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Julian  D. W. Phillips

Julian D. W. Phillips

Global Watch: The Gold Forecaster covers the global gold market. It specializes in Central Bank Sales and details, the Indian Bullion market [supported by a…

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Will Gold be Bolstered by the Goldman Sachs Fraud Case?

Entrance

Initially the gold price fell on the news of the S.E.C. civil fraud charge against Goldman Sachs in the belief that both they and Paulson's hedge fund would have to sell their gold holdings. A reaction that was founded on uncontrolled emotions, you would rightly suppose. The reaction was very like gold market after the news that Greece is going to the EU & I.M.F. [because few believe that Greece will correct matters thereafter] for their bailout. The € fell as the Greek crisis impinged on the value of the €. The additional reaction in gold was based on the supposition that gold is tied to the €.

Not a great deal of thought goes into these reactions, but if you can make money by inciting investors like this, why not? These reactions illustrate that emotion, alongside the Technical picture drive short-term prices, exclusively. Longer-term investors apply more thought to their investments than this. It is their view that needs to be looked at with depth if we are to understand just how the Goldman Sachs story could influence future gold and silver prices.

The Morality of the Matter

A moral is concerned with right and wrong. As we all know there are a considerable number of definitions of 'goodness or badness' in this world. In business this is particularly so. Today, it seems that such definitions in the business world hinges on a code of practice that allows the business world to function effectively, defining as bad those practices that hurt the smooth running of the business/financial/money worlds. That gives a huge scope to our activities, doesn't it?

Within this parameter, we are hearing these comments pointed at Goldman Sachs: -

Gold Bars
  • Politician Nick Clegg [UK] "the allegations against Goldman Sachs are a reminder, if we needed one, of the recklessness and greed that disfigured the banking industry as a whole."
  • Politician George Brown [U.K.] described their behavior as "morally bankrupt".
  • Wall Street's unquenchable thirst for profits and utter disregard for ordinary consumers led to a pattern of greed and recklessness that darn near led to a complete collapse of our financial economy, millions of Americans lost their jobs." Senator Christopher J. Dodd [U.S.]

That was the short version, but this will do for now. What is Goldman Sachs response to these charges?

  • The bank said that it had concluded in an earlier internal investigation that Tourre had done "nothing wrong."
  • They feel that they too, by extension, have done nothing wrong.

This speaks of a failure to share the same morality, so what should be done? Is GS shameless? How many executives face a 'morality' test that applicants are required to pass? The subject doesn't even come up. Usually the assumption is that all of us have the same basic morality. The government and existing laws are the arbiter of such behavior? And if the law is not sufficient, pass another one that is. And that's where we are now.

In practice, the most important aspect of such morality is that it should allow the money systems to work and inspire confidence in them. Compare this to what's been happening and do you see trust or confidence improving either inside the U.S.A. or the rest of the world? In this case, the horrified reaction of the worldwide public is in the process of undermining both confidence in and the workability of the banking system, already undermined by the "credit-crunch" and the government bailouts. The winners, at all points, have been the bankers, with burgeoning profits, fewer competitors and the inside track on the world's business dealings.

Clashing Principles

Right now the U.S. is facing a clash of principles in capitalism and the free markets. The democratic structure of the U.S. has a system where, from individuals up to institutions, each is independent, while being inter-dependent. The U.S. lauds this system as the best in the world. In Europe with its more socialist system, government control is more exacting. In China there is no such independence and all will do as the governments says.

The performance of the gold price over the last decade tells us that the workability of money systems has been found wanting. Stand back and see that this is not about Goldman Sachs but the entire system. The U.S. system is in trouble and by extension the systems of the rest of the developed world. Internationally, there is no regulatory body to govern it. Jurisdiction gets in the way. Right now, to all intents and purposes the U.S. money system rules the world.

While politicians across the world are trying to control or increase regulations on banking activities, we ask, "do governments have sufficient power to control money systems?" Does the U.S. government have the power to do so? With the current belief that the banks are behaving exclusively in their own interests, at the expense of others, in the name of profits an acid test is upon us! Why do we believe the issue is this big?

