Wednesday

By Rudy J. Fritsch

As the clouds of war gathered before the start of the Great War, the ‘War to End Wars’, WWI, the pundits were predicting that any major war could not last more than a few months; the treasuries of the combatants would rapidly run out of money…

This was an astute observation; war is by far the most expensive ‘activity’ that humankind can indulge in… Not only is the direct cost of supplying ‘guns’ enormous but also War entails capital destruction, population loss, trauma, desolation… truly Hell on Earth.

Nevertheless, instead of a ‘few months’ the carnage went on for years… millions killed and maimed, Europe razed… so how was this possible? After all, even though England called its loans, there was still far from enough money available in the treasury to support years of war instead of months.

Once the treasury is empty, Government seemingly has only two choices to keep the war machine fed; increase taxes, or borrow money. Neither option was possible; increasing taxes would lead to revolution… if there was in fact any more taxable income left in the economy. Borrowing was too expensive, if there was in fact any more money available to be borrowed.

Thus the paradox; how could the combatants pay for mayhem far beyond the money (Gold) holdings of their treasuries? To unravel this we need to examine the history of money, and the ‘classical’ Gold standard that the world lived under during the build up to WWI.

A true or ‘unadulterated’ Gold standard has three components or ‘legs’… Gold is first and most essential; Gold is money and only Gold is money… a la J. P. Morgan… with Silver and Copper as supplemental money to allow smaller transactions to take place. Gold coins are too valuable for day to day purchases.

The other two legs are debt (borrowing) and credit (not borrowing); today, debt and credit are lumped together… big mistake, they are two separate phenomena. Borrowing can be represented by the bond market, or by mortgages. Mortgages are simply collateral backed loans… while bonds are unsecured (based on ‘faith and credit’).

For example, the Treasury issues (sells) a bond; a promise to pay back the principle in a number of years, depending on maturity, and to pay interest during the life of the bond. The buyer ponies up cash to buy this paper, in order to collect interest… at least so it was. Today, holding bonds is a sucker’s game, most bonds are bought and sold in the anticipation of capital gains; a drop in interest rates will make the bond more valuable and vice versa.

Credit on the other hand involves no money changing hands; credit is given not borrowed. For example, a tank truck with 20,000 Liters of gasoline pulls up at the gas station, to refill the tanks. This delivery represents about $40,000, depending on the current price of fuel. No way the gas station attendant pays this sum; no COD. Rather an invoice or bill is signed with payment due in thirty, sixty, or up to ninety days.

In effect, the funds to pay this bill will come from ongoing sales of fuel. In the meantime, the signed bill has value as it will inevitably be paid, redeemed in cash; only a true calamity would prevent the ongoing sale of gasoline… or of beer, flour, cabbages… or any other consumer good in high demand.

In the days before WWI these bills were called Bills of Exchange, or as Adam Smith named them, Real Bills. These bills were in full circulation; in other words, were used as payment for most transactions… a vital monetary role. The Bill market represented the clearing system of the Gold Standard. Crucially, Bills could only be drawn against real goods delivered to retailers; unlike bonds, which could be printed and sold on a whim.

As more consumer based buying takes place, more goods are delivered and more bills come into existence; providing monetary flexibility, the very flexibility that ‘pure’ (Rothbardian) Gold money circulation does not have. Indeed, this lack of ‘flexibility’ is one of the excuses Gold haters use to knock Gold; while clearly the problem is not Gold per se, but the lack of a Bill market; the clearing mechanism of a proper Gold standard… a market that was destroyed with the onset of WWI… and was never restored.

Furthermore, Bills are not inflationary; All Bills expire (are paid) in not more than ninety days, Bills mature into Gold coin. Contrariwise, newly printed Fiat never disappears… but stays around to fuel inflation. This is not just monetary theory; world trade before WWI was cleared by Bills of Exchange in circulation; after the destruction of the Bill market, pre WWI levels of international trade were not regained until well into the nineteen seventies.

The Pre WWI British empire, the one on which ‘The Sun Never Sets’,  was run from London; and the British central bank had a miserly 250 Tons of Gold in its vaults; today the US Fed has supposedly 8,000 Tons; and various other countries each hoard several thousand tons as well. Of course, there is no Gold in circulation and no Bills of Exchange either.

