Applied Philosophy

The following is a short exposition of Professor Fekete’s models of the capital market. These models are abstract representation of how the capital market functions when money is gold.

The Square Model

In considering the problem of exchanging income and wealth we may isolate two fundamental needs: (1) the annuitand’s need to convert income into wealth, and (2) the annuitant’s need to convert wealth into income. Typically, the annuitand is a younger man who is looking forward to getting married and starting a family. He tries to provide for the future needs of his family: for the education of his children, for emergencies caused by ill health, as well as for his and his wife’s old age. By contrast, the annuitant is an older man in his harvest years, looking forward to his twilight years with equanimity. He has by now accumulated the wealth that he is ready to convert into a suitable income. If the annuitand (annuitant) is restricted to direct conversion due to institutional restraints on the exchange of income and wealth, then the optimum conversion is furnished by gold hoarding (dishoarding). By the definition of marketability in the small, no further improvement is possible.

—THE PENTAGONAL MODEL OF CAPITAL MARKETS, by Antal E. Fekete

The annuitand is the saver who puts away part of his income, after many years of hard work he receives wealth. The annuitant is the pensioner who has wealth and no income.

The simplest case as described above means that the annuitand will have wealth equal to the sum of his savings, this will mean two things: first he will have to save a high portion of his income and second the saved income will leave the market. For the annuitant the income he will spend can not exceed his wealth and the money only enters the market slowly.

The problem is solved by the introduction of two more actors:

On the one hand, the annuitant’s need is answered directly by the entrepreneur who is anxious to give up income in exchange for wealth. He can profitably invest wealth in productive enterprise that will provide him with a larger income that he can easily share with his partner, the annuitant. On the other hand, the annuitand’s need is answered directly by the inventor anxious to give up future wealth in exchange for income. He is working on a new production tool or process that may take several years to perfect before it can be put in place. In the meantime he has to sustain himself and to defray the cost of his research and development (R&D). The new tool or process he is perfecting represents future wealth that he can easily share with his partner, the annuitand, who provides for him the necessary income in the interim.

—THE PENTAGONAL MODEL OF CAPITAL MARKETS, by Antal E. Fekete

The entrepreneur needs wealth to buy machines and materials, once production is started the enterprise will be self-sustaining and the excess income will be distributed to the shareholders (possibly more than one annuitant). The two problems are solved: first the annuitant will receive income as long as the enterprise goes on and wealth enters the market immediately.

The inventor needs income to sustain him while he develops and research, once the development finishes the results could be sold to an entrepreneur and the wealth distributed to those who supported the inventor. Again the problems are solved: the annuitand will receive wealth exceeding the sum of his savings and the money is returned to the market.

The Square Model of the Capital Market

The annuitant-entrepreneur relationship is very common, people usually invest in their relatives business ideas (as prof. Fekete explain “The family is the social unit providing a primitive framework for the exchange of income and wealth among its members”). The annuitand-inventor is less common, but should be viewed in the more general term: for example starting a company that offers a new service is a kind of an invention. As prof. Fekete puts it: “The invention introduces higher order production goods,” this can also be done by introducing new services.

Today all workers are annuitands and yet there is strong impediment to “R&D capital” formation. Instead of paying the income to inventor modern workers pay it to financial institution that gambles the money on assets appreciation. A large amount is taken by the government which promises future income from future tax receipts; the money is spent and equal government bonds are issued:

[T]he government spends the net premium income on current consumption while letting future taxpayers shoulder the burden of disbursing the retired population, there is the more subtle and sinister problem of depriving the inventor from his traditional source of financing.

—THE PENTAGONAL MODEL OF CAPITAL MARKETS, by Antal E. Fekete

The Pentagonal Model

The problem with the square model is that annuitants and entrepreneur have to be matched together, while annuitands and inventors have to find each others. Outside of family and close relations it is very difficult task. Since the entrepreneur and the inventor need the annuitant and the annuitand they might be pushed to giving up more than the fair share in exchange for capital. This can be solved by introducing a fifth player into the market:

This impairment of the bargaining position of the entrepreneur and inventor can be somewhat assuaged by the services of a fifth protagonist entering the capital market. As we pass from the square to the pentagonal model the marginal entrepreneur and the marginal inventor, who have been left out in the cold, can be accommodated as follows. They could form a partnership whereby the entrepreneur provides the income needed by the inventor to complete his project. The partnership will be net long of present wealth and net short of future wealth. But in as much as present and future wealth are not exchangeable in the absence of credit, the partnership is not viable. The entrepreneur and inventor must find a third partner who is willing to provide the needed credit in offering present for future wealth. This need has led to the emergence of a new actor in the drama of human action. He is the capitalist, and his entry heralds the advent of the pentagonal model of capital markets.

—THE PENTAGONAL MODEL OF CAPITAL MARKETS, by Antal E. Fekete

The capitalist is a person with excess wealth (the annuitant has wealth but needs immediate income), while the entrepreneur is a person who wants to start production but lacks the necessary capital (he might have part but not all the capital). The inventor is the researcher, the engineer, the designer; any person who is working to produce higher value in the future.

The Pentagonal Model of the Capital Market

Let us consider the historical development of the capital market—leaving the abstract models of Professor Fekete for a moment—before the development of limited liability companies and modern finance the entrepreneur was limited to a small workshop with him as the master-craftsman. The inventor was also limited and thus invention moved slowly and only by incremental steps.

As capital grew, thanks to colonial conquest and limited liability laws, the capitalist started to overshadow the entrepreneur. A capitalist would invest in industry and hire workers, craftsmen and managers. The capitalist would also hire engineers, designers and researchers. Companies not only produced products, but also developed newer and improved products. Once the capitalist entered the stage invention accelerated leading to better standards of life; this what Professor Fekete calls “progressive economic system.”

The triangular partnership of the entrepreneur, inventor, and capitalist, or troika for short, is the most potent and dynamic force in the economy that society has heretofore produced. Ludwig von Mises considers members of the troika the “most progressive elements” in capitalist society. They benefit the non-progressive majority in every possible way. The particular combination of talent, brain- and will-power represented by the troika heralds a new epoch of progress, far beyond the capabilities of individual talents if employed in isolation.

—THE PENTAGONAL MODEL OF CAPITAL MARKETS, by Antal E. Fekete

This judgement might had some truth in the halcyon days of the British Empire (which had a gold standard), today with dominant corporations and finance industry with unlimited money and a legal system built to preserve the position of established corporations the system does not have the same level of progress. Whatever the view of capitalism few would agree that the capitalist is the patron saint of the common man, as Professor Fekete describe him.

The Hexagonal Model

The last actor to enter the stage is the investment banker, who is an abstract representation of financial services when money is gold. This abstract banker exist only in an abstract world without fiat currencies and no central bank to dictate investment. With his entrance the saver (annuitand) and the pensioner (annuitant) have a solution in case they can not find a suitable investment for their money.

[The investment banker's] entry was made necessary by the marginal annuitand and the marginal annuitant. The former is the one who has just missed his chance to form a partnership with the inventor, and the latter his, with the entrepreneur. Without the
services of the investment banker the resources represented by the savings of the marginal annuitand and the marginal annuitant would be lost to society.

If the two formed a partnership whereby the former provided income for the latter, it would be net short of future wealth while net long of present wealth. It would take the skills of a specialist to nurture present wealth into future wealth of undiminished value. This specialist was the investment banker. He would invest the wealth of the annuitant in such a way that its value would grow and it could in due course be exchanged for income to pay an annuity to the annuitand. Under the gold standard the investment banker would buy gold bonds, the safest paper available for the preservation of wealth.

—THE HEXAGONAL MODEL OF CAPITAL MARKETS, by Antal E. Fekete

Once gold bonds are outlawed and replaced with fiat currency, that loses its value on a daily basis, the paradigm described above breaks down. The gold bond (my candidate for the common man’s patron saint) make it possible for the poorest member of the working class to save money without taking any risk, the simple act of depositing a small amount of money on a regular basis provides capital to lift the worker or provide money for his old age.

