How Much Imaginary Gold Has Been Sold?

By Adrian Douglas
Gold Anti-Trust Action Committee
Friday, October 16, 2009

http://www.gata.org/node/7908

On October 10 I published an article that postulated that the gold market is a Ponzi scheme because it sells gold that doesn't exist by implementation of the principles of fractional reserve banking. (See http://www.gata.org/node/7887.) Since writing that article further information has come to light that supports this claim and allows an estimate of how much gold has been sold that doesn't exist if the owners of the gold ask for it.

In other words, there are several owners for each ounce of physical gold.

By complete coincidence Paul Mylchreest of The Thunder Road Report has just written an in-depth study into the daily trading volumes of gold on the London over-the-counter market, which can be found here:

http://www.gata.org/files/ThunderRoadReport-10-15-2009.pdf

The London OTC market is where most physical gold is traded. This market is a wholesale market where trades are conducted only between the bullion trading houses on behalf of their clients. About 95 percent of the trading is by way of gold that is held in unallocated bullion accounts.

The unique characteristic of gold is that about 50 percent (80,000 tonnes) of the above-ground stocks are held as a store of wealth (investment). The other 50 percent exists as jewelry. When gold is bought as a store of wealth it can perform that function for you wherever it is in the world. Given this unique characteristic many large investors in bullion prefer to leave their gold with the bullion dealer from whom they bought it so that it can be stored in their vault and easily resold. This is identical to the situation with stocks, where most stock certificates are held by brokerage houses, not by individuals.

That people are buying and selling gold without ever taking delivery means that there is the opportunity for bullion houses to sell gold that doesn't exist.

Now the bullion houses probably don't view this as illegal or dishonest because they will operate a fractional reserve type of system, just as the banks do with fiat currency, and will make sure they have enough gold on hand for what would be the maximum estimated volume of gold that could be called for delivery. After all, trading is done with unallocated gold, so how much more unallocated can it get if it doesn't exist at all?

This is what caused bank runs in the days of the gold standard. People would deposit gold in a bank and receive bank notes (dollar bills) in exchange. At any time the depositor could return and hand over his bank notes and receive from the bank the same quantity of gold he deposited. The banks realized that under normal circumstances a maximum of about 10 percent of the gold deposited could be requested. So the banks saw an opportunity. They could issue up to 10 times as many bank notes in loans as there was gold in the bank and they could earn interest on the bank notes. The system worked until there was difficulty meeting withdrawals. Then word spread quickly that the bank was insolvent, and as holders of the banknotes rushed to the bank to redeem them for gold, the bank would admit it had insufficient gold and would declare bankruptcy.

The origin of the word "bankruptcy" is from the Latin words "bancus" and "ruptus," which means literally that the bank is broken. Banks have gone bust frequently enough to have earned themselves the ownership of the word to describe the phenomenon. Isn't that ironic when banks are meant to be a safe store for money?

This basic scam is at the center of modern gold market manipulation. Instead of real gold, paper substitutes for gold are sold through derivatives, futures, pooled accounts, exchange-traded funds, gold certificates, etc. I estimate that each actual physical ounce of gold has multiple ownership claims to it.

For the scam to be sustained there must always be plentiful physical gold for those who want it. The market is, in effect, a giant inverted pyramid with a huge paper gold market being supported by a small amount of physical gold at the tip of the inverted pyramid. The scam can continue until there are indications of a shortage of physical gold. If all the claimants of each ounce of real gold demand their gold, then there is the potential for a squeeze such as has never been seen before.

To lend support to the idea that all the gold in the world has been sold several times over I cite the case of Morgan Stanley, which was sued in 2005 for selling non-existent precious metals. Morgan Stanley even had the audacity to charge storage fees. The firm settled the class-action lawsuit out of court but no criminal charges were ever filed. If Morgan Stanley was doing this, you can bet that it is the tip of the iceberg.

Paul Mylchreest has done fabulously detailed research into data on the daily trading of gold on the London OTC market. He concludes that 2,134 tonnes of gold are traded each and every day. That is a shocking number because this is 346 times larger than all the gold that is mined in the world each day.

But this on its own is not sufficient evidence to indicate that the market is fraudulent. For example, if I have a 1-ounce gold coin and I have a hundred friends I could sell the coin to a friend and then he could immediately sell it back to me or sell it to one of my other friends, who could sell it back to me. If I were to transact with all my friends in the same day in this way, I could have turned over a volume of 100 ounces in trading transactions but no fraud would have occurred because the last friend I traded with owns the 1-ounce coin, even though it went through a hundred sets of hands before it got to him. There are no multiple ownership claims to the coin because the trades were sequential, not simultaneous.

But if I were to sell 1 ounce of gold to all my friends and promise I would keep the gold for them, the trading for the day would be 100 ounces but now fraud has been committed because I have a liability of 100 ounces while I have possession of only 1 ounce. If they never ask for the gold and I can pay them cash when they want to sell their gold, then there is a good chance my friends would be none the wiser ... until the day when at least two friends insist on receiving the 1-ounce coins they each supposedly own.

The daily gold trading in London is simply humongous. We talk of the gold market being a tiny market. It is anything but. It has a daily turnover of $70 billion. To put this in perspective, the world consumes 86 million barrels of oil each day. The total cost of the global daily oil consumption is a mere $6 billion!

But as discussed above, the daily volume traded does not in and of itself prove that a fraudulent fractional reserve operation is being conducted. Mylchreest did some more work using statistics from the GFMS metals consultancy to determine the maximum quantity of gold stock the OTC market could be holding with which it can back the huge daily trade volume. The gold that is traded has to be in the form of London Good Delivery (LGD) bars, which are 400-ounce bars. Mylchreest estimates that there can be only about 15,000 tonnes of such bars in the world. Let us assume that the London OTC market holds them all. We will show that by comparison with the trading of other unallocated gold products that 15,000 tonnes is nowhere near enough gold stock for the gold not to have more than one ownership claim to each ounce.

The purpose of buying investment gold is for it to store wealth. This necessarily implies that it is held for a long time. If gold is bought and traded quickly it would destroy wealth, not store it, because there would be a large loss due to transactional fees. The figures we have so far suggest that the entire stock of gold of the London gold market could be turned over every seven days (15,000 / 2,134 = 7). That would hardly be characteristic of a market that is supposed to be selling a "buy and hold" product. For the purposes of illustration, in a town of 15,000 houses would you expect 2,134 houses to be sold each day? Or that each house on average would have 52 owners during the year?

