Midas commentary for April 11, 2000

10:45p EDT Saturday, April 8, 2000

Dear Friend of GATA and Gold:

In a new essay, Reg Howe of www.GoldenSextant.com has examined the available
data about the U.S. Treasury Department's Exchange Stabilization Fund and has
concluded that it is consistent with a program of capping the price of gold.
Howe's research and understanding of the markets are, once again,
extraordinary. He makes it plain that the friends of gold and free markets
should direct their clamor at the ESF so that it faces full accountability to
the public.

Howe's essay, reproduced below, contains a chart that may or may not line up
well in email. It may look better at the GATA archive at EGroups:

a href=http://www.egroups.com/group/gatahttp://www.egroups.com/group/gata/a

Please post this as seems useful.

CHRIS POWELL, Secretary/Treasurer
Gold Anti-Trust Action Committee Inc.

* * *

The ESF and Gold: Past as Prologue?

By Reginald H. Howe
www.GoldenSextant.com
April 9, 2000

The recently released March 2000 Treasury Bulletin
(www.fms.treas.gov/bulletin/b10esf.pdf) contains the Exchange Stabilization
Fund's balance sheet and profit-and-loss statement for the quarter and fiscal
year ending September 30, 1999. Prior quarterly statements, in mildly varying
formats but similarly limited levels of detail, are available in earlier
bulletins. These are summarized for five-year intervals from 1935 to 1995 in
tables 1 and 2 contained in A.J. Schwartz's quot;From Obscurity to Notoriety: A
Biography of the Exchange Stabilization Fund,quot; in the Journal of Money,
Credit, and Banking (Vol. 29, No. 2, May 1997), pp. 135-153. Although the
ESF's current balance sheet shows total assets of about $41 billion, this
number must be reduced by at least the $8.2 million of liabilities for SDR
certificates to arrive at total resources available to the ESF. For more
discussion of the intricacies of the ESF's balance sheet, including
quot;monetizingquot; SDRs and quot;warehousingquot; foreign currencies with the Federal
Reserve, see W.P. Osterberg et al., quot;The Exchange Stabilization Fund: How It
Works,quot; Federal Reserve Bank of Cleveland, December 1999
(www.clev.frb.org/research/com99/1201.htm).

Created by the Gold Reserve Act of 1934, the ESF began operations in April
1934, financed by $2 billion of the profits realized from the New Deal's gold
confiscation and subsequent devaluation. But only $200 million was made
available to the ESF as working capital, of which $20 million was soon
invested in gold, held mostly at the U.S. Assay Office, and $30 million in
silver. The other $1.8 billion remained in the Treasury's gold account and
ultimately was used to fund part of the original U.S. subscription to the
International Monetary Fund. All SDRs allocated to or otherwise acquired by
the United States are turned over to the ESF.

A review of the ESF's past quarterly statements, together with other
quarterly
international financial statistics contained in the same bulletins, reveals
some interesting facts: 1) Until April 1989 the Treasury's gold stock and the
total U.S. gold stock, which also included gold held by the ESF, were
reported
separately in table IFS-1; 2) From 1974 to April 1989 these two numbers were
the same, implying that the ESF held no gold during those years; 3) In 1973
and prior years, the ESF reported gold holdings of varying amounts. According
to Schwartz (p. 148), this gold was held in a special ESF account at the New
York Fed and in 1974 was consolidated with the Treasury's other gold in
anticipation of its 1975 and 1978-79 gold auctions. Schwartz also reports (p.
138, fn. 6) that at the 1977 IMF gold auctions, the Treasury purchased gold
that it sold to the ESF, and that this gold appeared on its balance sheet for
the first three quarters of 1977 but not thereafter. Why the ESF purchased
this gold and what it did with it remains unclear.

Of more relevance for present purposes is the ESF's income statement, and
particularly the first line: quot;Profit (+) or loss (-) on: Foreign Exchange.quot;
In
the statement for December 31, 1977, this account read: quot;Profits on
transactions in: Gold and exchange (including profits from handling charges
on
gold).quot; Similar language appeared in prior statements, so that until the end
of 1977 profits or losses on gold and foreign exchange were lumped together
in
a single line item. In the statement for September 30, 1978, the language was
similar, but there were separate line items for gold and foreign exchange.
However, only the line for foreign exchange showed activity during the year.

In the statement for December 31, 1978, the separate line item for gold was
eliminated, and the current format of a single line item for foreign exchange
with no specific reference to gold was adopted. Accordingly, if the ESF has
resumed trading in gold or gold derivatives, historical practice indicates
that the profits or losses on these activities should be reflected in this
line item absent creation of new line item for gold.

The following table shows the ESF's profits or losses (-) on foreign exchange
by quarter and fiscal year from fiscal 1981, the first year of the Reagan
administration, through fiscal 1999, the most recent data. All amounts are in
US$ millions.

