"The heart has many reasons that reason does not understand."
Silver Satamana Bent Bar
Taxila Janapada 600 BC
This commentary was originally posted at www.financialsense.com on 19th May 2005.
A fair amount of ground is going to be covered in what follows. First the manipulation of the precious metals will be examined. Included is a discussion of Gibson's Paradox. I would like to thank Reggie Howe for his gracious approval to reference his work on the subject, and to Nick Laird for providing the charts.
Next will follow a look at the presently popular topic of deflation, inflation, stagflation, and hyperinflation. It seems just about everyone has a different take on the subject, so one will be offered that is seldom heard. Included is a difference of opinion regarding a particular view on the subject.
Please note that the intent of such discussion is to endeavor to look into every possible nook and cranny of monetary "theory" in search of any gems that may have been missed in the ruff, as the present state of our monetary system is in dire straits and could use all the help it can get. The eleventh hour has come and gone, and the clock is fast approaching midnight.
Finally a look at a somewhat different monetary theory, and its explanation of hyperinflation will be presented. This "theory" is not mine, but is being offered because it is the most coherent and complete monetary theory as of yet put forth by man. It is the work of professor Antal Fekete.
There will be a silver and gold Ariadnean thread running throughout the topics discussed, readily discernible, revealing not only evidence of their importance in monetary theory, but also as to their unique role as the only viable remedy to our present day monetary problems.
The solution is Honest Money, a system of honest weights and measures of silver and gold, without any fixing of exchange rates, thereby allowing the free market to determine the rate of exchange. And the precious metals should be left as they are, precious and pure, without fixing an amount of so many dollars to the coin, which then acts as an albatross about it's neck, as the ancient mariner can so attest.
Silver and gold, if left alone and unfettered, will exhibit their natural qualities of purity and fineness, as honest weights and measures. When silver and gold speak - all tongues remain silent.
A call to return to the monetary system of the Constitution should be the order of the day, proclaimed by all loyal citizens, to their elected representatives, whose job, and in several cases their sworn oath of office, is to uphold and serve the Constitution.
Some Call It Manipulation
I would like to thank Reggie Howe and the GoldenSextant website for providing some of the following information as duly footnoted where applicable.
Paradoxes are very interesting critters, as they appear to be absurd, contradictory, and inconsistent with common every day experience. Amazing how similar that sounds to a description of the Federal Reserve System. But enough, on with our tale:
Once upon a time there was a story named Gibson's Paradox, which had a sequel called Gibson's Paradox Revisited: Professor Summers Analyzes Gold Prices. Prior to becoming our Treasury Secretary, Mr. Summers was the Nathaniel Ropes professor of political economy at Harvard. He co-authored the above paper with Robert Barsky.
It was, however, Lord Keynes, in one of his more lucid moments, who coined the term "Gibson's Paradox", in an attempt to explain the correlation between interest rates and the general price level observed during the years of the classical gold standard.
Notice the similarity of the subject matter with Jackson's and Fekete's linkage theory between interest rates and the price level, as discussed in part three of Silver Is Money.
The reason it was a paradox is that Irving Fisher, to whom most things appeared to be a paradox, suggested that interest rates should move with the rate of change in prices, i.e., the inflation rate or expected inflation rate, rather than the price level itself.
Another one of those inexplicable conundrums. Not so said Summers - I shall explain, so that all mere mortals may better understand the arcane workings of the wizardry of finance. The Professor spoke, as a hushed silence descended upon the audience:
"The properties of the inverse relative prices of metals today ought to be similar to the properties of the general price level during the gold standard years. We focus on the period from 1973 to the present, after the gold market was sufficiently free from government pegging operations and from limitations on private trading for there to be a genuine market price of gold."
"The price level under the gold standard behaved in a fashion very similar to the way the reciprocal of the relative price of gold evolves today. Data from recent years indicate that changes in long-term real interest rates are indeed associated with movements in the relative price of gold in the opposite direction and that this effect is a dominant feature of gold price fluctuations." [courtesy of GoldenSextant]
The above basically translates into English as meaning that gold prices move opposite (inverse) to real interest rates - in a free market that is. Free markets, however, is wishful thinking, and a bit of a stretch for all but the tallest giraffes in the jungle. Although free markets are doubtful, the rest of the thesis remains plausible, at least for awhile.
Nick Laird at www.sharelynx.net compiled the following chart expressly for Reggie Howe GoldenSextant to illustrate the relationship between the price of gold and real long term interest rates. With both Reggie's and Nick's gracious approval, the chart is presented below. The 30-year U.S. Treasury bond yield minus the annualized increase in the Consumer Price Index (calculated as the sum of the monthly CPI increases for the preceding twelve months) is used to define real long term interest rates.
The chart clearly shows that the inverse relationship between long term interest rates and the price of gold remained fairly intact until something funny happened around 1995, as the relationship suddenly diverged in the opposite direction of what it had been.
Interest rates and the price of gold are no longer running inverse to one another, but in the same direction - and the direction is down.