Let's compare how much of the inventory of the precious metal exchange-traded funds are traded each day to get a good idea about how frequently investors trade something they have bought as a store of wealth. The most liquid and highly traded ETF is GLD. It has 325 million shares outstanding and the fund trades on average 11.9 million shares each day. This means it trades one share each day for each 30 shares outstanding. Central Fund of Canada trades one share for each 140 shares outstanding, while the Gold Trust Unit trades one share for each 300 shares outstanding.

The GLD ETF is a way of buying, holding, or selling unallocated gold. One would expect the investors' behavior in this ETF would be similar to those trading the unallocated accounts on the OTC. If the investor trading mentality on the London OTC is similar, then 2,134 tonnes should be 1/30th of the gold stock held by the OTC. This equates to 64,000 tonnes of gold. But Mylchreest estimates that the OTC can hold no more than 15,000 tonnes because that is the entire global stock of LGD bars. If we use the CEF example, the stock would have to be 298,000 tonnes, or by the GTU example it would have to be 640,000 tonnes.

Probably the GLD comparison is the most relevant, as that exchange-traded fund claims to hold 1,100 tonnes gold, which is comparable to the maximum 15,000 tonnes that could be held by the OTC participants. However, the OTC is restricted to wholesale traders and has a minimum trade limit of 1,000 ounces. In GLD the minimum trade is a tenth of an ounce and trading is open to everyone. Considering these limitations it is likely that OTC participants would turn over a lot less than 1/30th of the inventory in a day. But even taking the GLD estimate, the OTC participants should be holding 64,000 tonnes when according to what can be deduced from GFMS statistics they can be holding only 15,000 tonnes.

This means that each ounce has at least four owners. I think this is probably very conservative because the GLD vehicle is set up to be easily traded and in units as small as a tenth of an ounce. I would guess that it is more likely to be as high as 10 or even 20 owners to every ounce, particularly when the banking world has used a 5-10 percent reserve ratio with fiat money for a long time and bankers are creatures of habit.

This would imply that the liability for unallocated gold that has been sold is probably closer to 150,000 tonnes (taking the more conservative 10 percent figure), but the liability is backed by a totally inadequate maximum of only 15,000 tonnes of physical gold. So it's likely that between 45,000 and 135,000 tonnes of unallocated gold has been sold that does not exist.

This is between 50 and 170 percent of the entire existing investment gold stock that has taken 6,000 years to mine and accumulate.

We are hearing of more and more cases of gold investors wanting to take physical delivery or have allocated gold.

In my recent article I said:

"A couple of months ago Greenlight Capital, the large hedge fund, switched $500 million of investment in GLD to physical gold bullion. ... Apparently Germany has requested that its sovereign gold held by the New York Federal Reserve Bank be returned to Germany. Hong Kong has requested the same of the Bank of England, which stores its sovereign gold. Robert Fisk, a respected journalist for the UK's Independent newspaper, reported this week that the Arab oil-producing states, Japan, Russia, and China have been holding secret talks to replace the dollar as the international reserve currency and as an accounting unit for trade. He reports that the basket of currencies they propose instead of the dollar would include gold. If gold is going to regain its monetary role, then you can understand why those in the know want actual physical bullion. There are some very real and significant signs that a run on the Bank of the Gold Cartel for physical gold is commencing."

Talking of runs on the bank, Rob Kirby of Kirby Analytics in Toronto, a GATA consultant, did some brilliant sleuthing work. His sources have told him that there was panic in the London gold market around September 30 as participants in the market wanted to take delivery of their purchased gold and refused generous cash settlements that were offered instead. Central banks had to come to the rescue to provide the gold via leasing. Apparently even the central banks could not provide bars that met LGD standards, which indicates that an acute shortage of physical gold is developing and that perhaps already many OTC clients have drained a large proportion of the 15,000 tonnes of gold stock from the London OTC market.

This supports what I have been discussing above.

Paul Walker, CEO of GFMS, recently said that gold was going up because of some "large lumpy transactions in a market with a degree of illiquidity."

If the OTC was selling only gold that the participants own, there could never be a lack of liquidity. The panic that occurred at the end of September confirms that there is a chronic lack of liquidity. This necessarily implies that there is multiple ownership of the same ounce of gold and it is, therefore, fraudulent. Leasing of gold from central banks provides only temporary liquidity, because the central banks want their gold returned at some later date, and it looks as if the bullion bankers may have dipped into that well one too many times already.

The gold market is in a precarious position. Just as in the days of the gold standard it requires only one customer not having his deposit returned to bring down the bank, because a domino effect results in all depositors asking for their deposits to be returned. If my estimates are correct, that somewhere between 64,000 and 150,000 tonnes of gold have been sold against a reserve of only 15,000 tonnes.

But how much of even this 15,000 tonnes remains?

The panic at the end of September suggests that liquidity is very tight, in which case only a small percentage of investors asking for their gold to be delivered or placed in an allocated account will blow up the gold market and expose the scam -- a scam that has been repeated time and time again throughout history. Why should this time be any different?

If you think you own gold, you should take a few precautions.

If you have unallocated gold in some sort of pool account that does not have a satisfactory audit or you own shares in an ETF that does not have a reliable audit, take action. Take delivery of gold or move your investment to reliable and audited allocated storage.

If you do nothing about it and when the music stops you are left with just a piece of paper that says you own gold but no one is able to give it to you, then perhaps you will be able to take comfort in your having dismissed the German government, the Hong Kong government, Greenlight Capital, and many others as a bunch of nuts who don't know as much as you do about counterparty risk in the gold market. But the "nuts" who are realizing that there are multiple claims to each ounce of gold will at least have their gold if they ask for it first.

Adrian Douglas is a member of GATA's Board of Directors and editor of the Market Force Analysis letter. Reprinted with permission. "How Much Imaginary Gold Has Been Sold? Part 2", October 18, 2009, can be found here.

For further reading:
"The Gold Basis is Dead - Long Live the Gold Basis!", Antal E. Fekete, October 18, 2009
"Don't ease up yet on MorganChase, CFTC", Adrian Douglas, August 22, 2009
"Getting to the bottom of negative gold-leasing rates", Izabella Kaminska, July 15, 2009
"Remobilize Gold to Save the World Economy!", Antal E. Fekete, July 10, 2009
"The gold backwardation theory", Izabella Kaminska, December 9, 2008

Latvia Goes "No Bid"

By Steve Goldstein
MarketWatch
Wednesday, October 7, 2009

http://www.marketwatch.com/story/the-latvia-domino-may-be-ready-to-fall-2009-10-07

LONDON -- It's never good news when a government bond auction fails. It's particularly bad news when an auction fails for a note maturing in just six months. And it's really bad news when there isn't any bid at all.

