Friday, August 14, 2009

The Waterfall Effect


Well, the inflation-deflation debate has surfaced once again. Not in a big way, but in a way that drives me to clarify my position a little. Perhaps you will be surprised.

Divergence

Today's economy consists of an expanding divide driven by opposing forces. Like the jaws of life, they are ripping open a gap between reality (real economic goods) and fantasy (the US dollar). On one side we have the collapsing real economy, and on the other we have unprecedented electronic reproduction of the base unit of measure. On one side we have the exponential expansion of social promises denominated in trillions of dollars, and on the other we have a real economy incapable of delivering such value.


This divergence has been ongoing for some time. But in 2009, the angle of opposition has finally reached 179 degrees. The graph of opposing parabolic trends is almost complete. The only possible outcome at this point can be the Waterfall Effect as described by Martin Armstrong.

The Waterfall Effect describes the "overnight" collapse of a complex system, without even the forewarning of a run up (like gold in 1980 or the dot com run up). The following two graphs demonstrate this effect as seen in the collapse of Roman money in the 3rd century AD. The similarities to today are chilling.



The economy is such a complex organism with so many variables that it simply cannot be controlled. It is the height of arrogance that our politicians and so-called economists think they can control it. And it is the absolute height of arrogance that they attempt to do so in such a way as to ALSO benefit their selfish goals. With this level of stupidity, unintended consequences become many orders of magnitude more probable than the intended consequences. In fact, betting on the exact opposite of stated political goals is a sure bet for the long run right now. And the payoff will be tremendous!

In "How ALL Systems Can Collapse Overnight", Martin Armstrong uses the concept of entropy. Entropy is the amount of chaos, disorder or unknowable elements in any system. A system has low entropy when it is highly organized, ordered, controlled, contained, and all the elements are known. A system has high entropy when it is disordered, chaotic, out of control, and many elements cannot be known. Science teaches us that everything in the universe ultimately ends in absolute entropy (chaos) through the passage of time. In other words, ashes to ashes and dust to dust.

One thing that can affect the natural progression of entropy along the way is adding energy into a system. In certain closed systems with a high degree of order and control, adding energy can actually reduce entropy, increasing organization and order. This can be seen in the wonders of life and reproduction. In the closed system of a baby, we add energy (food) and watch it grow. Ultimately, though, entropy wins out and we return to dust.

But adding energy to a system usually has the opposite affect. It speeds up the journey to absolute entropy. This can be seen in an explosion. A bomb can take an entire building from low entropy to high entropy in a fraction of a second. Another example is a forest fire. The fire is energy added to the system (the forest) and it speeds up the journey from order to chaos. A fireman can slow this process because he has the knowledge that adding water, another form of energy, will affect the progression to entropy in a positive way. But what if the fireman was acting without perfect information? What if the fireman sprayed gasoline on the fire?

I will say it once again because it is worth repeating; the economy is such a complex organism with so many variables that it simply cannot be controlled... ESPECIALLY by politicians. The same fuel that ignited this fire is being used to put it out!

The fact of the matter is that this entropic journey our economy is on must be played out to its natural end. There is no amount of information or energy the politicians or so-called economists could come up with that would be able to turn back time. Nature must play out. And by adding imperfect, frantic energy, by adding fuel to the fire, they are doing the equivalent of setting off a time bomb. They are ensuring that we will all have to ride the waterfall!

Deflation Talk

Deflation is the shrinking of the money supply relative to the economy. It causes the purchasing power of money to rise and prices to fall. But according to our modern deflationists, today's deflation comes at a time of shrinking economy and rising money supply. According to them it is driven by the lack of demand from the collapsing economy, and it is defined by the falling price of assets like homes.

Robert Prechter is out and about today talking about the deflationary depression, with stocks, commodities and real estate all falling together. He says that we are just coming off a top the likes of which have not been seen in 200 years. He says that the best way to ride this out is in the "safest possible cash equivalents".

Basically, he sees this next major down-leg in the depression taking stocks, commodities and real estate down another 85%. He says that oil will ultimately fall to between $4 and $10 per barrel! The danger in making a prediction like this is while it may be fundamentally sound, it is still denominated in the dollar, a piece of paper with shaky credibility.

While I view Robert Prechter as extremely bearish, I must say that I agree with him to a certain extent. The extent at which I do not agree with him is the steady state of the dollar. Prechter views the world through his Elliot Wave cycle theory, which is not unlike Martin Armstrong. But the problem is that the waves he measures are against the backdrop of a steady state dollar.

Like Prechter, I expect all aspects of the economy will continue downward to depths below that of the great depression. But during the great depression, we did not have Ben Bernanke and we did not have a purely symbolic currency as a measuring stick. We had a gold-backed dollar.

Think about this for a minute. The average retiree on Social Security receives about $1,100 per month, or $13,000 per year. This is a dollar denominated promise. If the crash from top to bottom is 90% or more as Prechter predicts, this would give each and every Social Security recipient the equivalent purchasing power of $130,000 per year when purchasing real estate, the stock market or even commodities. Basically everything.

And this will be true not only for Social Security, but for anyone on the receiving end of a dollar denominated promise, including all pensioners, anyone with a tenured job, like teachers and government workers, and including everyone in Congress. Virtually everyone with an income or cash savings will see their purchasing power rise ten-fold!

The problem with this view is that the real economy right now cannot even afford to deliver real economic goods at TODAY'S dollar purchasing power, let alone another 800% rise in purchasing power, with Ben printing new ones the whole way there.

So Bob and I both see a waterfall approaching, but how can we reconcile our seemingly opposite views on deflation?

Currency is the key!

Take another look at the first chart at the top. Something has to give, and soon! Think of those two diverging lines as fingers stretching a rubber band. Then ask yourself, what IS that rubber band? I'll tell you. It is the dollar, the unit of measure for everything economic.

There is a quote I like that comes from Le Metropole Cafe. It goes, "we will have deflation in everything we own, and inflation in everything we use". This is partly true. It is true during the run up to the rubber band snapping. It is true until we hit the waterfall. At that point I have my own version of the quote. "We will have hyperDEflation in everything measured against real money, GOLD, and we will have hyperINflation in everything measured against paper dollars."


So, just to clarify one more time, we will see hyperinflation in gold as the dollar collapses on the world stage and loses its global reserve privilege. This will be followed by nominal hyperinflation in all things priced in dollars as the US frantically prints more and more to support its dying dream of a socialist paradise. The distribution systems for these new dollars will be wide and varied. But distribution will not be through wages tied to economic increases in production (traditional inflation). It will be through a variety of programs that will be called "stimulus". (See my "New Stimulus Plan" and "Free Money" for clues).

The deflation that Prechter sees (as well as Mish, Denninger, Ackerman, Weiss and many others) is very real. It is the collapsing economy and paper financial structure. It is real deflation in real terms. But unfortunately for them, the dollar is not the true base of the pyramid, and it will only benefit temporarily as a "pass through level". (See "All Paper is STILL a short position on gold").

Hyperinflation (a currency event as Jim Sinclair so eloquently tells us) is always concurrent with deflation (economic malaise) when measured in real terms (gold). The dollar is only paper, and it is being printed like crazy. So to measure things in dollars becomes very confusing when looking to the future. The above-mentioned deflationists cannot imagine the hyperinflation event that I describe because they are stuck on their cycles and technical analysis that has always been measured in dollars. But in this crisis, the currency itself is the key. All else is noise.


Sincerely,
FOFOA

References:
Images 1, 3 & 5
Image 2
Image 4
Prechter 1
Prechter 2
New Stimulus Plan
Free Money
All Paper is STILL a short position on gold
Jim Sinclair "Currency event"

78 comments:

BOBALOO said...

WOW---THANK YOU SO MUCH. I HAVE BEEN COMPLETELY CONFUSED WITH THE WHOLE INFLATION/DEFLATION ARGUMENT FOR A YEAR NOW. I HAVE READ DENNINGER/MISH/MCHUGH/PRECHTER ETC AND COULD NEVER MAKE SENSE OF WHY WE HAD DEFLATION-- WHEN BERNANKE WAS PRINTING UP A STORM.
I WAS TOLD BY MY GRANDFATHER A LONG TIME AGO THAT I SHOULD BUY PRECIOUS METALS, BUT NEVER COULD AFFORD MUCH UNTIL JUST RECENTLY, AND SO I HAVE ONLY BEEN ABLE TO SAVE UP A SMALL AMOUNT 225 OZ"S OR SO. I HAVE BEEN ABLE TO BUY A LITTLE GOLD (A COUPLE OZS), BUT CANT AFFORD MUCH BECAUSE IT COSTS SO DAMN MUCH.
I NOTICED THAT FIRST CHART, IS THAT LAROUCHES LATEST TRIPLE CURVE?
I KNOW LAROUCHE,JIM SINCLAIR,CHRIS MARTENSON, AND PETER SCHIFF HAVE ALL BEEN CALLING FOR A DOLLAR COLLAPSE AND HYPERINFLATION, AND I SEE NOW HOW THIS MAKES SENSE EVEN WITH THE CURRENT DEFLATIONARY ENVIRONMENT. THANKS AGAIN FOR THE GREAT ARTICLE!!!

