Wednesday, June 2, 2010
"It's the Debt, Stupid"
(h/t Greyfox for title inspiration)
Why is global recapitalization impossible through fiat, yet inevitable through gold?
The answer is quite revealing.
It's the debt. Not the currency itself. The government could easily decree its money to be 50 times more valuable. It could announce that your taxes are cut to just 2% of what they used to be (in nominal terms), increasing the value of the currency already in circulation 50-fold. But the problem is all the private debt that's denominated in that currency!
For it to be a system-wide recapitalization, every debtor would have to pay (in real terms) 50x more than he signed up for. Salaries would be cut by 98% yet your debt would remain the same. If your monthly mortgage is $1,000 and your monthly income is $4,000, under a 50x fiat revaluation/recapitalization your mortgage would stay at $1,000/mo. and your income would drop to $80 per month. Can you see how this is impossible?
But gold is different. The (100%) holders of physical gold can become 50x wealthier and no debtor has to lift a pinky. (Someone holding 2% in physical gold would retain the same purchasing power.)
I know what some of you are thinking, and you're right. There is SOME debt denominated in gold. And that debt is in the paper gold contract market. Gold contracts are often denominated in gold. But this is where Another and FOA come in. They revealed that when the dollar-denominated paper gold market shifts into cash-only settlement mode (perhaps this month?), that Eurosystem $-paper gold contracts will be converted into euro denomination to save the banks. Think about this in relation to the present state of the euro, the Eurozone banking system, and the ECB's recent actions.
Here are a few extracts from Gold Trail Four:
FOA: At some point, our dollar denominated paper gold system will crack and plunge in value as its credibility to be converted into real gold is destroyed. In the process taking down most of the gold industry. An industry who's stock equity value is daily marked to, and closely follows, said dollar gold system. In time, we will all understand the currency supporting function and the industry killing nature of a Free Gold price. As its surging value more than compensates the dollar's lost value in the hands of foreign CBs.
This particular line of perception is being driven home in recent ECB commentary as their President, Mr. D., has discussed the very mechanism to delineate foreign held Euro money assets. (see Randy's recent ECB news) Assets that, per my above to Randy, will explode in numbers as our busted paper dollar gold market drives these institutions into Euro financing arrangements. These new, increasing, non-expansive assets will be balanced by their system's surging gold price and exported bullion from other nations. A process that in part allows the US to adjust its gold ownership just to stay in the game.
The world is changing and the Physical Gold Advocates will be the ones keeping score!
FOA (6/9/01; 16:36:42MT - usagold.com msg#75)
A letter from Another to me.
All were present at the meeting. I think contractual conversion became topic of some urgency. This BIS must now consider the values these forms will hold in ours and their new futures. Values that will no longer be dictated in dollars, rather realigned in conversion and gold market failure. Truly, this failure of current gold will be reflected as anguish in these western goldbugs, both bankers and investors. All done as the saving wealth for your gold advocates and new reserve bankers finds its new mark in our time. Your work, good man, has been as trying to reconcile the religions of this world. Telling both they are just while only one can be right in the end. So it is in this day of gold.
Some knew what was coming from the beginning. With the Hague Conference of Heads of State in 1969 sprang Copenhagen Report of 23rd July 1973. We pointed and all continued to turn away to follow where power was, not where it was going. With the Solemn Declaration in Stuttgart (1983) closely followed by the Single European Act (1987) even the BIS then understood the final goal. Margaret (Thatcher) soon expressed that signing that proposition (the Solemn Act) was her greatest mistake in office. While I do agree with her on a strategic political basis, such reflections by British leader only exposes the ignored, nearing failure of their shared singular currency dominance (both USA and England). Little is expressed of the wealth lost of our peoples and that of most Western economies as these governments' efforts to preserve this failing
$-system drains real wealth from our world.
Now these leaders' full attention must focus on this money transition itself as Blair's next initiative (the Euro) will lead to a realignment of contract values of all kinds. Before the fact! The Maastricht Treaty allows that by Jan. 2002, all contracts will be converted into euros and new contracts must be denominated in euros. Because Blair has overseen the signing of both Amsterdam and Nice Treaties, his closest people understand the full impact Britons intentions will have on this world's paper gold market. As it be contractually expressed in dollars. The credibility of these to not only represent gold but to maintain loan collateral on books will lead to several high level agreements to address this loss. Indeed, how does one transition a metal contract without moving the metal once again?
