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The Gold Standard
Issue #34 ● 15 October 2013
The Gold Standard Institute
1
Editorial
We have explained and extolled the virtues of an
unadulterated gold standard for almost four years
now. For those many who have recently signed up
for our monthly journal, it may be time to again state
our position, and perhaps clarify it.
The Gold Standard
The journal of The Gold Standard Institute
Editor
Regular contributors
Philip Barton
Rudy Fritsch
Keith Weiner
Sebastian Younan
Thomas Bachheimer
Ronald Stoeferle
Publius
John Butler
Charles Vollum
Occasional contributors
The Gold Standard Institute
The purpose of the Institute is to promote an
unadulterated Gold Standard
The Gold Standard Institute supports free markets.
While history unequivocally validates this stance, we
base it on moral principles as well as on the practical
fact that free markets create wealth, while all
‘systems’ destroy it.
Most proponents of free markets understand the
practical and moral benefits of allowing people the
freedom to produce and exchange, but fail to realize,
or point out, that for a market to be truly free,
money and credit must also be free – free from
government control.
www.goldstandardinstitute.net
Money is the foundation of every single commercial
exchange. How can there be a free market if each
exchange is distorted by a government monopoly?
President
President – Europe
President – USA
President – Australia
Editor-in-Chief
While it is unlikely that governments will ever
voluntarily relinquish monetary control, this does not
mean that the effort should not be made; nor does it
mean that the effort cannot succeed.
Philip Barton
Thomas Bachheimer
Keith Weiner
Sebastian Younan
Rudy Fritsch
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Contents
Editorial ........................................................................... 1
News ................................................................................. 2
Cognitive Dollar Dissonance: Why a Global
Deleveraging and Reblancing Requires the DeRating of the Dollar and the Remonetisation of Gold
........................................................................................... 2
An election, a banking symposium – and a
frightening parallel.......................................................... 6
Trust Your Neighbor; Tie Your Camel ...................... 7
The Theory of Interest and Prices in Practice ........... 9
We are on the threshold of a unique circumstance.
Our globalised world and towering debt means that
when one major paper money collapses, all collapse.
The Gold Standard Institute does not believe that
this is an improbable outcome; on the contrary,
without a major change in direction we are certain
that this is the unavoidable outcome.
The dawn of this reality will reignite a one thousand
year long argument; one that disappeared into the
shadows of history upon the death of the mediaeval
economist Nicole Oresme – that control of the
money rightfully belongs to market participants.
By not only reintroducing this argument, but by
more fully fleshing out the intellectual case for a free
market in money, the Gold Standard Institute staked
an early claim to being a part of that discussion.
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Issue #34 ● 15 October 2013
Our intention is that this latest in a long line of
monetary disasters brought about by government
monopolisation of money is the last.
have been ordered in to wipe up the mess by taking
over the factory of the largest manufacturer. No
matter, they will be able to use their currency soon.
Since Croesus of Lydia and Darius the Persian, the
world has laboured under the yoke of governmentmonopolised money. Always, without exception, the
money has ended up degraded and the society
collapsed. While coin has reliably been adulterated,
in no other age has the crass swindle of a worldwide
irredeemable paper money been attempted.
≈≈≈
Our job at the Institute is to make the case for the
unadulterated gold standard. It may not have been
obvious, so let me make it so; the unadulterated gold
standard is not feasible without a free market –
including, and most importantly, in money.
Forbes: American wages in gold
≈≈≈
Gold smuggling in India is booming. These would
be just the tip of the iceberg:
2-kg gold seized at goa airport
Smuggling along nepal border
Gold smuggling from dubai customs
Gold biscuits seized from two passengers at airport
Gold biscuits seized from passenger
Kochi airport gold haul
Philip Barton
≈≈≈
News
Amazon: Beyond Mises by Rudy Fritsch – now for
sale on Amazon (Kindle edition)
≈≈≈
Seeking Alpha: I would be genuinely interested in
how many of our readers can spot the primary
confusion in this piece
≈≈≈
Business-standard: Gold flavoured tea
≈≈≈
Cornwall Standard Freeholder: Money to burn
≈≈≈
Yahoo: Super rare gold coin sells for $2.75 million
≈≈≈
Daily Mail: Just in the last 13 years the UK has spent
1.4 trillion pounds on welfare
≈≈≈
BBC: Venezuelan central planners form a central
committee to overcome the shortage of toilet paper
that their central price controls created. The military
And now for something completely different… The
Song of the Golden Dragon – pretty good guitar!
Estas Tonne
Cognitive Dollar Dissonance: Why a
Global Deleveraging and Reblancing
Requires the De-Rating of the Dollar
and the Remonetisation of Gold
For most of the 1990s and 2000s, the economic
academic and policy mainstream essentially ignored
gold. No longer. Notwithstanding a decline in price
over the past two years, the longer-term secular bull
market has returned gold to a subject of active
debate. Moreover, following 2008, monetary
debasement by most central banks has been far
greater and has continued far longer than the
mainstream originally thought at all likely or even
possible. As some have recently claimed, referring to
Japan’s lost decades amidst perennial quantitative
easing, “we are all turning Japanese.” However, to
the extent that the mainstream acknowledges gold,
the debate remains relegated primarily to its role as
an alternative store of value, rather than as a
monetary alternative to the fiat currencies that
provide the bulk of the global monetary reserve base,
including most importantly the US dollar.
