Think like a Giant

Footstep of a Giant - Photo of Fraser Island dunes in Australia.

By Yann Arthus-Bertrand from his book Earth from Above.

In his interview, Aquilus talked about our recent email exchange and how he had encouraged me to turn it into a post. So, with his permission, here it is. There are three sections:

1. Think like a Giant
2. It is gold that denominates currency
3. QE3

Think like a Giant

From: Aquilus
Sent: Friday, June 29, 2012
To: FOFOA
Subject: Marginal Utility Q

As I was plowing through the comments (and getting annoyed at times) I thought : why don't people understand the concept of marginal utility of gold for really, really wealthy entities? Why don't they get that if say, you get 100M in every day, that after you've bought your yachts, airplanes, cars, houses, islands, etc, the only item whose marginal utility does not diminish in time is gold. Why can't they see that, but they think that the only thing with infinite marginal utility is the dollar (or fiat money)? Why don't I turn it around and ask them: what is the marginal utility of a dollar when you're a giant? Would they get it more if that question was asked?

I know you wrote an excellent piece on marginal utility a while back (the one with the BMW example), but do you think there's any more clarity to be gained for people from this angle?

______

From: "FOFOA"
Date: Jun 29, 2012
Subject: Marginal Utility Q
To: "Aquilus"

Hello Aquilus,

Do I think people would understand marginal utility better if it was explained using dollars instead of goods? I don’t know. I think most people cannot put themselves in the thinking-shoes of a Giant no matter what. They carry too much baggage. Perhaps they think the Giants are like evil Rothschild Bilderberg illuminatis or something, so they put on those shoes and start thinking about how to plan the next false flag to keep the masses enslaved in their own filth. Or maybe they think that there’s not really any old money “super producer” Giants per se, but that all old money was earned the old fashioned way, it was stolen. Those types don’t even think of the Saudis as Giants in the sense that they are super-producers because they are too obsessed with their own judgment of the morality of original acquisition.

My point is that I don’t think the problem is the medium in which they are considering the concept of marginal utility, but it is in thinking like a Giant. Thinking like a Giant is a very handy tool in doing what I do in writing this blog. But it is a skill that must be learned and then practiced. I think marginal utility is a good step in learning that skill, but you can see that thinking like a Giant is the real prize, not understanding marginal utility. You can understand marginal utility but not be able to think like a Giant. But you cannot not understand marginal utility if you are able to think like a Giant. See the difference?

I remember reading somewhere that the Rothschild dynasty owns something like 12 castles around Europe. That’s a lot of property to maintain. I imagine at least some of those castles were probably acquired during the last 100 years within (and because of) the $IMFS. If we’d had Freegold (i.e., free floating gold) for the last 100 years, I imagine that the Rothschilds would have fewer castles yet they would still be equally as wealthy.

See? Without Freegold, you gotta put your money somewhere. So first you put it in property with a house, then you stuff that house with fine rugs, curtains, furnishings, art and classic cars, then you build a pool and a garden, and then what? You gotta buy another castle and start over. And that’s a real Giant who knows how to save.

With Freegold, I can imagine the Rothschilds downsizing a bit, maybe to 8 castles or something more reasonable like that. But unless you can think like a Giant, you’d never understand WTF I’m talking about.

Sincerely,
FOFOA

______

From: Aquilus
Sent: Friday, June 29, 2012
To: FOFOA
Subject: RE: Marginal Utility Q

On the Rothschilds under freegold, I assume the point you're making is that under continuous freegold, the same weight of gold would have locked in a lot more of their net surplus, and therefore left less cash for castles, ergo: only 8 instead of 12 castles.

On understanding marginal utility, yes, you make an excellent distinction about it being a necessary effect of thinking like a giant, instead of understanding marginal utility leading to understanding how giants think!

Actually, I was not suggesting explaining marginal utility using dollars, I just did not explain myself properly. What I was after, was explaining to people FROM the point of view of a Giant what the marginal utility of current things are, including the dollar. Unlike your excellent existing marginal utility article, this time however I was thinking of really hammering the point home ONLY from the point of view of a Giant, and using some shock and awe numbers (shocking for ants that is).

So for example, start out with a Giant that has 100mil piling up on his doorstep every day. That should get the ants' attention!

What is the marginal utility of cars, yachts, etc after a reasonable number? How about castles? Ok, once we establish that, say, 50 days worth of income takes care of all that, and additional items have diminishing utility, let's move on.

How about the ultimate liquid IMFS SoV, the dollar? What's the marginal utility of holding 315 x 100mil dollars that depreciate (queue infamous dollar purchasing power over time chart). 315 being 365-50 obviously. Not to mention hoarding the very MoE that commerce needs! What if I used dollar surrogates: treasuries? Same effect, plus I am the market after a while.. No good.

What other options do I have? Commodities? And create industry shortages? I'd get slammed pretty fast. So what's left? Quick! Think, because tomorrow I get another 100mil piling on top of what I currently have... And no, I am not ok with losing purchasing power in the long run. As a matter of fact, it's probably 3-4 generations before this should even be needed.

