Tuesday, April 3, 2012

Peak Exorbitant Privilege

"Importing more than you export means lots of empty containers. That visual manifestation of our trade deficit is what drivers see as they pass the Port of New York and New Jersey on the New Jersey Turnpike. In the first eight months of 2010, the port saw the equivalent of 700,000 more full 20-foot containers enter than leave.

45% of containers exported from port operator APM Terminals’ Port Elizabeth facility (part of the Port of New York and New Jersey)
are empty, a reflection of the trade imbalance."
Source

_________

In the wake of WWI (1914-1918) there was an international movement in Europe to return to the stability of fixed exchange rates between national currencies. But all of them had been inflated so much during the war that reestablishing the peg to gold at the pre-war price would have implied an overvaluation of currencies that would have led inevitably to a run on all the gold in the banking system, monetary deflation and economic depression (good thing they avoided that, eh?). At the same time, they feared that raising the gold price would raise questions about the credibility of the new post-war regime, and quite possibly cause a global scramble into gold.

This "problem" with gold was viewed at the time as a "shortage" of gold. And so one of the stated goals of the effort to solve this problem was "some means of economizing the use of gold by maintaining reserves in the form of foreign balances." (Resolution 9 at the Genoa Conference, 1922) To economize means to limit or reduce, often used in conjunction with "expense" or "waste". So to "economize the use of gold" meant to limit or reduce the use of gold.

Meanwhile, the United States had emerged from the war as the major creditor to the world and the only post-war economy healthy enough to lend the financial assistance needed for rebuilding Europe. And so even though the U.S. wasn't directly involved in the European monetary negotiations that took place in Brussels in 1920 and Genoa in 1922, it was acknowledged that any new monetary order was likely to be a U.S. centered system.

The Genoa negotiations were led by the English including British Prime Minister Lloyd George and Bank of England Governor Montagu Norman who proposed a "two-tier" system especially designed to circumvent "the gold shortage". The British proposal described a group of "center countries" who would hold their reserves entirely in gold and a second tier group of (unnamed) countries who would hold reserves partly in gold and partly in short-term claims on the center countries. [1]

The proposal was named the "gold-exchange standard" (as opposed to the previous gold standard). In 1932 French economist Jacques Rueff proclaimed the gold-exchange standard that had come out of the Genoa conference a decade earlier "a conception so peculiarly Anglo-Saxon that there still is no French expression for it." [2]

The gold-exchange standard that officially came into being around 1926 (and lasted only about six years in its planned form) worked like this: The U.S. dollar was backed by and redeemable in gold at any level, even down to small gold coins. The British pound was backed by gold and dollars and redeemable in both, but for gold, only in large, expensive bars (kind of like the minimum gold redemption in PHYS is 400 oz. bars but you can redeem in dollars at any level). Other European currencies were backed by and redeemable in British pound sterling, while both dollars and pounds served as official reserves equal to gold in the international banking system. [3]

Since only the U.S. dollar was fully redeemable in gold, you might expect that gold would have immediately flowed out of the U.S. and into Europe. But as I already explained, the U.S. emerged from WWI as the world's creditor and the U.S. Treasury in 1920 held 3,679 tonnes of gold. By the beginning of the gold-exchange standard in 1926 the U.S. was up to 5,998 tonnes and by 1935 was up to 8,998 tonnes. By 1940 the U.S. Treasury held 19,543 tonnes of gold. After WWII and the start of the new Bretton Woods monetary system, official U.S. gold peaked at 20,663 tonnes in 1952 where it began its long decline. [4]

In Once Upon a Time I wrote, "Once sterilized [at the 1922 Genoa Conference], gold flowed uncontrolled into the US right up until the whole system collapsed and beyond." My point was that before the introduction of "paper gold" as official reserves in the form of dollars and pounds, the flow of physical gold in international trade settlement governed as a natural adjustment mechanism for national currencies and exerted the spur and brake forces on their economies. But after 1922, this was no longer the case.

After 1922, the U.S. provided the majority of the reserves for the international banking system in the form of printed dollars. And as the world's creditor and reserve printer, dollar reserves flowed out and gold payments flowed in. From the start of the gold-exchange standard in the mid-1920s until 1952, about 26 years, the dollar's monetary base grew from $6B to $50B while the U.S. gold stockpile grew from 6,000 tonnes to more than 20,000 tonnes. [5]

The Roaring Twenties was not just a short-lived period of superficial prosperity in America, it was also a time when a great privilege was unwittingly granted to the United States that would last for the next 90 years. And I say "unwittingly granted" because the U.S. did not even participate in the negotiations that led to its privilege. As Jacques Rueff wrote in his 1972 book, The Monetary Sin of the West:

"The situation I am going to analyze was neither brought about nor specifically wanted by the United States. It was the outcome of an unbelievable collective mistake which, when people become aware of it, will be viewed by history as an object of astonishment and scandal." [6]

I should pause here to note that gold standard advocates and hard money campers will quickly point out that the post-1922 gold-exchange standard is not what they want. They want to return to the gold standard of the 19th century, the one before WWI. But that's not my position. And anyway, it's not gonna happen and even if it would/could happen, it would not fix the fundamental problem. Just like time, we move relentlessly forward and, luckily for us, the future is much brighter than the past.

Now, back to this privilege which, in the end, may turn out to be more of a curse. In order to really understand how the gold-exchange standard and its successor systems, the Bretton Woods system and the current dollar standard system translated into a privilege for the United States, we need to understand what actually changed in the mid-20s as it fundamentally relates to how we use money. I will explain it as briefly as possible but I want to caution you to resist the temptation to make judgments about what is wrong here as you read my description. As some of you already know, I think there is only one fundamental flaw in the system and it was present even before the gold-exchange standard and the U.S. exorbitant privilege, but that's not the subject of this post.

What changed?

People and economies trade with each other using money – mainly credit, denominated in a national currency – as their primary medium of exchange so as to avoid the intractable double coincidence of wants problem with direct barter. So we trade our stuff for their stuff using bank money (aka fungible currency-denominated credit) and the prices of that stuff are how we know if there is any inequity or imbalance in the overall trade. When we periodically net out the bank transactions using the prices of the stuff we traded, we inevitably come up short on one side or the other. And so that imbalance is then settled in the currency itself.

But because different countries use different currencies, we need another level of imbalance clearing. And that international level is cleared with what we call reserves. So, in essence, we really do have two tiers in the way we use money. We have the domestic tier where everyone uses the same currency and clearing is handled at the commercial bank level with currency. And then we have the international tier where everyone doesn't use the same currency and so trade imbalances tend to aggregate and then clear with what we call "reserves" (aka international liquidity) at the national or Central Bank level.

This is built right into the very money that we use, and have used, for a very long time. To see how, we will regress conceptually back to how our bank money is initially conceived. And because most of you have at least a basic understanding of the Eurosystem's balance sheet from my quarterly RPG posts, this should be a fairly easy exercise. If not, RPG #4 might be a good place to catch up quickly.

Recall this chart from Euro Gold:


It shows the change, over time, in relative value of the two kinds of reserves held by the Eurosystem: 1. gold reserves and 2. foreign currency reserves. And in RPG #4 I explained the difference between reserves and assets on the CB balance sheet. Assets are claims against residents of your currency zone denominated mostly in your own currency. Reserves are either gold or claims against non-residents denominated in a foreign currency.

In our regression exercise we'll see the fundamental difference between reserves and assets. Reserves are the fundamental basis on which the basic money supply of a bank is borne, while assets are the balance sheet representation of the bank's extension of credit. Changes in the ratio between reserves and assets exert opposing (enabling/disabling) influences on the ability of the system to expand.

So, now, looking back at the very genesis of our money, we've all heard the stories of the gold banker who issues receipts on the gold he has in his vault, right? Well, that's basically it. Money as we know it today ultimately begins with the monetization of some gold. The Central Bank has some amount of gold in the vault which it monetizes by printing cash.

CB
Assets-------Liabilities
Gold | Cash

For the sake of this exercise, let's say that the government deposits its official gold in its newly-created CB and the CB monetizes that gold by printing cash which is now a government deposit. So let's simplify the balance sheet even more. CB = Central Bank, R = reserves, A = assets and C = cash (or also CB liabilities which are electronic obligations of the CB to print cash if necessary, so they are essentially the same thing as cash within the banking system).

CB
R|C

That's reserves (gold) on the asset side of the balance sheet and cash (the G's deposit) on the liability side. Now the G can spend that cash into the economy where it will end up at a commercial bank. Let's say COMMBANK1 = commercial bank #1, C = cash (or CB liabilities) and D = deposit.

COMMBANK1
C|D

Now that the G spent money into the economy, our first commercial bank has its own reserves and its first deposit from a government stooge who received payment from G and deposited it in COMMBANK1. In the commercial bank, cash is the reserve on the asset side of the balance sheet whereas cash is on the opposite side, the liability side, of the Central Bank's balance sheet. Also, all the cash issued by the CB remains on its balance sheet even after it has left the building and is sitting in the commercial bank (or even in a shoebox under your bed).

At this point we have a fully reserved mini-monetary system. Both the CB's and the commercial bank's liabilities are balanced with reserves. The CB's reserves are gold and the commercial bank's reserves are cash or CB liabilities. That's fully reserved. But let's say that the economy is trying to grow and the demand for bank money (credit) is both strong and credible. So now our banks can expand their balance sheets.

As credit expands, the asset side will be balanced with assets (A) rather than reserves (reserves are gold in the case of the CB and cash in the case of COMMBANK1). Also, I'm going to put the CB under the commercial banks since it is essentially the base on which the commercial bank money stands.

COMMBANK1
ACC|DDD
________________________________________
CB
AR|CC

Here we see that our CB now has an asset and a reserve. The asset is a claim denominated in its own currency against a resident of its currency zone, and the reserve is the gold. Let's say that the CB lent (and therefore created) a new C to the government. Meanwhile, our commercial bank COMMBANK1 has had two transactions. It has received the deposit from a second government stooge and it has also made a loan to a worthy entrepreneur.

So on the COMMBANK1 (commercial bank) balance sheet, the A is a claim against our entrepreneur and the two Cs are cash reserves. The first C came in when our first stooge deposited his government paycheck and the second C came in when the second stooge deposited his payment which G had borrowed (into existence) from the CB. The three Ds (deposits) belong to our two stooges and the entrepreneur.

I'm not going to go much further with this model but eventually, as the economy and bank money expands, we'll end up with something that looks more like this:

COMMBANK1
AAACC|DDDDD

COMMBANK2
AAACC|DDDDD

COMMBANK3
AAACC|DDDDD

COMMBANK4
AAACC|DDDDD

COMMBANK5
AAACC|DDDDD
________________________________________
CB
AAAAAAAAAR|CCCCCCCCCC

And here we have a simple model of our monetary system within a single currency zone. There are two observations that I want to share with you through this little exercise. The first is the tiered nature of our monetary system even within a single currency zone. And the second is the natural makeup of a Central Bank's balance sheet.

You'll notice that one thing the Central Bank and the commercial banks have in common is that the asset side of their balance sheets consist of both reserves and assets. Remember that assets are claims denominated in your currency against someone else in your currency zone. But you'll also notice that the commercial bank reserves are the same thing as the Central Bank's liabilities. So the Central Bank issues the reserves upon which bank money is issued to the economy by the commercial banks.

The fundamental take-home point here is that reserves are the base on which all bank money expands. CB money rests on CB reserves and commercial bank money rests on commercial bank reserves which are, in fact, CB money which is resting on CB reserves. So you can see that the entire money system is built up from the CB reserves.

The deposits (D) in the commercial banks are both redeemable in reserves and cleared with reserves (reserves being cash or CB liabilities). Deposits are not redeemable or cleared (settled) with assets. If a commercial bank has a healthy level of reserves it can expand its credit. But if it expands credit without sufficient reserves for its clearing and redemption needs, it must then go find reserves which it can do in a number of ways.

Notice above that we have 25 deposits at 5 commercial banks based on 10 commercial bank reserves. Those commercial bank reserves are Central Bank liabilities which are based ultimately on the original gold deposit. Before 1933, gold coins were one component of the cash, and CB liabilities were also redeemable by the commercial banks in gold coin from the CB to cover redemption needs. So the commercial banks (as well as the Fed) had to worry about having sufficient reserves of two different kinds. As you can imagine, this created another level of difficulty in clearing and especially in redemption.

Clearing and Redemption

Very quickly I want to go over clearing and redemption and how they can move reserves around in the system. Here's our simple system once again:

COMMBANK1
AAACC|DDDDD

COMMBANK2
AAACC|DDDDD

COMMBANK3
AAACC|DDDDD

COMMBANK4
AAACC|DDDDD

COMMBANK5
AAACC|DDDDD
________________________________________
CB
AAAAAAAAAR|CCCCCCCCCC

Now let's say that one of our depositors at COMMBANK5 withdrew his deposit in cash. And let's also say that another depositor at the same bank spent his money and his deposit was therefore transferred to COMMBANK4 and that transaction cleared. Here's what it would look like:

COMMBANK1
AAACC|DDDDD

COMMBANK2
AAACC|DDDDD

COMMBANK3
AAACC|DDDDD

COMMBANK4
AAACCC|DDDDDD

COMMBANK5
AAA|DDD
________________________________________
CB
AAAAAAAAAR|CCCCCCCCCC

A few quick observations. There are now only 9 Cs in the commercial banking system even though there are still 10 Cs outstanding on the CB's balance sheet. That's because one of them is now outside of the banking system as on-the-go cash in the wallet.

Also, notice that COMMBANK4 received its sixth deposit which cleared and so COMMBANK4 received the cash (C) reserve from COMMBANK5. This transaction bumped COMMBANK4 up from being 40% reserved to 50% reserved. But because COMMBANK5 had to deal with two transactions, one redemption and one cleared deposit transfer, COMMBANK5 is now out of reserves.

In this little scenario, COMMBANK4 is now extra-capable of expanding its balance sheet, while COMMBANK5 needs to forget about expanding and try to find some reserves. To obtain reserves, COMMBANK5 can call in a loan, sell an asset for cash, borrow cash temporarily while posting an asset as collateral, or simply hope that some deposits come his way very soon. But in any case, COMMBANK5's next action is, to some extent, influenced by its lack of reserve.

This is an important point: that as reserves move around, their movement exerts some influence on the activities of both the giver and the receiver of the reserves.

International Clearing

Now let's scale our model up and look at how it works in international trade. Commercial banks deal mostly in their own currency zone's currency. But in today's fast-paced and global world we have a constant flow of trade across borders, so various currencies are also flowing in all directions. Some international commercial banks handle these transactions, but as you can imagine, clearing and redemption becomes a bit more complicated.

You might have a deposit (D) at COMMBANK5 in the U.S. being spent in Europe somewhere and ending up at a European commercial bank where it is neither redeemable nor clearable as it stands (currently denominated in dollars). The U.S.-based COMMBANK5 will transfer both the C and the D to the European bank. The European deposit holder who sold his goods to the U.S. will want his bank to exchange those dollars for euros so he can pay his bills. So the European bank will look to either the foreign exchange market or to its CB to change the currency.

If trade between the two currency zones was perfectly equal at all times, there would be an equal amount of euros wanting to buy dollars and vice versa. But we don't live in a perfect world, so there's always more of one or the other which is why the exchange rates float. If, instead, we had fixed exchange rates, the CBs would be involved in equalizing the number of euros and dollars being exchanged, and then the CBs would settle up amongst themselves using their reserves, which was how it was before 1971.

But even today, with floating exchange rates, the CB's still do get involved in what we call the "dirty float" to manage the price of their currency on the international market. This is essentially the same process as during fixed exchange rates except that they don't maintain an exact peg, but instead they let it float within a range that they deem acceptable. And the way they do that is essentially the same way they did it back in the fixed exchange rate system of Bretton Woods and before. They buy up foreign currency from their commercial banks with newly printed cash.

Or, if there's a glut of their own currency in foreign lands trying to get home, then they have to buy back their own currency using up their CB reserves. Which brings us to the makeup of a CB's balance sheet, most pointedly its reserves. And the take-home point that I want to share with you here is the difference between finite and infinite from a CB's perspective.

From the perspective of a CB, its own currency is infinite while its reserves are finite. So if there's a glut of foreign currency in its zone, it has no problem buying up as much as it wants with printed cash. In fact, theoretically, a CB could buy up foreign currency that is accumulating in its zone until the cows come home. On the other hand, if there's a glut of its own currency abroad, its buy-back power is finite and limited to the amount of reserves it stockpiled earlier.

So why do it? Why does a CB spend its precious reserves buying its own currency back from foreign lands? What happens if it doesn't? Currency collapse is what happens. If there's a glut of your currency abroad and you don't buy it back, the market will take care of it for you by devaluing your currency until it becomes impossible for you to run a trade deficit. And this is a painful process when the marketplace handles it for you because it not only collapses your trade deficit to zero, it also tends to bring your domestic economy to a standstill at the same time, a double-whammy.

And this is how the monetary system above scales up to the international level. While the commercial bank reserves (Cash) are good for clearing, redemption and credit expansion within a currency zone, only the CB reserves work in a pinch on the international level. And if the CB runs out of reserves, the currency collapses due to market forces and, therefore, the commercial bank reserve (Cash) upon which commercial bank money is expanded devalues, and so bank money, too, devalues. It is all stacked upon the CB reserves from whence the first bank money was born.

And as you can see above, the natural makeup of a CB's reserves is gold. But that changed in 1922.

Now obviously there are a myriad of directions in which we could take this discussion right now. But the direction I want to keep you focused on so that I can eventually conclude this post is that when a Central Bank's finite reserves are ultimately exhausted in the international defense of its currency, its local commercial bank's reserves (Cash) are naturally devalued by the international market. And with the commercial bank reserves being what commercial bank deposits are redeemable in, so too is local money devalued.

But in 1922 they "solved" this "problem" with the introduction of theoretically infinite reserves.

As we move forward in this discussion, I want you to keep in mind my first fundamental take-home point which was that reserves are the base on which bank money expands. Commercial banks expand their bank money on a base of Central Bank-created reserves. And (as long as there is trade with the world outside of your currency zone) the Central Bank's reserves are the base on which the commercial banks' reserves stand. So the corollary I'd like to introduce here is that theoretically infinite reserves lead to theoretically infinite bank money expansion.

Of course it doesn't take a genius to figure out that infinite money expansion does not automatically translate into infinite real economic growth. And so we need to look at who, in particular, was the prime beneficiary of these newly infinite reserves.

In 1922 the Governor of the Bank of England which had around 1,000 tonnes of gold at the time (less than the Bank of France which had about 1,200 tonnes) proposed economizing the use of gold by declaring British pound sterling and U.S. dollars to be official and recognized reserves anywhere in the world. The "logic" was that dollars and pounds would be as good as gold because they would be redeemable in gold on their home turf.

Three Fair Warnings

The reason I went through this somewhat-lengthy exercise explaining the significance of reserves in our monetary and banking system was to help you understand the words of Jacques Rueff who first warned of the catastrophically dangerous flaw embedded in this new system—a flaw which continues today—way back in 1931. The term "exorbitant privilege" would not be used until 30 years later under a new system, but I hope to help you see, as I do, the common thread that ties all three systems together, the gold-exchange standard, Bretton Woods and the present dollar standard.

As we walk through this timeline together, you'll read three warnings at times of great peril to the system. The first was delivered by Rueff to the French Finance Minister in preparation for the French Prime Minister's meeting with President Hoover in Washington DC in 1931. The second was delivered to the U.S. Congress by a former Fed and IMF economist named Robert Triffin in 1960. And the third will be delivered later in this post.

To put it all in perspective, I drew this rough timeline to help you visualize my thought process while writing this post:


Those of you who have been reading my blog for a while should be aware that the U.S. has run a trade deficit every year since 1975. You should also know that, since 1971, the U.S. government has run its national debt up from $400B to $15,500B, and that foreign Central Banks buying this debt have been the primary support for both the relatively stable value of the dollar and the perpetual nature of the U.S. trade deficit.

But it wasn't always this way. Before 1971 the U.S. was running a trade surplus and the national debt level was relatively steady during both the gold-exchange standard and the Bretton Woods era. During the gold-exchange standard the national debt ranged from about $16B up to $43B. It increased a lot during WWII to about $250B, but then it remained below its $400B ceiling until 1971.

Another big difference during this timeline which I have already mentioned is the flow of gold. The U.S. experienced an uncontrolled inflow of gold from the beginning of the gold-exchange standard until 1952, and then a stunted outflow ensued until it was stopped altogether in 1971.

The point is that with such a wide array of vastly disparate circumstances, it is a bit tricky for me to explain the common thread that binds this timeline together. Very generally, let's call this common thread the monetary privilege that comes from the rest of the world voluntarily using that which comes only from your printing press as its monetary reserves. It started as a privilege, grew into an exorbitant privilege 35 years later, and then peaked 45 years later at something for which, perhaps, there is not an appropriately strong enough adjective.

Robert Triffin thought it had gone far enough to warrant warning Congress in 1960, but just wait till you see how much farther it went over the next four and a half decades. But first, let's go back to 1931.

First Warning

In his 1972 book [6], Jacques Rueff writes:

Between 1930 and 1934 I was Financial Attache in the French Embassy in London. In that capacity, I had noted day after day the dramatic sequence of events that turned the 1929 cyclical downturn into the Great Depression of 1931-1934. I knew that this tragedy was due to disruption of the international monetary system as a result of requests for reimbursement in gold of the dollar and sterling balances that had been so inconsiderately accumulated.

On 1 October 1931 I wrote a note to the Finance Minister, in preparation for talks that were to take place between the French Prime Minister, whom I was to accompany to Washington, and the President of the United States. In it I called the Government's attention to the role played by the gold-exchange standard in the Great Depression, which was already causing havoc among Western nations, in the following terms:

"There is one innovation which has materially contributed to the difficulties that are besetting the world. That is the introduction by a great many European states, under the auspices of the Financial Committee of the League of Nations, of a monetary system called the gold-exchange standard. Under this system, central banks are authorized to include in their reserves not only gold and claims denominated in the national currency, but also foreign exchange. The latter, although entered as assets of the central bank which owns it, naturally remains deposited in the country of origin.

The use of such a mechanism has the considerable drawback of damping the effects of international capital movements in the financial markets that they affect. For example, funds flowing out of the United States into a country that applies the gold-exchange standard increase by a corresponding amount the money supply in the receiving market, without reducing in any way the money supply in their market of origin. The bank of issue to which they accrue, and which enters them in its reserves, leaves them on deposit in the New York market. There they can, as previously, provide backing for the granting of credit.

Thus the gold-exchange standard considerably reduces the sensitivity of spontaneous reactions that tend to limit or correct gold movements. For this reason, in the past the gold-exchange standard has been a source of serious monetary disturbances. It was probably one cause for the long duration of the substantial credit inflation that preceded the 1929 crisis in the United States."
Then in 1932 he gave further warning in the speech at the School of Political Sciences in Paris which I wrote about in Once Upon a Time:

The gold-exchange standard is characterized by the fact that it enables the bank of issue to enter in its monetary reserves not only gold and paper in the national currency, but also claims denominated in foreign currencies, payable in gold and deposited in the country of origin. In other words, the central bank of a country that applies the gold-exchange standard can issue currency not only against gold and claims denominated in the national currency, but also against claims in dollars or sterling.

[…]

The application of the gold-exchange standard had the considerable advantage for Britain of masking its real position for many years. During the entire postwar period, Britain was able to loan to Central European countries funds that kept flowing back to Britain, since the moment they had entered the economy of the borrowing countries, they were deposited again in London. Thus, like soldiers marching across the stage in a musical comedy, they could reemerge indefinitely and enable their owners to continue making loans abroad, while in fact the inflow of foreign exchange which in the past had made such loans possible had dried up.

[…]

Funds flowing out of the United States into a gold-exchange-standard country, for instance, increase by a corresponding amount the money supply in the recipient market, while the money supply in the American market is not reduced. The bank of issue that receives the funds, while entering them directly or indirectly in its reserves, leaves them on deposit in the New York market. There they contribute, as before being transferred, to the credit base.

