Sunday, February 19, 2012

Yo Warren B, you are so OG!


Tell me why are we, so blind to see
That the ones we hurt, are you and me

-Artis Leon Ivey Jr. (aka Coolio)

I'd like to sincerely thank Warren Buffet for so clearly making many of the points I've been trying to make lately in his most-recent submission to Fortune magazine. If anyone hasn't read it yet, it's called 'Why Stocks Beat Gold and Bonds' and you can read it here. Of course, with the King of Bonds himself ringing the closing bell on the bond market just last month, I'm guessing that Warren was aiming at gold more than at bonds with this piece. Bless his heart. Yo Warren B, you're so OG (but your aim ain't quite what it used to be)!

Alrightythen, let's just tear into this juicy carcass and have us a feast!

Warren B: Investing is often described as the process of laying out money now in the expectation of receiving more money in the future. At Berkshire Hathaway (BRKA) we take a more demanding approach, defining investing as the transfer to others of purchasing power now with the reasoned expectation of receiving more purchasing power -- after taxes have been paid on nominal gains -- in the future. More succinctly, investing is forgoing consumption now in order to have the ability to consume more at a later date.

Indeed it is! And "saving" (unlike Warren's "investing") is the forgoing of consumption now in order to PRESERVE that purchasing power for a later date. The difference between a saver and an investor is that saving is the passive activity of most people while investing requires a tolerance for the risk of loss and active, specialized knowledge and focus. As I wrote in both Glimpsing the Hereafter and The Studebaker Effect:

"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."

Warren B: From our definition there flows an important corollary: The riskiness of an investment is not measured by beta (a Wall Street term encompassing volatility and often used in measuring risk) but rather by the probability -- the reasoned probability -- of that investment causing its owner a loss of purchasing power over his contemplated holding period. Assets can fluctuate greatly in price and not be risky as long as they are reasonably certain to deliver increased purchasing power over their holding period. And as we will see, a nonfluctuating asset can be laden with risk.

Very good! Yes! Risk is the reasoned probability that you will lose purchasing power over a period of time. Listen up if you happen to be a Berkshire Hathaway investor reading this. I have been spending the last three years working out the reasoned probability that you will lose purchasing power in the near future with your BRKA investment. And over that same holding period, physical gold in your possession is "reasonably certain" to deliver a massive increase in purchasing power. Warren is correct, nonfluctuating assets can be laden with risk while at certain times, the very safest asset will be revalued. Again, as I wrote in both Glimpsing the Hereafter and The Studebaker Effect:

"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!"

Warren B: Investment possibilities are both many and varied. There are three major categories, however, and it's important to understand the characteristics of each. So let's survey the field.

Investments that are denominated in a given currency include money-market funds, bonds, mortgages, bank deposits, and other instruments. Most of these currency-based investments are thought of as "safe." In truth they are among the most dangerous of assets. Their beta may be zero, but their risk is huge.

Over the past century these instruments have destroyed the purchasing power of investors in many countries, even as these holders continued to receive timely payments of interest and principal. This ugly result, moreover, will forever recur. Governments determine the ultimate value of money, and systemic forces will sometimes cause them to gravitate to policies that produce inflation. From time to time such policies spin out of control.

Yay! Warren and I agree again! Investments denominated in currency may be nominally safe—if you expect to have a million dollars after a given holding period, you WILL have a million dollars at that future time, but you may only be able to purchase a single roll of toilet paper with that million—but their risk in real terms (purchasing power terms) is HUGE… especially today! It almost seems like Warren has been reading some FOFOA. In any case, here are a few applicable posts that he might have studied:

Moneyness
Deflation or Hyperinflation?
Big Gap in Understanding Weakens Deflationist Argument
Just Another Hyperinflation Post - Part 1
Just Another Hyperinflation Post - Part 2
Just Another Hyperinflation Post - Part 3

Warren B: Even in the U.S., where the wish for a stable currency is strong, the dollar has fallen a staggering 86% in value since 1965, when I took over management of Berkshire. It takes no less than $7 today to buy what $1 did at that time. Consequently, a tax-free institution would have needed 4.3% interest annually from bond investments over that period to simply maintain its purchasing power. Its managers would have been kidding themselves if they thought of any portion of that interest as "income."

Yup! Warren's been around for a long time, alright. And it just goes to show how tough it has been during our entire lifetime for a saver who simply wants to preserve her purchasing power. She has to chase a 4.3% yield every year just to stay even! Crazy, isn't it? What if there was a way to perfectly preserve your purchasing power over any time horizon without chasing a yield? To what percentage of the population do you think that would appeal? Better yet, to what percentage of Warren B's clients do you think that would appeal? Just sayin', what if?

Warren B: For taxpaying investors like you and me, the picture has been far worse. During the same 47-year period, continuous rolling of U.S. Treasury bills produced 5.7% annually. That sounds satisfactory. But if an individual investor paid personal income taxes at a rate averaging 25%, this 5.7% return would have yielded nothing in the way of real income. This investor's visible income tax would have stripped him of 1.4 points of the stated yield, and the invisible inflation tax would have devoured the remaining 4.3 points. It's noteworthy that the implicit inflation "tax" was more than triple the explicit income tax that our investor probably thought of as his main burden. "In God We Trust" may be imprinted on our currency, but the hand that activates our government's printing press has been all too human.

Word. The one-time tax on nominal gains is bad enough, but the vanishing of savers' purchasing power through inflation is the real killer over long time-frames. But why you gotta conflate the issues of real income from an investment and simply protecting one's purchasing power with the least risk, OG? Is this part of your game? Why yes, I dare say I think it is!

Warren B: High interest rates, of course, can compensate purchasers for the inflation risk they face with currency-based investments -- and indeed, rates in the early 1980s did that job nicely. Current rates, however, do not come close to offsetting the purchasing-power risk that investors assume. Right now bonds should come with a warning label.

Holla, G! Maybe the warning label should read – Nothing about this bond, packaging or color should be interpreted to mean safer? How 'bout this one for Berkshire Hathaway – Savers beware, we will try to do more than preserve your purchasing power at the risk of losing your purchasing power, but either way, I was in first, I'll be out first and I always get my cut?

Warren B: Under today's conditions, therefore, I do not like currency-based investments. Even so, Berkshire holds significant amounts of them, primarily of the short-term variety. At Berkshire the need for ample liquidity occupies center stage and will never be slighted, however inadequate rates may be. Accommodating this need, we primarily hold U.S. Treasury bills, the only investment that can be counted on for liquidity under the most chaotic of economic conditions. Our working level for liquidity is $20 billion; $10 billion is our absolute minimum.

I will only note here that, although the link leads to data about bonds, Warren specifically wrote bills which usually means a duration of one, three or six months. Since there is no FDIC protection for cash accounts with $20 billion, T-bills are the guaranteed cash equivalent. This, of course, brings to mind OBA's Time-Currency Theory referencing the subzero-bound $IRX as well as my conveyance of his theory over the years.

Warren B: Beyond the requirements that liquidity and regulators impose on us, we will purchase currency-related securities only if they offer the possibility of unusual gain -- either because a particular credit is mispriced, as can occur in periodic junk-bond debacles, or because rates rise to a level that offers the possibility of realizing substantial capital gains on high-grade bonds when rates fall. Though we've exploited both opportunities in the past -- and may do so again -- we are now 180 degrees removed from such prospects. Today, a wry comment that Wall Streeter Shelby Cullom Davis made long ago seems apt: "Bonds promoted as offering risk-free returns are now priced to deliver return-free risk."

Ah, now here we start getting a glimpse of Warren's actual game! Notice the word "mispriced" in the above category. This is a key to Warren's strategy, which begins to expose the reasoning behind why he would choose to share this part of his shareholder newsletter with the general public. I realize he's talking about bonds here, but this principle applies to stocks as well (although not necessarily to gold).

Warren likes to buy and sell things that are "mispriced". That is, he knows better than the market the true value of things. And if they are "mispriced" he is, in fact, making money off of the mistakes of others if he turns out to be correct. Bear in mind that I'm not judging him on this issue per se, but simply exposing his game in a way that was most definitely concealed in this latest "newsletter".

Warren, like his lieutenant Charlie M, wants you in the same paper he likes to buy and sell so that he can capitalize on your "mispricing" mistakes. As I wrote in The Value of Gold, price and value are two different things, and that's Warren B's game:

"Probably the most common misconception is that price and value are the same thing. They are not. They are related but different. Price can be precisely known, but true value can only be estimated or guessed. And because price changes, price is always wrong while true value is always right, even though it is unknown. So price and value are always different. Value is always either higher or lower than price."

Warren will tell you that it's not just about capital gains. Warren LOVES yields, be they high rates of interest or dividends from stocks. But the thing about chasing yields is that the more people chasing, the lower the yield goes, and that's when Warren strikes. That's when things become mispriced. If he was only after yields, he would not want to let the world know what he's doing. But since he's publishing his drive-by on gold in Fortune magazine, I can only assume he's really after the capital gains that will come from the mispricing that will result from millions of people following his "advice".

