The consolidation of gold’s bull phase from October 2008 to the peak last September was a classic three-leg correction: an initial slide, rally, and final sell-off. Silver followed a similar but more violent pattern. The psychology was there too, with the final sell-off convincing many investors the game was finally over.
Those who sold will most probably be kicking themselves. Consolidations that break established trends, such as 200-day moving averages, shake out weak holders who will buy again higher up when they are more confident. The big traders in the futures market know this: your losses are simply their gains. And as a result both gold and silver are on a far sounder footing with these weak holders out of the way. It is lethal for your savings to play this game. Instead it is more sensible to understand what is happening in simple economic terms. To do this you must turn your normal thinking upside down, and realise that what is happening to precious metals prices is only a reflection of what is actually happening to paper money.
Put simply, governments all over the world are debasing their paper monies at an accelerating rate. Printing euros to rescue the banks has been in the headlines, but this process has only just begun. America, which has to be the focus of monetary attention, is committed to zero interest rates for the next three years, which is unprecedented. The result is that the price of gold has been left behind by exceptional monetary events. You can see this clearly in the chart below.
This chart shows US dollar True Money Supply (cash, instant deposits and checking accounts plus a few other minor cash balances) expressed in official gold reserves held at the US Treasury. This has soared over the years, and we can expect it to accelerate further from December’s figure of $31,600 per ounce of gold. Meanwhile, the percentage of TMS actually backed by gold stood at 4.8% at the year-end, and this is shown by the blue line.
The chart clearly shows that while gold has risen dramatically over the last decade in nominal dollar terms, adjusted for the extra money in the system it has only risen 150%. Amazingly, the price of gold measured in these TMS terms has only risen to where it was in late 1991, when the nominal price was $360. Gold’s valuation is therefore still at exceptionally low levels.
The sense of perspective charts like this imparts is vital for understanding the dangers from the tsunami of paper money and debt. Conventional portfolio managers have missed this point entirely, being hampered by the legacies of portfolio management theory and Keynesian economics. But there is a growing band of private individuals around the world who do get it and are accumulating physical gold and silver. They are beginning to understand that paper money is falling rather than gold and silver rising.
The message is if you think like an investor, you will probably lose your investment. Be aware of what is happening to paper money and you probably won’t.
This article was previously published at GoldMoney.com.
“All within the state, nothing outside the state, nothing against the state.” Benito Mussolini
Those who have eyes to see and ears to hear will have noticed the accelerating trend towards interventionist policies and assertive state action all around us. This is not a conspiracy theory circulating on the internet. It is a phenomenon that is now so blatantly obvious that it makes the headlines in the highbrow pro-establishment media: The Economist and the Financial Times are talking openly about the trend towards “repression” and “national capitalism” as if it was simply the latest fashion in crisis management. A century ago, Randolph Bourne pointed out that “war is the health of the state”. It turns out that so is economic crisis.
Politicians, bureaucrats and many of their claqueurs in the media have drawn conclusions that are conveniently in their own interests: to them the crisis is evidence that things cannot be left to the markets, to consumers, to greedy bankers, and the spontaneous interaction of the public. If the state does not regulate and control everything, chaos ensues. We need more government. More control. More regulation. More oversight. Politicians and bureaucrats need more power.
Conveniently, the public believes it was greedy bankers and ‘unfettered capitalism’ that brought us down. But cheap credit through state fiat money and the systematic subsidization of the housing market are not features of the free market but of politics. The present mess is the result of decades of institutionalized monetary debasement and the accumulation of public debt. These policies have left us with bankrupt welfare states and overstretched banks, yet none of this has diminished the enthusiasm of politicians and bureaucrats to give us more of their medicine.
Let’s not forget that it was politicians and their central bankers, with the intellectual support of ambitious but misguided economists, who got rid of the gold standard. They considered the gold standard an inconvenient monetary straitjacket that was best replaced with a system of limitless fiat money under central bank control. Limitless money allowed unrestricted bank credit creation and state deficit spending. Once that system was in place, it was politicians who accumulated all that public debt and issued the deluge of unfunded and unkeepable promises that pit large sections of society against one another. And it is the central bankers who happily funded this gigantic debt bubble for decades with cheap credit.
After 40 years of fiat money the world is in a deep and deepening financial crisis. Excess levels of debt, weak and overstretched banks and distorted asset markets – all of this marks the inevitable endgame of a system based on persistent monetary debasement. But politicians and central bankers are merrily undeterred. “Nothing that cannot be papered over with more paper money!”
Authoritarianism needs ever more authorities
So the problem is not with the policy establishment but with us, the masses. We need to be controlled better. Mr. Martin Wheatley, inaugural head of the UK’s new Financial Conduct Authority, told the Financial Times last week that his agency will “step into the footprints of investors – who cannot be counted on making rational choices.” Apparently, we, the consumers and savers, cannot be trusted with our own money. We need someone to tell us what we should or should not buy. But don’t worry. Mr. Wheatley assures us that his interventions into our financial affairs are based on the latest insights of science, namely the latest research in “behavioural economics.”