That's a raw draft of the kind of scenario that I had in mind: force-put the ant in the place of the Giant, no inkling as to where the money comes from (so to not get into rent-seeking), and FORCE them to pick a place for a multi generation investment that keeps its purchasing power. Make them feel the power of the daily dollar avalanche coming in so that they understand the scale at which this game is played. Does it make any sense at all, or has that been done/beaten to death enough in your opinion?

Aquilus

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On Jun 30, 2012, "FOFOA" wrote:

Hello Aquilus,

You wrote: "On the Rothschilds under freegold, I assume the point you're making is that under continuous freegold, the same weight of gold would have locked in a lot more of their net surplus, and therefore left less cash for castles, ergo: only 8 instead of 12 castles."

They don’t want 12 castles, never did. And they certainly don’t need 12 castles. So why did they buy, furnish and perfect 12 castles? When did the marginal utility of castles drop off for them? After 5 maybe? So why did they keep buying so many castles? Couldn’t they have just bought gold instead? Why do you think they didn’t buy gold instead of more castles after they already had 5 and the marginal utility of more castles dropped?

Answer that question because it leads then to what you want to talk about… "a Giant that has 100mil piling up on its doorstep every day."

Let’s imagine the Rothschilds had this very problem! So why did they buy castles instead of gold or other things they could have bought? I think you brushed past the Rothschild example too fast. Your answer: "I assume the point you're making is that under continuous freegold, the same weight of gold would have locked in a lot more of their net surplus and therefore left less cash for castles, ergo: only 8 instead of 12 castles." … is not exactly what I had in mind, and that’s not how I would explain it.

Sincerely,
FOFOA

______

On Jun 29, 2012, "Aquilus" wrote:

Well, let me see:

1. Why not just buy gold ?

Imo because at this price, dumping 100 mil a day in allocated physical you upset the apple-cart and exhaust the physical supply.

2. Why castles and art and collectible cars, etc?

Because under IMFS they are a decent long-term SoV. as they are completely in the physical plane,are unique, and therefore are meant to be hoarded and keep their value long term. Unlike say, McMansions in the suburb or Camaros :-)

Am I even close?

______

From: Aquilus
Sent: Friday, June 29, 2012
To: FOFOA
Subject: RE: Marginal Utility Q

Well, I think you have me the answer already here :

"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."

______

On Jun 30, 2012, "FOFOA" wrote:

Don’t forget that they bought most of those castles before 1971! Why not gold then?

______

From: Aquilus
Sent: Saturday, June 30, 2012
To: FOFOA
Subject: RE: Marginal Utility Q

:-) Thanks for your patience with me.

1. Physical supply: My instinct tells me that it's because the flow was so much more restricted before 1971. Production was much lower given the price/oz: http://www.goldsheetlinks.com/production2.htm

But that can't be it by itself... Let's see... Politically, hoarding gold would be hoarding "the money of the state" before 1971 and prevent money expansion when needed. The Rothschilds may have to care about that, but why would the Saudis? Hmm...

What's left? What am I missing from my ant perspective?

Let's see, how about I revisit my premises; it's usually where mistakes originate: it's 1970, I'm a Rothschilds Giant, the dollar is massively overvalued compared to the fixed gold price, gold flows are small, sovereigns like France are redeeming their dollars for gold, Rueff is making his arguments..

So do I overly corner the restricted gold flow from mines and make Central Banks pissed because they would have to dis-hoard in order to keep the flow going?

Or do I take the chunk of overvalued dollars that I cannot buy gold with, and hoard other items that are meant to be hoarded, that keep their value: art and unique properties?

They can soak up a lot of value over time very well if I choose unique ones, nothing easily reproduced; basically things another Giant would recognize as desirable in the future when I would like to unlock the purchasing power for whatever reason.

But then again, castles are highly visible and my wealth is on full display. Why, why, would I choose this option and not something more discrete? Unless (a) visibility is not that concerning, (b) nothing more discreet exists, like art for example, in the quantities I require.

And I can't forget that if I own most of "something" in the world, that something is not that valuable any longer as it loses its network effect value...

Ok I'll stop here. I feel like I'm missing something important, yet it should be obvious.
I appreciate you teaching me how to fish, not just giving me the fish to eat.

P.S. sorry for the occasional clump of words that may not make sense. I'm using my tablet's soft keyboard to "Swype" (http://www.swype.com/) the words in and the autocorrect decides it knows better than me at times. Well, on second thought, you know, maybe it's right :-)

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On Sat, Jun 30, 2012, FOFOA wrote:

Hello Aquilus,

That’s good! I think you’re getting close!

Now, if you’re a giant on the Rothschild scale, and you’ve got $100M per day coming in from your various businesses, what are you going to do with all that money?

Are you going to try to make money with your money? Buy stocks and bonds, play a little in the different sectors?