Warren B: The second major category of investments involves assets that will never produce anything, but that are purchased in the buyer's hope that someone else -- who also knows that the assets will be forever unproductive -- will pay more for them in the future. Tulips, of all things, briefly became a favorite of such buyers in the 17th century.

This type of investment requires an expanding pool of buyers, who, in turn, are enticed because they believe the buying pool will expand still further. Owners are not inspired by what the asset itself can produce -- it will remain lifeless forever -- but rather by the belief that others will desire it even more avidly in the future.

What Warren is referring to here are sometimes called "hard assets". They are durable, physical items that generally hold their value well because people always seem to want them. Like well-preserved classic cars, quality antique furniture or rare baseball cards, hard assets do not generate yields like stocks and bonds. And so Warren is invoking the greater fool theory with regard to hard assets (before even revealing to you the specific one he's targeting) to lay the foundation that YOU are the fool if you think these are a wise way to store your savings.

In fact, if you click on the greater fool link above, you'll find Warren's name right there in the last line. You might also want to click through and read the Keynesian beauty contest principle of stock investing. Warren tells us later just what beautiful stocks look like. They look like Coca-Cola and See's Candy. But if too many people chase those yields, they disappear and even great stocks like that can become mispriced. And that, my friends, is when OG sells!

For example, Berkshire just sold out of its entire position in ExxonMobil after the price surged 17%. Berkshire also sold off Johnson & Johnson and Kraft shares. Fine companies with lots of earnings, so why sell? As for Coca-Cola, that's one of Berkshire's biggest holdings right now! Just sayin'.

Warren B: The major asset in this category is gold, currently a huge favorite of investors who fear almost all other assets, especially paper money (of whose value, as noted, they are right to be fearful). Gold, however, has two significant shortcomings, being neither of much use nor procreative. True, gold has some industrial and decorative utility, but the demand for these purposes is both limited and incapable of soaking up new production. Meanwhile, if you own one ounce of gold for an eternity, you will still own one ounce at its end.

AMEN! Thank you brother. "If you own one ounce of gold for an eternity, you will still own one ounce at its end." Warren's words, not mine. But I'll bet you that I will be milking this quote for a long time to come!

Remember earlier I asked, "What if there was a way to perfectly preserve your purchasing power over any time horizon without chasing a yield? To what percentage of the population do you think that would appeal?" Well, what if physical gold, that singular hard asset that is also held by central banks (precisely BECAUSE it has the fewest industrial uses), was on its way to becoming the singular global reference point for purchasing power, instead of the dollar with everyone chasing a 5.7% annual yield making it harder and harder to catch?

"If you own one ounce of gold for an eternity, you will still own one ounce at its end." In other words, perfectly preserved purchasing power. See? Please read my post Reference Point Revolution for more on this transition that's already underway.

Here is what I am suggesting. That Warren Buffet is the one, regardless of his protestations to the contrary, who is practicing the greater fool theory and the Keynesian beauty contest principle of investing while we, my friends, are the ones who are smartly front running the network effect (aka demand-side economies of scale) and the focal point transformation of the biggest thing in a thousand years.

Warren B: What motivates most gold purchasers is their belief that the ranks of the fearful will grow. During the past decade that belief has proved correct. Beyond that, the rising price has on its own generated additional buying enthusiasm, attracting purchasers who see the rise as validating an investment thesis. As "bandwagon" investors join any party, they create their own truth -- for a while.

On the contrary, homey, it's that the dollar is so overvalued because of the sheer weight brought on by the fact that all dollar "wealth" has a counterparty, and that those counterparties in aggregate can't POSSIBLY perform to expectations in real terms, that a massive adjustment is not only inevitable, but long overdue. EVERYTHING is mispriced right now because the dollar is so massively overvalued at present. And while I can't speak for all gold investors, I'm not buying gold because I think the ranks will grow. In fact, I think the ranks will ABANDON "gold" at the worst time in all of history.

As I wrote in a recent comment, "My scenario… ALL TRADERS dump ALL gold, paper, physical, whatever, in my scenario. It has nothing to do with insiders. It has to do with traders and weak hands." But that's a difficult concept to wrap your head around. If you'd like to try, I wrote about it in my 2010 post, The Shoeshine Boy. The point here is that the true gold thesis is not "the belief that the ranks of the fearful will grow." That is simply Warren Buffet's unfortunate misunderstanding of the gold thesis.

Warren B: Over the past 15 years, both Internet stocks and houses have demonstrated the extraordinary excesses that can be created by combining an initially sensible thesis with well-publicized rising prices. In these bubbles, an army of originally skeptical investors succumbed to the "proof" delivered by the market, and the pool of buyers -- for a time -- expanded sufficiently to keep the bandwagon rolling. But bubbles blown large enough inevitably pop. And then the old proverb is confirmed once again: "What the wise man does in the beginning, the fool does in the end."

It is so incredibly striking to me that "the best of the best," the Oracle of Omaha himself, is still reciting these same tired old arguments. It simply defies logic that Warren Buffet is comparing gold to the housing and dot-com bubbles to save you out of the goodness of his heart. If he doesn't want you engaging in a "bubble", it's only because he wasn't there first. In fact, there are plenty of gold bugs who actually THINK gold will eventually be a bubble, and that's precisely why they're in it. But not me.

More than two years ago I debunked the ridiculous and shallow comparison of gold to past bubbles in Gold: The Ultimate Un-Bubble:

"And since gold production cannot be ramped up to meet demand like it can in bubblicious items, there is no reason for gold to fall back. Gold mining does not debase gold in the same way that dollars, tulips, homes, Dot Com IPO's or government bonds are debased through production. Mine production is taken from known reserves that are already valued, owned and traded, and all gold on the planet Earth is a fixed amount, the same fixed amount it was a million years ago. All we do is move it around, like poker chips on a table, to those savers that value it the most.

Furthermore, the price of gold is completely arbitrary. This means that gold can go as high as the people of Earth want to take it without EVER exceeding objective valuations by common metrics like earnings, interest or the sum value of its component elements. Gold IS the element. It cannot be broken down further, except perhaps by the LHC.

One of the most common criticisms of gold's use as an investment is that it cannot be valued the way stocks, bonds and real estate can. They are all commonly valued by their yields, and gold has no yield, therefore it cannot be fairly valued, or so the argument goes. But if we invert this argument then gold can never be OVERvalued either, whilst those other things can, and are... in a bubble!

The price of gold is arbitrary, ergo, there is no such thing as a gold bubble."


Of course that is not the whole story, it's only a teaser from the post. But the point is that if Warren Buffet is truly avoiding gold because he thinks it's a bubble like Pets.com or Miami condos, you should really question EVERYTHING that comes out of his mouth. Now I will admit that PAPER gold is a bubble, but physical gold? Never!

Warren B: Today the world's gold stock is about 170,000 metric tons. If all of this gold were melded together, it would form a cube of about 68 feet per side. (Picture it fitting comfortably within a baseball infield.) At $1,750 per ounce -- gold's price as I write this -- its value would be about $9.6 trillion. Call this cube pile A.

Let's now create a pile B costing an equal amount. For that, we could buy all U.S. cropland (400 million acres with output of about $200 billion annually), plus 16 Exxon Mobils (the world's most profitable company, one earning more than $40 billion annually). After these purchases, we would have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge). Can you imagine an investor with $9.6 trillion selecting pile A over pile B?

No, and neither can I imagine a saver with a regular job, a life to live, an aversion to risk and a desire to merely preserve his purchasing power wanting to own a bunch of oil and farming companies. Besides, if Exxon Mobil is so profitable, why did Warren just sell his entire stake in it? Could it be that even profitable companies become mispriced (overvalued) when everyone is chasing a yield?

Okay Warren, can I imagine an investor with $9.6 trillion buying all the gold in the world? Of course not. No choice could be more stupid if such a person could exist. As I have written many times, gold would be completely worthless if one person (or even just a few people) owned it all. Gold's greatest value comes from its widest distribution amongst savers, and the greater the value, the more efficiently gold performs its primary function. It is a virtuous and self-sustaining feedback loop. From Relativity: What is Physical Gold REALLY Worth?:

"One of the unique characteristics of gold that sets it apart from commodities is that its primary use - store of value - has no weight or mass requirements. In commodities, where industry is the primary user, weight is critical.

[…]

One ounce [of gold] could do just as good of a job as 100 ounces. In fact, one ounce would do a BETTER job than 100 ounces! The less gold it takes to store your value, the better it does its job. This particular “gold dynamic” sets it apart from all commodities.

One ounce would store your value more efficiently and stably than 100 ounces because A) your storage and security costs would be lower (efficiency), and B) if one ounce is worth $100,000 then that infers gold is being valued by many more people relative to when it was $1,000 per ounce. This wider distribution brings with it a more stable base of valuation and less relative volatility in price (stability).

