The Gold Must Flow

In the last thread of comments, Jaqship asked about the possibility of a future Freegold tax, a punitive tax on gold meant to intimidate regular folks and steer them away from gold, and also to capture for the collective any windfall profit coming from a gold revaluation. Jaqship, who gave me permission to use his real name, is a long-time reader and supporter named Jeffrey Schramek. Jeff has an interest in these questions because he deals in rare and valuable historic treasures including a 1935 Nobel Prize made from 23K gold. Here is his website.

Jeff is certainly not a paper bug because his savings are tied up in these rare artifacts, not in a 401(k). And it turns out that moving from hard assets into bullion is a tougher calculation than moving from paper into gold. Really big money loves hard assets with numismatic and rare value because you can transport a lot of value through time and space in a much smaller package than you can with plain bullion. Also, billionaires aren’t as concerned with profiting from revaluation as they are with simply preserving what they already have.

The coin above is a Brasher Doubloon which was recently sold by a dealer in Irvine, California for $7.4 million, the most expensive private coin sale on record. The gold content of the coin is worth around $1,300 today, so that's a numismatic premium of about 570,000%. And while premiums won't enjoy the windfall revaluation of the metal, they will likely hold their present value quite well, preserving and shuttling purchasing power in a very small package. Imagine, you could fly anywhere with that coin mixed in with the spare change in your pocket.

The point is that the questions of taxes and confiscation on plain bullion are important to someone who is already holding hard assets and considering his options. And part of Jeff's reasoning was that gold bullion would be the most likely metal to be taxed "precisely because gold is useless" to the economy. So I thought this was an important enough topic that I'd take a stab at answering his questions in a post, so that everyone can benefit and discuss these issues. Here are a few excerpts from his questions in the previous thread:

Jaqship said…

My fear is that they will at some point mess with what is left of the middle class, e.g. by imposing a punitive tax on gold sales -- to intimidate regular folk from using gold to protect themselves from HI. Maybe likewise on sales of silver and platinum, although to attack those largely- industrial metals may bring unacceptable immediate harm to real production in the economy.

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Given that "the Right People" control policy, what's to stop them from the proxy confiscation
of draconian tax rates in the US (enforced upon all but themselves and their friends)?

Precisely because gold is "useless", such taxation of it wouldn't put what's left of the economy at the sort of risk that such taxation of industrial metals like silver (and maybe platinum) could cause.

If so, moving much capital immediately post-Freegold into silver might be the wise course for Americans.
Am I missing something?

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"Once the USA sees capital escape..." assumes that such escape will not be blocked for all but "the Right People" (who would be allowed to duck the harsh taxes anyway).
Italy has already introduced draconian capital controls.
The IRS and DHS may enjoy working together to crush any gold etc. Black Market that tries to emerge.

My guess is that much of US policy in recent years is driven by the aim of the Elites to stealthily reduce the masses to peonage, preferably without crashing the whole economy.
If this is right, silver (because it is so used in industry) may be the only safe haven which the Elites may hesitate to harshly tax.

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"the large gold holders will run the country. They won't make rules that hinder themselves."

I fear they will indeed make such rules, but they'll arrange that the rules are only enforced against shrimps; just as they have been doing for the last 10+ years, e.g. against small brokerage houses (most of whom have had to fold).
(This collapse of the US system's rep for fair treatment has much to do with gold's recent rise, according to folks like Janszen.)


"... they'll be more than happy to tax silver into oblivion -- exactly *because* it is necessary for industry."

Only if they'll be OK risking the utter collapse of an already dying economy. I must admit that they may be just fine with that, but they may flinch at that extreme; they may be OK with what their handiwork will already have done to enserf the middle class.

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Hi Jaqship,

This is a common concern, that the higher the nominal gain, the higher the tax that will be levied on that particular asset. It is sometimes called a Windfall Profit's Tax. The last time we had such a tax levied in the US was in 1980 on the oil companies. That tax was repealed in 1988 and we haven't had one since. The tax was on producers of oil since the second oil crisis of the 1970s, the Iranian Revolution, reset the price of oil from $15 in early 1979 to $37 in 1980. President Carter decided to deregulate domestic oil prices allowing the oil companies to increase production and ease the shortage. But in return for the deregulation, the government decided that the majority of the difference between production cost and price should be captured by the hungry collective.

But there are a couple of things to note here. First of all it was actually an excise tax on domestic oil and not really a profits tax. And most importantly, it was a tax on producers. I fully expect such a tax on gold producers once we see the way the Superorganism resets the price of gold far above the cost of production. But to see why this will NOT be the case for private gold—gold which has already been mined and is now held in private ownership—you must try to understand why and for what purpose the human Superorganism is revaluing physical gold.

