Monday, March 23, 2009

All Paper is STILL a short position on gold

Think about this great business idea for a minute. Let's borrow some surplus stuff and sell it for whatever we can get. We'll buy a futures contract to get it back at some certain future date, so we're covered. Meanwhile, we'll earn an interest spread plus commissions. While we're at it, let's sell puts and calls against the stuff even if we don't have it on hand. Our mathematical models will guarantee that our position is always neutral, and we'll clean up on commissions, interest and other fees on the options too.

The foregoing approximates the rationale of the present day, little-known gold derivatives pyramid. John Exter, a famous gold analyst almost two generations ago, was the first to suggest that gold related to paper assets in the form of a pyramid. He described the relationship of gold to paper assets as an inverse pyramid balanced on trust. Currency at one time was a gold derivative. Government issue was backed by physical gold held by central banks. Because currency was a claim on gold, it was in effect a short position against a physical asset that was relatively easy to calculate. Governments hated the idea because they could never seem to stop issuing new paper. Even the pretense of a link has been long abandoned. Since currencies no longer have gold backing, and the world still appears to function, nouveau central bankers assert that gold is superfluous.

The gold derivatives pyramid is a vigorous free market creature. It cannot be put down with a simple declaration that the paper is no longer redeemable in gold, as governments did with currency. It is a short selling scheme that has become a trap from which few short sellers will escape. Paper claims in the form of derivatives far exceed the underlying physical metal on which they are based. The trust, which balances this new pyramid, is based on false assumptions and lack of information. Paper gold claims have proliferated at a pace rivaling any government printing press. A surfeit of paper gold has driven down the price of the physical on which it is based.

The above was written by John Hathaway in 1999. Here is John Exter's inverse pyramid:

Click on images for a larger view

Today I read an article titled "Hyperinflation is Impossible: Part 1" by Matt Stiles. It articulates the position of the deflationists well and it makes some powerful arguments in this regard. The most powerful argument is quoted in this article. It is:
It is often said that we live with a "fiat currency" or with "paper money." This is not entirely accurate. A very small portion of our total supply of money and credit is in the form of physical currency. It depends on how you count it, but regardless, it is under 10% of the total. This is what differentiates our monetary system with that of Zimbabwe or Weimar Germany circa 1920's. Their economies were based on nearly 100% physical currency because nobody would accept the promises of government in order to issue credit.

The vast majority of our money supply is in the form of electronic credit. Electronic credit can be destroyed, while physical notes issued by a central bank cannot. This is why deflation is possible in a credit based monetary system, but not in a paper based monetary system.

This is an argument that seems very convincing on first glance. So I decided to make a few comments on Stiles full article. Here they are:
Hyperinflation is Impossible: Part 1
by Matt Stiles

The government and Fed only control a small portion of the total supply of money and credit

I get a lot of emails and questions from readers and friends about whether I think the U.S. Dollar could collapse and start a bout of terrible hyperinflation. The questions are usually stemmed from watching an interview on TV with extremely biased energy/gold analysts. People who have every reason to sell you on hyperinflationary doom in order to make themselves a quick buck. I have no respect for these people, so I will not publish their names. They know who they are. I call them the "opportunistic hyperinflationists."

FOFOA: With the people he says he greatly respects in the next paragraph, I'm not sure who he is referring to here. Are Jim Sinclair and John Williams out to make a quick buck? Perhaps he is talking about Jim Willie who charges for a newsletter, but also writes many public articles as well. Chris Laird? Same story. Even some of the deflationist newsletter writers like The Privateer are now talking about a hyperinflationary collapse. So I'm not really sure who it is that he disrespects so much that he won't name. Maybe it's Glenn Beck.

But there is another group of "inflationists" who I do respect greatly. Guys like Peter Schiff, Jim Rogers, Doug Casey and Jim Puplava. These guys have spent years, if not decades, railing against the growing debt bubble and warning that it would end badly. A large faction of the Austrian School of Economics (of which I consider myself a student) had been doing the same. They are the "ideological hyperinflationists."

However, this group of economists/pundits/analysts have been terribly wrong in predicting how this debt bubble would unfold. And I am certain that they will continue to be wrong as it continues and reaches its ultimate conclusion. Typically, these folks have a fundamental dislike of our current system of currency. They feel it is immoral, illegal by the U.S. constitution and is doomed to failure as all paper currencies have been since the beginning of civilization. I agree with them on all counts. But as a function of their dislike for paper money, they have been enchanted by its most obvious replacement: gold. They carry it around with them and flash it at interviews. They become walking salesmen for the return to a gold standard. And they point to a rising price of gold as proof that they have been right all along.

They haven't and aren't.

FOFOA: Matt, in this section I think you expose your anti-gold bias, and you also draw into question your statement that you are a student of the Austrian School. I realize from later statements you make that you are paying attention to the psychology of the markets instead of just the math (which is an Austrian tenet), but that may be where your Austrian similarities end. Let's see.

Their arguments are usually the same. That in order for the massive amounts of debt to be repaid, the Federal Reserve and other central banks are going to have to resort to monetizing that debt via the "printing press." Their claims are well documented. Even the chairman of the Federal Reserve has promised to do this, should it prove necessary, earning him the nickname "Helicopter Ben" (after promising to drop money from helicopters to prevent deflation). And it appears he has already started. We can see it in their own figures. By now, I'm sure all of my readers are familiar with the Monetary Base "Hockey Stick" graph below that shows how the Fed has essentially doubled the monetary base in just a few short months. This, claim the inflationists, is visual evidence that hyperinflation is already occurring and will inevitably start showing up in everyday prices:

Another common claim by these folks is that inflation is running at far higher levels than what is reported by the very flawed CPI measurement. For proof of this claim, they'll point to John Williams' "Shadowstats" counting of inflation in charts like the one below. It shows that if we only counted inflation like we did pre-Clinton Administration, inflation would be much higher than we're told.

In this article, I will explain why these arguments are wrong.

Money and credit

First and foremost is the apparent misunderstanding of the differences between money and credit. At times, they may appear to have the same characteristics. At other times they act completely opposite from one another. As an economy is expanding, an increase in the total amount of credit would appear to have the same effect as an increase in physical dollars because credit is widely accepted as an equal to money. In a sense, they are the same. They are both "fiduciary media" (in english they are both a representation of something else, rather than having intrinsic value themselves). But when the economy is contracting, the prospect of default is thrown into the equation. When this happens, money increases in value relative to credit. Money is more valuable than credit because in the event of default, the physical dollar holders are king. Yes, the U.S. treasury could default on it's obligations. Holders of treasury bonds would get a big, fat zero, while holders of physical currency would still have a claim. In effect, they act similar to a preferred share as opposed to common stock. They are a step above in terms of priority.

FOFOA: You make a very good point in this paragraph. Physical currency (M0) is farther down on the inverse pyramid than the higher M's, and certainly farther down than debt like TBills. And during an asset deflation, capital flows down the pyramid. In deflation "Cash is King", a point I made in On "Hyperinflation". But the question is what is really the "cash" that statement is referring to? What is really the bottom of that inverse pyramid that capital is striving for? Is it government paper? Or is it still the old foundation, gold?

It is often said that we live with a "fiat currency" or with "paper money." This is not entirely accurate. A very small portion of our total supply of money and credit is in the form of physical currency. It depends on how you count it, but regardless, it is under 10% of the total. This is what differentiates our monetary system with that of Zimbabwe or Weimar Germany circa 1920's. Their economies were based on nearly 100% physical currency because nobody would accept the promises of government in order to issue credit.

The vast majority of our money supply is in the form of electronic credit. Electronic credit can be destroyed, while physical notes issued by a central bank cannot. This is why deflation is possible in a credit based monetary system, but not in a paper based monetary system.

FOFOA: The differentiation you are making here needs to go even further. Yes, electronic money credits can be spent just the same as paper money. But the actual electronic money credits that can be spent, cannot be destroyed, unless a bank fails and actual M1 deposits are not replaced by the government (FDIC). The only credit which is destroyed is money that has been stored in assets (asset deflation) and the ability of people to draw money into the present from their future productivity (credit cards, financing, etc...). The destruction of those do not reduce the money supply. They create "asset deflation", but not monetary deflation more commonly known as "price deflation".

