Thursday, July 28, 2011

Does Fiat Produce an Endless Sea of Wars?

Does fiat produce an endless sea of wars?

Mish says it does, in Fiat Money Produces Endless Sea of Wars, Debt, Social Inequality, Economic Bubbles, Rampant Consumerism, Environmental Rape; Why Gold is the Answer. (As for the other plagues he enumerates, and perhaps even for the endless sea of wars, the real culprit is described in FOFOA's dilemma. More on this below.)

Dominic Frisby also says it does, in the video that was the centerpiece of Mish's post:

And Lew Rockwell said so back in 2006 here:

But of all the consequences of central banking and fiat money, war is the worst because it exacts the biggest price from citizens and foreigners and everyone else caught in the crossfire. That is why sound money — by which I mean the gold standard — is a key to peace and freedom.

I really despise this kind of gold bug rhetoric because it damages the true story of gold by destroying the credibility of the gold community in the eyes of everyone else. This concept that fiat produces wars is almost axiomatic within the gold community. It is used as a powerful argument for the return to gold money. But what if this gold bug axiom is actually a fallacy? What if it is simply wrong? How much effort has been wasted over the years? How much credibility lost? Here is Randy Strauss (aka TownCrier) on the subject:

TownCrier (8/4/06; 13:14:41MT - msg#: 146358)
taking a HARDER look at fiat and war

Attractive as it would be to simply take Rockwell at his word regarding his association between the making of fiat money and the making of war (essentially saying that war could be abolished if fiat currency were abolished), history begs us to identify that notion as a utopian falsehood. Two handy examples from very close to home (in space and time) provide the necessary instruction on this point.

1) We launched into the U.S. Civil War despite our being on a bi-metallic (gold and silver) currency system.

2) We launched into World War I despite many of the participants being on a gold standard.

Sure, paper greenbacks and confederate currency came along to prominence in the Civil War, as did the abandonment of the gold standard and implementation of fiat currency in WWI, but this development misses a most important point.

That point being, if the metallic monetary standard fails to prevent the war in the first place, then all subsequent arguments about the nature of money go out the window. Because once a nation deems itself engaged in a struggle for its very survival, there is no power on Earth that can compel such a nation to cling fast to its metallic currency standard if the legislators deem that a fiat currency would be expedient to facilitate the war effort.

Here's the bottom line on it: In the very thick of it, the scale and scope of a nation's participation in war is not limited by the extent of the metal or paper fabric of a nation's currency, but rather by the extent of that nation's real resources. Throughout the affair, the role of money (whether in the form of gold currency or paper) is merely an accounting mechanism that the nation uses in the economic mobilization of its resources and production.

And as it all shakes out, the wealth of a nation in PEACETIME is ALSO determined in very much the same way -- upon the extent of its resources and the efficiency of its production and mobilization of capital. And the role of money is to help organize and lubricate the workings of the economy. To be sure, any gold metal within a nation is counted among the nation's total stock of resources, and very obviously, it need not (and ought not) any more than any other physical resource be enmeshed (underutilized) in the physical makeup of the nation's currency/banking system.

Given the structure of fractional reserve lending as the basis of our monetary system, the cold hard truth is that use of metallic (gold) currency propagates a nasty falsehood -- the coins are just a subset of the entire money supply but it nevertheless causes ill-informed participants to wrongly believe that the entire money supply is "as good as gold".

It is Another cold hard truth for some people to swallow, but in light of the preceding paragraph, the use of a fiat (paper) currency system is a much more honest means to represent the intangible "nothingness" -- the appropriate embodiment of the network of accounting which is the actual basis of a monetary system.

Clearly, the conclusion to be had from all of this is that a nation's monetary/currency system does not represent the wealth of that nation. Money is merely a utility to be used, to be borrowed and spent. Again, think of it solely as a mobilizing lubricant within an economy -- it has value while in use, but none otherwise. The wealth of a nation, and of its people, is not in its artificial money, but rather in its various resources which can be mobilized for both local and international deployment. It makes little sense to "save" money, as money is an ethereal utility which can be mismanaged and hyperinflated into dysfunction.

Because of this difficult truth, "Your wealth is not what your money say it is," as Another used to say. Instead, your wealth, properly measured, is the tangibles you've accumulated, the store of resources you've saved. And among the world of tangibles, gold is globally the most liquid -- the most universally recognized, honored, and accepted.

In time of war, governments may (and history has shown they often do) recognize and declare that gold is too valuable to be wasted underutilized (undervalued) in the representational coinage of national currency. Therefore, fiat currency is adopted, and gold is instead mobilized in its fully-valued form -- a tangible resource uniquely and reliably suitable for any and all international settlements.

Blunt summary:
Our monetary system, in an attempt to be HONEST, chooses mere digits and PAPER as its representational currency. And consequently, in an effort to act WISELY, we unabashedly use this currency for immediate transactions, whereas we SAVE for our livelihoods by acquiring GOLD.


Now that's an interesting concept. Fiat is actually more honest than a gold standard. Perhaps I could write a few words about it. Oh, wait. That's right, I already did.

--> The Return to Honest Money

There's a promising trend developing today. More and more of the West's intelligentsia are speaking openly and positively about a 'gold' reference/standard/focus. Here is James Grant, publisher of Grant's Interest Rate Observer on Bloomberg TV last week:

From the video:

Carol Massar: Okay, but do you really think anybody is going to adopt [a gold standard], Jim?

James Grant: Carol, in Brooklyn we have a saying: This is not a threat, this is not a promise, it's gonna happen. […] We have a credit card, and a gold standard would be our debit card! That's what we need.

Carol Massar: I love that idea, that you say we need a debit card.

I love it too! But how about if the gold becomes Mises' "secondary medium of exchange"? Meaning it floats against, and must be exchanged for, the primary medium of exchange (fiat) before it can be spent. Then the US debit card will debit from America's WEALTH which will float in VALUE until that time at which it must be spent to fill the hole left by the trade deficit.

In essence, we'd be accounting for our gold, our ASSET backing our debit card in its VALUE rather than its VOLUME. Doesn't this make more sense than foolishly trying to control (fix) the value just so we can use volume as our accounting method? Talk about shooting ourselves in the foot.

Notice that I called the US gold an ASSET. That's what it is, ever since Nixon severed its link to fiat, just like Treasury bills. Assets are Mises' "secondary media of exchange".

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

Claims employed as secondary media of exchange have, because of this employment, a broader market and a higher price. The outcome of this is that they yield lower interest than claims of the same kind which are not fit to serve as secondary media of exchange. Government bonds and treasury bills which can be used as secondary media of exchange can be floated on conditions more favorable to the debtor than loans not suitable for this purpose.

Even Bernanke agrees:

So if gold is an ASSET and not money, as even Bernanke states, why are we the only ones still accounting for it by VOLUME rather than VALUE? When gold was money, and it was fixed in value to the dollar, it made sense to account for gold in VOLUME, because the value never (rarely) changed. But after 1971, that link was severed and gold began to float. Today, as Bernanke says, gold is an asset. Should it not be accounted for by VALUE now rather than VOLUME?

