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Introduction
The Inaugural Session of
Gold Standard University was successfully completed at the Martineum Academy in Szombathely, Hungary, in February,
2007. By unanimous request the original program Gold and Interest was extended to include Basis as well. As those who follow my writings on the Internet
well know, basis is the difference between the nearest futures price and the
spot price. The gold basis is one of the most sensitive economic indicators
with a seismographic predictive power. In particular, if taken in conjunction
with other indicators such as the silver basis, volume, open interest, and
the lease rates for the monetary metals, it is capable of predicting the
beginning of the disintegration of the world’s payments system. No
other scientific method can provide early warning. Moreover, basis could also
be used as the guiding star of bimetallic arbitrage between the gold and
silver market. If you have a program to accumulate gold and silver, and wish
to get rid of a certain amount of irredeemable dollars regularly at every dip
in the price of the monetary metals, then the basis will tell you whether at
that moment in time it is more efficient to add to your gold or to your
silver account. You always go after the metal with the wider basis.
It is nothing short of
amazing that all the websites which concern themselves with the analysis of
gold and silver, with the remarkable exception of www.silveraxis.com,
ignore the basis in spite of my repeated prodding to start tracking and
reporting it. I have now proof that this is not due to lack of demand.
Accordingly, I have made the announcement that at the next session of Gold
Standard University scheduled at the Martineum for
August 15-31, 2007, we present a blue-ribbon panel discussion with the title Last Contango:
First Sign of Disintegration of the World’s Payments System. The
present essay is a primer for prospective participants.
The Janus-face of marketability
Gold, interest, and basis
are strongly inter-related. At the Inaugural Session we have covered the
concept of marketability. Gold and
silver have become money through an evolution as the most marketable goods.
In more details, gold is most marketable in
the large. This can also expressed by saying that gold is more saleable than any other commodity.
Silver is most marketable in the small.
This can also be expressed by saying
that silver, along with gold, is more hoardable than any other
commodity. The Janus-face of marketability can be observed if we contemplate
that gold is the preferred agent when one has to transfer value over space. The preferred agent in transferring
value over time is silver followed
by gold. We may clearly recognize the dual nature of money throughout
history. In the ancient world money was cattle and salt. Cattle was most
marketable in the large, while salt was most marketable in the small. Later
two other commodities, far more similar to one another, took over these
functions, but the dual nature of money has been maintained to this day, in
spite of the silver and gold demonetization farce. This is no accident.
Duality has to do with the paramount fact that space and time are absolute
categories of human thought.
A new theory of interest
Hoardability leads directly to the concept of interest, which arises out of the
desideratum to optimize conversion of income into wealth and wealth into
income. In choosing the conversion problem as our point of departure to
develop a new theory of interest we have deliberately discarded the old-line
theory based on the exchange of present for future goods that assumes,
wrongly, that without exception a present
good is valued more highly than an equivalent quantity and quality of future
good. A more careful analysis shows that this is true only if the delivery of
the various factors to the site of production or consumption is dove-tailed.
Early delivery may result in a loss.
The solution to our
optimization problem answers two of the greatest of human needs: providing
for one’s old age, and planning for the education of one’s
offspring. If the conversion of income into wealth is done through hoarding,
and the reverse conversion through dishoarding ─ a process also known
as direct conversion, ─ then
optimum is achieved by choosing the most hoardable
commodity as the agent of conversion. However, direct conversion can be
further improved upon, by passing to indirect
conversion, through the agency of exchange. Typically, a younger man will
give up part of his income in exchange for part of the wealth of an older, as
the former is anxious to go into business for himself for which the latter
puts up the capital. Then interest appears as the value of improvement in
efficiency through the exchange over direct conversion. In particular, direct
conversion means zero interest. By contrast, interest becomes positive if
social arrangements admit indirect conversion.
