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I am a man of excessive wordiness under the best of conditions, and right now I am in no mood to curtail my excesses. So I will apologize in advance if I bore anyone with this tirade.
My Background
I have been interested in finance and in business for many years. I have also dabbled in the stock market with mostly positive results. I have been self-taught for the most part in my endeavors, but I have taken some classes in accounting and business over the years which if nothing else taught me the difference between a debit and a credit and an asset and a liability. So when the extent of MCI WorldCom's accounting fraud came to light in 2002, I wasn't amazed by the sophistication of it so much as I was the stupidity of it. It was something a first year accounting student could have caught, and it's amazing that their outside auditing firm didn't catch it. Of course, considering that firm was Arthur Andersen (which was essentially later forced out of business over their botched audits of Enron) maybe it's not so surprising.
Corporate Fraud
My current opinion is that fraud happens all the time at publicly traded companies and that as long as it's not rooted out and punished it is typically rewarded. Companies have emphasized short-term profit at the expense of long-term solvency for so long now that it's no longer even noteworthy when a new CEO comes into a company and makes tens or hundreds of millions of dollars in bonuses and then is forced out a year or two later because the company profits (and stock price) have gone into the toilet. After the fact we frequently find out the so-called record profits that led to those bonuses were based on fraudulent accounting. That's one of the reasons I'm out of the corporate equities market, I have no way of knowing who's telling the truth and who isn't.
Government Fraud
The fraud I mentioned earlier is specific to the corporate world but the same kind of dishonesty is more and more being found in government bookkeeping as well. Hiding liabilities in off-balance sheet accounts has become something of an art form in the corporate world but it is practiced no less in the world of government finance. It has increasingly been hitting the news as more and more of the Eurozone countries are found to have falsified the extent of government spending and liabilities, but the U.S. is no stranger to these gimmicks and lies as well.
Inflation Misreporting
There are three areas that the U.S. has increasingly twisted statistics farther and farther from reality in the meat grinder of government reporting, two of which I will discuss here. One area is accounting for inflation, otherwise known as the decreased purchasing power of a currency over time due to expansion of the monetary base by the central bank responsible for that currency. The numbers went from stupid to crazy, and now they're just crazy stupid. How does this misreporting benefit a government, exactly? It benefits a government specifically in the sense that any spending that is tied specifically to increased inflation (COLA adjustments, yields on TIPS securities, etc.) gives a direct financial benefit to the government that is understating the rate of inflation. In other words, that government has to pay out less money in benefits, salaries, interest, etc.
There are other "knock on" benefits, as the Brits would say. Understating inflation overstates GDP, which makes a nation's economy look stronger than it is. It also makes a country's stock market look more attractive than it really is, a stock market can go higher and higher in nominal terms but be performing more and more poorly when adjusted for inflation. The stock market in Zimbabwe was on a huge tear when the currency collapsed and hyperinflation ensued, but when adjusted for inflation it was still a terrible investment, just not one as bad as the actual currency itself.
Unemployment Misrepresentation
Another area of statistical misrepresentation is unemployment statistics. There are two obvious reasons I can think of for this to happen so frequently. One is to make the economy look better than it actually is. Another is to make the government look like a better steward of the economy than it actually is, thereby leading one to conclude that the various different elected officials and government bureaucrats who are in charge of laws and regulations are doing a better job than they are actually doing and should be allowed to keep said jobs.
If employment is booming and you can't find a job, there must be something wrong with you, not the economy. If a lot of people are out of work, that might indicate that something is wrong with the whole system, not just you.
If there is no punishment for lying, and the reward is to be able to continue lying more and more brazenly, is it any surprise that we continue to see lie after lie coming out of the bowels of the government reporting apparatus?
The Labor Force Participation Rate
By the way, there are some statistics that are harder to put a positive spin on, two of which are payroll tax receipts and the labor force participation rate. The last reported LFPR number I saw (it is expressed as a percentage, being calculated by the number of people who are working divided by the number of people in the age group that is considered to be the normal working age range) was 63.3%, which is the lowest number that has been seen in this country since 1979. The depression of the last six years has essentially wiped out 34 years of employment gains, if I am reading this correctly. More than one out of every three people of working age is not working, if these numbers are to be believed. And yet the official unemployment rate is supposed to be only 7.6%. What happened to the other 29.1% of the population that could be working, but isn't? Did they all win the lottery and they're reclining on a beach somewhere sipping piña coladas? I don't think so.
