Six years ago today, I started this blog as a tribute to something I'd only discovered three months earlier. The fact that I'm still at it six years later speaks to the depth of the material I had only glimpsed when I started. I once started another blog on a different subject and lost interest after only a couple of months. I do tend to lose interest easily. In college, I changed majors and colleges several times, and after college I changed careers twice. Six years on one subject, for me, is remarkable.
I have no formal education or background in the subjects I explore on this blog. Everything here I learned since 2008, through reading, thinking and writing this blog. Once you understand the basics, it's mostly common sense. But the real strength behind my subject matter is the foundation I chose as my muse, the five years of Freegold archives left behind by someone calling himself "Another" and his friend, "Friend of Another" or FOA.
Many people write blogs related to their profession or area of expertise and influence. This is not one of those blogs. If I have any level of expertise or influence in the subject of my blog (which is not my judgment to make), then it comes from writing this blog, not the other way around. So I am deeply moved whenever real professionals make comments praising what is essentially my hobby.
As this is an anniversary post, here are comments from a couple such professionals over the past six years. Krassimir Petrov is an economics professor from Bulgaria who has been blogging and writing articles since well before the global financial crisis. He received his PhD in economics from Ohio State University and now teaches in the Middle East and Southeast Asia. In 2010 on his blog, he sent his readers to one of my posts with this recommendation:
"This is one of the very best contributions in the inflation-deflation debate. It is long and detailed, but the topic is extraordinarily complex."
Two weeks later, after reading some of my earlier posts, he added this:
"FOFOA is probably one of the very best analyst in the whole world. The more I read from him, the more I am convinced of his vast superiority over most experts and analysts…"
In 2011, I wrote a post directed at Rick Ackerman. Rick is a professional trader, financial advisor and blogger with a large following, well known as a hard-core deflationist. My post was an attempt at addressing his 30-year aversion toward dollar hyperinflation as the final outcome, using FOA's reasoning. Within days of my post going up, he left the following comment on my blog which made the hairs on my arms stand at attention when I first read it:
"Sheesh! Where to begin? It's difficult to give up a belief system that took root 30 years ago, but I find your arguments irresistible. I took notes as I read the essay, thinking to rebut you point-by-point; instead, halfway through it, I found myself overwhelmed by the clarity of your thoughts. The real power of this essay is that each step of the hyperinflationary endgame it foresees is entirely consistent with human nature, particularly where self-interest and self-preservation are fated to play out.
I will have to find a way to break this gently to my readers, perhaps starting with the joke about not having to outrun the bear. It goes a long way toward explaining how the Masters of the Universe will actually benefit from hyperinflation. You've also helped me understand how I could have been so bullish on gold over the years even though I considered myself a hard-core deflationist. It was a conflict between head and heart, really, but you’ve resolved it with the most persuasive argument I’ve seen in favor of gold. Even better, you’ve provided a sound basis for arguing that at $1500 per oz., gold has barely begun to discount the dollar’s final fall.
I especially appreciate the patience and humility you showed in walking readers through your argument one gentle step at a time. By not trying to overpower your opponents, you have produced a treatise that is certain to engage many minds. Thanks for engaging mine -- at a depth that had eluded me for three decades."
Such comments are wonderful confirmation for my efforts and my presentation, but again, I have no real experience or background in the subject matter. My secret is my deference toward the view presented by Another and FOA. I work to hone the lens they left behind in order to share the view with others, but all credit for the view itself goes to them.
In my last two posts, I have been progressing toward the simple concept that Freegold is all about clean floating exchange rates. Not just a clean float in the price of gold, but in currency exchange rates as well. It's a little more complicated than that, but not really. To "float" simply means that the private sector (also known as the market) determines the exchange rate.
It's not a proposed change of rules or anything like that. Instead, it is the recognition that this is where things are heading on their own, without any further rule changes. It's not a system that will require a clean float or punish a dirty float. Instead, it is the observation that a clean float is what everyone who matters now wants. It is the direction they are all heading today, including the US, Europe and China, and that once a fresh starting point is reached, the rationale behind it will be obvious to everyone and exchange rate manipulation will, for the most part, become a thing of the past.