Sure, you might buy into some more businesses, but you’ve already got plenty of businesses. Your businesses are already bringing in $100M per day and your biggest problem right now is figuring out the smartest thing to do with that money. So if you buy more businesses, that’s only gonna grow your problem bigger.

Your wife does the charity circuit, but that’s only good for a few mil a month, and you’ve got $100M per day coming in.

So what do you do with it? What are you biggest concerns when considering what to do with it?

You probably have more money than anyone else. At least you have more than 99.99999% of everyone else. So would you like to double your money? I think not. At some point you’re like “holy shit, look what I got” and you don’t dare want to buy anything that’s likely to deliver you another windfall and draw more attention to your wealth than you’re already getting. So if you hear about Freegold, are you gonna pile in?

Your biggest worry is keeping what you’ve already got… not getting more. You’re even willing to lose some just to keep your profile as low as possible. The wife’s charity work helps with that, but again, you don’t even want to give too much away because that draws additional attention to your wealth.

If you hoard physical commodities you’ll piss off the people, right? And if you hoard paper commodities you’ll drive up the price and you’ll piss the people off! You’re so big that you move markets by just looking at them.

You’re so big that you’ve got to spend your money coming in as fast as possible or else the money supply will start contracting because you’ve got too much of it! (That may be a little bit of an exaggeration, but not under the gold standard!)

So tell me, did they have ANY choice at all besides what they actually did? And even that, at some point, starts drawing that negative attention. You can only have so many castles before people start wondering if you have too much money.

So what to do? At some point, the only thing to do might be to slow down a bit. Quit working. Is that what our world desperately needs? For the super-producers to quit working so much?

Sincerely,
FOFOA

______

From: Aquilus
Sent: Monday, July 02, 2012
To: FOFOA
Subject: Marginal Utility Q

FOFOA,

1. So the answer to buying castles pre 1971 (and after) was: they had no other choice. That or stop producing.

2. I'm sure I'm not telling you anything new, but parts of this thread would make the kernel for a great post!

Seeing the world from this perspective is diametrically opposed to what most people experience (The Ant: how can I get MORE cash / The Giant: how do I manage all this cash coming in?). It has only been tangentially touched upon in different articles, never as the main focus of a post. Blondie tried to explain in lately, but that was "theory", to say so. Some examples like we have here are key to most people's understanding IMHO.

You know how you had "Life in the Ant Farm?" this could be something like "What choices does a Giant have?" or " Meanwhile, in Giant land" or "The view of a Giant". I'm sure you can come up with better titles than this.

Seriously, it would be a dynamite post!

Aquilus

______

It is gold that denominates currency

From: Aquilus
Sent: Friday, August 03, 2012
To: FOFOA
Subject: Why does oil not price currencies

Hi FOFOA,

If you have time/feel like it, I wanted to run some thoughts by you on

"gold prices currencies, but oil does not".

Here's what I have:

Because:

1. Oil is mostly physical market with some futures. Paper oil market not structured as dangerous to currencies (no fractional reserve)

2. If oil flow stops, Mad Max world ensues and real economy collapses. Politically not acceptable - immediate wars. If gold flow stops, currencies can make themselves desirable again, real world plane not hurt.

3. Oil is not cornered (no expected deliveries as a multiple of existing flow), quite the opposite.

So best oil can do is insist that price in currencies ensure gold acquisition for oil extracted over what Saudis need for budget expenses + lifestyle expenses.

Am I anywhere close to the right track?

Aquilus

______

On Aug 3, 2012, "FOFOA" wrote:

Hello Aquilus,

Oil is a means of production. If you find yourself sitting on top of (and thereby owning) the largest underground oil field in the world, you find yourself on top of a great stockpile of capital (means of production used by the entire world).

Alternatively, there are 170,000 tonnes of gold out there, all in someone’s ownership/possession. All this gold marks the net-production of someone in the past. If you see someone sitting on a large pile of gold you can think “golly, he sure gave away a lot of useful wealth in exchange for all that “useless” metal that just sits there in a vault.”

So there now, you have one guy sitting on top of this oil field, and another guy sitting on top of this gold. What’s the difference? Is the guy sitting on the oil going to sell that to a net-producer in exchange for his excess production? Nope. A net-producer has no need for that oil in exchange for his “underconsumption”. He wants gold.

So we can see that the guy with the oil and the guy with the gold have different customers. The oil guy’s customers are everyone in the economy, and the gold guys customers are net-producers (savers). The net-producer might buy some of the oil guy’s oil for his production purposes, but then with his excess production he buys from the gold guy.

But the oil guy’s overhead is soooo cheap compared to the commercial value of his oil, he too is a net-producer in currency terms without even trying, and without any austerity.

When we hear the word “overhead” we generally think of it in terms of the costs of running a business. But it could also apply to the costs of running a standard of living. Everything useful that you buy and use in maintaining your lifestyle is your overhead. Anything beyond that is your savings. To an oil sheikh a pimped out 747 and 8 Rolls Royces might be part of his overhead. Also, an indoor ski slope and the world’s tallest building in the middle of the desert is part of his overhead. It’s the cost of being a rich oil sheikh. Savings is anything over and above that. And like I said, the sheikh has savings even without any austerity in his lifestyle.

