Welcome back, Ari!! If you don't know ARISTOTLE, that's probably because he took a brief hiatus of 7 years and 3 days from posting comments about Freegold. And that was after 6 years of posts and comments prior. So needless to say, I'm THRILLED to have him back!
Ari wrote me an email the other day including this: "In the meanwhile, I'm happy to note that Bill Gross has (yet again) stepped up to the challenge of carrying some water for us today. Begins folksy and ends golden. Now that's what I call having a worthy waterboy(!),,, he being manager of the largest mutual fund on the planet (i.e., PIMCO's $242 billion Total Return bond fund)."
Here's the quote with which Bill Gross begins his latest and greatest, Life and Death Proposition:
Where do we go when we die?
We go back to where we came from
And where was that?
I don’t know, I can’t remember
Virginia Woolf, “The Hours”
With this lead-in he draws a comparison between death and the hereafter, and the death of our financial system built upon the lending of real savings to debtors with what comes next. He goes on to explain, "The transition from a levering, asset-inflating secular economy to a post bubble delevering era may be as difficult for one to imagine as our departure into the hereafter." But at least he gives it a shot with a little help from Virginia, ending with, "Where does credit go when it dies? It goes back to where it came from."
Now, while I can't help you very much with the pearly gates, I can indeed help you imagine the monetary and financial hereafter. It matters little to me if you believe me or not, because I still think there is value in sharing this vision either way. Someone (who incidentally named his band Third Eye Blind) once remarked, "I don't really believe in crystal balls, but I respond to the need for them." And so now I'll dust off my own very special crystal ball with a wink and a nod to a few of you who understand this need.
I do recommend reading Bill's entire piece as he lays it out nicely how hitting the zero-level floor in USD interest rates is inevitably leading to a "liquidity trap" for earned savings. It sounds to me like the inescapable gravitational pull of a black hole singularity that, perhaps, creates similar difficulty in trying to see through to the other side.
Bill Gross is in the business of helping savers lend their savings to debtors through the use of bonds. And he has done very well in this business, which is why he is acutely tuned in to the implications of zero interest. With zero interest, you can't earn a yield or a capital gain as you can when interest rates are high and falling. And so there is no reason for savers to lend money to debtors for the longer terms necessary in order to run an economy. In fact, it is terribly risky for savers to do so in a zero rate environment.
The New Normal
There is no "fiat management" solution for the problem Bill describes. The savers simply cannot lend their savings to debtors anymore in a way that is beneficial to both the economy and the savers. Even the King of the bonds himself is sounding this alarm. But there's another trend in this new normal that should be even more alarming to savers still holding longer dated debt. Whenever and wherever push comes to shove, the savers will be and are being forced to take losses while the system protects itself on a nominal basis. Just look here:
Obama to Use Pension Funds of Ordinary Americans to Pay for Bank Mortgage "Settlement"
"[P]revious leaks have indicated that the bulk of the supposed settlement would come not in actual monies paid by the banks (the cash portion has been rumored at under $5 billion) but in credits given for mortgage modifications for principal modifications. There are numerous reasons why that stinks. The biggest is that servicers will be able to count modifying first mortgages that were securitized toward the total. Since one of the cardinal rules of finance is to use other people’s money rather than your own, this provision virtually guarantees that investor-owned mortgages will be the ones to be restructured. Why is this a bad idea? The banks are NOT required to write down the second mortgages that they have on their books. This reverses the contractual hierarchy that junior lienholders take losses before senior lenders. So this deal amounts to a transfer from pension funds and other fixed income investors to the banks, at the Administration’s instigation."
Please allow me to translate. If you or your pension fund bought any kind of fixed-income securities (also known as bonds), you loaned some of your savings to debtors. Private debt is created by banks expanding their balance sheets. Some of it remains on the bank balance sheet and some of it is sold to savers like you. Securitized and sovereign/public debt is the $IMFS proxy for gold. But when the debt defaults, the savers take the loss. The system will be protected at all costs. It may make you angry, but that's just the way it is and always has been.
