Buying GOLD Safe-Haven Assets, Not so Safe

I don’t trust buying gold safe-haven assets as something that is certain to appreciate in bad times, and I have one very simple reason why. You might think a writer who predicted our unfolding financial crisis before the Great Recession began … and who is predicting the global economy will collapse in the final quarter of 2015 … and who is predicting a stock-market crash in 2015 … would be heavily invested in gold bullion; but I have none.

Let me guide you to my reason with a simple question: Who owns the vast hoards of gold that exist in this world? Follow the money, and your mind goes right away to the major central banks of this world and to the hoards of gold in national treasuries — not always one and the same. The stockpiles of billionaires pale to insignificance when compared to the sovereign treasures of gold held in the vaults the Federal Reserve, Fort Knox and other such places.

Next, ask yourself why these central banks, which usually scoff at gold, own so much of it … and/or store so much of it. If they don’t recommend it, why do they want so much of it for themselves?

First, a primer on who owns all the gold in the Federal Reserve

Contrary to popular belief, the Federal Reserve owns no gold. That might surprise you because it used to own a lot of gold, but it gave away all of its gold to the US treasury in 1934. Now, why would the Fed do such a generous but dumb thing as give away all of its gold? That’s an interesting little story that goes back to the early days of the gold standard.

When the Federal Reserve was established at the start of the twentieth century to create and become steward of the United States’ national currency, it issued paper money. Such money already existed, issued by various banks as their own creation with their own names on it, but people didn’t trust it. They knew by experience that, if the bank that issued paper went bankrupt, its money was worthless. The money was only as good as the bank that issued it.

You could give your gold, silver and copper coins to the banker, and the bank would issue you easy-to-carry paper that could be redeemed for the US mint coins you brought in. You could get the same amount of money back, but if the bank that issued that paper went out of business, you couldn’t get a dime. In the early years of the paper-money experiment, many people learned that lesson the hard way, and others learned by hearing all about it.

To make a long story short, after a few bank failures along those lines and resulting recessions, the Federal Reserve System was created to save the day. (For details on how the Federal Reserve is not a government entity but a consortium of private banks, use the link just provided.) The Federal Reserve made paper money more stable by issuing gold certificates and silver certificates with US backing. These promised that the bearer of the note could redeem the note for its full value in gold or silver in a system backed by the federal government, not just backed by an individual bank.

Durable metals had been the currency of choice for thousands of years with national mints putting their premature on the metal to authenticate the value of the gold, silver, brass or copper contained therein. Therefore, to make the more easily portable, transportable, storable and processable paper currency something people would trust, it had to be immediately exchangeable for gold or silver. The government’s name on the paper money worked like the stamp on the coin, authenticating its value.

Still, the people didn’t trust the paper much at first. They tended to hoard gold and silver to store their wealth, but used the paper some for daily transactions because of its convenience and because it now had that official US government status. People regularly redeemed their gold certificates and silver certificates and found they always got the amount of gold or silver that was promised by the note. As a result, they began to trust the notes more and redeem them less.

Within a decade, people hardly ever redeemed their gold or silver certificates. The Federal Reserve, which had no restriction on the amount of money it could create, began printing many more certificates than it had gold or silver to back them with on the basis that it had far more than enough gold or silver to redeem the few notes that came in. Because everyone who wanted to redeem them got what they wanted, everyone was happy.

For a very short time.

It didn’t take long for people to  learn that the notes were no longer fully backed by gold and silver. With greater printings of paper money, inflation took place. With less trust in the backing of the money, people reverted quickly to wanting their gold and silver back. Runs on the banks ensued. The banks ran out of gold and silver and could not redeem the notes. The Great Depression began. (This is the short version of the story.)

Since neither the Federal Reserve nor the federal government had enough gold or silver to redeem all the certificates, a federal solution was required. As part of that solution, President Franklin Delano Roosevelt issued a decree that all gold bullion be exchanged for new treasury notes. This included all the gold owned by the Federal Reserve. In exchange the US government would pledge its full faith and credit behind the new notes printed by the Treasure, but issued through the Federal Reserve banks that would now run under a stronger guarantor of deposits known as the Federal Deposit Insurance Corporation (FDIC), created in 1933. The FDIC would, of course, examine the banks it insured in order to make sure they could live up to their obligations.

The US president decreed gold out of service as a form of money and pledged the full credit of US government behind the new notes, which no longer said they could be redeemed for gold or silver but only redeemed for “legal money,” whatever that meant. I suppose in the minds of most people it meant the kinds of gold and sliver coins they were used to calling “money.” Since the newly created FDIC stood behind bank deposits, people returned again to holding their money in national banks and using the paper money issued through those banks, which could be redeemed for something. Redeemed for more of the same money?