Those of us in the real world have to choose between austerity and less savings. We can reduce our austerity and also reduce our savings, or we can increase austerity and increase our savings. But the sheikh almost literally has savings no matter how well he chooses to live.

So in this example, “overhead” is that portion of money that everyone spends on their lifestyle and business operations etc… and savings is that smaller portion over and above “overhead” that (only) some people put into presently useless things like treasuries, accounts or “useless” gold.

Now that I’ve distinguished “overhead” and “savings”, it should be clear to you that all oil purchases fall under “overhead” while all gold purchases fall under “savings”. And like oil, everything else in the world (except gold) also falls under “overhead” while (in the physical plane) only gold falls under “savings”.

So now that we’ve identified the main difference between oil and gold, we can say that “savings price currencies, overhead doesn’t.”

Now along this same line of thinking, we can also say that surpluses are entirely attributable to savers. In any zone that’s running a trade surplus (on any scale), the entirety of that surplus is equal to savings in that zone, so the surplus is attributable to the savers.

Can you see a pattern starting to emerge here? The relevance of savings and savers to everything? (and I’m not making a morality play here, because like I said, those rich oil sheikh’s are automatically savers no matter how big of a harem they maintain as part of their living standard, so they remain relevant to everything)

But for their savings, those oil sheikhs are not interested in hoarding currency. They want gold, as do all the big savers (and surplus zones) in the world.

So in the “overhead department” we have all the real goods and services in the world traded back and forth kind of like barter, with currency as the lubricant. But then we have this little portion on top we call savings.

It is the savers (net-producers) that run the show.

Sorry, but that’s all the time I have for now. Didn’t quite get to my point, but hopefully I gave you some more thoughts to consider.

Sincerely,
FOFOA

______

From: Aquilus
Sent: Monday, August 06, 2012
To: FOFOA
Subject: RE: Why does oil not price currencies

First of all, thank you for those thoughts.

I would like to take this conversation down this path:

“savings price currencies, overhead doesn’t.”

I feel that I am at the edge of really understanding this idea, but have not quite arrived there yet.

Are savings pricing currencies because they are a claim on future production that may or may NOT be deployed though currency? Because most (sizeable) savers can easily exist comfortably from overhead without ever dishoarding any savings unless the currency price of savings is satisfactory?

Is that really what makes savings price currencies?

______

On Mon, Aug 6, 2012, FOFOA wrote:

I don’t think it’s that simple. There are many moving parts. It is a dynamic system.

In terms of “overhead”, it’s really just a goods for goods trade… barter if you will, with currency simply lubricating the trade. Goods price other goods. An apple is worth two bananas. Doesn’t matter what currency you use.

But it’s when you try to be austere (to save, to underconsume) that it’s no longer “goods pricing goods”. Time becomes a factor when you save. Remember that the difference between a medium of exchange and a store of value is only a sliding scale in the time dimension. Any medium of exchange is also a store of value to some extent, and any store of value is a medium of exchange to a degree.

Those who use currencies in the here and now “overhead dimension” exert little effect on that time dimension.

But that doesn’t mean you want savers holding the currency for a long time. When that happens (like it is today), a currency becomes overvalued and unstable, susceptible to a disruptive collapse. What you want, instead, is a healthy balance on that “sliding scale in the time dimension”.

______

From: Aquilus
Sent: Tuesday, August 07, 2012
To: FOFOA
Subject: Re: Why does oil not price currencies

Hmmm,

I realize now that what I keep missing is the ACTUAL definition of "pricing a currency".

It keeps changing and morphing in my head from, and that might be why I don't grasp it.

Here's what I see right now, using a muddled "pricing a currency"

When talking "overhead" in the context of pricing currencies, because in the here and now, the MoE really does not matter, it could be anything from the acceptable plethora all the way to pseudo or full barter. So "pricing" a MoE on a short time scale is simply observing what amount of that MoE is necessary for my product so that the ratio of what I'm selling to what I'm planning to consume shortly, stays in an acceptable range.

On a longer time scale purchasing power comes into play, as I would like that ratio to stay in range for a long time. So the choice of SoV is crucial. I also need to be able to acquire that SoV with my currency. But if I cannot acquire the SoV in my currency (0 flow),that does not mean that the SoV is worthless, but rather that my currency has utterly failed as an MoE, as I cannot exchange it for my SoV. Same SoV that I can acquire and trade in a different currency.

So in this extended time scenario, I think I understand the pricing for the extreme margin (like in calculus when you have a limit problem - in this case $ value goes to 0 as Au flow in $ area goes to 0). What I don't quite get is the idea of gold pricing a currency away from that limit. Can you help me with what that pricing is (certainly is not the number of currency units per weight, right?)

