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A Letter to Governor Dodge - Part 1

David Jensen
P.O. Box xxxxx Sasamat
Vancouver, B.C. V6R 4P2

October 11, 2007

David A. Dodge, Governor
Bank of Canada
234 Wellington Street
Ottawa, Ontario K1A 0G9

Dear Governor Dodge,

Thank you for taking the time from your busy schedule to speak to the Vancouver Board of Trade. It was most enjoyable to once again make your acquaintance. I enjoyed the discussions that we had at UBC in the late 1990s and have followed with interest your progress at the Bank of Canada.

I have pondered how to approach the following topic; one to which I have now dedicated more than 6,000 hours outside of my employ over the past 5 years. I have concluded that the best way to approach this matter is straight-up as it suits your temperament and mine as well.

In your speech, you referred to the recent market turbulence as a re-pricing of risk after markets had become complacent after a period of excess. The implication is that the market is correcting itself as it should and that after a period of adjustment it will progress forward on a more stable footing. I believe that there is something profound underway with the subprime market turmoil representing an initial tremor in an approaching and severe correction in the world's capital markets.

The market distortions inducing the current imbalance are difficult to perceive as two critical measures that provide critical reference points for economists and investors (and central banks) have themselves been distorted through intervention:

  • The distortion of the measure of inflation calculated as the CPI as calculated not just in the US, but in Canada, Australia, and the Euro zone as well; and
  • The price of gold.

Let me first deal with the distortion of the CPI. John Williams is an economist who was retained by Boeing in the late 1980s to resolve problems with their key economic models that had functioned well for decades up to that point. Boeing requires accurate economic models to forecast accelerations and deferrals of its commercial aircraft to maintain a functioning production line. The Boeing 747, for example, has over 2 million part numbers with some lead-times over 2 years. If the supply chain is whipsawed by inaccurate forecasts, supply disruptions, as occurred at that time, quickly manifest themselves.

What John Williams found was that the economic models worked fine. However inputs of inflation, which impact economic growth calculations, had been altered through adjustments in calculating the index by the Bureau of Labor Statistics (BLS) resulting in inflation being understated. Methods such as substitution effect, hedonics, owner-imputed rents for shelter costs, geometric vs. linear weighting, etc. had the effect of systematically understating inflation. When CPI inflation was calculated using the prior method used by the BLS, these economic models (and the resultant calculation of true economic growth and thus commercial aircraft demand) recovered their former high functionality.

John Williams maintains a website www.shadowstats.com where he provides a calculation of inflation using a constant method initially utilized by the BLS before modifying it with the above noted methods. The SGS (shadow government statistics) calculation of CPI differs by 8% from the current CPI-U. We can see that the divergence from the BLS's original CPI calculation started mildly in 1982 and then strongly diverged in 1994/1995 just as Chairman Greenspan started announcing that inflation would decline due to internet related productivity improvements. As you can see in the following article, the CPI adjustments which accelerated in the 1990s occurred as a result of Mr. Greenspan's efforts with the BLS http://www.shadowstats.com/cgi-bin/sgs/article/id=871.

The second distortion introduced above is the price of gold. It has been noted by John Maynard Keynes and other economists supported by several centuries of historic data that real interest rates and the price of gold have a close one-for-one inverse correlation. As real interest rates fall, the price of gold climbs and vice versa. When real interest rates become negative such as in the late 1970s and early 1980s, the price of gold can accelerate quite strongly. Keynes called this phenomenon "Gibson's Paradox" as interest rates correlated with the gold price level and not the rate of change of the general price level of goods as had been originally predicted. This relationship was so strong that he remarked it was "one of the most completely established empirical facts in the whole field of quantitative economics".

If a low interest rate policy were to be embarked-upon, it would be essential that the price of gold be contained. Mr. Greenspan is well aware of the importance of gold penning several articles on gold including one in the Wall Street Journal suggesting that it might be beneficial for the US to return to a gold standard (see: Can the U.S. Return to a Gold Standard?, The Wall Street Journal, September 1, 1981).

Greenspan has further commented twice in 1998 that "central banks stand ready to lease increasing quantities of gold should the price rise" (See: http://www.federalreserve.gov/boarddocs/testimony/1998/19980724.htm).

Greenspan's reference to gold leasing is of interest and gold leasing has been recently acknowledged by Barron's Magazine in an article "A Secret Time Bomb Made of Gold" (See: http://online.barrons.com/).

Prior to this article, three separate analyses of the gold market completed roughly 5 years ago came to the conclusion after studying the bullion markets that Central Banks had been leasing on average 1,000 tonnes per year into the world's gold market for more than a decade. With annual mine supply of gold of approximately 2,500 tonnes p.a. this represents a very substantial amount. I will not go into too much detail here however the studies can be found at the following links:

  1. Frank Venerosso; "Facts, Evidence, and Logical Inference" (http://www.gata.org/node/5275). Frank Verosso is an international banking consultant and his clients have included the World Bank, the O.A.S., and numerous governments.

  2. James Turk; "More Proof" (http://www.fgmr.com/moreproof.htm). James Turk is the owner of goldmoney.com .

  3. Reg Howe "Gold Derivatives: Moving Towards Checkmate" (http://www.goldensextant.com/commentary23.html#anchor19855). Reg Howe operates www.goldensextant.com.

