The Restructure of the Monetary System - Gold's Role Redefined
by James Sinclair, Jan 30/03
Bull Market is Born in 2004
Dear Mr. Sinclair,
Q: Being aware of the fact that economic policies of your country have consequences for the whole world, I am directing these queries to you from a small island in the Caribbean, which is Curacao, the Netherlands Antilles.
A: I do not take the position that the world revolves around the dollar as some form of a reincarnation of the policy of "Manifest Destiny". We have to analyze markets this way because of the excellent selling job the World Bank and IMF have done in promoting the almost universally accepted "Dollar Reserve Policy" on this planet.
Q: I understood from your memo on the future price of gold that Mr. Greenspan plans to curb the present trend of devaluation of the dollar by increasing the price of the Gold certificates, which partially back the liabilities of the Federal Reserve Banks, towards the market value of gold. To be able to do this USA has to buy more gold at present market value.
A: Right now there is no tie between gold's market value, treasury gold and the US dollar other than as another asset of reserve status. That means just another asset held by the US Treasury on behalf of the United States.
In order to answer your question completely, we also need to review a few concepts and a little history:
1/ Gold's convertibility for a currency is a control mechanism of a disciplinary nature attached to trade considerations. The convertible attribute of the dollar to gold, when it existed, worked to discipline the balance of trade by outflow and inflow economic implications of a reserve asset - gold.
2/ The Federal Reserve Gold Certificate Ratio, known as the Gold Cover Clause historically, when triggered affected interest rate adjustments by edict. Therefore, this mechanism had the effect and implication that today are focused as the result of decisions made by the Federal Reserve Board concerning the expansion and contraction of monetary stock or simply the amount of money in circulation.
3/ The problems today have their genesis not as much from imbalances in trade which tends to be more a result than a cause. The cause of today's problems traces its roots back in the Nixon Administration when the Federal Reserve Gold Certificate ratio was reduced to 0%. Historically it was as high as 45%. When working, that ratio meant that the value of gold held fell below this percentage point as compared to Treasury liabilities interest rate penalties caused a general increase in interest rates that would work to control the impact of too much money in the system. The Federal Reserve gold Certificate ratio is NOT coming back in that form.
4/ Gold convertibility is not coming back because dealing with effects is like treating the symptom and not the disease.
5/ Although the Chicago School of Monetary Theory seems to be as dead as a door nail with its major proponent now sounding more like Bernanke concerning the Fed.'s electronic money printing press, their "Trained Horse Theory" will be reincarnated. That theory said that you had a trained horse as Chairman of the Federal Reserve rather than a human bespeckled professorial sage. This horse would be brought into the Fed boardroom with proper precautions taken. The board would put the question to the horse once a year concerning M3 growth targets. The horse upon hearing this question yearly would stomp it's foot three times. The decision was made. M3 maximum growth that year would be 3%. Growing economic engines always require more grease in their wheels. The grease of the economic wheel is money supply. Grow it by the "Equine Method" is a simplistic reduction of the Chicago School of Monetary Theory thesis. In a new form the Chicago School of Monetary Theory Equine M3 method is coming back into the halls of acceptance. I can envision those personages that look over their noses while wearing reading glasses sitting in the leather chairs, sipping an armanyaq at the London Society of Economists Club and declaring in low but definitive terms: "Well done 3%."
6/ The problem the world has now is a predictable fall out from a situation of too many dollars. All was well as long as the planet soaked up all the dollars that the USA exported into the total international monetary system. The US's sales force is the IMF and World Bank. They successfully sold the idea of the Dollar Reserve Policy that functioned by storing all these dollars in US Treasury instruments primarily as reserves of the various countries, even those today regarded as enemies of the state by the US.
However, in the floating currency system it was only time before the dollar bull market barrel rolled over into the dollar bear market barrel. That bearish US dollar roll over is now creating a serious rethinking of the real risk of holding only US Treasury instruments as the reserves of, for instance, the oil producing nations.
The Euro is valuable only as an inverse image of the dollar. That is because the Euro carries no name of any definitive state thereby enjoying a quasi freedom from the economic problems of the states that make up the currency package called the Euro. But in truth the tactic of selling US dollars and buying Euros is akin to jumping off one sinking ship into another sinking ship and therefore a solution to nothing long term.
