Equilibrium

FRIDAY, JUNE 18, 2010

Equilibrium

I would like to thank Karl Denninger and Gordon Gekko for providing the backdrop I was looking for in order to present a few concepts and Thoughts.

Karl to Gordon Gekko: You can no more provide evidence that "gold is the only real money" any more than I can prove there is a Christian God.

What I can provide is evidence that gold is the only real wealth reserve accepted by those that create our money. Debt instruments, like Treasury Bonds, have a strange parity relationship with the value of the currency. They don't quite float, making them a poor wealth reserve. If/when the dollar collapses, so does the debt denominated in it. Gold, on the other hand, when marked to market, floats quite well, even in a currency collapse.

As for gold being the only one with this specific characteristic, just have a look.

Karl to Gekko: But to believe that gold will offer you sanctity, you must believe several things:

1. The currency you have now (dollars, in the case of the US) will collapse. Again, if you're going to predict this, you must both predict an event and a time or your prediction is not actionable.

Not true. In some cases throughout history it was best to prepare for the normal event of currency collapse as soon as its possibility became apparent. Currency collapse is a normal event, even if it is extremely rare. Just like death, it only comes once; but it does come once to everybody. And the logical implications and extremely high impact of this event are great enough that it is well worth preparing for without knowing an "actionable time".

In fact, those that took Another's and FOA's advice "too early", back between 1997 and 2001, have had to "suffer" through a 500% increase in the marked to market value of their wealth reserves while waiting. Sometimes it is best to be early.

2. Gold (or whatever) must maintain it's value in real terms. That is, I must continue to be able to buy and sell it in exchange for other things. But you already claimed there would be none on the market at any price - that is, there would be no trade in it at all. If this is the case then it is worthless, not priceless.

What is referred to here is the chaotic transition period between the failure of the fractionally reserved paper gold markets and the emergence of a physical-only free gold market. During this rocky transition any former parity between "the price of gold" and the price of actual physical pieces will be broken. This is when no physical will be available at the published price.

As for the physical price, it will be unknown as it rockets in the background to new heights. So yes, any paper gold will be worthless during this time, and any physical gold will be priceless. Congratulations, you are both right!

3. Government cannot steal it, or you won't have it. But history says that government will steal it. And they don't have to do so by outright confiscation either - they can whack you with a 90% tax on it at the point of sale and demand that all dealers register and report. Oops - they already did the latter after 9/11!

What Karl says here is technically possible as long as continuity is maintained in the official pricing of gold. But what I write about here is a functional change for physical gold. And in this new function governments will find it in their best interest to encourage citizens to hold gold for the purpose of decentralized clearing. This will be preferable to the alternative which will be holding your trading partner's currency.

Gold will not be a transactional currency. That will be the dollar or other fiat currencies around the world. But gold will replace the centralized function of the US Treasury bond and other debt instruments, in a decentralized way.

We will transition from this:

Into this [1]:

I will not go into great detail here, but logical deduction is the best proof that it will not be plausible for governments to track and tax the capital gains realized by physical gold holders who ride out the fire of change. I am talking about discrete, disconnected and discontinuous pricing before and after.

And I am warning of the chaos that paper gold holders and paper gold price-trackers will realize as their price goes to zero. This is the price governments track for capital gains purposes. Most Western gold investors will be wiped out when this price ultimately proceeds from $1,250 today to $0 at some point in the future.

I have also collected logical evidence and arguments as to why a physical gold confiscation is nothing to worry about this time around. Please see: Confiscation Anatomy - A Different View

And lastly, on this subject of confiscation through taxes, the governments of the world will find their softest and most sensible target in the mining operations that they license. Not in the small percentage of Western gold bugs that had the foresight to buy physical coins instead of shares.

Costata put it succinctly in a recent comment:

1. The gold miners will be the targets for high taxes. For political and practical reasons they are the soft option.

2. Anyone holding paper gold when the transition to Freegold comes will be burned.

3. Personal holdings of physical gold will be encouraged by governments for practical reasons.

Here is where Costata gets his direction. There is a lot of wisdom, understanding and foresight in the following words. Nothing religious. Just advice you can take or leave. But you only do yourself a disservice by dismissing it without consideration:

Date: Sun Dec 07 1997 18:45
ANOTHER (THOUGHTS!) ID#60253:

Try to live in this outcome and see how different the world will be. It will not be the end of all things, only the changing of most things in "western thought". The "Digital Currencies" will still trade, but we will value them as not before.

Anyone who has sold gold they do not have will not be allowed to cover that position. Anyone who has bought gold they do not have will not be allowed to cover that position. Many will lose all they have in a world without honor!

Looking back, one will ask, "how could I have thought that noone wanted gold, when more of it was being bought than existed"? Indeed, more gold than exists or will be produced in the next ten years! And some say, "only a fool would say the market was cornered".

