Thursday, June 21, 2012

The Debtors and the Savers 2012

Like Dust in the Wind

There are 31,530,000 seconds in a year. A thousand milliseconds in a second. A million microseconds. A billion nanoseconds. And the one constant, connecting nanoseconds to years, is change. The universe, from atom to galaxy, is in a perpetual state of flux. But we humans don't like change. We fight it; it scares us. So we create the illusion of stasis.

We want to believe in a world at rest—the world of right now. Yet our great paradox remains the same. The moment we grasp the now, that now is gone. We cling to snapshots, but life is moving pictures, each nanosecond different than the last. Time forces us to grow, to adapt, because every time we blink our eyes, the world shifts beneath our feet.

Change isn't easy. More often, it's wrenching and difficult. But maybe that's a good thing. Because it's change that makes us strong, keeps us resilient, and teaches us to evolve.
–Tim Kring

Prices change. Don't they? Yes, of course they do! We don't always like it when prices change, but they do nonetheless. And why do prices change? Because values change! That's right, I'm talking about the way humans value things relative to other things. Relative values change constantly, and because relative value is a subjective choice made by each individual, what actually changes is demand.

I remember back in 2008 BlackBerries were all the rage. First generation iPhones were a little buggy and RIM (the maker of the BlackBerry) was rocketing toward $150. Both RIM and Apple were around $140 at about the same time. Today iPhones are cool, RIM is $10 and Apple is $577. Demand changes, relative values change, prices change. We don't always like it when things change, but they do nonetheless.

So why are some people so stuck on that old objective cost theory of value? One thing I have learned through writing this blog is that these people in particular, when they come across my blog, seem to be the most obsessive about "debunking" me. Yes, I'm talking about our old Marxist frenemy Ash. In the first draft of this post I had links to a couple of others as well, one who wrote something like Debunking FOFOA and another who devoted no less than six posts to the cause. But there's really no need to look any further than everyone's favorite Marxian with his ten posts and counting. He has an ongoing series over at "The Automatic Earth" devoted to debunking Freegold!

Marvin the Marxian

The Marxian View

Ashvin Pandurangi: "This series was a comprehensive attempt to debunk the [Freegold] theory by attacking its foundations, which range from Hegelian idealism to the (more concrete) marginal utility theory of value, and by replacing those foundations with what I believe to be more solid ones. Among these were Marx's theory of capitalism, spanning his concepts of surplus value, rate of exploitation, over-production and realization of value…"

In my 2010 post, The Debtors and the Savers, I explained the "Marxian" view of class struggle like this: "Simply put, Marx says it's the rich versus the poor. According to Marx the rich exploit the poor to get themselves a "labor-free income", which spawns a class struggle." This flawed perspective makes it impossible to understand Freegold, which is perhaps why they are so driven to debunk it.

Hegelian Idealism

With the correct delineation being the debtors and the savers (aka the easy money camp and the hard money camp), Freegold simply explains how, with the termination of the $IMFS, what remains is a system in which these two camps will no longer be in a perpetual state of monetary conflict. This is what Ashvin dubs Hegelian idealism; the idea that mutually beneficial coexistence between those whose innate tendency is to net-produce (produce more than they consume) and those who prefer easy money through borrowing, taxing and printing is even possible. His argument that it is not possible boils down to "they" (the evil ruling elite) will never let it happen.

Marginal Utility Theory of Value

Simply stated, the Marginal Utility Theory of Value which Marxists object to is really just the subjective view of value which I described at the top. They prefer Marx's objective view of value which says that value flows up through the costs embedded in the supply side rather than down from the subjective choice of the end user. And while Marx has been thoroughly discredited in economics, this objective view of value persists because it fits the "exploitation of the workers" theme that is so popular among impressionable young minds and scary doomers with batshit-crazy worldviews.

Which brings us to Ashvin's "more solid" foundations of Marxian "surplus value, rate of exploitation, over-production and realization of value."

Surplus Value

In this view, surplus value comes only from the Capitalist's exploitation of workers, be it from selling goods back to the workers for a price higher than the value (value being the cost of production paid to the workers), or from lending to the workers for interest or rent (labor-free income).

Rate of Exploitation

The rate of exploitation, as you can imagine, is simply the rate of surplus value accumulated by the Capitalists at the workers' expense. So if surplus value is the stock, the rate of exploitation is the flow.


Here's a quick excerpt from on over-production:

The real problem when goods lie on the shelves is that no-one can afford to buy the commodities; in other words “over-production” should really be called “under-consumption”.

In another sense however, the term “overproduction” is valid; but it is not goods and services which have been over-produced, but capital.

During a boom period – the rising phase of a capitalist crisis – profits run high and a mountain of fictitious capital is built-up by speculation and borrowing for unwarranted future expansion. All this fictitious capital has to be fed by the surplus extracted from workers and this grows to be more and more of a burden on the backs of the workers until profitability can no longer be maintained, and slump takes over.

Realization of Value

Again from

Realisation is the transformation of something from an ideal or potential form to an actual or material form. Realisation of value is the conversion of a profit or payment in the form of a surplus product or credit into money form.

Commodity production is based on the production of a product which the producer themself does not need, on the basis that their own need can be met by exchange or sale of the surplus product. In particular capitalist production can only complete the cycle of capitalist reproduction when the labour power is used, the product sold and paid for.

The beginnings of crisis often lie not so much in the failure to produce a surplus as in the failure to realise surplus production.

Are you starting to get the picture? These guys don't like the concept that value is in the eye of the beholder. They need value to be an objective metric in order to explain how the Capitalist exploits the worker. How the rich exploit the poor. How the bourgeoisie exploit the proletariat. From my 2010 post, here are Marx's classes in his version of the class struggle:

Marx's classes were:

1. Labour (the proletariat or workers) - anyone who earns their livelihood by selling their labor and being paid a wage for their labor time. They have little choice but to work for capital, since they typically have no independent way to survive.

2. Capital (the bourgeoisie or capitalists) - anyone who gets their income not from labor as much as from the surplus value they appropriate from the workers who create wealth. The income of the capitalists, therefore, is based on their exploitation of the workers.

And here is my corrected delineation:

The two classes are not the Labour and the Capital, the rich and the poor, the proletariat and the bourgeoisie, or the workers and the elite. The two classes are the Debtors and the Savers. "The easy money camp" and "the hard money camp". History reveals the story of these two groups, over and over and over again. Always one is in power, and always the other one desires the power.

1. Debtors - "The easy money camp" likes to spend (and redistribute) money it did not earn, either by borrowing it, taxing the savers for it, or printing it. They like easy money because it is always and everywhere constantly inflating, easing the repayment of their debts.

2. Savers - "The hard money camp" likes to live within their means and save any excess for the future. They prefer hard money (or in some cases "harder" money) because it protects their savings and forces the debtors to work off their debts.

Some of my readers thought this was my most profound post. Others picked up on my theme and wrote their own articles about "the debtors and the creditors" thinking they had corrected my obvious error. It wasn't an error. It was intentional. The Debtors and the Savers are the two inherent camps. They are not, and should not be, direct counterparties! More on this in a moment.

In Time

In The Debtors and the Savers I posted a very short version of a forgettable movie which helped make the point that individual members of the two camps are not as obvious as the superficially rich and poor. In fact, many in the West who are living like kings are actually up to their eyeballs in debt.