Quite amusingly, the US Treasury "updated" its gold reserves on the same day as the ECB's MTM party. Here is the June 30, 2011 Update. And here is the March 31, 2011 Update as I captured it for Reference Point: Gold - Update #2.

So each quarter, as the Eurosystem has its Mark to Market-valuation party, the US Treasury has its Mark to Volume party. And actually, the Treasury busybodies do it every month! But Treasury is only recording any tiny changes in the VOLUME of the US gold, just like when it was money. The value hasn't been changed in 40 freakin' years! And in fact, the volume hasn't changed either! Here are the monthly back reports going back 2.5 years. A special prize goes to anyone who can spot a single change anywhere in these 30 monthly reports. Yet as crazy as this sounds (US gold still valued at $42.2222/oz.), there is historical precedence for this antiquated system of asset valuation.

As I pointed out in Euro Gold, the 1993 IMF guidelines for central bank MONETARY GOLD valuation states, "Monetary gold transactions are valued at the market prices underlying the transactions." (Section 444) In other words, mark them at the initial purchase price. Yet the IMF does in fact distinguish between "Monetary Gold" and "Gold held as a store of value" believe it or not (see "Gold" in the index). And for "Gold held as a store of value", as for all assets relevant to the Balance of Payments (balancing trade imbalances), the IMF recommends continuous revaluation to market prices:

Valuation of Stocks of Assets and Liabilities

107. In principle, all asset and liability stocks
comprising a country’s international investment position
should be measured at market prices. This concept
assumes that such stocks are continuously (regularly)
—for example, by reference to actual market

prices for financial assets such as shares and bonds or,
in the case of direct investment, by reference to
enterprise balance sheets.

202. Nonmonetary gold covers exports and imports of
all gold not held as reserve assets (monetary gold) by
the authorities. Nonmonetary gold is treated as any
other commodity and, when feasible, is subdivided into
gold held as a store of value and other (industrial) gold.

438. Monetary gold is gold owned by the authorities
(or by others who are subject to the effective control of
the authorities) and held as a reserve asset.10 Other gold
(nonmonetary gold, possibly including commercial
stocks held for trading purposes by authorities who
also own monetary gold) owned by any entity is
treated in this Manual as any other commodity. Transactions
in monetary gold occur only between monetary
authorities and their counterparts in other economies or
between monetary authorities and international
monetary organizations. Like SDRs (see paragraph 440),
monetary gold is a reserve asset for which there is no
outstanding financial liability.

So which is it? Is the US gold a monetary or a non-monetary asset? Ben says it is not money. In fact, he was careful to call it a FINANCIAL asset, which he also called US Treasuries. So if that's his lexicon, I agree. But I do think that gold is probably the most credible ASSET available today, primarily because it doesn't involve an outstanding counterparty liability. In which case even the IMF appears to recommend regular MTM revaluation.

You know, this happened once before. In 1997 the German Bundesbank was valuing its gold under an even more conservative principle than the US, called Niederstwertprinzip. The principle of Niederstwertprinzip means you value your assets at the lower of two possible prices, the purchase price or the market price, whichever is lower at revaluation time. In other words, you record unrealized losses but never the gains. This is a highly prudent and conservative method of valuing one's assets. They would value their liabilities the opposite way, at the highest possible value. But in practice, this was an overly conservative method of valuing an asset whose price had appreciated over many decades.

And so, in line with modern best practices of accounting, the EMI (European Monetary Institute), forerunner of the ECB, announced in April 1997 that the Eurosystem would base its asset values on market valuation rather than the antiquated German system of Niederstwertprinzip. What this meant for Germany was that it had until launch day, January 1, 1999, to revalue its gold or else the financial gain from revaluing its gold contribution to the ECB would be formulaically distributed throughout the Eurosystem, rather than going entirely to Germany.

In the run up to launch day, politicians all over Europe were struggling to meet the Maastricht criteria of a budget deficit of no more than 3.0% of GDP, and total public debt of no more than 60% of GDP, by the end of 1997. This included Germany. And in 1997 Germany was also struggling with its highest unemployment rate since the Great Depression, 12.2%. And so, without being able to grow its GDP in 1997, this left only two options for getting the budget deficit down from 4.0% in 1996 to 3.0% in 1997; either raising taxes or cutting spending.

But that year, the political right successfully blocked all efforts to raise taxes while the left blocked the proposed spending cuts. Is any of this sounding familiar? It's what we call "between a rock and a hard place!"

So anyway, everyone wanting into the EMU had two targets to hit. 60% total debt and 3.0% deficit. And in early 1997, after the Dutch and the Belgians sold some gold to help hit their targets, it was ruled that the proceeds from official gold SALES could not be used to offset budget deficits but could be used to pay down the debt. This ruling left open an interesting technical option for Germany.

Since Germany would only be revaluing its gold reserves and not selling them, it could virtually erase the budget deficit it was facing in 1997 rather than running into an embarrassing breach of the Maastricht criteria in the critical year. For the politicians, the formulation of this revaluation plan was a godsend. And it was completely within their constitutional power to implement. The only necessity was changing a law governing the Bundesbank a little earlier than necessary, yet a law that would have to be changed before launch day anyway. You see, unlike in the US where the gold is owned by the government, not the Fed, in Germany the gold is actually owned by its central bank.

But the Bundesbank (Germany's CB), with its legendary reputation for fierce independence from politicians, did not want to be viewed publicly as having assisted these politicians to resolve a fiscal challenge (their problem) through a change in monetary policy (the Bundesbank's solemn responsibility). So when, on May 14, 1997, this plan was leaked to the press, the problems began. It was in the shadow of this uncomfortable leak that German Finance Minister Theo Waigel offered the following plea:

These reserves represent the success of the German national economy over the last 50 years. It is a savings which we have amassed from abroad. It was indisputably proper that the Bundesbank valued gold and foreign reserves with extreme caution over the last 50 years. … The new valuation will proceed with all necessary caution. The financial respectability of the Bundesbank will be guaranteed. Precautions against currency risks and the volume of the gold reserves will remain untouched. Not one ounce will be sold. It follows that not one ounce will finance the budget… It is both proper and inexpensive to use this 'ancestral credit' to wipe out our historic liabilities.

Unfortunately for the politicians, this public statement came across as pure desperation. The government denied that it was panicking and claimed the gold revaluation was simply one small part of a much broader plan to fix the budget problem. But, in fact, the gold revaluation would have made up for the entire budget shortfall all on its own! And having this debate go public threatened to undermine the credibility of the new ECB right out of the gate because the ECB's credibility rested on 50 years of Bundesbank credibility as a currency manager and defender.

The Bundesbank Governing Council, flexing its legendary independence, ultimately blocked the effort to use the necessary gold revaluation to bail the politicians out of their fiscal crisis. On May 28, 1997, following its Council meeting, the Bundesbank issued a press release agreeing to the revaluation of the gold before launch day, but rejecting immediate revaluation for the 1997 fiscal year, calling it "an infringement of the Bundesbank's independence."

The politicians fought back in the court of public opinion, but this conflict between politicians in charge of fiscal operations and a central bank in charge of only monetary operations hung a cloud of doubt over the timely launch of the euro. This endangered the exchange rate stability the politicians were counting on leading up to euro launch day. And this connundrum left the political push for EMU in an awkward position.