Part and parcel of this trend is the global fight against cash. Authorities want to monitor and record ALL your transactions. They don’t want you to use cash. Ever more countries restrict the amount of cash you can take across borders (noticed the signs at airports?), and in Italy and Spain, proposals are being discussed to limit the amount of cash citizens can use for individual transactions. “Cash has been a problem for a long time” the UK’s top taxman, Dave Hartnett, told The Daily Telegraphlast week. Hartnett wants the citizenry to stop giving cash to their cleaners, gardeners, and to small tradesmen and other potential tax cheats and economic criminals so that they can no longer avoid paying taxes. Hartnett’s vision of Britain is a society of snoops and denunciators. “Households have a duty to ensure that other people do not evade paying their share of tax. The people who are worried about it should use our whistle-blowing line to tell us. We are getting better and better at finding people who receive cash.” Nice touch. A tinge of the former GDR’s Stasi culture for the British way of life?
The beauty of a big state is apparent to Mr. Hartnett: “Tax provides the funding to run the country.” Really? No, I don’t think so. It is rather Mr. Wheatley’s irrational savers and Mr. Hartnett’s tax-avoiding cleaners, gardeners and shopkeepers who are running whatever is still functioning in this country, the productive, independent middle class, who are able to and do look after themselves and their children, but who are also forced to fund the largely parasitic class of self-deluded authoritarians with their wasteful government projects.
Decent citizens don’t use cash. Cash is used by tax-cheats, terrorists, drug-dealers and child pornographers. Once this is established it will be a short step to severely restricting or even banning the withdrawal of cash from bank accounts. As all banks will soon anyway be mere branches of the ever-expanding central bank, which prints the money to keep the nominally private banks alive, all transactions will then be just electronic bookkeeping adjustments at the state central bank. All financial transactions will then be entirely transparent to the authorities. “Irrational” behaviour can be identified early and – eliminated.
Whatever you may think of Julian Assange’s Wikileaks, it is deeply troubling how quickly and easily this organization was crippled by Visa and Mastercard cutting it off from its donors. This gives you a taste for where we are going.
Fiat money and central banking are incompatible with free banking, with a system in which banks are independent capitalist enterprises. But more than that, fiat money and central banking are incompatible with capitalism and a free society. Central banking is central planning.
Hey, who is boss?
The bureaucracy is annoyed. The public is not giving it enough credit for its excellent management of the economy. The public is still pessimistic and concerned about banks and the overall direction of the equity market. Okay. So the government just stops them from acting on that pessimism. Show them who is boss:
In France, Spain and Belgium the government has ruled that shares of financial companies cannot be shorted. In Italy you are banned from shorting any stocks. Shorts on stock indices are banned in Italy, France, Belgium and Spain. Is this arbitrary? Of course it is. But the real measure of power is if you can use it arbitrarily. Make it clear to people what you, the government, likes or dislikes. Then you ban what you don’t like.
Government is not voluntary association, contractual cooperation and trade. “Government is essentially the negation of liberty” (Ludwig von Mises). “Everything a government does rests on the use of force. No law actually is a law unless it is backed by the threat of force.” (George Reisman). And a government that is digging itself an every deeper economic hole will, in its growing desperation, apply force ever more readily. Count on it.
But what does the sovereign do, the democratic masses? Well, they obey. Like obedient sheep they stand patiently in line at airports in the UK, the USA, and elsewhere, calmly watching their six-year olds being padded down by security personnel. And they happily pay their Starbucks Coffee and the pack of cigarettes (as long as we are still allowed to smoke somewhere) at Tescos with their debit cards, or buy everything on the internet, leaving for whatever they do a perfect paper trail, a seamless record kept forever. “It is so convenient. And I have nothing to hide.”
And, naturally: “the government is here to help, so why not cooperate with the government? After all it is still a democratic state.” Every four to five years each of us has an opportunity to cast a vote of infinitesimally small importance to decide which of two gangs will get almost unlimited power over the ever growing state apparatus, and this, it seems, is to many sufficient compensation for handing over control of their lives and property to others. Stimmviehvolk is how an incredibly prescient Friedrich Nietzsche described them more than a hundred years ago: voting cattle.
Prosperity through money printing
The persistent debasement of money in the modern state fiat money system is an obstacle to the smooth operation of the market, the production of wealth and the growth in prosperity. It keeps the middle class in bondage as its efforts to save and gain financial independence are constantly undermined by the official policy of inflationism. But the central planners and central bankers and their apologists among journalists and economists tell us that it is exactly the other way round: “Prosperity through monetary debasement” is Big Brother’s slogan, and he has spokespeople with outstanding academic credentials to explain this absurdity to the masses. In November 2010, MIT and Princeton man Ben Bernanke, the U.S. government’s money-printer-in-chief, wrote this in the Washington Post when explaining to the less educated why creating $600 billion out of thin air and massaging yields on government debt down was a clever policy:
Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.
Well, that was 14 months ago. As it turns out, manipulating the economy by artificially lowering rates (lowering rates not by saving but by simply printing money) has not started a virtuous circle. Such manipulations come with nasty unintended consequences, and after a few decades of such a policy the accumulated unintended consequences far outweigh whatever short–lived growth blip money debasement may have manufactured otherwise. None of this has anything to do with healthy growth and a functioning free market economy.
But it is important that those in positions of authority do not admit that they are clueless. They never make mistakes. Their policy is never wrong. They simply need to do more of the same – and then even more. As I write this, the Fed is, of course, preparing another round of quantitative easing, and so is the Bank of England. And the ‘economists’ on Wall Street and the City of London cheer them on.
