The 100 Year Clearing

Let's start with this article. In it, Hugo Salinas Price points us to an observation he makes that he hasn't seen mentioned anywhere else. And that is the sudden decline in the non-gold reserves held by the Central Banks of the world.

He concludes the article with this question:

What is the significance of the drastic change in the growth-trend of International Reserves, from explosive growth, to the sudden beginning of a contraction?

I hope others, more competent than myself, address this question. I believe it is quite important that we have an authoritative answer to it.

I certainly don't consider myself more competent than Mr. Price, nevertheless I will take a shot at addressing his question with a little help from the most perspicacious A.E. Fekete.

First, let's take a look at the graph in Price's article because it is a little misleading:


If you notice the first 80% of the graph goes parabolic, then it levels off for the last 20% with a slight decline. What is misleading is the x-axis of time. The first 80% covers 60 years of time, and the last 20% covers only 3 months of time. So in reality, if we were to compress that last 20% so that it matched the time progression it is not a leveling off at all, it is the very beginning of a sharp decline.

This is important to understand because any parabolic function like this cannot be maintained for very long. What goes straight up, must come down very quickly. A good example of this kind of parabolic rise and subsequent crash is this chart of the price of gold, which peaked in 1980:


So the question is, what is going on with the Central Bank "paper" reserves? To find the answer, I turn to some history and theory from Antal E. Fekete. On Monday, he spoke to the Civil Society Institute at Santa Clara University in California. In his address I found a thought that leads me to what may be happening with the decreasing Central Bank reserves. You can read Fekete's paper here.

The issue I am focused on is the clearing mechanism of the entire world's economy. A smaller, fractal example of this is a clearing house for stock market trades. By the end of each day, all buy and sell orders are cleared either internally or through a trade on the floor of the exchange. There is a time limit to the clearing mechanism. It must be done each day. The orders fly around all day, but by the end of the day the net of all the orders must be settled, or cleared. And once this is done, the bills, or orders just disappear because each party has received his net of money and/or stock. You could say that these orders to buy or sell throughout the day were "self-liquidating" by the end of the day.

Fekete takes us back to the Middle Ages with a fine example of self-liquidating credit, clearing, and final settlement:

A ‘fairy’ tale

Let us look at another historical instance of clearing that was vitally important in the Middle Ages: the institution of city fairs. The most notable ones were the annual fairs of Lyon in France, and Seville in Spain. They lasted up to a month and attracted fair-goers from places as far as 500 miles away. People brought their merchandise to sell, and a shopping list of merchandise to buy. One thing they did not bring was gold coins. They hoped to pay for their purchases with the proceeds of their sales. This presented the problem that one had to sell before one could buy, but the amount of gold coins available at the fair was far smaller than the amount of merchandise to sell. Fairs would have been a total failure but for the institution of clearing. Buying one merchandise while, or even before, selling another could be consummated perfectly well without the physical mediation of the gold coin. Naturally, gold was needed to finalize the deals at the end of the fair, but only to the extent of the difference between the amount of purchases and sales. In the meantime, purchases and sales were made through the use of scrip money issued by the clearing house to fair-goers when they registered their merchandise upon arrival.


Those who would call scrip money “credit created out of nothing” were utterly blind to the true nature of the transaction. Fairgoers did not need a loan. What they needed, and got, was an instrument of clearing: the scrip, representing self-liquidating credit.

You see the clearing mechanism, the scrip money, figured the final settlement of gold. At "the end of the day", the trades were netted out and those who were owed received a final payment of gold. I say this payment was final because it didn't require the future performance of any counterparty. You took your gold home and you were done.

But what's important, is that all debts were cleared on a regular time basis. Fekete also talks about the Real Bills Doctrine in which debts are cleared within 91 days of creation. This time restraint is based on the length of a season, because that is a sufficient amount of time for seasonal products to get from a producer to a final user. The Real Bills Doctrine originates with Adam Smith.

