A Winner Takes the Gold

Ladies and gentlemen, we have a winner! Fox Business correspondent Dagen McDowell takes the gold medal in Wasted Airtime for demonstrating her very "special" gold standard of loud, obnoxious and completely closed-minded cluelessness. But before we get to the incredible video of the win, I would like to refresh your understanding of the intellectually-challenged view that drives this amazing woman.

It is a view so disconnected from reason and logic that I am compelled to write this post. And it goes something like this: "You owe it to society to give your savings to Wall Street so that your excess productivity can be more easily used or consumed by others, since you aren't using it right now." And I have yet to find anyone who has articulated this fabulously fallacious and deliciously deleterious view of reality better than the great Charles T. Munger of the esteemed Berkshire Hathaway Corporation:

"Oh, I don't have the slightest interest in gold. I like understanding what works and what doesn't in human systems. To me, that's not optional. That's a moral obligation. If you're capable of understanding the world, you have a moral obligation to become rational. And I don't see how you become rational hoarding gold. Even if it works, you're a jerk. (Laughter)"

Now I'm not suggesting that Ms. McDowell learned her very special spiel at the Munger school of gold-bashing, but wherever it was, I'm guessing it wasn't the long bus that dropped her off. Enjoy: try clicking here.

This is not simply a competing viewpoint in the grand marketplace of ideas, folks. It is wrong wrong wrong. And not only that, it is irrational, irresponsible and dishonest. More on this in a moment. But first I'll start off slowly so as not to lose the Dagenites right out of the gate.

Ms. McDowell goes on and on about how bonds "produce income." She apparently prefers interest and dividend payments over raw capital gains. Here we are, a decade into the bull market with gold's run so far equal to a compound annual growth rate of 18.8% for ten years running, and her main argument is still that gold doesn't produce an income? In what universe is receiving debt service payments superior to the escalation of real value over time as the economy grows against gold's limited physical supply?

Next she yammers on about gold having no "industrial worth." Again, in what universe is "industrial worth" always superior to non-industrial value? Should the Mona Lisa be fed into a wood chipper so as to tap its "industrial worth" as stuffing for a mattress? No, gold has INFINITE marginal utility in its service to the social realm. And by "infinite," Dagen, I mean much higher, broader and long-term usage value than any manufacturing or industrial input. If you can, Dagen, please read my post on The Value of Gold.

She also seems to have this strange obsession with timing, desperately wanting to hear the other guy say he didn't catch the exact start of the bull market. Sorry dear, but the only significant timing that matters today is "the earlier the better," or "better a decade early than a moment too late." Gold's marginal utility does not diminish as a matter of timing. Any day is a good day to set aside some savings for the next rainy day. And I can see storm clouds gathering on the horizon.

Here is FOA writing about Credibility Inflation. Credibility Inflation is that warm fuzzy feeling Dagan receives from her income-producing bonds:

When people try to protect their assets against the effects of fiat money, what are they really fighting against? The first inclination is to say "rising prices." Yet it's much more than that! Most everyone agrees that the interest rate paid by the banks never covers the loss of buying power brought on by price inflation. Especially the "after tax" return. It's the same old story, played out decade after decade. We must "invest our savings" (or become a day trader?) because the money will erode in value! Even at 3%, price inflation can eat away at any cash equivalents.

But, price inflation isn't the only story that impacts us. Rising prices come and go, but money inflation continues to affect us without fail. So why do people feel better when price increases slow or stop, even as money inflation runs ever upward? The good feelings usually evolve from the effects that money inflation (increases in the money supply) has on financial instruments. These assets take on the very same characteristic that the rising prices of goods once exhibited. They run up in currency price.

During these periods of "less goods inflation" another sinister form of mindset lurks in the shadows. Credibility inflation! Yes, it has been here many times before as every fiat currency alternates its effects upon the feelings of the populace.

