Sunday, April 3, 2011

A Winner Takes the Gold

Ladies and gentlemen, we have a winner! Fox Business correspondent Dagen McDowell takes the gold medal in Wasted Airtime for demonstrating her very "special" gold standard of loud, obnoxious and completely closed-minded cluelessness. But before we get to the incredible video of the win, I would like to refresh your understanding of the intellectually-challenged view that drives this amazing woman.

It is a view so disconnected from reason and logic that I am compelled to write this post. And it goes something like this: "You owe it to society to give your savings to Wall Street so that your excess productivity can be more easily used or consumed by others, since you aren't using it right now." And I have yet to find anyone who has articulated this fabulously fallacious and deliciously deleterious view of reality better than the great Charles T. Munger of the esteemed Berkshire Hathaway Corporation:

"Oh, I don't have the slightest interest in gold. I like understanding what works and what doesn't in human systems. To me, that's not optional. That's a moral obligation. If you're capable of understanding the world, you have a moral obligation to become rational. And I don't see how you become rational hoarding gold. Even if it works, you're a jerk. (Laughter)"

(Video will start at 1:04:43)

Now I'm not suggesting that Ms. McDowell learned her very special spiel at the Munger school of gold-bashing, but wherever it was, I'm guessing it wasn't the long bus that dropped her off. Enjoy:

(If your browser won't play the video, try clicking here)

This is not simply a competing viewpoint in the grand marketplace of ideas, folks. It is wrong wrong wrong. And not only that, it is irrational, irresponsible and dishonest. More on this in a moment. But first I'll start off slowly so as not to lose the Dagenites right out of the gate.

Ms. McDowell goes on and on about how bonds "produce income." She apparently prefers interest and dividend payments over raw capital gains. Here we are, a decade into the bull market with gold's run so far equal to a compound annual growth rate of 18.8% for ten years running, and her main argument is still that gold doesn't produce an income? In what universe is receiving debt service payments superior to the escalation of real value over time as the economy grows against gold's limited physical supply?

Next she yammers on about gold having no "industrial worth." Again, in what universe is "industrial worth" always superior to non-industrial value? Should the Mona Lisa be fed into a wood chipper so as to tap its "industrial worth" as stuffing for a mattress? No, gold has INFINITE marginal utility in its service to the social realm. And by "infinite," Dagen, I mean much higher, broader and long-term usage value than any manufacturing or industrial input. If you can, Dagen, please read my post on The Value of Gold.

She also seems to have this strange obsession with timing, desperately wanting to hear the other guy say he didn't catch the exact start of the bull market. Sorry dear, but the only significant timing that matters today is "the earlier the better," or "better a decade early than a moment too late." Gold's marginal utility does not diminish as a matter of timing. Any day is a good day to set aside some savings for the next rainy day. And I can see storm clouds gathering on the horizon.

Here is FOA writing about Credibility Inflation. Credibility Inflation is that warm fuzzy feeling Dagan receives from her income-producing bonds:

When people try to protect their assets against the effects of fiat money, what are they really fighting against? The first inclination is to say "rising prices." Yet it's much more than that! Most everyone agrees that the interest rate paid by the banks never covers the loss of buying power brought on by price inflation. Especially the "after tax" return. It's the same old story, played out decade after decade. We must "invest our savings" (or become a day trader?) because the money will erode in value! Even at 3%, price inflation can eat away at any cash equivalents.

But, price inflation isn't the only story that impacts us. Rising prices come and go, but money inflation continues to affect us without fail. So why do people feel better when price increases slow or stop, even as money inflation runs ever upward? The good feelings usually evolve from the effects that money inflation (increases in the money supply) has on financial instruments. These assets take on the very same characteristic that the rising prices of goods once exhibited. They run up in currency price.

During these periods of "less goods inflation" another sinister form of mindset lurks in the shadows. Credibility inflation! Yes, it has been here many times before as every fiat currency alternates its effects upon the feelings of the populace.

Fiat currencies must, by definition, always expand in quantity. Their continued usage and acceptance is always obtained with the bribe of "more wealth to come!" Without that bribe, humans would never fall for holding a debt to receive the same goods in the future if they could get the real thing today. Human nature has always dictated that we buy what we need now instead of holding someone's IOU to receive it later. That nature is only changed through the "greed to obtain more." Like this: "I'll hold my wealth in dollars as long as my assets are going up. Later those increased assets will buy me a better lifestyle as I purchase more goods and services than I could buy now."

This is the hidden dynamic we see today. Just as destructive as "goods price increases," "credibility inflation" impacts our emotions to "hold on for the future, more is coming!" In every way, "credibility inflation" is just as much a product of an increase in the money stock as "regular price inflation" is. As cash money streams out to cover any and all financial failures, we begin to attach an ever higher credibility to the continued function of the fiat system. In effect, the more money that is printed, the higher we price the credibility factor.

But what Dagen should know about her unhealthy obsession with timing is that Credibility Inflation doesn't unwind smoothly. Instead, it "snaps all at once":

The same thing is happening today. People destroy the currency structure by thinking it can deliver more than reality will allow. Instead of all debt failing slowly with each upward march of price inflation, prolonged "credibility inflation" snaps all at once as investors try to suddenly revert to a "buy now mentality". The inability of government authorities to contain the fiction of "good debt" is usually the feature behind the investor mood change. A currency run induced by an IMF stalemate would qualify as just such a function change. The "snap back" into a sudden "real price inflation situation" caused during this stage by a currency failure always breaks the whole structure. We approach this end today!

