This is a wonderful article that cuts through to the bone of the ‘what should monetary policy be’ debate. Amongst other gems, there is a great analogy in there…
Please click here to answer a quick survey for Freedom Fest. They are looking to locate the fifty most influential Libertarians. Freedom Fest is a big deal in the US. Any organisation promoting genuine freedom will be supported by the Gold Standard Institute.
Self-interest? Of course; the achievement of genuine freedom would mean circulating Gold.
It is odd though, that the person working most effectively to promote Gold and economic freedom is not even on the lists. I refer of course to Dr. Keith Weiner.
There are many people who still do not understand the connection between Gold, and not just economic freedom, but the freedom of the individual across the whole span of existence.
First published here January 1, 2013
By Keith Weiner
The Root of the Problem is Debt.
Worldwide, an incredible tower of debt has been under construction since 1971, when President Nixon defaulted on the gold obligations of the US government. His decree severed the redeemability of the dollar for gold and thus eliminated the extinguisher of debt. Debt has been growing exponentially everywhere since then. Debt is backed with debt, based on debt, dependent on debt, and leveraged with yet more debt. For example, today it is possible to buy a bond (i.e. lend money) on margin (i.e. with borrowed money).
The time is now fast approaching when all debt will be defaulted. In our perverse monetary system, one party’s debt is another’s “money”. A debtor’s default will impact the creditor (who is usually also a debtor to yet other creditors), causing him to default, and so on. When this begins in earnest, it will wipe out the banking system and thus everyone’s “money”. The paper currencies will not survive this. We are seeing the early edges of it now in the euro, and it’s anyone’s guess when it will happen in Japan, though it seems long overdue already. Last of all, it will come to the USA.
The purpose of this article is to present the early warning signal and explain the actual mechanism to these events. Contrary to popular belief, it will not be that the central banks increase the quantity of money to infinity. The money supply may even be contracting (which is what I expect).
To understand the terminal stages of the monetary system’s fatal disease, we must understand gold.
First, let me introduce a key concept. Most traders define “backwardation” for a commodity as when the price of a futures contract is lower than the price of the same good in the spot market.
In every market, there are always two prices for a good: the bid and the ask. To sell a good, one must take the bid. And likewise, to buy the good one must pay the ask. In backwardation, one can sell a physical good for cash and simultaneously buy a futures contract, and make a profit on the arbitrage. Note that in doing this trade, one’s position does not change in the end. One begins with a certain amount of the good and ends (upon maturity of the contract) with that same amount of the good.
Backwardation is when the bid in the spot market is greater than the ask in the futures market
Many commodities, like wheat, are produced seasonally. But consumption is much more evenly spread around the year. Immediately prior to the harvest, the spot price of wheat is normally at its highest in relation to wheat futures. This is because wheat inventories in the warehouses are very low. People will have to pay a higher price for immediate delivery. At the same time, everyone in the market knows that the harvest is coming in one month. So the price, if a buyer can wait one month for delivery, is lower. This is a case of backwardation.
Backwardation is typically a signal of a shortage in a commodity. Anyone holding the commodity could make a risk-free profit by delivering it and getting it back later. If others put on this trade, and others, and so on, this would push down the bid in the spot market, and lift up the ask in the futures market until the backwardation disappeared. The process of profiting from arbitrage compresses the spread one is arbitraging.
Actionable backwardations typically do not last long enough for the small trader to even see on the screen, much less trade. This is another way of saying that markets do not normally offer risk-free profits. In the case of wheat backwardation, for example, the backwardation may persist for weeks or longer. But there is no opportunity to profit for anyone, because no one has any wheat to spare. There is a genuine shortage of wheat before the harvest.
Why Gold Backwardation is Important
Could backwardation happen with gold?? Gold is not in shortage.. One just has to measure abundance using the right metric. If you look at the inventories divided by annual mine production, the World Gold Council estimates this number to be around 80 years.
In all other commodities (except silver), inventories represent a few months of production. Other commodities can even have “gluts”, which usually lead to a price collapse. As an aside, this fact makes gold good for money. The price of gold does not decline no matter how much of the stuff is produced. Production will certainly not lead to a “glut” in the gold market pulling prices downward.