Fiat currencies must, by definition, always expand in quantity. Their continued usage and acceptance is always obtained with the bribe of "more wealth to come!" Without that bribe, humans would never fall for holding a debt to receive the same goods in the future if they could get the real thing today. Human nature has always dictated that we buy what we need now instead of holding someone's IOU to receive it later. That nature is only changed through the "greed to obtain more." Like this: "I'll hold my wealth in dollars as long as my assets are going up. Later those increased assets will buy me a better lifestyle as I purchase more goods and services than I could buy now."

This is the hidden dynamic we see today. Just as destructive as "goods price increases," "credibility inflation" impacts our emotions to "hold on for the future, more is coming!" In every way, "credibility inflation" is just as much a product of an increase in the money stock as "regular price inflation" is. As cash money streams out to cover any and all financial failures, we begin to attach an ever higher credibility to the continued function of the fiat system. In effect, the more money that is printed, the higher we price the credibility factor.

But what Dagen should know about her unhealthy obsession with timing is that Credibility Inflation doesn't unwind smoothly. Instead, it "snaps all at once":

The same thing is happening today. People destroy the currency structure by thinking it can deliver more than reality will allow. Instead of all debt failing slowly with each upward march of price inflation, prolonged "credibility inflation" snaps all at once as investors try to suddenly revert to a "buy now mentality". The inability of government authorities to contain the fiction of "good debt" is usually the feature behind the investor mood change. A currency run induced by an IMF stalemate would qualify as just such a function change. The "snap back" into a sudden "real price inflation situation" caused during this stage by a currency failure always breaks the whole structure. We approach this end today!

Look, it is precisely because gold has the least "industrial worth" that it delivers the most value, not only as insurance against the inevitable "snap back," but as the focal point for net-producers and savers in a healthy, growing economy as well. You can read all about it in my post Focal Point: Gold.

Furthermore, gold is the most socially responsible valuable good to "hoard" (save), which is another reason it is the focal point. John Locke wrote way back in 1690 that it is "foolish and dishonest" for men to hoard up things of short duration, things that are consumed in the support of life, or any more than one can personally use from the common stock of perishables and truly useful supports of life. This, Locke wrote, is how man came to value durable things of no industrial worth, that "he might heap up as much of these durable things as he pleased… and keep those by him all his life," because "he invaded not the right of others." [1]

And today it is incumbent upon us to extend Locke's wisdom even further given the modern monetary plane that didn't exist in Locke's time. Above I wrote that Munger and the Dingbat (Munger and the Dingbat: a new animated series coming this fall) have a deleterious (harmful) view of reality. So let's consider reality for a moment.

Say you produce more widgets than you consume, thereby leaving some extra widgets "on the table" (so to speak) for others in the marketplace to buy, use and consume. You are a net-producer/saver, and you have expanded the global economy by leaving economic goods "on the table." But how to account for your savings?

Well, in the modern world trade is much more global than it was in John Locke's time. In other words, a Chinese saver's "excess widgets" are very likely consumed in the United States. And so how does that Chinese net-producer account for his savings in our modern monetary plane? First he changes the dollars he received selling his widgets to the US back into the local yuan. That yuan represents a "here and now entitlement claim" to more widgets inside China. Next, the Chinese central bank sends those dollars the saver exchanged back to the US where the US Federal Government spends them on widgets, some of which are imported from China. In exchange, the US Federal Government exports to China one of Dagen McDowell's favorite investments, a bond!

In the modern world of monetary magic, economists keep track of this back-and-forth flow with something called the balance of payments (BOP). The BOP is a way to keep track of international flows of both real stuff and paper promises. And if we dial the BOP into just the net flow of real stuff (also called the balance of trade or net exports) here's what it looks like. The balance of trade is the difference between the monetary value of exports and imports. A positive balance is known as a trade surplus (green below) if it consists of exporting more than is imported; a negative balance is referred to as a trade deficit (maroon below). This first one is cumulative from 1980 through 2008:

And this next one is what it looks like if we adjust for population size. Again, green means you are a net-exporter per capita, maroon is a per capita net-importer (of real stuff), also cumulative for '80-'08:

And, as you probably guessed, those people that mostly import the real stuff also mostly export the paper promises! So when you think about the fact that those illustrations are cumulative over 30 years, try to imagine all the real stuff that exchanged for paper promises and wonder about how those promises will be fulfilled. The answer is they won't, because they can't.

