Snippets on Euro, Gold, Dollar and International Trade

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The presentation focussing on the separation of gold (store of value) from the currency (medium of exchange) as a separation of the international reserve form the local currencies goes back to Blondie’s insistence that gold cannot have constant purchasing power if it is to function properly in international trade. The discussion took place in the comments section at FOFOA’s blog between costata, Blondie and myself between October 25, 2012 at 1:05 AM and November 10, 2012 at 9:10 PM. We returned to this topic on the Neuralnetwriter forum around 17 March 2013 where Blondie explained his point of view to MF. Blondie also reposted the relevant excerpts of the original discussion.

Further Discussion

In a private discussion, I wrote

Thinking that the real price of gold would be approximately stable is a hard money fantasy. Get rid of that baggage, gentlemen. No, I cannot predict exactly how much the real price of gold will fluctuate, but fluctuate it must.

The ECB will not use gold open market operations in order to target consumer prices. That would be unstable (and of course foolish as it would be pro-cyclic rather than counter-cyclic, precisely the same instability as that of the gold exchange standard). No, in order to target purchasing power, the ECB needs to target some money supply measures in the conventional way by influencing the credit creation in the banking system.

The only gold open market operations consistent with the framework of freegold are the sterilization of a capital inflow or its converse.

As DP and milamber remarked on twitter and on my page, it is the option of the ECB to act like this that enforces compliance of their trade partners (I called them ‘China’ in my examples). Just the threat that the ECB can do this is enough to create an incentive for ‘China’ (either the private sector or, if they for some reason don’t do it, the PBoC) to settle in gold whenever there is the threat that the Euro zone might end up a net importer of goods and services (ex gold), because this is precisely the situation in which the Euro would decline with respect to gold. This creates stability of capital flows in addition to the known stabilization of trade flows.

For some reason, no CB official uses the words ‘gold’, ‘oil’ or ‘exorbitant privilege’ any longer. The Europeans just speak of ‘international imbalances’. If you take this into account, Noyer’s announcement that the Euro would be purchasing power stable and his invitation to hold Euro central bank money as a safe store of value, given that you as an Asian central banker know that gold will be the international reserve, guides you to precisely one conclusion:

1. The ECB will target purchasing power of the Euro.
2. This means they will not target a specific real gold price (otherwise the Euro would be on a soft gold exchange standard)
3. Both 1 and 2 tell you that the ECB must sterilize any excessive inflow of capital by gold open market operations. Monetizing anything else would conflict with 1.
4. If Noyer invites you to hold Euro base money as a safe store of value, he must commit to 3. or be inconsistent.

Remember that I wrote above that in order to target consumer prices, the ECB needs to target a suitable measure of money supply.

In all of the European debt crisis, the ECB has demonstrated that they are doing precisely this. The Euro is effectively ‘hard’ money. Creditors and debtors are not bailed out at the expense of deviating from the mandate of price stability. The entire handling of the European debt crisis is a grand lesson on how the new financial system will look like.

You just need to listen to what the relevant ECB/BIS officials say (Noyer, Weidmann – see below) and watch what they are doing. They are pretty frank, aren’t they? Here is Jens Weidmann in a recent interview. Every other month they give you a clear statement that the Euro is not going to be devalued with respect to goods and services (not more than the announced 2%), but rather that they will enforce enough deleveraging to keep its purchasing power on target.

I cannot see that the ideas that

1. Gold will be purchasing power stable
2. The Euro will devalue with respect to goods and services (by more than the stated ECB mandate)

would have any sound foundation. The first is a hard money fallacy and the second is Anglo Saxon mainstream economics.

Finally some people seem to think that in view of the excessive debt it will not be possible to keep the purchasing power of the Euro stable. Well, there is a big difference between allowing the inevitable deleveraging and allowing consumer price deflation. With the Euro being paper money, not caring about the real price of gold, there is a new degree of freedom that allows the ECB to differentiate between the two, allow deleveraging but not deflation.

