Sunday, September 6, 2009

The End of a Currency


Debt Based Money and Interest Rates

Isn't interest the real price of money? As more and more people demand money through credit, this drives up the cost of money, right? This drives up interest rates. Rising demand for easy money causes rising interest rates which cause falling bond valuations.

Does it follow that artificially lowering the price of money will raise demand for easy money? Does it follow that artificially propping up the value of bonds and bills will levitate a plunging real world economy that is built on credit and debt?

Don't bet on it!

As the stock market rises during "normal" times, rising interest rates follow. Likewise, as the stock market falls, so do interest rates. Economic expansion and contraction drive real interest rates in a "healthy" fiat system. This is the check and balance that keeps the system "healthy", keeps it in relative balance.

What we are witnessing today is NOT a healthy fiat system. What we see is NOT a healthy economy. In fact, practically everything we watch today on CNBC is the result of government acts. The government wants desperately to save the stock market, not the economy... because over the past 30 years the stock market has gradually become the US economy!

Wonderland Breaks from Reality

Remember this graphic?


All those fake numbers being put out by Wall Street, the government and CNBC showing magical growth on the Ponzi paper digit (Alice in Wonderland) side of the equation must be juxtaposed against the real world manufacturing economy that has been in decline for 30 years.

This is the 30 year digital/Ponzi-paper inflation crescendo that has finally crested and, like an ocean wave, will curl over and break. This is also the 30 year engineered interest rate decline that has finally reached its nadir, 0%!


So is the price of the dollar actually zero? Perhaps price and value are the same thing in this particular case!

What did I say at the top? "Rising demand for easy money causes rising interest rates..." So what does a zero Fed Funds rate say? Zero demand for worthless money? I don't know. You tell me.

Here is what I see: 30 years of digital/financial Ponzi-paper inflation has gradually decreased the efficiency of all capital investment, everywhere! Mal-investment is so ubiquitous now that it cannot even be distinguished! Confidence in the future is at an ALL TIME LOW! And mass-confusion about inflation, deflation, stagflation, etc... is at an ALL TIME HIGH! We have truly built our own Tower of Babel!

Sound Money
"...achieving 'sound money’ is the easiest thing in the world! Just stop creating more of it! That’s all you need!"
-Mogambo Guru

Imagine a hypothetical perfect gold standard. There is nothing but gold used as money, and its supply remains constant. As man labors and builds, the economy will grow, and gradually one piece of gold will equal more and more real goods and services. Over time, in this perfect gold standard, the value of that piece of gold will rise and the cost of goods and services will fall.

Now imagine a lender and borrower. The lender lends 10 ounces of gold to the borrower, who then trades it on the open market for the goods he needs to be productive, say, farm equipment.

Let's say the term is a 5 year loan and there is no interest in this perfect world. After 5 years, the borrower must return the 10 ounces of gold that he borrowed.

During those 5 years, the value of gold will rise and prices of goods will fall, what we currently think of as "deflation". So in 5 years when the farmer must reacquire gold on the open market, he will have to surrender more goods than he received for that same gold 5 years earlier. Likewise, the lender will receive his gold back with greater purchasing power than it had 5 years earlier.

In essence, the lender received "interest" and the borrower paid "interest", even though the money supply remained the same. All that changed was the economy against which the money is measured! The interest was the productivity that the borrower added to the economy. The lender profited from this economic growth and the borrower labored to meet his obligation.

So in this perfect world, the price of borrowing money means keeping up with the average productivity of everyone else in a growing economy.

In other words, money is priced in goods and labor. The price of money is goods or labor. You must either create them or surrender them for money.

Now, in our imperfect world, we can borrow without being productive with the money we borrow. We can borrow for pure consumption! But to do so we must pay the interest out of our own body. We must eat away at our own net capital to pay the vig if we choose not to be productive. Like a stranded starving hiker whose body begins to devour itself. Herein lies the fatal flaw in our system.

Fiat systems work the opposite of gold. While gold increases in value against the real goods that price it, fiat money supply grows commensurate with the goods and services it is priced in; the money supply tracks the economy!

This is supposed to create "price stability" during an economic expansion. You cannot have price stability in an expanding economy on a pure gold standard, you instead get "the evil deflation".

