my Puritan forebears' belief in predestination had merit, for in some strange way this trip seems as much a voyage of destiny as discovery. More so, because I carry other spears.

My grandfather, for whom I am named, died eight years before my birth. A member of the original faculty of Middlesex School, in Concord, Massachusetts, he used his first sabbatical to earn a doctorate in natural sciences from the Sorbonne in 1912. An accomplished sailor, as founder and first headmaster of Belmont Hill School, he chose for its symbol the sextant, a navigational instrument requiring greater skill to master than a compass but giving more precision over a vaster area based on surer physical principles. My website and the essay from which it grew thus bear, as it were, a sort of family crest. By example, his own and those of the faculty he hired, my grandfather tried to instill in his students the principles of integrity and honesty for which gold stands. So I carry a spear for him.

The extraordinary efforts of James P. Warburg on behalf of sound money, as well as those of his father, Paul M. Warburg, are the subject of a prior commentary, as is The Money Muddle, Jim Warburg's polemic against the monetary policies of Franklin Roosevelt, whom he served as monetary adviser until resigning in the wake of the failed London World Economic Conference of 1933. Born in Germany, the younger Warburg in his own words "became an American" largely as a student at Middlesex, where he lived in Hallowell House, presided over by my grandfather. My grandmother's younger brother, Bill Barker, a student in the same class, lived there too. When Jimmie, Bill, and three other close friends went on to Harvard College, Jim asked his father for an allowance sufficient to cover the Harvard expenses of all five, to which Mr. Warburg agreed since none of the other four had well-to-do parents.

As a member of the Allied Expeditionary Force in World War I, Uncle Bill participated in the Meuse-Argonne offensive as an artillery officer. After returning from "the war to make the world safe for democracy," he taught at Middlesex and later Belmont Hill, but passed away before my time, leaving a collection of books including a copy of The Money Muddle bearing this inscription: "Please make it required reading, Bill. [signed] Jim." So I carry a spear for them.

There is a spear, too, for the three great New England legal heroes whose deeds first attracted me to the once honorable profession that I have now forsaken: John Adams, Daniel Webster and Justice Oliver Wendell Holmes. It is a spear too heavy for me to throw, but one I never drop.

The Golden Sextant,, opened less than a year ago, born of my conviction that the British gold sales announced May 7, 1999, were proof of large scale official manipulation of the world gold market, and that the time had therefore arrived to rejoin the battle for sound money. Early support from Bill Murphy and Chris Powell of Le Metropole Cafe and GATA, quickly followed by encouragement from old friends in the gold community, helped greatly to get me started. To my considerable astonishment, much wider interest and appreciation soon arrived from gold bugs all over the world, leading to many new friendships and experiences, and demonstrating the amazing reach and power of the internet. So for all these wonderful people, to whom I will be forever grateful, I also carry a spear, with more than few good tips on where to aim it.

Lots of spears, however, do not guarantee any hits, let alone victory. But the forces for unlimited paper money are sufficiently strong and arrogant to guarantee their own ultimate downfall. Like the money changers in the temple, no sacrilege is beyond them. In Paris they will thumb their noses at some far more fearsome spear chuckers than GATA and its allies. Goldman Sachs plans to fete its guests, clients and friends at the conference with a grand soiree at Les Invalides, featuring a tour of Napoleon's tomb before they get down to serious partying. Guess I'm too much a sailor ever to tempt the gods in so brazen a manner. There are no unsinkable ships for me.

The paper pushers who spill drinks on the soil of Bonaparte's grave invite a divine retribution that need not arrive with pyrotechnics from the heavens. Napoleon himself prophesied: "When China awakes, the world will tremble." A $50 gold rally in Hong Kong on the heels of Goldman Sachs' party would almost be worth a bargain with Devil. Even without Daniel Webster to plead the defense, there would be some comfort in Hell watching gold's foes burn. True justice, in places not too civilized to administer it, includes seeing the guilty get their due. For that very reason in the early years of the American republic, coin shaving -- which now masquerades under the more polite name of inflation -- was a capital crime punishable by public hanging.

Still, the ultimate goal of us gold bugs is not the destruction of our enemies. It is honest money with permanent value. It is constitutional money protecting our freedoms and restoring integrity to our political institutions. It is an international payments system that creates a level playing field for all nations to trade, invest, and pursue their economic development. It is, in sum, a world where the expression "as good as gold" is not a reminder of past glories, but a statement of expected standards. In that sense, it is a world like the one which existed before the Great War. That world owed much to the Napoleonic era. Ours may soon cry out for another Napoleon.