The gold ponzi scheme

I have written a couple of posts on how there is more gold paper than there is physical gold.  A year ago, Adrian Douglas wrote that there were four owners for every ounce of physical gold that is traded.  Recently, he told Peter Schiff that 45-100 times more gold paper exists than physical gold (see this post).

I concluded yesterday that banks which sell gold certificates do so on a fractional reserve basis.  How can they dare take such risk?  If the price of gold doubles, so would their liabilities!  I was thinking about it after writing yesterday’s post.  It is clear that the banks count on always being able to sell new certificates as their old customers begin to cash in the old ones.  Thus, they count on an active trade in gold certificates and continue to make a profit on the premiums, as well as continue to lend out the proceeds from the sales.  The Bank of Nova Scotia, which today has a market capital of 55 billion dollars, had 3.5 billion in Gold and silver certificates and bullion liabilities in their 2009 Annual Report.  Now let’s imagine a scenario in which the majority of holders of gold certificates become anxious and therefore go to their banks and demand delivery of physical gold–a bank run–and that this happens not just in Canada to Scotia Bank but globally to all the sellers of paper gold.  Suddenly a 3.5 billion dollar liability could become a 35 or even a 350 billion dollar liability, as banks scramble to buy physical gold, but suddenly gold becomes scarce instead of plentiful because no one is accepting the paper anymore.   This is something that could bankrupt the banks–indeed, it is the classic means by which banks have bankrupted themselves.  They issue more paper than what they have physical money, and people suddenly all come in to redeem their paper for real money (gold and silver).  Some financial institutions have even charged their clients storage fees for the gold and silver that they were supposedly holding for them! (See e.g., regarding Morgan Stanley).

Now, perhaps an esteemed reader of this blog says to me, “The banks wouldn’t be that stupid.”  But these are the same banks that bundled good and bad mortgages and sold them to the world in the form of derivative products called “CDOs”, saying that the housing market will never go down; this resulted in the sub-prime mortgage crisis and it has proven that banks are not run by the brightest people, but rather by immoral people whose desire to become rich leads to destruction and chaos.

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