The debasement of paper money certainly continues.
Both the US Federal Reserve and the European Central Bank are now offering limitless quantities of new money – the ECB to support the banks, and the Fed for reasons (despite explanations) that are not entirely clear. The Fed in its press release announced that it expected interest rates to “warrant exceptionally low levels for the Federal Funds Rate at least through late 2014.” The fact that the central banks governing the two most important currencies in the world are issuing money to all-comers at very little interest cost for up three years has not been lost on gold and silver, whose prices shot up in response to the Fed’s announcement.
The Fed has effectively extended its zero interest rate policy (ZIRP) for another 18 months. The reason stated is “low rates of resource utilisation and a subdued outlook for inflation in the medium run”. More important perhaps and unsaid is the presidential election due later this year and the need to finance a deficit that seems impossible to cut.
The Fed is running huge risks with its extended ZIRP, principally with monetary inflation morphing into price inflation. To help achieve its low inflation target the Fed uses the Personal Consumption Expenditures Price Index (PCEPI), which assumes that consumers switch spending from higher priced goods to those that are stable or falling. The result is that this index rises at about one-third less than the Consumer Price Index, which itself rises at less than half the CPI calculated on the more honest methodology used before 1980. The upshot is that the Fed uses inflation targets that are so heavily adjusted that they are effectively meaningless.
To the Keynesians at the Fed, subdued inflation is linked with a sluggish economy, and here the Fed is very selective in its approach. It admits that employment is picking up, and household spending “continues to advance”; but instead chooses to worry over slowing fixed investment and a depressed housing sector. Surely, whatever your views, there are enough signs of economic stabilisation to justify sitting on the fence, instead of committing to ZIRP for an extra 18 months.
I take the view that Gross Domestic Product is likely to surprise on the upside, as I wrote in an article for GoldMoney on 10 January. In that article I gave concrete reasons why, and suggested that money will begin to flow from capital markets into the economy. This is important, because GDP is only a money quantity and can rise without any underlying economic progression – the difference being reflected in the prices of goods and services. So GDP can actually rise with no underlying improvement in economic activity, it merely reflecting higher prices.
Changes in the prices of goods and services are actually impossible to measure and so cannot be quantified. Under-reporting price increases by using an index approximation such as the GDP deflator, which represents price inflation similarly to the PCEPI, artificially inflates real GDP. It will be interesting to hear what excuse the Fed comes up with then for the continuing for even longer with ZIRP. The reality is that the Fed and other central bankers are cornered and have only one tool left: issue as much paper money as it takes to prevent systemic financial calamity. This realisation is only just dawning on individuals with savings to protect, which is why precious metals were right to rise so sharply.
This article was previously published at GoldMoney.com.
Published yesterday at RealClearMarkets, as South Carolina’s voters went to the polls.
Two candidates – Newt Gingrich and Ron Paul – are campaigning on the gold standard. Polling, including for South Carolina, shows the gold standard to be a powerful vote getter as my colleague Andresen Blom and I pointed out recently in Roll Call. Both Gingrich and Paul supported gold long before it was cool – each with a record of meaningful support that goes back at least a quarter century.
As it happens, South Carolina has an exceptionally rich history when it comes to an aversion to pure paper money … like Federal Reserve Notes. South Carolina sent four delegates to the Constitutional Convention. History unequivocally shows that all four were anti-paper and pro-gold – and that at least two of them led the fight to use the Constitution to shut the door against paper money.
In the Constitutional Convention Pierce Butler, a distinguished South Carolinian and delegate, seconded the motion to strip the federal government of the power to issue paper money. Madison recorded:
Mr. BUTLER. remarked that paper was a legal tender in no Country in Europe. He was urgent for disarming the Government of such a power.
Brigadier General Charles Coteworth “C.C.” Pinckney, also a delegate to the Constitutional Convention from South Carolina, famously, while a prisoner of war, said: “”If I had a vein that did not beat with the love of my Country, I myself would open it. If I had a drop of blood that could flow dishonorable, I myself would let it out.” He was an important member both of the Philadelphia convention and in South Carolina’s ratifying convention.
Here, at the South Carolina ratification debate, is what Gen. Pinckney had to say about paper money:
With regard to Mr. Lowndes’s question ‘What harm had paper money done?’ General Pinckney answered, that he wondered that gentleman should ask such a question, as he had told the house that he had lost fifteen thousand guineas by depreciation; but he would tell the gentleman what further injuries it had done – it had corrupted the morals of the people; it had diverted them from the paths of honest industry to the ways of ruinous speculation; it had destroyed both public and private credit, and had brought total ruin on numberless widows and orphans.
Charles Pinckney, C.C.’s cousin, Senator and Member of the House of Representatives, 37th governor of South Carolina, progenitor of 7 South Carolina governors, had this to say in South Carolina ratifying convention:
If we consider the situation of the United States as they are at present, either individually or as the members of a general confederacy, we shall find it extremely improper they should ever be intrusted with the power of emitting money, or interfering in private contracts; or, by means of tender-laws, impairing the obligation of contracts.