Look, it is precisely because gold has the least "industrial worth" that it delivers the most value, not only as insurance against the inevitable "snap back," but as the focal point for net-producers and savers in a healthy, growing economy as well. You can read all about it in my post Focal Point: Gold.

Furthermore, gold is the most socially responsible valuable good to "hoard" (save), which is another reason it is the focal point. John Locke wrote way back in 1690 that it is "foolish and dishonest" for men to hoard up things of short duration, things that are consumed in the support of life, or any more than one can personally use from the common stock of perishables and truly useful supports of life. This, Locke wrote, is how man came to value durable things of no industrial worth, that "he might heap up as much of these durable things as he pleased… and keep those by him all his life," because "he invaded not the right of others." [1]

And today it is incumbent upon us to extend Locke's wisdom even further given the modern monetary plane that didn't exist in Locke's time. Above I wrote that Munger and the Dingbat (Munger and the Dingbat: a new animated series coming this fall) have a deleterious (harmful) view of reality. So let's consider reality for a moment.

Say you produce more widgets than you consume, thereby leaving some extra widgets "on the table" (so to speak) for others in the marketplace to buy, use and consume. You are a net-producer/saver, and you have expanded the global economy by leaving economic goods "on the table." But how to account for your savings?

Well, in the modern world trade is much more global than it was in John Locke's time. In other words, a Chinese saver's "excess widgets" are very likely consumed in the United States. And so how does that Chinese net-producer account for his savings in our modern monetary plane? First he changes the dollars he received selling his widgets to the US back into the local yuan. That yuan represents a "here and now entitlement claim" to more widgets inside China. Next, the Chinese central bank sends those dollars the saver exchanged back to the US where the US Federal Government spends them on widgets, some of which are imported from China. In exchange, the US Federal Government exports to China one of Dagen McDowell's favorite investments, a bond!

In the modern world of monetary magic, economists keep track of this back-and-forth flow with something called the balance of payments (BOP). The BOP is a way to keep track of international flows of both real stuff and paper promises. And if we dial the BOP into just the net flow of real stuff (also called the balance of trade or net exports) here's what it looks like. The balance of trade is the difference between the monetary value of exports and imports. A positive balance is known as a trade surplus (green below) if it consists of exporting more than is imported; a negative balance is referred to as a trade deficit (maroon below). This first one is cumulative from 1980 through 2008:

And this next one is what it looks like if we adjust for population size. Again, green means you are a net-exporter per capita, maroon is a per capita net-importer (of real stuff), also cumulative for '80-'08:

And, as you probably guessed, those people that mostly import the real stuff also mostly export the paper promises! So when you think about the fact that those illustrations are cumulative over 30 years, try to imagine all the real stuff that exchanged for paper promises and wonder about how those promises will be fulfilled. The answer is they won't, because they can't.

Imbalances lead to instability. In the end, instability destroys the value of those promises. So who wins in the end? Those that got 30 years of relatively free real stuff? Or those that will no longer be paid with promises that die?

The Wikipedia article on the balance of payments says, "With record imbalances held up as one of the contributing factors to the financial crisis of 2007–2010, plans to address global imbalances have been high on the agenda of policy makers since 2009."

And Nobel Laureate Joseph Stiglitz writes in last Thursday's Financial Times, "The international monetary system needs fundamental reform. It is not the cause of the recent imbalances and current instability in the global economy, but it certainly has been ineffective in addressing them." Of course then he goes on to babble incoherently about SDRs. But my point in mentioning these quotes is to show you that it is the common (main stream) view that large trade imbalances cause instability which causes financial crises which our current monetary system is unable to address.

Now I'm probably going to lose the Dagenites here, but it's time to learn about the balance of payments concept, courtesy of Wikipedia (edited by me for simplicity):

A balance of payments (BOP) sheet is an accounting record of all monetary transactions between a country and the rest of the world. These transactions include payments for the country's exports and imports of goods, services, and financial capital, as well as financial transfers.

When all components of the BOP sheet are included it must sum to zero with no overall surplus or deficit. For example, if a country is importing more than it exports, its trade balance will be in deficit, but the shortfall will have to be counter balanced… by running down reserves or by receiving loans or investment capital from other countries.

Note the bolded portion. During the Bretton Woods years the US trade deficit was balanced "by running down reserves" through the gold window. After 1971 that method was replaced "by receiving loans from other countries" by selling Dagen's favorite income producing investment, bonds.

While the overall BOP sheet will always balance when all types of payments are included, imbalances are possible on individual elements of the BOP, such as the current account. This can result in surplus countries accumulating hoards of wealth, while deficit nations become increasingly indebted. Historically there have been different approaches to the question of how to correct imbalances and debate on whether they are something governments should be concerned about. With record imbalances held up as one of the contributing factors to the financial crisis of 2007–2010, plans to address global imbalances have been high on the agenda of policy makers since 2009.

