How is that different from Freegold?

FOFOA reader and supporter Cyril asked me by email:

I have a little question that I’d like to ask you. I don’t know if you are familiar with Peter Schiff: he has a radio show every day where he talks about macro-economics.

So the other night, I was listening to it and a caller brought you up in his question. He was a little dismayed that Peter Schiff was not aware of your work (and so was I). That’s probably why he didn’t do a very good job in summarizing the Freegold concept, but to be fair, I don’t know if anyone would have been to able do it in 20 seconds. But here’s the exchange:



Peter Schiff’s first reaction was to ask “OK, and how is that different from what we have now?” I realized that this was a question that I always had in my mind and never found an answer for.

Right now I can buy an ounce of gold for $1373.70. I can also buy the same ounce for 1015.84 Euros. This means that 1US Dollar is 0.000728 ounces of gold and 1 Euro is 0.000984 ounces of gold. How is that different from Freegold?

Good question Peter and Cyril! By the way, Peter Schiff may not have heard of the FOFOA blog, but he has met me. He signed my copy of Crash Proof at one of his "events" in early 2008, before I had even heard of ANOTHER and FOA.


Now most of you know that I consider this topic, Freegold, to be extremely deep. But I'm going to try not to go there in this post. I'm going to attempt to "superficially" focus only on this one question in the hope that this post stays reasonable in length and finds its way to Peter.

Sure, gold is floating against all currencies today, just as it has been since Nixon ended the fixed gold standard. But it is a pretty volatile float, wouldn't you say? From $40 up to $850 back down to $250 and up again to $1,400. All in 40 years. During the prior four decades, gold was locked at $35 per ounce. That's some long term stability! Granted it was a synthetic stability, prone to explosively painful crises like the 1970s.

Freegold will once again deliver a stable gold price, unlike today. The kind of stability Freegold will provide, which will be able to last much longer than 40 years, will form the bedrock foundation of global trade, monetary policy and international finance for the next era. And it will be stable because of two main factors:

1. SUPPLY - Gold will trade on a stable supply of above-ground physical gold in the absence of external influences like "paper gold" (Bullion Bank "BB" liabilities that can be created on demand by a mere book entry on a BB balance sheet, etc.).

2. DEMAND - Gold will also trade on a stable demand due to the global clarity that will emerge as to gold's best and highest function—being only a physical wealth reserve asset and nothing else.

How we get there is easy to visualize. As the physical reserves within the BB system are all moved into allocated accounts, at some point the remaining claims will simply have to be cash-settled. At that point all paper gold markets will cease to exist and all that will be left is the stable supply of above-ground physical gold in the absence of external inflatable (or deflatable) influences.

And when this happens, the dollar will fall in value very quickly, and with it, all savings tied to debts denominated in dollars. What this will reveal on any balance sheet that contains both dollar-based assets and gold, is that gold will rise to fill the void left by the dollar. The balance sheet will not collapse. But the wealth will have transferred from dollar assets into gold.

This is the main significance of all the Central Banks stocking up on gold today as well as the Eurosystem's quarterly mark to market party, I mean policy. When the BB fractional reserves finally run out, this will be a very quick revaluation.

But while I expect a quick and dramatic reset at some point in the near future, this process can be clearly observed happening in slow motion today, both from a political standpoint and on the balance sheet of the ECB. In my post, Reference Point: Gold - Update #1, I highlighted the results from the latest revaluation party, a decade-long trend that has brought the "foreign fiat reserves" portion of the Eurosystem's balance sheet from 69.5% down to 32.9%. Meanwhile, physical gold as a portion of the Eurosystem's reserve assets has risen from 30.5% to 67.1%, even while declining in volume. A virtual flip-flop as I called it in my post.

So while most cannot understand the significance of this slow motion trend today, the explosive "rock meets hard place" encounter that is overdue at this point will be sure to wake even the sleepiest sheep. And at that point gold's best and highest function—being a physical-only wealth reserve asset—will be known by all. And the meeting of such a wide (awake) demand with a newly physical and stable supply in the absence of external (paper) influences will reveal a gold price that is multiples of any that has ever left Peter Schiff's lips.

