Sunday, May 19, 2013
When the world ain't treatin' you good, you got to hold on…
When everybody's lookin' at you funny, you got to hold on…
You got to hold on…
"Hold On" by Alabama Shakes
When everybody's lookin' at you funny, you got to hold on…
You got to hold on…
"Hold On" by Alabama Shakes
I want to discuss one more concept, the concept of strong hands going into Freegold.
Each time the price swings up and down like this the "gold" traders trade their way in and out of their favorite paper gold positions. But the physical side is slowly working its way into stronger and stronger hands with each swing. Strong hands buy the dips while weak hands are selling in a panic.
This could potentially be the final shakeout of weak physical hands, because there will be plenty of strong hands catching that physical even though physical buying won't stop the price from falling. Unfortunately for a few long-time gold bugs, the lack of a fundamental and foundational understanding of a much higher value could see them liquidating at the worst possible time in all of history. And that would truly be a shame. At least I have given fair warning. I'm not predicting that this is the way it will play out. Only that it could. And being aware of this possibility has value if it gives you strong hands at a key point in time. 
That's an excerpt from an old post, about a year and a half ago, after gold had fallen about $250 during the preceding four months. Today it has fallen about $325 in four months. My perspective reveals that the "price" of gold may fall quite low just prior to a very quick revaluation upward. But that is just the temporary price that's falling, not the true value of physical gold.
All of my savings are in physical gold coins and bars, and yet I have been anticipating an eventual price plunge to some really low number at least since my post The Shoeshine Boy back in 2010. And now, ever since this past December, I have been discussing the possibility of a plunge in the price of gold this year, with more frequency than in previous years, and how it fits within my view. I even dubbed 2013 "The Year of the Window" on New Year's Day, referring to the possibility that this is the year it happens. So why would I keep all of my savings in physical gold at the same time as I expected an eventual collapse in the price of gold? Interesting question, isn't it? Here's how I illustrated my view in that 2010 post:
I'm not trying to scare anyone, quite the opposite actually. I want to help people have the same strong hands and peace of mind that I have, even if the price of gold continues downward. And those things come from understanding a well-reasoned scenario that looks a lot like what has been happening so far this year. I don't want anyone to take my advice. I only want you to understand the scenario and make up your own mind.
Another question you might be asking is why wouldn't I wait for the lowest price and buy my gold then? That's a great question, and yes, the answer is here in my blog somewhere. ;D You know, a funny thing has been happening lately. It's quite an unusual phenomenon if I do say so myself. While gold bugs far and wide are either panicking or throwing in the towel right now (some forums have even been closed), the "evil gold hoarders, jerks, time misallocators and brainwashed cult members"  here are all cheering as the price goes down. Isn't that weird?
Anyway, I was wondering why I haven't seen more curiosity about why these strange PGAs (physical gold advocates) would be cheering for a gold price decline. Perhaps no one has actually seen this phenomenon in action, so I thought that maybe if I put some of it here, front and center in a post, a few of the panicking gold bugs might take notice and ask WTF?
So here's just a sampling of what some of my followers on Twitter have been saying since the gold price really started tumbling on April 15th:
@jimc3 @burningfiat @darenpa72 We must be the weirdest type of supporters. We cheer every time the price declines. xD
— Motley Fool (@Am_a_Fool) May 14, 2013
Those freegolders are feeling good when the price goes down #gold #transition #speed #stress #system !GLD #euro
— Freegolds (@freegolds) April 18, 2013
@am_a_fool @jimc3 @darenpa72 Yes, it must look pretty bipolar for outsiders, hehe... #Freegolders #HopesGoldPriceCrashes
— burningfiat (@burningfiat) May 14, 2013
@jimc3 Why, hellooooo sexy! Looks like I might get my wish! #InterestPiquedAgain
— Max De Niro (@maxdeniroPGA) April 15, 2013
@jimc3 Hm back from lunch. $1375? Doesn't everyone know this stuff is worthless by now? #disappointed
— Jim (@jimc3) April 15, 2013
@5kofx Silver typically has more downside leverage than gold. Plus I'm selling silver and accumulating more gold. Lower price? Bring it
— Kay Ling (@polly_metallic) May 16, 2013
@freegolds Not cheap enough!#Grumble #Grumble
— Aquilus (@Aquilus_sum) April 8, 2013
— Jim (@jimc3) April 22, 2013
@burningfiat Resistance appears solid at 1440. Let's hope it breaks down further this week and goes splat. @darenpa72
— Jim (@jimc3) May 14, 2013
Oh boy, gold is dropping like a rock... What to do what to do #nothing
— Freegolds (@freegolds) April 12, 2013
@matrixsentry That would be pretty hard to believe. Funny, I see perfect sense in a weak gold price, and it is extremely bullish for GOLD.
— Matrixsentry (@matrixsentry) April 9, 2013
As the price of gold drops, physical gold is transferred from weak hands to strong hands.
— Nickelsaver (@Nickelsaver) April 17, 2013
Remember, a falling price speeds up the transition #gold #euro
— Freegolds (@freegolds) April 23, 2013
Nervous about the price of gold? You wouldn’t be if you’d learned how to walk in the footsteps of Giants: youtu.be/EYIWebkeFMg
— RonaldJamesPadavona (@RJPadavona) April 15, 2013
@darenpa72 Zero, zero, zero, zero!
— Aquilus (@Aquilus_sum) April 12, 2013
If you want more gold..what do you want..cheaper gold off course #Asians #ME
— Freegolds (@freegolds) April 17, 2013
Dear gods of gold, some fiat is coming my way. Can you get me a better price still ? Thank you.
— Freegolds (@freegolds) April 5, 2013
Yay not ouch RT @matthewphillips: Down goes gold! Ouch. $GLD #GoldMore here: qz.com/72981/gold-is-… twitter.com/MatthewPhillip…
— Aquilus (@Aquilus_sum) April 10, 2013
@alderlaneeggs i will sleep like a baby
— Freegolds (@freegolds) April 12, 2013
There's something else that a few of my Twitter followers have been watching in addition to the declining price of gold. And that's the declining inventory in GLD. They even have a contest each day to guess how many tonnes will be leaving that day! GLD has lost 315 tonnes or 23% of its inventory since mid-December. I think this is symptomatic of the physical reserves of the LBMA leaving the system, either through allocation or delivery. You can read more about why I think that in this post.
