From the Silver Bear Cafe:
"Investment houses
leased gold from central banks, paying the central banks a tiny annual
interest rate, usually well below 1 percent of the value of the gold
leased, and then sold the gold into the market and invested the proceeds
in government bonds, earning perhaps 5 percent annually. The huge
difference in interest rates meant a virtually free stream of income for
the investment houses, income paid by central banks as interest on the
government bonds purchased by the investment houses, secure as long as
the investment houses could be protected against sudden rises in the
price of gold."
The Federal Reserve has some gold. The gold sits in its vault. The gold has value but the problem is that the gold does not earn income. To gain some income, the Fed asks Morgan Stanley if they want to lease some of their gold. So the Fed and Morgan Stanley sign an agreement. The Fed agrees to lease the gold to Morgan Stanley. Let's say they agree to lease Morgan Stanley 1 ton of gold. Morgan Stanley takes in their possession one ton of gold. In return they pay the Fed 1% of the value of the gold leased out. So the Fed no longer has their gold, it is given to Morgan Stanley. In return the Fed gets a note saying that Morgan Stanley will pay 1% of the value of the gold on an annula basis. The Fed is happy because now they get a 1% return on the value of their gold. Plus techincally, they can call their gold back and cease getting the 1% return if they'd like. But they do not want to do that because they lose on the 1% income the get on an annual basis.
So how does Morgan Stanly benefit from this when they now have a liability in that they owe the Fed 1% a year. Morgan Stanley simply sells that is right sells the gold they got from the Fed to the open market. Let's say in this example the Chinese. The Chinese buys the physical gold from Morgan Stanley at market price. Morgan Stanley now has a bunch of cash. It takes that cash and invests it in such vehicles as government bonds that pay perhaps 5%. So the difference between what they pay 1% and what they get 5% is pure profit.
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