Thousands of years ago, all debt was cleared every 7 years through debt forgiveness. This worked because it was known by everyone and was therefore figured into the lending practices of the day. Christopher Laird of the Prudent Squirrel put it well in his latest excellent article:

The second thing that might get the world out of this impending economic depression and a collapse of the USD later would be to forgive all debts. Possibly that would wipe out the USD too anyway. But that would set the stage for a huge world economic recovery.

The trouble with debt forgiveness is it never seems to happen. Believe me, I am not talking hogwash about debt forgiveness. The Bible, for example, talks about how every 7 years and every 70 years there is to be total debt forgiveness. It’s called the Jubilee. The idea is a legitimate concept that can work and has worked.

You don’t think that’s viable? Well it can work because all that happens is that the lenders who offer credit have to factor in either payment in full or forgiveness over a 7 year period. This can be done and would actually result in the biggest sustained world economic boom ever imagined.

Perhaps this is where we get our 7 year bankruptcy laws?

Fekete goes on to explain how this periodic clearing mechanism was surreptitiously eliminated by the passage of legal tender laws in France and Germany in 1909. This was done in preparation for WWI, but what it also did was to set in motion a sea change in which debt was now required by law to be settled in non-self-liquidating bills issued by governments, rather than the self-liquidating bills previously issued by private banks which were periodically cleared by a settlement in gold.

So now, because these government bills did not disappear upon the final consumer paying for the final product in gold coins, they would start to accumulate. This was a slow process that happened over many years. People would not notice a difference right away because gold coins still circulated in the system.

But on the largest scale, the worldwide scale, these legal tender bills began to pile up, or accumulate as the final settlement of any net national trade deficit or surplus. In our modern world this happens as a Chinese exporter is paid in US dollars for his shipment of goods sent to the US. Then he takes those dollars to his local bank and trades them in for his local currency. The bank then trades those US dollars with the Chinese Central Bank for freshly printed currency and the Central Bank uses those dollars to buy US Treasury bills to hold in reserve. The Treasury bills are preferred because they pay interest.

Up through the 1960's this was accepted by the world because it was thought that this debt could be cleared at any time through the final settlement of gold from the US Treasury. But in the late 60's, the French tried to clear their accounts and take final payment and the "gold window" was promptly closed.

Ever since then, the world has somewhat reluctantly accepted the continuation of this system because they could still use the dollars to buy cheap oil and gold on the open market, even if there wasn't an official clearing mechanism any more.

But as you can see from Price's graph, their holdings of our paper debt products has greatly exceeded their need to spend it, and has gone parabolic, an unsustainable rise.

So now, 100 years after legal tender laws eliminated the periodic clearing mechanism at the smallest scale, the fractal pattern of debt has grown to it breaking point on the largest scale. We have arrived at the forced clearing of debt on a worldwide scale. And because there is no official clearing mechanism, this will happen on the open market.

Of course it is a little more complicated than that. For one thing, the ultimate debtor/purchaser, the American consumer, has run out of "scrip money". Imagine if Fekete's Medieval Fair went on for a really long time without it's daily clearing function. As time went by, the paper scrip money would pile up with the sellers, and the buyers would be going farther and farther into debt, until finally the fair would stop issuing new scrip money to the buyers, and the sellers would demand a clearing, a final settlement.

That is what is happening right now on a worldwide scale. The creditors are forcing the clearing of the debt. This is probably intentional, though it could easily be a natural response to that parabolic rise in reserves. From 1909 through 2000, the US debt rose to $1 Trillion. Then from 2000 to 2008 it rose from $1 Trillion to $10 Trillion. That is a parabolic rise that directly matches the rise of reserves in the world's Central Banks.

And because this debt must now be cleared on the open market, the only outcome that I can possibly see is a world where FreeGold prevails. This debt will be cleared by the purchase of "real things", of which gold is a major component. I'll end with a quote from FOA which speaks about the "world's massive trade settlement":

During the events directly before us, any and all contracts will be swept along on this raging river of economic turmoil. Be they contracts for, gold, currencies, bonds, stocks or commerce, all of them will lose credibility as the worlds massive trade settlements shifts from one medium to the next....when the armies invade they grab the rare coins, art work and gold. Forget the currency!

FOFOA