So, what would a lower price on gold for future delivery mean compared to a higher price of gold in the spot market? By definition, it means that gold delivered to the market is in short supply.
The meaning of gold backwardation is that trust in future delivery is scarce.
In an ordinary commodity, scarcity of the physical good available for delivery today is resolved by higher prices. At a high enough price, demand for wheat falls until existing stocks are sufficient to meet the reduced demand.
But how is scarcity of trust resolved?
Thus far, the answer has been via higher prices. Higher prices do coax some gold out of various hoards, jewelry, etc. Gold went into backwardation for the first time in Dec 2008. One could have earned a 2.5% (annualized) profit by selling physical gold and simultaneously buying a Feb 2009 future. Gold was $750 on Dec 5 but it rocketed to $920—a gain of 23%–by the end of January.
But when backwardation becomes permanent, then trust in the gold futures market will have collapsed. Unlike with wheat, millions of people and many institutions have plenty of gold they can sell in the physical market and buy back via futures contracts. When they choose not to, that is the beginning of the end of the current financial system.
Think about the similarities between the following three statements:
“My paper gold future contract will be honored by delivery of gold.”
“If I trade my gold for paper now, I will be able to get gold back in the future.”
“I will be able to exchange paper money for gold in the future.”
The reason why there was a significant backwardation (smaller backwardations have occurred intermittently since then) is that people did not believe the first statement. They did not trust that the gold future would be honored in gold.
And if they don’t believe that paper futures will be honored in gold, then they have no reason to believe that they can get gold in the future at all.
If some gold owners still trust the system at that point, then they can sell their gold (at much higher prices, probably). But sooner or later, there will not be any sellers of gold in the physical market.
Higher Prices Can’t Cure Permanent Gold Backwardation
With an ordinary commodity, there is a limit to what buyers are willing to pay based on the need satisfied by that commodity, the availability of substitutes, and the buyers’ other needs that also must be satisfied within the same budget. The higher the price, the more that holders and producers are motivated to sell, and the less consumers are motivated (or able) to buy. The cure for high prices is high prices.
But gold is different. Unlike wheat, gold is not bought for consumption. While some people hold it to speculate on increases in its paper price, these speculators will be replaced by others, who hold it because it is money.
Gold does not have a “high enough” price that will discourage buying or encourage selling. No amount of price change will bring back trust in paper currencies once the gold owners have lost confidence . Thus gold backwardation will not only recur, but at some point, it will not leave its backwardated state.
In looking at the bid and ask, one other observation is germane to this discussion. In times of crisis, it is always the bid that is withdrawn -there is never a lack of asks. Permanent gold backwardation can be seen as the withdrawal of bids denominated in gold for irredeemable government debt paper (e.g. dollar bills).
Backwardation should not be able to happen at all as gold is so abundant. The fact that it has happened and keeps happening means that it is inevitable that, at some point, backwardation will become permanent. The erosion of faith in paper money is a one-way process (with some zigs and zags). But eventually, backwardation will become deeper and deeper (while the dollar price of gold is rising, probably exponentially).
The final step is when gold completely withdraws its bid on paper. Paper’s bid on gold, however, is unlimited, and this is why paper will inevitably collapse without gold.
The Mechanics of the Collapse of Paper
Let’s look at what will happen to non-monetary commodities when gold goes into permanent backwardation.
People who hold paper but who desire to own gold will discover gold-commodity arbitrage. They can buy crude or wheat or copper for paper, and then sell the commodity for gold. This will drive up the price of crude in terms of paper, and drive down the price of crude in terms of gold. The crude price in dollars will rise exponentially and its price in gold will fall exponentially.
For example, today the price of a barrel of crude in terms of paper is around $100 and an ounce of gold priced in crude is 17 barrels. It is possible to trade $1700 for one ounce of gold this way. Right now, there is no gain to this trade. Anyone buy an ounce of gold directly for $1700.
But when gold is no longer offered for dollars, this indirect way will be the only way to buy gold. The more this trade is used, the more that both the dollar and gold prices of a commodity will be moved, up and down respectively. Let’s look at an example. If the price of crude in paper rises to $2000 and the price of gold in crude rises to 150 barrels, then one would need $300,000 to trade for one ounce of gold this way. There will always be a gold bid on crude, but it doesn’t have to be high.
