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I am Sir Thomas Gresham reincarnated. Just as in my previous life, I spend my time pursuing the subjects of money, credit, exchange & speculation: — in modern-day terms, you might call me an 'independent analyst'. For all those who may be interested, I write about markets & political... More
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  • 40 Years of Fiat Currency – Is Gold as ‘Cheap’ as it was in 1971?
     

    Monday was the 40th anniversary of the irredeemable fiat dollar. Unlike the preceding 39 anniversaries, this one was actually noticed! Here, I present several charts that show the changes to the Fed’s balance sheet since 1971. I conclude that the current gold price may be as ‘cheap’ as it was in 1971!

     

    To review what happened just over 40 years ago, I quote from Murray Rothbard’s fantastic little book, What Has Government Done to Our Money?:
     

    On August 15, 1971, at the same time that President Nixon imposed a price-wage freeze in a vain attempt to check bounding inflation, Mr. Nixon also brought the post-war Bretton Woods system to a crashing end. As European Central Banks at last threatened to redeem much of their swollen stock of dollars for gold, President Nixon went totally off gold. For the first time in American history, the dollar was totally fiat, totally without backing in gold. Even the tenuous link with gold maintained since 1933 was now severed. The world was plunged into the fiat system of the thirties—and worse, since now even the dollar was no longer linked to gold. Ahead loomed the dread spectre of currency blocs, competing devaluations, economic warfare, and the breakdown of international trade and investment, with the worldwide depression that would then ensue.

     

    The Charts:

    Federal Reserve


    As can be seen on the chart above, the Fed’s assets have exploded since the collapse of the Bretton Woods agreement. Until 2007, the expansion was mainly in favor of US government securities. The period from 2007 to 2010 brought about a large increase in the quantity of ‘other assets’ (mainly Mortgage-backed Securities and other junk). With the most recent quantitative easing program (QE2), the Fed’s assets are reverting back in favor of Long-term US Government Securities.

    Federal Reserve

    Of course, we can see precisely the same explosion in the Fed’s liabilities. Until 2007, this expansion was largely in favor of Federal Reserve Notes. Since 2007, the increase in the Fed’s liabilities has been in favor of Reserve Deposits. This was the real bailout of the banks. If one takes a moment to contemplate this, one realizes that all dollar holders (Worldwide!) took an enormous implicit haircut to preserve the status quo of the American Banking System!!!

    Federal Reserve

    The chart above shows the Fed’s assets on a proportional basis. ‘Gold Reserves’ as a proportion of the total balance sheet have been declining ever since the collapse of the Bretton Woods Agreement. Currently, ‘Gold Reserves’ seem negligible (this is partly due to the Fed’s funky accounting). It is clear that there have been some periods where large changes were made to the composition of the Fed’s assets, however it is equally clear that such changes pale in comparison to the drastic alterations seen over the past 3-5 years.

    Federal Reserve

    Again, the sheer size of the bank bailout is evident from the chart above. After declining proportionally for 35 years, ‘Reserve Deposits’ exploded in 2007/2008. The declining proportion of ‘Reserve deposits’ shows the progressively greater doses of leverage used in the American banking system. The recent explosion in ‘Reserve deposits’ demonstrates the enormity of the bailout! The low in the light blue portion on the chart above was the peak in excitement about banking. The current peak represents the banking industry’s march towards boredom.

     

    [NOTE: The following charts are available on the 'Long-Term Charts' page (where they go back to 1915). They are updated every week.]

    Total Size of the Federal Reserve

    Since August 11, 1971, the Federal Reserve’s total balance sheet size has expanded from $88’711 million to $2’876’236 million (over 32 times!).


    Total Size of the Federal Reserve

    Same data on a logarithmic scale.


    Market Value of the Federal Reserve

    Since August 11, 1971, the market value of the Federal Reserve’s gold has increased from $12’050 million to $463’229 million.