And in a perfect fiat system, where no government or central bank cheats by creating money at will for the "inflation tax" it provides, and all borrowing is for productive purposes, the system could be quite sustainable for a very long time.

Sure, it is still essentially a Ponzi scheme because if everyone paid back their debt all at once the money supply would vanish except for the monetary base. But in our perfect scenario, there is always new volume added to the economy to match the production of new money, and prices remain stable.

But this is not good enough for the bankers and governments who add little real value to the economy. They want something for nothing. So they cheat, which leads to a collapsing real economy set against a mountain of debt money that must grow like a cancer until it kills the host system.

The only conclusion to this systemic flaw is not deflation like we saw in our perfect gold standard. It is not price stability like we saw in our hypothetically perfect fiat system, nor is it even normal inflation like we get in the early stages of a real world fiat system. No, the only conclusion is repudiation which leads to currency collapse, hyperinflation and the end of the system.

So what is the price of money? It is the real economy that it is juxtaposed against. Too much easy money always comes at the cost of the destruction of the real economy!

Hyperinflation

Hyperinflation is a mass psychological event. It is the revelation that the juxtaposition of paper obligations and the real economy no longer match in any way that can be resolved. It is the epiphany on a mass scale that the proverbial music has stopped and not just one, but millions of musical chairs are missing.

One of the biggest misconceptions about hyperinflation is that it is initially caused by the massive printing we saw in Weimar, Germany and Zimbabwe. But the fact of the matter is that all the inglorious printing, the dropping of zeros, and the million-dollar-notes are simply a subsequent RESULT of the initial condition that caused the currency repudiation.

In dollar terms, the hyperinflation of fantasy digits has already happened! It has been accumulating and accelerating for at least 15 years now. The stage is now set for repudiation on a global scale. What ultimately follows will be up to our wise leaders in Washington, DC. But it is my guess that they will follow the time-tested political path of printing more currency and passing it out. At that point, we will see a familiar sight:


But just know that the wheelbarrow is only a symptom of the disease, not the disease itself. The disease is already present in the dollar, and unfortunately it is terminal.

Protect Your Savings

Currency digits that are not spent on consumption can either be held in their raw form (cash) or stored. Storage of excess digits is available in both paper form and real world elemental form. Over the past 30 years the paper storage of digits has grown many times faster than the real world storage options. And right now, because of "fractional reserve debt" (that it is mathematically impossible for all debts to perform), the paper option is burning in the public square like so many books in 1933 Berlin.


So you can view this as deflation if you would like. But as the entire world watches Ponzi-paper storage burn and runs to safety, you have to wonder, will they stop running once they reach the raw digits of paper created by Ben Bernanke? Or will they keep running to the golden safety of a physical element created in the stars billions of years ago?


This is what it is all about: Capital Flow! You may not have much capital yourself, but if you want to make the right decision for your own savings, you must put yourself in someone's shoes who does. You must follow in the footsteps of giants!

A Little Context from a Friend

It was when the British Empire started to lose its colonial wealth generating tools that the pound sterling lost its dominance and standard value. This is the only story that I intuitively compare with the actual status of the dollar. The sterling didn't go "hyper", but it lost its intrinsic value provided by the enormous amount of goods and services that it represented. The colonies produced these valuable products for practically nothing. So, behind each printed note, there was an enormous amount of tradable tangibles.

As soon as we start to increase the amount of paper to compensate for a contraction in goods and services, we are depreciating that piece of paper. In the case of the pound sterling it was easier to understand how the crumbling colonial wealth eroded the corresponding value of the same existing amount of paper. The same exercise is more difficult to proof for the dollar. But we have some criteria:

- What will happen with global dollar-debt against the increasing amount of dollar-paper?

- Up until now, declining interest rates, put some lid on the expanding debt. When do we reach the confidence-culmination-point? How will we react once we realize thoroughly that nothing is what it seems? My guess is pure HYPERINFLATION.

This extremely strong tendency of more paper for less goods and services is similar to what happened with the sterling and its colonies.

Gold and oil are, IMO, two beacons to signal the above looming dangers. Presently, they don't seem to do their job. The valuations of currencies, relative to each other, is very confusing. Gold and oil are the most universal standards one can come up with.

