20 November 2015

An Essay Considering the Current Monetary Orthodoxy and Gold


This message from a person in the financial business,which is included in quotations below, was shared with me by a reader who received it from a journalist for a major media outlet.  Since it was not clear if this was intended as a private communication or public statement, I will not attribute it by name.

I wanted to use the word 'modern' in the title of this, since this pronouncement below smacks of modernism. You know, the belief that all those who have come before us were ignorant primitives, and those who are not of the same received insights now lack sufficient wisdom and piety.  But since those two words combine to describe a particular and unrelated school of thought, modern monetary theory, whose adherents have already excommunicated me for my stubborn and profane disbelief, I think I will skip that and use 'current' instead of 'modern.'

I could not resist sharing this message with you because it is such a nice, compact expression of what the modern financial media thinks about gold and money. Or at least to the extent that they think about anything, and do not just read their thoughts off the teleprompter provided by the moneyed interests that sustain them.  Or what is considered 'acceptable' by the very serious people, those who are described by Larry Summers as 'insiders.'

It starts as many of these things do, with a few simple statements that seem reasonable and ordinary enough, and use a sort of formalistic style to make it seem 'scientific' and contrast our modern thought with the ignorance of prior days.
"Why do you invest in anything? Because you want to extend the duration of your surplus earnings, the sort of stuff that would have been perishable in olden times.

There are two ways to do that:
1. Share your surpluses today and run a credit exposure to the counterparty that is obliged to pay you back in the future an absolute relative rate that compensates you with respect to income lost and potential earnings made.

2. The alternative is to sell transform your surpluses into something more durable, but which maintains market risk exposure."
Ok, fair enough.  If you have an excess of some presumably perishable asset, you want to do something with it to extend its usefulness to you. Or else it ends up like the neglected lettuce left in a damp plastic package in the back of the fridge.

One way to do that is to provide its use to someone else on loan, and receive adequate compensation that may include some allowance for risk.  Or you may wish to sell it outright, and receive something more durable in return, but again with some allowance perhaps for risk.

Hard to argue with that, right?  It is perhaps a bit simplistic, narrowing down all human economic activity with regard to 'surplus wealth' as investing or saving.  One may donate that surplus to some charitable endeavor, or sacrifice it to their gods of the day for example.  Didn't we just do that with TARP, and the uncounted trillions in bank subsidies?

Or perhaps trade it for something not required but desirable nonetheless, like finely crafted jewelry for one's beloved. Investment? The commercial messages for jewelry would like us to think so, but it rarely works that way in romance except for a fleeting moment, and with a greatly diminishing effect over time.

Not all exchanges of 'surplus wealth' are for productive investments or a truly more durable asset.   What then is 'surplus?'  Anything more than food, water, and shelter?

But let's not quibble about what defines 'surplus' and just say all right for now.  But believe we when I say that people's definitions of what is 'surplus' versus necessary wealth can vary widely, especially in these days of elephantine greed.

That definition of 'surplus' is important because it is so subjective, and yet is later used in this modern theory as a high falutin' accounting entity, the equivalence of all monetary valuation.  But it sounds so 'scientific.'  Is what we spend on food and shelter necessary and all else 'surplus?'  How about healthcare?  Cars and electric lighting?  Things that support knowledge like books?  Would there be a common consensus on what the definition of surplus represents, from let's say between Dorothy Day and Donald Trump?

Let us bookmark that thought and move on.
"Gold was an obvious choice because you could keep it under your bed and it wouldn't depreciate in form ."
Ok, that is a bit snarky, since I do not believe there is a long history of people hiding their gold, or any other large amounts of their durable wealth,  cavalierly 'under the bed.'  But it does serve the modern polemicist who seeks to disparage a choice they do not favor as uninformed, primitive, and naive.

Let's just say that for one of the alternative uses for 'surplus' wealth which is 'savings,' some durable, compact assets were found to be very useful. And that they were stored safely in some appropriate manner, since everyone who was born before our time was not necessarily a complete fool or incompetent naif.

We need to distinguish I think between what is asset barter and what is actual money at some point.  I would like to think that describing the difference is achievable.  For example, we might apply some criteria that suggests that a widespread, highly organized society might be more applicable to our thinking than an isolated island people who have no means of mining or access to precious metals and little access to widespread consensus.

As I recall the first formal coins made for widespread use were gold, silver, or an alloy of gold and silver that started showing up around 600 BC in the eastern Mediterranean. You know, that place where trading cultures that sailed from place to place flourished. Although it is known that gold and silver and certain precious and semi-precious stones were recognized as having great value, as shown by artifacts found as early at the 5th millennium BC in the graves of Varna man.