The Issue of Size

Globe of the World showing North America

The days when a bank was just a part of community business has gone. Today, banks have grown to be the veins and arteries of all aspects of U.S. and the world's financial life. Everybody uses the banks for every financial transaction. Not only have they become "to big to fail" but dominating. To what extent?

In 1995, the assets of the six largest banks totaled 17% of the nation's G.D.P. Now they have assets amounting to 63% of G.D.P. The share of all banking industry assets held by the top 10 banks rose to 58% last year, from 44% in 2000 and 24% in 1990. In a face-off with government, who holds the power? If government [SEC] loses the GS case, just what will happen to trust and confidence in the world's money systems?

You may say that all the U.S. banks account for that number not just these main banks. But Goldman Sachs is the biggest U.S. investment bank and among the top six U.S. banks overall. The credit crunch reduced the competition as the size and importance of the six largest banks [Bank of America, Citigroup, JPMorgan Chase, Wells Fargo, Goldman Sachs and Morgan Stanley] increased throughout it. Merrill Lynch is now part of Bank of America, Bear Stearns part of JPMorgan Chase and Wachovia part of Wells Fargo. Of more importance, Goldman and Morgan converted to bank holding companies to gain access to lending from the Fed's discount window. The backing that the U.S. Taxpayer gave to these banks required no onerous terms of repayment but was designed as a loan all of us would want, 'pay back when able'. [Can you get one like that from your bank?] Banks are the backbone of the global economy!

So the revelation of the fraud charge against Goldman Sachs is all the more critical! It is a structural fault in the system!

Please note that we are looking at the impact of these issues on the long-term gold price, which essentially defines how sick trust and confidence in the system really are. It is not our role to moralize but to forecast from what is happening now.

Regulatory Reaction

What are the objectives of financial reform? When the credit crunch hit the Fed acted to save the financial system with saving the banks as the focal point. And now are these objectives targeting trading excesses? Is reform to ensure that banks do lend more and support the economy, or is the main aim to maximize profits still?

Looking back at the efforts to date to repair the financial system, have regulators succeeded? We're still waiting!

The U.S. needs a reformed, consumer supportive, banking system if the U.S. or any other developed world economy is to get back to pre-crisis levels. It hasn't happened yet and, so far, there's nothing there that will restore confidence and trust.

Let's see if the government is able to regulate the $450 trillion derivatives market. If GATA are right, effective reformation will not lead to a fall in the gold price at all, but the closure of so many short positions that the gold price must soar. Or will new laws allow the big banks to squeeze past such proposed regulations? The debate begins next week.

Even President Obama has said, "We have gotten into one of those places where we need to update those rules of the road and if we do so, not only is that good for the economy, not only does it protect consumers and investors, it's also good for the financial sector, because it will rebuild trust. Finance ministers from the Group of 20 nations will meet in Washington this week to consider global reforms, including a proposal by the International Monetary Fund for two new taxes on banks to fund future bailouts. Any superficial action will drive up gold prices long-term.

How will Goldman Sachs fare against the S.E.C.?

This question has a direct bearing on the future price of gold, long-term. If the bank doesn't fight or settles out of court, it will have lost, because of the residual uncertainty as to whose interests they favor, theirs and selected clients or do they really have integrity? We believe it has made a serious mistake as far as trust and confidence in the banking system goes. After all, it is not a matter of showing it kept the rules [which were clearly inadequate] but proving their integrity. Right now it seems that no matter what happens, it will take them many years to be trusted and inspire confidence again.

The banking system overall will be tarred with the same brush and if the damage in the C.D.O. market extends to mishandling sovereign states such as Greece, then the global banking system becomes almost cancerous. The global monetary system will continue as is, it won't collapse, because it's the only system out there, but the prudent investor will add 'investments' outside the banking system to his portfolios.

With a fraud charge against the biggest and the best U.S. Investment bank, when anger against banks is red-hot [after being helped by the taxpayer], with bailed-out bankers making huge profits, but not doing too much to help the taxpayer in return, banks could not have done that much more to invigorate the gold price than it has. It will take the full course of the court case to press that point home but the journey can't be stopped now. So yes, the Goldman Sachs case will bolster the gold price, but how?

The impact on the Gold Price
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