As real rates declined from 4% to 2% the price of gold dropped from $400 an ounce to around $270 an ounce. According to Summers and Gibson's Paradox, the price of gold should have moved in the inverse direction - or up in price. So what happened? Did one of the four horsemen suddenly appear?
One possible explanation that Mr. Summers provides in his paper is what he refers to as "government pegging operations". Hmm, I wonder if that is the same as government intervention in the markets? Or perhaps it is as innocuous as trying to force a square peg into a round hole for a psychological job evaluation test, job related of course.
A search for further evidence that might shed some light on the shadows seems to be appropriate. Recall in part three of Silver Is Money that some important definitions of critical terms from the Nymex were listed. One of them stated:
A custom-tailored, individually negotiated transaction designed to manage financial risk, usually over a period of one to 12 years. Swaps can be conducted directly by two counterparties, or through a third party such as a bank or brokerage house. The writer of the swap, such as a bank or brokerage house, may elect to assume the risk itself, or manage its own market exposure on an exchange.
Swap transactions include interest rate swaps, currency swaps, and price swaps for commodities, including energy and metals. In a typical commodity or price swap, parties exchange payments based on changes in the price of a commodity or a market index, while fixing the price they effectively pay for the physical commodity. The transaction enables each party to manage exposure to commodity prices or index values. Settlements are usually made in cash.
What Did They Say?
From the transcript of the minutes of the Federal Open Market Committee on March 26, 1991 the following "exchange" took place between Federal Reserve Governor Wayne Angell and Federal Reserve Chairman Alan Greenspan.
Chairman Greenspan: "Is there not any mechanism by which we can create swaps or RPs or something of that nature in which essentially we have fixed the exchange rate of our holdings?"
Fed Governor Wayne Angell: "You could have an exchange of puts. In effect, you could swap puts and thereby assume that somebody would ultimately want to exercise that added advantage."
Mr. Greenspan: "Well, the point at issue is that it's a [forward] exchange transaction that has a date on it. ... And effectively that gets factored into the market and neutralizes your position. What I'm thinking of -- and I just thought of it at this moment, so there might be plenty of reasons why not -- is an open-ended fixed-price mutual put, to put it in the terms that Governor Angell stipulated, so that we can eliminate part of the problem that is on the negative side of the current" -- [sic, end of paragraph].
Mr. Angell just prior to the end of the meeting said: "There's one slight addendum to this discussion: We have a reserve holding that costs us more money than what is reasonably in prospect to happen on foreign exchange rates and that is that we really are not a small reserve holding currency country.
I think we actually have official reserves of $85 billion, Sam, compared to Taiwan's $75 billion. And if you mark our gold to the $358 price, we end up with something like $170 billion. There are opportunity costs because we don't get interest on that gold as we do on our foreign exchange [holdings].
That cost is out there also. I would hesitate for us to have foreign currency holdings that have swap puts that just sit there, [which] is now becoming the case for our gold."
[quote courtesy of GoldenSextant]
Did You Catch That?
He said, "swap puts that just sit there" on the U.S. gold reserves. Enlightening.
Couple the above with the Fed's general counsel, J. Virgil Mattingly's 1995 statement to the FOMC:
"It's pretty clear that these ESF operations are authorized. I don't think there is a legal problem in terms of the authority. The statute [31 U.S.C. s. 5302] is very broadly worded in terms of words like 'credit' -- it has covered things like the gold swaps -- and it confers broad authority." [quote courtesy of GoldenSextant]
So the Federal Reserve's general counsel doesn't think there is a legal problem in terms of authority. That's good to know, such assurances gives one a warm and fuzzy feeling all over, knowing the vigilance of those on watch.
I shudder at the thought of what the consequences would be if the authority isn't legal, as that may imply that the keepers of the temple have no idea what they are doing; or at least no regard as to the possible ramifications of what they are doing; or perhaps they are aware of all such issues, but are not concerned with the consequences of their actions, as they must obey all dictated policy orders to keep their jobs.
For some reason, I don't get the feeling that the keepers of the temple take helpful criticism all that well. Less than 700 hundred years ago they used to execute and or sacrifice those who didn't agree. But of course that was then and now is now, whatever that might mean.
The below figures show that as of May 13, 2005 there were 6,129, 795 troy ounces of gold on reserve at the Comex. This is according to the Warehouse Stocks information section provided by the Nymex at the referenced website. A summary if offered in the below table.
Gold Warehouse Stocks Troy Ounce as of close of business: 05/13/2005
Hopefully I have this all wrong, and either the Nynex or Comex, or perhaps the reincarnation of Midas can straighten this all out, but something just doesn't seem right with the above situation, if it actually exists, which according to the data would seem to be the case. Apparently another scintillating example of fractional reserve policy gone amiss.
The creatures are stirring - all through the house. While the people have just settled down, for a long winter's nap. The master can be heard mumbling what sounds like a rhyme, something about sage, Rose Mary and time. But I have perhaps digressed, so back to our tale.
If there are approximately 6 million ounces of gold on reserve or deposit at the Comex, this amount would equal approximately 60,000 futures contracts in gold, as each gold futures contract represents 100 ounces.