It's not even that floating exchange rates are the most fundamental principle involved. After all, the euro took many countries which used to have their own currencies and combined them into a single currency zone. There's no floating exchange rate between France and Spain. The more fundamental principle than floating exchange rates is functioning automatic adjustment mechanisms. This principle applies across all borders, whether they share the same currency or not.
The difference is, for adjustment mechanisms to function automatically, wherever an exchange rate exists, it must float, i.e., it must be determined by the private sector. Whenever the public sector intervenes in exchange rates, it prevents the automatic adjustment of imbalances and therefore causes imbalances to accumulate. It's a pretty simple concept.
Public sector intervention in exchange rates covers everything except a common currency and a clean float. Hard fixed, pegged, adjustable peg, dirty float, they all prevent imbalances from correcting gradually and therefore cause them to accumulate, which leads to an unstable and vulnerable situation. Using a common currency or having a clean floating exchange rate leads to balance, stability and invulnerability.
Covering this point properly would require an entire post, and it's one I may write in the future because it is somewhat controversial. But in brief, the reason it is controversial is because one famous economist in particular thinks that hard fixed exchange rates are essentially the same thing as sharing a common currency. They aren't, because what can potentially work in theory has been shown time and again to not work in practice. As FOA said, "This is the way fiats work, whether gold backed or not, they always break from strict printing discipline."
For hard fixed exchange rates to work like a common currency requires "strict printing discipline" in response to international imbalances, while a common currency and a clean float do not. And it's not just discipline that's required, because the complexity of getting the adjustments just right would challenge even a supercomputer. Yet it seems to follow that if a hard fix can work, then looser fixes or adjustable pegs are fine too. But the complexity and difficulty multiplies as you ease away from the hard fix, then it disappears suddenly when you finally give control over to the marketplace.
In any case, such academic exercises are irrelevant at this point as the trend away from fixed exchange rates toward either a common currency or a clean float has been established by those who matter for the last 40 years and then some. It is now "baked into the cake" as they say, so none of this is meant to be a discussion of possibilities. It is simply part of the lens and the view.
What a clean float from a fresh starting point (which I should stress that we do not have yet) will do is to balance trade automatically through the exchange rate. There will be no need for the systemic settlement of trade imbalances. Economy-wide trade imbalances will be corrected gradually, almost imperceptibly, over time through changes in exchange rates.
Different economies obviously produce different things, and different things have different (and constantly changing) relative values. Some economies produce more valuable products with less effort, while others produce less valuable products with more effort. Nor is consumption or the enjoyment of the fruits of one's production equal across different economies. The United States, for example, produces a lot of stuff, more than any other country in the world. We are, in fact, the largest economy in the world (unless you count Europe as a single economy) based on gross domestic product.
Yet even as the largest producer in the world, we still consume more than we produce. FOA said it well. "Collectively, [we use] our own attributes and require the use of other nation's as well… We cannot place [our attributes—our enormous resources and high productivity] up as example of our worth to other nations unless we crash our lifestyle to a level that will allow their export! Something our currency management policy will confront with dollar printing to avert."
Running a trade imbalance is a choice that is most easily made by the net-producer. The choice is to consume less than you produce, which is what makes one a net-producer by definition, and nearly anyone can make that choice. The choice to consume more than one produces, on the other hand, generally requires support from an external source.
Profits are income in excess of costs. They can be invested, saved or consumed, so profits alone don't define a net-producer. It is what you do with your profits that determines whether or not you are running a trade imbalance. Here's a rather confusing comment from Another in 1998:
"As you ponder these thoughts, consider that; all economies today are truly equal in production as the exchange rates are the manufactures of profit!"
As you think about this comment, recall that in my last post I quoted an article about Airbus calling for the ECB to intervene in the foreign exchange market to weaken the euro. The article explained:
"Airbus, which sells its aircraft in dollars but incurs costs in euros, is one of the most exposed groups in Europe to a strong single currency. Other groups such as Unilever, SAP and BMW have also faced currency headwinds."