Mantis said...

Legislating an economy is like legislating the weather. It cannot be done successfully. One may seed rain clouds or quantitatively ease the money supply, but all be will for naught, as the complexity of the system and the energy contained therein eventually overwhelm any attempt at controlling it.

Your analysis reminded me of John Exter's Inverted Liquidity Pyramid, which none of your ideas contradict, thus lending them credibility. Moreover, you understand the fallacy of using the dollar as a unit of measure.

Very well presented, FOFOA.

FOFOA said...

Hello Mantis,

Thank you! Please read this post which I linked at the bottom. I think you will find John Exter there. :)

Sincerely,
FOFOA

Mantis said...

Ah, yes, there it is! Excellent.

Also, I'm glad you referenced this particular Martin Armstrong essay, as it is one of his better ones as of late.

Keep up the great work.

The Mad Scientist said...

FOFOA,While we have had our disagreements, I have never seen someone breakdown Prechter's argument which such clarity. Great Work!

Tablemaker said...

Awesome post! I find myself checking this blog all the time as the information is so clear and well presented. I was wondering about shortages associated with hyperinflationary depressions, what sorts of things become nearly impossible to find?

Anonymous said...

I keep on asking myself one Big question :

Many do see what is happening and do pay attention on all kinds of serious analysis...But WHY can't these astute observers come to conclusions as what to do to protect themselves ...with goldmetal in their fists ?

Anyone ?

Shanti said...

FOFOA,

Chapeau for your excelent skills to the clear explanation on this hot subject, not seen many analist comming even close to this reality.

We will watch this waterfall evolution together.

Keep up the good work !

Anonymous said...

Tablemaker: This is the list I'm working from:

http://www.thepowerhour.com/news/items_disappearfirst.htm

anon

Dave said...

Your example of imperfect information causing the fireman to employ gasoline instead of water is so appropriate for our economy today, and underscores why central planning cannot ever work – forever, that is. The possibility, or likelihood of having imperfect information is why systems should be decentralized, distributed and autonomous to the maximum extent possible, so that each small system can best respond to its circumstances in the most appropriate manner.

Sure, some small systems will make errors and possibly destroy themselves, but the larger network of such systems will continue to function and either absorb the failed smaller system or at least be in a position to help it get back on its feet. The broader, distributed system will thus be resilient to failure. With centralized planning of a monolithic system, a single mistake is fatal to the entire system.

We’re seeing that potential for failure being realized in spades today, especially with regard to monetary policy, which seems to me to spell certain death for the dollar. “Health care reform” and “cap and tax” are another couple of grandiose mistakes sure to cripple the entire economy.

If the people “running” the system today really want to fix the economy, what they should be doing is dismantling as many trappings of centralized control as possible and making every effort to build a true free market economy. Of course, that’s completely at odds with the agenda of the politicians who seek power, as well as that of corporations which seek to establish government-protected monopolies.

I believe that we might see a general “deflation” of real prices for tangible goods as peoples’ ability to purchase them declines. That’s simply the law of supply and demand at work. However, it’s totally conceivable to me that we could simultaneously have a dollar that’s crashing in value – due to accelerating debasement – far more rapidly than real prices are falling, which would show up as hyperinflation of prices for those same goods. For example, suppose the real price of a loaf of bread is falling by 10% per year, yet the dollar is suffering hyperinflation, causing prices to rise 1000% per year. Which force will be most manifest in the price of a loaf of bread one sees in the store? Obviously, the 1000% figure. Applying both the 10% real price drop and the 1000% increase due to hyperinflation yields a net increase of 900%, or thereabouts.

Dave - Erstwhile Urban Wanderer

Mantis said...

Armstrong's latest
http://www.scribd.com/doc/18600361/CyclesPatternProjections809

Museice said...

I have been hesitant to write because sometimes it is better to let the teacher speak and attempt to absorb but I have reached the point where my level of knowledge, acquired from you, requires me to finally raise my hand. First, thank you for totally destroying what I thought I knew about the economy and what a dollar bill represented. I'm fairly confident that, like myself, there are many people who could have lived their entire lives comfortably oblivious to the true nature of wealth/money/assets and the relationship between gold/oil/fiat currency.

I'll start with a simple question. I agree that the Stock Market (DOW SP500) is vastly overvalued and a correction will occur (let's say 90%) and I agree that the ever increasing number of dollars will still be chasing a finite number of things (stocks, eggs, real estate). But you state that the person with a constant dollar denominated income could/would have a "800% rise in purchasing power".

How do these two truths work together? How is a stock that is suddenly valued at $1.00 per share (after crash) not purchased in multiple quantities by a person who is making the same amount of income after the crash (forgetting whether or not this person can afford food and how hyperinflation affects other purchases)? Why is real estate that is devalued not gobbed up by this same person with constant income? How can the market crash and stay low if there are that many more dollars able to enter?
I believe I understand your final paragraph but I'm confused.

Questions from a first year student...

Anonymous said...

The problem with your analysis, which is interesting, is that it assumes that the money "printing" the Fed is doing is not being offset by the destruction of the money supply due to the absence of bank lending and/or defaults on loans in the commercial banking system. Every time a borrower defaults on a loan and the bank is forced to write it off, that is a contraction of the money supply. If the commercial banks aren't lending and if borrowers are defaulting in large numbers, those two factors will result in a contraction of the money supply even if the Fed is printing money "like crazy." The vast majority of the growth in the money supply is due to the "money multiplier" that only kicks in when commercial banks lend.

Are you factoring this into your analysis?

FOFOA said...

Hello Muse,

The "800% rise in PP" is the natural conclusion of the deflationist's argument. I am saying this is impossible.

You must understand the difference between "real terms" and "dollar denominated". It is possible for the Dow to go back to 14,000 and still be a 90% crash if the dollar goes down the waterfall at the same time. This is why it is fundamentally sound to say "the Dow will crash 90%". But it is NOT fundamentally sound to say "the Dow will go to 1,000 and it will be a 90% crash". If the Dow goes to 1,000 (which IS possible), I say it will be a 99.999% crash because "paper has burned". In other words, stock certificates as paper claims prove to be complete junk.

I don't know if the Dow will go to 20,000 first, or 1,000 first. But I do know the dollar is almost at the waterfall.

This is a particularly difficult concept in the West where we have valued everything in steady state dollars since the day we were born. It is easier to understand in countries where the loss of a currency is commonplace.

Does this make sense?

FOFOA

FOFOA said...

Hi Anonymous,

I have written a great number of posts on this very subject. What you are describing is a wider measurement of the money supply which applies to normal inflation, but not to hyperinflation. Hyperinflation is a collapse of currency credibility in the face economic collapse. There IS no credit money (money multiplier) in hyperinflations. Actual money supply is less of a factor at the very beginning, unlike with normal inflation, but it ends up experiencing an exponential acceleration in the end (through printing, not through lending).

But what matters more than credit money in the early stages of hyperinflation is the measurement of base money, money that is not backed by debt, not backed by a "hole" on some bank's balance sheet. The nature of existing money also matters. Credit money can contract along with a contracting economy, base money cannot. Also, credit money is often "earmarked" for specific sectors, like housing or financial markets. Base money is not. The guarantees, bailouts and QE have converted large swaths of credit money into base money, and more is happening daily, all in the face of a dollar credibility crisis.

Sincerely,
FOFOA

Anonymous said...

I see it the same way as anon 12:37. The finance institutions have leveraged trillions of BS. The Fed is simply printing dollars to replace all that garbage of derivatives etc... that they hold to make them whole again. Until they decide to put the money in play, nothing will happen. If they just clean up their garbage (balance the losses with printed money) without lending, does it really have any impact? As far as I understand mishes perspective, he sees it the same way.

The question becomes then, when will the banks etc... being bailed out start to spend or loan out the monopoly money? If I was running one of these banks and getting all this "free" cash, I would be buying any commodity I could particularly metals, agriculture (food) or energy. Isnt this what china is doing?