For this post I'd like to direct your attention to the movie In Time starring Justin Timberlake and Amanda Seyfried. It's a much less forgettable movie than Tiger's Tail, so check it out. Here's a two-minute trailer:

The premise of the movie is that time is the currency. And since time passes automatically, that’s like inflation. If you just sit on your currency doing nothing, it will leak away with time. In the movie, when you run out of currency, you run out of time and you drop dead on the spot. Most of the people live in the ghetto and they never have more than a day or two at a time, so they have to keep working just to stay alive.

Then there are the rich people who have eons of time. You can literally live forever in this world if you accumulate enough currency which is also real time. And the rich get richer not by producing lots of good stuff, but by loaning their surplus time to the poor at usurious rates.

The story is told from the perspective of the poor, but from another perspective it really drives home the point that wealth is best kept not mixed in with the transactional currency by relying on debtors' servitude. In the movie the rich could only live forever as long as the poor lived hand to mouth, always working, producing, and never getting ahead to the point where becoming a consumer was an option. So the wealthy relied on the production output of poor debtors for their wealth which, in this world, was an endless life of luxurious consumption.

But as a net-producer (one who produces more than you consume) that’s not the best way to store your purchasing power. If you could pick a counterparty for your future, would it be a debtor who lives hand to mouth always on the precipice of bankruptcy, or a fellow net-producer? How about if you could choose between either all of the debtors as your counterparty, aggregated by a government which has every incentive to debase your savings, or all of the net-producers/savers with a 5,000 year track record of their innate drive to net-produce and save for the future? Which would you choose if such a choice existed?

This film is a classic illustration of the popular "Marxian" view of perpetual class struggle: exploitation of the workers. The wealthy live the good life consuming as much as they want on the backs of the indebted poor who must slave away producing just enough to stay alive, plus some surplus for the wealthy to consume.

But is this reality?

With the proper perspective and a little quiet contemplation it becomes obvious that, today, we highly indebted Westerners have a much higher living standard and luxurious rate of consumption than the net-producers of the world. Those supporting our lifestyle are not indebted to us—it's the other way around. And other things become clear as well. Like that credit (debt) is demanded by the debtors (remember, human demand drives everything), not forced upon them. And that banks, whose job it is to extend credit (aka easy money), are actually in the easy money camp along with the debtors. More on this in a moment.

The Mungerian View

Over on the other side of the coin we have Mungerian paperbug Capitalist and fair-weather friend to the "goldbugs" (a term with which I cannot identify), Izabella Kaminska [1], who, after "enduring" a few tweets from Freegolds among others, thought she schooled her buggy friends with a two-part series creatively titled, Debunking goldbugs.

I say she's the other side of the coin because Izabella thinks the savers owe it to the debtors to be their direct counterparty and earn some labor-free income via interest which the Marxians call exploitation. And I called her a Mungerian paperbug in honor of Charlie Munger because she sounds just like Munger and the Dingbat from my post A Winner Takes the Gold. Remember that Charlie thinks you’re a jerk if you hoard gold? Well Izabella says you're a selfish, anti-social cheat.

She even tries channeling John Locke's reasoning into an argument against hoarding gold with this clever quote from the conveniently titled

Suppose I have twelve loaves of bread, and you are hungry. I cannot eat so much bread before it goes stale, so I am happy to lend some of it to you. “Here, take these six loaves,” I say, “and when you have bread in the future, you can give me six loaves back again.” I give you six fresh loaves now, and you give me six fresh loaves sometime in the future.

In a world where the things we need and use go bad, sharing comes naturally. The hoarder ends up sitting alone atop a pile of stale bread, rusty tools, and spoiled fruit, and no one wants to help him, for he has helped no one.

Here's some John Locke from my post dealing with Munger and the Dingbat:

Furthermore, gold is the most socially responsible valuable good to "hoard" (save), which is another reason it is the focal point. John Locke wrote way back in 1690 that it is "foolish and dishonest" for men to hoard up things of short duration, things that are consumed in the support of life, or any more than one can personally use from the common stock of perishables and truly useful supports of life. This, Locke wrote, is how man came to value durable things of no industrial worth, that "he might heap up as much of these durable things as he pleased… and keep those by him all his life," because "he invaded not the right of others."

Of course you don't want to hoard perishable goods like loaves of bread! That's just silly. But it is an important concept to understand. So why hold someone else in debt rather than simply hoarding a durable thing of no industrial worth, as the real John Locke recommends? Well, Izabella's argument is that you are better off if you lend your surplus to someone so that you can later ask for it back. She calls this the "favour system" and she says that if you hoard gold then you are "opting out" of this "collaborative process".

But how does holding someone else in your debt make it more likely that you'll be able to redeem your six loaves than if you simply sold them and bought a durable thing that is extremely likely to be considered valuable by other savers in the future? In fact, it doesn't! And Izabella addresses this issue.

She says that you're better off not holding a specific person in debt because he might die, but rather holding your government's debt! She says the "sovereign lord" provides the vital service of credit aggregation and central clearing (which is true for the transactional currency) and thereby creates "fungible" and "non-perishable" debts for saving! (At least she didn't go so far as to call government debt infinitely divisible, discreet, transportable and pretty.)

But even though government debt may be relatively fungible and (nominally) non-perishable, you're still at the mercy of the government should it decide to debase your savings. Izabella says this is not only a good thing, but it is your social duty:

Luckily for the system, the sovereign can expand or contract the number of debts that circulate within its community to match the current production/wealth profile of the nation and keep the system in check.


You could say, the sovereign borrowed from the rich (those with surplus wealth which will otherwise perish) and redistributed the wealth according to the needs of the community. Since everybody received something, including the ‘rich’, a tax (cancellation of debts outstanding) kept the system in balance. Very MMT.

What she's saying here is that too much savings is a burden on the system and the government provides the valuable service of debasing burdensome levels of savings down to a socially healthy level. How does that make you feel? And yeah, Izabella is apparently quite fond of MMT, which is why this part reminded me of someone else who once said that savings above "a certain level" are a "burden". I'm talking about our very own MMT Greg:

I don't disagree with your idea of saving but it cannot be done to much of a degree on a macrolevel. There must be someone to consume your oversupply after a certain level. Savings is a burden when excessive. How to predetermine the "right" amount ? Dont know. How to know it when you see it....... right now. We have OVER produced a lot of things.

As Mosler is fond of saying, economics is the opposite of religion, in economics it's better to receive than to give. If you produce extra and [loan] it to me so I don't have to produce it myself .....THANKS is the proper response.

In part 2 of her bug schooling affectionately titled Gold’s Anti-Social Behaviour Order, here is Izabella expressing the same sentiment as MMT Greg regarding excessive savings being a burden on the system (my emphasis):

…there’s no denying a promissory note is a much more practical unit of exchange and store of value than a bar of gold.

The problem with promissory notes from a goldbug’s point of view, however, is that a sovereign always has the means to “manipulate” supply so as to regulate the system’s excesses and deficits for the benefit of the group: bringing their purchasing power of the notes down when there is an abundance of goods to notes “by printing more”, and bringing their purchasing power up when there is a deficit of goods to notes.

