asleeper

Gold Breakdown

Anarchist wrote:
"But never the less the majority of the world no longer sees gold as a hedge against anything."

You might want to read Adam Hamilton's piece, "Global Gold 5"
www.321gold.com/editor...

"But to understand how gold really did during late 2008's devastating stock panic, you really need to consider all these currencies concurrently. The takeaway is gold's panic performance ranged from excellent to spectacular in 7/10ths of these currencies which include the very important euro and British pound. Only the US, Japan, and China saw local-currency gold charts that looked weaker than investors hoped during the panic episode."

In much of the world, gold not only held all of its value, it hit all time highs at the end of 2008.

What Is Going On With Gold?

The “goldbug” club has been advocating an investment with the following track record in nine currencies.

GOLD ANNUAL CHANGE
USD AUD CAD CNY EUR INR JPY CHF GBF
2001 2.5% 11.3% 8.8% 2.5% 8.1% 5.8% 17.4% 5.0% 5.4%
2002 24.7% 13.5% 23.7% 24.8% 5.9% 24.0% 13.0% 3.9% 12.7%
2003 19.6% -10.5% -2.2% 19.5% -0.5% 13.5% 7.9% 7.0% 7.9%
2004 5.2% 1.4% -2.0% 5.2% -2.1% 0.0% 0.9% -3.0% -2.0%
2005 18.2% 25.6% 14.5% 15.2% 35.1% 22.8% 35.7% 36.2% 31.8%
2006 22.8% 14.4% 22.8% 18.8% 10.2% 20.5% 24.0% 13.9% 7.8%
2007 31.4% 18.6% 10.4% 23.0% 17.9% 17.5% 24.7% 21.5% 29.2%
2008 5.8% 32.5% 32.4% -1.1% 11.9% 30.4% -14.9% 0.2% 44.3%
AVG 16.3% 13.3% 13.6% 13.5% 10.8% 16.8% 13.6% 10.6% 17.1%

Any investment still returning an average of 10% – 17% percent after this past eight years is a winner in my book.

Regarding backwardation, it isn’t a theory, it is a fact due to a drawing down of physical inventory. So many people were taking delivery in December that the price of gold for immediate delivery dropped below the future prices.

“If you had told me in December of 2007 that the global stock market would fall 40% in 2008 I would have told you to buy gold and nothing else because of its safe haven characteristics.”

Any investment including gold requires attention be paid to the dynamics of: money, markets, and the economy. Broad trends are one thing; timing is another. The Nasdaq crashed in March, 2000, and the Fed did what it always does. It lowered interest rates and increased the money supply. But, gold did not jump right away. Gold was only up 2.5% in 2001. It takes a while for increases in the base money supply to manifest in broader measures of money supply, price inflation, and the price of gold. Don’t expect immediate results in 2009 until the credit freeze begins to thaw or foreign governments begin to dump dollar reserves.

”[Gold fell, and the dollar rose.] Why did this happen?”

The dollar rose in a counter-trend rally because the banking sector tightened credit and the market crashed. No credit meant businesses, hedge funds, and individual investors had to raise cash to operate and service existing debt. Weak investments were sold first, then stronger investments. Everything fell except cash and 5-10 year bonds. Gold fell as hedge funds sold stocks and futures to raise cash, but it fell less than most stocks. Forced selling led to demand for dollars, raising the value of the dollar. Gold is now still off its peak, but the only thing that outperformed gold year over year in 2008 was 5-10 year bonds.

Gold IS the anti-dollar, but it doesn’t rise on increased Fed Base Money supply alone. There must be evidence that the base money is finding its way into the economy via lending and multiplication due to fractional reserve banking. Currently, there is little evidence the base money increase is going anywhere except to bolster bank reserves, pay executive bonuses, and buy out other banks.

“When you buy gold you're essentially buying a hard asset currency with the hope that one day it will become the world's choice of currency again.”

Sort of, but not really. Gold need not ever become the world currency of choice to protect against several dangers. All that is required is that people remember gold is easily concealed, portable, a store of value and insurance against: inflation, loss of confidence in paper assets, and civil unrest.

So, your basic premise is basically correct, to understand where the price of gold is going, the dollar is important. But where is the dollar is going and when? That is the question. Right now, I would bet all paper currencies will see renewed inflation in the second half of 2009, but nothing in life is certain.

Is It Time to Buy Gold?

No one knows what Monday holds, let alone the next month or year. Even analogies to the Depression do not hold. The amount of debt-liquidity being provided by the Fed to member banks is completely without precedent.

Market forces are not determining stock market and precious metals prices. Financial engineering is going on behind the scenes, hence the lack of transparency concerning where all the money under the "tarps" is going.

Precious metals bets in the paper markets are little better than chips on the craps table in Vegas; it is pure gambling, not investing because you do not know how the wheel is rigged or when the pit boss will push the button for "00", red, or black.