Comparing this “gold dynamic” to any industrial or food commodity we can see a stark difference. What commodity could perform its job BETTER at a price 100x higher than today? Can you name one?"


And from a comment in 2009:

"Gold would not be valuable if one person owned all of it. It is most valuable in its widest distribution possible, the wealth reserve, which requires a much higher valuation than it has right now. A higher valuation denominated in hard assets, not just fiat currencies!"

And another comment from 2010:

"Just look at the BIS' own gold actions. Their owned gold hoard has shrunk from 194 tonnes to 120 tonnes over the last 6 years, as has the entire Eurosystem's hoard over the last decade (from 12,576 tonnes down to 10,833 tonnes). Most gold movements in Europe have either been lateral reshuffling or dishoarding and encouraging citizens and other entities to start hoarding physical gold themselves.

I have written this before... if you were King of the World with 35,000 tonnes of gold in a world of 160,000 tonnes, you would gladly - happily - reduce your "stash" to 10,000 tonnes if that reduction came with a 50x revaluation. Trying to get ALL the gold into your hoard is a fool's strategy."


Like I said, Warren, buying all the gold in the world would be about the dumbest thing such an investor could possibly do, kinda like a doctor owning an oil company and calling it savings.

Warren B: Beyond the staggering valuation given the existing stock of gold, current prices make today's annual production of gold command about $160 billion. Buyers -- whether jewelry and industrial users, frightened individuals, or speculators -- must continually absorb this additional supply to merely maintain an equilibrium at present prices.

Hahaha! B's worried about who's gonna buy up the annual physical gold production? How about who's gonna keep buying the annual paper production bearing dubious counterparties in the upper left-hand corner? I think it's Warren B who is worried about who's gonna keep buying the stuff he's into.

With well over $100T in cash, cash equivalents, debt and equity investments posing as savings for the risk-averse, I think it's more than safe to say that ANOTHER had it exactly right when he said that the paltry $160 billion flow of gold is (and has been for a long time) cornered. Heck, nearly a third of that is going to India alone, and they aren't even one of the surplus nations like Saudi Arabia, Germany or China!

Warren B: A century from now the 400 million acres of farmland will have produced staggering amounts of corn, wheat, cotton, and other crops -- and will continue to produce that valuable bounty, whatever the currency may be. Exxon Mobil (XOM) will probably have delivered trillions of dollars in dividends to its owners and will also hold assets worth many more trillions (and, remember, you get 16 Exxons). The 170,000 tons of gold will be unchanged in size and still incapable of producing anything. You can fondle the cube, but it will not respond.

Fondle the cube? Alrightythen, no more Mr. Niceguy here either. Once again, Warren, why did you sell Exxon if it's so great and saving money is all about dividends and earnings rather than taking (OPM) money from the greater fool? What a hypocrite! Is it also possible that companies can be mismanaged, like, say, BAC?

Here are a few other "good companies" that Berkshire dumped since it (BRKA) took a 50% nose-dive in 2008 (actually late 2007 to early 2009): Nike, Comcast, Lowes, Home Depot. And in case you are still under the illusion that OG is all about solid, benevolent analysis rather than political monies for OG's pocket, his company is still the largest shareholder in Wells Fargo (NYSE: WFC) and "he has practically bought at any chance he gets." Nothing against Wells Fargo (I have an account there) but this, combined with his drive-by assault on gold (the hard asset preferred by those who actually produce stuff) should settle any debate about whether or not he carries a bias in his baggage.

Warren B: Admittedly, when people a century from now are fearful, it's likely many will still rush to gold. I'm confident, however, that the $9.6 trillion current valuation of pile A will compound over the century at a rate far inferior to that achieved by pile B.

"Pile A" does not compound. It simply remains. Remember? "If you own one ounce of gold for an eternity, you will still own one ounce at its end." That said, there's no guarantee that pile B will be worth more than pile A in 100 years. A lot can happen in 100 years, wars, hyperinflations, companies go bankrupt… If you were to be put into a deep sleep coma-like state for a century, and you had trillions in wealth, which pile would you pick to shuttle your wealth through 100 years?

Warren B: Our first two categories enjoy maximum popularity at peaks of fear: Terror over economic collapse drives individuals to currency-based assets, most particularly U.S. obligations, and fear of currency collapse fosters movement to sterile assets such as gold. We heard "cash is king" in late 2008, just when cash should have been deployed rather than held. Similarly, we heard "cash is trash" in the early 1980s just when fixed-dollar investments were at their most attractive level in memory. On those occasions, investors who required a supportive crowd paid dearly for that comfort.

And finally, here's the argument that only Helen Keller could believe, that today's contrarian is staying as far away from gold as possible. Especially that physical gold. Look at the lines to buy gold at the dealers. They wrap around the block. You can't find a place to eat these days without having some dolt at the next table talking about gold. Heck, even the shoeshine boy can tell you what coins are best and where to buy. It's obviously a bubble. Yeah, right.

Warren B: My own preference -- and you knew this was coming -- is our third category: investment in productive assets, whether businesses, farms, or real estate. Ideally, these assets should have the ability in inflationary times to deliver output that will retain its purchasing-power value while requiring a minimum of new capital investment. Farms, real estate, and many businesses such as Coca-Cola (KO), IBM (IBM), and our own See's Candy meet that double-barreled test. Certain other companies -- think of our regulated utilities, for example -- fail it because inflation places heavy capital requirements on them. To earn more, their owners must invest more. Even so, these investments will remain superior to nonproductive or currency-based assets.

By superior, he means that he views investing as superior to saving. He is, after all, an extraordinary investor. But most of his audience is, in fact, made up of savers. As far as savings go, for the near future (i.e., the transition period) gold will be far superior to Warren's investments as the transition brings REAL gains of tremendous value to those who hold the goods. And in the distant future, physical gold will be a far superior savings medium as it will be the very benchmark of purchasing power everywhere. In that future, owning companies will potentially bring you real returns whereas gold will not. But it will also carry risks and responsibilities. And if you carry gold from here into that future, you will be one of the fortunate few faced with that choice.

Warren B: Whether the currency a century from now is based on gold, seashells, shark teeth, or a piece of paper (as today), people will be willing to exchange a couple of minutes of their daily labor for a Coca-Cola or some See's peanut brittle. In the future the U.S. population will move more goods, consume more food, and require more living space than it does now. People will forever exchange what they produce for what others produce.

Absolutely true! In fact, this is the Debtors & Savers Zone he is describing. The part of the pyramids occupied by everyone!


What's missing in his description is what the savers will trade amongst themselves to perfectly preserve their purchasing power during periods of deferred consumption. Sure, someone will own all those companies OG loves so much. And like I said, if you carry some of that physical gold from here into that future, it might just be you!

Warren B: Our country's businesses will continue to efficiently deliver goods and services wanted by our citizens. Metaphorically, these commercial "cows" will live for centuries and give ever greater quantities of "milk" to boot. Their value will be determined not by the medium of exchange but rather by their capacity to deliver milk. Proceeds from the sale of the milk will compound for the owners of the cows, just as they did during the 20th century when the Dow increased from 66 to 11,497 (and paid loads of dividends as well).

Of course they will, Warren! No one at this blog is predicting the collapse of modern society. The gold thesis discussed here is about that which is mispriced (overvalued or undervalued) coming back in line with reality. The dollar is overvalued and physical gold is undervalued. I described it as a seesaw in The Studebaker Effect:

"Devaluations play out like a seesaw. There is a force (the crisis devaluation), a fulcrum (what is being devalued against), and a load (the beneficiary or the winner)."


That fulcrum is the physical plane of goods and services in aggregate. Everything is mispriced today, some things more than others. But if we look at how Warren's favorite investments, company stocks, carried through past devaluations, we find that while they obviously do much better than currency or currency-based investments like bonds, they don't do quite as well as hard assets and they don't even preserve purchasing power. Perhaps it's because an overvalued currency also tends to overvalue its economy.

Here's a bit from my post Greece is the Word on how Warren's equities might fare during the currency devaluation he expects:

"But what about the stock market? Someone emailed me saying,
"During a currency crisis in the western world, we may see a very powerful stock market rally as equities are a form of real asset. Better to own a piece of Procter and Gamble than a unit of currency that can devalue quickly. Look to the Argentina general equity market MERVAL index during the peso crisis. It shot up – although not as much as the 3:1 currency devaluation."

The writer answered his own point. The stock market shot up LESS than the currency devalued. So while the stock market in Argentina performed MUCH better than debt fixed to the value of the currency, it only chased - and lagged - actual inflation. (Actually, short term hyperinflation.)This is partly because the economy is usually in shambles at the time of a currency devaluation. So while you would expect real things like real companies to compensate for a falling currency, you must also weigh in any previous bubbling that might deflate and any economic factors that might reduce company profits.