This puts the interests of the group above those of the individual, because — in the words of goldbugs — it “steals” wealth from individuals.

These regulative processes of course are necessary. They’re a correcting mechanism that ensure efficiency and curb wasteful production. And, as we’ve stated before, it is anticipated that promissory notes are eventually extinguished via the payment of taxes. In a perfect system the sovereign should provide for you, once you’re no longer productive anyway.

In other words, it is good that the government can reduce "excessive savings" through debasement. In fact it is the government's job to do that, just like it is the government's job to take care of you when you get old according to Izabella. And here is "gold's anti-social behavior" in a nutshell:

What gold thus represents, we would argue, is an opt out, and a cheat, from participation in the group correctional process. Its existence undermines the sovereign’s ability to regulate the supply of debt to match the needs of the system. In a situation where there are too many goods, and too little monetary sovereign debt, the sovereign clearly needs to create more sovereign ‘debt money’ — and debase the store of value — to encourage more of this overproduction to be used and efficiently allocated.

Since gold can’t be “debased”, it begins to attract investment from those who would rather not consume today’s overproduction (and via that sharing wealth and ‘favours’) but continue to hoard these for the purpose of individual wealth accumulation.

In the opposite scenario, when there aren’t enough goods to satisfy sovereign debt claims and the sovereign intervenes by contracting the money supply — by making it extremely expensive to borrow but extremely attractive to invest in the production of goods — gold attracts investment from those who would rather not delay consumption until tomorrow for the benefit of the community.

Gold in this way symbolises humanity’s selfish streak.


So while gold may be a workable underlier for a redemption option, this doesn’t change the fact that at the heart of the system it is faith and faith alone which holds everything together. Whether that faith is reflected in a sovereign’s ability to manage the economy on behalf of the group, in the sovereign’s guarantee to honour a gold option, or faith in the gold god himself… faith is the constant. Not gold.

What’s more, while gold encourages anti-social behaviour and hoarding in individuals, a fiat-based system encourages the very opposite: sharing, distribution, collaboration and cooperation.

And then she concludes with two options:

Which leaves two possible plans out of the crisis:

1) The goldbug plan: based on encouraging everyone to hoard ever greater amounts of natural wealth for themselves and themselves in what is ultimately a commodity you might never be able to eat.

2) The fiat plan: based on encouraging society to trust each other again, and via that storing, redeeming and returning favours until the system’s ails are eliminated.

This is obviously someone with both feet firmly planted in one camp telling the other camp what they should do. Almost reminds me of that famous quote about sharing and unselfishness by… hmm, I forget, was it Jesus? "From each [producer] according to his ability, to each [consumer] according to his needs." Funnily enough, here's what Wikipedia says about that quote:

In the Marxist view, such an arrangement will be made possible by the abundance of goods and services that a developed communist society will produce; the idea is that there will be enough to satisfy everyone's needs.

Now compare that idea with Izabella's post one week later titled The end of artificial scarcity:

It’s an environment that we have argued requires a new paradigm for the world. A transition towards a steady-state where money has no choice but to depreciate because its role as a store of value has been made redundant due to the general abundance of goods in society, brought about by technological innovation and efficiency. In a post-scarcity environment there is no need to delay or hurry purchases, or to even have a store of value. You use only what you need.


And when that happens money itself will die, because who needs to save for their old age, if over the time the system is going to provide ever more “stuff” you need for free or almost for free.

Not convinced?

We’d argue the signs that this is happening are already appearing.

Да здравствует революция indeed!

In truth, Izabella's whole argument in the two goldbug posts was based on a flawed premise considering that they were spawned by her frustration at interaction with "Freegolds" and a few of my other "regulars" on Twitter rather than with true goldbugs. That premise was her assumption that they (we) have, in her words, an "utter and complete hatred of the so-called paper money system."

The truth is that we view the primary and secondary functions of a monetary system separately. Paper money (and electronic currency) is, in fact, the best thing since sliced bread in the transactional role. Here's a quote from our very own Aristotle describing his personal journey and discovery that paper money is not only good, but necessary, back in 2000:

"Going in, I was a charter member of the Goldhearts club [aka a goldbug], and I emerged even more excited about the prospects of Gold than before. The future for Gold is bright, and it is rapidly approaching in the manner I laid out, if I'm reading the signs correctly.

In working on this project, I was personally shocked when I discovered that we absolutely NEEDED paper currency in order to set Gold free."

Freegold is not about making easy money a little bit harder. On the contrary, it is about the debtors and the savers coexisting without the perpetual monetary conflict embedded in all prior systems. (See The Debtors and the Savers 2010 for more about this perpetual conflict.)

Izabella has probably never heard of FOFOA's dilemma. Here it is, from The Return to Honest Money:

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.

And from that same post, here's my definition of Honest Money: "My definition is that honest money is simply money that does not purport to be something it is not." As I explained in that post, money's two main functions, medium of exchange and store of value, are actually fulfilled by two different media, even today: a primary and a secondary medium of exchange. Today (and in Izabella's ideal world) that secondary medium of exchange is debt denominated in the primary medium.

The quote at the top of my blog reads: "Everyone knows where we have been. Let's see where we are going!" Well, everyone knows we have been where debt is the systemic store of value, its "tier 1" reserves, and Izabella doesn't seem to be arguing the inevitability that this is also our future. Instead she seems to be arguing that it is simply the better of two choices—the socially responsible and unselfish thing to do with your savings. But is she correct? Is debt really better than gold for the overall society?

In order to answer this question I think we need to look carefully at which one is better from two different perspectives; from the perspective of the savers and from the perspective of society at large. I'm attributing the perspective of society at large to that of the debtors as well. As I pointed out earlier, Izabella is clearly in the debtor camp. This doesn't necessarily mean that she's in debt. It simply means that she's in the easy money camp as opposed to being in the hard money camp—what she thinks of as "the goldbugs".

She may in fact have savings, but as she says, she "puts the interests of the group above those of the individual" and she's happy to do her civic duty of letting the government debase her savings when necessary. This puts her firmly in the debtor camp. And being in the debtor camp, she is obviously arguing for the benefit of the overall society or economy. So that's why I say I'm attributing the perspective of society at large to that of the debtors as well, because they are apparently one and the same.

Now would probably be a good time to restate that "the debtors and the savers" is a dichotomy, not a moral judgment. It is a way of viewing the world in two camps that corrects Karl Marx's most enduring (and harmful) legacy. Neither camp is better than the other any more than women are better than men. It is simply a model for understanding how two groups with apparently different innate tendencies have always been placed in conflict with each other throughout history due to the emergence of monetary systems. If you haven't read The Debtors and the Savers yet, now would be as good a time as any! ;)

From the Viewpoint of the Savers

Is money positive or negative equity? Izabella correctly implies money to be fungible claims on each other's goods. And she goes on to explain that these claims can sometimes be too numerous "when there aren’t enough goods to satisfy" all of the claims. This, she explains, is when the government steps in and makes adjustments to keep the number of claims roughly in line with the number of goods.

So when we look at money (or claims against the physical plane of goods and services) in aggregate, we can clearly see that hypothetically doubling or tripling the number of claims actually reduces the specific amount of equity in the physical plane each fungible claim represents. It is for this reason that I like to think of money in aggregate as negative equity, and also why I like to delineate between the monetary and physical planes.