So yes, we have more electronic money, and less actual paper money in circulation than either Zimbabwe or Weimar Germany. But that electronic money, especially if it is backed by the government through the FDIC, is just as hyperinflationary as the paper in Zimbabwe. In fact, it may be even more so, as it can be created cheaper, faster, and easier than physical printing. (See my last post, New Stimulus Plan).

There are hundreds of trillions of dollars floating around the world in credit. Much of that is an insurance contract on top of another insurance contract, on top of a securitized mortgage, on top of an asset. The total value of all the aggregate claims on the asset vastly outnumber the value of the asset itself. That is what this crisis is about at its very heart. Picture an inverse pyramid with assets occupying the bottom bit, securitized mortgages in the middle, and credit derivatives at the top. A stable economy would have a right-side-up pyramid with assets occupying the bottom, etc.

FOFOA: Here, let me help you out with this picture. During a credit expansion like we have had for the last 27 years or so, capital flows UP the inverse pyramid. And as the private sector leverages up and creates credit money in many multiples of real money, it creates new products to buy. New places to store this "wealth". John Exter created his inverse pyramid in the 1970's, so let's add some new, monstrous levels for the 21st century. The arrows show how capital flows during a credit expansion:

Our problem now, is not that the assets are going to go to zero. It's the value of the much larger derivatives and mortgages that back the assets going to zero. Their values were derived from faulty computer models that grossly underestimated risk in the underlying asset, but more importantly in the ability for a counterparty to make good on their promise in the event of a default. The counterparties, like AIG or Citi, issued 30 or 40 times more in insurance than there were in assets to back them up. Their models told them that the possibility of all the different assets declining at the same time was negligible, therefore justifying such enormous leverage. Now that the assets have fallen by at least 20-30%, the holders of the securities that were tied to them want to be paid for their insurance. Only there's nothing to pay them with. So the people that hold these contracts are trying to get rid of them as fast as they can, and for whatever price, because they fear that if the counterparty goes belly-up, they'll get nothing. If they can sell, they take the loss. If not, they keep the asset off their balance sheet in what's known as a SIV (Special Investment Vehicle) until they can be sold. While they are kept off the balance sheet, they are still considered to be worth 100% of their original value.

FOFOA: Here, let me help you with this one too. Again, it is the flow of real capital that we need to look at. And which direction is it flowing now?

That's right, it's flowing down the inverse pyramid as those upper levels shrivel and dry up. There is much loss of perceived value in this downward flow. In fact, that's what's causing it. But as we bail out entities like AIG so they can pay off the winning tickets held by Goldman Sachs and others, we are feeding more good money into this downward cascade. What should have been a loss of perceived wealth is actually being converted into REAL, SPENDABLE wealth at the taxpayer's expense. "Whew!", says Goldman Sachs as he collects on his winning ticket. Do you think that fresh digital money he just collected is going to go back UP the inverse pyramid? Not a chance! It will go down to safety along with everything else.

The total amount of these assets is far greater than the equity banks have and their sum represents future losses that eventually need to be realized. No, the value of these assets is not completely nil - because the value of the underlying assets are not nil. But for all intents and purposes, it might as well be zero because it dwarfs their tangible equity.

FOFOA: In the inverse pyramid, each level you go up is essentially a derivative of the lower levels. And during expansionary times those derivatives yield a little more than the lower levels. That is why capital climbs during the good times. But when PRINCIPLE is destroyed, this dwarfs the meager benefits of a yield and the capital scurries down the ladder to safety.

That was a very long-winded explanation of what the difference is between "money" and "credit" but it is essential to understand this difference. Not only if you want to be an econo-weenie like myself, but in order to understand the very essence of our economy, banking or investing. Any other information is essentially useless unless you can wrap your mind around this concept.

FOFOA: Got it! Thanks. But wasn't that more of a long-winded explanation of the difference between "money" and "assets" (or let's say between "wealth" and "perceived wealth")? Credit is essentially the ability to pull future capital into the present. Digital money credits are different, they are actually money, just like printed paper money. And wealth held in shitty assets is neither credit nor money. Right? It is simply an asset, or a derivative of an asset that gives you the perception of holding wealth, until "all that paper starts to burn".

So the next time you hear that the Federal Reserve is "printing money," please do not automatically assume that they are printing physical notes. They are creating electronic reserves (credit) to support the balance sheets of the big banks. There is absolutely nothing inflationary about this. The banks are simply taking it and using it to cancel out their derivative losses or are hoarding it in order to prepare for future losses. Previously, banks would have used the electronic reserves to go out and make 10x that amount in loans to consumers or businesses (in reality the order was the other way around - loans first, then reserves). That is not the case anymore, and until the bad assets are completely liquidated, it will not be the case again.

FOFOA: With all due respect, I think you are wrong here. If the Fed "prints" electronic reserves (credits) it is absolutely as inflationary as printing physical notes. These "electronic credits" are being used to "make whole" some investments that went bad because of counterparty failure. And when someone's misfortune is reversed, when they are made whole, they now have real spendable currency. And with that currency they are able to pay their people. And those people (that may have otherwise been out of a job) can now go spend their bonuses on whatever they want. It is not credit at that point, it is spendable money they wouldn't have had if the Fed had not created "electronic credits".

Thus far, we have a total of $9.7 Trillion dollars in total government/central bank assistance in the United States. An amount equal to that and more has been provided by their counterparts around the world. More is promised. But the fact remains that the minimal inflationary impact these actions have are negligible in comparison to the amount of "problem assets" being devalued around the world. Much of it is just in guarantees - that is, more insurance. The Federal Reserve will offer to swap good assets for bad. All this does is cancel out debt from somewhere else. It's like moving money from one pocket to another. The act of putting money in your right pocket does not make you any richer.

FOFOA: No, it is making a bad investment that should have been a total loss whole again. In fact, it is turning an "asset" into "money", which the free market already ruled should be a loss. Those top levels of the inverse pyramid are already dead. And you will notice that the lower levels of the pyramid are much smaller. So it will only take a small portion of the capital from higher up being made whole and flowing down to overwhelm the bottom of the pyramid. We are already seeing this in the Treasury bubble and the US dollar bubble. But you've got to ask yourself, are those really the final destination of this downflow?

Zimbabwe and Weimar Germany never had those higher levels of the pyramid. They never had the credit system to create them. But as those levels collapse here they offset all that credit that made them possible, and the downflow of remaining capital here in America will be like Niagara Falls trying to fill a plastic kiddie pool.

All in all, the central banks are not nearly as powerful as they'd have you believe. The amount of the total money supply that is controlled by them is minimal. They won't tell you that. They'd prefer you to think that just by them moving their lips they can affect the entire economy's decision making processes. It simply ain't so.

FOFOA: This is a true statement, but not for the reasons you think and not to the ends you expect. See my posts on Freegold.

This begs the question: why is gold going up? Who knows. It has a mind of it's own. But if it really only moved due to inflation concerns, it wouldn't have declined 75% over two inflationary decades (80's, 90's) would it? If inflationary concerns were real, we would see TIP yields rising along with the gold price. They're not. We'd also be seeing other typical inflation hedges rising - like property prices. That is obviously not the case. A better explanation is that gold is rising because of increased instability. People want to own a little bit "just in case." As they should. But an even better explanation is that it is going up because it is going up. Pure speculation.

FOFOA: Matt, you must be talking about "paper gold". It is true that the prices you follow are heavily driven by speculators in the paper markets for gold. But what you are missing is that real physical gold is not an inflation hedge, it is simply a wealth reserve. And it is a wealth reserve that will survive and prosper even through the nuclear annihilation of paper assets. It is a hedge against the collapse of the system. This, and the official control of the gold price as presented by GATA, are the reasons the price of gold stagnated through the 80's and 90's. But that era is over now. We are entering a new era.

But I do understand why you think the way you do. You are 26, right? Born in 1982? You see, ever since 1971 the establishment has convinced you and almost everyone else that they successfully moved the very foundation of the inverse pyramid and placed it up amongst the investments categories:

But ask yourself this. Did they actually move it? Or did they just create the illusion that they moved it? As John Hathaway said at the top of this post, "The gold derivatives pyramid is a vigorous free market creature. It cannot be put down with a simple declaration that the paper is no longer redeemable in gold, as governments did with currency. It is a short selling scheme that has become a trap from which few short sellers will escape."