The next step in discovering how Freegold (or Reference Point Gold "RPG") is different from what we have now is the concept of "captive money." Today gold is traded like a volatile commodity by gamblers who like to call themselves traders. Or else it is held as a small percentage of one's wealth for the expressed purpose of "insurance." Gold is actually a pretty poor inflation hedge as long as it is under external influences such as the inflatable supply of paper gold BB liabilities. So the only way it can even hope to perform as prescribed is as insurance in physical form only. Yet so many investors still hold "paper gold" as the insurance portion of their portfolio. This alone really highlights the confusion in Western "professional" investment Thought.

Most people are savers, not investors or traders. Yet today we are all forced to be investors chasing a yield because there is no such thing as a perfect inflation hedge. If there were such a thing, a large portion of the "investing public" would not be anywhere near stocks and bonds. Even the most "risk free" bonds, US Treasuries, have the greatest risk of all, currency risk. And in the case of the dollar, this is exposure to a risk that, today, is well out of the hands of the currency manager thanks to seven decades of functioning as the global reserve standard.

Furthermore, a saver must look deeper than the CPI, or even its shadow-equivalent, for the real inflation that must be protected against. And that is the inflating VOLUME of savings with which one must compete. A perfect inflation hedge would not only keep up with the shadow-CPI but it would also rise in VALUE (as opposed to volume) relative to changes in aggregate monetary savings. Given such a "perfect inflation hedge," I maintain that it would become the Focal Point of savers all over the world.

I read an interesting piece on Egypt by George Friedman of Stratfor. I thought it described an interesting little microcosm of the dollar's international monetary and financial system ($IMFS) and how it is detrimental to savers. Here are a couple snips from the article:

"One cannot simply walk out of Egypt, so since the time of the pharaohs the Egyptian leadership has commanded a captive labour pool. This phenomenon meant more than simply having access to very cheap labor (free in ancient times); it also meant having access to captive money. Just as the pharaohs exploited the population to build the pyramids, the modern-day elite – the military leadership – exploited the population’s deposits in the banking system. This military elite – or, more accurately, the firms it controlled – took out loans from the country’s banks without any intention of paying them back…

"There were many results, with high inflation, volatile living standards and overall exposure to international financial whims and moods being among the more disruptive.

"Over the past 20 years, three things have changed this environment…

"By 2010 the system was largely reformed and privatised, and the military elite’s ability to tap the banks for “loans” had largely disappeared. The government was then able to step into that gap and tap the banks’ available capital to fund its budget deficit."

I realize that I am side-stepping George's point here to make my own. But the point is that today, all over the world, people's savings are "captive money" inside the $IMFS. One cannot simply walk out of the $IMFS today and hope to retain one's purchasing power over the long run. Therefore the people's savings, their 401Ks, IRAs, pensions and trusts are all captive to the managers of the system. Under Freegold this will be different.

That's the big difference for the majority of todays "investing public," the savers. But then there are those dastardly traders. Those traders are not only capturing fiat profits from gold's volatility, but they are creating the very volatility they aim to capture, which itself is the antithesis of gold's best and highest role, that of being a stable benchmark wealth asset. The activity of trading "gold credits" for volatility is part of the reason we do not have Freegold today. Not only are the traders never holding real gold, but they are denying the rest of us the beneficial stability of price that gold was born to deliver. This "gold gambling arena" will not exist in Freegold.

First of all, there is no incentive for people to gamble on price changes in something that is stable in price. And second, the gamblers' casino chips, ambiguous claims on some illusory pile of gold somewhere back in the cage, will no longer exist. This is probably the most important difference between Freegold and what we have today. After the failure of paper gold liabilities to continue trading at par with physical during the dramatic revaluation, every discrete piece of the 160,000 tonnes of above-ground gold will be **unambiguously** owned!

Furthermore, in every gold exchange, there will be an **unambiguous** seller and an **unambiguous** buyer. This does not necessarily mean that all gold exchanges will be face to face and entail the physical movement of gold. But it does mean the end of ambiguous pools of unspecified gold and its unallocated owners. I realize that this part is difficult for many to visualize today given that it is how a good deal of the gold market presently operates. But I believe that if you give it enough thought, you will ultimately come with me to this conclusion. Otherwise, as Another said, time will reveal all things.

