In our last article, Fed Lawyer Alvarez: “The Federal Reserve Does NOT Own Any Gold at All”, we explained why the widespread belief that the Fed owns any gold is false and that the Fed’s reported holdings of gold certificates are actually a misnomer and really represent claims to cash, not gold, from the Treasury. The story does not end here, however.
As already noted in Part 1, the Fed was forced to give up their gold holdings at a rate of $20.67/oz in 1934 in exchange for gold certificates worth ~$3.617 billion. After this transaction, the dollar was devalued by revaluing the gold price to $35 and the Fed, along with all other Americans whose gold was forced away from them, absorbed a capital loss in real terms as the Treasury gained. The next gold revaluation in 1972 moved the statutory gold price from $35/oz to $38/oz and in 1973 the legal price was moved up once more to $42.22/oz where it still stands today.
Monetizing the Gold
Every time the Treasury was able to revalue their gold, they were left with an increased paper profit on their gold holdings. The Treasury however, in a desire to realize the value of the gold without selling it, used their gold as collateral against gold certificate issuance to the Fed in exchange for fresh cash for the Treasury to spend. The Treasury is able to print as many gold certificates as they choose, under one restriction from the Gold Reserve Act : the amount of gold certificates outstanding shall at no time exceed the value of gold held by the Treasury, priced at the statutory rate. This meant any increase in the value of the Treasury’s gold could be matched by printing gold certificates and those certificates could be used to acquire new Federal Reserve Notes (dollars) from the Fed.
Gold Production Surplus
Despite the fact the US government under Presidential order from FDR had outlawed the ownership of gold in 1933, gold production and mining was still a legal and productive industry. See the historical gold output production in the US:
During the abolishment of gold ownership between 1933 and 1974, when Gerald Ford repealed FDR’s order, gold ownership was exempted for some industry use, mainly dentistry like rockwest dental, and jewelery making. Whatever gold supply from production was left over after the minimal industry demands would get purchased by the US Treasury via chequing against their Federal Reserve account. This led to the Treasury accumulating large amounts of gold while also leaking out large amounts of dollars. Since the US Treasury’s gold reserve was growing, and their dollar account dwindling, they were then able and inclined to issue new gold certificates to the Fed to have their dollar accounts replenished.
In addition to gold production, gold inflows from foreign nations due to trade and capital movements also enriched the Treasury’s gold account with which they could then issue more gold certificates against. See the contributing factors to the net accumulation of gold which began after the passing of the Gold Reserve Act in 1934:
The Treasury amassed an unusually large wealth of gold after 1934 which only dwindled as foreign redemptions for gold began to pile up starting in the 60′s under the failing Bretton Woods Agreement:
Monetary Policy Run by the Treasury
From the passing of the Gold Reserve Act in 1934 up till the 70′s when the Fed’s gold certificate account stabilized, the Treasury was in effect the major influence in the direction of monetary policy, accounting for about half of the Fed’s total asset movements and the entire volatility of the gold certificate account. The Federal Reserve and their supposed pride in independence did not exist even remotely throughout this major period of Fed history. Essentially anytime the Treasury wanted to expand the money supply they could have the Fed print new dollars against freshly printed gold certificates. The only thing restricting the Treasury was the quantity of gold they owned, which was the legislatively regulated base for the issuance of gold certificates. But the Treasury used their gold for almost everything they could within their allowable limit by monetizing nearly their entire gold stock in the process. The only major exception to this was the gold the Fed transfered to the Treasury initially, following the seizure in 1934, and this gold accounted for the accumulation then of ~$3.617 billion worth of gold certificates by the Fed, instead of the usual transfers of Federal Reserve Notes to acquire certificates thereafter. This leaves about ~$3.617 billion of non-monetized gold certificates and 9.7 million ounces of non-monetized gold outstanding, when the initial gold seizure from the Fed and the US’ IMF account holdings are considered (possible changes to the US’ IMF gold account since the end of 1970 are not accounted for here).
The Treasury not only influenced the Fed to expand monetary policy but also forced a contraction of monetary policy when inflation fears became abound or by force of the 1:1 relationship they had to maintain with their gold stock to gold certificate issuance. See the Treasury’s influence on the Fed’s balance sheet as shown by the growth and decline of gold certificates as a percentage of total Fed assets (zoom in to see full size):
Bretton Woods and the Decline of Gold Certificates
Under the Bretton Woods agreement the US dollar was appointed the international currency reserve for all major nations. In essence, most countries pegged their currency to the US dollar and maintained fixed exchange rates. The US dollar became the base for almost all international settlements and transactions and was held on reserve by all major central banks. An important part of the agreement also included a convertibility of dollars to gold at the official price, but this privilege only existed for major foreign financial entities as US citizens were still barred from ownership. Despite having the means to convertibility, for the most part foreigners forfeited this right because of wide-spread complacency for US directed policy.
This trend did not last forever, though. The US began to have difficulty maintaining the gold peg when foreign markets had gold trading above the official US price which prompted the US and seven other major central banks, known as the gold pool, to attempt to sustain the peg by selling their gold when the private market price rose too high. As gold dwindled from the pool the group began to lose faith in the scheme to uphold the gold/dollar peg and France eventually pulled out of the pool leading to its collapse in 1968 and an attempt to end private gold trading. Despite these efforts, attempts to arbitrage the artificially under valued US gold price continued and an assault on the US’ gold stock ensued. Towards the end of the 60′s and early 70′s, the US gold stock was diminishing at such a rapid pace, with France as a notable leader in the redemptions, that President Nixon eventually was forced to close the gold window and default on gold payments to avoid losing all of the Treasury’s gold.