Tax Receipts?
I was looking around trying to find some real numbers of payroll tax receipts that were anywhere near current and had no luck. It could be that these are some kind of state secret since I had no luck finding them online. I know they are currently higher since the temporary 2% social security tax cut was allowed to lapse, and it looks like that is bumping up the tax receipts this year compared to last year. A very rough estimate (ignoring earners who have a higher salary than the cutoff for social security taxes) would show that doing away with the 2% tax cut by itself is going to add around 14% to the social security taxes paid all by itself.
Inflation, Revisited
Let's return to the inflation theme I was discussing earlier. I gave a thumbnail definition of inflation earlier that is close enough to the dictionary definition that most people won't quibble with it. We know what inflation is, more or less, but why is there inflation? Why do governments and central banks print money (either paper money or the electronic equivalents of it) and expand the money supply, what's the motivation?
Friend of the Debtor, Enemy of the Saver
There are many motivations. One of the strongest is that inflation is the friend of the debtor and the enemy of the saver. Most governments are in debt because it's always easier to spend money you don't have and many governments are financially captive to the moneyed interests in their countries (if you don't believe me look it up in a history book -- sovereigns have been in hock to bankers since the middle ages if not earlier). If I borrow money at an interest rate of 5% and then inflate the money supply by 10% every year, when I pay back the money in 10 years that I borrowed the creditor will get money back that is worth less than 66% of the money that was loaned out (even after getting their 5% interest compounded per annum).
Why would anyone engage in such a foolish bargain? Individuals do it all the time because they don't understand how inflation is insidiously stealing the value of their money. Some institutions do it because they are forced to hold certain percentages of their assets in government bonds, whether the bonds have a negative real yield or not. Governments do it because they are in effect participants in a giant ponzi scheme and they know if they don't buy some other government's crappy dept the other country won't buy their crappy debt.
Risky Investments
By the way, government bonds are not the secure investments they are promoted as. There have been some premature warnings to that effect (such as Meredith Whitney's call on U.S. municipal investments a few years ago) but when the shit really starts hitting the fan there will be very few government bonds that will actually be risk free. Entities below the national level are going to start defaulting in large numbers and countries that can't print their own currency are going to default, as we've already started seeing with the Eurozone countries such as Greece and Cyprus. Countries that can print their own currency can always repay their debts with debased money which is worth a fraction of the original debt, but that's another story.
The reason we're going to see more defaults is because the world economy is much shakier now than anyone would like to admit. What happened in 2008 was just the beginning, things weren't so much fixed then as they were swept under the rug. Main Street was pillaged to keep Wall Street from taking a richly deserved haircut and Wall Street may be doing fine now but Main Street is still in a world of hurt.
Who Benefits from Inflation?
Another reason that inflation is encouraged is that those interests who are first to receive the newly minted money are the ones who receive the most utility from it. Those who have first use of the new money can get the most bang for their buck since they can buy financial assets with it before the money has worked its way into the financial system of the country and caused other buyers to bid up the price of the assets. In banana republics and third world countries the people who have access to the money first are the cronies of the dictators, their family members, and political elites that support the current government. In the United States the money that is created by the Federal Reserve System goes first to the big banks that are members of the Federal Reserve Cartel -- most of these are also known as Primary Dealers. Of course it also goes to those in power in Washington D.C. and their various different political cronies, so in that respect the U.S. is not terribly different from any other banana republic.
Debasing the Currency
One of the best known quotes of the French philosopher Voltaire is this one: "Paper money eventually returns to its intrinsic value -- zero".
If you're a sane, rational person, you're probably thinking "WTF? Why would anyone want to blow up their own currency, it doesn't make any sense?" You are right, if we were dealing with sane, rational, moral people. But what we are dealing with are the biggest gangs of thieves that have ever lived in the entire span of recorded history. If you beat up your next door neighbor and steal his beer or walk into a convenience store with a gun and walk out with a couple of twenties and get caught, you'll be facing some serious hard time in the county jail. But the people in charge of our wonderful system have figured out that you can steal billions of dollars, even trillions, with no repercussions, no jail time, no worries except for some bad karma and occasionally getting spit on by an OWS protestor on a street corner.