During that time, a gold stock in the hand will not trade on an open market! And the government of the country, of the land, of the mine, will no doubt speak with you of new taxes on GOLD!

Date: Sat Mar 07 1998 23:37
ANOTHER (THOUGHTS!) ID#60253:

Mr. Mozel,
The USA placed a special "windfall profits" tax on domestic oil during the last major rise in prices. I do think the oil stocks would have shown a greater value had this tax not been in place. Because gold will soon become a currency, mines will be taxed in a much greater way. Also, domestic mines will be asked to sell directly to the treasury at the "perceived commodity value" value of gold, plus an operating margin. As no private company will be allowed to do your treasury's job, "produce money". Gold in the hands of the public will be thought of as a good thing, as citizens are asked to "pull own weight" as the government is much under.

Date: Sun Apr 19 1998 15:09
ANOTHER (THOUGHTS!) ID#60253:

REPLY:

Date: Sun Apr 19 1998 03:38
Drifter ( ANOTHER'S Thoughts ) ID#270447

Date: Sun Apr 19 1998 14:18
OLD GOLD ( ) ID#238295:
There will be ample time for holders of gold bullion and gold shares to sell their holdings for huge profits. Drifter was right on target here. Let's worry about getting POG to $350 this year. We have a long way to go on the upside before confiscation and/or taxation becomes a realistic concern.

Mr. Drifter and Mr. Old Gold,
If you search the "thoughts" posts provided by Mr. Sharfin, many of your conclusions are addressed. Many do feel that if "the gold mines were safe in the past", "they will be safe in the future". I submit this persons thinking for your consideration:

"The Western public has always thought of gold as money. Even after the 70s and 80s, most private investors held a small side thought, that gold was still, somehow dollar money. It was only during the late 80s and 90s that people started to completely lose the connection of paper spending money and gold.

Clearly, all evidence shows that prior to the 90s and particularly prior to the 50s, the push was to change the publics thinking away from gold money, to paper currency as money. In this political climate, gold mine investments were the correct move, as the business of gold was encouraged over the usage of gold as money! That is why the metal was called in and the mines were untouched.

However, today, the change will be counter to the prevailing public opinion, that gold "is not money". The world debt system and currency exchange, as we have known it will implode and leave little room for political maneuvering.

The governments will revalue gold and "demand" that the public carry it and use it! It will be the source of all gold, the mines, that will be controlled! That's Controlled, with a capitol "C", not confiscated!"

Mr. Old Gold,
Sir, I do read your writings and consider your thoughts! Thank You

8/10/98 Friend of ANOTHER

Michael Kosares,

Basically, this is the direction the Euro group is taking us. This concept was born with little regard for the economic health of Europe. In the future, any countries money or economy can totally fail and the world currency operation will continue. What is being built is a new currency system, built on a world market price for gold. Michael, you are absolutely correct in that the USA will see a hyper inflation of its currency and a gold price in dollars that reflects it.

Unfortunately, for most investors, the gold price rise will be sudden and also hyper fast, as it will occur just after a rapid plunge in dollar based assets including, stocks, debt and the entire banking system. This action will destroy virtually all gold based paper assets as they are also dependent on a functioning economic system. A local gold mine, in any country, must sell production to realize a profit. The contract system they deal with will not be functioning during this time. Contrary to many hopeful investors, local treasury officials will not allow miners to pay employees or buy equipment with physical gold. When the dust does clear for mining to continue, gold will be recognized worldwide as real money, and the mining of money will, no doubt, carry Extreme taxation. Stock prices of these operations, after being priced to zero, will then double or triple in price. Zero times three equals?

9/3/98 ANOTHER (THOUGHTS!)

Replies (9/3/98):

However, never before in history has gold been cornered in currency terms. Not physical terms. Never before in history, has a world reserve currency, the dollar, been forced from a high gold valuation to a low gold valuation, along with a destruction of world gold market. Because gold is traded today, worldwide in dollar terms, the transition will destroy the capital assets of 99% of all mines. Please place yourself in "the context of future events". Physical gold will not reach $30,000/oz because noone is buying it! It will come to this level because the dollar, today, is already inflated to the level that will bring this price.

The perception that this dollar is "no longer a good reserve", it will bring the flood of buying. This "already printed and in circulation today" currency will seek gold!

Governments will tax mines for the right to produce money and force them to sell production in terms of whatever the new world reserve currency" is at that time. Euro? Because gold mines are the "unique" circumstance in world of investments, their owners will suffer a "unique" problem of defining what they really own!

Also, remember, gold will rise soon as world trading continues this course of change. However, at some point, when the dollar market is destroyed, noone will know the currency value of gold thru an official market. Paper gold will not do well as the currency world is at war! The true surge of gold in dollar terms will not show until perhaps a year has gone by. During this time of trouble, physical gold will prove to be "the investment and holding for a lifetime".