Anonymous said...

"Your analysis reminded me of John Exter's Inverted Liquidity Pyramid, which none of your ideas contradict, thus lending them credibility. Moreover, you understand the fallacy of using the dollar as a unit of measure.

Very well presented, FOFOA."

Very well said Mantis.

Justin_n_IL

Museice said...

It's difficult to erase a lifetime of 'Steady State Dollar' Western Teaching overnight. Your writing has helped, but...

I'm still having a difficult time thinking about what happens when someone buys at the new low level. A stock that was $100 is now $1.00 and instead of buying 1 share a person can buy 100 shares. Same value, just more pieces of paper. Nothing has changed. Correct? But real estate feels different. And now I want to have an argument with myself because if everyone is still paid in the same number of dollars but the 'land' is valued much less then more dollars chase the land and the selling price reflects the supply and demand so even though... but that is exactly what is happening now and yet the price of 'land' continues to fall because no one wants to buy it at current prices so at some point it will cost what some one regards as it's value and that is it's price...
So the price of a stock can drop (assuming Goldman supplied by the Fed isn't supporting it) until it reaches a level of the demand.

But I have a feeling all this is mute if we are talking about the demise of the dollar. But if we are talking about a 'new value' of the dollar then isn't there a point where things just cost (in dollars) what they will cost and then can't a 'fixed wage' buy more of it? Am I just neglecting adding everything that it costs to live (food, rent, air) as part of the equation so therefore there isn't, won't be anything extra left over (even with fixed income) because it takes all wages just to breath? Is that what you mean by '800% rise in PP is impossible'? There is no money in people pockets to use so there is no rise in purchasing power? I can understand that concept.

And I have of course been following your/FOA/Another theory on gold. I can see why gold changes this equation if the cost (assuming gold is valued in dollars) rises against the fall of the dollar. People without gold will pay all of their wages to breath, those with gold will have more capital to spend when it is revalued.
Is this right?

"We will have hyperDEflation in everything measured against real money, GOLD, and we will have hyperINflation in everything measured against paper dollars."

I feel like I'm being reprogrammed from the ground up.
And thanks for answering what must be mundane questions.

FOFOA said...

Muse,

This is all very logical. You need to think it through on your own. Try letting go of dollar pricing. Understand that the value of any given thing "floats" against all other things in a giant pool. Right now, some things are held down lower than their buoyancy would take them, and other things are held higher. Imagine the dollar is also in the pool. But it is a lead weight that is about to be dropped.

Try pricing a house in cans of peas. How many cans of peas does a house cost right now? If the housing bubble has popped, where is the price of houses heading in terms of peas? And if food becomes scarce, where will the price of peas head in terms of houses? And what if both happen at the same time?

Also, think in terms of "percentages". In any given item, there is only 100% in existence, except paper promises. When you buy something real, you are buying a certain percentage of the total in existence. With unlimited money you could theoretically buy up 100% of any one thing, cornering the market on that item. Only the market for paper promises can never be cornered, because new promises can always be made.

FOFOA

manu k said...

The problem is people view dollar as something different from commodities... Dollar is like a commodity and same laws of economics apply to it...But its also a special type of commodity that sets the price of everything else....plus its a commodity whose production is controlled by humans not limited by nature....So any kind of distortion in the supply of dollar will result in some sort of
phenomenon in the natural commodities Inflation/hyperinflation/Deflation or maybe something new ? god only knows....

Anonymous said...

FOFOA,

I'm still confused.


"The nature of existing money also matters. Credit money can contract along with a contracting economy, base money cannot."

I'm not following this at all. Why? If borrowers default on their loans, wouldn't the reserves (i.e. base money) get eaten into?

"Also, credit money is often "earmarked" for specific sectors, like housing or financial markets. Base money is not."

Why is this relevant?

Thanks,

Anonymous 12:37

Anonymous said...

Hummana-Hummana,Hummmmmmmana!
One-of-these-days,Alice,POW!Gold-goes
straight-to-the-moon.Or-at-least-Zimbabwe.

FOFOA said...

Anonymous,

"If borrowers default on their loans, wouldn't the reserves (i.e. base money) get eaten into?"

Most of these holes have been filled in with fresh base money. They were not allowed to do their job. Many more have been guaranteed.

"Also, credit money is often "earmarked" for specific sectors, like housing or financial markets. Base money is not."

The relevance of this is in the way hyperinflations play out. High velocity money chases necessities not luxuries. Therefore, to say that expanding credit which was earmarked for non-necessities is no longer available, is irrelevant to hyperinflation.

Here are some posts you should read if my words confuse you...

http://fofoa.blogspot.com/2009/03/all-paper-is-still-short-position-on.html
http://fofoa.blogspot.com/2009/07/little-perspective.html
http://fofoa.blogspot.com/2009/06/bermuda-triangle-of-currency.html

Also, one other factor I forgot to mention was velocity.

1. Global velocity can reverse overnight.
2. Velocity and money supply have the exact same effect.

Richard Maybury:
A key point is that velocity and money supply can act as substitutes for each other. A 10% rise in velocity has the same effect as a 10% rise in money supply.

The biggest problem with velocity and money demand is they can turn 180 degrees overnight. If people trust the currency, and suddenly perceive some kind of big threat to their futures, money demand can shoot up.

That's exactly what happened last year. The supply of dollars certainly did not go down, but when the real estate crash happened, people became so frightened they were afraid to let go of their dollars.

Within a few days, money demand shot up, people stopped spending and held onto their dollars, and this had the same effect as an instantaneous deflation of the money supply...

And, my key point is, it's all controlled by emotions. By fear.

What are you more afraid of? The dollar becoming worthless? Or losing your job and running out of dollars?

The whole world is constantly shifting back and forth between those two fears, so money demand bounces up and down like a yo-yo, and velocity — the speed at which the money changes hands — does, too.


from: http://fofoa.blogspot.com/2009/05/what-obama-does-not-know.html

FOFOA

Tablemaker said...

Awesome list! Thanks very much.

- said...

“He says that the best way to ride this out is in the “safest possible cash equivalents”.”

“Like Prechter, I expect all aspects of the economy will continue downward to depths below that of the great depression. But during the great depression, we did not have Ben Bernanke and we did not have a purely symbolic currency as a measuring stick. We had a gold-backed dollar.”

All those deflationists who criticize the value of gold in a deflationary environment should remember that cash in the great depression was gold (backed). Most importantly if there was hyper deflation the US would no longer be able to back either it’s bonds or cash deposits and any public default would leave the currency worthless.

Janna said...

Brilliant as always FOFOA. I've long considered deflation and inflation as a part of a linear progression. Deflation due to lost buying power, followed by inflation as failures leach into other systems. I have however, always used the dollar as a measure, even knowing it would fail. That so complicates things... as timing is so important (to me), your simplified view will make it far easier to see through the noise.

Hugo said...

Hi

First time commenting here, but wanted to say that this was a great explanation. Made everything very clear.

The Mad Scientist said...

Prechter also says the most stupid thing you ever can " The Government will not be able to print because people will lose faith in Govt money"
And that is deflation?

Hermit said...

Thanks for posting this piece. In all honesty trying to understand this makes my head swim at times, as it seems the more I learn the less I realize I know.

Anonymous said...

FOFOA,
This is 12:37 again. Let me start by saying that I actually am more in the hyper-inflation camp. So I am not necessarily disagreeing with you. However, I have read some of Mish’s pieces lately, and I think he makes some points that I have not seen any of the hyper-inflationists adequately rebut. I’ve looked at your responses below and am still not persuaded. I’ve laid out my objections below and would appreciate seeing what your responses are.
Thanks,
Anonymous 12:37

12:37: "If borrowers default on their loans, wouldn't the reserves (i.e. base money) get eaten into?"

FOFOA: “Most of these holes have been filled in with fresh base money. They were not allowed to do their job. Many more have been guaranteed.”

Unless I’m misunderstanding, you seem to be conceding my point. If the holes have been filled in by fresh base money, you are acknowledging that the contraction in the supply of credit money does eat into base money. Otherwise, there would have been no need to fill in the holes in the base money. And this undermines your claim above that base money cannot contract. It can.

* * *

12:37 asked why this statement was relevant: "Also, credit money is often "earmarked" for specific sectors, like housing or financial markets. Base money is not."

FOFOA’s Response: “The relevance of this is in the way hyperinflations play out. High velocity money chases necessities not luxuries. Therefore, to say that expanding credit which was earmarked for non-necessities is no longer available, is irrelevant to hyperinflation.”