[…]

By the same token, the gold-exchange standard was a formidable inflation factor. Funds that flowed back to Europe remained available in the United States. They were purely and simply increased twofold, enabling the American market to buy in Europe without ceasing to do so in the United States. As a result, the gold-exchange standard was one of the major causes of the wave of speculation that culminated in the September 1929 crisis. It delayed the moment when the braking effect that would otherwise have been the result of the gold standard's coming into play would have been felt.
Are you starting to get a sense of the key issue yet? Reserves move from one bank to another to settle a transaction. When our depositor at COMMBANK5 spent his deposit and it was thereby transferred to COMMBANK4, the cash (C) reserve was also moved to COMMBANK4 to settle (or clear) the transaction. This put a certain strain on COMMBANK5 since it had also lost another reserve to redemption which forced COMMBANK5 into the action of seeking reserves.

Or when a Central Bank expends its reserves trying to remove a glut of its currency abroad so that the marketplace won't devalue (or collapse) it, that CB is generally limited to a finite amount of reserves which, once spent, are gone. So the movement of reserves serves two purposes. It is not only attained by the receiver but it is also forfeited by the giver. Both are vital to a properly functioning monetary system.

But with the system that began around 1926 and still exists today, we end up with a situation in which one currency's reserves are actually deposits in another currency zone:


Notice that I am avoiding the use of gold in my illustration. The warnings given in 1931 and 1960 were presented in the context of a gold exchange standard of one form or another, and therefore they (of course!) heavily reference the problems as they related to ongoing gold redemption. But the real problem, as I have said, transcends the specific issues with gold at that time.

The real problem was and is the common thread I mentioned earilier: the monetary privilege that comes from the rest of the world voluntarily using that which comes only from your printing press as its monetary reserves. It was and is, as Jacques Rueff put it, "the outcome of an unbelievable collective mistake which, when people become aware of it, will be viewed by history as an object of astonishment and scandal."

Another angle which was apparent from the very beginning—because Rueff mentioned it in 1932 (as quoted above)—was that of international lending. It basically worked in the same way as the three steps above except that the net international (trade) payment was an international loan. Remember that the U.S. was the prime creditor to the world following both wars. This may partly explain the inflow of gold payments that brought the U.S. stockpile up from 3,679 tonnes in 1920 to 20,663 tonnes in 1952. A dollar loan was the same as a gold loan and was payable in dollars or gold. But as Rueff pointed out above, the lent dollars came immediately back to New York just as the pounds came back to London:

"During the entire postwar period, Britain was able to loan to Central European countries funds that kept flowing back to Britain, since the moment they had entered the economy of the borrowing countries, they were deposited again in London. Thus, like soldiers marching across the stage in a musical comedy, they could reemerge indefinitely and enable their owners to continue making loans abroad."
Now think about that for a moment. The same reserves (base money) getting lent out over and over again like a revolving door. And let's jump forward to the present for a moment to see if we can start connecting some dots between 1932 and 2012. Here's a recent comment I wrote about the revolving door of dollars today:

Hello Victor,

The point of JR's excerpts is that the real threat to the dollar lies in the physical plane (real price inflation) rather than the monetary plane (foreign exchange market). The source of the price inflation will be from abroad and it will be reflected in the exchange rate, but the price inflation, not the FX market, is the real threat.

Imagine a toy model where the entire United States (govt. + private sector) imports $100,000 worth of stuff during a period of time (T). T repeats perpetually and, just to keep it real, let's say that t = 1 second, which is pretty close to reality. So the US imports the real stuff and exports the paper dollars. But the US also exports $79,000 worth of real stuff each second. So 79,000 of those dollars come right back into the US economy in exchange for the US stuff exports.

Now, in our toy model, let's say that the US private sector is no longer expanding its aggregate level of debt. And so let's say, just for the sake of simplicity, that $79,000 worth of international trade over time period T represents the US private sector trading our stuff for their stuff. And let's say that the other $21,000 worth of imports each second is all going to the USG consumption monster.

So the USG is borrowing $21,000 **from some entity** each second and spending it on stuff from abroad. This doesn't cover the entire per-second appetite of the USG consumption monster, only the stuff from abroad. The USG also consumes another $114,000 in domestic production each second, which is all the domestic economy can handle right now without imploding, but we aren't concerned with that part yet.

Now, if the **from some entity** is our trading partner abroad, then there is no fear of real price inflation. The USG is essentially borrowing $21,000 this second -- that our trading partner received last second -- and the USG will spend it again on more foreign stuff a second from now and then borrow it again. See? No inflation! The same dollars circulate in perpetuity, the real stuff piles up in DC, and the USG debt piles up in Beijing.

But what if that **from some entity** is mostly the Fed, and has been for two years now (and they are calling it QE only to make it sound like its purpose is to assist the US private sector)? If that's the case, then the fear of real price inflation is now a clear and present danger to "national security" (aka the USG consumption monster). Not so much for the private sector which is now trading our stuff for their stuff, but mostly for the public sector which trades only $21,000 in paper nothings, per second, for their stuff.

Under this latter situation, you now have $21,000 per second piling up outside of US borders and it's not being lent back to either the USG or the US private sector (which has stopped expanding its debt). It's either going to bid for stuff outside or inside of US boundaries.

The USG budget approved by Congress does account for this $21,000 per second borrowing, but it also assumes reasonably stable prices. If the general price level starts to rise faster than Congress approves new budgets, this creates a problem for the USG. It's not as big of a problem for the US private sector, since we are trading mostly stuff for stuff. If the cost of a banana rises to $1T, it will still only cost half an apple. But if you're relying only on paper currency to pay for your monstrous needs, real price inflation is an imminent threat!

FX volatility has more to do with the changing preferences of the financial markets. It is a monetary plane phenomenon on most normal days. But it will also show up when the price of a banana starts to rise.

When the USG cuts a check, it is drafted on a Treasury account at the Fed. Sometimes those funds are all ready to go in the account. Sometimes they are pulled (momentarily) from a commercial bank into the Fed account for clearing purposes. And sometimes the Fed simply creates them, adding a Treasury IOU to its balance sheet.

This latest Executive Order paves the way for the Fed to start stacking not only Treasury IOUs, but also Commerce Dept. IOUs, Homeland Security IOUs, State Dept., Interior, Agriculture, Labor, Transportation, Energy, Housing and Urban Development, Health and Human Services, etc… IOUs. Whatever it takes to keep the real stuff flowing in! If you think the Fed's balance sheet looks like a gay rainbow now, just wait!

But from a financial perspective, if you are stuck in dollar assets when real price inflation takes hold, you are going to want out. And the quickest way out is through the currency itself. So we could see a spike (outside of the US) in the price of Realdollars even as the dollar is collapsing against the physical plane and the USG is printing like crazy to defend its own largess! How confusing will that be to all the hot "experts" on CNBC?

The financial markets can cause dramatic volatility in the FX market, and vice versa. But that's all monetary plane nonsense. A small change in the physical plane might not even register at first in the FX market, especially if a financial panic is overpowering it in the opposite direction. But even if the dollar doubles in financial product purchasing power terms (USDX to 150+), that's not going to lower the price of a banana in the physical plane while the USG is defending its consumption status quo with the printing press.

Sincerely,
FOFOA
I highlighted the part relevant to our revolving door discussion, but the whole comment is relevant to the whole of this post because I had this post in mind when I wrote the comment. Anyway, can you see any similarity between what Jacques Rueff wrote about the sterling in 1932 and what I wrote last week?

How about a difference? That's right, the U.S. is now the world's premier debtor while it was the world's creditor back in the 30s. But in both cases the dollar currency is being continuously recycled while notations recording its passage pile up as reserves on which foreign bank money is expanded while the U.S. counterpart of reserves and bank money is not reduced as a consequence of the transfer.

If you print the currency that the rest of the world uses as a reserve behind its currency, that alone enables you to run a trade deficit without ever reducing your ability to run a future trade deficit. Deficit without tears it was called. For the rest of the world, running a trade deficit has the finite limitation of the amount of reserves stored previously and/or the amount of international liquidity (reserves) your trading partner is willing to lend you.

Another thing that happens is that, as the printer of the reserve, the rest of the world actually requires you to run a balance of payments deficit or else its (the rest of the world's) reserves will have to shrink, and its currency, credit and economy consequently contract. So to avoid monetary and economic contraction, the world not only puts up with, but supports your deficit without tears. Here's a little more from Jacques Rueff:

The Secret of a Deficit Without Tears [6]

To verify that the same situation exists in 1960, mutatis mutandis, one has only to read President Kennedy's message of 6 February 1961 on the stability of the dollar.

He indicates with admirable objectivity that from 1 January 1951 to 31 December 1960, the deficit of the balance of payments of the United States had attained a total of $18.1 billion.

One could have expected that during this period the gold reserve would have declined by the same amount. Amounting to $22.8 billion on 31 December 1950, it was, against all expectations, $17.5 billion on 31 December 1960.

The reason for this was simple. During this period the banks of issue of the creditor countries, while creating, as a counterpart to the dollars they acquired through the settlement of the American deficits, the national currency they remitted to the holders of claims on the United States, had reinvested about two-thirds of these same dollars in the American market. In doing so between 1951 and 1961 the banks of issue had increased by about $13 billion their foreign holdings in dollars.

Thus, the United States did not have to settle that part of their balance-of-payments deficit with other countries. Everything took place on the monetary plane just as if the deficit had not existed.

In this way, the gold-exchange standard brought about an immense revolution and produced the secret of a deficit without tears. It allowed the countries in possession of a currency benefiting from international prestige to give without taking, to lend without borrowing, and to acquire without paying.

The discovery of this secret profoundly modified the psychology of nations. It allowed countries lucky enough to have a boomerang currency to disregard the internal consequences that would have resulted from a balance-of-payments deficit under the gold standard.

Second Warning

By the early 1960s, Jacques Rueff was not alone in speaking out against the American privilege embedded in the monetary system. Another Frenchman named Valéry Giscard d'Estaing, who was the French Finance Minister under Charles de Gaulle and would later become President himself, coined the term "exorbitant privilege". [7] Even Charles de Gaulle spoke out in 1965 and you can see a short video of that speech in my post The Long Road to Freegold.

But perhaps more significant than the obvious French disdain for the system was Robert Triffen, who stood before the U.S. Congress in 1960 and warned:

"A fundamental reform of the international monetary system has long been overdue. Its necessity and urgency are further highlighted today by the imminent threat to the once mighty U.S. dollar."
To put Triffin in the context of our previous discussion, here's what Jacques Rueff had to say about him:

"Some will no doubt be surprised that in 1961, practically alone in the world, I had the audacity to call attention to the dangers inherent in the international monetary system as it existed then.

I must, however, pay a tribute here to my friend Professor Robert Triffin of Yale University, who also diagnosed the threat of the gold-exchange standard to the stability of the Western world. But while we agreed on the diagnosis, we differed widely as to the remedy to be applied. On the other hand, the late Professor Michael Heilperin, of the Graduate Institute of International Studies in Geneva, held a position in every respect close to mine."
And here is what Wikipedia says about Robert Triffin's Congressional testimony:

"In 1960 Triffin testified before the United States Congress warning of serious flaws in the Bretton Woods system. His theory was based on observing the dollar glut, or the accumulation of the United States dollar outside of the US. Under the Bretton Woods agreement the US had pledged to convert dollars into gold, but by the early 1960s the glut had caused more dollars to be available outside the US than gold was in its Treasury. As a result the US had to run deficits on the current account of the balance of payments to supply the world with dollar reserves that kept liquidity for their increased wealth. However, running the deficit on the current account of the balance of payments in the long term would erode confidence in the dollar. He predicted the result that the system would not maintain both liquidity and confidence, a theory later to be known as the Triffin dilemma. It was largely ignored until 1971, when his hypothesis became reality, forcing US President Richard Nixon to halt convertibility of the United States dollar into gold, an event with consequences known as the Nixon Shock. It effectively ended the Bretton Woods System." [8]
(For more on the Triffin dilemma, please see my posts Dilemma and Dilemma 2 – Homeless Dollars. And for a glimpse at what I view as an even more fundamental dilemma, you'll find "FOFOA's dilemma" in my post The Return to Honest Money.)

As noted above, Triffin's prescription in the 1960s was at odds with Rueff and the French contingent. In fact, even today, the IMF refers to "Triffin's solution" as a sort of advertisement for its own product, the almighty SDR. [9] From the IMF website:

Triffin's Solution

Triffin proposed the creation of new reserve units. These units would not depend on gold or currencies, but would add to the world's total liquidity. Creating such a new reserve would allow the United States to reduce its balance of payments deficits, while still allowing for global economic expansion.

But even though Triffin proposed something like the SDR (a proposal the IMF loves on to this day), I think that actions speak louder than words.

Robert Triffin was a Belgian economist who became a U.S. citizen in 1942 after receiving his PhD from Harvard. He worked for the Federal Reserve from 1942 to 1946, the IMF from 1946 to 1948 and the precursor to the OECD from 1948 until 1951. He also taught economics at both Harvard and Yale. But in 1977 he reclaimed his Belgian citizenship, moved back to Europe, and helped develop the European Monetary System and the concept of a central bank for all of Europe which ultimately became the ECB five years after his death in 1993.

Final Warning

With the end of the Bretton Woods monetary system in 1971, three things (besides the obvious closing of the gold window) really took hold. The first was that the U.S. began running (and expanding) a blatant trade deficit. It went back and forth a couple of times before it really took hold, but starting in 1976 we have run a deficit every year since. [10]

The second thing that took hold was something FOA called "credibility inflation". You can read more about it in my aptly-titled post, Credibility Inflation. This phenomenon, at least in part, helped grow the overall level of trade between the U.S. and the rest of the world in both nominal and real terms. In inflation adjusted terms, U.S. trade with the rest of the world is up almost eightfold since 1971. [11]

The third thing was that the U.S. federal government began expanding itself in both nominal and real terms by raising the federal debt ceiling and relying more heavily on U.S. Treasury debt sales. From Credibility Inflation (quoting Bill Buckler):

Way back in March 1971, four months before Nixon closed the Gold window, the "permanent" U.S. debt ceiling had been frozen at $400 Billion. By late 1982, U.S. funded debt had tripled to about $1.25 TRILLION. But the "permanent" debt ceiling still stood at $400 Billion. All the debt ceiling rises since 1971 had been officially designated as "temporary!" In late 1982, realizing that this charade could not be continued, The U.S. Treasury eliminated the "difference" between the "temporary" and the "permanent" debt ceiling. The way was cleared for the subsequent explosion in U.S. debt. With the U.S. being the world's "reserve currency," the way was in fact cleared for a debt explosion right around the world.
Here are the debt ceilings through 2010 as found on Wikipedia:


That's all well and good, but to really see the U.S. exorbitant (is there a stronger word?) privilege of the last 40 years in stark relief, we must think about those empty containers we export from the picture at the top. Those containers come in full and leave empty, just to be refilled again overseas and brought back in. Those empty containers represent the real trade deficit, the portion of our imports that we do not pay for with exports. Those empty containers represent the portion of our imports that we pay for with nothing but book entries which are little more than lines in the sand. [12]

Here's my thesis: that the U.S. privilege which began in Genoa in 1922, and was so complicated that only one in a million could even fathom it in 1931 and 1960, became as clear as day for anyone with eyes to see after 1971. And so, to see it in real (not nominal) terms, we can very simply look at the percentage of our imports that is not paid for with exports. So simple, which might be why the government doesn't publish that number and the media doesn't talk about it. All you have to do is compare the goods and services balance (which is a negative number or a deficit every year since 1975) with the total for all goods and service imports.

That's comparing apples with apples. For example, in 1971 total imports were $60,979,000,000 and total exports were $59,677,000,000 leaving us with a trade deficit of $1,302,000,000. It doesn't matter what the price of an apple was in 1971, because whatever it was, we still imported 2.14% more stuff than we exported. 1,302 ÷ 60,979 = 2.14%.

A trade discrepancy of 2.14% in any given year would be normal under normal circumstances. You'd expect to see it alternate back and forth from deficit to surplus and back again as it actually did from 1970 through 1976. But it becomes something else entirely when you go year after year (for 36 years straight) importing more than you export. And that's why I showed that little dip in the above timeline visualization of the U.S. exorbitant privilege at 1971.

And now here's what it looks like charted out from 1970 through 2011:


Here's the data from the chart:

1970 -4.14%
19712.14%
19727.49%
1973-2.13%
19743.43%
1975 -10.32%
19764.09%
197715.17%
197814.30%
19799.88%
19806.66%
19815.21%
19828.07%
198317.84%

198427.26%
198529.66%
198630.88%
198730.31%
198820.99%
198916.05%
199013.13%
19915.11%
19925.98%
19939.86%
199412.28%
199510.82%
199610.89%
199710.38%

199815.11%
199921.39%
200025.99%
200126.42%
200229.85%
200332.42%
200434.23%
200535.50%
200634.04%
200729.63%
200827.48%
200919.49%
201021.39%
201120.97%

As you can see, the U.S. exorbitant privilege (essentially free imports) peaked in 2005 at an astounding 35.5%, or more than a third of all imports! Stop and think about that for a second. For every three containers coming in full, only two went out full. So how do we reconcile that number (35.5%) with the report at the top of this post that said 45% of containers are exported empty?

The answer is simple. The trade deficit includes both goods and services. But services are not imported in containers. In fact, the U.S. has been running a trade surplus on services every year since 1971. Imagine that! So if we look only at the portion of goods coming and going, we get an even higher percentage. So let's look at 2005 in particular.

In 2005 we imported $1.692T in goods but we exported only $911B for a goods balance of payments of negative $781B. That equates to 46% of all containers being exported empty in 2005. That goods deficit has since dropped down to around 33% for the last three years, so perhaps 45% empty containers in 2010 can be explained by the location of the Port Elizabeth facility being only 200 miles from Washington DC, consumption capital of the world.

But all of this is kind of beside the point. The point is that the U.S. exorbitant privilege peaked in 2005, for the last time, at its all-time high of a third of all imports, and soon it will go negative, where it hasn't been in a really long time.

I can say this with absolute confidence because the signs are everywhere, even if nobody is talking about them in precisely these terms. Here's one bloodhound who's at least onto the right scent (from Barrons):

But more recent Treasury data show China has been selling Treasuries outright. And while the markets have been complacent to the point of snarkiness, MacroMavens' Stephanie Pomboy thinks that's wrong. Unlike other Cassandras, she's been right in her warnings -- notably in the middle of the last decade that the U.S. financial system was dangerously exposed to a bubble in U.S. real estate. Hers was a lonely voice then because everybody knew, of course, house prices always rose.

As for the present conundrum, there's an $800 billion gap between the $1.1 trillion the Treasury is borrowing to cover the budget gap and the roughly $300 billion overseas investors are buying, Pomboy calculates.

[…]

But Pomboy has little doubt that the Fed will step in to fill the gap left by others. In other words, debt monetization, a fancy term for printing money to cover the government's debts, which in polite circles these days is called "quantitative easing."

"Having pushed interest rates to zero, launched QE1 and QE2, there's no reason to believe that the Fed is going to allow free-market forces to destroy the fragile recovery it has worked so hard to coax forth now. And make no mistake, at $800 billion, allowing the markets to resolve the shortfall in demand would send rates to levels that would absolutely quash this recovery…if not send the economy in a real depression."

But her real concern is a bigger one. "The Fed's 'need' to take on an even more active role as foreigners further slow the purchases of our paper is to put the pedal to the metal on the currency debasement race now being run in the developed world -- a race which is speeding us all toward the end of the present currency regime." That is, the dollar-centric, floating exchange-rate system of the past four decades since the end of Bretton Woods system, when the dollar's convertibility into gold was terminated.

[…]

That would leave the Federal Reserve as lender of last resort to the U.S. government to fill the gap left by its biggest creditor. Think this Zimbabwe style of central-bank monetization of an unsustainable government debt can't happen in one of the world's major industrialized democracies?
[13]
That was from March 2nd. Here's another one from the same writer at Barrons just a few days ago:

Our friend, Stephanie Pomboy, who heads the MacroMavens advisory, offers some other inconvenient facts about the Treasury market: Uncle Sam is borrowing some $1.1 trillion a year, while our foreign creditors have been buying just $286 billion.

"I'm no mathematician, but that seems to leave $800 billion of 'slack' (of which the Fed graciously absorbed $650 billion last year.) Barring a desire to pay the government 1% after inflation, there is NO profit-oriented or even preservation-of-capital-oriented buyer for Treasuries," she writes in an email.

"For the life of me, I can't understand why NOBODY is talking about this???!!!"

Having known Stephanie for a few years, I can't recall her being this agitated since 2006, when she insisted the financial system's hugely leveraged exposure to residential real estate posed grave risks. She was called a Cassandra then, but both ladies' prophesies turned out to be right.

The U.S. fiscal situation hasn't mattered as long as the Treasury could readily finance its deficits at record-low interest rates. Even after the loss of America's triple-A credit rating from S&P, Treasuries rallied and yields slumped to record lows.

That's no longer happening. For what ever reason, assurances by the Fed Chairman aren't impressing the bond market. Neither is weakness in the commodity markets. Maybe Stephanie is on to something.
[14]
Of course they are looking only at the monetary plane, the silly market for U.S. Treasury debt which the Fed can dominate with infinite demand. As I keep saying, the real threat to the dollar is in the physical plane: the price of all those containers being unloaded and then exported empty.

The U.S. government has grown addicted to its exorbitant privilege over the years. It is a privilege that has been supported by foreign Central Banks buying U.S. debt for the better part of the last 30 years. But as I wrote in Moneyness, and as Ms. Pomboy has noticed above, that ended a few years ago. From Moneyness, the blue that I circled below shows the Fed defending our exports **of empty containers** with nothing more than the printing press and calling it QE:


I would like you all to give this some serious thought:

1. The U.S. exorbitant privilege peaked in 2005 (before the financial crisis) and is now on the decline, meaning it is no longer supported abroad.
2. The U.S. government (with the obvious assistance of the Fed) is now in defensive mode, defending that inflow of free stuff with the printing press.
3. The U.S. federal government budget deficit (DC's "needs" minus its normal revenue) **eclipses** the trade deficit by more than a 2 to 1 margin.

So what could possibly go wrong? The recession has already contracted the U.S. economy, all except the part that resides in Washington, DC. And just to maintain its own status quo (when has it ever been happy doing only that?) our federal government needs to insure our national business of exporting empty containers at its present level.

What could go wrong? Prices! If the price of an apple doubles, what do you think happens to the price of a full container? Those of you who think we are due for some more price deflation in the stuff that the USG needs to maintain its status quo should really have your heads examined. Even Obama is winding up to pitch the whole ball of twine at the problem. He just delegated his executive power to print until the cows come home to each of his department heads. I quote from Executive Order -- National Defense Resources Preparedness:

"To ensure the supply… from high cost sources… in light of a temporary increase in transportation cost… the head of each agency… is delegated the authority… to make subsidy payments"

In case you're having difficulty connecting the dots I've laid out (not) so subtly, I'm talking about a near-term dollar super-hyperinflation that will make your hair curl and make Weimar and Zimbabwe seem like child's play in the rearview mirror. If you're new to this blog, you should know that the rate of hyperinflation does not follow the printing. An apple does not end up costing a trillion dollars because they printed enough dollars to price all apples that way. Hyperinflation comes from the margin, from the government defending its own needs, and there's never enough "money" for us mere mortals to pay the prices which are running away from everyone during hyperinflation.

Also, hyperinflation turns physical (as in physical cash) very quickly once it takes hold. So if you're expecting some sort of electronic currency hyperinflation, fuggedaboutit. If you think we're more technologically advanced than bass-ackward Zimbabwe or ancient Weimar, you are not understanding what really happens during currency hyperinflation. It cannot play out electronically all the way to the bitter end because, when prices are rising that fast, physical cash always brings a premium over electronic deposit transfers which require some amount of time (and thereby devaluation) to clear.