The list price of an Airbus A380 is $400M (€298M at the exchange rate at the time of writing), but a tough market has forced them to discount the price significantly in order to sell airplanes. Having spent $25B developing the A380, plus the cost of producing each unit, it is estimated that the break-even point will be once they sell 420 planes. So far they have delivered 138 planes and have orders for 180 more.
The bottom line is that their costs of production are still higher than their income for this plane. They need to cut costs or sell more planes at higher prices in order to turn a profit. In a competitive market, you need to be competitive in order to profit. But there is a potential shortcut.
Just as a simplistic exercise, let's say A380 sales are happening at $300M per unit (€224M at the current exchange rate), and production costs are €230M per unit, for a net loss per unit of €6M. If the euro exchange rate was to decline 5% from $1.34 to $1.27, the $300M price would suddenly convert to €236M and the €6M loss per unit would magically become a €6M profit per unit. Without any cost cutting, competitive improvements or increase in price, a profit would have been magically manufactured by simply manipulating the currency exchange rate.
Now read Another's comment again and see if it makes any more sense the second time around:
"As you ponder these thoughts, consider that; all economies today are truly equal in production as the exchange rates are the manufactures of profit!"
Manual labor, like factory work, has the same basic output anywhere in the world. A screw turn is a screw turn whether you're Chinese, French or American. By moving the production facilities for certain parts to China, Airbus could cut costs because, even though the output is the same, the manual labor is cheaper. Part of the reason for that is China's support of the dollar. By weakening the yuan, China lowers the living standard of manual laborers which increases the nominal profits of the company owners, wherever they may reside. This is how exchange rates manufacture profits.
You may think that Chinese laborers work cheaper than, say, United Auto Workers in Detroit, because they are accustomed to a lower standard of living. While it may be true, it will be irrelevant with a clean float. I think we'll all be stunned by how quickly the purchasing power of comparable work on comparable products will equalize across borders between comparable economies with clean floating exchange rates.
Getting the ECB to lower the euro exchange rate through FX intervention would have a similar effect to moving production to another country that already manipulates its currency. It would lower costs at the expense of a lower standard of living for all workers in the local economy while elevating the nominal profits of the company owners, the bonuses of its executives, and the standard of living in America where we can buy overseas using an overvalued dollar. As FOA said, "the world does not hate America; rather they hate the free lifestyle our dollar's illusion value brought us yesterday and today."
There is another way, other than currency exchange rate manipulation, to manufacture profits. That other way is through real cost cutting and real improvement in output, in other words by becoming competitive. From the articles quoted in my last post:
"Currency manipulation is not a route to competitiveness, it is a soft alternative to hard explanations to the electorate."
"We have to concentrate on whether the European economy is competitive and then we will have an appropriate exchange rate."
With this latest honing of the lens, I think that the view of not only what is unfolding in real time is becoming clearer, but also some of Another and FOA's posts from 16 years ago are also making more sense. Here's another one that should be familiar to most of you. Please let me know if you think it makes any more sense with an improved lens:
ANOTHER 5/26/98: "The Western mind does focus on "what I buy today for the lowest price". Yet, in this modern world economy, the lowest price is always the function of "the currency exchange rate"? The Yen, it is compared to the dollar today, and used to purchase goods. One year later and the Japan offers these goods for much less, as the Yen has fallen to the US$. The currency value of this purchase, was it "true" today or a year ago? Understand, all value judgments today are as subject to "exchange rate competition"! It is in "this exchange rate valuations" that the private citizen does denominate all net worth! A safe way to hold the wealth for your future, yes? You should ask a Korean or the Indonesian?"
Here are a few more:
FOA 9/22/98: "The currency confidence factor comes from a strong positive exchange rate, much like that enjoyed by the dollar today. The average European will buy from the USA in the same way that Americans buy bargain goods from other countries. Using an overvalued dollar makes one feel as there is no inflation, even though there has been massive dollar currency inflation over the last twenty years (the real cause of price increases is when the exchange rate is allowed to balance a negative trade deficit)."