Of course, this window will shut sooner or later. Producers and hoarders of commodities will refuse to sell for dollars when they understand gold-commodity arbitrage, not to mention once they see the dollar losing value so quickly. And while this is happening, everyone is running to the stores to trade paper for whatever goods they can get their hands on. This is the “Crack Up Boom.” The currency will no longer be acceptable in trade.
Permanent gold backwardation leading to the withdrawal of the gold bid on the dollar is the inevitable result of the debt collapse. Governments and other borrowers have long since passed the point where they can amortize their debts. Now they merely “roll” the debt and the interest as they come due. This leaves them vulnerable to the market demand for their bonds. When they have an auction that fails to attract bids, the game will be over. Whether they formally default or whether they just print the currency to pay, it won’t matter.
Gold owners, like everyone else, will watch this happen. If government bonds holders sell their securities in response to this crisis, they will only receive paper backed by that same government and its bonds. But the gold owner has the power to withdraw his bid on paper altogether. When that happens, there will be an irreconcilable schism between gold and paper, with real goods and services taking the side of gold. And in a process that should play out within a few months once it gets started, paper money will no longer have any value.
Gold is not officially recognized as the foundation of the financial system. Yet it is still a necessary component. When it is withdrawn, the worldwide regime of irredeemable paper money will collapse.
In my last article ‘The Crisis Heats Up’, I wrote about a best-selling book by Strauss and Howe; ‘The Fourth Turning’… and how the authors studied history and drew some interesting conclusions. Namely, they drew the conclusion that we are in a Fourth Turning, a Crisis.
As a total readaholic, I confess that I just finished another ‘interesting’ book; this one by James Rickards, ‘The Road to Ruin’. Even though Rickards is hip to history, he does not take a traditional historian’s role.
Instead, he writes as an insider, a witness to the fatal errors and misconceptions held by the PTB; the trillionaire hedge funds, the ’too big to fail’ banks, the FED, the Treasury; in other words the controllers of the Fiat economy.
His thesis is that the tools used by funds, by the fed, and the treasury to ‘manage’ the economy are not only obsolete, but are fatally flawed. These tools are based on false assumptions; assumptions such as the ‘efficient market’ hypothesis, the ‘random walk’, ‘Monte Carlo’ analysis, etc. Rickards believes that the assumptions underlying the most sophisticated computer programs the Fed uses to ‘fine tune’ the economy are wrong from the get go.
Now this is not a great new insight; New Austrian economists have been pounding the table on these gross errors seemingly forever. We have insisted that the economy is highly non-linear, whereas the conclusions of traditional mainstream economics… projections and policy… are based on the assumption that the economy is linear… and that markets are random; unpredictable with no memory. Nonsense; markets are results of action taken by people, and people do have memory.
Today these flaws are becoming blatantly obvious; the failure of monetary policy, of demand/supply curves, of Keynesian intervention can no longer be papered over. Rickards draws similar conclusions, while coming from a different point of view.
To understand the economy, we have to let go of linear assumptions… and also of assumptions that markets are random. Markets and economies are neither random, nor deterministic. Markets are complex. But be careful; complex is NOT the same as complicated. For example, a Swiss watch is highly complicated, but is fully deterministic. Indeed, it is built for that specific purpose; wind it up, and it will run as predictably (deterministically) as technology can make it.
The opposite of deterministic is random; like a series of coin tosses is random. The odds of a coin toss coming up heads or tails is 50/50. It is quite impossible to predict the outcome of the next toss, and the next toss does not depend on the previous… coins have no memory. However, the more tosses, the more closely the mean approaches a 50/50 distribution.
By definition, complex phenomena lie somewhere between deterministic and random; and any hypotheses based on the assumption that markets and economies are random or deterministic are bound to be wrong.
Furthermore, a deductive study of economic data is also wrong; statistics (data mining) cannot predict the behavior of complex systems… and the Fed clearly states that its decisions are ‘data driven’. Data is ‘mined’ to determine trends, trends that are then extrapolated into the future… but this methodology leads to huge problems.