Note again the bolded part. Roughly, the current account is the net flow of current paper claims, or currency. In the case of the US and China, the US has a net outflow of currency (we send China more currency while they send us more real stuff). Therefore, China has a net inflow of currency. This accumulates as currency savings for the Chinese people, and currency-denominated debt for US citizens. So when Wikipedia says this can result in [Chinese people] accumulating "hoards of wealth," it really means hoards of currency savings, like a savings account at the bank. "Wealth" is perhaps a poor descriptor for what the Chinese are accumulating while "indebted" fits well with the US population.

Since 1974, the two principal divisions on the BOP have been the current account and the capital account.

The current account shows the net amount a country is earning if it is in surplus, or spending if it is in deficit. It's called the current account as it covers transactions in the "here and now" - those that don't give rise to future claims.

The capital account records the net change in ownership of foreign assets. It includes the reserve account (the international operations of a nation's central bank), along with loans and investments between the country and the rest of world.

I bolded the part about central bank reserves because this is the easiest item with which to visualize the capital account. The capital account is the inverse of the current account. And by inverse, I mean (roughly):


So the way the US sells Treasuries to China means the US has a "capital account surplus." And China has a "capital account deficit." You see, when we ship currency to China in exchange for real stuff, that's a deficit for us. But when China ships currency to the US in exchange for Treasury bonds, that's a deficit for China. I know, it's confusing, but this is how the modern monetary wizards make things balance today. They call it the balance of payments!

But what you must be starting to realize is that either one of the two principal divisions of the balance of payment sheet roughly represents the real stuff trade imbalance by itself! You simply make one positive and the other one negative and presto-shazam, you've got a balance of payments! Wikipedia explains it succinctly: "By the principles of double entry accounting, an entry in the current account gives rise to an entry in the capital account, and in aggregate the two accounts should balance."

Now let's look back at Bretton Woods again. Earlier I pointed out that the US trade deficit used to be settled by the US running down its monetary reserves—gold. But that was back when gold was money. After 1971 they demonetized gold which forced the US into the second option which is running up debt. If you are running a trade deficit you can either run down your reserves or run up your debt. Now I want you to think about this for a moment and commit it to memory, because I'm going to tell you about another option, so simple and obvious that "only one economist in a million may identify and understand" (my thanks to Keynes and Fekete for the felicitous phrase).

But because most of you are not burdened with a PhD or worse, a Nobel Prize in economics, you will probably catch the genius and elegance of this option immediately. At least I hope so.

Before 1971 the trade deficit was settled by exporting gold (via the gold window) to those running a trade surplus with the US. The problem with this system was that gold was fixed at a dollar price. So the US reserves were quickly run down by maybe 65% in 20 years. This was a problem because it was clearly unsustainable.

After 1971 the trade deficit was settled by exporting US Treasury debt bonds. And as we can see, this system is also clearly unsustainable. It cannot be reversed without collapsing the system. Joseph Stiglitz alludes to this in that FT piece:

"These deficits are necessary, for creating sufficient global liquidity, but they also generate excessive indebtedness, both external and internal. So if the US were to shrink its deficit too quickly, a deficiency of supply of the global reserve currency could result."

Simply stated, the modern monetary system creates a debt monster that must be perpetually fed. I have explained this dead-end cycle in past posts using my own illustrations like these:

Greece is the Word

Bondage or Freegold?

Now I'm sure some of you are probably thinking these modern monetary shenanigans are pretty lame. Obviously we need to balance the trade of real stuff. We can't just keep running a trade deficit into perpetuity and hope the PhD and Nobel Prize-winning economists will somehow fix it on paper, can we? Of course not! And close you are to discovering the final, elegant solution!

Gold is no longer money, like fiat currencies and government bonds. Today it is just another part of "real stuff." Call it a commodity. Call it "honest money." Call it whatever you want. But as long as we define gold, once and for all, as that physical element created only by God/nature, excluding any and all ethereal counterfeits, no one can disagree that gold falls squarely into the category of "real stuff."

Now savings is production minus consumption. If you consume more than you produce you don't have savings, you have debt. So savings is the way net-producers account for those extra widgets they "left on the table," growing the size of the global economy. What if, just what if, all those net-producers, those powerhouse engines of economic growth, saved the value of their excess productivity by buying that real stuff we call gold? Would it be bad for the economy or a bad investment as Munger and the Dingbat obnoxiously proclaim? Or not?

Here's that BOP formula again:


And I'll give you one more:


And of course:


So as you can see, these formulas can be expanded as such:




That "= ZERO" means that the BOP is a zero-sum game. Notice that if the capital account were somehow magically zero (which would represent balanced "real stuff" trade), then savings would automatically be exactly equal to domestic investment. Or said another way, all excess real production would go right back into the local economy via domestic investment… automatically!

But that's only in a trade-balanced world, if things like Treasuries didn't exist. Because of Treasuries, the US has a large capital account surplus (large debt) while China has a large capital account deficit (lots of promises of future entitlement claims from America!).

This might be a difficult concept for you all to swallow, and I'm sure I've lost the Dagenites by now, but one thing the PhD and Nobel Prize-winning economists know for a fact is that those above formulas are, what they call, inviolable. This means that no matter what part of the equation you try to manipulate, it will always equal zero.