Buying the physical metal is different. It is not investing either in times like these; it is capital preservation. If you cannot predict how the dollar will be destroyed - it IS being destroyed by out-of-control deflation or by hyperinflation to come - your only recourse is to shelter some of your capital in the form of a physical asset such as gold, silver, platinum, or palladium.

In really bad deflation, when money is extremely hard to come by, precious metals are still money. In really bad inflation, when money is abundance but nearly worthless, precious metals still have value. You might not get rich, but whatever happens, the value of precious metals does not go to zero as the value of paper money can and has done repeatedly in the past.

So, the debate about when to "invest" in gold is misguided. Gold is a lifeboat should the economy really go down the tubes, not an RV.

Don't Miss the Coming Gold Bull

I've been in precious metals and commodities since 2000 when the Nasdaq crashed. Study of market crashes led me to the historical fact that the Fed inflates the money supply whenever markets crash. Since then, I've recouped most of my Nasdaq losses. It is harder than it might seem to consistently make profits even in an eight year precious metals bull market, because precious metals are so volatile.

But, history says Fed measures being taken now to inflate the money supply will eventually show up as price inflation and be reflected in the precious metals. That being said, gold could easily dive before rising. If you want into the precious metals markets, never say the price cannot drop when you least expect it.

Right now, commoditities and most precious metals have taken a dive, even silver, platinum, and palladium. Comparatively, gold hasn't taken a significant dive. If you think it has, you haven't been investing in gold for very long or you are only thinking of gold in terms of the USD.

Why hasn't gold dived? Because enough people, including bankers, still think of gold as money, much more so than the other precious metals. And, they study history, they watch the Fed, and they sense monetary inflation coming after the current price deflation abates.

You can believe that people will lose faith in gold and it will drop like all the other commodities. You can believe that the banks will take down gold again if it approaches $1,000 again (many believe the banks, most notably JPMorgan, take gold down periodically by shorting futures and via mysterious unspecified "derivatives"). You can believe that "de-leveraging" is not over and will knock gold down again as hedge funds take profits. Or, you can believe that Fed reflation of the money supply will fail and it is Great Depression II, and everything but cash is a bad idea. Or, the market can just decide to stab you in the eye for no particular reason.

I'm going with the idea that history will repeat itself again and gold and gold stocks will provide outsized gains as they have since 2000. Myself, I'm wary of those sharp unexpected drops, and I think the gold price ratio to the other precious metals is significantly out of whack at the moment. Gold could drop to a price more in line with the other precious metals before it rises again. That's why I'm heavily into silver at the moment, not gold, slightly into palladium, and I'm eying platinum and palladium. The gold/oil ratio is out of whack too, so I'm also now into oil.

But, I'm ready to sell everything and short or double short the S&P500 if the overall market turns ugly again. This is not a buy and hold market.

2008 Was Bad - Will 2009 Be Worse?

The Economist: U.S. In Depression, Not Recession
www.prisonplanet.com/t...

Respected mainstream international publication, The Economist, reports that the U.S. is in a Depression now. The PrisonPlanet page posting the Economist article also includes the links to related articles shown below.

Related articles:
1. Britain may need 0% interest rate to avoid a depression, leading economist warns
2. Nobel Prize Winning Economist: Crisis As Bad As Great Depression Or Worse
3. Renowned economist Mikhail Khazin : U.S. will soon face second “Great Depression”
4. Rogers: The Elite Are Turning A Recession Into A Depression
5. IMF warns of Great Depression
6. Top Economist Mishkin: Worse Than the Depression
7. Roubini Sees Worst Recession in 40 Years, Rally’s End
8. Congressman: “If We’re Not Very Lucky Or If We Don’t Do Everything Right, We Could Easily Have A Ten- Or Fifteen-Year Depression”
9. Economy Is ‘Already In Recession’
10. Poll: 60% say depression ‘likely’
11. Former Fed chief says U.S. now in recession
12. Banking crisis: Is Britain heading for the worst recession since the 1930s?

Returning to a Gold Standard Is a Bad Idea

Richard,

The best performing asset class the last year was physical gold. But, similar to what Jim Myrtle said about banks, if you don’t want to invest in gold, don’t do it. I’m not trying to convert you or Jim but simply trying to share what I’ve learned since 2000 investing in precious metals and studying the monetary system.

Take it or leave it as you prefer, but you decide to take some of it and use it as a springboard for further study, one thing you will quickly learn is that prior to the establishment of the Fed, the monetary system and central banking was one of the hottest topics in American history dating all the way back to and before the Revolutionary War.

Sure there are “goldbugs” around who talk blithely about civic unrest, stockpiling food and guns and other unpleasant topics, but I don’t buy into the Armageddon scenario either. Surprisingly, my brother who is VP of a large commercial bank is more inclined to buy into that whole mega-disaster scenario than most “goldbugs”.