We are probably making a mistake by considering the dollar-paper against other paper. We are comparing how good we are as Americans or Europeans against the Turkish or South Africans. We lost an important universal standard... 38 years ago (smile).

My intuition tells me that ALL paper is depreciating. Or is it that services are more and more over-valued? Isn't it strange that most produced goods decline rapidly in price while services are constantly rising in price? Aren't we doing something similar to the British empire? Surfing the world in a quest for the lowest price for manufactured goods, undervaluing Chinese/Indian etc... services and overvaluing the services we provide to ourselves? This global imbalance cannot exist forever. The outcome is most probably an inflationary solution.


Words of Wisdom

And since I, myself, am a mere shrimp following giants, I will close with a few selected quotes from FOA on The Gold Trail:

The dollar is toast because most of the world doesn't like the management policy. They didn't like it in 71, but tolerated it because gold was suppose to keep flowing in repatriation payments. And if they didn't like it back then, they god awful hate it now!

We like to think that the dollar is what it is because we are so good. (smile) But, the truth is that for over a two decade period +, none of our economic policy, our trade financing policy, our defense policy or our internal lifestyle policy has pleased anyone outside these borders. We managed the dollar for us (U.S.) and the rest could just follow along.

Our fiat currency has survived all these years because others have supported our dollar flow in a way that kept it from crashing its exchange rate. We talk and think like we are winning the tug-of-war when, in fact, they just aren't pulling very hard.

My friends, a national fiat in our modern world only functions if the whole world uses and supports its flow and most importantly likes its management (political styling is the catch word). This support and use of our dollar can and will change faster than many think possible. Our dollar is not going to become a "banana" or "nada" in the future, as auspec notes. It already is and has carried this trait for some time now as does every fiat today. The only thing that keeps them from cascading away is world support and use.

That dollar value is there now, you just don't see it yet. The price inflation that many don't or can't see happening, will be the result of our currency management changing to confront the nature of all the above. As this happens the US will have to raise rates even as it massively prints more currency to support our internal economy [obligations!]. Our entire economy will slow and fail as this price inflating process moves on. Some will call it stag/flation, but will change that description as it becomes more of a crash/hyperinflation.

We must not confuse a currency's "total demise" or "falling out of use" with a "loss of identity". In our time there have been few major moneys that went away. Today, we have a whole world of national fiats "in use" and "not demised" that still carry their nations identity. They lose value at an incredible rate, are mismanaged to the highest degree, are laughed at and despised. But, still they are "in use" as they function for their governments and economies. Make no mistake, the entire internal US sector can and will function as its currency runs a price inflation just like these third world countries. We will adapt as they have by dropping our living standard accordingly.

The prestige that we have the largest military force in the world does not help our money problem. We talk as if we will let any country die that does not use our money or support our currency. I point out that the British also made such comments and it didn't stop their downfall. Nor the Russians.

I point out that many, many other countries also have the same "enormous resources; physical, financial, and spiritual" that we have. But the degrading of our economic trading unit, the dollar, places the good use of these resources in peril. We buy far more than we sell; a trade deficit. Collectively, net / net, using our own resources and requiring the use of other nation's as well. Not unlike Black Blade's Kalifornians sucking up their neighbors energy supplies (smile). We cannot place our resources up as example of our worth to other nations unless we crash our lifestyle to a level that will allow their export! Something our currency management policy will confront with dollar printing to avert.

No, this country will not turn over and simply give in. But, we will give up on our currency! Come now, let's take reason in grasp. Our American society's worth is not its currency system. Around the world and over decades other fine people-states have adopted dollars as their second money, only to see their society and economy improve. Even though we see only their failing first tier money. What changes is the recognition of what we do produce for ourselves and what we require from others to maintain our current standard of living. In the US this function will be a reverse example from these others. We will come to know just how "above" our capabilities we have been living. Receiving free support by way of an over valued dollar that we spent without the pain of work.

And lastly, a Q&A w/ FOA:

Q: [Will we see] Brazilian or Weimar style hyperinflation of the USD? The Big Banana, or the 'little banana'?

FOA: Full on, wide open, in your seat, flat out! It's in the pipeline!

[Note: Zimbabwe's hyperinflation hadn't happened yet when this was written]

Q: Debt is designed for default as fiats are for debasement. [Right?]