So if China wants to reduce its trade imbalance with the West it appears to have three options. 1. Increase imports that would feed into increased domestic investment. (But with China's yet-empty cities and shopping malls, increasing domestic investment may be an uphill option.) 2. Somehow get its people to stop saving or 3. consume more. In fact China has a fourth option. Encourage their citizens to buy gold, combining savings with consumption.

Remember; savings = production – consumption. And as I wrote in my last post, buying physical gold acts just like consumption with regard to the balance of trade, yet it also works like net-producing/saving to the global economy in that it leaves "on the table" all useful net-production as well as all of John Locke's "things of short duration, things that are consumed in the support of life, and things that invade the rights of others."

Okay, that's enough density. Put simply, there is a very simple, good, moral and ethical solution to the problem of global trade imbalances. And before I tell you what it is, I will say this: If you're not part of the solution, you are part of the problem. And that includes Munger and the Dingbat.

The simple solution to all the world's monetary and trade-imbalance problems is...... dot dot dot....... Buying PHYSICAL gold with your savings. It works (very roughly) like this:

If every Chinese saver were to take his cash savings (yuan) out of the bank and start buying the limited stock of physical gold already inside China, the price of gold in yuan would start to rise. This would create a theoretical arbitrage opportunity to buy gold cheaper outside of China and import it. Gold would flow into China. Of course this arb would happen naturally and automatically which would equalize the price of gold across borders.

And this gold flowing in would balance all other trade. If China exports X amount of goods and imports Y goods plus Z physical gold—with X > Y obviously—then X = Y + Z. The quantity of gold required to settle the accounts would float in price. Arbitrage through the open market between currencies and gold would automatically remove imbalances over time. Imports would always equal exports as long as the price of gold fills the void. And over time the price and flow of gold would automatically stabilize, as would the global monetary system.

Of course this would require a physical-only gold market with a free-floating price in all currencies because imports and exports of gold would then become part of the "real stuff" trade formula and could no longer exist in the monetary and physical realms simultaneously as they do with "Bullion Banking" today. All that currency spent on gold would continue to circulate in China. So it's not a matter of these gold-hoarding Chinese "jerks" (cf. Munger) denying others their net-production. That net-production would be still sitting "on the table" so to speak.

And as long as our net-producer/savers (young super-producers) outnumber our dishoarders (retiring ex-super-producers), the gold will still flow, only in lower volume by weight and higher nominal value. In other words, the price will rise. So... as the price of gold rises, more and more real economic goods are "left on the economic table." The economy expands... wait for it... as the price of gold rises! So gold is not the doom and gloom investment Dagen thinks it is. Oh no. It's the economically prudent and morally responsible investment!

And I'm not necessarily implying that borrowing (bonds) and economic investments (stocks) won't exist. But those who net-produce and then funnel their savings into those antiquated financial instruments have and will always make somewhere between a much lesser and a massively negative contribution to society than the gold hoarders. I say massively negative because it is they, Dagen and Munger, that enable systemic malinvestment and incentivize the kind of lowering of prudent lending standards that almost brought the system down in 2008. By contrast, gold savers force banks to use their own capital when funding the debt-based consumption of the widgets left on the table. Paper investments pinched off by the sphincter that is Wall Street only encourage and enable banks to make too many loans, far beyond the weight (and prudence) of their capital.

So Munger and the Dingbat are wrong wrong wrong! You're a jerk if you save in paper, enabling the destruction of Western Civilization. Rational people everywhere have a moral obligation to buy ONLY physical gold with their savings. If you're capable of understanding the REAL world, you have a moral obligation to become rational. And I don't see how you become rational investing in Charlie Munger's paper. Even if it works, you're a jerk, just like ol' Chuck.


[1] Second Treatise of Government – CHAPTER V – Of Property


Adrian said...

Agree with your analysis and when I lived in San Diego, and watched Fox (at that time I had no economics training, or awareness of how corrupt the financial system is) Dagen McDowell always shouted down some young Jewish guy (can't remember his name, but if you watched Fox you'll know who I mean), and I'm guessing is laughing at her now on gold, and most things financial. It wasn't just gold as the issue however, but Fox is a joke, and I haven't watched it for years. I hear lots of stories from Fox on the Web, but nothing that would ever make me watch it again.

Anonymous said...
This comment has been removed by the author.
Terry said...

As usual, another great piece! I must take exception to the premise that gold has no industrial uses. I participate in it's consumption and have for two years.

As with so many potentially beneficial discoveries, gold has a commodity use that has been suppressed by our revered government How many other beneficial discoveries has our government stifled. Can you honestly believe anything that the government publishes. Do you think the oil companies will allow a discovery of free energy to debut without a fight? Do you think a cure for diabetes will be made available as soon as it is discovered? Here is information on an industrial use for gold that, when allowed to become public knowledge, will make gold a much sought after commodity. Of course, the amount of disinformation about the uses has, and will continue until knowledge of its uses become demanded by the public. For your listening pleasure, I offer the following 6 part lecture by its discoverer.


Currently, you can buy gold products at quite a few locations. More information is also available in the book "Lost Secrets of the Ancient Ark" by the late Sir Laurence Gardener.