Burning Fiat even wrote a "GLDpuker app" for his Twitter account which automatically detects and then tweets the daily decline (or increase) about 10 seconds after the SPDR spreadsheet updates on their website. Strangely, after he launched the app, organizations like Sprott Global and Fitch Rating agency followed him on Twitter. Here's how it looks:
|GLDpuker app| #GLD change today (16-May-2013): -5.71t (-0.55%), inventory now: 1041.42t— burningfiat (@burningfiat) May 16, 2013
ByiamBYoung sent me a donation last week, and somehow he fit quite a long message into the Paypal message box:
Hi FOFOA, A long time since I promised to contribute, but finally I can throw in a donation. I hope many in the hive are doing the same! Great new post. It seems that the winds of change are blowing more erratically every day lately. The hereafter may not be so far off... Maybe Mrs FOFOA could write a guest post, for all of those hand-wringing spouses out there? I know someone I would forward that link to ;) Cheers, byiamBYoung
I forwarded it to Mrs. FOFOA as I do with all donations, and here's what she came back with:
Ha - me write a guest post? It would be simple...
The time has finally come. Be at peace with the plummet because the pot is about to explode at the other end of the rainbow!!! Enjoy the ride - I know I am :)
Now I must tell you that Mrs. FOFOA is just as bad at timing as me, so please take her pronouncement with more than just a grain of salt. You'll never hear me say this is it, it is now. All I can offer are possibilities and probabilities along with reasoned scenarios. You know where I have all of my savings, you know that I'm not worried about the price of gold, and if you follow this blog, you know why.
I don't care what the price of gold does tomorrow. It can go up, or it can go down. I don't know if this is it. I don't know if this year is the year. "Window" means opportunity, possibility and probability, and it is backed up with a well-articulated and well-reasoned theory. If you disagree, that's fine with me.
All I can tell you is what I think "it" will look like. And as I said, I've thought it would look a little like this since at least 2010. So in my mind that raises the probability at present. And that's why I don't like the idea of long-time gold bugs selling off their physical gold right now without at least considering this perspective for balance.
This post isn't meant to give you my full perspective, or even links to the appropriate posts, like The Two-Legged Dog, Legs or Checkmate. I only hope to catch your attention. And then, if you have questions about my view, I'm sure that a few of the regulars, maybe even some of the twits featured above, will be more than happy to either answer them in the comments or direct you to the appropriate posts or comments.
And be sure to check out the song below. It's a recommendation from JR that was meant to inspire a post. Indeed it worked! JR has a good track record with songs like Wake Up, Bankrupt on Selling and How It Ends, so I always pay attention to his music recommendations. I just hope this quick and dirty post lives up to his expectations. JR's email was titled "Alabama Shakes got 'Strong Hands'".
 Excerpt from The Gold Must Flow
 "Evil gold hoarders, jerks, time misallocators and brainwashed cult members" is the affectionate title I came up with for my followers. It is based on just a few of the insulting names we have been called over the years. Scroll down to the very bottom of the blog if you'd like to join the cult. ;D
2013 Grammy nominated for Best New Artist & Best Rock Performance
"Hold On" by Alabama Shakes:
Wednesday, May 15, 2013
In this, my 400th post, I will peer into the future, to the Freegold revaluation and beyond. But I do not have an actual crystal ball. All I have is logic and reason, and a little help from Another and FOA. So to quote FOA, "If you came with a notion that I am someone who sees the future, grab the children and run far away." But if you came bearing your own logic and reason, then perhaps you will find this post useful. :D
I will touch on a few topics that have been the subject of recent discussions, both here and elsewhere. The first topic is gold mining shares. I will explain why I do not own any. It is really simple logic, but I think that I would be doing a disservice if I did not make it perfectly clear right now. Anyone considering Freegold should at least be aware of this reasoning, whether they accept it or not.
Next I will discuss the difference between gold-denominated lending and the use of gold as physical collateral for currency loans following the Freegold revaluation. And, finally, we'll delve into the deep topic of gold's true function in the new Freegold paradigm. If Freegold frees gold so that it can function properly, what does that actually mean? This has been a topic of debate for a few months now, and I'll attempt to put that debate to rest.
But before we get started, let's take a moment to enjoy this Leonard Cohen video called "The Future" from my first Glimpsing the Hereafter post 15 months ago:
Mining Shares and the Freegold Revaluation
This is a touchy subject for those who are already deeply invested in gold mining. Indeed, mining shares had a great run in the 1970s. And gold mining is a big topic, but for today's Freegold investor there's one question that precludes everything else. Given the presumption of Freegold, are even the best mining shares a viable and comparable alternative to physical gold? If gold is revalued in real terms, as Freegold presumes, then the new value will be many multiples of the cost to pull new gold out of the ground. This is simple logic.
Therefore, if the value of gold is to become many multiples of the cost to pull it out of the ground, then this would constitute a windfall profit for gold miners. Whereas everyone else in the world would have to expend, say, $55K worth of resources to obtain an ounce of gold, a gold miner would only have to expend ~$1,200. On the surface, this makes gold miners seem like a good investment today, especially if you're expecting the revaluation of physical gold.
But here's the catch. I have written about what I call the moment of "peak risk" which is the moment of revaluation. The biggest risk in Freegold is that someone else will take or simply keep the windfall profit that you thought was yours. In my opinion, the best way to avoid someone else taking or keeping it is to possess your own gold.
In every case where someone else is holding your gold for you, there is some amount of risk. Here's a purely hypothetical example just to illustrate my point. Imagine you have a custodian holding your numbered bars when the revaluation occurs, but then he reports to you the very next day that your bars are missing from the vault. They must have been stolen!
The problem is that the LBMA is now closed indefinitely and the COMEX is frozen, and the last-known price was $1,400 per ounce. You know that your gold will soon be worth $55K per ounce, but your custodian has put in the insurance claim at $1,400 per ounce and is already in the process of sending you a check. It's a sticky situation, because now you're going to have to sue your custodian in court. But the bigger problem is that it wasn't just your gold that was stolen, it was all of the gold he was holding. His insurance is capped at the limit which is linked to the last London fix, and there's no way he'll be able to cover everyone's windfall profit, even with a total liquidation. He is judgment proof. The most likely outcome is that he'll file for bankruptcy and eventually disappear to a private island somewhere.
