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FOFOA
reader and supporter Cyril asked me by email:
I have a little question that I’d like to ask
you. I don’t know if you are familiar with Peter Schiff: he has a radio
show every day where he talks about macro-economics.
So the other night, I was
listening to it and a caller brought you up in his question. He was a little
dismayed that Peter Schiff was not aware of your work (and so was I).
That’s probably why he didn’t do a very good job in summarizing
the Freegold concept, but to be fair, I don’t
know if anyone would have been to able do it in 20 seconds. But here’s
the exchange:
Peter Schiff’s first reaction was to ask
“OK, and how is that different from what we have now?” I realized
that this was a question that I always had in my mind and never found an
answer for.
Right now I can buy an ounce
of gold for $1373.70. I can also buy the same ounce for 1015.84 Euros. This
means that 1US Dollar is 0.000728 ounces of gold and 1 Euro is 0.000984
ounces of gold. How is that different from Freegold?
Good question Peter and Cyril! By the way, Peter Schiff may not have heard of
the FOFOA blog, but he has met me. He signed my copy of Crash Proof at
one of his "events" in early 2008, before I had even heard of
ANOTHER and FOA.
Now most of you know that I consider this topic, Freegold,
to be extremely deep. But I'm going to try not to go there in this post. I'm
going to attempt to "superficially" focus only on this one question
in the hope that this post stays reasonable in length and finds its way to
Peter.
Sure, gold is floating against all currencies today, just as it has been
since Nixon ended the fixed gold standard. But it is a pretty volatile float,
wouldn't you say? From $40 up to $850 back down to $250 and up again to
$1,400. All in 40 years. During the prior four decades, gold was locked at $35
per ounce. That's some long term stability! Granted it was a synthetic
stability, prone to explosively painful crises like the 1970s.
Freegold will once again deliver a stable gold
price, unlike today. The kind of stability Freegold
will provide, which will be able to last much longer than 40 years, will form
the bedrock foundation of global trade, monetary policy and international
finance for the next era. And it will be stable because of two main factors:
1. SUPPLY - Gold will trade on a stable supply of above-ground physical gold
in the absence of external influences like "paper gold" (Bullion
Bank "BB" liabilities that can be created on demand by a mere book
entry on a BB balance sheet, etc.).
2. DEMAND - Gold will also trade on a stable demand due to the global clarity
that will emerge as to gold's best and highest function—being only a
physical wealth reserve asset and nothing else.
How we get there is easy to visualize. As the physical reserves within the BB
system are all moved into allocated accounts, at some point the remaining
claims will simply have to be cash-settled. At that point all paper gold
markets will cease to exist and all that will be left is the stable supply of
above-ground physical gold in the absence of external inflatable (or deflatable) influences.
And when this happens, the dollar will fall in value very quickly, and with
it, all savings tied to debts denominated in dollars. What this will reveal
on any balance sheet that contains both dollar-based assets and gold, is that
gold will rise to fill the void left by the dollar. The balance sheet will
not collapse. But the wealth will have transferred from dollar assets into
gold.
This is the main significance of all the Central Banks stocking up on gold
today as well as the Eurosystem's quarterly mark to
market party, I mean policy. When the BB fractional reserves finally run out,
this will be a very quick revaluation.
But while I expect a quick and dramatic reset at some point in the near
future, this process can be clearly observed happening in slow motion today,
both from a political standpoint and on the balance sheet of the ECB. In my
post, Reference Point: Gold - Update #1, I highlighted the results from the latest revaluation party, a
decade-long trend that has brought the "foreign fiat reserves"
portion of the Eurosystem's balance sheet from
69.5% down to 32.9%. Meanwhile, physical gold as a portion of the Eurosystem's reserve assets has risen from 30.5% to
67.1%, even while declining in volume. A virtual flip-flop as I called it in
my post.
So while most cannot understand the significance of this slow motion trend
today, the explosive "rock meets hard place" encounter that is
overdue at this point will be sure to wake even the sleepiest sheep. And at
that point gold's best and highest function—being a physical-only
wealth reserve asset—will be known by all. And the meeting of such a
wide (awake) demand with a newly physical and stable supply in the absence of
external (paper) influences will reveal a gold price that is multiples of any
that has ever left Peter Schiff's lips.