I’m not a goldbug (I’m pretty sure), I don’t represent goldbugs (I’m sure), I’m not sure what you think I don’t grasp, and I don’t know what ends you think I advocate, so I’ll continue to try to explain my views better.

I think you believe I don’t understood what Jim’s been saying. BTW, I said the bank may have put up all or none of the original $1,000, and Jim was right about the total loan amount being $9,000, not $10,000.

Of course the bank pays interest on the $10,000 on deposit in the example, but do you understand that if you try to explain to 100 people that the bank need only put up at most, $1,000 of its own money to generate $9,000 in “loans” and then earn $450 per year on their $1,000 investment, a 45% return per year, that 99 of them will think you have gone crazy? Because everyone “knows” that banks lend out their depositors money and how can they generate more than $1,000 in “loans” if they only had $1,000 to begin with?

Jim certainly understands the mechanics of banking and I do too, but most people do not understand where the $9,000 in loans comes from. The first $900 they understand, but after that, most people see it as smoke and mirrors and think that you are lying when you try to explain how a promise to repay $900 can be turned into dollars on deposit, which can be spent, re-deposited in the bank and serve as new reserves for the issuance of more more credit. Economists know it causes monetary inflation, and if the monetary inflation exceeds economic growth, it creates price inflation too.

Were you aware that I already wrote in this thread that I do not advocate a gold standard? The author stated that a return to a gold standard would be disasterous, which cannot really be discussed without discussing our current monetary system. I’ve been trying to get across how our monetary system works, its weaknesses, its unfairness, not extol its virtues obviously. Anyone can read the purpose of the Fed on its own website or out of an Econ 101 book. But they do not advertise its drawbacks.

I know all the same pro-Fed explanations and arguments you do. Do you understand what I’ve been writing or do you just consider it bunk because you do not recall the Econ 101 book saying there were any drawbacks to the current monetary system? There are alternatives to the existing system that are not gold standards, but why even consider them if you do not know how the existing system works or what it might be doing wrong? My goodness, most people do not even believe the Fed represents a cartel of private banks. They think it is a Government Agency.

Econ 101 does say that “Capitalistic systems are built off savings, which are then properly invested in projects that increase a nation’s wealth and productivity.”

But, wait one minute. If I put the $1,000 in the bank, my savings, to kick off the great capitalistic enterprise, why does the bank get $450 per year on $9,000 worth of loans and I get about $5 for my 0.5% interest per year on the capital that started it all? Why does everyone have to start their own bank to get a fair share of the “capitalist” system. Seems like the banks who have the least capital of all but have a corporate franchise to turn debt into money make out like bandits.

And, why are American renowned and reviled worldwide for not saving if saving is such a great part of the capitalistic enterprise? The Government exhorts people to spend, not save. Economists say that if people save instead of spending, the consumer sector of the economy will collapse. If people save instead of borrowing, the money supply will collapse and we will have disastrously high deflation, because debt = money.

Are Americans stupid? I say they are smart or at least they do the best they can with little or no understanding of the monetary system, and the monetary system is stupid. The Fed wants steady inflation and inflation that exceeds what middle and low income people can earn on investments. So, they don’t save and they borrow instead. Economists say that, too. I’m not out on a limb there. Instead of saving, they borrow and leverage the biggest hard asset they own, their house, expecting it to appreciate fast enough due to inflation to make a profit as the money supply expands. It works until banks tighten credit and inflation slows or reverses as just happened recently. People don't understand that what goes by the moniker "business cycle" is really just bank credit expanding and contracting.

Regarding seniors, financial advisors typically advise seniors not to seek aggressive returns but to put savings into “safe, conservative” investments to preserve savings rather than gamble with it. The kinds of investments they recommend, such as fixed income annuities and permanent life insurance typically do not beat inflation.

Middle class and low income people typically keep money in banks, bonds, or CDs. It’s really upper middle class who have any real money to invest in stocks, businesses, commercial real estate and the like, high return investments. Bank savings, bonds, and CDs typically don’t beat inflation over time. Social Security certainly doesn’t keep up with inflation. It’s indexed to the CPI, which consistently understates inflation.

You may be smarter than most seniors, most investors even, but you need not disrespect those less fortunate than you in order to toot your own horn. Would you feel disadvantaged by a monetary system that leveled the playing field a bit?

If you don’t mind, what is your background socioeconomically and education-wise? What has been your average compound rate of return per year of all your liquid assets, after taxes. For most people, even you probably, it is much less than you would estimate off the top of your head. Most people are not fully invested all the time, and they do not take into account funds that are idle. Very likely you haven’t beaten inflation or if you have, you haven’t beaten it by much. Most professional money managers don’t beat it by much. Some years like 2008 are gauged by how little is lost, not how much is gained.

