The Disappearing Gold

by Jeff Thomas
International Man

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During the Cold War, Germany moved much of its gold to New York in case the USSR invaded Germany. It was assumed at that time that the US would be a safer storage location, and of course, they could always ask to have it returned if they wished.

But German citizens have become increasingly worried about the security of the 1,536 tonnes of German gold reputedly held at the Federal Reserve in New York. This has resulted in the Bundesbank pursuing repatriation of the gold, beginning with a request to view it in the basement of the Federal Reserve Building, where it is claimed to reside.

Of course, the German government had received periodic assurances from the Fed that the gold is there; however, the issue began to get a bit sticky recently, when the Fed refused a request for inspection.

The world then raised a collective eyebrow, and, whilst not panicking over this development just yet, closer attention has come to bear, not only on the Fed, but on any institution that is entrusted with the storage of gold for other parties.

Concern spread to Austria, where a question arose in Parliament as to where Austria’s gold is stored. The answer provided was that 80% of it (224.4 tonnes) is in the UK. (It was claimed that the reason for this is that, if a crisis of some kind were to occur, it could be more easily traded from London than from Vienna.)

Seems reasonable enough, except that the return of the gold to Austria, if it were requested, may be a bit difficult, as the gold seems to have been leased out by the UK.

To many, a second eyebrow might go up at this point. Lease out the wealth of another nation? Isn’t this a bit… irresponsible?

The New Gold Shuffle

Not to worry, it’s done all the time. In fact, the practice has been endorsed by none other than Alan Greenspan, former Chairman of the Fed. The gold is leased to a bullion bank, which typically pays one percent interest to the Fed, with a promise to return it on a specified date. The bullion bank then sells the gold on the open market and uses the proceeds to buy Treasury bonds, which will net a three to four percent return.

The nicest thing about such an arrangement is that the lessor continues to claim it on his balance sheet as a line item: “gold and gold receivables.” After all, an asset that we have leased out is still an asset, even if it has now been sold by the lessee.

In effect, this means that, if you bought a gold bar today, it is possible that it is a bar that was shipped from the Bundesbank to the Federal Reserve decades ago and is presently listed by the Fed on its balance sheet as “gold and gold receivables.”

Both you and the Fed are claiming to possess the same gold bar. The fly in the ointment, of course, is that only one bar can be the actual bar. The other is a receivable and therefore is an asset on paper only. This, of course, means that there is less gold in the world than has been claimed. How much less? That’s anyone’s guess.

The New Risks

But even if it became generally known that the Fed (and others) are holding paper, rather than physical gold, couldn’t we carry on as before? What could go wrong? Here are some immediate possibilities:

If there were a dramatic rise in the price of gold and the lessor were to call in the return of the gold by the bullion bank, the bullion bank could easily lose far more than the small two to three percent margin it had been enjoying.

If there were a crash in the bond market and hyperinflation set in, the bonds that the bullion bank had purchased could become worthless.

If the nations who shipped their gold to London and New York for safekeeping were to request their return, the storage banks could only deliver if they were to purchase gold at the current rate. If that rate were significantly above the rate at which the gold had been leased to the bullion banks, the storage banks would sustain a significant, possibly unsustainable, loss.

That’s quite a bit of risk.

In the present market, there are any number of possible triggers that could cause the people of Germany, Austria, or a host of other nations to demand that their gold be returned home. Indeed, pressure is on the increase. The governments who have shipped out their gold for “safekeeping” would have a lot of explaining to do to their constituents, if the storage banks are not forthcoming.

So, is it time for the odiferous effluvium to hit the fan? Not quite yet. Before that occurs, there will still be some dancing around by the Fed and others.

The Fed has already stated, in so many words, “We’re sorry, but we can’t let you have all your gold at one time, but we’d be prepared to send it to you over a period of years.”

For many observers, the present situation should be well beyond the point of the raised eyebrow. It should be glaringly apparent that the amount of gold presently claimed to be in storage in the world’s banks is, to a greater or lesser extent, overstated.

Continuing the Charade

The Bundesbank should, of course, now say, “I’m afraid that’s not good enough. It’s our gold. We’ve advised you how much of it we want back now, and we must insist that you produce it immediately.”

If they were to take this perfectly logical step and the Fed refused, there could be a run on the banks, and, very possibly, within as short a period as twenty-four hours, a worldwide bank holiday might be declared with regard to gold.

However, this is not what will transpire. Neither logic nor sound banking practices are the object here. The object is to maintain the charade that exists within the banking community. The Bundesbank is just as fearful of a run as the Fed and will be only too willing to accept the Fed’s terms.

What must be borne in mind is the root cause of the request. It was not the Bundesbank itself that originally wanted the transfer to take place; it was the German people who, quite rightly, have become distrustful of the fact that their gold has been in New York for so long and want to see it repatriated. It is not the banks who wish to correct the situation. Not one bank wishes to expose the inappropriate practices of any other bank. Their loyalty is to each other and not to their depositors.

So, is that it? Have we heard the last of this issue? I think not. The cat is out of the bag at this point, and the depositors’ distrust and uncertainty will not be quelled by the counter-offer. Tension will continue to mount amongst depositors, and, at some point, the situation will reach an impasse.

All those who presently have gold in a banking institution would be prudent to keep an eye on the present situation. We might consider taking delivery of any gold we have in a bank, wherever it may be. Regardless of what form it is in, from ETFs to allocated gold, we would do well to assess the degree to which we feel our gold is at risk. In doing so, we may determine that a gold account is more at risk in, say, a New York or London bank than a Swiss bank. (Not all banks will be equal in terms of risk.)

If we do resolve to divest ourselves of bank-related precious metal holdings, it would be prudent to take action soon. (Clearly, those who attempt to remove their wealth the day after a run has occurred tend to do less well than those who attempt to remove their wealth the day before the run.)

We might also consider whether a possible run may become systemic, causing a bank holiday on all the bank’s activities, thus freezing any currency that we may have on deposit. We may conclude that it is prudent to only retain in our bank enough money to allow cheques to clear – an amount sufficient to cover a few months’ expenses.

In the near future, we may well find that a significant amount of gold that is claimed to exist in the world will “disappear.” Whilst we cannot control this eventuality, we may be able to save the gold that is being held in our names from disappearing.

Reprinted from International Man with permission.

January 31, 2013

Jeff Thomas [send him mail] is British and resides in the Caribbean. The son of an economist and historian, he learned early to be distrustful of governments as a general principle. He began his study of economics around 1990, learning initially from Sir John Templeton, then Harry Schulz and Doug Casey and later others of an Austrian persuasion.

Copyright © 2013 International Man

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