This earmarking concept is beside the point. When a commercial bank makes a loan, the money supply increases by the amount of the loan, which, in turn, influences the value of the currency. If the borrower is in a particular sector, that borrower is still going to spend the money, and the recipient of that money will spend the money, etc., until the money works its way into the wider economy and influences prices. In other words, the credit money ends up chasing necessities. Moreover, the credit money can at any point be converted into base money because it is redeemable in federal reserve notes.

So, when a borrower defaults on a loan, the bank is never getting that money (the money it created) back. As a result, it has nothing to pay the original depositor with unless it dips into its reserves (which, for the most part, will be base money). This results in a contraction in the money supply.

Anonymous said...

a) what happens if they delete all leverage (derivates) that is a lot of money GONE.

b) would the gold price collapse, a lot of money would be OUT OF THE SYSTEM

c) i ask in another way, if they say we buy back XX TRILLION of $, so they are gone.

d) nobody every saw were they went, but on paper they are back gone,

e) i'm sure goldprices would drop

f) why is that impossible ?

J said...

Anon,
The credit money came into existence because of the base money. The base money is not created from the credit money.

Base money is the building block of the fractional reserve system. When you add more base money you are throwing down an additional block for which another shaky upside down Fiat Pyramid came be built.

Anonymous said...

7:54 (j),

"The credit money came into existence because of the base money. The base money is not created from the credit money."

This is not entirely true. It can go both ways. Base money consists of the Federal Reserve Notes in circulation + the commercial banks' reserve deposits at the Federal Reserve. In essence, this is the liabilities side of the Federal Reserve balance sheet. Every time a person deposits money in a commercial bank, that bank takes a percentage of the deposit and deposits it with the federal reserve. That is base money creation, and it absolutely can come from credit money deposits. For example, let's say that Person A deposits $100 in Bank A. Bank A then deposits $10 in reserves with the Fed and loans out the remaining $90 to Person B. That is a $90 increase in the money supply. Person B then goes and deposits the $90 in Bank B, which puts 10% of the $90 (say $9) on reserve at the Fed. That $9 deposit is now on a liability on the Fed's balance sheet and represents an increase in "base money." This is why, as I pointed out above, a contraction of credit money eats away at base money as well.

Anonymous said...

This seems to be taking on the aspects of "how many angels can dance on the head of a pin".

FOFOA...I'm thinking somewhat along the lines of you on much of this, only life experience tells me that large,complex systems are unlikely to change abruptly (I won't say what you envision can't happen...only history says it's a long shot to happen suddenly).

Let's look at the price of GOLD....$950 USD'ish. Probably we'll see this dip in price (as usual) tomorrow morning when the NY gold markets open. Sure, it seems the gold market is manipulated by "paper gold". Well the Powers That Be must be doing a good job of it. So why should tomorrow, or day after tomorrow or next month be different? Why would they suddenly lose their control of throttling gold? Oh sure, Jim Willie or other gold bug says something is about to change.

Ahhh.. so how's this different than me hearing preachers (since being a kid) telling me that the world was going to end soon?

Will the Fed,GS,JPM,etc. traders suddenly have a change of heart one morning and decide gold no longer needs to be contained.
Will average folks wake up one morning and say ...oh my god... stocks, real estate,treasury bonds are over run bogus, I need to move to the real thing -- gold-- right this moment)?

Right...I'm holding my breath in anticipation.

Anonymous said...

Hi FOFOA,

Sorry if I am questioning something that has been discussed, but in case of hyperinflation of dollars, how this will affect foreign exchange with other currencies such as yen or euro?

Does other currency will collapse along with dollars or do other currencies have more purchasing power against dollar?

Thank always for your insight.

Anonymous said...

@ Anon 9:02 >

You certainly know what happenend overnight on the 15th of august 1971. (goldprice $42 > $850)

In 1999, we had the CBGA (WAG),...overnight. (goldprice $250 > $1035)

celia said...

If you want to know why it would be possible that stocks,real estate and treasury bond end up to be worthless in circumstance unforseeable for most.Please consider the following circumstance.

When a lot of people's debt are going to be due at around the same time and their loans can no longer be renewed.

For a lot of those people, stocks,real estate and treasury bonds are the only assets they have left.So they sold them for money in order to repay them.

Then a lot of those assets would be flooding the market.

When there is excessive amount of them in the market,the value of them would drop quite significantly.

celia said...

PS: think about it,when the amount of gold available to us is below what we expect and when the availability of real estate,stock and treasury bond above what we expected than you got what I mean.

Anonymous said...

You are talking about the Armageddon case here. If that is the case, I would not be so certain that gold is going to save you. In fact I doubt it. You can not eat it. Also the people with guns can take it from you if they are stupid enough to want it at that point.

Anonymous said...

Three things to consider
1) The US still has, by far, the strongest military in the world. As long as that does not diminish too much, the dollar will hold up reasonably relative to other currencies.
2) Credit and the velocity of money are both imploding far faster than the fed is printing money at the moment. As long as that continues, deflation will have the upper hand. I can see hyperinflation if either 1 or 2 reverse...but not until then. A spike to new lows in commodities and stocks (in dollar denominations) could happen in a few weeks/months, and would kill the price of gold short term. Precter could be right, and still hyperinflation could follow. Its a matter of timing.
3) If you are one in the gold camp that thinks the dollar will die via hyperinflation - this would likely lead to worldwide meltdowns in supply chains and you may want to consider guns and food rather than gold to survive. Gold will mean nothing in the violent cases laid out in this blog - as violence and crime and those who control food and protection will be in power rather than those with gold.

Rick Ackerman said...

FOFOA's essay was linked in my own forum. My response was as follows:

"Thanks for posting this excellent essay, Patrick. The author takes care to note that inflationists and deflationists see the same end result: catastrophic economic collapse and a world thrown instantly into beggary. He is respectful of Prechter, who in my opinion is the worlds' foremost authority on deflation. Prechter has gotten into trouble with inflationists because of his once very bearish stance on gold. But his thinking has evolved, as gold bugs will have surmised, and he now writes that gold should be a part of any defensive portfolio, since it is bound at the very least to hold its purchasing power.

"My own views have evolved as well. I have always believed that a hyperinflation lay somewhere down the road; however, I was uncertain about how far down the road. I am still unsure about this, but my hunch is that it won't come in time to 'save' tens of millions of Americans from statutory bankruptcy. Doing so is manifestly not a political goal at this point, since all measures so far have sought to protect creditors (i.e., the banks). Moreover, I still doubt that the political will exists to hyperinflate, which would be tantamount to destroying savers as a class, as well as all of the institutional conduits of saving (i.e., the bond markets). My hunch is that hyperinflation will occur in the way described in this forum by Ed Moyer (see below), and earlier by Peter Schiff -- i.e., through a parabolic increase in the purchase of Treasury paper by the Fed.

"The resulting collapse of the dollar is certain, and it will happen as Martin Armstrong has described it - instantaneously, in a waterfall cascade. There are compelling reasons for us to expect the entire deflationary episode to play out in a matter of days, and for the ensuing collapse to put the economy in a severe deflationary wallow that will last for at least a generation. That is not how the Weimar inflation played out -- it took nearly ten years -- and we can assume the speed of the coming financial collapse holds very daunting economic implications for all, even those who have secured their assets in gold."

-- Rick Ackerman

Joe Sixpack said...

Good analysis. I think I am in your camp, as far as where things are headed.

Tekin said...

@ Anonymous August 17, 2009 8:37 AM;

4) Since the military strength depends on economic strength, decrease in economic strength would lead to military weakness. This is what happened to all previous empires in the history. The US establishment, therefore, would prefer to have the dollar devaluation now, before the military strength evaporates. Reports from Harry Schultz, Jim Sinclair, Jim Willie reinforce this conclusion.

5) Since the disruption of supply chains is a great risk, stockpiling food and other basic necessities is a must. The trick is "to outlast the neighbors". Life would gradually return to some sort of normality eventually. Otherwise the "establishment" could not remain in power. It is not only my problem, it is also the problem of the "elites".

6) Of violence and gangs... Well, it depends on the personality. However, evasion and practicing "invisibility" may outlast the tough man Rambo approach. Invisibility = do not attract attention, be a man of the crowd, blend to the environment...

Ender said...

Hi FOFOA,

http://3.bp.blogspot.com/_cvdgPlEKW9k/SoYQY5APV5I/AAAAAAAAAn8/20_ZF2-faSs/s1600-h/Waterfall.JPG

In a way, it would have been nice to see a chart that had a waterfall that didn’t take years to complete. The chart you chose has a wonderful picture of a drop, yet the time span shows it taking about 10+ years. Also, probably more importantly, this chart is content of silver per coin. It really doesn’t show perchasing power per coin.