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Issue #34 ● 15 October 2013
To bifurcate the debate around the gold in this way,
however, is to demonstrate cognitive monetary
dissonance. This is because, as Kopernick, Gresham,
Carl Menger and others have demonstrated, money
must be both a medium of exchange and a store of
value. It cannot be just one or the other, or it will be
abandoned over time in favour of something else.
The economic academic and policy mainstream,
therefore, cannot claim on the one hand that a global
deleveraging and rebalancing requires a much weaker
dollar, as is generally acknowledged, and then claim
on the other that the dollar can remain indefinitely a
reserve currency. Yet this is what many appear to
believe. As we know, cognitive dissonance is not
uncommon, but when such dissonance dissipates, it
tends to do so abruptly, in an ‘awakening’ of sorts.
Hence the international remonetisation of gold,
while an inevitable consequence of the global debt
crisis in my opinion, is likely to occur in
spontaneous, unpredictable fashion, rather than
being driven in any conscious way by economic or
monetary officials.
In a previous article I wrote in this Journal about
how a reallocation of global monetary reserves away
from the dollar and into gold is already well
underway. Recent data suggest that, if anything, this
process has accelerated over the past year. China and
Russia, among others, appear to be growing their
gold reserves at an elevated rate. In both cases, it is
impossible to know exactly how much is being
accumulated, but available mining and import data
are supportive of this view. Many other countries
also continue to accumulate gold reserves.
Accumulation of dollar reserves, conversely, has
clearly slowed over the past year and, far more
importantly, is increasingly concentrated in a few
hands. The fewer the countries still accumulating
dollar reserves, the more unstable the current global
monetary equilibrium becomes. This is because,
according to game theory, stable systems require that
one or more players can adjust their strategies to
address changes in their own specific internal
circumstances without forcing a change in other
players’ strategies. Yet if only a few countries are still
willingly accumulating dollar reserves, then if just
one of them changes policy in favour of building up
gold reserves, the other players must take up the
remaining slack or the value of dollar reserves will
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fall. And each time another player does so, the
process accelerates non-linearly, as ever fewer players
accumulate a comparable amount of dollar reserves.
The last player in the game, of course, will be left
holding the entire bag of sharply devalued dollars. As
with many such games, while there is only a small
‘first-mover advantage’ in this game, there is a
disproportionately large ‘last-mover penalty’, hence
the fundamental instability of the equilibrium,
regardless of the number of players involved.
By corollary, as the move away from dollar to gold
reserves accelerates, so does the requirement that
future cross-border balance of payments are settled
not in depreciating dollars but in gold, as reserves
will be increasingly so comprised. This process can
and is occurring spontaneously as the system evolves
away from the essentially 100% dollar-centricity of
Bretton Woods, the legacy that explains why a purely
fiat dollar, rather than one backed by gold, has been
able to remain a reserve currency at all.
That said, it does appear that certain players in this
evolving game, in particular the BRICS, are
beginning to coordinate their strategies in ways that
might include certain pro-active initiatives in future.
Various bilateral currency arrangements are now in
place between the BRICS and also many of their
various trading partners, contributing to a reduced
role for the dollar. This process could easily
accelerate, especially if US monetary, economic or
foreign policies are perceived to impinge upon one
or more vital BRIC national interests. The recent
showdown over Syria is but one obvious case in
point. The process could also accelerate if it were
perceived that the US Fed remained unconcerned
about maintaining a stable dollar, as the recent flipflop regarding the so-called ‘taper’ could have done.
Notwithstanding the evidence above that the game is
changing, the economic academic and policy
mainstream in the developed economies, in
particular the US, nevertheless continues to embrace
the cognitively dissonant narrative that, while gold
may well be a superior store of value in a world with
excessive debts and need to rebalance and
deleverage, it has no business being remonetised,
internationally or otherwise. Back in November
2010, Robert Zoellick, President of the World Bank,
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Issue #34 ● 15 October 2013
let the golden genie out of the mainstream’s bottle
with the publication of an opinion piece in the
venerable Financial Times, in which he observed that
gold should henceforth “serve as an international
reference point of market expectations about
inflation, deflation and future currency values.” He
also noted that, “markets are using gold as an
alternative monetary asset today.”
At the time, considering of course the source, this
came across as something of a bombshell. “Why on
earth is the president of the World Bank talking
about gold?” many must have asked, scratching their
heads. Well, one must consider to whom Mr Zoellick
was speaking at the time. With the western banking
systems having stared into the abyss in 2008 and
early 2009, and with their economies having received
vital assistance via stimulus from the developing
economies, including from the BRICS, perhaps he
was acknowledging a certain pressure emanating
from those quarters, that is, that there were limits to
which the US dollar could be devalued without
triggering a BRIC Treasury buyers’ strike. Perhaps he
was also trying to control the terms of international
debate, to ‘ring-fence’ gold into a purely
nonmonetary role. This effort, however, will
ultimately fail. A look at what has happened recently
in India helps to illustrate why.
India is a country where gold has always been part
and parcel of the culture. Gold is wealth. Rupees are
nothing more than a medium of exchange. Among
Indians, it is considered complete nonsense to ‘save’
in rupees, and, thus, the rupee only has economic
meaning to the extent that it is the enforced legal
tender of the land, required for use in legal (and
taxable) exchange. This bifurcation between these
two roles of money is arguably greater in India than
in any other country in the world. It is thus
instructive to see how the Indian authorities are
responding to a surge in private demand for gold
alongside clear evidence that the economy is slowing,
government finances are deteriorating and the risks
of monetary debasement commensurately growing.