The falling gold stock in the US had other consequences as well. Most notable was the wave of US dollars flowing into the US in exchange for gold, which was not spendable in the US, flowing out. As the Treasury lost gold, they were required to keep the relationship of their gold stock and outstanding gold certificates in line, and in this case were forced to absorb back gold certificates from the Fed. This fact, coupled with fears of a runaway inflation, led the US Treasury to exchange dollars with the Fed for the return of their gold certificates which had no trading value outside the Treasury and were effectively destroyed once redeemed. Dollar inflows to the Fed led to the money supply decreasing relatively and could have helped delay inflationary problems from exacerbating at the time by diminishing the supply of liquid currency in the US. This did not occur on net however, as the Fed’s limitations for debt issuance by a requirement to maintain a certain quantity of gold certificates was removed in March of 1968 and the Fed began to expand their other assets.
The Status of Gold Certificates Going Forward
Though the gold certificate holdings of the Fed have not changed in over 30 years, the Fed is still sitting on $11.15 billion worth at $42.22/oz. Since the Treasury has no financial means or desire to acquire more gold, the only way for them to revive the gold certificate program is to revalue their gold holdings again. If the congress revalues gold the Treasury could technically be in a position to monetize their new paper profits by issuing gold certificates to the Fed in exchange for cash. Given the market price of gold, justifications for a massive increase in the statutory price are not politically out of the question. The need for the cash by the Treasury is quite pertinent as well given the recent problems over the debt ceiling and the possibility of a cash flow insolvency without newly borrowed funds.  However, should this occur, the inflationary consequences will be far from negligible as the Fed will likely end up printing somewhere in the hundreds of billions and the Treasury will likely mobilize the cash quickly. For the Treasury to monetize their gold, there is a distinctive difference to the gold being sold in the open market, as some have suggested. The key difference is the Fed funds the purchase out of newly printed money while for the Treasury to sell in the open market would require payment out of already existing money. This means when the Treasury utilizes new Fed money, the gold gets purchased without the need for any other spending in the economy to adjust, and contributes to the overall spending abilities and, therefore, demands of the economy.
Also important to emphasize is the fact that every time the Treasury revalues their gold they diminish the Fed’s real collateral value. For example, the Fed currently holds $11.15 billion in gold at $42.22/oz which amounts to a total of 264.1 million ounces of collateral. Should the Treasury revalue their gold to $100/oz, the $11.15 billion on the Fed’s balance sheet does not adjust, but the real value of the gold collateral moves down significantly to 111.5 million ounces and this difference is what frees up the ability of the Treasury to acquire more cash in exchange for issuing new gold certificates.
We hopefully have helped demystify the majority of this complex and incestuous relationship between the Treasury and Fed. For years the Treasury was the main driver of monetary policy, and still has the ability to reenter this role. The Fed, far from being independent, has always been at the mercy of the Treasury, and even today, has focused almost the entirety of their purchase stimulus programs on the most sensitive bill/bond issuance from the Treasury, an effective monetization of much of their debt. The Treasury seemed content with using Treasuries as the new gold certificate as a means of funding, but the upcoming debt limit on borrowed funds restricts its use and makes the reuse of gold certificates likely again.
Despite having solved much of the issues, a major question still remains: Does the Treasury still retain enough gold to account for the Fed’s gold certificates (~261.4 million ounces)? Without a proper, up-to-date audit we cannot be sure if the Treasury has leased or sold any or all of its gold holdings, some of which is held in custody by the Federal Reserve Bank of New York. If this is the case the Treasury is in breach of the Gold Reserve Act, but the consequences of this possibility are not exactly clear. Regardless, the right to know from the public is clearly important and efforts should be directed, not only at auditing the Fed, but also the Treasury and their supposedly in tact gold stock.
Please comment or send us any questions or comments you may have. Special thanks to Michael Owen for his invaluable insight in assisting GoldNews.com in developing this research report.
Footnotes (↵ returns to text)
- 1. Taken from the Gold Reserve Act of 1934 Section 14 (4)c↵
- 2. See reference↵
- 3. Bretton Woods is an international monetary agreement, largely designed by John Maynard Keynes, that was set up in the mid 40′s and collapsed in the early 70′s. It replaced the previous gold standard with a dollar standard world wide and the dollar alone remained with some linkage to gold↵
- 4. The Fed was in a sense forced to cooperate with the Treasury by virtue of the Federal Reserve Act’s restriction on the Fed’s ability to issue reserve notes or deposits without having sufficient gold certificates in relation. The Fed was restricted to hold at least 40% of its circulating Federal Reserve notes and 35% of its deposit liabilities in gold certificates↵
- 5. Treasury received paper profits after the gold revaluation in 1934 from $22.67/oz to $35/oz. About $2 billion of this profit was moved into an Exchange Stabilization Fund, $1.8 billion of which was considered inactive with the remainder going to general Treasury expenses. When the US joined the IMF, $687 million worth of gold out of the inactive portion of the Exchange Stabilization Fund was transferred to their IMF account, and the remainder was deposited back into the general fund of the Treasury. At the end of 1970 the IMF account of the Treasury had been reduced to $340 million with the remainder reentering the Treasury’s domestic gold stock for other transaction purposes. In total, all of the Treasury’s gold has been monetized except for about $340 million at $35/oz or 9.7 million ounces and the amount of gold initially given to the Treasury, 175 million ounces less the gold devaluations -> monetization since 1934 amounting to 88 million ounces, for a sum of non-monetized gold equaling 97.7 million ounces.↵
- 6. The Fed’s historical balance sheet (1941-1970), asset side only, can be seen here:
- 7. See reference: NBER paper on page 481↵
- 8. It is our understanding the debt ceiling limits borrowed funds only, and issuing new gold certificate liabilities would not apply to the debt limit.↵
- 9. See Ron Paul’s plan for solving the debt limit issue by selling the Treasury’s gold↵
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