The following point is
important. The nexus between gold and interest is established by the fact
that if indirect conversion is hampered by secular or canonical proscriptions
(e.g., usury laws), the economizing individual is not helpless. He can still
achieve his goals by falling back on direct conversion through hoarding or
dishoarding gold. He will do that even in the absence of proscription. In
case interest is suppressed by the banks or the government, he will hoard
gold in protest, and dishoard it as the rate of interest is subsequently
allowed to rise. Thus gold is the agent to validate one’s time preference. This aspect of gold
is almost always ignored by authors, including Ludwig von Mises
to whom gold hoarding is a ”deus ex machina”. He failed to see that time preference
would hardly amount to more than a pious wish if gold hoarding did not give
it teeth. Moreover, this is true whether on
a gold standard or off. When on,
gold hoarding means withdrawal of bank reserves whereby the individual forces
the banks to adjust their lending rate to the rate of marginal time
preference. Thus the gold standard makes the adjustment crisis-free. That is
its main excellence. When off, hoarding makes the gold price soar, leading to
a monetary crisis. The upshot is the same: higher interest rates. The
difference is that it is achieved in a crisis-prone environment. Moreover, it
generates a swinging interest rate structure, most damaging to savers and
producers. Gold hoarding provides escape from the harsh consequences of the
predatory monetary and credit policies of the banks and the government, as
they plunge society into debt slavery. In the absence of the safeguards of a
gold standard, debt slavery is inevitable for all those who fail to use the
only prophylactic available against bank and government preying on the
individual saver and producer, gold.
Paper boat on uncharted waters
Let us turn from the
nexus between gold and interest to the nexus between interest and basis.
Mainstream economics made a fatal mistake when it failed to study the
consequences of the emergence of the futures markets in monetary metals. It
was not a spontaneous failure. It was inspired by the banks and the
government that have taken upon themselves the ”burden”
of financing research. They have a hidden agenda: to keep the public in deep
ignorance and stupor.
Recall that there are no
futures markets in monetary metals under a gold standard for lack of
volatility, without which speculation cannot be profitable. But no sooner had
volatility appeared than futures markets in silver and gold sprang up. As
they did, a whole new field of tantalizing research opened up for
investigation. Unfortunately, what it shows is an appalling and scary
prospect for the Brave New World of global irredeemable currency. It shows
dissipation and destruction of capital on a large scale through falling interest rates, and the drying
up of new savings through rising interest
rates. Recall that it is the first time ever in history that irredeemable
currency has been foisted upon the entire
world, causing gyration of the rate of interest. Humanity was herded aboard a
paper boat named ”Dollar” and tossed
onto a stormy sea with no anchor on hand. No wonder that the powers that be
are anxious to put research under taboo. It is in their interest that the
public stay in blissful ignorance about the fact that the captain of their
paper boat has no navigational instruments while sailing on uncharted waters.
Gold Standard University was started in defiance of that taboo.
Primer on basis
The condition that
obtains when the futures price is above the spot, or the more distant futures
price is above the nearby, is called contango and, the opposite, backwardation. Thus the basis is positive or negative according
as the market is in contango or in backwardation.
The prevalence of contango is a necessary condition
for the warehousing business. Unless there is an expectation for contango to return after sporadic and temporary
backwardation, warehousemen would go out of business and supplies for future
delivery would be all but unavailable.
The question arises what
determines the basis. On the upside it is limited by carrying charges
including freight, storage, insurance, and interest. In the case of gold and
silver the lion’s share is interest. On the downside there is no limit: theoretically the
basis can go negative and keep falling indefinitely. It indicates that a
tightening supply is facing increasing demand. Ever larger number
of sellers withdraw their offer to sell. This is the basis risk: the risk of hedging
inventory in the futures market. The cash price may start going up faster
than futures prices forcing hedgers to take an opportunity loss on inventory.
A contemporary example is Barrick Gold Company
with a phony hedge plan losing tons of shareholder money. Note that price risk behaves the other way
round. It is limited in the downside (as the price cannot fall below zero)
but is unlimited in the upside (as there is no theoretical limit above which
the price may not rise).
Interest and marginal utility
The monetary metals are
characterized by great stores above ground. The stock-to-flows ratio is a
large multiple for gold. Silver analysts deny that the same holds for silver.
They are at a loss to account for the disappearance of huge stockpiles of
U.S. official silver in any other way but assuming that it has been
dissipated through consumption. There is no hard evidence that this is indeed
the case. We can account for the disappearance of monetary silver through a
more plausible hypothesis, namely, that most of it has gone into hiding. It
shall resurface at the right time and right price, as indeed some of it
already has after the silver price hit a high of 15 dollars per ounce.