All Paper is STILL a short position on gold!

No matter how much credit is issued, it cannot make up for the massive contraction elsewhere. The net result will be deflation - even though it will be less than it would be without any interventions. Japan has discovered this over the last two decades - and they had huge demand for their exports, whereas the current situation is global. America discovered this in the 30's - and they had a far smaller debt burden than now. We will discover the same.

FOFOA: No, the net result will be ASSET deflation, not deflation. Japan had a slight net INCREASE in the CPI during the lost decade even though they had massive ASSET deflation. Asset deflation and monetary hyperinflation are completely compatible with each other, they happen at the same time, and they happen together in all cases of hyperinflation. Hyperinflation and currency collapse are basically the same thing. Hyperinflation and deflation are almost the same thing. And hyperinflation and inflation are similar in name only. Please read the Daniel Amerman articles linked at the bottom to learn about the differences between asset deflation and monetary or price deflation. You will also learn that what was discovered in the 30's was actually the opposite lesson. It was that a determined government CAN stop deflation on a freaking dime whenever it wants to. Yes, we will discover the same... very soon!

Will the U.S. Dollar collapse?

Closely tied to the belief in imminent hyperinflation and a skyrocketing gold price is the misplaced belief that the U.S. Dollar is on the brink of collapse. Essentially, they are one and the same. Many of my arguments against hyperinflation are the same against a dollar collapse. But there is even more evidence stacked against such an occurrence.

Ultimately, the Dollar will end up at zero - but that is not going to happen any time soon, and I would argue is likely decades away. Until then, the massive amounts of deleveraging will increase our appetite for dollars to pay back debt. There is too much credit in the system, and as we rid ourselves of it slowly, we need to acquire dollars. A large portion of the credit derivatives I mentioned above are denominated in dollars even though the underlying asset may be priced in another currency. This is a theoretical short position on the dollar. A "carry trade" in other words. It must be unwound, just like the Yen carry trade.

FOFOA: It is all about the flow of capital. You will notice that the dollar is at the bottom of the inverse pyramid, right above gold. So as capital flows down the dollar certainly sees a rally. But that will be short lived. You see, the dollar is not the true foundation of the pyramid and it is neither an asset nor real money. It is merely a "symbolic currency". And as such, its value can be EASILY controlled by the Fed. We saw a hint of this last week. It is not decades away, it is happening right now. Sure, it is true that we need dollars to pay off our debts. That is because it is legal tender. But we don't need to store our extra wealth in dollars. That would be silly. And foreigners don't either. That would be even more silly. And the higher levels on the pyramid have simply become too dangerous for storage of wealth right now. So there is really only one place for capital to flow to. Gold!

If everything above the dollar is a "theoretical short position on the dollar", then it is all (including the dollar) STILL a theoretical short position on gold. Think about it. Yes, this carry trade WILL be unwound!

This is what is meant when we call the U.S. Dollar the world's "reserve currency." Most people hear the word "reserve" and automatically conclude that because many other countries hold the dollar as their primary currency in their foreign exchange "reserves," that is what is meant by "reserve currency." It is not. Total foreign exchange reserves of dollars are far smaller than total foreign credit contracts denominated in U.S. Dollars (reserves worldwide are "only" ~4.6 Trillion). It is the reserve currency because it is the default currency for international trade and commerce in general. In order for that to change, 100's of trillions in contracts would need to be re-written. Not practical.

As such, demand for U.S. Dollars will persist.

FOFOA: Close, but not quite. The dollar is the reserve currency because it currently supplies the "usage demand" of the world. That is changing. As such, demand for U.S. Dollars will die down. Once necessities on the world market, like oil, are priced in something other than the dollar, no one will need to hold dollars, dollar reserves, or contracts denominated in dollars anymore. The global flight from dollars will be so fast we will likely hear a sonic boom.

Additionally, the U.S. Dollar is not alone in its state of affairs with an overindebted government and central bank getting itself in all sorts of trouble. In fact, nearly every other currency has the same issues facing it. And even though the numbers aren't quite as dire elsewhere, they are far more likely to collapse than the U.S. Dollar due to the reserve status. Fair? No. But neither is life.

FOFOA: True, all fiat currencies are in a race to the bottom. And as such, the floating exchange rate system which first appeared on this planet in 1971 is likely to be the greatest systemic threat out there. Time will tell. But one thing the dollar has that all those other currencies don't have is an Achilles heel. That heel is the fact that the dollar has been spread so far and wide being the reserve currency for decades that when it collapses, the flood of dollars coming home will make the collapse of other currencies seem like a local boom in comparison. The dollar itself was hyperinflated long ago as it was shipped off by the boatload to all of our trading partners and creditors.

In summary, there are many multiples more debt than capital in the world economy. Debt is being liquidated and will continue to do so until it reaches a sustainable level relative to capital. The process of this debt liquidation puts a higher value on dollars relative to debt, thus ensuring an oversupply of dollars is impossible.

FOFOA: So in your view, Ben Bernanke, Geithner, Obama and our fine Congress can keep printing and buying their own debt with more printing for years and years to come? And those newly created dollars will keep increasing in purchasing power the whole time? The government can build bridges, trains, museums, wind power, and all the other great projects with newly printed money and each year that money will buy more and more because it is increasing in value? All because an oversupply of dollars is impossible?

Matt, I have some reading recommendations for you as I mentioned earlier.

Here are the two articles by Daniel Amerman that will explain the difference between asset deflation and price or monetary deflation:

Puncturing Deflation Myths, Part 1

Puncturing Deflation Myths, Part 2

I also recommend that you read Another and FOA to give you a different perspective on gold, the new gold market, and the possibilities for the future of gold, Freegold.

Most sincerely,



Here is a "derivative" of John Exter's pyramid found on Zero Hedge. Notably absent is the gold foundation.


The Mad Scientist said...

That was an awesome post!

FOFOA said...

Mad, you are a very fast reader!!!

I'm still proofing the darn thing for mistakes!

But thanks!

The Mad Scientist said...

Did not see any mistakes....
What do you make of Geithner's plan?

Anonymous said...


Great post! I always look forward to reading your blog and Eric's blog.

I was googling "Kress Cycle" and found this image. It looks similar to Martin Armstrong's economic model cycle.

FOFOA said...


On Geithner's plan (not on deflation) I will go with Mish. "A con job". And even Krugman. "Cash for trash" seems to sum it up. And if the private part of the public private partnership doesn't show up, there's always those Caribbean accounts stuffed with freshly printed credits to step in and pretend they are private.

The PPT sure celebrated its CEO today with a nice rally. But the funny thing is, an acquaintance of mine's large account actually went down today. It is widely diversified. So it makes me wonder if only the stocks in the index funds rallied today. They wouldn't be painting the tape, would they? While ignoring poor stocks that don't move the averages?

Krugman quotes that Mish put up:

The Geithner plan has now been leaked in detail. It’s exactly the plan that was widely analyzed — and found wanting — a couple of weeks ago. The zombie ideas have won.

The Obama administration is now completely wedded to the idea that there’s nothing fundamentally wrong with the financial system — that what we’re facing is the equivalent of a run on an essentially sound bank. As Tim Duy put it, there are no bad assets, only misunderstood assets. And if we get investors to understand that toxic waste is really, truly worth much more than anyone is willing to pay for it, all our problems will be solved.

Why was I so quick to condemn the Geithner plan? Because it’s not new; it’s just another version of an idea that keeps coming up and keeps being refuted. It’s basically a thinly disguised version of the same plan Henry Paulson announced way back in September.

Why am I so vehement about this? Because I’m afraid that this will be the administration’s only shot — that if the first bank plan is an abject failure, it won’t have the political capital for a second. So it’s just horrifying that Obama — and yes, the buck stops there — has decided to base his financial plan on the fantasy that a bit of financial hocus-pocus will turn the clock back to 2006.

And Mish - This is similar in nature to fraudulent schemes that promise "what's inside the bag is worth $1 million, unless you open the bag".

Other than that, I haven't really given Geithner's plan much thought. It's kinda like a flunky student who turns in his term paper a month late claiming it took longer to write because it's so good, only to find out he copied it off the internet.


FOFOA said...