The silent leasing of gold would be a critical tool in containing gold prices as in the latter stages of the the London Gold Pool in the late 1960s it experienced private off-takes of 400 tonnes of gold per day as the Pool tried to publicly maintain an appearance of strength of the dollar. By leasing gold, and showing gold holdings on central bank balance sheets as current assets while these assets were increasingly disbursed to the public through bullion bank leasing then sale of these assets, an invisible supply of gold could be brought to market containing the price of gold during a "new economic era" of low inflation along with liberal increases in the money stock. (I refer to the broad money stock from an Austrian perspective and also as proposed by several European banks such as Commerzbank ( https://www.commerzbank.co.in/)

Non-reporting of gold leases has been within policy strictures of the IMF (although the IMF has announced that it will release new policy guidelines on the reporting of leased gold), but of extremely dubious wisdom both due to the fact that the supply of central bank gold for lease is not eternal and the economic distortions that accompany an artificially low gold price, artificially low interest rates, and the resultant overextension of credit.

Coordination of gold leasing by key G7 central banks appears to have occurred through the BIS in Switzerland. William R. White of the BIS in a 2005 speech noted that the organization has served as a vehicle for the influencing of the price of gold "where this might be thought useful".

Apart from the BIS, Switzerland plays a key role in the world's physical gold trade. As noted by James Turk:

"As the IMF report states, even back in 1993 Switzerland "has retained its dominance in physical gold trading by providing specialized banking and ancillary gold services in an essentially unregulated and confidential environment." In other words, Switzerland is the center of the world's gold lending activity, and its transactions in physical metal dwarf the other gold-trading centers. While London remains the center for pricing gold, Zurich is by far the dominant location for transactions involving physical metal."


In addition to gold leasing by central banks, evidence of the manipulation of the price of gold both on the Comex and the Tocom (Tokyo) gold derivatives markets has also been documented by several observers. In the following graph prepared by Dimitri Speck, what appears to be a very statistically significant depression in the price of gold during trading hours on the Comex in New York can be observed. For a period, containment of the price of gold via the gold derivatives market is advantageous as, until such intervention is discovered, only small amounts of physical bullion are required. The appearance of the intervention in NY, repeatedly led by principal actors JP Morgan Chase and Goldman Sachs, is so marked that a particular day August 5, 1993 can be identified as the date of onset of the anomalous downward trade in gold on the NY Comex.


The impact of the combination of the distortion of the CPI measure along with suppression of the price of gold can be observed in the following graph prepared by Nicholas Laird of sharelynx.com showing the inflation-adjusted price of gold (plotted in inverse) vs. real interest rates where the nominal interest rate proxy is the 30 year bond and the rate of inflation used to calculate both an inflation-adjusted price of gold and real interest rates is as calculated by John Williams using the BLS's CPI methodology of the early 1980s.

It can be observed that with real interest rates of approximately -3.8% in 1980, gold surged to approximately $5,000 in 2007 dollars but then began a distinct departure from tracking the real interest rate starting in late 1987 to the point today where we now have real interest rates of -5% (using a constant methodology) and gold prices that are nowhere near their norms. Interest rates or the price of gold (or both) must go much higher from current levels. Given our record indebtedness and the instability of the real estate and derivatives markets, such movements couldn't come at a worse time.

As a consequence of these distortions that have accelerated since the early 1990s, we are now at the tail-end of the greatest overextension of credit in the modern era and are in an economic landscape that is littered with the resultant bubbles in the equity markets, the housing and bond markets, and the derivatives market - accompanied by fearless speculators who know that Central Banks are in a position where they feel that their only choice is to intervene when market disruptions and liquidity shortages, such as in the CDO derivatives market this past summer, appear. The markets have now been distorted from a price discovery mechanism to a speculative arena with unstable structures such as the derivatives market that give potential for systemic dislocation.

Mr. Greenspan himself saw the dangers that would arise as a consequence of the accommodative Fed policy underway in 1997 and spoke about them in a speech in Belgium at the Catholic University at Leuven. That speech received no media coverage, however, Dr. Larry Parks has published a detailed analysis of that speech in his book "What Does Mr. Greenspan Really Think?" a .pdf of which I will forward in a follow-on e-mail. The market turmoil that we are now experiencing is induced by entrenched moral hazard itself a consequence of years of monetary expansion and Fed intervention and was foreseen by Greenspan even then.

Governor Dodge, I realize that this is not a pleasant aggregation of data and that its impact is disturbing. Many of the concerns mentioned above have also been stated repeatedly by the Gold Anti-Trust Action Committee (www.gata.org), however they have met with official sector silence.

I believe we are facing a crisis that must be addressed or we will experience what Christopher Ondaatje states will be "the end of this era of paper and its abuse which will end with horrific consequences". These consequences will be felt not just in our economies but in our societies as well.

Canada now faces a challenge that may well impact her very sovereignty in the years ahead. I see 3 primary challenges that require urgent and near-term action:

  1. Currency reform to stabilize Canada's currency when the inevitable unwind of this era occurs.

  2. Financial market reform.

  3. Alternative energy development. The U.S. imports approximately $500 billion of petroleum (60% of its consumption) each year in exchange for exported debt. If a currency crisis occurs, the US will face extraordinary pressure on its ability to import this critical resource whose demand is relatively inelastic in a functioning economy.

The above are the basic elements of my concern. I thank you for considering this matter and please feel free to contact me if I can be of any assistance or if you seek additional information.

Sincerely yours,

David Jensen

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