You can read the whole story here, but in the end, facing the damage that the public confrontation had done to the international credibility of German finances and to the reputation of the Bundesbank, the German Finance Minister (equivalent of the US Treasury Secretary) and the President of the Bundesbank (equivalent of the Fed Chairman) agreed to a compromise. The agreement was that the gold would be revalued in 1997 but that the distribution of any gains would not take place until 1998. The government would not be able to use the gains to offset budget deficits during the crucial year. The politicians would still have to fix the budget.

The agreement was reached in June of 1997 and the German gold was revalued. The Bundesbank's working capital was automatically increased and a portion of the proceeds went into a currency volatility fund (like Treasury's ESF) to deal with any repercussions of the revaluation. The distribution to the government's Fund for Redemption of Historic Liabilities would not take place until 1998. That was the deal. And ironically, even without the help of these funds, by the end of 1997 Germany met the Maastricht criteria with a deficit to GDP ratio of 2.9%.

Now I don't know if there are any lessons in this story that are particularly relevant to President Obama and his current, very public (and credibility damaging) budget confrontation. There are many obvious parallels as well as some clear differences. And one of the most glaring differences is that the US gold is not owned or controlled by the US central bank like the German gold, but it is instead in the custody of the US Treasury, which is part of the Executive Branch of which Obama is the chief executive.

Part of what led to this scheme to revalue Germany's gold at a key point in budget negotiations was that Germany's Niederstwertprinzip valuation policy left its gold beneath the level that 11 out of its 13 EU partners valued theirs:

Click image to enlarge:
Notice that the book value of Germany's gold in 1996 was only 27% of its market value at that time. Only Sweden had a lower valuation at 15%. So where would the US fit into this chart?

In 1996 the US was even lower than Sweden at 12%, but today our gold sits idly by at 2.6% of its market value.

Now even though a few of you went to excellent elementary schools, I'm sure that some of you have forgotten how the American budget process actually works. I know for a fact that some really smart people think Congress makes the budget. Here's a very brief refresher courtesy of Wikipedia:

The United States federal budget is prepared by the Office of Management and Budget (Executive Branch), and then submitted by the President to Congress for consideration. Invariably, Congress makes many and substantial changes. Nearly all American states are required to have balanced budgets, but the federal government is allowed to run deficits. The Office of Management and Budget (OMB) is a Cabinet-level office, and is the largest office within the Executive Office of the President of the United States (EOP).

It should be fairly obvious since I'm quoting Wikipedia that I am no expert in the US budgetary process, but even I can see that there are a few options that have never been explored or considered. And these are options for employing America's historical wealth, hidden in gold all these years, in defense of the credibility of her modern finances and the reputation of her currency. Instead of constantly trashing the currency and destroying credibility, it seems to me that there may be a few options and opportunities for Obama to step out and go down as one of the great statesmen in American history (but don't hold your breath).

I have brought up similar ideas in the past, so I'm not going to waste time repeating myself here. Instead, I thought why not come up with a fresh idea that would really shake things up? Why not figure out something that Obama could do right now, on national TV, that would definitely make it into the history books, something that would finally earn him that peace prize? So here's what I came up with:

First Obama makes a speech about credit cards versus debit cards with Jim Grant operating the teleprompter.

Then Obama hands Congress a new one page budget that reads simply:

Projected income: X
Budget: X
Spend it anyway you want.

Then Obama announces that he has instructed Treasury to audit the gold and then act as market maker to determine the US$ price required to balance the USG balance sheet and thereafter to maintain a free market in gold. He goes on to say that all taxes and any remaining restrictions on gold ownership will be removed to ensure the efficiency of this important new balancing mechanism.

Obama explains that through this process Congress will get a clean balance sheet and the American people will have an independent benchmark on the value of the US dollar every day. In effect, he will have hit the reset button and given the USA a fresh start.

From here he returns to his opening remarks about debit cards versus credit cards. He explains that for the last 40 years America has been maxing out one credit card after another, building the most powerful nation the planet has ever seen… on credit. But now that credit card will have competition from the new US debit card. We'll let our debit card compete with our credit card. If the world wants our gold more than our debt, they will pay the price that balances our books.

And as they bid up the price of gold, the balance in our debit account will grow, it won't shrink, because it is funded with a financial asset (as Ben Bernanke called it), a secondary medium of exchange (as Mises called it) that from here on out will be accounted for in VALUE not VOLUME. We still have more gold than any other single nation in the world, he'll remind the audience. And if they want it, they'll pay the price that balances our trade with the outside world.

At some price the gold will reverse our international trade deficit, and then our debt will become the better bargain. You can forget credit ratings. We'll have competition between our debt and our equity, our credit card and our debit card. Global trade will finally balance in physical goods and services because the price and flow of physical gold will make it so. The simplest answer ever. One for the history books.

Turning to Gold for the Answers

The more our mainstream intelligentsia turn to gold for answers, the more they look to the gold community for direction. And what they find there is all this nonsense about returning to one of the gold standards of yesteryear. Is that really where we are headed?

Gary North didn't think so in 2003. In one of my favorite articles by him, The Myth of the Gold Standard, North calls "the ideal of the gold standard" "one of the movement's least understood and most futile political causes." He goes on to explain how proponents of the gold standard unwittingly "defend big government in the name of limited government. And, just like almost everything else in the conservative movement, it eventually backfires. It backfires for the same reason the other conservative programs backfire whenever inaugurated: it calls on the State to limit the State."

"The next time you hear someone waxing eloquent — and, in all likelihood, incoherent — about the marvels of the gold standard, ask him this: 'Why don't you trust the free market?' This question is intended to elicit what I like to call a jude awakening.

"Be prepared for a blank stare, followed by 'Huh?'"

"A gold standard is a promise made by a self-licensed professional counterfeiter that he will always stand ready to redeem his pieces of paper and official digits in exchange for gold at a fixed ratio. As the mid-1950's comedian George Gobel used to say, 'Suuuuuuure he will.'"

Do you see the difference here? It's the difference between what I'm talking about and what Mish and others are talking about. Mish wants the government to affix the price of gold (fix, control, read: government price control) to its currency preventing gold from floating. They don't trust the free market. They want government control. They are unwittingly asking for big government. I on the other hand want the market to choose the price of gold from day to day, the price that is necessary to resolve the global trade imbalances and set us back on a sustainable course.

More North:

"The gold standard became universal in the nineteenth century. Because the public had the right of redemption for a century, 1815 to 1914, the price level remained relatively stable for a century. This right of gold redemption was invariably suspended during major wars, but it was restored a few years after the war ended…

"The nineteenth century was the first stage of an international sting operation. As in the case of every con game, the con man must create a sense of trust on the part of his mark. Whether it is a Ponzi scheme or a more traditional scam, if the targeted sucker distrusts the con artist, he won't surrender his money. For the con game to work, the con man must create an illusion of reliability. In short, he must present himself, economically speaking, as if he were 'as good as gold.'