There is a purpose for highly valued gold in Freegold. It has everything to do with the savers (net-producers) in the economy, and little to do with mining companies. Miners will become tools for the state, much like the printing press is a tool today. Only the gold already in the hands of savers will be revalued to the benefit of private parties. Gold in the ground will be viewed much like oil in the ground in 1980. As it comes out of the ground most of the substantial difference between production cost and price will be captured by the hungry collective. But before we talk about windfall taxes on gold savings, there's something you really need to understand.

The Gold Must Flow

The bottom line is that private gold needs to flow as a fertile member of the balance of trade. There will be no advantage for the USG to confiscate or tax above-ground gold this time. Gold may be utterly "useless" to the present debt-based economy, but it will be absolutely vital in the Freegold economy. (Here's a comment I wrote last April about the importance of privately held gold.) This seems incomprehensible when viewed from within the current paradigm which is why you must try to put yourself in the next one to see what I'm talking about. I can try to help you see what I see. It's not easy to explain, but I'll certainly give it a valiant effort once again.

Here's the way to look at it. Today the US is running a trade deficit of 21%. We import $2.34T worth of goods and services but we only export $1.84T for a deficit of $500B or 21%. What this means is that we pay for only 79% of our imports with goods and services in return. The other 21% we borrow and then consume. Every day, every month, every year, we are borrowing and then consuming 21% of our imports. And even though the private sector has cut back on its consumption since 2008, government sponsored consumption has increased so the total hasn't changed much. And 21% is about the average for the last 30 years.

All those goods and services that we borrowed and consumed for decades on end can never be paid back. And they never will be paid back. This is a certainty. But that doesn't mean it will continue. And that's what this paradigm shift is all about. That's why the Superorganism is revaluing physical gold. So that the gold can flow along with all the other goods and services in payment for imports.

We do export gold even today. US gold exports flow primarily to London, Switzerland and India for reasons that should be apparent. But the way gold is traded on the markets today sterilizes it in terms of globally moderating and regulating the delicate balance of trade. Gold is still traded in terms of debt, or paper promises of future gold. Gold debt. This is what goes out most of the time, and any kind of international debt only increases imbalances while actually reversing the spur and brake forces a physical-only gold market would otherwise exert.

It's kind of like if you built a car where the accelerator and brake pedal functions were reversed. It would be really hard to drive that car without eventually wrecking it if every time you needed to brake you accelerated, and when you needed to accelerate you came to a stop.

Imagine that Germany is shipping more goods to London than it is getting in return. So Germany is supporting London's trade deficit in the same way that China is supporting ours. Germany is letting London "borrow" extra goods and then consume them. In exchange, let's imagine that London pays for its trade deficit with paper gold, just like the US pays China with US Treasury debt. Germany will start stacking the paper gold in the same way that China stacks Treasuries. The debt will grow. The imbalance will grow. Nothing has actually flowed opposite Germany's goods and services except debt.

If, on the other hand, physical gold flowed from London into Germany and the price was high enough that it offset the trade deficit, then there would be no trade imbalance. There would be no accumulation of debt. Everything would essentially be settled on a cash basis with no international debt. But in order for this to work in reality, the price of gold will have to be much higher than it is today because there's simply not enough gold to flow at today's prices in order to fill the trade gaps that already exist.

And here's another interesting note. It won't matter if London is still using the pound or if they switch to the euro. The gold still balances trade as it flows. So no, it's not a flaw of sharing the same currency that the PIIGS can't balance trade with others in the euro's core. It's a flaw of the current system which existed long before the euro was even born. Within the current system, the euro does remove the possibility of local currency collapse as an alternative adjustment mechanism, but honestly, that's part of what they wanted with the euro. The current system is one of irreversible debt-buildup and gold-debt which sterilizes the flow and price of gold.

Spur and Brake

Once gold is flowing at a high enough price to balance international trade, it will start accumulating in countries that run a trade surplus excluding gold (including gold, trade will balance). Likewise, it will start disappearing from those countries running a trade deficit ex-gold (excluding gold). This is how the spur and brake forces work on an economy in Freegold.

As the gold supply within a "deficit ex-gold" nation dwindles (think: USA), each piece remaining will become more and more dear in terms of other goods and services within that zone. In other words, the purchasing power of gold will rise in the "deficit ex-gold" zone vis-à-vis goods and services in that zone. Likewise, the purchasing power of gold will begin to fall in the "surplus ex-gold" zone (think Germany or China) versus goods and services in that zone because of the large and growing accumulation of gold.