Competitive Currency Devaluations -- Yeah, Right!
Oh, and by the way, don't believe the bullshit you read about currency devaluations being good for countries trying to expand their export markets. That's been a fairy tale that's been used at least since the 1930s, and it's no more true now than it was true then. Currency devaluations are about screwing creditors and screwing savers, nothing more, nothing less. Any benefit that a country derives from it as a trade tool is miniscule. For all the crowing we hear about China being closed to exports because of their currency peg, the real barriers to entry in China are regulations, requirements, tariffs and import quotas (published or not) that keep foreign companies from selling their goods there. Not to mention the culture of corruption there that means you have to grease someone's palm (or many palms) to get anything done.
Bank Robbery Through Printing
The reason that money printing is so seductive and so out of control is simple math. Let's say you live in a country where the money supply is a million quatloos (or krugmans, or bernankes, or greenspans, or whatever ...). There is no inflation, there is actually mild deflation because the country's population is growing slightly, and the money supply isn't. The government of that country decides they need at ATM card because they want to go to war with the neighboring country of Elbonia. Rather than borrow the money legitimately (which is expensive) they decide to create a central bank and just print the money they need. They decide they need another million quatloos to wage the war successfully so they print it. Here's the beauty of the scheme: Even if they were rich before they expanded the money supply (maybe they controlled 10% of the country's wealth) by doubling the money supply they now have 55% of the wealth of the country versus the 10% they had before. They debased the value of their original 10% down to 5% of its previous value but more than made up for it by creating the additional money out of thin air. Money, but not wealth. The wealth of the country is no more than it was before, but now the people who control the central bank have a much bigger share of it because they control the money supply and used that control to create legal counterfeit money.
As former bank regulator Bill Black states, "The best way to rob a bank is to own one". He actually wasn't talking about central banks (I think) but the quote is still apropos. Maybe in this case it should be: "The best way to rob a country is to own its central bank"?
The Wealth Effect
People's perceptions that they have more wealth (the so-called "Wealth Effect") and the beneficial economic consequences that purportedly result from people spending more of their hard-earned cash thereby stimulating the economy, is one of the pretexts for expanding a country's money supply enough to spur a small amount of inflation, without creating so much inflation that it causes economic dislocations and actual hardships. I would love to know how that actually works out, since so often if a little bit of something is considered good then a lot more is obviously better, right?
Inflation Hedges
There is a lot of disagreement over what instruments are good inflation hedges. Government bonds are probably the worst thing you can be in, and that's even if there is no risk of default, which is demonstrably not true at this point in time. TIPS (inflation indexed Treasuries) would be useful if you had any faith that the government would use an honest barometer of inflation, which I don't. The stock market? Better than nothing, certainly better than cash, but not nearly as good an inflation hedge as it's made out to be. Some industries can weather bouts of inflation better than others, and if you can figure out what those industries are it would make sense to buy equities of companies in those sectors. But some sectors are going to fare poorly and you don't want to own shares of those companies.
Anything that is tied to real, tangible assets will do better than cash. Land and housing is worthwhile, as long as the property taxes on them don't rise to a confiscatory level. Gold and silver should be good hedges, but right now they're not doing well. What's that all about, anyway?
Precious Metals
Gold and silver both have centuries and millennia of history as money. They were used as money because they shared these characteristics that are all useful for money to have: Durable, Divisible, Portable, Recognizable, Stable, Scarce, Reproducible.
In some parts of the world gold and/or silver are still used as money, particularly in Asia but also in other parts of the world where governments and banking establishments are not trusted. In India a woman's dowry traditionally consists of gold, and the more money her family has the more gold will be in her dowry. This is her property, not her husband's, and if there is any problem with the marriage and the wife has to leave she is theoretically able to leave with all of her dowry. Private gold holdings in India are substantial although there are no official estimates; the best guesses range from at least 10,000 metric tons to several times that amount. In Vietnam, gold is commonly used to buy land, and also as a hedge against central government debasement of the currency (a characteristic also shared with India). China historically used silver as money but has had a prodigious appetite for gold in recent years as both Chinese citizens and their institutions have taken foreign currency reserves generated from China's trade surpluses and used that money to buy hard assets including gold and silver.