But Argentina is still a good example for us to look at. In January of 2002 the currency devalued 3:1. At the same time the stock market rose in response to the devaluation and then stayed up (because the currency stayed down). But what is interesting about Argentina is that just prior to the devaluation, in December of 2001, inflation dipped into negative territory (deflation?) and the stock market dipped as well. Then they almost immediately exploded out of this head-fake in an unexpected devaluation. See the charts. The first is the MERVAL and the second is CPI:



Hmm... look familiar?

Bottom line: The stock market, because it represents equity not debt, will fare much better than the rest of the paper world. But the stock market does suffer from dilution, manipulation and bubbles. Expect the stock market to languish in economic chaos as it chases real inflation only to fall a little short.

But gold is different. The system desperately needs a counterweight, and gold is it. The counter is already in place, only the weight is yet to come. And once we have seen the reset in gold as it performs its phase transition from commodity to wealth reserve, it will then chase (hyper)inflation along with the rest of the "non-dollar" world, only it will be the ONE AND ONLY THING that will be immune to the economic mess that will still need to be worked out."


So what we can do is to place Warren's favs just to the left of the fulcrum on the seesaw. They won't devalue much in real terms, but they also won't fare even as well as boring old hard assets like antique furniture (I'm sure he'll just love this one):


Warren B: Berkshire's goal will be to increase its ownership of first-class businesses. Our first choice will be to own them in their entirety -- but we will also be owners by way of holding sizable amounts of marketable stocks. I believe that over any extended period of time this category of investing will prove to be the runaway winner among the three we've examined. More important, it will be by far the safest.

And thus ends Warren B's drive-by assault on gold. What do you think? Did he hit his target?

So where is Warren coming from?

Try to imagine a bizarro world where we simultaneously encourage everyone to consume as much as possible through debt (because, ldo, consumption is the engine of the American economy) and also to save that same debt through ERISA and 401(k)s. What you end up with is a whole society of people deferring consumption (saving) on the one hand, and pulling into the present that very same future consumption they saved on the other. You end up with underwater homeowners with negative net-worths and hundreds of thousands sitting in their 401(k) or IRA.

With everyone chasing a yield, be it through interest rates on currency investments or dividends from equities, you eventually drive all those yields to zero. Luckily for the Warren Buffets of the world, most of that "savings" knows no better than to float around in Warren's world, where Warren not only gets his management cut, but he can also make amazing capital gains as those "savings" slosh around mispricing one thing after another.

Now think about that person, let's call him Bob, with $201K in debt and also a $200K pension or IRA through work. In essence, he could be almost debt-free were it not for his "savings". But then if that were the case, Warren wouldn't have that $200K sloshing around in Warren's world. This is, of course, only a mental exercise in how inane (or should I say insane?) the Western financial system really is.

Which camp do you think Bob is in? The Debtors or the Savers? And what would be the state of Warren's company valuations were it not for all this additional "savings" sloshing around? How about the yields available for real savers? Perhaps there would be some yields to be found were it not for Bob and his "savings"?

The point is that companies are not de facto good investments just because they make things. They can become overvalued when chased by too much money and that's when Warren sells. Warren talks a good talk about compounding dividends, but what he's really after is your money. Either you're with him (investing in BRKA) and he takes his cut while using your financial weight as his own, or you're against him out there on your own. And then he's looking for areas where you've mispriced something so that he can buy it from you or sell it to you.

I can tell you which camp OG is in. He's in the easy money camp (the debtors)! He's in debt to easy money:

Warren Buffett is on Squawkbox right now defending the bailout, which he wrote an op-ed about in today's New York Times.

Then he dropped this line, which sounds like an exaggeration: "If the government hadn't acted, I would be eating Thanksgiving dinner at McDonald's."

(Business Insider)

Perhaps he wasn't exaggerating:

A good chunk of his fortune is dependent on taxpayer largess. Were it not for government bailouts, for which Buffett lobbied hard, many of his company’s stock holdings would have been wiped out.

Berkshire Hathaway, in which Buffett owns 27 percent, according to a recent proxy filing, has more than $26 billion invested in eight financial companies that have received bailout money…

…It takes remarkable chutzpah to lobby for bailouts, make trades seeking to profit from them, and then complain that those doing so put you at a disadvantage.

Elsewhere in his letter he laments “atrocious sales practices” in the financial industry, holding up Berkshire subsidiary Clayton Homes as a model of lending rectitude.

Conveniently, he neglects to mention Wells Fargo’s toxic book of home equity loans, American Express’ exploding charge-offs, GE Capital’s awful balance sheet, Bank of America’s disastrous acquisitions of Countrywide and Merrill Lynch, and Goldman Sachs’ reckless trading practices.

And what of Moody’s, the credit-rating agency that enabled lending excesses Buffett criticizes, and in which he’s held a major stake for years? Recently Berkshire cut its stake to 16 percent from 20 percent. Publicly, however, the Oracle of Omaha has been silent.

(Reuters)

So maybe you are starting to see why Freegold is not such a welcome development for an OG like Warren B. But don't worry too much about Warren. He'll still be a multi-billionaire come Freegold. And if you follow him, at least you won't be broke (see the seesaw above). I suppose there might even be something altruistic about leaving the Freegold revaluation windfall for others. But that's not Warren's motivation.

Warren's power comes from keeping as much of other people's savings as possible in the stock market where he plays. It doesn't matter if it comes in through his company or on its own, just that it's in there. And that's why he wrote this piece trashing gold. Because when you buy a tube of gold coins and put it in your sock drawer, it's out of OG's reach.

Sincerely,
FOFOA





Power in the money, money in the power
Minute after minute, hour after hour
Everybody's runnin, but half of them ain't lookin
At what's goin on in the kitchen, but I dont know what's cookin

They say I gotta learn, but nobody's here to teach me,
If they can't understand it, how can they reach me?
I guess they can't; I guess they won't
I guess they front; that's why I know my life is outta luck, fool!

We've been spending most our lives
Living in a Gangster's Paradise

247 comments:

«Oldest   ‹Older   201 – 247 of 247
JR said...

Greece's pledged a portion of its gold to the ECB and gave control over its foreign reserve assets to the ECB in joining the euro.

Umm, why do you think Greece is putting its gold up for seizure?

=================================

The proper thing for the Greek people is to declare a Sovereign default:

...

The Greek people needs a fresh start (free of insane interest rate / GDP expenses). The creditors (AKA banks) absolutely _needs_ to find out the hard way that the $IMFS is broken.


Umm, hyperinflation is the currency adjustment mechanism under the $IMFs, and its that adjustment mechanism Greece is tying to avoid.

But debt itself is not the cause of our problems today. Today we have a situation where the vast majority of excess production value (excess capital) is enabling massive amounts of global malinvestment through new debt creation. That has peaked and is now contracting. But the problem is not the debt itself. The problem is the enabling effect of excess capital not having a viable alternative that floats against the currency. The problem is the lack of the adjustment mechanism of Freegold. There is no viable counterbalance against uncontrolled debt growth today. So we are only left with credit collapse and hyperinflation of the monetary base to clear the malinvestment from the system.

The Return to Honest Money

JR said...

OMG dieuwer well said,

I see that in my micro-world too :)

¡Visca el Superorganism!:

Superorganisms exhibit a form of "distributed intelligence," a system in which many individual agents with limited intelligence and information are able to pool resources to accomplish a goal beyond the capabilities of the individuals.

Nineteenth century thinker Herbert Spencer coined the term super-organic to focus on social organization... Similarly, economist Carl Menger expanded upon the evolutionary nature of much social growth, but without ever abandoning methodological individualism. Many social institutions arose, Menger argued, not as "the result of socially teleological causes, but the unintended result of innumerable efforts of economic subjects pursuing 'individual' interests."

burningfiat said...

JR,

Greece's pledged a portion of its gold to the ECB and gave control over its foreign reserve assets to the ECB in joining the euro.

Umm, why do you think Greece is putting its gold up for seizure?


I'm not saying they are. That greek dude(ss) in the NYT article were saying that.


Umm, hyperinflation is the currency adjustment mechanism under the $IMFS, and its that adjustment mechanism Greece is tying to avoid.

That makes no sense. Are the Greeks trying to avoid HI? I thought they were part of the Euro. HI in the Euro is decided by the Euro-holders/ECB alone, not the Greeks.

Try telling the Greeks that debt is not the issue. I agree that the _systemic_ root cause is not debt, but lack of Freegold, but look at Greece like an alcoholic. Maybe some other issue caused the alcoholism, but right now, to get Greece afoot again, first cause of action is to stop drinking (AKA taking on more debt/paying more debt).

I already told you the solution to the _systemic_ cause:
The Greek people needs a fresh start (free of insane interest rate / GDP expenses). The creditors (AKA banks) absolutely _needs_ to find out the hard way that the $IMFS is broken. The lesson: Gold - GOOOD. Sovereign debt - BAAAD.