Money’s value is based on the emotional attachment and confidence that people apply to it. Back then, I’m sure there was apoint at which people would not accept a reciept against silver or gold held on reserve by any official of the Roman Empire. And, I’d be willing to bet that people were forced to trade goods based on the unit of measure rather than the silver content in the coin – at least to someone representing the Empire.

As we move into this fall, some people are going to find really good deals when acquiring coins.

Get what you need to survive, get out of debt and place your excess into golden savings. Afterwards, smile and enjoy the show.

FOFOA said...

My oh my. My little blog post seems to have drawn some attention. 6,000 people and counting.

It is interesting to snoop around and see what people are writing about it elsewhere. Obviously this "debate" is a hot topic!

I think the point of the Waterfall Effect is that the normal fluctuations, up, down, up, down, up... that we short-term viewers of the world expect to see on into perpetuity do not always continue like that. Occasionally there is a phase transition in the collective thinking of the world that sends the graph pattern over a waterfall.

Whether or not we are there at that point right now is clearly a lively debate!

FOFOA

FOFOA said...

Hello Ender,

Thanks for pointing out the weakness in that chart! ;) Actually, since I was using Armstrong's "waterfall" for this post, I used his charts and example too. In his article he talks about a "phase transition" that happens, similar to the point heating water starts to boil, its progression instantly loses its linear quality at that point and shifts radically in a new direction. This phase transition is what happens "overnight" and this is the crest of the waterfall.

It is true that we have no way of knowing the actual purchasing power of those coins. But we do know that the Emperors were debasing the currency by stealing the silver content from the coins each time they issued new ones. And these coin finds are a forensic way to chart the fall of Roman money in the absence of a perfect historical record. I believe Martin himself commissioned the study that created that chart.

Here is how Armstrong answers your complaint in his own words:

"The shocking thing that emerges from the long-term data, is that drastic movements that topple civilizations along the way, take place in the shortest amount of time. This in the short-term world can even be explained as what we are seeing right now - the "contagion." The detailed chart I have provided of the 3rd Century Meltdown took place on a massive scale within just 13 years! That is stunning insofar as we are not looking at just short-term, but a 1,000 year history! This dispels the slow and steady linear progression, and reflects the true nature of how major events do take place just as in the movie "The Day After Tomorrow." This is important to understand, because it effects our perspective of possibilities."

Sincerely,
FOFOA

FOFOA said...

Hello Rick Ackerman!

Thanks for stopping by. I appreciate your response.

You seem to focus primarily on the improbability of a politically-driven, internally-initiated hyperinflation scenario. Either that or the forced monetization of debt by the Fed.

I would argue that the former is not as improbable as you suggest, because it would be done as a "devaluation" of the dollar to relieve dollar denominated promise pressure that threatens the entire system. And I would also argue that there are many external threats to the dollar, much more than just these two, any one of which would cause a cascade of events.

The combined total probability of a dollar collapse, given a large set of marginal probabilities, as Reverend Thomas Bayes would tell us, is quite high.

Sincerely,
FOFOA

FOFOA said...

Hello 12:37, 9:02 (same person?),

Sliced, diced, packaged, sold, resold, and insured mortgages imploded. They nearly brought the entire system down. Bringing the system down would have been the banks filling in those holes with their own equity; either base money reserves, liquidated assets, or their sick, insolvent selves being liquidated through bankruptcy. But this did not happen. Why do you think that is? What filled the holes if not the bank's own carcass?

When I take out a loan, I promise to return real value to the economy in exchange for this new "money" creation. There is balance; thin air money versus my contract to work it off. If I fail to fulfill my contract, the bank is supposed to fill it for me (minus collateral value) with its own equity. This is book entry money. It is very different from base money.

The bailouts replaced large amounts of book entry money with brand new base money.

Then, the subsequent >>guarantees<< by our fearless leaders, both explicit and implicit, have effectively done the same thing to almost the entire "book entry money supply".

Everyone's bank account is guaranteed, even though the FDIC is broke!!

Earmarked easy credit money creates bubbles in the "ears". This is not inflation as it is not a balanced response to existing money supply. Bubbles require constant flow air. Take that air supply away and they pop. This popping sound, though deafening, should not be confused with deflation. In hyperinflation there is no credit money creation. Only base money creation.

Moving on... none of the above even matters all that much!! Because currency collapse is a global psychological event, not a mechanical failure. The economy is not a machine, automatically adjusting to money supply measurements. It is a living organism.

"When we listen to politicians and the mainstream press talk about the economy, we usually hear comments such as, the economy is sluggish, or, the economy is slowing down. We need to speed it up, to jump start it, or repair it, or tune it up.

But the economy is not a machine. It's an ecology, made of biological organisms — people — you and me and our loved ones, and millions of others."


Have you read the posts I recommended? All of your counterpoints have been discussed here, either in posts or comments underneath. I am pleased to continue this dialogue with you as long as it remains constructive.

Sincerely,
FOFOA

FOFOA said...

Posted today on JSMineset.com:

Below is a quote from Armstrong’s latest dated August 7th. Regardless of the intrigue in his life, this man has yet to wrong on any major trend if you understand what he is doing for you. If you demand the day, the time of day, the price and the immediate direction, you are asking too much from a human. Armstrong has been consistently right on the trend and the trend is the only friend you will find on the floor of any exchange.

“Gold continues to consolidate below $1000. This is a critical sign that confidence is swinging away from the government. Just as China is concerned for the dollar, they speak the truth, unlike the BS from Washington. They are speaking from self-interest and so is Washington. China is concerned about its holding in dollars and has been reducing the maturity of their holdings. The Washington crowd has been speaking out of their self-interest insofar as they do not want to face reality and keeps telling everyone “don’t worry-be happy.””

It appears that gold is building a base from which a rally up to $2,500 – $3000 area is very likely. There is even a possible rise to the $5000 level, but that is the most extreme projection. This is suggesting that confidence in the dollar is declining. This is not the classic, “Inflation nonsense, but a collapse in currency value consequence.”


I would add that hyperinflation, a non classic inflation, is always and will be again be the CONSEQUENCE of a CURRENCY EVENT no one understands now or will understand when it happens, which it will.

There are 82 days to go.

I am not the least bit concerned about the price of gold.

All dollar rallies are going to be sold by those seeking diversification, most certainly those governments that do seek the US’s best interests such as Russia.

Respectfully yours,
Jim Sinclair

Anonymous said...

FOFOA

I agree with your assessment concerning the ultimate demise of
the dollar and all fiat currency. I understand that the price of au as demoninated in dollars will skyrocket. But what happens then? Won't the government using a variety of means, confiscate the gold or its profits thereof? How does one protect oneself against that scenario?

http://www.financialsense.com/fsu/editorials/kovaka/2009/0812.html

FOFOA said...

Hello Anonymous,

The long calm rational view recognizes that physical gold confiscation this time around is unlikely and illogical. Articles like the one you provided are suspect when taken in with this view. They are meant to add "gold angst", not to provide wealth protection advice.

"Won't the government using a variety of means, confiscate the gold or its profits thereof?" My short answer is no, because it will be acting in its own best interest. My long answer is co-mingled with many other subjects in the posts and comments on this blog.

But just to be on the safe side, I don't consider the ETF's the same as physical gold in your own possession. Legally, they are an easy target for confiscation, as are the gold mines.

If you would like to read about the monetary evolutionary journey I believe we are on, which takes us to 2010 and beyond, not back to 1933, I encourage you to read Another and FOA linked at the right side of this blog. Then hopefully, this blog can serve as a supplemental guide on the gold trail of understanding that began back in October of 1997.

Sincerely,
FOFOA

Anonymous said...

many thanks. It is said that most people view an average of 12 websites a day. I'm sure my number is greater than that but your blog ranks as number 1. I am sharing with all my friends and family. Gold is indeed precious for many reasons. Take a look at the periodic chart. Of the elements abbreviated by two letters, it is the only one with two vowels. What is a vowel? A vowel is a voice speech sound created by relative free passage of breath unobstructed by the oral cavity/mouth. Vowels give life to words, the spirit of words. We all know the vowels in the English language:a,e,i,o,and u (I'm leaving out y). from a to u: Au. The beginning to the end. Alpha to omega. As Fekete writes in his works, it is God's gift to man,God's money. And what is it's enemy? Fiat currency not backed by gold or some other valuable material in general and specifically, the dollar. Even it's symbol is serpentine and makes parody of the symbol of the cross: Au (t) vs. Dollars ($). Different path to the same conclusion you have made in this blog. The Spirit (gold in this example) will not be obstructed, as with the vowel sounds.