Yet that's what happened Wednesday when Latvia tried to sell close to $17 million of paper. It's not hard to figure out why.

The Baltic country is squabbling with Western -- mostly Swedish -- leaders over spending cuts, and it's a very real possibility that the country may be forced to devalue its euro-pegged currency if emergency global funds don't arrive.

Latvia, like Baltic neighbors Estonia and Lithuania, were republics of the Soviet Union from 1940 to 1991.

Were Latvia to devalue, that would hit economies in neighboring countries like Lithuania, and Swedish banks would rack up additional losses on the loans they have made throughout the region.

The real nightmare scenario would be the Swedish banks then pulling down other European banks, and then triggering Credit Crunch: Part 2.

There is, of course, a long way before that unwieldy scenario comes to pass. Latvia hasn't devalued -- yet - and, even if it does, that doesn't mean it would drag the Swedish banks under.

Lenders like Swedbank -- which has more branches in the Baltic countries and Ukraine than in Sweden -- have endured plenty of losses, and Swedbank, for one, just raised more than $2 billion to weather stormier times. See earlier story.

Still, investors might recall a minor matter involving teaser loans that only took down the entire world economy.

Not every domino falls. But there's one that's looking shaky.

Steve Goldstein is MarketWatch's London bureau chief.

For further reading:
"Latvia could cope with controlled devaluation", Reuters, October 16, 2009
"Lessons of the lat", The Economist, October 15, 2009
"Latvia's Woes Rise as Auction Fails", Wall Street Journal, October 8, 2009

Are Online Currencies Striking Gold?

By Duncan Jefferies
The Guardian
Wednesday, October 14, 2009

http://www.guardian.co.uk/technology/2009/oct/14/online-currencies-striking-gold/print

The economies of virtual worlds and social networks are growing in strength and sophistication – with real-world consequences


Without the gold standard, argues consultant Dave Birch, pounds are no more real than World of Warcraft gold. Photograph: Getty Images

Money. The stuff that makes the world go round. Every day we earn it, spend it, exchange it and lose it. But you won't find any Linden dollars, Eve ISK or Facebook credits down the back of the couch.

Virtual currencies like these are used for transactions in online worlds and social networking sites. While real-world currencies are on the slide, many virtual ones are going from strength to strength. In the second quarter of the year the equivalent of $144m (£91m) was traded on the LindeX, the official currency exchange of Second Life, where residents buy and sell Linden dollars for their US counterpart – a 20% increase on the previous quarter, while the US economy shrank by 1%. Trading activity increased by 6% in the last quarter of 2008.

"New ideas about money are beginning to evolve," says Dave Birch, a director of Consult Hyperion, a management consultancy that specialises in electronic transactions. "You'd have a tough job convincing me that the pound is any more 'real' than World of Warcraft gold. Where is your starting point? The UK hasn't had a gold standard for the past three generations."

Old money, new money

It's not the first time that virtual currencies have been mooted as the future of online payments. Several were launched in the late 1990s; but the likes of Beenz and Flooz were doomed to failure, suffering fraud and lack of consumer interest.

Lisa Rutherford, president of Twofish, which manages virtual economies for social, gaming and entertainment services, says the online landscape has changed. "If you've going to do a large-scale universal currency, you need to have a certain level of scale, and it needs to be serving a certain purpose. That's really what the fundamental shift has been."

Massively multiplayer online games have long featured complex virtual economies where players can purchase items and skills for their avatars. In Second Life, US dollars can be converted into Linden dollars and vice versa through channels in the virtual environment. Eve Online, however, operates a closed system: ISK brought by the player can only be used in the virtual environment, and conversion into real-world currency is prohibited.

Users caught breaching the rules are banned, but a black market has developed nonetheless; a Google search for "Eve ISK" lists hundreds of websites selling it along with other virtual currencies.

Eve Online's economy is now more or less player driven, says Eyjólfur Guðmundsson, a PhD economist who works for Eve Online's developer, CCP. "It is simply monitored by us just like any other economy in the real world is by a central bank, finance minister or national economic institute."

Without careful oversight, cash can accumulate in the system, causing inflation. Linden Lab uses several controls to keep the exchange rate in Second Life relatively stable at about 265 to the US dollar. These include the pricing and promotion of various "sinks", such as the cost of uploading content or posting classified ads, which remove currency from circulation. The volume of new Linden dollars available for purchase can also be adjusted.

Second Life's European residents pay VAT on some purchases in order to comply with EU tax regulations, and virtual economies could also be subject to further taxation in future.

"The controversy is whether taxable income is in fact created at the point when you obtain the virtual assets," says Vili Lehdonvirta, a researcher at the Helsinki Institute for Information Technology who studies virtual economies and goods.

Despite careful oversight, even virtual worlds are not immune to financial chicanery. Allegations of a massive theft recently started a run on EBANK, which handled deposits in Eve Online's ISK currency. One of the bank's founders was accused of stealing about 250 billion ISK, exchanging it for £3,115. A similar incident in Second Life led Linden Lab to prohibit residents from offering interest or any direct return on an investment without proof of "an applicable government registration statement or financial institution charter".

Lehdonvirta expects to see further regulation of virtual banking. "This is the direction it needs to go in the future if these virtual currencies are to be used as a serious platform for commerce," he says.

While some entrepreneurs keep a significant balance in their virtual accounts, most people have a relatively small amount stored online. "For example, while Second Life residents hold roughly $25m in Linden dollars, this is spread across millions of accounts," says Tom Hale, chief product officer at Linden Lab.

Big in China

By comparison, China has taken to virtual currencies in a big way. Last year nearly $2bn of virtual money changed hands in the country, according to the China Internet Network Information Centre. Most virtual currency is spent on virtual items, but Chinese consumers also use it to purchase physical goods and services – a practice the Chinese government recently clamped down on.

Social networks have also launched their own currencies. Facebook credits can be used to buy virtual gifts – such as cupcakes, toys and flowers – from the Facebook Gift Shop. Select developers may soon be able to incorporate Facebook credits into their games and applications, with Facebook getting a cut of the profits. Business Week recently reported that Zynga, creators of the Mafia Wars Facebook game, could make $100m from its virtual offerings this year, mostly from Facebook sales.