    Gold Covering or Backing the Gold Since the Collapse of the Bretton Woods Agreement - Click to enlarge. Source: St Louis Fed

    Using the data just mentioned above, we might conclude that the ‘degree to which the dollar is backed by gold’ (at market prices) hasn’t changed very much. On August 11, 1971, the dollar was 13.6% ’backed by gold’ and now the dollar is 16.1% ‘backed by gold’! This begs the rather startling question; is gold roughly as cheap as it was in 1971? Was the early part of the mid-20th century gold bull market covered up by the semantics of governmental meddling with money?
    Aug 19 4:43 PM | Link | Comment!
  • The Historical Ties between the ‘Deflationists’ & the ‘Gold Bugs’
    The seemingly perennial inflation vs deflation debate is littered with mutually antagonistic groups. The two most notable combatants seem to be the ‘Deflationists’ and the ‘Gold Bugs’. In the interest of being a lover and not a fighter, I thought I’d outline the historical ties between these two groups and explain why the widely publicised misgivings between them may be misplaced.

    Tug of War Between Gold Bugs & Deflationists

    The Seeming Contradiction:

     

    If I were to hazard a guess at the most commonly held beliefs relating to deflation and gold, I would say that the two assets are regarded as mutually incompatible. Gold — it is said — is an ‘inflation hedge’, and thus cannot possibly be favored by the steadfast deflationist! Likewise, if you have a long position in gold, you’re surely a gold bug that eats deflationists for dinner, right?

     

    But wait… ‘Gold Bugs’ used to be the ‘Deflationists’!?

     

    It is important to note that currency systems as we know them today – that is, iredeemable fiat currencies – are a relatively new thing. The time-honored monies of the world have been the precious metals. Historically, then, the money supplies of the world have consisted of gold and/or silver (in their metal forms) as well has ‘IOU claims’ upon those metals (in the form of notes or checking deposits at banking institutions).

     

    So, back in the day, the investors that believed that the mountain of ‘IOU claims’ upon ‘money’ (back then, gold and/or silver) were faltering, were — you guessed it — gold bugs! As Irving Fisher explained in ‘The Money Illusion‘ (available at the greshams-law.com book store):

     

    When the price level is falling, the money-lender (the bondholder) is getting the advantage of the changing conditions and the public nickname him, as in the Bryan days of 1896, the “Gold Bug of Wall Street” or the “bloated bondholder.

     

    Essentially then, the rudimentary event that the ‘deflationists’ fear may come to pass (the mass extinguishment of ‘IOU money’), is exactly what the original ‘gold bugs’ feared most of all!

     

    Have things changed all that much?

     

    Now, I know that the gut-reaction is to say; ‘well, things have changed, we’re in the modern world, … ‘, and although I grant those statements, I humbly request that you consider the following questions: Isn’t it strange that the ‘gold bugs’ and the ‘deflationists’ should be considered polar opposites given that they were one and the same thing not so long ago? Moreover, isn’t it strange that – for example – George Soros would sell his gold for the reason that he no longer believed thatdeflation (that’s right, not inflation) would come to pass?

     

    Reconciling the ‘Deflationist’ & ‘Gold Bug’ Positions:

     

    As is often the case with such arguments, it pays to look at the terms in which the arguers are speaking. Here, the tendency to conflate notions such as inflation, monetary debasement, increases in the ‘money supply’ and increases in a ‘consumer price index’ seems to hold the key. If you can wrap your mind around the fact that gold is not an inflation hedge (in the sense of hedging against consumer price index increase) — and yet that it is a hedge against monetary debasement (in the sense of balance sheet expansions), then I think you’ll get on the right track.

     

    Since the World’s currency systems are irredeemable, there is no danger of an explicit run on central banks. However, given that the price structure must – in some sense – reflect the fact that the dollar, euro, pound etc. are at most as good as what backs them, there are consequences to balance sheet expansions. Instead of a run when Central banks print money, we often have to see a rise in central banking liability price (e.g. federal reserve note) of central banking assets (which — of course — includes gold).