Suddenly, from out of the blue, comes forth that rare oddity known as - a goldbug, and she wants to buy real gold, as in physical gold, not a paper obligation or promise to deliver that is settled in cash, but the actual physical delivery of the gold. A rare treat in deed.
Is There a Limit On the Amount One Can Purchase
Let's say this investor has fairly deep pockets, and she wants to purchase 5000 futures contracts per month for the next 12 months, and to take delivery on all of the contracts. This would come to 60,000 contracts which, according to the above chart, represents all of the present gold on reserve at the Comex.
Couple the above number of contracts and the physical gold it promises to deliver to this one warrior princess, along with other "regular" buyers that may also want to take delivery. Suddenly it would seem that there might be a shortfall of physical gold for delivery, at least as represented by the presently listed existing reserves.
Not to mention the difference between the eligible and the registered categories of the reserves, which could easily make things twice as messy. But alas, it seems we already have enough of a mess to figure out, without making things worse.
Considering that the open interest averages about 250,000 contracts per month, this figure (5000 contracts) is just a mere pittance in comparison, representing approximately 2% of the open interest. At least it is a small pittance when comparing paper to paper. However . . .
Compounding is a means to very successful investing, one of the best methods available, but as with all things, compounding has another side to it, it can also work against one, especially if one is short a commodity. That old geometric thingy - nothing like a bad case of inverse compounding to ruin one's day.
If the price of gold were to rise significantly, the shorts would be forced to "cover" or exit their positions by buying into a rising market price, which would only add fuel to the already raging fire. This has been explained very astutely by Professor Fekete in his paper What Gold and Silver Analysts Overlook.
Fear can cause that wonderful herd instinct called a stampede to occur - others call it a short squeeze.
Such a stampede could short circuit [no pun intended] the system, bringing down the proverbial house of cards with it - the destruction of the irredeemable paper fiat currency that goes by the name of Federal Reserve Notes, the bastardized rendition of the United States Dollar of the Constitution.
This is the similar situation that Dave Morgan has written on regarding silver in his excellent paper titled Let's Get Physical. We have used the above example of gold because it fits in with Gibson's Paradox. The same holds true for silver as well, actually the case for silver may even be worse in regards to reserves.
Not to worry say those that provide a safe haven to all pirates of the Caribbean, we know where the secret hoards of silver from ancient times are stashed. Aye mate, and how much will that cost me and make for you? Another case of two for them and none for us. Who was that masked man?
The Fit - Or Is It The Fix
As noted earlier in the discussion of Gibson's Paradox, up until 1995 the relationship between gold and real interest rates stayed fairly consistent. Suddenly in 1995 the relationship diverged in the opposite direction. The most plausible explanation given by Summers was "government pegging operations."
So our one time Secretary of the Treasury, former Harvard Nathaniel Ropes professor, and Harvard University President, states that the most likely explanation for the breakdown of Gibson's model is because of government pegging operations, which sounds an awful lot like government intervention. To reiterate:
Gibson's Paradox involves the correlation between interest rates and the general price level
The rate of change in prices is the inflation rate - not the price level itself
Interest rates should move with the expected inflation rate, rather than the price level
The general price level is the reciprocal of the price of gold in terms of goods
Reduction in the real price of gold is equivalent to an increase in the general price level
In a free market gold prices should move inversely to real interest rates
The price of gold moves inversely to long-term rates
In 1995 the above inverse relation of the price of gold and interest rates diverged
Summer's explanation is that of government pegging or market intervention
The breakdown of the inverse relation between gold and interest rates in 1995 goes against the workings of a free market according to Summer's and Barsky's work
Testimony by treasury officials appears to admit of government interference in the markets
So the question of the centuries is before us - does interference by the government in the markets preclude there being free markets? The reader is left to decide for themselves, vote accordingly.
Another insight on silver manipulation from a Comex floor trader to one of the foremost silver professionals in the world:
I enjoyed your newsletter excerpt of Feb 12, which I found on the Kitco website. You stated perfectly some key reasons for silver's problems in getting out of its own way, and your call for further weakness was prescient.
I guess I'm part of the problem. I've traded COMEX futures actively from the pit for over 15 years. Over the years, the amount of futures contracts that we've traded has surely dwarfed the actual physical market, making it difficult for silver to manifest its true fundamentals.
As you alluded, it's "Groundhog Day" again on the floor. Over the past month I watched one fund accumulate an eye-popping long position, and I followed its progress as best I could through the open interest and commitment figures. When prices started slipping away from last week's test of the $4.85-4.90 level, I could hardly believe my eyes when I saw early evidence that this fund was starting to sell. I went across the pit to a trader whom I knew was trying to stick with his longs and I said, "I've got bad news for you -- that selling you see over there may take three weeks."
The fund sold heavily all last week. The usual bank traders were sopping it up, secretly relieved, I think, that prices had failed to break into ground they could not control. Younger traders ask me how these funds can keep getting chopped up like this. They don't realize that a 30-cent chop in silver is a minor inconvenience compared to the strong positions most of these guys have in gold and crude.