With people's savings no longer captive in a financial system that lends them out at will, interest rates will once again be a direct function of the supply of (as well as demand for) capital inside the system. Yes, banks will still be able to conjure "thin air money" on their balance sheets to make loans, but the aggregate of loans within the banking system will once again be constrained by the capital ratios in the banking system as no secondary market for this debt will exist. And as a result, we will witness the return of prudent lending standards.

All of these subtle changes/differences will flow from the inevitable loss of the paper gold market that presently denies us the stable benchmark that is gold's ONLY job. As will the end of the seemingly infinite well of power that currently springs from the U.S. dollar printing press. And with the loss of this free-flowing fountain of power what I like to call a global **meritocracy** will emerge. And by global I mean on all scales, from national, regional and international on down to the individual.

Through the unavoidable **meritocracy** that is coming straight at us with the inertia of a runaway locomotive, we will witness the unexpected retreat of the social welfare state as well as the reversal of the destructive force of regulatory capture. You see, without the captive money of the savers to be diluted, the printing press becomes a self-defeating mechanism that will be controlled because it will be in the self-interest of the printer to do so. As F.A. Hayek wrote (which I quote and source in Windmills, Paper Tigers, Straw Men and Fallacious Fallacies):

"There are many historical instances which prove that it is certainly possible, if it is in the self-interest of the issuer, to control the quantity even of a token money in such a manner as to keep its value constant."

"I have no doubt, and I believe that most economists agree with me on that particular point, that it is technically possible so to control the value of any token money which is used in competition with other token monies as to fulfill the promise to keep its value stable."

As for running straight back to a gold money system (instead of Freegold), Hayek writes (which I quote and source in Freegold Foundations):

"I do believe that if today all the legal obstacles were removed… people would from their own experience be led to rush for the only thing they know and understand, and start using gold. But this very fact would after a while make it very doubtful whether gold was for the purpose of money really a good standard. It would turn out to be a very good investment, for the reason that because of the increased demand for gold the value of gold would go up; but that very fact would make it very unsuitable as money. You do not want to incur debts in terms of a unit which constantly goes up in value as it would in this case, so people would begin to look for another kind of money: if they were free to choose the money, in terms of which they kept their books, made their calculations, incurred debts or lent money, they would prefer a standard which remains stable in purchasing power."

Why Freegold is far better than Another run through Another gold standard time-line which will ultimately end like all the gold standards of the past is Another subject altogether. Check out my post The Debtors and the Savers for a clue to my Thoughts on it. But for this post I simply wanted to lay out the many ways Freegold is different than what we have today.

So here is a quick cheat sheet of the differences covered in this post (which really only superficially scratches the surface as I said I would do for Peter):

Stable physical-only supply
Stable, wide, awake and global demand
Much higher price
The end of captive savings
The end of gold traders
Unambiguous ownership
Supply resumes its role in fiat interest rates
The return of prudent lending standards
The return of capital ratio relevance
The retreat of Socialism
The reversal of regulatory capture
Meritocracy

This is not a dream or utopia. It is simply the swing of the pendulum. If this list seems to you to be too good to be true, then I suggest you spend some time in the archives and give it a little more Thought. As FOA wrote, "This not only has everything to do with a gold bull market, it has everything to do with a changing world financial architecture. And I have to admit: if you hated our last one, you will no doubt hate this new one, too."

"Return to a gold standard" advocates like Peter Schiff have a really hard time wrapping their heads around Freegold because they are so focused on monetary currency that circulates when what really matters is monetary wealth that lies very still. I think the simplest way to express the separation of these two monetary roles to the gold standard advocate is the application of Gresham's law. "Bad money drives good money out of circulation." In other words, the bad (fiat) money circulates while the good (gold) money lies very still… and floats in value relative to the circulating bad money.

Sincerely,
FOFOA

PS. Blondie gets the one-liner of the day award: "So I guess 'Peter Schiff was right!' destroyed any chance of him getting out of his own way." – LOL



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Possibly related:

Peter Schiff echoes FOFOA on U.S. currency crisis
By GoldSubject on May 9, 2010
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