The more scientific uses are seriously stifled by our government because they are changing science. The government doesn't want any other governments to acquire this knowledge because of the scientific ramification's.

sirch said...

Many of you will find this on your own, but ZH posted a link to watch the documentary "Inside Job" for free. This what happens when society feels compelled to lend their savings to Wall St.

Aaron said...


Great post as always and a nice lesson in BOP to boot!

@ sirhc

Thanks for the link to Inside Job. I would have missed it otherwise. Looks like my entertainment is lined up for the evening.


Desperado said...

Fofoa, I have been saying the same thing almost as long as I have been reading your blog. We all have a moral obligation to buy gold in order to put a stop to this farce known as the federal government.

Where I differ from you, Fofoa, is that I recognize that the EU government and their fiat enslavement tool, known as the Euro, are as just as sinister as the Fed, Obama, Munger and the Dingbat.

Diamond Jack said...

Great post, I like it when FOFOA gets riled up, makes me think he might become an activist.

I have never seen this woman before. My first thought was, "I'm glad her names not Dagney". I recall Microsoft creating great wealth before ever paying a dividend. By the time they started one, the smart money was long gone.

This post shows clearly the relationship between savings and production. And we learn humanity gets it's production up front!

The battleground of personal savings is a moral one. Here is the heavy artillery in our war against the Bernak. Mona Lisa to the wood chipper. Gold to line urinals. Rather, we must find value in what can not be defined. At the point of a gun. I see better days ahead.

As elegant and devestating as the logic and thought may be I will argue it must be balanced with action. Mind/body is thought/ action.

The Fungold Personal Fuels Company
Fungold Prospecting

In the days of barter, my bet is whiskey will outperform silver as a currency.

Unknown said...

Peter Schiff expertly explains the trade imbalance (this FOFOA post) at the Council for Foreign Relations. I don't know how Schiff got an invite from the CFR but its a must watch.

Unknown said...


If you held German marks or bonds through the wiemar hyperinflation, WW1 and WW2 you would have been wiped out 3 times. If you held Siemens stock through the same time, you would still have some modicum of capital. (as far as i know)

So what is most likely to happen to real productive stocks ?

Will they be priced in Euro's possibly ?

Indenture said...

matt's Peter Schiff link:

How Should the United States Address Its Chinese Trade Imbalance? (Video)

Robert Mix said...

Another excellent, excellent piece. Thanks FOFOA! Your words are practically crackling off my monitor.

Thanks again for reminding us of the moral correctness in saving something with little industrial worth, although I will still hold my modest amounts of Pt and Ag, thank you.

I have my doubts about China. Historically they mess just when they are on the verge of greatness. Every Dynasty so far, I expect the Communist Dynasty to do so as well. But, I am no expert (N. N. Taleb would be OK with that)! If the Chinese DO start buying gold in a BIG way, then RPG will arrive soon thereafter at your local coin shop.

Some 10 - 15 years I remember reading and hearing about what great guys and investors Buffett and Munger were. Huh, now we have seen just how cozy Berhshire is with .gov. Wall Street / the Treasury / the Fed are are all so sleazy. As mick_richfield (at ZH) would say:

Fed delenda est.

As individuals we can do almost nothing to end the Fed, but we can front-run them and buy (physical) gold! And maybe some lead and lead delivery systems to help protect it.

julian said...


Sparkling lesson yet again!!

I'm really starting to get a feel for this idea of Savings being Consumptive also, in our case it would be the "consumption" of Physical Gold as "savings". How it plays an intriguing role economically, real world cause-effects.

More thoughts on this are perhaps warranted.

The concept seems so simple. Not being familiar enough with macro accounting doesn't help, but your basic explanation is expert in this post. After a second reading I should have a much better grasp.

Pursuant to Terry's comment, this is something I've contemplated before. Particularly the thought of gold no longer being "useless" in industry. Curious indeed.

But still, FOFOA, I think this most recent view you've been sharing, namely that saving in gold ecnonomically counts as consumption too, is in some way a final move of all moves. How else can a high-level economic thought be so accurately expressed? Mises Institute should entertain such a Thought. I wonder if any of them already do? :)


- Julian

Anonymous said...


thanks, very nice!

Something unrelated. Kitco News (March 31, 2011) have an interview with Ron Paul in which he says
1) he wants to make sure the mint produces enough coins to satisfy demand
2) he wants to introduce a bill in order to make the official gold and silver coins exempt from sales tax and capital gains tax, in order to create a competing currency


costata said...


This proposal contains the seeds of its own failure here:

2) he wants to introduce a bill in order to make the official gold and silver coins exempt from sales tax and capital gains tax, in order to create a competing currency

I'm going to assume that this bill does not seek to repeal the legal tender laws. If it does please ignore the following paragraphs as the USG would collapse inside of a week after the bill's passage.

As A/FOA observed "debt is the essence of fiat". Fiat currency must inflate (devalue). To be a currency the metals must circulate. If either or both metals are valued above parity to the fiat currency and Gresham's Law kicks in then the metal will not circulate.

Let's assume for a moment that this proposal succeeds and the "bad" money drives out the "good" money. Logically one or both metals would be saved/hoarded as a store of value and the fiat currency would be held for short periods to exchange for consumption needs, pay taxes etc.