So it appears that the system will write down the debt held by savers before that held by the banks in this case, to protect the system. When debt defaults, SAVINGS are destroyed because debt is the proxy for a store of value in the $IMFS. Wherever possible, earned savings will be forced to take the losses first. But if too many losses happen at once, they will be socialized to protect the system. The system always protects itself, first by sacrificing the low hanging fruit, then by sacrificing the currency itself.
I'm sure that by now you have all learned the two new buzz-terms, "the ISDA" and "the credit event". If not you can read about them here. Basically, a group consisting of bankers has the job of deciding whether the banks or the savers will take the loss on Greek debt. The deck is stacked against us wherever we turn.
I'm not here to cast judgment on this systemic inequity between banks and savers. I have long followed in FOA's (and ARI's) footsteps in pointing out that this is simply the way it has always been. That's a pretty good reason to not save within the system, wouldn't you say? When push comes to shove, the system will protect itself and force losses onto the savers. Ultimately, inevitably, today's dollar will lose so much real value that it will save the banks nominally while putting all systemic losses onto everyone holding dollars, regardless of the default of debtors.
Here's a quote from an article that caught my eye the other day:
"It’s tough for risk averse savers but that is what US monetary policy has been about—forcing them to buy risk, and higher returns. That policy is working but trillions of savings still sit in cash or bonds."
Savers are not investors, traders or speculators
This little concept is something ALL Westerners are going to relearn one way or another. Mark my words right here and now. In The Studebaker Effect I wrote:
"A saver is different from an investor or a trader/speculator. A saver is one who earns his capital doing whatever it is he does, and then aims to preserve that purchasing power until he needs it later. Investors and traders aim to earn more capital by putting their already-earned capital at risk in one way or another. This takes a certain amount of specialization and focus. But this difference is a big topic for another post. And anyway, it doesn't matter so much in terms of the gold thesis for today.
Today the system is in transition, so you can throw your ideas about these differences out the window. There is no safe medium for simple preservation of purchasing power when the entire system shifts from the old normal to the new normal. When systems implode, the safest place to be pays off big time!"
That second paragraph denotes the difference between stasis and punctuation in monetary evolution. Today we are approaching a period of punctuation, but in the hereafter stasis we will all understand that savers are not investors, traders or speculators.
I have refined my best advice for buying gold over the last few years. Here it is, quoted from a recent email response I wrote to someone asking if his parents, serious savers, would do well to take on as much debt as possible in order to "save" more physical gold:
"Firstly, let me say that I never recommend anyone taking on debt to buy gold. That is what speculators do and savers are generally not equipped with the necessary tools it takes to be a successful speculator. There are too many potential pitfalls for savers to do something like that. In general, my advice is to get out of debt and put at least 5% of your savings into physical gold coins or bars in your possession (or at least under your immediate control). I believe that 5% is a no-brainer. You don’t really need to understand much about gold to go in 5%. But I wouldn’t do it in any kind of paper gold or even paper products claiming full physical backing. Paper gold is for ease in trading, not for saving. I say do it in physical and 5% will at least keep you whole come hell or high water.
Beyond that, I say buy only as much gold as your understanding allows. For many who have read my blog for years, understanding has led them to be 90% to 100% in physical gold. I, myself, am very close to that. And I know a few that have been 100% all in since the late 90s, with $millions in physical gold. But you don’t do that unless you have complete understanding of what you are doing and why. Only buy a percentage of gold equal to your understanding. 5% is a no-brainer and anything less than 5% is reckless pigheadedness with what's happening today. That’s my best advice."
You see, a saver is still just a saver, even today, even when we are in the punctuation phase. And that's not a put-down. The greatest giants in the world are savers. When we look at what it is to be a Capitalist, it is completely separate from the act of saving. The primary definition of a Capitalist is one who has capital invested in business.
