Gold's Rise: Something to Worry About Jude Wanniski October 22, 2003

At $385/oz. per ounce and climbing, the dollar/gold price is now threatening to break the $400/oz. level we think would put a major crimp in the financial markets and the economy. When gold last broke $390/oz. in late September it may have been no coincidence that equities sold off, recovering only when gold sharply retreated. What we now have to worry about is an unintended consequence of the Patriot’s Act, one that almost certainly is steadily reducing the demand for dollar liquidity in a way that produces upward pressure on gold and downward pressure on the dollar relative to G6 currencies. These are in the provisions designed to track down suspicious transactions that might be endangering homeland security, specifically those referred to as “Know Your Customer,” (KYC). The due diligence is horrendous, with the problem not in the language of the Act, but in the way Treasury is writing the regulations. Earlier this month, it published a “clarification” to Section 326 of the Act, which requires financial institutions to have a process to identify customers and periodically check data about them against watch lists maintained by Treasury’s Office of Foreign Asset Control. But while the Act requires financial institutions to develop the ability to detect and report money laundering by
suspected terrorists, there are more than 46 specific subsections that cover enforcement requirements. 

The net effect is unambiguously to partially destroy the “moneyness” of the dollar, i.e., in its ability to serve as an international invoice currency and also reducing its value as a reserve asset. At the margin, this acts like a tariff on the use of the dollar and reduces demand not necessarily for “cash dollars” in circulation, but in the liquidity that underpins the dollar. Inasmuch as the Fed pays no attention to the dollar price of gold as a policy signal, it would not be putting two-
and-two together, i.e. missing the inflation implications of the Act.  

We’re getting anecdotal evidence that dollar transactions that were capable of completion in 3-5 days are now requiring 30-45 days. The KYC requirements go far beyond mere identification. Inquiries pry into as much information as possible about the assets and business dealings of every party, especially if the party is wealthy. The inquiries seem to want to know all about each party's property, and how that party goes about making money. From the viewpoint of the disclosing party, there is a concern both for government confiscation and private competition. Wealthy people in this circumstance have been and are now relocating to expatriot domiciles. Since the Patriot Act requirements follow them if they continue to do business in dollars, they are switching to euros. Here’s how one party explained it on the Internet: 

If you are trying to by $100M in paper from a company in England, it should be a matter of transferring the funds (possibly through an escrow agent) and receiving the executed  documents. End of story. But now, the Fed wants to know the providence of the paper and your funds. But, wait! You don't have all of the money. You are borrowing the money from a bank, with the help of a guarantor, who has secured an insurance wrap on the deal. Well now, the government wants to know the providence of the guarantor's funds. Then, when they find out about the insurance wrap, they have to investigate the insurance company and the individual broker who will benefit. In the mean time, they find out that the way that you were put in contact with the seller, was through a broker -- let's call him Al -- who learned of the deal from broker Bob, who learned of it from broker Cal, who learned of it from broker Don, who learned of it from broker Ed. Well now, the government wants the passport copies and banking data on all five of the brokers, even though their combined take will only be 0.5% of the total price paid. If the paper is discounted at 30% of face, then all five brokers will split only $150K, or $30K each on an even split. But, until the government learns everything about every party to the deal, they will hold up the entire $100M ($30M discounted) deal. 

If you had not heard, the Moscow Times on October 9 reported that Russia is again looking at pricing oil sales in euro instead of dollars, reflecting the euro's growing role as a reserve currency. “European leaders have long expressed interest in seeing energy contracts priced in euros rather than dollars to promote the currency and boost price stability in the European Union. Most energy contracts are settled in dollars, meaning that for European buyers, trade in gas and oil is subject not only to fluctuations in their market prices but also to variations in the value of the U.S. currency. In 1999, just after Vladimir Putin became prime minister, he laid out a proposal to move Russia's trade out of dollars and into euros.” Is this connected to the Treasury regs? There does seem to be a link, with the Eurocrats encouraging this move into euros and getting unexpected help from the KYC provisions.

I’ve heard indirectly that Treasury officials are pooh-poohing these concerns, saying there are other reasons causing the dollar to fall against the euro and that there is plenty of red tape in Europe. This misses the point entirely, if indeed mega-million dollar transactions are being delayed by several weeks. The invitation to shift to European red tape is a tempting one, especially for big transactions and wealthy participants. There is no red tape in Europe that demands as much confidential information as the Treasury regs. With the new “clarifications” issued earlier in October, the anecdotal evidence of a giant screw-up should be making its way to the top via the big banks. There is nothing in my memory of this kind that would pose such a threat to the U.S. dollar as the world’s key currency, which helps to explain the shift into euros and gold and out of dollars.

 Updates: The Medicare reform with prescription drug benefits may get shoved through the House next week without members getting a chance to pore over the bill being put together in closed sessions by House Ways&Means. By all accounts it will be quite a mess, with pressure from the White House to deliver something for the President’s signature, even if it means having to revisit next year to fix those pieces, which won’t be appreciated by seniors when they do get a whiff of the changes and costs. Next week too, Ways&Means will go to mark-up of the FSC legislation, with Chairman Bill Thomas slicing away some of the supply-side provisions to pick up the votes he needs from his committee, but maintaining the tax holiday for the multinationals. It will be a busy week.