By the way, the term "debase" is a holdover from when precious metals were used as money. It literally meant to mix base metals with precious metals in monetary coins, making the coins less valuable but keeping their face amount the same. This practice is not the same as alloying for toughness, where as much as 10% of the quantity of the coin could be a base metal to improve durability for circulating coins (in these cases the actual weight of the coin would be more than the stated weight of precious metal used in the production of the coin).
Not Money, But What Is It?
In 1933, during the depths of the Great Depression, the U.S. government hatched a scheme to defraud the American people of their gold holdings and use the proceeds from the theft to fund government operations and also create something called The Exchange Stabilization Fund (a government agency empowered to intervene in foreign exchange currency markets at that time but probably used for much more than that since its inception). With Executive Order 6102 and its successors President Franklin Roosevelt outlawed the possession of more than a few ounces of gold (with exemptions for people who handled and sold jewelry). Although many people complied with the order a number of wealthy Americans had their gold shipped to Switzerland and other foreign countries to avoid confiscation.
For the gold that was turned in the holders were reimbursed $20.67 per ounce, which was the legal definition of what the gold was worth in US dollars. Once the gold that was seized was in the hands of the government, the gold was revalued to $35 an ounce. And so 40% of the monetary wealth of those who complied with the executive order was expropriated by the government of the US, the land of the free and the home of the brave.
After 1933 the US currency was still technically backed by gold, and gold was still used between nations to settle their debts, but gold coins other than collectibles disappeared from American pockets. Silver was still used in US coinage until 1965, when it too was demonetized. The US dollar was still theoretically backed by gold until August 1971, when President Richard Nixon issued Executive Order 11615, which ended convertibility between the US dollar and gold. At that point American money became "fiat", backed by nothing except any sense of restraint or common sense possessed by the people running the US Federal Reserve System. How's that working out, by the way?
From Demonetization to Demonization
Freed from the shackles of the US dollar, the price of gold soared from $35 an ounce in 1971 to $850 an ounce in 1980. Freed from the shackles of gold, the US dollar did what fiat currencies do; it crashed, leading to prices of commodities like gasoline rising from 30 cents a gallon in 1971 to around $1.20 a gallon in 1980.
The printing presses at the Federal Reserve had been humming along all through the decade trying to keep American government and trade deficits funded with ever larger piles of American dollar bills. While OPEC was widely blamed for the rise in prices, and stores which raised their prices were reviled as gougers and speculators, the real culprit was loose American monetary policy and the ever expanding American money supply.
Paul Volcker was appointed head of the Federal Reserve in 1979. Volcker was serious about stabilizing the dollar and keeping inflation under control. He raised the federal funds rate to 20% in his attempts to rein in inflation. The high cost of money took a huge toll on the US economy, but in wringing the last vestiges of inflation out of the economy Volcker laid the foundations for a solid economic recovery that lasted for almost 20 years, a unique accomplishment in the annals of modern central banking (the downturn of 1989-1991 was comparatively mild although some would beg to differ -- it was certainly not as bad as things were in the 1970s).
Volcker's tenure as Fed chairman ended in 1987. By then the price of gold had fallen from its high of $850 an ounce in 1980 to $460 an ounce (in August, the same month that Volcker left office). With stable monetary policies in place and US government budgets under control, the price of gold ultimately fell to $256 an ounce in February 2001. By that time it was no longer considered a serious investment vehicle and was no longer mentioned as even being worth having as a disaster hedge in most portfolios.
In an interview with the Nikkei Weekly in 2004 (referring back to the events of the late 1970s), Volcker was quoted about gold: "Joint intervention in gold sales to prevent a steep rise in the price of gold, however, was not undertaken. That was a mistake."
Which begs the question, what was the mistake? The monetary policies that led to the dire inflation of the late 1970s, or the inability (or unwillingness) to actively suppress the price of gold, what I would call the "kill the messenger" approach? As much as I respect Volcker, the mindset that is revealed in that quote is a disturbing one.
Precious Metals Resurgence
I mentioned earlier that the price of gold fell as low as $256 an ounce in February 2001. Between 2001 and September 2011 the price of gold rose from that low to around $1900 an ounce. The highest price I have found listed on a London gold fixing was $1895, although I have seen a reference elsewhere to a spot price of $1908 an ounce.