I apprehend these general reasonings will be found true with respect to paper money: That experience has shown that, in every state where it has been practised since the revolution, it always carries the gold and silver out of the country, and impoverishes it–that, while it remains, all the foreign merchants, trading in America, must suffer and lose by it; therefore, that it must ever be a discouragement to commerce–that every medium of trade should have an intrinsic value, which paper money has not; gold and silver are therefore the fittest for this medium, as they are an equivalent, which paper can never be–that debtors in the assemblies will, whenever they can, make paper money with fraudulent views–that in those states where the credit of the paper money has been best supported, the bills have never kept to their nominal value in circulation, but have constantly depreciated to a certain degree.
John Rutledge, who served as the fourth South Carolina delegate to Philadelphia, spoke at a special session of the South Carolina legislature in September 1785 called by the governor to address a debt crisis:
as not wishing to waste time ‘in fruitless and unavailing discussion of’ paper money schemes that ‘could answer no good purposes, whatever.’ He called an emission of paper currency ‘ludicrous, because it was not in their power to establish funds for its redemption.’ Depreciation was inevitable. There ‘could not possibly be … any public benefit from such a scheme.’
South Carolina has a noble heritage when it comes to fighting paper money and standing for constitutional money with integrity: gold and silver. Are its citizens still made of the same stuff as Pierce Butler, John Rutledge, and Charles and CC Pinckney?
We now know the result: a decisive victory for Gingrich (though a disappointing fourth place for Paul).
The super-committee of Congress is the latest group to confess abject defeat by the Treasury budget deficit. Who can be surprised by this total failure? During the past generation Congress has made as many as fifteen legislative attempts to control government spending — aimed ultimately at a balanced budget. The most notable efforts were those sponsored by the all-time budget hawk, Senator Phil Gramm of Texas. But every administrative and legislative effort by the authorities, no matter how well-intentioned, has collapsed. Why is this so?
Nobel economist Milton Friedman believed the solution to the budget deficit problem was to deny Congress tax revenues. So he advised Congressmen and Presidents to oppose all tax increases — thereby denying bloated government the funds with which to increase spending. But Friedman’s advice has failed, too. We know this because marginal tax rates have been reduced from as high as 70% in 1964 to 15-20-39% in 2011 — depending on the type of income. But congressional spending has nevertheless increased every year — such that, today, only 60% of the Federal budget is financed by taxes, the remainder by Treasury debt. Total direct Federal debt is now about equal to total U.S. output.
The intractable budget deficit and the inexorable rise of government spending has a simpler explanation. Congress and the Treasury are in possession of several open-ended charge accounts — “permanent credit card financing” — with no limits. With its charge cards the Treasury can borrow new credit (money) from the banking system — much of what it needs every year to finance the ever-rising budget deficit.
A look at the current Federal Reserve Balance Sheet shows that the Fed has created about $1.7 trillion of new credit (money) with which to purchase Treasury debt. Foreign central banks have created about $2.7 trillion of new credit to purchase U.S. Treasury bonds. This global, electronic, money-printing exercise has financed almost 30% of the total direct debt of the U.S. Treasury. In 2002, Ben Bernanke, now Chairman of the Fed, did not mince words to describe this process:
[U]nder a fiat (that is, paper) money system, a government (in practice, the central bank in cooperation with other agencies) should always be able to generate increased nominal spending and inflation, even when the short-term nominal interest rate is at zero…. [T]he U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost.
He might have added that these “no cost” dollars, printed by the Fed, are the enablers of the perennial U.S. budget deficit.
But the Fed is not the only credit card used by the Treasury to finance the budget deficit. Because the dollar is the world’s reserve currency, foreign central banks also finance U.S. budget deficits (as the custody account of the Fed balance sheet shows). Domestic and foreign commercial banks, too, supply vast amounts of new credit to the U.S. Treasury because domestic, foreign, and international bank regulators, such as the Basel authorities, define U.S. sovereign bonds as high quality assets for which bank reserves are not necessary. Therefore financial institutions can qualify their overleveraged balance sheets by loading up on Treasury Securities. Indeed, only 10-20% of the total direct debt of the U.S. Treasury is now owned by the non-bank, non-government private market. Given the reserve currency role of the dollar, the Federal Reserve and foreign central banks have been given every institutional incentive to finance the U.S. budget deficit. Beginning with World War I, every monetary discipline has been removed by domestic and international authorities, such that runaway government spending everywhere relies on the ultimate credit card — newly created money in the banking system.
The simplest solution to the government spending problem in Congress is “to tear up” its credit cards. The way to do this is not with ad hoc and unavailing administrative patchworks, all of which are nullified by world banking system credit made available to the U.S. Treasury. Instead, the effective democratic solution is authorized by the U.S. Constitution — in Article I, Sections 8 and 10: — whereby the control of the supply of dollars is entrusted to the hands of the people — where it stayed for most of American history, especially from 1792 to 1914. This was America’s longest period of rapid, non-inflationary, economic growth — almost 4% annually, with the budget under control except wartime.
Congress need only mobilize its unique, Article I, constitutional power “to coin money and regulate the value thereof.” From 1792 to 1971 Congress defined by law the gold value of the currency such that paper dollars and bank demand deposits were convertible to their gold equivalent — by the people (1792-1914) and/or by governments (1933-1971). Congress should exercise this constitutional power to restore dollar-gold convertibility, because of the proven budgetary and economic growth benefits of a dollar as good as gold.