Here are a few of my recent posts in which I explore what little we can do to prepare for what is inevitably coming our way:

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

That's right, I saved the "crazy super-hyperinflation talk" for the tail end of a really long post. Because A) people who think they have it all figured out already tend to abandon a post once they read the word "hyperinflation", and B) the stuff in this post really happened and is still happening so it's only fair to you, the reader, to give its inevitable denouement the appropriate weight of a bold conclusion. If I didn't do that, I would not have done my job, now would I? ;)

And in case you didn't figure it out yet, this third and final warning was only for the savers who are still saving in dollars. It's way too late to fix the $IMFS.

Sincerely,
FOFOA

PS. Thanks to reader FreegoldTube for the custom video below! He just happened to send me the link while I was considering songs for this post. The band is Muse and the song is Uprising from their album titled The Resistance.

[1] http://mauricio.econ.ubc.ca/pdfs/kirsten.pdf
[2] The Age of Inflation –Jacques Rueff
[3] http://mises.org/money/4s3.asp
[4] http://www.gold.org/download/pub_archive/pdf/Rs23.pdf
[5] research.stlouisfed.org/publications/review/03/09/0309ra.xls
[6] http://mises.org/books/monetarysin.pdf
[7] http://en.wikipedia.org/wiki/Exorbitant_privilege
[8] http://en.wikipedia.org/wiki/Robert_Triffin
[9] www.imf.org/external/np/exr/center/mm/eng/mm_sc_03.htm
[10] www.census.gov/foreign-trade/statistics/historical/gands.txt
[11] Using data from [10] and the BLS inflation calculator at http://www.bls.gov/data/inflation_calculator.htm
[12] Lines in the sand is a reference to my Ben and Chen island analogy in Focal Point: Gold
[13] http://online.barrons.com/article/SB...5246.html
[14] http://online.barrons.com/article/SB...6544.html

643 comments:

1 – 200 of 643   Newer›   Newest»
Yannick said...

Thanks FOFOA. (haven't read everything yet!)

The slowdown of purchases of US public debt by foreigners, you can follow it live here:
http://research.stlouisfed.org/fred2/graph/?g=6bK
or, in a "%change for a year ago" way, which I prefer:
http://research.stlouisfed.org/fred2/graph/?g=6bL
(Their new graphing tool is really neat!)

Another anecdotal evidence of the changes underway, right now..

Bjorn said...

Thanks FOFOA, that was excellent. Now if I read it again I might even be able to explain it to others...

And than you Yannic also. Thats what falling off a cliff looks like!

And also it gave me an excuse to post some FOTC. ;-) Friends draw graphs together

burningfiat said...

Thanks FOFOA,

Looking forward to reading this.
Cool video at the end!

78Rubies said...

Comments…

costata said...

Excellent post FOFOA,

Powerful.

Allow me to head off the MMT crowd at the pass. MMTers, your observation of causation in the creation of deposits has been covered in this passage from the post above (my emphasis):

....If a commercial bank has a healthy level of reserves it can expand its credit. But if it expands credit without sufficient reserves for its clearing and redemption needs, it must then go find reserves which it can do in a number of ways....

So to our dear friends in the MMT camp, kindly do not harangue us with those claims that others do not understand how banks create money. Constructing the model your way would have introduced an unnecessary layer of complexity and it would have been beside the point to boot.

And it wouldn't fill any of those empty containers with real goods either ;). Sometimes "pictures of dead Presidents" just won't get the job done.

Cheers

JoyOfLearning said...

Thank you for another brilliant article! Loved the big picture view and how you explained everything on a trade big picture not even going into gold, and having a bigger picture. Thank you!

I do have one nagging question though: what about stuff that's information/digital/media? It doesn't go into containers, yet it can easily cost a fortune, and might be worth more than real stuff to many people. In all history and all walks of life some people have happily payed with many apples a teacher who gives information, or an entertainer who does a performance. For example I have recently moved to Germany with my family, and am trying hard to fit in, to learn the language and everything. Yet I can't seem to find blogs or podcasts such as your own in german. So although this forum is I know full of people who value physical stuff, and I do too, and probably one might argue that germans do in particular, that doesn't stop them from paying with a lot of physical stuff for stuff that can't be touched. Take for example software, ranging from operating systems to architectural to design to security software, software that costs hundreds to thousands of euros, I get a feeling most of it is made in the US. A similar feeling with the huge movie, music and the increasingly bigger game industry: I get the feeling most of the products are made by US companies. So as long as people across the world, producers of physical stuff, are happy to be exchanging their physical stuff for bits of information, for tv series and books/knowledge produced in the us, is there a problem with the containers? Isn't this just like the historical thing with the romans spending their money to buy spices to burn? Of course what I'm asking here is anecdotal evidence, and I have no real idea weather these things are big enough to make a dent, but as a physical person to me it seems like (at least in europe) a lot of money is payed on software/movies/music/books/videos/advertising content that is produced in the US. Doesn't that mean that you can't take empty containers as meaning that much when a lot of this content flows through wires, internet, radio, satellite? These can have zero volume in containers, yet have a high price (information can be very expensive, and most of todays information seems to move around in english, as I'm painfully noticing). Put another way, what if there are products which are very valuable per volume? Like let's say the rest of the world is sending the us watermelons, and then in those containers you ship back Iphones. Suddenly those containers would be 90% empty for the same price because of the higher value per volume density.

Please don't take my question as an attack, I'm just trying to learn. I want to believe, but this is definitely a question I would imagine my friends asking when I would try to tell them of this great article, so please take my question as a search for knowledge. Thank you!

ampmfix said...

Awesome, thanks, time to hit the jar everybody...

Woland said...

As I was reading through the first half of this outstanding
post, I couldn't help thinking, "This should be a textbook".
Well, maybe not a textbook, but certainly a book. And I
wonder if it is not time, in order that this perspective and
understanding be more widely shared and appreciated, that
what we all have, and still do, receive for free, be made into
a form more EASILY SHARED with others. You might argue,
what is easier than telling our friends to click FOFOA. Well,
technically you would be right, but the practical result might
not follow. On a personal level, should our host be willing
to consider such a project, I would be glad to make a
substantial contribution to such an effort. Better than a T
shirt? What say ye?

JR said...

Hi Costata,

Last thread you asked:

Does the ECB/Eurosystem have enough tools in place now to manage the overall currency supply and the activities of the European banks to ensure that they cannot frustrate the pursuit of the ECB currency stability mandate?

If we accept this:

Reserves are the fundamental basis on which the basic money supply of a bank is borne, while assets are the balance sheet representation of the bank's extension of credit. A relative increase in reserves enables the expansion of bank money while an increase in assets (notes) relative to reserves has the opposite effect at the margins.

[...]

If a commercial bank has a healthy level of reserves it can expand its credit. But if it expands credit without sufficient reserves for its clearing and redemption needs, it must then go find reserves which it can do in a number of ways.


Then the EBA does, yes?

Example

Banks will soon find out what regulators think of their plans. Financial institutions, including Deutsche Bank of Germany and BNP Paribas of France, had to submit their recapitalization strategies to national regulators by Friday. The European Banking Authority will review the plans in early February, and regulators have the power to veto any capital-raising plan they don’t agree with.

Much of Europe is expected to enter recession this year, so authorities are likely to reject capital-raising efforts, like cutting lending to businesses, that reduce support for the European economy.

9e3c4952-7e5a-11e1-924f-000bcdca4d7a said...

Has anyone here read Trade With Dave? He has A little differant Take on Gold!

Desperado said...

So as the HI hits, all the remaining $ currency swaps that the ECB and Switzerland made are going to go to 0, while the €'s and CHF's at the Fed will go to infinity. Meanwhile there will be a complete collapse of EU exports to the US just as every one of their economies crash into major recession. EU budget deficits will blow up almost as fast as the HI.

Meanwhile, we have to wonder what OPEC is going to think about all of these shenanigans. Are they going to simply accept €'s for oil after getting burned in $? I am confident that many here will argue that this wonderful RPG mechanism will give OPEC complete confidence in the € despite the protests, layoffs, strikes, squabbling, and ultimately suspension of the Schengen accords (and collapse in intra-EU trade).

Finally, I would point out that the $ reserve currency has not only been the exorbitant privilege for the US, but also the ultimate soft money and dumping ground for all nations exporting to the US. They too will face gigantic political hurdles to get their economies back to health in light of their debts, their demographics, their corruption, and their complete lack of any popular mandate.

Likely there will be civil war and conflict across the entire planet.

Ryan said...

Comments.

JR said...

Ramon,

I know you may not care for me but its not mutual, my disdain is solely wrt to Bitcoin, so please don't take it personal. I am posting because I like you and am trying to help.

I don't see how the fixed supply is detrimental.

FOFOA's dilemma: When a single medium is used as both store of value and medium of exchange it leads to a conflict between debtors and savers. FOFOA's dilemma holds true for both gold and fiat, the solution being Freegold, which incidentally also resolves Triffin's dilemma.

You can't be both a MoE and a SoV and be sustainable. And a sustainable SoV is what it is all about:

An explanation of how people keep their wealth and property from the State is then Counter-Establishment economics, or Counter- Economics [2] for short.
SEK III

Did you see what RJP wrote last thread? Here's the quote:

Just as gold is evolving back to its original role in our tribal days, I think the way in which humans assimilate is evolving more toward our tribal roots as well. As nation-states and their credibility continue to deteriorate, humans will still desire some type of collective representation. (the Superorganism at work again)

Like gold, the way we're evolving back to our tribal roots in assimilation has the same variable involved: the modern, digital age. I believe the way in which our tribes are formed will become completely different from the tribes of old. With the advent of the Internet, we're no longer restricted to forming our relationships based on geography. In the modern era, we can assimilate based on similar ideas. This Freegold community we have here is a perfect example of that.

As a result of governments going bankrupt and no longer having the ability to provide certain services, something will have to fill that void. I believe that over time, something similar to the services provided by labor unions will evolve. Except it won't necessarily be connected to your labor. This collective representation will be connected to like-minded ideas and they'll represent you in multiple areas. I would liken it to web-based Mafias that will provide protection, healthcare, and various other services for their members.

Most of these ideas I've ripped off from futurists and sci/fi novelists. But one thing I've noticed is these writers don't know anything about gold. They don't factor the role of gold in any of their predictions for the future. As honest money and honest information are colliding with this world at relatively the same time, I think it's important to see the correlation.


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

Hmm, this line of thought sounds akin to this idea from Life in the Ant Farm:

We are all like ants in an ant farm when we patronize Wall Street. Our contributions to society, should they exceed our day-to-day needs, are deployed by a system that does not care how they are deployed, just that they are deployed ASAP. If you would like to make a real contribution to the future of civilization then please buy physical gold and find a way to keep it close. Hoard your efforts outside of the system and watch as they receive a tremendous power boost just in time for deployment. You will be rewarded with the freedom to choose when and how your saved effort will be deployed and in so doing, you will help shape the future.

JR said...

Hi Esau,

Likely there will be civil war and conflict across the entire planet.


We shadowdance the silent war within.
The shadowdance, it never ends...
Never ends, never ends.
Shadowboxing the Apocalypse, yet again...
Yet again.
Shadowboxing the Apocalypse,
And wandering the land.

thedeadfauvi said...

I haven't read your post yet, FOFOA, but I've watched the video.
IT'S THE BEST VID I'VE EVER SEEN!!!
On a such gray day we have now here I really needed it, this little piece of optimism especially at a point in time were I gave up on anything like timing and planning. We just stick to not not giving up and live under the radar.
WE WILL BE VICTORIOUS, someday.
Thanks. Now back to the intellectual part, enough re emotions, which are wonderfully stimulated by that unique colour yellow. Why is it so appealing to our brains, I wonder? Is it just greed or security feeling?

Gary said...

Desperado, in one paragraph you both grasp reality, and then also don't!!

'Are they going to simply accept €'s for oil after getting burned in $? I am confident that many here will argue that this wonderful RPG mechanism will give OPEC complete confidence in the € despite the protests, layoffs, strikes, squabbling, and ultimately suspension of the Schengen accords (and collapse in intra-EU trade).'

The reality you accept is that the EU is currently facing economic reality (you know, that lots of wealth/trade is just built on debt, has been for years, and it's going to collapse). So, good man!

As for OPEC, when this collapse happens it is highly probable they will accept Euros, because of what will then be nearly 100% physical gold reserves. If they don't trust any fiats though, any ideas what they might accept.

Physical only gold pricing is coming soon! Maybe you don't see it though. Shame.

/SleepingVillage/ said...

Good stuff as always, professor FOFOA. Thanks!

I had THIS song playing in my head while I read.

victorthecleaner said...

Thanks, FOFOA, love the article.

A few comments. Everyone from Goldman Sachs to the goldbugs as KWN was expecting more QE already towards the end of 2011. There was none. Somehow there are still enough people who buy US government debt.

If somebody earns a surplus and then buys government debt with it, how does this look like from the MMT point of view? Is it a voluntary donation to the government?

Finally, if you look at this table, the "marketable securities held in custody", you see that the figure is close to its summer 2011 high. No net selling, at least not yet. I remember a Zero-Hedge article that listed the holders of US treasury debt by location (i.e. basically by broker and not by owner), and this indicated some selling by China, but an offsetting amount of buying from Japan (I think probably BoJ) and from the UK (I think probably private sector). I have no idea how long this can go on for.

JoyOfLearning,

I think FOFOA mentioned that the number of containers does not exactly match the total value of goods exported versus imported. This is understandable for many reasons
1) exports of grain etc. go in bulk ships, not containers
2) $1bn worth of iPhones needs less space than $1bn worth of Chinese made furniture

Victor

victorthecleaner said...

The table was missing:

http://www.federalreserve.gov/releases/h41/hist/h41hist9.txt

JR said...

Hi VtC,

If somebody earns a surplus and then buys government debt with it, how does this look like from the MMT point of view? Is it a voluntary donation to the government?

I believe MMT views it as savings. From Moneyness

One of the main tenets of MMT is the accounting identity that roughly states the amount the USG deficit spends (government spending in excess of the taxes it takes in) is always equal to private sector net savings plus the trade deficit (exports minus imports, or stated another way, our trading partners' net dollar savings).

This is generally explained with the analogy that the USG spends money into existence and taxes money out of existence. So if the USG (God forbid) taxed as much as it spent (or spent as little as it taxed), there wouldn't be any extra USG money for us mere mortals to save. So by spending more than it takes in, the USG is graciously giving us money for savings. And then, the USG issues Treasuries in an amount equal to that deficit spending (extra money for us to save Woo hoo!) to give us an interest-bearing exchange for our net-production.

JR said...

Hi JoyofLearning,

In addition to VtC's point, this:

"It doesn't go into containers, yet it can easily cost a fortune, and might be worth more than real stuff to many people. In all history and all walks of life some people have happily payed with many apples a teacher who gives information, or an entertainer who does a performance."

Gets into not just goods, but *services*. From above:

As you can see, the U.S. exorbitant privilege (essentially free imports) peaked in 2005 at an astounding 35.5%, or more than a third of all imports! Stop and think about that for a second. For every three containers coming in full, only two went out full. So how do we reconcile that number (35.5%) with the report at the top of this post that said 45% of containers are exported empty?

The answer is simple. The trade deficit includes both goods and services. But services are not imported in containers. In fact, the U.S. has been running a trade surplus on services every year since 1971. Imagine that! So if we look only at the portion of goods coming and going, we get an even higher percentage. So let's look at 2005 in particular.

victorthecleaner said...

JR, of course, you are right. I was 50% joking...

Alternatively to FOFOA's $IMFS privilege'o-meter, i.e. trade deficit per total imports, we could watch the $IMFS life support'o-meter, i.e. exports of capital from the US. Both values should be rather similar because

trade account +- payments of interest and dividends = current account

and

current account +- capital account = balance of payments

where the capital account includes the transfer of financial capital, i.e. in particular government bonds.

If foreigners don't hoard a lot of cash (real dollars), but typically only bonds, the balance of payments is small. If interest/dividends do not matter much in the big picture, the trade account is minus the capital account.

This means running the trade deficit is basically the same as foreigners purchasing U.S. assets (real and financial) which has been predominantly bonds.

And so if the foreigners one day stop purchasing US financial assets, the trade deficit will be zero immediately. In a world with free movement of goods and capital, this is possible only if imports in the US are so expensive and exports so competitive that the trade account balances. But this works only if the foreign exchange value of the US$ is much lower immediately.

Does this make sense?

Victor

victorthecleaner said...

Perhaps we want to look at capital exports per GDP.

costata said...

Hi JR,

Looking good EBA! (My emphasis)

The European Banking Authority will review the plans in early February, and regulators have the power to veto any capital-raising plan they don’t agree with.

Much of Europe is expected to enter recession this year, so authorities are likely to reject capital-raising efforts, like cutting lending to businesses, that reduce support for the European economy.


Bankers forced into being, er, bankers! What a novel idea. I hope it spreads.

Cheers

AdvocatusDiaboli said...

VtC,
yes, thats something to consider.

"And so if the foreigners one day stop purchasing US financial assets,"

Is a US stock company an financial asset? CocaCola? Or how about Exxon, Intel, Pfizer...?
If the $ goes to zero, where do those go in terms of euro? I mean I rather own those than these disgusting euros.
Greets, AD

victorthecleaner said...

AD,

I am not sure I want to follow you in this direction, but if you insist, you could look at companies whose products involve a lot of labour inside the U.S. and resources from the U.S. and who export a lot. They should do okay.

But then take a look at stocks during 1922/23 Germany. Yes, they did not go to zero, and they indeed recovered, but you would have been a lot better off holding gold (=sterling at that time), plus with gold you have the option of buying these stocks later, when they are actually undervalued. Right now, large U.S. companies are around 75% overvalued.

If you already have enough of the shiny stuff (can you ever have enough?) and you insist on stocks, I would go for small companies from continental Europe that don't depend too much on exports out of the Euro zone. They are valued about average, and the 'not too much export' condition should be evident.

In terms of the capital account, different countries use slightly different terminology. Some say 'capital account' for 'real' assets (direct ownership of companies) and 'financial account' for financial assets (stocks and bonds). This distinction is weird, and I would rather distinguish real assets (businesses and stocks) versus nominal assets (bonds etc.). But, hey, don't ask the economists about logic.

Victor

e_r said...

JoyofLearning,

I find it easy to visualize in graphs.

Here is the graph for Trade balance-Goods and Trade balance-Services for the United States over the past 20 years.

You can visualize what FOFOA states in the article. There is a surplus in services and a huge deficit in goods.

Victor,

And so if the foreigners one day stop purchasing US financial assets, the trade deficit will be zero immediately. In a world with free movement of goods and capital, this is possible only if imports in the US are so expensive and exports so competitive that the trade account balances. But this works only if the foreign exchange value of the US$ is much lower immediately.

Can you elaborate a bit more? I can't understand what you are saying clearly. How can the trade deficit go to zero immediately, since these foreign CB's still hold these USG bonds on their books right?

JR said...

Yes Costata,

As you point out, the EBA was expected to support the ECB's currency stability mandate and "reject capital-raising efforts, like cutting lending to businesses, that reduce support for the European economy". Otherwise, such credit reduction could pose a deflationary threat to the ECB's currency stability mandate.

JR said...

VtC,

The Fed can buy them, no?

Moneyness:

"We don’t need China to buy our bonds in order to spend. China gets pieces of paper with old dead white men on them in exchange for real goods and services." (Cullen Roche)

In other words, if they don't buy our Treasuries (run a capital account deficit), then they'll just stack the Benjamins. In other words, that's just the way it is. See? It's an accounting identity.

But then a reasonable person might point out that the USG still issues Treasuries equal in amount to all its deficit spending. And if we and the Chinese aren't buying them, then the Fed has to, so it makes up a cool name like QE2 to disguise the real purpose of the purchases. Not so fast, MMT says. The Treasury does not need to issue debt in order fund its spending. When it spends, it simply credits private sector accounts with new credit money and the banks with new base money. There is no direct connection between sales of Treasuries and money spent other than a myth in our confused minds.

[...]

I want you to notice a small detail in the above quote that probably slips by most people. Wray writes (my emphasis): "Treasury would continue to spend by crediting bank accounts of recipients, and reserve accounts of their banks."

Out here in the real world of the productive economy, when we spend, only the account of the recipient gets credited. Not the reserve account of their bank. The "reserve account of their bank" is that commercial bank's account at the Federal Reserve Bank. Remember? You and I can't have accounts there. Only the banks and the government can. Our spending is netted out in the system each night and the imbalances between banks are cleared with those substantially smaller reserve accounts.

I imagine there's a good reason Randall Wray was careful to include this small technicality in his piece. That's because raw government-created money through deficit spending is fundamentally different than "our money." Government spending adds one unit of credit money (our money) to the system as well as one unit of base money (their money). The bank receiving the deposit gets a reference point unit asset to match the liability it takes on.

So the volume of the base is expanded when the government spends, and it is likewise contracted when the government taxes and/or sells Treasuries to the private sector (including our trade partners like China). But when the government spends in excess of those two operations (taxing and debt selling), the base volume is simply expanded. And MMT apparently sees no difference between the true concept of money (all that 100s of trillions of credit denominated in a single reference point unit) and the base which it references.

[...]

What this section, roughly encompassing the last three years, apparently shows is that 1. The debt sold by the USG jumped dramatically, 2. The debt purchased by the foreign sector decreased, and 3. The domestic US private sector apparently picked up the slack dropped by the foreign sector. I propose to you that "the domestic US private sector" in this case was mostly Ben Bernanke and the Federal Reserve.

victorthecleaner said...

e_r,

How can the trade deficit go to zero immediately, since these foreign CB's still hold these USG bonds on their books right?

for the U.S. to run a trade deficit, it is not sufficient that foreigners own U.S. debt. They have to keep accumulating additional debt.

Well, that's just the trend and not exactly true because these foreigners could alternatively purchase real assets inside the U.S. (real estate, businesses, ...) - is there a Being Bought By The Enemy Act? I guess there will be.

Victor

JR said...

Yo Warren B, you are so OG!

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:

[image]

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.

AdvocatusDiaboli said...

VtC,
I appreachiate your investment advice alot, although, that was NOT my question ;)

The question is: Do stock US ownership/purchase from outside the $-zone balance the budget in the same or different way, like buying "financial assets" (what you mentioned).

This especially under consideration of the company examples I gave: International companies with supstantial turnover outside the $-zone. (Personally I am not really happy with those, but just a very small hedge against euro break up and dollar strength neutral.)
Greets, AD

P.S. From the above stocks I mentioned, I sold all, except Pfizer, because I strongly believe in Obama-Idiocracy ;)
P.P.S. I stay with my conviction: If somebody put's 100% in one asset, he is just a stupid gambler, no matter how much he claims to "understand" of that asset.

victorthecleaner said...

JR,

no, I don't think so. Take a look at the cash. If the U.S. import goods, they pay with US$ (credit money or base money). These US$ accumulate outside the U.S. This would be a balance of payments deficit.

I was assuming that the foreigners do not hold cash in the long run. In fact, historically, they hold almost exclusively treasury and agency debt. But in this case, these US$ are sent right back into the U.S. in exchange for title to the debt.

So if the foreigners in aggregate neither hoard cash nor debt, they can only purchase U.S. goods and services (but then this wouldn't be a trade deficit), or they purchase other real assets inside the U.S. (real estate, businesses, think of Dubai Ports...), or they sell their US$ in the foreign exchange market.

If the foreigners stop buying either U.S. assets (real or financial), the only option left is to sell the US$. This continues until the exchange rate has adjusted in such a way that there is no trade deficit left.

My example above basically suggests that the rate at which the purchases of US debt by foreigners slows down is the same as the rate at which the trade deficit shrinks. If they stop buying at all, the exchange rate drops like a stone until the trade deficit is gone immediately.

Does this make sense?

Victor

victorthecleaner said...