The Hexagonal Model of the Capital Market

Without a gold bond there is no safe way to save money, the money would lose purchasing power faster than any added interest, there is no saving account where pennies can be deposited so one day the worker would have enough money to buy a simple machine (e.g. a sawing machine), set up a household or send his child to school. Without the gold bond the working man is a sucker.

To make fiat currency acceptable the central bank lowers the interest rate to appreciate the price of assets. To pacify the working-class huge pension funds are set up to collect their savings and participate in the asset appreciation bonanza.

The Capital Market

Now we have all actors in the market, but the market is more than the sum of the actors:

The hexagonal model of the capital market brings about a great increase in scope for the most successful combination of capitalist production: the troika of the entrepreneur, the inventor, and the capitalist, already mentioned in the previous Lecture. From now on they can form their partnership even if unbeknownst to one another. The inventor need not waste time in seeking out a congenial entrepreneur, nor do the two of them in finding a suitable capitalist. If the invention is good and the enterprise sound, then they could start production on the most favorable terms immediately through the good offices of the match-maker, the investment banker. He will line up a capitalist to make the troika complete. Nor does the capitalist have to remain wedded to the same inventor and entrepreneur for the entire duration of the project. Through buying and selling gold bonds he can always go after the project that appears most promising to him. The problem of forming optimal triangles midstream can be safely entrusted to the bond market.

—THE HEXAGONAL MODEL OF CAPITAL MARKETS, by Antal E. Fekete

This is a description of an ideal abstract market. The five main actors all revolve around the investment banker, finance industry functions as plumbing in a house channelling money from one part of the market to the other:

The Capital Market

Let us start in the lower left corner and move clockwise: The annuitand deposits money into his saving account on a regular basis. The entrepreneur sells shares to his company and borrows money, he pays down his debts and distribute dividends. The capitalist buys shares and bonds and reinvest the interest and dividends. The inventor receives investment or draws on lines of credit, later he shares the wealth and pays off his debts. The annuitant buys shares and bonds and lives on the interest and dividends.

Let us now take a modern corporation, for example let us consider the old General Motors (bankrupt 2009): The annuitand were the workers who pied monthly contribution to a pension fund that invested in GM. The entrepreneur were the management who were paid many millions and rewarded with share options to the determinant of the shareholders. The capitalist were mutual funds and individual shareholders who owned GM shares. The Inventor were the large contingent of engineers and designers working for GM. The annuitant were retired workers and old people convinced by their bankers to buy GM bonds.

The financial services in reality has grown beyond the role of clearing and brokering overwhelming the whole economic system. Instead of plumbing it now represent the house’s main load beam.

Conclusion

Gold facilitates the primary division of labour, between different professions. Money in general and gold in particular will only develop after the development of this division, which usually start within the family unit and then expands through barter. I covered the importance of gold in The Difference between Future and Past Labour.

Real bills (i.e. discounted gold bills) facilitates the secondary division of labour, between different stages of production. Again this will only develop if the secondary division of labour has already developed, when some people chose to buy ready-made products. I covered the importance of real bills in Real Bills are Not Usury.

Lastly gold bonds facilitates the division of finance. As described above this happens only after the development of capital market.

Clearly a high level of division is preferable, despite the risk of systemic failure. The growth of industrialisation first took place within a single layer of division: for example in place of a thousand weaver a single capitalist would employ five-hundred to produce double the amount of cloth, quadrupling the productivity. The concentration of capital, due in large part to factors outside of the economic domain, lead to the growth of this trend to include multiple stages of production.

After a century of industrialisation and capital concentration the modern production line was born, subsuming the whole production process. This happened at the same time as real bills practically disappearing due to the breakdown of international trade during the Great War.

The replacement of fiat currency for the gold coin caused a gradual transformation of society, the slow process went hand-in-hand with the loss of value now standing at 99%. Small shops, private practices, partnerships, family restaurants either go out of business or grow to become corporate entities taking over other similar enterprises. Doctors and lawyers are no longer gentlemen but salaried workers. This change starting since the great depression had a great social effect beyond the economy, its greatest effect might be the slow strangulation of western democracy.

Banishing the gold bond from the economic system, in the last forty years, caused the concentration of financial powers into the hands of a few companies. Now large financial institutions with assets exceeding the yearly GDP of their countries control the world and when they suffer loses threaten complete destruction unless the state rescue them. One might call that the parasitic model of the capital market.

See also:

• Bagehot on Money a 5-part series discussing Bagehot’s book on how capital markets developed historically.
• Human Freedom Rests on Gold Redeemable Money (PDF) by Howard Buffet, US congressman.

God is dead

Fred

Fred is dead

God

—The Benny Hill Show, circa 1985

I remembered this joke when I heard the latest remarks by Warren Buffet about investing in gold. I clocked Buffet the first time I read his Wikipedia page way back in 2006, I realised then that he is a financial creature and not an economy investor (I described him as ‘odious’ in December 2008). The general public were quite taken with the sage but mistrust started when he stood up to defend the financial sector in 2008. Dislike came from seeing how much he was cosy with the Obama administration and China. Today a lot of people are turning away in disgust as he disparages gold buying.

The real problem is not Buffet but the gold enthusiasts who advertise gold as an investment: gold is not an investment. With friends like these gold is an easy target for a viper like Buffet. Gold is physical wealth that functions as money, it is not an investment. I would buy gold because I know that fiat money will lose all exchange value in the market sooner or later, but I would not buy it as an investment, because gold is not an investment (I said it three times now).

If gold is money then what are dollars? The dollar is a Federal Reserve Note, i.e. a zero-interest rate debt security that never mature, Treasury notes on the other hand pay interest and mature in less then a year. Some people who advocate gold say that there have been 10 years of growth, but in reality there has not been any growth. An ounce of gold ten years ago is still just an ounce, it did not germinate and produce a hundred ounces nor did it get pregnant and produce an ouncelet. What has happened in the last ten years is that the dollar lost value:

The Dollar Priced in Gold (Feb 98 - Jan 12)

(source The World Bank, Graph made with LibreOffice. Image created with GIMP)

This is the correct graph that reflects reality instead of illusions. You can not in invest in gold, but you can profit from a falling dollar to make real money. First you have to adjust the way you carry your accounts: all accounts have to be in gold instead of dollars and profit measured in gold and not dollars. Success means increasing the weight of gold owned and not the amount of dollars. A typical account book would look like this:

Example of accounting with Gold instead of Dollars

(Table made with LibreOffice. Image created with GIMP)

I personally would carry silver apart and other bullion with gold. I take into account the physical premium when converting dollars to gold so the price of dollars is set lower than the market rate. Receivables are any promise to deliver physical gold at a later date or on demand. I do not add a haircut on receivables to account for counter-party risk, but that can easily be done; it might be also useful to separate receivables according to risk. Other assets, stock or real estate, can be added in the same way. The bottom line is in gold, growth can only happen by increasing the bottom line.

Now we can do three different things: the first is to do nothing. This will result ultimately in a lower bottom line as the value of the Federal Reserve notes go to zero. The second option is to convert all dollars to gold, this will leave us without any legal tender and in case of an emergency we will have to buy dollars at a loss. The third option is to invest in dollars to increase the bottom line.

How do you invest in dollars? Easy all we have to do is to apply the old rule of buying low and selling high. We buy dollars when the price is low (translated: sell gold when the price is up) and sell them when the price is high (translated: buy gold when the price is down). You have to be nimble to take advantage of declines (gold price spikes) and spikes (gold price declines), but a careful trader without using margin can probably grow his gold every year.

Earning gold through the future markets is nearly impossible (a single contract is 100 oz. and taking delivery is very difficult). Having a retail shop is great, you would buy bullion by weight and sell it marked up; a shop requires independent means of living (so you would not eat your capital if people stop buying) and a culture of buying gem-less jewellery. Most people can increase their gold by earning dollars and buying bullion from the government mint (some private mints give good prices for bulk buying).