Being a claim, it is merely one half of a physical plane barter transaction. You sold a good or provided a service in the physical plane and received a claim in the monetary plane. Once you redeem that claim for a good or service in the physical plane you will have completed a full transaction. But until that time, while you are holding money, you are only halfway there. And for as long as you remain in this barter purgatory, you are exposed to the effects of your claim being negative equity which I just described.

(I used the term "money" above because if, hypothetically, the gold stock could be doubled or tripled quickly enough, the same principle would apply to gold.)

Clearly it is the well-known exchange rate between monetary claims and the physical plane—as opposed to some intrinsic or cost-derived value—which gives these claims their value. It is the observed completion of other transactions today, yesterday and last week, which informs us of what we can expect to get for the claims we are holding. But as savers, we intend to hold these claims for a long time, perhaps even decades, so we want some sort of additional reasoning as to why they will hold this present known value for such long periods of time.

Of course very few savers hold the primary medium of exchange for long periods of time. We hold what Mises called secondary media of exchange. And the world is full of things other than "the common stock of perishables and truly useful supports of life" which we can hold (hoard) for this purpose, from stocks to bonds to antiques, classic cars or even baseball cards. Here is Mises from his book Human Action explaining the concept of secondary media:

A first-class bond is more marketable than a house in a city's main street, and an old fur coat is more marketable than an autograph of an eighteenth-century statesman. One no longer compares the marketability of the various vendible goods with the perfect marketability of money. One merely compares the degree of marketability of the various commodities. One may speak of the secondary marketability of the vendible goods.

He who owns a stock of goods of a high degree of secondary marketability is in a position to restrict his cash holding. He can expect that when one day it is necessary for him to increase his cash holding he will be in a position to sell these goods of a high degree of secondary marketability without delay at the highest price attainable at the market.


Consequently there emerges a specific demand for such goods on the part of people eager to keep them in order to reduce the costs of cash holding. The prices of these goods are partly determined by this specific demand; they would be lower in its absence. These goods are secondary media of exchange, as it were, and their exchange value is the resultant of two kinds of demand: the demand related to their services as secondary media of exchange, and the demand related to the other services they render.


One must not confuse secondary media of exchange with money-substitutes. Money-substitutes are in the settlement of payments given away and received like money. But the secondary media of exchange must first be exchanged against money or money-substitutes if one wants to use them—in a roundabout way—for paying or for increasing cash holdings.

Claims employed as secondary media of exchange have, because of this employment, a broader market and a higher price. The outcome of this is that they yield lower interest than claims of the same kind which are not fit to serve as secondary media of exchange. Government bonds and treasury bills which can be used as secondary media of exchange can be floated on conditions more favorable to the debtor than loans not suitable for this purpose. The debtors concerned are therefore eager to organize the market for their certificates of indebtedness in such a way as to make them attractive for those in search of secondary media of exchange. They are intent upon making it possible for every holder of such securities to sell them or to use them as collateral in borrowing under the most reasonable terms. In advertising their bond issues to the public they stress these opportunities as a special boon.

I included all of that long excerpt so that you could see how he explained, in his own words, the concept of a focal point in this secondary media role. Many items will suffice as a secondary medium of exchange, but the more an item is used in this function, the more value it derives from this particular function, over and above the value from other uses: "…their exchange value is the resultant of two kinds of demand: the demand related to [1] their services as secondary media of exchange, and the demand related to [2] the other services they render."

And then you probably noticed that his search for the focal point led him to government bonds. I figured this would make Izabella smile if she's still with us. So why do you think he didn't mention gold as one of the secondary media of exchange? Perhaps it was because, when he wrote the book in 1940, gold was the primary medium of exchange.

I think I'm now at the point where I can narrow the focus of the discussion substantially. Izabella and I are both talking about government debt versus gold as the two main competitors to becoming the focal point store of value (aka secondary media) of the future. So let's just stipulate that and move on. Also, I think we can both agree that government debt has been the official (and focal point) secondary medium of the recent past. Furthermore, Izabella says that between government debt and gold, gold is the more selfish choice. I'll stipulate to that as well.

In a moment we'll investigate whether the "selfish" choice is the better one for the economy as a whole, but in this section we are looking at it from the "selfish" viewpoint of the savers. Izabella admits that the government debases its own debt, which, taken along with her labeling of gold as the "selfish" choice, leads me to believe that she would be okay stipulating that, at least on the surface, gold appears to be the better choice from a "selfish" saver's perspective. So then the only question remaining is whether or not gold actually is better as it appears to be. Izabella says no.

Izabella warns "us" via Twitter: "The problem with gold (imho) is that it isn't a scarce commodity. You have to physically make it scarce by hoarding it."

The only problem with her tweet is the word "problem". Other than that, she's absolutely right! There are 170,000 tonnes of gold out there somewhere, 60 times annual production—that's a 60 year "supply overhang" in commodity terms—and yet the flow today is barely more than what's coming out of the ground. That's not a problem. That's absolute proof that gold is far more valuable than its commodity price today!

Gold’s value really comes from intergenerational Giants who have no need to ever sell it. They really just net-produce and net-produce and they do it willingly for more and more gold, and then just sit on that gold until they die and pass it on to the next generation. And they will keep doing this no matter what the $PoG does. They're not buying it for its weight, but for proven long run currency exchange value! But if there’s no flow for them to get some, then they have to buy things like extra castles and cars and stuff that drives up prices and drives down everyone else’s purchasing power.

So it’s better for everyone if there’s a steady flow of gold. Remember how Another said they justified the "gold as a commodity" (strong dollar) trade because they thought it would induce the mining industry to produce greater and greater quantities of gold?

Date: Mon Feb 16 1998 14:40

Now, back to gold. The deal: you may stand your army for us, in return, "oil will back the dollar if the dollar is made strong by gold" "in as much as our people may replace the lost value of oil with gold" "in as much as we will produce oil in amounts to equate a gold/oil/dollar ratio close to that which existed at our previous agreement in the 70's" And, pray tell, how does the USA make the dollar strong in gold ? The BIS leads the creation of a paper gold market that will lower the world price of gold to the extent that it remains above "production costs".

Guess what, it worked! Contrary to all expectations of oil shortages, inflation, debt collapse and what have you, It Worked! But, there is one small problem?

The BIS and other various governments that developed this trade (notice I didn't use conspiracy as it was good business, as the world gained a lot), thought that the paper gold forward market would have allowed the gold industry to expand production some five times over! Don't ask where they got this, as they are the same people that bring us government finance and such. But, without a major increase in gold supply, the paper created by this "gold control operation" will either be paid by, 1. new supply. 2. the central banks. 3. rollover existing. 4. cash? or 5. total default! As the Asians started buying up everything last year ( 97 ) , numbers 5 and 5 started looking like the answer! When the CBs started selling into this black hole of demand, the discussion of #5 started in their rooms also.