Startups such as Jambool and Spare Change have launched virtual currencies that are interoperable across a range of games, applications and social networks, but Twofish's Rutherford believes only a company of Facebook's size can deliver the "brand promise" that would give a universal currency widespread appeal. Hale thinks that eventually there will be "a few dominant virtual currencies that by dint of their size become exchange currencies, just as the US dollar is to the global economy today".

With faith in real-world currencies shaken by the financial crisis, perhaps virtual ones will find a more receptive mainstream audience in future.

When Money Becomes Worthless

By Martin Hutchinson
PrudentBear.com
Monday, October 12, 2009

http://www.prudentbear.com/index.php/thebearslairview?art_id=10296

The Financial Times last Tuesday noted a disturbing new trend – hedge fund and other investors are increasingly seeking to invest in physical commodities themselves, rather than in futures. Given the excess of global liquidity, this is not entirely surprising. It does, however, raise an ominous possibility of a supply shortage in one or more commodities, caused by investor demand that exceeds available mine output and inventory. That could potentially produce a collapse in economic activity similar to that from the 1837-41 and 1929-33 liquidity busts, but with the opposite cause.

The problem arises because of the size of the world's capital pools in relation to its volume of trade. The total assets of U.S. hedge funds in September 2009 were $1.95 trillion (down from almost $3 trillion a year earlier). That compares with total U.S. imports of goods and services in 2008 of $2.1 trillion. However, in addition to the hedge funds, there are other huge pools of money available for deployment in commodities markets. For example China and Japan each have around $2 trillion of foreign exchange reserves, while Saudi Arabia and the Gulf states have comparable sized pools of liquid assets available for investment. Since the available inventory of commodities is a fraction of their annual production, we could potentially end up with an extreme case of too much money chasing too few goods.

This would not matter much if investment were concentrated in futures markets. The open interest in such markets is controlled by the traders, who arbitrage to close positions as the settlement date nears. Thus when huge speculative money flows pour into futures markets, they drive up the price of the commodity concerned, but do not significantly interfere with the production of that commodity, nor with the flow of the commodity from producer to consumer.

Normally, commodity investment is confined to futures markets because it is much more convenient. The cost to a hedge fund or other financial investor of holding stocks of a commodity is quite high, normally sufficient to deter investors from attempting to buy commodities directly. They will only buy commodities directly if they are afraid that the normal arbitrage mechanisms between the futures markets and the commodity markets will be overwhelmed by the volume of demand, so that investment in futures will prove less profitable than it "should."

When investment moves to physical commodities, as it may now be doing, it potentially disrupts trade flows. A ship laden with copper ore that would normally have sailed from Chile to a smelter on the U.S. West Coast is instead parked in a holding area in order that investors can profit from the rise in value of that copper. That reduces the amount of ore available to smelters. Since the balance between supply and demand of most commodities is quite delicate, and supply cannot be ramped up by more than a modest percentage at short notice, that could result in a physical shortage of the commodity at the smelter, shutting down the smelter for a period and depriving its customers of the copper products they need for their own operations.

Disruptions of commodity flows of this kind can potentially cause both hyperinflation and a major recession. The value of copper to the smelter and its customers is much higher in a shortage than if it is available normally, because the cost of closing their own operations is large – hence the price of any spare copper that might be available locally zooms upwards. Equally, the economic cost of shutting down the smelter and its customers far exceeds the value of the copper ore shipment. Products containing copper are suddenly in short supply, while workers lose their paychecks and so are forced to stop consuming at the same level.

The effect of a gross liquidity surplus is thus quite similar to that of a sudden shortage. In the shortage case, as in 1837-41 and 1929-33, prices decline sharply – in those two cases by as much as 20-25% – economic activity is hugely reduced as businesses are unable to obtain financing and workers are laid off. The resultant decrease in demand causes producers to lose money, eventually closing their doors, as well as bankrupting the financial system.

In a gross liquidity surplus, in which investment capital disrupts commodity trade flows, inflation rather than deflation results, probably very rapid inflation rather than the moderate 5% to 10% inflation we became used to in the 1970s. That inflation still further increases demand for commodities, worsening the problem. Businesses unable to obtain raw materials close their doors, workers' real incomes decline sharply (even when they keep their jobs) and Gross Domestic Product declines similarly to the deflationary case.

We have never experienced a global hyperinflation, in which money is unable to purchase goods, so it becomes worthless. In particular countries, wars have produced this effect, notably in the Revolutionary wars in both the United States and France, when the "continentals" and "assignats" became of no value. Similar effects have been produced by excess money printing in Latin America; in hyperinflationary periods citizens of Argentina have starved, even though the country is one of the world's greatest food producers. However, globally we have experienced nothing worse than the moderate worldwide inflation of the 1970s, in which trade flows were disrupted and incomes and assets affected, but commodities generally remained available in the market and output weakened but did not decline sharply.

The fascination of adding another chapter to economic historians' textbooks is not sufficient to make global hyperinflation anything other than an event to be avoided at all costs. It might help the Ben Bernanke of 2080 to make better monetary policy decisions than the current incumbent, since he would have the chance to be the world's greatest expert on the hyperinflationary crash of 2011. However, as far as this column is concerned, future generations can take their chances – we need to avoid hyperinflation happening to this generation.

The cost of avoiding this disaster appears to be steadily increasing. Once articles start appearing in the Financial Times about investors choosing to buy physical commodities rather than futures, many more such investors will be drawn into this activity. A moderate tightening of monetary policy that might well have deflected the forces of hyperinflation if it had been instituted several months ago may well prove ineffectual at this stage.

In determining the necessary monetary policy, the gold price provides a very useful signaling device (and its definitive breakout through previous highs last week provides a stern warning.) It does not matter one whit whether investors demand physical gold rather than futures, because gold has only insignificant industrial uses and the stocks of gold available in "inventories" such as Fort Knox are far more than sufficient to supply those uses for a decade if necessary. However, the commodity investment impulse is closely tied to the gold investment impulse; both reflect a well warranted distrust of fiat money and a desire to hold items of secure long-term value. Hence the gold price is available to show policymakers whether their monetary policy is appropriate.

If, following last week's breakthrough, the gold price continues to increase, heading for $2,400 per ounce, the equivalent in today's money of the 1980 high, that will be an excellent signal that monetary policy urgently needs tightening.

If, after a first monetary tightening, the gold price retreats for a few weeks and then breaks through its recent highs, that development will be a signal that monetary policy must be tightened further, as the flight to commodities has not halted.