See also:

• Human Freedom Rests on Gold Redeemable Money (PDF) by Howard Buffet, congressman and father of Warren.
  
• The S&P 500 went DOWN 13% in 2010, the stock market measured in gold.
• Will the Fed ever Get Paid Back, why the dollar is going down.
• Will the Real Gold Standard Please Stand Up, relationship between silver and gold.
• The Difference between Past and Future Labour, why gold is money.
• High Treason in Zimbabwe, specifications for a new gold coin.

In How to Honour your Financial Obligations I discussed the UK War Loan. Jeremy Warner of The Telegraph writes on his blog:

In their best selling book, This Time is Different: Eight Centuries of Financial Folly, Carmen M. Reinhart and Kenneth Rogoff describe the cut – from 5pc to 3.5pc – as a default, which actually it wasn’t, either technically or in any other regard.

The prospectus for the original war loan gave the Treasury the right to redeem the stock at any time. Given that interest rates had at that time sunk significantly below the original rate, all the Debt Management Office was doing was exercising its right to refinance the debt at a lower rate. There was nothing new about this exercise. The same thing had been done with a number of other government debts in the 1880s. These were swapped into “consols”, which like the 1932 War Loan, are still around to this day.

—Britain has never defaulted – or has it? (technical) [my emphasis]

Bond face value paying 5% interest at different interest rates

The terms of the War Loan was to repay the bond in 1947 and the Treasury had the right to redeem it at face value at any time. I have already explained in Liquidating the Debt of the United States that when the interest rate declines the value of a bond rises. The terms protected the Treasury, because declining interest rates means that deflation increases the purchasing power of money. The Treasury did not pay the face value of the whole War Loan, it swapped them for other bonds; the new bonds had a lower coupon and no redemption date. Here is the historical context from the Bond Vigilantes blog:

Another event that I would classify as a default was the changing coupon on the gilt known as War Loan. Issued in 1917 (“If you cannot fight, you can help your country by investing all you can in 5 percent Exchequer bonds. Unlike the soldier, the investor runs no risk”, the adverts said), the bond’s coupon was reduced from 5% to 3.5% in 1932. You can read Chancellor Neville Chamberlain’s speech announcing his plan in Hansard, here. This was a voluntary conversion – you could have had your money back – but the moral screws were on. Chamberlain ends his speech saying “For the response we must trust, and I am certain we shall not trust in vain, to the good sense and patriotism of the 3,000,000 holders to whom we shall appeal”. 92% of holders accepted the new, lower coupon (probably not just for patriotic reason, but because 3.5% was still a better rate of interest than was available elsewhere in those deflationary times). Today, we have seen the ratings agencies classify similar events as defaults, even if such disadvantageous changes were consensual.

—What happened the last time the UK defaulted? [my emphasis]

Contrary to what Mr. Warner states it was a voluntary restructuring with 92% of the holders agreeing. If the terms gave the Treasury the right to exchange the debt with another debt, there would have been no need to consult the holders. As the link between gold and the pound was severed in 1931 the value of the loan declined drastically.

We’ve written about War Loan before it was issued during World War I with the 1917 advert stating “if you cannot fight, invest all you can in 5% bonds. Unlike the soldier the investor runs no risk.” The “no risk” bit wasn’t strictly true. In 1932 its coupon was “voluntarily” reduced from the original 5% to 3 1/2% – I’ve argued before that this should be viewed a default event for the UK Government . Additionally, because inflation has at times been way above 3 1/2% in the intervening decades, the real returns have therefore been sharply negative, and as recently as 1990 the bond traded at a price below 30 pence in the £.

—Will the Debt Management Office redeem War Loan? [my emphasis]

Jeremy Warner himself confess that: “Since 1932, [inflation] has utterly destroyed the value of of the £1.94bn of war loan outstanding.” Today the total notional value of the War Loan would buy less than one half of one percent of the gold that it would have bought a hundred years ago.

Lost value against gold between 1900 and 2012

The three most clicked links on my blog are:

Click for a better view

Two of the first three are images in the post Metallic value in Euro coins published only 14 months ago. Despite coming three years after the start of the blog it grabbed the first and third places; traffic is driven by search engines. Clearly people are wondering, just like I did, what is the real value of a coin. I designed the worksheet so that I can update the prices and get new ratio’s, but, unfortunately, I don not have access to it presently.

The interest, and problem of rising intrinsic values, is also present in the US. A recent CNN article gives valuable information about the situation in the US (the article is worth reading, I am only quoting the part about intrinsic values):

The raw material cost of the metals used in a current penny is only about 0.6 cents per coin, according to prices quoted on the London Metal Exchange, and a breakdown of a penny’s composition from the mint. The mint paid 1.1 cents on average for the metal used in a penny in 2011, but that is the cost of ready-to-stamp blanks from the supplier, not raw material traded on commodity markets.

There have been times in recent years when a run-up in zinc and copper prices has taken the raw material value of a penny above one cent.

That’s the case for a nickel today. Its more expensive metal mix means the raw materials in each are worth almost 6 cents per coin, based on current market prices.

—Obama wants cheaper pennies and nickels [my emphasis]

A penny (1 cent) has 60% ratio, while a nickel (5 cents) has 120% ratio. Before you rush out to get nickels you should be aware of the law:

The US Mint specifies that this coin weigh 5.000 g and be composed of 25% nickel (1.250 g) and the balance of copper (3.750 grams). On June 13, 2008, the value of the metal in a United States nickel coin reached $0.06013, a 20.3% premium over its face value. This was due to the rising price of copper and nickel and the decline in value of the United States dollar. In an attempt to avoid losing large quantities of circulating nickels to melting, the United States Mint had earlier introduced new interim rules on December 14, 2006 which criminalized the melting and export of cents and nickels. Violators of these rules can be punished with a fine of up to $10,000, five years imprisonment, or both. See Title 31, United States Code Section 5111(d). The rules were finalized on April 17, 2007.

—Nickel (United States coin): Metal value [my emphasis]

Think about it for a second: the government uses force to make you accept pieces of metals for more of their intrinsic value and the same government uses force to prevent you profiting from the same pieces of metals. This law will hold as long as the punishment is greater than the reward, as the ratio rises the coins will have to be withdrawn (see Metal Theft in the United States at Wikipedia for more information).

I wrote it once and I will write it again: all persistent inflation is hyperinflation! When inflation is followed by deflation that restores the lost value and then some, one can talk about ‘inflation’. Inflation that is never balanced by deflation and accumulated lost value that consumes 99% of the currency is hyperinflation, regardless of the time-scale. When prices doubles every month and you live from pay-check to pay-check, everybody can see the ‘hyper-’, when prices double every twenty years such things are not mentioned in polite society. If, however, your time-scale is measured in decades you will be suffering from all the ills of hyperinflation without even realising (or daring to mention) why.

Governments cannot change the composition of coins every decade, because all vending machines, counting machines, fraud detection machines would have to be changed. Sometime a solution could be found, like after the inflation of the seventies, when all-copper pennies were replaced with copper-coated coins, but this is not the norm.

The US Dollar has lost 98% of its value against gold. The British Pound has lost 99% of its value against gold. This happened in the eighty years since the Great Depression. The Euro have lost about 75% of its value against gold during its 13 years of existence. At the end I can only repeat what I have already written: Coins are problematic in an inflationary environment due to their substantial intrinsic value compared to paper money, sooner or later their intrinsic value will exceed their face value.

See also:

• Beware the Boom! discussion of hyperinflation.
• Defining Inflation long-term graphs of the dollar.
• Zimbabwe’s Monetary Policy instead of learning from it the West made fun of Zimbabwe’s plight.

Contrary to what might you have heard, dear reader, the S&P 500 index was not up 13% in 2010, it actually went down 13%.

First an updated graph of the S&P 500 which I first posted in Beware the Boom! showing the S&P 500 index in nominal terms and relative to gold price:

S&P 500 Index, nominal and relative to gold

For those of the opinion that gold price is a bubble I would advice they take a good look at the graph above and bear witness that the S&P 500 three decades bubble is coming to an end.