Fiscal Oct./ Jan./ Apr./ Jul./ Total
Year Dec. Mar. Jun. Sep. FY

1999 1699 -817 -500* 1257 1637
1998 -754 -333 -135 576 -646
1997 (Korea/ -383 -1093 402 -538 -1613
Asia)
1996 -449 -547 -419 -214 -1629
1995 (Mexico) -38 2623 276 -2054 808
1994 -1116 1388 883 102 1257
1993 -1700 965 412 437 114

1992 1264 -1267 1495 1191 2683
1991 1020 -1357 -421 739 -19
1990 327 -722 944 1752 2301
1989 545 -555 -501 471 -39

1988 994 -236 -414 -133 212
1987 (Louvre) 96 589 -51 -15 618
1986 456 488 478 504 1926
1985 (Plaza) -57 50 43 441 477

1984 -26 107 -165 -162 -246
1983 524 -64 41 112 613
1982 439 -475 -95 99 -32
1981 -217 -390 -806 241 -1172

* Income of $36 million for quot;Commissionsquot; reported
as separate line item this quarter; no similar
entry before or since.

Because the ESF is self-funding, its earnings on gold and foreign exchange
trading (as well as its interest income on investments held) are accumulated
in the fund, and it has incentive to operate profitably. As these reports
make
clear, the ESF does not confine its foreign exchange trading to interventions
for purposes of currency stabilization. Indeed, the Treasury has reported to
Congress that the ESF did not conduct any quot;interventionsquot; in 1998 or 1999,
yet
its activities nevertheless generated foreign exchange profits or losses, as
they did in prior years when interventions for the purpose of currency
stabilization were few or none. But since the ESF is sometimes used as a
vehicle for providing aid to other countries -- among others, Mexico in 1995-
1996, Korea possibly in 1997 -- some losses in certain years may be
attributable to these activities, which really are undertaken to stabilize
not
the dollar but the currencies of other nations.

For 14 years, from 1982 (the second year of the Reagan administration)
through
1995 (the third year of the Clinton administration), the ESF's foreign
exchange trading was generally quite profitable, suffering small losses in
only three years (1982, 1989, and 1991) and a moderate loss in just one
(1984). This creditable record began to fall apart in 1996, with by far the
largest loss on foreign exchange trading in the ESF's history, followed by
another similarly large loss in 1997, and a significant loss in 1998. Good
results in the first quarter of 1999 were halved by losses in the second
quarter, and further reduced by a smaller but sizable loss in the third,
which
is also the quarter in which the British gold sales were announced.

Another noteworthy feature of this quarter is the appearance on the ESF's
income account of a separate line item for quot;commissions.quot; No such entry has
appeared before or since. The closest historical analogue are the quot;handling
charges on goldquot; included in the profits line prior to 1978.

While an examination of the ESF's skeletal financial reports cannot possibly
prove that it has engaged in efforts to quot;stabilizequot; the gold price in recent
years, there is nothing in these reports to suggest that it has not. What is
more, there is much to arouse suspicion.

As I have suggested in earlier commentaries, official efforts to cap the gold
price probably began in late 1995 or early 1996 as the gold price challenged
$400/oz. with the deepening of Japan's economic crisis. These dates also
coincide with the ESF's transition from profits to losses. Generally
speaking,
official bodies like the ESF should make profits on foreign exchange trading
when profits rather than currency stabilization are their objective, since
they are likely to have relevant information and intelligence unavailable to
others. On the other hand, when they intervene to stabilize a currency in
opposition to fundamental market forces, experience suggests that large
losses
are likely to occur. Accordingly, particularly during 1998 and 1999, when the
Clinton administration denies making any interventions and when there were no
other obvious activities of the ESF that might explain losses on foreign
exchange trading, the losses themselves -- especially large ones -- raise
questions.

They become even more suspicious when plotted against gold prices over the
past two years, where on a quarterly basis and allowing for shorts lags in
realizing profits or losses, firm or rising gold prices tend to correspond
with ESF losses and falling prices with ESF profits. This relationship does
not hold true for the last calendar quarter of 1997 (first quarter of fiscal
1998 for the ESF), but then declining gold prices reflected concern about
lower demand and even dishoarding as a result of the Asian financial crisis,
which may have affected the ESF's results adversely as well. Thereafter,
rising gold prices in the first four months of 1998 correspond with ESF
losses
in the second and third fiscal quarters, and falling gold prices to September
with a small recovery that month with ESF profits. From October 1998 through
the end-of-the-year gold prices remained weak and in declining mode, and the
ESF had one of its most profitable quarters.

For the first two months of 1999, gold remained firm at around $290, spiking
upward toward $300 in early March. This rally was contained despite
apparently
good fundamentals for gold, and the price receded to around $280 by the
beginning of April. Then another rally began, pushing the price back above
$290 at the end of the month, largely powered by increasing doubts that the
proposed IMF gold sales would be approved. In the second fiscal quarter
(first
calendar quarter) of 1999, the ESF lost almost half its profits from the
prior
quarter, and its losses continued into the next quarter on a scale that if
continued would have pushed it into a loss position for an unheard-of fourth
straight year.