"The era of limited government led to enormous economic expansion. It also led to the mass production of high-tech weapons. Governments had to get their hands on these weapons in order to defeat other governments. There were few Third World nations in 1885 that could afford fifteen minutes of ammo for a Maxim machine gun. The big governments, in the words of nineteenth-century New York City politician George Washington Plunkett, 'seen their opportunities and took them.' The age of modern empires began in earnest.

"The bigger the world's economy got, the bigger the national governments got. The bigger the national governments got, the more they jostled with each other for supremacy. By 1914, they were ready for mass destruction on an unprecedented scale.

"World War I began with the suspension of gold payments by the commercial banks. This was the violation of contract — a lie from the beginning — that fractionally reserved banks would redeem bank notes and accounts at any time for gold coins. As soon as the governments all retroactively validated this violation of contract by commercial banks, they used their central banks to extract the gold from the commercial banks. They have yet to give it back…

"There are conservatives who still present this 2,700 year-old con job of State-issued honest money as a philosophy of limited government. Whenever I hear this assertion, I always hear the faint sound of a piano playing Scott Joplin's "The Entertainer." My mind becomes clouded by an image of Paul Newman and Robert Redford, arm in arm, walking away with my gold. Fade to black."

So… does fiat produce an endless sea of wars? Perhaps it is gold standards that produce wars! After all, as both Randy Strauss and Gary North pointed out, we were on a bi-metallic standard at the beginning of the Civil War, and a gold standard at the beginning of WWI, a gold exchange standard at the beginning of WWII, and I'll add the French Revolution into the mix as well. And don't forget Jim Rickards' words from my post Greece is the Word:

"…this is taken much more seriously by the Europeans. I mean you go all the way back to the Counter-Reformation in the late 16th century which was extremely bloody. And then the Thirty Years' War which was devastating. And then the Seven Years' War and the Napoleonic Wars, the Franco-Prussian War, World War One, World War Two... this is one catastrophe after another! And Europe literally destroyed itself and exhausted itself in fighting all these wars. And finally after WWII they said enough! We're going to pursue unification. It's the only way to keep from fighting each other.

Now, political unification has had modest success. Military and foreign policy unification has really had no success at all. But the crown jewel of European unification is their monetary system, the euro and the European Central Bank."

How many of those wars were produced by easy (fiat) money? Perhaps this one? But of course this is not my stance.

Gold standards don't cause wars any more than fiat causes wars. If any flaw in our monetary plane has a causal relationship with war in the physical plane, it is not the ease or hardness of the chosen money. It is the proclivity of our systems, whatever side is running them at the time, to fail to acknowledge and address the needs of two distinct groups, the debtors and the savers. Money is naturally bipolar for this very need. So how strange is it that no one has ever noticed?

FOFOA's dilemma applies to both fiat and gold standards. Here it is:

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

Herein lies your causal relationship with Mish's list of plagues foisted upon the human race: Endless Sea of Wars, Debt, Social Inequality, Economic Bubbles, Rampant Consumerism, Environmental Rape. Perhaps a better subtitle would be: Why Freegold is the Answer.

Mish ends his short piece with this: "All fiat currencies including the US dollar are doomed. The only debate is the path it takes to get there." I guess this calls into question Mish's definition of doomed. If, by "doomed", he means the present purchasing power of the dollar is doomed, well then that's a bingo. But if by doomed he means we won't be using dollars as the medium of exchange in the future, guess again.

You can read about this concept at great length in my post The Return to Honest Money, but for now I'll end this post with a few relevant comments from FOA:

We must not confuse a currency's "total demise" or "falling out of use" with a "loss of identity". In our time there have been few major moneys that went away. Today, we have a whole world of national fiats "in use" and "not demised" that still carry their nations identity. They lose value at an incredible rate, are mismanaged to the highest degree, are laughed at and despised. But, still they are "in use" as they function for their governments and economies. Usually, they function along side whatever major reserve currency is in vogue. Today, the dollar, tomorrow the Euro. Make no mistake, the entire internal US sector can and will function as it's currency runs a price inflation just like these third world countries. We will adapt as they have by dropping our living standard accordingly and adopting the Euro as our second money. Also:

The prestige that we have the largest military force in the world does not help our money problem. We talk as if we will let any country die that does not use our money or support our currency. I point out that the British also made such comments and it didn't stop their downfall. Nor the Russians. Also:

I point out that many, many other countries also have the same "enormous resources; physical, financial, and spiritual" that we have. But the degrading of our economic trading unit, the dollar places the good use of these attributes in peril. Besides, the issue beyond these items is our current lifestyle. We buy far more than we sell, a trade deficit. Collectively, net / net, using our own attributes and requiring the use of other nation's as well. Not unlike Black Blade's Kalifornians sucking up their neighbors energy supplies (smile). We cannot place your issues up as example of our worth to other nations unless we crash our lifestyle to a level that will allow their export! Something our currency management policy will confront with dollar printing to avert. Also:

NO, "this country will not turn over and simply give in" as you state. But, we will give up on our currency! Come now, let's take reason in grasp. Our American society's worth is not it's currency system. Around the world and over decades other fine people states have adopted dollars as their second money, only to see their society and economy improve. Even though we see only their failing first tier money. What changes is the recognition of what we do produce for ourselves and what we require from others to maintain our current standard of living. In the US this function will be a reverse example from these others. We will come to know just how "above" our capabilities we have been living. Receiving free support by way of an over-valued dollar that we spent without the pain of work.

And later:

Won't happen! Plan on Americans using inflating dollars as their local transactional currency and Euros as their second currency.

And again:

Of course I own dollars and will likely keep using them right thru any super inflation. I never expect the dollar to disappear.


Mind you, this is all happening while Western style "Hard Money Socialists" are defending their stance by saying the Euro is just another fiat. Ha!

That's FOA for ya!


Monday, July 18, 2011

Forum 1600

Date: Tue Mar 31 1998 08:32

Now, with the world awash in "US dollars" and "gold paper", a new asset is being formed to "draw" the oil producers closer to Europe! The offer is the "exact opposite" of the "US dollar agreement", this new offer will drive gold to a value that will allow it to become "the world oil asset and currency".

Date: Sat Apr 25 1998 23:35

There will come a time when gold and Euro are as "the same". Not in price or value, but as used for "real money".

Money is not what you afford, you earn it! In the near future, gold money will buy more than dollar money, much more! It is as to compare a one dollar bill to a hundred dollar bill, both money, just one buys more!

Many think the only way gold can rise in dollar terms is if USA prints too many! Truly, they have printed too many already. Gold will rise in dollar terms, many thousands even if treasury inflates currency no more.


From Sam: For whatever percent backing by gold, will the Euro be convertible to physical gold, and by whom (i.e. all or limited)?

ANOTHER: Your question of Euro gold backing? The Euro will not be backed or fixed in gold. It will be the first "modern currency" to hold true "exchange reserves" in gold. It is important to understand that "exchange reserves" of gold are much more powerful a tool for currency defense than gold backing!

8/10/98 Friend of ANOTHER

The Euro will not replace gold, it will evolve into a gold transactional currency. It will also price Euro gold very high, perhaps $6,000 in current dollar terms buying power. However, in actual dollar terms of the future, $30,000 US will reflect the American debt as the negative reserve asset it truly is.