Among other measures to shore up a weakening
rupee, Indian economic officials recently imposed
large taxes on gold imports. Prior to their enactment,
there was a huge rush to import gold, accelerating
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the rupee’s slide. Now that the taxes are in place,
gold smuggling has apparently soared as Indians try
to avoid the tax, something that is seen by most as
illegitimate anyway. Moreover, Indian officials have
sought to learn more about the gold holdings at
various temples and belonging to various religious
groups and sects. These actions have not gone over
well, meeting with stiff public resistance. Arguably
they have backfired, fuelling a surge in distrust of the
government, which is not exactly held in particularly
high esteem by Indians in the good times, much less
when the economic going gets rough.
The toxic combination of slowing growth, a
dependence on imports and nervousness that the
government might seek to arrogate to itself greater
control of the country’s quasi-religious gold stocks
have all contributed to a sharp decline in the external
value of the rupee and a scramble for gold.
Gresham’s Law is playing itself out, as indeed it
always will do in such circumstances.
The plunging rupee recently resulted in the central
bank surprising the financial markets with a rise in
interest rates which, in short order, caused a sharp
decline in the stock market. Spooked by this
reaction, the central bank then reversed the hike and
explained that it stood by to maintain financial
market stability. Well, which is it then? Is the central
bank committed primarily to maintaining the stability
of the rupee, which has plunged in the gold terms in
which it is measured by Indians; or is it committed
to propping up the stock market, which no doubt
has imparted a large wealth effect on the Indian
economy in recent years, contributing, however
unsustainably, to growth? The uncertainty so created
is only going to contribute to an ever-greater
propensity for Indians to accumulate gold at the
expense of rupees, placing upward pressure on
interest rates.
Returning to our primary topic of international
monetary dynamics, what is playing out in India with
gold and the rupee today is but of microcosm of
what is happening in the world as a whole vis-à-vis
gold and the US dollar. The Fed has explicitly sought
to support the US economy with higher asset prices
in recent years. The dollar has been at times weak
and at times strong versus other currencies. With the
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Issue #34 ● 15 October 2013
Fed’s recent decision to extend Treasury purchases
indefinitely, the dollar has weakened yet again. As
with India, the uncertainty created by a Federal
Reserve that is demonstrably failing to deliver on its
promises to get the US economy on a sustainable
growth path is only going to increase the propensity
for international economic agents of all stripes to
accumulate gold at the expense of dollars, placing
upward pressure on interest rates.
As higher interest rates naturally threaten the Fed’s
goals and methods of supporting US economic
growth via asset price inflation, they are likely to be
resisted. Should Treasury yields continue to rise, the
Fed might well accelerate their rate of purchases
rather than scale them back. Trapped as they now
are in a vicious circle of their own making, it is
unknown just how many iterations of this process
will occur before the dollar reserve game collapses
entirely, to be replaced by a general remobilisation of
gold reserves to settle those international balance of
payments transactions. As with any iterative process,
at each stage certain global investors or other actors
will see the future endgame that little bit more clearly
and, in my opinion, each stage will be accompanied
by a renewed and quite possibly sudden rise in the
price of gold.
Eventually, the gold price will rise to a level
sufficient to allow existing gold stocks to settle
existing global trade imbalances. These imbalances
are huge; themselves a legacy of the dollar’s longheld reserve currency status. The gold price
sufficient to imply sufficient cover for these
imbalances is thus many multiples of where it is
today.
The cognitive dissonance of the mainstream
nevertheless continues. Professor Barry Eichengreen
has long predicted a weaker dollar as a necessary
requirement of a general global economic
rebalancing, yet he does not see any likelihood or
purpose of an international remonetisation of gold.
More recently, at a US gold mining and investment
conference, Walter Russell Mead, formerly the
Henry A. Kissinger Fellow for US foreign policy at
the esteemed Council on Foreign Relations, pointed
out that, “There are some very grim facts out there
about the dollar at home. There are also signs of
serious opposition to the dollar abroad.” He then
added that the outlook for gold was positive, because
“There will always be a desire by a significant
number of people to have that one kind of asset they
feel would hold its value against the worst of
catastrophes.” Yet although he acknowledged the
challenges faced by the dollar and the likelihood that
it will continue to decline in value, he nevertheless
concluded his remarks by observing that the dollar is
in no danger of losing its reserve currency status.
These comments, in effect, echo those of Mr
Zoellick from 2010. Notwithstanding the
accumulating evidence from China, Russia, India and
elsewhere that the game is changing rapidly, the
academic and economic policy mainstream refuses to
acknowledge that a “game” is being played at all.
Gold IS being de facto remonetised, because it is
simply not possible to artificially and sustainably
bifurcate money’s essential roles as both a store of
value and medium of exchange. One look at India
today illustrates the point; but stepping back and
looking at the bigger picture of the broad history of
international monetary relations does the same.
Superior money has, always and everywhere,
ultimately replaced inferior. And the verdict has
always and everywhere been the same: gold and
silver, or high-grade alloys thereof, provide the
superior money. Thus gold and perhaps silver will
provide the monetary foundation for the global
economic rebalancing and deleveraging that all agree
is both necessary and inevitable.