AD,

I though I had answered that question: Yes, if foreigners buy U.S. businesses or stocks, this shows up the capital account (the version that includes both real and financial capital). Yes, it is an alternative to buying U.S. debt. Yes, this could go on for a while. But when you think about it and estimate that there are about $8000bn outside the U.S., then you could buy a lot. Question is do you really want to own it, and second, will the U.S. sell it to you. I think the answer to both is no, at least not for all of the $8000bn (before the exchange rate drops).

I suppose this is one aspect that came up already during the 1970s in the form of petrodollar recycling. There is just so much currency involved that you eventually have to buy debt, simply because there are not enough reasonably valued real assets around. (all this assumes, of course, that the U.S. gold is not (yet) for sale).

Victor

JR said...

Hi VtC,

I was more focusing on this:

And so if the foreigners one day stop purchasing US financial assets, the trade deficit will be zero immediately.

As you point out they can use dollars to buy stuff outside of the US. Does this "or they sell their US$ in the foreign exchange market" include gold in your mind?

JR said...

miner49er (05/06/03; 10:06:12MT - usagold.com msg#: 102429)
Homeless Dollars...


The really big holders of dollars are the central banks. What they do with their reserves will make or break. Their influence over other banks and financial institutions will also largely dictate the destiny of these dollars. In the gold standard, the currency acted as something of a title deed for a specific good at a specific price. Central Banks could and did take these "receipts" and claim gold from each other. In this day, there is nothing for CBs to "claim," as these dollars are no longer "title deeds." Rather, they are like non-expiring calls for things on demand, at the variable and going price. CBs are likely to neither a) dump them on the forex markets, as this would simply devastate the currency, and risk dreaded instability globally -- something banks are NOT prone to do; or b) race to our markets to try and buy things (like gold), as this would also be fruitless, since a market revaluation for this action would instantly make gold unpriceable, and it would not even be offered. Again, why engender the instability?

Without a certain weapon in the arsenal of the euro's design, the foreign CBs would indeed be over a barrel. Previously they were forced to evermore be on a dollar standard, since they would realistically only opt for this as the lesser of two evils. The alternative of saying no to the dollar at that time, would only have meant a return to a gold standard, and the politically unacceptable bone-crushing depression that would follow (as well as instability). In 1979, the European CBs began marking their gold reserves to market. This one act demonstrated immense foresight, and would provide the escape valve from the rock-and-hard-place no-win choices between eternal dollar support, or global depression.

Quietly, the euro-system banks have been divesting themselves of dollars. Collectively they retain something like 211 bn. currently. (This is not a large amount relatively speaking, but consider fractional reserve lending, and quickly we perceive the immesity of euro-dollar infestation.) This decline in dollar holdings is desired to take place concurrently with a rise in the price of gold to offset this. Spoonfeeding dollars into the system won't crash it, as well a slow commensurate rise in gold. The discipline that they have thus far maintained is indicative of the tectonic movement of the geopolitical strata. Ideally there will be no rash or even discernible activity. The perfect result is to simply keep shifting these plates until we wake up one day and the world has been remapped. Reality of course is that there are points of friction that cause tremors of unpredictable frequency and proportion all along the way. At some point critical mass will be reached, and the dollar contract markets for gold will no longer be able to contain its price as market perception on a large enough scale discounts paper parity with the real metal accordingly. It is at this juncture that the gold reserves of the CBs will provide immense expansionary leeway, as they are for a season revalued constantly upward. This bona fide liabilityless reserve base will make the ECB member banks the premier lending institutions to fuel the economic growth of the euro zone, and those align themselves with it.

[..]

The strategy of the level-headed is to slowly remap the globe financially. This involves as much as possible a SLOW transformation from one currency paradigm to Another. These dollars en masse will not return home. They were born in exile and will die in exile. We will hyperinflate ourselves, and won't need help from overseas...

victorthecleaner said...

JR,

if you are a foreigner and you use your US$ to buy gold from a foreigner, then the US$ goes down relative to gold, but this has no effect on the capital account. Yes, this would be in the "sell the US$ in the foreign exchange market" case.

So if a U.S. importer pays for a shipment of goods with US$ and the foreign exporter immediately sells these US$ abroad (rather than investing them back in the U.S.), the only effect is that the US$ goes down relative to other foreign assets (Euros, gold, real estate in Paris, iron ore from Brazil, whatever). This drop would continue until the trade account is balanced.

Victor

JR said...

Good.

Suppose somebody buys paper gold.

victorthecleaner said...

JR,

Suppose somebody buys paper gold.

Very good question. Would work, I think. Paper gold would go up.

Where is Freegold? Opinions?

Victor

JR said...

And keep in mind this is a theoretical exercise, for a Miner49er indicated above, and as FOFOA indicated in his comment to you last thread that he incorporated above:

Hello Victor,

The point of JR's excerpts is that the real threat to the dollar lies in the physical plane (real price inflation) rather than the monetary plane (foreign exchange market). The source of the price inflation will be from abroad and it will be reflected in the exchange rate, but the price inflation, not the FX market, is the real threat.

[...]

The USG is essentially borrowing $21,000 this second -- that our trading partner received last second -- and the USG will spend it again on more foreign stuff a second from now and then borrow it again. See? No inflation! The same dollars circulate in perpetuity, the real stuff piles up in DC, and the USG debt piles up in Beijing.

But what if that **from some entity** is mostly the Fed, and has been for two years now (and they are calling it QE only to make it sound like its purpose is to assist the US private sector)? If that's the case, then the fear of real price inflation is now a clear and present danger to "national security" (aka the USG consumption monster). Not so much for the private sector which is now trading our stuff for their stuff, but mostly for the public sector which trades only $21,000 in paper nothings, per second, for their stuff.

Under this latter situation, you now have $21,000 per second piling up outside of US borders and it's not being lent back to either the USG or the US private sector (which has stopped expanding its debt). It's either going to bid for stuff outside or inside of US boundaries.

[...]

But from a financial perspective, if you are stuck in dollar assets when real price inflation takes hold, you are going to want out. And the quickest way out is through the currency itself. So we could see a spike (outside of the US) in the price of Realdollars even as the dollar is collapsing against the physical plane and the USG is printing like crazy to defend its own largess! How confusing will that be to all the hot "experts" on CNBC?

The financial markets can cause dramatic volatility in the FX market, and vice versa. But that's all monetary plane nonsense. A small change in the physical plane might not even register at first in the FX market, especially if a financial panic is overpowering it in the opposite direction. But even if the dollar doubles in financial product purchasing power terms (USDX to 150+), that's not going to lower the price of a banana in the physical plane while the USG is defending its consumption status quo with the printing press.

Gary said...

Hello JR/Costata,

Not sure about this:

The EBA was expected to support the ECB's currency stability mandate and "reject capital-raising efforts, like cutting lending to businesses, that reduce support for the European economy". Otherwise, such credit reduction could pose a deflationary threat to the ECB's currency stability mandate.'


If you were running a bank in the Eurozone (or anywhere really) and you can see what is heading along the road, would you be rushing to lend your money? I doubt it.
I've worked in a bank, and no matter what government regulations exist, you lend when the bosses tell you to lend (even up to 100% of a property value), and you stop when they tell you (the pendulum always swings too far both ways). Credit scoring can be tweaked very easily these days to decline more loans.

Also, if you were running your own business would you be rushing out to borrow to expand?

And if you were a household, would you be leveraging up, or the opposite. I know in the UK, households are deleveraging, I suspect the same across Europe.

Isn't this debt deflation a natural reaction to the contraction in the real world?

As for the currency stability mandate, I suspect the ECB will have to find some other way to balance out these deflationary pressures, perhaps some more gentle monetary easing QE-esque, non-sterilised bond buying?

JR said...

And so if the foreigners one day stop purchasing US financial assets, the trade deficit will be zero immediately.

Is not gonna happen until dollar price inflation takes off. Sure a little bit will finds its way to the US, and that is the danger in a little inflation from Moneyness. But:

The strategy of the level-headed is to slowly remap the globe financially. This involves as much as possible a SLOW transformation from one currency paradigm to Another. These dollars en masse will not return home. They were born in exile and will die in exile. We will hyperinflate ourselves, and won't need help from overseas...

JR said...

Right Gary,

The banks are saying we can cut lending, we don't need to raise capital.

The banking authorities (the ESFS, of which the EBA is a part, along with the ECB) are saying no dice, that would place deflationary pressure on things.

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

Isn't this debt deflation a natural reaction to the contraction in the real world?

Debt deflation happens when credit doesn't expand, except we have a fiat money system with an expandable base so we don't have to have debt deflation. So i dunno what you mean by natural reaction, but the natural reaction in a ftta system is to inflate our of a credit crunch, not deflate. And sure the ECB supporting the banks is a part of this.

Its not like the European authorities want their banks to stop lending, we agree, right? This would cause deflation and not be in line with the Euro's currency stability mandate, yes?

e_r said...

JR,

If I understand FOFOA's comment to Victor correctly - there would be a massive currency spike in the monetary plane because of the threat of real price inflation causing all dollar holders to move through the currency , but this strength is really a massive weakness in disguise, which is revealed only in the physical plane?

Physical plane real price inflation in tandem with monetary plane severe currency spike: that would be incomprehensible to the CNBC hot heads ;)

JR said...

FMP:

"but the natural reaction in a fiat system is to inflate out of a credit crunch, not deflate."

e_r said...

Gary,

Isn't this debt deflation a natural reaction to the contraction in the real world?

ought to be rephrased as debt deflation is the contraction in real world, for which as JR points out - natural reaction will be to avert any credit crunch in a fiat money system.

Gary said...

I think in the rea world JR banks will have no trouble in reducing lending (in the same way that they had no trouble lending too much to any old Tom, Dick or Harry).

I also think the issue is more the lack of demand.

I guess I feel that governments/central banks would love to feel they can control these things (both supply and demand) but in the real world they are often impotent.

Yes, debt deflation is just a follow-on result (natural reaction to) of the real world contraction in economic activity.

I believe the ECB have to find another way to inflate if the Euro price stability is threatened on the downside.

JR said...

Yes e_r,

Point being he doesn't think the monetary plane will cause HI (aka forex moves), but the physical plane will.

This:

Foreigners dumping dollars in mass is not the cause. Rather, its the danger of a little inflation from a little bit of those dollars competing with the USG for goods that currently satisfy the USG's consumption fix that sets it off. The reaction of the US is to effectively hyperinflating itself as its tries to outbid others for its physical plane fix.

JR said...

I think in the rea world JR banks will have no trouble in reducing lending (in the same way that they had no trouble lending too much to any old Tom, Dick or Harry).

Of course Gary, which is why the regulators were contemplating not letting them do it. Of course its an issue of demand. The market wants to go one way (deflation) and the Euro regulators were contemplating means to trying to fight these credit deflationary forces to maintain currency stability.

Regulators regulating banks (both in terms of deflation and inflation) to ensure the currency stability mandate, yes?

JR said...

The issue was could the Euro regulators contain inflation by regulating private bank credit creation. Of course they can fight deflation by printing. The point is if the EBA, working with other authorities, can regulate reserves, they can control credit to the upside (and also help assist the more effective means to fight deflation on the downside).

victorthecleaner said...

JR and e_r,

isn't it the case that there is no need for the foreigners to 'dump' their dollars. It would be enough if they stopped accumulating additional US$ debt. This would be enough to crash the foreign exchange value of the US$.

Assume you are in a meeting with BIS members, oil, and China. You are trying to find a way of getting rid of the US$ without creating global chaos. Wouldn't you decide to slowly wean the U.S. and try to slowly decrease the rate at which US$ debt accumulates outside the U.S.. This way you would slowly take down the foreign exchange rate of the US$ and give your industry some time to adapt.

The U.S. on the other hand are trying to keep the US$ high as long as possible. The oil price and the usage demand for US$ through oil (purchased by non-US entities) might play a role in this. The U.S. might have decided it is best if they crash the US$ suddenly, i.e. they keep it up as long as they can, and then they suddenly let go. This way they have the least difficulty in servicing their external debt in real terms. It would all go in a single flash once they are prepared.

Does this perhaps explain some of what we have been observing since 2001?

Victor

Gary said...

JR, I wish the EBA the best of luck in forcing banks to lend and forcing other entities to borrow!

JR said...

Its more like banks saying they will reduce lines of credit and short term commercial lending and the regulators indicating they thought they decreasing liquidity was not the best idea in this environment.

No one is forcing anyone to lend or forcing other entities to borrow.

I realize you don't like that, okay, don't shoot the messenger.

JR said...

Assume you are in a meeting with BIS members, oil, and China. You are trying to find a way of getting rid of the US$ without creating global chaos. Wouldn't you decide to slowly wean the U.S. and try to slowly decrease the rate at which US$ debt accumulates outside the U.S.. This way you would slowly take down the foreign exchange rate of the US$ and give your industry some time to adapt.

Not exactly. I keep re-posting miner49er's homeless dollars for a reason:

Without a certain weapon in the arsenal of the euro's design, the foreign CBs would indeed be over a barrel. Previously they were forced to evermore be on a dollar standard, since they would realistically only opt for this as the lesser of two evils. The alternative of saying no to the dollar at that time, would only have meant a return to a gold standard, and the politically unacceptable bone-crushing depression that would follow (as well as instability). In 1979, the European CBs began marking their gold reserves to market. This one act demonstrated immense foresight, and would provide the escape valve from the rock-and-hard-place no-win choices between eternal dollar support, or global depression.

Quietly, the euro-system banks have been divesting themselves of dollars. Collectively they retain something like 211 bn. currently. (This is not a large amount relatively speaking, but consider fractional reserve lending, and quickly we perceive the immesity of euro-dollar infestation.) This decline in dollar holdings is desired to take place concurrently with a rise in the price of gold to offset this. Spoonfeeding dollars into the system won't crash it, as well a slow commensurate rise in gold. The discipline that they have thus far maintained is indicative of the tectonic movement of the geopolitical strata. Ideally there will be no rash or even discernible activity. The perfect result is to simply keep shifting these plates until we wake up one day and the world has been remapped. Reality of course is that there are points of friction that cause tremors of unpredictable frequency and proportion all along the way. At some point critical mass will be reached, and the dollar contract markets for gold will no longer be able to contain its price as market perception on a large enough scale discounts paper parity with the real metal accordingly. It is at this juncture that the gold reserves of the CBs will provide immense expansionary leeway, as they are for a season revalued constantly upward. This bona fide liabilityless reserve base will make the ECB member banks the premier lending institutions to fuel the economic growth of the euro zone, and those align themselves with it.

Gary said...

JR, I have no feelings either way (liking or disliking) regarding this issue.

I just don't think regulators are up to much generally, that's all, and I don't believe they can stop debt deflation in Europe(other than by printing).

victorthecleaner said...

JR,

the point I was making was that the foreigners have to keep accumulating additional US$ debt, albeit at a slower and slower rate.

What do you do with those US$ that the US importer is giving you and that you don't want to buy more debt with. Apparently, the Euro CBs go laissez faire and let the private sector act. The developing countries' CBs seem to consistently buy physical gold with a part of these US$ while they keep accumulating another part of the US$. You also don't want to crash the London gold market too early, and so you have to exercise restraint. Perhaps you have decided you want to unwind the market gradually over two decades, and you carefully watch how much physical gold you can take out.

An additional difficulty is that there is also the private sector which, at least in Europe and Japan, is more or less free to act. And the private sector is disloyal and easily scared and quite unpredictable.

Victor

JR said...

I agree with the first paragraph VtC.

With regard to the other, stuff, I think this from miner49er is insightful:

The really big holders of dollars are the central banks. What they do with their reserves will make or break. Their influence over other banks and financial institutions will also largely dictate the destiny of these dollars.

JR said...

that's all, and I don't believe they can stop debt deflation in Europe(other than by printing).

Of course they can't at the end of the day, but telling some big banks to keep credit lines open and letting them know you will back them if it goes bad can help alleviate the need for more printing, at least in the immediate term.

And the immediate term is what its all about - winning the currency war:

FOA on currency war: We will see the beginnings of a currency war like no other in our time...

Several years ago, many gold bugs and gold advocates missed the path as the trail turned. Something I pointed out at the beginning of these "message" talks. As most of you will no doubt agree, almost all gold discussion still centers around "the dollar's war with gold". Truly, the evolution of this story will be how that war ended then and now the dollar's war with the Euro began! A very large part of that war strategy, employed by the ECB/BIS, was to let the dollar / IMF faction hang themselves by expanding and supporting the whole arena of this dollar paper gold market. Inflating the gold market place with so much "paper gold" that we would eventually have to bankrupt ourselves just to keep the dollar in the war game against the Euro.

Yes, the war now is between the Euro and the dollar! The Washington Agreement placed gold "on the road to high prices" as it signaled a phasing out of Euro support for our American gold values. How fast gold can, now, rise will gauge how much staying power the dollar has in all this. If there is any gold war now, it's to be in just how fast the dollar gold market can disintegrate into worthless IOUs! So, don't count on this destruction of our paper gold market to mark the real value and availability of physical gold; that ratio will split somewhere down the goldtrail. This action will scare most harden gold investors to death; especially the ones in leveraged gold stocks and lesser white metals!

The war between gold and the dollar has been over for a while now. The action, today, is between the dollar and the euro arena and this is what will break the price lock on gold. Leaving gold bugs with a lot of questions that ask why this: both systems will strive for a higher currency price for gold; one doing it because they have to; the other doing it because they want to! The casualty on this battlefield will be the world gold market as we know it. A market caught between how Western perception thinks gold's price should be "discovered" and at what price level trading in physical gold craters the entire paper structure. A structure of American based "paper gold".

We have been saying for some time that this will be "the" show to watch unfold; but only if your holdings allow you to stay still in your seat as it happens (smile).

They shifted their war on gold to become a war on the Euro,,,, only too late. Now, knowing that the Euro is a fact, we must have a super gold price if the dollar is to stay in the game! The question becomes one of supporting a cheap paper price for the sole function of keeping the market and all its bullion players alive. With the war on gold over, they need to turn their tanks around to face the real enemy but cannot.

FOA (10/3/01; 10:21:26MT - usagold.com msg#110)

Now that the Euro block is passing a point where the Euro currency is viable; this same past dollar support that built American's illusion wealth will now fall away. In its place we will see the beginnings of a currency war like no other in our time.

e_r said...

Victor,

It would be enough if they stopped accumulating additional US$ debt. This would be enough to crash the foreign exchange value of the US$.

I'm not sure if this statement is true. The foreign exchange value of the currency would be based on the supply and demand of the currency (barring any externalities such as CB interventions). The US$ debt is not immediate transaction currency, so any foreigner holding huge amounts of this debt would have to move carefully and slowly reducing their holdings.

I think real price inflation is a truly legitimate risk to contend, if the dollars are not getting absorbed by private foreign entities.

somanyroadsinvesting said...

My concern is the world govt will use some crazy SDR or Bancor idea to keep the game going another 10-15 yrs. Just seems like they have an amazing ability to postpone and prolong.

JR said...

Freegold Foundations

So, the point about currency is, and mainly for those of you that fret over a NWO currency, or "whatever currency," an Amero or SDR or euro-whatzit... chill TF out! Currency is no big deal. Currency is not the issue that matters here. What matters is what we, as a planet, choose to save.

RS Comment: So often in commentaries of this sort that propose a “solution”, the author is strangely obsessed with the notion of replacing the dollar (as a reserve currency unit) with simply another institutional emission of similar ilk (such as currencies of other nations, SDRs, bancors and whatnot). Their avoidance of any meaningful discussion of the most obvious remedy is almost pathological in the extreme. To be sure, we don’t need to invent any manner of universal reserve currency to fill the role of a unit of account because that role is already served in a fully functional capacity for any given country by its own monetary unit.

What IS desperately needed, however, is a universally respected reserve asset capable of filling our current void with a reliable presence that serves as a store of value. And far from needing to be conjured or created by complex international committees, that asset is already in existence and held in goodly store by central bankers and prudent individuals around the world — it’s known as gold. From amid the ruins of a chaotic financial crisis that was brought about by its own complexity, a degree of sanity will prevail, and gold as a freely floating asset will arise in stature as THE important element of global monetary reserves. The floating aspect is the vital evolutionary improvement over all previous structural monetary failures which tried to use a gold standard at a fixed price (i.e., unit of account) perversely joined to the very elastic money supply of any given country’s banking system.

R.

RJPadavona said...

Professor FOFOA,

Thanks for another enlightening epistle. I swear I get smarter every time I come to this website. Something of much greater value than a college degree can be obtained here. I hope everyone shows their appreciation for your hard work by sending some loot your way. (Hint, Hint, Wink, Wink, Say no more!)

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

Although I haven't been posting here all that long, FOFOA and me actually go way back. We first met on a cruise back in the 1960's. I'm a bit of a slow learner, so it's taken some patience on his part to teach me a few things. I'm forever grateful.

I was digging through some old photo albums the other day and ran across something. If I recall correctly, there were some rough seas during that cruise and we had to make a stop on an island. I believe FOFOA was trying to explain Triffin's Dilemma to me when this pic was taken. BTW, I'm the one wearing the hat :-P

http://www.flickr.com/photos/rjpadavona/7046571039/

RJP

Nickelsaver said...

First I would like to echo sentiments of RJP (I guess if you are Gilligan, that makes me a coconut) with one addition.

Consider the phrase "Peak Exorbitant Privilege" - that's all of us; the fortunate ones that have not only found this blog, but who have reaped the rewards of understanding reality from a perspective hidden from most of the world.

Bravo FOFOA

costata said...

Hi Gary,

Let's approach this issue of shrinking loan books from a political perspective. When the BIS, EBA, ECB started to pressure the European banks to improve their capital position the banks turned to the politicians and played this "card":

"We aren't going to raise capital we will shrink our loan books."

The subtext (which the politicians got straight away) is the threat to engineer a credit crunch. The banks can do this two ways. Halt new lending and/or pull lines of credit from existing borrowers. So I see this as a negotiating tactic divorced from the supply and demand situation in the market for credit.

Clearly the banks making this threat had their own preferred options for recapitalizing themselves and/or underwriting their risks in lending. I think we have seen some of those preferences with TARP etcetera.

What I am seeing taking shape here on the CB and regulator side of the negotiating table is an attempt to influence the plans of the European banks for meeting the new regulatory requirements. Not an attempt to override the fundamentals in the credit markets.

If a bank submits a plan that says "won't lend" then the EBA et al has the opportunity to intervene and put pressure on that bank to reformulate its plan. Liquidity programs like LTRO give them negotiating power with these banks that bypasses the politicians. So the EBA, ECB et al are not powerless in dealing with these banks.

This might also help to put some steel in the spines of the European politicians in their own negotiations with the banks in their jurisdictions. The spectrum of responses from those politicians could range from Ireland (throw the citizens under the bus) to Iceland (tell the private and sovereign creditors to eat some of the losses).

Cheers

Gary said...

Hello Costata, I can see that LTROs give the authorities some negotiating power. This discussion makes me realise again what a bunch of evil gits bankers are, and that the idea of banking becoming a quasi-public utility, perhaps with very heavy regulation, is the way forward. Perhaps the ECB is leading the way in this regard, as they did with MTM reserves.

Two other snips of interest: I just heard on Bloomberg that the Swiss Franc has broken above 1.20 Euros, for the first time since the ceiling was established. Be interesting to see if the SNB gives it up, or hits the Ctrl P button again. (Evidence of CB futility in trying to control the markets).

Second snip, of similar import, is that Bruce Krasting's latest post at ZH posits that Bernanke was forced by the markets (oil price especially) to rule out further easing this year. Again, there is no doubt in my mind that he would love to do another QE when Op Twist ends, but it would be too obvious that price stability was being sacrificed. He'll need to wait, allow prices to moderate, before pumping some more. I recommend reading Bruce's article.

So, central bankers eh? They think they are Gods, I think they are Dogs!

Blondie said...

That's a bit hard on dogs, isn't it?

AdvocatusDiaboli said...

"Peak Exorbitant Privilege"?

Even with the $-HI, the question is what are the alternatives and who is stupid enough to hold euros?

Wanna see what the EURO stands for?
http://www.welt.de/politik/ausland/article106158409/Chavez-aus-Frankreich-mischt-Wahlkampf-auf.html
That's right, 100% income tax and an increase on the mnimum wage.