The point of this hypothetical is that, in the eyes of the law, all of the investors were made whole insofar as they recovered their initial investment. All that was lost was their expected windfall profit from the Freegold revaluation. That windfall was taken from them by someone else, and without the recovery of the underlying physical, there was no other way to recover that value.
Let me be clear. This is only an extreme hypothetical example and not a prediction. I certainly hope nothing like that happens. But the point is simply that the biggest risk in a revaluation is that someone else will have the opportunity to take—or simply keep—your expected gain. And the bigger point of this exercise is that *gold in the ground* is possibly the most at-risk gold in terms of someone else keeping the one-time windfall profit. The logic is simple enough that you should be able to decide for yourself if it is worth the risk. I'm not trying to tell you what to do, I'm only explaining the logic so that you can decide for yourself.
The government, which is the representative of the collective population, what I like to call the hungry collective, has a claim on that windfall that trumps even the miner's claim.
The miner has a claim on the ground, a claim recognized by the country. But the country owns the gold in the ground in extremis. The miner is licensed or permitted to dig it up. That permit comes from the country, from the government.
Another and FOA explained this point and, again, it's just simple logic. And the logic is this:
If the hungry collective has a claim on the windfall profit, a claim that is senior to the miner's claim, will they use it or not?
If not, then why not? Because they didn't know they could? And if they do claim the windfall, then how would they go about it? Here's how Another put it:
Date: Sun Apr 19 1998 15:09
ANOTHER (THOUGHTS!) ID#60253:
The world debt system and currency exchange, as we have known it, will implode and leave little room for political maneuvering. The governments will revalue gold and "demand" that the public carry it and use it! It will be the source of all gold, the mines, that will be controlled! That's Controlled, with a capital "C", not confiscated!
Here's how I put it back in 2011:
I can see that you like owning a fractional interest in a corporation licensed to dig up a country's gold! But what we are talking about here is maybe a 30x revaluation of gold against all other commodities as well as against the cost of mining. This will happen as a functional change for gold, a global shift away from its present treatment as just another commodity.
When that happens the mines will be treated in one of three ways: 1. They will be nationalized as gold in the ground will suddenly be viewed as national reserves (unlikely). 2. They will be forced to sell all production to the government at a low "commoditized" price (less likely). 3. They will be able to sell to the public at market prices but will have to pay a windfall profits tax and deal with many restrictions (most likely). In other words, the windfall profit of a 30x revaluation will not be passed on to those holding a government license to dig up gold that is still in the ground, a profit that can thereby be claimed by the hungry collective.
As a commodity, with the price of gold only slightly higher than the cost to mine it, governments grant license to the mining companies to dig it out as with all economic minerals. But when the value of that natural resource is suddenly worth 30 to 40 times the cost of mining, that government license will suddenly become very expensive.
When that Sunday evening announcement finally comes, that the banking system will be on holiday starting Monday morning, you want to be sitting on gold that has already been pulled out of the jurisdiction governed by the classification of gold as a simple economic mineral or commodity. FOA may be right that there will come a day on the other side of the punctuation when gold mining will be very profitable. But between now and then, few investors will be able to stomach the ride down to zero.
And here's what FOA wrote about mining shares back in 2000 and 2001:
FOA (1/6/2001; 9:49:51MD - usagold.com msg#52)
Gold production, everywhere will eventually be extremely controlled with citizens reporting unofficial mining in much the same way as people report each other to the IRS. But, make no mistake, miners and citizens will all benefit. All mines, both big and tiny will make huge profits on the limited production allowed because the price will be so high. ($30,000+ in dollars (big smile) But, the road between here and there will more than likely price mine owners close to zero, first.
FOA (05/14/00; 20:39:25MT - usagold.com msg#22)
There will be some huge profits to be made by holding certain mine stocks. But, almost all of them will go close to zero first. I doubt many investors could hold their current percentage through this price action. Physical gold will find a new market and soar in that medium of trade. In the face of this, few if any stockholders will hold their falling mining shares while watching gold soar. Yes, some will (like me) hold through thick and thin because they have a right percentage of (the best) mine shares to bullion. But, many, many others will pressure the market as they attempt to adjust to (our) level of holdings.
FOA (8/2/01; 12:52:55MT - usagold.com msg#87)
An investment in the gold industry, not just mining, can be nothing more than an investment in a business that balances fiat production cost against fiat market prices for its product; gold. The return, if any, is always in fiat and places this portion of one's wealth smack on the tracks of more political manipulation. Today, we can see this play out all over the world as fiat returns in the gold business head towards and even sink below zero. The investor watches this fiat illusion of his net worth drain away while the opportunity to build a real wealth of "bullion ownership" escapes yet again.
FOA (10/23/01; 10:30:12MT - usagold.com msg#123)
Truly, if ever there was a way to profit from gold mining, today, it's by buying this almost free physical gold the mines are producing; while mine players and paper gamblers pound their wealth into the dirt. This is what PGAs [Physical Gold Advocates] call benefiting from the leverage in mining (smile).
Here are the questions that you should answer for yourself, now that I have explained why I don't hold mining shares, and also based on your personal understanding of Freegold. The issue isn't, "Will mine shares go up or down?" The issues are, "As compared to physical gold, are mines worth the risk?" and "Do mines offer any diversification value in addition to holding physical gold?" and "Are you prepared if mines go to zero for a time?" and "Can you pick the mines that will survive?"
Lastly, here's a wonderful video tribute to the tireless gold miners and their priceless product, by Freegoldtube. It is true that you can't really eat, wear or seek shelter in gold. We don't need it to breathe, and it's not very fun on the water. But once you come to understand gold's true function, you'll see that it is an irreplaceable, invaluable, truly priceless and almost incomprehensibly vital component in the human Superorganism's effort to survive and thrive. So God bless the miners, even if they don't get to keep the revaluation windfall on the gold that's still in the ground at the moment of revaluation:
Gold lending and collateral use in Freegold
On the subject of gold lending versus the use of gold as collateral for a fiat loan in Freegold, here are some thoughts.
This topic has been a source of discussion, debate and confusion for a long time. Does there need to be a law passed to prevent the reemergence of paper gold? No, I don't think so. I don't think Freegold requires any changes in the law, international or otherwise, but that doesn't mean there won't be some new laws. It only means they aren't a necessary prerequisite.