There is a difference between preserving purchasing power and trying to increase your purchasing power by navigating your way through risk. As the quote above correctly describes savers, they are "risk averse". That's the very definition of a saver. Any deviation from full risk-aversion and a saver becomes something else; an investor, a trader or a speculator.
My point is that the header for this section is a deep concept, a timeless truth, a little bit of wisdom from the ages. Savers are not investors, traders or speculators. And since this post is about glimpsing the hereafter, give me a few minutes while I consult my crystal ball. Here's some music while you wait…
After The Transition
One of the things I have found that people have a hard time grasping is that ALL savers will want to be in gold after the transition, even though it won't deliver ANY real gains like we've had over the past decade. This is a difficult concept to wrap one's head around. People seem to think that they are in gold only for the big 30-bagger revaluation and then they'll want to find something else in which to put their little dollar soldiers to work earning a yield. Either that or they imagine that Freegold will be an environment of perpetual real gains for gold holders. It will not.
Freegold will be simple purchasing power preservation, and you'll love it! No gain, but also no risk and no loss. That's what savers need and want. And most of us are savers whether we admit it or not. This is a really big idea we need to contemplate if we don't want to be run over in the end.
Any financial advisor in today's $IMFS can explain the reasoning behind investing in fixed income securities also known as bonds. They are for risk-averse investors looking for a constant and secure nominal return on their investment. In theory, the safest bonds will deliver a nominal return equal to the purchasing power your principle investment loses to inflation over time. So, in theory, the safest bonds are supposed to do what gold will in fact do in Freegold, perfectly preserve your purchasing power over time.
How can gold perfect the preservation of purchasing power you ask? It's quite simple really. It will come from a global shift in perception as to the very reference point for purchasing power. What is the benchmark for purchasing power today? The Big Mac? Ha! Think about that one and get back to me. In the meantime, check out my post Reference Point Revolution!
So in today's system, securitized debt is the way various tranches of debtors bid savings away from the savers. And over the three or four decades in which this has been the norm, a strange concept has grown into nearly universal acceptance. That is the idea that savers have a moral obligation to society to lend their savings to the debtors, and that by hoarding gold instead, you are somehow depriving society of your vital net-production. An absolutely ridiculous, bass-ackward notion!
Charlie Munger said it this way:
"Oh, I don't have the slightest interest in gold. I like understanding what works and what doesn't in human systems. To me, that's not optional. That's a moral obligation. If you're capable of understanding the world, you have a moral obligation to become rational. And I don't see how you become rational hoarding gold. Even if it works, you're a jerk."
To Charlie I responded with this:
"So Munger and the Dingbat are wrong wrong wrong! You're a jerk if you save in paper, enabling the destruction of Western Civilization. Rational people everywhere have a moral obligation to buy ONLY physical gold with their savings. If you're capable of understanding the REAL world, you have a moral obligation to become rational. And I don't see how you become rational investing in Charlie Munger's paper. Even if it works, you're a jerk, just like ol' Chuck."
Imagine I produced 50 million iPhones for the marketplace. And through that net-production I was able to save $10 billion. If I buy gold with my $10 billion rather than lending it, am I depriving the economy of my iPhones? Of course not! Have I deprived the economy of my accumulated purchasing power? Nope. I simply gave it to another saver who was ready to end his consumption deferment. And, amazingly, the credit money system still allows the debtors to borrow purchasing power to buy my iPhones. But the best part is that hoarding gold does not deprive the economy of anything. You can read more about this concept and my response to Charlie M. in my post A Winner Takes the Gold.
Before and After
My long-time readers are aware that, beginning with All Paper is STILL a short position on gold in March of '09, I have been refining a conceptual model of the $IMFS stasis and punctuation periods based on the inverted pyramid developed by the deflationist economist John Exter in the 1970s.
Exter put gold at the bottom of the liquidity pyramid, just below the dollar. He said that gold was the most liquid asset. And in the end, he envisaged a rush down the pyramid to liquidity in which we would see the dollar and gold rise together for a time. As Gary North wrote in 2009, "So far, his theory has yet to be tested. We have not seen a rising dollar and a rising price of gold."