John Butler
John Butler is a founding partner and the CIO of Amphora, a
commodity-focused hedge fund. He has 19 years' experience in
the global financial industry, having worked for European and
US investment banks in London, New York and Germany. Prior
to founding his independent investment firm, he was Managing
Director and Head of the Index Strategies Group at Deutsche
Bank in London, where he was responsible for the development
and marketing of proprietary, systematic trading strategies. Prior
to joining DB in 2007, John was Managing Director and Head of
Interest Rate Strategy at Lehman Brothers in London, where he
and his team were voted #1 in the Institutional Investor research
survey. He is the author of The Golden Revolution (John Wiley and
Sons, 2012), and author and publisher of the popular Amphora
Report investment newsletter. His research has been cited in
the Financial Times, the Wall Street Journal and other major
financial publications, and he has appeared on CNN, CNBC,
ReutersTV, RT and BBC programmes.
The Gold Standard
Issue #34 ● 15 October 2013
An election, a banking symposium –
and a frightening parallel
The German general election, the main political
roadblock of the year 2013, has come and gone.
Many pressing problems have not been tackled
because no politician dared to touch them before the
elections.
A resounding victory for „Mutti“ – as the German
chancellor is called part lovingly and part disdainfully
– has turned into a very tricky situation. She has
conquered the socialists in a very convincing manner
but still finds herself in a cul-de-sac since all parties
remaining in the Bundestag have hurried to
announce they intend to sell their skins dearly.
The choice of coalition partner is a foregone
conclusion and the SPD will demand heavy
concessions for their cooperation.
The situation becomes ominous when looked at
from the currency point-of-view because all eurocritical parties have not made the mark. The
traditionally Europe-skeptical FDP has not been
elected to the Bundestag for the first time since the
Second World War and has missed clearing the 5 per
cent hurdle by only 0.3 per cent.
Equally close was the result for AfD (Alternative for
Germany). This party was founded on a euro-exit
ticket but has softened their goals of late to include
only mild alterations to the euro in their election
programme. They had to contend themselves with
4.8 per cent and have thus missed entering the
Bundestag.
Two euro-skeptical parties, both failed by a tiny
margin. A coincidence – or does it relate to last
summer’s new motion in Brussels, home of
uncounted hordes of bureaucrats, suggesting a future
ban of Europe-critical parties?
Yes, you have read correctly. The EU organization
did not shy away from using heavy-handed gestures
reminiscent of the Stalin regime. True to the motto
of anti-democrat Jean-Claude Juncker: first we try
some measures, and when the people do not resist
we continue. Should there be a public outcry, we
rescind the suggestion and after a two or three year
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wait we suggest the same in a slightly different form.
In any case, after the German elections there is NOT
ONE truly Brussels-sceptical party in power, but
several losers instead: on the one hand the euro/EUcritical parts of the population, who still believe in
the democratic achievements of the past, on the
other hand the seeming election winner Merkel, who
is being hounded by the leftist parties and will be
plucked like a goose in coalition talks. A Pyrrhic
victory, indeed!
But political variety and democracy also count
among the losers of this Sunday that is so eminently
important for Europe. The winners are the EU
organization and their political proponents that have
managed to shed a number of adversaries and need
no longer suffer any troublemakers in the parliament
of the European economic powerhouse.
Yet another frontier where the EU bureaucracy has
made headway is in banking. I had the chance to
witness the biggest Austrian banking symposium in
Alpbach/Tyrol. Here, too, one could observe an
unsettling scene.
This event has taken place for almost 30 years now
and is a popular meeting point for bankers and their
corporate customers. In various panel discussions
and seminars, participants could pick up valuable
knowledge.
For the last two years now, EU banks and their
regulations have gained more and more importance.
This year, bankers were being prepared for the fact
that in the future, SME (small and medium sized
enterprises) financing will be available almost
exclusively via the European Investment Bank and
other so-called promotional banks. It was obvious
that the EU wants to concentrate funding and
liquidity provision (the most essential banking
service) in their hands – with commercial banks
being reduced to sidekicks.
The current crisis (that has been going on for 5 years
now) helps these concentration attempts because
pesky commercial banks can be beaten about the
brow if not outright killed with cumbersome and
enormously expensive regulations as well as insane
equity requirements.
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Issue #34 ● 15 October 2013
Next to EU representatives there were still some
prominent bankers on the panel who duly criticized
the current and proposed rules and regulations in an
unusually candid manner. Many banks would fail to
jump the hurdle of these new regulations due to
excessive compliance costs, according to these
veteran bankers. These warnings sounded a bit like a
swan song.
Any politically interested person could only listen in
astonishment at how clearly and vehemently these
plans were presented to the attending bankers,
corporate CFOs and members of the press and at
the sheer pace with which the concentration of the
banking and money world unfolds in front of our
eyes.
Even a long-standing critic of the banking industry
has to acknowledge that the currently implemented
measures do not serve to protect the savings of the
small bank customer. Rather, the crisis is used by the
eurocrats to concentrate the banking business and
thus power in their own hands.
It does not take a clairvoyant to recognise: at the end
of this path lie banks controlled by eurocrats that
runs the entire show and rule over today’s banking
industry. Commercial banks will lose their
independence and become mere servants. The death
of (banking) variety, competition and hence the
citizen’s right to choose is preordained.