Gold lending and gold used as collateral are two totally separate issues. I have no problem with gold being used as collateral for fiat-denominated loans in Freegold, my only problem is with lending (credit/debt) denominated in gold ounces. But I also don't think there will need to be a law to prevent it for the simple reason that it won't be a profitable activity. The reason there may be a law passed is to simply preempt the reemergence of fractional reserve bullion banking somewhere down the road, and that would be more than enough of a motive for someone like the Eurozone to pass a simple law that otherwise didn't need to be passed. FOA never pushed this subject, he only explored it when others pushed for "but, but, what if…" answers.
One of the common arguments I hear is that people will still want to lend their gold. I disagree.
Where does the silly notion of gold lending even come from? Well, pre-1971 gold was money to one extent or another. Money is credit/debt which means that debts were more or less denominated in gold ounces, off and on, from 1971 going back to cavemen. So when money was gold, people lent gold, even if they didn't have physical gold to lend. They simply extended credit to credible people and the repayment was denominated in gold ounces, even if it was paid back in other ways. That's gold lending. Freegold is different because gold isn't money.
Around 1983-1985 was the birth of modern gold lending, via the European CBs actively encouraging and supporting the expansion of a new paper gold market meant to buy the time necessary to launch the euro. What we think of as gold lending today didn't really exist before the 80s for all intents and purposes. (You can read more about what changed in the 80s in Checkmate, and don't miss the great Freegoldtube video that sums it up at the bottom of the post!)
The fact of the matter is that, unless gold is money, there is no good reason other than price suppression for gold lending. There's no profit motive to lend gold when its price is falling, and there's no profit motive to borrow gold when its price is rising. So to bring both counterparties together, lender and borrower, one of them must be motivated by something other than profit. In the 80s and 90s, the lenders were CBs and the borrowers were mines and hedge funds. This is the crux of what Another explained. In Freegold, gold won't be falling in price so who'd want to borrow it, and the CBs won't have a reason to lend at a loss.
I can't think of one good reason why anyone would lend gold in Freegold, be it the lending of actual physical gold or simply lending dollars but denominating the repayment in gold ounces.
Let's think about one instance in which it might make sense to actually borrow physical gold, which is if you were a gold fabricator. You work with a very expensive medium to turn a profit that is tiny compared to the price of the raw material, so it would make sense to borrow your working stock. But would it make sense to the lender?
Your output is the sale of a finished product and your income is in dollars, so why would you need to borrow in ounce-denominated units? Why not borrow the cash to buy your working stock? Even if I'm the one providing you with raw gold, why would I lend you the gold? Why not extend you the credit to buy my gold and you pay me back in dollars after you have added value and sold the finished product to someone else? I'm not giving you gold to have you return it to me in a different form. I'm selling you gold to make a currency profit from the interest on the currency loan which you easily cover by adding value to the gold.
Can you think of a good reason why someone would lend gold in Freegold? And if there's no good reason why anyone would do it, then there's no pressing urgency for a law prohibiting it.
It is the existence of credit denominated in gold ounces that automatically suppresses the price of gold. Using gold as collateral for a loan denominated in fiat currency does not. The conflation of these two totally separate issues and the confusion it causes arises from FOA's explanation of how easy it would be to prohibit the denomination of credit in gold.
It's quite simple. It's about enforcing the seizure of, foreclosure on, or liquidation of attached collateral in the case of default on a loan. The courts will only enforce foreclosure on attached collateral in the case of default on a standard fiat loan. If the loan is denominated in anything other than fiat currency, like tractors, Renoirs or gold ounces, then it will be a non-standard loan and the most the courts will do is to issue a default judgment denominated in fiat which might be impossible to collect.
Like this. Say you want to borrow my car for a week. I say sure, but I'm going to need the deed to your house as collateral. So you give me the deed and we write up a basic loan contract where you borrowed 1 car and you owe me 1 car. Then let's say you lose the car, or crash it, or you simply sell it and ignore my phone calls; a blatant default on our contract. So I go to the court with the contract and demand to foreclose on your house since you defaulted on the 1 car loan. Absurd, I know. What's the court going to do? If the court doesn't tell me to get lost, at most it will issue me a fiat judgment in an amount equal to the value of the car, but it will not enforce the attached collateral of your house, not because the house is worth more than the car, but because it was a non-standard loan.
Remember, I don't really care if gold is used as collateral. The only thing I care about is the numéraire for repayment on the loan document. You can use any numéraire you want, but if it's not fiat currency, then the courts won't enforce the attachment of collateral.
In most gold lending, no physical gold is actually lent. It is simply a loan denominated in gold ounces and then converted to dollars at the current exchange rate so that it can be spent. If actual physical gold is lent, then it must be sold first before it can be spent.
Like this. Imagine you wanted a car loan and I said I would lend you a tractor so that you can buy a car. We draw up a contract, and your new car is going to be my collateral. I lend you 1 tractor and you owe me 1 tractor. And I will hold the pink slip on your new car as collateral against your repayment of 1 tractor. But you can't take my tractor down to the Chevy dealer and buy a new car with it. You have to sell the tractor first to get fiat currency and then you can go buy the car. And then, to pay me back one tractor, you'd have to buy it back or buy another one just like it. This is a non-standard loan. It is absurd on the face of it. And the same principle will apply to gold loans.
Why would I lend you gold when you're just going to have to sell it to buy whatever you want to buy? Why wouldn't I just sell the gold and lend you the fiat currency, that way I could attach your purchase as collateral in case you fail to pay. If I lend you the gold and make you go sell it and the loan is, therefore, denominated in gold ounces, then I'd better hope you don't default because the courts won't enforce the collateral attachment.
So it's not my fear of not being able to recover the lent gold that keeps me from lending it, it's my fear of not being able to enforce foreclosure on your property if you default on the loan.
Gold used as collateral for fiat loans is a totally different subject from credit denominated in gold ounces. I have no problem with gold used as collateral. But if I am a lender, I'll probably want to hold that collateral so it doesn't get lost in a boating accident. A house is easy collateral. You can't lose a house in a boating accident. A car is a little trickier because I have to hire a repo man to chase you down. Do they even have gold repo men? ;D
Here's how gold might be used as collateral in Freegold. Imagine I am a giant with 1 tonne of physical stored at my bank. I'm also a businessman and I regularly draw on my credit line at the bank. As long as I have no need to sell my gold anytime soon, I will allow the bank to attach my property as collateral to my credit line which will translate into a lower interest rate for me than I would have otherwise paid. This is not paper gold. It is not financial collateral. It's the same as a house, a car, a tractor or a Renoir being used as physical collateral for a fiat currency loan. If I died with an unsettled credit balance, the bank would have the right to sell some of my gold to settle the balance before turning the rest over to my estate. This reduces the bank's risk which is why I get a discounted rate of interest.
