Page 1 of 5 CHINA'S DOLLAR MILLSTONE, Part 4 Gold, manipulation and domination
By Henry C K Liu
All over the world, trade in gold had been the favored device for evading
national foreign exchange controls from the end of World War II to 1971. In
1946, the Bretton Woods regime adopted in 1944 became operational, thereby
forbidding the importation of gold for private speculative purposes in
signatory nations. Britain was a signatory but Portugal was not.
Thus a gold-smuggling operation between the Portugal colony of Macau and the
British territory of Hong Kong flourished until 1974, two years after the
United States took the dollar off gold, in effect abolishing the Bretton Woods
system of fixed exchange rates, when Hong Kong abolished a law that requires a
special license to import gold for re-export. Tiny Macau became one of the
biggest importers and re-exporters of gold during this period.
Instability in the exchange value of the British pound sterling in the late
1960s pushed Hong Kong, a British territory since 1841, to switch to a
gold-backed US dollar pegged at $35 per ounce of gold. Hong Kong trading firms
bought gold legally on the London gold market beyond the reach of US law
forbidding private purchase and ownership of gold on US soil, at a pegged price
of $35 per ounce. They then passed it along to Macau gold syndicates for a
service charge to recast the gold into physical shapes suitable for smuggling
back to Hong Kong, where it could be sold at above-peg prices for use in
financial transactions around the world out of range of Bretton Woods
From 1960 to 1980, Turkey strictly regulated the flows of gold in and out of
the country. The government passed a law on the "Protection of the Value of
Turkish Currency" to control gold smuggling. During this period, the price in
the domestic market was around US$12 per ounce higher than in international
markets. Before 1980, when importing gold was prohibited, smuggled gold volumes
into the country reached 80 tons a year.
In 1980, together with a general policy change on liberalization and
globalization, the foreign exchange market and a number of commodity markets
were deregulated. In 1985, the central bank was given responsibility for
importing gold against the Turkish lira. During this period, the average price
difference between the domestic and international markets decreased to US$7.65
per ounce. In 1993, further liberalization ended the central bank's monopoly
and allowed gold bullion imports and exports by authorized market participants
on a declaration basis. In 1992, the average price difference between the
domestic and international markets decreased to US$1.28 per ounce.
The opening of the Istanbul Gold Exchange (IGE) on July 26, 1995, and the price
difference between domestic and international markets decreased still further
to US$0.72 per ounce. This meant that Turkey's citizens were paying less for
gold but the Turkish currency was appreciating as the money supply shrank to
slow the economy.
In 1939, at the start of World War ll, gold imports into British India were
controlled or banned. This British legacy of colonial exploitation was
continued by Indian government. Gold control laws were enacted that stopped all
legal gold imports into India. Gold smuggling continued the gold traffic. The
gold control laws corrupted four generations of Western-trained Indian
government officials and politicians, made gold expensive in relation to Indian
income and kept Indians in poverty longer.
Overseas drain of gold from the US
By 1971, the US gold stock had declined by $10 billion, a 50% drop. At the same
time, foreign banks held $80 billion, eight times the amount of gold remaining
in US possession. A growing US balance-of-payments deficit meant that foreign
governments were accumulating large amounts of dollars - in aggregate volume
far exceeding the US government's stock of gold. The central banks of these
governments could show up at any time at the gold window of the US Treasury and
insist on trading in their dollars for gold, which would precipitate a run on
the US gold reserve.
The issue was not theoretical. By the 1960s, many foreigners were buying gold
at an artificially low price of $35 set by Bretton Woods and sold it in the
black market for easy profit. The result was that the US began to bleed gold
through her fiscal and trade deficits and by the increasing amount of dollars
sent overseas, know as euro-dollars. France under Charles de Gaulle realized
that this trend was unsustainable. The US was printing more dollars than its
gold holding could support and dumping the dollars in world markets.
To deal with the problem, president John F Kennedy approved the suggestion of
newly appointed undersecretary of the Treasury Robert Roosa that the US,
Britain, France, Germany and other European nations pool their gold resources
to prevent the commercial price for gold from exceeding the Bretton Woods
mandated rate of US 35 per ounce. Acting on this suggestion, the central Banks
of the US, Britain, West Germany, France, Switzerland, Italy, Belgium, the
Netherlands, and Luxembourg set up the "London Gold Pool" in early 1961.
The London Gold Pool came unstuck when France under de Gaulle pulled out and
began to send the dollars earned by exporting to the US back to the US and
demanding gold rather than Treasury debt paper in return. Under the terms of
the 1944 Bretton Woods Agreement, France was legally entitled to do just that.
As the drain on US gold became acute, the London Gold Pool folded in April 1968
because it did not command enough gold to support the price at $35 per ounce.
The demand by foreigners for gold held by the US surged.
George Pompidou, then as prime minister under de Gaulle and later French
president observed: "The international monetary system is functioning poorly
because it gives advantages to the country issuing the reserve currency. Such a
country can have inflation by making others pay for it."
John Connally, Treasury secretary under president Richard Nixon, had told
foreign finance ministers that "the dollar was America's currency, but your
problem". To solve the problem, France redeemed its dollar holdings in gold in
early August 1971 by sending a French battleship to New York to take delivery
of French gold from the vault of the New York Federal Reserve Bank and to bring
it to the vault of the Banque de France in Paris. The French raised gold
reserves and dumped dollars. Banque de France eventually increased its gold
holding to 92% of its reserves.
Even Britain, the ally with a "special relationship" jumped the monetary ship.
