Gold News

Sterling, gold and the Bernanke Put

The Bank of England can't fight inflation – or gold – thanks to US Fed policy...

"I ONLY KNOW of two men who really understand the true value of gold," remarked Nathan Mayer Rothschild, the Victorian gold magnate – "an obscure clerk in the basement vault of the Banque de Paris and one of the directors of the Bank of England.

   "Unfortunately, they disagree."

   Former owner and operator of England's Royal Mint Refinery, N.M.Rothschild was the primary gold agent to the Bank of England in the early 1800s. When the Bank of England's gold reserve was drained by the costs of the Napoleonic wars, down to 235,000 ounces (£1 million) against note issue liabilities of £15.5 million, it was Nathan who sent secret shipments of gold and silver to Wellington's army in Europe and financed the defeat of Napoleon.

   In 1825, it was Nathan who rescued the Bank of England and prevented the collapse of the entire British banking system, after a run on gold caused the collapse of 145 banks. And in 1919, when the Bank of England – determined to restore London as the main gold market – reached an agreement with seven South African mining houses to ship their gold to London for refining, it was the firm of N.M.Rothschild that got to sell that gold at the best price obtainable, giving the London market and the bullion brokers a chance to bid.

Head of the world's gold market for 85 years

   The London Gold Fix was set at the London merchant bank N.M.Rothschild from Sept. 1919 until April 2004. N.M.Rothschild had profound influence at the London Bullion Market, where trading volume was 42 million ounces of gold per day (more than twice South Africa's annual gold production), including dealings in physical, leased and forward sales.

   The Rothschild empire helped to establish and finance oil giant Royal Dutch Shell, cemented De Beer's control of the world's diamonds, and – following World War II – invested in vast areas of resource rich properties in Canada, and in base metals giant Rio Tinto. Legend has it that the Rothschild fortune measures in the trillions of dollars.

   Rothschild's huge stash of gold and natural resource shares is tailor made for the day when the public wakes up to the fraud of fiat currency. Nowadays, the clerks at Bank Paribas are working overtime, trying to determine the value of sub-prime US mortgage debt sitting in their vaults.

   European banks are afraid to lend money to each other, after two German banks nearly collapsed from the toxic US sub-prime slime. Eschewing a sense of responsibility, the Federal Reserve is expected to try and cover-up the mess, conjured-up and distributed by Wall Street brokers, by exercising the "Bernanke Put", or lowering the Federal funds rate and flooding the world with more US dollars.

Gold in Sterling: watching the Fed closely

   Gathered around a table in one of the Bank of England's grand meeting rooms, a select group of Britain's top gold traders could not believe what they heard. It was May 1999, and the gold price was stagnant around $275 per ounce after a long and extended bear market.

   The UK's Treasury chief Gordon Brown had decided to sell 400 tons, or more than half of the country's centuries old gold reserves – and in a move that astonished dealers, Mr Brown insisted on selling the gold in open auctions.

   The first sale drove the Spot Gold Price down to $254, the low-point of an 18-year slide. There were 17 auctions between July 1999 and March 2002, yielding an average of $275 an ounce. The proceeds were unwisely switched into 40% Euros, 40% US Dollars, and 20% Yen.

   Since March 2002, the US Dollar has plunged 42% against the British Pound, while the Japanese Yen is 23% lower against Sterling. Only the Euro has risen.

   With the Gold Market now trading at $680 an ounce, Mr Brown's decision to break ranks with the US, Japan, France, and Germany by selling 400 tons of its gold in 1999 has cost UK taxpayers more than £2 billion.

   But moving further away from monetary discipline, the Bank of England also oversaw the rapid expansion of the British M4 money supply, rising to 13% annual growth in July 2007, double its growth rate of March '02.

   The rapid expansion of the British M4 money supply, now growing at a 16-year record, is fueling house price inflation that ran at an annual 12.8% rate in August, up from 10.3% in the previous month.

