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Outsized Short Position Weighs on Silver Prices

Forbes Columnist George Leef on Betrayal of Sound Money and the Road to Restoration Stefan

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Welcome to this week’s Market Wrap Podcast, I’m Mike Gleason.

Coming up we’ll dive into a disturbing topic of just how far our nation has strayed from the Founding Fathers’ ideals when comes to sound money – with devastating effects on our freedoms and the economy. In my exclusive interview with George Leef of Forbes Magazine, you’ll also learn about the growing movement to restore gold and silver back into the monetary system. Don’t miss my conversation with George Leef, coming up after this week’s market update.

A busy news week in Washington gave investors cause for both hope and fear, but they chose to focus mostly on hope. Major U.S. stock averages lifted toward new record highs as the Trump administration rolled out its tax cut proposal. Meanwhile, gold and silver markets got hit with selling despite escalating tensions on the Korean peninsula and a weakening U.S. dollar.

Gold prices currently check in at $1,267 an ounce, down 1.5% on the week. Silver is off 80 cents or 4.4% since last Friday’s close to trade at $17.25 per ounce. The one bright spot in the precious metals complex is palladium, which closed Thursday near its high mark for the year and is surging again today. As of this Friday morning recording, palladium is up 4.3% on the week to $832 an ounce and now sits at a 26-month high. And finally, platinum is off 2.7% to trade at $949.

In both the gold and silver futures markets, commercial traders have amassed enormous short positions. Banks and other large institutions have bet big on falling precious metals prices. In silver, the net short position among the commercial trading institutions has reached record levels. The latest Commitment of Traders data show the net short position at about 125,000 contracts, which is equal to 625 million ounces of silver or more than 70% of annual silver production.

It’s difficult to see any particular fundamental reason why such an outsized bearish position would be taken out at this time. The mining industry doesn’t have a sudden need to hedge in a much bigger way than it ever has before. The likely explanation is that commercial traders want to drive the price lower by taking out concentrated short positions. They’ve gotten two straight weeks of price drops in silver despite the U.S. Dollar Index falling now for three straight weeks.

Whether you want to call it manipulation or something else, it’s no coincidence that the banks usually get their way when they pile onto one side or the other of a market. The risk for precious metals investors is that the current correction could persist for weeks before the commercial traders shrink their net short positions back to neutral levels.

That doesn’t necessarily mean silver prices will go down any further. It could be a more of sideways correction from here. It could also be the case that some event causes short covering to accelerate and prices to rally at any time.

Political and geopolitical developments could certainly spark volatility in markets without warning or notice. As I noted earlier, stock market investors are still putting a great deal of hope in the ability of Team Trump to deliver for the economy. Optimism toward the prospects for economic growth persist even as the GDP report due out today is likely to show the economy got off to a weak start in the first quarter.

Tax cuts, if enacted, could certainly provide some stimulus for the economy. President Trump wants to lower the tax rate on corporations, and on capital gains and dividends, while providing working families with a larger standard deduction.

But establishment Republicans in Congress are insisting that the tax package be revenue neutral. That means the total amount of revenue extracted from taxpayers wouldn’t actually be cut. Any lowering of rates would have to be offset by eliminating loopholes and deductions. The Trump administration also wants to employ so-called “dynamic scoring” – a budgetary trick that assumes tax cuts will partially pay for themselves over time through projections of higher rates of economic growth.

It’s true that an economy less burdened by taxes will tend to grow faster. But not even the rosiest of growth projections will lead to a balanced budget absent gigantic cuts in federal spending. And right now even small cuts to any of the largest portions of the federal budget are politically impossible.

Quibbles in Congress over budget priorities could extend the threat of a so-called government shutdown into next week. Although a shutdown makes for dramatic news coverage, markets probably won’t take it too seriously. When the last government shutdown occurred in 2013 from October 1st to October 16th, the S&P 500 actually posted modest gains during the impasse. Gold prices traded range bound with no major fear-driven buying spikes.

Regardless of what Washington does or doesn’t get done this year, the fiscal outlook for the years ahead will include rising spending commitments, rising deficits, and the risk of much higher borrowing costs. Government’s appetite for dollars will grow and grow by the trillions. If the dollars can’t be taxed from the productive economy, they will be created out of thin air by the Federal Reserve.

It’s a dangerous environment in which to invest based solely on hope. Prudent investors prepare for good times as well as bad, and physical precious metals are the only asset class that can fare well when bad times hit currencies and financial markets.

Well now, without further delay, let’s get right to this week’s exclusive interview.

George Leef

Mike Gleason: It is my privilege now to welcome Forbes Magazine columnist George Leef. George is a hard money advocate and a law graduate who has dedicated his professional life to teaching and education rather than practicing law, and over the past fifteen years has worked at the James G. Martin Center for Academic Renewal, a free market think tank that takes a critical view of higher education. Underneath George's byline on any of his Forbes.com columns, you'll find the words, "I write on the damage big government does, especially on education." And today, we're going to get into just how uneducated many are when it comes to the government's heavy-handed role as to our money.

George, thank you very much for taking the time to visit with us today. How are you?