False extrapolation and the unanticipated breaking of trends are why we hear about ‘black swan’ events, why CEO’s complain about being ‘blindsided’ by ‘unexpected’ market changes. Markets are complex in the sense of being subject to periods of relative stability interrupted by moments of wild, trend breaking, causality breaking crises.
Complex systems behave like the proverbial ‘flutter of a butterfly wing in Tokyo causes a hurricane in Miami’. The question is which butterfly; there are thousands, and they all flutter their wings; so which butterfly starts the hurricane… and when?
Earthquakes are another example of complex systems; we all know that the stress in the Saint Andreas fault is rising, and one day the ‘Big One’ will hit… but when, and exactly how big? Conventional studies are helpless in predicting these non-linear effects.
Although the stress builds steadily enough, and is studied extensively, no one knows when the trend will end, the built-up stress released, and a new trend started. At least, no one using traditional methods knows…
Interestingly, some (fringe) scientists do make earthquake predictions that are significant. They use out of the mainstream methods and data… like electrical effects, releases of various gases, and even the unusual behavior of animals! Plus, the proliferation of fore shocks.
Rickards also uses out of the mainstream methods; his methods are based on complexity theory. His methods use inductive logic, rather than deductive. Methods like Bayesian probability; a method used by the intelligence community to predict behavior when there is no extensive data set to analyze; there was only one Great Depression (so far) so there is no data base of why depressions occur.
Rather, the Bayesian method looks closely at the single occurrence, hypothesizes the most likely cause, and makes predictions based on the hypothesis… then studies the aftermath, and if the predictions turn out correct, the hypothesis is strengthened.
To make a long story short, Rickards considers the 1998 failure of Long Term Capital Management to be a foreshock, predicting greater shocks… and the Big One… to come. He was intimately involved in the LTCM debacle, and reports clearly how the underlying assumptions of the quants and Nobel Prize winners running LTCM were wrong; and how their fundamental error led to the loss of hundreds of billions of dollars.
In broad terms, LTCM made bets on the ‘return to the mean’ hypothesis; a belief in economic linearity, a belief based on projections of trends into the future. LTCM found distortions in the markets, and bet heavily that the distortions would be corrected in time; that the markets would ‘return to the mean’. Then they leveraged the heck out of their bets, using 100 and even 200 to one leverage.
This worked rather well… for a while… as long as the current period of relative stability held. Indeed, they made hundreds of billions of Dollars for themselves. Unfortunately, greed overcame common sense; a few hundred billion seemingly was not enough. They kept on pushing their method… perhaps aiming for a trillion?
But guess what; the butterfly started to ‘flutter its wings’… but this butterfly was in Moscow, not Tokyo. The USSR economy collapsed, and Russian bonds defaulted. Instead of a return to the mean, the mean also started to collapse… quickly.
Within a matter of days, as highly leveraged bets went sour, the hundreds of billions disappeared like snowflakes in hades.
Due to the interconnectedness of the markets, these losses would have brought down other players… like the Italian Government, for one example. The net exposure of the (hedged, therefore supposedly risk free) bets no longer counted; what suddenly counted was the notional exposure. The counterparty supporting the hedge disappeared. The insurance was gone; the leveraged bet was left naked.
The problem was so serious that the Fed had to take immediate action; they called in several Wall Street players, knocked some head together, and bailed out LTCM… to preserve the financial system. For the story of LTCM, I suggest you read;
When Genius Failed: The Rise and Fall of Long-Term Capital Management’
by Roger Lowenstein
So, there was a lesson here; reversion to the mean can fail… and leveraged bets placed on reversion to the mean can fail big time. Was the lesson learned? Clearly not at all… in ten years, we had another, even heavier ‘foreshock’; this time not just a hedge fund in trouble, but sovereign debt in trouble; the Great Financial Crisis of 2008.
This time, bail outs were not enough; so called bail-ins as well as bail-outs were instigated by TPTB; that is, the money of innocent bystanders was grabbed, to once again paper over the gambling losses. The GFC was the second foreshock, much stronger than the first one; but the lessons still have not been learned.
The ‘too big to fail’ banks are bigger than ever, the quantity of Fiat borrowed into existence (the total Global debt) is larger than ever, leverage is greater, interconnectedness is tighter. The ‘Big One’ is getting closer.