   "Broad money is growing rapidly and that does pose an upside risk to the inflation forecast, so money certainly matters," confessed BoE chief Mervyn King in Nov. 2006. BoE hawk Andrew Sentance added on July 10th this year, "The rapid pace of money growth is a warning signal we should pay attention to."

   To regain some control of the UK's M4 money supply, the BoE hiked its base lending rate five times starting in late 2003, some 125 basis points higher to 5.75% – the highest level since April 2001.

   The last rate hike occurred on 5th July 2007. "The margin of spare capacity in businesses appears limited, and most indicators of pricing pressure remain elevated. The balance of risks to the outlook for inflation in the medium term lies to the upside," the BoE said.

   But the upside risks to UK inflation emanate from the double-digit growth of the British money supply. And while the BoE's baby-step rate hikes to 5.75% helped rein in M4 growth to 13% in July, they still leave the central bank far behind the monetary inflation curve.

   In order to lower the growth rate of M4 into single digits, the BoE would probably need to lift is base rate another 75 basis points to 6.50%. But the newly installed UK prime minister – Gordon Brown himself – argues there is little point using money supply targets to control inflation, since the relationship is not stable.

   "Rigid monetary rules that assume a fixed relationship between money and inflation do not produce reliable targets or policy," said Brown on June 10th.

BoE rate hikes trumped by the "Bernanke Put"

   The turf war between Mr Brown and Threadneedle Street over a quarter-point rate hike to 6% came to an abrupt halt on August 17th, when the US Federal Reserve decided in a hastily arranged meeting to exercise the "Bernanke Put".

   In an about face, the Fed lowered its discount rate by a half-point to 5.75%, and implied it would do whatever it takes to prevent the financial markets and US housing market from tumbling.

   On August 21st, Fed chief Bernanke told Senate Banking Committee Chairman Christopher Dodd that he was willing to use all the tools available to him to calm turbulent financial markets. Then on Sept 1st, Bernanke told a gathering of the world's top central bankers at Jackson Hole, Wyoming, that "the Federal Reserve stands ready to take additional actions as needed to provide liquidity and promote the orderly functioning of markets."

Gold in Sterling: the Bernanke Put

   Over the past decade, a pattern has emerged in the US financial markets. Every time there has been a financial crisis, the Fed has opened the money spigots and poured liquidity into the stock market to mute the impact on the real economy.

   The "Greenspan Put" was a bet that Easy Al would respond instinctively to financial crises by lowering short-term interest rates, putting a floor beneath US asset prices. Greenspan's response to the bursting of the Dot Com Bubble was to slash the Fed funds rate to less than zero in inflation adjusted terms for more than a year. Now Chicago futures traders are pricing in 75 basis points of Fed rate cuts to 4.50% by year's end, starting with a quarter-point cut on Sept 18th to ease the pain of Wall Street banks and brokers from the sub-prime mortgage slime.

   Most interesting, the upcoming exercise of the "Bernanke Put" is expected to begin at a time of elevated inflation pressures, high oil prices, and a weak US Dollar. The Fed itself admitted only a month ago that "although the downside risks to growth have increased somewhat, the FOMC's predominant policy concern remains the risk that inflation will fail to moderate as expected. Moreover, the high level of resource utilization has the potential to sustain those pressures."

   Meantime in London, the exercise of the "Bernanke Put" is putting a monkey wrench in the BoE's plan to hike its base lending rate to 6%. Other central banks in Australia, Canada, the Eurozone and Korea also find themselves in the same predicament – unable to lift short-term interest rates to control explosive money supply growth.

   Hiking interest rates overseas, while the Fed is lowering its rates in the US, could grease the skids under the US Dollar, knocking it into a violent free-fall. So like most other central banks, the BoE is engaged in a game of competitive currency devaluation with the Bernanke Fed.