George Leef: I'm very good, and my pleasure to be on with you, Mike.

Mike Gleason: I'm excited to cover this topic with you and first would like you to brush up our listeners on the role the US government was originally designed to play vis-à-vis our money. And contrary to popular belief, nowhere in the Constitution do we find anything about granting our governmental overlords a monopoly power in the creation of money, do we?

George Leef: No, we don't. The Constitution sets forth the powers that the government is supposed to have. In Article 1, Section 8, the powers of Congress are enumerated and that includes the power to coin money and regulate the value thereof and also the power to punish counterfeiting of US securities or US money. As I note at the beginning of my article, which is available on Forbes.com, that does not include the power to create a governmental monopoly in the creation of money. There would be no reason to think that the founders would have wanted such monopoly for several reasons. They had been unhappy with British monopolies like the East India Company that tried to sell them overpriced tea, and we know what happened to that tea.

We also know that at the time prior to the founding and after the ratification founding, there was lots of non US-produced coinage in circulation. There were coins in circulation that had been minted by the Spanish government. That's where we got the idea that the “piece of eight” and “two bits”. The colonists liked to cut the Spanish eight-real piece up into smaller pieces and they used that in trade. There were also privately minted coins in circulation. The people who wrote the Constitution knew about this and it didn't bother them in the slightest.

What they had in mind as the monetary system of the new country would be based on gold and silver. In fact, they wrote that into the first Coinage Act in 1792. They couldn't have cared less who minted gold or silver coins. All they were intent upon was that the coinage of the United States not be counterfeited. That, of course, was also written into law early in the country that it was illegal to counterfeit. They did not by any stretch of the imagination envision that the federal government would have monopoly on the production of money.

Mike Gleason: It was a certain amount of gold and silver grains, I guess, made up a dollar. They did have the ability to change that metric if they needed to, but that was the true backing.

George Leef: That's true. They adopted a bimetallic system. The dollar was designed both as a weight of gold and a weight of silver, but they understood that the market value between gold and silver would probably change over time, which is what they meant when they said “regulate the value”. What they meant was that they could change the ratio between gold and silver as needed, which, in fact, Congress did in about 1834, as I recall, changing the ratio between gold and silver. I'm trying to remember whether it was gold that was starting to go out of circulation or silver because one was over-valued. Anyway, that's what they meant by regulate the value of money.

Again, it does not entail any power to punish people for making other forms of money. In fact, I think if you had been able to talk to James Madison or any of the other drafters of the Constitution back then and asked, "Does this mean that the federal government can punish people who produce gold or silver coins or copper or anything else?" they would have said, "Of course not. As long as you're not counterfeiting or defrauding people with these coins, we don't care what coinage people use in their transactions."

Mike Gleason: Now as we turn towards the Bernard von NotHaus case that I'll ask you about in a moment, the role of government with respect to money was primarily, if not exclusively, to prevent people from producing fake money, counterfeiting, which you alluded to a moment ago. They've taken that notion and really expanded it, haven't they?

George Leef: Yes. During the Civil War, Congress added a section to the criminal code, Section 18 of the United States Code, Section 486, which purports to make it a crime to produce coins that could be used in substitution for "the current money" of the United States. They didn't want competition with the cheap money the Union was producing during the Civil War. That provision still remains on the books and has recently become key in a case against a man who was producing what was called the Liberty Dollar. His name was Bernard von NotHaus. Oh, quite a few years ago, back in 2005 and earlier, he began producing a pure silver coin, which, of course, the US government itself stopped doing way back in the mid-1960s. They took the silver out of the coinage and just made these clad coins we now use.

He was making a silver dollar he called the Liberty Dollar, which he sold to people at the price of the silver in it plus a markup. His point was that he wanted to emphasize that the United States was not living up to its legal obligation of providing true money, valuable money, money backed by something. His activities came to the attention of the federal government, which, of course, loves to throw people in jail who speak ill of its policies these days, and, of course, the policy for a long time has been to flood the country with Federal Reserve notes, cheap money that’s backed by nothing.

So they prosecuted Bernard von NotHaus for violation of 18 USC 486, and they said, "You are producing money that competes with current money of the United States, and that is illegal." The case went to trial in the western district of North Carolina, Federal Court, in 2009 and Mr. von NotHaus was found guilty of violating federal law in 2011 and he was recently sentenced, although the sentence is fairly light. He was sentenced to only six months of house arrest by the judge, which I think speaks at least of a token of good sense inasmuch as the taxpayers have wasted enough money and they don't need to waste more money putting this innocent and harmless man in jail.

Also, and this, I think, is what really makes the government's point, they seized some seven million dollars' worth of his assets, gold, silver, the presses used to make the coins. Most of that is going to be kept by the federal government at the judge's order under civil assets forfeiture. Some of it is supposed to be returned to Mr. von NotHaus. So they made a spectacle of this guy, convicted him for doing something that was perfectly honest and harmless.

Mike Gleason: Yeah. They definitely feel like they should be the only ones that have the ability to counterfeit our money or what should have been money and definitely don't like other people doing it. I guess the fatal mistake he made was that he put the dollar label on those coins. Is that what I understand?