I’m not sure I fully understood your shoe example, but if “everyone else is better off, Mr. Entrepreneur more than anybody”, what is the problem? If Mr. Entrepreneur lowers his prices a little he could lower his prices a little, sell even more shoes, take market share from another shoemaker, and make a bigger profit.

That kind of thing, productivity increases, happens far more rapidly in the semiconductor industry than changes occur in the overall money supply. One of my two brothers works for a semiconductor manufacturer that has almost no debt. They finance capital improvements almost entirely out of profits, and they design or customize much of their production equipment. Productivity increases and price reductions do not result in lower wages at their company, but market share does. People who work for companies that fail must go to work for another or move into a new industry that is starting up. That is capitalist “creative destruction”.

The only other thing I can think of to say is that the state budget crisis in my state might mean a substantial but in my pay before long. However, if deflation continues like it has in recent months, my expenses will drop even faster, except for my mortgage. Debt is the real problem in a deflation. Debt in high deflation = bad, debt in high inflation = good. Unemployment is always bad.

Enough arguing. May all your investments in the New Year beat inflation!

Returning to a Gold Standard Is a Bad Idea

On Jan 02 04:40 PM Jim Myrtle wrote:

> "Otherwise, modern banks make “money
> from thin air” the same way that medieval goldsmiths did, when they
> issued more warehouse receipts for gold than they had gold"
>
> False.

Really? In the goldsmith's day, you could distinguish between gold and paper warehouse receipts. Gold was money and paper a representation of money, easier to handle, but money only by virture of representing gold. If a bank issued more paper as "credit" than it had corresponding gold on deposit, it not only inflated the money supply and caused inflation, it risked a bank run. With no way to distinguish between the original receipts of actual gold depositors and the receipts created as "credit" by the bank, depositors who had actually put gold into the bank could be cheated out of their gold in the event of a bank run by debtors rushing to obtain gold for their receipts.

Fast forward to modern banking and consider that each of the original $1,000 deposited at the bank is analogous to gold. Say, you sign each bill with a metallic gold flake pen to emphasize the idea. By the time the bank finishes issuing credit, there is 10,000 dollars circulating in the economy, going to and from the bank as people make payments and deposits by check or electronically, even if the gold pen marked bills never move. The modern bank inflates the money supply by issuing credit not all of which is backed by the original $1,000, just as the goldsmith did with paper receipts and gold.

The modern day equivalent of the medieval goldsmith's bank run on the depositor's gold would be the news that the bank intends to shut its doors. As people rush to the bank to withdraw their money in cash before the doors close, the only cash available is the gold pen marked $1,000. Yet depositors demand to withdraw $10,000. The original depositor of the marked $1,000 is just as much at risk of losing his money to debtors as the gold depositor was in the first example.

If everyone demanded cash for their deposits at every bank, the Treasury could print bills for 100 years and probably still not be able to produce the cash reserves for depositors. At a typical branch bank, I know from personal experience that you would be lucky to be able to withdraw $5,000 on any given day without advance notice.

So, conceptually they are the same racket. $10,000 worth of IOUs backed by $1,000 cash is not the same thing as $1,000 cash. Just as $10,000 worth of warehouse receipts for gold backed by $1,000 worth of gold is not the same thing as $1,000 worth of gold.


> "Going back to the $1,000 deposit idea. Suppose a person deposits
> one thousand dollars in the bank. The bank then does not “loan” any
> of the $1,000. Assuming a 10% reserve, it creates credit of $900
> and calls it a “loan”."
>
> Why wouldn't you call a loan a loan?

Why wouldn't you call a left hook and a right cross both punches? Because they are not the same and left hook and right cross are more accurate. "Credit" is a more accurate term than loan that does not obscure the money creation aspect of circulating bank created IOUs as legal tender. "Monetized debt" would be be an even better term, but then everyone would know that the only thing backing it was an IOU.

If I want to lend you $10 to buy lunch, I must give you $10 from my wallet. You have ten more, I have ten less, and no new money has been created. That's a traditional loan, like loaning a lawnmower. If you choose not to borrow from me and manage to convince the restaurant to accept an IOU from you, that is credit. You can call it a loan if you want, but most people call it credit. It is not bank credit though, because it cannot be circulated or spent like legal tender, so just like a real loan, it does not increase the money supply or cause inflation.

Bank credit is even stranger. It ought to have its own special name, but it doesn't. Bankers prefer that people believe they are actually lending depositor's money, which they most certainly are not. Banks are allowed to "lend" to a borrower the borrower's very own promise to repay and once the bank has done that, the borrower can spend his promise to repay. In effect, the bank waves a magic wand over the borrower's promise to repay and converts it into legal tender. Banks are given the legal franchise to do this, create credit that is legal tender backed only by the borrower's promise to repay. The debt instrument is very much like the restaurant IOU, except the bank is allowed to convert it into legal tender. It becomes money by fiat, that is by law.