The next step in discovering how Freegold (or
Reference Point Gold "RPG") is different from what we have now is
the concept of "captive money." Today gold is traded like a
volatile commodity by gamblers who like to call themselves traders. Or else
it is held as a small percentage of one's wealth for the expressed purpose of
"insurance." Gold is actually a pretty poor inflation hedge as long
as it is under external influences such as the inflatable supply of paper
gold BB liabilities. So the only way it can even hope to perform as
prescribed is as insurance in physical form only. Yet so many investors still
hold "paper gold" as the insurance portion of their portfolio. This
alone really highlights the confusion in Western "professional"
investment Thought.
Most people are savers, not investors or traders. Yet today we are all forced
to be investors chasing a yield because there is no such thing as a perfect
inflation hedge. If there were such a thing, a large portion of the
"investing public" would not be anywhere near stocks and bonds.
Even the most "risk free" bonds, US Treasuries, have the greatest risk
of all, currency risk. And in the case of the dollar, this is exposure to a
risk that, today, is well out of the hands of the currency manager thanks to
seven decades of functioning as the global reserve standard.
Furthermore, a saver must look deeper than the CPI, or even its
shadow-equivalent, for the real inflation that must be protected against. And
that is the inflating VOLUME of savings with which one must compete. A
perfect inflation hedge would not only keep up with the shadow-CPI but it
would also rise in VALUE (as opposed to volume) relative to changes in
aggregate monetary savings. Given such a "perfect inflation hedge,"
I maintain that it would become the Focal Point of savers all over the world.
I read an interesting piece on Egypt by George Friedman of Stratfor. I thought it described an interesting little microcosm of the
dollar's international monetary and financial system ($IMFS) and how it is
detrimental to savers. Here are a couple snips from the article:
"One cannot simply walk out of Egypt, so since
the time of the pharaohs the Egyptian leadership has commanded a captive labour pool. This phenomenon meant more than simply
having access to very cheap labor (free in ancient times); it also meant
having access to captive money. Just as the pharaohs exploited the population
to build the pyramids, the modern-day elite – the military leadership
– exploited the population’s deposits in the banking system. This military elite – or, more accurately, the firms
it controlled – took out loans from the country’s banks without
any intention of paying them back…
"There were many
results, with high inflation, volatile living standards and overall exposure
to international financial whims and moods being among the more disruptive.
"Over the past 20 years,
three things have changed this environment…
"By 2010 the system was
largely reformed and privatised, and the military
elite’s ability to tap the banks for “loans” had largely
disappeared. The government was then able to step into that gap and tap the
banks’ available capital to fund its budget deficit."
I realize that I am side-stepping George's point here to make my own. But the
point is that today, all over the world, people's savings are "captive
money" inside the $IMFS. One cannot simply walk out of the $IMFS today
and hope to retain one's purchasing power over the long run. Therefore the
people's savings, their 401Ks, IRAs, pensions and trusts are all captive to
the managers of the system. Under Freegold this
will be different.
That's the big difference for the majority of todays
"investing public," the savers. But then there are those dastardly
traders. Those traders are not only capturing fiat profits from gold's
volatility, but they are creating the very volatility they aim to capture,
which itself is the antithesis of gold's best and highest role, that of being
a stable benchmark wealth asset. The activity of trading "gold credits"
for volatility is part of the reason we do not have Freegold
today. Not only are the traders never holding real gold, but they are denying
the rest of us the beneficial stability of price that gold was born to
deliver. This "gold gambling arena" will not exist in Freegold.
First of all, there is no incentive for people to gamble on price changes in
something that is stable in price. And second, the gamblers' casino chips,
ambiguous claims on some illusory pile of gold somewhere back in the cage, will no longer exist. This is probably the most
important difference between Freegold and what we
have today. After the failure of paper gold liabilities to continue trading
at par with physical during the dramatic revaluation, every discrete piece of
the 160,000 tonnes of above-ground gold will be
**unambiguously** owned!
Furthermore, in every gold exchange, there will be an **unambiguous** seller
and an **unambiguous** buyer. This does not necessarily mean that all gold
exchanges will be face to face and entail the physical movement of gold. But
it does mean the end of ambiguous pools of unspecified gold and its
unallocated owners. I realize that this part is difficult for many to
visualize today given that it is how a good deal of the gold market presently
operates. But I believe that if you give it enough thought, you will
ultimately come with me to this conclusion. Otherwise, as Another said, time
will reveal all things.