Some of your American gold must come into play during this game of kings. It must, as the BIS will sanction a complete disposal of contract liabilities from metal into Euros unless some real US gold is given up.
FOA: In the event of a large enough default, the entire world of paper gold trading will be forced into full cash settlement. The question will be presented: "if there isn't enough gold around to settle these commitments, then there isn't any point in letting the price rise further to effect still no metal settlement",,,,,,, "This was a contract trading market anyway, not a gold market"! Further, the international banking industry, in accords with their governments, will enforce a kind of "position limit" on the amount of gold liability they or their customers can carry. Both long and short. It will have nothing to do with the exchanges, rather it will be a bookkeeping problem being addressed by the banks. Still, it will impact the illusion price we use for gold,,,, downward. The net effect of this will be just the opposite of what paper gold players expect as positions are "force liquidated" prior to even a "cash settlement". This sudden dumping of major contract commitments onto the markets will drive the cash settlement price of gold,,,,, ?.
This is the reality of the political banking world we live in. Neither the EuroZone or DollarZone banking world is going to let the destruction of the Anglo/Dollar gold market shut down their financial system. Take some loses? Sure! But this portion of the pie is nothing compared to the troubles to be managed by the US (our Fed) as the dollar's role as reserve is removed. Granted, once the game is underway a true Free Gold market, trading noncollateral gold, will come about. It will be endorsed as governments settle a small portion of their political scores using physical gold reevaluated up into the "low oxygen zone". Mostly it will be US gold being moved.
Witness the recent long blowout of paper players on the comex? The so called "big traders" these guides thought were about to demand delivery. They were not the real "Big Traders" (I know) were they? If they were they would have demanded delivery even if the short side sold 500,000 contracts short. Even it they (sellers) drove the paper price down with empty sales! The reason these real gold advocates (Giants) buy physical gold is because they are waiting for this dollar casino of a gold currency market to shut down. This reality will end in a locked, no delivery market! Once again, Believe it!
Truly, this recent move was long "little traders" wanting to make currency profits without the real assets to back it up. Nothing more. We will see more of this as it all comes to its end. When the real gold run Another points to comes,,,,, no one will profit anything near the amounts physical gold advocates will.
Society has a way of changing the rules when the economic wealth that their savings are based on comes into risk. Our fiat banks will not be allowed to fail. Just as in 1971, when that real gold demand suddenly expands its boundaries to include ordinary gold investors, the supply rules will be changed again.  Fortunately for us Physical Gold Advocates, the next rule change will evolve from a reserve system that has no threat from a rising dollar gold price. Even if the contract markets crash and physical gold traded in Europe goes into the thousands, the Euro will find strength from such an occurrence. The ECB will embrace it and promote the same.
Dollar gold in the thousands,,,,,, USA inflation going hyper,,,,, The EuroZone dealing with the changes as the BIS settles all our gold dealings,,,,,,,,, And cheap Euro oil making sure Europe doesn't fail too.
Do I wish for this? Only a fool would comment to ask such a question. Am I preparing for this transition? Another would be happy to see that I am! (smile)
Gold, from times past was a wealth asset more so than it was in the form of money. Granted, it became the fastest moving form of wealth, but as it traveled on the road it was still simply seen as a tradable wealth. It has been American and Western ideals that made gold a lend able money and forced its competition against failed currency systems. We set currencies in fixed gold amounts and then inflated the currency. No wonder gold competed against currencies. The ECB will allow gold to go to the moon and everyone will love them for it. People will use the Euro whether gold is at 1 Euro or a trillion.
Arguments against this new logic (by failing Gold Bugs) are little more than a throw back to their outmoded Western money logic. ET (a USAGOLD poster) even thinks that by freeing gold to rise to whatever level it wants,,,,, we are somehow governing it??? That direction of thinking is caused by "promoted investing". The logic is to somehow invest in gold (the industry or its paper leverage) more so than owning the metal. Leaving the agenda of physical gold storage to be something the official governments or private enterprise should do for us. They base their concepts on a return of gold recognition as a somewhat official government money after price inflation discredits the local currency (Dollars).
Such logic suggests we buy into the various SEC-sanctioned (government) paper gold substitutes while governments somewhat allow a devaluation of their money against gold. Say to $800? In this way the dollar is saved a little while the gold exchanges continue life as before. This, my friend, was a failure in the past and the future will provide a very different rendering.