If the restaurant had the same legal rights as the bank, it could print out little dollar bills and "lend" them to you. You could pay your $10 bill with it, but that would be a transaction separate from the loan. After paying your bill, you would still owe the restaurant $10, plus interest. Meanwhile the restaurant could spend the $10 you paid for your meal and wait to collect your repayment of the loan principal, plus interest.

Of course restaurants cannot do this, only banks can. If a restaurant did this, it would be prosecuted for counterfeiting. Banks do it legally. But no matter who does it, when credit circulates as money, it inflates the money supply, the amount of legal tender chasing goods and services.


> " The “borrower” withdraws the $900 and spends
> it. The recipient of the $900 deposits it back into the bank, where
> it serves as a reserve for $810 of new bank credit"
>
> Excellent! You have 2 deposits, one for $1000 and one for $900. Total
> $1900. This supports 2 loans, one for $900 and one for $810. And
> no one counterfeited or created anything out of thin air. You'll
> notice that each loan is smaller than the deposit it comes from.

Critics of this process refer to it as counterfeiting for two reasons:
1) A promise to repay is not equivalent to payment, and
2) It is legally not considered counterfeiting by legal fiat.
Anyone who tries to do what a bank does without legal charter as a bank is guilty of counterfeiting, and legal protection does not alter the effect of the practice on the economy.


> "There are several problems inherent in this scheme. First, the bank
> put up no money of its own, but now collects interest on $10,000"
>
> If the bank is collecting interest on $9,000 in loans and holds $1000
> in reserves,it must be paying interest on $10,000 on deposits.

Have you checked that recently? Interest paid on deposits is almost zero and interest collected on bank "loans" probably averages 5% or better. Let's say the bankers put up the original $1,000 dollars themselves. Their return on the $1,000 then is the interest on $9,000, or $450 per year. Forty five percent per year is not bad. And, that is assuming the bankers put up the entire reserve. Not bad at all. If depositors put up all the reserves, the returns are infinite.

Nine Ways to Profit in 2009

Thank you for making specific and detailed predictions. Right or wrong it makes for more interesting discussion.

Oil could go as low as you said. The charts suggest it is possible. But, I'm betting the low is in or close to it for two reasons. Even if some people think oil could go as low as you say, $20-$30, I think most people expect it to rebound in 2009, just as you said. If they expect it to rebound to $45-$85 by the end of the year, why risk missing the opportunity to buy at $30-$35 and chasing the price up should it head back up early? Why not buy in at $30-$35 and add more if the price weakens. I think most people would see it that way and such an attitude will prevent the price from dropping all the way down to $20.

Also, historically the price has already dropped as much percentage-wise as it did after the 1970's oil crisis. To fall all the way to $20 would mean a much larger drop percentage-wise. It could happen, but if it does, it would confirm that that this recession/depression is as bad as you think.

To me, the opportunity to buy oil at $30-$35 now and probably double the investment in a year or two years at most seems like a very good bet. I bought USO at very close to $31 with about half the money I wished to dedicate to oil before Christmas. I'll hold the other half and see how it goes 1Q '09. If the price drops to $20, I'll buy more. If the price goes up and the future looks as bleak then as it does now, I'll sell and bet on a second big decline in the market to buy back in.

Thanks again for your predictions.

Returning to a Gold Standard Is a Bad Idea

On Jan 02 03:38 PM Jim Myrtle wrote:
“GDP didn't fall further during those panics? How much did GDP shrink after the Panic of 1873? How long did that Depression last?”

Are you an economist? Can you cite enough sources on both sides of the issue to prove a consensus? Have you compared the metrics of 1873 with the metrics of the Depression. Because there are scholarly papers taking both sides of the issue. You made the assertion. Now prove it, if you can.

asleeper wrote, "And no matter if there was a consensus, it would have to be qualified by noting that there has never been a pure gold standard or bimetallic standard in the U.S. "

Jim Myrtle wrote, “Don't tell the goldbugs. LOL!”

LOL all you want, and tell them yourself. If all you intend is to play cat and mouse with supposed “goldbugs”, then by all means keep fooling around. The larger issue addressed by the article is the monetary system.

Although I do not advocate a return to any of the past "gold standards", I did begin reading several websites published by those I suppose you would call goldbugs after the Nasdaq crash. As a result, learned enough about the monetary system to earn a lot of money back that was lost and to know that the Fed and private fractional reserve banking is a very bad system for most of society.

Returning to a Gold Standard Is a Bad Idea

On Jan 01 08:55 PM Jim Myrtle wrote:

“Thanks for the link. The only thing is, modern banks don't issue warehouse receipts for gold. I agree, that would be "money from thin air", but since that no longer occurs, I don't think it's relevent to our discussion.”