What exactly changed between 2001 and 2011? Quite a few things, as it turned out. The American economy started hiccupping in 2000 and 2001, and even before the terrorist attacks on 9/11 events had taken a decided turn for the worse. Fed Chairman Alan Greenspan, with nowhere near the sense of restraint that Volcker had possessed, liberally loosened the purse strings to try and goose the US economy back to life. Once the terrorist attacks happened US President George W. Bush, who had come into office on a platform of fiscal conservatism, among other things, launched in quick succession a "War on Terror" followed by a war on Afghanistan and then a war on Iraq. Left unmentioned was the collateral damage to the US budget deficit and US government spending, both of which ballooned.
By the way, I can't take a shot at Bush Jr. without throwing in this much about Obama. He is apparently the most ignorant president we have ever had when it comes to economics and finance. He is completely and absolutely clueless on that front. That, combined with his inability to speak truthfully or knowledgeably on virtually any subject, makes Bush Jr. and Obama the perfect one-two punch to torpedo the US economy. I just can't figure out if Obama is doing what he is doing because he wants to destroy the country, or if he is a puppet put in place by other malefactors who have that goal.
Across the pond, the great monetary experiment of the Euro shared currency started with lots of promise and then turned into a giant monstrosity. Recalcitrant electorates who felt disinclined to join the Eurozone were bribed, cajoled, threatened and blackmailed into joining the common currency bloc. Countries who voted no in referendums were given new referendums until they voted yes. What was billed as an exercise in expanding human rights, making war impossible, and liberalizing economies has taken a turn that I dare say is decidedly fascist.
Back in America, the ultra loose monetary policies that Greenspan had been pursuing kept creating asset bubbles which kept popping. The first one to pop was the stock market, which started selling off in 2000. Once that had deflated the hot money started pouring into the US housing market, causing home prices in some markets to essentially double between the late 1990s and 2006. Europe started having its own housing bubble, with real estate prices in sunny Mediterranean countries like Spain running up to unsustainable levels.
The Bernanke Era
Greenspan's term as Fed chairman ended in January 2006 and he was replaced by Ben Bernanke, an academic whose SAT score of 1590 (out of a possible 1600) exhibits his high IQ. Unfortunately for Bernanke, his role as replacement captain on the SS Titanic has not won him accolades commensurate with his IQ.
Greenspan, by the way, has stated that he did not understand how dangerous US residential subprime lending was until some time in 2005 or 2006, either close to the end of his term as Fed Chairman or after he had already left office. He has issued some mea culpas for his role in the ensuing financial crisis but has issued just as many contradictory statements absolving himself and his policies from blame.
Bernanke comes across as clueless in his public appearances but that is an act. He knows exactly what is going on and what he is doing, but finds it more expedient to perjure himself before Congress than to truthfully answer questions he would rather not answer. He is obviously getting tired of the charade and it seems he is plotting his departure from the Fed. I don't blame him; it must be a thankless job. My gut instinct is that he blames Congress and the President for the insanity he is being forced to underwrite, and wishes they would either get their houses in order or Go F*** Themselves.
In any event, the Fed policies of easy money and the US government policies of unrestrained spending, coupled with fears of fiscal and economic uncertainty in Europe (probable sovereign defaults, unrestrained government spending, capital controls, property confiscation, probable breakup of the Eurozone, etc.) all combined to drive the price of gold up a breathtaking 740% between February 2001 and September 2011, a span of just over 10 1/2 years. Gold was the trade of the 2000s. I don't have the exact prices for silver but it did pretty well too.
The Great Retrenchment
Once gold had touched $1900 an ounce, with none of the problems apparently resolved that had fueled its meteoric rise, the sky seemed to be the limit for the precious metal. Silver also reached $49 an ounce, and the dynamic duo seemed poised for even more gains. Things were not getting any better in Europe, and protestations notwithstanding from the mainstream media in the US, things were not going that well here either. There were bold prognostications that gold would hit $2500 or even $3000 an ounce within the next year to eighteen months. Some were forecasting a collapse in the dollar and a gold price of $5000 an ounce or more.
A funny thing happened on the way to the races, though. The day after touching $1900 an ounce, gold suffered a sharp decline and the value of the London fixing from September 6th to September 7th fell off a rather steep $85 an ounce. Not necessarily something that hadn't happened before, but a bit jarring. From there the hits kept coming and by the end of the year the London fixing had declined to $1531 an ounce, a rather steep decline of 19%. Silver also was whacked, I forget the exact numbers but it dropped from $49 an ounce back to around $30 an ounce.