If there are no taxes there is no "gatekeeper" role for the USG. Physical metal would transact through private or public markets and float against the official legal tender currency.

Also given the huge amount of US$ on issue (and US currency equivalents) it would also seem logical to assume that in a free market one or both metals would trade at a much higher fiat currency price than they do now.

The only party with the capacity to act as market maker at dramatically higher prices would be the Central Bank/Treasury. In other words the issuer of the currency. They could make a market in gold using their reserves. Silver would be problematic in this regard.

Is this scenario starting to sound familiar?

PS. If it proceeds this could be a game changer for silver.

Warren James said...

@Costata, just a quick thought - what if Ron Paul's 'competing currency' is more like a trojan horse to make bullion an unhindered wealth asset? The hoarding would take place without taxation, making it a perfect wealth asset.

It just occurs to me that Freegold must be brought to the public; but it may have to be advertised to the masses as a different more familiar name (like 'currency'). What better means of introduction than Ron Paul's "revolutionary" ideas?

p.s. by example, in Singapore you buy physical gold with a 7% GST attached - but 'paper gold' doesn't attract GST (we know why). If the taxes were removed then physical gold buying would suddenly be all the rage in SG.

swattsup said...

I am mortified that you would so insult the brave and honorable participants of the Special Olympics by associating them with this sort of thing.

Furthermore, anyone choosing to be/remain blind and/or mentally challenged in no way compares to having them foisted on oneself.

Please try to come up with a more appropriate "reward."

Edwardo said...

An excellent dismantling of The Fox personage, whose existence was news to me. And I'm delighted that you did the same to Charlie "The Jerk" Munger who, as a devout follower/believer of Human Systems, clearly needs a major tune up in his understanding of said systems. It's his moral obligation after all.

Edwardo said...

Let me go out on a limb, albeit a very sturdy one I think, and offer that what Ron Paul is promoting with respect to gold and silver coinage doesn't have a snowball's chance hell of being realized.

In the meantime, if Mr. Paul has any sense, he has an ulterior motive along the lines Warren is suggesting. That may be giving him far too much credit though, and, as a feckless as Mr. Paul is, I'm not sure I want him on my side.

Terry said...

Doctor Paul is a strict constitutionalist, and as such, his goal is widely recognized as getting back to real constitutional money. That would be gold and silver coin.

Greenie said...
This comment has been removed by the author.
Greenie said...

The words 'moral obligation' and Charlie Munger do not go together -

Terry said...

Edwardo, how could you call Doctor Paul feckless? Doctor Paul is the single most ardent advocate of gold and silver in the entire US Congress, and with the help of the late Howard Katz, was instrumental in instituting the current program for minting gold and silver coin in the US, instituted in 1986. The good doctor is an enemy of the banking cartel, and as such, puts himself in peril because of his promoting the demise of the Fed. Because the rest of Congress benefit from the banking cartel's generosity, Dr Paul gets very little support.

Edwardo said...

Perhaps someone here would care to respond to this.

Edwardo said...

Terry, you no doubt know the meaning of the word feckless, and, so, with no exceptions, by my gauge anyway, on matters of great import, Ron Paul's record is one of futility. Perhaps that will change, but I'm not, no pun intended, banking on it.

Motley Fool said...
This comment has been removed by the author.
Terry said...

Edwardo, I inferred from your post, Ron Paul to be incapable of effective action. You don't consider his creation of the "Eagle" minting program, where no minting was taking place, as effectual? If feckless, it would be because he gets very little support from his Congressional peers, or his economically illiterate constituency. That doesn't even address the inherent danger suffered by the politicians who have opposed the banking cartel, as did JFK. I strongly disagree with your assessment of Doctor Paul. I do respect your right to your opinion.

Motley Fool said...


Edwardo said...

Terry, I don't consider Ron Paul's minting program to be terribly consequential, ergo my qualifier, "of great import."

JR said...


RP's bill calls for repeal, so yeah.

Nonetheless, you would be surprised, RP is pushing more a Hayekian competition in currency. He has said he is not expressly advocating for a gold standard.

And our host has done of wonderful job of exploring the fertile overlap between Hayek's commentary on competition in currency and Freegold.

The bill won't pass but that's beside the point. The times are changing, just as we would expect.

Cheers, J.R.

@mortymer001 said...

King Ibn Saud’s 35,000 British sovereigns – Gold’s historic undervaluation versus oil; ~Michael J. Kosares

...At the time (1933), the British sovereign’s value stood at $8.24 each, or $288,365 for the lot. The price of oil was about 85¢ a barrel, and a British sovereign could buy about ten barrels....
...For gold to buy the same amount of oil now that it did in 1933, the price would have to go to nearly $5000 per ounce — an interesting calculation for those who think gold is overvalued and in a bubble. ..."

Redhill said...

Great post FOFOA!

Physical gold IS a great extinguisher of debt (promissory currency notes).

PS: Agreed with swattsup about the inappropriate use of the Special Olympics medal in your graphic. Looks like mercury-retro is in the works.

Matt said...

rick ackerman writes a fatally flawed piece on hyperinflation

already a couple of references to FOFOA's writing in the comments

The Dork of Cork said...