Only when the gold price breaks definitively downwards, dropping 25% or more from its high, will policymakers know that they have succeeded in breaking the commodity investment mania. Such a development is however likely to occur only after a definitive crack in government bond markets, forcing policymakers to address their gigantic budget deficits as a matter of urgency.

Given the predilections of today's policymakers, it is unfortunately unlikely that they will tighten monetary policy sufficiently to break the commodity flight, whatever the gold price does. Instead, led by the determined Keynesians of the International Monetary Fund, they are much more likely to attempt to control the gold price itself, either surreptitiously by selling off massive quantities of the world's gold reserves, or openly by imposing limits on gold futures trading and possibly, like Franklin Roosevelt in 1933, making it illegal for ordinary individuals to own gold or to buy gold futures.

That will of course only make matters worse; it would be equivalent to trying to avoid a speeding ticket by smashing the car's speedometer. Manipulating the gold price to pretend that liquidity is not excessive does not stop liquidity from being excessive. Nor does it lead any but the stupidest institutional investor to believe that his urge to invest in physical commodities is misguided. Rather, it will cause commodities investment to be carried out through shell companies in tax havens, away from regulators' radar screens. The effect on global supply chains will be equally damaging, but policymakers will no longer have a straightforward way of determining how to avoid the resulting economic depression.

I wrote last week that tightening liquidity directly by entering into a central bank "exit strategy" is dangerous. However , the Financial Time's story itself and the gold price breakthrough have significantly increased the size of the hike in interest rates necessary to halt the flight to commodities.

Time is short, and the probability of disaster is rising.

For further reading:
"How Much Gold Does the US Have In Its Reserves", Jesse's Café Américain, October 13, 2009
"Demand for Physical Possession of Gold is Driving the Price of Gold", The Golden Truth, October 12, 2009
"Interest sparked in physical commodities", Financial Times, October 6, 2009

The Explosive Dynamics of the Gold and Silver Markets

By Adrian Douglas
Gold Anti-Trust Action Committee
Saturday, October 10, 2009

http://www.gata.org/node/7887

This week gold closed above $1,000 per ounce for the fourth consecutive week and made another all-time weekly high close. But the top-callers have come out in their droves declaring that gold is in a bubble that is about to burst and that because the recession has been declared as over there is no reason to hold such a safe-haven asset.

All that is nonsense and I will explain why. The dynamics unfolding in the gold and silver markets are nothing short of explosive.

The dynamics are different for gold and silver so I will start by discussing gold.

Gold is a unique substance. It is about the only thing on the planet that is bought and stored and never consumed. Almost all the gold ever mined still exists above ground. The purpose of gold is to act as a store of wealth. This singularity of gold makes it susceptible to a scam that was first perpetrated by goldsmiths in the 16th century. The goldsmiths realized that customers would buy gold and leave it for safekeeping in their vault. This meant that they could show the same gold bar to many customers and sell it many times over. This was the early form of fractional reserve banking, where banks retain only a fraction of the money on deposit, gambling that no more than 10 percent of the money will ever be called upon to be paid out.

This scam is at the center of modern gold market manipulation. Paper substitutes for gold are sold, instead of real gold, through derivatives, futures, pooled accounts, exchange-traded funds, gold certificates, etc. I estimate that each ounce of gold has been effectively sold 20 times over or more. To maintain this Ponzi scheme, some real gold is required, because some investors or jewelers demand to take possession of real gold. For the scam to be sustained there must always be plentiful physical gold for those who want it.

This physical supply has been met from mine supply and central bank leasing and selling.

The market is in effect a giant inverted pyramid with a huge paper gold market being supported above a small amount of physical gold at the tip of the inverted pyramid. The scam can continue until there are indications of a shortage of physical gold. If the 20 or so so claimants of each ounce of real gold demand their gold, there is the potential for a squeeze such as never been seen before.

To lend support to the idea that all the gold in the world has been sold several times over I cite the case of Morgan Stanley, which was sued in 2005 for selling imaginary precious metals to its customers. The firm had the audacity to charge storage fees for metal that didn't exist. Morgan Stanley settled the suit out of court but no criminal charges were ever filed against the firm. If Morgan Stanley was doing this, you can bet that it is the tip of the iceberg.

As further evidence just look at the monster over-the-counter derivatives market. Standing at approximately $1,000 trillion, it is multiples of the liquidated value of all the assets and currency in the world. Clearly derivatives must be selling some sort of claims to assets that cannot be fulfilled because there are not enough underlying assets.

The price discovery of gold has been achieved almost exclusively through the shuffling of paper gold promises between investors and bullion banks on the New York Commodities Exchange with very little real gold ever changing hands. But the situation is changing. Some big entities are now demanding physical gold. These entities are almost certainly countries, not individuals, such as China, Russia, India, Venezuela, Iran, and the Gulf states, to name but a few. This demand for real gold, instead of paper substitutes, is putting a strain on the gold market.

Paul Walker, CEO of the metal consultancy GFMS, recently said the price of gold was going up because of "large lumpy transactions in a market with a degree of illiquidity." Roughly translated, this means that there are large demands for physical metal that the market is struggling to meet. That is a cartel apologist's limp-wristed reference to the explosive dynamics I am defining.

The supply that feeds the bottom of the inverted pyramid to support the gold price suppression via a paper market is drying up. Mine supply has been declining for almost a decade and this year central banks became net buyers of gold for the first time in 20 years. The stress in the physical market is starting to show to those who are paying attention.

For example, the London PM fix of the gold price is coming in at historic highs day after day, the contango in the futures market has contracted dramatically, and the U.S. mint is routinely suspending production due to shortages of metal. But most importantly we are seeing astute investors display a growing preference for real bullion. A couple of months ago Greenlight Capital, the large hedge fund, switched $500 million of investment in the exchange-traded gold fund GLD to physical gold bullion. The supposed gold holding of GLD has not grown to a record high despite a record high gold price.

Apparently Germany has asked that its sovereign gold held by the New York Federal Reserve Bank be returned to Germany. Hong Kong has requested the same of the Bank of England, which stores Hong Kong's gold.

Robert Fisk, a respected journalist for Britain's Independent newspaper, reported this week that the Arab oil-producing states, Japan, Russia, and China have been holding secret talks to replace the dollar as the international reserve currency and as an accounting unit for the oil trade. The Independent reports that the basket of currencies they propose instead of the dollar would include gold.

If gold is going to regain its monetary role, you can understand why those in the know want real bullion. There are some significant signs that a run on the bank of the anti-gold cartel for physical gold is commencing.