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

Michael H: "Who says that events since 2001 haven't played out as A/FOA expected?"

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

Monday, July 11, 2011

Euro Gold

(Photo: REUTERS)
A gold bar carrying the Euro sign is seen during the European Central Bank's Euro Exhibition organised by the Romania's Central Bank in Bucharest March 10, 2011.

A little over a week ago on "Snapshot Day" (Thurs., June 30), the Eurosystem MTM party began with the CB rendition of "Whoop, There It Is" –-> Gold: EUR 1,043.382 per fine oz. – promptly followed by a dip down to EUR 1,022. Of course it has now recovered and is up at the all-time high in the EUR 1,100s. And even though this wasn't the all-time high quarterly snapshot in EUR terms, it was only 1% under the previous ATH and it was the first ever quarterly close over $1,500.

Then on Wednesday the ECB released its quarterly ConFinStat (Consolidated financial statement) for the Eurosystem. Here are the top two lines from that statement (my emphasis):

In the week ending 1 July 2011 the increase of EUR 12.6 billion in gold and gold receivables (asset item 1) reflected quarterly revaluation adjustments.

The net position of the Eurosystem in foreign currency (asset items 2 and 3 minus liability items 7, 8 and 9) decreased by EUR 0.6 billion to EUR 176.6 billion.

In other words, the decade-long trend continues, with the Line #1 asset gold floating upward while the Line #2 asset, foreign currency, sinks downward.

Value and Volume

Now, the ECB puts out a ConFinStat every single week, 52 weeks out of the year. And every week it makes quantitative volume adjustments, like net increases or decreases in both gold and foreign currency reserves. But it only makes qualitative or value adjustments on four of those 52 statements. This is when the ECB marks its reserves to what the market says they're worth. The MTM party! And for the last 12 ½ years the trend has been that, proportionally, the Eurosystem's gold reserves have been rising while their foreign currency reserves (mostly dollars) have been falling. Here's the chart:

Yet if we look at those reserves only quantitatively by volume, the opposite is true. Foreign currency reserves (again, mostly dollars) have grown over 12 ½ years in volume, from roughly $260 billion to $310 billion from a dollar-denominated perspective. Meanwhile the Eurosystem's gold reserves have fallen, again, only quantitatively, from 402 million ounces to 347 million ounces in volume.

This view, the volume-only view, is the fundamental modus operandi of the $IMFS that praises quantitative (voluminous) expansion and "growth" while ignoring qualitative (value) degradation. The reason is that governments and central banks can only print volume, not value. Think about this for a moment.

A clear example, of which I'm sure you are all aware, is that the official US monetary gold stockpile is still held on the books at $42.22 per ounce. But would you believe that this arcane (some would say moronic or worse) treatment of national reserves is actually codified in the official guidelines governing global central bankers operating under the $IMFS?

It's true! Since 1993, the last word in international reserves has largely gone to the IMF as set forth in the Fifth Edition of its Balance of Payments Manual which can be found on the IMF website here. Under 'Structure and Classification' you'll find chapter XXI: Reserve Assets, paragraph 444 on Valuation (my emphasis):


444. In principle, all transactions in reserve assets are recorded at market prices—that is, market exchange rates in effect at the times of transactions, market prices for claims such as securities, and SDR market rates as determined by the Fund. Monetary gold transactions are valued at the market prices underlying the transactions. For valuation of stocks of reserve assets in the international investment position, market prices in effect at the ends of appropriate periods are used.

In other words, the IMF guidelines are out of step with modern best practices insofar as they lamely prescribe that reserve assets be recorded at the market price in effect at the time of the transaction that acquired them. Hence, there is no provision for periodic MTM adjustments to provide a rational reassessment of the evolving market-health of the balance sheet.

Recognizing this particular valuation/accounting shortcoming (along with "a few" others), the ECB has been at the institutional forefront implementing useful deviations. Essentially acknowledging the IMF's own admissions of ambiguity within the manual, the ECB tactfully says, "the definition of reserve assets included in the 5th edition of the IMF Balance of Payments Manual leaves some room for interpretation," setting the stage for its own definitive refinements as put forth in its "Statistical Treatment of the Eurosystem's International Reserves" formally published October 2000 and found on the ECB website here.

So, from this volume-only view loved by the $IMFS, here's what a chart of the Eurosystem's gold would look like:

But from the volume times value view (which ldo makes tonnes more sense and also assists the little guy deciphering the monetary mess), here's the true picture:

A different view, wouldn't you say? Do you remember this quote from ANOTHER?

"Know this, "the printers of paper do never tell the owner that the money has less value…"

The funny thing is that writing this post made me want to go look up that quote. It was written on 5/26/98, six months before the euro launched as a unit of account and 42 months before the ECB launched its euro medium of exchange. Now yes, of course, at that time (1998) no printers of paper currency told you their product was losing value. The dollar was still showing gold on its books at $42.22. But here's what I started to think about: Today, the printer of the euro, the ECB, tells all the owners that the money it prints has less value in gold… once every quarter! And not only that, but it encourages people to save in gold through system-wide mandates. Dang, now that's quite a 'something different' when you really stop to think about it!

You see, there are two fundamental differences between the euro and the dollar that most Westerners simply can't grasp, no matter how many times you try to explain their significance. Wim Duisenberg, the first ECB president, stated them pretty clearly in this 2002 speech:

"The euro, probably more than any other currency, represents the mutual confidence at the heart of our community. It is the first currency that has not only severed its link to gold, but also its link to the nation-state. It is not backed by the durability of the metal or by the authority of the state. Indeed, what Sir Thomas More said of gold five hundred years ago – that it was made for men and that it had its value by them – applies very well to the euro."

There's a lot in that one paragraph, but the two fundamental differences with the dollar are the severed links to gold and the nation-state. Hopefully I have sufficiently addressed the former above. I will now try to explain the significance of the latter.


Homo sapiens generally tend to focus on the minutiae of any situation, or else on what everyone else is saying about it. And in the case of the euro, that would be "the debt" or "Greece". Somehow most people always seem to miss the giant big-picture elephant tromping about the room. And in this case, that elephant is the euro's severed link to the nation-state. When Duisenberg said this was a "first", he meant it. And Milton Friedman also said it in 2001 (my emphasis):

"The one really new development is the euro, a transnational central bank issuing a common currency for its members. There is no historical precedent for such an arrangement." [1]

In the world of currencies, there are many varieties. The way a nation chooses to manage its currency relative to the world outside its boundaries can have a wide range of effects and consequences, ranging from long-term stability to periodic hyperinflation. If you want a hard currency, then, ideally, you want it managed by someone else—a disinterested third party. Here's Milton Friedman again:

"A hard fixed rate is a very different thing. My own view has long been that for a small country, to quote from a lecture that I gave in 1972, “the best policy would be to eschew the revenue from money creation, to unify its currency with the currency of a large, relatively stable developed country with which it has close economic relations, and to impose no barriers to the movement of money or prices, wages, and interest rates. Such a policy requires not having a central bank.” [Milton Friedman, Money and Economic Development, (Praeger,1973), p.59] Panama exemplifies this policy, which has since come to be called 'dollarization.'"