ANOTHER: Gw, I would say, all forms of physical gold is good to own. Even the rare ones offer the "art form", yes? Even in war, the art work is looted first, then the jewels, and always food. I prepare for not the war of men, but the war of currencies! This conflict will bring forth a new concept for many: "western governments will encourage people to hold physical gold "! When the Euro has defeated the Dollar, citizens will be asked to use gold as a savings, for holding the Euro will be frowned on. Gold will not bring your "capital gains tax" as the mines will be taxed to compensate.

Yes, rare gold will be good, but not as liquid as "bullion type" gold.

Thank You

Karl to Gekko: Then your base claim - that gold is a inflation hedge - that is, it will hold value - is false.

This is true under today's semi-free gold trade. The paper market automatically suppresses the price of physical gold through physical parity with inflating paper gold. The same as gold was suppressed at $35 in 1970. This is true even if you don't believe GATA that the Fed actively suppresses it.

It was also true under the fixed parity of the gold exchange standard. But just like physical gold holders in 1933 and 1971 profited from revaluation, so today physical holders will profit when parity is broken between paper contract gold and physical gold in hand.

And once this separation is complete and physical gold finds its natural equilibrium as a wealth asset parallel to fiat currencies, then and only then will gold be the inflation hedge par excellence. This future stasis is what I call Free Gold. [2]

Karl to Gekko: Indeed, your position is nothing other than a speculative bet - a gamble.

What isn't a gamble today? We are on the brink of a major discontinuity. Are stocks not a gamble? Perhaps they are the best gamble if you expect normal inflation and economic recovery. Are bonds not a gamble? Perhaps they are the best gamble if you expect deflation of the type that perpetually increases the value of the dollar, even in the face of unsustainable debt.

But how do each of these investments fare in the opposite situation? How are stocks in a deflation? How are bonds when the dollar is falling? How do derivatives fare when counterparties cop to insolvency?

And what happens to all of the above when the currency collapses? No, it's not the dollar bills in your wallet nor the quarters in your pants pocket that threaten the system. It is all the contractual debt that requires payment in those things. If that debt can't be paid to the satisfaction of the creditors that earned what they loaned with real labor, then that dollar in your wallet will fail. The mountain of debt is inextricably linked to the currency itself.

Sure, foreign debt can cause a currency collapse quickly. But what about domestic debt? What about the biggest debt in the world being owed by the biggest printer in the world? How long does that take to collapse? 30 years? 40 years? And when should we start counting?

So which is the bigger gamble with your life's savings, your family nest egg, you children's inheritance at this particular time in history? Is it a bigger gamble to keep it denominated in a precarious piece of paper printed by the global debtor par excellence? Or is it the solid, private, physical wealth reserve with a 6,000 year track record that, incidentally, the central banks and sovereign wealth funds hold astheir wealth reserve?

The health of your nest egg is a very private matter, just like the health of your body. Do not entrust it to the opinion of others who will not lose a penny if you lose. Do not blindly follow the advice of anyone. Answer the questions above yourself. Think it through. Understand! Then decide for yourself.


(from Chris Martenson's Crash Course video Chapter 20)

This is no cult as Karl thinks it is. Some people here lost a lot of money in stocks, bonds and real estate before they started thinking it all through. Others here made a lot of money in these same schemes, and then went in search of the best way to consolidate that wealth before the coming discontinuity that anyone with eyes can see coming. Yet others, some that I have received generous support from, have family money, old money, and they thank me for sharing publicly what they already understand.

Here is the big picture historical context. When it comes to hard money and soft money history records a story of struggle between two classes of men. It is always the same two classes. Those who worked hard to save for the future and want hard money to protect the purchasing power of their efforts, and those who prefer soft money that always inflates away value making the repayment of their debts easier as time goes by. The savers and the debtors.

Sometimes the debtors rebel against the savers, as in the French Revolution. And sometimes the savers flee the debtors as in the American Revolution. Sometimes the conservative saving class makes monumental errors, as when the Regent of France put John Law in charge of their money. And sometimes the liberal soft money crowd takes it all too far, as with the dollar today.

I know you all perceive the banker as the opposition. But just know that the banker is merely the middleman between these two classes of men. The banker facilitates the loans from the savers to the debtors, and the repayment back again.

The banker makes his largest profits during times in history when the liberal soft money crowd is in power both politically and monetarily. And he makes his most absurd profits when the debtor class allows its debt to go too far... to the very mathematical limit. But don't worry. This unstoppable avalanche will reduce banking and central banking to what it should be; a utility for the public good. [3]

As money has evolved since the time of John Law, we have always had one or the other, hard money or soft money. And this always leads to conflict or currency collapse. With hard money you get conflict when the debtors revolt against hard payment terms. Look at Greece today, or France in 1790. And with soft money you always get currency collapse.