Anonymous said...

Hello FOFOA

9:02 here.
Just to be clear...I think highly of your site and the way you conduct yourself. Thank you for taking the time to make this Blog happen, but adoring groupies with their "FOFOA you've made everything so clear" comments don't solidify arguments to my way of thinking.

In life there is what I wish to happen, what should (rightfully) happen, and what will likely happen. I don't confuse them.

When it comes time to allocate my hard earned (albeit modest) savings, I do so based on rational,thoughtful analysis.

Going with Gold as a reservoir for savings "feels" right on a gut level, but I am prone to play "devils advocate" in order to stimulate you and posters to flesh out arguments.

No offense or disrespect meant...it's just that we live in a world where no one gets held accountable anymore. Enough of that. These days everybody has to earn their credibility with me.

Anonymous said...

FOFOA,

It’s 12:37/8:08 here.

Let’s start with a definition:

“In economics, the monetary base (also base money, money base, high-powered money, or, in the UK, narrow money) is a term relating to the money supply, the amount of money in the economy. The monetary base comprises only coins, paper money, and commercial banks' reserves with the central bank.”
http://en.wikipedia.org/wiki/Monetary_base

In short, base money consists of two things: (i) coins and notes in circulation and (ii) commercial bank reserves at the Fed. Are we on the same page with this definition?

In my post at 8:08, I showed why base money absolutely can contract. Base money (commercial banks’ reserves at the Fed) is precisely what the commercial banks dip into to cover their losses when there are defaults on loans. Granted, if their reserves fall below the reserve requirement, then they may need to dip into their own stockholder equity in order to fill the hole. But the reason they have to dip into stockholder equity is precisely because they depleted their reserves in the first place. And, of course, once their stockholder equity is depleted, then they have nothing further to dip into other than base money, and this reduces their ability to lend and creates a downward pressure on the money supply.

Now let’s turn to your arguments:

“When I take out a loan, I promise to return real value to the economy in exchange for this new "money" creation. There is balance; thin air money versus my contract to work it off. If I fail to fulfill my contract, the bank is supposed to fill it for me (minus collateral value) with its own equity. This is book entry money. It is very different from base money.”

This is where we disagree. There is no fundamental difference between deposits at the Fed (base money) and deposits at commercial banks (your so-called book entry money). The only difference is where the account is and the fact that the commercial banks can’t lend effectively when they don’t have a sufficient amount of reserves kept at the Fed as base money. The only reason people make a big deal out of the amount of base money is because the larger the base money supply, the more the commercial banks will be able to inflate the money supply through lending. In other words, it is significant precisely because it is a springboard to the creation of “book entry money,” which, due to the money multiplier, is where the real inflation is created.

Granted, because of the enormous increase in base money, IF the commercial banks start lending to their full legal limits, there will be massive inflation. But, as Mish has pointed out, as long as the commercial banks continue to refrain from lending, as long as loans are in default and not being repaid, the banks’ increase in base money is being offset to some degree by the decrease in credit money. And when credit money contracts, it eats into the base money supply because banks become undercapitalized and have to dip into their reserves (i.e. base money) just to stay solvent.

“In hyperinflation there is no credit money creation. Only base money creation.”

What does this mean? 100% of money created is sitting at the federal reserve? 100% of the money circulating is in notes/coins? See the definition of base money provided above, and please explain how this happens given the meaning of “base money.”

“Moving on... none of the above even matters all that much!! Because currency collapse is a global psychological event, not a mechanical failure.”

Okay, but the point is that with the credit markets collapsing, the money supply collapses (despite attempts to inflate the supply through the creation of new base money). This is net dollar destruction. Why is that likely to lead to the global psychological event you describe?

Regards,

12:37/8:08

Anonymous said...

question: With respect to Exter's inverted pyramid, where would a life insurance policy (with cash value) be placed, if at all?

S said...

I have read your posts about reserves and base money and your points are well taken. When you look at the data (PPI, CPI globally, bank lending survey, and the bank balance sheets themselves) it is clear banks are in crouch mode. That said excess reserves are at a record. So yes the embedded option on a massive surge in lending exists.

Anyway, the seminal questions in the inflation/deflation debate that gets ignored is the productive potential of the economy. Not to come off Malthusian, but the problem with the Austrian argument that the money is simply filling holes is that those weren’t holes, they were malinvestment supported by asset and credit bubbles assisted by a foreign generosity to buy bad US debt. Therefore, you can argue the credit destruction offset all day long, but underneath it all is the productive potential of the economy (supply and more importantly DEMAND - despite the supply side trickle down claptrap). Keeping the water (GDP) level at the inflated height (recall GDP is up $5 trillion since 99 with virtually no job creation and lower wages) is basically arguing another asset bubble will take hold because without some speculative boom there will be no way to support the mushrooming debt load (the problem why it melted down in the first place). That is why it is so mission critical that the Fed pump up equities to keep the insurance and pension complex solvent. Indeed nondiscretionary equities should go up in a hyper scenario as their cash flows simply get reprice din the new metric. The problem with why equities would appear to underperforms in such scenarios (though I have no data to support, just conjecture) is that the bursting destroys much of the fake demand that kept so many in business unnaturally.

This is why I totally agree with FOFOA's argument. The underlying capacity of the US economy is irredeemably impaired. Has been for a long time. It is policy that is papering over that impairment for the optical and civil good (order) of the US.

S said...

The Fed/US (force for good) would have you believe that the US is indispensable globally and thus the rest of the world has to continue to play along (ergo the TIC data focus). Talking to anyone without a US passport, and I mean like minded democracies, and that bubble is burst. As an aside consider the article in the FT this am that China is seen as a predator in emerging countries asset/resource stripping them. I read that and all I could think about was the majors, FCX in Indonesia with the Grasberg est.’s China pursues its interest and it is asset stripping, the US pursues its interests and it is benevolent. Economic warfare and disinformation in the open.

The Fed is trying to avoid the write-down desperately for good reason and quite rationally I might add. The problem is the ability to continue the charade means the rest of the world has to cooperate. The argument for why global cooperation has to continue are well tread, but none make sense in th most basic economic analysis: sunk cost. At some point it ends and not slowly but abruptly as articulated here. Indeed isn't it the case with interest rate signaling that the only way to have a major impact is to ensure that it is a total surprise? If it isn't you essentially have so much leakage that you fail to achieve the goal (capture). that is why devaluations happen abruptly. if everyone knew it was coming would not it have happened already as market aficionados argue rationality in actors.

Now of course the slow bleed is exactly what the Fed wants - heat it up slowly and you don't know your dying. But the problem is the RoW and increasingly the entirety of the US knows this. Someone is taking these losses and rest assured it will be done "in the interest of the people/US."

There are myriad reasons why global cooperation will not continue - unless of course there were some grand geopolitical tradeoff with china akin to acceding to the Iron Curtain at Yalta (or elsewhere).

As for the US military, which I think you referenced, the US was rewarded with rents for its security umbrella. I thought it particularly interesting that Hillary Clinton was in the Middle East some months back threatening iran with the extension of the US nuclear umbrella (or Obama in Russia renegotiating an antiquated arms control treaty). The reality is that media, technology and weapons proliferation (nuke especially) have eroded the US power position as is seen in the repeated open defiance of US desires. The blue water status of the US is in decline and others in ascendance. The nuclear option broadly is really no longer a credible threat with proliferation and technology transfer accelerating. The performance in Iraq and Afghan only solidifies this outlook. Check out John Robb's blog global guerrillas for a different peak into the future.

S said...

Finally, there is this... whcih comes on heals of Goldman's call about commodity crisis approaching bigger than the credit crisis...


"Today's loose monetary policy will bring tomorrow's disaster - a commodity crisis with spiking oil prices - Francisco Blanch, head of global commodities research at BofA/Merrill says. "In their effort to bring the good times back, most central bankers have conveniently chosen to ignore the second-round effects of exceptionally loose monetary policy."

Anonymous said...