First, the discipline of convertibility would automatically set the limit on Treasury access to its Federal Reserve credit card. If the Federal Reserve created more money than participants in the market wanted to hold, people would get rid of the inflationary excess by promptly exchanging paper and credit money for the gold equivalent. But under the true gold standard, the Fed and the commercial banks would be required by law to maintain dollar-gold convertibility at the statutory gold-dollar parity — or suffer insolvency. In order to maintain dollar convertibility to gold, the Fed and the commercial banks must reduce the quantity of money and credit, including credit to the Treasury — thus controlling government spending increases and inflation.
Second, the empirical evidence of American economic history also shows that convertibility to gold stabilizes the value of the dollar. The same evidence shows that a stable dollar also stabilizes the general price level over the long run. For example, under the gold standard, the price level in 1914 was at almost exactly the same level as it was in 1879 and in 1834. There was no long term inflation, even over an 80 year period! But from 1971 — Nixon’s termination of dollar-gold convertibility — until 2011, the purchasing power of the dollar (adjusted by the CPI) has fallen 85% in a 40 year period.
Third, gold convertibility of the dollar leads to a vast outpouring of savings from inflation hedges such as commodities, farmland, art, antiques — almost anything perceived to be a better store of value than depreciating paper currencies. Stable money also creates incentives to save from income. Combined with the global release of trillions of hoarded, inert, unproductive inflation hedges, convertibility triggers new savings which would pour into the productive investment market. The new investment would give rise to a general economic expansion — through new business, new products, new plant and equipment, creating thereby a renewed demand for labor to work the expanding production facilities.
The restoration of a dollar worth its weight in gold provides not only a missing and necessary brake on government spending, but a stable dollar supplies the missing steering wheel by which to guide the immense, hoarded savings into long-term productive investment. Dollar convertibility to gold is the simple, institutional financial reform which terminates the fear of rapid inflation — thus transforming unproductive, store-of-value hedges into real investment capital with which to inaugurate a new American era of rapid economic and employment growth.
I recently posted an article for GoldMoney showing how US True Money Supply (TMS) appeared to be growing at a hyperbolic rate, and that gold was also on a hyperbolic course. The difference between hyperbolic and exponential is a hyperbola’s rate of growth increases with time, while exponential growth does not. Hyperbolic growth in the quantity of money ends with hyperinflation, while exponential growth can go on for ever. Both TMS and the dollar price of gold are pointing to a hyperinflationary outcome. This article explains why this might be so.
There are five apocalyptic engines pushing the growth in US money supply: they are the government’s budget deficit, its debt trap, the financial condition of the banks, the delusion of Keynesian solutions, and lastly simple compounding arithmetic.
The US government collects only 55c in taxes for every dollar spent. It is relying on economic recovery to reduce welfare payments and increase tax revenue to close the gap. This prospect is receding and establishment economists advise against cutting government spending.
The US government’s debt trap is concealed by the exceptionally low interest cost of funding. The only reason this cost is not higher is the Fed maintains a zero interest rate policy. However, as surely as night follows day, price inflation will start rising as monetary inflation feeds through, forcing the Fed to allow interest rates to rise long before any economic recovery occurs. The rise in interest costs will escalate the budget deficit, which will be financed, directly or indirectly by further monetary expansion.
The banks’ balance sheets are considerably weaker than stated, because of unrealised losses on assets, loan collateral and write-downs on their own debt. Real estate collateral write-downs alone probably exceed bank equity of $1,400bn. On an honest analysis the US commercial banks are collectively bankrupt. To simply survive the banks have no alternative other than to reduce loan exposure while requiring continuing monetary support from the Fed.
Keynesian economists, aware of the banks’ difficulties are terrified of bank credit contraction. For this reason, the macroeconomic establishment strongly promotes the expansion of narrow money to buy off a deflationary depression.
As the purchasing power of the dollar falls, the result of past monetary expansion, yet more dollars have to be issued to cover increased government costs. Past inflation becomes a compounding factor behind price rises.
Essentially, money will be printed at an accelerating rate to buy time rather than face the three realities of government default, an over-indebted private sector, and a bankrupt banking system. The Keynesians are belatedly aware of the dangers and see no alternative to printing as much money as is required to defer these problems. The monetarists in the central banks are hesitant, torn between Keynesian fears of outright deflation and worries about the rate of monetary expansion so far.
However, the history of monetary inflation confirms that once it enters a hyperbolic phase, it is almost impossible to stop. Armchair critics have derided the stupidity of central banks and economists in past hyperinflations, such as in Weimar Germany, Argentina and Zimbabwe. The truth is that when hyperinflation has become visible at the price level, it has already gone past the point of no return at the monetary level.
This article was previously published at GoldMoney.com.
In this video Philipp Bagus, Assistant professor of Economics at Madrid’s Universidad Rey Juan Carlos and author of The Tragedy of the Euro and Alasdair Macleod of the GoldMoney Foundation talk about the eurozone facing the problem that is characterised in the “tragedy of the commons” analogy. Bagus explains this phenomenon by way of an example of overfished and over-exploited oceans due to a lack of property rights on oceans. In Europe, governments run larger deficits than their “competitors” in order to externalise the costs to all users of the currency. Knowing these incentives, the Stability and Growth Pact was put in place as per the early 1990s Maastricht Treaty, capping budget deficits at 3% of GDP and the debt to GDP level at 60%. However there was no enforcement of these rules which is why there have already been more than 80 infringements to this stability pact without any repercussions.