Two questions that seem to come up a lot are 1) how do you see the world after the Freegold phase transition, and 2) what if things don't fall the way you foretell? In this section I will attempt to address both of these questions with the assistance of links to two of my older posts.
One mistake I see a lot of people make is when they realize we are at a tipping point, "living on a knife's edge", and that things could go either way. The mistake is that they see the US/$IMFS/NWO on one side and Europe/euro/Freegold on the other. Or any number of other combinations that I'm not going to list here.
We are at a tipping point alright, but those and the others are not the two sides of the fence. The two sides are Freegold with international trade and economic continuity on one side, and Freegold with trade interruptions and economic chaos on the other.
Who are the productive engines of the world? In a very general sense they are the Middle East for oil and Germany and China for manufacturing. And to a lesser extent the BRICS. These are the surplus areas. The rest of us are running trade deficits. Who needs whom?
Next look at gold versus debt, particularly US Treasury debt, the "paper-producing engine" of the financial and monetary world today. Treasury debt (new or past issued) has a ceiling in its price, unlike gold. It cannot go any higher than its ceiling and it is there now. The ceiling is the 0% yield. The only thing that can happen beyond that is compression into the ceiling, as yields farther and farther out on the yield curve are pushed toward the 0% boundary. This is happening now.
US debt is the biggest bubble of all. Peter Schiff wrote this in Crash Proof back in 2006. He was absolutely correct, even if a few years too early.
Literally, Treasuries have only one way they can go from here... down. Compression can continue a while longer, but prices can't go any higher than the ceiling, the 0% ceiling. And the greater the compression, the more explosive the downward move will be when it finally happens.
This is a 30 year trend that has just hit its ceiling during this crisis. It cannot be continued indefinitely. You cannot offer yields below zero, and you cannot stay pinned to the ceiling.
This is connected to everything in today's crisis. Once the Treasury bubble pops, everything else will collapse too. Conversely, any number of unknown things, "Black Swans", could pop this Treasury bubble. It is the US Achilles' heel right now.
Of course Ben is just going to keep printing and loaning "discount" 0% Benny-Bucks to the primary dealers who then carry the Treasury debt on the down-low until the market finally calls him (and them) on it. But how long do you really think this "pushing on the ceiling" can last? The USG has an appetite of a few trillion a year now WITHOUT any inflation and without any black swans. And a good deal of that is structural.
So when will this bubble pop? What will it mean to everything else? And what will the world look like once everything settles down again?
Well I cannot answer the first question other than to say "sooner rather than later." But as this debt collapse happens, gold can and will recapitalize our world with its broken balance sheet built on debt. Gold will, simply because it is impossible for fiat to do it.
It is important to understand that "holding fiat" means not only holding currency, but also anything denominated in it, debt, long term contracts, bonds. Stocks are a little different because they are equity positions. But they too will suffer because a lot of the companies that issue stock have also issued debt into the debt markets. And these debt markets are senior to the stock markets, meaning that if/when a company is liquidated, the stock holders get nothing and the debt holders get a haircut.
So it is all very complicated and confusing, how collapse will play out.
Someone suggested that I should summarize Freegold in one post. My response was that the more you simplify a complex, paradigm-shifting topic like Freegold, the more the doubters swarm. Each Freegold element left only as a summary or a bullet point seems so foreign to the modern, Western mindset, that it just begs for the seemingly easy rebuttal.
So this is why I write long posts on various elements of Freegold as viewed from different angles and perspectives. As I recently wrote, this strategy allows me to not only share my understanding of a difficult subject, but also to test it out. And so far I have not seen a single argument that debunks it.
I read all the arguments all of you post in the comments, and I respond to a few. But most of them are on topics I have covered at length in the past. So, by all means, keep them coming. But please pay attention when other readers direct you to older posts. You might find them helpful. Some here know my blog better than I do! It's true!
But in the spirit of sportsmanship, here is a sorry attempt at a Freegold summary in as few words as possible:
Debt into Equity
Separation of the monetary functions:
Store of value --> Gold
Medium of Exchange --> Fiat
Unit of account --> Split between Fiat and Gold depending on time preference
All (or most all) debt paper will burn
Gold will be repriced once, enough to make your nose bleed, not as a commodity or money, but as a real wealth asset, kind of like the Mona Lisa, only better
(From: Gold is Money - Part 1, Part 2 & Part 3)
The debt part is the most important. I am not overly religious, but there is a good reason that all the world's major religions prohibited usury hundreds and thousands of years ago.  But man evolved these rules over time to fit his desires. For example, in Islam interpretive differentiation emerged between lending for consumption and lending for commercial investment. And also between the lending to fellow Muslims versus non-believers. And in Christianity, the New International Version of the Bible written in the 1970's and 80's changed the word usury to "bank interest" putting a positive spin on it.