The difference between Rothbard’s warehouse receipts for gold and modern fractional reserve banking is that modern banks use deposits of paper assets such as Federal Reserve Notes, T-bonds, and T-bills as reserves instead of gold. Otherwise, modern banks make “money from thin air” the same way that medieval goldsmiths did, when they issued more warehouse receipts for gold than they had gold.

Going back to the $1,000 deposit idea. Suppose a person deposits one thousand dollars in the bank. The bank then does not “loan” any of the $1,000. Assuming a 10% reserve, it creates credit of $900 and calls it a “loan”. The “borrower” withdraws the $900 and spends it. The recipient of the $900 deposits it back into the bank, where it serves as a reserve for $810 of new bank credit. The new “borrower” spends it and the new recipient deposits it back into the bank, where it serves as a reserve for more credit to be issued by the bank. This process continues in a decreasing geometric series until the bank has issued $10,000 in credit. The original $1,000 may still be sitting in the bank, but the amount of dollars chasing goods in the economy was $10,000 in this example. More dollars implies monetary inflation and monetary inflation implies price inflation.

There are several problems inherent in this scheme. First, the bank put up no money of its own, but now collects interest on $10,000.

Second, the increased money supply causes inflation which penalizes savers and retired people on fixed incomes. That is why Americans traditionally have saved so little since the establishment of the Fed. In a use it or lose it situation, t doesn’t pay to save.

Third, “Borrowers” who have first access to new loans can buy goods before others, such as wage earners, have access to the new money and before inflation caused by the new money manifests in the general economy. That is why wage increases always lag inflation and that is where stealing from wage earners comes in.

Fourth, if all loans are to be repaid, some borrowers must necessarily go bankrupt because the bank created the principle when it issued the credit, but it did not increase the money supply by an amount equal to the interest. So, if most of the loans are paid back with interest, not enough money remains to pay interest on the others. That is why our Government cannot pay off the national debt. If it did, the money supply would shrink dramatically causing terrible deflation. When money = debt, you cannot extinguish debt without extinguishing the money supply too. This problem is ameliorated to some extent by spending of bank profits back into the general economy, but for the most part, compensation is accomplished by the issuance of new loans and the accompanying incessant inflation.

Fifth, in a centralized system, such as the Fed, leaders of the member banks can profit from what is essentially insider trading, from the knowledge of future credit terms. That is why the bailout money authorized by Congress did not go to buy toxic assets as Paulson said it would, but is being used to shore up balance sheets and buy out competitors for pennies on the dollar, because the Fed member banks knew full well that credit would not loosen up anytime soon.

Here is a good link to a video on how banking evolved: video.google.com/video...

I recommend skipping the first 1:50 - it is mostly well-known quotes about the banking industry – and skipping the part about an alternate money system at the end. The middle is a very explanation of how fractional reserve banking actually works.

Returning to a Gold Standard Is a Bad Idea

On Dec 31 10:03 AM Jim Myrtle wrote:
“I refer to price deflation because that is all that people care about. The money supply could grow 1% while GDP grows 3%, causing prices to drop 2%.

You could be "technical" and say we were "suffering" 1% inflation, but all people care about is the impact that 1% "inflation" has on prices, in this case it causes them to fall 2% a year.

And you can pretend that there was no inflation or deflation (in prices)while we were on the gold standard, before the Federal Reserve was created, but you'd be wrong.”

You needn’t suppose what I might say or not say or try to imply that I “pretend” anything.. That is a false way of arguing. Not to go by the same tack, I’ll stick to what you have just written.

Price deflation is not all that people care about as is evident in this thread and in other blogs where people are discussing the economy. People also care about the possibility of high inflation and even hyperinflation, because the Fed has massively increased the base money supply. Just because we are suffering price deflation at the moment does not mean we will not suffer high inflation should the banks loosen credit again.

You implied (I think) that I am a “gold standard” advocate who “pretends” there was no inflation or deflation on the gold standard before the Fed was created. You are wrong on both supposed points. A little history on the “gold standard” is in order.

The U.S. has never been on a pure gold or even a pure bimetallic money system. The US was on a bimetallic “standard” during the 1800s, mainly gold and very little silver, but, banks could and did issue paper money on a fractional reserve system against metals on deposit at the same time.

A true Federal Government Gold Standard was only in effect from 1900-1933 with the Gold Standard Act, but this law did not prohibit fractional reserve banking which continued unabated. The Gold Standard Act came to an end in 1933 when President Roosevelt outlawed private gold ownership except for jewelry.

Bretton Woods, enacted by the US in 1946 created a system of fixed exchange rates that allowed governments to sell their gold to the US at $35/ounce. Nixon ended Bretton Woods in 1971.

From 1946 to 1971, US citizens could not redeem dollars in gold, only foreign Governments could, and no one could redeem dollars for silver. U.S. citizens could not legally own gold again until Jan.1, 1975.