Okay, thats France, let's look at Germany:
http://www.welt.de/politik/deutschland/article106158546/Politiker-streiten-ueber-eine-Demografie-Abgabe.html
You get to pay a fee, if you managed to grow older than 25yrs, a proposal from the RIGHT wing of Merkel. Okay, so whats going on at the left wing?
http://www.mmnews.de/index.php/wirtschaft/9841-schroeder-will-den-totalen-euro
Just abondon any kind of national sovereignty, transfer it to the EUdssr politbureau.

And to prevent the dumb german sheeple from running away the latest legislations are prepared:
http://www.welt.de/wirtschaft/article106158662/Schwarzgeld-in-der-Schweiz-wird-hoeher-besteuert.html
Bring your money to swizterland and we will tax it anyway.

Greets form the Old-Golden-Economy probably this was, what some wise prophet viewed 15yrs. ago.

JoyOfLearning said...

Thank you very much for your answers Victorthecleaner,JR and especially e_r for that graph. I think I get it now: so if I'm reading it right it seems that though there might be a surplus of exports in areas such as software, movies & music that is about 4 times smaller as the deficit in imports of physical goods, right?
Thank you for your patience!

JR said...

Dogs are gods.

P.S. - Hey B.O., don't forget to notice who's the hero in that 50 year old movie you're screening - (its not the sheriff or the law, it the next door neighbor - gogo community)

Woland said...

JR: "A market caught between how "Western Perception" thinks
gold's price should be "discovered" and at what price level trading
in PHYSICAL gold craters the entire paper ( futures/derivatives
complex) structure. (of price discovery)
The quote made me think of markets in terms of MARKETNESS, or
the degree to which they possess the attributes of markets. On a
scale from 1 to 4:
1. A flea market: Price directly negotiated, physical changes hands
2. A supermarket: no negotiation, physical changes hands
3. A stock market: negotiation? A claim to a future value changes
hands in the form of an ENDURING share or electronic equivalent.
4. A gold futures contact: An EXPIRING claim to the price of gold
changes hands, with no right co claim the underlying.
So, that's what "western thought" thinks about gold price discovery.
I'll take the flea market.

Jeff said...

Two items of interest, or why is the US so nervous about European debt?

From UBS Financial Services

Consorting With The Other Side - Fortune broke an interesting story on a private lunch that Bernanke had with some key bankers. Here’s a bit:
FORTUNE -- After completing a series of public lectures in Washington, D.C. last week, Federal Reserve Chairman Ben Bernanke quietly slipped into New York City for a private luncheon on Friday with Wall Street executives.

Fortune has learned that attendees included Jamie Dimon (J.P. Morgan), Bob Diamond (Barclays), Brady Dougan (Credit Suisse), Larry Fink (Blackrock), Gerald Hassell (Bank of New York Mellon), Glenn Hutchins (Silver Lake), Colm Kelleher (Morgan Stanley), Brian Moynihan (Bank of America), Steve Schwarzman (Blackstone Group) and David Vinar (Goldman Sachs).

Sources say Bernanke spoke at length about monetary policy, in an apparent effort to persuade attendees that they needed to take a more active role in helping to deal with the European debt crisis. He spent virtually no time discussing regulation, although that mantle got taken up by both Dimon (domestic regulation) and Schwarzman (global regulation).

I find it absolutely fascinating that he concentrated on the problems in Europe and not on U.S. lending or jobs. Is there more connectivity and concern with Europe than we think? We’ll watch more carefully.

and:

WASHINGTON: IMF managing director Christine Lagarde implored the United States to help back-stop debt-ridden European countries Tuesday, wading neck-deep into bubbling US political waters.

http://timesofindia.indiatimes.com/business/international-business/IMF-chief-calls-on-US-for-more-cash/articleshow/12522131.cms

Jeff said...

FOFOA: this very scenario—$IMFS collapse—was faced 32 years ago and a solution was crafted at the highest levels. That solution took 20 years to launch (at great cost, mind you) and today it stands at the ready. If you read too much ZH and thereby think the European debt crisis changes things in some way, guess again. The European debt crisis is a symptom of the dying $IMFS, not the Eurosystem. In every way this is true...

The Achilles' heel of the $IMFS is that debt is the system's official store of value and foreign exchange reserve. And bearing this flaw, savers, currencies, banks, governments and even entire countries are all vulnerable to the inevitable failure of the debt.

The problem with debt performing these functions is that debt is a derivative of the currency itself. Currency moves opposite the flow of real goods and services. And with a derivative of the currency acting as the only counterbalance to uneven trade, there emerges the exact opposite of a natural adjustment mechanism for correcting trade imbalances.

With debt as the store of value and official reserve asset, the party producing more real goods has no way to record his net production (savings) other than lending that excess currency back to the consuming party, encouraging him to consume more, and recording the new debt. A true adjustment mechanism makes the balance swing back and forth. But the debt system requires an infinite debtor. So the system is designed to fail. The debt backing the system is designed to fail. And as the official store of value and reserve asset, the savers, currencies, banks, governments and even entire countries are destined to fail in the end… under the $IMFS."

Infinite debtor, please step up and defend your exorbitant privilege.

Jeff said...

FOFOA: Yes, we will have a grand deflation... denominated in GOLD! It will be brought on by all the same factors the deflationists correctly recognize. The failure of debt, the winter cycle, etc... And it will look the same as they imagine. Depression, unemployment, falling prices (when priced in GOLD), black and white pictures, etc...As FOA said, "As debt defaults, fiat is destroyed." Or another way to say is, "As debt defaults, fiat savings are destroyed."

FOA: Every time the ECB doesn't "blink", ANOTHER economic nation block looks closer at the EuroZone as the backing economy for a new reserve currency. As each day passes with the EuroZone showing even marginal growth without the benefit of an American style trade deficit, the internal economic dynamics of the USA builds against it's dollar management policy. Eventually forcing the US into a full blown super inflation that has no limits.

AdvocatusDiaboli said...

and if you dont like the US balance sheet, take a look at this one:
http://www.bankofgreece.gr/BogDocumentEn/Balance_sheet_BoG.xls

What will happen when the "Peak Exorbitant Privilege" of the Bank of Greece is hit? Oh by the way, here in Europe we call it differently, it's called "Emergency Liquidity Assistance" and I guess every Euro-fan knows about it by now.
Greets, AD

hat4uk said...

The quality and depth of this argument is amazing. I will take more time to digest it.
Over and over one notices dumbed coverage about 'the US recovery', without that giving any thought to how much of it is earning or costing the US dollars. We have the same problem in the UK; as for the EU, it's a madhouse where black is white and up is down.
I wonder what the author (or anyone else) thinks of the idea of having currencies tied to an energy standard rather than gold?
The Slog

JR said...

Hi hat4uk,

The current regime of "backing" $IMFs with oil is ending.

5/22/98 ANOTHER (THOUGHTS!)

If the Euro does fail, gold will become the "world oil currency". We do know this full well, "the Central Banks will hoard all gold and buy any offered if this new European currency does not work" and "debt currencies fail". If this does come, no paper asset of world economic system will survive, nothing! Not a good thought, no? Thank You

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

5/3/98 ANOTHER (THOUGHTS!)

The urgent drive to create a new "reserve currency" began in the early 80s, after the last small "gold war". The road to making this new Euro did never include gold in large amounts, until the last few years! Even one year ago, the news would say, 5% or less. Today, we speak of a much greater amount! This is interesting, yes? The BIS did "hatch" this deal in a very late fashion! The future of the Euro was found to be "weak", as the Middle East oil imports onto the continent would continue in dollars! This was so, from the dollar being made strong in gold. Gold priced in dollars at near production cost offered a "no switch currency" position, for oil. This position has been unstable for the last year, and the alternative of a switch to gold was in progress! You have read my "Thoughts" before. Now the BIS does offer to "change the rules of engagement", a real reserve currency is offered!

Few do grasp what is happening and why! They think the holding of gold reserves by the Euro is of a little point, as to what good are gold reserves? One cannot use gold as Marks or Yen to intervene in currency market to support the Euro. My friend, the BIS has played the, as you say, "big poker hand"! The holding of large reserves by the ECB and the withholding of sales from the market will not only bring the end of the London paper gold market, it will, thru a high USD gold price, "make the dollar weak in gold"! From this position, the dollar will lose the "oil backing" from the Middle East! At first, all oil for Europe will be in Euro's, then all producers want "strong currency"!

There is more: Many say, how to defend Euro without much currency reserves? If gold go to many thousands US, what will be used to bid for Euro as defense? I say, these persons will find a problem on their computer screens! You see, the Euro will start as "nothing", no holdings of size, anywhere! The dollar is held as reserves as "the stars in heaven"! It is to say, "the dollar will bid for the Euro", not "the Euro will bid for the dollar"! All currencies will "flow into the Euro for trade". But, if the Euro becomes so strong, how to compete in world trade? It will be the price of oil that will make the "trading field" level! The soaring US$ price of gold will make even a 10% Euro reserve be as 100% today, in USD! Oil will become, very, very cheap in Euros and allow that economy to do well! Many other countries will see this and also want to join the new "world reserve currency" that has become"the new world oil currency"!

The politics of the ECB? It is as a "side show". We watch this new market, yes?



See that:

From this position, the dollar will lose the "oil backing" from the Middle East!

JR said...

Credibility Inflation

Part of the reason the rest of the world did not abandon the dollar in 1971 was that the rate of economic expansion flowing from Middle Eastern oil cheaply priced in U.S. dollars was already exceeding the expansion rate of the money supply. So the switch from a semi-gold-(con)strained monetary system to a much more expandable "balance sheet money system" as I like to call it — or another name I like is "purely symbolic monetary system" — allowed for the non-deflationary addition of many new "quality of life" gadgets, widgets and shipping lanes that the world had never before imagined.

For the next three or four decades we would be able to comfortably afford the new introduction of Betamax VCR's, microwave ovens in every home, personal computers, DynaTAC cell phones, camcorders, digital cameras, LaserDiscs, Compact Discs, DVD's, MP3's, and on and on. Eventually, all of these wonderful products would be built cheaper by someone else on the other side of the world and shipped to us cheaply using the oil purchased from the Middle East with easily available U.S. dollars.

[...]

Even at the higher oil prices of the 1970's, the economic demand for oil proved to be a far superior "backing" to the dollar than the depleting Treasury gold had been.

[...]

It was reasoned at that time that more than just the ridiculous price of gold being broken, the system itself was broken, and needed a global finance structural change. So the international consensus was to let the U.S. default outright on its gold obligations rather than lobbying for a revaluation of its gold at a new fixed rate. But then continue using the dollar anyway, as long as relatively cheap oil could be gotten for dollars.

And with this decision, the stage was set for a renewed global (Western?) economic growth spurt, much like after the end of WWII. Only this time, the value lost through the non-delivery of U.S. Treasury gold would be more than replaced by the value oil brought to the new world economy, especially with first-of-a-kind products like Pong, released for the Christmas season in 1975.


See that:

Even at the higher oil prices of the 1970's, the economic demand for oil proved to be a far superior "backing" to the dollar than the depleting Treasury gold had been.

More good stuff on network effects and the currency for oil invoicing in Dilemma.

Nickelsaver said...

Gold: The Ultimate Wealth Reserve

Energy, as well as all commodities, make for a very poor reserve asset.

victorthecleaner said...

Gary,

Bruce Krasting's latest post at ZH posits that Bernanke was forced by the markets (oil price especially) to rule out further easing this year.

My interpretation is different. I get the impression that the US are trying to keep the oil price as high as possible so that it just does not hurt the economy too badly. Why? Perhaps they have again a vision of becoming energy self-sufficient just as in the 1970s. Why? Perhaps to get their trade deficit under control - not all of it, but at least the non-discretionary part: energy. Cheap plastic toys from China are not essential. Oil is.

In order to achieve this, you have to take as much cheap OPEC oil off the market as possible and to create a geopolitical situation in which it will take as long as possible before the ME countries become stable and can invest in large projects again.

But this time (in contrast to the early 1970s) they are on a clear collision course. Recall the letter by Ali Naimi in the Financial Times two weeks ago who stressed at least three times that the price is too high for Europe (and who did not mention America one single time).

Victor

victorthecleaner said...

hat4uk,

with all due respect, I think you are getting the interpretation of the European situation wrong (perhaps too much exposure to UK media?) - but at least you are here to discuss! Good choice and welcome!

Here is the short answer: When the US went off the international gold backing in 1971, they did this in order to raise the price of oil which, they hoped, would help them become independent of cheap OPEC oil. But they made sure that oil is always traded in US$.

Now this imposes a huge tax on their allies in Europe. These had to first export something into the US in order to acquire US$ and could then use these US$ in order to purchase oil. The US, in contrast, could just increase their own credit volume and pay for their oil with newly created US$.

On top of this, they were able to make sure that the oil producers invested the majority of their US$ surplus back into the US (real dollars) and UK (eurodollars) financial institutions, providing additional reserved for further credit expansion.

For a long time, this was a perpetual motion machine that allowed the US to get free oil and free funds to run their government (read: military) whereas the Europeans were automatically conscripted to funding this enterprise whether they liked it or not. (if all oil is sold for US$, what other option did they have?)

Do you think the Europeans liked it or did they not? This is the explanation for why the Euro exists today, why the Europeans want gold back into the international monetary system, why there will be no return to a gold standard in Europe, but why the Europeans will eventually shot the gold price to the moon, and finally for why the Euro will not break up.

It also explains why the Euro is the most serious danger to the US and UK financial systems and why US and UK fear the Euro and bash it whenever possible.

Who cares about the bankruptcy of some smaller countries? Who cares about whether some pension funds or life insurance companies lose part of their assets in the write-downs. What's at stake on the big chess board is access to the world's resources for the next century. The European debt crisis is peanuts on that scale.

Victor

Motley Fool said...

Thevisualthesaurus.com lists extortionate, usurious, unconscionable, steep and outrageous as relevant words. ^^

I'm liking unconscionable. :)

TF

JR said...

Good stuff MF,

But unconscionable implies unscrupulousness, a fleecing of one by another. It is also a legal term that basically means a contract that is so unfair it will not be enforced because no reasonable person would have agreed to it, typically because of the inequity of bargaining power/duress/inequity of sophistication of the contractual parties.

But Jacques Rueff would disagree with this characterization, yes?:

"The Roaring Twenties was not just a short-lived period of superficial prosperity in America, it was also a time when a great privilege was unwittingly granted to the United States that would last for the next 90 years. And I say "unwittingly granted" because the U.S. did not even participate in the negotiations that led to its privilege. As Jacques Rueff wrote in his 1972 book, The Monetary Sin of the West:

"The situation I am going to analyze was neither brought about nor specifically wanted by the United States. It was the outcome of an unbelievable collective mistake which, when people become aware of it, will be viewed by history as an object of astonishment and scandal.


But whatever, they did it to themselves but they figured it out and played the "Big Poker Hand" in setting up the euro with gold reserves, so no need to feel sorry for them I guess.

e_r said...

Here's a recent piece by Jim Grant, which was a speech he delivered at the NY Fed recently. His sense of history is admirable and his explanation for the after-effects of interest rate supression and its consequences, commendable. But towards the very end, he goes on to recommend the Classical Gold Standard (I can already see eyeballs rolling ;)) as the panacea.

Perhaps, somebody ought to recommend Grant as to why Credit suppresses the gold price and the classical gold standard return is impossible.

I find a pathological negligence of the fact by most American/UK financial analysts regarding the Euro's gold reserves allowed to freely float. Why is that? I mean -- these are all intelligent people, yes? They've been doing these analyses for decades.

Gary said...

Victor, too many 'perhaps'.

Keeping it simple, it's an election year, the Fed will be a target if it allows animal spirits to run too wild and inflation spikes.

Therefore Bennie boy needs to cool things down a bit, even allow the economy to show (yet again) that it is incapable of standing on its own two feet. Bernanke's hands are tied whilst the market expects QE3. So he is forced to get the market to un-expect it. Then he'll unleash the next trillion post-election when every man (and his dog!) are begging for it.

But this is the first time the market has got ahead of Bennie boy. Hope he enjoys it in the doghouse!

Aaron said...

Absolutely excellent comments Victor! I think you just summed up 2,000 pages of reading (literally) into eight short and sweet paragraphs.

For anyone that's read the entire Gold Trail and is still confused, scroll up and re-read Victor's short summary.

--Aaron

Motley Fool said...

JR

Sure, it didn't start that way perhaps, but at present and for a while now I would say the USA has been aware of and has been using, to put it mildly, this privilege for all it's worth.

As time passes, things change. :)

Unfortunately there doesn't seem to be better words to choose from.

TF

victorthecleaner said...

e_r,

I find a pathological negligence of the fact by most American/UK financial analysts regarding the Euro's gold reserves allowed to freely float. Why is that?

Yes, sometimes I think GATA is actually run by the Treasury Department in order to divert the critics into a corner in which they cannot do any harm.

Victor

Motley Fool said...

JR

Oh, yes. I wanted to thank you for your reply to Ramon, I had the idea to add BTC, for fun, to the dilemma to show the flaw. Been away a few days though, so you beat me to the punch. :P

TF

victorthecleaner said...

e_r,

yes, there are strong indications that basically the entire rest of the world wants a higher gold price (perhaps only after buying more, but nevertheless...). And yet, they all refuse to look.

Victor

AdvocatusDiaboli said...

somehow I missed the last MTM party here on FOFOA.
What happend? I mean what happend in the meantime after the last MTM party? Let me recall:
The reserve requirements got lowered from 2% to 1%. Draghi printed another .5 trillion of base money (after .5 in december), but okay VtC taught me that this printing is good/neutral (basically the same crap BenB tell's the audience).
TARGET2 (the bad bank special purose vehicle of the ECB) expanded even further....
What's about that Au-MTM party in the meantime?
NADA!!!
Greets, AD

victorthecleaner said...

AD,

the London pm fixing on Dec 31, 2011, was $1574.50. If we get a continuation of the 19% annual increase that we have seen since 2002, this implies the following prices:

March 31, 2011: $1644
June 30, 2011: $1716
September 30, 2011: $1793
December 31, 2011: $1873
December 31, 2012: $2228
December 31, 2013: $2652

The actual value on March 30 was $1662.

We are on track, aren't we?

Victor

AdvocatusDiaboli said...

VtC,
"September 30, 2011: $1793
The actual value on March 30, 2012 was $1662.
We are on track, aren't we?"

Yes tell me on which track are we, since in the meantime trillions $+€ have been printed?
Greets, AD

AdvocatusDiaboli said...

oh, VtC,
and before you give me some "economist excuse":
Isnt gold supposed to be an "oil" currency?
At least since September 2011 until March 2012, fuel didnt got cheaper although gold did. Exactly the opposite.
So what we have here: Euro-Lalala-MTM does not fit. Oil for gold vice versa does not fit.
Greets, AD

victorthecleaner said...

Ooops. I got all the years wrong - we are in 2012 after all. The numbers ought to read:

March 31, 2012: $1644
June 30, 2012: $1716
September 30, 2012: $1793
December 31, 2012: $1873
December 31, 2013: $2228
December 31, 2014: $2652

Victor

victorthecleaner said...

since in the meantime trillions $+€ have been printed?

I don't think my purchasing power in Euros would have been eroded by more than 19% annually since 2002.

Victor

AdvocatusDiaboli said...

VtC,
in the last six month, ask somebody from Europe if his purchasing power has declined, it did!

And by the way, since you live in the US, you shouldnt be concerned about inflation over the last six month at all anyway, since Ben told you there isnt any significant.
Greets, AD

Biju said...

AD,

you are trash talking like people do in ZH forum.

VTC did not tell that Euro did not devalue against real things like a HamBurger. He only mentioned Euro has not devalued 19% annually.

So if a Burger was Euro 5 in 2001. compounding annually . is the price of the same Burger 5*[(1.19)^10] = Euro 28. Has not happened right ?

Biju said...

Actually I will agree with Ben Bernanke that in US, price has not increased much. CPI as given by Govt is more or less accurate.

Food probably would have gone up 20% in last 10 years, and rents would have gone up probably 10%.
Education and Health has probably gone up the most, but since Rents are the big expense, I will agree that the price increase "felt" by common folks have been inline with Govt statistics approx 3% annually.

AdvocatusDiaboli said...

Biju,
the year 2001 was something VtC brought up, actually completely irrelevant to the MTM topic after all, just to distract from what I stated.

But your right, instead of gold or euros or $ or whatever, I just might have stacked copper in 2001 as an MTM reference point.
Greets, AD

Biju said...

Copper was $1.45/lb in 2001. Now it is $3.8/lb.
ie 10% annual increase for each of the 10 years.
Not high or consistent as Gold.

Anything else gone as big as Gold annually ?

Biju said...

Silver went up better but it was not consistent during 2008 crash

RJPadavona said...

Hello Friends,

During the housing boom in America, some of the most popular shows on television were 'Flip This House', 'Flip That House', 'House Hunters', etc. Now some of the most popular TV shows are "Pawn Stars', 'Storage Wars', 'American Pickers', 'Operation Repo', etc.

A few years ago, everyone and their brother was flipping homes on the side or as a full-time job. Now the only new businesses I see popping up are Cash4Gold, consignment shops, and scrap-metal recycling yards.

Do you see the trend? That's right. That trend is the mass liquidation of all the shit Americans have accumulated as a result of the exorbitant privilege we've been granted by the monetary gods.

I'm not sure if this trend is still intact as it was in 2010, but I would assume it still is:

"America's Biggest Trade Export to China is Trash":

http://www.usnews.com/opinion/blogs/jodie-allen/2010/03/03/americas-biggest-trade-export-to-china-trash

So, the empty container stats FOFOA mentioned are actually more discouraging than the numbers imply because much of what we're exporting is just our garbage. Not actual goods we've produced.

So it seems Americans are trying to reduce the trade deficit by liquidating all our accumulated excess, but the USG picks up the slack by consuming more.

FOFOA wrote: "Hyperinflation comes from the margin, from the government defending its own needs, and there's never enough "money" for us mere mortals to pay the prices which are running away from everyone during hyperinflation."

Just as there's never enough money to pay the prices that will run away from us during HI, apparently there's never going to be enough of our garbage to liquidate in order to narrow the trade deficit either:

http://www.youtube.com/watch?v=qmYt0e88ANo

RJP

costata said...

Absolute must read from Stewart Thomson IMHO discussing the institutional view of global economic prospects and how they will act (based on their perspective) in gold, the miners, bonds etc:

http://www.kitco.com/ind/Thomson/20120404.html

Also recalling the discussion in the "India's Gold" thread it would be very interesting if the Chinese pulled their bids during the recent gold strike in India.

Shipped any of those big ugly gold bars to the LBMA lately Bron due to a softening in demand from Asia?

JR said...

Hi MF,

I love MF's FOFOA's dilemma, it reflects the concise precision of an intellect of which my space-cadet mind could only dream.

Sure, it didn't start that way perhaps, but at present and for a while now I would say the USA has been aware of and has been using, to put it mildly, this privilege for all it's worth.

Indeed things change. But one must consider the alternative, no?

Without a certain weapon in the arsenal of the euro's design, the foreign CBs would indeed be over a barrel. Previously they were forced to evermore be on a dollar standard, since they would realistically only opt for this as the lesser of two evils. The alternative of saying no to the dollar at that time, would only have meant a return to a gold standard, and the politically unacceptable bone-crushing depression that would follow (as well as instability). In 1979, the European CBs began marking their gold reserves to market. This one act demonstrated immense foresight, and would provide the escape valve from the rock-and-hard-place no-win choices between eternal dollar support, or global depression.

There was no choice, yes? An exorbitant privilege indeed, but as miner49er explained:

The alternative of saying no to the dollar at that time, would only have meant a return to a gold standard, and the politically unacceptable bone-crushing depression that would follow (as well as instability).