With people's savings no longer captive in a financial system that lends them
out at will, interest rates will once again be a direct function of the supply
of (as well as demand for) capital inside the system. Yes, banks will still
be able to conjure "thin air money" on their balance sheets to make
loans, but the aggregate of loans within the banking system will once again
be constrained by the capital ratios in the banking system as no secondary
market for this debt will exist. And as a result, we will witness the return
of prudent lending standards.
All of these subtle changes/differences will flow from the inevitable loss of
the paper gold market that presently denies us the stable benchmark that is
gold's ONLY job. As will the end of the seemingly infinite well of power that
currently springs from the U.S. dollar printing press. And with the loss of
this free-flowing fountain of power what I like to call a global
**meritocracy** will emerge. And by global I mean on all scales, from
national, regional and international on down to the individual.
Through the unavoidable **meritocracy** that is coming straight at us with
the inertia of a runaway locomotive, we will witness the unexpected retreat
of the social welfare state as well as the reversal of the destructive force
of regulatory capture. You see, without the captive money of the savers to be
diluted, the printing press becomes a self-defeating mechanism that will be
controlled because it will be in the self-interest of the printer to do so.
As F.A. Hayek wrote (which I quote and source in Windmills, Paper Tigers, Straw Men
and Fallacious Fallacies):
"There are many historical instances which
prove that it is certainly possible, if it is in the self-interest of the
issuer, to control the quantity even of a token money in such a manner as to
keep its value constant."
"I have no doubt, and I
believe that most economists agree with me on that particular point, that it
is technically possible so to control the value of any token money which is
used in competition with other token monies as to fulfill the promise to keep
its value stable."
As for running straight back to a gold money system (instead of Freegold), Hayek writes (which I quote and source in Freegold Foundations):
"I do believe that if today all the legal
obstacles were removed… people would from their own experience be led
to rush for the only thing they know and understand, and start using gold.
But this very fact would after a while make it very doubtful whether gold was
for the purpose of money really a good standard. It would turn out to be a
very good investment, for the reason that because of the increased demand for
gold the value of gold would go up; but that very fact would make it very
unsuitable as money. You do not want to incur debts in terms of a unit which
constantly goes up in value as it would in this case, so people would begin
to look for another kind of money: if they were free to choose the money, in
terms of which they kept their books, made their calculations, incurred debts
or lent money, they would prefer a standard which remains stable in
purchasing power."
Why Freegold is far better
than Another run through Another gold standard time-line which will
ultimately end like all the gold standards of the past is Another subject
altogether. Check out my post The Debtors and the Savers for a clue to my Thoughts on it. But for this post I simply wanted to
lay out the many ways Freegold is different than
what we have today.
So here is a quick cheat sheet of the differences covered in this post (which
really only superficially scratches the surface as I said I would do for
Peter):
Stable physical-only supply
Stable, wide, awake and global demand
Much higher price
The end of captive savings
The end of gold traders
Unambiguous ownership
Supply resumes its role in fiat interest rates
The return of prudent lending standards
The return of capital ratio relevance
The retreat of Socialism
The reversal of regulatory capture
Meritocracy
This is not a dream or utopia. It is simply the swing of the pendulum. If
this list seems to you to be too good to be true, then I suggest you spend
some time in the archives and give it a little more Thought. As FOA wrote, "This not only has everything to do with a gold bull market, it
has everything to do with a changing world financial architecture. And I have
to admit: if you hated our last one, you will no
doubt hate this new one, too."
"Return to a gold standard" advocates like Peter Schiff have a
really hard time wrapping their heads around Freegold
because they are so focused on monetary currency that circulates when what
really matters is monetary wealth that lies very still. I think the simplest
way to express the separation of these two monetary roles to the gold
standard advocate is the application of Gresham's law. "Bad money drives
good money out of circulation." In other words, the bad (fiat) money
circulates while the good (gold) money lies very still… and floats in
value relative to the circulating bad money.
Sincerely,
FOFOA
PS. Blondie gets the one-liner of the day award: "So I guess 'Peter
Schiff was right!' destroyed any chance of him getting out of his own
way." – LOL
____________________________________________
Possibly related:
Peter Schiff echoes FOFOA on U.S.
currency crisis
By GoldSubject on May 9, 2010
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