S, good point. Current monetary policy is only making things worse, whether price distortions, malinvestment or investment disincentives at the worse possible time.
Now we must take seriously that this will be background noise in the event of trade war, war or the threat of war. Many will dare not criticize government but rally around it as import and finished goods prices rise, and interest rates soar. A currency crisis and soaring gold would thus be somewhat subsumed beneath the most immediate exigencies, you or your neighbor may have to enlist in citizen service crews and your movements and communications could be restricted.
Oil prices are especially susceptible to an Israeli strike on Iran or a 'terrorist incident' somewhere that provokes other strikes in the Middle East.
An oil supply squeeze would certainly result from an Iranian sabotage in the narrow Straits of Hormuz, blocking tankers.
ANY increase in geopolitical uncertainty from here on could combine with momentum oil trades and Asian hoarding to blow up oil and gas.

FOFOA said...

Hi 12:37,

"This is where we disagree. There is no fundamental difference between deposits at the Fed (base money) and deposits at commercial banks (your so-called book entry money)."

I suppose we can fairly disagree. But here is how I see it...

The problem with broader measurements of money is that, other than the base money, it is all assets. In other words, it is all private entity liabilities. Sure, reserves at the Fed are the Fed's liability, but it is a liability for paper that it creates. No private entity can print to cover its liabilities. So this is one big difference between base money and credit money. Base money is either no one's liability (physical notes or coins), or the Fed's liability, the only entity allowed to print money. All other (broad) money is the liability of private entities that must cough up real value if it is called in.

So raw base money is not backed by anything, not even some poor sucker's liability. And it is not redeemable at the Fed or Treasury for anything real. It is only redeemable within the system, therefore it is only backed by systemic confidence in the currency. Therefore the production of pure base money is the surest sign of monetary profligacy.

What kind of money was used last year when the Fed grew its balance sheet taking on all those "illiquid assets"? What kind of money was it that added liquidity to the system?

If I have $100K sitting at a bank, they don't hold the cash for me. All they hold is the liability to me, an entry in their books (book entry money). If I had a thieving insider at the bank credit my account electronically with $10 million, have I counterfeited $10 million dollars? No, I have stolen equity from the bank. But just suppose the Fed did the same thing for some PPT operation. That WOULD be counterfeiting. Just making a point here, not suggesting the Fed does this. ;)

The vast majority of daily electronic "monetary" transactions are cleared without ever touching the legal tender. Banks use various forms of their own paper and electronic scrip to clear a complex network of transactions, and the only legal tender required is to settle net imbalances or customer cash withdrawals.
...

FOFOA said...

...

Another difference between base money/reserves and credit money is that base money is non-interest bearing. It is like a bearer bond, whether held by a bank or an individual. It is discrete and unconnected. It is a reserve that receives no yield in exchange for not carrying the risk of failure (disappearance). With my $100K, I can leave it as an asset in the bank earning a small amount of interest, or I can take it out in cash and store it in a shoe box. At times like this (when the FDIC is out of reserves) there is a security gain with base money in the shoe box in exchange for the loss of yield. Even FDIC insured accounts are SUPPOSED to carry risk in the case of an FDIC failure. This is why I say the new guarantees change the nature of certain sectors of the money supply.

It is true that base money reserves held at the Fed can be destroyed in extreme cases, but how often has this happened during the crisis? Even with the failed banks today, the good reserves are simply transferred to a new bank, depositor liabilities backed by the fictitious, symbolic FDIC (printing press), and the other liabilities are left to wallow in a murky swamp of bad assets. So where is the contracting offset happening?

The problem is that the rules have been changed mid-game. This will have a disastrous effect on the global confidence in the stability of the currency.

All I see in the credit contraction is the slowing of bubble blowing and the loss of perceived value as assets tumble in value. Deflation in the money supply can only be seen if you view certain asset classes as money (a view the Fed supports).

Again, I am not talking about normal inflation. I am looking at a confidence collapse in the currency under the worst economic (and credit market) conditions.

What made the Icelandic Krona drop so suddenly? It was almost like a waterfall! Was it a sudden credit market expansion? Or a sudden loss of confidence?

In Zimbabwe and Weimar Germany, once hyperinflation (currency confidence collapse) took hold the governments were forced to print high denomination notes, jumping from 100 dollar bills to million dollar bills to billion dollar bills. How much of that quadrillion dollar money supply was from credit expansion? And how much was pure base money printing?

The printing of trillion dollar base money (physical) notes swallowed the previous credit money supply whole. And the new base money supply entered the system through the monetization of government activity and government (public) debt. The same thing we are doing today. The high denomination notes were not the cause of hyperinflation, they were merely a late stage symptom in the death of a currency.

Sincerely,
FOFOA

Siege said...

Thanks for sharing your views S. Your statements further reinforce the position FOFOA has taken and which I feel is accurate.

I'd like to add that the commodity shortage forecast by GS is bigger than most recognize. Goldman doesn't just have forecasting power; they control enough money and trade to cause whatever shortage they desire. Whether there is a genuine shortage or not won't matter... Goldman has decided there will be one and unless their leaders change their minds, we will have one.

Ender said...

Sir FOFOA,

If you get some spare cycles, it would be nice to see YOU expand upon your 5:06 post above regarding gold confiscation. It is a topic that comes up time and time again to which it would be nice to have a focused discussion on.

Anonymous @ 4:23 above,

Gold today is valued at the most important financial asset that a central bank can hold. In quarterly statements, they declare that gold is an important monetary asset in their reports, usually, on the first line or first bullet point.

To governments (political units) they don’t care about gold but rather care that confidence is maintained in the paper that they are able to create in a ‘hand shake’ with the central bank. That paper buys them just about anything for free. The political organization will do anything that they can to NOT monetize gold into the system for it cripples their ability to freely create paper and … spend it.

As gold regains its international settlement role (specifically regarding imbalance of trade) it must be available for external entities to buy. If the government were to call it in and become the facilitator or dispensing gold – for settlement – they would quickly run out of gold at the current prices. At 1,000x or 10,000x (or more) they might be able to buy a little time but in any case, the government would be setting the price and would eventually run out again.

An alternative is to put as much gold into the economy as you can and give it the role of being the safe haven for savers and NOT get into the business of facilitating settlement. Rather, let those that want to buy or sell gold in the open public market do so. By doing this, the government will never run out of gold for settling debts until the country is completely gold-less AND the political organizations can continue to print ‘money’ in a hand-shake with the central bank without restraint.

Freegold is a system that provides a technical means of balancing the books with regards to international trades while also providing a measuring stick to the businessman to measure local government policies. In today’s world, a businessman can invest just about anywhere so it’s in the best interest of the tax gathering politicians to create the best business environment from which to gather their bounty. What better way than to create an environment that shows the price of gold dropping over time – effectively telling the businessman that if you hold our currency, you will be able to buy MORE gold tomorrow than today. The only way they can do this is to create an economy that exports more than it imports so the savers will bring home gold from other countries. The more gold in the economy, the lower the price goes.

Continued…

Ender said...

Now to the specific case of the US. If the US where to outlaw gold (call it in) in order to monetize it, the act would effectively make gold money ounce again. At that point, any central bank around the world could/would exchange their dollar reserves for the best reserve asset on Earth – gold. Why hold paper if you can hold gold? … the wealth of nations.

At this point, the government can either set a low price and run out of gold quickly, or set a very high price and run out sometime later – but they will run out! Every government in history that backs the currency with gold runs out. Always.

- If they choose a low price the gold immediately moves offshore and the treasury is left empty.
- If they choose a high price, the gold moves slower, but everyone else in the world instantly gains in purchasing power against the dollar. Thus, all the women in India exchange headdress gold for houses in the US. Americans become servants or 3rd world citizens.

To compound the problem, if gold is free to trade in other countries what would the price of an ounce be in that local currency? If the US government says gold is worth 1mill$/ounce does that mean that it’s instantly worth 3/4Mill Euros/ounce? Or, is it saying, the dollar is now only worth 1/1000th of its previous purchasing power? In which case you need 1,500$ to exchange for a Euro? And gold trades around 750 Euro/ounce?

The biggest problem is that if gold is outlawed here, yet not EVERYWHERE else, all gold will flow to a market that is open for trade. If all other markets are open for gold settlement, who would hold a dollar? Ultimately, every businessman would invest in countries that had a positive trade balance so that they currency they hold will eventually buy MORE gold in the future. If the US fixes the exchange AND meddles in the exchange rate, no businessman will ever have confidence in getting future gold at a decent exchange using a dollar! They will hold other currencies.

Another, FOA and many other posters spent hours and hours discussing why the US government is cornered with regards to gold and all concluded that there really are just two solutions – the extinction of human life on earth via war or a Freegold financial system.

The future monetary system is not in the hands of the US politicians but rather in the hands of those that hold gold.

FOFOA said...

Eric Janszen: Snowball in Summer

Quotes:
"It’s deflation alright, of the currency."

