In my recent article ‘Entrepreneurial Magic’, I discuss the topic of trust based credit… or how to make money without money. I discuss how trust based credit reduces the cost of doing business… any business. In today’s G’man dominated world, only fringe businesses can benefit from using trust based credit. These benefits should be available worldwide to all business. Indeed these benefits were available under the Classical Gold Standard; as observed by Natural Philosopher Adam Smith.
Adam Smith saw that the ‘heavy lifting’ in world trade was accomplished not by the circulation of money (Gold and Silver coin) but mainly by the circulation of Bills of Exchange. Indeed, some people call this observation ‘The Real Bills Doctrine of Adam Smith’… as if Adam Smith had invented this ‘doctrine’.
Like any true natural philosopher, Adam Smith observed reality, saw what was happening with clear, unbiased vision… and then proceeded to write up the observations and hypotheses based on his observations. Quite unlike today’s mainstream ‘science’; where observations are selected to support current dogmas.
In any case, Adam Smith saw the almost magical qualities of Real Bills… aka Bills of Exchange. If you missed the last couple of articles, Real Bills are commercial bills drawn against urgently needed consumer goods delivered to retailers, with terms… that is, the bills have an extended due date… unlike retail bills that need to be paid cash on the spot.
Until their due date when they must be paid in full, Real Bills carry the value of the merchandise they were drawn against, and will circulate as a means of payment… increasing the efficiency of Gold and Silver money virtually without bounds. They are called Bills of Exchange because they change hands in clearing payments.
They are also called Real Bills because they are drawn against real goods already delivered. These goods are in urgent demand by consumers… consumers who will pay for the merchandise in Gold coin, thus allowing the bill to be paid in time by the retailer… indeed, perhaps paid before due date if consumption is brisk; prepaid at a consideration. This ‘consideration’ for pre-payment is the origin of the discount rate. Unlike interest that originates as the cost of (borrowed) money, the discount originates as the consideration offered for early payment of Real Bills.
As discussed in my last article ‘Trust Your Neighbor-Tie Your Camel’, the cost of doing business by borrowing to pay for inventory is very high… around 50% of net realized profits go to pay the cost of funds…! To see how detrimental this is to employment, consider the idea of the Marginal Productivity of Labor…oops, bit of economic jargon slipped in here… but the idea is simple once you look at it more closely.
Margin is the line dividing two things… like the border of two countries for example. The productivity of labor is simply how much value an hour of work creates… whether the labor is shoveling coal, doing brain surgery, or cutting the patron’s hair. All work is called ‘labor’. Margin is the line between labor that is profitable… and labor that is not profitable. This is the Marginal Productivity of Labor; the line dividing profitable from non-profitable (loss making) economic activity.
Suppose the work of digging up 100 Lbs. of potatoes creates value of $20.00. That is, from a hundred pounds of potatoes in the ground to one hundred pounds of potatoes in a sack ready to ship creates (adds) value of $20.00. Now suppose an expert can dig 100 Lb. in one hour… ($20 worth) while a less experienced or less motivated picker digs 75 Lb. per hour ($15 worth), and a rooky, wimpy picker bags 50 Lb. ($10 worth).
Our expert creates value of $20.00 per hour, the journeyman creates value of $15.00, and the rooky creates $10.00. Assume the overhead cost of the potato digging business is $10.00 per hour, and the minimum wage is $5.00… Overhead is an indirect cost, wages are a direct cost. Overhead is the ‘cost of doing business’. It includes costs of capital, compliance costs, taxes, etc… Direct cost is the payment made to the worker; paid directly for the work of potato digging.
If we take $10.00 (overhead) and add $5.00 (wages) we can see that the net value created by the expert is $5.00 ($20.00 -$15.00 = $5.00). This net value pays profits… or bonuses, or expansion of the farm, or whatever. On the other hand, the journeyman digger creates net value of $15.00 – $15.00 = $0.00… Break even!
There is no room for profit, or bonuses, or growth of the farm… this is the margin… the ‘marginal productivity of labor’ in the potato digging business is $15.00 per hour. Finally, the rooky who produces $10 of value per hour, will not create any NET value; indeed, $10 – $15 = -$5.00 … a five dollar per hour loss. The farmer cannot afford to hire the rooky; he is ‘sub marginal’.
So what can we do to improve the situation? Clearly the liberal stance of ‘increasing the minimum wage’ will put more workers out of work… as an increase in the cost of doing business raises the marginal productivity of labor; more workers will become sub-marginal. If the minimum wage is pushed to $10.00, the expert will become marginal. This wage increase will put the expert out of a job, and force the farmer out of business… or cause an uptick in the cost of potatoes to compensate for the increase in costs.
On the other hand, the conservative stance of ‘getting rid of minimum wages’ may put more workers to work… but at starvation wages. Neither liberal nor conservative views are complete; the real answer is to reduce the cost of doing business… or, the same thing, to lower the marginal productivity of labor; make it profitable to hire less productive workers.
Suppose overhead costs are reduced from $10.00 to $5.00… by reducing the cost of capital (through the use of trust based credit instead of bank borrowing) and by reducing compliance costs and taxes; now the journeyman worker indeed produces a net positive value. $15 – $10.00 = $5.00 of net value. The expert picker would also produce more net value; $20.00- $10.00 = $10.00. Why, the expert may even get a raise.
And our rooky? He produces $10.00 value per hour; overhead costs are $5.00… so he may sneak in at wages of $5.00 per hour… The rooky is now the marginal labor, instead of the journeyman. A new, lower margin (break even) at $10.00 per hour has been established. If the minimum wage is reduced to $4.50, we can be pretty sure the rooky will be in a position to be hired… and be in a position to learn, to upgrade his skills, soon to become a journeyman who easily picks 75Lb per hour.