We can see the change of the S&P 500 and gold in US dollars last year with this graph from StockCharts.com:

Gold and S&P 500 nominal performance in 2010

Their ratio went from 1.017 to 0.89 in one year, a decline of 13%. If their ratio goes to 1983 level, about 0.30, that would be a decline of almost two thirds from current level; a simple example would be gold rising to $4500 or the S&P 500 crashing to 400.

The end of the third year for this blog seems an opportune moment to examine its track record and update some graphs.

Tsunami

On March 25, 2008 more than 24 months ago I posted the following graph in The Coming Unemployment Tsunami:

Forecast

The target was reached in less than a third of the forecasted duration:

Actual

Result: Predicted employment ratio correct, predicted duration wrong.

Shattered

On July 4, 2008 I posted the following graph in Shattered and announced that US banks were insolvent:

US banks are insolvent

Few months later I updated the graph in The Unemployment Tsunami Has Arrived:

reserves climb from $44 billion to $315 billion in two months

Now the situation looks like this:

Non-Borrowed reserves at $1 trillion

First the Fed kept total reserves constant by lending to the banks, the money was raised by selling treasuries and not printed. This went on from the start of the recession until Lehman went under, at which point the Fed started printing money and flooding the banks with cash.

However, “Quantitative Easing” is a very dangerous hallucinogenic drug, and quoting Santayana again, “Those who do not learn from history are doomed to repeat it.” Fed chief Ben “Bubbles” Bernanke, who strongly endorsed “Easy” Al Greenspan’s ultra-low interest rate policy earlier this decade, which was designed to inflate the commodity, housing, and sub-prime debt bubbles, is now fueling a massive Treasury market bubble, and legions of speculators are taking collective leave of their senses and succumbing to delusions of zero-percent 10-year yields.

—Beware – “Quantitative Easing” is Hallucinogenic by Gary Dorsch [my emphasis]

As newly printed money was absorbed by the banks, they started paying back the Fed. Their borrowings from the Fed steadily declining since then. The printed money did not cause inflation because the banks kept it in reserve with the Fed, but slowly the money is seeping to assets. Now the Fed is going to print $600 billion new dollars, but the reserves are not going higher.

The high reserves are like a huge body of water behind a dam and the economy is the little village at the foot of the dam. Would you sleep soundly if you knew there were cracks in that dam?

Result: The cure is worse than the disease.

Fed Balance Sheet

On May 15, 2009 I posted the following graph in Four Graphs:

Treasuries held by the Fed

First the Fed sold about $300 billion of treasuries to fund lending to the banks (see graph above). When Lehman collapsed the Fed stopped selling Treasuries and monetised the banks bad assets. Afterwards it started monetising treasury debt, but it did not buy back what it sold, as the following graph shows the Fed has sold short term treasuries and monetised long term federal debt. Treasury Bills (reddish lines) declined, while Treasury Notes and Bonds increased (green, blue and magenta lines).

The Fed's Treasury securities composition

China treasuries holdings, October 2010

When the interest rate increase the value of all these bonds will decline below what the Fed ‘paid’ for them. The Fed will most certainly not mark them to market, resulting in a balance sheet that does not reflect the truth, just like the banks that ‘suddenly’ went bust after years of profit making. The reality was that their balance sheets were not reflecting their true financial position.

Now the Fed’s balance sheet resemble China’s holdings of US treasuries (graph from China Sells Long-Term Bonds In October As Foreign Inflows Moderate, Fed Untouchable At Top Of US Paper Holders List at ZeroHedge.com). While banks and financial institution hold short-term debt, that must be refinanced at the new higher rate, the Fed and China are stuck with long-term debt that they can not sell without taking a loss and if they hold until maturity they will be paid with worthless dollars. For the Fed that is not a problem, for China (and everyone else)  it is a catastrophe.

Result: Federal Reserve balance sheet is going down the drain.

Euro Abattoir

On March 16, 2010 I predicted in Bear to Bear, Lehman to Lehman that after six months of Greece’s ‘bailout’ another such slaughter will take place.

On the evening of 21 November 2010, the Taoiseach Brian Cowen confirmed that Ireland had formally requested financial support from the European Union’s European Financial Stability Facility (EFSF) and the International Monetary Fund (IMF), a request which was welcomed by the European Central Bank and EU finance ministers. The request was approved in principle by the finance ministers of the eurozone countries in a telephone conference call. ….
…
On November 28, the European Union agree to a €85 billion rescue deal of which €22.5 billion from the European Financial Stability Mechanism (EFSM), €22.5 billion from the IMF, €22.5 billion from the European Financial Stability Facility (EFSF) and bilateral loans from the United Kingdom, Denmark and Sweden. The remaining €17.5 billion will come from a state contribution from the National Pension Reserve Fund (NPRF) and other domestic cash resources.
Eurogroup President Jean-Claude Juncker said that the deal includes €10 billion for bank recapitalisation, €25 billion for banking contingencies and €50 billion for financing the budget.

—2008–2010 Irish financial crisis, Wikipedia [my emphasis]

The workers’ pension fund is raided to bailout foreign creditors of private banks. Ireland is the second to enter the slaughterhouse, but it will not be the last.

Result: Prediction was accurate, but took two months longer.

Hyperinflation

Hyperinflation has been a recurring theme on this blog. People in the West have many misconception about hyperinflation, it conjectures up images of wheelbarrows and banknotes burning in the heater. The reality is that hyperinflation is more subtle than that (see Beware the Boom!) and most likely such images will not be seen in Western countries any time soon; there must first come an intermediary period of high inflation. This period will be: The Great Inflation 2011-2012.

One scenario could be: In the coming year prices of essentials will rise but those of non-essentials and wages will decline. This means that profit margins and disposable income will decrease. The year thereafter will see shortages as producers go out of business. Most of the inflation will be concentrated at the end of the second year. Afterwards the economic crisis will metamorphose into a political/social crisis. The US will enter long-term stagnation, while the EU will leave stagnation (entered a generation ago) and start to visibly decline.

Inflation is coming one way or another, gold and oil have risen respectively 24% and 8% year to date. Food cost is going up, led by wheat prices. People are starting to worry about inflation, which is the best measure of inflation.

Result: The End is Nigh.

In Bacon on Usury I claimed that there were other ways to get financing than usury. In this post I show a way to finance the production of consumer goods. This method is suitable for fast moving goods, for example perishables, seasonal cloths, etcetera. I will show an example and then go into a more systemic discussion.

Real Bills Practical Example

Imagine there is a baker with a bakery ready to transform flour to tasty backed goods to satisfy public demand. The only problem is that he has no flour; a miller has flour ready for the market. The obstacle is that the baker has no money to pay for the flour. The solution is for the miller to sell flour to the backer on a delay payment scheme.

The backer will take possession of a $95 worth of flour on the first of the month and give the miller a bill drawn on the fifteenth for $100. The miller is giving up value but not receiving value back for it, thus the ancient law of barter is not satisfied. The miller, although giving up possession of the flour, is not giving up ownership of it. Until the bill is paid by the backer the flour is the property of the holder of the promissory bill, i.e. the miller.

The backer will bake bread and cakes and sell them to the public. To fulfil the ancient law of barter the public must give the backer real value, e.g. gold or silver coin, but that is a subject that has already been covered (see The Difference between Past and Future Labour). The backer’s total sales will be, for example, $120 (in any way higher than $100) due to the added value of his labour. He will pay the miller’s bill and maybe $10 for other costs and the last $10 is his income.

Let us say that after one week of selling the flour the miller’s son falls and breaks his leg, the miller now needs cash to pay the medical costs. The miller can not sell his mill just for a small amount of cash; he can sell some of the corn, but that is his working capital. The miller would want to sell flour, because that contains the added value of his labour, while the corn only contains the value of what the miller paid the corn merchant for it.

The miller still owns the flour he gave the backer and the bill is the proof of that ownership. The miller knows that the grocer sells $97.5 worth of goods for a $100 one-week delayed payment, so the miller sells the bill to the grocer for $97.5. This time the backer’s bill is not only a promissory note but also represent value, so the ancient law of barter is satisfied by the exchange. After a week the grocer submits the bill to the backer and collects a $100.