The point here is that it was not just 'gold' that was considered a durable asset.  Silver was valued as well as a few other things from time to time. They all tended to have similar characteristics.  But at some point the precious metals passed from 'grave artifact' to widely accepted 'coinage' and were used for widespread, diverse trade across governing bodies in addition to asset barter.  And I would not discount barter, which may also be called the black market, as a continuing alternative which may be more viable even now than most theorists will allow.

So why not just trade with rocks and put them under one's bed?  Granite and marble are very durable.

Yes the asset must be durable in that it does not spoil or rot or rust away.  It has to be enduring with regard to time.  But there has to be enough of the durable asset to function as more than ornamentation for a few of the finest people.  It must be malleable enough to be systematized into some uniformity of size and purity so that it can be easily weighed and measured and exchanged to facilitate trade without introducing excessive transactional friction.

And so we notice that the author has ignored one key point: manageable scarcity.  What facilitated that transition of precious metals from grave artifact to money?  I would suggest that it was a manageable scarcity combined with social organization and broad consensus that set standards on purity and form.  It was both a natural and social agreement that was widespread and acceptable enough to be effective.  And that manageable scarcity had to be as reliable as the durability of the material.  The scarcity was not expected to be wildly unpredictable and certainly not discretionary by some ruler over time.

So we will not use common rocks because they are not scarce, and not particularly portable.  There has to be a natural scarcity, to make that durable item 'special.'  But there does have to be enough of it so that it can be widely used by more than just a few of the top people.

Moving along.
"Gold is only worth the total surplus of the nation.  When surpluses are running high there's a lot of spare capacity in the system. Gold will be easily swapped into almost anything."
This is of course where we start to smell a reductio ad absurdam and the authority of the modern equivalent of a burning bush.   Let's read on a bit and see where this is going.
If there's a deficit of stuff, neither gold nor money guarantee you access to current output. 
Yes, is there is a deficit of highly desirable 'stuff' any money and not just gold will guarantee you access to it. Unless it is backed by some hairy knuckled fellows holding weapons, in which case they do not even need to bother with the facade of money.   In the strict sense of the word only your own death is guaranteed.  And maybe the recurrence of whacky theories designed to separate the common people of their rights and wealth.

But assuming that a market still exists, which presumes the dynamic of supply, demand, and price,  and a willingness of participation, then the 'prices' or the exchange value of money of whatever form will rise to meet whatever the holders of that highly desirable item may be.  If there is no market, and the item is highly desirable enough, they may be robbed of it, and they have been, but that is besides the point.

I think this may be the point where someone who was writing this has had a recollection of Adam Smith and is distorting the things which he has said to justify some modern theory.  As if Adam Smith was a received source of truth when it suits their purposes, or so they think.

One of the few advantages of not belonging to a 'school of economic thought' is that you are not compelled to carry its baggage, pro or con.  And believe me when I say that in economics there is more baggage, and much of it having nothing to do with economics and everything to do with politics and a pursuit of position and advantage, than on a Kardashian vacation.  While people say 'money is power,' it might be more correct to day that for some types of people power is everything, and money is just a means to it.

There is no shame in misconstruing Adam Smith's thought.  Some of our finest economic minds may have done it from time to time, despite an otherwise admirable record for the most part.  Nobel prize winner Paul Krugman did it in spades not all that long ago by misconstruing things that Adam Smith 'said' about gold.

What Adam Smith was actually addressing in the paraphrased thought was the non-productive hoarding of 'money' while placing greater emphasis on widespread economic transactions, the 'organic real economy' if you will as opposed to the financialized economy.  And he did favor the flexible expansion of money, as typified in fractional banking it seems, as long as it was in response to a legitimate increase in real activity that produced things.

I do think that Smith would have been dismayed though by the actions of the monetarists who believe that one can create the vigor of a wealthy economy by merely expanding the money supply, in QE for example, and doing nothing else in conjunction with it.  I have previously described that as 'cargo cult economics.'   If big plane of real economic activity brings nice things, we can get more nice things by building some things that look like the big plane of real activity out of paper and sticks.

I wonder at what point the money masters will admit that QE is counter-productive rubbish?  Don't hold your breath.  People of privilege will never let go of what gives them advantages willingly.