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

Credibility Inflation

Through '78 and '79 the dollar plunged against foreign currencies, and in July of 1979 a desperate Jimmy Carter appointed the tough New York Fed President Paul Volker to head the "deeply divided, inexperienced, soft and indecisive" Federal Reserve Board. Then in early October of that year, while attending an IMF meeting in Belgrade, Yugoslavia, Volcker received "stern recommendations" from his European counterparts that something big had to be done immediately to stop the dollar's fall. The general fear at that meeting was that the global financial system was on the verge of collapse.

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

Dilemma

Please think back to what the rise in gold during the 1970's did to the dollar and the international monetary system. It panicked European central bankers to the extent that they confronted Paul Volcker in October 1979 at an IMF meeting in Belgrade, Yugoslavia with "stern recommendations" that something drastic had to be done immediately to stop the dollar's fall. The fear among the European central bankers at the meeting was that the global financial system was on the verge of collapse.

Now compare that to today. As the gold price rises, the euro's monetary reserve assets rise in both value and confidence. They know that even if the dollar collapses today, the gold portion of their reserves will more than compensate for the loss of dollar-denominated assets. And they also know that today, unlike in 1979, there is an alternative currency of sufficient size and scope to pick up the global financial slack. No need to panic like 1979.

JR said...

Moneyness

The US has enjoyed a non-stop inflow of free stuff including oil (a trade deficit) ever since 1975, the last year we ran a trade surplus. In the 1970s, following the Nixon Shock and the OPEC Oil Crisis, the US dollar went into a tailspin. Because the US dollar was the global reserve currency, this was bad news for the global economy. If the dollar had failed then, without a viable replacement currency representing an economy at least as large as the US, international trade would have ground to a standstill.

Europe was already on the road to a single currency, but it still needed time, decades of time. So at the Belgrade IMF meeting in October of 1979, a group of European central bankers confronted the newly-appointed Paul Volcker with a "stern recommendation" that something big had to be done immediately to stop the dollar's fall. Returning to the US on October 6, Volcker called a secret emergency meeting in which he announced a major change in Fed monetary policy.

Meanwhile, the European central bankers made the tough decision to support the US dollar, at significant cost to their own economies, by supporting the US trade deficit by buying US Treasuries for as long as it took to launch the euro. As it turns out, it took 20 years. After the launch of the euro, the Europeans slowly backed off from supporting the dollar.

JR said...

The U.S. didn't force it on anyone. The dollar was dad in the 1980s and the BIS/Euro/etc. group kept it alive. The BIS/Euro/etc. faction created a paper gold market to support the $IMFS, they kept the dollar afloat amid the turmoil of the second oil crisis and rising gold in the late 1970's, yes?

Synthesis

5/22/98 ANOTHER (THOUGHTS!)

If the Euro does fail, gold will become the "world oil currency". We do know this full well, "the Central Banks will hoard all gold and buy any offered if this new European currency does not work" and "debt currencies fail". If this does come, no paper asset of world economic system will survive, nothing! Not a good thought, no? Thank You

6/4/98 ANOTHER ( THOUGHTS! )

The last small gold war ended in the early 1980s, as the choice was to use the US$ or go to a gold based economy. No other reserve currency existed, and gold lost the war as all continued to buy dollar reserves.

But by 1980, Europe was working with the BIS to implement a new "reserve currency".


The European plan was to support the $IMFS at least until a new fiat "reserve" currency could be established, one large enough to absorb the shock of a failing reserve currency, to avoid being forced back 100 years into a physical gold-based economy which would have been very traumatic. This effort took 20 years from 1980.

JR said...

"They" wanted an alternative, to usher in a new era, yes? As FOFOA wrote European central bankers made the tough decision to support the US dollar, but why? To avoid a bone crushing deflation and afford them time to build a new currency for the future, yes? They gave the otherwise dead dollar the privilege, yes?


"5/5/98 ANOTHER (THOUGHTS!)
Mr. Kosares,

A few thoughts for you, as the questions are asked.

Q: ** It seems that both you and your friend believe that the world is splitting up into currency/trading blocks -- much as the world did for both World Wars. There has been much discussion around the world about the imposition of a NEW WORLD ORDER and international one world government. Simultaneously, we see another, opposing force at work -- regionalism, nationalism, even tribalism. What do you make of this? Is the Euro a child of the forces of the New World Order, or the forces of regionalism/nationalism/tribalism? **

A: Sir,

I would say, "Old World Order" to return. To understand/explain better: "A very easy way to view this "order", would be to simply say that the American Experience is reaching the end! As we know, world war two left Europe and the world economy destroyed. Many thinkers of that period thought that the world was about to enter a decades-long depression as it worked to rebuild real assets lost in the conflict. It was this war that so impacted the idea of looking positively toward the future. The past ideals of building solid, enduring, long term wealth were lost in the conception of a whole generation possibly doing without! In these fertile grounds people escaped reality with the New Idea of long term debt, being held as a money asset. Yes, here was born the American Experience that comes to maturity today.

New world order, regionalism and tribalism are but modern phrases that denote "group retreat to avoid paying up". The worldwide currency system is truly a reflection of an economy built from war, using the American Experience, the US$ and the debt that it represents. But, for the American dollar to continue as the representative of the global financial system, in the form of being the reserve currency, maturing generations of all countries must accept it, and the tax on real production it clearly imposes! In the very same mindset that people buy the best value for the lowest price (Japanese cars in the late 70s), and leave an established producer to die, so will they escape the American currency and accept any competitor that offers a better deal. And because we are speaking of currencies here, the transition will be brutal!

....

Q: **One other item you might clarify for me is "Who is really behind BIS?**

A: Perhaps, "who control them"?

Q: **The Swiss?

A: Yes.

Q: **The eurocentral banks?

A: Yes.

Q: **Who does BIS really represent?

A: "old world, gold economy, as viewed thru modern eyes" or " way to move from US$ without war".

JR said...

Once Upon a Time

...What we learned from ANOTHER thirty years later was:

1. The purpose of the euro was to provide an international transactional alternative to the dollar.
2. The consequence of the launch of the euro would be that gold would undergo "the most visible transformation since it was first used as money."

Quote - Monday, August 6, 2001 - GOLD @ $267.20 - FOA: "The result will be a massive dollar price rise in gold that performs over several years."

Tuesday, January 1, 2002 - Launch of euro notes and coins
Friday, February 8, 2002 - GOLD ABOVE $300
Monday, December 1, 2003 - GOLD ABOVE $400
Thursday December 1, 2005 - GOLD ABOVE $500
Monday, April 17, 2006 - GOLD ABOVE $600
Tuesday, May 9, 2006 - GOLD ABOVE $700
Friday, November 2, 2007 - GOLD ABOVE $800
Monday, January 14, 2008 - GOLD ABOVE $900
Monday, March 17, 2008 - GOLD ABOVE $1000
Monday, November 9, 2009 - GOLD ABOVE $1100
Tuesday, December 1, 2009 - GOLD ABOVE $1200
Tuesday, September 28, 2010 - GOLD ABOVE $1300
Wednesday, November 9, 2010 - GOLD ABOVE $1400
Wednesday, April 20, 2011 - GOLD ABOVE $1500
Monday, July 18, 2011 - GOLD ABOVE $1600
Monday, August 8, 2011 - GOLD ABOVE $1700
Thursday, August 18, 2011 - GOLD ABOVE $1800

What I can tell you with full confidence is that this is only the very beginning of gold's functional transformation.

Phat Expat said...

And here is a comment by London Trader suggesting what the floor is for gold and why:

"...Every day at the fix, regardless of price, sovereign entities are buying physical gold. They are averaging in at the fixes, as well as during the declines. On top of that, there are bids for hundreds of tons of physical gold starting at the $1,610 level and below. This is why the recent decline in gold halted $2 above that level.


Regardless, these physical buyers will be purchasing at the fix going forward, even if the price of gold rises. This is why the smart money, the few individuals and entities that are in the know, continue to accumulate physical gold. These well financed individuals and entities are buying because they know they will be in profit. ..."

Ref: http://kingworldnews.com/kingworldnews/KWN_DailyWeb/Entries/2012/4/5_London_Trader_-_Feds_Global_War_Against_Gold_Escalating.html

Hmmm... We shall see. As to VtC's historic view of gold appreciation (19% p/a), well, I'm looking forward to a serious change to that trend; quite possibly beginning this year (and in-line with the Thomson link provided by costata). More GME? Sure, why not...

e_r said...

For a proper ripping apart of KWN, please read My oh My the Gold Manipulation, by Dan @ the Fundamental View.

Phat Expat said...

e_r

Would love to. But your link leads to:

Sorry, the page you were looking for in this blog does not exist.

Nickelsaver said...

ER,
love this part in that article

"If the above statements don’t make you chuckle a bit then really, you need to get out more often. The Federal Reserve now monitors King World News to guage sentiment so it can hammer gold? Really? Stop!!!"

link seemed to work for me

Nickelsaver said...

hmmm...here is that link again. it worked from my email feed but not from here

http://thefundamentalview.blogspot.com/2012/04/my-oh-my-gold-manipulation-right-on.html

Phat Expat said...

NS
Really? Huh, okay, I had to dissect it to get it to work... Reading now...

e_r (or anyone else...)
Are you refuting London Trader's numbers? If so, evidence please...

Phat Expat said...

Okay, fair enough. Ho hum... I especially like this one:

"There is manipulation in every market in one way shape or form but please, I am getting tired of hearing the same old arguments every time the market acts the way it is supposed to act when it doesn’t get the news it expected."

Hey, just accept it, it is what it is... Yeah, no, I think not.

And while it is true that JS (and others) trumpet events that don't come to pass; well, we are all big boys and girls and shouldn't base our decisions solely on what ANYONE thinks or does.

costata said...

Hi All,

Re: Directions

From the second last paragraph of this comment:

Arguably these topics go beyond the remit of this blog. Would this be a good thing or a mistake?


Hi Gary, JR, VTC et al,

Re: Euro

I feel I'm starting to get a better sense of how the ECB Eurosystem is going to control the Euro and continue to prepare for the post-transition period.

One of my long running concerns about the Euro Freegold-RPG regime has been the question of how the issuer could control the money supply under a regime where the banks issue 95 per cent of the "money'.

I thought that the issuer would have to go the 100-per-cent-reserve route to be able to fulfill its mandate of currency stability under a Freegold-RPG regime. In other words, control the money supply via base money primarily (or exclusively?).

(BTW I have had some heated arguments with FOFOA about this issue and other banking system related issues. Disclosure: my attitude to bankers and their business model in particular places me somewhat closer to Gary's attitude on the good-versus-evil-gits "continuum".)

However I'm moving away from this opinion about reserving. I think the ECB may be heading down a regulatory pathway instead. I think the EBA is an initiative of the "never waste a crisis" kind. Pundits (Martin Armstrong included) arguing that some kind of fiscal consolidation is a solution now, or would have been a solution in the past, are barking up the wrong tree IMO.

I think the main goal is bank regulatory consolidation across the EU/EMU rather than control of the minutae of fiscal policy. Let me be clear on this point. I'm not suggesting that Brussels will not press ahead with its attempts to implement some tighter controls on the borrowing and spending parameters for European governments. Call it harmonisation if you will.

I think the ECB is playing its own game related specifically to the Euro and its mandate. In my opinion this game is to implement credit rationing tools, tighter control over credit allocation across sectors and regions, more influence on bank margins (through interest rates and collateral requirements) and to support the BIS initiatives on capital adequacy.

I would describe this as moving from (Deeply) Flawed Bank Business Model V1.0 to (Less) Flawed Bank Business Model V2.0.

At the risk of being contentious I think the superorganism has its own ideas on how this situation should evolve. Personally I think the superorganism is trying to disintermediate the "evil gits" out of many of their current roles in the financial system. Of course, even if I am right about this, it will be resisted tooth and nail by the banks.

If we can have a sane discussion about the banking system I would be happy to raise other issues for discussion about the role of capital versus debt, economic policy and fiat currency under a Freegold-RPG regime. Arguably these topics go beyond the remit of this blog. Would this be a good thing or a mistake?

If we go down this path and the trolls hi-jack the discussion of these issues, or it devolves into an idealogical slanging match, I'm out of here and this can go back to being a private discussion (or no discussion at all if the long term contributors prefer that course).

Cheers

PS. I urge everyone to read that post from Stewart Thomson which I linked earlier. Note the convergence on this 2013 to 2015 period in the "timetable" for profound change that is nominated by many observers. Is this a case of shifting the goal posts or is consensus developing?

Motley Fool said...

JR

"The alternative of saying no to the dollar at that time, would only have meant a return to a gold standard, and the politically unacceptable bone-crushing depression that would follow (as well as instability)."

I disagree with him here, on several points. A gold standard was a (bad) option if the official price of gold was raised, no need for depression and instability. Furthermore I don't think it was the only option.

I will concede your point though. It was circumstantial and events were dictated by what had happened before and the mindsets of the players. This privilege was not conceived for sinister purposes.

"If the dollar had failed then, without a viable replacement currency representing an economy at least as large as the US, international trade would have ground to a standstill."

International trade as an aggregate is composed to individual production and consumption preferences. Saying this is akin to saying that people would just sit in the street and die if hyperinflation happened. The drive for survival is strong...Something would have happened to allow trade to take place.

Of course the European chosen method of transition will be a much smoother one than a $ collapse scenario would have been, and is perhaps worth the cost to them.

Peace

TF

AdvocatusDiaboli said...

costata,
I appreciate your posts alot, despite for me here at the blog often the reality check is completely missing.

"One of my long running concerns about the Euro Freegold-RPG regime has been the question of how the issuer could control the money supply under a regime where the banks issue 95 per cent of the "money'."

Here's a reality check for you: The banks didnt issue 95%, no they issued 98% of the money. But since 18th January they are now allowed to issue 99% of the money. I wonder when they will step to 99,5% and 99,9% and 100% in the end.
Greets, AD

JR said...

HI Costata,

I'm not really sure other than you should keep posting here. And do it more. About this:

"Pundits (Martin Armstrong included) arguing that some kind of fiscal consolidation is a solution now, or would have been a solution in the past, are barking up the wrong tree IMO.

I think the main goal is bank regulatory consolidation across the EU/EMU rather than control of the minutae of fiscal policy."


Yes

"Basically, this is the direction the Euro group is taking us. This concept was born with little regard for the economic health of Europe. In the future, any countries money or economy can totally fail and the world currency operation will continue. What is being built is a new currency system, built on a world market price for gold."

somanyroadsinvesting said...

Great post! Enjoy reading. I forwarded to all my skeptic friends.

One question I had related to the dollar amounts needed to maintain the price as it goes higher. As the price goes higher greater dollar amounts will be needed just to soak of production/scrap supply.

I have read in some of FOFOA posts showing a chart with potential of $55k real(today's) dollar price. That would imply huge inflows into gold. I have not done the math but is that even possible? For example at $3k gold would need roughly double the amount of money from now going into gold just to maintain is price from mining and scrap supply every year.

This has more to do with basic buying/selling dynamics vs any monetary theory discussion.

Thanks

Gary said...

Hello Costata, I echo JR's comment, anything that adds to my knowledge of these sorts of things is welcome (my knowledge is currently tiny in this area, so doubt I'll be able to add much).

Those that have Euro hang-ups will try to bait you and others, so my usual suggestion of ignoring the cretins (apart from sometimes ridiculing their infantile posts) would help avoid any silly arguments.

Michael H said...

costata,

Your comment re: Euro banking regulation reminds me of FOFOA’s assertion that banks will become boring businesses like public utilities. I only recall mentions of this concept in passing and not a full description of why, how it would come about, and what it would look like when the transition is complete.

Do we need banks? Will banks need to be connected to savings deposits, or could there be entities that issue purely unbacked credit? Or maybe there would truly be ‘commercial banks’ working as utilities, with the sole function of clearing transactions and storing currency needed for liquidity, paired with ‘investment banks’ that people could put their money in, at their own risk, to search for yields.

Where would mortgages originate? Auto loans? Would this type of debt still exist?

*****

For anyone looking to add to their reading list, I would like to suggest “Sacred Economics: Money, Gift, and Society in the Age of Transition” by Charles Eisenstein. It is available online here.

The book is divided into three parts, the first of which describes our current system. I think part I is good enough to warrant a serious look at parts II and III, which describe Eisenstein’s suggestions of how to move forward to a better monetary system.

He includes in his discussion two notable concepts:

- Separation of medium of exchange from store of value (though he is not in favor of gold).

- Distinction between human-created capital (buildings etc) and natural capital (land, minerals, resources, etc).

Readers who are not into hippie-idealism might have adverse reactions to Eisenstein’s language, but as I said I think his description of our current system is good enough to warrant an open-minded reading.

Gary said...

Hello Somany,

Re: 'I have read in some of FOFOA posts showing a chart with potential of $55k real(today's) dollar price. That would imply huge inflows into gold. I have not done the math but is that even possible?'

It's more to do with the paper/electronic markets breaking down, and the money that thinks it has gold in an ETF, or a futures contract for example realising that actually they don't. The current gold price just doesn't actually reflect the price of physical gold. It represents a fractional amount of that.

Coupled with the realisation that valuations of other 'assets' such as UST's and most debt/equity are based on incorrect assumptions about the future, and the collapse of the dollar too...add it all together, and physical gold will fly to the moon, maybe higher. An instantaeous explosion in demand for physical will be met be zero supply....the maths could be very interesting.

I'm sure other posters will perhaps explain a bit better for you, along with some Fofoa links to help. Dig into the archives here, lots to read and learn, I am still doing that!

JR said...

Good stuff Gary!

Further along those lines, somanyroadsinvesting its not about "huge inflows into gold." From Today's (quote-unquote) "Gold":

Dollars bidding on MSFT stock set the value of that stock. If dollars are frantically bidding on MSFT (high velocity), the stock skyrockets. If dollars stop bidding for MSFT all at once (low velocity), the price falls to zero. This is true for everything in the world **except gold**.

Gold bids for dollars. If gold stops bidding for dollars (low gold velocity), the price (in gold) of a dollar falls to zero.

[..]

As I said (because ANOTHER taught me), "Gold bids for dollars. If gold stops bidding for dollars (low gold velocity), the price (in gold) of a dollar falls to zero." So you see, there doesn't need to be a stampede into today's "gold" for real, physical gold to become "priceless". ANOTHER wrote, "Gold! It is the only medium that currencies do not "move thru". It is the only Money that cannot be valued by currencies. It is gold that denominates currency. It is to say "gold moves thru paper currencies"."

So now I'm looking only at physical gold **IN SIZE**, the kind of size that represents entities that know WHY they are holding gold (i.e., not for paper profits). And I'm wondering when physical gold will stop moving through paper currencies, at least at parity with today's "gold", the $PoG. And I think that will probably happen when the $PoG goes too low. OBA has a neat theory about that.

[...]


So just imagine another quick run-up like July/Aug. to, say, $2,333 correlating with a big spike in the USDX/$IRX (price) and then a crash in the $PoG down to ~$1,000 or lower. How hated would today's "gold" be by the homeless savers then? That's some serious beta!

So that's why I said in the post, "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." And at the same time… because the return is surprisingly shitty all of a sudden… "physical gold **IN SIZE**, the kind of size that represents entities that know WHY they are holding gold" … "stops bidding for dollars (low gold velocity), the price (in gold) of a dollar falls to zero."

This is when the stock to flow ratio explodes to infinity and physical gold goes into hiding, when the price (the $PoG aka today's "gold") gets too low to support parity between it and "gold the wealth reserve, which means physical gold only."

[...]

The point is, there is no price discovery market for "gold the wealth reserve" that could even require an expanding pool of buyers. There's only the stock to flow ratio of physical gold (gold the wealth reserve) as a tiny component part of the wide $PoG basket, today's (bastardized) "gold", a ratio which is already very high and struggling to keep from going infinite (parabolic). [Any stock with "zero" flow has an "infinite" s/f ratio because in the function r=s/f, as f approaches zero, r approaches infinity.] A rising $PoG "stretches" the existing flow making it "larger" in currency terms and keeping it from falling to zero. But what if the $PoG suddenly dips below even the cost of mining gold? What is that cost today?


somanyroadsinvesting,

Do you see how its not about "huge inflows into gold?"

JR said...

Hippie-idealism isn't all bad

JR said...

Seriously, its okay to believe in other people. Humanity is fun. Gogogo Superorganism!

Edwardo said...

Costata,

When you ask the following:

"Is this a case of shifting the goal posts or is consensus developing?"

What exactly do you have in mind regarding goal post shifting? With respect to a consensus developing, all I can say is that I've observed a number of personages identify the middle of this decade, give or take, as being important as a time for a sea change in monetary affairs.

Desperado said...

@Costata: Calling someone who disagrees with you and tries to debate you on an economic and political issue of as much importance as the viability of the Euro a "troll" is the blog equivalent to one politician calling another a "racist" because he doesn't agree with Obama's policies. If you want to keep the tone of this blog civil and prevent thread "hijacking" the first thing you, Gary and others should do is refrain from slandering people by calling them trolls. VtC never does and he has even more of my respect for that.

Bernanke and Draghi are desperate to continue GME but they have to hide it from the markets, the politicians, the media and the sheeple. We know that Bernanke had some secret meetings with the big bank heads this week, IMO they are working on another strategy to continue GME but hide it. This is because if they don't continue purchasing the wests sovereign debt then the jig is up once interest rates start to rise, see the recent rise in PIIGS interest rates.

But I think the root of the looming crisis coming in the US will be political:

- the expiring Bush tax cuts that Obama will not be willing or able to extend untouched but that his opposition will not allow to be turned into more "fair sharing of wealth". This means that they will not be extended but there will be a nasty fight.

- the debt ceiling increase and the automatic spending cuts that will be forced by the inability of the US government to lower the deficits.

- the looming SCOTUS decision that Obamacare is unconstitutional

- the US presidential elections

And who can guess how EU politics will have heated up with French elections and continuing collapse in PIIGS sovereign debt.

These political events will all be coming to a head in Oct-Nov 2012. Throw in another Iran Nuke crisis, other problems in the ME, and the bond markets are going to have a lot to worry about. Stewart Thompson's estimates that GME will cause "GDP to grow at 3-4% for the next 6-18 months" will be irrelevant, and that 3-4% is nominal anyway.

It is this area where politics and economics fuse that the fireworks are going to occur in the second half of 2012, and likely for a lot longer. The lack of appreciation for how politics often overshadow economics in determining economic outcomes is a glaring weak point in Fofoa's posts as well as in the comments section. I guess this is why there is so much disdain for ZH here.

KJ said...

Desperado,

I believe I understand your perspective so if I may, I believe Another et al, including fofoa, view the politics and games as just a side show; a distraction in many cases to where we are inevitably going ie freehold. I for one welcome this high level approach of fofoa and the various invaluable contributors as the approach provides clarity in a cloud of confusion. Viewed differently, politics will not change the eventual outcome.

As fofoa and/or vtc pointed out one or more times, let's focus on what central bankers do vs what they say and to a lesser extent, same can be said about politicians.

jojo said...
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Gary said...

Yeah, Costata, as Despairdo says, how rude of you to ignore the fine debating skills he and his pals display, just one example of which I have copied below:

'this is something where I see FG as a big hoax. People viewing ANOTHER as the ultimate cult leader, completely ignoring and blinding out REALITY. I mean this stuff you mentioned is REAL, regardless of this "lalalala-but-another-said" stufff. In my view this leads to the worst reputation for FO(Fo(A)) possible you can think of.'

Come on Costata, admit it, there's no answer to such incisive and deep wisdom as that is there?

Despairdo, suggest you join the throng over at antifreegold, it's a buzzing cool kind of place, don't shout too loud there, there's quiet an echo.

Desperado said...

@KJ:

"the approach provides clarity in a cloud of confusion. Viewed differently, politics will not change the eventual outcome.
...
let's focus on what central bankers do vs what they say and to a lesser extent, same can be said about politicians. "


No one here at this blog really knows what the CB's have done, let alone what they are doing right now. If you want to constrain the discussion to what is "known" about what they have done, then we would have to constrain the discussion to what went on 20 years ago and earlier. Bernanke secretly pumped $17T of liquidity into the market in 2009, we only found out about it in 2011. We still have little idea what else he might have done.