The result is that the backer received financing, the miller sold his goods and made a profit of $2.5 on his $95 in one week and the grocer made a profit of $2.5 on his $97.5 in one week (the difference follows from the fact that the miller discounted a bill of two weeks and the grocer discounted a bill of one week duration). The probability that the backer will fail to sell his goods is very small, there is very little that could happen in a fortnight to drastically change the market (natural disasters will devastate the whole market and loses will effect everyone).

The miller might have bought the corn from the corn merchant with the same method by discounting a bill drawn on a future date. In reality the whole path of consumer goods from raw materials to finished good can be financed by discounting bills, such that the amount paid by the final consumer settles all the bills.

Real Bills System Conditions

Let us start with a quote from Professor Fekete a champion of Real Bills:

All the government needs to do is to open the Mint to gold and to protect real bill trading against fraud. Funds raised through the bill market are public funds that must be protected against misuse just as other forms of public funds must. Let me mention just three types of misuse: (1) drawing more than one bill on the same consignment of merchandise; (2) drawing a new bill upon the expiry of the old on the same unsold merchandise; (3) financing stores of goods in the expectation of a rise in price by drawing bills.

Bills of exchange drawn on goods in most urgent demand and moving fast enough to the ultimate gold-paying consumer are capable of monetary circulation on their own wings and under their own steam, regardless whether or not banks are standing by, ready to monetize them. But if they are, legislation should prohibit banks from borrowing short in order to lend long. In practice this means that the banks would be prohibited from rolling over short term commercial credit at maturity. Commercial banks must also be prohibited from conspiring with the drawer of the bill. Withholding stocks from trade in expectation of a rise in price must be financed by an investment bank, never by a commercial bank. The two types of banks should be strictly separated by law. Commercial banks must also be prohibited from investing in brick and mortar. In practice this means that mortgages are “hands-off “.

Treasury bills are also “hands-off”, except on capital account. We know that people will want to eat and to keep themselves clad and shod tomorrow. That’s what makes bills the safest earning asset. We also know that people will pay their taxes only after they have eaten, clad and shod themselves. That’s why real bills as an earning asset are superior to Treasury bills.

—The Hungarian Connection by Antal E. Fekete [my emphasis]

The first step is opening the Mint, because Real Bills do not function with fiat money, discounted bills have to be settled with bullion coin. Professor Fekete states the following three misuses:

1. “drawing more than one bill on the same consignment of merchandise;”
   Once a bill is drawn on merchandise the holder of the bill is the real owner of the merchandise, drawing another bill on the same merchandise amounts to fraud.
2. “drawing a new bill upon the expiry of the old on the same unsold merchandise;”
   A discounted bill promises to pay coin at a certain date, rolling the bill breaks the implicit trust needed for the system to function.
3. “financing stores of goods in the expectation of a rise in price by drawing bills.”
   Only the bill of goods on the line of production that ends with the paying consumer can be discounted.

All three must be prohibited by law and severely punished, up to the death penalty. Although a single violation is a small crime, the system of Real Bills is based on trust and each violation undermines the trust and consequently the economy.

I would add the following condition: Ownership remains with the holder of the bill, the merchandise is given on trust. In case of failure to sell or destruction of merchandise the bill’s holder takes back the merchandise or absorbs the loses.

Compared to people like Friedman and Krugman Professor Fekete is an intellectual giant, but no one is perfect. Professor Fekete errs when he fails to distinguish that Real Bills are not usury (if the above conditions are satisfied) and thus falls into the trap of thinking that usury is anything but extremely harmful and must be prohibited at all times and under all circumstances. He thinks that it is enough to have usury “strictly separated” from the real economy, financed by real bills, to avoid the damage of usury.

When France and German enacted fiat currency laws in 1909 (see Professor Fekete’s article Forgotten Anniversary) the people did not riot, they did not object, no one minded. The people had been using fiat currency for a whole generation, since the 1870′s, the laws only codified the reality. The Federal Reserve act of 1913 strictly prohibited the Fed from buying anything other than Real Bills, now the Fed holds a trillion dollars worth of treasury debt; the law itself was changed during the depression in accordance with the reality.

The economy is the health of society, there can be no compromise when it comes to it. Societies are not like secure citizens, living in a safe society, they are more like animals living in a jungle, any weakness and the predators (sickness, rivals, etcetera) will jump on them.

Usury is the most dangerous sickness that strikes a society, usury is like cancer cells, it metastasises and consumes the whole body if it is not removed. Cancer is so dangerous that a doctor will either open the patient and cut it out just like a butcher filleting a carcase; or douse the patient with toxic cocktail of chemicals; or as a final solution radiates the patient with the same radiation released by nuclear bombs. Doctors take all these extreme measures to save a single life, while the damage of usury could destroy society and cause widespread devastation.

See also:

• Sovereign Credit is State Usury
• High Treason in Zimbabwe
• Real Bills: an Emergent Market Phenomenon by Bill Koures.

When I wrote Zimbabwe’s Monetary Policy that country was at the peak of its hyperinflation, since then a lot has happened: A unity government, the sacrifice of sovereign rights on the alter of international finance, a resumption of the economic movement of society, et cetera.

In this post I will examine a document from the website of the Reserve Bank of Zimbabwe “December 2009 Monetary Policy Statement: Consolidating the Gains of Macroeconomic Stability” a most interesting document as you will shortly see dear reader.

First the limits of the Policy Statement:

1.2

In drawing this policy framework, the Bank is also guided by Government’s overall short-term, medium and long term economic and social programmes, as recently enunciated in the 2010 National Budget that was unveiled by the Hon. Minister of Finance on the 2nd of December, 2009, as well as the Three Year Macro-Economic Policy and Budget Framework 2010-2012 (STERP II), which was unveiled on the 23rd of December, 2009.

1.5

Under the current multiple currency system, which STERP II has clarified that it will still be with us by 2012, the Central Bank will primarily focus on the following key areas, which form the nucleus of the Monetary Policy activities and priorities over the next 6 months:
(b).
Contingent upon the availability of resources, the Bank will perform the lender of last resort function to ensure continuity and stability in the financial sector’s intra-day trading activities;
(d).
Implementation of the country’s Exchange Control Guidelines and Regulations in a manner that strikes a fine balance between maximising the virtues of economic and trade liberalisation and the need to ensure that the country gets maximum value for its exports shipped out, whilst also getting full value for import payments effected at all levels in the economy;
(f).
As Banker to Government, and as is spelt out in the statutes, the Central Bank will continue to manage the country’s gross international reserves position, including the holding of the Special Drawings Rights (SDR) accounts at the International Monetary Fund (IMF), with Treasury charged with the actual usage of the funds therein;

Notice how the role of ‘lender of last resort’ is contingent upon the availability of resources; in reality the RBZ cannot be the lender of last resort; further on I will quote a paragraph that states just that.

The moment that Zimbabwe gave up its sovereign right to issue and regulate its own money it gave up having a lender of last resort.

Western banks can gamble knowing that their central banks will bail them out, while third-world countries with currencies pegged to foreign money are out-bid on national assets and sometimes completely bought out.

These limitations are quite different from the situation a year ago:

1.7

The events of the 2004-2008 epochs, where virtually all aspects of public sector policy implementation were thrust on the Reserve Bank were a survival necessity that should be avoided now and in the future through robust policy formulation and implementation across all structures of Government.

1.8

The Reserve Bank is on record saying that we will not interfere in any areas outside our statutory mandate if those responsible for those areas are doing their job.

That is exactly why all countries have given up gold and silver and adopted fiat currencies: control. Money is the blood that circulates in society, carrying value from one place to another. Government should control society by political, moral and religious authority. A corrupt government will try using money to effect social movements in its favour, the ultimate result of that is fiat currency and tyranny. Zimbabwe’s hyperinflation only revealed this hidden aspect of modern society.

