A Thought Experiment

A Thought Experiment

As I said earlier Max and his SLA give us an ideal opportunity to conduct a thought experiment. This experiment might lead you to conclude that in holding silver you are holding “the wrong metal” to carry you through a transition into a new monetary and financial system. If anyone wants to argue that the current system isn’t ‘terminal’ please jump right in with your comments and links. There are many ruinists* here of the hyper-inflation school (*h/t Rick Ackerman for that word). As promised we will also revisit, obliquely, the claim that there is a shortage of silver.

I’ve read a lot of the comments by Max Keiser and his SLA supporters about their campaign. Obviously I don’t believe for a moment that they can ‘crash’ JP Morgan by buying silver coins, teapots and small bars (or large bars for that matter). However, I don’t think that invalidates a thought experiment which treats the SLA as a proxy for the silver advocates and JPM as a proxy for the current system.

Many of team SLA, and other vocal advocates for silver, seem to be convinced that it will return to prominence in a new international monetary system. Others simply see it as “real money” returning to its rightful place in the world economy. Some, like Bix Weir, seem to see that rightful place as the pre-eminent “money”, the “people’s money” that will lift the yoke of a corrupt monetary regime from the necks of the citizens. I can see how firmly held beliefs such as theirs lead them to such passionate advocacy for silver.

What I can’t seem to find anywhere is a roadmap, a ‘battle’ plan from any of these silver advocates showing how they get to their ultimate goal. Will silver achieve their aims spontaneously? Is it likely to be unopposed by our proxy for the status quo, JPM? As the saying goes “if you don’t have a plan, plan to lose”. So as a thought experiment I would like to sketch out such a plan in order to test the achievability of the aims of the silver advocates.

Let’s recall that definition of a corner.
To “corner the market” is to control enough of a particular commodity to allow the price to be manipulated…..The corner operator hopes to gain control of enough of the flow of the commodity to be able to set the price for it.

The ‘military’ objective of the SLA is to corner physical silver. They want to control enough silver to set the price a lot higher and break JPM in the process. How are they going to do that if they don’t get a corner? Likewise if silver isn’t monetized how can it be part of any new monetary system they are advocating? They’re not going to get any support from the establishment. This will have to be done solely through people power.

The SLA’s war will have to be fought on three fronts. They will obviously have to corner the flow, but what if the stock begins to flow as well? Obviously I think it will flow. And more on this ‘third’ front at the end of our thought experiment.

Is there any precedent for this type of military adventure? As luck would have it, yes there is - gold. A similar war has already been fought in gold. So we can examine the recent history of gold and glean some lessons for the SLA plan and the topography of the battlefields they will be fighting on. Along the way we’ll identify some similarities and some differences in the circumstances of the two metals.

After WWII gold was effectively cornered by the US government. Over the next several decades that gold became more evenly distributed into the asset reserves of other central banks, governments and private hands. The stock of gold flowed freely during this post-war period despite the general public, in most countries, being prevented or discouraged from owning gold.

Fast forward to the present. Somewhere around 30,000-33,000 m/t of gold is in CB and government coffers while the balance, over 130,000 m/t is ‘out there’ in private hands - right now. (Whose hands? That’s one of the issues we discuss at this blog.) In this thought experiment it doesn’t matter whose ‘private hands’. Only two things matter. Firstly, this stock has not flowed despite a fivefold increase in the price of gold since the first Washington Agreement signaled the end of central bank leasing of gold to the bullion banks. This gold stock is not giving any indication that it will join the flow, quite the reverse in fact. The gold stock has become highly immobile. It is in the strongest of strong hands.

The investment demand for gold has had to compete solely for the flow of gold in recent years. This flow has been supplemented by a huge increase in the supply of scrap gold which was readily absorbed by investors. (Gold scrap topped out about a year ago.) The gold fashion jewelry market is a shadow of what it was. The demand for gold displaced in this market, by silver and other materials, had to be absorbed by gold investors as well. They did, comfortably.

According to some estimates there was a single digit increase in mine supply last year. The only countries with substantial increases in their (already large) mine production (mainly China and Russia) have also been adding to their own reserves. Gold investors have demonstrated their ability and willingness to fully absorb all of this flow by continuing to bid the price of gold up.

The gold investors also now have some extremely powerful de facto “allies” that the SLA does not. The Central Banks and Treasuries are net gold buyers again. These are fantastic allies to have. They issue their own fiat currencies so there is no objective limit to how high they can bid the price of gold. They can never “run out” of that currency either. They just need sound reasons for bidding for gold and those reasons are the raison d’etre of this blog. Now why would gold investors want this competition for the flow? For the stragglers, “over 130,000 m/t is ‘out there’ in private hands - right now.” This de facto alliance is between the private and public owners of the stock, not with those investors who are now competing for the flow.