The Fed, which had essentially become bankrupt because it didn’t have enough gold to honor all of its commitments, readily turned over all of its gold and silver to the US treasury in exchange for this federal bailout. What the Fed got in return was a small number of really pretty gold and silver certificates from the US Treasury that said it had this much unredeemable gold and silver now held in the treasury to be guarded by the US government to back the nation’s money supply. Under law, the Fed could not sell or trade those certificates, except to their own member banks, so they have in time become interesting only as wall-hanging artifacts.

However, the certificates gave the average citizen some assurance that the federal government held gold that it could use to back the money in a pinch. It seemed likely that not all banks would fail at once, so there would be enough gold to back a run on any particular banking corporation. That was vital because people still could not bring themselves to trust paper standing all on its own … not at that point in time … as most had been born when money was something you could bite.

The federal government gave the people another important insurance that backed the Fed. It promised to closely regulate what the Federal Reserve and all of its member banks could and couldn’t do through the Glass-Steagall Act of 1933. (Eventually, in 1999, that was also considered an artifact of the national preoccupation with gold and silly things like bank supervision and done away with, too.)

And, so, the Federal Reserve System was saved through major overhaul and heavy regulation and at the cost of turning over all of its gold and silver; but what it obtained in return was worth far more than gold — the right to continue create at will and without limitation by the federal government all money deemed legal tender by the US government for use by the government and its citizens with only the requirement that it preserve the value of that money as the official steward.

A coterie of twelve people within the Federal Reserve, would govern a committee that would have all this power vested in it called the Federal Open Market Committee (FOMC). Seven of the twelve people governing the nation’s money were appointed by the president of the United States and confirmed by congress, while five of the twelve were presidents of the Fed’s privately owned member banks.

Along with the right to create and govern all of the nation’s money without any direct government involvement, the FOMC had the right to dole out all of that money exclusively to the Fed’s member banks, which could, then, loan it out for interest. They were also allowed to loan out a set percentage more than the the amount of new money created, thus leveraging that money. They might, for example, get a million dollars of newly created money deposited by the Fed in their own Reserve Bank account, but they would be allowed to issue five-million in loans against those assets.

Granted, the Fed had similar rights when it was created at the turn of that century, but that would have all gone up in a ball of flames if not for this government bailout and reform. In exchange for all its gold, the Federal Reserve held the right to be the nation’s exclusive money tree, which meant something very important:

The US dollar is a proprietary, privately-owned product!

The Fed might harshly contest my words, claiming that it is not privately owned; but, in fact, all of its twelve Federal Reserve Banks are wholly owned by private national banks, whose presidents rotate on and off the FOMC. For a bank to call itself a “national bank” it must by law own shares of one of the Federal Reserve Banks. In exchange for coming under the regulations of the Federal Reserve System and buying shares in a Federal Reserve Bank, such a bank gains the full pledge of the FDIC over its deposits and the credibility of being a “national bank,” which was at one time important to citizens.

If there is a smattering of conspiracy theory in this article it will be in my next suggestion, which is simply that it is hugely in the interest the national banks that wholly constitute the Federal Reserve System to make certain that the government-appointed members of the FOMC are friends of the national banks. Naturally, former bank presidents make good candidates for government appointees because all US presidents and all sitting congresses have shown a strong predilection for big credentials as proof that one is an expert at whatever one is going to be appointed to oversee.

College economic professors also have the right credentials, but conveniently often have their own career connections to major national banks (as board members or as former employees). Banks for some reason that you might speculate about have huge influence with congress and naturally will find many ways to promote the expertise of those who will vote in favor of all that is good for large national banks as the federal government looks for candidates to fill the FOMC. With five of the votes on the FOMC wholly in their own pocket, the banks have only to make sure that two of the remaining seven people who govern the US monetary system are in their pocket.

You figure out the likelihood of that kind of thing happening for yourself, but it is my opinion that the government-appointed members of the FOMC are not likely to be out of step with those members of the FOMC who are presidents of the reserve banks. If that’s the case, then national banks effectively own the nation’s currency outright, and the dollar is a proprietary product that they create and control that their own discretion.

Why are nations and central banks buying GOLD safe-haven assets?

In the case of the US central bank, the gold is owned by the United States government, but the US government has pledged its backing to the dollar, which is owned by the Federal Reserve. As the dollar is essential to all US dealings and the daily lives of all citizens, the US government has every possible interest in assuring the stability and value of the dollar.