Thanks (and I hope that I'm not bugging you too much - please let me know if you'd me rather post these in comments)

Aquilus

______

On Tue, Aug 7, 2012, FOFOA wrote:

It’s simply this. You said it right here:

“So the choice of SoV is crucial. I also need to be able to acquire that SoV with my currency. But if I cannot acquire the SoV in my currency (0 flow),that does not mean that the SoV is worthless, but rather that my currency has utterly failed as an MoE, as I cannot exchange it for my SoV. Same SoV that I can acquire and trade in a different currency.”

With that in mind, read what I and ANOTHER wrote…

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.

______

From: Aquilus
Sent: Tuesday, August 07, 2012
To: FOFOA
Subject: Re: Why does oil not price currencies

Beautiful, the light bulb just stayed on when it came to gold denominating currencies! :-)

Now I have one more thing I need hand-holding on the following (my underlining):

On the one hand (Another):

Gold! It is the only medium that currencies do not "move thru".

and on another (from http://fofoa.blogspot.com/2012/02/todays-quoteunquote-gold.html)

"currency flows through assets, not into them. In fact, a limited amount of dollars can flow through the same gold many times, over and over, driving it higher and higher with each pass"

Both passages, whereas talking about currency through gold and at first glance contradictory, cannot possibly talk about the same thing. Whereas I do understand what you're talking about with the repeated flow in your post, I must be missing something very obvious in Another's statement, or over-thinking it.

So, again, let me back it up to premises (that's how I learn). When A buys gold from B, a certain amount of currency flows from A to B and gold from B to A.

Is Another's idea of currency not moving through gold the fact that A now keeps the gold as long term savings (and thus currency flow for A stopped), and unlike things that are consumed, the gold acts like a storage tank for the purchasing power ? To be stored for long term and released into currency of different purchasing power at a different time?

And if so, all other possible saving mediums would fail the uniqueness test, not because they do not hold value, but because they cannot "bottle up" the pressure needed from the currency side (having industrial uses and not being a "focal point")?

Aq

______

On Tue, Aug 7, 2012, FOFOA wrote:

"I must be … over-thinking it."

Yes.

"currency flows through assets, not into them."

Are we agreed on this part? There’s no “currency” in the stock market. If you bought $100K in stocks your currency flowed through those stocks, not into them, and now you hold assets, not currency. Agreed?

And how do we know the value (price) of those assets? We know it by its currency price, right? China’s Treasuries are not currency. The currency China receives through its trade surplus it gives to the USG to spend. The currency flows through those Treasuries to the debtor. Now China holds those assets, not currency, right?

"currency flows through assets, not into them."

Okay, as long as we’re agreed on this part, let’s look at gold. We could say the same thing about gold. If you bought $100K worth of gold your currency flowed through to the seller of that gold and now you only hold an asset, right? The gold. And how do we know the value (price) of that gold? Do we know it as a currency price? Is that correct?

If the USG goes ballistic defending its inflow of real goods and services with the QE printing press, who is going to dishoard some gold for dollars? No one, you say? So if there’s no dollars and gold being exchanged, how do we know the value (price) of that gold? Is it valueless now that there is no dollar price for it? Or is it priceless?

How about your stocks? How about your Treasuries?

Of course we could run the same exercise with a tanker full of oil that you just purchased for $100M versus $100M in currency assets. It doesn’t become valueless just because the dollar loses value because we know oil's value relative to other goods and services. But gold’s value does not relate to other goods and services because its main use is SoV. Gold value "is arbitrary!"

So with the oil, as long as we could determine the dollar price of something, anything, we could know the going price of oil, right? Just like in Zimbabwe. Currency still priced eggs even when three eggs cost a billion Zdollars. Currency prices oil just like currency prices everything in the “overhead” realm. Because currency is only the middleman between these things’ relative value to each other. Only gold’s value is not relative to everything else in the physical plane. Gold’s value is arbitrary. It has no economic or utility metrics by which to compare it to the rest of the physical plane.

Currency prices everything (but gold) because currency is simply that middleman between their known relative values. Everyone knows that an apple is worth two bananas. So currency between apples and bananas prices those items. But there is no intrinsic, calculable relative value between an ounce of gold and a men's suit. Their relationship is arbitrary… it can be whatever subjective value the superorganism takes it to without affecting anything else. No chain reaction will happen.

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".

Get the concept!!! Don’t get too hung up on the words. It’s all about concepts, not necessarily the words. Words are fallible and limited in scope. Concepts (if they are true) have infinite resolution. Test the infinite resolution of this concept:

It is gold that denominates currency.

______

From: Aquilus
Sent: Tuesday, August 07, 2012
To: FOFOA
Subject: Re: Why does oil not price currencies

SMILE! Got it. It's nice to see how simple it is really.

Everything's value is related to everything else, except for the one "useless" SoV focal point.

I have to say, the words "gold moving thru currencies" is definitely not intuitive (to me). The "Gold denominates currencies" expression is much more on target.

If you don't have another post ready, you might want to consider putting up this last explanation as a placeholder. Explaining this concept past where the original words might be confusing is done very well in this last email. It's straight forward, full of real world asset examples, idiot-proof I might say. Just what's needed. Just my 2c.