The case is different for
non-monetary commodities. Here the stock-to-flows ratio is a small fraction.
The reason is declining marginal
utility in contrast with monetary metals with near-constant marginal
utility. Mises argues that constant marginal
utility is contradictory because it implies infinite demand. He is plainly in
the wrong. He ignores the nexus between gold and interest. In more details,
interest acts as obstruction to gold hoarding. In case of non-monetary
commodities obstruction to hoarding is precisely declining marginal utility.
Demand for monetary commodities can only become arbitrarily large if interest
is suppressed by the banks and the government. Thus interest is an exclusive
characteristic of monetary commodities. John Maynard Keynes made a colossal
blunder when he kept talking about the ”wheat-rate
of interest”, ”coal-rate of interest”, etc. Interest can
only exist in relation to a monetary metal with constant marginal utility.
The marginal utility of wheat and coal declines very fast indeed.
”It takes three to contango”
Keynes made another
terrible blunder when he talked about what he called normal backwardation. To him backwardation was the natural state
of the markets, and contango, the aberration. He
argued that speculators ”charge an insurance
premium” for shouldering the price risk while carrying the commodity
for future delivery. It is this premium that shows up in the futures price as
backwardation. This shallow theorizing faithfully reflects the Keynesian
mindset that is haunted by visions of overproduction, market gluts,
deflations, depressions, and unemployment, in one word: the
”curse of capitalism”. The fact, however, is that ours is
a world of scarce resources. Man is engaged in a constant struggle to
overcome the niggardliness of nature. In particular, he has to have foresight
to provide for future needs. If he succeeds, then future goods will be
available to meet future demand in adequate quantities at the right time.
This would not be possible without the services of the warehouseman and
without contango in the futures market. We express
this by saying that ”it takes three to contango”: the producer, the warehouseman, and the
speculator. Keynes got it all wrong when he blithely ignored the second
member of the troika.
Hoarding is not a dirty
word, least of all gold hoarding, in spite of dark hints to that effect
dropped by Keynes. The essential services of the warehouseman must be studied
seriously and without prejudice on the same footing as those of the producer.
The marginal bondholder who decides to sell his
bonds in protest against low interest rates, and to invest the proceeds in
gold, must not be depicted as Scrooge. He is a legitimate warehouseman who
carries social savings at a time when banks behave like drunken sailors on
leave at the waterfront, and governments engage in compulsive overspending as
if there was no tomorrow. The resulting capital destruction is appalling.
After Armageddon no one but the warehouseman, alias gold investor, will be in the position to supply capital for
reconstruction. Thank heaven for goldbugs. Without
them we would have to go back and start from scratch as cavemen.
Backwardation can
certainly occur, in particular, when supplies are drawn down just before the
new crop of agricultural goods is ready to be brought in. However,
backwardation for monetary metals is a gross anomaly, a red alert. It
indicates cumulative mismanagement of the monetary and credit system in the past, and potential breakdown in the not-too-distant
future. Gold Standard University has championed the cause of doing pioneering
research to refine this tool, to take it in conjunction with other market
indicators such as lease rates, or the yield curve and its various types of
inversion. It is hoped that this research will help people to escape the
worst when catastrophe strikes. Forewarned is forearmed.
Lysenkoism ─ American style
The reason why mainstream
economics is silent on the subject of gold, interest, and basis is that the
interplay of these reveals the incredible mismanagement of the economy in the
twentieth century, as well as the corruption of the monetary and credit
system by the banks and by the government in the twenty-first. Universities
no longer serve the cause of search for and dissemination of truth. Instead,
they provide refuge for a reactionary conspiracy trying to cover up
mismanagement and corruption reinforced by seventy years of Keynesian and
thirty-five years of Friedmanite brainwashing. No
university in the entire world, save Gold Standard University, is prepared to
study in a detached manner the subject of gold, interest, basis, and the
theory of warehousing as it applies to the hoarding of monetary metals.