I have had discussions about the core "cause" of the GFC with some of the commenters here. I argue that the most fundamental cause of today's GFC is the evolution of usury to its present, climactic form. Some say it is energy (ie. oil). And others say it is the evolution of unbacked paper money. But I'll stick with usury (nominal debt, as I define it).
I believe I can reduce all the other "causes" down to man's innate desire to borrow and spend other people's money so as not to risk his own.  This underlies even the emergence of fiat money. And it is an evolution that has reached its climax today. The biggest debtor in the world's debt has now hit the ceiling and is presently compressing.
This explanation also works fractally, on all scales. From the individual homeowner who is struggling from a broken balance sheet to the sub-prime housing crisis that was the initial spark of the GFC, to the explosive potential of the paper gold market. These are all caused by the failure of debt. One man holds as his wealth the future productivity (or promise) from another man. Both of these men are in trouble today. Gold is the recapitalizing savior, in its physical form only, because it removes one half of the debt equation, the debtor. Gold in your possession is wealth without counterparty!
And as this concept gradually (or not so gradually) permeates the collective mind, we will move from a debt-based system into an equity-based system. A system where even the poorest of the poor hold positive equity. It can be very small equity, like 1%, but not the big negative limitless hole that is debt.
Remember that debt is infinite. It potentially runs from negative infinity on the deficit end of the spectrum to positive infinity on the surplus end. Equity, on the other hand, ranges only from 0% to 100%. (Please read Metamorphosis for more on this)
You may wonder, how could things like first-time home buying work in an equity world?
It would work something like this. Say you want to buy a house that is $200,000. You have $50,000 to put down and the bank "invests" the other $150,000 in you and the house.
You now own 25% of the house and the bank owns 75%. As you pay down your loan over time, your percent increases and the bank's share decreases until you finally own 100% of your home.
But the big difference is that your equity (and the bank's equity) is always calculated as a percentage. So you and the bank are BOTH exposed to the house value going up or down.
In today's debt world, the buyer has all the benefit of house price appreciation. This contributed to the false idea that homes were an investment, and also to the housing bubble and the GFC.
And the other side is that the home buyer is also the only one exposed to the downside today. If the value drops more than his down payment, he is underwater. And he can then (in the US at least) just walk away so that BOTH sides of the debt coin lose. The bottom line is that a debt-based system must always keep expanding... to infinity! Because it cannot handle a severe contraction without collapsing.
But in an equity world, if the value of the house drops to $100,000, then the buyer still owns 25% and the bank still owns 75%. Likewise, if the value rises to $800,000, the bank can claim a nominal (paper) $450,000 income (increase) while the homeowner only has claim to 25% of the rise.
This is how an equity-based system will work, generally. And our global financial system will switch to something like this because as debt collapses, both sides get screwed. The homeowners are all negative and the banks are all insolvent. The debt-based system simply cannot stand a severe contraction without undergoing a drastic change.
So how will this equity world work on the national scale? How will governments operate?
They will issue equity shares in themselves, just like corporations do today. No more debt, no more bond markets. Those will be completely discredited as they collapse the system and all the debt-paper burns. And it will become obvious, even to the blind, that they ultimately caused the very contraction that wiped out everyone's pension plans and wealth. So bond markets, after the collapse of the Treasury bubble, will not be viewed kindly, to say the least.
Fiat currencies will be the equity shares of nation-states and stocks will be the equity share of corporations. Both nation-states and corporations will only have two choices for income. Produce or dilute. National fiats will be judged by their ability to buy gold. National Treasuries will once again have an incentive to encourage the flow of gold back into their regions. If a government issues too many shares (fiat) it will quickly pass the point of diminishing returns and its "shares" will be able to buy less and less gold no matter how many more are created. Classic hyperinflation.
This brings us full circle back to Freegold. Please read Bondage or Freegold? for more on this.
 This video offers a great twist on FOA's statement, "Just as in 1971, when that real gold demand suddenly expanded its boundaries to include ordinary gold investors."
 History of Usury Prohibition
 Please see: Say Goodbye to Wallstreet