Meanwhile most investors and analysts are focused only on the net short position of the commercial traders on the Comex, which has reached a record level and has in the past signaled the onset of a major correction. But such market observers are watching only a side show of the main event. The main event is all about a growing tightness in supplies of gold in the physical market.

I don't think the commercial net short position of 800 tonnes is that important. What is important is that the world's stockpile of 140,000 tonnes of gold may have been sold several times over. In all likelihood half of the supposed 30,000 tonnes of central bank stockpiles have been sold at least 20 times over. The gold short position could well be 300,000 tonnes (15,000 times 20) against a total world inventory of only 140,000 tonnes, much of which is not available to the market.

Could there be a more bullish scenario for gold?

If you think that such business practices could not be tolerated, I can hold up the example of the airlines, which regularly and knowingly oversell the seats on their flights, expecting that not all passengers will show up. Bullion bankers oversell their inventory of gold knowing that only 10 percent of customers will ever ask for it, just as the goldsmiths figured.

One cannot discuss the gold market in isolation, as it is linked to the U.S. dollar and Treasury debt. The major impetus behind the suppression of the gold market was to maintain a strong dollar despite massive overissuance of the currency. This has allowed the United States to live beyond its means because the rest of the world accepts the funny money as payment for goods and services. In a study he did when he was a professor of economics at Harvard titled "Gibson's Paradox and the Gold Standard," former U.S. Treasury Secretary Lawrence Summers showed that in a free market gold and real interest rates move inversely to each other. But since 1995 the United States has had low gold prices and low interest rates. In the absence of a gold standard this could have been achieved only by surreptitiously fixing the gold price through market manipulation. This was the essence of the "strong dollar policy" of Robert Rubin, the mechanism of which was never explained to the public.

The dynamics of the silver market are different. About 90 percent of silver production is used for industrial applications. Only 10 percent is purchased for investment. Clearly paper substitutes for silver cannot be used in industrial processes. The investment market is suppressed by paper silver substitutes as described above with respect to the gold market. It is this market, specifically the Comex futures exchange, that controls the price of silver.

The very low price of silver over the last 30 years has encouraged large holders of silver to dishoard it. After all, who wants to pay costly storage fees for something that is of low and declining value and bulky to store? This dishoarding has filled the gap between silver production and industrial demand, which runs at more than 200 million ounces annually.

Much of the investment demand has been met with paper substitutes and scams that are variations on the one that was perpetrated by Morgan Stanley. Because of the suppression of the price of silver it has been uneconomic to recycle most industrially used silver, with the exception of silver used in photography. This has meant that most industrially used silver finds its way into landfills. All the above-ground silver is now less than 1 billion ounces. Considering that the exchange-traded fund SLV alone claims to have more than 250 million ounces of silver, it is reasonable to estimate that investors have been sold something of the order of 5 billion ounces of silver. But how much is supported by real metal?

If the same ounce of silver has been sold 20 times over, as with my estimate in gold, then only 250 million ounces of investment silver bullion exist. This means that 4.75 billion ounces of silver could potentially be demanded in a market where only 1 billion ounces of stockpile exist and mining supply is already oversubscribed to the tune of 200 million ounces annually. One can probably add to this picture that investors who cannot easily find physical gold will come looking to buy physical silver. What is even more bullish is that the industrial users will not sit idly by watching a manic silver grab. They will join in the fray because they cannot remain in business unless they have silver inventory. They will try to stockpile silver at a time of acute shortage.

So the dynamics of the gold and silver markets are wildly bullish. This is no longer about whether the commercials will knock down the price by selling more contracts short. This is about a lot of market participants who have been content to hold precious metal paper substitutes but who now increasingly will want to own real bullion. This has been happening slowly but will gather pace. Because in the last 30 years most investors have trusted the brokers, dealers, and bullion banks to have the metals that have been sold, there has been no "run on the bank." This is changing. Many indications point to significant supply stress building.

Why are the entities that hold the largest short positions on the planet custodians of the bullion depositories for the largest ETFs? That's like putting a sex offender in charge of the day care center or Bernie Madoff in charge of your company pension fund.

The argument against holding physical bullion yourself has always been the risk it might get stolen while in your possession. But the risk of holding bullion substitutes is that it already has been stolen or never existed.

The precious metals market is now akin to a game of musical chairs with perhaps only one chair for every 20 players. It might be prudent to follow in the footsteps of Germany, Hong Kong, China, and Greenlight Capital and get your chair before the music stops.

If the physical markets for precious metals lock up due to shortages, then the short squeeze will be of epic proportions; it will be something to tell your grandchildren about. It will be a far better story for your grandchildren if you are on the right side of the trade.

Adrian Douglas is a member of GATA's Board of Directors and editor of the Market Force Analysis letter. Reprinted with permission.

For further reading:
"The Game Changer?", Ted Butler, July 14, 2009
"Did the ECB Save COMEX from Gold Default?", Avery Goodman, April 2, 2009
"The Future of Gold", Naufal Sanaullah, January 26, 2009
"The Manipulation of Gold Prices", James Conrad, December 4, 2008

Central Banks Rescue Naked Gold Shorts

By Rob Kirby
Financial Sense University
Friday, October 9, 2009

http://financialsense.com/fsu/editorials/kirby/2009/1009.html

Impeccably reliable sources have informed me that as recently as Sept. 30, 2009 – the last possible day of trade in the Sept. 09 gold futures – a number of well-heeled market participants “bought” substantial tonnage worth of gold futures on the London Bullion Market [LBMA] and immediately told their counterparties they wanted to take instantaneous delivery of the underlying physical bullion.

The unexpected immediate demand for substantial tonnage of gold bullion created utter panic in at least two banks who were counterparties to this trade – J.P. Morgan Chase and Deutsche Bank – because they simply did not posses the gold bullion which they had sold short [an illegal act which in trading parlance is referred to as a “naked short”].

Because these banks did not have the bullion to honor their contracted commitments, one or both of them approached the counterparties and asked if there was any way they could settle this embarrassing matter quietly on a “cash basis” to absolve the banks from fulfilling their physical bullion delivery obligations. The purchasers were not interested in a ‘cash settlement’ and demanded delivery of physical bullion giving these banks 5 business days to resolve the situation. A premium of as much as spot plus 25 % [that would be 1,250 – 1,300 per ounce of gold] was offered to settle this matter in fiat money instead of the embarrassment of a very public “failure to deliver” on the part of the London Bullion Market Association.