That's not similar to Martin Armstrong's model, that IS his Economic Confidence Model. Check the dates. They are nearly the same. The 1999 paper he wrote lists them going all the way out. It looks like someone did more accurate calculations of the actual dates based on his model, because they got April 19th right! I'd have to check them all to make sure it is, but that's what I'd guess.


Ender said...

Nice debate FOFOA, When I look at the black arrows you’ve drawn next to the inverted pyramid, you might be able to label them ‘trust’. The size of the arrows would represent the rate of change of the ‘trust’. Trust must be maintained for the system to remain together.


FOFOA said...

Hello Ender,

Welcome back! I would love to see more of you.

Trust is a delicate thing. It can take years to gain someone's trust, but only a fleeting moment to lose it forever.

Building trust is a slow and cautious process. But the destruction of trust is painful, quick and panicked, as one flees the scene, realizing she has been betrayed.

So up arrows would all be small, short and numerous, but down arrows would be long, bold and singular. Simple really. I think we are there.


Anonymous said...

Did not yet read the entire article, however when the paper gold topic is brought up I always wonder: is gold really the only commodity of which more is sold on paper then there exists in real life? As far as I am concerned the same could happen to any other commodity and I believe it is as a matter of fact happening.
The reason for bringin that up is that it would make the "gold case" a lot less special, and instead charge the entire ETF system...

Also, should the entire system be "corrupt" it will take more to take it down, since the reliance on it and trust in it sums up to a much bigger amount that would it just concern gold.

Anonymous said...


This is a good read.

Who's at risk as deepening economic distress foments social unrest?

Anonymous said...

Also I do not understand this sentence: "the vast majority of our money supply is in the form of electronic credit. Electronic credit can be destroyed, while physical notes issued by a central bank cannot. This is why deflation is possible in a credit based monetary system, but not in a paper based monetary system."

What is it that makes paper notes so indistructible?

Anonymous said...

But the question is what is really the "cash" that statement is referring to? What is really the bottom of that inverse pyramid that capital is striving for? Is it government paper? Or is it still the old foundation, gold?

Certainly an interesting question, but it does not really need to be answered here. The point Matt is trying to make is that paper currency is worth more than credit and you have already agreed to that ("Physical currency (M0) is farther down on the inverse pyramid than the higher M's, and certainly farther down than debt like TBills.").

You are just trying to bring in gold here, which is not at this point really necessary.

Anonymous said...

"Yes, electronic money credits can be spent just the same as paper money. But the actual electronic money credits that can be spent, cannot be destroyed, unless a bank fails and actual M1 deposits are not replaced by the government (FDIC). The only credit which is destroyed is money that has been stored in assets (asset deflation) and the ability of people to draw money into the present from their future productivity (credit cards, financing, etc...). The destruction of those do not reduce the money supply."

So credit is not part of the money supply I assume?

Anonymous said...

"So yes, we have more electronic money, and less actual paper money in circulation than either Zimbabwe or Weimar Germany. But that electronic money, especially if it is backed by the government through the FDIC, is just as hyperinflationary as the paper in Zimbabwe. In fact, it may be even more so, as it can be created cheaper, faster, and easier than physical printing."

Again I assume that electronic money does not refer to credit?

(Credit destruction does not influence the money supply in your view..)

Anonymous said...

"In fact, it is turning an "asset" into "money", which the free market already ruled should be a loss."

An asset equals perceived wealth/money and was counted by banks as money aready in perception ("it is simply an asset, or a derivative of an asset that gives you the perception of holding wealth"). Now they transfer this asset to the FED and receive "real" money in return.

However, the inflation that is supposed to cause had already occured when perceiving the asset to be worth the money received now. So nothing changes really. Al it does is maintain an "illusion" that was already used as a foundation for our economy.

Anonymous said...

All Paper is STILL a short position on gold!

Sure, all cash in a bank deposit is a short position on the real money in the bank. In case of a bank run you will end up with nothing, but only in case of such an event. The same hold for paper gold: only a short position in case of a run on physical gold (which so far has not occured over the past decades).

Anonymous said...

"But one thing the dollar has that all those other currencies don't have is an Achilles heel. That heel is the fact that the dollar has been spread so far and wide being the reserve currency for decades that when it collapses, the flood of dollars coming home will make the collapse of other currencies seem like a local boom in comparison."

Very true indeed. However, this Achilles heel is also its strenght. Al those parties holding dollars in their reserves have a lot to loose by the dollar collapsing and they also have power to prevent this. They will certainly use that power.

Anonymous said...

For illustration take remarks like this one: “Investors would be wise to buy some gold, whether or not gold goes up, down, or remains unchanged next week,” Tom Hartmann, a commodity analyst at AltaVista Worldwide Trading LLC in Mission Viejo, California, said on March 19. “The larger picture here is greater than a one-week time frame. Inflation is certain to come.”


Sounds a bit like the real estate market doesn't it? Buy a property, do not care about price movements it is guaranteed to go up...oops..

FOFOA said...

Hello Martijn,

You asked the same question regarding gold price suppression several days ago on another post. I answered you right away but you have obviously not read my answer. I am starting to wonder if you are even interested in hearing, or just in being heard.

As for credit and the money supply. If you have a new credit card with a $12,000 limit on it, do you have $12,000? If you cut up that credit card, did you just reduce the money supply by $12,000? Credit is the ABILITY to bring money into the present from the future. It is this ABILITY that has been destroyed. Not money.

The same goes for assets. If someone gives you a rare vase worth $100,000, do you have $100,000? If you drop the vase and it breaks, did you just reduce the money supply by $100,000?


Anonymous said...

@FOFOA: my bad, I lost track of the posts I answered to and forgot to check that one. I will do so now and perhaps get back on it. Thanks anyway.

Btw I believe you did not responded to my remark on Peter Schiff @ time for a change of events (perhaps that is because I did not ask a question?).

Now regarding the credit question: the credit card is indeed not yet money, only if I use it. The same goes for assets. Beeing very tight on that, gold is also an asset I believe (just for the record). In my opinion we could define credit a bit differently though: using credit is making (a part of) the current money supply go an extra round (and increasing velocity) on the promise to not make it go that round (decrease velocity) in the future (in stead of buying something you then repay the money).

How do you feel about that?

I will reread my other remarks and your responses and let you know.

Anonymous said...

Btw: about the difference between assets/credit and money: banks keep assets on their balance sheet as if it is (deposited) money, do they not?
They take money from deposits, loan it out or buy assets, and say everyhting is ok because the balance add up. So although we see a difference, they do not really distinguish.

Ender said...

@Martijn, Inquisitive? Helps if you focus on a question or two and it's prudent to provide your understanding as it unfolds.

I will keep it brief. You asked "is gold really the only commodity of which more is sold on paper then there exists in real life?" :) Have your heard of the strong dollar policy? Basically, if you own the ability to print the currency that everyone uses to buy resources, you are at an 'advantage'. You have something that no other currency owns. Your cost for goods is equal to or less than any other currency.

Explore this policy further and you may see many things in a much different light.

FOFOA said...


Credit that is actually used and spent does become actual money in the present. In terms of the aggregate money supply, the aggregate of credit spent is somewhat offset by one person's savings that get lent to another person. But through the fractional reserve system, credit growth greatly exceeds any offsetting factor. It feeds real new monetary units into the system. These monetary credits, units, dollars (whatever you want to call them) flow THROUGH assets. They don't reside IN the assets. When you buy an asset, the person who sold it to you now controls the money. When that asset disappears, the money did not disappear.

During the credit expansion, new monetary units are created constantly. None of these units have disappeared. The credit expansion has stopped, but all the previous monetary units remain. And all the assets that were inflated during the expansion are now collapsing because the flow of new credits which fed the new assets has stopped. But money is not disappearing.

So now money is flowing downward into much smaller vessels. All the previous monetary units remain, and new ones are still being created by the Fed right now. But they are not flowing into those higher asset levels. They are and will continue to flow into lower ones which are much smaller.

So first of all, it is a mistake to think of the value of any assets as part of the money supply. And secondly, it is a mistake to think that just because the costs of higher levels of the pyramid are falling, that the cost of the entire pyramid will fall.

We could add an infinite number of pancakes into that pyramid. We could put in a level for gasoline. We could put in a level for bread. Anything that money can flow through, can have a level in the pyramid. And as capital abandons the dangerous heights for the safety of the foundation, the size or value of that foundation will swell.

You said, "gold is also an asset I believe (just for the record)."

