An Accident in Waiting

The price of gold dropped $20, and silver 43 cents. For reference, $20 was once worth just about an ounce of gold. Dollar was a unit of measure, a weight of gold equal to 1/20.67 ounce of fine gold.


A gold certificate from the time when the dollar still represented a fixed weight of gold [PT]


Today, it is an irredeemable currency, defined not as a unit of weight but as a unit of central bank liability which is backed by government debt, which is payable in this unit. The price of this unit is constantly changing, and mostly dropping. It is currently 1/1497 ounce.

It has dropped from 0.048 to .00067, which is a loss of over 98.6%. Gold, not consumer prices, should be used to measure changes in economic value over long periods of time. The cost of producing everything is vastly lower today than it was a century ago. Even with the added useless ingredients.

So using consumer prices to measure the dollar—which are themselves measured in dollars—is rather like using a falling chunk of wood to measure the velocity of a falling brick. The brick may be falling faster than the wood, but one should use sea level as the objective reference for altitude. And gold for economic value.

Anyways, stress in the repo market is not showing up as fear of counterparty risk. If it were, we would expect to see backwardation rear its head in the gold market. Nada. Does that mean that there aren’t systemic problems, built up over a decade of zero interest rates and other new perverse incentives, piled on top of all the perverse incentives that existed prior to—and caused—the 2008 crisis? Oh, there are problems aplenty.

It is just that market participants don’t fear them imminently. This may be because they expect the Fed and other central banks to jump on top of each incipient crisis, quashing it before it can blow up a major financial intermediary.

Of course, central bank intervention can no more prevent bank insolvency than jamming pennies in the fuse-box can prevent circuit overloading. It does two things. One, it postpones the problem. Two, it ensures the problem will be larger or even systemic. Instead of burning out a fuse, the penny approach causes the house to burn down.

Market participants do not look so far into the future. As Chuck Prince, then CEO of Citigroup said on July 10, 2007, just over a year before the crisis went thermonuclear:


“When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.”


Today, everyone believes the Fed will be faster to react and will act more decisively than it did back then. All taboos have been shattered, it has no reason to hesitate as it did before 2008. It is possible that there will be no more crises until the dollar and the monetary system collapse. Or, if there is a crisis, it will be something that no one recognizes as a problem.

One thing is for sure. The Fed recognizes that lack of liquidity can be a problem. Ergo, liquidity won’t be allowed to dry up and trigger a catastrophic process. Thus, last week’s Fed intervention in the repo market.

Another thing we would bet on: the system is now fragile enough that if another crisis gets going, it will carry a greater threat of banking system collapse than the crisis of 2008. So the Fed will act in any way it deems necessary to prevent this. Reason, morality, economics, and law be damned, if necessary.

Who knows how long they can keep it going? The Bank of Japan is about to enter the fourth decade of managing what has become a zombie system. For much of that time, observers have watched the debt to GDP ratio rise and rise, the interest rate approach zero, and other signs of The End.

It hasn’t come yet. So some economists of the Cargo Cult persuasion have said it never will. Meanwhile, indicators keep moving further into unsustainable territory.

Now, the same zombification is occurring in Switzerland, Germany, and other countries in Europe. The interest rate on long treasuries has resumed its fall.

Gold backwardation will be our early warning signal. The gold price will not tell us if risk is rising or defaults are imminent. Only the gold basis will indicate this.

Last week, we said:


“Whatever the ramifications of the repo crisis, they do not yet include systemic trust concerns. We do not expect the repo problem, in itself, to lead to such concerns or gold backwardation.”


And it did not, at least this week. And, like a respiratory distress patient in the Intensive Care Unit after a bad vape, survival after a week indicates a high probability of survival.


Fundamental Developments

We will look at the basis, which is the only true picture of the supply and demand fundamentals. But, first, here is the chart of the prices of gold and silver.


Gold and silver priced in USD


Next, this is a graph of the gold price measured in silver, otherwise known as the gold to silver ratio (see here for an explanation of bid and offer prices for the ratio). The ratio rose this week.


Gold-silver ratio, bid and offer


Here is the gold graph showing gold basis, co-basis and the price of the dollar in terms of gold price.


Gold basis, co-basis and the USD priced in milligrams of gold


The scarcity (i.e., the co-basis) rose a little bit this week. At least the near contract (but not the gold basis continuous). There is no profit to decarry gold. The profit is to carry it — that is buy gold and simultaneously sell it forward, warehousing it for the duration. For December, which is just 3 months, one can make about 1.7% annualized.

This week, the Monetary Metals Gold Fundamental Price fell $33, to $1,459.

Now let us look at silver.


Silver basis, co-basis and the USD priced in grams of silver


In silver, there was a small rise in the scarcity along with a big rise in the price of the dollar.

The Monetary Metals Silver Fundamental Price dropped 62 cents, to $17.30


© 2019 Monetary Metals


Charts by Monetary Metals


Chart and image captions by PT


Dr. Keith Weiner is the president of the Gold Standard Institute USA, and CEO of Monetary Metals. Keith is a leading authority in the areas of gold, money, and credit and has made important contributions to the development of trading techniques founded upon the analysis of bid-ask spreads. Keith is a sought after speaker and regularly writes on economics. He is an Objectivist, and has his PhD from the New Austrian School of Economics. He lives with his wife near Phoenix, Arizona.




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