Imbalances lead to instability. In the end, instability destroys the value of those promises. So who wins in the end? Those that got 30 years of relatively free real stuff? Or those that will no longer be paid with promises that die?

The Wikipedia article on the balance of payments says, "With record imbalances held up as one of the contributing factors to the financial crisis of 2007–2010, plans to address global imbalances have been high on the agenda of policy makers since 2009."

And Nobel Laureate Joseph Stiglitz writes in last Thursday's Financial Times, "The international monetary system needs fundamental reform. It is not the cause of the recent imbalances and current instability in the global economy, but it certainly has been ineffective in addressing them." Of course then he goes on to babble incoherently about SDRs. But my point in mentioning these quotes is to show you that it is the common (main stream) view that large trade imbalances cause instability which causes financial crises which our current monetary system is unable to address.

Now I'm probably going to lose the Dagenites here, but it's time to learn about the balance of payments concept, courtesy of Wikipedia (edited by me for simplicity):

A balance of payments (BOP) sheet is an accounting record of all monetary transactions between a country and the rest of the world. These transactions include payments for the country's exports and imports of goods, services, and financial capital, as well as financial transfers.

When all components of the BOP sheet are included it must sum to zero with no overall surplus or deficit. For example, if a country is importing more than it exports, its trade balance will be in deficit, but the shortfall will have to be counter balanced… by running down reserves or by receiving loans or investment capital from other countries.

Note the bolded portion. During the Bretton Woods years the US trade deficit was balanced "by running down reserves" through the gold window. After 1971 that method was replaced "by receiving loans from other countries" by selling Dagen's favorite income producing investment, bonds.

While the overall BOP sheet will always balance when all types of payments are included, imbalances are possible on individual elements of the BOP, such as the current account. This can result in surplus countries accumulating hoards of wealth, while deficit nations become increasingly indebted. Historically there have been different approaches to the question of how to correct imbalances and debate on whether they are something governments should be concerned about. With record imbalances held up as one of the contributing factors to the financial crisis of 2007–2010, plans to address global imbalances have been high on the agenda of policy makers since 2009.

Note again the bolded part. Roughly, the current account is the net flow of current paper claims, or currency. In the case of the US and China, the US has a net outflow of currency (we send China more currency while they send us more real stuff). Therefore, China has a net inflow of currency. This accumulates as currency savings for the Chinese people, and currency-denominated debt for US citizens. So when Wikipedia says this can result in [Chinese people] accumulating "hoards of wealth," it really means hoards of currency savings, like a savings account at the bank. "Wealth" is perhaps a poor descriptor for what the Chinese are accumulating while "indebted" fits well with the US population.

Since 1974, the two principal divisions on the BOP have been the current account and the capital account.

The current account shows the net amount a country is earning if it is in surplus, or spending if it is in deficit. It's called the current account as it covers transactions in the "here and now" - those that don't give rise to future claims.

The capital account records the net change in ownership of foreign assets. It includes the reserve account (the international operations of a nation's central bank), along with loans and investments between the country and the rest of world.

I bolded the part about central bank reserves because this is the easiest item with which to visualize the capital account. The capital account is the inverse of the current account. And by inverse, I mean (roughly):

CURRENT ACCOUNT – CAPITAL ACCOUNT = ZERO = BOP

So the way the US sells Treasuries to China means the US has a "capital account surplus." And China has a "capital account deficit." You see, when we ship currency to China in exchange for real stuff, that's a deficit for us. But when China ships currency to the US in exchange for Treasury bonds, that's a deficit for China. I know, it's confusing, but this is how the modern monetary wizards make things balance today. They call it the balance of payments!