The last points of the first section might be the most important:

1.11

The Reserve Bank wishes to once again reiterate the inescapable truism that for as long as Zimbabwe remains under the hurdle of the illegal sanctions imposed on it, the fragility of the economy and the current multiple strains on its vital social sectors will be elongated over the outlook period.

1.12

This will continue to slow down the pace of meaningful resource mobilisation, investment promotion and vibrancy of the productive sectors of the economy.

Sanctions are the modern form of medieval sieges, the only difference is the number of people affected. A siege might affect ten thousands and kill a few hundreds, while sanctions affect ten millions and kill hundred of thousands.

I repeat what I wrote before:

Domestic poplar support in the west for such inhuman, unjust and illegal sanctions is the prelude for inhuman, unjust and illegal domestic restrictions; sooner or later societies will pay for their crimes (see The Seven Deadly Sins of Society).

We move forward to the second section and the state of the banking sector:

2.6

Our banking sector is now largely dominated by commercial banks following conversion of lower level licences in recent years.

All investment banks in the US have transformed into bank-holding companies, to be able to tap the Fed in case of a credit shortage.

The RBZ have been very innovative during the last few years, coming up with total new financial systems every six months or so; let us see if their latest idea’s have taken off:

2.7

In my previous Monetary Policy we advised that the Banking Act [Chapter 24:20] had been amended to provide for the licensing and supervision of microfinance banks by the Reserve Bank.

2.8

To date the Reserve Bank has received two applications for Microfinance banking licences, which are currently under consideration.

So micro-usury did not take off in Zimbabwe they are better off (see: Micro Credit is Usury), but the important question is how did the banks weather the end of the hyperinflationary storm:

2.12

The introduction of the multicurrency system necessitated the restatement of banking institutions’ balance sheets to take into account the value of assets which in conventional accounting terms had been depleted to zero, following the period of hyperinflation. The take-on balances were confirmed by the banks’ external auditors.

2.13

As supervisory authorities and in agreement with the accounting / auditing profession and the IMF, the Reserve Bank accepted restated values of owner-occupied and investment properties, subject to prudential “haircuts”, as part of qualifying capital.

Assets depleted to zero, i.e. debts hyperinflated away. The bank might have a note of one million, but can not collect because the smallest currency bill is worth ten millions. The solution was the same one used in Weimar Germany, but instead of the central bank mortgaging the property to back the currency in Zimbabwe it was the private banks that mortgaged the land and property to back their balance sheets.

You might wonder dear leader how the banks survived if their assets have been reduced to zero, easy: banks function according to the principle of the balance sheet, everything they lend (i.e. asset) is balanced by something they owe (i.e. liability); assets as well as liability were inflated away, including customer saving accounts.

Let me illustrate with a story from Germany circa 1922, it goes like this: A gentleman had sixty-thousand marks in his saving account. The bank sent him a letter telling that his account has been closed and they are sending him a one million mark banknote because that is the smallest available banknote in circulation. The punchline of this story, the post stamp on the letter was worth five million marks!

Save your fiat money in usury-banks and you will lose it all; it happened in Germany, Hungry ,Thailand, Argentina, et cetera.

Impact of the Global Financial Crisis

2.29

The effects of the global financial crisis have been far-reaching, affecting both the financial and the real sectors of the economy. The most evident impact of the crisis is declining demand for local and regional exports, depressed global commodities prices, job losses and currency dislocations.

2.30

The level of international capital inflows, including foreign aid, has also declined, as countries attempt to consolidate their financial positions.

2.31

Access to both international and regional lines of credit has been constrained, contributing to market- wide illiquidity and hampering effective financial intermediation by the banking sector, particularly, to the productive sectors of the economy.

Poor weak countries that open their markets to international foreign capital play a very dangerous game against an opponent who holds all the cards and changes the rules to suit himself, the only outcome is loss of national capital & resources.

Countries that become specialised exporters, following the fake advise of Western experts will be under the mercy of circumstances playing out on the other side of the world:

The eruption destroyed millions of flowers—in Kenya Floral exports make up 20 percent of the Kenya’s economy—and they have been completely shut down by Europe’s flight ban. The head of the Kenya Flower Council told the BBC that local growers have been forced to destroy 3,000 tons of flowers since last week with devastating effects on the local economy.

—Iceland’s volcano: 9 strange facts

Most of these countries have opened up their markets to receive aid from the West. Aid to Africa is one tenth of the money removed from Africa and even that small amount is used to implement policies favourable to the giving power (see Michael Hudson’s book The Myth of Aid). We saw that clearly with Zimbabwe, aid withheld when the people were dying in the street and given when a pro-Western government came to power.

Credit Reference Bureau
2.34

The Reserve Bank encourages banking institutions to consider funding the setting up of a Credit Reference Bureau.

2.35

The establishment of a Credit Reference Bureau will provide a central database for credit information sharing which will, among other things, augment credit risk management, and provide the requisite support infrastructure for the implementation of Basel II.

Such agencies as the ‘Credit Reference Bureau’ are not set up to protect the consumer from bad loans, but instead to protect the lenders from borrowers. Note how the banks are going to set up this agency and not the state, because it will function to their benefit.

When a lender decides to knowingly lend to people with bad credit and then sell these loans as triple A loans you get a ‘sub-prime crises’.

Zimbabweans should not borrow money because the Credit Reference Bureau give them a high score or a passing grade, forewarned is forearmed.

But banks are secondary, let us examine what is happening in the real sectors:

3.33

In terms of debt owed to Non-Paris Club members, China remained the largest creditor at US$323.4 million, followed by South Africa (US$16.3 million) while the balance is owed to Saudi Arabia (US$1.6 million) and Israel (US$1.2 million).

China is moving into Africa, their influence will be short lived as they face collapse of central government in less than thirty years (see: The Future History of China Today)

Gold

3.62

Gold output is estimated at significantly increase from 3 072 tonnes recorded in 2008 to 5 tonnes in 2009 [should read: from 5 tonnes in 2008 to 3702 tonnes in 2009]. This is largely due to the late resumption of operations by gold miners.

3.63

The liberalisation of gold marketing introduced in 2009 has, however, allowed gold mines which had suspended operations to resume production. In addition, the issuance of gold dealership licences to gold producers has resulted in mining houses securing lines of credit, critical in increasing production.

3.64

As a result, Zimbabwe’s largest gold mine, Metallon Gold, which had closed down its five mines, has since re-opened two of its mines, and is expecting to reopen the other three by year end.

3.65

In addition, capital injections allowed Mwana Africa to re-open its Fredda Rebecca mine and enabled it to complete its first phase of operations in September 2009.

3.66

Gold production as at November 2009 stood at 3 700 kgs.

Interesting developments in golds. I wonder what happened to all that gold though?

4.18

Since the liberalisation of Gold exports in January 2009, the country has exported Gold worth USD106.32million as at 31 December 2009.

$106 million is about 3700 kg worth of gold. Gold out, worthless dollars in. The 3,7 tonnes of gold would have produced 950 thousands zimbi’s (see: Hight Treason in Zimbabwe), more than enough for circulation. Building an economy based on a stable gold coin would have made Zimbabwe the only country in the world with a non-fiat currency, that would have been a magnet drawing capital from the moon itself!

3.81

In the absence of a lender of last resort facility and a non functioning interbank market, banks are not prepared to over expose themselves through increased lending to private sector.

3.82

The perceived high credit and liquidity risks in the country have seen banks forgoing returns on lending to productive sectors by depositing their excess funds offshore.

3.83

Financial institutions’ foreign assets are largely composed of deposits with foreign corresponding banks. As at October 2009, deposits with foreign banks accounted for 51.2% of foreign assets.

“In the abasence of a lender of last resort”! what happened to statement 1.5(b): “the Bank will perform the lender of last resort function” you might ask dear reader. Well that was only contingent on the availability of reserves. In most third-world countries the central bank can print its own currency but because of liberal capital regulations it has to defend the value of the currency in the open market with reserves. The result is that credit is withheld by the central bank resulting in the same situation as in Zimbabwe. Again the hyperinflation of Zimbabwe did not create these conditions it only exposed the cover.