George Leef: Yeah. He put the dollar sign on it, and the prosecution made a big deal about that. In point of fact, nobody who bought a Liberty Dollar could possibly have thought that it was actually United States currency. It was made out of silver, which our coins are no longer made out of. It didn't say United States Government on it. It certainly was not a case of fraud or of counterfeiting. It did not look like US coins. No one could have possibly mistaken them for US coins.

Mike Gleason: Turning to the Federal Reserve's role in all of this, you alluded to it a moment ago. It seems that the current system is all about the Fed monkeying with the money supply, controlling interest rates, and even stepping into the market to buy literally trillions of dollars of bonds. This has not only created tremendous distortions in asset prices and bubbles, crashes, financial turmoil, but also the purchasing power of the dollar is down some ninety-seventy percent in the last century. Now in a column you wrote earlier this year where you reviewed a great book by Professor Richard Timberlake titled Constitutional Money, you quoted Timberlake as saying, "What we have learned is that the rule of experts, no matter how brilliant their credentials, is far inferior to the stability of a self-regulating market." Explain why you believe that to be the case.

George Leef: I'm glad you brought that up, Mike. I'd like to encourage people to read this excellent book by Professor Timberlake entitled Constitutional Money, published last year by Cambridge University Press and which I reviewed on Forbes. What his argument is a counterargument to the progressive status argument we hear about, medical care, Obamacare, and many other things, that we have to rely upon government experts to get things right, whether it's medical care or the money supply or something else. If we turn it over to the right people, they will create the right circumstances for the country, and then we'll be just fine, but we couldn't rely upon market processes.

What Timberlake is arguing is that we should rely on market processes and stop relying upon the so-called experts at the Fed, for instance, because what they have done is ruined, they've undermined our monetary system. They have given us this, among other problems, this zero interest rate policy that is ruinous to people who used to depend and thought they could depend on the return from monetary assets that they had invested in. We'd be much, much better off if we returned to the constitutional concept of money, which is a market-based money, money based on gold and silver or any other valuable commodity that people would like to use in making their exchanges and take the power of manipulating money away from these federal bureaucrats. That's his argument.

In fact, he continues by saying that the entire Federal Reserve system really should be regarded as unconstitutional the way it has turned out. They're doing things that are clearly in violation of the role of government and money that the founders had envisioned.

Mike Gleason: Speaking of manipulation, we got a great example of that in past history. In the column you wrote about Timberlake's book, you also point out the Fed's policy decisions and immediate reaction to the early stages of the Great Depression made it much worse because they prevented gold from functioning as the monetary base. Gold ownership was made illegal in America. It was officially demonetized and then locked up in Fort Knox by the politicians. With gold drummed out of the monetary system and taken out of people's hands, they could essentially politicize the nation's economy. Why was that so detrimental?

George Leef: That's precisely what the progressives, FDR and his New Dealers had in mind. They wanted to politicize everything, including the monetary system. That's why they confiscated gold; they made it illegal to make contracts for dealings using gold. They wanted to lock the people into dependency upon the federal government in every way they could, including the use of money. Perhaps the most striking argument in Timberlake's book is his point about how gold was locked away, seized by the government, put into Fort Knox. If that had not been the case, he argues, the money supply of the country would not have shrunk the way it did. That's what really caused the wave of bank failures and business failures that hit the country in the early '30s, lasting into FDR's first term. It was all the monetary blundering of the Federal Reserve officials that made a bad situation much, much worse.

Mike Gleason: Well this notion of free currency and the resurgence of precious metals is an important monetary asset across the globe. It seems to be gaining traction even here in America, particularly in several states, that the US Constitution says that states should recognize gold and silver coins as legal tender in the payment of debts. We're seeing several states, Utah being the first, if I'm not mistaken, formalizing this through legislation in the past few years. So this is an issue on the rise and thank goodness more people like you are talking about it. You've covered this a lot. Are we gaining traction in this area?

George Leef: Oh, I think people are becoming more and more nervous about our monetary system as the federal debt continues to go up and will no doubt continue to go up at an exponential rate. People are going to get more and more nervous about money and they're going to start asking the right questions about what has the government done to our money? What should our monetary system really be like? What are the alternatives to this system we have where the supposed experts in the Federal Reserve just crank out as much money as they think is ideal. This is going to gain traction. I think we'll see more states taking these kind of steps, which they're perfectly entitled to do under federalism, to allow people to make their own transactions however they want to. That's the freedom that the founders envisioned. Maybe it's due for a comeback, and I think we're going to start seeing it.

Mike Gleason: It definitely starts with education, and you're, of course, at the forefront of that. We definitely appreciate what you're doing there and certainly thank you for your insights and the works you're doing there at Forbes.com, and we hope we can visit with you again as this all unfolds.

George Leef: Oh, absolutely, Mike. Glad to be on with you.

Mike Gleason: Well that will do it for this week. Thanks again to Forbes columnist George Leef of the James G. Martin Center for Academic Renewal.

Be sure to check back next Friday for our next Weekly Market Wrap Podcast. Until then, this has been Mike Gleason with Money Metals Exchange. Thanks for listening and have a great weekend, everybody.

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