Gold's True Function
The debate I mentioned at the top began with this comment from Blondie last November. The question it raised is this: Will gold be the focal point store of value for savers as A/FOA and this blog have proposed, or will currency finally fulfill this role once gold has been revalued and is free to function properly? Because if "functioning gold" means gold will have to fluctuate wildly, including short term declines in purchasing power in order to transmit price signals and moderate the imbalance cycle, then it will make a poor medium of savings.
This section is my answer to the debate.
What if gold never declined in price again after revaluation? What if it only rose (in real terms, of course)? If that were true, then gold would indeed be the focal point for savers, would it not? If it never performed worse than base money in real purchasing power and, in fact, gained purchasing power more or less over any timeframe, then gold would be the medium for savings in Freegold. Can we at least agree on this hypothetical statement?
Okay, good! Now I will make two arguments that will, if not put this debate to rest, at least establish a new front for the other side to attack. Remember that we are discussing the future on the other side of a singularity called the Freegold revaluation, so keep in mind that the following glimpses are based mostly on common sense and reason, with a little help from A/FOA. And then each of you can decide for yourself whether I have settled the debate here, or whether you wish to follow Blondie and Victor down a slightly different trail, one which Poopyjim humorously dubbed "Freefiat".
Poopyjim wanted to mock what I wrote and said:
"I say we start calling it "freefiat" because what it really frees are CBs from their obligation to inflate against USD. Finally CBs will be able to shoot for that 0% inflation target they wanted all along."
I'd say he is spot on. Freegold frees the CBs from the obligation to inflate their fiat along with the old paper reserve currency (=dollar) and, for the first time in history, allows them to manage their fiat currency as a proper SoV.
This is really a debate about what it means for gold to "function" in Freegold. Victor and Blondie believe that gold's function will make it a poor medium for savings, therefore Freegold actually means a return to holding currency as your savings. They say that gold will "fluctuate wildly" with a guess of maybe 5% in a year, and this includes wild declines in the real purchasing power of gold by that amount, which would mean that the newly stabilized currency will be a much better store of value for the savers. And gold will, therefore, be an "investment" because it will carry short term price risk.
So I am going to make two related arguments:
1. I will show that, logically, gold should be expected to perpetually rise in real terms in Freegold. There is no logical reason it should ever decline in real terms again, once it is revalued, except in the case of economic disaster in which case fiat will most certainly be sacrificed so it won't be any better.
2. I will show that, theoretically, gold need never decline again in real terms in order to "function" in international settlement and to act as spur and brake in the cycle. It need only rise to greater or lesser degrees depending on what's happening in each zone, which makes perfect sense while "wild fluctuations" do not.
1. Why gold will always rise in Freegold
In Victor and Blondie's ideal 0% inflation world, this means both nominally and in real terms, since they are the same. So the price of gold would simply never decline. It would just rise and rise, at differing rates of speed of course.
I know… never say never. What I mean by never is almost never, and if it ever does decline, that would be a rare anomaly and certainly not significant enough to scare away the savers.
Now let's look at that word, "savers". Also, "savings" and "store of value", because these concepts seem to be at the heart of the debate.
Savings is not some perfect basket of purchasing power carried through time. Savings is a choice made by savers. And most people are savers, as opposed to investors, so they are a large group. Whatever savers choose to save in becomes the de facto savings medium.
Now when I say that most people are savers, that simply means they are more interested in preserving their surplus purchasing power than gaining from it. They will forego a gain in favor of a lower risk of loss. Today the focal point savings medium is fiat. So in the "Freefiat" world, that focal point doesn't change even though we move from a broken paradigm—broken by saving in fiat currency—into a new paradigm. That's a pretty big divergence from the Gold Trail that I have been following!
Back to gold…
The global supply of gold is relatively fixed. Today it grows at about 1.5% per year. There is disagreement on what will happen to mining after revaluation. Some think that 1.5% will increase, and I think it will decrease because surplus zones will likely choose to leave their reserves in the ground. But no matter. As long as the global economy is expanding faster than the global gold supply, the real value of gold will always be increasing.
So if the real value is always increasing, why would its price ever fall? Let's look at a few reasons why it could fall. If it had previously been overvalued then the price could fall. But in Freegold we expect gold to always be properly valued due to two major changes, the revaluation and the physical-only market, i.e. the elimination of paper gold.
Really, the only way for gold to fall in Freegold is for supply to exceed demand at some price. And if that excess supply isn't coming out of the ground, then it must be coming from dishoarders. The alternative is that demand drops, but that would be the disaster scenario. Since we're assuming a global economic growth rate greater than ~1.5% (greater than the expansion rate of the gold stock), we can assume a steady to growing demand for gold at all times, which leaves us with supply shocks as the only possible cause for a declining price. So let's look at some possible causes for supply shocks.
An aging community would be one. We tend to save during our productive years and then spend that savings in our retirement years. So imagine a dying society with such a low birthrate that every year the percentage of retired people grows. If this was a closed society like North Korea, then the real price of gold would fall as gold supply constantly exceeded demand. But in the real world it won't, because another society with more productive workers than elderly dishoarders will supply real goods to this aging community for its gold.
This is a good example of how the spur and brake is not a function of wild gold price fluctuations. Would you expect in this hypothetical dying society, where nearly everyone is simply dishoarding their gold until they die goldless, that the (real) price of gold would drop forcing them to get out of their Barcaloungers and build some factories, or at least greet people at Walmart? I wouldn't, because the spur isn't a punishing decline in the price of gold. It is much more subtle than that. And without young, productive workers to require an inflow of gold, all of the gold in this dying zone can theoretically flow out without ever declining in price until it is gone and no one else remains.
You've heard of the carrot and the stick? The Japanese have a similar saying, a whip and a candy. Two forms of motivation, punishment and reward. Rather than being the declining price of gold which punishes everyone saving in gold, the spur is simply the growing opportunity for easy profits that lures only the marginal gold saver (net-producer) into expansionary and/or different entrepreneurial pursuits with his ongoing surplus income, not necessarily selling gold to build a factory, but rather redirecting his current surplus income back into production. In fact, the opportunity to profit might even cause the migration of younger workers into our hypothetical aging society as long as culture, language and immigration laws weren't an obstacle.