Currency instability is a common problem for smaller nations. The hard fixed exchange rate described above is one way a small country can share the same currency stability enjoyed by larger nation-states. This is in contrast to the (dirty) floating exchange rate among most large, modern economies or the pegged rate of countries like China today, where a central bank uses brute force to try and overpower the normal market adjustment mechanism in order to maintain its desired valuation peg.

Bretton Woods was a pegged system, and one of the characteristics of pegging seems to be the buildup of market pressure that must be periodically released through a currency crisis like we saw in 1933, 1971 and again in the 90s with Mexico and East Asia. The market wants what the market wants, and trying to fight a force as powerful as that always ends in tears for someone. But sometimes the market simply bypasses the choices of the currency manager by using secondary media of exchange.

There are many examples over the last century where the dollar was used by the marketplace as a hard currency in conjunction with a local, unstable currency. Even today it is a common practice in small nation-states for the dollar to be the market's longer term store of value circulating in concert with the local medium of exchange, which you only want to hold for the short term. And this is an example of how the market force, or the demand side of the currency equation, fights back against profligate nation-state printers.

As I explained in Big Gap in Understanding Weakens Deflationist Argument, the value of any currency is determined by a kind of tug-of-war between supply and demand. The demand side is the marketplace and the supply side is the printer. This was true even when gold was the currency. If the market demand for gold was rising faster than it could be pulled out of the ground, the value would rise and the circulation velocity would slow, often causing a slow-down in the economy sometimes resulting in recession or even depression. This tends to lead to monetary revolt and the re-emergence of easy money.

The point is, all the market wants is a stable currency, not too hot, not too cold. It is like a sleeping giant. Give it a stable currency and it will keep sleeping. Wake it and you (the printer) will lose control of the value of your currency and everything else you try to control. The market is the demand side of the equation. And the market is by far the more powerful of the two sides in this tug-of-war. If this isn't making sense, please read my post linked in the paragraph above because I'm not going to explain it all here.

To summarize, there is a whole menu of options for the aspiring money printer to choose from when stepping into the supply side shoes of the monetary game. And as a supply sider, his job is providing a service to the demand side, the market, which wants one thing and one thing only, a stable currency. And if he wants to keep his job, he'd better give his clients what they want, because if they wake up to an unstable currency, they can easily take the reins of control away from him. So if his mandate is—or evolves into—anything other than a stable currency, he will not be long for this monetary world. And one last thing; instability means quick changes both up and down. The client doesn't want drastic inflation or deflation.

The Debt

Most of you already know this quote from FOA:

"My friend, debt is the very essence of fiat. As debt defaults, fiat is destroyed. This is where all these deflationists get their direction."

Now that's not the whole quote, of course. But that's enough to warrant some extra thought. Just think about it for an extra few seconds before continuing onward. And then next I want to jump from that to this; chapter 82 from The Triumph of Gold by Dr. Franz Pick, written in 1985:

"82. How currencies die

As currencies become more and more devoid of substance, they perpetuate their existence through their multiples. The milreis replaced 1,000 reis, and the bilpengoe tried to substitute for a billion pengoe. The conto was worth 1,000 escudos. The Greek talent was equal to 6,000 drachmae or 36,000 obols. In Java, the bahar was good for 100 million candareens. In India, the nil replaced one hundred billion rupees

Some coins were flattened to the point where they were as thin as a sheet of paper, or actually chopped up into strips, or cut into bits of all sizes and shapes. Some were punctured and the holes then plugged with inferior metal.

These strategems did not and will not save currencies, which are all doomed by the passage of time."

He's talking about debasement. Debasement is not monetary expansion through credit expansion. Debasement is the base money behind the credit being expanded in volume by the supply side as its only possible response to value degradation coming from the demand side. Note in particular the last line: "doomed by the passage of time." And here is some more FOA from 2000 which I reposted in Freegold in the Proper Perspective:

"...Our dollar has had a usage period that corresponds with the society that interacts with it. Yes, just like people, currencies travel through seasons of life. Even gold currencies, in both metal and paper form have their "time of use". Search the history books and we find that all "OFFICIAL" moneys have at one time come and gone with the human society that created them. Fortunately, raw gold has the ability to be melted so it may flow into the next nation's accounts as "their new money".

This ebb and flow of all currencies can be described as their "timeline". We could argue and debate the finer points, but it seems that all currencies age mostly from their debt build up. In a very simple way of seeing it, once a currency must be forcefully manipulated to maintain its value, it is entering the winter of its years. At this stage the quality of manipulation and debt service become the foremost determinant of how markets value said money. Suddenly, the entire society values their currency wealth on the strength and power of the state's ability to control, not on the actual value of the money itself. Even today our dollar moves more on Mr. Greenspan's directions than from the horrendous value dilution it is receiving in the hands of the US treasury.

This is where the dollar has drifted into dangerous waters these last ten or twenty years. If you have read most of Another's and my posts, it comes apparent that preparation has been underway for some time to engineer a new currency system. A system that will evolve into the dollars slot once it dies.

Out here, in deep water, we can feel what the Euro makers are after. No one is looking for another gold standard, or even something that will match the long life and success of the dollar. We only know that the dollar's timeline is ending and a new young currency must replace it. No great ideals, nor can we save the world! But a reserve currency void is not acceptable.

Now look back to shore and watch the world traders kick ankle deep water in each other's faces over the daily movements of Euros. From here, up to our necks in blue water, you ask "What the hell are they doing?" I'll tell you. They are trying to make $.50 on a million dollar play! Mostly because they are seeing the chess game one move at a time. (smile) Truly, their real wealth is in long term jeopardy.

Our dollar has already entered a massive hyperinflation. Its timeline is ending and there will be no deflation to save it..."

And a little more from Franz Pick:

"85: Few people understand the concept of currency debasement

This process of debasing the currency to pay for government deficit spending has been going on for centuries. The Egyptians did it, the Greeks and Romans did it. Countless other nations have done it. Now it's going on all over the world. The process of monetary inflation – and its result, soaring prices – is a simple concept. Adam Smith understood it, as did John Stuart Mills, David Ricardo, and other classical economists.

But, alas, today few people understand the concept. Instead, thanks in large part to the writings of John Maynard Keynes, higher prices are laid at the feet of excessive labor wage demands, greedy corporations, Arab oil sheihs, and the disappearance of anchovies off the coast of Peru. Mon Dieu! The media – woefully ignorant of currency theory – propagandize these stupid explanations, and the public is left totally in the dark as to the real cause."

And to complete FOA's quote at the top of this section:

"My friend, debt is the very essence of fiat. As debt defaults, fiat is destroyed. This is where all these deflationists get their direction. Not seeing that hyperinflation is the process of saving debt at all costs, even buying it outright for cash. Deflation is impossible in today's dollar terms because policy will allow the printing of cash, if necessary, to cover every last bit of debt and dumping it on your front lawn! (smile) Worthless dollars, of course, but no deflation in dollar terms! (bigger smile)"

Saving the Debt

Now I want to talk about "the process of saving debt at all costs, even buying it outright for cash" because this is something they are doing in Europe as well, and, therefore, is one of the arguments the euro critics use to claim that the euro is no different—or even worse—than the dollar. Should we be surprised or shocked that they are doing this in Europe having read A/FOA all those years ago? Well, no. Unless, like many, you didn't really understand what you read.