As you know, the banks will continue to play puppet master as long as the silver game remains "closed." The banks know the upper parameters of the funds' buying power; the banks know when the funds have reversed themselves into an untenable short position. It will take new "players" to get the "Bill Murray" silver market out of this loop. Certainly investment demand is the wild card that banks and recurrent short sellers cannot control.
Silver will be called lower on Tuesday a.m. and, although I'm a bull, I'll be getting short on the bell. There is no short-term success in getting in the funds' way.
Thanks again for your insight -- A Comex Floor Trader
And Still More . . .
This effort [by the Federal Reserve, Bank of England and BIS to turn back the gold price] was later described by Edward A. J. George, Governor of the Bank of England and a director of the BIS, to Nicholas J. Morrell, Chief Executive of Lonmin Plc:
"We looked into the abyss if the gold price rose further.
A further rise would have taken down one or several trading houses, which might have taken down all the rest in their wake.
Therefore at any price, at any cost, the central banks had to quell the gold price, manage it.
It was very difficult to get the gold price under control but we have now succeeded." [Governor of the Bank of England]
The U.S. Fed was very active in getting the gold price down. So was the U.K. [Howe vs. Bank for International Settlements et al Gold Price Fixing Case]. Click link for full brief.
As Murray Rothbard was fond of saying:
"The existence of gold in the economy is a constant reminder of the poor quality of the government paper, and it always posesa threat to replace the paper as the country's money."
A Strange Brew
The sisters three have been hard at work, stirring fortunes cauldron as it swirls about - the resulting brew still in doubt. Some say this, some say that; others say either this or that; but could it even be - this and that. Who can tell the future that lies ahead, it changes with the forces that cause the breeze to first blow one way, and then the other, still leaving the way of the other two brothers.
The pendulum of creation follows a design, one that no mere mortal can resign. The best we can do is to go with the flow, to follow the journey according to its glow - to the end of the beginning and the beginning of the end - the alpha and omega of the point and the circle.
What path is our monetary system going to traverse? Is it just going to muddle along, or might it implode? Does it choose to stagnate, or will it explode? Will we experience deflation or inflation, and are there other less desirable choices lurking about, known by the name of hyperinflation? Which of the four horsemen are going to appear?
These are tough questions, the answers to which, no one knows with any certainty - the future is not ours to predict. All we can do is to keep a watchful eye, ever vigilante on the distant horizon, as it is from that direction that the perfect storm will approach, making known the meaning of the words - behold a pale horse.
Gold and Deflation
Recently there has been a plethora of opinions on not only the deflation or inflation debate, but also on the issue of how gold and or silver will fare during certain episodes of the "flations". I have chosen the following example of one such opinion of the deflation/inflation debate to discuss, as it contains a good deal of the most important points on the topic.
The intent is to simply offer a view not often told, providing the reader with some additional grist for the mill, to use or not use as they so choose. It is only by differences of opinion and the questions engendered that progress can be had. Other comments and differing opinions are invited.
There are four issues to be discussed, each represented by a specific quote. All four quotes are to be offered together to provide a basic understanding of the issues at hand, then each will be dealt with individually to allow for more specific and detailed discussion.
"Specifically, during deflationary episodes of the past gold was the official money of the land -- gold coins either circulated as currency or the world's senior currency was convertible into gold at a fixed rate -- and, as a result, it represented liquidity. All taxes could be paid in gold, all debts could be repaid in gold, and almost all purchases could be made in gold. Under such a monetary system, when the purchasing power of the national currency rose as a result of deflation there was a concomitant rise in the purchasing power of gold."
"Under the current monetary system gold is not the official form of money and therefore does not represent liquidity. In particular, taxes cannot be paid with gold, debts cannot be paid with gold unless a special agreement to do so is made between the borrower and the lender, and more than 99% of purchases cannot be made with gold. Therefore, in a situation where dollar-denominated obligations were huge and the supply of dollars was contracting many private investors would probably be forced to sell their gold in order to obtain the dollars needed to meet their financial obligations."
"The last remaining official link between gold and the dollar was severed in 1971 and, not coincidentally, deflation hasn't occurred since that time. Unfortunately, this means there aren't any historical examples of how gold performs during deflation when the metal is not the official form of money. However, we can get an idea of what to expect from gold if deflation were to occur now by a) looking at how silver performed during the 1930's, and b) looking at how gold performed in yen terms during the first half of the 1990's (the period following the bursting of Japan's credit bubble)."
