Streetwise Professor

April 7, 2010

Still Buggy After All These (350+) Years

Filed under: Commodities,Derivatives,Economics — The Professor @ 2:55 pm

My post on Gold Bugs from last week drew a lot of comment at SeekingAlpha.  It was largely predictable, tiresomely so.

Life being short, and the effort pointless, I won’t respond to the invective, insult, insanity, etc., all of which validated my judgment that it is an exercise in futility to engage in these matters.  But there is one thing that strikes me as so funny that, at the risk of unleashing another torrent, I have to write about it.  (Maybe I should hedge myself, by buying shares in Kraft, the manufacturer of KoolAid.)

Specifically, one of the supposedly shocking! shocking! discoveries that proves, proves I tells ya, that the precious metals markets are manipulated is that the amount of claims on gold exceeds the physical supply of gold.  As an example:

Continuing on the trail of exposing what is rapidly becoming one of the largest frauds in commodity markets history is the most recent interview by Eric King with GATA’s Adrian Douglas, Harvey Orgen (who recently testified before the CFTC hearing) and his son, Lenny, in which the two discuss their visit to the only bullion bank vault in Canada, that of ScotiaMocatta, located at 40 King Street West in Toronto, and find the vault is practically empty.

. . . .

It appears that this kind of lack of physical holdings by all who claim to have gold in storage, is pervasive as the actual gold globally is held primarily in paper or electronic form. Lenny Organ who was the person to enter the vault of ScotiaMocatta, says “What shocked me was how little gold and silver they actually had.” Lenny describes exactly how much (or little as the case may be) silver was available – roughly 60,000 ounces. As for gold – 210 400 oz bars, 4,000 maples, 500 eagles, 10 kilo bars, 10 one kilogram pieces of gold nugget form, which Adrian Douglas calculates as being $100 million worth, which is just one tenth of what the Royal Mint of Canada sold in 2008, or over $1 billion worth of gold. As Orgen concludes: “The game ends when the people who own all these paper obligations say enough and take physical delivery, and that’s when the mess will occur.”

. . . .

It is funny that central bankers thought they could take the ponzi mentality of infinite dilution of all assets coupled with infinite debt issuance, as they have done to fiat money, and apply it to gold, in essence piling leverage upon leverage. They underestimated gold holders’ willingness to be diluted into perpetuity – when the realization that gold owned is just 1% of what is physically deliverable, you will see the biggest bank run in history.

Maybe this is one of those things that just crept up on us “gradually” (the explanation of Adrian Douglas).

Yeah, if by “gradual” you mean “since the middle of the 17th century.”

What has the Bugs Gang so exercised is, in effect, fractional reserve banking in gold.  Which started in the middle of the 17th century.  Indeed, fractional reserve banking started in the gold market.

The story goes that in response to expropriation by King Charles I of gold stored in the Tower of London, holders of gold deposited metal with goldsmiths.  The goldsmiths issued receipts for the deposited gold, and soon recognized that they could engage in a lending business because the gold owners’ demand for return of the physical metal was usually only a fraction of the gold that had actually been deposited.  Thus, fractional reserve banking was born.

No doubt the Bugs are mainly skeptical of fractional reserve banking generally, and not just in gold.  And there have been a variety of arguments for requiring 100 percent reserve backing for certain kinds of bank liabilities, in particular, that fractional reserve banking is subject to runs/crises.  But there are benefits to liquidity and maturity transformation (inherent in fractional reserve banking), and the survival of the institution that achieves this transformation suggests that the benefits exceed the costs.

But regardless of where you stand on the issue of fractional reserve banking generally, you look pretty foolish when you consider it to be a shocking revelation that gold warehousemen engage in the practice.  I mean, they’ve been doing it only for the last 450 350 odd years.

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