A 100% default is the clearest way to tell the banksters that debt is a bad SoV.

/Burning

AdvocatusDiaboli said...

Lisa,
"I would expect Greece to fight to save its gold"
Why? Have you watched any news lately? They do not need to fight for anything at all, that's what happened the last three years. They will be bailed out forever (wait till the ESM is at full power). They took the Euro hostage, why should they do anything at all, absolutely no reason? There is no legal way to kick them out. Nobody will allow them to fail. EVERYBODY in power is eager to kick the can down the road. NOBODY in power has any interest to change anything about the current setup, it just works perfect for everybody: The ECB-Draghi-Connection, the EU-burocrats and EU-fascist-politians, the banks, the insurance companies, the industry EVERYBODY is just happy, except the people of europe, but hey, who cares a shit about what the people want anyway.
Greets, AD

Peter said...

Drachma = HI

Euro != HI

JR said...

Air-ball. Please read the thread.

Fail:

Maybe some other issue caused the alcoholism, but right now, to get Greece afoot again, first cause of action is to stop drinking (AKA taking on more debt/paying more debt).

I already told you the solution to the _systemic_ cause:
The Greek people needs a fresh start (free of insane interest rate / GDP expenses). The creditors (AKA banks) absolutely _needs_ to find out the hard way that the $IMFS is broken. The lesson: Gold - GOOOD. Sovereign debt - BAAAD.


No, they need to restructure their economy and consume less and produce more. Destroying their economy through a credit collapse aka hyperinflation as you suggest is not good. That's why the joined the Euro - to not have to go through the $IMFS adjustment mechanism do that.

The problem is the enabling effect of excess capital not having a viable alternative that floats against the currency. The problem is the lack of the adjustment mechanism of Freegold. There is no viable counterbalance against uncontrolled debt growth today. So we are only left with credit collapse and hyperinflation of the monetary base to clear the malinvestment from the system.

=================================

Once Upon a Time

You can't squeeze blood from a turnip. That's an old saying. It means that you cannot get something from someone that they don't have. In order to pay its debt in real terms, Greece needs to ultimately get back to producing more than it consumes. And as counterintuitive as this may sound, they will first need to run a BOP surplus in order to get there. You do that by exporting more value than you import.

I realize how backward this sounds, but that’s only because we haven’t seen gold function properly in more than 90 years—beyond living memory. And this is why the limited stock of physical gold is far more valuable than the paper gold promises of New York and London would have you believe. This is why Greece will never part with its gold at today's prices. It is far more valuable. Greece ultimately needs to get back to importing gold which is what happens when you produce more than you consume. But you can't get back to that place by spewing your real capital at imaginary capital prices.

burningfiat said...

Fail right back at you:
No, they need to restructure their economy and consume less and produce more. Destroying their economy through a credit collapse aka hyperinflation as you suggest is not good. That's why the joined the Euro - to not have to go through the $IMFS adjustment mechanism do that.

Defaulting 100% and staying within the euro-zone leaves them no choice but to restructure their economy and consume less and produce more.

You just can't see that a sovereign default is a perfectly fine way to force both creditors and debtors to acknowledge the reality while still giving the people (aka humans) a chance, huh?

Reality being for creditors and debtors respectively:
Sovereign debt is a bad SoV (use gold instead), and learn to live within your fscking means.

Suit yourself though.

/Burning

Anonymous said...

As I said many times, I am still waiting for Greece to default and to stay inside the Euro zone.

The talking about the gold (today repeated by ZH with zero additional substance) is just BS by the dollar faction.

Even after the 'voluntary' haircut (if that is eventually agreed), Greece's public finances are unsustainable. The only thing that can be done is to choose the date of the default, but it will eventually happen. So it makes absolutely no sense to use the gold now.

Victor

tripper said...

@Winters: "[...] which country sent one to prison for years for owning gold?"

Think communism, bolsheviks, stalinizm, western europe. There were few periods of different 'severity'.

As far as I know, bolsheviks did confiscate the Church's gold. The cleriks resisted, dozens were executed, hundreds imprisoned.

Here, in my yard, communist government enacted 'monetary reform' (that's what they called stealing 2/3 of people's money). During 5-6 years that followed, owning gold or foreign currency carried a risk of 15 year sentence. Trading gold was punishable by death. Can't confirm if people were actually sentenced, only heard stories about it. It's easy to belive, tho. If you had gold, you probably had other stuff that could get you in trouble. It was quite easy to end up 'enemy of the state'. And during those times, there were many of them, imprisoned, tortured and executed.

However, I know of at least one case of a person sentenced in 70s for engaging in gold trading (and probably smuggling). During those times, owning was no longer punishable, but the flow was heavily restricted and controlled. Hence rampart black market and government hunting for 'gold gangs'.

@JR: "[...] I suspect Greece pledges some gold in currency terms."

I guess that would make more sense. If this has ECB's approval (which it probably has to have), then I wonder. Would they not expect the revaluation before the time to pay up comes? I'm guessing that the 'managed' appreciation of gold would not do the trick. The freegold revaluation would make things much easier for Greeks (and whole eurozone as a consequence), no?

Well, I guess we'll see.

Anonymous said...

Victor,

I read your Many values of gold post and it's quite illuminating. Thanks!

I had a question about one part of the essay though. You state:

Obviously, as soon as the banking system creates credit and the credit money, i.e. account balances (for example in electronic transfers) and credit notes (tangible bank notes), circulates freely along with gold coins, all being equivalent at the margin, the total currency supply is a lot larger than the number of actual gold coins. The term currency supply here refers to the total amount of gold coins (currency base) plus the credit created by the banking system.

I know that in my previous discussions with JR, he stated that the position established by Sandeep Jaitly in his paper Duration Mismatch and Perpetual Debt is a "Hard Money Socialist" type stance.

I suppose the position of the Freegold thesis ("Never denominate credit in a weight of gold") is essentially accepting the fact that banks won't play by the rules, neither do the governments. The innate nature of entropy and deterioration within the populace can still be regulated by allowing gold to be free. yes?

What I don't get is that why is Freegold inevitable/unstoppable. I guess I need to read more on Euro and the way it treats gold,then?

Robert said...

After a long hiatus from buying gold, I bought a few old gold coins today. I went into a coin shop and inquired about my favorite denomination, which most buyers usually shun. She quoted me spot! Spot! My eyes bulged and I struggled to keep my composure. I double checked with the calculator. Yeah, she really quoted me spot! How many do you have? Okay, back to the bank!

For the life of me I cannot understand why believers in Freegold buy these monster 1oz coins. Just today I saw that tulving was selling Austrian 1 ducat pieces for $2.95 each. What a steal! What a no-brainer! Post Freegold I would much much much rather walk into a coin shop to sell a tiny $10,000 coin (and attract much less attention) than walk in to sell a $100,000 coin! But that's just me, I guess. I would rather have an abundant supply of small coins than can easily mix in with change in airport security screens, rather than a supply of larger coins that are much more visible and easily targeted.

But then again, no worries if you buy FOFOA's argument that post Freegold governments will not aggressively tax gold.

JR said...

Defaulting 100% and staying within the euro-zone

Purple unicorns!

Guess what - as DP pointed out, maybe somebody is else is dictating what Greece does, like the somebody in charge of the currency union Greece joined so they would not have to suffer the $IMFS's adjustment mechanism. To quote a brighter bulb than mine:

Drachma = HI

Euro != HI


==================================

Reality being for creditors and debtors respectively:
Sovereign debt is a bad SoV (use gold instead), and learn to live within your fscking means.


LDO, that's what our system is - an easy money system that socializes the losses onto the savers

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.

Glimpsing the Hereafter

===============================

There will be defaults and restructuring and devaluation, but Greece isn't gonna just blow off its debts and stay in the Euro.

JR said...

What I don't get is that why is Freegold inevitable/unstoppable.

Because the $IMFS is collapsing, and the dollar severely misprices stuff like gold and oil.

The flaw in the dollar is that it was brought up with gold tied at the hip. Gold was always fixed to the dollar at a specific parity. So gold was no obvious alternative store of value to dollar debt. So for 100 years now the savers have found dollar-denominated debt to their liking.

[...]

Anyway, this is what Freegold is all about. It is about deducing the inevitable implications of an unstoppable avalanche. And it is about fiat currency finally finding its natural equilibrium with a parallel physical gold wealth reserve. And trust me, fractional paper gold promises won't work in this new world, so equilibrium will likely be somewhere north of $50,000 per ounce (and that's from just the functional change, don't even ask me about the inflation-adjusted price).


Equilibrium

==================================

"I cannot see a dollar collapse without a simultaneous revaluation of something else. It's a seesaw. The dollar isn't collapsing against gold. It is collapsing against the physical plane of goods and services. That's the fulcrum, not gold. Dollar collapse is the force, goods and services the fulcrum, and gold the load. So gold is revaluing against goods and services. The gold revaluation is against the physical plane so as to fill the reserve void left by the dollar's collapse." Like this

Unambiguous Wealth

JR said...