That is because you believe they successfully removed the foundation of the pyramid and stuck it up amongst the investment categories. But consider this. Those same central banks that tell you gold is merely an asset still consider it a monetary reserve. Even the US Fed counts its gold as a reserve, albeit at a low valuation. So what do all the central bankers know that they aren't telling us? Why are the central banks net buyers of gold right now? Are they just building "assets"? Or is something else going on?


Anonymous said...


Nice writing.

Stiles, in summary, just repeats the official position of the government and central bank (CB): "inflationary pressures are low due to deleveraging and deflation, so there is no problem with inflating the money supply". He sums it up when he says that the amount of paper-asset deflation is so much more than the monetization acivities of the CB that there is no expectation for inflation.

We can go endlessly through these academic arguments until we end up at the bottom line: is the Keynesian political economy a sucess or not?

FOFOA said...

Hi alek_a,

I believe that Ben Bernanke is disingenuous when using the term deflation. If you read Amerman's part 2 article, it is clear that smart economists are aware of the difference between asset deflation and the standard deflation people think of regarding the Great Depression. I think Bernanke allows this misunderstanding to persist so that he can run his own little Keynesian experiment on the rest of us.

He knows he is in uncharted waters. He has said as much. If this was real deflation, it would not be uncharted. But its not. The US dollar is a completely symbolic currency now. It was not during the Depression.

As I just said, it is a mistake to associate paper-asset values with money supply. They are different things entirely.

Ben and Co. are so committed to the Keynesian experiment that Farragut's "damn the torpedoes... full speed ahead" is the battle cry.


FOFOA said...

Per The True Money Supply (TMS) was formulated by Murray Rothbard and represents the amount of money in the economy that is available for immediate use in exchange. It has been referred to in the past as the Austrian Money Supply, the Rothbard Money Supply and the True Money Supply. The benefits of TMS over conventional measures calculated by the Federal Reserve are that it counts only immediately available money for exchange and does not double count. MMMF shares are excluded from TMS precisely because they represent equity shares in a portfolio of highly liquid, short-term investments which must be sold in exchange for money before such shares can be redeemed. For a detailed description and explanation of the TMS aggregate, see Salerno (1987) and Shostak (2000). The TMS consists of the following: Currency Component of M1, Total Checkable Deposits, Savings Deposits, U.S. Government Demand Deposits and Note Balances, Demand Deposits Due to Foreign Commercial Banks, and Demand Deposits Due to Foreign Official Institutions.

MMMF shares are Money Market Mutual Fund shares. They are counted as part of M2. I bring this up to make the point that to the Fed, counting money is more of an art than a science. If you can make people believe that an asset is actually money, then it is not a very big leap to later say that high level asset destruction is deflationary, when in fact, no money has been destroyed. And then it is not so hard to get a green light to just start printing and delivering boatloads of new credits to your friends in government who then dish them out to your friends on Wall Street and spend them on make-work projects that will result only in political capital flowing back to the politicians. This is the game.

But each newly created dollar reduces the real value of all other dollars in circulation, no matter what hokus pokus the Fed uses to count them. This is a basic truth that is not lost on the Chinese, nor on any large holder of dollars. The big shift that has yet to hit us is for the actual HOLDING of dollars during a time of high printing to be perceived as dangerous. The market already knows this is dangerous, even though the current flow of capital is creating the illusion of a rising dollar. But that is all it is, an illusion. Just as the true value of a dollar is purely symbolic. Its value is in the pass through, the use, not in the holding as a wealth reserve.

This shift is coming. And then you will see that all-elusive velocity that everyone is talking about. Think of velocity as the black swan that the deflationists are saying doesn't exist... until it appears.


The Mad Scientist said...

It seems everyone still wants to buy Gold. Although I agree that it is probably the best bet in the long run...Gold got immensely overvalued recently versus every other commodity.
I have been suggesting for sometime now that Gold will correct a lot in value if not in price before the next up move begins.
Look at the weekly chart of gold versus oil or S and P. Would you ever buy something that looked like that based on technicals?

and here

FOFOA said...

Hi Mad,

I won't argue technicals with you. I'm not a TA guy at all. But I sure wouldn't want to be betting against gold at the one time in history when its technical graphs are likely to encounter a sudden phase transition.

"Gold got immensely overvalued recently versus every other commodity." Yes, it certainly seems that way if you view gold as a commodity.

Interesting that I wrote this post around the same time you wrote "Stick a fork in it". Quite the opposite perspective. But then again, I'm not really a trader. I only have a small Scottrade account to occasionally buy some SKF (check out the 6 mo. chart). Perhaps April 17th will be a good day to buy SKF and ride the rocket like I did in November. I could certainly see gold struggling from now until the G20. But I'm not betting on it.


The Mad Scientist said...

I just read that post...You know what they say about great minds :)
I personally own a lot of silver and some gold. Most of the stocks I own are either deep water drillers,fertilizer companies or royalty trusts

FOFOA said...


Here's a TA guy that says gold could be ready to go into hyper-drive, based on TA.


The Mad Scientist said...

Oh I think Gold will go up in price soon and maybe a lot but it will go down in value versus everything else for now.

Anonymous said...

Even though I can also see the upside of silver here is a link describing some of its risks:

old european said...


I am a gold bull. I follow my guts, a couple of fundamentals on this and I trust a number of gold commentators (e.g. Roger Wiegand).
I certainly enjoyed your commenting the Exter pyramid. I saw it before on Ian Gordon's website but wasn't able to fully grasp the intrinsic dynamics behind it : now I can, thanks to your post ! (kudos!)
But you have to admit that your whole argument stands or falls with the premise that the inversed pyramid is a valid representation of monetary (and wealth) reality.
What if it isn't ??

Regards, Jan (AKA the Old European, and proud of it: proud of having said no to the Iraq war nonsense back in 2003...)

old european said...


Is this the Martijn who used to work At a big (almost) blown up bank in Brussels. If so, It's with me he should be argumenting about gold now :-)


FOFOA said...

Hi Jan,

I appreciate your comment.

Believe it or not, I didn't build that post around the Exter Pyramid. It was built around a general idea I have in my head about the way money works, with each new level being a sort of "derivative" of the previous one... deriving its value from the previous level in some way.

If you look at my post Fun With Numbers you can see that I described this as a ladder. Gold was at the bottom, then M0, M1.... on up to M6, then stocks and bonds, ETF's and Funds, and CDO's, MBS's and CDS's on top.

This was the general idea, but I found that Exter's pyramid illustrated it nicely. I got Exter's pyramid off Wikipedia and did a little "photoshop" on it to make my points.

So I wouldn't say that my arguments rely exactly on that pyramid. But sure, they rely on my general idea that gold is the foundation of money. Like I said in the post, you could make a pyramid that included things like boats and jetskis, and also included gasoline and bread. Obviously gas and bread would be near the very bottom and boats would be at the top. It is all about the flow of capital. And where it flows to under different circumstances.


old european said...

Thanks for the comment. I can see how you got to your point. Yet, there are still a number of ways the deflationistas might be proven right : the hurry down the pyramid (or the ladder) could end where credit gets "credible" again, without ever touching the gold layer. This way, yet another generation might grow up without discovering the true nature of money (a lot of the gold upside potential will depend on this possible rediscovery of the virtues of gold to the grand public). You made a similar point in the post here above.

FOFOA said...

Hi Jan,

The only way I can see credits becoming credible again is if they acknowledge the foundation on which they stand. And in essence, that will be the same thing as freegold.

In one case, the common man will force freegold into existence and kill the credits system. In the other case, the credits will "come to Jesus" at the last minute before death and embrace their original foundation. In this way they may survive, but only if that foundation is traded freely and credibly.

Another said, "There are nations that will try to "resource a new currency" as the old financial system implodes. Oil or gold or both may be used. If it is done at the correct time, much will be gained by all! Fail this Attempt, and gold will never trade on an open exchange again, in our lifetime! We will see this end in our time."

Can you think of another way that a paper currency could become credible?


FOFOA said...

Jim Sinclair on a similar subject...

The Guarino article on Black Scholes model, derivatives in general and market forecast stands on a premise that is totally incorrect.

This article can be characterized as the “Black Hole” thesis. It says that all the bailout funds disappear into some loss entity within the balance sheet of the losing side of the derivative.