So perhaps a painful spur isn't the best analogy. It's more like a carrot dangling in front of the horse than a painful jab. And then the brake, rather than being the pulling of the reins, would simply be the absence of the carrot once it is eaten. Like I said, much more subtle.
Now there's one other way that supply from dishoarders can overwhelm demand, driving down the real price of gold, and that is if gold was just one of many investment options rather than the focal point store of value. If that was the case, then we could see capital outflows from gold as gold is traded for different investment options according to changing investor preferences over time. But this becomes a circular argument. Like this: Gold is merely an investment choice among many because it will fluctuate wildly, but it will only fluctuate wildly if the majority of people consider it an investment choice among many.
Finally, let's talk about the real versus the nominal price of gold in Freegold, just in case we don't end up with Victor and Blondie's 0% inflation. If we have, say, 2% inflation, then I'm contending that the very worst gold will do is to track inflation. In real terms its value will rise more or less at the rate that global growth exceeds gold supply growth. So its nominal price will rise, more or less, at that rate plus the rate of inflation. But the very worst it will do in any zone, deficit or surplus, is to keep up with inflation. Therefore, the only way we'll ever see a declining nominal (but not real) price of gold in Freegold is during bouts of deflation. How likely is that? It is unlikely because, very generally, I expect to see higher price inflation in the deficit zones and higher gold appreciation (in real terms) in the surplus zones, which will of course switch back and forth from deficit to surplus (ex. gold) over a reasonably short cycle.
Gold does not need to beat long term investment returns. That is old-paradigm thinking. Savers don't have a real focal point choice today, they have to go with a "diversified portfolio" just to stay even with minimal risk. The most important concepts here are that "most people are savers," and that "savings," or the focal point store of value for savers, is a choice made by the savers.
Victor and Blondie's main point seems to be that, in Freegold, "currency will finally perform all three functions." Of course currency performs three functions, MoE, UoA and SoV. But the function of SoV is different from the focal point medium for SoV chosen by the savers as a group. It is no argument to say that currency will finally be stable. I have said that all along. Here's what I wrote in The Return to Honest Money:
The Money Concept
FOFOA: The measure of any money's store of value is a continuum of time. It is directly linked to demand and velocity. Even the worst money (say, Zimbabwe dollars during the hyperinflation) works as a very temporary store of value. Perhaps you read stories about workers in Zimbabwe getting paid twice a day and then running out to spend it before coming back to finish the shift. This is an example of the briefest time period in which currency stores value.
FOA: Was gold a medium of exchange? Yes, but to their own degree, so were the bowls. Was gold a store of value? Yes, but to a degree, so were dinner plates. Was gold divisible into equal lesser parts to define lesser barter units? Yes, but to a degree one could make and trade smaller drinking cups and lesser vessels of oil.
Here's the thing, 'store of value' and 'medium of exchange' are relative terms. Anything real stores value (a painting, a computer, a jewel), and lots of things are media of exchange in various settings (dollars, other currency, cigarettes in jail, etc). And for stores of value, there is a continuum as to how long things store value. What we are talking about is degree. And this gets to the heart of a semantic issue about money being media of exchange and a store of value.
Both of the above quotes get at the idea that, because money is a medium of exchange, it is also, to some degree, a store of value. Even Zimbabwe dollars were a brief store of value, but being a store of value isn't what money is all about. Being a store of value is not its central function—it is derivative of its being a medium of exchange. Being a medium of exchange is money’s essence—what makes money money. This means that, by definition, money’s ability to serve as a measure of value and store of value is secondary.
And here's what I wrote in Moneyness 2: Money is Credit:
In the future, I think that if you are saving for something known, especially something with a known currency price like a down payment or a car, you'll save currency or "money". But if you're saving for the unknown future, you'll apply your newfound understanding of the difference between money and wealth and you'll probably choose gold, the most salient and liquid of the tradable wealth items.
So if you want to believe that the savers will dishoard gold, not because they need the cash for retirement consumption, but to swap it for a different SoV, you need to explain how and why the real price of gold will have periods of "wild" decline even after revaluation and even in a physical-only market. I think this requires the swapping of gold for other investments rather than dishoarding for consumption spending, which is the circular argument I mentioned above.
I contend that, in Freegold, gold will be viewed and used as the tradable wealth item that it is and, because of the two major changes in the gold market, it will perform better than currency in the short run and worse than good investments in the long run, making it the focal point store of value for savers in particular, while no longer being the plaything of investors, traders and speculators.
Here's something that's worth thinking about for a little while. The revaluation of physical gold does not require new buyers. It only requires the sellers *IN SIZE* (other than the mines) to stop selling, which may have already happened. So when gold is revalued, every single ounce will already be owned by a saver at that point, one who already understood gold, more or less. And if the savers-in-money who lost their savings during the transition don't take notice, I'll be really surprised. I'm not advocating a fundamental change in the savers' perception, I'm predicting it.
In the next section I'll explore price signal transmission in Freegold and gold's role in such. I'll also explore gold's role in trade settlement and how it is about the physical flow, not changes in the price, which will bring us right to the heart of gold's true function. It's "the gold must flow," not "the gold must fluctuate wildly."
2. Why gold doesn't need to decline or fluctuate wildly in order to function
Just above, I explained why gold would always rise in Freegold, sometimes faster, sometimes slower, but almost never declining in real terms/price/value outside of a disaster scenario. The following argument is a little different because I want to address why it doesn't need to decline in order to "function" in settlement and price signal transmission as Victor and Blondie claim. But before I dig in, I think a little background is needed.
First of all, I want you to keep in mind that when I talk about theoretical principles in the new Freegold paradigm, they will generally apply at any and every scale, from the individual to the family unit, to the neighborhood, to the city, to the state, to the region or nation, and even up to the most broad of categories, the East and the West. One of the things that I think Victor tends to do in his "Freefiat" arguments is to focus on international settlement as a key factor, when "distributed settlement" or "decentralized settlement" at all scales will not only effect international settlement, but it will also preclude its primacy.
Here is an example of what I mean. In Freegold, net-consumption over long periods of time will no longer be possible. It will be a thing of the past. This applies on all scales, although of course it doesn't apply to those who are simply incapable of surviving without assistance. And net-consumption over short periods of time is, of course, perfectly natural and will continue. But in general, any group, from the individual on up to the hemisphere, will not be able to net-consume indefinitely like we see happening today.