On August 11, 1971, the British ambassador in Washington received instructions
from London to go to the Treasury Department to request the conversion of $3
billion into gold and to have it moved from the United States Bullion
Depository at Fort Knox to the underground vault of the New York Federal
Reserve Bank, where foreign government gold was stored. US gold reserves had
dropped from 20,000 tons to 8,500 tons (32,150 troy ounces = 1 metric ton). At
$35 per ounce, 8,500 tons of gold had a cash value of $9.56 billion. Four days
later, on August 15, 1971, President Nixon announced that the United States
would no longer redeem dollars for gold, making it the final step in abandoning
the gold standard.
The breakdown of the Bretton Woods monetary system in 1971 was precipitated by
short-term capital movements out of the dollar into the key European
currencies, leading to the floating of the rising German mark and the Dutch
guilder. But the long-standing payments deficit of the US and her deteriorating
current account and fiscal account since 1965 were the fundamental causes.
At first the short-term capital flows of early 1971 signaled the reverse of the
great floods of money that had moved to the US between 1969 and 1970 when the
US business cycle peaked and the Federal Reserve made concerted effort
belatedly to restrain the growth of the money supply. The combination of
inflation momentum and abrupt tight money pushed interest rates to
unconstructive levels. As usual, the Fed response on dated incoming data caused
its time-lagged response to overshoot, exacerbating volatility. This is known
in the market as the Fed always falling behind the curve.
When real data on the US business cycle topping out finally became visible, the
Fed again belatedly eased monetary policy excessively to cushion the fall
already in process. As frequently in previous crises, the time lag of the
effect of Fed actions on market behavior caused the Fed to overshoot both
coming and going. Dollar rates dropped precipitously in November 1970 and money
flooded back to Europe like a tidal wave. The flow at first only reflected
interest rate differentials, but as always, interest-rate-driven flows induced
The massive rush of funds into Germany threatened to undermine Bundesbank
efforts to contain inflation in Germany. The German central bank opted to
suspend the fixed exchange rate of the mark and allowed it to rise against the
dollar to fight domestic inflation, against which Germans have a historical
phobia. A similar sequence of events ensued in the Netherlands. The flight from
the dollar continued and eventually accelerated. US gold reserves were visibly
inadequate to maintain even the semblance of convertibility, forcing Nixon to
close gold convertibility to foreigners. After the gold window was formally
closed, the major currencies either floated or were shielded against further
dollar inflows by capital controls.
The silver Hunts
The family of Texas oil patriarch H L Hunt was one of the richest in America.
The sons, Nelson Bunker and William Herbert, played a very significant role in
the discovery and development of the oil fields in Libya, which were later
nationalized by order of Muammar al-Gaddafi. In 1973, the Hunt brothers decided
to buy precious metals as a hedge against inflation. Gold still could not be
legally held by private citizens at that time, so the Hunts began to buy silver
in large quantity. By 1979, the Hunt Brothers, together with wealthy Mid-East
investors, controlled a pool of more than 200 million ounces of silver,
equivalent to half the world's deliverable supply.
When the Hunts began accumulating silver back in 1973, the price per ounce was
in the $1.95 range. By early in 1979, the price had risen to $5. By September
1979, the price reached $11. But in January 1980, the price went to the $50
range, peaking at $54. Gold hit a then historic high of $850 in 1980, making
the silver/gold ratio at 15.74/1, very close to the historical ration of 15/1.
It looked like that the Hunts were restoring the gold standard with bimetal
Once the silver market was cornered by the Hunts, outsiders joined the chase.
The Hunts and other silver traders were financing their silver buys and
holdings with bank loans in futures contracts. A combination of changed trading
rules on the New York Metals Market (COMEX) and the intervention of the Federal
Reserve punctured the speculative bubble and the price of silver began to
slide, culminating in a 50% one-day decline on March 27, 1980 as the price
plummeted from $21.62 to $10.80. As the price of silver fell, the Hunt Brothers
were unable to meet a $100 million margin call.
The collapse of the silver market meant countless losses for speculators. The
Hunt brothers declared bankruptcy. By 1987, their liabilities had grown to
nearly $2.5 billion against assets of $1.5 billion. In August 1988, the Hunts
were convicted of conspiring to manipulate the silver market.
Soviet monetary system
The ruble has been the Russian unit of currency for about 500 years. From 1710,
the ruble was divided into 100 kopeks. The amount of precious metal in a ruble
varied over time. In a 1704 currency reform, Peter I standardized the ruble to
28 grams of silver. While ruble coins were silver, higher denominations were
minted in gold and platinum. By the end of the 18th century, the ruble was set
to 18 grams of silver or 1.2 grams of gold, with a ratio of 15:1 for the values
of the two metals. In 1828, platinum coins were introduced with 1 ruble equal
to 3.451 grams.
On December 17, 1885, a new standard was adopted that reduced the gold content
to 1.161 grams, pegging the gold ruble to four French francs. This rate was
revised in 1897 to 1 ruble = two-and-two-thirds francs, or 0.774 grams gold.
With the outbreak of the World War 1 in 1914, Russia dropped the gold standard
and the ruble fell in value to cause hyperinflation in 1920s. Between 1921 and
1922 inflation in the USSR reached 213%.
In 1992, the first year of post-Soviet economic reform, inflation was 2,520%,
the major cause being the decontrol of most prices in January. In 1993 the
annual rate was 840%, and in 1994, 224%. The ruble devalued from about 40 to
the US dollar in 1991