So it’s good for everyone if there’s a steady flow of gold and a stable price for the Giants. These Giant super-producers (including oil producers) will produce the most stuff and leave it on the economic table for us without running up the prices of things we need to buy as long as gold is flowing unrestricted. And also, when CBs and nation-states start valuing gold the way these Giants do, we won’t have the mines running at full steam trying to add more to the supply. First of all they'll want the price to stay steady for the economic benefit net-producers bring to the table, and second of all they'll want their own treasure to hold its value. And to the nation-state, gold in the ground is a treasured reserve as well as gold in the vault.

It may seem counterintuitive, but the flow of gold from the mines will eventually be controlled or regulated by the government and, in most cases, will be just enough to keep the miners economically viable. This is why I view mining shares as a terrible Freegold play. Today the flow of physical gold is mostly from the mines to the savers. In Freegold, the flow will be almost entirely from the above-ground stock, from one saver to another.

As I wrote about in Glimpsing the Hereafter, gold is like a closed circuit for the savers, isolated from the transactional currency system which is used by everyone, debtors and savers alike. Some might call it selfish. I can live with that. Here's a taste from that post:

I think that if we look closely at how the debtors use the fiat money system with and without the assistance of the savers, it will become clear that we will all be better off with a bifurcated monetary system. And it will certainly be clear that the savers have no business taking debtors on as the counterparty to their savings.


So gold has kind of a double float. It floats with the inflation/deflation of everything else. And then it also floats in a closed circuit consisting only of savers (and their "hoard/dishoard" choices), of whom the majority (measured by value stored) are intergenerational giants.

The way the gold market works today is a little different. It is kind of a flow within a flow. On the surface, anyone can very easily buy exposure to the price of gold. In fact, this "exposure" is all that most Westerners want, including traders, speculators, goldbugs, hedgefunds, anykindafunds, banks, you name it. And most of this group is firmly in the debtors (easy money) camp. But underneath this superficial flow is the physical flow from the miners and physical gold pukers in the West to the true savers like the Giants in the oil-rich Middle East and net-producing Asia.

The key to keeping this gold market humming along, however, is that anyone who asks for physical in any size has to get it. But those who can afford real size also know that hogging the flow and stressing the system is not the best way to get what they want. So here's what we know. In 1997 the LBMA leaked to the Financial Times a paper gold clearing volume far greater than anyone imagined. This was the same time that Another said "the Asians started buying up everything" and that "the CBs started selling into this black hole of demand."

About two years later we heard from the European CBs through the WAG (the Washington Agreement on Gold) also known as the CBGA (the Central Bank Gold Agreement). The agreement came on the heels of the euro launch and, even though it was announced in Washington DC during an IMF meeting with Larry Summers and Alan Greenspan present, it was only between the European central banks. It stated very simply the following:

In the interest of clarifying their intentions with respect to their gold holdings, the undersigned institutions make the following statement:

1. Gold will remain an important element of global monetary reserves.

2. The undersigned institutions will not enter the market as sellers, with the exception of already decided sales.

3. The gold sales already decided will be achieved through a concerted programme of sales over the next five years. Annual sales will not exceed approximately 400 tons and total sales over this period will not exceed 2,000 tons.

4. The signatories to this agreement have agreed not to expand their gold leasings and their use of gold futures and options over this period.

5. This agreement will be reviewed after five years.

Two years later, in 2001, gold began a relentless climb in dollar-denominated price of about 18% per year which continues today:

And then, in 2009, the CBs in aggregate became net-buyers of shiny rocks:

In 2011 the LBMA released a survey revealing not just the clearing volume it began reporting in 1997, but the total daily turnover in LBMA bullion bank gold credits. From my post Once Upon a Time:

And that's because the price of gold today still does not reflect the physical flow of gold that would normally be a function of arbitrage, with speculators transporting gold to where its purchasing power is highest. The flow of gold today is still sterilized by the paper gold trade within the LBMA bullion banking system that, by a recent LBMA survey, was around 250 times larger than the flow of new gold from the mines. That's a total turnover in the LBMA (sales plus purchases) of 5,400 tonnes every single day. That's the equivalent of every ounce of gold that has ever been mined in all of history changing hands in just the first three months of 2011. That's what the LBMA members, themselves, voluntarily reported. And that's a lot of paper gold that is still sterilizing the economically beneficial price mechanism that physical gold would otherwise be transmitting.

Yet things are changing, even today. That's what the rising price of gold since 2002 tells me. This is about much more than just a rising price. It's not just about a gold or even a commodity bull market. As FOA said, "it has everything to do with a changing world financial architecture." Gold's function in the monetary system is changing. And as FOA also said, "None of the other metals will play a part in this."

Gold will return to its pre-1922 function, but that does not mean we will return to a pre-1922 gold standard. This post is not about the merits of the gold standard. It is not about praising the hard money camp’s decision in 1445 over the easy money camp’s decision in 1922. It is about the choice of the Superorganism over the management of men. The pre-22 gold standard, although it allowed gold to function, still carried the same flaw I point to so often; that using the same medium for exchange and savings leads to regular recurring conflicts between the two camps.

Then in 2012 (just a couple of days ago actually), the US FDIC announced that gold bullion is up for consideration as an equal to government debt with a zero risk weighting. And just yesterday Ben Bernanke signaled his subconscious support for this measure by choosing to wear a gold tie. ;)

I'm sure this is all very insignificant information to a Mungerian paperbug like Izabella Kaminska, but let's just think about this for a second as it compares to her racehorse: government debt.

From a saver's perspective—one who wants to hold claims for a long but unknown, unspecified amount of time—debt is attractive in a falling interest rate environment. This is because debt usually has a specific maturity date and yet savers can't know precisely when they'll need their money. So debt is appealing as long as there is a liquid secondary market with plenty of upside to run.

This is most obviously true when interest rates are allowed to be set as high as necessary by the unfettered marketplace and then they begin to fall for one reason or another. As interest rates fall, old promissory notes signed when rates were higher become more dear. Debtors seek refinancing while savers can easily unload their saving without losing purchasing power.

This was the case from 1981 to present. Interest rates fell (for one reason or another) from around 20% down to 0%. Today there's not a whole lot of room for them to fall any further except for maybe going negative, and then you're just losing principle. So there's not much upside for debt today like there was in 1981, but with ZIRP there is a whole lotta potential downside.

Not only that, but in this case we're talking specifically about government debt. And what are our choices today? We can choose between almost no interest (actually negative real interest) from a government which is openly debasing its currency and diluting its bond market, or a slightly higher interest rate from a government with serious budget problems and some non-zero likelihood of default. That's quite a choice for a secondary medium with limited upside and unlimited downside!

Then there's gold, with limited downside and lots of upside potential. It's a tough sell to savers who have been swimming in a sea of Mungerian paperbuggerdom their whole lives, but not to the true Giants who already hold 170,000 tonnes and aren't letting it go at today's paper gold prices. As I have already pointed out, the intergenerational Giants who hold a great deal of this physical gold have no need to ever sell it. This is a key concept you might want to stop and ponder.

Lastly, I want to mention the nominal savings argument. Government debt, especially a government like the USG which can print its own currency, is at least nominally safe. If you save a million dollars you'll get a million back at the end of the day. The only question is what will be the purchasing power of those dollars when you need them. Well the same nominal argument applies to gold when applied properly. If you buy 500 ounces of gold you will still have 500 ounces of gold at the end of the day. The only question is what will be the purchasing power of those ounces when you need them. See?