But I will note that ANOTHER wrote something in 1997 that seems to back Exter's view:
Date: Wed Nov 05 1997 20:33
ANOTHER (THOUGHTS!) ID#60253:
The price of the metal in currency terms will be made for all to see as it moves quickly upward for a very short period of time ( 30 days ) . After that only black market traders and third world noones will understand its price! When is this going to happen? I have no idea. Is there anything to look for that will tell us when the problems have started? At first the US$ and gold will go up together against all other assets!
8 months after the "All Paper" post I wrote Gold is Wealth in which I built an upright pyramid under Exter's, representing the physical plane of goods and services, and forming a kind of hourglass shape:
10 months later, in Just Another Hyperinflation Post - Part 3 I used this model to illustrate the flow of capital during a currency collapse:
And now, what I'd like to do is to take a stab at modeling what this might look like after the transition to Freegold. All modeling up until now has been before and during transition. But presumably things will look a little different hereafter, don't you think? Costata and I have been discussing where gold should go in the "after" model for a while now. Should it be in the monetary plane or the physical plane? Should it be parallel but off to the side of the currency, or what?
While we have not come to an agreement on the nitty gritty details of the "after model", I'd like to put my general thoughts out there because I think that you will find them useful (and my crystal ball says so too). So here's the very basic before and after. I have put gold up where the financial system collapsed in the old $IMFS. But don't worry, I'm not going to leave it there:
So what’s the purpose of this exercise? Here’s what I’m thinking. Everyone uses the bottom pyramid, both debtors and savers. And everyone uses the currency portion of the monetary pyramid. But only the savers utilize the top portion of the monetary pyramid. The debtors are no longer the counterparty to the savers so they have no business up there. The only way to get up there is to produce more than you consume so that you have some excess capital with which to buy gold. Then you are a saver. So it looks something like this:
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Yes, I do realize that there will still be investors, traders and speculators willing to risk capital in search of a yield, even in the hereafter. But once you come to terms with how much of that investing and trading world of today is actually filled with savers who think that's the only way to preserve purchasing power, you'll see just how tiny by comparison it will be after the transition.
We ALL exist in the physical plane. That’s where we produce and consume. Currency facilitates the flow of value in the physical plane of production and consumption. Some consume amounts equal to their production, some consume more than they produce, and some consume less than they produce. Only this last group ventures above the currency line. The rest all exist comfortably below it.
Currency’s main purpose is to lubricate the flow of value. Gold’s main purpose is to store or stockpile value. Stock and flow. Gold and currency. Currency will also store value for periods of time, but that is not its main purpose. If currency happens to behave as a temporary store of value, that’s only a secondary effect created by its suitability to its primary role. Mises said as much (which is in my Honest Money post):
Mises: Money is a medium of exchange. It is the most marketable good which people acquire because they want to offer it in later acts of interpersonal exchange. Money is the thing which serves as the generally accepted and commonly used medium of exchange. This is its only function. All the other functions which people ascribe to money are merely particular aspects of its primary and sole function, that of a medium of exchange.
It’s probably best to replace Mises' use of the term "money" with "currency" for the purpose of my new model. It comes down to the whole semantic issue of whether Freegold is DEmonetizing gold as FOA said, or REmonetizing it as Moldbug says. Potato po-tah-toe semantics IMO. FOA's demonetizing really means de-currency-fying, or removing any sort of link between gold and currency that would cause a direct correlation between their prices. Moldbug's remonetizing means gold moving from a commoditized role into a wealth reserve or store of value role, which is commonly thought to be one of the three functions of "money" today (although Mises might disagree as in the above quote).