FOA: My friend, debt is the very essence of fiat. As debt defaults, fiat is destroyed. This is where all these deflationist get their direction. Not seeing that hyperinflation is the process of saving debt at all costs, even buying it outright for cash. Deflation is impossible in today's dollar terms because policy will allow the printing of cash, if necessary, to cover every last bit of debt and dumping it on your front lawn! (smile) Worthless dollars, of course, but no deflation in dollar terms! (bigger smile)

Q: At $30,000 POG [115 times the current price at the time this was written] the US[$] as we know it will be no more, agreed?

FOA: Agreed, but still in use. Just like all those Pesos around the world! But remember, at the very least, the first $10,000 [38 times the POG at that time] of that figure would represent the current purchasing power of the dollar today. We will most likely get there long before price inflation jumps way up, once the current dollar gold market fails and gives way to a free physical price[...]

Q: What advantage would it be to the Power Elite to destroy the dollar?

FOA: Wrong context. What advantage does the Power Elite gain by expending assets to save an already failed currency. Better to do what major players have done for centuries and are doing now, buy gold and evolve your power base to use the next reserve.

Q: The end of a currency's lifetime always ends in gold debasement?

FOA: In almost every case. Sometimes in the open, sometimes hidden.

Sincerely,
FOFOA

30 comments:

MKHAN said...

FOFOA,

What do you think about the following proposal:

please follow link:

http://seekingalpha.com/instablog/402756-mansoor-h-khan/26372-a-plan-for-the-resolution-to-the-insolvency-of-the-united-states-banking-system

Anonymous said...

Ambrose :

http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/6146859/Does-the-world-have-the-courage-to-deal-with-its-debts.html

Debt is getting heavier and heavier.
Ambrose nails the Big Catch-22.

B.

FOFOA said...

Hello Mansoor,

Your solution is logical and good, but vanishingly improbable in my opinion. In other words, it can't happen. Politics will not allow the painful transition.

I am a pragmatist, which is required to preserve capital through this transition. Activism is a different pursuit, equally noble, less practical.

My only qualm with your piece was that you claim no net new money is being created. Yet you are still guaranteeing all deposits beyond the limits of the FDIC. The offset you claim is destruction of assets, not money. While I don't see this as novel to what will happen anyway, it is still hyperinflationary as it converts massive amounts of perceived money into base money.

But overall, my review of your piece is "thumbs up!"

Sincerely,
FOFOA

Mansoor H. Khan said...

Fofoa,

Thanks for reading my article on seeking alpha but please read it carefully I am requiring that all demand deposits of the commercial banking system will be "transitioned" to digital cash. So they WILL BE destroyed in the transition (or converted to base money as you said). True base money can be pyramided via fractional reserve lending. But I am thinking if deposit insurance is removed there will be far less fractional reserve lending post conversion.

Mansoor

FOFOA said...

Hello Mansoor,

"All demand deposits" are not cash. They are private entity book entries backed by assets and reserves. This is what I meant. The FDIC backs all eligible deposits, but beyond its limited assets, they are only backed by Congress and the printing press.

Sincerely,
FOFOA

Anonymous said...

Paper cash conveys anonymity... Something vitally important in this day and age, and not available at all with electronic money - or gold (are you going to pay for that loaf of bread with gold coins??). Thus paper money has some intrinsic value more than just digits in a computer.

Martijn said...

Fofoa,

A while ago we were talking about inflation. You stated that by guaranteing worthless debts, money was being printed. That is not entirely true I believe. Whether the money actually gets printed, depends on the loan being repayed or not, doesn't it?

In a broader perspective, money and credit remain interesting. If I lend you money, I do not actually print money, as your debt to me is not really money. However, it is regarded as so by many. This also goes for bank accounts. If I deposit money in an account, I am actually lendig that money to the bank. The money I believe to have in my account, is actually credit: the bank owes me money. However, in determining what is and what is not money, I would argue that psychology is important. While the money I believe to have in my account is not actually money, it is very close to it: I can withdraw it any time I want, thereby asking the bank to repay its loan to me.

So, technically all bank deposits are not real money; they're credit. However, the people owning those accounts, do perceive it to be money, and found their investment decisions on that idea. This creates a somewhat grey area that I find difficult to perceive.

