What the LIBOR Scandal Means for Gold

A few weeks ago, the London InterBank Offered Rate (LIBOR) scandal erupted, alleging that the big banks were fixing interest rates in order to increase their revenues at the expense of millions of customers worldwide.

As the investigation continues, certainly more big banks—from the 20 big banks that are implicated thus far—will be named in the corruption scandal along with possibly central banks and regulators.

The problem with LIBOR is that it is inherently open to corruption by the big banks.

LIBOR is quoted daily and arrived at from a group of big banks. LIBOR is the basis on which 10 currencies are set, including many interest rates, thus affecting mortgage rates.


For example, representatives of 18 big banks come together to tell those that publish LIBOR what they would be paying to borrow U.S. dollars on that day from other big banks. The four highest rates and four lowest rates submitted are tossed out. The rest is averaged out and, voila, the LIBOR rate to borrow in U.S. dollars is created.

The obvious problem with this process is that the big banks are setting the interest rates and not the market. The second problem is that nothing prevents the big banks from submitting interest rates that conform to the interest rate or mortgage rates they want.

The LIBOR interest rates that are published every business day are used to determine the interest rates for more than $10.0 trillion in credit card purchases, mortgage rates, and student loans. They determine the currency values, interest rates, and mortgage rates for the $700 trillion in derivates traded in the world.

Obviously, the big banks are now under the microscope, as this story has just begun to unfold. What is fascinating is that the central banks of the world are speculated to have been complicit in this whole affair. While that remains to be seen, the simple implication has caused politicians and media outlets to start asking questions.

Sure, central banks throughout the world are manipulating interest rates and mortgage rates in the hopes of stimulating economic growth. The Federal Reserve itself said that one of the accomplishments of its QE programs was achieved: it helped the stock market move higher.

The issue more people are thinking about is this: if big banks and central banks are manipulating interest rates, and mortgage rates (and thus the stock market), then they are certainly keeping a close watch on the one currency that trades opposite of all fiat currencies…the one currency they can’t print and that has no counterparty risk in this intertwined global financial system.

The next scandal, I believe, will be about gold bullion being manipulated. I’ll be following this story very closely. (Also see: China to Become World’s Biggest Buyer of Gold in 2012.)

Where the Market Stands; Where it’s Headed:

Why do the government and Fed want a higher stock market? A rising stock market creates wealth, which gives consumers the confidence to spend. A rising stock market also encourages businesses to issue stock; hopefully taking the funds and investing them in their businesses to create jobs.

Unfortunately, after the $2.3 trillion the Fed has poured into the economy since the credit crisis hit in 2008, consumers still have their wallets closed and businesses still prefer to put their cash in the bank as opposed to growing their businesses.

Consumers and business owners are not stupid. They are concerned about the economy going forward. They are worried about the “next shoe dropping.” It is obvious to them now there has been no structural improvement in the economy; just artistically low interest rates, rising government debt, and money printing.

We are at the end of a bear market rally in stocks that started in March of 2009.

What He Said:

“The conversation at parties is no longer about the stock market, it’s about real estate. “Our home has gone up this much or our country home has doubled in price.” Looking around today it would be very difficult to find people who believe that one day it could be out of vogue to own real estate, because properties would be such a bad investment. Those investors who believe a dark day will never come for the property market are just fooling themselves.” Michael Lombardi in Profit Confidential, June 6, 2005. Michael started warning about the crisis coming in the U.S. real estate market right at the peak of the boom, now widely believed to be 2005.