The crazy situation in Zimbabwe where the savings of the people are lent to foreign banks who bankroll their own companies to go into Zimbabwe and buy all the assets, is the same one prevailing in almost all of the poor countries of the world. The world is currently lending money to the raiders of Wall Street to buy their assets and national resources.

Poor countries in Africa, Asia and south America who open up their small weak markets to the powerful forces of international capital and finance imperialism will never have a “monetary policy” because they have already given up their destiny. The slaves of Rome had more control of their destiny than these wretched sovereignties.

I leave sections 4 & 5 to the curious reader.

Click to view

I am really tired of writing articles that no one read; I had promised an article about the Gold Standard, the above diagram was prepared months ago.If you want to read the article that should have accompined accompanied the above picture leave a comment below and in a week’s time I will write a paragraph for each IP address (so no cheating!).

The use of gold and silver coin has no inherent weakness. It is the concept of legal tender that is flawed and unjust. By fixing the rate of exchange between gold and silver, and declaring what constituted legal tender, the powers that be seriously intervened within what was supposed to be a free market. Any chance to function as a free market was gravely impaired. The system was doomed to fail from the start, as the seed of its own destruction lay within – waiting to blossom. Alexander Hamilton was the architect of its design; and he did not knowingly make mistakes. He was very capable and as accomplished as they come.

It is one thing to fix or set the standard of a monetary system. This the Coinage Act of 1792 did when it set the standard as a weight of silver: 371.25 grains of pure silver. This is sound monetary policy.

To fix the exchange rate between gold and silver at 15 to 1 is an entirely different matter. This would have been better left undone. Let the free market decide upon the exchange rate between gold and silver, not a statute or legal tender law, which is nothing more than forced obedience – the King’s prerogative. This was all Hamilton’s doing.

—The Constitution On Legal Tender and Lawful Money (pdf) by Douglas V. Gnazzo [my emphasis]

In Beware the Boom! I wrote the following

The gold standard with a floating gold-silver ratio is the true standard. Fixing the ratio of silver to gold turns it into a derivative of gold. This feature of the British gold standard was a flaw that caused its ultimate demise and replacement by pure fiat currencies. A floating ratio means that the money supply can expand and shrink with the economy automatically without the need of an external regulator. A central bank will always be behind the curve and either shrink or expand the money supply more than needed, creating structural problems in the system; these will ultimately bring the system down.

I have been planning to write an extensive post on this subject (I even prepared a graphical item!) but time constraints prevented me from doing so. I will try to post some press-clippings until I have enough time to do the research and write the long-awaited post about the real gold standard.

In High Treason in Zimbabwe I suggested the introduction of a gold coin, which I called the Zimbi, to solve the hyperinflation of Zimbabwe:

The zimbi would have turned the monetary system of Zimbabwe from the weakest on Earth to the only one based on gold, thus ensuring that Zimbabwe becomes the world’s only country with a trustworthy currency. Capital would pour into Zimbabwe from all over the world and its economy would boom.

Now Reserve Bank of Zimbabwe Governor Dr Gideon Gono has suggested a plan to reintroduce the Zimbabwean dollar as a gold backed hard currency:

THE GOLD STANDARD

1.23 The gold standard is a monetary system in which money in circulation is freely and fully convertible into a fixed amount of gold. Under such an arrangement, the value of local currency is fully backed by gold. The system allows holders of local currency to redeem paper money for gold at a specified rate.

1.24 The total amount of money in the country would be fixed in relation to the amount of monetary gold. The Central Bank is only able to expand money supply if there is a corresponding increase in gold reserves.

1.25 The gold standard, which is characterised by stable exchange rates removes business uncertainties and facilitates trade and commerce.

THE CURRENCY BOARD

1.26 Under a Currency Board arrangement, Monetary Authorities only issue domestic currency, backed by foreign exchange reserves. The Central Bank issues notes and coins that are convertible into the anchor currency at a fixed rate of exchange.

1.27 Under a Currency Board, however, the country loses monetary autonomy to the anchor country.

OPERATIONAL MODALITIES OF ISSUING THE GOLD/DIAMOND BACKED LOCAL CURRENCY

1.28 Under the gold/diamond backed monetary system, Government will need to provide adequate mineral resources to back each unit of the local currency issued.

1.29 It will be critical to capacitate local gold and diamond producers in order to produce adequate mineral resources.

1.30 Government will establish an Independent Committee of Stakeholders to ascertain and certify the quantity of gold or diamonds produced to back the issuance of the local currency. This Committee would, thus produce certificates of authenticity, indicating the true levels of gold, diamonds, platinum, against which now money would be printed.

1.31 The operational modalities of the gold/diamond backed local currency issuance are as follows:

Step 1:

1.32 Diamond/Gold producers deliver to the designated delivery point

Step 2:

1.33 An all inclusive Independent Panel of stakeholders certifies the quantity of gold/diamonds produced and delivered.

Step 3:

1.34 Upon delivery of gold/diamonds the Independent Panel of experts issues gold/diamond certificates to RBZ, authorizing it to issue local currency equivalent in value to the amount of gold/diamond delivered.

Step 4:

1.35 RBZ instructs Fidelity Printers to print local currency equivalent to the value of the gold/diamond certificates and reports back to the Panel for verification and transparency,.

Step 5:

1.36 Fidelity Printers prints local currency amount equivalent to the value of gold/diamond delivered.

Step 6:

1.37 RBZ issues local currency to the Public through the Banking channels.

RESULT

1.38 The result would be smooth functionality in the country’s payments system, without the risk of over supply of money.

—Reintroduction of Zimdollar – the Defence, by Gideon Gono

Although this plan will not solve all problems and will have problems of its own, it is a thousand times better than the treasonable act of dollarisation. Reaction:

“Reserve Bank of Zimbabwe Governor, Dr Gideon Gono who has identified inflation as the country’s number one enemy and fought to give the national currency a semblance of value, has generated intense debate after he recently called for the reintroduction of local unit.

In a presentation he made in Parliament this week, Dr Gono proposed that the new currency be backed by gold or diamond production in the country, so that it has actual value, as one could have a measure of gold in exchange for money.

The reintroduction of the Zimbabwe dollar, he said, was therefore ‘not a blind return to the money printing press.’”

—Zimdollar Debate – More Than Simple Economics

Addendum

By adding diamond to gold in his plan, Dr. Gono, is confirming what I wrote in Liquidating the Debt of the United States:

Gold is the most liquid hard asset and at the same time easily manageable and transferable, but other hard assets could be mobilised by a government.

In Beware the Boom! I wrote the following about China’s gold reserves:

China’s official numbers are constant, but gold produced in China is not exported, hence the gold is being accumulated outside the official reserve.

And now we read:

“China, owner of the world’s biggest forex reserves, said Friday its gold reserves had risen to 1,054 tonnes by the end of 2008.

China is now the fifth biggest holder of gold reserves in the world, with only six countries having a holding of more than 1,000 tonnes, Hu Xiaolian, head of the State Administration of Foreign Exchange, told Xinhua in an interview. The new figure represents an increase of 454 tonnes from 600 tonnes in 2003, the last time China announced an adjustment of its gold holdings.

The country adjusted its holding of gold reserves twice this century. It raised its holding from 394 tonnes to 500 tonnes in 2001, and to 600 tonnes in 2003, Hu said.”

-China’s gold reserves reach 1,054 tonnes, China Daily

Over the last six years China’s gold reserve has been increasing at a yearly rate of about 10% while all published statistics showed it as a constant. Since 2000 the reserve has increased two-and-a-half times. Even with the latest increase the reserve is still pitiful, equalling about a three-hundredth of an ounce per person. The following table compares that to other countries:

Click to view

In ancient times people had to perform labour to extract from nature the substances they needed to survive, thus direct labour resulted in direct satisfaction.

Later barter developed where people would perform labour and extract from nature more than they needed, afterwards they would exchange their surplus with a different substance extracted by someone else. Thus in this situation past labour was exchanged for past labour.