"I recommend to deflationists that they focus their minds on one fact: governments cannot print purchasing power."

"Our supply crash theory from last year is that the Keynesians have the credit crunch story only half right."

"Here is a chart of every other deflation spiral that has occurred throughout history.

[empty chart]"

"Substitution and the weak dollar: Welcome to the third world

This is not deflation. A three quarters full box of corn flakes sold for the same price today as a full box last year is not deflation. Fish and chips made with cheap versus premium cod and sold for the same price is not deflation. Getting packed like a sardine into a passenger jet that flies a given route half as often as before the depression started is not deflation. Getting a giant plate of rice or spaghetti sprinkled with vegetables and meat is not deflation."

"The deflationsts told us many years ago that the chart above was impossible. No way, no how is the Fed going to buy all that junk. Yet no matter how many times events prove them wrong, they keep on keeping at it.

The latest gambit: falling velocity of money and a declining money supply. This is supposed to prove the deflation spiral case. Here I argue otherwise.

No deflation spiral, nor will the U.S. experience a Japan style stag-deflation. For that a nation needs to be a net capital exporter."

"The other source of inflation is the depreciating dollar."

FOFOA said...

Adrian Douglas: Central banks are NOT ordinary gold investors

"Financial market letter writer Adam Hamilton's latest essay, "Central Bank Gold Agreement," which can be found at Gold-Eagle here is a fairy tale. Hamilton writes that central banks are just investors in gold like everyone else.

What Hamilton and most people overlook in analyzing central bank gold sales is that they are a farce that beats the best Monty Python sketches. The central banks have printing presses and now computers that can generate loads of fiat money. It is beyond side-splittingly funny that we should take central banks seriously that they need to sell gold in exchange for the stuff they manufacture for free.

Can you imagine the Saudis selling oil in exchange for sand, or Eskimos selling fish in exchange for ice, or Paul McCartney selling an apartment in London in exchange for a Beatles poster autographed by himself? Yes, you think those examples are funny, don't you? So why not have a big fat laugh at a central bank selling its gold for the funny paper it produces in infinite quantities?

Central banks run the world's biggest Ponzi scheme, issuing bits of paper that people will accept in return for real goods and services. If you enjoyed this privilege to the tune of a few trillion dollars that finance an empire, expending a few tonnes of gold to keep it going would be a no-brainer.

Central banks do not sell gold to get a few billion of their own fiat money in return, money they probably would throw on top of the stack of half a trillion freshly printed notes that rolled off their presses just that morning. No, central banks sell gold to make it appear that the paper stuff is more desirable than its true supply and demand fundamentals would allow. And when the game looks like it's coming to an end, the central banks can always buy back the gold.

It is not a problem to buy back the gold at even $50,000 per ounce when any amount of paper currency can be printed.

What is a big problem is if the currency loses its value so fast that no one will sell the central banks any gold for any amount of paper. (Try buying gold with Zimbabwean dollars.)

If that happens, the central banks lose and the people win, because when the music stops the people have the gold and the central banks are stuck with the depreciating paper..."

Anonymous said...

Anyone care to tell me why gold hasn't already shot to at least $5k an ounce? Are they not printing enough money?? An enormous amount of wealth and credit has been destroyed, more than they have printed as far as I can tell. In addition the deleveraging of the quadrillion derivatives market needs to be taken into account as well. I'm also not sure why goods care if it is base money or credit money they are getting bought with. From where I am sitting (my couch), in general there are less dollars out there and many things are becoming cheaper. This is reality and what is happening in the real world. Oil and gold are manipulated so are poor measures of anything. Inflation WAS a serious problem prior to the collapse of the US economy. Also, the world gets out of equilibrium if dollars get too cheap. This government would confiscate gold in a heartbeat, they've done it before and are worse now than they have ever been.

Anonymous said...

Hello Sir

Your asset chart had a minor CRC error.


Project Mayhem has taken the liberty of repairing the jpeg.

see:
http://img41.imageshack.us/img41/6323/down2e.png

Cheers

Anonymous said...

Hi Fofoa!

Important discussions here and thanks to all "educators" but can't you arrange it that this so called anonymity becomes less disturbing for such deep insights?
Fauvi (your Follower)

The Mad Scientist said...

Hi FOFOA,
You have to read this
http://www.sprott.com/Docs/MarketsataGlance/August_2009.pdf

Hermit said...

The illustration that Martin Armstrong created for the cover of this essay "The Waterfall Effect" is especially interesting. It reminds me of a quatrain written Nostradamus in 1555:

The copies of gold and silver inflated,
which after the theft were thrown into the lake,
at the discovery that all is exhausted and dissipated by the debt.
All scrips and bonds will be wiped out.

Hermit said...

Similar warnings about the machinations of the fiat money system have come from other wisdom keepers as well. Native American elders of the Cree have long warned of the time coming when Man will discover that he cannot eat money.

Related to this, in Arizona there are sacred traditional lands that have long been desecrated by Peabody Coal company. Lehman Bros. later took over Peabody, and it seems they ended up inheriting the resulting karma. In 2001 traditional elders from tribes including the Navajo, Hopi and Lakota warned Lehman about the spiritual consequences of their actions. Lehman decided on a different path, and we all know how that worked out:

http://www.atlanticfreepress.com/content/view/5315/81/

Thanks for taking the time to read this. Now, you too, know.

Anonymous said...

Encore !

ECB urges further stimulus measures
By Ralph Atkins in Frankfurt

Published: August 19 2009 11:32 | Last updated: August 19 2009 19:14

Emergency growth-stimulating policies are still needed to support continental Europe’s fragile economic recovery, even though Germany and France have emerged from recession, a top European Central Bank policymaker has warned.

Axel Weber, Germany’s Bundesbank president, made clear he would not rush to withdraw the extensive measures taken by governments and the ECB – which he said had helped the recent improvement in economic performance in Germany.

Jay Midnyte said...

Britain's Uber-bear is growling again. After predicting a torrid "relief rally" over the early summer, Bob Janjuah at Royal Bank of Scotland is advising clients to take profits in global equity and commodity markets and prepare for another storm as winter nears.
"We are now in the middle of a parabolic spike up," he said in his latest confidential note to clients.
"I expect this risk rally to continue into – and maybe through – a large part of August. What happens after that? The next ugly leg of the bear market begins as we get into the July through September 'tipping zone', driven by the failure of the data to validate the V (shaped recovery) that is now fully priced into markets."
The key indicators to watch are business spending on equipment (Capex), incomes, jobs, and profits. Only a "surge higher" in these gauges can justify current asset prices. Results that are merely "less bad" will not suffice.
He expects global stock markets to test their March lows, and probably worse. The slide could last three months. "A move to new lows is highly likely," he said.
Mr Janjuah, RBS's chief credit strategist, has a loyal following in the City. He was one of the very few analysts to speak out early about the dangerous excesses of the credit bubble. He then made waves in the summer of 2008 by issuing a global crash alert, giving warning that a "very nasty period is soon to be upon us" as – indeed it was. Lehman Brothers and AIG imploded weeks later.
This time he expects the S&P 500 index of US equities to reach the "mid 500s", almost halving from current levels near 1000. Such a fall would take London's FTSE 100 to around 2,500. The iTraxx Crossover index measuring spreads on low-grade European debt will double to 1250. ...
The elephant in the room is the spiralling public debt as private losses are shifted on to the taxpayer, especially in Britain and America. "Ask yourself this: who bails out Government after they have bailed out everyone?"
Mr Janjuah said governments might put off the day of reckoning into the middle of next year if they resort to another shot of stimulus, but that would store yet further problems. "If what I fear plays out then I will have to concede that the lunatics who ran the asylum pretty much into the ground last year are back in control." more at telegraph


And

Read about the disturbing Morgan Stanley SILVER FRAUD. Any investor doing this would get MANY YEARS in Prison! PDF FILE HERE

All this from The Coming Depression

Anonymous said...

Liu !

http://www.atimes.com/atimes/Global_Economy/KH20Dj02.html

The role of a reserve currency in international trade is to keep all trading nations monetarily honest. A reserve currency issuer, such as the United States, can violate the laws of monetary integrity to finance fiscal and trade deficits - but not forever, and not with impunity.

Jay Midnyte said...

Don't know if you guys caught Jim Cramer on the Daily Show in March getting ripped for conspiring against the American public...

Video here.

Anonymous said...

I saw that. Hillarious. Jim Cramer -- what a tool.

Anonymous said...

It is certainly interesting for me to read that blog. Thanks for it. I like such topics and anything that is connected to them. I would like to read a bit more on that blog soon.

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