In my 2009 post Gold is Money – Part 2, I wrote, "And it was always known, but has now been proven, that the system will be saved at ANY cost." When I wrote that I was discussing the dollar and the dollar system, aka the $IMFS, aka Wall Street. But this applies to any monetary and financial system. The system always takes political precedence over the currency. The currency will always be debased if that is needed to keep the system functioning nominally. This is nothing new and it should not be surprising, yet it's apparently very surprising to 99.9% of all financial analysts.

Politicians and central bankers can only expand the monetary base in volume. They cannot expand its value. And at the first sign of systemic trouble, this is what they do. They do this because to not do it would make them redundant. A void, a vacuum of empty space with no politicians or CBs would do nothing which would allow our money, credit, to collapse down to its base, so the politicians and CBs have to do something to distinguish their fine selves from nothingness. Sure, they talk the hard money talk during normal times, but at the first sign of systemic trouble they print. Here's one more chapter from Franz Pick, 1985:

"83. The pious pronouncements to hold the money supply in check will not be kept

The fellows in the central bank make pious pronouncements about fighting inflation and holding the money supply in check. But they panic immediately when they see signs of distress-borrowing in the banking system, as debtors, many of whom are corporations having interest payments larger than their pre-tax profits, try to keep their enterprises from going under.

Although the Federal Reserve system makes a lot of noise about controlling the money supply and reaching monetary targets, it is at times difficult to understand just what exactly they are controlling. Be that as it may, they will in time revert to form and resume the process of what is coyly referred to as "reliquifying the economy."

This will lay the groundwork for another cycle of currency destruction, which could assume unprecedented dimensions. Though "to deflate or not to deflate" may be the question, the only answer to America's growing financial and economic malaise is to debase."

The point is that the Eurosystem's response (volume expansion) to its current systemic threat (the debt crisis) is not surprising. Does this mean the euro will collapse (experience hyperinflation)? No. Because, for one reason, it has severed the link to the nation-state. The euro is behaving perfectly predictably in maintaining the nominal performance of its system through expansion, but it cannot be forced to fund the future government profligacy of the PIIGS through volume-only expansion. That link is severed.

But the dollar, on the other hand, is nominally on the hook not only for the debt mistakes of the past, but for all future dollar-denominated liabilities, obligations, entitlements and promises of the biggest debtor in all of history, on top of a debt mountain that is probably another $100T in size depending on your measurement criteria. That's a big difference. The dollar is an old currency in the winter of its life, linked to the greatest profligate debtor the world has ever known. The euro is a young currency that has severed its link to the nation-state. The ECB can save its own system, but the member states cannot force it to fund perpetual profligacy.

Here are a few simple principles that will save you the hassle and embarrassment of constantly being surprised by the actions of politicians and central bankers. They will never sacrifice the system to preserve the value of the currency. But they will always sacrifice the currency to save the system. And there is a very simple formula for how they do it.

There are four players to keep in mind; the debtors, the savers, the banks and the printer. They never print and give the money directly to the debtors to pay off their debt. Instead they print and give the money to either the creditors (banks) or the savers (e.g. pension funds) in exchange for the older bad debt which they then put on the public balance sheet to socialize the lost value.

So they "bail out" the banks and the savers nominally, which in turn (through currency debasement) actually bails out the debtors and screws the savers. The banks come out even because they only require nominal performance. But the retirees and pensioners that require real performance at the supermarket get screwed.

It is important to understand the difference between nominal and real. Nominal means you get the number you expected. Real means you get the purchasing power you expected. Nominal expansion is volume-only expansion which is all the politicians and central bankers can do. Real degradation is the value degradation that goes along with nominal expansion or debasement. The banks don't mind this because they only require nominal performance and their CEO's are comfortably seated at the business end of the printing press where they can turn their personal share of the bailout into real returns.

So now that you know what is, and always has been, perfectly predicable and expected, perhaps you will not be so surprised at the news coming out of Europe. Instead, far more interesting is the news coming out of Washington DC.

A Fairy Tale Expanded

Now I'm going to share with you an analogy that I think will help as we compare and contrast the EU and the USA from a currency perspective. As I have discussed on several occasions, the pure concept of money which maintains continuity from thousands of years ago when it first emerged until today, is the common knowledge of the relative values between real goods and services conceptualized and symbolized by a shared and agreed upon unit. And currency, in the context of the pure concept of money, is nothing more than the clearing system for the trade of real goods and services.

As a foundation for this analogy, please read A.E. Fekete's "A 'fairy' tale" from a speech he gave in 2008 (pdf) which I have used on a few occasions:

A ‘fairy’ tale

Let us look at another historical instance of clearing that was vitally important in the Middle Ages: the institution of city fairs. The most notable ones were the annual fairs of Lyon in France, and Seville in Spain. They lasted up to a month and attracted fair-goers from places as far as 500 miles away. People brought their merchandise to sell, and a shopping list of merchandise to buy. One thing they did not bring was gold coins. They hoped to pay for their purchases with the proceeds of their sales.

This presented the problem that one had to sell before one could buy, but the amount of gold coins available at the fair was far smaller than the amount of merchandise to sell. Fairs would have been a total failure but for the institution of clearing. Buying one merchandise while, or even before, selling another could be consummated perfectly well without the physical mediation of the gold coin.

Naturally, gold was needed to finalize the deals at the end of the fair, but only to the extent of the difference between the amount of purchases and sales. In the meantime, purchases and sales were made through the use of scrip money issued by the clearing house to fair-goers when they registered their merchandise upon arrival.

Those who would call scrip money “credit created out of nothing” were utterly blind to the true nature of the transaction. Fairgoers did not need a loan. What they needed, and got, was an instrument of clearing: the scrip, representing self-liquidating credit.

The Modern European Fair

Now imagine if you will a giant fair with dozens of E-Z Up tented booths and tables full of merchandise, kind of like a swap meet at your county fairgrounds. As Fekete says, you show up at the fair with your goods and services for sale, your E-Z Up tent, your table and your shopping list. But when you arrive you must first check in with the fair operator to pick up your scrip money. I imagine the husband then works the booth while the wife goes shopping.

At this particular fair we are imagining, let's call it the Eurosystem, when you register with the fair operator you pay a small fee, deposit your gold for safekeeping during the fair and also for publication of your amount of gold to the other fair participants, and you are issued your scrip money for trade at the fair. But your scrip money is not a receipt for your gold. It is simply the clearing system for trade at the fair, so you are issued an amount consistent with the goods and services you brought to market.

There are a wide variety of booths at this fair. To give you a bit of a mental image, there's a large booth called Germany where you can buy fast cars and good beer! (I know, a strange combination.) There's another one with a fancy custom tent called France. There you can buy funny hats and cheese. And then there are smaller booths, one is called Greece. At Greece you'll find a table loaded with stacks of colorful vacation brochures.