Hi tripper,

Would they not expect the revaluation before the time to pay up comes? I'm guessing that the 'managed' appreciation of gold would not do the trick. The freegold revaluation would make things much easier for Greeks (and whole eurozone as a consequence), no?

I would say yes, they won't pay up and let the gold flow until it is revalued. I think this is a part of it too:

Might promoting the use of gold as collateral boost its profile and assist the upward movement in its price, effectively letting the market do much of the heavy lifting (as opposed to revaluing it yourself?). As the $IMFS system of debt fails, good collateral becomes more important/precious/valued, and what better collateral is there?

Anonymous said...

ephemeral_reality,

I suppose the position of the Freegold thesis ("Never denominate credit in a weight of gold") is essentially accepting the fact that banks won't play by the rules, neither do the governments.

It is not even that. Under the gold standard, there was simply no rule about how much credit could be created. The reason is not that the debt camp circumvented the rules or the spirit of the system and that the government or the Fed was too weak to stop it.

The problem is that credit volume ought to fluctuate because that's what varying economic activity requires (I agree that debt levels have been blown up excessively during the recent years, I agree this is 'bad', but this is not the primary issue here). The gold stock, however, does not fluctuate. So if you make credit equal to a weight of gold, you are inviting speculation against the 'system'.

The problem is that the very idea of a 'gold standard' is foolish. It is not a political issue that it was poorly managed or that someone broke the rules and caused it to fail and that next time you would manage it better. Every gold standard will fail in the long run.

Victor

Anonymous said...

PS: It is also not fractional reserve banking that is the problem. Even in the private market, without any banks that your government might be able to regulate, you can create contracts that produce some sort of loan certificates that can be passed on to someone else and that can start to circulate.

The problem is that credit can be traded and is accepted as a form of payment. This is what makes the market price of credit diverge from the intrinsic price of bullion.

So why did the gold standard work so well before the end of the 19th century? I think this is because essentially all payments were in cash. And so credit had to be liquidated first, people had to obtain cash, then used the cash as a form of payment. So all transactions went through cash. Then, if the volume of cash is managed well, the system can work.

Victor

Anonymous said...

Victor,

you say: It is not even that. Under the gold standard, there was simply no rule about how much credit could be created.

A relevant excerpt from Sandeep's paper:

The determination of the proportion of any individual’s silver that is required on demand is a purely subjective process. It is certainly not the prerogative of the storehouse owner. The subjective determination of silver required on demand coupled with the recursive procedure detailed above gives rise to a system of financial assets and liabilities that match perfectly in duration by subjective
definition.


To address your question: Under the system discussed by Sandeep, the rule for the total amount of credit creation would be the collective subjective judgments of all individuals depositors in a financial institution.

Collective subjective judgments => no duration mismatch => the level of debt is decided by the Super organism so to speak.

There are several problems inherent within this system: Gold is subject to system risks. 1. Banks could loan out to non-productive enterprises who will squander real capital.(fault with the banks) 2. The borrower eventually ended up failing in his enterprise (even though he ventured it thinking it will be productive). [the bank vetted the borrower thoroughly in this case].

I admire the beauty of the freegold system where savers *never* take any counterparty risk.

You say: The problem is that the very idea of a 'gold standard' is foolish. It is not a political issue that it was poorly managed or that someone broke the rules and caused it to fail and that next time you would manage it better. Every gold standard will fail in the long run.

Even in a perfectly duration matched and balanced system, there can still be disruptions and savers getting ruined due to no fault of their own. I don't think what Sandeep states is foolish, although it may be naive to assume that banks (the greatest fraud perpertrator known to mankind) will be honest. Or that the borrower always succeeds.

Anonymous said...

I admire the beauty of the freegold system where savers *never* take any counterparty risk.

They have counterparty risk only for the period during which they hold the transactional medium or if they voluntarily decide to extend a loan, purchase debt assets, bonds, etc. Today, many are happy to hold other peoples' debt for 30+ years with 100% of their portfolio without asking a question.

In this sense, what still separates us from freegold is that the savers have not yet decided to reduce their counterparty exposure.

Sandeep just talks about how to regulate banking. I don't think this is the point. If he was to succeed, he would have to regulate all private contracts in the economy, whenever A trusts B and accepts B's word as payment for goods or services, Sandeep would have to step in, verify credit worthiness and whether the durations match. In reality, they never do. In fact, Sandeep's analysis is a good illustration of how impossible this task is.

Victor

DP said...

Greece isn't gonna just blow off its debts and stay in the Euro

Didn't Greece buy equity in the Eurosystem when it was allowed in? 15% of which was physical gold transferred to the ECB's centralised ownership, alongside the other 85% in foreign currency?

If they chose to walk away, would they not forfeit their equity position in the Eurosystem. At the very least.

Peter said...

DP,

Yes (Phew! That's better.)

That would be just the start of their real nightmare.

Drachma = HI

Euro != HI

Anonymous said...

Victor,

You say: Sandeep just talks about how to regulate banking. I don't think this is the point. If he was to succeed, he would have to regulate all private contracts in the economy, whenever A trusts B and accepts B's word as payment for goods or services, Sandeep would have to step in, verify credit worthiness and whether the durations match. In reality, they never do. In fact, Sandeep's analysis is a good illustration of how impossible this task is.

Not exactly what Sandeep says. What he's saying is each individual depositor gets to choose his time-preference portion of the total deposit he makes at the bank . It is the bank's responsibility to honor this individual time-preference. Therefore the bank by ensuring it honors this, is already a part of the system that's perfectly matched in duration.

Banks will use the fund pool for each time preference to loan out to borrowers who's time preference also matches. Banks are the market maker in this regard, banks are not needed per se, but they facilitate and make the lending/borrowing process much more efficient that's all.

It is easy to see how such a system can be easily usurped by corrupt entities (be it banks or governments).

So as such, I don't see anything fundamentally wrong with what Sandeep says, except that to put trust in such a system would mean we put trust in banks (which history shows that it never works). Banks get together to shaft savers.

Edwardo said...

JR wrote:

"No, they need to restructure their economy and consume less and produce more."

They may need to, but I submit that even were Greece capable of painlessly eradicating all of their debt by tomorrow morning, producing more than they consume may not be possible without first suffering a massive reduction in the size of their economy that is, at least in part, the result of circumstances beyond their control.

Robert LeRoy Parker said...

This is very hilarious to me:

WSJ: What inning are we in with Greece until we know if we’re at the resolution to end all resolutions?

Mario Draghi: I don’t know baseball. But if we didn’t have that package finalized, there would be no game.

Anonymous said...

So as such, I don't see anything fundamentally wrong with what Sandeep says, except that to put trust in such a system would mean we put trust in banks (which history shows that it never works).

His proposal is wrong for two reasons. Firstly, it misses the point. In order to make a gold (or silver) standard work, it is not enough to regulate banking (or some formalized market for private-to-private loans), but he would have to interfere with every private contract in which full payment in not made in physical gold or silver.

Secondly, already the little part of private contracts that he does cover, makes his proposal so incredibly complicated that it fails the common sense test. Just be honest with yourself: Who is going to follow that proposal???

Again, the issue is not that some bankers are corrupt and break the rules, but that the proposed rule in nonsense in the first place.

Victor

Motley Fool said...

High 5's VtC. :P

Anonymous said...

it is not enough to regulate banking (or some formalized market for private-to-private loans), but he would have to interfere with every private contract in which full payment in not made in physical gold or silver.

I don't see why private contract payments will not be settled in gold or silver under a metallic standard. Such private contracts cannot even exist under such a standard, right?

Secondly, already the little part of private contracts that he does cover, makes his proposal so incredibly complicated that it fails the common sense test. Just be honest with yourself: Who is going to follow that proposal???

Why is it incredibly complicated? I don't get it. Each individual makes their choice of time-preference, which means the banks are inherently tied by the collective choices of these individuals. The max duration and funds in this case, cannot be arbitrary like 30 year T-bonds, rather it is the maximum duration chosen by the individuals and the funds they have collectively allocated for the said duration.

These durations need not be arbitrary, they can be discrete like 90-days, 6 months, 1 year etc. (just like CDs).

So overall, I don't see how you can write off the whole concept as nonsense, though I understand your point on people being unwilling to follow such a proposal.

JR said...

Well said Edwardo,

Greece needs more than someone "painlessly eradicating all of their debt by tomorrow morning," they need fundamental change.

You can't squeeze blood from a turnip. That's an old saying. It means that you cannot get something from someone that they don't have. In order to pay its debt in real terms, Greece needs to ultimately get back to producing more than it consumes. And as counterintuitive as this may sound, they will first need to run a BOP surplus in order to get there. You do that by exporting more value than you import.