"Before we re-visit our opinion that a bigger inflation problem is what the next few years hold in store we will quickly address the idea that gold, at the present time, is an effective hedge against both deflation and inflation. This idea violates the laws of logic because something can't be itself and simultaneously be something else. Or, to put it more aptly, it is not possible for something to be a hedge against one financial outcome and to simultaneously be a hedge against the opposite outcome. What this means is that if you are an investor in gold you cannot avoid taking a position on the inflation/deflation issue. It certainly makes no sense to just buy gold and assume that you are going to be fine regardless of whether we get inflation or deflation." [Gold and Deflation www.speculative-investor.com]
The following are nine key points of the above stated issue:
During deflationary episodes of the past gold was the official money
Gold coins either circulated as currency or the currency was convertible into gold at a fixed rate
When the purchasing power of the national currency rose as a result of deflation there was a concomitant rise in the purchasing power of gold
Under the current monetary system gold is not the official form of money
If dollar-denominated obligations are contracting many investors would be forced to sell their gold to obtain dollars needed to meet financial obligations
The last link between gold and the dollar was in 1971 and deflation hasn't occurred since
No historical examples of how gold performs during deflation when the metal is not the official form of money
By looking at how silver performed during the 1930's we can get an idea of what to expect from gold if deflation were to occur
Gold cannot be an effective hedge against both deflation and inflation
As stated earlier, regardless if any of these ideas are correct or incorrect, it is irrefutable that they offer excellent commentary and discussion concerning some very crucial issues that need to be exposed to further enhance public awareness and understanding of a very complex and critical subject. The future of our children and their children is at stake. A more detailed discussion of the nine issues will now be presented.
The Critical Issues
It is unquestionably true that during all past deflationary episodes in the United States that gold coins either circulated as currency or the currency was convertible into gold at a fixed rate.
However, is this the same as saying that during deflationary episodes of the past that gold was the official money? I think not. For a detailed discussion see the full series Honest Money at FinancialSense Online.
This is the Keynesian myth that the powers that be have insidiously ingrained into the minds of the populace to brainwash them into accepting the unacceptable. Silver and gold coin circulating as the currency is a far cry from paper money convertible or redeemable at a fixed rate of silver and gold. The first is day, the second night.
As has been shown in parts one through three of Silver Is Money and GOLD: Sovereign of Sovereigns as well as well as the Honest Money series, the original hard money system of the Constitution called for a silver standard with a bimetallic coinage system of silver and gold coins.
To confuse the constitutional hard money system of specie only, with a system that uses paper money that is only fractionally backed by silver and gold, and supposedly redeemable in specie, is a grave mistake of utter folly.
The debasement of the currency began the first day that paper notes were issued, irregardless of what was backing it. That was the fateful day Congress chose not to follow the mandate of the Constitution, and as is clearly evident, we are now paying the price of that mistake - as the United States is now the world's largest debtor nation. A most unenviable distinction.
Our monetary policy is on the level of a banana republic. The net foreign investment position of the U.S. is minus 3 trillion dollars. [-3,000,000,000,000.00] That is equal to 25% of our yearly gross domestic product. It also indicates that foreign entities own a good piece of the United States, a piece that is continually growing larger, similar to that of a cancerous growth.
There was no mention of paper money in the Constitution, and bills of credit were specifically disallowed according to In Article I, Section 8, Clause 2 and Article I, Section 10, Clause 1, of the Constitution. Article I, Section 10, Clause 1 also disallows the states from issuing anything but gold and silver coin as legal tender in payment of debts.
Which brings us to the statement that "when the purchasing power of the national currency rose as a result of deflation there was a concomitant rise in the purchasing power of gold." This is confusing the hard money system of silver and gold coin with the paper currency that was only fractionally backed by silver and gold. They are two entirely different monetary systems that consequently function completely different from one another. To think otherwise is to accept black as white. The tail is being allowed to wag the dog. Sit boo-boo might be a good start.
The statement that this "idea violates the laws of logic because something can't be itself and simultaneously be something else" is relevant, but not in the context as presented in the article.
Silver and gold coin are not the same as the paper money that at times they have been used to "back". If they were the same, why would there have been any need to back one with the other? That which did the backing - silver and gold coin and or bullion, is far superior to that which it backed - paper money. Paper money cannot be itself and simultaneously something else - the silver and gold that backed it.
The silver standard defined our unit of money. The dollar was a specific weight and fineness of silver - the silver dollar. Silver defined the dollar. The dollar did not define silver. Paper money was backed by silver. Silver was not backed by paper or anything else, it had no need to be, it was as good as gold. To consider the unconstitutional issuance of paper money as the same as silver and gold coin is to accept the unacceptable. It is saying that black is white and white is black.
Hence, the statement that "when the purchasing power of the national currency rose as a result of deflation there was a concomitant rise in the purchasing power of gold" is utterly ridiculous when referring to any paper currency system. Paper fiat money is immoral and unconstitutional. Any monetary theory based on the acceptance of such is starting off on the wrong foot and is invalid.
Silver and gold are not defined by paper dollars or Federal Reserve Notes, to believe so is to accept a false premise which means all other postulates based on it, and all syllogisms derived from it, are false as well.
A dollar bill or Federal Reserve Note is not the same as
the dollar of the Constitution - the Silver Dollar
And as a total monetary system, paper money has always been - irredeemable, even when it was supposedly backed by specie. The most that paper money was ever backed by specie was 40%, which means that 60% of the paper currency was not redeemable on demand. Also, often times the backing with specie was suspended for considerable time periods, and then reduced overtime to 20% and less, to eventually no backing at all.
