The current financial crisis,
may progress to a phase where people demand and hoard dollar bills but take
electronic deposit credits only at a discount which increases until
electronic deposit credits are repudiated entirely. The Federal Reserve would
be powerless to solve the problem, because while they can create unlimited
electronic deposit credits they can't create unlimited paper dollar bills, "money
you can fold" as Professor Antal Fekete calls it. There would be a glut
of electronic deposits, but a shortage of dollar bills.
Before the financial crisis
metastasized in 2008, Fekete wrote a paper that I think is underappreciated
and under-discussed. "Can We Have Inflation and Deflation at the Same
Time?" (http://www.safehaven.com/article/8507/can-we-...t-the-same-time)
In his paper, he discussed the "tectonic rift" between paper
Federal Reserve Notes (i.e. dollar bills) and electronic deposits. By
statute, the Federal Reserve cannot print dollar bills without collateral
(e.g. Treasury bonds). Also, they have limited printing press capacity that
is insufficient to keep up with a catastrophic crisis.
He discussed the inverted
pyramid of John Exter. Gold is the triangle at the bottom, and then above is
silver, dollar bills, and then the various kinds of electronic deposits,
stocks, real estate, etc. In a crisis, people want to move from top to bottom
of the pyramid, but of course there isn't enough of the stuff at the bottom.
In a scenario in which
desperate, panicky people are trying to cope with the enormity of a collapse
that they don't and can't understand, I think this split between
"physical" dollars and "electronic" dollars is very
plausible.
Just as there is nothing to be
accomplished by selling an underlying security as it becomes worthless, only
to buy a derivative of it, selling Treasury bonds and buying dollars is
equally nonsensical. The dollar is the Federal Reserve's liability, backed by
the Treasury bond as the asset. If you believe the Treasury bond is
worthless, then you ascribe no value to the dollar either. This is why gold
will go into permanent backwardation. Holders of dollars will provide an
unlimited bid for gold that will not be reciprocated by holders of gold. The
latter own the only safe asset, and the only monetary asset that is not
ultimately backed by the Treasury bond or the dollar, and they will have no
desire to give it up.
The concept of backwardation
is simple. It is when people accept a future promise to deliver only at a
discount to physical stuff handed over right now. This could be when there is
a shortage, such as wheat before the harvest. Or in the case of gold,
backwardation signifies a collapse in trust. But isn't this the same
phenomenon of a tectonic rift between paper dollars and electronic deposits?
In a certain sense, the
"money you can fold" behaves like a physical commodity, a present
good (I realize I am stretching the concept here more than a bit). The
electronic deposit credit is most definitely a future promise. In my gold
backwardation thesis, the action begins with the offer on the futures
contract falling below the bid on spot gold. The bid-ask spread on spot gold
widens, as the offer is relentlessly advancing, pulling the bid behind it.
The bid-ask spread on the futures contract also widens, as the offer remains
stubbornly high, but the bid withdraws and retreats as gold buyers don't
trust futures and buy physical gold instead. Eventually, there are no more
sellers of physical gold and that is that (except for the
dollar-commodities-gold arbitrage, a backdoor way for dollar holders to get a
little gold before the end of the game).
If this split occurs in the
dollar, I think it will play out the same way. At first, sellers of real
goods may accept electronic credit money, but demand a higher price. The
spread on the electronic dollar widens, with the bid from real goods falling.
At the same time, virtually unlimited demand for the "real" paper
you can fold causes the bid on the paper dollar to rise.
Who knows how long it could
last? People could go on accepting paper dollars out of long habit.
Obviously, this is an unstable situation that must necessarily collapse.
Unlike gold, the paper dollar has no value other than the broken promises
that back it.
I dub this "dollar
backwardation".