During gold’s recent rise the US dollar has remained strong, which implies gold’s rise shows not just dollar weakness, but gold strength. This aspect of gold’s action in the past two weeks ought to encourage gold investors, but we shouldn’t overlook the deeper meaning.
Dennis Wheeler writes a thoughtful newsletter, Gold Stock Report. I always enjoy reading it, but sometimes Dennis really hits a home run. This month (2/02) he reached back to something John Exter used to talk about, the upside-down debt pyramid. (In 1991 interviewed Mr. Exter, a former Federal Reserve vice president, head of New York Fed gold operations in the early 1950s, and former Citibank executive. Again in October 1998 I reprinted that interview. You will also find it posted on our website, and I strongly recommend that you read it now.)
Dennis dwelt on Mr. Exter’s point that the present financial system resembles an upside down pyramid, with increasingly risky instruments and debts piled higher and broader over a tiny point of gold. In an economic collapse, investors and money flee down the pyramid away from riskier and toward safer instruments, finally landing on cash and gold. This “flight to quality” materializes in every financial panic. Dennis Wheeler comments,
“[S]o investors move farther down the pyramid until they come to cash, which is where they are now. Interest rates have fallen dramatically, as the price of cash instruments --- 90-day T-bills – have soared. But these investments, even though they pay virtually nothing at present, are much safer than the dot.com stocks were a few years ago. So T-bills find a good market as people seek safety.
“This explains why the dollar is rising. As the system collapses and investors seek safety, they are more concerned to assure themselves the return of capital rather than a return on capital.
“But, according to Exter, the cash, too, would fail in time. Then investors would move to the apex of the pyramid, the point of the highest quality of all – GOLD.
“This, too, is happening and that’s why we’re seeing gold and the dollar rise together against other investment vehicles, such as stocks and foreign currencies. Gold will be the only one standing at the end and those who have purchased early will have been able to buy a lot more for their dollars than those who come in later. Of course, the dollar price of gold will have risen substantially before the floodgates break and the global public comes rushing in [as the Japanese are now doing].” (end Wheeler quotation]
Here in this article I have illustrated John Exter’s upside down pyramid, but I have added something. Since I interviewed Mr. Exter over eleven years ago, derivatives of all types have ballooned into the largest and riskiest class of speculations. The Bank for International settlements estimates their notional value at $100 trillion world wide, over twelve times the US Gross Domestic Product.
The flight to quality is only beginning. No one has yet heard how far Enron’s tentacles had spread into the derivatives market, although before the bankruptcy it had transmogrified into one gigantic hedge fund. I have even heard that Enron’s sudden departure from electricity futures, for example, has sent that market tumbling. I don’t know whether that’s true, but in principle when any very big player dominates a market, removing him removes his bias from the market. Ahh, that makes me think of JP Morgan Chase, that now holds (by a margin of two-thirds) most of the positions in gold and interest rate derivatives. What a mess if they were forced to unwind that position! Or perhaps, the gold market is already offering us a peek at that unwinding.
-- F. Sanders The Moneychanger
Dennis Wheeler writes a thoughtful newsletter, Gold Stock Report. I always enjoy reading it, but sometimes Dennis really hits a home run. This month (2/02) he reached back to something John Exter used to talk about, the upside-down debt pyramid. (In 1991 interviewed Mr. Exter, a former Federal Reserve vice president, head of New York Fed gold operations in the early 1950s, and former Citibank executive. Again in October 1998 I reprinted that interview. You will also find it posted on our website, and I strongly recommend that you read it now.)
Dennis dwelt on Mr. Exter’s point that the present financial system resembles an upside down pyramid, with increasingly risky instruments and debts piled higher and broader over a tiny point of gold. In an economic collapse, investors and money flee down the pyramid away from riskier and toward safer instruments, finally landing on cash and gold. This “flight to quality” materializes in every financial panic. Dennis Wheeler comments,
“[S]o investors move farther down the pyramid until they come to cash, which is where they are now. Interest rates have fallen dramatically, as the price of cash instruments --- 90-day T-bills – have soared. But these investments, even though they pay virtually nothing at present, are much safer than the dot.com stocks were a few years ago. So T-bills find a good market as people seek safety.
“This explains why the dollar is rising. As the system collapses and investors seek safety, they are more concerned to assure themselves the return of capital rather than a return on capital.
“But, according to Exter, the cash, too, would fail in time. Then investors would move to the apex of the pyramid, the point of the highest quality of all – GOLD.
“This, too, is happening and that’s why we’re seeing gold and the dollar rise together against other investment vehicles, such as stocks and foreign currencies. Gold will be the only one standing at the end and those who have purchased early will have been able to buy a lot more for their dollars than those who come in later. Of course, the dollar price of gold will have risen substantially before the floodgates break and the global public comes rushing in [as the Japanese are now doing].” (end Wheeler quotation]
Here in this article I have illustrated John Exter’s upside down pyramid, but I have added something. Since I interviewed Mr. Exter over eleven years ago, derivatives of all types have ballooned into the largest and riskiest class of speculations. The Bank for International settlements estimates their notional value at $100 trillion world wide, over twelve times the US Gross Domestic Product.
The flight to quality is only beginning. No one has yet heard how far Enron’s tentacles had spread into the derivatives market, although before the bankruptcy it had transmogrified into one gigantic hedge fund. I have even heard that Enron’s sudden departure from electricity futures, for example, has sent that market tumbling. I don’t know whether that’s true, but in principle when any very big player dominates a market, removing him removes his bias from the market. Ahh, that makes me think of JP Morgan Chase, that now holds (by a margin of two-thirds) most of the positions in gold and interest rate derivatives. What a mess if they were forced to unwind that position! Or perhaps, the gold market is already offering us a peek at that unwinding.
-- F. Sanders The Moneychanger
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