This is the dishonesty of the beast of fractional reserve banking.
It is impossible for such a system to be fully honored.
This goes to the point of the quality issue of money - its purchasing power, which in regards to paper money has been debased by 95% of its original purchasing power - why, because it is not real money, it is not silver or gold coin. Paper fiat cannot survive the relentless march of time.
The final coup d'etat was the issuance by the International Monetary Fund of the rule that states that no member can have a currency backed by gold. This is the straw that broke the back of the Swiss hard money currency. See Ferdinand Lips book: Gold Wars: The Battle Against Sound Money As Seen From A Swiss Perspective
The statement "under the current monetary system gold is not the official form of money" is true in practice but it is not in accordance with the Constitution and the Supreme Law of the Land. In the context that the statement is being made, I accept it as given.
The same is true of the statement, "the last remaining official link between gold and the dollar was severed in 1971 and, not coincidentally, deflation hasn't occurred since that time", as well as the statement that "unfortunately, this means there aren't any historical examples of how gold performs during deflation when the metal is not the official form of money."
It is imperative to remember that in 1862, and during the Civil War that Congress allowed for the first legal tender paper currency - the greenbacks. Congress kept the greenbacks as irredeemable currency until the 1870s. Starting in 1913 the Federal Reserve was allowed to issue its own paper currency - Federal Reserve Notes. They too were at one time partially redeemable. That too had a quick demise.
Then came the infamous New Deal by Roosevelt in 1933. Congress declared Federal Reserve Notes legal tender for all debts, public and private, and rescinded the requirement that those notes be redeemable in gold coin.
Then in 1933 and 1934, Roosevelt, and then Congress, seized all the gold coin in circulation and nullified all public and private contracts that called for payment in gold.
So, by 1934 the paper dollar - the anti-Christ of honest money, had become the official currency. In 1971 the last tie with gold was broken, the United States government reneged on their promised obligations to foreign countries to pay in gold.
This equated to the United States declaring bankruptcy, as it reneged or defaulted on its contractual obligations to settle foreign accounts in gold.
Next the article states, "however, we can get an idea of what to expect from gold if deflation were to occur now by a) looking at how silver performed during the 1930's." That's a bit of a stretch of the imagination.
Our original monetary system had silver as the standard, coupled with a bimetallic system of silver and gold coinage. Silver and gold originally exchanged at the fixed rate of 15 to 1. It was a mistake to fix the legal exchange rate of gold and silver.
The legal definition of the currency can differ from the economic reality of the market place and the market exchange rate that it places on the metals. This allows Gresham's law to play havoc with the exchange system, first driving away one metal and making the other dearer and then vice versa.
This is a perfect example on how one specific point can cause the ruin of entire system built upon it. The fixing of the rate of exchange between silver and gold was a mistake and a curse, perhaps intentional, perhaps not. Regardless, it caused the downfall of the hard money system. See the Honest Money series for a detailed explanation.
To then use past historical examples of such dishonest and unconstitutional monetary systems as proof or evidence of how some economic or monetary theory is now going to explain how silver and gold will act during deflation or hyperinflation is misguided folly.
The first and most important point in trying to explain our present paper fiat monetary system is to realize and understand that it is dishonest and unconstitutional, and just what the consequences and ramifications of such means.
As previously explained in Honest Money, Gold Sovereign of Sovereigns and the first three parts of Silver Is Money, first silver was driven out from circulation and then gold, on several different occasions during our history.
Eventually the reputations of both metals became purposefully tarnished, allowing the silver and gold standards to falter, so that a paper fiat system could be put in place as the perfect mechanism of wealth transference.
To look back at silver's history to hope to glean a blueprint of how gold may react in a present day deflation is utter nonsense. Those whom the gods wish to destroy, they first make mad. Be not deluded by the jokester of irredeemable paper fiat. As Professor Fekete says regarding silver:
"Understanding the Silver Market"
"By no stretch of the imagination can the silver market be called free at any time since 1871. In that year two powers demonetized silver: Germany and the United States. The governments of both were cashing in on the war-booty from their respective victories. Prussia had just defeated France, and in the United States the North had just defeated the South. These governments were dumping silver in order to raise the gold needed to run a gold standard. The price of silver fell from $1.29 an oz and continued falling for more than 60 years to a low of 0.25 ¢, or less than one-fifth of the old official price (although there was a brief spike back to $1.29 at the end of World War I) as all other countries with the significant exception of China followed suit in abandoning silver and turning to gold." [Fekete - What Gold and Silver Analysts Overlook]
In the meantime the U.S. Treasury was made by law to purchase silver from the Western states at prices above market. The silver-purchasing program of the United States remained in effect for over 75 years, after which the Treasury initiated a silver-selling program at prices below market. All in all, 6 billion oz of Treasury silver was sold during the past fifty or so years and, by now, the U.S. is allegedly out of silver. [Fekete as above]
Well, maybe out of silver, but not out of the silver business. Holding the line on the silver price, or at least yielding ground to higher prices only gradually, is considered the first line of defense by the U.S. government protecting the dollar. If silver were allowed to be cornered, then gold would follow and that would be the end of the dollar, and the financial domination of the world by the U.S. government. [Fekete as above]
In regards to Japan, the same argument of the original definition of the dollar according to the Constitution applies here as well. Gold was priced globally in dollars, the upside down apostate definition of honest constitutional money. Accordingly, it took fewer yen to buy gold because it took fewer yen to buy the dollars needed to buy gold. This is nothing more than Keynesian babble or expression of the dollar-yen exchange rate coupled with the inverse of the constitutional definition of a dollar.