THat also holds for the debts now insured by the treasury. Although strictly speaking they were not money, in a sense banks perceived them to be. When more and more debts were defaulted on, the distinction between money and credit grew. With the government guarantees, the old situation has been restored: credit and money are perceived as the same again. And in case of a default, money is printed. However, as long there are no defaults, there will be no money printed.

Now the most difficult thing is when and how this inflation from addational money printing in case of a default will occur. Basically the money lent out by the bank is already in the economy. Its effects are too. In case the debt is repayed, the lender subtracts that money from the economy and delivers it to the bank again, thereby cancelling the outstanding credit. This would hence destroy credit that is to some extend perceived to be money. However, when the loan does not get repayed, money is printed by the government, and the bank receives it. In both cases, the bank is somewhat likely to do the same thing with the money, whether the borrower or the bank pays off the debt (with either already existing money, or freshly printed money).

The main difference is that in the first case, money is retracted from the economy, and provided to the bank, while in the other case it is printed. I am wondering what the implications of that are. Especially when we regard the speed of circulation. In the case where the debt is being repayed, we could argue that the circulation speed is higher that when it is defaulted on, couldn't we?

Martijn said...

Interesting read on China: http://www.telegraph.co.uk/finance/economics/6146957/China-alarmed-by-US-money-printing.html

China is buying more gold, but doing so carefully as to not drive the price. This information in itself should probably drive the price, so this is clever political play: China openly states to not be willing to push up gold prices, but by saying so, they probably do.

Anonymous said...

FOFOA,

Over the next few months, given the relatively small size of the gold market, it would make sense that reported holdings would come under more scrutiny. I would be curious as to your thoughts on UST's continued convention of carrying gold at BV. China's recent tonnage is carried at 40-50x that of the US.

http://www.fms.treas.gov/GOLD/current.html

w said...

And lets not forget that the China state owned entities have decided that they can unilaterally cancel "Bad" derivative commodity futures contracts.

Callistenes said...

Here's the derivative link
http://www.chinaeconomicreview.com/today-in-china/2009_09_01/SOEs_may_cancel_bad_commodity_derivatives_contracts.html

Martijn said...

it would make sense that reported holdings would come under more scrutiny
Why and by whom?

Governments will do what suits them best. Giving extra attention to the importance of gold by revaluing it, will certainly not help their case. The only ones wanting to do such a thing are the ones that are in a good position already. However, they might as well use this time to keep purchasing quietly, so I doubt any government will revalue.

As for the market: perhaps so. But this will have to happen by market force. Investers should/shall move away from risk, and start buying physical.

Martijn said...

Here is an interesting post on computer trading.

http://www.silverbearcafe.com/private/09.09/crash.html

Guess what? It does not look sustainable.

FOFOA said...

Martijn,

You said: "You stated that by guaranteing worthless debts, money was being printed."

That is not what I said. Here is what I actually said on the subject:

The last issue I want to discuss is the nature of Zimbabwe's money supply during the last years of its life. Credit had disappeared. Government debt disappeared. There was no interest rate high enough to lure in real capital. The entire money supply, M1, M2, M3 etc... was replaced with BASE MONEY! In hyperinflation, it is only BASE MONEY that matters! This is because hyperinflation IS currency collapse!

What if all of our government guarantees are used? Every "perceived" dollar becomes a real base dollar! When future liabilities are funded by the printing press, this is all BASE MONEY flowing into the system. When the Fed buys government debt, this is BASE MONEY the government is spending. And when a bank is bailed out by either TARP or the Fed, it is BASE MONEY being exchanged for bad debt that should have SHRUNK the money supply.

And what if... the mere GUARANTEE of all this debt actually changes its core NATURE to that of base money? I'm just saying what if. If this is the case then it is up to the markets, the producers of REAL ECONOMIC GOODS to determine the meaning.


I was saying that theoretically, guarantees change the nature of the underlying assets to be more like base money which cannot disappear. Even if the guarantee is not used, the nature perceived by the market is changed. This does not mean printing. It means the THREAT of printing.

From your article: "And what do the five have in common?

All five are virtually guaranteed to be propped up by the government in one way or another (CIT indirectly through Goldman and other government-aligned groups). This summates today's market like nothing else: folks are ONLY trading the investments that they know are on life support from the government."


I think this makes my point. The market is responding to the very existence of implied guarantees!