Thanks again for taking the time to clarify all this for me!

Aquilus

P.S. Since May, I've been trying to get through all the posts from the beginning of the blog (in my spare moments/time). I'm now up to "Credibility Inflation" in 2010. It's quite an experience to understand a lot of the material before reading the posts - so much more enjoyable. But at the same time, I get these unclear things that I've been bugging you about :-) And I still have not made it through the original Trail. I think FreeGold will be upon us before I do at this pace.

______

QE3

In this case someone else emailed me a question first. I answered it and simultaneously Aquilus was tweeting similar thoughts, so I forwarded my correspondence with the other reader to Aquilus:

On Thu, Sep 13, 2012, FOFOA wrote:

Hello Aquilus,

I thought you would appreciate this. Nice tweets today.

From: T
Sent: Thursday, September 13, 2012
To: FOFOA
Subject: Questions

Hi FOFOA,

I know you've got a few great posts up coming, and I imagine that you were right on top of the FED's announcement today. My question relates to MBS purchases and I have had this thought for some time now. The FED is clearly out to gobble up this market, as it really is running out of things to buy without limiting itself to only 70% market share, however, how does the process of MBS purchases help to fund the Gov? The FED is purchasing these securities, but wouldn't this fund the banks as opposed to the Treasury? As funding the Gov't is really the bottom line here, how do these purchases work towards funding the nations yearly deficits? Which, as outlined prior, is really the aim of QE?

Thanks for all that you do.

-T

From: FOFOA
Sent: Thursday, September 13, 2012
To: T
Subject: RE: Questions

Hello T,

All the money the Fed prints for MBS purchases will be cycled through the USG Treasury account (spent into the economy by the USG). At least an amount equal to the issuance of new Treasuries.

Most people think that money from the stock and bond markets can get "scared" and run to Treasuries for safety. But the fact of the matter is that there is no "money" in the stock and bond markets. There are only assets. The USG cannot spend assets, it can only spend base money, and base money is either earned in the physical plane or it is printed by the Fed. So it cannot be the case that a bunch of "money" would ever flee the stock market and go to the USG (to hide in Treasuries) for safety. If/when that ever happens, someone who earned actual base money in the physical plane would be buying those "frightened stocks" at bargain basement prices and then the sellers would give that money to the USG to spend. The money has to come from somewhere, and it doesn't come from inside the stocks or bonds. I repeat, there's no "money" in the stock and bond markets—only assets. There has to be money coming in from the physical plane (or from the Fed's printing press) at all times.

So what the Fed is doing is injecting actual base money flow into this paper asset "arena", since the physical plane earners (both foreign and domestic) are not coming in (in sufficient quantity). Actual base money is the only "fuel" the USG can burn. It needs real base money coming in, either from foreigners via the trade deficit or from new domestic savers who earned that money, earned not through asset appreciation in the stock and bond markets, but through real physical plane production.

You can think of the stock and bond markets (including the Treasury market) as a big "arena". Money (base money) flows through it, but it never resides in it. Some comes in, some goes out. And whenever new paper assets are added as in the case of regular Treasury auctions, that is one of the avenues where money flows out of the arena. This outflow must be matched by inflow, period. If there's not a sufficient inflow, then the Fed must print, which it is doing now.

Of course they are also hoping to goose the housing market, but understand that new mortgage creation does not require a constant flow of base money the way new Treasury creation does. The big banks have plenty of reserves right now so the only thing limiting new mortgage creation is demand from borrowers, not supply of base money reserves. And mortgages are created "out of thin air". Treasuries are not. Treasuries require 100% base money flow. And that's what the Fed is injecting into this "arena".

Sincerely,
FOFOA

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From: Aquilus
Sent: Monday, September 24, 2012
To: FOFOA
Subject: Re: FW: Questions

FOFOA,

I do have a question on the stuff below, when you get a chance.

For purchasing Treasuries, I am not seeing something important: I can see why Treasury spends base money, just not why the money buying treasuries cannot be credit.

I can imagine any US bank creating credit to buy treasuries, and holding those treasuries on the balance sheet as risk-free assets. I guess I don't see is why is it necessarily base money that flows into Treasuries?

Can you help me out with this please?

Thanks
Aquilus

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On Sep 24, 2012, "FOFOA" wrote:

Okay, say a commercial bank expands its balance sheet for the purpose of buying Treasuries. It has created new liabilities which it has transferred to the Treasury. The Treasury "bank account" is at the Fed, so those liabilities get cleared with 100% reserves. In theory, the commercial bank which expanded its balance sheet now owes (has liabilities to) the USG's bank, which is the Fed. But the commercial bank also has an account at the Fed, its reserve account, consisting of liabilities of the Fed to the commercial bank, its reserves.