In the last Fourth Turning crisis, Gray Champion Franklin Delano Roosevelt shut down the bank system (bank ‘holidays’) and confiscated American’s gold… to ‘save the system’.
This time around, the problem is much bigger, so it will command much larger, much more drastic measures. Rickards predicts that the whole (digital) financial system will be frozen. Banks closed for sure, along with ATM’s, but also money market funds, stock markets, futures markets, the whole enchilada.
I cannot disagree with his prognosis; what governments are able to do, they are likely to actually do, in a desperate effort to save the system. Look at the situation; war on cash, promotion of digital ‘money’, and full coverage of every financial transaction… when the tsunami hits, all trends will break; no ‘reversion to the mean’ will be possible.
Now Rickards does give some advice on how to ameliorate the coming crisis; his suggestion for the system is to reinstate the Glass-Steagall act. This law was passed by the US Congress in 1933, during the Great Depression. It was a law prohibiting commercial banks from ‘speculative’ (gambling) activities.
It separated commercial banking from ‘investment banking’… it kept the banks from gambling with depositor’s (our) money. The Clinton administration repealed this law in 1999… Just after the LTCM debacle… and the system has run wild ever since.
If the law is reinstated… and Trump has suggested he is in favor of this, and several states as well as congressmen have been pushing the law… then the derivative bomb will be constrained. By Rickard’s reckoning, the separation would reduce risk (instability) by reducing the size… or ‘scale’… of the system. Less at risk, less connectivity leads to more stability of complex systems.
While Glass-Steagall would not reduce the debt problem, it may at least give us more time before the ‘Big One’ hits. Time to change direction, one hopes.
For the individual, Rickards’s advice is to invest your wealth in a ‘1/3, 1/3, 1/3’ pattern; one third non digital money (Gold, Silver and cash under the mattress… assets that cannot be frozen), one third land, and one third art. I certainly agree with part one; own Gold, Silver, and small denomination cash notes… I have been making this very same suggestion for years.
Land is a hedge against financial destruction; but it must be owned free and clear, and preferably offshore; extreme taxation/confiscation are not impossible. Owning farm land in particular is brilliant; farm land, as valued in Fiat, has been appreciating for decades, and I suggest this trend will not only continue but will pick up speed.
Art is also a hedge against inflation and monetary collapse, but there is a learning curve. Unlike bullion or cash, art is subjective and thus a neophyte is at a disadvantage. Nevertheless, 22 carat Gold jewelry (art?) is a great idea, as it is not as likely to be subject to confiscation as bullion coins or bars.
To sum it all up, The Road to Ruin is a very interesting book, and I do recommend it. The only negative is that it is not really complete; it does not come to any final conclusions… indeed, Rickards himself intends to write a sequel. Hopefully the sequel will bring closure. I am looking forward to reading it.
R. J. Fritsch
by Thomas Allen
In 1877, Henry Varnum Poor (1812-1905) wrote Money and Its Laws: Embracing a History of Monetary Theories, and a History of the Currency of the United States. He was a financial analyst and founder of a company that evolved into Standard & Poor’s. Poor was a proponent of the real bills doctrine and the classical gold-coin standard and, thus, the quality theory of money. He gave little credence to the quantity theory of money — especially if credit money, such as bank notes, were convertible on demand in species. Also, he contended that the value of money depends on and is derived from the value of the material of which it is made and with paper money, its representation of such value.
In the latter part of his book, he discusses leading monetary theorists from Aristotle (350 B.C.) to David A. Wells (1875). Most of the economists whom he discussed were proponents of the quantity theory of money. We will look at his discussion on Dugald Stewart. My comments are in brackets. Referenced page numbers enclosed in parentheses are to Poor’s book.
Dugald Stewart (1753-1828) was a Scottish philosopher and mathematician, who popularizing the Scottish Enlightenment. He was a professor of moral philosophy at the University of Edinburgh. Among his writings are Elements of the Philosophy of the Human Mind (in three volumes, 1792, 1814, and 1827), Outlines of Moral Philosophy (1793), and The Philosophy of the Active and Moral Powers (1828). Poor reviews Stewart’s monetary philosophy as presented in his Lectures on Political Economy.