Now let’s try to apply some of the lessons from gold’s experience to the silver advocates game plan. The SLA has a de facto ally (but a very unwilling one) in the industrial silver users. Because their demand is inelastic they have to pay the going price. They will, whether they like it or not, help the SLA with one of their key objectives—to increase the price of silver—by competing for the flow.

The SLA will need to expand its share of the annual flow of silver into the market to a level where they can take control of the price of silver. The existing SLA silver holders must hold and continue to buy in ever increasing amounts or the SLA will need a constant stream of new recruits. Rising silver prices and altruism (or anger and resentment toward JPM) are the only recruitment strategies they have, as far as I can see.

Based on gold’s ‘battlefield’ experience, in order to achieve their ultimate goals the SLA (and retail silver buyers in general) will have to continue buying as each of the following events unfolds (but not necessarily in this order).

At some price level, some of the stock of silverware and all the old coins will begin to flow into bullion. The SLA will have to absorb this flow and bid the price up. At some price the silver fashion jewelry market will collapse. There are other white metals and alloys and there is no silver bullion jewelry market to speak of. The SLA will have to absorb this flow and continue to bid the price up. At some price the scrap silver market will turn into a flood (just like it did for gold). The SLA will have to absorb this flow and continue to bid the price up. Then the going will start to get a little rough for them.

If I am right about SLV being used as the “swing producer” in the physical silver market it is already part of both the stock and flow. At some point the silver in the other physical silver ETFs will also start to flow. The sponsors of these ETFs cannot prevent this. If enough shares are presented they must tender the physical silver. If the SLA absorbs all of the flow described above, while bidding the price up consistently, they will demonstrate to speculators that there is a rock solid arbitrage opportunity. Speculators will pull this silver out of the ETFs and coin it to sell to the SLA. The silver ETFs are not ‘strong hands’. They are the weakest hands of all.

Then another problem will emerge. There are silver “traitors” outside the SLA and troops in the SLA ranks planning to “desert” at the first whiff of grapeshot. People who have no intention of holding silver indefinitely. Some, like Robert Kiyosaki, are waiting for the right time to offload to the “suckers” as he calls them. Others have a target for the GSR. When reached they intend to roll their silver for gold. Perhaps the SLA can keep up the pace of recruitment so that it adds new recruits to replace the deserters and continue expanding its forces. Another problem may emerge (later rather than sooner) for the SLA: increased mine supply.

The silver advocates take comfort in the fact that silver is used in such small quantities in each product that the industrial silver users sell, that high prices, even incredibly high prices, will not deter them from buying. That is most probably true. Score that one for the SLA. However, the SLA may have completely misunderstood the threat. The price may be irrelevant. Earlier in this thought experiment they cornered the flow and the stock. The political heat from the industrial users, including the military-industrial complex, will be ferocious if the SLA threaten the supply lines of these users. (Recall the recent controversy over China’s corner in rare earth metals.) Perhaps the politicians will stay firm. Perhaps they will only sequester the silver mine supply on national security grounds. If so, the SLA is still in the game.

If the SLA can overcome all of the challenges that have been listed so far and “bullionize” all of this silver into retail product, it will then be confronted with the most terrifying enemy it has faced in this war. Their third front – 160,000 m/t of gold. Michael Maloney explained why (indirectly) gold and silver are enemies. There is enough silver too. If necessary it could be the sole monetary metal, even if that meant dividing it into atoms. Do you understand the implications?

You see this phrasing all the time “gold and silver”. There is no “and silver”. In this thought experiment the correct perspective is “gold or silver”. If the SLA and the other silver advocates are successful in making silver the premier monetary metal then gold won't just be less valuable, it will be worthless to everyone, everywhere. Superfluous. Redundant. Just like silver is now in the monetary system. Gold now has no other purpose than being the crème de la crème of monies. If silver wins this contest gold will have no value at all except for a small range of industrial applications and as cheap jewelry. Hooray for the SLA.

Hold it right there SLA. This thought experiment isn't over yet.

The SLA needs to ask itself a few questions as we conclude this thought experiment: Who is holding this gold? Why are they holding this gold? How much power and influence do they have? What are their options and capacity to respond to the threat you pose?

If the SLA gets carried away with delusions of grandeur and the silver advocates start to achieve their aims, then the governments and Giants who hold this gold will respond. You can understand that, can’t you? The moment that silver presents a ‘clear and present danger’ to their interests, they will understand this threat. The threat that their gold is soon to become worthless. They will squash the silver bugs – like a bug. Silver would then be a losing bet for political reasons. If the SLA is clearly going to fail then the silver holders will be perfectly safe. The gold holders will simply ignore them. Silver will be a safe losing bet until game theory kicks in.

Let’s wrap this up with a final question: Are you holding the right metal?

http://fofoa.blogspot.com/2011/05/costatas-silver-open-forum.html