So there's a 1:1 (non-fractional) correlation between the new asset and the number of reserves required to clear that transaction. In other words, if the commercial bank bought $1,000,000 in Treasuries, its reserve account would be debited $1,000,000 in reserves which would be transferred over to the Treasury's account. The commercial bank liabilities would all be cleared. Then when the USG spends those dollars into the economy, the reserves would reenter the commercial banking system and the liability would reappear at whatever bank the USG stooge deposited his check. That bank liability would now be a liability to the Stooge, until he spends it passing it on to someone else.

So, now, looking at the original commercial bank's balance sheet, the one who "bought treasuries from thin air", the Treasuries were added to the asset side of the balance sheet but they were not matched with added liabilities. Instead, they simply displaced existing reserves which were removed and given to the USG to spend. Can you see the difference?

If the bank had instead originated a new home loan "from thin air", that new asset (the mortgage) would be offset with new liabilities. The mortgagor would then spend those liabilities and they'd be transferred to another commercial bank so they'd clear fractionally along with other transactions. It's all a big churn of available funds. For us in the real world, the private sector, we churn bank credit and then the banks in turn churn reserves fractionally among themselves to clear our transactions.

But all spending that goes through the government carries a unit of base money (reserves) with it. When the USG spends, some stooge gets a paycheck. When he deposits that paycheck, the bank gets a liability (to the stooge) and a reserve (from the Fed) added to its balance sheet.

So, in reality, our bank at the top did not "expand its balance sheet". It simply swapped a reserve of one kind (base money) for a reserve of another kind (Treasury). It was simply an asset swap. So the money buying the Treasuries was the bank's base money reserves, not pure credit.

"just not why the money buying treasuries cannot be credit."

Imagine a bank with insufficient reserves trying to buy Treasuries with only its credit. It will transfer its liabilities to the Treasury's account at the Fed and now its liabilities to the Fed will exceed the Fed's liabilities to the bank. This bank will now be essentially reserve-less. In fact, it will be in a position of negative reserves. The only way for it to get reserves back would be for the Fed to buy some of its assets. So now, who actually funded the Treasury in this case? The Fed did by creating new reserves for the bank which bought the Treasuries.

The key to pay attention to is that every dollar the USG spends into the economy comes with 1 unit of credit money + 1 unit of base money. In other words, the USG emits a liability along with a reserve into the commercial banking system. Anyone other than the government who spends money only emits (transfers) a commercial bank liability. But the USG emits an attached pair, like a molecule with two attached atoms.

The monetary system is simply the record keeper of what's going on. We think of the government taking in money and then spending it. But in reality, the government is not constrained. It will keep on spending no matter what. The only thing that can stop it from spending is a crash in the value of its unit (hyperinflation).

So we look at "what's going in" and compare it to "what's coming out" of the USG spending machine. "Money going in" comes from three sources: 1. Taxes, 2. Borrowing, 3. Printing. What we're interested in (or what we should be interested in) is whether that "money going in" is a fully formed molecule with two atoms or simply a lone atom which the USG then converts into a molecule.

In the case of taxes it's all molecules going in. In the case of borrowing, it's all molecules as long as the purchaser of the Treasuries is spending a commercial bank liability (credit atom) he earned. As that credit money passes to the USG account at the Fed, it attaches itself to a commercial bank reserve unit which temporarily leaves the commercial banking system until the USG later spends it back into the commercial banking system.

Only the Fed can create new unattached, individual (base money) atoms. Like I said, the USG's spending is technically unconstrained. It can and will simply keep on spending. But if its spending exceeds the money coming in from taxes plus earned credits lent to the USG, then the aggregate balance sheet of the monetary system will fall out of balance. To keep it in balance, the Fed creates new atoms. Which the USG converts into molecules.

Say the Fed does $600B in QE but only buys MBS from the commercial banks. The Fed has created $600B new atoms (reserves) which only become molecules once they pass through the USG spending machine. All the Fed has done with the commercial bank balance sheets is an asset swap, a new reserve for an asset. No new credit money (commercial bank liabilities) has been created. New credit money is created when the USG spends in excess of the credit money coming in, either through taxes or borrowed from real savers. This commercial bank who just swapped MBS with the Fed for new base money could now swap that base money asset with the Treasury for a Treasury asset. And yet still, no new credit money has been created… until the USG spends it.

So, in essence, the commercial banking system created new credit money (commercial bank liabilities) when it originated the home loans which created the MBS. That is now circulating. Then the Fed created new base money which it swapped for the MBS. Now the commercial bank is free to swap that base money with the Treasury who will create more new credit money by spending it.

"I can imagine any US bank creating credit to buy treasuries, and holding those treasuries on the balance sheet as risk-free assets. I guess I don't see is why is it necessarily base money that flows into Treasuries?"

Can you see now how any US bank cannot create credit which the USG can spend? The USG can only spend earned credit (earned through production in the physical plane) or else the USG is actually creating new credit money when it spends, without any offsetting production in the physical plane. The money the USG spends either comes from taxes, net-producers (real savers), or else it is inflationary. A base money unit passes through the USG with every dollar it spends. A credit money unit exits along with that base money unit as well. The only question is whether that credit money unit (commercial bank liability) was surrendered to the Treasury from someone who earned it, or created from thin air by the very act of the government writing a check to a government stooge.