So, not that I think I have convinced Izabella of anything, but just so that we can move on, let's agree that from the viewpoint of the savers—perhaps even a selfish viewpoint if that helps—who want to hold fungible "claims" on goods and services for a long but unknown/unspecified amount of time, gold beats government debt today hands down. If you don't agree then please return to the top of this section and read it again. If you agree, let's move on to the viewpoint of the debtors, aka the viewpoint of the economy as a whole.

From the Viewpoint of the Economy as a Whole

In the simplest terms, I like to refer to the savers as net-producers. All this means is that a saver consumes less than she produces. It's really the simplest way to differentiate the debtors and the savers. In general, the debtors either consume as much or more than they produce by borrowing, taxing or printing money. Of course everyone consumes, and everyone produces to one extent or another. But at the margin, debtors consume and savers produce.

My delineation does go a little deeper than this, though, to include monetary preference. That's why I use "the easy money camp" interchangeably with "the debtors". The easy money camp prefers easy money for various reasons including not just the ease of repaying debts but also that easy money may be how they make a living. And this is why I put the banking industry, including Wall Street, in the easy money camp along with the debtors.

Banks, of course, are often the creditors to the debtors. And that's why it's the debtors and the savers rather than the debtors and the creditors. The debtors and the creditors are in the same camp together! As I said earlier, it's not a good idea for the savers to be counterparty to the debtors. But, of course, Izabella Kaminska disagrees. She thinks it's the savers' civic duty to be the debtors' counterparty.

In thinking through which is best for the economy as a whole, it is important to understand that the excess money earned from net-producing does not disappear no matter how it is saved. It is always passed along to someone. The money remains in the economy. Hoarding gold does not deprive the economy of your excess earnings any more than buying government debt does.

If you choose to save in debt, your money is passed on to a debtor. A debtor's natural inclination is to net-consume (consume at the margin) rather than net-produce (produce at the margin) if at all possible. So by saving in debt you actually encourage a natural predilection to produce less since you enable specifically those people with the tendency to borrow rather than produce. In the long run you end up with high unemployment.

But in Freegold, the money that comes from net-producing is passed on to other net-producers who choose to sell their gold for one reason or another. These "dishoarding" net-producers (savers) are either going to use that money for consumption or they will use it for productive purposes like starting or expanding a business. All of these uses tend to employ someone. And if the easy money camp is managing the currency prudently, some may even sell their gold for money just so they can lend it for productive purposes, or invest it in promising ventures.

Debt-financed consumption only expands the total amount of debt and the ranks of the unemployed. The idea that debtors borrowing to consume can sustainably raise employment levels is pure hogwash.

So in no uncertain terms, Freegold is the key to true full employment! Debt as an alternative to gold ultimately leads to high unemployment! Izabella, Munger and the Dingbat are all dead wrong!

The Winds of Change

Are you enjoying high unemployment yet? The $IMFS is, even though its leaders will never admit it. One of the Fed's (quote-unquote)
"mandates" is full employment and Obama touts (quote-unquote) softening unemployment while the number of PhDs on food stamps has tripled.

Everyone would enjoy full employment, right? The debtors, the savers, the economy as a whole? Well, maybe everyone except the welfare junkies. And who's the biggest welfare junkie of them all? The only hint I'm gonna give you is look at the picture at the top of this post. See? Welfare junkies don't always look like this:

The flight plan to global unemployment was filed in 1922 when they came up with the brilliantly circular idea of using credit as the store of value foundation for credit. Of course global unemployment is a fantasy island destination, so here we have had an emergency hard landing on the island of reality with a brief layover before heading toward our new destination, change.

Banks can provide all the credit the debtors need beyond their ordinary income (and that includes governments). There is no fundamental economic need for the savers to contribute their surplus earnings through debt securitization as a store of value. All that does is encourage unemployment.

The savers have no business being counterparty to the debtors. A German economist, uber-easy money camper and social justice activist who wrote the book on easy money a century ago even said as much. From his book cleverly titled 'Free Money' on which John Maynard Keynes showered fulsome praise, here's Silvio Gesell:

"And it is clear that money cannot be simultaneously the medium of exchange and the medium of saving - simultaneously spur and brake.


I therefore propose a complete separation of the medium of exchange from the medium of saving. All the commodities of the world are at the disposal of those who wish to save, so why should they make their savings in the form of money? Money was not made to be saved!"

And a fun quote from Keynes:

"I believe that the future will learn more from Gesell’s than from Marx’s spirit."

The Debtors and the Savers is simply a common sense adjustment to the prevailing dichotomy of the Capitalists and the Laborers, or the bosses and the workers. It is a slightly altered lens with which to view the history of the world. The old lens has a bloody history of leading to dangerous and deadly confrontations. It will also prevent you, personally, from understanding Freegold early enough to profit from that understanding.

Of course all present goods and services get used in the present, but that doesn't mean that surplus value is only an illusion based on exploitation. Surplus value is very real, and savable through any length of time and in theoretically limitless amount. But not if you're using debt as the medium. Using debt, too much "savings" becomes a burden which is then dealt with one way or another.

Everyone will understand this eventually, although it may not specifically be called "Freegold" in the end. Thinking for yourself pays. Seeking reassurance feels good, but it doesn't pay. Waiting for official confirmation is also rewarding, but the reward isn't money.

"Change isn't easy. More often, it's wrenching and difficult. But maybe that's a good thing. Because it's change that makes us strong, keeps us resilient, and teaches us to evolve."

FOA: "It has everything to do with a changing world financial architecture. And I have to admit: if you hated our last one, you will no doubt hate this new one, too. However, [and here's the all-important caveat] everyone that is positioned in physical gold will carry this storm in fantastic shape."


[1] Note to Izabella: When I use you in a post like this you shouldn't take it personally. I never expect to change a fixed mind. You were simply used as a literary device, so please don't take it personally. Or do… that could be fun!

Sunday, June 10, 2012

Blondie's View

I thought Blondie's excellent comment was just about good enough to be a post. And when RJ called it Sermon on the Mount material, that tipped the scale. But be careful not to miss the forest for the trees, or the fractal for the chaos, because Blondie pretty much nails it. It's all in the view—the perspective. And even though you may not be a giant, you can still learn to view the world as a giant with a little practice. It's easier than you might think. All you have to do is gently set your shrimp baggage on the ground and walk away.

Blondie on the Mount

Another said:
"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"

If this statement appears the least bit cryptic, if it does not make 100% crystal clear sense, then little else written on this blog by either the contributors or the scant few commenters who do understand it will make complete sense to you, despite your best efforts.

You see, my friend, in this world there are two types of people: those who PRODUCE, and those who consume. YOU consume.

Those who PRODUCE, and there is perfectly good reason why it is written in caps, are giants. Everyone else, including YOU, is a shrimp.

Another’s statement above is the perspective of the giants, not the shrimps. So don’t feel bad if its inherent truth is not self-evident, you have simply never directly experienced life as a giant. No shame in that! That in itself means nothing at all.

Except that you don’t have the perspective from which to understand gold. So you'll have to build it from scratch.

In this case actually understanding gold means firstly having to discard an awful lot of fundamental beliefs about the way things work. This is also the single biggest barrier to discussing gold with anyone else… they will never understand without ditching some of what they hold as fundamental beliefs, so you may as well not bother. If you win anyone over it is ultimately only because of their faith in you and your perceptions, not their own understanding. But I digress.