So, as far as US citizens are concerned, gold has not been money and we have not been on a gold standard since 1946, at the latest, even earlier if you go by the right of citizens to own gold. Silver has not been money since 1900. No gold standard of any kind has been used in any major economy since 1971. And, still we have “business cycles”, financial panics, bank failures, recessions, and what now looks like a depression looming.
The gold standard in effect from 1900-1933 was not a stable money system and did not prevent over-expansion of the money supply due to fractional reserve banking during credit booms or over-contraction during credit busts, because banks could create too much credit-money by loosening credit or too little by tightening credit.

When banks and brokerages tightened credit in 1929 after a period of loose credit, the stock market crashed, the money supply began to contract, and the Great Depression was on. Gentle price deflation due to stable money and productivity increases was not the problem. Credit tightening by member banks of the Fed, most notably JP Morgan, was the problem. A dramatic drop in the money supply resulted, made possible by the fractional reserve banking, fiat money regime. The drop in the money supply caused the drop in prices which you claimed is all that people care about.

I do not advocate a “gold standard”; I advocate a near-stable money supply that can be expanded approximately 0-5% per year by the Government and cannot be deflated. That would mean no Fed, no fractional reserve banking, and a loan would actually be a loan, not credit. I leave it to the economists to design the system.

Resurgent Dollar Leaves Gold in the Dust

"The irony is that just about every goldbug was also a convinced dollar bear a year ago, and their emotionally charged analysis has proved utterly misconceived in a deleveraging global economy."

HIndsight is always 20/20. If the author was aware in advance that the dollar might be the best investment possible from 10/08 to now, was he advocating dumping all stocks and commodities at the time? I did, even my gold and silver ETFs.

In reality, just about about every goldbug knows that precious metals are volitile, and the "structural" matters in the market that lead to volatility are difficult to understand.

That is why even goldbugs pay particular attention to events that do not fit their conception of where markets and gold price are going. Practically every goldbug I now was all over the structural "deleveraging" idea in short order as the market crashed, gold went down, and the dollar rallied. This is NOT new news.

As a consequence, I got out of gold and silver very quickly, caught the first first bounce and recovered my initial loss, got out again, and waited for the carnage to end.

This business of knocking goldbugs cracks me up. They are like the stock pusher's bogeyman who cannot be mocked enough. Take it all with a grain of salt folks. The person you want to pay attention to is the person who KNOWS what is coming next. Good luck finding him.

Let's Just Say It: Print More Money

The author is badly mistaken in his advice as most commentors have noted by saying that more of the same that got us into this mess will not get us out. That is, given the existing monetary system remains intact. However, I am perpetually amazed at how few commentors are willing to go beyond that realization to say that a wholly new monetary system is needed.

When the banks deny credit, our system falters because our system is based on dollars being created by banks in response to people and organizations being willing to take on debt. If new credit (equal to the debt principle) is not continually added to the system in response to such willingness to take on debt, then paydown of debt by existing debtors extinguishes the money supply causing other debtors to find it even more difficult to earn the funds needed to pay down their debts, principle plus interest.

The author is therefore correct in saying the essence of the problem in a crisis such as this, a credit crunch, is not enough money in the system. He is incorrect in saying that the Government and the Fed are capable of supplying that money in a way that will help, given our debt-based origination mechanism for creating new money.

I understand that this is an investment web site, and very few who post here consider it likely that our monetary system will be redesigned in the next year, so any mention of what is needed to REALLY solve the financial crisis is not likely to help make investment decisions in the next six months. However, if the dollar truly does self-destruct in a hyperinflationary scenario at some point down the road, because of Government and Fed efforts to pump cash into the economy, a rare opportunity to re-design the monetary system might present itself.

We would all be better off if some way could be found to transition to a better monetary system without a collapse of the existing system, but as the existing system is a private, for profit system, the Fed and its supporters are not likely to look favorably on any proposal for a new system. For the present, we remain desperately searching for ways not to be screwed by the financial machinations at the highest levels in Washington and Wall Street.

What Is Going On With Gold?

Oops, correction. Re: backwardation, the price of gold for immediate delivery exceeded future prices.

Returning to a Gold Standard Is a Bad Idea

On Jan 03 04:08 AM Jim Myrtle wrote:

> "A borrower from a goldsmith would have signed something akin to
> a “loan document” just like a modern borrower. The borrower would
> have received a gold receipt of some kind and promised to repay it
> with interest just like a modern borrower"
>
> The most important difference being the goldsmith was printing receipts
> for multiples of his gold deposits. Modern banks can only loan their
> deposits less their reserve balance. Because they don't print FRNs.

If the money the bank "loans" is redeposited in the bank, cannot the bank continue to lend until the total loans are a multiple of the original deposit, the original deposit being the "base" the multiples are built on, the same way that multiples of gold receipts are built on the original gold deposit in the goldsmith's bank? And, both multiplying effects cause inflation?