Poor writes, “Stewart was an ardent admirer of [Adam] Smith, and assumed to reduce to precise and logical terms what his great master only more generally outlined” (p. 171). Nevertheless, Stewart objected to Smith’s belief that the value of gold and silver depended largely on “their beauty, utility in the arts, and scarcity; that such qualities, among others still more important, fitted them to serve as money” (p. 171). For Stewart, the intrinsic value of gold and silver in a coin is “merely accidental circumstances.” Stewart asserts, “When gold is converted into coin, its possessor never thinks of any thing but its exchangeable value” (p. 171). If the intrinsic value of gold and silver are annihilated, i.e., their conversion to flatware, jewelry, etc., they could still function as money as they did when they had intrinsic value. Money is merely a ticket or counter. “It is general consent alone which distinguishes them [gold and silver], when employed as money, from any thing else which circulates in a country; from the paper money, for instance, which circulates in Scotland and England.” (p. 172). If a country were isolated from the rest of the world, gold or silver coin as a medium of exchange would have no advantage over paper currency. Also, whether the circulation medium consists of gold or paper would make no difference on the national wealth. Moreover, according to Stewart, whether gold or silver was abundant or scant would not matter. “The only utility which is essential to gold and silver as media of exchange is their peculiar adaptation (divisibility, durability, &c.) to this purpose” (p. 172). [For the most part, fiat money proponents agree with Stewart’s monetary theory.]
Poor replies that like Smith, Stewart errs in his assumption “that money was an invention, — an arrangement entered into from a sense of its necessity” (p. 172). Stewart also errs in his conclusion “that value is not a necessary attribute of money” (p. 173). [Poor is correct: Money was not an invention. It evolved over time from spontaneous market operations. Only after money came into being did governments get involved.]
However, Stewart’s idea of money is a logical derivation from Smith’s idea. From the premises laid down by Smith, Stewart concluded that “value is no attribute of money.” Poor remarks, “the real value of money must equal its nominal value, or, in case of symbols, the values of what they represent must equal their nominal value in coin, or value is no attribute of money whatever” (p. 173). [Today’s fiat paper money is based on Stewart’s premise that value is no attribute of money. That is, the quality of money is irrelevant. Force is the only thing behind, or backing, today’s fiat paper money.]
Stewart states, “We never think when we receive the precious metals as money, of their value in the arts” (p. 173). To which Poor replies, “But were they not first taken, and chiefly, for their value in the arts? and if we do not now consciously go through the same mental process that was gone through when they were first taken, is it not that such consciousness is concealed from us by habit, not that it does not exist” (p. 173)? People practice many things without conscious thought about how such practice came into being. Acting this way “is no proof that the mind is not engaged in one case as in the other” (p. 173). Poor notes:
Stewart, however, wholly misstated the fact that gold and silver are taken without any consciousness of their value in the arts. As a rule, we do not raise the inquiry; we assume from experience that coins are what they purport to be: but let it be noised abroad that debased coins of a particular denomination are in circulation, then every one of the kind, good or bad, will be subjected to the closest scrutiny, and, if taken at all, will only be taken at its value in the arts, measured by the amount of pure metal it contains (pp. 173-174).
Stewart claims that if all gold and silver mines were exhausted, all the gold and silver in existence would be converted to money. Poor disagrees. First, he doubts the possibility of exhausting of all mines. If gold and silver were to disappear, civilization would disappear with them. However, if all mines were exhausted, Poor doubts that all gold and silver would be converted to money. Poor writes:
As it [gold] gradually disappeared from loss and attrition, commerce and trade, and with these, civilization and wealth, would gradually die out. As these disappeared, gold and silver would gradually flow back into the arts, and almost wholly in time; for, as there would be no trade, money would not be wanted. It is a fact of universal observation, that gold and silver possessed by the savage races are not used as money, but almost wholly in the arts (p. 174).