If you want to know what the CB's are going to do, and you try to eliminate all political considerations, then you might as well try to model the worlds economic system based on conclusions from a simulated island where the only product is sushi. If you want to constrain yourself to what we know then we can only deal in the past.

I would bet that a lot of readers out there really want to know where the trail is leading, not where it has gone. If you don't think that the CB's play politics and are purely selfless and interested in the common good then you are extremely naive.

I really don't care if VtC and Costada want to limit their discussions to knowns about CB actions and motivations. It may be interesting, but if you want to know how and when the HI is going happen then you cannot separate the out politics simply because including it would be messy.

So here is a question to you: does Bernanke want Obama re-elected or not? If you can answer me that question then I can tall you more about what he is going to do in the next year and when the HI will come than Costata and VtC can in 10 posts.

Gary said...
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Gary said...

Despairdo, how can you see a year ahead what BB is going to do when your head is stuck where the sun doesn't shine? Just wondered?

AdvocatusDiaboli said...

Desperado,
"No one here at this blog really knows what the CB's have done, let alone what they are doing right now."

Really good point. So I personally prefer to try to take a look at the nature of some person, just to judge over him from my personal experience. I think the stomach feeling on experience is something no one should underestimate, it's an old instinct that helps you, when you are unable to judge, because you have not enough data for an rational judgement.

Getting to the point: What really scares me, is that to me CBers appear to be even much smaller shrimps than me. Not good, not at all. I mean scarry, e.g. if Hildebrandt has such a low character to do his personal carry trade with his wife just for making a few bugs, or if Ben announces that his son is proudly taking a 400K university loan. So my conclusion is: These people really believe in that crap they preach (except probably GS people). Of cause they are realizing by now that this will not end well, but now it's too late, they killed the monetary system just kicking the can. And with Weber&Stark leaving it makes much more perfect sense.

Greets, AD

burningfiat said...

Desperado,

I don't agree that FOFOA doesn't touch on the political stuff. See for instance his latest post regarding the Executive order.
I agree that this blog doesn't go into real nitty gritty details of the political stuff, but instead reduces politics to its economic net impact. Like: POTUS needs to keep on paying government empl. to avoid deflation and chaos hence the outlook for an on-going deficit, which will have to be monetized.

That approach can be used to reduce any size law to a number: Impact on (public/private) spending, hence impact on need for printing, hence impact on confidence. And for the purpose of this blog, that is actually quite useful.

Yes, politics can and do impact our lives in many other ways (war, revolt, repression especially comes to mind) than the financial side of business, but as this blog is about the broad monetary/financial outlook, I respect that these sides of things are mostly left out/reduced.
AND: If FOFOA's single prediction about a new worldwide monetary and financial system comes true, that will be the single biggest thing ever to impact our lives anyway.
Then we will perhaps be able to say that FO(FO(A)) was geniuses to outline the big picture, and reduce rather unimportant details.

/Burning

somanyroadsinvesting said...

Gary, JR,

Thx for your thoughtful responses. I think I understand the logic. However, what happens when the price discovery for physical shoots the price to the moon; won't you still need massive flows to maintain the price there at this new 'moon' price? Its one things getting a massive move on flow drying up, but eventually there needs to be some flow. Who will buy the annual mining supply etc at these 'moon' prices. Would that not still require massive inflows just to maintain the price there?

Thx

Dr. Octagon said...

Ron Paul talks about a free market price of gold. I thought this was interesting - I thought he was an advocate for the old-style gold standard with a fixed dollar-gold price, but perhaps he has changed his mind.

jojo said...
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jojo said...
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jojo said...
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AdvocatusDiaboli said...

by the way: is it possible to be neither in the deflationist, nor the inflationist camp?
Greets, AD

e_r said...

Desperado,

The lack of appreciation for how politics often overshadow economics in determining economic outcomes is a glaring weak point in Fofoa's posts as well as in the comments section.

Have you read Big Gap in Understanding Weakens Deflationist Argument or Deflation or Hyperinflation ? Seriously, each of FOFOA's blog posts are like a thesis work. It takes a significant amount of time to read, even more time to reflect.

I've said this before and I'll say it again: There is NO OTHER blog in the whole world, where the topic of Hyperinflation and its related complexities (monetary, political and the essence of human nature itself) has been explored in both breadth and depth as FOFOA has done.

I think FOFOA has mentioned once that he has confined this blog to only two main topics (Freegold and HI) and to the extent that these two topics are connected to the political dynamic - I'd say those dynamics have been explored and well written.

What I think this comments section hopefully wouldn't become is to be something like ZH, where there is lack of intelligence and just a bunch of 'Bitchez' type comments.;)

Victory said...

et al,

Who are the creditor banks in the statement below commercial banks or central banks?

'During this period the banks of issue of the creditor countries, while creating, as a counterpart to the dollars they acquired through the settlement of the American deficits, the national currency they remitted to the holders of claims on the United States, had reinvested about two-thirds of these same dollars in the American market. In doing so between 1951 and 1961 the banks of issue had increased by about $13 billion their foreign holdings in dollars.'

tx,

V

Winters said...

Bravo FOFOA. Another awesome post. I've read it once, skimmed it again a second time and think I will need to read it again slowly to fully comprehend and savor it.

and now generally to the board:

One take away I had from this is that the erosion of the US gold stockpile was inevitable. I previously thought/read that it was the profligrate printing for the Vietnam war that triggered France to run the gold window - but with the US needing to print up enough USD paper to keep world trade lubricated, they were required to print tickets to their gold (admittedly they would have spent these into the world) but with the money multiplier of fractional reserve, dollars could saved and then lent (expanded) in exile and then used to make a claim on the US stockpile of gold.
So even if the US was reasonably austere in their money printing, the closure of the gold window was an inevitible outcome of becoming the world reserve.
Is this right or am I talking nonsense?

I also find it curious that world reserve currency was thrust upon the US without their involvment at the 1922 meeting. "So US - we all took a vote and decided you could be world reserve"
"oh, ok. um thanks for letting me know!"

jojo said...
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costata said...

JR et al,

I thought this transcript from an interview by Max Keiser might be of interest. This is Professor Michael Hudson speaking about the period after Nixon closed the gold window:

I wrote about this in my book Super Imperialism …. I wrote it in 1972 right after America went off gold. The plan then was to make foreign Central Banks finance America’s military war spending. The largest purchasers of the books were the State Department, the Pentagon and the CIA and the CIA gave me a contract to explain what it was doing and they said ‘My God, by accident we’ve pulled the biggest rip-off in human history. This is great.”

LOL and here's me thinking Dr. Evil was hard at work.

Jeff said...

Winters, as long as you solve FOFOA's dilemma (which also solves Triffin's dilemma), you will have a world reserve that doesn't suffer from a run on gold. The problem is dollar management, not having a world reserve. JR posted many relevant quotes in comments to Yo Warren, and here is one more.

FOA: Because the ECB has no pressing need to keep gold prices in place, gold could initially run in Euros also. Still, eventually Euro gold prices will not be anywhere close to dollar gold prices as international dollar reserves are liquidated. In effect, the disgorging of dollar reserves will show no negative accounting on ECB books as gold prices more than make up for dollar reserve destruction. In fact, once the Euro becomes the world reserve, there will be no reason to hold dollars at all.

In fits and starts, oil prices will keep rising based on an expected reserve currency transition, not dollar oil use economics. Any substitution of alternate oil resources in the US will run head long into a local cost inflation roadblock. $200 dollar crude will not be seen as enough to drill for reserves nor switch to other fuels.

The Euro will keep taking market use share from the dollar, especially if major US players continue to trade the Euro down to parity. Eventually (and presently as this is happening now), dollar reserves held outside the US will be forced into shorter and shorter maturities as the "return on" these holdings becomes more important than their "use as trading currency".

Aristotle said...

To Victory -- 4:34 PM

The answer you seek:

The Central Banks are being cited there.

Short and sweet.

--- Ari

costata said...

AD,

Here's a reality check for you: The banks didnt issue 95%, no they issued 98% of the money. But since 18th January they are now allowed to issue 99% of the money. I wonder when they will step to 99,5% and 99,9% and 100% in the end.

Here's a reality check for you. You may have read comments where I refer to the bank issued segment of the monetary pool as "bank credit money". I don't know if the Bundesbank invented that phrase but it was a discussion paper issued by the Bundesbank where I first saw the term a few years ago.

In that paper they acknowledged that 95 per cent of the money supply is/was created by banks under both the Euro and the Deutschmark. I don't think it matters whether the percentage is 95 or 99. The important issue is that banks create the bulk of the money supply.

There is no magical property in a base currency which makes it inherently good or bad. I would go further and say that it doesn't matter who produces the currency, who issues it or whose picture appears on the face of the currency.

What matters is how much currency is issued, how the currency and monetary system are managed and the level of trust and confidence in a currency of those who use it. Over the past 100 years the solution adopted by people burdened by a soft currency has been to adopt a dual fiat currency system.

FOFOA has discussed the key conflict in the money system many times in these pages. When you use the fiat currency as both a store of value and medium of exchange you place the easy money camp and the hard money camp on a collision course. The Euro architecture deals with this problem by separating those roles between gold and fiat currency respectively.

The conflict between the interests of politicians (the inflators) and the custodian of the currency is resolved by severing the currency's ties to the nation state and to gold. The method employed to achieve this in the EU was to create the ECB Eurosystem which in turn was modelled on the Bundesbank - an independent currency issuer and manager.

In order for the ECB to manage the Euro effectively it needed the EBA to excercise regulatory powers over the European banks because they issue the bulk of the money supply.

If the ECB Eurosystem mismanages the Euro so badly that there is a catastrophic loss of confidence in the Euro then the Euro will fail. In my opinion the key difference between the ECB and the Fed/USG is in their incentives. The ECB has nothing to gain and everything to lose by the failure of the Euro.

The Fed/USG has the opposite set of incentives. As Conally said: "It's our dollar but it's your problem". The tables are now turned. Sadly for the Americans "It's your dollar and it's your problem". I'm sure JR will be happy to provide a few links to posts explaining the solution to their dollar problem.

That quote from Michael Hudson contains a hint:

‘My God, by accident we’ve pulled the biggest rip-off in human history.

I think we will come to view the episode Hudson was discussing as the "second biggest rip off in human history" of dollar holders. Prudence dictates that we get out of harms way and regardless of what FOFOA and I may disgree about we are in full agreement on this issue.

Cheers

costata said...

Edwardo,

Some commentators who have been expecting this system to break down for years have predicted the timing and been proved wrong. They could be accused of "shifting the goal posts" in suggesting new targets in future years.

What's more interesting to me is that people who expected this process to reach its climax much later (such as John Williams of Shadowstats) are now expecting resolution in this 2013 to 2015 period. And people who have never made a prediction about timing seem to be getting bolder.

I don't recall if I ever made a statement about when I think the $IMFS will blow up. For me the anticipated loss from moving into gold too late was so great that I didn't feel the need to worry if I was too early and was leaving some money on the table elsewhere.

I do feel that the situation is getting out of control. I think using SWIFT as a weapon was a huge mistake. I also interpret that executive order in the same way that FOFOA and others here read it. It looks like a measure one would put in place to deal with HI.

costata said...

Winters,

So even if the US was reasonably austere in their money printing, the closure of the gold window was an inevitible outcome of becoming the world reserve.

Or they could have allowed gold a clean float. Big mistake IMHO but consistent with the thinking of the time. So the outcome was inevitable unless one believes that any country can run deficits endlessly while refusing to allow foreign investment on a scale that would balance the trade deficit.

That's merely a theory of course. The jury is still out on whether foreign direct investment can balance a trade deficit. It may simply be a double entry accounting identity with no real meaning outside the monetary plane.

victorthecleaner said...

Phat Expat,

the 'London Trader' is outright fraud - not worth any further commenting.

costata,

the ECB's primary mandate is price stability, and they explicitly say they mean inflation below, but close to, 2% annually. Now the obvious question is how this would look like through the transition and after the transition.

Should there be a risk of bank failures and a chain reaction, they can always print money in order to prevent this. Should they fear price deflation, they can do the same. Apart from this, the commercial banking system is in deleveraging mode and, in my opinion, will be for several further years, simply because all the bad speculation has to be cleared out of the system.

So the ECB has a huge space in which to operate. Just by regularly printing some money and otherwise letting the deleveraging run it course, I think, they can remain in control. The most difficult problem for them will probably be to make sure that there are enough loans to businesses available - but this is a side-effect of the low interest rates.

So they should try to raise interest rates as soon as this can be done without blowing other things off. The huge difference between the ECB and the Fed, BoE, BoJ is that the ECB lets the interest rates on government debt rise. Did you see that when the commercial banks repo bonds with the ECB as part of their LTRO, that the ECB applies a 'haircut' depending on the risk of the bond and requires a cash margin should the bond value go down?

The ECB can now squeeze the banking system whenever they want. The ECB could, for example, sell some of their Italian bonds into the market and let the yield of these bonds rise. As a consequence, they could request a cash margin payment from all banks that have repo'd Italian bonds as part of the LTRO. To me this looks as if it was done intentionally.

In this light, one can perhaps even understand Trichet's SMP (direct purchase of government bonds). The point was not to keep interest rates low (in the same way as the Fed or the BoE do), and indeed it did not happen, but rather to have something to sell !!

Finally, in order to maintain their 2% annual inflation, in my view, they will eventually need to control the credit volume.

But why cannot they switch from an interest target to a credit volume target? I also think that post-transition, the market interest rates would be substantially higher which should already remove much of the speculation from the banking system.

What is missing is to acknowledge the gross exposure of all OTC contracts as risky and to require capital set aside. That's missing and I wonder when and how this one will be resolved. Well, the next phase of the crisis is due soon.

Concerning Stewart Thomson, I largely disagree. I usually refrain from trying to make short-term predictions about the economy (simply because this cannot be done), but if you asked me, I'd expect the US economy to do down the next cliff by mid-year.

AD,

Ben announces that his son is proudly taking a 400K university loan

Did he really do this? Cool. By the way, student loans in the U.S. are (one of the) next subprime crises. The volume is now over $1000bn. I would have never dreamt this. How silly... If you want to compare the student debt with mortgages, then we must now be somewhere in 2006, i.e. perhaps one year left and then the first securitized loans blow up.

Victor

victorthecleaner said...

Costata,

I didn't know the book by Hudson, but what he says seems to contradict Another. Another said the U.S. wanted to raise the oil price in order to be less dependent on middle eastern oil, and therefore terminated gold convertibility.

Consensus among Western CBs at that time was that the official gold price should have been raised, perhaps a lot, but that Bretton-Woods should have continued to operate. The U.S. acted unilaterally against this consensus. But not by accident ???

Victor

costata said...

somanyroadsinvesting,

The market maker (CB most likely) in gold and a local currency won't have to buy or sell a large quantity of their gold to discover the price that the private holders will accept to mobilize their holdings.

If gold is flowing out of the CB then the price is too low. If gold is flowing into the CB then the price is too high. All they have to do is keep their sell price slightly too high and their buy price slightly too low. As market maker they provide the liquidity backstop to the local private gold:currency market.

On the other hand if the currency issuer wants to affect the exchange value of their currency through the money supply as a matter of policy then gold would be one tool they could use to do this ie. by draining currency from circulation or increasing the amount of currency in circulation.

But IMHO they had better have collars on those bank credit money issuing puppies if they hope to succeed in managing their currency in this way.

We have a field experiment, called China, in progress that may give us some valuable data on whether the traditional checks and balances in a CB/FR banking system will give the authorities the control they seek and also, perhaps, whether they should seek to excercise control in the first place.

The MMT crowd might want to take a close look at China's banking system as well. If your banks are state owned and controlled how is that different to the greenbacker prescription for monetary nirvana? They're paying any profits they make to themselves after all.

According to our old pal Cullen Roche implementing the MMT recommendations requires "good governance". If you don't have to play the populist with the electorate I guess you can "governance" as good as you like. So the China field experiment should be just the ticket.

costata said...

VTC,

I don't think that Hudson had the oil part of the story so I don't see any contradiction with Another's explanation. And the reason may have been irrelevant from Hudson's perspective. He was hired to explain the implications of what they did (closing the gold window) to various government departments not why they did it.

There may have been no incentive to look beyond the official story. From various pieces I have read it appears that a lot of the blame was put on Charles De Gaulle for demanding gold.

costata said...

VTC,

Interesting analysis of the levers at the ECB's disposal and how they may be using them.

I think there's a crucial difference between a mandate for "monetary stability" and "price stability". Having a specific inflation target argues that stable prices isn't their aim if you expect inflation to be reflected in prices.

Productivity gains of 2 per cent per annum appear to be quite feasible so they might achieve overall price stability as well if the productivity gains aren't siphoned from the majority to the minority as they have been elsewhere.

In regard to this issue of deleveraging. As you point out reducing the bank credit money component of the pool creates room for an increase in the supply of Euro provided the two components of the pool remain fungible. This need to maintain fungibility could explain why the ECB stepped up to the plate with such alacrity when the inter-bank market froze.

The tricky part (which I am still trying to wrap my head around) is how the deposits in the banking system which are no longer backed with performing loans can be stripped out.

Perhaps one of the reasons that the ECB/EBA accepted such a broad range of collateral from the European banks was so they could have a long hard look at all of the collateral the banks delivered. If true, this would amuse me greatly. The ECB has sneaked a peek under all of their kilts.

Continuing with my musing for a moment longer. It wouldn't surprise me if they are drawing up a list of which banks will be put under to purge the system of the unbacked deposits through "mergers" of the shotgun wedding variety.

Arguing against this notion, I read a piece that claimed the principal difference between the US banks and the European banks was that the US banks are less dependent on the wholesale market for funds (relying more on deposits). The report claimed that European banks rely on the wholesale market for 80 per cent of their funding.

I'm still in two minds (shades of our friend Charles Hugh Smith) as to whether this is an advantage or a disadvantage for the Europeans. If deposits are a low proportion of bank funding in Europe then orphan deposits may not be such a problem. Likewise is a high level of deposits an advantage for the US banks? These are liabilities on their balance sheets after all.

I have an idea how we might be able to find out. We could look for an anomaly, say, among the Irish banks compared to the banks on the continent. Could the Irish banks have been more reliant on deposits? I have often wondered why the ECB funnelled so much cash (50 billion or so I heard) into Ireland when bank deposits were migrating to mattresses in volume during the height of the (ongoing) GFC.

Perhaps they were punting on this cash being hoarded rather than spent. Or perhaps they could see where it was migrating to through the Target 2 system. But then again I'm making the bold assumption that Euro notes all have serial numbers and they can be tracked. Has optical character recognition technology found its way to Europe yet?

Cheers

Wendy said...

vive las vegas mes amis :D

costata said...

Hi Wendy,

Have a great time.

costata said...

A snippet from Doug Noland's Prudent Bear letter:

April 2 – Wall Street Journal (David Enrich and Sara Schaefer Munoz): “Even as the European banking crisis shows signs of easing, lenders across the Continent are engaging in a variety of maneuvers to avoid, or at least delay, coming to terms with potential problems lurking on their books.

Some banks are concocting unorthodox structures designed to improve all-important capital ratios, without raising new capital or moving unwanted assets off their balance sheets. Others are engaging in complex transactions with struggling customers to help temporarily avoid loan defaults…

Banks now have greater flexibility to pursue such tactics because of the roughly €1 trillion ($1.33 trillion) of cheap three-year loans that the European Central Bank recently handed out to at least 800 lenders.”


http://boards.prudentbear.com/index.php/creditbubblebulletinview?art_id=10650

Is the LTRO program a one off? Perhaps the banks have been given until the end of 2014 to sort themselves out.

BTW VTC I don't see the wheels falling off this year. Though all bets are off after the Presidential election.

AdvocatusDiaboli said...

costata,
"I don't think it matters whether the percentage is 95 or 99."

I perfectly agree with you on this one. Except: It is the tremendous change 2->1 of rules in the middle of the game, what is so significant for me.
Greets, AD

costata said...

AD,

Now you need to explain why you think this is so important.

Cheers

costata said...

Ouch!!!

Gold imports to India, the world's top importer crumbled more than 55% in March....

....Imports of the precious metal shrank to 90 tonnes in the January-March 2012 period, as against 283 tonnes in the corresponding quarter of last year.


http://www.mineweb.co.za/mineweb/view/mineweb/en/page32?oid=148725&sn=Detail&pid=102055

We should ask Bron to commment on whether they have been selling into the LBMA.

AdvocatusDiaboli said...

costata,
For me is intersting, that there was no really official reasoning for doing so. You dont do something so essential just for the fun of it, do you?
So I can only guess. Maybe the ECB is sick of receiving toilett paper, saying "keep the toilett paper, here's the license to print up whatever you want, the end is near anyway"?
Greets, AD

costata said...

Mega Ouch!!!

From the same article I linked above:

Silver imports too were substantially down in March at an estimated 20 tonnes. Import of silver during the same three-month period last year is estimated at 300-400 tonnes. In 2011, almost 4,874 tonnes of silver were imported into the country.

I wasn't going to post a link to the following article because I read it as too biased but it may not be as unfair as I first thought in light of the news out of India.

He added, "At the same time, silver turnover on the Shanghai Gold Exchange is relatively low compared to where it was last year......

"One of the drivers last year was private investor buying of silver in China," Citigroup analyst David Wilson said. "Once they got their fingers burnt, they haven't been back."

On the supply side, miners are expected to have produced another record amount of silver in 2011, with metals consultancy GFMS forecasting a 31 million ounce rise in output last year.


Photography off-take, which accounted for 213.1 million ounces of annual demand in 2001, slumped to 72.7 million ounces by 2010.

http://www.cnbc.com/id/46964557

costata said...

AD,

Okay, but the banks can only "print" by lending the money into existence. If their loan books are static or shrinking then this could simply be an attempt to fatten their margins in order to help them trade out of their problems.

Requiring the banks to post collateral (with haircuts on the value assigned to it) leaves any solvency issues with those banks not the CBs. I think these initiatives give the ECB Eurosystem more control over the money supply not less.

BTW Ambrose Evans Pritchard is singing from your hymn book in relation to the Euro but he seems to singularly unimpressed with Germany's leaders.

http://blogs.telegraph.co.uk/finance/ambroseevans-pritchard/100016038/german-ideology-emu-and-the-wolfson-break-up-prize/

AdvocatusDiaboli said...

costata,
"I think these initiatives give the ECB Eurosystem more control over the money supply not less."
Sorry, but I absolutely dont get it, how lowering the reserve requirements gives more control to the ECB. I just try to figures out how it would be to chancel the requirements at all to zero, probably together with giving banking licencees away for free to everybody on the street. You're telling me that this gives even more control to the ECB?
Can you explain?
Greets, AD

AdvocatusDiaboli said...

costata,
thanks for the CNBC silver bashing link. Tell's me to buy more silver (after CNBC stated "BUY GOLD").
Isnt it amazing? Although the gigantic silver price rise during the last five years, mining industry only managed to increase output by 5%? Are there any silver mining companies that make huge profits?
Sure, with silver I will not get that "illusionary FG rocket" - okay with me, but also it's good to hold something not object for manipulation interest.
Greets, AD

Gary said...

http://www.zerohedge.com/news/its-latest-nonfarm-payroll-mea-culpa-goldman-stumbles-answer-and-changes-rules-game

Goldman suggesting they have discovered that it is the continuing flow of UST purchases, rather than the stock, that affects the yields. Could be an example of a pig at a trough trying to put pressure on the pig-farmer to feed him more and more slop so he'll deliver more bacon? In both cases, a fair analogy, as in the real live pig case, the flow is vitally important of course, and from Goldman's perspective, they're buggered if the flow stops too.

Anyhow, I'm sure the effectiveness of each and every QE exercise by the Fed on risk assets is a diminishing return, until eventually it gets to a zero impact, and then finally a negative impact, then game over.

Phat Expat said...

@VtC
Re: London Trader
I will leave it at that.