Bonds are printed on a whim and bought with cash; most stay around for years, if not decades. Bills are drawn against real goods delivered, and mature in not more than ninety days; responding instantaneously to market changes. This fast feedback mechanism is vital to maintaining financial stability; prices and interest rates respond far too slowly to sudden changes in the markets. Wild and growing fluctuations in the economy are the result.

Unfortunately, we never had an unadulterated Gold standard; the ‘Classical’ Gold Standard as it existed had another ‘leg’ or component, usually called the ‘Fiduciary’ component… Fiduciary meaning promises rather than Real Bills or real money.

Historically Banks offered products that provide convenience. For example, letters of credit were issued by banks hundreds of years ago; a merchant planning a trip to make foreign purchases went to a bank, and gave the bank Gold in return for a letter of credit. This way he could avoid the risk of carrying rather large sums in Gold coin on his travels; he would present the letter to a bank at his destination, redeem his Gold, and conduct his business.

Furthermore, banks held not only Gold in their vaults, but also Bills in their portfolio… in fact, banks were often called discount houses. Bills are the form of paper closest to physical gold… and are also an earning asset. A bill with a due date ninety days in the future has less current value than the same bill on due day; this is the discount.

Like this; suppose the gas station has a spurt of sales, and sells the 20,000 Liters early; now has cash to pre-pay the invoice. Clearly the gasoline wholesaler and the retailer can make an agreement; the retailer will pre-pay for a consideration (discount) and be ready to order a new gasoline delivery.

But there are a few inconveniences with Bills; in order to use a Bill to pay another party, the Bill has to be re-assigned… just like a letter of credit it’s not a bearer instrument, but is assigned to one payee. Furthermore, Bills come not in round denominations, but in all manner of amounts; a truck load of Gasoline is rarely $40,000 in round numbers, but more like $38,672.80… Not so convenient when making payments.

Finally, every exchange of Bills involves (re)calculating the discount; every day closer to maturity increases the market value of the Bill… and this fact needs to be taken into account.

In the interest of convenience, banks started to issue bank notes; large denomination notes, bearer instruments, with round number values… and to balance their accounts, they held Gold (and Silver) in their vaults, as well as Bills in their portfolio.

Crucially, the books of the bank must balance not only in amplitude (assets = liabilities) but also temporally. Notes are fully liquid, a cash equivalent; to balance notes issued, assets held must also be cash equivalent (fully liquid) else we run into problems. Of course, Gold and Silver in the vault are cash… but Bills of Exchange in the portfolio are (almost) as good.

In order to keep Bills in their portfolios, banks had to constantly buy new bills as the old ones matured into Gold coin. One hundred percent of Bills mature in not more than ninety days…so, in case of unusually large demand for Gold, the bank would simply cut down on Bill buying… and allow Gold to accumulate and meet the demand. Worst case, stop buying… or even go into the superbly liquid Bill market and sell (rediscount) some bills even before they mature. No runs on the bank!

If we only stick to the three legs, we have a stable, market driven financial system; the Classical Gold standard came close. My father used to refer to pre WWI days, with a fond faraway look in his eyes as ‘The Peaceable Days’. Under the Classical Gold Standard, the world enjoyed the most peaceful and prosperous era in Human history. Unfortunately, the camel had his Note… er nose… in the tent. Chicanery began on two fronts.

On the bank liability side, small denomination Notes were issued; these had only one real purpose, to start convincing people that paper Notes (at first redeemable in Gold) were actually as ‘Good as Gold’; a bare-faced lie. IOU’s are not real stuff; claims on Gold are not Gold.

On the bank asset side, more chicanery; in addition to cash equivalent assets like Gold and Bills, the banks started to use Bonds as assets. This is where the real trouble lies; bonds do not mature into Gold in ninety days or less, rather they mature (if they ever actually do mature) in years or decades. Thus, if there is a large demand for Gold (cash) Bonds must be sold.

Selling bonds causes bond values to drop; capital losses and illiquidity if not bankruptcy soon follow. Thus lethal runs on the bank become possible. To counter this, rather than forbid Banks from holding bonds in their portfolios, central banks ‘lenders of last resort’ were created… as if lending could resolve problems caused by too much lending!