I realize how backward this sounds, but that’s only because we haven’t seen gold function properly in more than 90 years—beyond living memory. And this is why the limited stock of physical gold is far more valuable than the paper gold promises of New York and London would have you believe. This is why Greece will never part with its gold at today's prices. It is far more valuable. Greece ultimately needs to get back to importing gold which is what happens when you produce more than you consume. But you can't get back to that place by spewing your real capital at imaginary capital prices.

Anonymous said...

Thanks JR for the Equilibrium post link. As always, a clearly thought out and written article.

FOFOA says: This is probably money's most important function, transactional medium or medium of exchange. But in this function, in this transactional role the specific value of a currency does not matter at all. All that matters is stability, or relative stability since perfect stability is impossible.


This neatly ties with another link that I read on Resilience Stability Tradeoff.

The author of that link akins macro economic stabilization to river flood management where every action at stabilizing the system leads to even more fragility built within the system, up to a point where the system itself breaks down and completely collapses.

He writes:
In the hands of a responsible central bank the ability to issue a fiat currency is beneficial, but in an excessively stabilised economy, it allows the process of stabilisation to be maintained for far longer than it would otherwise be. And just like in the case of the river Kosi, the longer the period of the stabilisation the more catastrophic are the results of the inevitable normal disturbance.

Prof. Fekete's Premature Obituaries also talks about a similar concept, called economic resonance.

He says:
As may be recalled, this
rather rare physical phenomenon caused the Tacoma suspension bridge in Washington state plunge into the river in 1940. Parcels of energy bombarding the bridge in gusting winds resonated with one of the characteristic harmonic
frequencies of the bridge. As a result total energy, rather than dissipating harmlessly, kept piling up. It ultimately overwhelmed the statics of the bridge. Engineers have forgotten to take runaway resonance into account when the bridge still existed only as a blueprint. Likewise, designers of the regime of irredeemable currency have failed to consider economic resonance. Runaway vibration exists in economics whether recognized or not. It can destroy currency and bond values just
as it can destroy bridges.

Anonymous said...

ephemeral reality,

Alice to Bob: Bob, can I buy the old Ferrari that you are not using anymore?
Bob: Sure, but it is still in good condition and fast as hell - I would request 2000 ounces of silver.
Alice: Sure. You know I just got that new job at the dental lab. But first, I have to pay for all the new furniture. After one year, I will be fine, and so can I pay you after one year? I'd be willing to pay some interest on top, say 2100 ounces in total?
Bob: Sure, I have known you for ten years now. This is fine with me. Here are the keys, but please let us write a letter about the contract and both sign it.

Where is Sandeep? Did he check whether the maturities match? Why is Bob accepting the deal? The reason is he trusts Alice. This is enough to make the proposal fail.

Victor

Anonymous said...

Where is Sandeep? Did he check whether the maturities match? Why is Bob accepting the deal? The reason is he trusts Alice. This is enough to make the proposal fail.

Let me take your own example and explain how I understand such a transaction would work in Sandeep's proposal of a system with matching maturities.

Alice is selling a car to Bob, therefore Alice is parting with an asset that she has and should be paid in full immediately upon transaction completion.

Bob goes to the bank and takes out a loan of 2000 ounces of silver with a 1 year term and the interest he's required to pay for his loan to the bank is 100 ounces.

The bank gives him a loan ensuring that he has the capacity to pay back the loan. The bank uses funds from customers who have deposited silver ounces with the bank and indicated that their time-preference is 1 year on those silver deposits. The customers expect a modest rate of interest in return as well. So the overall 100 ounces that the bank got from Bob will be distributed to all these said depositors at the end of the 1 year.

The bank earns money on the spread.

Anonymous said...

@Victor -

Of course Alice gets paid in full as soon as Bob takes out the loan.

Anonymous said...

I have two objections: I real life, nobody would go to the bank that is run by Sandeep - way to complicated. Sandeep would be out of business immediately.

Also, in real life, Bob trusts Alice. So why use a bank at all. And no, Bob does not receive payment in full for the car. He receives a letter that Alice will pay him one year down the line plus interest. That's different from payment in full.

Victor

Anonymous said...

PS: You see that non-existing silver (the one that Alice promises to give to Bob at some time in the future) has bid for a real asset, the Ferrari.

So the currency price of silver declines relative to Ferraris. This is just because Bob trusts Alice. That's all that it takes.

Victor

Anonymous said...

I real life, nobody would go to the bank that is run by Sandeep - way to complicated. Sandeep would be out of business immediately.

LOL, Please answer the question: why did banks even come to exist in the first place?

And you make it sound "complicated", whereas in reality it is not. Banks arise out of the need of efficient transactions required in the market place.

Secondly, there's nothing stopping Bob and Alice from conducting a private transaction, even if there is a bank present. The level of trust in itself is a subjective component.

Typically, the banks were the market makers so they were trusted with the responsibility of knowing the quality of the borrower and making sure the transactional system has integrity.

We're way off from honesty and integrity at this point, but all I'm saying is that Sandeep's paper shows that a perfect system can be usurped by private interests.

JR said...

Remember from Moneyness that the people's money throughout history has been credit denominated in something. The majority of exchanges up until the invention of paper money were largely on the basis of credit and trust, with accounts later cleared and imbalances settled in metal. In this way, a relatively small and stable monetary base serves a much larger economy.

Unambiguous Wealth

=================================

Randy (@ The Tower) via Gold is Money - Part 3

"Mr. Untermyer, THE FUNDAMENTAL PRINCIPLE OF BANKING, perhaps more than some others, is CREDIT." [emphasis added]

It seems that George Baker sensed (rightly?) that the public, familiar with their Currency being a tangible asset (gold coin), would NOT be readily comfortable with the truth about Money. That is to say, that they might struggle to accept the reality that their Money Supply, as represented on the books of the bank, was created by credit, and existed through the grace of confidence. In effect, the tangible Currency had become a mere symbol for the Money (credit) it represented while circulating outside of bank account ledgers.

If you don't care to believe my assessment, I have another point for you. When Untermyer had J.P. Morgan on the witness stand, he asked him, "Is not commercial credit based primarily upon money or property?" [In this exchange, it appears that Untermyer ignorantly used the word "money" as equivalent to gold coin, a usage which Morgan plays similarly until his concluding point about granting CREDIT.]

Morgan responded, "No, sir, the first thing is CHARACTER." [emphasis added]

Untermyer, shocked, reiterated, "Before money or property?"

Morgan reassured, "Before money or anything else. Money cannot buy it. [credit]"

Untermyer remained obstinate against this notion, as though there were communication difficulties, and pressed again on this point.

Morgan then conclusively stated his conviction on the point that commercial CREDIT is based on character: "Because a man I do not trust could not get MONEY from me on all the bonds in Christendom."

From two eminent bankers who surely knew their business, you now have it that the creation or granting of Money (the extension of Credit) has more to do with the creditworthiness of the borrowers than the collateral that secures against possible default. And recall, these comments occurred while on a gold standard AND in total absence of a government-sponsored central bank -- which was authorized (against Baker's preference) a year later.

As you come to understand how Money and Credit are interrelated, the more you will understand the separate Wealth of gold and why you need it now more than ever.


[FOFOA] The point here is that our modern understanding of money, or any money concept for that matter, combined with our modern taste for borrowing, lending and trading of credit and debt, may not NECESSARILY be a perfect fit with a pure gold standard. Even a gold standard, with gold as the actual currency, is manipulated by the banks through confidence-based lending schemes. Sure, a gold standard somewhat limits the collective in its more nefarious pursuits, but it also has flaws that always seem to lead to the same conclusion... failure.

Anonymous said...

One further thought: 'Money' is the concept that Alice owes Bob something in exchange for the Ferrari. This is part of a network of social contracts: Who owes some goods or services to somebody else?

Silver is a real asset.

A letter of credit or a printed statement of your account is a token that symbolizes 'Money'.

A warehouse receipt from your vault custodian is a token that symbolizes silver.

Victor

Anonymous said...

Apologies for the million of short postings - I'll try to improve, but it won't work.

The problem with Sandeep's silver standard is that there are unregulated private contracts involving debt that is denominated in silver.

This leads to silver's price being depressed in the market place relative to goods and services.

So you have 'silver' (the contract that says that Alice owes Bob 2100 ounces) and silver (the tangible thing in my safe deposit box).

The more 'silver' exists, the cheaper its becomes relative to goods and services. And so I will start speculating against the system, purchase 'silver' in the market, have it exchanged for silver by my bank's teller, and I lock away the silver.

Eventually Sandeep's silver standard runs out of resources because only 'silver' circulates, but the silver is all locked away in my vaults. When the system blows up, I am rich and Bob (who is unlucky and has only 'silver') ends up poor.

Problem is the real economy is turned into a wasteland when that happens.