FOA 9/26/98: "The possibility of FXC (Foreign Exchange Controls) is very real. This topic has been discussed in several well written books spanning 25 years. In a way, the closing of the gold window in the early 70s was a form of FXC. Anyone outside the country could no longer get their gold because too many dollars had been printed to cover the gold in the US treasury.
Today, too many derivatives have been printed (paper gold is one of them) than can be covered by the outstanding dollars! The US Federal Reserve either prints a load of dollars to cover this contingent or the system falls apart. If the Fed prints, the Americans get inflation. If the Fed doesn't print, the world financial system, based on a dollar reserve currency, starts to implode and foreign holders of dollar assets try to exchange these for their local currency. To do this they must take the dollar home to the USA for exchange! During this exchange, if the dollar loses too much value in the exchange rate, these foreign holders just SPEND THEM in America!
Again, the US experiences price inflation, only this time it's during a global deflation in dollar assets. To stop this chain of events, this time the US Treasury closes the dollar window. It's usually a last effort to hold the banking system together. The gold window was closed by holding gold at a low price valuation and not selling any of it. The dollar window will be closed by buying dollar currency at a rate so low as to stop most major holders from exchanging. This usually brings a two tier market, dollars inside the country worth more than outside the country. For some time, all dollars outside the US were called Eurodollars! Will we see these Eurodollars exchanged for Gold????"
Very briefly, I want to draw your attention to these curious charts of Foreign Direct Investment or FDI in the US:
They come from here, and the data comes from the US Dept. of Commerce Bureau of Economic Analysis, or BEA. You can download the latest BEA Excel spreadsheet for FDI Financial Transactions here. I noticed a curious coincidence when I decided to compare the mysterious FDI outflow to the puzzling "Belgian" Treasury buying from the same quarter.
The net decline in FDI for the first quarter was $117B, but the decline from Europe alone was $124.6B which is on line 15 of the spreadsheet. And if you add up the first quarter increase in "Belgian" (Euroclear?) Treasury holdings from the TIC data, that is, take Belgium's March total ($381.4B) and subtract its December total ($256.8B), you get the same number for the same time period, $124.6B. I'm sure it's just a strange coincidence. ;D
Back to Another and FOA:
ANOTHER 11/17/98: "It is the "practical understanding" that our modern world must use a "digital paper money" for commerce. All accept this. However, without a "gold currency" priced daily in the "free market", and used as real reserves, any "world reserve currency" would expand using "debt only" as the tool. This result brings the eventual reckoning for all users. The "host country" finds all other nations supporting its "lifestyle", even as those country's private financial infrastructure is destroyed. It is the rising US equity markets and falling inflation that so indicates the last days of the dollar! Many say this is a sign of strength for America, yet they know not what time of life the dollar has attained. The "old man" has he become even as persons place their financial horse upon his shoulders. The world debt structure of this "old man" is such that the true pricing of gold in a new currency, will bring such a weight as it will end his life! The purpose of the evolution in "paper gold trade" is offered in many reasons. At first, it was the "deception" to hide the "life age" of the dollar. Much as your Hollywood actors obtain the "facelift", yes? This "deception"(low gold price in US$), to the surprise of many, was created by the "Euro makers" not the "dollar makers". To their advantage, world traders and dollar investors were greatly fooled and, as you say, "jumped on band wagon" to help sell paper gold down! This action did prolong life of dollar as was needed, for the Euro was taking much time to complete…
It has always been the desire for the "hard currency" to settle old dollar debts. Dollar debts made "unreasonable" by the loss of "honest commerce" by "dishonest exchange rates". As has been from the past, and will be in the future, Gold does always settle the score!"
FOA 5/20/99: "The largest difference between the two (Euro / Dollar) is found in how the exchange rate value of each is "Managed" for political purposes. The dollar is ruled by one country and one country only. This implies that only one Economy is taken into consideration when policy is discussed, the USA."
FOA 3/14/99: "This brilliant, modern free trade system and all of its benefits cannot be implemented using the US dollar as a reserve currency. It shuts off commerce that in turn limits the use of commodities such as oil, metals, food and the like. Many hail the low price inflation in the US as a victory and ignore the intent other nations had in following "free trade". That being to promote a world economy, not just a US economy.