You also say, "In case the debt is repayed, the lender subtracts that money from the economy and delivers it to the bank again, thereby cancelling the outstanding credit. This would hence destroy credit that is to some extend perceived to be money. However, when the loan does not get repayed, money is printed by the government, and the bank receives it. In both cases, the bank is somewhat likely to do the same thing with the money, whether the borrower or the bank pays off the debt (with either already existing money, or freshly printed money)."

Let me restate your point. When I take out a loan to buy a home, say, for $500K, where does that $500K come from? Do you think the bank was just sitting on $500K waiting for me to come along? Now let's say I pay it back in one month. I change my mind and decide that I want to pay cash for my house. Then what happens to the $500K I just paid the bank? Do you think the bank gets to keep it even though my loan was created from thin air?

Now when I pay the $500K cash back to the bank, I am removing my own cash from the money supply. But if I default immediately and the government bails out the bank, paying off the same $500K, does that also come out of the money supply? And what happened to the $500K I borrowed. Where is that money now?

You say, "I am wondering what the implications of that are. Especially when we regard the speed of circulation."

The implication is that $500K of the money supply has been changed from credit money to base money. There is no longer a hole in the bank's balance sheet to offset my original loan funds which are still circulating!

Of course it's a little more complicated than this. Actually, the amount of money "converted" is not the whole $500K. It is the difference between the original loan amount and the current value of the collateral (the house). If I defaulted immediately, the bank would actually not need a bailout if it had done a true appraisal of the house I was buying.

FOFOA

Martijn said...

I was saying that theoretically, guarantees change the nature of the underlying assets to be more like base money which cannot disappear. Even if the guarantee is not used, the nature perceived by the market is changed. This does not mean printing. It means the THREAT of printing.
I was misunderstanding you. With the above I can agree.

This summates today's market like nothing else: folks are ONLY trading the investments that they know are on life support from the government.
Point proven indeed.

Let me restate your point. When I take out a loan to buy a home, say, for $500K, where does that $500K come from? Do you think the bank was just sitting on $500K waiting for me to come along? Now let's say I pay it back in one month. I change my mind and decide that I want to pay cash for my house. Then what happens to the $500K I just paid the bank? Do you think the bank gets to keep it even though my loan was created from thin air?
So, money circulates in the economy, and when it touches a bank it either in- or decreases the credit money supply, depending the nature of the contact (loan or repayment).
If the government pays of your default, it substitutes credit money by real money.

That does clears it up a bit. However, the distinction between real money and credit money is not that enormous it seems. From what I have been reading on the internets, people seem to find it quite difficult to even make a distinction. Apart from the printing and the rest, a default does seem to increase the speed of circulation, does it not?

FOFOA said...

Martijn,

Bill Bonner on The Daily Reckoning says it in his own words...

"...the Fed doubled its balance sheet in just the last 18 months. This last bit of information is stunning. It took the central bank nearly 100 years to build a balance sheet of $1 trillion. Then, under the leadership of Ben Bernanke, it added another $1 trillion in just a few months.

What does that mean, exactly? It means they bought a lot of debt from US agencies and the financial sector. It means also that they “monetized” this debt... >>transforming it into cash<< by paying for it with money especially created for that purpose."


FOFOA

Martijn said...

Well, that cash is a bit more liquid than the debts it replaces. However, those debts had also been converted in something very close to cash by all the slicing and dicing, hadn't they?

So there is a difference, but perhaps it is not that big as one might think, or is it?

FOFOA said...

@ Anonymous 8:38:

The marked to market concept for gold held as a central bank reserve asset essentially demonetizes that gold. It moves it from the money side of the equation to the value judge side. It is a statement that the gold is now a true wealth reserve. That gold is what prices money! This is the essence of Freegold and the ECB is the leader in this regard.

By keeping its book value locked in the 1970's, the US is clinging to an artifact of the past. It is denying the present reality that gold has been demonetized.

In my post I made the statement that money must be juxtaposed against reality in order to be priced. So imagine a traditional scale. Freegold places gold on the reality side of the scale, balancing or judging the fiat currency money supply on the money side. The dollar keeps its gold restrained on the money side of the scale so that it cannot reveal the true value of the dollar.