I like Adam Smith.  I recall visiting his grave once in Edinburgh.  And he was therefore just a man, whose ideas must be considered as his and of his time and experiences.  I do not hold any dictates of dead economists as sacred, and their 'laws' are all too often opinions and observations written in sand.

Paul Krugman Does Some Injustice to the Thoughts of Adam Smith On Money, Gold, and Silver

Adam Smith was no economist.  He was a 'moral philosopher.'  And many of our modern financial shamans have tried to take the moral considerations completely out of economics, in their vain quest to turn it into a pseudo-science of equations and a priori pronouncements from the god of the market that dictates policy as if it were an oracle, or a black box.

But I digress.  Let us move on.
"Money [fiat money] will hold its value better because in an inflationary period it can't be mined."
There it is. The modernist 'money shot.'  And delivered with a straight face.

There is a lot of nonsense wrapped up in this, combined with a leap of faithlessness to the facts.  Let's just take supply, demand, and price and throw them out the window, along with geology and any sense of the current reality.

Firstly, one of the enduring attractions of gold, and to a slightly lesser extent silver, is that they cannot be created by human means.  They exist on and in this world at least in what can be described as a natural scarcity relative to other things.

I cannot speak to the specific numbers, but it is my understanding given the current state of reality that one does not add to the supply of gold via actual mining without effort and delays.  And I think if we keep distorting the markets and driving the mining companies into red ink we will obtain a serious object lesson in this.

Mining takes time and effort, implying 'costs' and 'risks.'  Yes, the supply of gold and silver may be increased, but it takes money, luck and hard work.  And the pricing of the market adjusts to supply and demand with valuation dynamically as it does all commodities.  And gold and silver are commodities as well as 'money.'  More gold is not mined unless it is a profitable venture in a market economy.

But to contrast gold with fiat paper money and say gold is more easily expansible is a real howler.  Has the author looked at the Fed's Balance Sheet lately?  How much time and effort did that take?

Yes gold and silver can be mined.  There is also the recovery of scrap which, like real physical mining, is more difficult and costly to do than just creating fiat money out of thin air, electronic digits.  We have thousands of years of experience with mining and scrap recovery. How much and what type of experience do we really have with purely fiat money tied to no external standard or limiting factor including transparent exposure to public scrutiny?

Unfortunately it is true that the Western gold supply these days is increasingly 'synthetic' in that the financiers are expanding this supply through selling and reselling claims on the same bullion with leverage.  But this is not real gold or silver but paper claims to it.  They are non-transparently mining the stores of gold in central banks and funds and unallocated supplies and multiplying it on paper in a web of non-transparent counter-party risks.
"Money on the other hand can be withdrawn from supply and ratioed up."
Ok, there is the real heart of the matter. This is where the rubber of financial engineering hits the road to power.

Gold can be 'mined' and therefore it is no good, but 'money' can be manipulated quite easily, both up and down.

But now we get into a stickier subject of a 'gold standard,' of gold and silver as formal money.  As you may recall I am making the case for gold and silver as private stores of wealth, against what are some fairly narrow and nonsensical arguments.  The reasons for this will be provided later.

Our experience with a gold standard and its uses are historically knowable.  Which of course the author completely ignores.  Gold and silver are physical units of measure by purity and weight.  They act as a 'brake' on money supply of sorts.

If one wishes to expand their money supply against a gold standard, are they stuck?  Not happening?  No, they alter the valuation of their particular currency against gold, which is the 'universal money' especially with regard to trade amongst diverse currency regimes.  This is what Roosevelt did in 1933.

What makes this particularly unattractive to the modernist is that it requires a transparent and conscious act which the people can see for themselves.

Since 1971 the world has substituted the US dollar as the 'gold of universal reference,' the reserve currency.   This was the replacement of the 1944 Bretton Woods agreement, which tied the US dollar to gold directly, with what some have called 'Bretton Woods II.'

The Federal Reserve of the US has quite a bit of latitude with regard to the expansion of that US dollar supply AND the distribution and use of that creation through its member banks.  And that is power, real power.

And people who have that kind of power do not give it up easily.  Theoretically in the hands of philosopher princes a purely fiat monetary system can 'work' like a gold standard.  Greenspan said it could 'emulate it.'  And by that he implies restraint and rigor and transparency tied close not to economic models and the whims of power but to real economic activity. And then he betrayed this principle himself.