Victor

Anonymous said...

Sorry, "Sandeep's silver standard runs out of _reserves_".

JR said...

Trail Guide (2/12/2000; 9:52:36MDT - Msg ID:25137)
Reality

[...]

Human society has from the very beginnings formed tribes and picked sides against each other. When we are not battling nation against nation, we jockey for position within our own groups. Right down to "me and my neighbour against the three houses down the street". As a tribe ,,, as a nation ,,,,,, as a group ,,,,,, our war is really a human problem with each other and always has been. In better context; the problems are in the way we use our laws and governments to gain advantage over the next in line.

Whether through force (war) or democratic means, we subject ourselves to the order of governments. We rightly perceive that,,,,,, the order gained from this action ,,,,,,, the security of a group, overcomes the rights and property lost on a individual level that living in a tribe requires. It's been this way through the ages. It's a political process that has always had its in-house battles ,,,,, namely portions of society try to circumvent their percentage of lost rights and property by maneuvering the rules (laws) in their favor. Yes,,,,,if I can gain the advantages of tribe life and still keep my "portions lost",,,,,I'm gaining wealth to the disadvantage of the group. Truly, the most obvious action of not paying your taxes,,,,,and that's only a small item when viewing the world battle as a whole.

So, how does this apply to money?

[...]

The use of money in any context, fiat, gold or seashells, has always entailed the use of borrowing and lending... And as long as economies function at a profit, debts are made and paid back without argument. However, when the eventual downturn arrives, some portions (perhaps a large portion) of the owed wealth (debt) cannot be returned.

It's here,,,,at this point in tribal life,,,,,,,that all of the context from above comes into play. The "reality" of life on this earth is this: ,,,,,,Some portion of society will use their influence or control of the leaders to make their debts easier to pay. In fact,,,,,it's times 2 for that number of government influencers ,,,, because even the ones that have debt owed to them will try to alleviate an impossible payback situation the ones that owe them face.

You see,,,,,tribal life and the human nature that comes with it,,,,,,,,will not allow any money system to "completely" destroy the wealth of a good portion of society. Even if everyone is plainly shown that they are going to lose something ,,,,,,they would still option for the good of the overall tribe. This is why we return,,,,time and again to fiat monetary systems. In the few examples where a gold system brings the harsh reality of loses to bear on a nation,,,,,,usually war is the result. Not a good outcome.

Yes, we can break gold into many small parts,,,,,,stamp it into coins and circulate gold certificates as money. We can borrow it, lend it and also circulate gold bonds as the economy grows. It is the perfect "weights and measures" monetary system. Exactly representing our productive efforts in every faucet of human endeavour. But, when the loses mount, our tribal human tendencies will not allow us to support a government or banking system that forces these real loses on only a portion of the group. Never has,,,,and never will! Without this escape valve, we go to war ,,,,,, internaly or on a world scale,,, so we all can share the loss,,,one way or another. As a human society of thousands of years,,,outside of war,,,,,we have learned to inflate our loses upon everyone as a whole,,,,,for the good of the keeping the whole from each others throats. Even to the point of a total loss of the current system,,,,,and all the destruction that entails for everyone.


Via Reply to Bron


also Debtors v. Savers II - FOA Retro House Mix

LD said...

comments

Anonymous said...

Finally, in real life, Charlie will open shop and set up a company that works in the private market, not subject to Sandeep's restrictive banking regulations, and that acts as a broker for private-to-private loans, matching the Alices and the Bobs of this world.

The company issues joint credit notes, representing not an individual loan but written against the entire pool of loans owed by their customers.

This happens not because Charlie is a crook who wants to undermine Sandeep's noble rules, but because in real life, convenience and efficiency count. People will love Charlie's services. And it will work for a few decades. And Charlie & Co's certificates will circulate and bid for Ferraris, driving the currency price of silver down and the price of Ferraris up.

Until Charlie & Co have a problem with a shortage of silver reserves, and then they blow up. Just as in 1929-1933.

I am offline now. See you tomorrow.

Victor

cyclecooler said...

comments.

Smiddywesson said...

I have to laugh that you spotted this piece by Buffet, it was priceless. He is either being completely disingenuous, or he has no clue about the world he has dominated. Is it a delicious admission of ignorance, or another misdirection by a very wealthy scoundrel and master of what used to work? I just have to make one little comment before I finish your article, because, like a good meal, it's so good I don't want to gobble it down all at once.

Buffet approaches the topic with the assumption that being an investor, especially his kind of investor, is always the smart thing to do, and he is SO desperate to be viewed as the smartest and most humble sage of the markets. The truth is that sometimes the market is a crushing tsunami bearing down on the participants. In those situations, the winners are the savers who latch onto palm trees that don't go anywhere, meaning they have "no return" like gold. In those situations, wily investors like Buffet are swept out to sea with the other lesser skilled investors (because they are doing the right thing at the wrong time). Sometimes, it's better to be an investor and latch onto the tree of life, a lesson Buffet's shareholders learned recently and are about to learn again.

Additionally, gold serves as more than just an anchor for savers when all other participants, whether they be the investors, the traders, or the speculators, are swept away. Sometimes, when the destruction is severe enough to wreck the monetary system, gold rises like Poseidon from the waves, like in the movie "Jason and the Argonaughts" overshadowing everything else and demanding man worship it in its own terms.

The awe inspired in that silly old movie is how I feel self righteous old farts like Buffet will respond when free gold makes the scene. It will undermine everything they ever believed about the world.

costata said...

A New Wealth Transfer Scheme?

I was going to post this comment as off topic but then I caught up with this excerpt from the Trail Guide posted by JR:

It's a political process that has always had its in-house battles ,,,,, namely portions of society try to circumvent their percentage of lost rights and property by maneuvering the rules (laws) in their favor. Yes,,,,,if I can gain the advantages of tribe life and still keep my "portions lost",,,,,I'm gaining wealth to the disadvantage of the group.

So this piece is not so off topic after all.

“The US taxpayer will get pennies on the dollar for these homes, and then be allowed to rent them back at market rates.”

Among the players that expect to profit big from this government-sponsored scam are the private firms that already manage properties for the government. The Department of Housing and Urban Development calls them “management and marketing contractors.” Their principal owners and officers tend to consist of former high-ranking officials with HUD, the Treasury, FHA and so on.

There are 20 of these “M&M” firms, according to a list on HUD’s website. On the theory that perhaps you could reclaim some of your tax dollars by investing in these firms — the same theory with which we suggested ITA, the defense and aerospace ETF — we examined whether any of them are publicly traded. None are. Sorry.

No, the only way you’ll be able to make any money off these insider deals will come long after the feast is over and you’re allowed a few crumbs. “Once the privatization has occurred,” one analyst observes, “and the properties are generating rental income for the investors, the initial investors will cash out by forming real estate investment trusts (REITs), real estate operating companies (REOCs) or limited partnerships that will be made available to retail investors.”


>> Read more: Uncle Sam's Fire Sale. Minimum Investment: $1 Billion http://dailyreckoning.com/uncle-sams-fire-sale-minimum-investment-1-billion/#ixzz1nFzuYlI6 <<

Wash, rinse, repeat!

Anonymous said...

Victor,

Thanks for your replies, I think after reading them, and also after reading Aristotle's mammoth piece in the Hall Discussion link, I get the fact as to why even a perfectly duration matched system of a metallic standard currency is still a problem.

Aristotle: Here's the key factor as detailed earlier in this commentary which ultimately argues forcefully for the proper role of Gold in the monetary system's architecture. In what has been revealed as a misplaced goal, with Gold as the circulating currency, artificial inflation of the Gold supply is the unavoidable consequence because money will always be lent by somebody to somebody else who wants to borrow. As a result, under any past System architecture, there has never been a truly satisfactory means to safely and reliably escape the ravages of inflation and deflation.

JR - thanks for your timely and relevant replies with such links.

I am amazed at the relevance of Aristotle's 12 year old essay even today.

It takes a significant amount of time to read these huge articles and even more time to reflect on them, understand them more clearly. The clarity of thinking in Another/FOA/Ari/FOFOA is staggering.:)

Smiddywesson said...

Uncle Warren doesn't like cash. OK, got it. He likes companies. Check. But many of these companies are holding a lot of cash, and those cash positions are at risk. For example, investors were hoping the $100 billion held by Apple would go their way in the form of a dividend check, but it didn't happen. Up until the time of his recent death, Steve Jobs regarded this cash position as a huge source of strength. However, I think even Mr. Buffet realizes these cash positions can be a ticking time bomb.

You've placed equities in general just to the left of the fulcrum, but the irony is that some that are regarded as very strong are way out on the end with the other trash investments.

somanyroadsinvesting said...

Did a post on Buffett recently. Let me know what you guys think.

http://somanyroadsinvesting.blogspot.com/

«Oldest ‹Older   201 – 247 of 247   Newer› Newest»

Post a Comment