Universities no longer serve the interest of the people anxious to secure
their economic survival in the face of untold dangers, as indicated by the Babeldom of runaway debt and exploding derivatives
markets. Rather, they are serving the interest of their paymasters.
History will not be kind
to mainstream economists. Keynes, Friedman, and their followers will be
lumped together with Soviet biologist Lysenko, stooge and sycophant of
Stalin. Lysenko sent his fellow biologists to the Gulag for opposing his
hare-brained theories, never to be heard from again. Lysenko betrayed science
as he betrayed humanity. He was, no less than
Stalin, a monster.
The Quantity Theory of Money
I have never subscribed
to the Quantity Theory of Money, nor have I ever believed that the downfall
of the regime of irredeemable currency must necessarily take the form of
hyperinflation. It could, of course, in the wake of wars and revolutions
destroying supplies of goods and facilities of production. But the Quantity
Theory of Money is a linear model that is wholly inapplicable to our highly
non-linear world, now at the peak of its productive powers. The
dénouement of the present global experiment with irredeemable currency
is not likely to involve hyperinflation (assuming that the world will not be
plunged into another World War). Unfortunately, a lot of innocent people will
be led astray and ruined financially by the nearly unanimous propaganda
predicated upon the Quantity Theory prophesying hyperinflation.
In order to see what is
happening to our money a more sophisticated theory is needed. The new theory
must assume a thorough understanding of both monetary metals,
warehousing, futures markets, basis. We must also have a new theory of
interest that takes gold fully into account. We must develop a non-linear
model for the global world economy. This is what the Gold Standard University
has set out to do. It will expose the central fallacy of mainstrean
economics in assuming that producers will forever put up with the plundering
of their capital accounts through driving interest rates down or will meekly keep accepting irredeemable promises to pay
in exchange for real goods and real services, and that savers will forever
put up with the pilfering of their savings accounts through driving interest
rates up or will meekly turn over
their right pocket when the banks and the government h ave
picked clean the left.
In the same order of
ideas, it is a grave mistake to explain rising gold and silver prices in
terms of the supply/demand equilibrium model. There is simply no scientific
way to define the speculative supply of and the speculative demand for
monetary commodities, without which the model becomes meaningless.
Speculators can jump back and forth between the supply and demand side of the market on a moment’s notice and, when
they do, they are likely to act en bloc.
The only thing that the supply/demand equilibrium model can predict is the
ever increasing volatility of the price of monetary metals.
Bull in bear’s skin
We must also exorcise the
boogeyman of silver analysts: the naked short
seller of monetary metals. The inordinate short interest in the futures
markets is better explained in terms of the activities of a market maker whom
I call ”bull in bear’s skin”. Typically, he is a
super-wealthy individual who has learned the trick how to derive an income in gold on gold ─ even while retaining
physical control over his holdings. He is not a naked seller by any stretch
of the imagination. He does have the gold and silver, but keeps them at a
safe distance from the commodity exchange and its predatory policies favoring the shorts at the expense of the longs. To his
mind it pays to pose as a short. He hides his full armour underneath a mask
showing him naked.
The proposition that it
is possible to earn an income in silver on silver without relinquishing
physical control of the stuff may sound like gaining something out of
nothing, contradicting the Principle of Conservation of Matter and Energy.
Yet we should not be too hasty in dismissing this possibility. It is true
that income and risk go hand-in-hand. Income is the reward for consistently
successful risk-taking. Show me a man who can generate an income without
taking risks, and I show you one who has invented perpetual motion.
Yet there is no
contradiction here. Paradoxically, it was mainstream economists themselves
who made this black art possible. They promoted the regime of irredeemable
currency with the result that the gold price fluctuates. If you keep your
book in terms of gold units rather than units representing irredeemable
promises, then it is indeed possible to earn an income in gold on gold, even without relinquishing your gold and thereby
incurring the risk of losing it. To understand this we only need to refer to
the possibility of harnessing the energy represented by the flow and ebb of
water in the oceans. Likewise, it is possible to harness the energy
represented by the fluctuating price of gold and silver. The best way of
doing this is to buy on dips whichever monetary metal can be stored more
efficiently at the going price. But how to determine the relative efficiency of
warehousing different goods? This is the same dilemma facing the elevator
operator when he is buying grain at harvest time. Should he buy more wheat or
more corn? The price could easily mislead him. The basis would not. He solves
the problem by always buying the grain with the wider basis. In this way he
maximizes the efficiency of his warehousing operation.
