Did December 2nd Mark the Beginning of the End for Paper Currencies?

Professor Emeritus of Mathematics Antal E. Fekete says that December 2nd marked the beginning of the end for paper currencies and wealth based on such currencies:

“It is no exaggeration to say that this event will trigger a tsunami wiping out the prosperity of the world.”

What’s he babbling on about?

Well, since at least 1972, the price of gold futures has been higher than the spot price of gold – a condition called “contango” by futures traders.

But on December 2nd, for pretty much the first time ever, the futures price went below the spot price – what futures traders call “backwardation” – and has stayed there for several days.

Fekete argues that this means that gold owners are hoarding their gold and simply won’t sell, because (1) they’re not confident that they’ll be able to buy it back in the future, and (2) they have lost all faith in paper currency. He writes:

“Once entrenched, backwardation in gold means that the cancer of the dollar has reached its terminal stages. The progressively evaporating trust in the value of the irredeemable dollar can no longer be stopped.

Negative basis (backwardation) means that people controlling the supply of monetary gold cannot be persuaded to part with it, regardless of the bait. These people are no speculators. They are neither Scrooges nor Shylocks. They are highly capable businessmen with a conservative frame of mind. They are determined to preserve their capital come hell or high water, for saner times, so they can re-deploy it under a saner government and a saner monetary system. Their instrument is the ownership of monetary gold. They blithely ignore the siren song promising risk-free profits. Indeed, they could sell their physical gold in the spot market and buy it back at a discount in the futures market for delivery in 30 days. In any other commodity, traders controlling supply would jump at the opportunity. The lure of risk-free profits would be irresistible. Not so in the case of gold. Owners refuse to be coaxed out of their gold holdings, however large the bait may be. Why?

Well, they don’t believe that the physical gold will be there and available for delivery in 30 days’ time. They don’t want to be stuck with paper gold, which is useless for their purposes of capital preservation.”

PhD economist James Conrad confirms the backwardation of gold:

Things … are changing fast … the first major mini-panic among COMEX gold short sellers happened last Friday. As of Wednesday morning, about 11,500 delivery demands for 100 ounce ingots were made at COMEX, which represents about 5% of the previous open interest. Another 2,000 contracts are still open, and a large percentage of those will probably demand delivery. These demands compare to the usual ½ to 1% of all contracts.***

European central banks no longer want to sell gold. China wants to buy 360 tons of it as soon as humanly possible, and as soon as it can be done without sending the price into the stratosphere. A close look at the Federal Reserve balance sheet tells us that Ben Bernanke eventually intends to devalue the U.S. dollar against gold***

Anyone who reads the written works of our Fed Chairman knows that Bernanke’s long term plan involves devaluing the dollar against gold. This is the exact opposite of most prior Fed Chairmen. He has overtly stated his intentions toward gold, many times, in various articles, speeches and treatises written before he became Fed Chairman. He often extols the virtues of former President Franklin Roosevelt’s gold revaluation/dollar devaluation, back in 1934, and credits it with saving the nation from the Great Depression. According to Bernanke, devaluation of the dollar against gold was so effective in stimulating economic activity that the stock market rose sharply in 1934, immediately thereafter. That is something that the Fed wants to see happen again.***

Huge international banking firms normally do not take metal deliveries from futures markets. They normally buy on the London spot market. The fact that they are demanding delivery from COMEX means one of two things. Either the London bullion exchanges have run out of gold, or these firms are finding it cheaper to buy gold as a “future” than as a spot exchange.

Smart traders at big firms may be buying on COMEX to sell into the spot market, for a profit. This pricing condition is known as “backwardation”. Backwardation is always the first sign that a huge price rise is about to happen. In the absence of backwardation, there is no rational explanation as to why HSBC, Bank of Nova Scotia(BNS), Goldman Sachs, and others are forcing COMEX to make large deliveries.

Is Conrad correct that Bernanke wants to devalue the dollar against gold? If so, that would be very bullish for gold, and we should all buy. Bernanke has indicated in his speeches that he believes that devaluation of the dollar against gold by FDR was the principal thing which stopped deflation during the Great Depression. But FDR’s actions took place under a gold-backed currency, which no longer exists. So would devaluing the dollar against gold really work? Conrad has previously written, “with the economy heading toward collapse, the possibility of a return to some kind of gold or silver standard, is quite strong“. So apparently Conrad believes that Bernanke will soon face a situation not that different from FDR, and will take similar steps.

However, Bernanke himself has indicated that he thinks that a gold standard increases the risk and severity of depression:

The extent to which a country adhered to the gold standard and the severity of its depression were closely linked. In particular, the longer that a country remained committed to gold, the deeper its depression and the later its recovery.***

If declines in the money supply induced by adherence to the gold standard were a principal reason for economic depression, then countries leaving gold earlier should have been able to avoid the worst of the Depression and begin an earlier process of recovery. The evidence strongly supports this implication.

So the devaluation argument may not be quite as strong as Conrad thinks.

Caveat: The dollar will eventually crash. But it may go way up before it does crash. Why? Because the European banks lent huge amounts to emerging countries (much more than the U.S.), and borrowers are teetering on the edge of default. In addition, the European central banks have recently slashed interest rates, so investors may flee the Euro in the next couple of weeks. So be careful – the dollar may soar much higher for some time before it crashes.

Note: Backwardation in the gold market has only previously occurred due to very temporary glitches lasting a few hours at a time.

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