At this point the large quantity of gold in the "surplus zone" will have a lower purchasing power against goods in its own zone, but a higher purchasing power abroad in the "deficit zone" and demand for imported goods will grow while exports will start to fall. This growing demand from abroad will be felt in the "deficit zone" and will be met with new supply. Likewise, the falling demand for imports from the zone with a declining volume of gold will be felt in the "surplus zone" and be met with decreasing supply. Incrementally, the "surplus zone" will slow production and increase consumption while the "deficit zone" experiences the opposite effect. Excluding gold, the balance of trade will shift back and gold will start to flow in the other direction.

Notice, please, that I'm not even talking about the flow of currency or price inflation/deflation in currency terms. Inflation or deflation in currency terms can be happening in either zone depending on how the monetary authority is managing the currency. But what matters in terms of the real trade flow will be the purchasing power of Freegold (not in currency terms, but) vis-à-vis the rest of the trade flow of goods and services.

If you have high currency inflation in the "deficit zone" because the government is printing like crazy, the price of gold will be rising even faster than the price of goods and services. On the contrary, if you have high inflation in the "surplus zone", the price of gold will be rising more slowly than the CPI, exerting its brake force on the economy because gold will still be found to have increasing purchasing power abroad and decreasing purchasing power on goods from its own zone. In other words, gold will be exported to other zones where its purchasing power is higher, spurring those other zones to produce more and putting the brakes on the overheated economy in the "surplus zone".

This flow will continue reversing back and forth forever, as it should be, because there is no such thing as a perfect equilibrium. And again, I want to draw your attention to the fact that I'm dealing only in the physical plane, ignoring the monetary plane. This is what Freegold does. And it doesn't matter if the "surplus ex-gold" and "deficit ex-gold" zones each have their own currencies or if they share a single currency. It still works the same way. Savers run the economy. Savers are the marginal surplus-producers and consumers. When the savers start saving more, it means the economy is producing more. When the savers start dishoarding and consuming, the economy is producing less vis-à-vis its balance of trade. This is the spur and brake force of Freegold, the international demand driven by the fluctuating purchasing power of gold as felt by the savers, regardless of any transactional currency effects with which the debtors may be tinkering.

Now that I've given you a brief description of how Freegold will work in the physical plane (it will also exert forces on the monetary plane, but that's a big subject for another post), let's take a quick look at how the present debt-based system, the $IMFS, differs in that it exerts the exact opposite spur and brake forces. In the present system it is debt that flows to fill in the same trade gap that will be filled by physical gold in Freegold.

As I said above, the US pays for 79% of its imports with goods and services exports. But the remaining 21% it pays for with debt that accumulates year after year. The US is the "deficit zone" and its trading partners who are accumulating US debt are the "surplus zone". Our trading partners send us 100% goods and services and we send them back 79% goods and services plus 21% US dollars. They then have to do something with those dollars. But they already have more than $4 Trillion in accumulated US debt. So what to do with those new dollars that keep coming?

If they were to insist on spending those extra dollars on more goods and services in order to balance trade, they'd simply drive up the dollar prices of goods and services relative to their own domestic goods and services. In the physical plane final analysis, they'd still receive less back from us than they sent us, and they'd simultaneously collapse the value of their $4 Trillion accumulated debt. So instead, they loan those extra dollars back to us at a nominal (not real) rate of interest and then we use them (again) to buy more of their goods.

So the more debt that flows as payment into the "surplus zone" economy, the more it is spurred to produce even more goods for the "deficit zone" to borrow. And the more "deficit goods" that flow into the deficit zone, the more dollars that must be recycled and the more the "deficit zone" must consume, which is, in effect, a brake force on the consumption-based economy. The brake force is being applied to the "deficit zone" and the spur force to the "surplus zone". The opposite of Freegold.

When debt flows, deficits accumulate and grow requiring more accumulation and more debt. The net-consumers are incentivized to net-consume more and more and the net-producers to produce ever more. There is no adjustment mechanism, no natural governor. This simply continues until the whole thing collapses. That's the only adjustment mechanism: periodic collapse. That's the $IMFS.

(For more on the Freegold adjustment mechanism, search for the word "Greece" in these two posts and start there.)

Strong Hands

So that's where the Superorganism is taking us. But before I get into the issues of a windfall profits tax and confiscation under Freegold, I want to discuss one more concept, the concept of strong hands going into Freegold.