Since then gold has never gone lower than $1540 an ounce (on 30 May 2012) or gone above $1792 an ounce (on 4 October 2012), until last Friday, 12 April 2013. That range of numbers has been enough for the mainstream financial media to trumpet that the bull run in gold is over, and trot out their frankly idiotic reasons as to why gold is done, equities are back in style, and gold is back to being just a barbaric relic again. The most hilarious of these excuses is the one that we have turned the corner on the economy and that since gold is only a "fear trade" we can kick it back in the closet again and relax because everything is fine and happy days are here again. The other fairly laughable excuse is that "Europe is finally fixed" which happens after every new crisis in Europe gets papered over. Which is all well and good until the next European crisis comes along in a month or two or three.
I'm not done with the Great Retrenchment, but for now, let's move on to what happened last Friday, on April 12th.
Black Friday
When the gold futures market opened in New York futures contracts for June totaling 100 tons were sold into the market. The markets absorbed this and the spot price of gold dropped from $1560 an ounce to $1540 an ounce. Two hours later 300 tons of contracts were sold into the markets in the span of 10 minutes. This had the effect of causing what is sometimes referred to as a "waterfall", when sell stops are triggered and margined players are forced to sell out of their positions, increasing the selling pressure on whatever instrument is under attack or being liquidated. This triggered another wave of selling which took gold down to $1480 an ounce by the end of the trading day in New York.
I'm not sure what the schedule is for the Asian markets but there seems to have been some carnage there over the weekend as well, probably triggered by the disorderly rout on Friday. In any event, in the US markets gold opened on Monday about where it had closed on Friday, but the selling picked up right where it had left off and by the end of the day gold seems to have closed at $1360 an ounce, down another $120 from the massacre on Friday. Monday was the worst ever day for the gold price as an absolute (largest dollar drop) and the worst day for gold percentage wise since 1983.
Now, I know a little bit about trading. I'm not that familiar with the futures markets but I do know that a lot of the players are margined and it's real easy to fuck with them. I also know that if you have a position you want to unwind and you don't want to lose money on it that you feed those contracts into the market slowly so as not to spook the herd. It's not hard to do, it just requires a little patience. If you're in the business to make money you also don't want to move the market by dumping so much stock into it that you lower the price you're going to get for the shares that sold later. Something else to bear in mind in this particular situation is the size of the position being unloaded -- 400 tons of gold futures is equivalent to 15% of global mine production for an entire year.
Now, it's possible, just possible, that someone had to legitimately liquidate a position and raise some cash. It's unlikely, but possible. And I have seen cases like this where the selling was clearly liquidation driven. In this particular case, though, I don't think it was. The next couple of paragraphs are short primers on some market features that most people are either unaware of or don't understand correctly.
Short Selling
By the way, this is not to be confused with a short sale on a house or land, which is a completely different situation.
There are a lot of misconceptions about short selling. Short sellers are sometimes demonized in the financial press as vultures or bottom feeders who drive down the share prices of good companies and ruin the stockholders. They've even been blamed for putting good companies out of business. Well, I can tell you this -- short sellers never put a good company out of business that was properly capitalized, and I'm honestly not sure they've ever put a company out of business at all. But they've been used as excuses by a lot of turkeys who didn't want to confess that their companies were in the toilet before the short sellers ever found out about it.
Here's how short selling works if it's done legitimately. You want to short a company, you route it through the order entry system of your broker, and the broker checks to see if there are any shares available for you to borrow to short sell. I know that's how it works because I've been that far in the process myself. If there are no shares available to borrow you'll get a message back that they can't process the request because no shares could be borrowed for you to short. Presumably if the shares could be borrowed they would be borrowed, they would be sold at the short sale price you specified, and the sale proceeds minus any commissions or fees would be deposited into your account. You are then on the hook to deliver an equivalent number of shares back to the brokerage house by a certain date. What the short seller is betting is that the share price of the instrument they short sold will decline between the time they sold the borrowed shares and the time they have to buy shares to deliver back to the broker. It's an ingenious concept, and it's been around since a Dutch broker or trader invented the concept of short selling shares back in the 1600s or 1700s.