What happened this September in Europe was a real
eye opener. We remain hopeful that many people
will realize soon that this is the road to perdition,
that is, a dictatorship. All measures now being
announced and implemented serve to solidify the
power of the EU.
The fundamental principle of politics with the
people as principle and politicians as their agents has
been perverted and turned on its head. It remains to
be hoped that the people of Europe will soon put an
end to these disgraceful goings-on. Ideally by
questioning and maybe abolishing the main tool of
this new dictatorship: the euro!
Thomas Bachheimer
President – The Gold Standard Institute Europe
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Trust Your Neighbor; Tie Your
Camel
In my last article, I introduced the topic of trust
based credit… or how to make money without
money. In today’s G’man dominated world, only
fringe economic activities like street vending of
umbrellas escape the all-smothering regulatory
blanket. But imagine if the whole world economy
could run on ‘trust based credit’… and escape the
‘vampire squid’ actions of the Bankster and the
G’man… impossible you say? Just a pipe dream?
Well, the historic reality is that prior to the madness
of WWI… the ‘War to End All Wars’… the world
economy did indeed run on such a credit system,
with the reality check of ‘trust your neighbor but tie
your camel’ in full effect. So effective and efficient
was this system of credit, that world trade volume
seen before WWI was not matched till the nineteen
seventies; almost three quarters of a century later,
despite huge growth in population and wealth.
To fully understand the trust based credit system and
the enormous and deadly ramifications of its
destruction during WWI, we need to understand
how the principles employed by the street vendor
and umbrella wholesaler apply in the whole world
economy.
We all know what a bill is; a paper record of what we
purchase… in restaurants the bill is called a check, in
bars a tab… but the idea is always the same. We buy
some merchandise; a meal, an umbrella (in a retail
store) or a pint of brew, get presented with the bill or
check or tab, verify the bill… by confirming that
what it claims we bought is true… then we accept
the bill, and pay it.
The only difference between a retail bill and a
commercial bill is the term; retail bills are COD… to
be paid immediately. Commercial bills are almost
never COD, but give terms; time to pay. Terms are
like 30 days net, 60 days, 90 days etc. Thus, while a
retail bill is paid immediately, and is ‘retired’… i.e.
paid in full and only kept for bookkeeping
purposes… the commercial bill stays ‘open’ or in
effect until the due date, when it is paid... and only
then retired.
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Issue #34 ● 15 October 2013
A big trailer truck carrying 30,000 Liters of gasoline
backs up to the gas station, fills the underground
storage tank… and the driver heads to the gas
station office to complete the paperwork. Suppose
gasoline costs $1 per Liter... do you imagine the
station attendant will pay $30,000 in cash? Not likely!
Nor can the attendant write a check… he simply
signs (accepts) the bill or commercial invoice. The
invoice specifies that 30,000 L of gasoline have been
delivered, and that payment will be due in say 60
days from the signing date.
Until paid in full, this bill represents value; the value
of the 30,000 L of gasoline delivered, and the value
of the payment that will be made in not more than
60 days. The holder of the bill, the gasoline
wholesaler, may simply hold the bill till it is paid… in
his ‘accounts receivable’… or may use it to pay the
refinery that produced the gasoline. If he does this,
he will assign the bill to the refinery, so that when
the gasoline retailer makes payment, the payment will
be made to the refinery, not the wholesaler.
This is the crux of the commercial credit system;
goods are placed on consignment, a bill written and
accepted, and payment made as per the terms of the
contract… the bill. Notice credit is granted, goods
change hands, but there is no borrowing involved.
No borrowing, no interest charges, no collateral…
simply trust that the retail gas station will indeed sell
the gasoline delivered, and use the proceeds of retail
gas sales to pay the bill when due. The bill thus
created can circulate, that is clear credit... make
payments. Such a bill, one that circulates, is called a
Bill of Exchange.
Suppose the retail gas-bar makes a profit of 8% on
gasoline sales, and the prevailing interest rates are
4%... reasonable enough assumptions under normal
economic circumstances. The retail gas-bar owner
has three choices to fund inventory; use bank credit
i.e. borrow the funds; use his own capital; or work
with ‘trust based’ credit. Today, most retailers except
fringe operations like street vendors, and ‘vertical’
transactions within one industry like petroleum
products, have only the first two choices available to
them.
To make an 8% annualized profit, the gas bar owner
will make a 2% profit by re-selling the gasoline in
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ninety days; he then buys another batch of 30,000
L... makes another 2% profit in the next 90 days...
and repeats this four times a year. Four times 2% is
8%, the annualized profit. Now consider this; if the
interest rate is 4% per annum that translates to 1%
per quarter... the 90 day period that the 30,000 L
must be funded. Isn’t this incredible; net profit is
2%, and cost of interest is 1%... half the profits go to
pay the Bankster!
The second alternative is to fund the purchase with
cash, the retailer’s own capital; this plays up the ‘you
need money to make money’ rule spread by the
Bankster... and yes, if the retailer has the cash, he can
indeed fund the purchase... but then he falls prey to
opportunity costs. The cash invested in gasoline
inventory could have been invested in a bond that
pays 4% annual interest income; so, the retailer is
still hit.
With borrowed funds, he pays 1/2 his profit to the
Bankster. With cash payment, the retailer loses 1/3
of the profit he could have made using the third
option, trust based credit to fund the gasoline... and
investing his own capital in something else. If he
makes 8% on gas sales, and 4% on interest earned
on his capital, that is a 12% per annum income on
the $30,000; not bad at all, is it?