But what you must be starting to realize is that either one of the two principal divisions of the balance of payment sheet roughly represents the real stuff trade imbalance by itself! You simply make one positive and the other one negative and presto-shazam, you've got a balance of payments! Wikipedia explains it succinctly: "By the principles of double entry accounting, an entry in the current account gives rise to an entry in the capital account, and in aggregate the two accounts should balance."

Now let's look back at Bretton Woods again. Earlier I pointed out that the US trade deficit used to be settled by the US running down its monetary reserves—gold. But that was back when gold was money. After 1971 they demonetized gold which forced the US into the second option which is running up debt. If you are running a trade deficit you can either run down your reserves or run up your debt. Now I want you to think about this for a moment and commit it to memory, because I'm going to tell you about another option, so simple and obvious that "only one economist in a million may identify and understand" (my thanks to Keynes and Fekete for the felicitous phrase).

But because most of you are not burdened with a PhD or worse, a Nobel Prize in economics, you will probably catch the genius and elegance of this option immediately. At least I hope so.

Before 1971 the trade deficit was settled by exporting gold (via the gold window) to those running a trade surplus with the US. The problem with this system was that gold was fixed at a dollar price. So the US reserves were quickly run down by maybe 65% in 20 years. This was a problem because it was clearly unsustainable.

After 1971 the trade deficit was settled by exporting US Treasury debt bonds. And as we can see, this system is also clearly unsustainable. It cannot be reversed without collapsing the system. Joseph Stiglitz alludes to this in that FT piece:

"These deficits are necessary, for creating sufficient global liquidity, but they also generate excessive indebtedness, both external and internal. So if the US were to shrink its deficit too quickly, a deficiency of supply of the global reserve currency could result."

Simply stated, the modern monetary system creates a debt monster that must be perpetually fed. I have explained this dead-end cycle in past posts using my own illustrations like these:

Greece is the Word

Bondage or Freegold?

Now I'm sure some of you are probably thinking these modern monetary shenanigans are pretty lame. Obviously we need to balance the trade of real stuff. We can't just keep running a trade deficit into perpetuity and hope the PhD and Nobel Prize-winning economists will somehow fix it on paper, can we? Of course not! And close you are to discovering the final, elegant solution!

Gold is no longer money, like fiat currencies and government bonds. Today it is just another part of "real stuff." Call it a commodity. Call it "honest money." Call it whatever you want. But as long as we define gold, once and for all, as that physical element created only by God/nature, excluding any and all ethereal counterfeits, no one can disagree that gold falls squarely into the category of "real stuff."

Now savings is production minus consumption. If you consume more than you produce you don't have savings, you have debt. So savings is the way net-producers account for those extra widgets they "left on the table," growing the size of the global economy. What if, just what if, all those net-producers, those powerhouse engines of economic growth, saved the value of their excess productivity by buying that real stuff we call gold? Would it be bad for the economy or a bad investment as Munger and the Dingbat obnoxiously proclaim? Or not?

Here's that BOP formula again:

CURRENT ACCOUNT – CAPITAL ACCOUNT = ZERO = BOP

And I'll give you one more:

CURRENT ACCOUNT = SAVINGS – DOMESTIC INVESTMENT

And of course:

SAVINGS = PRODUCTION – CONSUMPTION

So as you can see, these formulas can be expanded as such:

SAVINGS – DOMESTIC INVESTMENT – CAPITAL ACCOUNT = ZERO

Or:

PRODUCTION – CONSUMPTION – DOMESTIC INVESTMENT – CAPITAL ACCOUNT = ZERO

That "= ZERO" means that the BOP is a zero-sum game. Notice that if the capital account were somehow magically zero (which would represent balanced "real stuff" trade), then savings would automatically be exactly equal to domestic investment. Or said another way, all excess real production would go right back into the local economy via domestic investment… automatically!

But that's only in a trade-balanced world, if things like Treasuries didn't exist. Because of Treasuries, the US has a large capital account surplus (large debt) while China has a large capital account deficit (lots of promises of future entitlement claims from America!).