If that thesis does not hold then it shifts to a concept that says all these funds revolve back to the Fed as a practice of holding all the free reserves of member banks.

The writer somehow assumes that Motors, AIG and the like are members of the Federal Reserve system.

This writer entirely ignores the swaps done by the Fed to bail out non USA entities by providing dollars to other central banks who in turn use those funds to bail out their own non USA entities.

The writer would be better advised to use the statistic that can be obtained by subscription to

The writer should know that a loser on a derivative does not hold the funds on account for the winner.

The writer would be well advised to study the history of hyperinflation that always occurs directly in the middle of what appears to be his definition of deflation.

The writer would also be well advised to study what happens to the velocity of money in every hyperinflation scenario as they all occur in a depression economic setting. Velocity in these circumstances explodes. Hyperinflations are currency events and not economic events.

Every cent of bailout funds lies latent in the economy in the hands of the new shadow trillionaires. These shadow trillionaires now have a serious problem. Their enormous wealth is all paper.

The bailout money in all these entities comes in the front door of the loser and goes immediately out the back door to the winner on the derivative. The firms identified as the winner is not the principle on the trade. It is the broker only. You will never know who the principle is, ever.

There is no Black Hole that devours all the bailout money nor does it flow back into the Federal Reserve System.

The article’s conclusions are invalid because the premises supporting those conclusions are totally wrong. There is a complete misunderstanding of what an OTC derivative is.

The article has neither historical understanding of hyperinflation nor the role velocity of money plays. The writer does not understand that hyperinflation is a currency event, not an economic event and stands on confidence in the currency only. Because of this the writer’s conclusions are off the wall.

Please read the following New York Times article. The writer should also read it.

Cuomo Widens His A.I.G. Investigation
March 26, 2009, 6:17 pm

Attorney General Andrew M. Cuomo of New York said Thursday afternoon that he was widening his investigation of the American International Group to examine whether its trading counterparties improperly received billions of dollars in government money from the troubled insurer.

Those counterparties include Goldman Sachs, which received $12.9 billion, as well as Société Générale of France and Deutsche Bank of Germany, which each received nearly $12 billion.

“Our investigation into corporate bonuses has led us to an investigation of the credit default swap contracts at A.I.G.,” Mr. Cuomo said in a statement. “CDS contracts were at the heart of A.I.G.’s meltdown. The question is whether the contracts are being wound down properly and efficiently or whether they have become a vehicle for funneling billions in taxpayers dollars to capitalize banks all over the world.”

Other counterparties that received money from A.I.G. include Barclays of Britain ($8.5 billion), Merrill Lynch ($6.8 billion), Bank of America ($5.2 billion), UBS of Switzerland ($5 billion), Citigroup ($2.3 billion) and Wachovia ($1.5 billion).


Martijn said...


How would you explain that the pyramid lists commodities at almost the top level, while of the entire list commodoties and gold have the most in common?

Martijn said...


Credit is essentially the ability to pull future capital into the present.

Perhaps, but not entirely true. Basically credit swops present capital from one party to another in exchange for trust that the other party in the future will repay it.

So in a sense future capital is pulled in, although in real life it remains impossible to create future capital at present.

FOFOA said...


I think he put commodities up in the top as an "investment class". Notice the groupings are gold, then money, then usury, then investments.

You say, "of the entire list commodoties and gold have the most in common"

This is the point. Gold is money, not a commodity. But the CB's have tried to shove gold up with the commodities, to convince the sheeple it is a mere commodity, a mere investment.

You say, "Basically credit swops present capital from one party to another"

In some cases you are right. Like bonds. But in many forms of credit, the money you borrow is created out of thin air, backed only by your promise to work it off in the future. And since money is the proxy for your work, you have brought it into the present from the future. You have "stolen" it from the future.


Martijn said...

To my undderstanding commodities "came" before money in our evolution. I might agree with you that gold has emerged from commodity to money, but it's monetairy value/use should be seen on top of it being a commodity.
We first worked for our selves (maybe not alone but in groups), then started bartering, and only then "invented" money. The value you attach to gold is based on it's historic use (as money), and when looking at gold's history you should take into account it's entire history, which to me would seem commodity first, then money.
About putting commodities on top of the pyramid: perhaps. I does however not seem the only (or most) logical position when the (intrinsic) "value" of things is considered.

As far as credit is concerned: credit always transfers present (and not future) capital from one person to another. By creating money out of thin air this transfer also happens. We tend to refer to such a transfer as "inflation".
It's a difficult idea to grasp, and I am still thinking about it. The difficulty is in the alternative scenario's that stem from adding a promise to the equation; the promise is either kept and work is returned in the future, or the promise is broken, which would lead to the real transfer of present (by the time the promise is broken it's past) capital. Either way, the transfer of present capital is a fact, while the delivering of future capital remains to be seen. To me that's the difficulty.

FOFOA said...


You say, "but it's monetairy value/use should be seen on top of it being a commodity."

To me, this sounds like the view of someone who has been "brainwashed" by 38 years of propaganda. (since 1971)

A commodity is a real item (not a paper product), in a limited supply, with some sort of an economic use other than monetary. This distinguishes commodities from money. Some will argue that money is also a commodity, and they will even argue that money is the commodity with the highest demand of all commodities. This is a valid argument. But it gets down to the issue of the definitions we are using.

I agree with you regarding the pyramid. In the above post, I was not arguing for the absolute accuracy of John Exter's pyramid. But instead, I was using it to show how capital flows during times of economic, financial and monetary stress. It flows down.

And somewhere I even mentioned that if I built a completely detailed pyramid, I would put things like food and other survival necessities down near the bottom. This certainly includes some commodities. But not all commodities. Think Zimbabwe. Grain is very valuable. But copper and palladium are not in such high demand there.

"As far as credit is concerned: credit always transfers present (and not future) capital from one person to another. By creating money out of thin air this transfer also happens. We tend to refer to such a transfer as "inflation".

This is a very astute observation. And it is absolutely correct! The amount of REAL capital in the world is finite, and credit allows it to be MIS-distributed. This was a point I made in my very first post...

Another thing about houses is that we have likely borrowed a lot of the money for all this building of the last few years from foreigners. And through high inflation of the money supply and financial collapses we will likely have a de facto default on those loans in the near future. In other words, China and others have financed all this building of new homes and will never be paid back for their efforts. But they can't take back the homes. They are stuck here.

America borrowed money from China, used it to build REAL things, those things will remain in America. So when everything collapses, the final outcome is that REAL wealth was transferred from China to America permanently. And it will never be repaid in commensurate amounts because of hyperinflation (default).

Getting back to my point about credit tapping into the future, in the post above, that was more in response to Matt Stiles arguments. Matt was confusing money, credit, money credits, and assets. This had to do with the expansion and subsequent "contraction" of the supposed money supply. Matt is claiming that the money supply contracts. I am saying it does not, by carefully defining what is used as money right now.

I was referring to credit as "available credit" held but not used by a person. When that disappears, no money was destroyed. That "available credit" was basically that persons "ability to pull in his future labors to be spent now in the present." When that ABILITY is lost, no money is destroyed. However, if he SPENDS that credit now, then new money IS created in the present and it is never destroyed, even when credit collapses. It is now in the present, and it has MIS-distributed REAL capital just as you describe.

Does this clarify?


Martijn said...


On the topic of credit we seem to agree.

About commodities I am not so sure. What I ment to say is that in history we first "had" commodities and only later started to use money - whatever that was at that time.
For some reasons gold emerged as the material deemed most able to fulfill a monetary function, and perhaps today gold has little or no commodity function indeed.

Perhaps it is a matter of definition indeed. A commodity is a real item (not a paper product), in a limited supply, with some sort of an economic use other than monetary. What I ment is that I would argue the other way around. Something is real and in limited supply first, than people at to it the use of money, nothing is money by itself. E.g. if everyone would be truly self sufficient, money would not exist. Money exists only because people "specialize".

You are correct that gold is not the very foundation of the pyramid, and that we could indeed slide further down to food (and perhaps some other things).

FOFOA said...


Actually, I maintain that gold is still the bottom of the inverse pyramid. But remember, capital flow into gold is savings, it is not that which you need to survive today and tomorrow. I would put food and stuff like that just above gold. Because on an individual level, only so much capital can flow into that, and then the rest will flow down into gold, like your river running down the mountain.

It's not going to flow first into gold and then the overflow into food.

I would refer you back to that John Locke treatise. Remember, we can only hold so much of what we need to survive, then we must put our excess wealth into something that will not rot.

The only way I would say that survival necessities move below gold is if we to revert back to caveman status.

The dictionary defines a commodity as... 1. an economic good, as in a product of agriculture or mining, 2. something useful or valuable, 3. a quantity or lot.

So yes, it does boil down to definitions. But it makes sense to differentiate between that which CAN be used as money, but also has another more important use, and that which is ONLY used as money (for the most part). That very distinction is why Another went out of his way to explain what was going on behind the scenes among the extremely wealthy.

But in one thing you are right. If we did experience such a collapse that we reverted back to that agrarian society, much like the dark ages, and trade between groups came to a halt because everyone provided for themselves, then yes, gold would probably no longer be the foundation of the inverse pyramid.

But we are a long way from that magnitude of a collapse. At least I hope we are.


Martijn said...

My point was indeed that the "real" bottom of the pyramid would remove time from the equation and only focus on the "now". That would matches your concept that gold is the "bottom" of all savings, as savings include a "time value".

FOFOA said...

This is true! If the world was going to end in a week, you wouldn't have any use for gold.

But if only you were going to die in a week, you might still have a use for gold. To pass on your excess wealth to someone else who would live on.

Martijn said...

Correct. And luckily indeed the world does not seem to be falling apart that much for now.

FOFOA said...


I think you will enjoy this interview with Donald Luskin. While I think he is wrong in a lot of what he says, he is still very smart and worth considering. And he uses some of the imagery and concepts we have been discussing here.


Martijn said...


What Luskin fails to see is the difference between asset deflation and monetary deflation (the real deflation).
As we've talked about loans and bringing in the future, a loan is basically a mortgage with the future as collateral. What we are seeing now is that the collateral is not worth what is was supposed to be, and hence the value of the loans is shrinking.

From the interview:

I regard gold as substitute money.
Although you probably won't agree I believe he has a point. Only the people using it can determine what money is, and so far they have determined the dollars to be money. Should they loose faith in the dollar gold is most likely to be it's replacement, but we can never be sure as it remains up to the people to determine.
The discussion about gold price manipulation etc. basically revolves around how the people determine what money is and what forces are put into play to steer that outcome towards the dollar. As the function of money is to enable people to transfer wealth (value) and store it for a reasonable time (without too much leeking away), that function is money's only requirement.

So when the demand for money completely outstrips the supply of money, you get deflation. In that kind of world, even gold isn't a safe haven; the only thing that would do is liquid money.
We've talked about usury before, but if interest were seen as the price for money, the above statement should cause interest to rise, although we know that markets do not set interest freely as H. Ben interfears. Apart from interest money would rise against all assets (which he calls deflation). As he does not ask what money is, he believes money will rise against gold also.
Luskin has however not addressed the question of value. People loaned out value with the future as collateral. Now that collateral has turned out to be not as valuable as believed, so people who have loaned out their value now increase their demand for value. By not having asked what money is, Mr. Luskin is confusing money with value and falsely believes that money demand has increased, while in reality it is demand for value that has increased.
As H. Ben keeps printing, people might discover that money is also not value, and so the demand for value (not money) might increase even further (as in the pyramid). It's a game of faith, a battle for the peoples determination of what money is. The people (the market) are the jury, and Bernanke believes he can convince them of the dollar by weaving it in their face (the printing clearly indicates that he's a firm believer in the strenght of repetition).
Btw, I believe that the total value of money should equal the total value of all wealth people want to exchange within a certain time frame, plus perhaps some of the value people want to store.

In general investing might be a combination of a nintendo game and the value pyramid. You have to jump on blocks moving up, the higher you rise the more value you have. The blocks have different colours (according to the pyramid) and some rise faster than others. The only thing is that sometimes blocks also pop, causing you to fall back, and the blocks most likely to pop are the ones higher up in the pyramid.

The price of money is the inverse of the gold price, so when gold falls, money rises.
By money he obviously means dollars. I was always told that interest is the price of money.

So when anyone else in the world wants to save, as opposed to invest, you buy Treasury bills. It's just what you and I would do if we wanted riskless balances: we'd buy Treasury bills.
He is free to believe this, I don't as I wouldn't buy treasury bills when I wanted to save.

So with all this money being thrown at the Treasury from around the world, there's really no choice but to spend it.
Really? I believe I recently heard something about a nation debt. And besides it's funny that while all this money is being thrown at the treasury the Fed is still buying treasuries.

If this were a rational thing for the Treasury to do, then you could say it was rational for unqualified homeowners to accept subprime mortgages three years ago to buy inflated tract homes in Stockton, California, on the theory that three years from now when the mortgage reset, they could just walk away.
Perhaps not morally right, but it's not against the law at all, so yes, they should. The government should learn not to interfere with the market so much.

Ultimately, but we're funding most of this with debt that's with an average maturity of around three years. So three years from now, if the world credit crisis is healed and you don't have the world throwing money at you anymore, then this is going to reset and we're going to have to roll this debt. We're going to have to refinance. These three-year notes are going to mature, and what will interest rates be then, when people aren't desperate to own Treasury bills because they're afraid of owning anything else?
If confidence in the US treasury holds this scenario might indeed play out, which will cause the US big trouble.

So at the year-and-a-half point, when people start talking about it and it starts to be part of the dominant narrative, rates will start to go up.
That is indeed how mass psychology and large markets move work.

So the objective inflationary expectation, the water behind the dam so to speak, is objectively much greater than it was a year ago, and yet the gold price is 13% lower than it was a year ago.
He has a point there, if we assume that the gold price is determined fairly.

What Luskin is basically saying might play out, but that would require printed money to make up for the (perceived and future based) value lost, which might be difficult as I've seen none of the policy makers or bankers carrying a magic want.

In the comments someone linked this video of Luskin and Schiff to prove that Luskin is an idiot. Generally the video is not that interesting as it's old news (although Schiff is pretty sharp), but at 6:20 minutes they have an interesting discussion about the US dollar. Schiff askes why the US has such a big trade deficit and is replied that it is because the dollar is so valuable, on which Schiff replies that it's not, as it hardly costs a thing to print it.
Both are somewhat right. The first guy is correct that as long as the dollar is regarded an (the) international currency other countries will want to have it in their reserves and that there is one source only to get it: the US. As long as the dollar is the only global currency, local currencies will only have value locally, and hence the only way for other countries to obtain dollars is to exchange products for it as their national currencies are not of value to the US. Schiff is off course right that the dollar is easily printed. What he is refering to is the way the market determines what is a currency: they have to believe in it. If there is too much of it, or the supply varies too much, the will ditch it. I was addressing this earlier.

Martijn said...

Btw, I wonder whether the current rise in the market does not indicate inflation already. The economy is still shrinking, companies are declining in value, but the market goes up. I am however aware of the fact that markets often show countertrend corrections, so there is absolutely no certainty that inflation kicked in already.

FOFOA said...

Hi Martijn,

I really really don't thing the market rally is based on inflation expectations. Perhaps it SHOULD be based on inflation, but I really think it is not. My main reasoning is that if it was, it would show up first in different sectors than it is. During an inflation when the economy is contracting (stagflation like the 70's), there are many things that do much better than those which are rallying right now. The market knows this from experience. Therefore I don't think the market is responding to inflation expectations.

Nice comments on the Luskin piece. I think that Luskin makes some fundamental errors, but that his overall view is pretty smart. He certainly ignores the possibility of manipulation and PPT.

Did you read the new Fekete yet? I am curious to see your comments on that one.


PS. Don't forget, the judgement of the value of money is reserved for those to whom it is offered in exchange for what we need. Question: Do we need the stuff from China more? Or do we need the stuff from Arabia more? Between China and Arabia, which is a need, and which is a want?

Martijn said...

I agree on the inflation, I would not be surprised if the downward trend continues next week.

You are very correct in saying that the judgement of money will be made by those offering what we need in exchange for it.

Feteke is quite correct saying the the FIDC is totally worthless in any scenario that it would be called to the rescue. It's mainly psychological. Right now it is psychology all over. The system is structurally flawed, and the only thing preventing it from falling apart is trust in the value of the future as collateral. The quoted 1960s article indicates that trust has taken some blows before, but so far has survived. Right now it is in very dire straits again, and it is not unlikely that this time the system will not survive.