They talk about possible solutions to the euro crisis. Bagus points out that there are basically three different ways to go about it. Firstly, governments could make drastic cuts in public spending and privatise public assets in order to balance their budgets. However, there will be – and is – strong political resistance to such proposals. Secondly, the eurozone could disintegrate, driven by a reluctance of German citizens to pay for other countries’ expenditures. And lastly, central banks and governments could decide to print their way out of the crisis, leading to high inflation.
Bagus says that as long as the incentive for running deficits exists there won’t be an increase in countries’ savings rates. Macleod points out that there is great institutional resistance to breaking up the euro. Bagus explains that the official opinion towards the euro is positive in Germany; however the sentiment on the streets looks quiet different. But as long as there is no political party devoted to this issue this mood is not likely to gain traction at least as long as inflation remains moderate.
Amid the ongoing expansion of the money supply and persistent deficits, Bagus can’t see the dollar gaining in value over the medium to long term. He also says that ECB policies are a lot more pragmatic than the ones undertaken by the US Federal Reserve. Talking about sound money, Bagus explains different ways to go about its introduction. One way would be to back all the money in existence by gold, adjusting the price of gold accordingly. Another would be to take away legal tender laws and have competing currencies. However this would require the governments to impose dramatic reforms, which is partly why they will oppose such measures.
This interview was recorded on November 15 2011 in Madrid.
Gordon dealt with the flaws in IFRS, the reasons for the debt crisis, the case for hardening money, the need for international money in support of trade and more.
Later in the day, I said in the Commons that the Government’s response to the ICB report seemed to take accounting for granted, asking the Chancellor to consider the issue seriously in the forthcoming white paper.
“Clearly, Field Marshal Haig is about to make yet another gargantuan effort to move his drinks cabinet six inches closer to Berlin.”
- Captain Blackadder [Rowan Atkinson], from ‘Blackadder Goes Forth’, written by Richard Curtis and Ben Elton.
By some accounts, the general populace in Europe during July 1914 was largely unaware of the imminence of war until the end of the month. “Enjoying the warmth of a golden summer, Europe’s citizens turned their attention chiefly to news of more local importance.” And then a network of alliances, and events, exerted their inexorable gravitational pull, drawing what would become millions into a pan-Continental mincing machine. Archduke Franz Ferdinand had been assassinated on 28 June. Austria-Hungary issued an ultimatum to Serbia on 23 July, and issued a formal declaration of war on 28 July. Russia and Austria-Hungary mobilised on 30 July. Germany demanded that Russia demobilise on 31 July. Germany and France ordered mobilisation on 1 August. By way of response, “Stock exchanges panicked and many were closed.” But it was a bit late by then. As the saying goes, if you’re going to panic, panic early.
The definitive text that addresses this human frailty is Irving Janis’ ‘Groupthink’ (Houghton Mifflin, 2nd revised edition 1982). Janis examined a number of US foreign policy disasters, including failure to anticipate the Japanese attack on Pearl Harbour; the Bay of Pigs fiasco; the decision to escalate the Vietnam War, and concluded that all of these decisions had incorporated groupthink, “a mode of thinking that people engage in when they are deeply involved in a cohesive ingroup, when the members’ strivings for unanimity override their motivation to realistically appraise alternative courses of action”. William H. Whyte apparently first used the term in 1952:
Groupthink being a coinage – and, admittedly, a loaded one – a working definition is in order. We are not talking about mere instinctive conformity – it is, after all, a perennial failing of mankind. What we are talking about is a rationalized conformity – an open, articulate philosophy which holds that group values are not only expedient but right and good as well.
Janis went on to develop the theory, stating that
The more amiability and esprit de corps there is among the members of a policy-making ingroup, the greater the danger that independent critical thinking will be replaced by groupthink, which is likely to result in irrational and dehumanizing actions against outgroups.
Here are some suggestions. The great euro project itself was a creation of groupthink (sparked by “illusions of invulnerability creating excessive optimism and encouraging risk-taking”). It was reinforced by “unquestioned belief in the morality [primacy in political and economic theory] of the group [primarily and initially France and Germany], causing members [other, later euro adopters] to ignore the consequences of their actions.”
As tensions and obvious fault-lines started to develop in the common currency zone, groupthink was there to ignore them. Closed-mindedness on the part of the euro zone’s political leaders “rationalized warnings that might challenge the group’s assumptions” and “stereotyped those opposed to the group [not least among which, the UK] as weak, evil, spiteful, impotent or stupid.”
Groupthink continued to exert its pressure toward uniformity, incorporating the “Self-censorship of ideas that deviate from the apparent group consensus”, together with “illusions of unanimity among group members, where silence is viewed as agreement”. There was “direct pressure to conform placed on any member [of the EU] who questions the group, couched in terms of ‘disloyalty’.” And there were “mind guards – self-appointed members [the European Commission among them] who shield the group from dissenting information.”
Consensus-driven decisions [the adoption of a common currency without a common Treasury or unified tax-raising authority and the abandonment of rigorous selection criteria for the adopters] caused the establishment of a unified currency bloc destined for failure, fuelled by the groupthink practices of
Incomplete survey of alternatives
Incomplete survey of objectives
Failure to examine risks of preferred choice
Failure to reevaluate previously rejected alternatives Poor information search
Selection bias in collecting information
..and not least,
Failure to work out contingency plans.