In early May, just as gold was threatening a sharp rally that many expected
would carry it over $300 and perhaps to much higher levels, the British
announced their gold sales. For many knowledgeable about gold, this otherwise
inexplicable action was the smoking gun, proof that some official scheme was
afoot to cap the gold price. In its wake, the gold price declined within two
months to under $260, and stayed at these low levels until announcement of
the
Washington Agreement at the end of September. At the same time, the ESF had
another very profitable quarter, closing out fiscal 1999 with a large profit
for both the last quarter and the year.

All these events may be coincidence, but they are also consistent with an ESF
program of trying to cap the gold price through a program of selling call
options or backstopping calls sold by others. Gold loans and short selling by
bullion banks are largely responsible for the weak gold prices of recent
years. Both activities require access to a deep, liquid, and financially
credible market where call options on gold can be purchased. See, among
others, quot;The New Dimension: Running for Cover.quot; Absent such a market or its
functional equivalent, these activities simply become too risky, especially
for prudent, sophisticated players, because they have no means to hedge their
risk. At the same time, as the net short gold position grows, writing or
selling calls becomes more risky, and premiums tend to rise, eventually
choking off both gold loans and short selling. At that point gold prices
should rally, relieving some of the pressure.

But given its rather large resources relative to the gold market, the ESF
could have enabled gold loans and bullion bank short selling to continue past
their normal limits by selling or backstopping calls at reasonable premiums
when private parties declined to do so in sufficient quantities or at all. A
program of this sort would generally, although perhaps with a slight lag for
their actual realization, tend to show losses on rising gold prices and
profits on falling ones. Nor would it necessarily require access to official
U.S. gold reserves, either for sale or leasing. At first, relatively deep
pockets and a high tolerance for risk probably would be sufficient.

But ultimately, as the net short position grew and perceptions of risk
increased, central banks and others that loan gold would begin to step back.
No central bank wants to be caught with a defaulted gold loan. Then the
program to cap the gold price would break down without access of some sort to
physical gold, such as a friendly central bank willing to step into the
breach
-- either with bullion for sale or with a willingness to lease
notwithstanding
the risk. The British gold sales and Kuwaiti gold loan -- both otherwise
without apparent rational basis -- fit this pattern.

Given its long-standing culture of secrecy, any ESF scheme to cap the gold
price almost certainly would be carried out without notice to Congress, and
quite possibly without notice to the Fed either. As to mechanics, a hidden
relationship with one or a very few bullion banks would be sufficient. This
relationship would give the favored bullion banks an enormous edge in their
own gold trading operations, and one that no Chinese wall could likely
neutralize.

From the outset, the constitutionality of the ESF has been open to doubt. Its
self-funding operations largely immune from congressional oversight seem to
contravene both the separation of powers and the exclusive control over
appropriations vested in Congress. But any scheme by the ESF today to control
the gold price would face further legal and constitutional hurdles.

At the same time that it established the ESF, Congress put the gold value of
the dollar at $35/oz. and generally prohibited gold ownership by Americans.
Accordingly, Congress, not the secretary of the treasury, set the gold price
for the ESF to target. What is more, by outlawing most private gold
ownership,
Congress effectively foreclosed trading of gold. Thus there was little
likelihood that the ESF would come into conflict with private investors
trading gold or gold futures in New York or anywhere else in the country.

Of course today the situation is wholly different. Although Congress has left
standing an anachronistic official gold price of $42.22/oz., there is no
reasonable argument that this figure remains a legitimate target for ESF
stabilization efforts. Congress also has repealed the ban on gold ownership.
Substantial trading of gold, including bullion and coins and gold
derivatives,
including futures and options, now takes place daily in private transactions,
over-the-counter financial markets, and public commodities exchanges.

Any act by the executive branch -- through the ESF or otherwise -- to set the
dollar gold price today, under these circumstances, would be patently illegal
and unconstitutional. The public commodities exchanges are regulated under
the
authority of Congress precisely to assure that they function honestly and
fairly for all participants. Congress has effectively declared by its actions
that gold contracts on these exchanges should trade in a free market, not one
subject to manipulation by the ESF, the Fed, or anyone else, including the
bullion banks.

The monetary provisions of the Constitution grant to Congress sole and
exclusive power to determine the gold value of the dollar. The Supreme Court,
to its everlasting shame, has refused to decide whether Congress may
constitutionally sever any meaningful link between the dollar and gold or
silver. But if there is to be a link, the Constitution vests in Congress
exclusive power to define it.

Were I counsel to a bullion bank, my advice would be to avoid like the plague
any involvement or even suspicion of involvement in any ESF scheme to affect
gold prices. Activities of this sort could violate a wide array of federal
and
state statutes, many of which also confer rights of private action on injured
parties. Indeed, the blatant unconstitutionality of any such scheme could
well
deprive participating government officials of a range of defenses ordinarily
available when they perform authorized duties in good faith. But many
defenses
available to the government or its officials would not be available to the
bullion banks. In short, if the scheme blew up, their financial exposure
could
be enormous.