When anyone talks about "gold" today, that word identifies a whole panoply of gold-related investment options. They include unallocated gold credits, forward contracts for future gold, futures contracts for trading, ETF shares, gram-denominated savings accounts and e-money platforms, mining company shares, exploration company shares, certificates, options, derivatives and more. There are many ways to invest in this thing called "gold" through various counterparties today. And it is the market interplay of all these various options, much more so than transactions in and movement of physical, that determines "the price of gold" as it is widely referenced today.

This is what we mean when we say that today's "price of gold" is not the price of physical. Yes, you can still buy physical at that price, but it is the price of a wide range of products claiming the name "gold" more so than it is the price of a specific metal element.

This conglomeration of many tradable, counterparty options that purports to be part of something called "gold" is struggling to stay together as "the price of gold" rises. Market mavens like Jim Sinclair have long predicted the arrival of violent swings of magnitude as "the price of gold" battles its way higher. And it seems this breathtaking volatility may be just around the corner today.

In just the last 12 months we've seen "the price of gold" run from $1,350 up to $1,900 and then back down to $1,530. Not only that, but "gold" shot up $400 in just 7 weeks during July and August, and then it plunged $300 in three weeks. I wonder what the next run will look like. If it follows the same percentages as last year, we'll hit a very special number this year.

Each time the price swings up and down like this the "gold" traders trade their way in and out of their favorite paper gold positions. But the physical side is slowly working its way into stronger and stronger hands with each swing. Strong hands buy the dips while weak hands are selling in a panic.

I heard a story from a dealer recently about a poor sap who'd bought a bunch of Eagles from a company that advertises on TV, paid too high of a premium to cover all that expensive advertising, and he had also taken physical delivery which is why I heard the story. On the last big plunge into the $1,500s he walked into this dealer with his box of gold coins, head hung low, ready to cut his "losses". That's a weak hand. Someone who doesn't understand what he's doing when he buys gold coins.

As I've noted before, when I started this blog back in 2008, the highest "gold price" predictions I had ever encountered (other than A/FOA) were in the range of $1,650 to $2,000 per ounce. That has obviously changed. Today we read a variety of future price predictions ranging from $5,000 on up to $50,000 per ounce. But the problem I see with my fellow high price prognosticators is that they don't support those prices with an explanation as fundamental as Freegold. This is a problem.

That special number I said we could hit this year, if the trend doesn't accelerate and simply repeats, is $2,333. The low to high in the last 12 months matches a rise from today's price to about $2,333 in the next 7 or 8 months, if we were to have an exact replay. And the problem is that $2,333 is the inflation-adjusted (based on official inflation) peak from 1980.

Fair warning to all gold bugs who don't understand Freegold

I'll make a prediction right now. As we approach and surpass $2,333, other high price predictions notwithstanding, you'll read articles from all of your favorite gold bug writers making the comparison with the 1980 peak. And if the ascent is anywhere as vertical as it was back in July and August, that comparison won't be lost on a single gold bug. No one wants to miss the top like so many did back then.

So when it starts to fall after a vertical rise, and it will fall, no one will be thinking about those other high price predictions. Instead, they'll be thinking "get out now, just in case. I can buy back in later and make a profit." This group will include all paper gold traders as well as a good portion of the "physical" gold bug community. And because of the "specialness" of that number, $2,333, there won't be any paper gold buyers trying to catch the knife, so it will fall hard. Possibly too hard. No one wants to be that guy who bought on the way down in 1980.

This could potentially be the final shakeout of weak physical hands, because there will be plenty of strong hands catching that physical even though physical buying won't stop the price from falling. Unfortunately for a few long-time gold bugs, the lack of a fundamental and foundational understanding of a much higher value could see them liquidating at the worst possible time in all of history. And that would truly be a shame. At least I have given fair warning. I'm not predicting that this is the way it will play out. Only that it could. And being aware of this possibility has value if it gives you strong hands at a key point in time.

Tax That Gold!

Now we can talk about windfall taxes and confiscation (related topics). Hopefully you were able to absorb the above concepts. The human Superorganism is revaluing gold vis-à-vis not currency, but everything else, for a purpose: the gold must flow. Again, the Superorganism is revaluing gold in real, not nominal, terms. (It is also devaluing the US dollar in real terms, but that's a separate subject for a vastly different post.) And going into Freegold, physical will start out in the strongest of hands, meaning people like you and me who know what it's worth in international terms and Giants who don't need to sell during suboptimal conditions.