In every case of recorded history the financiers have stretched and strained against any and all regulatory restraints, and abused their power to create money.  Even for Adam Smith this was already a recognized phenomenon in 1776 when he published Wealth of Nations.  How could it not be with the memory from 1716 of fellow Scotsman John Law and his Banque Générale and the enormous wreckage it caused in continental Europe still fresh in his mind?
"When the people of any particular country have such confidence in the fortune, probity, and prudence of a particular banker, as to believe that he is always ready to pay upon demand such of his promissory notes as are likely to be at any time presented to him; those notes come to have the same currency as gold and silver money, from the confidence that such money can at any time be had for them...

The commerce and industry of the country, however, it must be acknowledged, though they may be somewhat augmented, cannot be altogether so secure, when they are thus, as it were, suspended upon the Daedalian wings of paper money, as when they travel about upon the solid ground of gold and silver."

Adam Smith, Wealth of Nations
But I would like to stop here and see if there are any real objections to what I have said in your mind. Think about it. Gold and silver are stores of value of wealth and, with the proper attention to form and purity, have functioned as a store of wealth, and of money at times, both widely and throughout record history in industrialized and organized societies.

Let us trudge on to the end of this.
"Gold is a volatile asset because it is only ever worth what anyone is currently prepared to pay for it. Since it has little consumption utility, the value is mostly maintained by the mass cornering effect of goldbugs who refuse to sell under any circumstances."
Gold and silver are not particularly volatile.  In their synthetic form, which is leveraged and hypothecated representations of bullion, they are volatile and encumbered with counterparty risks.  There are some who think that the current price manipulation in certain markets is intentionally volatile, for all the reasons that the recent rigging in so many other markets has occurred, and for years.

And that last sentence about gold bugs is just fatuous.  Who holds the greatest concentration of the world's gold?  Those ravening lunatics, the central banks.

One of the characteristics of 'money' versus asset barter is that money ought not to have much consumptive value in addition to its durability and nominal stability.  Have you ever tried to eat dollar bills?   People have used paper money to heat their houses.  But it is not very good at it.

What is particularly volatile now are the financial and international monetary markets, because the 'Bretton Woods II' monetary regime based on the US dollar as purely discretionary reference asset for international trade is falling apart, as theories such as Triffin's Dilemma have suggest that any fiat reserve currency would do.
"The use of a national currency, such as the U.S. dollar, as global reserve currency leads to tension between its national and global monetary policy. This is reflected in fundamental imbalances in the balance of payments, specifically the current account, as some goals require an outflow of dollars [Eurodollars, a component of M3] from the United States, while others require an overall inflow."
When considering who the stronger dollar benefits, would you be surprised to learn that it is primarily the dollar based financial sector?

I think the current volatility may continue for some time due to an historical event that so few really remark upon or even understand fully:  the unraveling of Bretton Woods II, and its slow replacement with something else.  But that begs the question of cause and effect.  It is not gold that is changing.  It is as it always is.  And so is silver.  It is the context in which they exist that is changing.

Valuations are wildly swinging in certain markets because of the mass creation of 'synthetic gold' that, with the effects of Gresham's Law, has caused real physical bullion underlying it to flow in increasing amounts to the centers of real wealth creation.   The 'synthetic gold' remains in the vaults of the West, and the real gold is accumulating in the vaults and strong hands of the East.

I am not proposing a return to the gold or silver standards.  As I have said previously, the existing financial system, and the political process it has corrupted, is in dire need first of rigorous reform. Our system is capable of corrupting almost any monetary changes that are introduced, including a gold standard.

Addressing a final assertion, we can stipulate that valuation of most things, and even people, can be purely arbitrary if such a valuation is enforced with sufficient, draconian power.  Some of the most notorious tyrants of the twentieth century have not only believed this, but have embraced and used it to inflict widespread suffering and death on their people.

What I would like is government to keep their noses out of precious metal pricing, so it may reach an equilibrium that is at least mildly sustainable in the face of massive flows of bullion into Asia. And to start reforming the financial system which quite frankly has slid off the rails several times already and looks perfectly capable of doing it again.  Our philosopher kings have feet of clay.  What a surprise.

But since the banking elite are living a lie, that the precious metals are not a currency even though they treat them as such, hold them as such, and interfere with their pricing relative to other currencies as such, it may take some time for that to unfold.

These poorly thought, often contrived, and politically motivated policies that serve special interests are the sort of things that plunge a country into endless wars, a proliferation of unproductive spending for anti-human purposes, increasing repression, and a financial culture of systemic fraud that over time drains the real economy of all of its vitality.

But what is power, if the powerful and privileged do not exercise it.  Even until their own eventual destruction.