So if you are waiting for "the people" to rise up and demand silver currency to defeat the enemy bankers, you may just be looking in the wrong direction. "The people" today don't want hard money. They are deep in debt. They want soft money. So do the Western governments and politicians. They all want to inflate away the debt in which they are drowning.

No, what is happening today is a little more complicated than in the past. Today, as in the past, we are staring directly at a currency collapse of monumental proportions. The global reserve currency now has a mountain of debt denominated in itself, at its very limit. It can no longer be rolled over on the backs of new savers.

But at the same time we are all interconnected electronically today. Never before in all of history has a soft currency been so amazingly efficient and fast in long distance transactions.

So what will happen? How will it all shake out?

If you can understand that the savers' savings today is tied up in the debtors' repayment, then you can understand that savers will be burned because full repayment today is impossible. And they will ultimately turn to a different wealth reserve than paper representing someone else's debt.

And if you can understand how the debt is inextricably linked to the value of the currency, then you can pretty clearly see the currency collapse coming.

But our modern soft currency excels at one thing greater than any soft currency in all of history, or any hard currency for that matter. It lubricates a healthy economy with greater speed and efficiency than anything else ever has. So where is the flaw? I'll get to that in a moment.

Everyone wants a soft currency today. The politicians do. The central banks do. The G20 nations do. The debtors do. Even "the people" do, because they are debtors too. And today we have the best soft currencies the world has ever seen! Since the computer came on line in the 1970's thing have never been faster.

This is probably money's most important function, transactional medium or medium of exchange. But in this function, in this transactional role the specific value of a currency does not matter at all. All that matters is stability, or relative stability since perfect stability is impossible.

The reason I bring this up is to point out that the dollar could devalue "Zimbabwe-style", then gain stability once again, lop off a dozen zeros, and get right back to performing its most important function, lubricating trade at the speed of light.

Can't picture this? That may be because I haven't gotten to the flaw yet, and the natural solution to that flaw.

Ever since John Law's time and even before, money has had three roles to play. And they were always played by the same money. This "shared functionality" always led to conflict in times of hard money or currency collapse in times of soft money. The three roles are 1. transactional medium (the physical currency), 2. unit of account (the denominator of debt), and 3. store of value (the wealth reserve).


The flaw in the dollar is that it was brought up with gold tied at the hip. Gold was always fixed to the dollar at a specific parity. So gold was no obvious alternative store of value to dollar debt. So for 100 years now the savers have found dollar-denominated debt to their liking. That was until the debt slaves rebelled and the savers' savings became worthless. I believe that was back in 2010. Or was it 2011? But I'm getting ahead of myself.

We can and will live with a modern, electronic super-efficient fiat currency. In this Karl Denninger is correct. But when the debt mountain collapses and the present value of our super-efficient fiat currencies find their new equilibrium, something will have to emerge as a parallel money to serve the store of value function that failed in the collapse. That something is gold, and gold alone!

In this, Gordon Gekko is correct. Gold is money and only money! But I don't think we will go back to shipping pallets of gold to China on Walmart Supertanker return trips. Nor do I think we will go back to gold and silver coins in our pocket on the weekly trip to the general store like Little House on the Prairie.

Gold need only perform in the savings function and the clearing of net imbalances. And not necessarily in a centralized clearinghouse. Gold’s clearing function will likely be decentralized but it will not be a currency for everyday trade.

What I see so clearly coming right at us is a separation of the traditional monetary functions into two separate mediums! The transactional role will go to the winner in that department, modern electronic fiat. And the wealth reserve role will go to the winner in that department, gold. But what about the unit of account?


Well, I have a few ideas about this, but they are all equal probabilities. Maybe this role will be split between the two mediums depending on risk appetite, time preference and knowledge or profession. In other words, carpenters won't dabble in fiat debt investing. With a golden alternative there will be no incentive to take such risks. Or maybe we'll switch from a debt-based system to an equity-based system. [4] I think this possibility is highly likely even though it seems completely alien right now.

Anyway, this is what Freegold is all about. It is about deducing the inevitable implications of an unstoppable avalanche. And it is about fiat currency finally finding its natural equilibrium with a parallel physical gold wealth reserve. And trust me, fractional paper gold promises won't work in this new world, so equilibrium will likely be somewhere north of $50,000 per ounce (and that's from just the functional change, don't even ask me about the inflation-adjusted price).

Sincerely,
FOFOA

[1] Please see: Bondage or Freegold?
[2] Please see: Evolution! for more on stasis and "punctuated equilibrium"
[3] Please see: Say Goodbye to Wall Street
[4] Please see: Metamorphosis

Michael Maloney on Confiscation and Hyperinflation
h/t to Raptor for this one: