The question was asked: Is this inevitable with any debt-based system?
Short answer for now. ;) Systemic collapse is inevitable as long as the item used for lending is the same item used for saving.
In a gold money system with gold lending (which is always demanded by the collective will) fractional reserve banking is the inevitable result. And from there, bank failures are the inevitable result at the first sign of panic (loss of confidence). And from there, some of the savers lose their money.
In a fiat system, the fiat is lent and the savers hold the notes, one way or another. This lending and note holding always increases the money supply just like gold lending and gold-denominated notes expand the gold money supply. You lend something and then you can claim it in the form of a note while the borrower claims it in the form of the currency. Even the notes circulate as they become marketable.
So lending always expands the money supply, whether it is gold or fiat. And when the savers save in the same thing being lent, collapse ultimately comes (or at least threatens), whether gold money or paper. And then the system must undergo a fundamental change one way or another.
The problem is that the expanding money supply due to lending always lowers the value of a unit of currency. Even if it is gold. If I loan you a $1 gold money, you now have $1 gold and I have a $1 gold note. The money supply has just doubled, and the value of $1 gold just dropped in half.
This is a fact of money systems. We can try to get rid of it by outlawing lending, but that is like outlawing swimming in the summertime, or beer drinking.
The solution is quite simple. And I didn't come up with it. The problem is that at the point of collapse, some of the savers are wiped out, whether gold money or fiat. Think about those at the back of the line during the bank runs of the 1930's. They didn't get their gold. They lost their money.
Today we don't have this problem anymore. The guy at the back of the line gets all his money, it's just worthless in the end. We solved the problem of bank runs (bank failures) but not the problem of value.
The solution is that the monetary store of value floats against the currency. It is not the same thing that is lent! It is not expanded through lending and thereby diminished in value. Instead, as $1 is lent, and now becomes $2 ($1 to the borrower + $1 note to you the lender) and the dollar drops to half its value, the saver, the gold holder will see the value of his gold savings rise from $1 to $2.
It's a concept so simple, yet so foreign (or alien) that almost no one can grasp it. Yet it has been around for quite a while.
The bottom line is that ALL money systems are debt based as long as you have lending and borrowing. And the process of lending and borrowing always dilutes the money supply and hurts the value of the money. So why should savers save that same money?
Why should national treasuries be at risk of a currency crisis? A nation's treasury is arguably one of the more vital forms of savings in civil society. Should a nation's treasure be capable of vanishing in a flash crash?
Hard Money versus ____ Money
When we talk about gold money we often use the term "hard money." And one misconception that pops into most people's mind is that "hard" money means hard like a rock, or hard like a piece of metal versus "soft" like a piece of paper that folds nicely into my wallet. Or the ultimate soft, a digital electron that moves at the speed of light.
This may not seem like a big deal, but I think it is. What is actually meant by "hard" money is that it is difficult, or hard to get. The opposite of hard being easy, not soft. Hard money cannot be expanded easily (without risk) because it has an anchor in the physical world.
We generally think of the people that want a "hard" money being the stodgy old rich Republican conservative white men that already have money. They want a "hard" money so the paupers will have to work "hard" in their big industry factories to get some of it. And so the money they already have will retain its value.
On the other hand, the debtors like easy money, especially the kind that loses value over the short term making repayment of their debt easier. The farmers love easy money. They take out a loan when they plant and by the time they harvest they are getting more money for their crops than they did last year. And the seed loan is easier to pay than when it was originated. More cash, easier terms, less pain.
So here's the question. Why can't we have hard money for the savers and easy money for the debtors? Is this possible? Could it work?
Now imagine that some people living under the "exorbitant privilege" of the United States for half a century spent a few decades designing the principles of a new currency that would help get them out from under that burden; the burden of supporting the perpetual trade deficit of someone else. They would have had a long time to evolve their thoughts and ideas and create a currency architecture unlike the world had ever seen before. Imagine that they were working on this for at least 37 years.
Now, let's take a look at the architecture of the euro. In January of 1999 the euro was born. And if we go to this page on the ECB website, page 51, we see that plans for the euro began in 1962:
1962 - The European Commission makes its first proposal (Marjolin-Memorandum) for economic and monetary union.
Obviously, now, the euro has its "easy" money for lending to the debtors and lubricating trade. Just look at the European banks or Greece getting in trouble. They just print up a bunch of euros and loan them to the banks or Greece at better-than-market terms. Voila – EASY MONEY.
But then the euro also has its savings, its "official reserves," which are specified to be at least part in gold. At the beginning, in January 1999, they were 30% in gold bars. And they also legislated that this gold should FLOAT against the new currency. So, now, for 46 consecutive quarters they have religiously revalued their reserves – their savings – against the euro.
Now the "official reserves" consist of mostly dollars on the one hand (euros are not a reserve to the euro, only foreign currency and gold) and gold on the other. So by FLOATING these reserves (the "savings"), gold has risen to 60% and the (mostly) dollar portion has sunk from 70% down to 40%. And notice that they are "floating" their "hard money" against THEIR "easy money." You can see it right here on their latest quarterly report:
Gold: EUR 1010.920 per fine oz.
Gold, floating in euros. Hard money floating in its own easy money. Not dollars, euros! Savings floating in debt, not being dragged down by it. The store of value floating – PUBLICLY – in a swamp of medium of exchange.
What else? Oh yeah! They now sell gold to the citizens right from the tellers at the bank (in some places?), with 0% VAT. Everything else has a VAT, including silver. If I recall, silver has a 17% VAT (perhaps someone in Europe can confirm). That's "Value Added Tax." Crazy, huh? Gold - 0%!
What else? Oh yeah! They convinced the EMU members to stop selling off their gold. This was a big problem. Politicians love to sell off the gold reserves to fund their pet projects. But the European CB's put a stop to that with the WAG in 1999. They limited the CB sales of gold to 400 m/t per year total, among all the CB's. So they had to cooperate not to go over that amount. Then they renewed the agreement in 2004 and again in 2009. And all the while the sales diminished until, in 2009, they reversed! In 2009 they actually took in some gold!
What do you think will happen to their "savings" (I mean "official reserves") when the claims on foreign currency (dollars mostly) default through currency collapse? Of course gold will rise! Will it rise more than 66%? In dollars that would be about $2,100. You think gold will exceed that when the dollar collapses? Will it exceed that value in euros? If it does, the euro's "savings" will rise, even without selling a single dollar! Dollar value will just disappear and reappear in the gold! A transfer of wealth, so to speak!
That's the beauty of savings that FLOAT!!!
Hmm… let's see. Did they actually pull it off? Did they create the perfect currency? With hard money for the savers and easy money for the debtors? Well, Greece and the banks are getting plenty of easy money right now, and the hard money is rising in value along with the process. I wonder how it will all work once the dollar system's conjoined twin, the paper gold market, fails along with the dollar.
How well will their hard money savings float against the easy money transactional currency once there is no fractionally-reserved paper structure weighing it down? Should be pretty amazing, huh? And I wonder what the price of gold coins will be then. They may have to mint tiny amounts with more alloys. Do you think? I bet a pure ounce of Maple Leaf will become a family heirloom at that point. Wonder if it will be soon? Hey, how much are those Maples right now?
Back to Hyperinflation
Another common misconception about the hyperinflation we face today was posed:
Many people look to the Weimar Republic in Germany and Zimbabwe as examples of hyperinflation, which were the results of government intervention and bad policy, and make parallels to our current predicament. In both cases wheel barrels and armfuls of cash are used to purchase everyday items, such as sundries. The merchants in the Weimar Republic would charge customers by the pound of currency rather than its face value. What you are seeing in these pictures is physical currency, not digital currency.
In the US economy there is only a small percentage of the money supply that is actually in physical currency form, with a good deal of that physical currency held outside the US.
Just think to what percentage of your wealth is held in physical form? Very little in fact, maybe less than 1%. Think of what percentage a population distrusting in the government and with no trust in the banking system would hold in physical form? Much more, possibly higher than 80%. Due to this fact I believe that you cannot accurately make a comparison between the US and Zimbabwe or Weimar
My point is that there simply isn’t enough physical currency to create a hyperinflation scenario similar to Weimar or Zimbabwe. While it is true that the Fed is creating copious amounts of money at the moment, it is only being created in the digital form and not the physical form. The term ‘running the printing presses’ is misleading you to believe that the Fed is printing currency when in reality it is creating a series of 1’s and 0’s that are being deposited into virtual banking accounts. All digital.
The digital money being ‘printed’ by the Fed is the type of money that most people would normally assume to be hyperinflationary; it’s the most potent type of money, it’s high-powered money and it forms the monetary base money. High-powered money is the foundation of the fractional reserve banking system. In the perfect economic climate this high-powered money would be loaned against to create 10x the amount of credit-money. But we currently don’t live in that perfect economic climate and that high-powered money is getting almost no traction at all. You have to have an economy that is functioning properly to ignite those digital dollars.
Here was my reply:
I put this image here again so I can refer back to it from time to time.
Throughout our journey up a graph similar to this one, there will be several monetary events which are difficult to contemplate right now. But I hope to ease this difficulty. And I also hope that previsualization will make it a little easier on my readers when this monster seemingly rears its ugly head "right out of the blue."
In my last post I mentioned the "excess reserves" that will ultimately have to be printed into physical cash. This is one of the monetary events that will happen near the beginning of the graph above. It won't require wheelbarrows at that point, but as we move up the graph you will need bigger and bigger ones. An SUV would actually be quite handy. Not a pickup truck, though (wind will blow your cash away). So be sure you have some gold so you can afford the impossible price of scarce gasoline for your SUV!
In Gonzalo Lira's second hyperinflation article, he asked the question, "Where will the bundles of cash come from?" Great question! And he answered it with "palliative printing." This is another of the events on the journey up the graph. Only "palliative printing" is near the top end of the graph.
Gonzalo correctly points to "palliative printing" as a wheelbarrow-enlarging event, which comes at the very end stage of a hyperinflation. And he presents it as palliative to the people. But this printing is usually most palliative to the government and its expanding rank of stooges. Sure, there will be "welfare" along the way, but for the most part the freshly printed cash will buy the most goods and services for the first hands it touches. And then less for the second. And even less for the third and so on. And this prime purchasing power will be mostly reserved for the government that prints it.
So these are two easily identifiable monetary events. I haven't gone into them in much detail yet because there is a deeper issue that we need to fully understand first. And that is the fundamental difference between digital money and physical currency. 99% of everyone has no real understanding of the difference.
The few deflationists that think they understand what will happen will tell you to hoard a boatload of cash. This advice will help you for maybe a week to a month. If you stored your emergency supplies like you should have, it won't help you much at all. And if you hoard only cash in lieu of real stockpiles of necessities and gold, then you will have ______ yourself in the end.
I tend to think that the ideal amount of cash you want to be hoarding when the fire starts is about a month's worth of expenses. Maybe a little more. But much more and you may have to juggle your cash back into your bank account as you "wait" for the inevitable, and you will probably end up holding a large stockpile of cash after it becomes worthless. Any less and you may miss out on some bargains during the week to a month that cash values exceed digital money. In any case, it's good to have a little cash under the mattress.
The week I'm referring to is the much-ballyhooed "bank holiday," while the Fed scrambles to get fresh cash out to the banks. It will last anywhere from a few days to two weeks in my estimation. And during that time, cash will have more value than plastic.
But to get where we are heading with this discussion, we must understand the fundamental difference between digital money and cash as I said. Most simply stated, in our modern system – cash is to digital money – as gold was to cash – during the gold standard years. Let this sink in.
Cash will become worthless, unlike gold after the 1971 parity split. So what will happen to digital money (today's "1970's dollar")? And what will become of gold?
Digital money is the same as what I call "credit money" or "balance sheet money." It is "thin air money." But… there is a fundamental difference between "thin air money" from a private bank and "thin air money" from the Fed. A HUGE difference. More on this in a moment.
When a bank creates money "from thin air" it is creating a liability upon itself. It owes a dollar. Yes, it owes a physical dollar once it creates new "balance sheet money" "from thin air." And unless it can legally print that physical dollar (which only the Fed can), then it must earn that physical dollar it now owes.
So if you borrow a dollar from a bank which it conjures on its balance sheet "from thin air," and then you walk out with a physical dollar, that bank is now short one dollar. But on the asset side of its balance sheet it has a note that says you owe the bank $1.10, which is why the bank let you walk out with that dollar.
But if you borrow a dollar from the bank and leave it in your account, then the bank still owes you a physical dollar while you owe the bank a physical $1.10. And when you pay the butcher with a $1 check and the butcher deposits that check into another bank, all that does is transfers your 'physical $1 claim against your bank' to the other bank. Your bank now owes the butcher's bank a physical dollar. And that other bank owes the butcher a physical dollar.
Now if the butcher pays the baker a dollar for a loaf of bread, with a check, and the baker deposits that check in your bank (you and the baker have the same bank), then that cancels out the physical dollar your bank owes the butcher's bank. And the butcher's bank no longer owes the butcher a physical dollar either.
So as you can see, "thin air money" is really just the 'physical dollar debt' of the banks that gets shifted around from bank to bank. So imagine if the bank were to write itself a big profit. All it would essentially be doing is saying, "I owe myself a dollar." You should try this. Make a balance sheet and oblige yourself to pay yourself a million dollars. Then go see if you can spend it!
I tried this once. Trust me that it doesn't work!
So all this digital money that everyone thinks has replaced physical cash is actually fundamentally inferior to physical cash in a **SIMILAR** way to how physical dollars were fundamentally inferior to physical gold in 1970.
But the big difference between then and now is that physical dollars CAN be created at will. BY THE FED! Gold, obviously, cannot.
Now let's get back to those excess reserves held at the Fed for a moment. They are FED liabilities, which are different from private bank liabilities. Fed liabilities are fundamentally different because the Fed can print gold, or at least gold's equivalent in today's banking system. The Fed can print physical dollars. So Fed liabilities are contractual obligations to PRINT gold, I mean physical dollars, while private bank liabilities (M1, M2 etc…) are all contractual obligations to EARN or find (or collect) physical dollars.
So what happens when the banks can't earn the dollars that everyone thinks they have on deposit?
…at some point the people lose the faith and begin turning over the money stock trying to grab real wealth. The timeframe of this switch in behavior is still up for debate with me.
As I say, I've kinda given up on the timing angle. Not only because this is impossible to time, but because I've finally realized that it doesn't matter. These goofballs that keep saying they know the timing and it's years away couldn't be more wrong. Yet they look like geniuses every time it doesn't come. Timing is a fool's game because hyperinflation is like an earthquake. It could hit at any moment once it is overdue.
…but the printing of physical currency is one of the last stages in the game.
No it's not. The printing of physical currency will be the central theme all the way up that curved graph. Hopefully above you got the point that digital currency is simply a promise by private institutions to find you a physical dollar that they don't yet have. Digital currency only circulates as a tethered unit, tethered to the institutional circuit of banks. Imagine a dog run, where you put your dog's leash on a taut steel cable and your dog thinks it is running free, but it is really tethered the whole way down the run. This is how digital currency circulates. When you transfer a digital payment to someone, your bank and their bank are the ones that actually agree to a new debt between each other.
This is important because it happens billions of times a day. But let's envision a large international wire transfer to make the point clear. Let's say you want to wire a million bucks to your buddy in Hong Kong. The wire may go through in a day, but what has actually happened? What happened was that your bank promised the bank in HK that it would ship over a million physical dollars! And the HK bank accepted that promise at full value before it handed your friend a million bucks.
No specially designed or officially approved electrons crossed the ocean through the wires. There was not physical "transfer." Only an agreement between two banks. An agreement to ship a million physical dollars! Now as I said, this happens billions of times a day and most of the agreements are cancelled out by promises in the opposite direction. But whatever is left unsettled ultimately gets settled in physical dollars.
If the two banks are in the Federal Reserve system then the unsettled portion is settled by transferring cash held at the Fed. Some of those reserves at the Fed get moved over from Bank A's account to Bank B's. But remember, reserves held at the Fed are the same as cash, because the Fed prints cash. I can't stress this enough. This is what BACKS the whole entire system… that the Fed prints cash. Cash backs the system. Physical cash. It is the reserve, just like gold used to be the reserve. There is NO SUCH THING as digital money that has replaced physical cash. It is an illusion!
And just because we have all bought into the modern banking system illusion of "digital currency" does not make it any more real. How real it is or isn't will be revealed when the system starts getting stressed! When institutions will no longer take the promise of another institution on the other side of the planet at full value!
Right now the Fed is barely maintaining institutional confidence by throwing around guarantees like they are nothing. But what do you think all these guarantees actually mean at their very core? They are all, every one of them, guarantees to print physical cash at the end of the day. This is what lubricates the whole international free market. The confidence that HK bank has that the US bank will ship physical cash if need be.
I realize that this is practically INVISIBLE to most of you, in a way similar to the allegory about the Peruvian Indians that could not see the Spanish ships when they first arrived because they had no prior knowledge of any such things existing. Because today you value that "digital currency" just the same as cash. Maybe you even value it more! So how can the HK bank possibly value physical cash more than promises from an American private bank?
Well, once your wire goes through, your buddy in HK will have the option to walk in with a suitcase and get that cash. That is a physical asset the bank is holding. And it will release that physical asset to your buddy on the promise that it can get more from your bank at a later time. If someone else sends a wire for another million and the HK bank doesn't have enough cash on hand left over, it could create a credibility problem for that bank, right?
…does the printing of physical currency require a banking panic leading to a bank run leading to a bank holiday?
I think your question is, Is a bank holiday inevitable, unavoidable? I believe it is. And here's why.
As I have said, hyperinflation starts before the first new dollar is even printed. It is a nasty little collapse of confidence in the currency (and its banking system) that begins in the hidden little corners you never even considered.
Remember above I said that the HK bank accepted the promise from the US bank at face value? Well let's say that something has just happened in the markets somewhere that shook them up. Let's say that everyone is a little uneasy about something that just occurred. Maybe it was something strange at a Treasury auction, or… who knows? Anyway, at some point there is going to be a risk premium for accepting institutional promises of delivery of something physical in the future.
That HK bank knows it will have to cough up the cash today if it accepts the wire, but it may not see the replacement cash for a week. Will that cash in a week be worth the same as the cash going out the door today? Probably. But if there's a chance that it won't, then there is a risk premium to be charged. This is one hidden little corner where that nasty hyperinflation bug may first appear.
Once the time factor begins to present a perceived risk to the institutional banking system, it's all over. The system will need a large infusion of physical cash. Each and every "digital currency unit" is a debt of a physical dollar, backed by a debt, backed by a debt, backed by a debt and so on. It is a very long chain. And like all chains, it is only as strong as its weakest link! And there are a lot of weak links out there. The FDIC says about 800 of them right now if you believe the FDIC.
When one of these weak links breaks, it will not be enough to simply feed the cash to that broken link. The time factor will come into play. The Fed will have to ship physical dollars to ALL the links in the broken chain at once to avoid a panic. This will require a large infusion of physical cash.
Luckily this is possible today! Cash is the reserve, and cash can be created at will!!
Back in the 30's, gold was the reserve, but gold could not be created at will. If it could have been, then they would have just closed the banks long enough to truck enough gold out to the banks. And it's not just the customers lining up outside the banks that forces this action. It’s the interbank settlement process and the interbank confidence that lubricates this process. And eventually it will also include the larger retailers, who operate with a huge degree of confidence in the bank clearing system.
Think about the amount of promises a large grocery chain takes in every day with the confidence that settlement will happen before it needs to pay its obligations. The whole economy is like this. Whether one realizes it or not, the whole economy is operating on the confidence of the ultimate delivery of physical cash in the clearing process.
How about a gas giant like Shell? Think of all the "digital money" promises it takes in with faith in the clearing system to clear all imbalances each night.
There will come a point very quickly after confidence is shaken by some event, that physical cash will start to carry a small premium over digital money. This will be the time factor rearing its ugly head. I know of one cigarette shop that advertises a "cash price" in the window! This store charges less if you pay cash! That's not because of the time factor, of course… yet! But at some point those signs will start showing up at more places.
Today most vendors will eat the 2% it costs them to accept digital money. But what about when that cost rises due to the time factor risk premium? If someone pays you in cash today, you can go to the grocery tonight and buy food with it. If someone pays you with plastic, it will take a couple days before Visa deposits 98% of that amount in your bank account. Will your bank have any physical dollars then? So that you can recoup the lost 2%+ by getting the better cash price at the grocery?
Once this time factor settles in it will spread very quickly. The cigarette seller will prefer cash and will give you a discount for it so that he can go quickly and get the cash discount from the grocer. The banks will need loads of physical cash at this point. And they already have some of what they will need, sitting in excess reserves at the Fed.
The First Mechanism for Extra Zeros
How much will the Fed have to print up, and how fast? Unfortunately, $1 trillion in $100 bills is still 10 billion physical notes. If the Fed tried to print that, all in hundreds, in one week, that would require a printing rate of 1 million notes per minute, or 17,000 per second, 24 hours a day for a week. In other words, it is impossible.
But there is a simple solution! It's been used many times before and thus has many precedents. The euro already has €200 and €500 notes, presently trading for $254 and $636 respectively against the dollar. So it wouldn't be a huge leap for the Fed to print $500 and $1,000 notes instead of $50's and $100's in an attempt to hold the banking system together. It's actually a no-brainer. It reduces the printing time by a factor of 10!
Now instead of 1 million per minute, it's only 100,000 per minute. Well, that might be tough too. So it'll probably take a couple weeks and even then be an insufficient amount.
There's another option as well. They've got all those new $100 bills already printed. They could release the new bills at 100:1 on the old bills. Most people don't see this as hyperinflationary. They think of it as "issuing a new currency." So what's the difference between the two? There is NO DIFFERENCE!
Issuing the new $100's at 100:1 would be the same as issuing a $10,000 note. Same exact thing. But you must realize, it's not the notes that are driving the collapse (hyperinflation), it's THE OTHER WAY AROUND.
The hyperinflation is driving the need for the notes! So simply issuing the new $100 at 100:1 would not be an instantaneous devaluation of the dollar against all goods and services. No, they are rising at their own rate, REQUIRING a $10,000 note! Whatever you could previously get for $100, like a banana, would still be $100 in old dollars (for a few minutes anyway) after the new currency is issued. Most people don't think about it this way.
They think of the issue of new currency as "solving the problem" or "stopping the collapse." They think it would cause an immediate 100:1 revaluation of all goods and services allowing the monetary authority "to get ahead of the hyperinflation" and stop it dead in its tracks. No, it doesn't work this way. Issuing a new currency is only a very temporary fix and worst of all, it feeds fuel to the fire.
Hyperinflation is very hard to stop once it starts. The only way you can stop it is by switching to a harder currency. But unfortunately for the dollar, this will not be a realistic option.
If the dollar tries to peg itself to a new parity with gold (a new "emergency" gold standard) in the middle of the hyperinflation process, it will experience a run on any gold it puts up as backing. Imagine if Zimbabwe had tried to stop hyperinflation by opening a "gold window," selling gold at a fixed price in Zim dollars. (See image at the top!)
In Zimbabwe, they only stopped the hyperinflation by officially switching to a harder currency, the US dollar. But what currency could the dollar switch to? The euro? This is a possibility, but more likely the hyperinflation will simply run its course over a few months and by that point we'll ALL understand Freegold.