> "Correct. One point to you. I didn’t bother doing looking up the
> formula and doing the math precisely. $900/(1-0.9) = $9,000. Doesn’t
> change the argument"
>
> Your math is still wrong. A $1000 deposit with a 10% reserve allows
> the bank to create exactly $900 in loans, not $9000.

We went over this before. If the $900 is redeposited in the bank, the bank can lend $810 more, and so on, until it can lend a total of $9000 with $10,000 on deposit, including the original $1,000. You agreed to that, even corrected my math on the total credit being $9,000 instead of $10,000.

> "The restaurant, at least in theory functioning as a bank, could
> obtain FRNs ultimately from the Fed which asks the Treasury to print
> them"
>
> If the restaurant wanted to wire money to the Fed, they could get
> FRNs. Not sure what that has to do with your story.

I felt you were quibbling about banks not being able to print FRNs, forcing me to revise my story to stay on point, which was that a handwritten IOU does not increase the money supply because it isn't equivalent to legal tender, and a bank loan does increase the money supply because it is equivalent to legal tender..

> "After which you would continue to owe the restaurant for the meal,
> because the FRNs were a "loan". Meanwhile the FRNs would begin circulating
> in the economy, increasing the money supply, until you pay off the
> loan"
>
> Now you owe the restaurant and the Fed, still not clear where you're
> going with this.
>
> "The salient point is that securitization of IOUs as legal tender
> increases the money supply.."
>
> Borrowing increases the money supply. Are you proving what I've said
> all along?

I've been saying all along that banks create money and increase the money supplying by the process of securitizing loan documents. That the act of securitizing the lenders promise to repay by the bank is the point of money creation by banks, referring to that act as issuing credit. And, I've been under the impression you been denying that. Apparently, there has been a "failure to communicate" all along arising over different assumptions about who meant what kind of money and what-not. And, maybe I've not been using banking industry-consistent jargon.

Sorry, but that cracks me up. One of my favorite sayings is that the strangest thing about communication is the illusion it has been accomplished.

> " If the accounts receivable consist of dollar equivalents such as
> credit card payments in process or checks, they can certainly sell
> the"
>
> They wouldn't sell credit card payments, they'd sell IOUs.
>
> "Restaurants cannot sell an IOU because the IOU hasn’t been securitized
> by a bank"
>
> You can sell an IOU that a bank hasn't touched. Suppliers that need
> cash can sell an IOU from WalMart (just an example) if they need
> the money now, instead of in 60 days (just an example).

Can your local corner restaurant really sell your handwritten IOU? Now, I'm not sure. Can he take it to the bank and use it to borrow money or exchange for FRNs as he could a check? if not, then I would say the IOU cannot increase the money supply.


> Don't confuse the money supply with FRNs. MZM, which includes FRNs,
> is narrow money. M1 is broader money. He can lend all day long and
> increase M1. He can't increase FRNs.

Yes retail banks can increase M1 but not FRNs. Modern money is rather slippery and has several definitions. But I've been referring to broader money measures than just FRNs, measures that banks can increase..

> "I’ve been saying that a bank can turn a promise to pay into legal
> tender"
>
> Legal tender? Like FRNs? A bank can sell your promise to someone
> else, for legal tender but can't turn on the printer in the vault
> to turn it into FRNs.

What I mean by "turn into" is that a bank can take my signed promise and physically hand me FRNs. Since my promise is not legal tender but my bank has given me legal tender for it, as far as I'm concerned, the bank has turned my promise into legal tender.

> "there is a real difference between $1,000 in FRNs and a signed loan
> document on which a debtor promises to pay $1,000 FRN’s plus interest?
>
> Of course there is a difference. One is very liquid, one is less
> liquid.
> One pays interest, one doesn't. One has risk of default, one doesn't.

Also, one is legal tender and the other is not. So, which one is money, the loan document on file at the bank or the credits in the borrowers account?

> "that a bank is able to turn a promise to pay $1,000 FRNs into the
> legal equivalent of $1,000 in FRNs?"
>
> I don't know your definition of "legal equivalent".

Dollar credits in the borrower's account. I say they are legally equivalent to FRNs because I can ask the bank to give me FRNs based on bank account credits and they must do it unless they don't actually have any FRNs on hand that day.


> "that creation of FRNs by the Fed and banks by securitizing promises
> to repay is the source of inflation that caused the FRN to lose approximately
> 95% of its value since 1913? "
>
> I don't dispute that the growth of high powered money and subsequent
> growth of M1, M2, M3 etc over and above the growth of GDP causes
> inflation.

Thank you. We agree on that and probably more if not for the communication gap. I'm curious, are you a banker, a teacher or neither? I'm a math teacher and ex-engineer.