The US Treasure could say that it continues to own gold because gold may from time to time be needed for transactions with other governments; however ALL of the gold owned by the US government is dedicated to backing those arcane gold and silver certificates issued to the Federal Reserve in 1934. While the certificate is nothing more than wallpaper, that relationship between the Fed and the US Treasury is more than Sterling.

Central banks cannot create gold, and they have to buy it the same way everyone else does in order to get it. (Unless they are communist or monarchies and can dictate that their citizens go mine some for them.) At the same time, the average citizen can own gold without going through the central bank or the national treasury to get it. At the end of the day, central banks have one proprietary asset to sell — their own currency. They create it. No one else can by law. So, it is effectively patented under the government. The government pledges to use all force necessary to protect that patent via investigation, arrest and punishment. The central banks give that money to themselves ONLY when they do create it. They, then, lend what they have manufactured in paper out to others at highly leverage levels to everyone else, thus creating much more of it. In fact, they don’t need the paper, as they have the authorization of government to lend out ones and zeroes on computerized accounts at will.

Their currency is their stock in trade, and it gives them huge control over the economy and over everything that happens in this world because the world does not move in any direction, except through their product. In the case of the Federal Reserve, their proprietary product, which they rent out for interest, is the dollar. For the European Central Bank, it is the euro. For the Bank of Japan, it is the yen. For the People’s Bank of China, it the renminbi or yuan. All of these exist in both electronic form and cash form.

There exists, however, one primary threat to all of those national monopolies — precious metals, particularly gold. People can trade in anything they want, but they are not likely to trade fish or cows or camels in high volume. So, trade of that kind is not much of a threat to the monopoly. But people still LOVE gold! And gold (and silver, etc.) is worth so much because it is still easy to store (doesn’t have to be fed like cows and camels) or require warehouses like wheat or refrigeration like fish so it works almost as fluidly as money for daily transactions. It doesn’t spoil, and it has far more tradition behind it than paper currency, bank credits or any other kind of government money.

Simply put, central banks and the governments they supposedly serve have a high vested interest in making sure that gold and silver do not become strong enough competitors to take people away from their proprietary products — the dollars, yens, pounds, euros, etc. of this world.

If any one of those currencies starts to fail, where do people run? To gold (and silver and platinum but mostly gold). Gold, because it is anonymous and is available universally outside of the central banks, is their most threatening competitor, which brings me to my conclusion:

Central banks and governments hoard gold and silver to control it

A basic fact of economics is that you do not necessarily need to own all of something in order to control it. If, for example, you own only 51% of the stock in a company, you can control the company as well as any autocrat. That there are other owners doesn’t even matter.

Likewise with markets. You need only to corner the market to control it. You need to, in other words, own enough of it that you can flood it with what you own if you want to bring the price down or keep buying more if you want to drive the price up.

In the 1970’s the Hunt brothers tried this with the silver market and nearly succeeded. Primarily through their own manipulations, because of their vast accumulation of silver during the seventies, the price of silver rose in 1979 from $6 per ounce to $48.70 per ounce, a gain of 712% in less than a year. The Hunt brothers were estimated to hold one third of the world’s supply in silver. They were put out of business, once this was discovered, by a simple COMEX rule. Until their manipulation was laid bare, however, they controlled the silver market by just owning a large share of it.

The same dynamic has existed in diamonds for decades. Through successful marketing, De Beers turned diamonds into the only stone of choice for engagement rings. (It used to be that other more colorful stones were more popular.) Because De Beers owns the largest share of the world’s limited diamond mines, they have the market cornered. Diamonds, which used to sell for less than sapphires because they are usually clear and colorless, now sell for far more because De Beers can regulate the supply just like OPEC controls the price of oil by regulating its supply.

Now, back to gold. I believe the primary reason that central banks and national governments choose to own huge hoards of gold (and to a lesser degree silver and platinum) is to guard their currencies. When there is a run on any national currency, people typically buy gold as a safe haven asset. A little of that kind of activity can be absorbed, but if nations are going to guard their currencies against major runs, their best protection is to own enough gold to corner the market whenever needed.

You, as an individual gold investor, are not safe when there is a run on the dollar or any other currency because nations like China, the US, the UK, Japan, etc., all make sure they own enough gold that they can dump it quickly enough and long enough to drive the price down even in the face of rapidly growing demand. They will make it painful for you to run from their currency.

Consider it this way, fiat currencies like the dollar (money created by government decree) are hot air balloons that carry a lot of heavy bags of gold for ballast. If the balloon starts to sink, they can cast off ballast in a hurry to keep it aloft. They make sure they own enough that ballast to give them the ability to corner the market long enough to keep their currency from sinking to the ground as it deflates in value.