The original law passed by Congress to create the Federal Reserve specified that the Fed’s assets be constrained to commercial paper only… holding Bonds (that is, monetizing Government debt) was specifically forbidden… Of course, the law against the Fed not being allowed to hold Bonds was broken almost immediately; the law was changed retroactively.

There we have it; the camel has now taken over the whole tent. Treasuries issued bonds and banks issued Notes ‘backed’ by the Treasuries. No limits in sight, no market reality. Thus was funded the mayhem of WWI; fake money printed with no firm limits. But it did not stop there; WWII was also funded by G’man bonds and bankster paper Notes; the US had the highest debt to GDP ratio in history towards the end of WWII… and the game goes on. Now we come to the crunch; today the US debt to GDP ratio is even higher than it was at end of WWII… and so is the debt to GDP of Western countries.

What cannot go on forever will not. All the Fiat currencies ever issued have failed; and the current crop of Fiat is no different. At the rate Fiat is being created today, the end or as Von Mises called it the ‘Crack Up Boom’ is now upon us. The only question is, will the world again accept some IOU to play the role of money… say SDR’s (special drawing rights issued by the IMF)?  If so, the tragedy will repeat down the road. Or, will Gold be recognized as Money… and will an honest society with honest economics be restored.

Hope for the best and prepare for the worst.

Rudy J. Fritsch

By Rudy Fritsch

There is an aphorism that states “it’s not getting the right answer but asking the right question” that is crucial. Readers of this site are surely aware of blurbs like ‘real money’, ‘honest money’, ‘Fiat’ money, printed money, borrowed money… ad infinitum.

Indeed, Aristotle named the desirable qualities of money;

Money must be durable

Money must be portable

Money must be divisible

Money must have intrinsic value

What question were Aristotle’s qualities the answer to? The question ‘what makes good vs not so good money’. This question is fundamentally different from ‘what is money’. If we ask what money is better/not so good, we assume that we already know what money is, and what money is not… a big assumption.

During recorded history, many things played the role of ‘money’ (mainly store of value and medium of exchange); cattle (pecus… Roman origin of pecuniary) salt (origin of salary) cowry shells, cacao beans, even cigarettes in POW camps during WWII… and of course Gold and Silver through the ages.

But before thinking about what is better money, we need to decide what is money… bad or good… and what is not money. One way to understand this dichotomy is to study history; the history of money… and the history of real vs. fake money.

Notice that cattle, salt, cowry shells, cacao beans, cigarettes, monetary metals etc. are all some kind of ‘stuff’… that is they are real items. Not a single ‘promise’ or ‘IOU’ in the bunch. On the other hand, paper ‘money’ (bank notes) is nothing but a promise… of something.

To make this clear, let’s simplify; consider a pound of sugar as the ‘stuff’… and an ‘IOU a pound of sugar’ as the promise. I borrow a pound of sugar from you, and give you an IOU for ‘one pound of sugar’; then the difference becomes obvious; the ‘stuff’ (pound of sugar)… and the promise… the paper IOU.

So what, you say? Well, you can certainly use the sugar to sweeten your coffee… but not so much the (paper) IOU. If you hold the pound of sugar, great; you have ownership, and can put it to use; but the IOU, no way. Only if you redeem the IOU will you hold any real value.

Notice that the pound of sugar is an asset… no matter who holds it. On the other hand, the IOU is an asset while it is in your hand; a claim on a pound of real sugar. Crucially, from my point of view the very same IOU is a liability; after all, it is a claim on me for a real item, a pound of sugar that I have to give back to you on being presented with the IOU.

The IOU is either an asset or a liability, depending on the point of view; the writer of the IOU vs. the holder. On the other hand, sugar is a ‘pure’ or ‘real’ asset; valuable no matter in whose hand it happens to reside.

This is what Aristotle considered ‘intrinsic value’… sugar has ‘intrinsic’ value, rather than the ‘derived’ value the IOU has. In simple words, the IOU has value only in so far as it is redeemed… and redeemable. This is often called ‘credit risk’ or ‘counterparty’ risk… the IOU is not very rugged; it will become worthless if the IOU writer defaults. Real stuff has no counterparty risk.

The very same IOU that is an asset in your hand is my liability… after all, if you present me the IOU, I am obligated to return to you a pound of real sugar… and so extinguish the IOU. Indeed, once redeemed, the IOU becomes worthless; paid in full… but the pound of sugar is still a pound of sugar… certainly not worthless.