Later indirect barter through a monetary commodity developed. Now the two people bartering did not have to meet and exchange their goods in one operation, instead surplus goods are exchanged for a monetary commodity, which in turn is exchanged for needed goods. The monetary commodity, like all commodities, represented past labour and it was also the most liquid thus guaranteeing that the second exchange operation will be completed.

Later (much later) gold and silver emerged as the final monetary commodities. The direction of development went towards mined products from the moment they became abundant to fulfil the role of money. The first mined commodity to play that role was salt, which did not need refining.

A British Guinea

A piece of minted gold contain the following labour: labour to discover the gold, labour to mine the gold ore, labour to refine the gold, labour to mint the gold, labour to secure the gold through this process. When one gives up his surplus product for a piece of gold he is exchanging past labour with past labour in monetary form. The new form has many advantages: it does wear out or perish, it is much denser making it easer to store and transport and most importantly it is liquid.

“Gold is the indispensable regulator of debt in society. … Well, we have just tried [bureaucratic regulation of the level of debt] and found that whenever irredeemable promises are to be liquidated by issuing more irredeemable promises, debt proliferates beyond any limit.
…
People wake up and realize that they are surrendering real goods and real services in exchange for irredeemable promises.”

-The Anti-Gold Gospel According to Kaletsky by Antal E. Fekete

Now we live in an age where all the developments of the last ten thousand years are being thrown away and replaced by new un-tested gimmicks. We throw away monetary commodities and replace them with fiat currency, but do we really know what we are getting ourselves into?

As I tried to show in The Printing Press is a Harsh Mistress one unit of fiat currency is equivalent to one unit of public debt on the central bank balance sheet. If one accepts a fiat currency then he will not be accepting past labour but instead the promise that future labour will generate enough public income (through tax, excise, et cetera) to service the public debt. Thus selling goods for fiat currency becomes an exchange of past labour for future labour.

Imagine a farmer exchanging his surplus wheat for the hunter’s surplus winter catch. The farmer fulfils his obligation at harvest but has to wait six months for his share. What would happen if the winter’s catch were too low? This is why meat is smoked or cured and exchanged at harvest time. The farmer gets last year’s catch instead of next year’s catch.

The problem with future labour is not only unforeseen circumstances but more importantly is that before generating a surplus enough has to be generated to pay the workers, but since they too are paid with fiat currency this will only increase the amount of future promises. This cycle means that the quantity of money has to increase exponentially at a rate outpacing the economy. As more money is created its exchange value drops, the dollar has lost about 97.7% of its value (gold from $20.67/oz. to $900/oz.) since becoming a fiat currency.

A US Gold Dollar

There is no need to add the phrase “In God We Trust” to coins with intrinsic value because if you have them then your prayers have already been answered by the Almighty.

The newly installed prime minister of Zimbabwe, Morgan Tsvangirai, is the worst kind of traitor; he has just surrendered the sovereign right of the people of Zimbabwe to issue money to the United States:

“Zimbabwe’s prime minister, Morgan Tsvangirai, has taken an important step toward establishing the new power-sharing government’s credibility by fulfilling a commitment to pay the army and other public-sector workers in dollars because the national currency is worthless.”

—Zimbabwe starts paying soldiers in US dollars, 19 Feb, The Guardian

From now on all assets in Zimbabwe will be priced in US dollars:

“Zimbabwe shares, battered by the world’s highest inflation rate and a decade-long recession, may rebound after the stock exchange reopened yesterday from a three- month suspension with listings re-denominated in U.S. dollars.
…
Reopening the exchange was one of the first steps by the coalition government formed last week as part of a power-sharing agreement between Mugabe, 84, and opposition leader Morgan Tsvangirai.
…
Zimbabwe may be forced to use a combination of the dollar, the rand and other currencies, Tsvangirai said.”

—Zimbabwe Stocks May Soar as Bourse Reopens in Dollars, 20 Feb, Bloomberg

Dollarisation of the economy is the worst kind of high treason, because it surrenders one of the most important sovereign rights of the people, giving up parts of the country (as the Germans did at the end of the Great War) is the height of honour compared to it. Even the most inflated fiat currency in the history of the world is preferable to this!

If they have any US dollars (they don’t) they should then send it all to the mint in South Africa and request the following coin:

Every one troy ounce of pure gold would make eight zimbi’s. The low weight and purity would ensure that there is no foreign demand for the coin from investors.

As to the Zimbabwean dollar, they would stop printing it but keep accepting it for public debt and taxes. People will pay the government with dollars while accepting only zimbi’s, very quickly all the dollars will be absorbed and there would be only zimbi’s.

The state can also exchange one zimbi for 4.66 gram of 22K gold (or equivalent), thus putting a 10% seigniorage on the coin; for every thousand coin given to the public the state makes a profit of a hundred zimbi.

The zimbi would have turned the monetary system of Zimbabwe from the weakest on Earth to the only one based on gold, thus ensuring that Zimbabwe becomes the world’s only country with a trustworthy currency. Capital would pour into Zimbabwe from all over the world and its economy would boom. The opposite is now happening:

“Reconstructing Zimbabwe may cost as much as five billion US dollars (four billion euros), Prime Minister Morgan Tsvangirai said Friday as he opened his hands to neighbouring countries.
…
Motlanthe said South Africa, chair of the Southern African Development Community (SADC) bloc, had directed regional finance ministers to develop a plan to help Zimbabwe, and again called for sanctions to be lifted.”

—Reconstructing Zimbabwe may cost $5bln, 20 Feb, AFP [my emphasis]

They might not have dollars ‘printed’ in the US, but they certainly do have gold mined in Africa:

“The Vice-President of Zimbabwe has been accused of trying to sell millions of dollars in gold nuggets and diamonds in defiance of international sanctions.
Joyce Mujuru used her daughter as a go-between to seek a deal for the gold, according to Firstar, a commodities trader based in Britain, which says that it was approached in November.
…
Firstar claims that Mrs Mujuru’s daughter and Spanish son-in-law, Nyasha and Pedro del Campo, offered to sell 3,700kg of gold for $90 million to Firstar Europe Ltd, a precious metal dealer. At the present market rate, one kilo of gold sells for $30,700 (£21,500). ”

—Zimbabwe’s vice-president foiled in 3,600kg gold deal, Times Online

Three tonnes of gold (let’s assume the 700kg pays all the costs) would make 771,803 zimbi’s; instead of using it in their own country they want to send to Europe in exchange of ‘paper’!

Successive Chinese dynasties built and maintained a magnificent wall to protect their empire. The Ming dynasty (an ethnic Han dynasty) maintained this great barrier and improved it to protect itself from the Manchu tribes in the northwest. The tribes were never able to overcome the wall, but a disgruntled general (Wu Sangui) decided to open the gates at Shanhai Pass and let the Manchu tribes enter.

The result was the fall of the Ming dynasty and its replacement by the Qing dynasty, a non-Han dynasty. The Qing changed China in a way that weakened it—they weakened the cultural bonds of society to bolster their domination—and laid it open to the Western powers in the nineteenth century. China has yet to restore its place in the world after four hundred years of one general’s treasonable act. Morgan Tsvangirai has just opened the gates of Zimbabwe for the barbarians.

Introduction

Today I would like to re-visit a subject that I have already covered twice. In When Gold is Worthless and Hyperinflation and Gold Bugs I argued that gold is not really the safe haven that some advertise it to be. My concern here is historical rather than economic, I am not interested in investment or wealth management; what concerns me is society and the ability of the economy to benefit all members of society.

There is a strong egotistical streak hidden behind the mask of Individualism, the predominate philosophy of gold bugs and those interested in preserving their wealth from the approaching hyperinflationary storm. Egotism is a shortsighted stance that eventually costs more at the end than what it promises at the beginning. Those who recognise that the system of fiat money is doomed are duty bound to do something about it, trying to save only themselves by buying gold is an egotistical solution that will fail at the moment it is most needed.
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