FOFOA said...

Hello Martijn,

I believe that the FDIC will ultimately be backed by blatant printing, as will almost every Pension Fund in America. And that this "cure" will be far worse than the disease.

This is exactly where we are heading right now. The road there is already paved.

I believe that the government's decision of whether or not to back the FDIC and the Pension Funds with outright printing is the only variable. The fact is that the banking and pension systems are already collapsing. At some point there WILL be a panic and the spiral will begin.

If they elect not to print replacement "credits" for everyone's deposits and retirement accounts [very unlikely], then we will have the system collapse in on itself and "all paper burns". Freegold as Another described follows.

If they DO elect to print replacement dollars [very likely - the electronic variety at first], then we proceed quickly to hyperinflation. And again, "all paper burns". And again, Freegold as Another described follows.

I believe that Fekete clarified his position in that article very well. He stated a similar view in Can we have Inflation and Deflation at the same time? back in Sept. 2007. But I think he did a better job describing it this time. I actually give his scenario a decent probability of happening. But I don't think it will be the final outcome. I think it is just one step on the way to where we are going.

Can you really imagine a scenario where older FRN's are hoarded and new ones are rejected for more than maybe a month? What Fekete describes is a world where physical US dollars will be viewed as you and I view gold and silver. This can happen, but only temporarily.

In an associated train of thought, I was just reading this piece by Eric deCarbonnel titled Wall Street Addicted to Selling Non-Existent Shares. It reminds me of the lectures you posted.

There is another house of cards that will come down. And it infests all those pension funds that are already teetering. They have already lost 40% of their value. Imagine when they find out that the shares they think they own were NEVER EVEN DELIVERED. That they only hold IOU's from bankrupt offshore hedgefunds. WHAT A FREAKING MESS.

Sometimes it seems like "all paper has already burned", we just don't know it yet because we haven't been allowed past the security wall to see the site of the destruction yet. [Think ground zero, NYC] The powers that be are standing guard saying, "continue on your way... there's nothing to see here..." and the people oblige. Meanwhile behind the fence their futures are smoldering in ashes. And whatever value remains is being secreted off in covered dump trucks like the heist in Die Hard 3.

This is what we are witnessing. What you think your net worth is, it is not, unless you can go and hold it in your hands and look at it. If someone else is holding it for you, it probably doesn't even exist.


FOFOA said...

I just came to your comment under Eric's post. I see you have already been there and left your mark!

JT said...

This was an incredible post. I have been trying to figure out the deflation/inflation argument for as long as I can remember. I've recently come to a similar conclusion in my mind (ie asset deflation / price inflation), but this really helped me understand it better.

I'm starting to think that it doesn't make sense to talk about 'price inflation'. All goods have different supply/demand curves, so will 'inflate' slightly differently. The problem (from a social perspective) is that the demand for food/necessities is the most inelastic, so they will see the most inflation.

One other point regarding the role of gold, there is nothing intrinsic that makes gold the base of the pyramid. Throughout history, the market has determined that the characteristics of gold make it the most useful as a unit of exchange (which causes it to become a store of value). But, this does not necessarily have to be the case. Perhaps, new technology in mining means that palladium or some other to-be-determined element is the base. I still put my money on gold, but also realize that this bet could be wrong.

In any case, many thanks.

FOFOA said...

Hello JT,

What makes gold the base of the pyramid is that it is widely distributed as THE monetary metal. Look no farther than this Wikipedia page to see it."

Foreign exchange reserves (also called Forex reserves) in a strict sense are only the foreign currency deposits and bonds held by central banks and monetary authorities. However, the term in popular usage commonly includes foreign exchange and gold, SDRs and IMF reserve positions. This broader figure is more readily available, but it is more accurately termed official international reserves or international reserves. These are assets of the central bank held in different reserve currencies, mostly the US dollar, and to a lesser extent the euro, the UK pound, and the Japanese yen, and used to back its liabilities, e.g. the local currency issued, and the various bank reserves deposited with the central bank, by the government or financial institutions.

Gold reserves (or gold holdings) are held by central banks as a store of value. In 2006, it was estimated that all the gold ever mined totaled 158,000 tonnes.[1] One tonne of gold equated to a value of US$30.27 million as of February 14, 2009 ($941.35/troy ounces)[2]. The total value of all gold ever mined would be US$4.78 trillion at that price.[note 1]

At the end of 2004, central banks and official organizations held 19% of all above-ground gold as a reserve asset.[3] About one percent of all above-ground gold (370 metric tonnes) was mined in the first five years of the California Gold Rush.[4]

Gold is the ONLY metal held as a MONETARY reserve by our global system. It holds about 20% of all the gold. The other 80% is mostly in private hands as either jewelry or as a wealth reserve.

Rarity is not nearly as important as stability of supply when it comes to a monetary metal. Neither is industrial use. In fact, industrial uses and extreme rarity make for a terrible monetary metal. In the case of a monetary metal, it is better that it NOT have any uses other than money. The best monetary "hoard" is one that does NOT infringe on any other function in society!

Check out this treatise by John Locke written in 1690. He explains it well. Here's a snip...

FOFOA said...

And indeed it was a foolish thing, as well as dishonest, to hoard up more than he could make use of. If he gave away a part to any body else, so that it perished not uselesly in his possession, these he also made use of. And if he also bartered away plums, that would have rotted in a week, for nuts that would last good for his eating a whole year, he did no injury; he wasted not the common stock; destroyed no part of the portion of goods that belonged to others, so long as nothing perished uselesly in his hands.

Again, if he would give his nuts for a piece of metal, pleased with its colour; or exchange his sheep for shells, or wool for a sparkling pebble or a diamond, and keep those by him all his life he invaded not the right of others, he might heap up as much of these durable things as he pleased; the exceeding of the bounds of his just property not lying in the largeness of his possession, but the perishing of any thing uselesly in it.

[Sec. 47] And thus came in the use of money, some lasting thing that men might keep without spoiling, and that by mutual consent men would take in exchange for the truly useful, but perishable supports of life.

[Sec. 48] And as different degrees of industry were apt to give men possessions in different proportions, so this invention of money [i.e., or unspoiling metal property] gave them the opportunity to continue and enlarge them: for supposing an island, separate from all possible commerce with the rest of the world, wherein there were but an hundred families, but there were sheep, horses and cows, with other useful animals, wholsome fruits, and land enough for corn for a hundred thousand times as many, but nothing in the island, either because of its commonness, or perishableness, fit to supply the place of money; what reason could any one have there to enlarge his possessions beyond the use of his family, and a plentiful supply to its consumption, either in what their own industry produced, or they could barter for like perishable, useful commodities, with others?

There are many arguments for silver or palladium or whatever, to be the money of the people. But as I often say, it matters not what SHOULD be, it matters only what IS.


Anonymous said...

Awesome post but this one is a bit shorter and expresses our Utility as I have a bent of mind to Austrian. Genesis chapter 47
Remember in regard to your great post that many people like me rather know bread cannnot come from stones but work and we feel it our right to avert socialism since debt is a future claim on labor and not a right to anothers economy. Gatekeeper has his duty. Some give from abundance some take its that simple. Matt knows the difference also I feel and picking up stones also has message.
Civilization can be impeded and we know who they are. Again great post.

Motley Fool said...



Exter's pyramid. A interesting thing.

One of my views : it is essentially a estimate of risk. The higher you go, the more risk. In times of crisis, people want less risk.. so they go down the pyramid. but since the pyramid is bigger at the top(leveraged), every level below is too small to hold the level above. Some people jump one level at a time, most people jump more. The more people jump, the faster the rest starts jumping. *contemplates a house of cards falling*

When we get to the level just above gold, paper dollars, bank runs occur, since there simply is not enough paper dollars to hold all the top levels. When people cannot get their savings in cash, they panic and civil disorder breaks out. Lets ignore gold for a moment( I know, it's hard :P ). The government has two options then. Print nothing... and the whole deleveraging thing makes every paper dollar worth a LOT more, which means deflation(and civil disorder).. which the government fears. Or try to print enough so everyone can get paper.. which means hyperinflation.

Guess what I think they will do. xD

The Fool

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