6/ Because the problem is too many dollars and the only solution to the world's present recessionary economic problems is to produce more dollars as Governor of the US Federal Reserve Bernanke and Chairman Greenspan have promised. The US dollar is going lower.
7/ A continued decline of the US Dollar will at a minimum cause a deceleration in the purchasing of US Treasury instruments to serve as reserves of non-US state treasuries. A simple deceleration of this purchasing will significantly effect lower long and medium term bond markets thereby increasing key interest rates for businesses. All immediate means of sustaining economic activity are dollar negative.
8/ Soon, a fix will be needed for the dollar's weakness if the tax cutting plans of the Bush Administration are to begin to work in middle 2004.
9/ The US dollar will have to made as "Good as Gold" if there is not to be a sharp reversal of the dollar reserve policy internationally and gold selling policies of international central banks becomes as it did in the later 1970s, a gold buying policy. This should occur in 2004.
10/ The use of gold will actually support the dollar under these circumstances and produce a significant improvement in general equity values. However, this will be in unique manner.
11/ Since the cause of the problem is the political/economic imperative that has driven the expansion over the last 35 years of M3, the solution must be tied to a reversal of this phenomena without curtailing long term economic growth potential.
12/ Therefore, we will return to a modified Chicago School strategy plus a revitalized and modernized Federal Reserve Gold Certificate ratio not triggering interest rates but simply tied to the size of M3 growth at the rate of an excess of 3% per year. This will be palatable to the politicians and will work as a discipline of gold of sorts. Disciplines in a floating system are simple alarms systems. They ring when something happens. There is no changing to fixed from floating systems now. That horse is too far out of the barn. When the Federal Reserve Gold Certificate ratio is revitalized in its modernized form, whatever gold is in Treasury then according only to published statistics times the value of gold in the free market on that day will be deemed to be that value of gold that supports the amount of M3 then existing.
From that day forward, for M3 to grows beyond 3% per annum rate, the value of gold held by the US treasury will have to grow by whatever percent above 3% the aggregate grows at the rate calculated annually. So if the rate of growth of M3 were at 10% then the value of the gold held would have to grow by 7%. This could be accomplished simply because the free market price grew at that rate or because the US Treasury purchased enough gold to meet that requirement. This is a discipline by which the dollar would be made as "Good as Gold" and confidence could be restored in the dollar as a reserve asset to be held by non-US governments.
I look for this to happen when and if the US dollar trades at .76 as measured by the USDX. If it is not applied then I believe we will have two head and shoulder formations in the USDX and two necklines breaks which duplicate the charts of both Enron and GE. The price objective then for the dollar will be .62 USDX. Gold will rise above the key level of $529 and the opportunity to act in a positive mode utilizing gold in a dollar relationship is lost.
Assuming a pre-emptive remonetization of gold as it pertains to the US dollar, the effect on the free market for gold will be to cause it to halt its price appreciation or price depreciation at the point when the Federal Reserve Gold Certificate ratio is reintroduced in its modernized form. Gold then will trade above and below that point as a measure of the five fundamental elements that have always been causal to bull or bear market in the metal. Assuming that this method is adopted before gold trades above $529, then I would envision gold trading above or below by $50.
If this method is not adopted before gold trades above $529, subsequent market developments will prevent its use. The world will break down into three currency blocks, The US Dollar block, the Dinar and Gold block and the Euro. Economic power and political influence will shift away from the Dollar Block towards the Gold, the Gold Dinar, The Arab big six Euro/Gold Dinar and the Euro in that order of percentage gain.
Q: What effect would this have on the monetary policy? Wouldn't the consequence of this move mean a reduction of money supply (M2) and through this reduction an increase of inflation? Would highly appreciate your explanation. EM
A: This approach would not take the monetary policy decisions away from the Chairman of the Federal Reserve and the board itself but rather make those changes ring an alarm which then would call for more of another asset other than paper to be held by the US Treasury to offset and prevent a depreciation of the dollar. The dollar goes down not as much because there are too many made but because fewer people wish to hold them. This system would work to balance that situation so that more valuable gold or more gold at a value offsets the potential effect of too many dollars. The dollar is a market and unfortunately psychology plays a huge part in its valuation. Inflation or deflation have many other working factors such productivity, expansion or contraction of market for various wealth factors, commodity supply and demand situations etc.
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