Earlier this week, no less than two Central Banks became involved in effecting the physical settlement of this situation. One of these Central Banks was British [that would be the Bank of England] – and reportedly, even they were only capable of providing less than pure, non-compliant gold bars that did not meet good delivery standards stipulated by the LBMA. Like it or not, this is a testament to lack of physical gold available, folks.

To summarize: Banks like J.P. Morgan Chase and Deutsche Bk. - who sold endless amounts of gold futures at prices of 950 – 1025 and then tried to make “side deals” with the folks they sold the futures to – offering them spot + 25 % [let’s say 1,275 per ounce] to settle in fiat – only after their counter parties demanded substantial tonnage of physical gold bullion.

Stunningly, if accurate [and there is absolutely no doubt in my mind that this is not], this means that gold is already in SEVERE backwardation and this fact is being hidden from the public.

Then, to protect the “integrity” of the futures market as a ‘price discovery mechanism’ – Central Banks – aiding and abetting - plunder the sovereign assets of their respective countries to bail out their agents / friends in an attempt to ‘sweep the whole bloody mess under the carpet’.

To think that anyone wonders why our financial system and fiat money will soon to be TOAST?

What a disgraceful insult to humanity.

Rob Kirby is proprietor of Kirbyanalytics.com and sales agent for Bullion Custodial Services. He is also a GATA consultant.

For further reading:
"Floating Derivatives in Uncertain Waters Increases Risk of Drowning", Bob Chapman, September 9, 2009
"Where's the Gold?", Nathan Lewis, June 26, 2009
"Will Increased Delivery Demand Break the Gold Warehouses?", Jim Sinclair, June 12, 2009

New Monetary Target

By Tom Braithwaite
The Financial Times
Wednesday, October 7, 2009

http://www.ft.com/cms/s/0/28db4010-b377-11de-ae8d-00144feab49a.html?nclick_check=1

Gold standing: a 1960 Fed guard in protective metal overshoes keeps an eye on some of its bullion. Congressmen once sent an investigator to its vault to ‘check it was there’.

It is an unlikely rallying cry. At marches and meetings against big government across the US, where some placards damn the president, others bear a catchy slogan: “End the Fed”.

Even Ron Paul can hardly believe it. Aged 74, fresh from a quixotic run for the presidency last year, the Texan Republican’s pet subject is winning a rash of converts. His book, also called End the Fed, is riding high in the bestseller lists. In it, he writes with delight about students in Ann Arbor, Michigan, chanting the phrase and burning dollar bills in the college quad as they discussed the crimes of the Federal Reserve.

That was before the financial crisis. In the aftermath, the signs and slogans have become more widespread, the anger more vitriolic. “It’s understandable,” says Mark Zandi, chief economist at Moody’s Economy.com and an adviser to John McCain during his presidential election campaign. “Many Americans have been put through the proverbial wringer and they are suffering and they are confused and they are upset.”

In Congress, too, the ideas of a tiny minority obsessed for decades with curtailing the power of the nation’s central bank have been supplemented by criticism from the mainstream. “It has become known to many Americans and congressmen that the Fed is more intrusive than we imagined,” offers Mr Paul by way of explanation.

For Mr Paul and his allies, removing the Fed would end almost a century of rule over the economy by an undemocratic institution that has weakened the dollar and stoked inflation. For most economists, “ending” the Fed – or just compromising its independence – could rock financial markets just as the bank weighs up when to tackle the feat of withdrawing the large unconventional stimulus without choking off recovery but before driving up inflation.

The Fed itself has argued that any whisper of political interference with monetary policy will drive up long-term interest rates and cost “current and future generations” of American taxpayers dear in higher costs of servicing the large national debt. Ben Bernanke, who has presided since 2006 over a network of 12 regional Fed banks, approaches a confirmation hearing expected in the next few weeks for a second term as Fed chairman with an unwelcome list of political problems adding to his duties in helping breathe life into an uncertain economic recovery.

A bill from Mr Paul to audit the Fed has more than two-thirds of the House of Representatives backing it. The Texan’s motives are not as nuanced as “audit” suggests – this is only the “first step” to the eventual abolition of a menace. “They can print money out of thin air and serve special interests,” he says. “It’s central banking that causes economic bubbles.”

It is certainly true that the most recent bubble, its bursting and the Fed’s actions in the aftermath have inspired existing critics and recruited new ones. Their first charge is that interest rates under Alan Greenspan, Mr Bernanke’s predecessor, were kept too low for too long, contributing to a bubble of easy credit.

Second, they say that the Fed’s doubling of its balance sheet to more than $2,000bn (€1,362bn, £1,259bn), using it to pump liquidity into banks, is an example of an unelected institution – and one not enshrined in the constitution – enjoying too much raw power.

Third, they worry about the ability to lend directly to floundering banks (and since 1991 to non-banks), which had not been exercised since the 1930s but was used during the crisis to prop up Bear Stearns, the investment bank bought by JPMorgan Chase, and AIG, the insurer now majority owned by the government. Concern centres on the diversion of billions of dollars of public money into private enterprises, with no certainty of repayment.

Fourth, plenty of politicians and other regulators say, the Fed should lose its responsibilities for protecting consumers (because it failed in doing so) and should not gain new powers for supervising systemic risk (because other regulators should have a hand in that too).

HISTORY OF UPHEAVALS

Andrew Jackson, the seventh US president and the most famous scourge of central banks and critic of paper money, is a man condemned posthumously to appear on millions of $20 bills issued by the Federal Reserve.

The US Treasury says the origins of the decision to use his face on the banknote are lost to history, so it is not inconceivable that it was an act of ironic revenge.

Jackson destroyed the Second Bank of the United States in 1836; the First Bank had lasted only 20 years (1791-1811) before southern states suspicious of the intentions of this northern-based powerhouse successfully lobbied to end its charter.

The Fed, created in 1913, has survived two world wars, the Great Depression, several financial crises and almost a century of existence.

Then there is criticism that predates the crisis. Some Fed supporters believe that is sometimes motivated by a long-standing anti-Semitic conspiracy theory that places the Fed at the heart of a cabal of Jewish bankers working for their own ends and foreign interests at the expense of the country.

But there does not have to be a racist taint to the charge that the Fed is anti-transparent, secretive and deliberately gnomic in its statements. Robert Auerbach, former chief economist for the House banking committee, recalls being sent to the New York Fed in the 1980s as a congressional investigator to go 80ft below ground into a vault that holds what is believed to be the largest collection of the world’s gold. The reason? To “check it was there”. That was the level of mystery and mistrust between Congress and the Fed.