The statement that "if dollar-denominated obligations are contracting many investors would be forced to sell their gold to obtain dollars needed to meet financial obligations" sounds good, but is it? This will presently be covered by the explanation of how hyperinflation occurs, however, there are other points applicable as well.
First, the entire gold market is a pittance in dollar terms compared to just one stock the size of Microsoft, etc., let alone all the other stock holdings of the public in total. To think that there is some hoard of gold in the publics hands, large enough to pay off the mountains of existing debt, while the price of gold is falling, per the above argument of how gold and or silver will fare during deflation, is incredulous.
Secondly, the purpose of the Federal Reserve is to create money and credit, they must inflate or die. As Fed Governor and helicopter pilot extraordinaire Ben Bernanke stated:
"But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation." [Remarks by Governor Ben S. Bernanke before the National Economists Club, Washington, D.C., November 21, 2002: Deflation: Making Sure "It" Doesn't Happen Here]
Couple the above statement with the Monetary Act of 1980 Depository Institutions Deregulation and Monetary Control Act of 1980 that allows the Fed to buy any asset it so desires at full face value, and you can see how deflation might have a hard time occurring.
True, the public cannot issue its own money, and the private sector can reach a saturation point regarding taking on more debt, but the government through the Federal Reserve is not encumbered by such restraints. This is a huge difference of significant importance. But deflation can still occur - it just isn't a given absolute as some seem to believe. Nor is hyperinflation a given. There are very few givens.
The Fed can print or create more credit and money at will -
Until the primary trend of the market fully expresses that it is a law unto itself.
If and when any large companies, hedge funds, or other entities that the Fed deems are to large to allow to fail, begin to go bankrupt, the Fed will step in and buy their assets, pay their pension funs, and fulfill its role as lender of last resort. The government is not the people. It doesn't have to apply, nor be approved for more credit. It can simply create the money and lend the credit to itself by declaring a national emergency.
This is how Roosevelt confiscated We The People's gold. He declared a national emergency by using The War and Emergency Powers Act [The Introduction to Senate Report 93-549]. If you haven't read the report, you have no idea of what your missing. Take the time - then vote accordingly.
Because there is nothing backing our money, and no labor required to print it, and no rules restraining such action, the Fed can run the printing presses at will, not that they use such means, now they simply make a few clicks on the computer and viola - instant funny money.
Also remember, the government at any time, can call in the currency, demanding that it be exchanged for a new currency, at whatever exchange rate they decree - like a new one dollar bill for 1000 existing dollar bills. Until...
The dynamics of the quality or purchasing power of money exerts itself and the confidence of the people in the paper currency dissolves, and then:
Behold a pale horse - It goes by the name of hyperinflation
And as Sir Alan well knows:
"Gold still represents the ultimate form of payment in the world. It's interesting that Germany could buy materials during the war only with gold." [interesting - quite the understatement]
"In extremis fiat money is accepted by nobody and gold is always accepted and is the ultimate means of payment." [Greenspan]
Hedge Against Deflation And Inflation
Alan Greenspan is not stupid, as a matter of fact he is quite brilliant, and an expert on all things monetary. However, somewhere along the line he chose to become a political animal as opposed to an honest money proponent, as he was in his early days, as is witnessed by the paper he wrote in 1964 Gold and Economic Freedom originally to be included in a publication of Ayn Rand's, who referred to the Chairman as "the undertaker".
Coupled with the above quote by Sir Alan you know he knows the truth, but for whatever his reason - he has chosen not to follow it. Perhaps he prefers to lead a pale horse, as opposed to accepting to follow silver and gold - as they are sovereign, not he. Absolute power corrupts absolutely as Lord Acton said.
"In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold. If everyone decided, for example, to convert all his bank deposits to silver or copper or any other good, and thereafter declined to accept checks as payment for goods, bank deposits would lose their purchasing power and government-created bank credit would be worthless as a claim on goods. The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves.
This is the shabby secret of the welfare statists' tirades against gold. Deficit spending is simply a scheme for the "hidden" confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists' antagonism toward the gold standard." [Alan Greenspan - Gold and Economic Freedom]
According to the quote by Sir Alan, gold represents the ultimate form of payment in the world. I would hasten to add - the only true payment (along with silver). Notice how he uses the words in extremis, saying that "In extremis fiat money is accepted by nobody and gold is always accepted and is the ultimate means of payment." I wonder what he means by in extremis?
The dictionary reads that the definition for extremis is "a condition where two things that are as far as possible from each other", as in the "farthest border, edge, end, or point", to "the outermost or utmost position".