Thus, money extinguishes debt; that is the hallmark of ‘real’ money. When (if!) I return your pound of sugar, the IOU is redeemed; the debt disappears, is extinguished by real ‘stuff’. We could even negotiate that instead of a pound of sugar, I give you ½ pound of salt; if you agree, then the IOU is also extinguished, again by real stuff. Substitute Silver and Gold for sugar and salt…

Suppose you decide to trade your IOU to Jane for the pound of sugar, rather than handing it back to me… if Jane agrees, you get your pound of sugar… but the debt is NOT extinguished; now Jane holds it, and I will have to give Jane the pound of sugar if she presents me with my IOU. The IOU served as medium of exchange; but NOT as extinguisher of debt. IOU plays (fake) monetary role, but is not money as it cannot extinguish debt.

Not only that; suppose I do not use the pound of sugar I borrowed, but instead lend it to Joe; in turn, Joe gives me an IOU for a pound of sugar… and magically, one pound of real sugar now has two IOU’s against it. Who would have thought! One pound of sugar, two IOU’s claiming the same pound of sugar. This process can proliferate with no end in sight; Joe could lend out the sugar again, etc… Endless IOU’s ‘backed’ by the same pound of sugar.

If you come to claim your pound of sugar, that I no longer hold, I cannot give you your sugar. Joe now has it; all I have is another IOU. Would you exchange the IOU that I gave you for the IOU Joe gave me? Mere exchange of debt notes… We start to see how real stuff is categorically different form IOU’s; debt notes masquerading as money cannot extinguish debt; they can only change the holder of the debt.

But it gets better, not just for silly debt like a pound of sugar IOU, but for debt in the real world. Let’s look at two companies; call them Co. ‘A’ and Co. ‘B’. Company ‘A’ makes grommets… and Company B buys grommets in order to incorporate them into its own product line of widgets. ‘A’ sells a hundred grommets to ‘B’; then on ‘A’s books, in Accounts Receivable, an entry is created for ‘one hundred grommets sold to ‘B’ for 100 monetary units, payable in 30 days’.

Similarly, in ‘B’s books, in Accounts Payable, an entry is created for ‘one hundred grommets bought from ‘A’ for 100 monetary units, payable in 30 days’. So far, nothing unusual; in 30 days, ‘B’ pays ‘A’, and the accounts are settled… the IOU is redeemed. Notice the IOU (for 100 grommets) is an asset on ‘A’s books, but a liability on ‘B’s book… just like the IOU pound of sugar. These IOU’s are two faced, assets and liabilities at the same time, depending on point of view.

Now suppose management of ‘A’ and ‘B’ decide to merge the two companies; ‘A’ and ‘B’ merge to become Company ‘Z’. So what happens? Well, the books of ‘A’ and ‘B’ are consolidated; the total assets and total liabilities are added, and appear in the books of the newly created Company ‘Z’.

But wait; if ‘B’ owes ‘A’ (payables of ‘B’, receivable of ‘A’) and ‘A’ and ‘B’ no longer exist, will these numbers be transmitted to ‘Z’; that is, ‘Z’ owes 100 monetary units… to ‘Z’?   Whoa. No way; the items cancel each other… any debts or payments due to other companies will stay… but the ‘A-B’ transactions cancel out. The IOU is consolidated out of existence by the merger of two previously independent companies.

Meanwhile, what about the grommets that ‘B’ just bought? Clearly these are now in the inventory of ‘Z’; and ‘Z’ will incorporate them in its product line of widgets. The real stuff stays; the IOU’s disappear. Real stuff is potentially money; real money cannot just disappear. IOU’s are not money; they can and do disappear. It’s that simple. Now substitute Treasury and Federal Reserve for ‘A’ and ‘B’, substitute treasury bills and Fed notes for grommets and widgets!

The bottom line; real stuff, ‘pure’ assets can be ‘real’ money… good or not so good. IOU’s that are assets/liabilities cannot. Unfortunately, the word asset is misused, applied to both ‘pure’ assets and to promises that are assets in one hand but liabilities in another. This is the core reason why the fake money system we currently live under is dying… and only real money comprising real assets can save our economy… and our civilization.