That's a short primer on short selling. There is another form of short selling where some of the formalities are ignored, which is probably why it's usually technically illegal ... but still widely practiced in some quarters.
Naked Short Selling
The only difference between "naked" short selling and short selling is that when someone is engaged in naked short selling they ignore one little requirement. They don't bother actually finding shares they can borrow of the equity or instrument they want to short sell, so they just pretend they have them and sell them anyway. That's probably why the practice is "technically" illegal.
The practice has probably been going on almost as long as short selling has. I know that naked short selling was a regular feature in the bear raids that Wall Streeters launched on each other back in the days when Commodore Vanderbilt once brought the Street to its knees by engineering a short squeeze on a firm he controlled that they were naked shorting. It ended well for Vanderbilt and badly for the naked shorters, which is probably why they stopped launching bear raids against his firms.
In any event, selling naked shorts is a convenient way to knock the stuffing out of a market you want to cause to crash. Just like what happened to the gold futures market last Friday. I'm not saying that's what happened, but it is certainly a possibility.
The Suspects
Assuming someone did intentionally crash the gold futures market last Friday, who would want to do it (the motive) and who would be able to do it (the means)? I know I couldn't do it, my broker won't let me naked short anything because they insist that I be able to borrow the shares of any security I want to short. But what if my brokerage house wanted to do it? They're a broker, they could probably sell the shares and just act as if they owned the security or contract.
Why would a broker do that, though? Well, they could do it to make money. It's kind of a nasty way to make money though. If you can dump enough shares into a market to cause it to crash, and then buy the shares back for 20% or 30% less than you sold them for, most of that money is profit. Now, once again, if you or I did that, we'd probably get investigated by the SEC or the CFTC or some other alphabet soup government enforcement organization and we'd probably end up serving some hard time in Sing Sing or some federal prison. But hey, no one on Wall Street has been thrown in jail over the last several years except for Bernie Madoff, so if you work on Wall Street you're pretty much immune from prosecution, right?
But, other than the profit motive, is there some entity or entities that would have a specific interest in taking the wind out of the sails of the gold market? Well actually, there is. If you go back to that quote from Paul Volcker, there it is in black and white:
"Joint intervention in gold sales to prevent a steep rise in the price of gold, however, was not undertaken. That was a mistake."
See, here's the rub. Central banks all over the world want to have the power to trash their own currencies and fuck over the people that hold the government bonds of their countries. But they don't want the price of gold to signal to the markets what is going on. They want to have their cake and eat it too.
If we follow that premise then who was responsible for the drive-by shooting of gold last week? Well, the likely suspects are either the Fed (directly) or one of the primary dealers (like JP Morgan Chase or Bank of America) or some other entity that is a shareholder in the Fed. What, you didn't know that the Federal Reserve System is owned by banks? Sorry, I forgot to mention that earlier.
I'm not sure it really matters who did it, if it was done. I think it was hedge fund guru Kyle Bass who said recently, "We don't have free markets any more, we just have interventions".
The Catalyst
Assuming that events have played out as I postulated, what was behind the timing of the strike last Friday?
I mentioned during "The Great Retrenchment" that gold traded sideways for the better part of a year and a half. "Sideways" isn't exactly the best way to describe it. Gold would rally sometimes for a few weeks. Then it would get smashed, much like it did last week, but not as severely. But there seemed to be a pattern to the trading activity. There were two scenarios that seemed to lead to flash smashes in gold, one foreseeable by mere mortals, the other one not so much.
On trading days where futures options were due to expire at the end of the day, there were obviously concerted efforts to smash the price of gold and silver down. The clear motive in those cases was to cause the futures call options to expire worthless, so that whatever entity was on the other side of that trade could make a few extra shekels.
The other scenario that is only noticeable in hindsight is that when really bad news comes out, either macroeconomic or some specific scenario playing out, we're talking bad employment numbers, another crisis in Europe, some central bank intervention gone bad, something that would be bullish for gold and/or silver and drive the price up, the release of those news items is frequently preceded by a flash smash on gold and silver.
Does this sound like conspiracy theory bullshit? You bet your sweet ass it does! Does that mean it's not true? Absolutely not! Ask the Jews of Germany and Austria if Hitler and the Nazis were conspiring to murder them. If you asked them in 1937 they would have probably said, "No, you're crazy! Mistreat us, treat us like dirt, take our possessions, drive us out of the country, yes! But murder, no! They are not animals, are they?"