Now we start to see the benefit of ‘trust based
credit’... cost of doing business drops drastically.
Indeed, there are many enterprises... and job
opportunities... that remain ‘in potentia’; they never
materialize because the cost of doing business on a
cash or borrowed funds basis is too high. These
‘phantom’ enterprises actually did exist under Gold,
when all retail business not just the fringe ones took
advantage of trust based credit. This is one major
reason there was no structural unemployment under
the Classical Gold Standard.
But really, we have just scratched the surface of the
magical benefits of ‘trust based credit’, often called
the Bills of Exchange system... or the Real Bills
Doctrine of Adam Smith. The full vertical and
horizontal circulation of Bills, the international BiIl
market, the discount rate... these all depend on the
free circulation of Gold and Silver coin. Much
G’man and Bankster effort goes into suppressing
Gold and Silver money, in order to suppress the Bill
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Issue #34 ● 15 October 2013
market... and to keep the world economy hooked up
to the ‘vampire squid’.
have been the peak (it has subsided a little since
then).
Once the Fiat paper regime collapses and real money
makes its comeback, circulation of Real Bills will
again arise. Monetary debasement will be replaced by
constantly increasing purchasing power of money.
Structural unemployment and the dole will be
replaced by full employment. Financial speculation
will be replaced by real wealth generation.
Several readers asked me if I thought this was the
beginning of a new rising cycle, or if I thought this
was the End (of the dollar). As I expressed in Part
VI, the End will be driven by the withdrawal of the
gold bid on the dollar. Since early August, gold has
become more and more abundant in the market.3 I
think it is safe to say that this is not the end of the
dollar, just yet. The hyperinflationists’ stopped clock
will have to remain wrong a while longer. I said that
the rising rate was a correction.
I can hardly wait.
Rudy J. Fritsch
Editor in Chief
The Theory of Interest and Prices in
Practice
Medieval thinkers were tempted to believe that if you
throw a rock it flies straight until it runs out of force,
and then it falls straight down. Economists are
tempted to think of prices as a linear function of the
“money supply”, and interest rates to be based on
“inflation expectations”, which is to say expectations
of rising prices.
The medieval thinkers, and the economists are “not
even wrong”, to borrow a phrase often attributed to
physicist Wolfgang Pauli. Science has to begin by
going out to reality and observing what happens.
Anyone can see that in reality, these tempting
assumptions do not fit what occurs.
Over five months, I wrote about 12,000 words (half
the length of my dissertation1 not including
appendices!) presenting my theory of how interest
rates and prices actually operate in our paper
monetary system.2 I argued that the system has
positive feedback and resonance, and cannot be
understood in terms of a linear model. When I began
this series of papers, the rate of interest was still
falling to hit a new all-time low. Then on May
5,2013, it began to shoot up. It rose 83% over a
period of exactly four months. That may or may not
A Free Market in Goods, Services, and Money
The Theory of Interest and Prices in Paper Currency Part VI
(The End) contains links to the other five parts.
I am quite confident of this prediction, for all the
reasons I presented in the discussion of the falling
cycle in Part V. But let’s look at the question from a
different perspective, to see if we end up with the
same conclusion.
In the gold standard, the rate of interest is the spread
between the gold coin and the gold bond. If the rate
is higher, that is equivalent to saying that the spread
is wider. If the rate is lower, then this spread is
narrower.
A wider spread offers more incentive for people to
straddle it, an act that I define as arbitrage. Another
way of saying this is that a higher rate offers more
incentive for people to dishoard gold and lend it. If
the rate falls, which is the same as saying if the
spread narrows, then there is less incentive and
people will revert to hoarding to avoid the risks and
capital lock-up of lending. Savers who take the bid
on the interest rate (which is equivalent to taking the
ask on the bond) press the rate lower, which
compresses the spread.
It goes almost without saying, that the spread could
never be compressed to zero (by the way, this is true
for all arbitrage in all free markets). There are forces
tending to compress the spread, such as the desire to
earn interest by savers. But the lower the rate of
interest, the stronger the forces tending to widen the
spread become. These include entrepreneurial
demand for credit, and most importantly time
preference. There is no lending at zero interest and
nearly zero lending at near-zero interest.
1
2
3
See the Monetary Metals Supply and Demand Report
The Gold Standard
Issue #34 ● 15 October 2013
I emphasize that interest is a spread to put the focus
on a universal principle of free markets. As I stated
in my dissertation:
“All actions of all men in the markets are various
forms of arbitrage.”
Arbitrage compresses the spread that is being
straddled. It lifts up the price of the long leg, and
pushes down the price of the short leg. If one buys
eggs in the farm town, then the price of eggs there
will rise. If one sells eggs in the city center, then the
price there will fall.
In the gold standard, hoarding tends to lift the value
of the gold coin and depress the value of the bond.
Lending tends to depress the value of the coin and
lift the value of the bond. The value of gold itself is
the closest thing to constant in the market, so in
effect these two arbitrages move the value of the
bond. How is the value of the bond measured—
against what is it compared? Gold is the unit of
account, the numeraire.
The value of the bond can move much farther than
the value of gold. But in this context it is important
to be aware that gold is not fixed, like some kind of
intrinsic value. An analogy would be that if you jump
up, you push the Earth in the opposite direction. Its
mass is so heavy that in most contexts you can safely
ignore the fact that the Earth experiences an equal
but opposite force. But this is not the same thing as
saying the Earth is fixed in position in its orbit.