To Stewart’s belief that “gold and silver, as a medium of exchange, would possess no value over the most worthless of substances” (p. 175), Poor replies:
This absurdity is repeated by every subsequent writer upon the subject of money. Suppose England to be the world, what then? Would all sense of beauty, of utility or value be lost to its people? Suppose, as Stewart assumes, England isolated, a Yorkshire grazier should take with him to London a lot of beeves; and upon their sale should be offered a leather medal, with curious hieroglyphics stamped upon it, in payment. The seller at first might consider the offer as a good joke; but, on finding the purchaser in earnest, he would believe himself to be dealing with a madman, and would take good care to get his beeves into his possession again, and to rid himself of such a dangerous customer. To be logical, Stewart must assume that, were England isolated from all the world, its people would have a sense of neither use nor beauty; in other words, that they would be lower in the scale than any race or tribe ever yet discovered. If the precious metals have no intrinsic value, then the Scythian was correct in assuming money to be useful only for the purpose of assisting in numeration and arithmetic. It is for this reason that Stewart held their value to be disadvantageous, in complicating thereby the theory of money. If value be not an attribute of money, he was quite right in eliminating from it all idea of such quality (p. 175).
[The fiat paper monetary system that has now taken over the world supports Stewart’s notion of money better than it does Poor’s. However, Poor’s notion is much closer to the truth than Stewart’s. Because of believing Stewart, the world is now on the edge of a monetary crisis the likes of which the world has never before witnessed. Civilization is on the verge of collapsing into an economic abyss from which it may never recover, such as that which happened when the dying Roman civilization collapsed into the Dark Age — only this time the collapse may be worse. Only a return to a monetary standard, such as the gold standard, where money has real value in non-monetary uses and can extinguish debt because it is no one else’s obligation, can save it.]
Poor asks if Stewart is correct in that money as such has no value, then what harm can come from debasing coins? When a coin is debased, the denomination remains the same. However, the precious metal content of the coin is reduced. [Historically, when precious-metal coins were debased, prices quickly rose to adjust to the precious metal content of the debased coin. Even the death penalty could not deter this price adjustment.] Poor remarks, “If the sole use of money, as asserted by Stewart, be to assist in numeration and arithmetic, then the different denominations of coin have only the force of numerals; and a piece of leather upon which is imprinted the word ‘dollar’ is in its proper essence the same thing as a piece of gold upon which the same word is impressed” (p. 176). He continues,
Hume was more logical and consistent. Agreeing with Stewart that the only value of money, as such, was to assist in numeration and arithmetic, he took the ground that the currency should be debased, as the means of eliminating value from it; naively remarking, that such debasement should be effected in such a sly way that the people should not discover the swindle. Of the two, Hume is to be preferred. The admission that the debasement was a swindle had the merit, at least, of putting the people on their guard (p. 176).
Stewart writes that money provides a “scale of value” instead of a “standard of value,” which is the term that Smith uses. Thus, Stewart is more accurate than Smith about his concept of money. Poor notes, “It would be a contradiction in terms to call that a standard of value which had no value. A thing may be a scale, without being a standard. A yardstick is a scale for measuring distance or extension, but not the standard of distance or extension” (p. 177).
Poor asks, “If all value is to be abstracted from money, then of what advantage are the qualities of divisibility and fusibility, in the materials composing it” (p. 177)? These are two of the qualities that Stewart claims make gold useful as money (p. 176). Moreover, Poor continues, “Why not have the denominations which are fitted to express ‘every conceivable variation, of value’ all of the same size and fineness? A bank-note for a thousand dollars has precisely the same size and quality of material as a note for one dollar. The only difference is in their inscriptions” (p. 177).
Continuing his comment on Stewart’s claim that divisibility and fusibility were qualities that fitted gold and silver for money, Poor writes, “According to Stewart’s theory, the qualities which fit gold and silver for money — divisibility and fusibility — are of the least importance; for pieces of similar size may be made by their inscriptions to express ‘every conceivable variation of value’” (p. 177).