     

    Commerical banks are required to redeem into central bank notes (i.e. federal reserve notes, euro notes, pound sterling notes etc.), and therefore are potentially subject to bank runs. A means by which central banks aim to avoid such bank runs (after all,.. ‘the whole world will end if we let that happen!’), is by monetary debasement – i.e. by increasing the size of central bank balance sheets.

     

    You see, the prospects of embracing gold and being very wary of credit contraction (or, in Austrian terms, the mass retirement of Fiduciary media) are mutually compatible ideas. In fact, we here atgreshams-law.com would go as far as to say as they are inseperable and that they spur each other on! Deflationary credit contraction is capable of being averted by monetary debasement. Yet that monetary debasement is incapable of correcting the inappropriate time-stucture of production that the fractional-reserve banking system produces. Inevitably then, insofar as the reaction to potential bank runs remains that of extreme and widespread petrification, continued moentary debasement is likely to follow.

     

    Conclusion:

     

    The ‘deflationist’ and the ‘gold bug’ intellectual positions aren’t to distant from one another. We’re all brothers even though we’re from other mothers – so let’s be friends, yah?


    Jul 05 5:43 AM | Link | Comment!
  • The ‘Art’ of Monetary Debasement
    The ‘art’ of debasing money is a strange one (don’t worry, I use the term ‘art’ jestingly!). Here, I get to grips with this peculiar endeavour and consider the implications for one’s speculative activities.

    Cartoon GIF of Money Printer

    Historically, monetary debasement has been a favourite means by which rulers have sought to replenish their coffers. Indeed, as has become evident over the past few years, it remains a favourite means. As Rothbard wrote in his excellent book, ‘The Case Against the Fed’ (available for free at the mises institute or – of course – at the greshams-law.com book store), this seems to be attributable to the hidden nature of such confiscations:

    Monetary inflation, then, acts as a hidden “tax” by which the early receivers expropriate (i.e., gain at the expense of) the late receivers. And of course since the very earliest receiver of the new money is the counterfeiter, the counterfeiter’s gain is the greatest. This tax is particularly insidious because it is hidden, because few people understand the processes of money and banking, and because it is all too easy to blame the rising prices, or “price inflation” caused by the monetary inflation on greedy capitalists, speculators, wild-spending consumers, or whatever social group is the easiest to denigrate. Obviously, too, it is to the interest of the counterfeiters to distract attention from their own crucial role by denouncing any and all other groups and institutions as responsible for the price inflation.


    So, given that most governments (& their friends) of the world are in trouble, and they love to debase their currencies, you’d be crazy to own even a small holding of cash, let alone a fairly large holding, right? [By 'cash', I mean central bank notes that you can put in your pocket or IOU claims upon such notes at solid institutions.] Well, here at greshams-law.com, we reply with that rather opaque phrase; yes and no (I’ll get on to what I mean by this below).

     

    Yes, government-run monetary systems have always collapsed, and yes, paper money systems have most frequently collapsed because they have gone to 0 (i.e. via hyperinflation). However, one could say ‘no’ in the sense that the proposition of owning a significant holding of central bank notes is nota secular one, but rather a matter of prudent timing. [That being said, as I mentioned here, certain types of investors with great quantities of capital may be able to do well without such prudent timing.]

     

    Rather, we contend that profound market distress will probably precede profound monetary debasement, and that such periods of financial stress are likely to be more than momentary.

     

    The Mechanics of Replenishing the Loot via Meddling with the Money:

     

    The pure paper money systems that pervade the world today are fairly new; the historic monies of the world have been the precious metals. So, the time-honored way of meddling with money has been to mess around with the coins. The particular mechanism by which rulers have messed around with their coins has been to reduce the precious metal content in (supposedly) gold or silver coins. In this way, the ruler could stretch X coins out to X+Y (Y>0) coins, and subsequently dispel previously accumulated debts. Alternatively, the ruler might mess around with the monetary system by monetary decree. As Doug French explained in ‘Early Speculative Bubbles and Increases in the Money Supply‘ (available here or here):
     