The regime of irredeemable money behaves quite
differently than the gold standard (notwithstanding
frivolous assertions by some economists that the
euro “works like” the gold standard). The interest
rate is still a spread. But what is it a spread between?
Does arbitrage act on this spread? Is there an
essential difference between this and the arbitrage in
gold?
Analogous to gold, the rate of interest in paper
currency is the spread between the dollar and the
bond. There are a number of differences from gold.
Most notably, there is little reason to hold the dollar
in preference to the government bond. Think about
that.
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In the gold standard, if you don’t like the risk or
interest of a bond, you can happily hold gold coins.
But in irredeemable paper currency, the dollar is
itself a credit instrument backed by said government
bond. The dollar is the liability side of the Fed’s
balance sheet, with the bond being the asset. Why
would anyone hold a zero-yield paper credit
instrument in preference to a non-zero-yield paper
credit instrument (except as speculation—see
below)? And that leads to the key identification.
The Fed is the arbitrager of this spread!
The Fed is buying bonds, which lifts up the value of
the bond and pushes down the interest rate. Against
these new assets, the Fed is issuing more dollars.
This tends to depress the value of the dollar. The
dollar has a lot of inertia, like gold. It has extremely
high stocks to flows, like gold. But unlike gold, the
dollar’s value does fall with its quantity (if not in the
way that the quantity theory of money predicts).
Whatever one might say about the marginal utility of
gold, the dollar’s marginal utility certainly falls.
The Fed is involved in another arbitrage with the
bond and the dollar. The Fed lends dollars to banks,
so that they can buy the government bond (and
other bonds). This lifts the value of the bond, just
like the Fed’s own bond purchases.
Astute readers will note that when the Fed lends to
banks to buy bonds, this is equivalent to stating that
banks borrow from the Fed to buy bonds. The
banks are borrowing short to lend long, also called
duration mismatch.
This is not precisely an arbitrage between the dollar
and the bond. It is an arbitrage between the shortterm lending and long-term bond market. It is the
spread between short- and long-term interest rates
that is compressed in this trade.
One difference between gold and paper is that, in
paper, there is a central planner who sets the shortterm rate by diktat. Since 2008, Fed policy has
pegged it to practically zero.
This makes for a lopsided “arbitrage”, which is not
really an arbitrage. One side is not free to move,
even the slight amount of a massive object. It is fixed
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Issue #34 ● 15 October 2013
by law, which is to say, force. The economy ought to
allow free movement of all prices, and now one
point is bolted down. All sorts of distortions will
occur around it as tension builds.
I put “arbitrage” in scare quotes because it is not
really arbitrage. The Fed uses force to hand money
to those cronies who have access to this privilege. It
is not arbitrage in the same way that a fence who
sells stolen goods is not a trader.
In any case, the rate on the short end of the yield
curve is fixed near zero today, while there is a pull on
the long bond closer to it. Is there any wonder that
the rate on the long bond has a propensity to fall?
monetary economists are to bellow from the
rooftops that this practice is destructive).
Today, duration mismatch is part of the official
means of executing the Fed’s monetary policy.
I have already covered how duration mismatch
misallocates the savers’ capital and when savers
eventually pull it back, the result is that the bank
fails. I want to focus here on another facet. Pseudoarbitrage between short and long bonds destabilizes
the yield curve.
Under the gold standard, borrowing short to lend
long is certainly not necessary.4 However, in our
paper system, it is an integral part of the system, by
its very design.
By its very nature, borrowing short to lend long is a
brittle business model. One is committed to a longterm investment, but this is at the mercy of the
short-term funding market. If short-term rates rise,
or if borrowing is temporarily not possible, then the
practitioner of this financial voodoo may be forced
to sell the long bond.
The government offers antiseptic terms for
egregious acts. For example, they use the pseudoacademic term “quantitative easing” to refer to the
dishonest practice of monetizing the debt. Similarly,
they use the dry euphemism “maturity
transformation” to refer to borrowing short to lend
long, i.e. duration mismatch. Perhaps the term
“transmogrification” would be more appropriate, as
this is nothing short of magic.
The original act of borrowing short to lend long
causes the interest rate on the long bond to fall. If
the Fed wants to tighten (not their policy post-2008!)
and forces the short-term rate higher, then players of
the duration mismatch game may get caught off
guard. They may be reluctant to sell their long bonds
at a loss, and hold on for a while. Or for any number
of other proximate causes, the yield curve can
become inverted.
The saver is the owner of the money being lent out.
It is his preference that the bank must respect, and it
is for his benefit that the bank lends. When the saver
says he may want his money back on demand, and
the bank presumes to lend it for 30 years, the bank is
not “transforming” anything except its fiduciary
duty, its integrity, and its own soundness. Depositors
would not entrust their savings to such reckless
banks, without the soporific of deposit insurance to
protect them from the consequences.
Side note: an inverted yield curve is widely
considered a harbinger of recession. The simple
explanation is that the marginal source of credit in
the economy is suddenly more expensive. This
causes investment in everything to slow.