Our fair, however, is a little different than Fekete's fair above. What we've seen over time at our fair is that some of the smaller booth operators like Greece took home more goods and services than they brought to market. And they did so on credit. Large operators like Germany, it turns out, gave Greece some extra goods in return for promises to pay later, and those promises were denominated in units of scrip money from the fair.

After some time, it became apparent that Greece could never pay back the debt at full value. This realization actually threatened the system, I mean the fair. So what the fair operator decided to do was to buy those promises to pay from Germany at face value, with newly printed scrip. This kept Germany in the game although it did devalue the scrip since now there was more of it than there were goods at the fair. But this was fine because the fair operator published a ConFinStat in which he told all the fair participants that the fair's scrip money was now worth less.

Those, like Germany, that had actually saved some income in promises to pay denominated in scrip, and then found those promises severely devalued by the recognition they would never be paid back at full value, received a nominal gift of the same number loaned to Greece, even though it was now devalued. Those that had not saved in scrip, but instead had cleared with gold at the end of each fair, simply carried on trading at the new, lower value of the scrip. You see, the fair operator, we'll call him the ECB, did not participate in the fair itself, primarily because he had severed his link to any specific booth operator. His only job was providing scrip, announcing its value, and maintaining the system, I mean the fair, even if it came at the cost of debasing the scrip money.

Back Across the Pond

Now in your mind's eye I want you to take a bird's eye view of this fair, looking down on all the colorful tents, and then zoom way out as if you were using Google Earth, spin the globe and zoom back in on a different fair "across the pond." We'll call this fair the USA.

On the surface, this new imaginary fair looks very similar to the other one. There are many different tents, tables, goods and services, buyers, sellers, debtors, creditors and, of course, a fair operator who we'll call the Fed/USG. And that's the first difference you'll probably notice, probably because I will point it out. The Fed/USG is not only the fair operator, but also a participant, just like Sy Sperling. At this fair, the link is not severed.

Here are a few more differences. The fair operator is not only a participant, but he is also the biggest debtor this fair or any other throughout all of human history has ever seen. He is literally printing up scrip to buy things from the fair. He is not only funding his ongoing (perpetual) trade deficit by printing and spending scrip, but he is also paying the interest on his past debt by printing scrip. And whenever his creditors start to worry about him paying his debts, he simply prints more scrip to buy back the promises to pay at face value. And he does all this without ever telling the fair participants that his scrip now has less value.

But it gets worse. This fair operator is truly cashing in on the reputation of his forebears. He's emptying his bank of credibility like there was no tomorrow. You see, for a long time his scrip has been used as the inter-fair clearing system instead of gold. So he is not only able to purchase goods and services with his freshly printed scrip within his own fair, he is also able to shop at far away fairs with his printed scrip, simply on the basis of squandering past credibility. And don't think this isn't getting noticed. Ooh baby, you better believe it is getting noticed!

But it gets even worse! The other participants at this fair include a wide variety just like the Eurosystem, including a large surplus vendor called Texas where you can buy ten gallon hats and concealed carry permits. There's also a large deficit/debtor vendor booth called California where you can pose on a fake wave while someone takes your picture. But these participants don't have to deposit any gold when registering, mainly because the fair operator confiscated the gold from their economies 78 years ago and hid it away out of sight. (Note: gold does not have to be in the hands of the state itself to benefit the economy in its stabilizing role in clearing.) So, unfortunately, they don't have any gold unlike the participants at the Eurosystem fair.

Some of the participants in the USA fair, like California, have lots of debt just like Greece. But unlike the ECB, the Fed/USG can't really deal with that right now because it has its own debt problems it is dealing with (printing away). Here's a thought… The USA states are republics not unlike the Eurosystem participants, and certainly as large. What would happen if the Fed/USG just gave that gold it confiscated 78 years ago to the states? Then the District of Columbia, with its modest population of gentlemen busily trying to distinguish themselves from nothingness, could just default on its ridiculous debt and unfunded liabilities. I, for one, would call that move "distinguished!"

Believe me, I know I'm fantasizing here. Remember? This is an imaginary world of fairs and E-Z Ups. But just think about it. We could still have the scrip (common currency) we are all used to (see: Mises' Regression Theorem here), the US dollar. The Fed's mandate could be modified to "only a stable currency" giving the marketplace the one and only thing it wants. Instead of "End the Fed" we could "End the Fed/USG". Doesn't that sound nice?

And in such a fanciful utopia as I am imagining right now for the dollar fairgrounds, one could rightfully proclaim that the dollar had joined the euro in severing its links to both gold and the nation-state. But, of course, this is just fantasy. Such a thing could never happen by choice of the printer, the supply side, because the USG is so large today that it literally forms its own giant parasitic organism, fighting for survival. In the EU, however, there is no such thing.

Quarterly Reflection

Over the latest quarterly cycle we have witnessed several curious advances in Europe. To name just a few, on May 24th the European Parliament's Committee on Economic and Monetary Affairs agreed unanimously to allow gold to be used as collateral in clearinghouses. [2] And then on June 7th the ECB encouraged investors to buy new Greek bonds to replace maturing securities with two separate unnamed European officials saying investors may be given collateral as one possible incentive to roll over the debt when it matures. [3] And finally, on "Snapshot's Eve", June 29th, we learned that China's SAFE (State Administration of Foreign Exchange) is actively doing all it can to transfer billions of its dollar-denominated holdings into euros. [4][5]

The monetary plane is changing. The signs are everywhere. Euro gold just broke EUR 1,100 today. Here's what it looks like in dollars:

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

Do you think this is the top? Do you think gold is expensive at $1,550? Do you think gold is just another commodity and will therefore collapse back to its 2002-2005 range if the economy tanks? Think again.

On timing, look up. It's already begun. But here is, I think, the question you should be asking yourself. It comes from John Rubino with a couple of Freegold edits from me [in brackets]: "Do you wait until it [the rapid RPG-Freegold revaluation] is underway at the risk of missing the discontinuity [gap up, punctuation, phase transition, etc.] that growing imbalances make likely, or do you load up on precious metals [sic—only physical gold IMO] and short Treasury bonds now, and just accept the fact that the coming year might be dominated by delusion?" [6]

Do you remember my "Orbital Launch Pattern" from Gold: The Ultimate Un-Bubble? "For all you technical analysts out there plotting and planning your eventual exit from gold before the blow off phase, I have a new pattern to introduce to you. I call it the Orbital Launch Pattern, or the Inverted Waterfall. In this pattern there is no blow off! It looks something like this..."

Feel free to reflect on this while you enjoy the music below!


[1] One World, One Money?
Robert Mundell and Milton Friedman debate the virtues—or not—of fixed exchange rates, gold, and a world currency.
[2] Bid to Use Gold as Collateral Advances (WSJ)
[3] Trichet Gives First Signal Endorsing Greece Bond Rollover (Bloomberg)
[4] It's Official: China Is The "Mystery" Daily Buyer Of Billions Of Euros (ZH)(WSJ)
[5] I also discussed these stories in this comment under the last post.
[6] Bondholders Should Be Under No Illusions (Rubino)