If there is a run on the dollar, the US government owns enough gold to drive the price of gold down hard enough, fast enough and long enough to scare everyone away from gold and right back to the dollar. Your only salvation from hyperinflation of the dollar or mass failure of US banks would be if other nations decide they want the dollar to fail and start buying up gold fast enough to keep gold’s value up and keep that run on the dollar going. Most likely none are in condition right now to do that, just as none are in condition to where their bonds will necessarily make a strong alternative if the dollar fails.

Weigh these words of the US Treasury before buying gold safe-haven assets

The following comment by a US Treasury spokeswoman, which echoes earlier thoughts by Treasury Secretary Timothy Geitner, might be worth its weight in gold. When asked why the US doesn’t just sell its gold to fund the government now that it is completely off the gold standard and so far away from it that we cannot even see that standard any longer, the Treasury replied

Selling gold would undercut confidence in the U.S. both here and abroad, and would be destabilizing to the world financial system.

What is the world financial system? Well, it is the dollar. The dollar is the global trade currency, so the Treasury appears to be saying pretty clearly here that keeping a large gold supply is essential to stability of the dollar. Thus, the treasury cannot use the money to fund the government. How is it essential to stabilizing the global currency, unless they would use it in a crisis in the manner I’ve described? How else can US gold stabilize the entire global financial system, except by stabilizing the dollar, and how does it stabilize a dollar that has not been pegged to gold for several decades now and that is no longer redeemable in gold?

In short, gold is wide open to the manipulation of central banks and their governments because they own more of it than all the billionaires within any nation. The US Treasury has 8,100 tons of it, all dedicated to backing the Federal Reserve. 8,100 tons is a lot of ballast. So, think twice before you conclude buying gold safe-haven assets will provide refuge from the manipulations and failures of central banks that is likely to escalate when and if the monetary system goes down. Why else would they own so much gold, themselves, when all their interest is in the value of the only product they have to sell — their money? Why else would they consider hanging on to that gold essential for stabilizing the global monetary system?

Gold safe-haven assets still have a place in a balanced portfolio

With that said, gold still has some place as a save-haven asset in a diversified portfolio. Just don’t think they are certain to appreciate in bad times or that gold is any more secure than money itself.

While central banks will do their best to suppress or even lower gold’s value when there is a run on their money, gold has also always recovered its value when the dust settles. Though it might not skyrocket as many people claim it will when fiat money fails, it has always been a pretty good store of long-term value.

I’d like to suggest you think about an alternative way of owning gold that is beyond the manipulation of central banks. It is hard for a central bank to control the market in collectible gold coins because they are too rare and in far too many different kinds that each have their own value. That makes it hard for the Federal Reserve to own enough of them to corner the market. (Dumping one kind of gold coin on the market to lower its value has no effect on all other gold coins.)

Old gold and silver coins are also too small in circulation for the Fed to have much interest in them. They fly under the radar. They have the intrinsic value of the gold they are made of as a base-level value, but they also have the added value of a collectible. Both parts of their value, of course, are subject to going either up or down; so, do not think anything provides guaranteed security in an economic collapse or at any other time. Life doesn’t give that kind of security, but gold coins are a good addition to a diversified portfolio because they are a completely different market from other assets.

You will want to educate yourself in the does and don’ts of coin collecting; but it is one way to step outside of the manipulations of the Federal Reserve, and it can be interesting. Some of the following books may be a good place to start learning about a hobby that can actually store a lot of long-term value:

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The value of gold can be manipulated, but the value of collectible coins is always golden:

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Gold bullion also has a place as a safe-haven asset in a diversified portfolio

Believe it or not, gold it can be held in an IRA as a retirement account, whereas collectible antique coins cannot. Newly minted gold bullion coins are not treated as collectibles when it comes to the government’s regulations on what you can hold in a tax-free retirement account.

If you’re interested in setting up an IRA for holding physical assets that can appreciate as a tax-free, completely self-directed retirement portfolio, I recommend Perpetual Assets to guide you through the process of setting up an LLC IRA that you own and run directly. I’ve talked with them, been on their radio show, and have talked with others who have used their services.

What I like about them, if you are interested in gold, is that they don’t own your gold or hold your gold or require you to buy your gold through them. They just, for an initial fee, help you professionally to set up a legal IRA that can hold a large variety of assets from gold bullion to stocks and other properties that you might not of have thought could be a tax-deferred retirement investment. You may even be able to roll over your current 401K and convert part of it into gold assets, depending on the contractual constraints of your 401K plan.

Click on the image below if you’d like to explore that more:

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November 23, 2015 @ 2:58 pm

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The Federal Reserve