Under the gold standard, this irrational practice
would exist on the fringe on the line between what is
legal and what is not (except for the yield curve
specialist, a topic I will treat in another paper), a getrich-quick scheme—if it existed at all (our jobs as
I argue that it always fails in the end in Duration Mismatch
Always Fails
At times there is selling of the short bond, at times
aggressive buying. Sometimes there is a steady
buying ramp of the long bond. Sometimes there is a
slow selling slide that turns into an avalanche. The
yield curve moves and changes shape. As with the
rate of interest, the economy does best when the
curve is stable. Sudden balance sheet stress, selloffs,
and volatility may benefit the speculators of the
world5, but of course, it can only hurt productive
businesses that are financing factories, farms, mines,
and hotels with credit.
4
5
Theory of Interest and Prices, Part III
The Gold Standard
Issue #34 ● 15 October 2013
Earlier, I referred to the only reason why someone
would choose to own the Fed’s liability—the
dollar—in preference to its asset. Unlike with gold,
hoarding paper dollar bills serves no real purpose
and incurs needless risk of loss by theft. The holder
of dollars is no safer. He avoids no credit risk; he is
exposed to the same risk as is the bondholder is
exposed. The sole reason to prefer the dollar is
speculation.
As I described in Theory of Interest and Prices in
Paper Currency, the Fed destabilizes the rate of
interest by its very existence, its very nature, and its
purpose. Per the above discussion, the Fed and the
speculators induce volatility in the yield curve, which
can easily feed back into volatility in the underlying
rate of interest.
The reason to sell the bond is to avoid losses if
interest rates will rise. Speculators seek to front-run
the Fed, duration mismatchers, and other
speculators. If the Fed will “taper” its purchase of
bonds, then that might lead to higher interest rates.
Or at least, it might make other speculators sell.
Every speculator wants to sell first.
Consider the case of large banks borrowing short to
lend long. Let’s say that you have some information
that their short-term funding is either going to
become much harder to obtain, or at least
significantly more expensive. What do you do?
You sell the bond. You, and many other speculators.
Everyone sells the bond.
Or, what if you have information that you think will
cause other speculators to sell bonds? It may not
even be a legitimate factor, either because the rumor
is untrue (e.g. “the world is selling Treasury bonds”)
or because there is no valid economic reason to sell
bonds based on it.
You sell the bond before they do, or you all try to
sell first.
I have been documenting numerous cases in the gold
market where traders use leverage to buy gold
futures based on an announcement or nonannouncement by the Fed. These moves reverse
themselves quickly. But no one, especially if they are
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using leverage, wants to be on the wrong side of a
$50 move in gold. You sell ahead of the crowd, and
you buy ahead of the crowd. And they try to do it to
you.
I think it is likely that one of these phenomena, or
something similar, has driven the rate on the 10-year
Treasury up by 80%.
I would like to leave you with one take-away from
this paper and one from my series on the theory of
interest and prices. In this paper, I want everyone to
think about the difference between the following
two statements:
1. The dollar is falling in value
2. The rate of interest in dollars must rise
It is tempting to assume that they are equivalent, but
the rate of interest is purely internal to the “closed
loop” dollar system. Unlike a free market, it does not
operate under the forces of arbitrage. It operates by
government diktats, and hordes of speculators feed
on the spoils that fall like rotten food to the floor.
From my entire series, I would like the reader to
check and challenge the sacred-cow premises of
macroeconomics, the aggregates, the assumptions,
the equations, and above all else, the linear thinking.
I encourage you to think about what incentives are
offered under each scenario to the market
participants. No one even knows the true value of
the monetary aggregate and there is endless debate
even among economists. The shopkeeper, miner,
farmer, warehouseman, manufacturer, or banker is
not impelled to act based on such abstractions.
They react to the incentives of profit and loss. Even
the consumer reacts to prices being lower in one
particular store, or apples being cheaper than pears.
If you can think through how a particular market
event or change in government policy will remove
old incentives and offer new incentives, then you can
understand the likely first-order effects in the
market. Of course each of these effects changes still
other incentives.
It is not easy, but this is the approach that makes
economics a proper science.
The Gold Standard
Issue #34 ● 15 October 2013
P.S. As I do my final edits on this paper (October 4, 2013),
there is a selloff in short US T-Bills, leading to an inversion
at the short end of the yield curve. This is due, of course, to the
possible effect of the partial government shutdown. The
government is not going to default. If this danger were real,
then there would be much greater turmoil in every market (and
much more buying of gold as the only way to avoid catastrophic
losses). The selloff has two drivers. First, some holders of TBills need the cash on the maturity date. They would prefer to
liquidate now and hold “cash” rather than incur the risk that
they will not be paid on the maturity date. Second, of course
speculators want to front-run this trade. I put “cash” in scare
quotes because dollars in a bank account are the bank’s
liability. The bank will not be able to honor this liability if its
asset—the US Treasury bond—defaults. The “cash” will be
worthless in the very scenario that bond sellers are hoping to
avoid by their very sales. When the scare and the shutdown
end, then the 30-day T-Bill will snap back to its typical rate
near zero. Some clever speculators will make a killing on this
move.
Dr. Keith Weiner
Dr. Keith Weiner is the president of the Gold Standard Institute USA,
and CEO of Monetary Metals where he write on the basis and related
topics. Keith is a leading authority in the areas of gold, money, and credit
and has made important contributions to the development of trading
techniques founded upon the analysis of bid-ask spreads. Keith is a sought
after speaker and regularly writes on economics. He is an Objectivist, and
has his PhD from the New Austrian School of Economics. He lives with
his wife near Phoenix, Arizona.
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