Rudy J. Fritsch

 

Monday

February 1st, 2021

From – Sound Money Defense League

More state lawmakers than ever are introducing sound money legislation in the opening days of the 2021 legislative session.

Several states will consider measures to remove sales or general excise taxes from the purchases of gold, silver, and other precious metals.

Many other states will weigh bills to eliminate income taxes on gold and silver.

Still others will decide whether state funds can be held in physical gold and silver — and may even consider establishing a state-chartered bullion depository.

With debt-funded spending and money-printing in our nation’s capital at breakneck speed, will states see the wisdom of enacting measures to counteract these policies of currency debasement?

Here’s a rundown on newly introduced state legislation:

In Mississippi, House Bill 375, sponsored by Representative Henry Zuber and Representative Brady Williamson, and House Bill 978, sponsored by Representative Joel Bomgar, include language to exempt precious metals from sales taxes.

Two of Mississippi’s neighbors, Alabama and Louisiana, have already exempted precious metals from sales taxes – so the Magnolia State will continue to be at a competitive disadvantage if it maintains its current policy of taxing real money.

South Carolina’s Representative Stewart Jones just introduced three sound money measures. House Bill 3378 excludes from gross income any net capital gain derived from the exchange of precious metals bullion.

And Jones’s House Joint Resolution 3379 would create a committee to explore the feasibility of a state-chartered metals depository. Finally, the representative from Laurens, South Carolina, has put forward House Bill 3377, which reaffirms that gold and silver are money.

Building on prior efforts to make precious metals purchases tax-free, Tennessee Senator Rusty Crowe introduced Senate Bill 251.

Meanwhile, Tennessee Representative Bud Hulsey and Senator Paul Rose introduced House Bill 353 and Senate Bill 279, respectively. These bills would create a study commission regarding a gold depository for the Volunteer State and a report of findings to the state Senate and House of Representatives.

In Arkansas, a measure that would eliminate the sales tax on precious metals purchases has been submitted for introduction by Representative Delia Haak, Representative Robin Lundstrum, and Senator Mark Johnson. Senator Johnson introduced a similar measure in 2019.

In Alabama, Representative Andrew Sorrell will re-introduce a measure to remove income taxes from gold and silver. While Alabama enacted a precious metals sales tax exemption into law in 2018, the original bill sponsor, Senator Tim Melson, plans to introduce a bill this year to clear up some ambiguity in the 2018 language and to push out a sunset provision for another 5 years.

Way to the west, Representative Val Okimoto and Representative Dale Kobayashi in Hawaii have introduced House Bill 1184, a measure to exempt precious metals from Hawaii’s general excise tax.

And Idaho Representative Ron Nate and Senator Steven Vick have put forward House Bill 7 to permit the State Treasurer to hold a portion of state funds in physical gold and silver. Idaho hopes to join Ohio and Texas as one of the few states make such a move to secure state assets against the risks of inflation and financial turmoil and/or to achieve capital gains as measured in Federal Reserve Notes.

Washington State removed sales taxes against sound money decades ago, but a lawmaker hopes to take it a step further. House Bill 1417, introduced by Representative Rob Chase and co-sponsored by Representative Bob McCaslin, seeks to eliminate all Evergreen State taxes on the only form of money mentioned in the U.S. Constitution.

Sound money forces could face some defensive battles in 2021 as well.

Fortunately, here are now 39 states that have removed some or all sales taxes from precious metals. But during the shortened 2020 session, revenue-hungry politicians in Maryland, Pennsylvania, and Washington State tried to buck the trend and repeal those sales tax exemptions.

All three of these recent attempts to reinstate taxes on the monetary metals have been defeated, but taxpayers should be wary of their return.

By communicating with lawmakers, providing testimony, and igniting a vocal grassroots response, the Sound Money Defense League and its allies continue to make the case for sound money and to defend the existence of current sound money policies.

Massive debt-financed government spending in response to COVID-19 has reemphasized the importance of sound money.

As state legislatures and Congress consider actions in the face of a global pandemic and an unprecedented economic meltdown, they would be wise to remove the disincentives that stand in the way of protecting citizens and their states with sound, constitutional money.

Jp Cortez is the Policy Director for the Sound Money Defense League, a non-partisan, national public policy group working to restore sound money at the state and federal level and publisher of the Sound Money Index.