@AD
No kidding; why not include the interview by Blythe Masters as evidence that JPM really isn't that bad after all. Sheesh...

tintin said...

I'd like to highlight the latest evidence that HI might be starting soon: from zerohedge taking notice of GoldmanSach's comment (quote):

...we have found some evidence that at the very long end of the yield curve, where Operation Twist is concentrated, it may be not just the stock of securities held by the Fed but also the ongoing flow of purchases that matters for yield
...
it is flow not stock that matters.
...
Translated simply, it means that it is irrelevant if the Fed's balance sheet is $1 million, $1 trillion or $1,000 quadrillion. A primacy of flow over stock means that UNLESS THE FED IS ACTIVELY ENGAGING IN MONETIZATION AT EVERY GIVEN MOMENT, THE IMPACT FROM EASING DIMINISHES PROGRESSIVELY, ULTIMATELY APPROACHING ZERO AND SUBSEQUENTLY BECOMING NEGATIVE!
(end of quote)
full piece here: http://www.zerohedge.com/news/its-latest-nonfarm-payroll-mea-culpa-goldman-stumbles-answer-and-changes-rules-game

AdvocatusDiaboli said...

PE,
how do you define "bad"? IMHO, You are only a Muppet, if you wanna be a Muppet.
Greets, AD

Gary said...

We're a lucky blog, we now have our own resident muppet expert eh?

Of interest to historians only, maybe our gracious host, a research paper on the Bellagio group, forerunner to the G30, and some well-known PGAs on the table:

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1951505

Edwardo said...

Thanks for the clarification, Costata. FWIW, I think, with respect to the looming new monetary world order, the proverbial event horizon is coming into view, ergo the apparent boldness of certain commentators/observers. In the meantime, around these parts, there is a consensus that the the EO from BO is a provision primarily devised to cope with the effects of HI.

Phat Expat said...

@AD
Yeah, maybe a Muppet, but not a Damn Muppet...
Gel, scheisse wenn man doof ist? Oh, did I mention I lived in good ole Deutschland for 12 years? Yeah, what an experience that was. ;-) Gruesse aus China...

Pardon the interruption and please continue with the regularly scheduled FG channel...

JR said...

FWIW if you take an econ 101 class (micro), you do the basic price formation supply and demand stuff and LDO of course they teach pricing happens at the margin. This is such wortheless crap:

Goldman suggesting they have discovered that it is the continuing flow of UST purchases, rather than the stock, that affects the yields.

The ZH is incredibly arrogant and pedantic, but this crap takes the cake - are they gonna start posting articles telling us we will die if we don't have oxygen yet? I know Goldman is supposed to do this, people pay Goldman lotsa money to have Goldman make them feel like they are dumb and Goldman is smart, but I thought ZH was suppose to be against the banker culture - not a carbon copy of their MO.

JR said...

Hi Somanyroadsinvesting,

You say:

However, what happens when the price discovery for physical shoots the price to the moon; won't you still need massive flows to maintain the price there at this new 'moon' price? Its one things getting a massive move on flow drying up, but eventually there needs to be some flow. Who will buy the annual mining supply etc at these 'moon' prices. Would that not still require massive inflows just to maintain the price there?

This is a big idea, but the dollar doesn't price gold. OK? Gold *PRICES* the dollar. You are asking abut the flow of dollars into gold, but what is relevant is the flow of gold into dollars.

This is what Another taught us, and is perhaps his greatest insight - from Today's (quote-unquote) "Gold":

"Gold bids for dollars. If gold stops bidding for dollars (low gold velocity), the price (in gold) of a dollar falls to zero." So you see, there doesn't need to be a stampede into today's "gold" for real, physical gold to become "priceless". ANOTHER wrote, "Gold! It is the only medium that currencies do not "move thru". It is the only Money that cannot be valued by currencies. It is gold that denominates currency. It is to say "gold moves thru paper currencies"."

So now I'm looking only at physical gold **IN SIZE**, the kind of size that represents entities that know WHY they are holding gold (i.e., not for paper profits). And I'm wondering when physical gold will stop moving through paper currencies, at least at parity with today's "gold", the $PoG.


This is not about dollars buying up gold - its about a loss in confidence in the dollar that leads to gold not wanting dollars.

Red Alert: Gold Backwardation!!!

Date: Fri Jan 23 1998 19:01
ANOTHER (THOUGHTS!) ID#60253:

All modern digital currencies do not go into an investment, they move THRU it... There is an alternative. Gold! It is the only medium that currencies do not "move thru". It is the only Money that cannot be valued by currencies. It is gold that denominates currency. It is to say "gold moves thru paper currencies".

This is the key to EVERYTHING!!! It is not "gold liquidity" that the bullion banks create... it is DOLLAR LIQUIDITY. Dollars bidding on MSFT stock set the value of that stock. If dollars are frantically bidding on MSFT (high velocity), the stock skyrockets. If dollars stop bidding for MSFT all at once (low velocity), the price falls to zero. This is true for everything in the world except gold.

Gold bids for dollars. If gold stops bidding for dollars (low gold velocity), the price (in gold) of a dollar falls to zero. This is backwardation!

Aquilus said...

Just a few observations on my understanding of the Fed flow/stock in Treasuries:

In my opinion, this is the monetary plane that the Fed can control at will. In this plane, flow will be provided because that's what they do, that's what they focus on. There will never be a question that Treasuries will go no bid, nor will HI originate in the Treasuries market.

Remember that the HI risk is in the physical plane, where those USD flows meet the real world and determine prices at the margin.

One way through which the Fed's monetary plane actions spill over and affect the physical plane is by affecting confidence.

It will be the decision of USD holders as confidence wanes to recycle more of them into the physical plane instead of the monetary plane, that gets HI started, with that action driving the prices of necessities up.

Oh, and don't think that when that happens, Treasuries will suffer, they won't. That balloon will be re-filled at the source by the Fed's buying.

On the other hand, with all those non-recycled USDs bidding real-wold prices (no need to print more that what's out there now), real prices go up, and budgets must be adjusted to provide more USD for the same units as before.

OK, but why won't demand for real things slow down when more USDs are needed? Well, they will from the US private sector, because they need to earn the USDs. But USGov will still bid since they don't look at prices, they are a self-funding bureaucracy, and bureaucracies are only concerned what they already established they "need", not what they can afford. Questioning affordability is for the aftermath.

OK, so the US private sector still bids for goods (but slower demand as they need to earn dollars), USGov increases budgets and spending to make up for price increases, Fed monetizes that, USDs outside US borders bid for the same items and as prices in USD go up (and leave even less of their USDs left to recycle into debt which increases reliance on Fed's base money)

Visualize that spiral to its bitter end, and IMO you see the HI process at work.

JMan1959 said...

Here's is what I don't get: Bernanke talks of future QE as if it is optional. But is it really? Someone please enlighten me as to who is going to pick up the slack on the long bond buying if/when the Fed ends their QE/Twist spree? It looks to me like it would take much higher interest rates to attract enough volume to replace their program, which would blow up the bond market and the Fed/USG balance sheets.

Aquilus said...

JMan1959,

Remember one thing in this monetary plane: it can be shifted and adjusted easily.

The Treasury, Fed and primary dealers are all part of the same larger group whose interest it is to maintain stability in the monetary plane.

So let's play the game that for political reasons the Fed cannot increase its balance sheet outright for a while. There are other ways to game it. Some examples would be

1. changing the maturity structure of the Treasury's issuance from long to short time frames (where the demand for storing cash currently is)

2. Change reserve requirements/incentives for primary dealers to create more credit money to acquire the debt (with assurances on worst case scenario from Fed)

3. Use inter-CB swap lines to fund cross sovereign debt purchases (Fed/BoJ for example where Fed provides unlimited swap line to Boj and Boj uses it directly or through affiliated banks to buy treasuries, and Fed does the same for BoJ)

4. The Treasury does not issue long term notes and thus does not reduce the quantity of base money out there, and speeds up USD depreciation.

There are many other ways - this is the monetary plane and accounting trick abound. It's really how they influence the physical plane that matters in the end.

e_r said...

Aquilus,

Excellent thoughts regarding the flow of Treasuries and manifestation of HI.

This is why FOFOA has been stating in the past few blogs about the trade deficit, which we need to keep a keen eye on.

Bernanke is well aware of these tail risks, which is why he keeps harping on fiscal policy makers to get things in order to ensure overall sustenance of the Status Quo. It is the fiscal policy that is going to have a significant impact on the physical plane.

The CBs and the primary dealers have a lot of tricks up their sleeve to "manage" the Treasury market, that is never an issue.

Which is why Ray Dalio stated in a recent interview: It is a test of us, test of us as a society .

http://www.youtube.com/watch?v=Ve2_5F_e8IY

There are many intelligent analysts who think that US can get its house in order, but the current and future liabilities of the USG combined with the complete lack of political will to recognize the predicament, portends quite the opposite.

Aquilus said...

E_r

You can stop any and all US deficits today - it does not matter any more - it's too late. Like I said a few days back in my Twitter marathon (no original thoughts, just regurgitating FO/FO/A and Mises): debt cannot be paid back at these levels of currency valuation even if you re-institute slavery and send all debtors to Ben-Hur like galleys.

The political front is now just a Kabuki show, the only real impact is in the direction of forceful constraints applied to citizens between now and that day when transition happens.

In the US it is irrelevant who the next president will be, or even if they bring the tax rate to 100% - it is a pimple on the elephant's ass compared to the volume of debt + guarantees to print when needed.

Watch credibility, watch credit ebs and flows, and watch flows from money into physical plane - don't gamble on timing.

JR said...

Deflation is the mechanism for paying all the debt back in real terms. This simply cannot happen. Those debts are now so big they can never be paid, and never will be. Once you accept this simple truth, and all of its necessary effects, it becomes clear that we are focusing on the wrong things.


Credibility Inflation

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

Today's debt (the bond market) is imaginary capital in that it cannot perform in real terms; with "real terms" defined as economic goods and services (under current economic conditions) plus gold—and this part is important—at today's prices. It is all nominal debt, but the price of goods and services—as well as the price of gold—is what connects it to reality. And at today's prices of each, bonds are imaginary capital.

Once Upon a Time

JR said...

"My friend, debt is the very essence of fiat. As debt defaults, fiat is destroyed."

What is the problem with Greece and the other so-called PIIGS? Is it profligate public spending/financing, the credit that enabled it, the system that helped hide it, and the mountain of unserviceable debt that resulted?

The difference between the $IMFS and Freegold is that the former encourages and enables the above while the latter never lets it get this far along so as to become a systemic risk. It's called 'balance as you go', as opposed to enabling the growth of an imbalance so large that it finally collapses back into balance.

I cannot give you the blow by blow that you ask for, but I can still show you what must happen. And it is helpful in this regard to work backward from the future until we come to two choices that will both result in the same end.

First is that we are facing a systemic shift from the $IMFS to Freegold. Don't forget that the actual value of an individual transactional currency unit (even a euro) doesn't really matter in the context of its primary function. So even though one currency is built for the new, emergent system, I would still not want to be holding that currency through the transition.

Second is that Greece's debt cannot be paid back in real terms, and neither can the aggregate planetary debt. It doesn't really matter if it is not paid back through default (bankruptcy) or through devaluation of the currency... it will not be paid back in real terms. But devaluation of the currency is certainly the more politically acceptable route.

Third is that all this planetary debt (including Greece's) is a function of the $IMFS. The eurosystem, even though it was built to thrive under Freegold, is still supporting the $IMFS. The action to look for is the passive action of withdrawal of support.

The way the $IMFS works is that, at the very end, it either bails you out or kills you dead, depending on who your friends are. Freegold spanks you along the way with a little pain here and there until you get your finances back in order.


"The Gold Man" (not Goldman) at the BIS

Gary said...

JR, I think it is all part of the game with Goldman putting its view out into the market, massaging public opinion, giving sly little hints to the Fed. Perhaps Goldman think they're being clever, but in reality they just open a little chink in the ponzi's armour.

ZH took it all a little literally I thought. But, I do think think the 'risk on' benefits of QE that the markets love so much is diminishing, and Aquilus hit the nail on the head in that it is all about confidence.

My view is that the day the market collectively realises that QE doesn't help anyone, and falls as another round is announced, is the first day of the collapse of it all. Once the world realises that the Fed/US Govt has no bullets left to use, it will all be over within weeks.

I wouldn't like to guess at the precise process, but I can see a mass exodus away from USTs, shares, and all the crappy forms of debt. Aquilus says it will go into the real world, but perhaps it will go to bank accounts and T-bills first, then to actual cash, then to the physical goods last.

JR said...

Re: Banks and public utility discussion,

My observation is that banking will be forced to evolve into a mere utility thanks to the collapse of the dollar. See my Say Goodbye to Wallstreet post. This is not so dissimilar to Bill Still's prescription for publicly-owned banks. In fact, it matters not if a bank is publicly owned or privately owned once the savers have a viable alternative to fiat-denominated savings. The final result will be virtually the same.
comment to Credibility Inflation

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

Say Goodbye to Wall Street


Which Came First, the Chicken or the Egg?

Which came first? The greed of the banksters to make usurious loans to the people? Or the demand of the people to borrow frivolous capital for whatever economic activity they chose without sharing profits?

Adam Smith (1723-1790) taught us that economies emerge as bottom-up spontaneous self-organized order that naturally arises from social interactions, not from top-down bureaucratic design. This is also true of banks.

Banks emerge in economies because man has the innate desire for a credit-based system in which he can engage his own economic folly at someone else's risk. Given pure equity, the individual man will not lend, but still demands to borrow. And as a society, we (rightly or wrongly) end up demanding that the risk of loss is spread far and wide. We say, "don't mind borrowing it, but damned if I'm gonna lose it!" (See: FDIC)

And with the recent bailout of the banks, it is repelling to think that we are responsible. It is true. We are all, as a society, responsible for the actions taken. It was a foregone conclusion a long time ago. That if losses ever loomed large enough to bring down the system, society at large would end up covering the losses. This is the very nature of the system we have built as a society. A system that sprung up from man's desire to borrow, not from man's desire to lend or steal. That came later.

[...]

You see, the Siamese twins, credit and equity, have finally been separated. Gold has been demonetized! It is now a world class wealth asset. A tradable wealth asset. A portable wealth asset. A durable wealth asset. Money, which has been deemed by society to be fiat currency only, no longer needs to carry the heavy burden of ALSO being a store of value. No longer must we raise entire industries that suck in generations of our best and brightest talent for the sole purpose of designing paper wealth derivative products in a vain attempt to make money be a store of value. No longer. Say goodbye to Wall Street.

AdvocatusDiaboli said...

Aquilus,
"debt cannot be paid back"
Oh really? Comme on, does any body was so naive to ever thought that at any time debt was meant to be paid back, no matter if $ or euro or whatever? That is the essance of fiat money not to pay back, why else have it?
FOFOA calls that "lubrication", from my personal view I call it fraud, if somebody is told that it was ever to be intended to be paid back. It was never intended, the only value given to fiat, are the naive entities that try to repay it instead of revaluing their balance sheet assets. PERIOD.
What makes me sometimes angry about the FG camp, is that IMHO "they" are even appear some kind of proud on this feature of credit money.
http://fofoa.blogspot.de/2011/07/does-fiat-produce-endless-sea-of-wars.html
See, personally my character is in the ultra hard money camp (none fiat, debt for lifetime working it of in slavery), but I dont mind if things are run the easy money camp way, but just be so realistic to notice what it really is.
Greets, AD

BlackSea said...
This comment has been removed by the author.
Aquilus said...

Gary,

Path of flow from monetary to physical is irrelevant really.

Yes, historically, if you look at other countries' HI, you do get a bout of currency appreciation/deflation before HI (see Argentina) but don't take your eyes off the ball, these are little tangents important for traders only.

The point is, if you keep dollars, unless you trade in and out, your purchasing power will be annihilated.

The only destination for monetary plane is the physical plane, not bank accounts, not cash equivalents other than as pass-throughs.

Gary said...

I think the relevance of the path from monetary to physical is because so many people want to have an idea of what signs to look for, and it will start in the monetary plane. And the flows into bills and bank accounts will show up somewhere and be reported no doubt, as further evidence that it is starting.

I may of course be wrong, but if I see QE announced and markets fall, I'll be out immediately stocking up on foods to go with my hoard of tinned stuff.

Aquilus said...

AD,

Your school's principal called and asked you to do your homework instead of wasting your time trolling sites, take things out of context, and write nonsense on both sides of every argument with fake knowledge. He said your grades are suffering. Wirklich!

Done with your style of BS, greets,
Aquilus

Aquilus said...

Gary,

Ok, yes, I see your point from that perspective.

JR said...

I wouldn't like to guess at the precise process, but I can see a mass exodus away from USTs, shares, and all the crappy forms of debt. Aquilus says it will go into the real world, but perhaps it will go to bank accounts and T-bills first, then to actual cash, then to the physical goods last.

Yo Warren B, you are so OG!

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.

JR said...

comment to Yo Warren B, you are so OG!

Look at Buffet's piece above. He's shunning bonds but keeping his cash in bills. That's what the savers are doing while they decide where to deploy that cash. All the financial advisors across the land are advising savers to hold some cash, because they just know there will be some deals soon. And for the really big money, that means T-bills, just like the $20B Berkshire is holding. And when a trade gets that crowded it chases the yield right away, which is why the T-bills are heading to sub-zero yields.

Look at Buffet's piece above. He's shunning bonds but keeping his cash in bills. That's what the savers are doing while they decide where to deploy that cash. All the financial advisors across the land are advising savers to hold some cash, because they just know there will be some deals soon. And for the really big money, that means T-bills, just like the $20B Berkshire is holding. And when a trade gets that crowded it chases the yield right away, which is why the T-bills are heading to sub-zero yields.

This is the rush out of future-dated debt into Here&Now cash (T-bills for the really big $$$). It's the bank run shoebox under-mattress effect en masse. This makes the dollar look (temporarily) strong and today's "gold" (the $PoG) look weak by comparison, gold bug protestations notwithstanding. So just imagine another quick run-up like July/Aug. to, say, $2,333 correlating with a big spike in the USDX/$IRX (price) and then a crash in the $PoG down to ~$1,000 or lower. How hated would today's "gold" be by the homeless savers then? That's some serious beta!

So that's why I said in the post, "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." And at the same time… because the return is surprisingly shitty all of a sudden… "physical gold **IN SIZE**, the kind of size that represents entities that know WHY they are holding gold" … "stops bidding for dollars (low gold velocity), the price (in gold) of a dollar falls to zero."

This is when the stock to flow ratio explodes to infinity and physical gold goes into hiding, when the price (the $PoG aka today's "gold") gets too low to support parity between it and "gold the wealth reserve, which means physical gold only."

FOA predicted something like this as well:

FOA (06/12/00; 19:48:25MT - usagold.com msg#26)
Put your cards on the table!

The current paper gold world will die (burn) as its value to users erodes, not increases!

…Again, most everyone in the Western Gold bug game is running with the ball in the wrong direction.

…So who is in danger of being hurt as this unfolds?

That's right, the Western paper gold long! I'm not talking about just the US market! This is about the entire world gold market as we know it today. The real play will be for the ones that get out in front of the move by owning physical…

It seems every Gold bug sees only half the trade and has great faith that contract law will favor a short squeeze. Yet, none of them see where it is the long that will be dumping and forcing the discount!

JR said...

I think the relevance of the path from monetary to physical is because so many people want to have an idea of what signs to look for, and it will start in the monetary plane.

Moneyness

Big Danger in "A Little Inflation"

I just received an advance copy of Jim Rickards' new book, Currency Wars (thank you Steve and Jim). And while I haven't had a chance to read it yet (because I've been working on this post), I have it on good authority that Jim thinks the Fed is actually targeting 5% annual inflation right now while saying 2% or a little more. This sounds credible to me.

So what's the danger in a little inflation?

If the dollar sinks, like they (the USG/Fed) want, sure, our exportable goods will become relatively cheaper abroad (even though their price here won't drop) and their (our trading partners’) exportable goods will become more expensive here. This will appear as good old-fashioned price inflation, since we’ll now have to outbid our own trading partners just to keep our own production, and pay more for theirs. And while the domestic private sector has already crashed its lifestyle somewhat, the currency issuer has increased its "lifestyle" to compensate.

The bottom line is that the USG cannot crash its own lifestyle. And when the dollar starts to "sink", that pile of pennies in the video above will be insufficient (not enough money). Luckily, that pile of pennies represents the budget of the currency issuer himself. So he’ll just increase it, to defend his lifestyle, while scratching his head at why the trade deficit has nominally widened rather than narrowing as he thought it would when he trashed the dollar.

One of the strongest arguments that the USD will not hyperinflate like Weimar or Zimbabwe is that the USG's debt is not denominated in a foreign currency. If it were, this would be a different kind of hyperinflationary feedback loop we were facing. If all the USG debt was in a foreign currency and the dollar started falling on the foreign exchange market, that debt service would lead to hyperinflation. But that is not the case. So it’s not the FX market (monetary plane) that is the big danger to the dollar.

The dollar is the global reserve currency, so it is the physical plane that is the biggest threat to the dollar in the same way the FX market was a threat to the Weimar Mark. And it is not the nominal debt service that is the threat like it was in the Weimar Republic, but it is the structural (physical plane) trade deficit. To the USG, that is the same threat as nominal debt service denominated in a foreign (hard) currency was to Weimar Germany.

As the German Mark fell, there was "not enough money" to pay the debt. And with a little inflation, there is "not enough money" to buy our necessities from abroad.

Gary said...

For those who may have plenty of time on their hands, there looks to be a treasure trove of fascinating stuff here:

http://www.group30.org/pub_02.shtml

(This one may appeal to Costata:
Credit Creation in the Euromarket: Alternative Theories and Implications for Control)

Some serious BIS boys on the G30 (and some great names from the past too, including Lord Richardson, and Alexandre Lamfalussy), as well as some $IMFS folk too. And the Chinese. Very interesting group. Trichet just tajken the helm.

costata said...

Thanks Gary,

The paper you mention was apparently written in 1980 so it may be a bit too old to be useful. I will take a stroll through their list of publications. If I find anything outstanding I will post a comment about it here (and with the names you mention there's sure to be some good stuff.)

Cheers

costata said...

US Exports

I thought it might be interesting to take a look at claims that an export led economic recovery for the US is possible as a result of a lower US dollar. This paper from the NY Fed isn't encouraging especially when you consider how the US dollar index has performed since the launch of the Euro:

http://www.newyorkfed.org/research/current_issues/ci18-1.pdf

From the introduction:

The U.S. market share of world merchandise exports has declined sharply over
the past decade. Throughout the 1980s and 1990s, approximately 12 percent
of the value of goods shipped globally originated in the United States; by 2010,
the share had dropped to only 8.5 percent.

Some observers have sought to explain the
nation’s diminished role in merchandise trade by suggesting that U.S. industry has
shifted its energies from the export of goods to the export of services.

As we shall see, however, the trade data offer no support for such an argument; in fact, they show that the U.S. share of world services exports also plummeted over the last decade.


Another nail in the coffin I fear.

Michael said...

Freegold Mountain, Yukon
http://www.northernfreegold.com/s/Freegold.asp

Phat Expat said...

@Gary April 7, 2012 12:50 PM
"... I may of course be wrong, but if I see QE announced and markets fall, I'll be out immediately stocking up on foods to go with my hoard of tinned stuff."

I like it! Exactly the kind of insight I believe benefits us all. Right or wrong, at least there can be discourse and maybe some more way-points will shake out. Nice!

From JR:
"So just imagine another quick run-up like July/Aug. to, say, $2,333 correlating with a big spike in the USDX/$IRX (price) and then a crash in the $PoG down to ~$1,000 or lower. How hated would today's "gold" be by the homeless savers then? That's some serious beta!"

And THAT is what I am looking for; the opportunity to dump my remaining silver holdings in exchange for gold. Another reason to make that exchange is to avoid a tax hit since, it is my understanding, this is considered a 'like' exchange by the IRS. Caveat Emptor.

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