Now play this very same scenario out over ALL business, all jobs, and ALL workers worldwide… and it becomes very clear why there was no structural unemployment under Gold. Borrowing costs were replaced by Real Bill profits. Under a fully developed Bill market, there is no need for the retailer to pre-pay his bill to get a discount; he simply buys other merchant’s bills as his till fills with the consumer’s Gold coin… and earns profits on these Bills as they appreciate.
If you think this can be compared to the retailer using a savings deposit or a CD to earn income on surplus cash, you miss the point; the money the retailer gets for his CD or deposit is more than offset in the economy at large by other borrowers, who pay the banks a much higher interest rate. The money the retailer earns by buying Bills is never borrowed, does not reduce any other merchant’s profits… rather flows strictly from the propensity of consumers to spend.
Remember, both the retailer and wholesaler, that is both the acceptor and initiator of a Real Bill benefit; the retailer gets merchandise on consignment (at no cost) and the wholesaler gets to sell more merchandise. Both parties benefit… else they would not make the deal. Neither borrowing nor lending is involved.
The structural unemployment we suffer from will not go away on it’s own. Dole payments are no substitute for wages and profits honestly earned. The World economy will never turn around as a result of more borrowing, more spending… but it will indeed turn on a Dime… if the Dime is real Silver, and if Real Bills that mature into Silver and Gold circulate freely once again.
Rudy J. Fritsch
Editor in Chief
Since 1971 the irredeemable monetary system has been in a constant state of paralysis. Over the last decade this state has only further deteriorated bringing global trade into unchartered and dangerous territory, crippling the global economy and desolating entire cities (Detroit is only one such tragedy). For the astute readers of this journal, the ills of the irredeemable monetary system are of no mystery, thanks in part to this publication which has relentlessly crusaded to intellectually illuminate this shadowy field. Yet it would be intellectually dishonest to make the claim that this publication is the only one. There are in fact many groups which advocate a gold standard; the Rothbard “100% backers” are just one example of the diverse array of gold standard advocates.
It is no secret that the Gold Standard Institute (GSI) advocates a particular type of gold standard, specifically an unadulterated gold standard which rests on the principle of the separation of state and economics. Yet unfortunately there is much confusion amongst our contemporaries concerning the kind of gold standard which will alleviate our monetary troubles.
One such group have been those commentators calling for an “international gold standard” to settle trade between countries and corporations as a relief to the dollar standard. The idea is a neo-Bretton Woods Agreement where countries would tie their currencies to gold and simply balance each account quarterly in gold bullion. This is a peculiar proposition in the realm of monetary history based upon unsound and impractical economics.
The first obvious flaw is the expression “international gold standard”. Money as a concept is universal to man irrespective to his geographical location. As pointed out in previous articles in this publication, gold is money. Prior to the dismantlement of the classical gold standard, if one held US Dollars and exchanged them for British Pounds, the “exchange rate” was merely the ratio of US Dollars to gold relative to Pounds to gold. There were no political trade agreements in place sanctioning such a trade except the laws of nature (in this case the ratio of currency to a weighting of gold). Since gold is money, by its very nature it has to be the most marketable good meaning it must be “international”- or universally accepted. Hence the advocates of an “international gold standard” are merely advocating a monetary cartel of sorts. The term “international” should be interchanged with “exclusive” as all are not are allowed to freely participate. This means that an international gold standard is just an exclusive arrangement between various entities for purposes more attune to political favour than economic virtue.
Such a monetary system contradicts the entire philosophical case for a gold standard; the defence of individual rights a la laissez faire capitalism. An international gold standard which is currently being advocated ignores the principles of a free market by its exclusive nature. Money is a tool strictly developed by the free action of man. Advocating a gold standard outside and apart from a free market is an entirely pointless affair. It reduces the status of gold to any other commodity, whether it is coal, oil or pork-bellies.
Nevertheless, setting the philosophical aspect aside, such a monetary arrangement will not work as it flies in the face of elementary economics. An international gold standard is an ill-conceived and highly problematic proposition for the same fundamental reason as the current monetary arrangement: One central planner’s policy for another. Bretton Woods collapsed as a result of the arbitraging forces between the fixed currency ratios, or price, to a weight of gold. To advocate a neo-Bretton Woods agreement would be akin to advocating just another type of disaster. Keeping in mind that Bretton Woods collapsed before high speed trading algorithms were off the ground, if a neo-Bretton Woods agreement were to be formalised and introduced, its greatest achievement would be for the agreement to survive longer than a month.
The practical virtue of an unadulterated gold standard is not the control of the quantity of money but rather stability of interest rates – a point almost entirely lost in economic academia. The quantity of money is almost immaterial to the stability of an economy or currency. An “international gold standard” has no answer to the issue of interest rate stability which has brought the global economy to financial ruin. Conceivably such a monetary arrangement would require assiduous interest rate fluctuation to balance out the excessive arbitrage and overcome speculation between gold, the currency in question and every other currency – something which no man or superman would be able to do leading to the systems eventual cannibalism. Governments would be forced to devalue their currencies to gold, most likely at an ever increasing pace, in order to preserve their own gold reserves. The entire affair would alleviate none of the present problems and only advance the case of those adversaries of gold and a free market.
An unadulterated gold standard is the ideal, one which the GSI strives to champion. Yet the process of realising and implementing an unadulterated gold standard is not a Sunday night presidential broadcast. It requires meticulous attention and transparency – not in managing it, but in introducing it. That is no small task.
President – the Gold Standard Institute Australia
Cognitive Dollar Dissonance: Why a Global Deleveraging and Rebalancing 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.
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 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 flip-flop regarding the so-called ‘taper’ could well 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, 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 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 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 long-held 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 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.