This might be a difficult concept for you all to swallow, and I'm sure I've lost the Dagenites by now, but one thing the PhD and Nobel Prize-winning economists know for a fact is that those above formulas are, what they call, inviolable. This means that no matter what part of the equation you try to manipulate, it will always equal zero.

So if China wants to reduce its trade imbalance with the West it appears to have three options. 1. Increase imports that would feed into increased domestic investment. (But with China's yet-empty cities and shopping malls, increasing domestic investment may be an uphill option.) 2. Somehow get its people to stop saving or 3. consume more. In fact China has a fourth option. Encourage their citizens to buy gold, combining savings with consumption.

Remember; savings = production – consumption. And as I wrote in my last post, buying physical gold acts just like consumption with regard to the balance of trade, yet it also works like net-producing/saving to the global economy in that it leaves "on the table" all useful net-production as well as all of John Locke's "things of short duration, things that are consumed in the support of life, and things that invade the rights of others."

Okay, that's enough density. Put simply, there is a very simple, good, moral and ethical solution to the problem of global trade imbalances. And before I tell you what it is, I will say this: If you're not part of the solution, you are part of the problem. And that includes Munger and the Dingbat.

The simple solution to all the world's monetary and trade-imbalance problems is...... dot dot dot....... Buying PHYSICAL gold with your savings. It works (very roughly) like this:

If every Chinese saver were to take his cash savings (yuan) out of the bank and start buying the limited stock of physical gold already inside China, the price of gold in yuan would start to rise. This would create a theoretical arbitrage opportunity to buy gold cheaper outside of China and import it. Gold would flow into China. Of course this arb would happen naturally and automatically which would equalize the price of gold across borders.

And this gold flowing in would balance all other trade. If China exports X amount of goods and imports Y goods plus Z physical gold—with X > Y obviously—then X = Y + Z. The quantity of gold required to settle the accounts would float in price. Arbitrage through the open market between currencies and gold would automatically remove imbalances over time. Imports would always equal exports as long as the price of gold fills the void. And over time the price and flow of gold would automatically stabilize, as would the global monetary system.

Of course this would require a physical-only gold market with a free-floating price in all currencies because imports and exports of gold would then become part of the "real stuff" trade formula and could no longer exist in the monetary and physical realms simultaneously as they do with "Bullion Banking" today. All that currency spent on gold would continue to circulate in China. So it's not a matter of these gold-hoarding Chinese "jerks" (cf. Munger) denying others their net-production. That net-production would be still sitting "on the table" so to speak.

And as long as our net-producer/savers (young super-producers) outnumber our dishoarders (retiring ex-super-producers), the gold will still flow, only in lower volume by weight and higher nominal value. In other words, the price will rise. So... as the price of gold rises, more and more real economic goods are "left on the economic table." The economy expands... wait for it... as the price of gold rises! So gold is not the doom and gloom investment Dagen thinks it is. Oh no. It's the economically prudent and morally responsible investment!

And I'm not necessarily implying that borrowing (bonds) and economic investments (stocks) won't exist. But those who net-produce and then funnel their savings into those antiquated financial instruments have and will always make somewhere between a much lesser and a massively negative contribution to society than the gold hoarders. I say massively negative because it is they, Dagen and Munger, that enable systemic malinvestment and incentivize the kind of lowering of prudent lending standards that almost brought the system down in 2008. By contrast, gold savers force banks to use their own capital when funding the debt-based consumption of the widgets left on the table. Paper investments pinched off by the sphincter that is Wall Street only encourage and enable banks to make too many loans, far beyond the weight (and prudence) of their capital.

So Munger and the Dingbat are wrong wrong wrong! You're a jerk if you save in paper, enabling the destruction of Western Civilization. Rational people everywhere have a moral obligation to buy ONLY physical gold with their savings. If you're capable of understanding the REAL world, you have a moral obligation to become rational. And I don't see how you become rational investing in Charlie Munger's paper. Even if it works, you're a jerk, just like ol' Chuck.

Sincerely,

FOFOA

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