Barney Frank, the Democrat now chairing the same powerful committee, remembers the change in policy in 1995 that brought in statements after monetary policy meetings revealing any change in the target federal funds rate. “How you set interest rates without telling people, God only knows,” he says.

Alan Blinder, former Fed vice-chairman and now Princeton economics professor, asks: “Over decades was the Fed vastly too secretive for very poor reasons? The answer is absolutely yes. If you go back to the way the Fed behaved imperiously one might say in the 50s, the 60s, the 70s, the 80s. There is a reason to gripe about that.”

But things have changed. Even some critics of the Fed acknowledge that it has become more transparent. Mr Auerbach and Mr Paul say that Mr Bernanke’s attitude is an improvement on Mr Greenspan’s. Under pressure, it has started publishing a monthly balance sheet, containing a wealth of information but not the names of those banks that have tapped its credit facilities. That has developed into a minor cause célèbre for Bloomberg news agency, which is pursuing the bank through the courts under the Freedom of Information Act.

Although the Fed has become more transparent, so long is the history of secrecy that perception lags behind reality. Mr Bernanke has inherited a “boy who cried wolf” position. So often has the Fed warned of disaster if its authority is tampered with that the current chairman has a hard task to persuade politicians when he identifies furry menaces on the horizon.

As each step into the sunlight fails to bring calamity – no one blames the latest crisis on too much central banking transparency – the Fed is left with a thinner margin of confidentiality and a weaker hand if it really needs to resist future calls for more openness.

Most economists argue there is something worth preserving. “I think Congress has to be very careful in changing its relationship with the Federal Reserve so as not to affect the independence of the Fed, actual or even just perceived,” says Moody’s Mr Zandi. “Global investors are particularly sensitive to the prospect that the Federal Reserve will be under pressure to monetise all the debt that is being created,” he says. “I think it’s fair to say that the most significant strength of our financial system is the independence of the Fed.”

For now, there is no evidence that foreign investors are unwilling to swallow US debt: long-term bond yields remain low. The Fed has warned that if Congress takes a more active interest in monetary policy, investors will fear rates will be kept too low in the short term as rate-setters fret about political pressure – and that long-term rates will rise as inflation fears increase as a result, adding to the cost of debt for “generations” of Americans.

As Congress weighs reform options for the financial system, the worst-case scenario for the Fed is still on the table: it loses its consumer protection authority; it loses its bank supervision powers; it is not given primary responsibility for systemic risk regulation; it endures sweeping audits, including scrutiny of its swap lines with foreign governments; it has to publish the names of counterparties.

Mr Bernanke and Scott Alvarez, the Fed’s general counsel, have helped themselves in recent testimony to Congress. Refusing to be riled by hostile questions before Mr Frank’s committee, the pair have sought to assuage lawmakers’ fears without resorting to the lecturing characteristic of some former Fed officials.

They have submitted themselves to browbeating by Mr Frank, who railed against the previous lack of transparency and published a list of alleged failings in consumer protection. “The Fed is a lousy consumer regulator,” he says. That belies the fact that Mr Frank, like Tim Geithner, the Treasury secretary and former president of the New York Fed, is seen as sympathetic to the central bank.

Indeed, this hairshirt treatment could offer a route to a liveable middle ground – between ending or severely restricting the Fed’s powers on the one hand and preserving and reinforcing them on the other. But it will require all the political savvy of Mr Bernanke and his staff in what is an avowedly apolitical organisation.

Under this course, consumer powers would go to a new agency, an outcome that is feared by banks but continues to enjoy the support of President Barack Obama – while many in Congress either support it or are afraid of voting down any legislation that is seen as pro-consumer.

This is not a disaster for the Fed. When Mr Obama interrupted his vacation in Martha’s Vineyard in August to stand shoulder to shoulder with Mr Bernanke and announce he was reappointing the Fed chairman, he gave the clearest signal of his administration’s support for the institution.

The administration, and particularly the Treasury under Mr Geithner, is working closely with Mr Frank to keep the Fed from being scarred too badly. It was the Treasury that came up with the plan for regulatory overhaul in June in which the Fed took the lead role in systemic risk regulation and was forced to cede only its consumer protection powers. More importantly, any new audit powers for Congress’s Government Accountability Office would stop short of scrutinising monetary policy or publishing interactions with other countries.

But some Fed watchers are still worried about Mr Bernanke’s ability to pull that outcome out of the congressional flux. “I think not easily at all,” says Mr Blinder. “At this point, it’s swimming upstream.”

Still in the bookshops, on the marches, on signs and on T-shirts and all over the internet is, meanwhile, that catchy slogan. The Fed needs a knockout response.

Proposed changes range from the plausible to the ‘very pernicious’

The Federal Reserve’s battle in the regulatory overhaul now under way in Congress would not be so arduous if the central bank were not having to fight on so many fronts.

Ron Paul’s popular bill to audit the Fed more thoroughly is the only one that presents, the bank believes, a threat to monetary policy. But in the words of Alan Blinder, the former Fed vice-chairman, it is “very pernicious though very unlikely to pass”. The Senate may provide the resistance that Mr Blinder expects.

Next in seriousness would be moves to strip the Fed of its powers of bank supervision, using the argument that it did not do enough to prevent the banks under its watch from taking on too much leverage and risk.

Here, the Senate under the banking committee of Chris Dodd is the proponent of change. He wants a far more radical consolidation of the four bank regulators than proposed by the administration of President Barack Obama, which has suggested only one merger – between the Office of Thrift Supervision and Office of the Comptroller of the Currency.

The one new power the Fed would gain under the reforms proposed by the administration is as the lead regulator in the supervision of systemic risk – problems such as AIG’s credit default swap positions last year – which can quickly spiral out from one institution to threaten the whole financial network.

This is proving to be one of the most bitterly fought turf wars, although Ben Bernanke, chairman of the Fed, is fighting with more calm than other regulators. He is relying on the persuasive power of Tim Geithner, Treasury secretary, who is adamant that the Fed must have this responsibility, not a new “council” of regulators.

But the Federal Deposit Insurance Corporation under Sheila Bair, its politically powerful chairman, is among the regulators arguing that the new council is perfectly capable in the practice as well as the theory of regulating systemic risk.

Finally, the Fed is likely to lose its powers of consumer protection to a new Consumer Financial Protection Agency. That is in spite of Mr Bernanke’s testimony that there are disadvantages in separating the supervision of consumers’ safety from the safeguarding of the “safety and soundness” of the banks. But if this is the only front on which he loses, Mr Bernanke will have had a good regulatory war.