But before I get into taxation, I'd like to discharge the confiscation meme once and for all. Physical confiscation only makes sense if you are going to confiscate the gold and then, and only then, nominally revalue it yourself hoping that your currency is strong enough that a nominal revaluation actually delivers you a real windfall (see: 1934). But as I said earlier, the human Superorganism is revaluing gold this time, not FDR or the USG. So taxation is the only option. That said, I would not leave my gold where it, or my capital gain, could easily be automatically absorbed during a short-lived government misstep, which is why I recommend personal possession or at least the closest thing to it.

The first thing you need to understand is that the IRS taxes nominal gains only. It does not tax real gains. It is as blind to real gains as it is to real losses. The tax law would have to be completely abandoned and rewritten from scratch in order to tax real gains. This is not going to happen.

So let's make an assumption and see where it leads. Let's assume that the Freegold revaluation has occurred and the USG has decided to impose a 90% windfall profits tax on its citizens who hoarded physical gold through the transition. What will be the consequences of this action and who will be hurt?

Now, because the US is blind to real gains, you'd have to sell your gold at the new Freegold price in order to make a taxable nominal gain. Until you sell, you still have the same thing you had before the revaluation, a single gold coin. For all they know you'll hang onto that gold and the price will once again fall and you'll still just have one gold coin worth much less. Or maybe you'll lose it in a boating accident, or it will be stolen, and you'll have no gain. The only gain the IRS recognizes is nominal gains. (Here's a comment I wrote back in 2010 on future gold taxes.)

Part of our premise in this exercise is that Freegold has arrived, along with everything that comes with it. So even though the USG has misstepped and put on a 90% gold tax, the rest of the world has not and is now enjoying a technically balanced trade flow along with the reappearance of Jacques Rueff's "forceful but unobtrusive master, who governs unseen and yet is never disobeyed."

Let's ignore hyperinflation for now and talk in constant dollars. Gold now has the purchasing power of $55,000 in 2012 constant dollars. Your gain per ounce is roughly $53,500 and the government wants 90% of that money, or $48,150 leaving you with only $6,850 worth of purchasing power for every coin you choose to sell. Meanwhile, those strong hands in other Freegold countries have $55,000 in purchasing power for each coin they choose to sell.

Strong hands in the USA have $6,850 in constant dollar purchasing power. Strong hands in the ROW (rest of the world) have $55,000 in purchasing power. The gold must flow, but will it flow from the USA as much as from other deficit countries under these conditions? If it does flow, it will still flow across international borders at the new Freegold value and vital goods and services will flow back into the US. But only 12.5% of the purchasing power of that gold will go to the person with the choice of "to flow or not to flow" while 87.5% goes to the USG.

Tax laws always change, and this is a fact that will also be factored into the decision "to sell or not to sell" that strong hands in the US will face. Another factor is black market arbitrage. A strong hand in the US won't have to engage in smuggling gold out of the country himself in order to gain more purchasing power than $6,850. With $48,150 per ounce in potential black market profit (that's $1.5 billion per smuggled tonne), it's not hard to imagine a vibrant black market that would gladly pay you twice your $6,850 off the books.

So if the gold in private hands in the US doesn't flow in sufficient amounts, given that US debt has been discredited through the Freegold phase transition, the government will have no choice but to continue printing money in its vain attempt to support the US trade deficit and its own status quo as Uncle Sugar to the people. And in a last-ditch effort to support its own failing currency, it will have to ship Fort Knox gold overseas. FOA mentioned something about this: "…the US will find itself shipping ever higher priced gold to defend an ever lower valuation of dollar exchange rates."

In this scenario, the need to continue printing in the face of an ongoing currency collapse will obliterate any miniscule gain that comes from the few shrimps who actually decide to sell their gold in an untimely way and pay the tax. The US has precious little gold in private hands as it is. And it will need that private gold to flow. It needs you to sell your gold to your dealer so your dealer can export it to our trading partners. That's how trade flows will resume under the new paradigm, with savers choosing to let their gold flow because of the amazing purchasing power it delivers.

And with international trade flowing again, the government will have much more economic activity to tax than it did when it tried to tax real capital in its purest form based on the silly notion that the hungry collective deserves a windfall nine times greater than the gold investors who kept gold inside the zone through a turbulent transition. The bottom line here is that I do not know if the USG will try to tax the windfall profit that comes from Freegold. What I do know is that, if they do, it won't last very long.

And once again, being aware of this possibility has value if it gives you strong hands at a key point in time.

Sincerely,
FOFOA

PS. See Mortymer's comments below for info on Euro-area gold taxes.