    The powerful Charles V was among the most culpable for altering the value of money. These alterations in the Netherlands came by monetary decree. In 1524, Charles raised the value of his gold coin from 9 or 10 to 11 3/8 times their weight in silver coins … Charles returned to a ratio of 10 to 1, not be lowering the value of his gold coins back to their value before 1524, but by degrading his silver coins. Four years later, in 1546, Charles struck again suddenly raising the value of his gold coins to 13.5 times the value of silver coins…


    Indeed, this kind of meddling money continued into the transition towards a democratised society. In short, the rudimentary road map was this:

     

    1. Ruler gets into a debt that he/it cannot pay.
    2. Ruler messes with the monetary system to reduce his/its debt burden.
    3. The ruler thus enriches himself/itself via the confiscation of wealth from others (whether they realize it or not).

    ‘Ok, Say Hello to my Systemic Friends’:

     

    Alas, with the passing of the 19th & 20th Centuries, we find that enormous sectors of commerce and finance have become pseudo-socialized. The line between private industry and the public sector has become so blurred that it’s really quite difficult to tell ‘private’ from ‘public’. Governments aren’t exclusively assigned the task of protecting private property rights, but have become involved wherever they can demagogically claim that government-control is necessary. ‘Bank deposits need to be guaranteed, the government must be involved!’; ‘Roads are super duper important, they’d be impossible — I tell you — impossible without governments!’; ‘The investment industry would murder everyone if it weren’t for the keen eye of — you guessed it — Government!’; ‘Phone lines are just too important to be left to private industry, the government has to get involved!’; ‘Internet advertising will manipulate the people, the government must regulate!’. [I could go on all day long.]

     

    Anyhow, the point is that continued GDP growth has become contingent on a whole host of inappropriately placed industries. And, since this is what we in the West seem to crave (see quote below from Carroll Quigely’s ‘Tragedy & Hope: A History of the World in Our Time‘), money printers are engaging in monetary debasement for a whole host of industries (some of which are yet to become friendly with the government) as well as itself. This is a change from the likes of Charles V debasing his gold so that he might easily pay off his debts.
     

    An economic system does not have to be expansive — that is, constantly increasing its production of wealth — and it might well be possible for people to be completely happy in a nonexpansive economic system if they were accustomed to it. In the twentieth century, however, peopie of our culture have been living under expansive conditions for generations. Theirmindsare psychologicallyadjustedtoexpansion,and they feel deeply frustrated unless they are better off each year than they were the preceding year. The economic system itself has become organised for expansion, and if it does not expand it tends to collapse.


    The point is that people like ‘Helicopter Bernanke’ are looking out for (supposedly) ‘systemic’ institutions’ as well as the US Treasury. Given that they seem to want to ‘keep the economy going’ (or — in our terms — keep economic disequilibria from resolving themselves), they have to debase for the least common denominator — which, in 2008, was everything pertaining to housing. So, finally we get to the crux of this article: the money printers of today do not know ‘how’ to print (i.e. what securities to monetize) until it’s too late and financial stress is upon us. They want to preserve some sort reasonable currency (and are pressured to do so by us), and yet they want to keep things going. Given that we had an enormous bubble in credit, where all sectors were affected, a continuous path to the inevitably inflationary future would only come to pass if they could anticipate which sectors will be the weakest ones.

     

    [This may become clear if we think about Europe. The woes of Greece, Spain etc. are due to the fact that the Euro cannot be debased to suit the assets and liabilities of Greek, Spanish etc. institutions. That is, the game can't be fixed to preserve the status quo in these countries. Now, the US economy's motion is dependent on many different 'systemic' industries. It is quite conceivable that Bernanke & co. will not foresee the industries that will be under the most duress, and that the dollar will be to those industries as the Euro is to Greece, Spain etc. If this comes to pass, then dollar bills and T-bills would do extremely well (for a relatively short period of time - maybe months or a year).]

     

    Conclusion:

     

    So, in this way, holding a sizeable chunk of Federal Reserve notes is not a way of saying; ‘We believe in you Bernanke!’, but rather is a way of saying; ‘We emphatically do not believe in you!’.

    Jun 27 10:49 AM | Link | Comment!
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