Also, if you read my Confiscation Anatomy post you will find a few more reasons why the US may want to keep its gold locked away in a high security 1971 time capsule.

Sincerely,
FOFOA

FOFOA said...

Martijn,

"However, those debts had also been converted in something very close to cash by all the slicing and dicing, hadn't they?"

You have to understand that our credit money system only works properly if money can be removed from the system in the case of a loan default. The mechanism for removing this money is that the bank must pay the deficit on a defaulted loan out of its own capital or equity. When the Fed buys these notes it is guaranteeing that the bank will not have to do this. It is essentially filling all the holes in any defaulting loans with its printing press.

What I am describing has nothing to do with liquidity, velocity or slicing and dicing. I am only describing the fundamental difference between base money (cash + reserves held at the Fed) and broad money (money created through credit).

The market fears default in the credit money system, unless the Fed guarantees that default will not end in institutional insolvency. This transfers the default risk from the securitized instrument to the currency itself. And it spreads the risk over the entire globe instead of concentrating it on the one bank that held the risky notes.

"So there is a difference, but perhaps it is not that big as one might think, or is it?"

I don't know. Is this a big difference? Currency risk for all dollar holders in the whole world instead of MBS risk for the banks?

FOFOA

Martijn said...

When the Fed buys these notes it is guaranteeing that the bank will not have to do this. It is essentially filling all the holes in any defaulting loans with its printing press.
And by doing so, the Fed creates inflation. By means of this deflation the risks that normally belong to the bank are smeared out over all the taxpayers. This system is somewhat socialistic, exept for the fact that bankers get paid massive bonusses for taking risks on the tax payers behalf.

So, where default risk would normally be absorbed by banks, it is now passed on to the tax payer, and eventually perhaps to the dollar.

Anonymous said...

Money is, in final analysis, a matter of trust and fraud. Regardless whether fiat or gold based, fraud is always possible. (A few months ago, it was reported that the gold bars in possession of I believe the Ethopian central bank turned out to be fake - no real gold). So the precondition for any sustainable monetary system is trust into the moral integrity of the people running the monetary system. That moral integrity can not be replaced by gold. It is a wishful thinking to believe that gold could somewhat restore integrity in a system based on a fundamental lie. The fundamental lie is the belief in economic growth. Unfortunately, in a finite world any type of growth can not be unlimited. The US monetary system has exceeded the growth limits imposed by the US economy. We ran out of essential resources (like oil and essential minerals like iron ore) roughly 40 years ago. The present crisis is a long delayed consequence of the fact that we are running out of cheap resources to support our way of life. Before the resources are totally exhausted, the accounting system (the monetary system) will collapse first. That is what is happening. We do not need gold. We need an honest fiat system with transparent rules and rigorous enforcement of these rules.

Martijn said...

We do indeed need honesty. So far however, fiat has not proven honest, and gold seems to be more so, as those buying seem to have better intentions for the moment.

As for the rest of the discussion: risk taken by individual banks is indeed passed onto holders of dollars at large by means of money printing. This practice will continue for as long as people holding stuff of real value continue to accept the dollar. Should a major shift occur, they are the ones to call it - despite whatever laws prohibit them from doing so.
Should that happen, it will be an event of significance beyond imagination. Therefore it will also require a very strong force to occur. That is why the money printers have been safe at least untill now.

Mantis said...

As Friend of Another once wrote, "Even if we have a pure gold system, human nature will find a way to turn it into securities. In doing so we will,,,,, come hell or high water,,,,,, lend more gold than we have and borrow more than we can pay back. One has but to return to the history books to see it all in plain print. Over and over again, we start with a solid gold foundation and soon degrade it into trash. It's not just the American way,,,,, it's the world's way."

FOFOA said...

A run on the Bank of the Gold Cartel

"Germany has asked for its sovereign gold stored in New York to be returned."

"Some big players have asked for delivery of gold in large quantities."

and "The Gold Cartel doesn't have the gold to meet these large deliveries."

"There is nothing new about the scam perpetrated by the Gold Cartel. Goldsmiths as early as the 16th century invented the fraud of "fractional reserve banking." They found that customers would buy gold from them but not take it away, leaving it with them for safe keeping. As long as the goldsmiths had a gold bar to show a new customer, they could sell him gold and give him a deposit receipt. The gold bar then was returned to the vault and could be sold several times over. The goldsmiths discovered that the "safe" buffer of gold to have in inventory was about 10 percent, as that was in practice the typical maximum demand they would see from customers wanting to take delivery."