Enter the Euro! Understand that the increased use of commodities is a good thing. It's not just for the purpose of making rising chart pattern so speculators can sell their calls! Commodity usage creates real things and helps the lives of real people. When citizens gain real productive mechanisms, they hold real wealth. Some would have you believe that third world people are enriched by saving US treasury bonds, not true! The only way to increase world trade, with an eye on building new consumers in all countries, is to remove the overhang of "dollar settlement"."
FOA 8/2/99: "My friend, I (as taken from Another) use the term "western view" because it is a clouded perception of how the world sees the dollar. For the dollar countries, it buys much at the expense of others. The very strong dollar that "bulls your stock markets" does not clearly represent the value of the foreign goods it is exchanged for. Your view is to save the dollar and the US economy because it is holding up the rest of the world. That is the very problem, as only on a dollar based reserve system does this occur. Instead of using a currency based upon only one countries interest, the USA, use a currency based upon the "conflicting" interest of many nations, the Euro! Under such a system, world trade and exchange rates will balance more fairly."
FOA 9/19/99: "Every day, new evidence emerges that shows Euro liquidity becoming as deep as the dollar with little threat of "dirty float" interventions in exchange rates… The ECB can now slowly phase out dollar reserves as the Euro assumes more of the world trade settlement function. A function in and of itself, that will further lower the dollars world need, use and therefore value. Because the US still runs a trade deficit, it still ships a surplus of dollars to most countries. In today's new Euro world, the dollar exchange rate will eventually be forced to fall enough to balance this flow."
FOA 12/5/99: "In the private sector, it was always the business trade that built up excess dollars as they sold more "goods" to the US for dollars than the US businesses sold to them. Using Japan, the net effect of all their private companies selling into the US created a huge negative balance of trade account. For many years now, if these countries walked into the foreign exchange markets and sold these excess dollars for Yen, it would have drove the yen way up. If done early and before a large position builds up, this is the "natural way" a true fair currency exchange market should work. If the US continues to buy more from Japan than it sells, the currency markets react until the goods being traded are evenly priced.
This action would protect the workers of both countries from being exploited, even though their productive efforts are equal. Contrary to the "business community propaganda" a worker in Japan does not tighten a bolt better or faster than one in the US. Take all the technology innovations and pour it into a big pot along with natural human nature and add some cultural differences. Boil it down and we find that through the world over everyone works the same for the same incentives. Of course the business community always leaves out a "true" incentive / compensation package when comparing national productive effectiveness. Trust me, I've been everywhere and seen it all. You would not work as "effectively" and as productively in, say India, if you received the same pay they do. No, by far and wide, the real national industry productivity measurements are all skewed from "engineered" exchange rates between nations.
So, back to our currency rates. No person or nation ever expanded its wealth by selling two TVs in exchange for one TV. The US knows that the road to national wealth is not in a strong currency by itself, rather it's through operating in a manipulated currency market! If your workers can tighten one bolt in exchange for foreigners tightening two or three bolts, your wealth, standard of living and voting citizens are better off.
Under the old dollar / gold standard, no foreign government wanted to see its people tightening 3 or 4 bolts in trade for every one the US worker did. Perhaps a ratio of one turn for two could work for a while until their economies grew. But no one wanted to get locked into doing this forever, as this modern dollar standard has forced them to do.
It worked better back then as they traded two turns of the nut for one US turn and they retained a little gold wealth in the form of US dollars. Are you still with me? This is important to grasp. …
So, as we can see, nations started holding dollars and US treasury debt because it represented a wealth for wealth exchange. Nations, Japan included, were content to have their Central banks enter the currency exchange markets and buy up the excess dollars their businesses created when they sold more to the US than they bought. In that time they did not think they were exploiting their workers into making two turns on the bolt for one US turn, because they were trading most of the additional "twists" for the wealth of gold.