Just removed from another Irish Blog for mentioning vague freegold concepts.
I know I am a annoying bastard but all you have to say on a Irish economic blog is that the medium of exchange function of currency is dying and you disappear.

Strange very strange.

Edwardo said...

Well, Matt, in all sincerity, I think you owe it to yourself to go over and point out the flaws in RA's argument.

Anonymous said...

I thought the interesting point about Ron Paul's proposal is that it would exempt the official gold and silver coins from sales tax and from capital gains tax (similar to the Utah bill, except that they alone cannot do anything about federal capital gains tax).

This would make the coins a preferred store of value. Combine this with his insistence that the mint always satisfy demand for silver and gold eagle coins.

As for Gresahm's law, he is not stupid. He would certainly pay his taxes in paper dollars and put his coins into a safe. But the proposal would offer a method of savings for everyone that is not based on a third party's debt.

By the way, I am not familiar with the issue about the US legal tender laws as I have never lived in the US. Can someone explain to me what the issue is?


Greenie said...

There will be no hyperinflation before we see severe deflation. That much is for sure. Where we go from there is the main question.

Aaron said...

Hi Edwardo-

RE: rick ackerman's article

While Matt formulates his response, maybe you might allow me to take a shot at it. A few quotes from RA's article below with my comments after each.

"While this appears to buttress the hyperinflationists’ arguments, and although Peter Schiff’s scenario – hyperinflation triggered by all-out monetization of T-Bonds – remains plausible in theory,"

That's the first error I see. Hyperinflation is trigged not by all-out monetization of T-Bonds, but rather by a loss in confidence in the currency, followed by a spending spree, followed by a printing spree. He's got the cart before the horse.

"it became quite clear to me, lying awake Sunday morning before dawn, why deflation will prevail"

Damn right it will, that is, right up to the point of hyperinflation.

"As Fergusson makes clear, this panic fed off a cash economy, not credit; and it required close collusion between the government and trade unions. In contrast, the U.S. economy is cashless and the unions are widely reviled."

Cashless? Really? Do you have some cash? I have some cash.

"That said, let me cut to the chase: Hyperinflation occurs when people, fearing their money is about to become worthless, panic out of currency and into physical goods."

Ding! That's one for RA.

"This is highly unlikely to happen in the U.S. for several reasons, to wit:"

"1) Whereas Germany’s hyperinflation took several years to ramp up, today’s financial markets are primed for a catastrophic collapse that could conceivably run its course in a week, if not mere hours;"

I'll let someone else take that one.

"2) under the circumstances, there would be no shifting of financial assets into hard goods simply because any financial assets one holds at the time of the collapse would become worthless before one could sell them;"

He's talking about digitally tracked paper assets. What about cash and real stuff in the physical world?

"3) at that point, there would be insufficient currency available to drive a hyperinflation,"

There's plenty of currency to support a hyperinflation -- in fact just take the majority of base money whatever that figure is, and that's enough. All that's needed is a loss of confidence followed by some wicked velocity.

"since mattress money is likely to be scarce and because branch banks keep only about $25,000-$50,000 in cash on hand."

He repeats this theme a few times, "I invite readers to attempt to rebut my argument in the Rick’s Picks forum – to tell me exactly where the cash will come from that would allow Americans to bid the price of hard assets into the ionosphere."

Is he looking for a dollar value? Because if so, it's a moot point. Take existing base money however much it is, crank up velocity, asset prices rise, government prints to chase previous onset of hyperinflation to keep stooges coming to work.


JR said...

Excellent Aaron!

Looks like someone else also took a flier at this task over at ZH and had some similar thoughts -

Cheers, J.R.

Edwardo said...

Aaron, you should post your response, but, I warn you, endeavor to answer the question that you have left to others to answer or you will likely be taken to task for the omission.

I'm going to come at this discussion from a somewhat different angle, which, from where I sit, addresses the most pertinent issue before us, namely, how can all the debt that is acting as the gravitational equivalent of a black hole be extinguished. The problem where U.S. indebtedness, broadly defined, is concerned, is that insufficient productive gains from U.S. economic activity, coupled with the excessive spending proclivities of the corp/gov state, overpoweringly act to mitigate against the orderly settling of debt.

This portrayal is accurate, but does it mean that a deflationary black hole must, ineluctably, take hold?

It only can mean that if there is no other means to extinguish debt, but that is not the case. This, in my view, is where FOFOA's -and his mentor's- insights regarding our on going financial predicament, are invaluable. FOFOA has written voluminously and compellingly about the role that physical gold is uniquely cast to play with regard to debt service and subsequent recapitalization. And while I can hardly do justice to the breadth and depth of exploration that has occurred as the result of his efforts, here are a few questions that I believe are in keeping with his general train of thought.

What stands in the way, besides the soon to be extinct practice of fractional reserve gold bullion banking, of physical gold, a substance which is infinitely divisible, acting to encompass and envelop every last dram of debt that is acting as a dead weight on the global economy?

What stands in the way of central banks and the wealthiest of the wealthy from around the planet, all of whom hold physical gold as a key asset, from seeing their collective will thwarted such that physical gold is not allowed to be priced, in fiat of all denominations, at levels that allow for most, or even all, of the outstanding debt, to be eradicated?

