The following is an excerpt from Michael J. Casey's The Unfair Trade: How Our Broken Global Financial System Destroys the Middle Class, which went on sale this week. Michael Casey is a managing editor for the Americas at DJ FX Trader, a foreign exchange news service jointly produced by Dow Jones Newswires and The Wall Street Journal.
Roni Rubinov runs two firms: New Liberty Loans, a pawnshop that lends money against pledges of jewels and other keepsakes, and New York Estate Buyers, which mostly buys and sells items made of gold. Their offices sit side by side up a flight of stairs from the chaotic, multiethnic sidewalk of Manhattan's 47th Street between Fifth and Sixth Avenues, a strip of jewelry stores known as the Diamond District. While I waited half an hour to talk to Mr. Rubinov, two street scouts kept escorting prospective clients up the stairs, each toting bags of wares to exchange for cash. Depending on whether they were borrowing or selling, Mr. Rubinov would exit one office and enter the other while his tall blond secretary would dutifully vacate one room's desk for the other.
It was July 2010 and Mr. Rubinov's twin gold-related businesses occupied a plum position in the middle of a post-crisis stand-off in the global economy. On the one hand, China's undervalued exchange rate, along with other savings-dependent and export-oriented policies, had produced a global glut of cheap goods that undercut U.S. producers and contributed to a slow, jobless recovery in America, where debt-laden, unemployed people remained desperate for cash. But on the other, the Fed's futile efforts to combat these global forces with monetary stimulus were feeding the fears of a growing number of cash-rich savers, who were equally desperate to exchange their dollars for gold out of fear of future inflation. This contradictory coexistence between deflationary realities and inflationary expectations created ideal demand and supply conditions in the gold market for Diamond District middlemen like Mr. Rubinov.
With the sidewalk littered with "We Buy Gold" pamphlets and crowded with scouts jostling for clients, the gold boom was not to the liking of everyone on the strip. Established in the 1940s by Orthodox Jews who fled the diamond districts of Antwerp and Amsterdam in response to the Nazi invasion, the District had for most of its existence been a center for the fine art of appraising and dealing in diamonds. Now the families who descended from those immigrants saw their District overrun with what many regarded as crass loan sharks.
There wasn't much they could do about it, however. By then, 47th Street was caught up in a nationwide bout of gold mania. Americans were being barraged with TV commercials and online ads touting investments in gold coins, gold bars, and gold-only investment funds, while others offered new ways for people to sell their gold jewelry for cash, all with the aid of celebrity endorsements. Bullion marketer Goldline International put former senator, presidential candidate, and actor Fred Thompson in its camp. Rosland Capital, which also sells gold coins and bars, hired convicted Watergate operative and loose-tongued conservative radio host G. Gordon Liddy for a series of ads. Glenn Beck's and Bill O'Reilly's shows on the Fox Network were heavily sponsored by gold sellers.
Cash-4gold.com, an outfit controlled by Green Bullion Financial Services of Florida, ran a Super Bowl spot in February 2009 featuring hip-hop star MC Hammer and TV legend Ed McMahon riffing about mailing in their gold sledgehammers, gold toilets, and gold microphones. Mr. T, star of the A-Team television series, became the spokesman for pawnbroker Cash America's gold mail-in service, telling a Bloomberg TV interviewer he believed in it because gold was one of the gifts given to the Baby Jesus. Meanwhile, people started hosting gold-selling parties. As the blurb on one promoter's website put it, "Think Tupperware party, [but] instead of spending, everyone leaves with large sums of CASH!"
Many profited from this merry-go-round of money. But an economy that incentivizes pawnbrokers to gather family keepsakes so that gold refiners can melt them into uniform 400-ounce gold bars is hardly a policy maker's dream. For far too many Americans, the economy remained in a sickly state, which most members of the Fed's rate-setting committee saw as a reason to prioritize policies that boosted jobs over those that fought inflation. Almost two years after the Lehman Brothers collapse, unemployment was still near 10% and inflation was lower than 2%, which meant that the march of bag-toting customers into pawnshops was accelerating.
The customer flow was a "gradual process," in which people's will to hang onto their valuables eventually broke, Mr. Rubinov explained. "It is not a sudden assault as if someone robbed them. It's that the well is slowly drying up," he said, describing the economic conditions as "the worst I have seen in thirty years of business."
Yet the U.S. central bank's response -- to keep short-term interest rates anchored near zero while conducting periodic "quantitative easing" bond-buying campaigns through which it would pump fresh dollars into the economy -- produced more unintended consequences than desired results. Growth stayed in an anemic state, and yet even the hint of a second round of "QE" from Fed Chairman Ben Bernanke sent commodity and foreign asset prices soaring. Hedge funds and other speculators saw it as a signal that the dollar would depreciate and so exchanged cash for hard assets. These investors sent their dollars almost anywhere but to the sectors of the U.S. economy that needed them, pushing the prices for oil, agricultural commodities, Asian real estate, and precious metals ever higher.
Gold captured this speculative energy more than any other market. After the Fed's November 2010 launch of "QE2"and its continuation through the first half of 2011, the 47th Street sidewalk became an even noisier, bustling bazaar as the price of gold reached a record $1,900 per ounce by September 2011, triple its level three years earlier. Later, concerns about the euro zone debt crisis prompted many institutional investors to do as Mr. Rubinov's customers were doing, and liquidate their gold for cash. Even so, the price never fell far below $1,600 an ounce, which left big gains in place and sustained the incentive for struggling Americans to haul their jewelry down to the Diamond District.
The gold rally had far-reaching global implications. It meant that families of Indian brides had to save three times as much for their dowries, for example. It turned the South African rand, the currency of one of the world's biggest gold producers, into the top or second-top performing currency for four years running, much to the chagrin of the country's winemakers. And it inspired tens of thousands of young men to risk their lives in precarious, 200-foot-deep makeshift mines dug into the red clay of northern Peru.
So while the Fed was virtually powerless to boost the U.S. economy, its actions were a potent source of disruptive, inflationary pressure elsewhere -- not a healthy combination. That worst-of-both-worlds outcome could be traced to some stark imbalances in the global financial system, both in the multi-trillion-dollar savings glut that an export-orientated China had built up and in the United States' economy's unhealthy dependence on credit and a gargantuan financial sector.
In this environment, the Fed was both constrained by and a driver of the sweeping global forces of our age, forces that both steered cash-strapped clients to Roni Rubinov's pawnshop and drove Peruvians into the suffocating darkness of a dangerous mine.
Reprinted from the book The Unfair Trade by Michael Casey. Copyright 2012 by Michael Casey. Published by Crown Business, a division of Random House, Inc.