In extremis, try to imagine ALL commercial banks swapping ALL excess reserves held at the Fed with the USG in exchange for Treasuries. Let's look at their balance sheets. Their liabilities would remain exactly the same, but their assets would have changed significantly from a healthy reserve ratio to a nonexistent reserve ratio… no reserves, all assets. Now the USG spends all those reserves back into the economy along with new credit money units (commercial bank liabilities). The reserves reenter the banking system but the liabilities increase 1:1 with the amount of reserves. Rinse and repeat.

While I suppose this is theoretically possible, it's not very practical; just think about how directly inflationary it would be! I'm not looking at monetary aggregates for the inflation. I'm looking at direct spending that's not offset by physical plane production. And I think another problem that's probably preventing something like this is the ongoing deleveraging within the banks. This deleveraging is competing with the Treasury for spendable reserves, which is another reason the Fed has to inject new reserves.

That ZH article linked by Michael dV said that the "shadow banking system" (which is really just "money markets" with no real money in them, only assets) has undergone $300B in deleveraging so far in 2012. You have the USG which needs to extract $3.6B per day from these markets competing against the deleveraging for the scant "new inflow" of money. The trade deficit seems to be supplying $1.5B per day, domestic "savers" (pension funds) must be supplying some amount, and the Fed seems to be picking up the slack. Remember, it's money in, money out. There's no actual money "in" these markets. Only assets with prices. And deleveraging is essentially "money out" competing against Treasury for the new money coming in, either from savers or from the Fed.

My sense is that the current rate of QE is simply not enough. The USG is not going to stop spending, so something has to give. Either interest rates explode upward (not going to happen), the stock market collapses in free fall (might happen, but then they'll print immediately), or the Fed ramps up QE somehow. Even if they manage to do this without a press conference, it will show up in the dollar exchange rate and/or CPI price inflation. That's where the death spiral begins.

Other analysts seems to want to look at quantitative measurements to determine timing. They want to see X hit Y% or whatever. But that's not how it happens. It happens where the rubber meets the road… at the margins where the USG spends. It happens where the monetary plane is exchanged with the physical plane, because that's the only exchange rate that matters. It happens in physical plane prices. And that roadside IED is very unstable, IMHO. It might take a big truck hitting it, or it might just blow if you look at it too closely.

______

From: Aquilus
Sent: Monday, September 24, 2012
To: FOFOA
Subject: RE: FW: Questions

Thank you!!! Very clear. More feedback tomorrow after I re-read.

Aq.

PS: it makes so much sense that I kick myself for not having taken that one extra mental step and asked "who is the Treasury's bank?" More tomorrow, but thanks again!

______

On Wed, Sep 26, 2012, FOFOA wrote:

Thank you, Aquilus.

BTW, I have a bold new concept I'm working on right now, which will include a proposition for you. I'll present you with the details soon. ;D

Sincerely,
FOFOA

PS. Have you ever used Skype?

______

From: Aquilus
Sent: Wednesday, September 26, 2012
To: FOFOA
Subject: Re:

Skype? Of course. Just let me know when.

I figured you'd be up to something. You've been quiet as a mouse for many weeks now :D Look forward to it.

P.S. I am not joking when I say that last email expanded perspective about the flow of base money/credit when it made me follow the transactions. I realized how intellectually lazy I had been - stopping at the initial concept of credit creation, gov spending that you spoon-fed us in the posts and not taking that deduction further myself. Just being honest with myself here. I like the "molecule" vs "atom" description.

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On Sep 26, 2012, "FOFOA" wrote:

Yes, the molecule/atom analogy is a good one! I came up with that one just for you! ;-)

I think the key is that "the markets" (meaning the stock, bond, treasury and money markets, including what ZH calls the "shadow banking sector") are all just assets with no "money" in them. There's "money in" and "money out". It's very similar to a Ponzi scheme in that no one can take out a single dollar unless a dollar is going in on the other side. Only money coming in supplies the drain of money going out. But unlike a Ponzi scheme where at some point there's not enough new money going in to fund the redemptions, the Fed can actually put brand new money in at any time.

Imagine if Bernie Madoff had a printing press. His Ponzi scheme would never have needed to collapse. It's kind of like the fact that 1930's style bank runs won't ever happen again. Instead, this time, the value of the dollar will collapse.

Money is fungible, so it doesn't matter where the Fed is injecting it, into MBS, or AAPL, doesn't matter. It's all part of the "money in" to the arena and the USG is the main "money out" so unattached new atoms all get combined through the USG. "Money in" from savers (domestic or foreign) is all full molecules. "Money in" from the Fed is unattached atoms and the USG is unique among the various drains on the system in that it can turn atoms into molecules. So that's how USG deficit spending is directly inflationary in the amount put in by the Fed, no matter where it put the new money.

Sincerely,
FOFOA

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