   The BoE tolerates 13% growth of its M4 to counter the US money supply, which is also growing at a 13% annualized rate on the M3 measure. Today, with the exercise of the "Bernanke Put" on the horizon, it's possible that M3 growth might accelerate into un-chartered territory above 15%, up to levels that associated with hyper-inflation.

   Interest-rate differentials have already swung by 200 basis points in the British Pound's favor over the US Dollar, lifting Sterling from $1.83 a year ago to $2.02 at the start of Sept. Exercising the "Bernanke Put" could send the British Pound even higher, which in turn could persuade the BoE to put its rate hike campaign on ice – thus allowing double-digit M4 money supply growth to kindle higher UK inflation.

   In a very interesting twist, while central banks in the Eurozone, the US, Japan, Canada and Australia have all intervened to boost liquidity in their money markets, the Bank of England has not so far injected emergency cash into the UK banking system. European banks are afraid to lend money to each other, fearing the other side is dangerously exposed to toxic sub-prime US mortgage debt.

   BoE chief Mervyn King is reluctant to bail out banks that bought toxic US sub-prime slime. This means there is no "King Put" option, and interest rates in the UK Libor market have already undergone a quasi tightening.

   The six-month London interbank lending rate (Libor) jumped to 6.75% at the start of Sept, reaching its highest since 1998. The gap between the BoE's 5.75% base rate and six-month Libor widened to its greatest gap since the mid-'80s, indicating great uncertainty over the solvency of some banks.

   On Sept 2nd, Bob Diamond, chief executive of Barclays – the UK's third-largest bank – called for the BoE to inject greater liquidity into the UK money markets to relieve some of the upward pressure on Libor rates.

   "For the recovery to continue we need to find more ways to get liquidity into the short end of the curve. That's down to confidence, and that's down to the central banks. We've seen thoughtful moves by the Fed and the ECB."

Gold, Sterling & Britain's money supply

   Hind sight is the best sight, but if UK bankers could exchange their sub-prime slime for gold today, they would gladly jump at the opportunity. Instead, they pray for a BoE bailout.

   As Nathan Mayer Rothschild was fond of saying, "I care not what puppet is placed upon the throne of England to rule the Empire on which the sun never sets. The man that controls Britain's money supply controls the British Empire."

   Is the Gold Price now ready to sustain a powerful rally above $700 per ounce, fueled by the exercise of the "Bernanke Put"? What is the major psychological hurdle that the Gold Market must overcome, before climbing to higher ground? What's keeping gold down right now?

   The answers are revealed in the blockbuster Sept 7th edition of Global Money Trends, as well as extensive coverage oF the global credit crunch – plus its likely impact on global stock markets, the US Dollar, crude oil, copper, and other commodities.

   To subscribe now for only $165 per year, enjoying 44 weekly editions – including access to back issues – click here and join Global Money Trends now, or call toll free (within the United States) from Sunday through Thursday, 8am to 10pm EST, and Friday 8am to 5pm, on 866-553-1007.

   And remember – "at some point, you have to choose between trusting the natural stability of gold and the honesty and intelligence of members of the government," as George Bernard Shaw said in 1928.

   "With due respect for these gentlemen, I advise you, as long as the capitalist system lasts, to vote for gold."

GARY DORSCH is editor of the Global Money Trends newsletter. He worked as chief financial futures analyst for three clearing firms on the trading floor of the Chicago Mercantile Exchange before moving to the US and foreign equities trading desk of Charles Schwab and Co.

There he traded across 45 different exchanges, including Australia, Canada, Japan, Hong Kong, the Eurozone, London, Toronto, South Africa, Mexico and New Zealand. With extensive experience of forex, US high grade and corporate junk bonds, foreign government bonds, gold stocks, ADRs, a wide range of US equities and options as well as Canadian oil trusts, he wrote from 2000 to Sept. '05 a weekly newsletter, Foreign Currency Trends, for Charles Schwab's Global Investment department.

See the full archive of Gary Dorsch.


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