The idea of overnight radical change in the fortunes of the financial/economic universe is one Rick seems more than a little fond of conjuring. Fair enough, I say, but, equally, I'd like to strongly suggest that any putative punctuated change will involve the spectacular restoration of gold's role as the ultimate extinguisher of debt.

Michael H said...

A couple of more points regarding the RA article:

He asks how much financial assets will be worth when the next financial crisis hits. Well, as we saw in 2008, the FED will likely trade those worthless assets for fresh promises of cash at par (full) value.

Also, he claims that hyperinflation in the US is unlikely because, unlike in Weimar Germany, the US currently does not have collusion between government and trade unions.

I would argue that the US government is colluding with the financial industry, and perhaps the defense industry as well. Hence, there are preferred interests who will be first in line for fresh-printed cash, and will not be allowed to fail.

Anonymous said...

On hyperinflation:

1) The day on which I panic, I will go out with both my credit card and my debit card and max out the credit card and empty the current account using the debit card. No cash required. The store owners will think they are having a very good week. Only later will they notice that they sit on a lot more digital money than they like. But that is a different story.

Hyperinflation does not need 'physical' paper money. Debit cards work perfectly well. When the authorities notice what is going on, it is too late.

2) I think that a loss of confidence inside the US would happen only after a considerable period of frustration about rising retail prices. Frustration includes the realization that the authorities do not want to stop the price increases.

How long exactly will this take? No idea. But I don't think we are there yet. Let's see how much the retail prices increase in Q4. If the Fed stop QE in June 2011, then the economy tanks, and then they resume QE, and commodities take off again, then we might be getting closer to a serious problem by the end of the year. On the other hand, if people remain gullible for longer, it might as well take another couple of years.


Matt said...

oops did not see the RA article had already been posted above me! i'd love to formulate a response but left it here in the hope that some of you smarter guys might chime in with something meaty. it deserves a better rebuttal than i could provide.

from where i am - he's entirely ignoring the political dimension to hyperinflation. he's also failing to factor in the enormous amounts of debt held externally and how this could affect confidence in a worldwide reserve currency. also, he states hyperinflation to be unlikely because of the nature of digital money but at the same time claims bernanke is losing control and a deflationary spiral will unfold. kind of contradictory. bernanke is just going to stop printing and admit defeat? politicians are going to put an end to the current system before they absolutely have to?

Edwardo said...
This comment has been removed by the author.
Edwardo said...

Pardon me, but I needed to make a few word changes to this paragraph.

What stands in the way of central banks and the wealthiest of the wealthy from around the planet, all of whom hold physical gold as a key asset, from seeing their collective will realized such that physical gold is allowed to be priced, in fiat of all denominations, at levels that allow for most, or even all, of the outstanding debt, to be eradicated?

Anonymous said...

I just can’t keep staying silent.

You all speak about “con-fidence.

I want to ask whose confidence do you expect to vanish?

Not in the Western world, I hope! How many people did you con- vince (vincere lat.) to buy gold ? I could convince just one person.
I’ve seen the reopening of the Zoo in Tokio. Masses of people, thousands as they said went there to see some pandas, but not golden ones. They just wanted some “distr-action” after all the horrors they went through!

Do you want a better example how con-fidence work? These people won’t even notice what happens to them until …. take your choice for how long they will listen to MSM and look for “distr-action”.
I sometimes take a look what they are told by their masters via MSM and realise as long as they can buy their grapes from South Africa and Italian olive oil they will still trust paper money, promises, entitlements and governments.

So, again, whose confidence is expected to vanish some day?

BusyB said...

The deflation argument's weakest point is the political one. Every deflationist I've talked with says,
"They (the powers that be) won't do that (print the money); it would destroy the currency, the financial system, and the government. They won't shoot themselves!" Some how the powers will stop just before it is too late; ignoring the fact that every government that tried fiat money through out history has never stopped before it was too late. Governments are nothing more than bandits and they will steal until there is nothing left from the citizens. This is the truth that deflationists can't face, their own faith in government is misplaced.

costata said...

Hi All,

I've read through the two essays that Rick Ackerman mentioned in his post.

IMO the paper that Charles Hugh Smith linked is absolutely outstanding work. The author is Vijay Boyapati. Economics buffs would be rewarded by reading it for its clarity of thought and scholarship even if they reject the Austrian position.

He does a brilliant job of debunking the money multiplier theory of fractional reserve banking. I'm happy to discuss the merits and flaws of Boyapati's paper if anyone is interested.

The Charles Hugh Smith article is, as usual, beautifully executed. Even if you disagree with some of his conclusions (and I do) it is as thoughtful as Rick Ackerman's piece linked earlier.

Unknown said...

There seems to be 2 Matt's here now. I am the original one

Unknown said...

@ thedeadfauvi

There is more dollars outside the US then inside. All it should take is some central banks losing confidence or just simply picking the time to move away from the dollar.

My name is in lower case so i guess that will differentiate me and the other Matt.

lyqwyd said...

Gonzalo Lira has a pretty solid takedown of Ackerman's post, click here to read the whole thing.

Post a Comment

Comments are set on moderate, so they may or may not get through.