The reason is simple—settlement. The only way net-consumption can continue for long periods of time is for imbalances to accumulate without a mechanism for reversal. Economists and central planners struggle with this all the time, scratching their heads while trying to come up with an appropriate mechanism (i.e., motivation/incentive) to either reverse the trend or to at least cap it.
To give you one example, I remember recently that Aaron spent some time emailing with an economics professor at the college where he works. This was a while back, and I recall that he was trying to explain some of the principles in my Macrofreegold'nomics post. In her reply, it was apparent that she not only couldn't conceive of a natural adjustment mechanism, but that she wasn't even open to discussing anything other than a centrally-planned and administered one. Her proposed mechanism was to cap imbalances by automatically reducing the value of reserves by a set percentage if and when they came to exceed a predetermined level.
I'm just going off memory here, but it went something like this. Think about China's accumulation of Treasuries as being close to the imbalance cap. Today they are at about $1.223T according to the Treasury. Say the cap was $1.25T. If China ever exceeded that cap, then the total value would automatically receive a 6% haircut or something like that. So China could theoretically run a trade surplus with the US forever, but its reserves would never exceed $1.25T, and every time they reached that limit, they'd fall back to $1.175T. So the incentive would be to never reach that level; to stop buying Treasuries. This was a dead serious proposal.
The point of mentioning this story is that almost everyone, even the so-called experts, thinks only in terms of a centralized, controlled, planned and administered solution at one specific scale. Also, it is, without exception, a "whip" or "stick" solution, a potential punishment that can be avoided as the motivation for reversal. This makes sense, doesn't it? Because how can anyone other than the Superorganism itself offer a "carrot" or "candy" (reward-based) adjustment mechanism?
I see this same type of thinking from Victor as well, in his description of trade settlement in "Freefiat". An interesting idea from Victor recently was that settlement-by-proxy could be achieved by a CB like the ECB if the Eurozone's trading partners insisted on accumulating euros so as to run a perpetual surplus against the Eurozone. Instead of capping the nominal amount of reserves that could be accumulated as in Aaron's professor friend's proposal, the ECB would simply print euros in an amount equal to those being hoarded abroad and use them to buy gold.
This was an interesting concept, but I'm sure that some of you are already sensing a few problems with it. First of all, no real settlement will have taken place. The trading partner accumulating euros is running a trade surplus against the Eurozone, so for settlement to take place, gold should flow from the Eurozone to the trading partner. But instead, the ECB is buying gold, essentially on behalf of the trading partner.
But it's not really on their behalf, is it? Because any increase in the €PoG will go to the ECB and not to the trading partner. If we assume Victor's 0% inflation in the euro, then the imbalance could potentially accumulate indefinitely in real terms (in terms of goods and services), but would be capped in gold terms, not too much unlike the nominal capping proposed above, except that Victor's plan would isolate or de-link gold from goods and services.
This arrangement would probably be fine with the trading partner, especially if gold was fluctuating wildly! Imagine reserves of perfectly preserved purchasing power in goods and services! Yet if the €PoG was constantly rising as I contend, they might notice that even perfectly stable base money was a less than optimal reserve. But even if gold fluctuated wildly, making 0% inflation base money the perfect reserve, imagine what would happen if disaster struck in the trading partner's zone, wiping out most of the production capacity but leaving the people, the consumers, intact. This could force "trading partner" to liquidate those reserves very quickly.
The ECB's response, according to Victor, would be to sell gold in order to mop up the rapid inflow of excess currency, keeping its sound money stable in goods and services. Blondie says, "'Sound money' is just stable money, money stable in its purchasing power. No more, no less." (I have a different definition of sound or honest money—it's money that doesn't pretend to be something it's not—but we'll save that discussion for another time.)
If the ECB did this, it would give the disaster zone full purchasing power for all of its reserves, transferring the most immediate impact of the disaster right into the Eurozone where the outflow of "disaster support" in real terms would be disproportionate to what it would otherwise be. Or, the ECB might do the right thing and favor its own economic zone over its purely symbolic token currency in that moment of crisis. This would allow a temporary inflation to take effect, limiting the transfer of wealth in real terms. And here, in this moment of crisis, even one that happens outside of the Eurozone, we see that a perfect currency during normal times can be no more reliable than an FDIC sticker when the time finally comes that you need to cash in your reserves. Gold, on the other hand…
And this brings me to one last point I wanted to make before I dig into my argument, and that is regarding the Debtors and Savers dichotomy. Just above, I proposed a disaster wiping out the productive capacity while leaving the consumers intact. Why didn't I say it wiped out the producers, leaving the consumers intact? That's because everyone is a consumer.
Blondie has told me on a few occasions over the years that he never liked my Debtors and Savers dichotomy, even from the first time he read it. He thought it should be the Producers and the Consumers. But that's a false dichotomy, because everyone is a bit of both. "Savers" denotes a specific group, those who net-produce and attempt to save their excess purchasing power for later. They are still consumers. They don't save everything they produce. Others have also criticized my dichotomy saying it should be the debtors and the creditors. But that's also a false dichotomy, at least in this context, because A) all savers are not engaged in lending, and B) savers should not be engaged in lending because that's a recipe for a disaster that historically ranges from tears to bloodshed.
Okay, let's talk about price signal transmission and imbalance settlement. I'm going to start with settlement. Here's another statement I made with which Blondie once told me he had a problem: "It's all about savers." Blondie said that statement was too imprecise, that it should be changed to: "It's all about the reserve."
Now I want to point out something that may not be obvious on first glance, and it is that my statement refers to a group of living, breathing people while Blondie's correction refers to an inanimate object. I didn't say it's all about the "savings" or "the savings medium", I said it's all about savers. My full statement was this: "Freegold is all about savers. Everything else flows from that." And Blondie's full correction was: "Freegold is all about the reserve. Everything else flows from that." Blondie's point in this particular disagreement was to illustrate for me how I could make my statements more precise to avoid people misunderstanding them, and yet I'm still fine with my original statement while I disagree with his.