So that whole gold section of the top pyramid is like an exclusive country club for savers, like the men-only clubs of yesteryear, where we savers all sit around smoking cigars, practicing secret handshakes and agreeing that we'll only buy gold with the excess left over from our net-production and deferred consumption. And if there was an actual club, the savings medium could theoretically be anything we agreed on, like baseball cards. But because there’s not an actual club nor a secret handshake, we rely on the focal point and network effect principles to identify and optimize that singular item.
All gold transactions are essentially from saver to saver. The debtors need not be involved nor concern themselves with our exclusive club interactions. When a saver produces some excess and leaves it on the proverbial table at the economic fair, he buys gold from another saver (either inside or outside of his zone) who has decided to dishoard some of his gold in favor of consumption. It is the changing purchasing power of gold that determines how much gold (by weight) changes hands. (Please review my post The Debtors and the Savers if you are unclear about my novel demarcation.)
Debtors net-consume on a sliding scale ranging from consuming exactly in proportion to their production on down to consuming as much as they can get away with borrowing. So netting it out, all net-exports from a zone come from the savers. The debtors consume their own production plus some of the savers' production, and if there’s anything left over it is exported. That’s what happens in the "surplus ex-gold zone". Gold is flowing into that zone. So the debtor's actions do have an influence on the balance of trade even though they don’t contribute to exports.
But when the debtors are borrowing too much currency and consuming too much in the physical plane, there is a mechanism in Freegold that ultimately slows them down. That mechanism is the purchasing power of the currency. When the debtors are consuming too much they'll experience price inflation which will force them to consume less. So it is the purchasing power of the currency that regulates the debtors. But changes in the purchasing power of gold within the exclusive savers' club is not linked to the mechanism which limits the debtors.
The purchasing power of gold can be rising or falling regardless of whether currency prices are inflating or deflating because gold is like an isolated circuit. Savers choose to hoard or dishoard (produce more or consume more) based on the changing purchasing power of gold, not currency. So the savers' savings is circulating in a closed circuit where it can be experiencing the same or opposite effects as the currency. It is truly an escape option like OBA's Maglev.
So we can cut gold off of the pyramid structure if we want to, and we can put it wherever we want. We can stick it back in the physical plane since gold is physical, just like baseball cards, or we can set it off to the side, or we can just ignore it and cut it off, like this:
Gold: The Ultimate Wealth Reserve (2009):
Imagine an island of 100 men with a money supply of 1,000 sea shells. That's 10 sea shells for each man. But over the course of a year each man on the island works and earns an annual salary of 100 sea shells. So the total economic power of the island over a year is 10,000 sea shells. We could say that the GDP of the island is 10,000 ss. We could also say that the demand for sea shells is 10,000 over the period of one year and that demand is met by a supply of only 1,000 sea shells.
Now imagine that ownership of a piece of real estate on this island costs about 2 year's salary, and that there are enough pieces of land for each man to either own or rent one. So each piece of property might cost about 200 ss. The entire island's worth of residential real estate would be in the ballpark of 20,000 sea shells, twice the GDP. Yet the money supply still remains at 1,000 sea shells and that limited supply somehow meets demand.
The reason this works is because sea shells are the currency. They circulate and pass from hand to hand over a short timeframe. This is called velocity and it has the exact same effect on the value of a single sea shell as does the size of the money supply. On our island 1,000 sea shells change hands 10 times per year creating an island GDP of 10,000 ss. If they changed hands 20 times a year the GDP would be 20,000 ss. Or if we doubled the money supply to 2,000 sea shells that changed hands 10 times per year it would also yield a 20,000 ss GDP. So velocity and money supply of the currency have exactly the same effect.
So we can have a physical plane whose total net value is much greater than the total amount of cash. That’s because "The pure concept of money is our shared use of some thing as a reference point for expressing the relative value of all other things." (quote from Moneyness, a must-read post IMHO!)
Same goes for gold. All the gold can be worth many multiples of all the currency. There is no need for any correlation. Gold (in size) circulates slower than homes. It circulates on a generational time scale. So the currency denominates the value of everything else without needing to have any quantitative correlation with all that stuff. Can you imagine if there had to be $500,000 cash sitting in a vault somewhere earmarked specifically for your house in order for your house to be worth $500,000? No, of course not! Your house is worth $500,000 because that's its value relative to other things with known prices.
