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War against gold is to rescue Japan

Section: Daily Dispatches

9:50p EDT Tuesday, July 13, 1999

Dear Friend of GATA and Gold:

Reg Howe's essays at, reposted
here yesterday as quot;War Against Gold is to Rescue
Japan,quot; have generated some interesting comment and

The Gold-Eagle web site -- -- which
many of us follow closely, plans to repost it.

Here is Vincent Cook's take on the relation between the
price of gold and Japanese interest rates, questioning
Reg's analysis.

Please post this as seems useful.

With good wishes.

Gold Anti-Trust Action Committee Inc.

* * *


July 13, 1999

By Vincent Cook

In his GATA egroup post of July 12, Reg Howe wrote:

quot;Another way to view gold's backwardation in yen on the
TOCOM is as payment or incentive to Japanese citizens
(and others) to defer the urge to convert yen to gold.quot;

To support his argument, Reg explained how a Japanese
investor might prefer to take a long position on a gold
futures contract rather than buy the physical, since
such an investor could earn both interest on his yen in
the interim and get a discount on the price he is
paying for gold when he takes delivery.

But to fully understand what is going on here, we need
to carry our analysis a bit further. Somebody (mainly
Mitsui and Sumitomo, according to Reg) has to be on the
other side of the TOCOM futures transaction to promise
future delivery of gold. So how does a firm like Mitsui
make such a promise and hedge its risks?

Mitsui could borrow yen and use it to buy gold, and
then lend this gold for the duration of the futures
contract. Over the lifetime of the futures contract, it
would be earning something like 2 percent on its gold
loan and paying about half a percent on its yen debt.
At expiration Mitsui would be repaid gold, which would
then be used to satisfy delivery on the futures
contract in exchange for the agreed-upon futures price.

Although this futures settlement price is discounted
relative to the spot price of gold that existed at the
time the contract was drawn up, Mitsui presumably
earned enough interest on its gold loan to make up for
this discount and pay back its yen loan plus interest
with a small arbitrage profit left over.

Note what the net result of the futures activity of our
hypothetical Japanese investor and Mitsui is: The
investor's yen is being diverted from loans to Japanese
debtors into the purchase of spot gold, which is then
used to create gold loans. The Japanese investor
becomes a gold creditor and captures most of the
interest on his gold loan. Mitsui gets the balance as a
small arbitrage profit.

In other words, capital is flowing out of yen credit
markets into gold credit markets, and strengthening the
yen price of gold in the process.

Reg is really just describing a complex form of
something that is very basic to the movements of
currency markets, namely capital flight from one
currency to another in pursuit of higher real interest

In the present situation, there is little doubt that
the Bank of Japan is artificially pumping up yen credit
and depressing yen interest rates, and prompting
Japanese capital to flee elsewhere. But the resulting
backwardation of gold on Japanese futures markets
should have precisely the opposite effect from what Reg
is suggesting; an artificially pronounced backwardation
gives the Japanese an incentive to BUY spot gold. Every
time the TOCOM open interest in gold increases, we
should expect Mitsui and Sumitomo to appear as buyers
in the gold spot markets and as creditors in the gold
loan markets.

If GATA is correct that central banks are lending
thousands of tons of gold, then their intervention
would tend to reduce gold interest rates and make
investing in gold debt less attractive as an
alternative to investing in yen debt. But this would
not really inhibit capital flight out of the yen, since
Japanese investors can still flee into appreciating
dollar-denominated investments that yield 5 percent or

If central bank gold loans are meant to prop up the yen
and rescue Japan, they aren't doing much good. It is
primarily gold debtors, not yen creditors, who benefit
from any infusion of central bank gold into gold loan


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