You may appreciate that we need gold to fix our monetary system, but that does not mean you actually understand how gold really functions.

Gold functions as the ultimate store of value. Nice words, nice idea, but you are a shrimp. You’ve never had value in a quantity that needed storing. Sure you may have “savings”, but you’ve never personally experienced diminishing marginal utility to the degree that gold’s function becomes apparent, so it remains a theory. There is a monumental difference between mere theory and theory corroborated by experience. The latter has graduated from theory to fact.

This is the basis of my previous comment about ‘new money’ and the fact that it does not necessarily understand gold. New money for the most part believes it has its surplus value securely stored in various financial instruments. Old money (real giants) knows better. This perspective is also why the idea that Oil would not require physical gold for their surplus is preposterous.

Another told you that you could follow in the footsteps of giants, and you can, but if you want to see their perspective there’s a bit more involved.

Newsflash: $US HI already happened. That’s what the ‘structural support’ since the early ‘80s has been in aid of, to avoid the conclusion of this process. As FOFOA has pointed out so clearly, as long as the marginal flow of excess dollars emitted by the US is absorbed into the market the dollar can continue to function. The devaluation of the currency is a market driven event, the final stage of every HI, but it does not occur as long as the excess currency is absorbed. Some entities have not wanted it to occur until they were better prepared, so they have, at no small cost, supplied the structural support to delay the denouement. Obviously they felt the costs were outweighed by the benefits.

The revaluation of gold is a distinctly separate though concurrent event.

If you understand how gold works you will appreciate that the giants have no incentive to directly trigger either of these separate but simultaneous events… they already have their gold, and they already know its value (and who wants to be blamed for something that was completely unavoidable?). If you don’t need to access the value you have stored in gold, then it is really irrelevant to you what the market currently values gold at. They don’t need the shrimps to tell them anything; rather it is the shrimps who need to wise up. Shrimps are the same ones objecting to “austerity” aka living within one’s means. Doesn’t occur to them that the fantasy may have been the time when they lived over and above their means, does it?

I got a good laugh from this article, particularly the opening paragraphs:

"So what is it about money that the leaders of the eurozone don't get?

Money has been around for a while, and it's not terribly complicated.

The key element is trust. That was true when money was a piece of metal that you could bite or bounce. Now that money is just a piece of paper, it's even truer. Today's money is nothing but trust.

That's why the euro crisis is so bizarre. The euro is, in theory, one of the world's great currencies. And yet, as this crisis has demonstrated, nobody actually stands behind it. There is no lender of last resort. There is no "full faith and credit." There's nobody on the other end of the promise.

And it's as if the leaders of the eurozone wanted to go out of their way to prove it. They've taken us up to the velvet curtain and then themselves, with a self-satisfied smile, pulled it aside to show us that there is no Great Oz.

And in the process they've done major, and perhaps irretrievable, damage to their own currency and to the very idea of money in our time. If you can't trust the euro, what paper can you trust?"

Looks to me like the “leaders of the eurozone” get it fine… the author is simply under the presumption he understands money. Doesn’t seem to have occurred to him that he may not.
He’s definitely not alone.

"It's just a shift in the perception of savers. Can't change that."

“Savers”: those producers who currently do not understand gold.
Consumers (shrimps) are just along for the ride.

As I said at the top, if Another’s statement is not crystal clear you don’t understand gold, so don’t delude yourself that you do, and bear this in mind when you compose a comment.

I've no doubt my comments will upset some people. That doesn't mean they're not correct, just that some people don't like them. A bit like "austerity" perhaps.

milamber said:

"... to this western shrimp’s mind, there is a whole lot of unlearning that I have had/am having to do!"

I appreciate that, having been there too. To be honest, it's not as difficult as it appears. Like many others, it became clear to me a few years ago that big things were going down. I felt compelled to find out what. It wasn't a big step to see that this was entirely a monetary issue. When I thought about it, I couldn't produce a really good definition of money, so ... I had some work to do. Build yourself a good definition and Another's perspective, not to mention the world at large, start making a lot more sense.

Friday, June 1, 2012

GLD Talk Continued

As many of you know from the comments here and on Twitter, Victor The Cleaner just completed a great new post called GLD – The Central Bank Of The Bullion Banks. The timing was pretty neat. Lance Lewis' GLD Puke Indicator delivered a buy signal on 5/22 and Victor and I have been emailing extensively ever since that day discussing my view of the GLD Pukes.

During our discussion Victor conducted an analysis of the Puke Indicator using a hypothetical trading strategy based on buying spot gold at the puke and selling once the gold in GLD is replenished and found that it optimized at a puke size of about .5% of the inventory. Using 250,000 ounces as the puke size, he found that the $PoG climbed four times as much (annualized) in only one-third of the time (between puke and replenishment) as it did during the remaining two-thirds of the time. This was a significant finding which, at the very least, showed that the Indicator really does work. Using Lance's 1% threshold the trading strategy was a little less optimal, but perhaps Lance's higher threshold is more immediately predictive of big moves like today. I don't know.

But that's some timing, huh? Vic finally got his post up late last night and then today we have a jumbo up-move of more than 4%! At the very least I think it demands a little bit of attention.

Costata really enjoyed Victor's post and he emailed me with a few comments about it. I felt that Costata had maybe missed some of what I thought was an important thrust in the post and so I tried to summarize in one short email a few of the things that Vic and I had discussed over nine days of long emails. Not everything we discussed made it into Victor's post. Victor is meticulous in his exposition while I often try to cover too much ground, requiring me to just touch on some things which, if it was Victor writing, would require a toy model, some characters with alphabetical names, and a fancy chart or three.

Anyway, Costata suggested that I should post my email and JR concurred, so here you go, with minimal polish:

Costata: "It also occurred to me just now that if this analysis is correct, it makes the possibility of a run on the unallocated accounts with the LBMA clearing members even more remote. The "large buyer" at the LBMA that VTC speculates about appears to be extremely disciplined - the BIS perhaps.


Me: No, VtC divided it into two possible theories. Large buyer who knows the bottoms in the markets is one theory, an unlikely one. The second theory he called “speculative interpretation” is the real message.

If the BBs are redeeming GLD shares to fulfill allocation demands, that implies that they do not have enough 400 oz. bars outside of GLD to fulfill those demands. And that also implies that the BBs are using GLD shares as reserves.

Obviously 400 oz. bars come and go. They come in from mines, scrap and hapless investors and they go out to allocation demands and deliveries. That’s the flow. So when we see a GLD puke, we infer they were essentially out of 400 oz. bars at the time. There is no other reason for a BB to redeem GLD shares, even if it is performing the arbitrage. GLD shares, for all practical purposes, are as good as 400 oz. bars not in GLD from the perspective of a BB. As shares, the BB reserves can even be lent at interest to those who want to short GLD. In fact, the BBs could potentially have only GLD shares as their reserves, which is why Randall Strauss called GLD a “central coat-check room” for the BBs. The pukes suggest to me this may be the case.

That flow from the mines to investors is the flow. Remember when there’s not enough supply in that flow is when the stock to flow ratio explodes toward infinity. With this view, we can infer this may be what is happening with each puke.