Ask that same question in 1945, of the Jews you could find that were alive, and you would get a different answer.
Ask the citizens of the United States in 1933 if the government was conspiring to steal their money and devalue it behind their backs. Negatory, Couldn't happen. No way Jose. Well, guess again, chumps.
Why We Fight
So, of course, there is the question. Why not just give up and get out of those gold and silver positions? You can't fight the Fed, you can't fight the system, you can't fight the government, you can't fight the Establishment. Give it up and get into the stock market like all the other sheep and make your money on the investments that are sanctioned and approved by the Powers That Be.
Well, here's the reasoning that I have. The stock market is a train wreck just waiting to happen. They can ramp it all they want but when the day of reckoning comes, nothing is going to be able to save the equities from a death spiral. The only thing I can think of that might save them (in nominal terms) would be a hyperinflationary dollar crash which would ramp the market in "dollars" but still leave you with pennies in inflation-adjusted dollars. The Japanese managed to ramp their stock market too, back in the day. I've looked at what the Nikkei is trading at lately and it's pathetic.
You can't stay in cash, not long term. The Fed is trashing the dollar, they've been doing it for a hundred years and they're going to continue doing it as long as the Fed exists. The Bank of Japan just announced they are going to double the monetary base in Japan over the next 18 months, how do you think that's going to work out? Cash only works in a stable environment or a deflationary environment, it's complete crap once you get into high enough inflation. And make no mistake, the Fed will not tolerate deflation. Everything they have done over the last five years is to combat deflation. Deflation will kill the banks and it will kill the government if they have to pay back that debt in money that's worth as much as it was when they borrowed it. The Fed will trigger hyperinflation before they will allow deflation to happen. And if they do trigger hyperinflation, gold, silver, food, water, guns, ammunition and medicines will be the most valuable things you can hold.
My ancestry is mostly Scots and Scots-Irish. We never back down from a fight, even one we know we're going to lose. You want a fight, bitches, well, bring it on! I will sell my gold and silver when I have to, and not a second before. We'll see if they can shake it loose before the Comex defaults and if the Comex defaults all hell will break loose.
The Comex, for those of you not in the know, is the Comex division of the NYMEX, the New York Mercantile Exchange. The Comex is where commodities futures contracts are traded in the United States. A default in the Comex would either break the bank on commodities trading or (more likely) show that the current system is already completely broken and has been systematically corrupted.
That may ultimately be what the price action of the last week was about, the Comex may actually be on the verge of default, and that would be the kind of thing that would bring on some desperate attempts to quash the price of the precious metals.
The other question I have to ask myself is, other than trying to discourage people from holding gold and silver because fake money is always going to be threatened by the real thing, are they trying to shake people out of the precious metals so they can replicate what Roosevelt did in 1933? Are they trying to shake loose the weak players so they can buy up all the gold and silver, switch course and then go long on it and use it to back a new American currency? The Chinese are not making much of a secret of it, they want to have the Yuan/Renminbi supplant the Dollar as the world's reserve currency. It just blows my mind how much gold they've been able to suck out of the western world by the ongoing price shenanigans in the precious metals. What do we think we're going to do, let them buy it all and then invade them to get it back? I don't think so.
I realize now, as I am about to wind this section up, that I never got around to the second teaser in my headline "A Random Walk Down the Corridors of Modern Finance and the Mazes of Central Planning". I guess a lot of what the Fed does could be considered central economic planning. It didn't work out that well for the Soviet Union and I don't think it's working out that well here. I will leave you with this thought as far as central planning goes. If the United States currency collapses and some significant segment of the economy collapses (above and beyond the current slow motion collapse we are already seeing), could that trigger a break up of the entire country, such as we saw with the Soviet Union in 1991?
I'd like to discuss that in the next segment. Not sure when I'll get around to writing it (this has been a whole day that I should have spent looking for a job) but the whole precious metals thing got me so worked up I had to write about it.
As I have written these words, multiple bomb explosions took place today at the Boston Marathon and have apparently killed three people and injured scores more. My prayers go out to them and their families. Boston is a wonderful city and I have really enjoyed my visits there, it saddens me to think of it as being the scene of this kind of senseless violence.