Another suggestion: just as they lost the plot in the run-up to war in 1914, the stock markets have been largely absent without leave of their senses as the euro zone moves inexorably toward explosion in 2011. Groupthinkers – Keynesians, more or less to a man – continue to believe that this is a problem that can be solved by the ‘big bazooka’ deployment of yet more money, more taxpayer milk dispensed from the giant teat of government. The reality is more prosaic, and more worrisome. Last week, the BBC’s Sarah Montague interviewed Kyle Bass, one of the relatively few investors who not only identified the sovereign debt crisis ahead of time but was able to profit from it. She resorted to the standard, lazy canard of citing speculation for the downfall of governments when the reality is that if governments don’t like the message they’re hearing from the bond markets, then they shouldn’t borrow more than they can afford from them. Or in Kyle Bass’ terms, “don’t hate the mirror because you’re ugly”.
The problem is two-fold but not distinctly so in that the culprits – ill-disciplined, over-indebted governments; and ill-disciplined, under-capitalised banks – are really joined at the hip,
two spent swimmers, that do cling together
And choke their art..
Forget bail-outs (although the euro zone authorities are unlikely to). The only ultimate resolution can be, in Bass’ words, massive debt restructurings and write-downs. Countries that have “sailed into a zone of insolvency” cannot be ‘resolved’. Their debts have to be written down. He also points out the inconvenient fact that only the UK and the US have made any progress in recapitalising their banks. But before we get to the fun of the debt restructuring endgame, we are likely to have to endure more fatuous money-printing at the behest of economically illiterate politicians and policy-makers. So there are two actionable conclusions: one is to maintain a defensive posture with regard to both debt and equity investments, especially in a European context. The second is to take advantage of any sell-offs to rebuild exposure to the one asset that is being fundamentally supported in this environment, namely monetary metal (gold and silver – and the mining companies represent arguably an even more attractive method than the physical of gaining inflation and currency insurance, given the unfolding macro outlook).
Or you could pin your hopes on wishful thinking. The eurocrats certainly are.
In explaining the conventional thinking behind ‘Why there could never be a war’, Captain Blackadder explains to Private Baldrick that
..in order to prevent war in Europe, two superblocs developed: us, the French and the Russians on one side, and the Germans and Austro-Hungary on the other. The idea was to have two vast, opposing armies, each acting as each other’s deterrent. That way there could never be a war.. [but] You see, there was a tiny flaw in the plan.. It was bollocks.
Before what came to be known as the Great War, Britain was the leading power in Europe. Many expected her to wait on the sidelines as the various power blocs clashed. Britain finally entered the war on 4 August 1914 on the back of a guarantee to maintain Belgian neutrality dating back to the 1839 Treaty of London. By 1945 and after two world wars and over a million of its servicemen and servicewomen dead, Britain had passed on the baton to the United States, and was inevitably diminished on the global stage. A policy of splendid isolation did not prevent her entry into hostilities in 1914. One can only hope that its equivalent today, in the form of our non-participation in the euro zone, will lead to a somewhat better relative and absolute outcome. It is quite clear that our current entente with the French is not entirely cordiale. Somebody should gently suggest to M. Sarkozy (and Frau Merkel for that matter) that when it comes to Europe, Britain has already done enough. If you break it, you pay for it.
So a Dollar was still a Dollar, as Richard Nixon told US citizens 40 years ago this summer.
Whether the Euro will be worth anything next week, who can say? But since then, 15 August 1971, that’s all the Dollar has been – one dollar alone, rather than a quantity of rare, indestructible gold bullion, that “barbarous relic” of pre-Industrial superstition, and beloved of the 21st century’s fastest-growing, wealth-accumulating societies today.
Does it matter? The day before President Nixon’s announcement, only a foreign central banker could have exchanged dollars for metal, demanding gold bullion from the US Treasury’s hoard with a fistful of what were in effect receipts. (The citizen’s right to swap the Dollar for gold had gone four decades sooner, along with that freedom to own or trade bullion finally revived under Nixon’s successor, Gerald Ford, on 31 December 1974.) But now the token replaced the metal entirely, and the Dollar became the thing in itself. Instead of representing a deeper, apparently “truer” money in underground vaults, the Dollar was all.
If this risks sounding metaphysical, so it should. “By nature, my friend, man’s mind dwells in philosophy,” as Plato wrote 2,400 years ago, and money is no mere idea within our thinking. It’s part of the fabric, the alphabet of how we conceive of the world, second only – if that – to language.
Imagine there’s no money? A world without money is literally unthinkable, never mind easy. Yet here we are, barely discussing – outside a handful of websites and chatrooms – how the basis of money has utterly changed inside one lifetime.
Yes, under the post-war Bretton Woods system, the almighty Dollar already underpinned the rest of the world’s currencies – the Deutsch Mark, Yen, Franc, Peso, Lira and the rest. But until 1971, that underlying asset was merely a staging post between all those monetary units and what was still deemed the real stuff, gold bullion. Swapping, say, Sterling for Dollars, and then Dollars for gold, a central bank could in effect redeem British Pounds for US gold bullion (an ever-more attractive play during the prolonged collapse of Britain’s international credit). Closing the gold window at the New York Fed, Nixon put in train that “eliminat[ion] of gold as the common denominator” of money worldwide announced seven years later by the IMF. And without rare, tightly supplied, indestructible gold to restrict it, money has run riot since.