So now let's talk about the debtors.
What they like to do is indenture themselves for the future in order to obtain purchasing power in the present. They can only spend that purchasing power once and then it's gone. It has gone from them to someone who earned it. So the next person who spends that "borrowed into existence currency" is someone who already contributed to the economy and earned it. The borrower gets to spend it once and then he has to work it off by contributing to the economy over a period of time.
In the previous section I told you that price inflation will be the automatic governor of any consumption binges undertaken by the debtors in the hereafter. But while price inflation will limit the debtors' ability to perpetually consume, it will not affect the purchasing power stored in gold by the savers. In fact, my crystal ball informs me that it is the savers lending their excess production directly to the debtors that allows for the perpetual deficits we struggle with today.
I think that if we look closely at how the debtors use the fiat money system with and without the assistance of the savers, it will become clear that we will all be better off with a bifurcated monetary system. And it will certainly be clear that the savers have no business taking debtors on as the counterparty to their savings.
It would certainly be massively inflationary if we went from no debt to all of a sudden everyone borrowing at the same time. But in reality, there is someone working off his past debt whenever a new debtor goes into new debt. Of course old debtors and new ones don’t precisely offset each other, but that’s okay, because gold savings first float against the currency, and then they also float in their isolated circuit of choices made by savers based on the changing purchasing power of gold (not its currency price, but its purchasing power).
So gold has kind of a double float. It floats with the inflation/deflation of everything else. And then it also floats in a closed circuit consisting only of savers (and their "hoard/dishoard" choices), of whom the majority (measured by value stored) are intergenerational giants.
Now that I've hopefully established that in the hereafter a) "a little money (currency) goes a long way" and b) the savers are sufficiently protected against any inflationary mayhem the debtors may cause, let's zoom in on that small "monetary plane" and think about how it works.
In a future post I plan to delve into the vital and delicate relationship and balance between base money and bank credit money and how it affects the value of our money in terms of its ability to lubricate commerce. But for now, I have a couple of questions for you to ponder.
In thinking about the money supply (cash and credit inclusive) that is actually in the economy, would you count cash that is stacked up inside an ATM as part of that supply? Here's a hint: That cash is not in the economy until someone withdraws it from the ATM. If you count it while it's still inside the ATM then you are double counting that money.
Is it a positive sign for the future when there are $Trillions in savings sitting in cash and near cash equivalents? All that money must mean we are loaded, right? It must mean our cash dollar is strong which implies the market thinks it will be that way in the future, right? If $Trillions are good, wouldn't $Quadrillions, $Quintillions or $Sextillions be that much better? And with this thought in mind, does a rising amount of savings crowding into cash and near-cash equivalents represent a positive or negative view of the future?
Those super-low rates at the short end of the yield curve represent really big money, too big for FDIC protection, that just wants to save itself. It is big money that, like Bill Gross says, is far more concerned about the return of money (purchasing power preservation) than the return on money (yield). That short end is an awfully crowded place in the land of ZIRP forever and monetary evolution, especially when you consider the time factor. (H/T OBA)
Of course, what I have described above is a simple model. The reality will be a bit more complex. For instance, gold will have some competition although it will be tiny in comparison to today. Some government debt will likely compete for your savings. But the US government, for example, will have to compete just like the Greeks do today. And we will still have a much more limited menu of investments and trading opportunities to lure you into putting your hard-earned savings at risk.
Like I said at the top, I can't help you much with what it will look like after you die. My crystal ball ain't that kind of crystal ball. But I can tell you that somewhere, some way, some day we will all find out. Fortunately though, my crystal ball does work for the monetary and financial future. It paints a nice, clear picture, yet on timing it's still a little hazy. But one thing it does make perfectly clear is that it's just a question of time.