FOA: "When the US "WALKS" FROM HONORING CUSTODIAL GOLD, once again like in 1971, that will be the end! The system wide banks of the ECB will allow the dollar gold market to soar. Creating a wealth reserve not unlike their holdings of other currencies, only far more true to human perceptions. As the dollar crashes on foreign exchange markets, these CB dollar holdings will be just cast down, as Another said. No need to spend them.

Elwood, they are not trying to Un-money gold! They are going to un-Westernize gold so it performs it's historic function of acting as a tradable wealth holding. No longer following the Gold Bugs view that governments need to control gold so it acts like real money in the fiat sense. Truly, the BIS and ECB are today "Walking In The Footsteps Of Giants"!"

David Alexander said...

The lack of confidence that occurs when the FDIC “fills in holes” on bank balance sheets is made worse since in recent years bank balance sheets have come to represent a much larger amount of lending. In the past, the amount of lending that the FDIC could be liable for was largely limited by the amount of savings and the money multiplier. In recent years banks have been able to lend additional amounts based also on amounts in checking accounts and these loans have been securitized and securities are supported in value by derivatives. Because of the much larger amount of potential defaults that base money could be destroyed by, the “holes” on bank balance sheets could become large so rapidly that the FDIC could easily run out of funds in the middle of a crisis as banks failed. Just asking for a FDIC bailout at such a time would make the situation much worse. There would be a need to ask for enough to fill in bank balance sheet holes as they were growing rapidly as banks failed with massive losses from derivatives that caused other banks to fail. The “holes” caused by defaults throughout the financial system would became “black holes” that sucked in amounts previously lent recklessly by banks. This makes it all the more important to implement some kind of solution before this happens.

Mansoor’s plan should be considered along with other possibilities. Any plan will need to be based on and acceptance of a large loss of purchasing power and economic strength for the US. Any plan will also need to include an organized allocation of losses which could include printing to some extent as a means to accept and distribute losses. This will avoid the potential for much greater losses with an uncontrolled distribution of losses which could occur during an economic collapse. As losses are accepted in an organized manner, this allows for an easier transition to a gold backed currency and future increasing economic strength.

Anonymous said...

Martijn said on 7 september :" Governments will do what suits them best."
Historical reference : In order to rescue the US economy, Roosevelt confiscated all the citizens'gold
read :Roosevelt Gold Confiscation Order Of April 3 1933. Franklin D Roosevelt, under Presidential Executive Order number 6102, confiscated all privately held Gold in the United States on April 5, 1933.
Today, Obama's media and press seem to encourage everybody to buy gold . It could be for the purpose of confiscating it when things go worse for the country.

GG said...

Excellent blog FOFOA! I just discovered it and haven't been able to stop reading. I am upto January's posts now (started in reverse). Project Mayhem @ Zerohedge led me to your blog.

FOFOA said...

Welcome GG,

And thank you! There are a few of you who recently found my blog and are now reading the whole darn thing. I know because you post comments in old posts and tell me so! I am tickled pink by it!

Sincerely,
FOFOA

Anonymous said...

the structure of ranking "safe" securities is pretty far off in the pyramid. Can you provide the sources for this graphic? Municipal bonds are far more secure than corporates or any equity investment for that matter.

FOFOA said...

The Exter inverse pyramid was never meant (on this blog at least) as an investing guide. It was used to demonstrated a concept and a flow. The pyramid itself was drawn in another era, in the 1970's.

Here is the source of the graphic: http://commons.wikimedia.org/wiki/File:Inverse_pyramid_of_John_Exter.png

Also, my post All Paper is STILL a short position on gold has more information on this pyramid.

Snip:
John Exter, a famous gold analyst almost two generations ago, was the first to suggest that gold related to paper assets in the form of a pyramid. He described the relationship of gold to paper assets as an inverse pyramid balanced on trust. Currency at one time was a gold derivative.

Also, this link has even more information about the Exter inverse pyramid.

And Trace Mayer has his own version of this pyramid on his site, runtogold.com.

Sincerely,
FOFOA

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