A Silver Dream

A Silver Dream
by Ralph Johnston

I had a dream last night. A silver dream.

It all starts with a regime change in the Latin American republic of La Plata. The new president is swept into office on the heels of 2000% inflation by an electorate fed up with IMF-induced bank failures. On his second day in office, El Presidente appoints a new central bank governor, an economist and former labor leader, who quietly informs the central bank's silver lease counterparties that the leases will no longer be rolled over. The silver must be returned at the end of the current lease term, 55 days hence, or the central bank will go public with announcement of the default. But the physical silver cannot easily be repaid, because it is long gone, having been sold into the spot market and used in industrial production a decade earlier. So the counterparties, large New York firms, have a challenge.

A distinguished New York financial executive and former US Treasury Secretary quietly contacts the La Plata Central bank governor and quietly proposes a settlement: a 20 million dollar contribution will be made to the central bank governor's favorite charity, and the leased silver will be offset by forgiving a substantial amount of La Plata Brady bonds. Surprisingly, though, the central bank governor replies no dice -- and by the way, Bob, El Presidente says to tell you that he's planning to retire those Brady bonds with La Plata reals, not US dollars, at the official exchange rate. Why should Yanqui bondholders be treated any better than La Plata bank depositors?

Over the next two days, the bribe offer is raised, first to 40 million dollars, then to 75 million. The rejection of the final offer is accompanied by a leak to the London financial press that El Presidente is considering appointing a blue-ribbon commission of La Plata business leaders and economists to study the concept of metal-backed currency. In Manhattan the message is received, and in a series of conference calls between New York and Washington the policy is established: default on the La Plata debt will be averted, at least in the short term, by assuring that the leased silver is promptly repaid. Initially it is assumed that Treasury, Exchange Stabilization Fund and Department of Defense silver holdings will be sufficient to meet the crisis. But a series of phone calls quickly reveals that in the past three decades, US government silver holdings have been drawn down from several billion ounces to near zero. The only stocks readily available are 320,000 ounces being held in the West Point mint and slated for production of US Eagles. This inventory is a small fraction of the amount payable to La Plata in 41 days, and the clock is ticking.

As the New York banking cartel enters the physical silver market, seeking sufficient bullion to repay the Plata Central bank, lease rates skyrocket. But some among the very few holders of substantial quantities of physical silver in good delivery form sense that the game is reaching its end, and refuse to come to market with their metal, even at higher lease rates. As the bullion bankers slowly begin to assemble the physical position they will need to meet the La Plata delivery date, industrial silver users are crowded out of the leasing market. Even before the La Plata deadline is reached, a series of cascading delivery defaults occurs, culminating in rumours that the US photo giant McCartney-Black will furlough its employees and close its plants for a few days because its just-in-time deliveries of silver, formerly supplied by the bullion bankers from leased stocks, will be delayed.

Meanwhile, as the leasing market is quietly falling apart, Comex trading continues. As Comex players first observe the higher lease rates, and then begin to hear rumours of impending delivery defaults, the bulls among them aggressively increase their long positions. For two days, silver prices fall in the face of strong buying, as two New York firms meet the buy orders with even more aggressive naked short writing. But on the third day, McCartney-Black, with the failure of their primary market -- the leasing market -- enters the Comex and begins taking physical delivery. This is contrary to long-standing practice and handshake agreements, but what else can they do? The instant the longs see this, they demand physical delivery, too. There is less than 100 million ounces in the Comex warehouses -- 35 million already certified. Mercifully, the stampede is curtailed by the early closing time of the precious metals markets, still on their post-September 11 shortened hours after more than a year.

That afternoon, reassuring statements are issued by the heads of the Comex, the CFTC, McCartney Black, and the Federal Reserve. The principal financial news television network spikes the story, and the major international television news channel downplays it on their evening financial broadcast. But it's too late; the word is out.

The next morning, every bar in the warehouse is committed, and silver opens limit up. Now, the only thing that can happen, does: in an action reminiscent of 1980, the Comex announces new rules: all silver contracts are to be settled in cash, and no new silver positions are to be opened.
Both of the two markets for physical silver have now ceased to operate, first the primary market, which is the OTC leasing market; then the secondary market, the commodity exchange. On the exchange, silver is still officially open for business, but as the ask rises above the limit, trading ceases.

Industry needs silver to operate. With the sole exception of photography, for which silver is a major input factor, manufacturers' cost of silver is a very small fraction of total production cost, but silver is essential to their processes, and no other element can substitute for it. Electronics, medical, auto, and defense producers must have small but steady inputs of silver. All have transitioned to just-in-time inventory practices, thus demand is urgent. The cost of curtailing production is huge, so the price of silver is very inelastic. It is a repeat of the 1990s’ run-up in palladium prices, but this time the demand is from every industrial sector, not just from auto manufacturers. A new, third market must emerge immediately to serve the industrial users. Nebraska-Western, a publicly traded holding company with large silver bullion holdings, quietly informs the purchasing managers of the twenty largest industrial users of silver that 80 million ounces in good delivery form is for sale at the London warehouse -- at a price of fifty dollars an ounce, cash and carry. McCartney-Black immediately charters a jet aircraft out of Gatwick and wires many dollars to a bank in Omaha.

The fiction of a Comex silver market is officially maintained. But the market immediately perceives that Nebraska-Western's price is the real market price. McCartney-Black and Nebraska-Western have agreed not to disclose their deal, but New York's Attorney General, now beginning his campaign for President as a crusading reformer of financial fraud, gets a copy of the contract from McCartney's CFO in exchange for full immunity, and leaks it to New York's newspaper of record. When the editors determine, under pressure from the New York bankers, that the story is unfit for print, the AG provides it to a small Connecticut paper, whose editor gleefully breaks the story.

As the public learns of the real price of silver, but is unsure how long it will prevail, small hoards of bullion and scrap come to market. Recyclers pick through their piles of circuit boards, recovering silver that was previously uneconomic. Eighty thousand silver bugs start bringing their bags of Kennedy-era silver coins to smelters and coin shops, a couple of bags at a time.

Mutual fund companies are bombarded with inquiries about silver funds, but none exist. Fund analysts are quickly redeployed from telcoms to silver, and they quickly conclude that there are only two first-rate silver companies in the world. Both are Vancouver-based. One is a miner, one is an explorer, and both have been acquiring silver properties at bargain prices during the long bear market. Their combined market cap is less than US$300 million, or was up until a couple of days ago. The shareholders of these companies sell a substantial fraction of their holdings to mutual fund managers, and invest the proceeds in gold.

Holders of physical silver and silver mining shares reap sizeable gains, but long futures speculators longs are disappointed. The exchange compels cash settlement of futures contracts at the official exchange price. The President of the United States, invoking unconstitutional emergency powers, declares silver to be a vital war commodity, imposes price controls, sets the official price at the commodity exchange level, and declares that anyone who has invested in silver and actually possesses it is a greedy hoarder and an international terrorist. After all, you’re either with us or against us. The chairman of Nebraska-Western immediately ceases selling his company's silver holdings, which are protected from U.S. government seizure by virtue of their offshore location. In response to inquiries from purchasing managers, Nebraska-Western says it will await the day when legal trading resumes at an economically rational price point. Later, in exchange for immunity from war profiteering charges, the company's chairman quietly agrees to sell twelve million ounces to the U.S. government at the official price, to be used in critical defense manufacturing.