So what did I mean by "it's all about savers"? Well, this is a big concept that encompasses many elements of Freegold, not the least of which is the element of imbalances and the need for settlement, which directly affects price signal transmission which I'll get to in a moment. Imbalances occur when one zone produces more than it consumes in aggregate. Yet not everyone inside that zone is a net-producer. Some are net-producers and some are net-consumers. So if, on aggregate, the zone is running a trade surplus against the rest of the world, then the net-producers inside that zone must be producing enough for their own consumption + the net-consumption of the net-consumers in that zone + the amount of the trade surplus. In other words, the net-producers are the only group inside that zone who are directly responsible for the trade surplus. The surplus (i.e. imbalance) is entirely attributable to the savers as a group. It's all about savers.
It's also all about savers because, just as imbalance is a choice made by savers, so is settlement. Consuming less than you produce is a choice. We have good examples of people who produce huge incomes and consume equal or even greater amounts, so underconsumption is a choice. Likewise, what the saver does with his surplus income is also a choice. To lend it to someone else is to not choose settlement. To lend is to choose imbalance rather than settlement. Likewise, to invest one's surplus is to not choose settlement. To invest is to bet on future imbalance changes.
Imagine a net-producer in a surplus zone investing his proceeds back into his own business. He is not choosing to settle, instead he wants to produce more; he is betting that his zone's surplus imbalance will expand even more, because if it doesn't, his investment will probably not pay off better than savings. Or he could invest in production in the deficit zone which would be a "foreign investment". This would, on average, be a better bet for a surplus-zone investor in Freegold.
But you don't have to worry about that choice, especially if you are a saver. Some people are just born investors, entrepreneurs and gamblers, while most of us are savers. They look for the best bet while we look for the least risk. Are savers better than investors? Nope. Or are investors selfless and giving while savers are greedy hoarders? No way!!! We both play important roles, and I am in no way casting moral judgments. I am only observing.
You see, the marginal saver will switch back to investing during the deficit leg of the cycle in his zone, but he is not the grain that tips the scale turning the cycle. Natural investors will "see around the corner" and invest wherever the best risk-weighted profit opportunities lie, either domestically or elsewhere. This dynamic movement, the expectation of growth potential, will shift real economic growth from the surplus zone to the deficit zone where it is needed, and then back again.
So then why did I say it's all about savers? Why didn't I say it's all about investors? Well, because an investor will do what an investor will do. That's not unlike saying that a debtor will do what a debtor will do. Think of them as relative constants when compared to the wild-ass variable of savers, the elephant in the room, or more like the bull in the china shop, as long as they don't have a good focal point to herd them out of the busy economic highway.
The best thing the savers can do for the economy is to get out of the price signal transmission business and settle their accounts. Simple as that. We don't need anyone to "help" the Superorganism in identifying and enabling credibility. That's a natural process. The savers, which most of us are, should simply get out of the way, settle their accounts and let the organism work. It is only the lack of such settlement that messes it all up. And that's the main point. That's why it's all about savers.
So what is settlement? Well, it's not lending. It's not investment. It's not speculating in commodities (i.e., betting on future price signals). It's not consumption. And it's not necessarily buying gold. It is simply spending your excess income on durable goods that are not consumable and are not economically important. And, for savers, this means goods that tend to have resale value because of the focal point and network effect principles. This includes all of the usual goods I list as collectibles, but without a real focal point, none of them suffices enough to do the job properly and get the savers, as a group, out of the way. The best durable assets currently are out of reach to most savers, and the ones in reach suck. So the savers turn to investments and speculation which messes with the price signal transmission system built into the human superorganism.
For a review of price signal transmission, I refer you back to "I, Pencil" in the Superorganism Open Forum. Price signal transmission is an impossibly complex symphony of price movements that direct the structure of production. From the post:
"First, while no central planner is responsible for pencil production overall, entrepreneurs and workers at each stage do have plans and expectations, which they strive to coordinate with one another across stages and time periods. The key to coordination is the price system. If there’s a brass shortage, rising prices will communicate that information to the ferrule and pencil makers. The downstream entrepreneurs will have to adjust their plans in response to the new conditions–say, by finding a substitute material. The demand for a substitute material will in turn set appropriate processes in motion as entrepreneurs react. In the real world of disequilibrium, change is the rule, so plans are always undergoing revision…"
You see, it's not the fluctuating gold price that is needed for price signal transmission… it is the exact opposite! It is the price of everything else that fluctuates, transmitting signals, and it is gold that remains stable enough to sequester the savers as a group and get them out of the way of the Superorganism so it can do its job! Gold does not need to beat investment returns. Born investors will not be drawn to gold, and we don't want them to be, because they are a fickle bunch which makes them an important component in the Superoganism's price signal transmission system. The savers just need to let them be, which is why I ended that post with "Let It Be" by the Beatles.
So "properly functioning gold" is not wildly fluctuating gold, it is steadily rising gold, not better than investments in the long run, and not worse than currency in the short run. This is not a hard money fantasy, it is a Freegold reality. It is not the result of stable money as Blondie says, it is simply the result of a revalued physical-only gold market.
One last thing. The settlement of a saver's account in gold doesn't deprive the economy of ANYTHING. Quite the contrary! Any money spent on gold that would otherwise have been lent or invested goes instead to a net-consumer who used to be a net-producer, and is spent on the consumption of chosen products. It thereby flows to deserving companies and their employees. One does the economy no favors by leaving the distribution of their excess income up to governments and banks, central or otherwise, who must engage—by definition—in central planning.
Forget about lending being something that someone has to lend. If someone has a credible plan to expand the economy, their credibility will be funded. They don't need to borrow the saved surplus of past production. They get credit based only on their future production, not on anyone's saved past production, and use that credit to rent whatever they need for their future production. Credit isn't something first earned, then saved, then lent. It is simply the enabling of the borrower's credibility. That's why we have banks that can "print money from thin air". Because that's how it has always been! If you're a saver, just buy gold and let it be.
Thursday, May 2, 2013
Three years ago today I wrote The Dukes of Wetton, and tonight you are in for a real treat. Dixie barber and storyteller extraordinaire
RJ Padavona reads this FOFOA classic for you and your kids.
Freegoldtube started this project a couple months ago, and he's asking a few of my readers to read their favorite post aloud and send him the MP3 file. Unbelievable, isn't it? I mean how many other blogs have anything like this? Soon I'll add an audio posts link to the sidebar, but for now you can enjoy Lisa reading The Debtors and the Savers here, right after you're finished with Boss Hogg and his damned HoggBucks…