Stewart claims that a scale of value renders “the ideas of value much more precise and definite than they otherwise would have been” (p. 177). Poor asks, “But how can ideas of relative value be made more precise by comparing them with a scale from which all value is abstracted? How can nothing be made to be the measure of the value of something” (p. 177)? [A great question. As far as I know, no one has satisfactorily explained how something of no value and does not represent something of value can measure value.] Continuing with an example, Poor writes, “A definite idea is conveyed in the statement that a gold dollar measures the value of a bushel of corn; but what idea can be formed of the value of the corn from a statement that its value is that expressed upon a worthless piece of leather or paper” (p. 177)? [With today’s fiat paper money, value is “measured” with worthless pieces of paper. Perhaps trying to measure something with nothing explains, at least in part, the devastating economic crisis looming before the world.]
Stewart also suggests that “the quantity of money required by a community was in ratio to the rapidity of its circulation” [i.e., the velocity of money or the velocity of circulation] (p. 178). [The concept of the velocity of money is an important component of the quantity theory of money.] To which Poor replies, “This suggestion, which naturally resulted from the assumption that money is not capital, but a scale of valuation, or an aid in enumeration and arithmetic, has become an axiom among all modern Economists” (p. 178). [Today, nearly all economists continue to agree with Stewart on this issue.] Commenting on the event that Stewart used to deduce his conclusion on the rapidity of circulation, Poor writes:
The result of these transactions was, that in the course of seven weeks the garrison had been paid 49,000 florins, the sutlers had sold supplies to the amount of 49,000 florins, and the commandant or government owed them 49,000 florins: so that in the end the latter had converted their supplies into money, and had in hand 7,000 florins, and a debt against the government or commandant for 49,000 florins. From all this Stewart deduces a law, — that the amount of currency required is in ratio to its activity. Suppose the garrison had required a certain amount of forage lying twenty miles off; and that, having but one horse, ten days were required for its transportation. With ten horses, the same work might have been done in a single day. Would Stewart from this fact have attempted to prove that one horse could do the work of ten? We wonder he did not fortify his argument by the following syllogism: ‘ten horses can do so much work in one day; one horse can do the same work in ten days; therefore one horse can do the work of ten horses (p. 179).
Stewart states “that the quantity of money and notes in circulation must bear but a small proportion to the value of the goods to be bought and sold, and that this proportion must vary according to the quickness with which the money circulates or shifts from one hand to another” (p. 179). To this claim, Poor replies, “If the proportion of money to the goods to be bought and sold be small, then the amount of goods bought and sold will be small. Stewart has only shown that, with a small amount of money, seven weeks were required to effect exchanges which might, with an adequate amount, have been made in one” (p. 179).
Continuing his comments on the rapidity of the circulation of money, Poor writes:
If money be capital, or the representative of capital, and if when it is exchanged it is exchanged for other kinds of capital, then there can be no greater activity in money than in other kinds of capital; and there can be no relation whatever between its activity and quantity. There would be just as much sense in saying that the quantity of wheat necessary for the consumption of a community was in ratio to the rapidity of its movement: that is, if the rapidity of its motion be made twice as great, one-half the ordinary quantity will suffice. . . . [Stewart] overlooked the fact, that, when money was used as the measure of value or the scale of valuation, the thing, the scale itself, passed from the party using it to the party whose goods had been purchased and measured by it. . . . With Stewart . . . money is an entity, possessed of volition and will, flying about the country eager to do some good deed; an active and lively piece doing twice the work of a dull, phlegmatic one. But money cannot move unless something else moves, no matter how eager it may be for work. Its eagerness must find its complement in some other kind of property; so that if volition, will, and activity be predicated of one, volition, will, and activity must be predicated of the other. Money has no attribute of activity different from that possessed by all other kinds of merchandise. The use of one involves the use of the other; the employment of one involves the employment of the other (pp. 180-181).
Poor concludes his review of Stewart with this comment:
One of the great evils resulting from the reputation of such a man as Dugald Stewart is, that every word that he uttered, which was recorded by himself or by others, is carefully gathered up and put into his ‘works.’ In the case of Stewart, these are swelled to eleven ponderous volumes, full of propositions of the correctness of not one of which the reader can have the least assurance. Had his ‘literary executor,’ instead of carefully raking up, burned three quarters of all he left, he would have rid the world of a vast mass of rubbish, and the painstaking student of a great deal of the most irksome toil. It may be set down as a maxim, that a person who assumes to write authoritatively upon every subject will write well upon none. Life is not long enough for one man to know every thing, or to construct an universal science (p. 182).