“With all its faults, gold does exercise the only important objective restraint upon that process of evolving a costless and limitless means of payment toward which the banking economy persistently progresses,” wrote John Henry Williams, then Harvard professor of political economy and soon to become vice-president of research at the New York Fed, in a 1932 essay, The Crisis of the Gold Standard, in Foreign Affairs magazine.
Put another way, 78 years later, “The heavy reliance on cash in most societies [still] represents a huge opportunity for banks and non-banks,” as McKinsey consultants said in a special report on non-cash transactions. By their maths, the payment-processing industry had just enjoyed its first $1-trillion year in revenues. Creamed off a global economy generating $63 trillion of business all told, that’s one hell of a rent.
Costless money has plain benefits, of course. Today’s photons and digits are no less “money” than yesterday’s wampum, paper or nickel alloy. Just much more efficient. They’re universally accepted too, unlike Bitcoin’s tragi-comic stab at creating a “new” money via the magic of computing code alone. But with no limit on money as a means of exchange, its second key function – holding its value, at least between when you receive and then spend it – looks increasingly shaky. Unlimited and costless, weightless and countless, isn’t money at risk of losing its meaning?
“The legend of King Midas has been generally misunderstood,” reckoned Nobel economist and Princeton professor Paul Krugman in a 1996 column, just as the death of gold was about to be proclaimed worldwide, together with the end of history. “Most people think the curse that turned everything the old miser touched into gold, leaving him unable to eat or drink, was a lesson in the perils of avarice. But Midas’ true sin was his failure to understand monetary economics.
“What the gods were really telling him is that gold is just a metal.”
All very true, and utterly wrong. Gold is “just a metal” on the chemist’s periodic table alone (and even there it’s unique). In every other sphere of human activity, it has always been very much more than “just” anything, bearing a religious, social and emotional power only an academic economist could dismiss. Silver too has also been used to store wealth since long before the myth of Midas, and also revered as sacred and eternal in every culture which ever mined or encountered it.
But what the legend of Midas really says isn’t about gold, however, nor greed. It’s about coined money – and how, right around its emergence sometime in 6th century BC Greece, the world was changed beyond recognition.
“However fascinating for us is the culture of premonetary Egypt and Mesopotamia,” writes Richard Seaford, professor of Greek at the University of Exeter, in his book Money and the Early Greek Mind, “it remains irreducibly alien. The earliest Greek poetry and wisdom, on the other hand, we citizens of a thoroughly monetised society recognise as…somehow more akin to us than anything from those earlier civilisations.”
How come? Tracing the role of gold and silver, gift-exchange, plunder and sacrificial rites through the writings left to us, Seaford spots “two unprecedented phenomena: the construction by individual ‘philosophers’ of impersonal cosmology, and [in tragic drama] the extreme isolation of the individual from the gods and from his own kin.” Any of us can feel those two pull on us today, in just the way that cat-headed ghouls blessing mummified souls on a pyramid’s wall do not.
Greek religion was previously built on creation myths, with all-too-human deities on Mount Olympus taking out their spite and passions on the people formed from clay below. Deep social rituals then kept things together on earth, most notably through the equal sharing of sacrificial meat on silver, copper or bronze skewers (called obols, which just happened to become the name of an early Greek coin) and the less-equal sharing of plunder and booty by war parties. Coined money ripped these certainties open, most obviously by making each man a king – metaphysically – able to turn anything he fancied into his personal treasure by presenting a round, stamped lump of silver or gold in exchange.
Hierarchy, family ties and tribal loyalties still counted, of course. But coined money cut across them more surely than a Persian scimitar. It was as a unit of account, however, and a yard-stick for the value of anything and everything, that money really fired synapses in the ancient Greek mind.
“The myth of Midas represents the reaction of the Greek mythical imagination to the novel and startling power of precious metal as universal equivalent,” writes Seaford. “[His] touch turning everything into gold expresses early Greek experience of money as a universal means of exchange.”
Money means everything in the Midas myth. He even saves himself by washing the curse off in the river Pactolus, from whose alluvial gold the first coins were most likely made. Another Greek legend attributes the invention of coinage to the real King Midas of Phrygia’s wife.
China and India also saw coined money develop around the 6th century BC, which surely deserves deeper study. The role of religion and rite in the emergence of Greek money has been noted for over 100 years. And we have plenty of what sound like our own money myths today. “The Fed believes in a strong Dollar…The ECB will not monetize government debt…I promise to pay the bearer on demand the sum of five pounds.” But these are just lies and absurdities, not parables to reveal anything useful, let alone to someone trying to understand or keep hold of their money.
Meanwhile, the meaning of money in our utterly monetized world – four decades after breaking 2,500 years of human tradition, and with its newest currency, the Euro, facing an existential crisis thanks to Athens and Rome – is less studied and more opaque than the ancient Greek myth of a king who, in yet another tale, also sprouted donkey’s ears because he upset the god of song.
How the ancient immortals would laugh! If only money hadn’t helped kill them first.