What appears as naked
short selling to silver analysts is more likely the activities of the ”bull in bear’s skin”. It is the tip
of the iceberg, that can be seen. What is not seen,
the bulk of the iceberg, is dynamic hedging of ever increasing gold and
silver hoards, and covered option writing, where the principal wants to stay
anonymous. He is actually very happy that analyts
believe, and spread the belief, that he is naked short. The longer he can
keep his ”cover” as being
”naked”, the better it is for his operations.
It is futile and puerile
to wait for the naked short to cover in a panic, sending the price through
the roof. This, of course, does not mean that the price may not go through
the roof, but if it does, then it is also likely to go through the floor next
time around when the pendulum swings back. It means that volatility is
increasing. The get-rich-quick crowd waiting for the miracle of the silver
price going to four digits overnight will be frustrated. Rewards will go to
the patient and industrious observer taking pains to study the market, and
who has the right strategy that can handle increasing swings in the price of
monetary metals. He doesn’t subscribe to linear models. His guiding
star is the non-linear model of the variation of basis.
Gold Standard University
is working out a strategy following these principles. It will be unveiled during the next
session in August, 2007. At this point let’s just say that the strategy
is essentially bimetallic arbitrage, but it uses the basis rather than the
bimetallic ratio for clues.
Conservation of matter and energy
But how do we answer the
objection that our proposed scheme contradicts the Principle of Conservation
of Matter and Energy? Simple. We don’t. We might as well admit up front
that the contradiction is real. Chalk it up as an unintended gift from the
managers of the regime of irredeemable currency. Helicopter Ben has air-dropped
manna to the enemy camp by mistake. Nor can he help but keep doing it. His
navigation system is all screwed up.
The gold standard, when
in force, is an instant reward/penalty system that rules out income generated
without risk. Were our schools allowed to teach economics properly, the
electorate would know this and it would demand the immediate scrapping of
irredeemable currency as the most wasteful and iniquitous monetary system
imaginable. It would also demand the immediate reinstatement of the gold
standard as the only monetary system serving even-handed economic justice.
Under a gold standard foreign exchange and interest rates are stable. So is
the price of monetary commodities. There is no profit in gold, silver, and
bond speculation. Interest rate derivatives and bond futures are unknown.
Debt is reined in by the ability to service it. Banks cannot lend long while
borrowing short with impunity. When they lend short, they are limited by the
size of their quick assets. Under the gold standard all economic risks are
created by nature, none by man. Helicopter Ben belongs to fairy tales, not to
banking, let alone central banking.
As the regime of
irredeemable currency defies natural law, it is digging its own grave. This
is the true explanation of the coming crack-up boom, not the
”overissuing” of the currency.
The currency was overissued already a hundred years
ago. What needs to be explained is the lag.
References
A.E.Fekete :
What Gold and Silver
Analysts Overlook, May 4,
2004, http://www.24hgold.com/viewarticle.aspx?langu...rticleid=124596
Bull in Bear’s Skin ? , May 4, 2006, target="_blank" http://www.24hgold.com/viewarticle.aspx?la...articleid=77915
Ultracrepidarian Musings, May 11, 20 target="_blank"06, http://www.24hgold.com/viewarticle.aspx...articleid=79019
The Rise and Fall of the
Gold Basis, June 23, target="_blank" 2006, http://www.24hgold.com/viewarticle.a...articleid=88729,
Monetary versus Non-Monetary Commodities, June target="_blank"25, 2006, http://www.24hgold.com/viewarticl...articleid=81018
The Last Contango in Washington, Ju target="_blank"ne 30, 2006, http://www.24hgold.com/viewart...articleid=81790
Tom Szabo,
The Silver Basis, www.silveraxis.com/explain_basis.html
Further information on
Gold Standard University can be obtained by writing to:
GSUL@t-online.hu
Antal E. Fekete
Gold Standard University
aefekete@hotmail.com
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