Here's What the Fed Does With Those 'Gold IOUs'

Posted by Adam English of the Wealth Wire

We all know that central banks sit on massive stockpiles of gold. We also know that they’re in the business of leasing it out to a small handful of elite banks to monetize their holdings.

However, few people understand exactly how this affects the market…

Gold leasing by central banks effectively does two things. It monetizes gold reserves and gets more gold out into the market.

Central banks start by leasing the gold to bullion banks. There are about six to eight banks that are doing this at any given time. Just like any other lease, terms are drawn up for payments and an expiration when the lease will end.

At this point, the central bank is done until some gold is returned at the end of the contract. Bullion banks then use rehypothecation to milk the gold lease for all it is worth

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Hypothecation is essentially the act of giving collateral, or access to it, to a lender. Rehypothecation is when the lender then uses that same collateral to support a second loan. In essence, the same collateral is now backing up two different loans. It can, and often does, keep going from there into many more loans that are based on that first small bit of collateral.

The IMF wrote a damning report on rehypothecation after the last meltdown for obvious reasons. Consider what would happen if several – or all – of the loans are called in at once. Now consider that in the UK, there is no limit to rehypothecation. In the USA, it is limited to 140% of the loan amount to a client.

Now, the bullion bank has sold the gold or used it as a form of collateral for several loans. They now have cash for these transactions, which they invest elsewhere for a return. After that, many take a portion of the return and use it to hedge with futures contracts.

So the central banks have leased out gold that has been sent off into the market for some fiat currency payments. The gold is then monetized by elite bankers into a chain of loans propped up by a minuscule amount of real assets. A profit is made, a carry trade is continued, and the process is repeated.

It is a pretty complex move – and a masterful financial sleight of hand. Did you see what the central banks did with their elite banker assistants?

They just took gold reserves, removed them from the vault, leased them out with a promise of their return. Their assistants then sold the gold and took a bunch of risk through highly-leveraged speculative contracts that would collapse their balance sheets if they came due.

The whole time, it is assumed that the gold is still functionally safe. If everything blows up, they’ll just make a call and get it back from the bankers that are taking highly speculative risks with it.

After all, it is just a simple lease, right?

Story courtesy of the Wealth Wire   http://www.wealthwire.com/news/metals/4303?r=1