Now, the subject under discussion is money and monetary systems, and the resulting associated states or conditions that the monetary system subjects itself to, as in inflation, deflation, stagflation, and hyperinflation.
The two farthest or most extreme conditions that a monetary system can find itself in are: deflation on the one end of credit collapse or implosion; and hyperinflation on the opposite extreme end of runaway credit expansion or explosion.
Sir Alan seems to be implying that silver and gold will work well in either situation - in extremis as he says. I wonder what makes him think that? Let's try and find out.
There are those that seem to think the opposite, as they say:
"We will quickly address the idea that gold, at the present time, is an effective hedge against both deflation and inflation. This idea violates the laws of logic because something can't be itself and simultaneously be something else. Or, to put it more aptly, it is not possible for something to be a hedge against one financial outcome and to simultaneously be a hedge against the opposite outcome." [www.speculative-investor.com]
We will save the reader the time and trouble of listening to a missive on logic, as logic is about as logical as any syllogism's original or first premise, which is assumed to be a "given". Why it is presumed necessary for something to be itself, and simultaneously be something else, in order to hedge either deflation and or hyperinflation, is beyond my understanding. Perhaps a future reply will provide some enlightenment.
Both deflation and hyperinflation are in extremis, the opposite ends of a paper fiat monetary system run amuck. I will elaborate on how it is possible for something to be a hedge against one financial outcome and to simultaneously be a hedge against the opposite outcome, in due course. One of the quoted article's footnotes even alludes to part of the explanation when it says,
"(2) It's actually more accurate to say that gold is now an effective hedge against the loss of confidence in fiat currency sometimes caused by inflation because during those times when the money-supply growth rate is high but the inflation is not perceived to be a problem -- during the late-1990s, for example -- gold does not perform well" [www.speculative-investor.com]
Ah, a new twist to the game, or is it? In all actuality it isn't new, it's always been one of the main tenets of a paper fiat system - confidence, as in a game of con-fi-dence. The author is right on in his observation of this, which is not his twist, but one of a twisted and distorted system. A twisted sister of sorts.
First we need to clarify the two beasts we are talking about: deflation and hyperinflation, and how closely they are related like Siamese twins - joined at the hip from inception to birth - two sides of the same sword: same pitch, same slope, same angle; slightly different cardinal point of direction; same ultimate destination, yet the means of getting there are different. A non-linear mutation. Very hard to predict.
Towards A New Theory of Money
The following new theory of money is not mine. I am simply reviewing the works of the great minds that have come before, and who contributed immensely to monetary theory, especially Ludwig von Mises, and Professor Antal Fekete.
Professor Fekete is the true father of a new theory of money, which goes beyond the quantity theory of the past, and takes on the arduous task of explaining the workings of hyperinflation - the pale horse whose rider's name is death. It is upon the foundation that professor Fekete has built that I attempt to offer a few suggestions or minor adjustment of the stones already put in place by the master craftsman.
As the professor states in The Supply of Oxen at the Federal Reserve:
"Let's define inflationary spiral under Kondratiev's long-wave cycle as the decades-long rise of prices and interest rates, and deflationary spiral as their similarly long fall. Interest rates may lead and prices may lag, or the other way round.
The important thing is linkage. The long-term movements of prices and interest rates are inevitably linked. Linkage epitomizes a huge oscillating money-flow back-and-forth between the bond and the commodity markets."
So we are back to Kondratiev's long wave cycle and the linkage between prices and interest rates and the flows of money from the bond to the commodity markets. This is the definition being used for the inflationary cycle. But what of hyperinflation? Does it march to the same beat or a different one?
In his paper Deflation or Runaway Inflation professor Fekete puts forth ideas rarely heard and less frequently understood.
"The explanation of the phenomenon of runaway inflation in terms of linear models is fallacious."
"The fact is that linear models are useless in studying runaway inflations. The phenomenon itself is non-linear in nature, as it is the culmination of a runaway vibration."
"For this reason explanations of past episodes of runaway inflations in terms of the quantity theory of money are irrelevant."
"Runaway inflation is not a monetary phenomenon. It is an interest-rate phenomenon, more precisely, an economic resonance phenomenon involving the rate of interest"
"The price level and the rate of interest resonate with the oscillating money-flows between the bond and the commodity markets."
"This economic resonance, under the concerted pounding by speculators, ultimately reaches the state of runaway vibration."
"When the fragile confidence in the value of irredeemable currency snaps, commodities are bought up and all bids for bonds are withdrawn."
"When the fragile confidence in the value of irredeemable currency snaps, commodities are bought up and all bids for bonds are withdrawn."
"The linkage may turn the inflation/deflation cycle of Kondratiev into a runaway vibrator. The ever wider fluctuations in the rate of interest and price level threaten the entire world economy with destruction. This is the threat of runaway inflation on a global scale, something that the world has never before experienced." [Fekete - Deflation or Runaway Inflation]
===> Continue to Silver Is Money : Behold A Pale Horse - Part Four - B