By 1971 the "dirty float" of currency exchange markets was normal practice until the US closed the gold backing for the dollar. Suddenly, all the dollars that were purchased overseas to adjust the exchange rates were now worthless! The only recourse for governments to regain real wealth for all the additional "nut turns" was to use the dollars to buy local American goods. One problem though, all the dollars were collected while the gold standard impacted exchange rates! Now, with only a pure dirty float for an exchange market, any reverse selling of the dollar into the US would drop that currencies value. So, the good purchased from the US would only represent a tiny return of the wealth value these dollars were originally traded for.
It is here that the story begins to change and the world heads for a new alignment. Everyone in the world was impacted by this move. From oil producers to auto makers in Japan. Everyone lost, big. If gold had become so worthless, as most US politicians proclaimed, why didn't they just revalue what they had left to, say $2,000 and call in what dollars were out there? They didn't because in that scenario they would have drained the dollar as a reserve unit and killed the notion of dollar supremacy. Gold would have regained its exact value as money to the world prior to currency / exchange / standards. Perhaps $3,000 or $4,000 an ounce (back then) and the US would have run some real inflation.
The world Central Bankers (and oil producers) took a real hit when this all happened and it won't be allowed again. They have supported the fiat dollar standard and even helped "pump it up". All in an effort to keep business rolling until a new currency could be created. One based on several economic national arenas, no dollar reserves and a world market price for gold. As opposed to the present IOU paper dollar gold system. Even though the Euro is born, this package is not complete, but it's getting there!
Truly, you have to have been around the turn a few times to understand that no one (and I mean NO one) is wanting a larger piece of the old dollar pie. The notion of currency parity for the purpose of trading up debt reserves is something being floated by the Washington think crew!
Are these nations trying to pay up for past US military action? Oh boy, not a chance. Why don't we pay Italy for all the good the Roman legions did for everyone!! No one is worried that the US will back away from protecting its interest after it's bankrupt. Whether it's oil or national security, they will act as best as able. See ORO's post about this, it's real good. Besides, look at Russia. No money, no nothing but still out there firing away!
Also: The present paper gold market depends on new hikers entering the gold trail towards its end. They buy paper gold as some kind of stock market / investment hedge without knowing the big picture. In the past their actions would have worked their purpose. But not in this transition. A currency exchange storm is going to sink a lot of these paper boats and kill the very assets many wanted to protect. Buy the gold not the price!
FOA 12/29/99: "Our modern currency history (the last 20 years) has shown that the world needs both of these moneys [fiat and gold], but needs them in a different format from the past. Our present dollar could do the same but it carries the baggage of huge unpayable international and local debts. Debt made non payable by the dollar reserve system that forces the social needs of just one people upon the world using unbalanced, rigged exchange rates. It eliminates the escape route of a "free market" gold price and therefore locks down the ability of other nations to trade outside this system. Free the world of this system and a great deal of American wealth will be seen for what it really is, an illusion of bookkeeping. Indeed, create a workable reserve medium, based on world needs and wants in a settlement format and the race will be on to use your product… Especially if it "includes" the money the world has wanted for all its history. Gold!"
FOA 1/11/00: "The strong US economic success has been spelled out more in our SOL (Standard Of Living) than if expressed in financial accounts. Dollar exchange rates, interest on dollars, stock market values, home values all represent what an American "can buy" if they decide to spend their wealth. Not what they presently have as owned wealth, paid up 100%. This leveraging of dollar affairs has created an "illusion of savings" that in effect allowed a high SOL. In other words, we live high on the hog today because our present equity values and savings don't really exist. Time has transformed the entire dollar system into a giant "futures contract" that only represents the wealth we could obtain in partial "future purchases". Just like the gold market, we mostly trade paper wealth and call it real. Yet, if a large percentage demand for delivery ever happened, the contracts would fail. Yes, our wealth and economy status is really based on us cashing in and buying just a little at a time. If we didn't, the illusion would be exposed. Only our present dollar economy is "super leveraged" not just into the future of US goods production, rather it also completely depends on future foreign fulfilment to produce those real goods. Truly, most of our present sizeable financial wealth is little more than a function of the "acceptance of dollars overseas" by others."
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