We can’t really look at the size of GLD and the size and frequency of the pukes and extrapolate a timeline. If you look at Lance’s chart, the size of GLD peaked in 2010. If we suddenly see a puke of, say, 10% of the GLD inventory, I’d say it’s game over starting there. The largest puke so far was about 4% over two consecutive days last August. That was about 50 tonnes when the PoG was around $1,800. That was HUGE. Almost $3B.

So when the pukes happen, that is BB heart attack time, but then the price rises and eventually (so far) the puke gets replenished. So as the price rises, the reserves are stretched and so is the inflow. As Victor said, the inflow of gold from the mines is relatively constant by weight but the outflow is normally constant in currency terms. So they raise the price until the puke is replenished and then they stop. That’s the message in the post.

How they raise it, which he didn’t go into, is a little more interesting. From that LBMA survey, we can see that the LBMA had net sales in one quarter of 7,575 tonnes of paper gold. That’s a gross increase in the amount of paper gold in existence over only three months. 100:1 actually seems conservative in this light. That’s most likely FOREX use of gold as a hedge or a currency play. But even still, the BBs have to hedge their price exposure when selling that much paper gold. Without a hedge, that would be a 7,575 tonne naked short position for the BBs.

So that net increase in paper gold is also a net inflow of cash for the BBs, cash which they use to hedge that net exposure. In fact, we can see from the LBMA survey exactly how much cash it was. It was $338B. That’s over 3 months, so it’s more like $5.4B per day inflow. That’s a small percent considering the daily turnover in paper gold used as a FOREX currency is $240B and the daily turnover of all currencies is $4T. So in a $4T/day FOREX market, that’s a $5.4B/day net flow from other currencies into gold. That was $5.4B per day in Q1 2011 that needed to be hedged by the BBs.

There’s no way they hedged all of that in the “gold” market (Comex/mining forwards/GLD). It’s simply not big enough to absorb that rate of flow without rising a lot faster than we saw it rise. So the BBs must be hedging this exposure the way they hedge net positions against other currencies in the FOREX market, simply using complex formulas and derivatives that look at correlations between different things. Correlations change slower than raw price changes which (they think) gives them time to adjust their hedges if the correlations start to exceed the model parameters.

Anyway, that is a plausible way they are hedging their exposure to the price of gold without doing so in the “gold” market per se. But they can also hedge some of that exposure in the gold market as well, by going long gold on the Comex or some other way. So if they want the price to rise in order to stretch the physical side and (hopefully) replenish the GLD puke, they would simply shift some hedges from complex derivatives into Comex.

So even though they have some control over the price of gold, they are still relying on other market players from the physical side to respond as expected. And from the view of GLD as their reserve pool, we can see that reserves are not only quite finite, but they also peaked almost two years ago.

A/FOA said the ECB/BIS strategy was to “expand and support” the dollar paper gold market so the dollar would eventually “bankrupt itself” just to keep the gold market going and stay in the game with the euro.

FOA (08/13/01; 07:24:30MT - msg#96)

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 [the ECB/BIS is supporting and expanding paper gold as a strategy]. 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.


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.

So it seems that as the war switched from dollar v. gold to dollar v. euro, the euro side helped make the dollar gold market TBTF. But with a rising physical gold price/demand, the dollar paper gold market has to keep up because it’s TBTF now. Too many of those “gold” FDIC stickers out there! If those stickers fail, the dollar loses. So the “gold” market is TBTF. Remember this from FOA?

FOA (10/9/01; 10:05:48MT - msg#117)

What doesn't seem to be obvious is the "why for" the paper market grew so large. It grew to dominate because worldwide dollar expansion reached its "non-hedged" peak. In other words, the dollar's timeline was ending as its ability to produce non price inflationary economic gains came into sight.

In order to push dollar holdings further, international players needed and purchased "paper financial hedges" to balance their risk. Within their total mix of derivative hedges were found "paper gold price hedges"; modern gold derivatives. The important thing to remember is that these positions are not and never will be used to demand physical gold. They are held to buffer financial and currency risk associated with holding any form of dollar based asset. To work these items don't need to really perform "dollar price movements" in the holders favor as much as they are present in the portfolio to act as insurance stickers.

In that truth, these paper gold positions act like FDIC insurance at our banks. It can and will manage only a small determined portion of bank runs,,,,, not a full scale failure of the banking system. In a real full banking failure we would all get, perhaps, 80% of our covered $100,000 and 10% of the rest.

The same is true for these gold position's performance; real gold delivery along with true price performance, matching real bullion trading, would be only for the very few. For that matter, an actual functioning paper gold marketplace would be for the very few, too! But, in the same way a bank account owner understands the credibility of FDIC insurance when times are good; the international dollar asset owner will not grasp that modern paper gold hedges cannot be allowed to work until after a real serious price inflationary run begins.

For the first time in this portion of the dollar's timeline and our lifetimes, such an inflation is about to show its face!

So the paper gold of the bullion banks is now TBTF. Of course that doesn’t mean it can’t fail. It either fails, or the USG hyperinflates the dollar as prices rise. They are related, and each will likely cause the other almost immediately, but either one could end up being the initial cause IMO. If price inflation forces the USG to hyperinflate then the paper gold insurance stickers will have to fail to perform. And if these price rises in the gold market fail to manage the flow (demand) of physical as they have so far, we’ll likely see a 10% or larger GLD puke at some point. That would signify more than a 120 tonne allocation demand, a system-busting size. They might think they can rocket the price at that point and get it back, but more likely we’ll see more allocation requests coincident with a falling (paper) "gold" price as the longs dump their worthless “insurance” while wishing they had the real thing.

FOA (06/12/00; 19:48:25MT - 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!

As I have said in the past, gold is so oversubscribed through the BB's paper gold it's more of a wonder when the $PoG rises than when it falls. Perhaps now we have a plausible explanation for why and how it has been rising over a decade, and also how it will end.


PS. I realize there's a ton of stuff I only touched on here. I hope that Victor will grace us with his presence and his meticulous Thoughts. ;)

"Effect And Cause"

I guess you have to have a problem
If you want to invent a contraption
First you cause a train wreck
Then they put me in traction
Well first came an action
And then a reaction
But you can't switch around
For your own satisfaction
Well you burnt my house down
Then got mad at my reaction

Well in every complicated situation
There's a human relation
Making sense of it all
Takes a whole lot of concentration
Well you can blame the baby
For her pregnant ma
And if there's one of these unavoidable laws

It's just that you can't just take the effect and make it the cause

Well you can't take the effect
And make it the cause
I didn't rob a bank
Because you made up the law
Blame me for robbing Peter
But don't you blame Paul
Can't take the effect
And make it the cause

I ain't the reason that you gave me
No reason to return your call
You built a house of cards
And got shocked when you saw them fall

Well I ain't saying I'm innocent
In fact the reverse
But if your heading to the grave
You don't blame the hearse
You're like a little girl yelling at her brother
Cause you lost his ball

You keep blaming me for what you did
But that ain't all
The way you clean up a wreck
Is enough to give one pause
You seem to forget just how this song started
I'm reacting to you
Because you left me broken hearted

See you just can't just take the effect and make it the cause