Another Snippet

In the new financial system, the CB basically has two options:

1) Manage the fiat currency in a way similar to the ECB, i.e. a sort of “hard paper money”. No inflation to expropriate savers, not preventing deleveraging, but they would print in order to fight deflation.

With such a CB, the currency becomes a store of value in Blondie’s sense. And yes, I still think the ECB can and will eventually target 0.5% inflation or even 0%. There is nothing bad about it.

It is reasonably safe for anyone to hold such a currency, at least if you can get hold of central bank money. If such a currency gets a capital inflow, their CB must buy gold.

2) Manage the currency with a higher or at least an unpredictable inflation rate. Savers will be reluctant to hold such a currency and go for gold more quickly. (Or perhaps buy Euros instead).

Following Blondie, I do think that once you take the oil privilege away from the dollar, and once you settle international balances in gold, not sterilizing the flow of gold, you will already have arrived in the new system. In this environment, it becomes possible to manage a fiat currency to have on average 0% consumer price inflation, and it would be safe to hold that currency.

In the earlier discussions about freegold, people used to claim that the savers would eventually (have to) withdraw all savings from all currencies, not hold curreny as savings at all and use gold as basically the only store of value. I now think that settling international balances in gold suffices. You can then still hold the Euro, it will be fine. You certainly want to avoid the dollar and all dollar anchored currencies because of what happens when it goes out of business as a reserve.

The only obstacle that prevents the world from transiting into this final Nash equilibrium of international gold settlement is a symbiosis between two parties that benefit from a different strategy: The U.S. keeping the dollar strong (where freegold says they ought to buy gold whenever they send currency abroad), and the oil producers demanding dollars for their oil, only exchanging a part of these dollars for gold. Once the oil producers accept an arbitrary currency and always convert all balances into gold, the new system has arrived.

On my claim that 0% inflation in fiat currency will be possible. Well, what happened before WW1? On time scales of 10-20 years, the currency was pretty exactly purchasing power stable. This worked because gold functioned internationally. But this caused wild price swings on a time scale of under 5-10 years. The real price of gold needs to fluctuate (wildly!) in order for gold to function.

What the modern economy doesn’t like is the wild fluctuations within 5 years. The fact that the currency was purchasing power stable over periods of 10-20 years and longer, wasn’t the issue. There is no reason why the economy would need structural inflation nor that anyone would benefit from it.

What went wrong starting with the Fed under the Harding administration around 1920 (see FOFOA’s “Once Upon A Time”) is that they didn’t like the strong price fluctuations due to the international function of gold. The Fed sterilized the inflow of gold in order to fight local price inflation. This was probably even well intended, but it contributed to the collapse of the international gold standard and thereby to the accumulation of imbalances.

Now if you have a fiat currency separate from gold, you can let gold fluctuate as is required by its international function while you can indeed fight inflation in your fiat currency locally (and deflation, too). Whether your fiat currency has a stable purchasing power over time frames of 10-20 years or whether it has 1.5%-2% inflation as per the Eurosystem’s current target, is a different question.

Since a 2% long term inflation target has no benefits, why not go for 0% and make your currency a proper store of value, too? As long as gold functions, there is no issue.

Speaking about gold’s function, remember Barsky-Summers. Gold will play that role again, too.

Of course, right now, the US dollar is running a high risk of hyperinflation, and in that case, the savers would indeed run away from the currency. But for the Euro zone, I don’t think it would be a problem for those who can hold base money (i.e. basically foreign CBs).

Yet Another Snippet

It is not the difference between a 2% inflation target and a potential 0.5% or even 0% inflation target what distinguishes soft money from hard money.

Under the old gold standard, a period of credit deleveraging always threatened the system by potentially triggering a chain reaction of credit collapse, falling consumer prices, recession, credit collapse, and so on. The inflation target of the ECB is going to prevent this from happening. It is just that the key is not the gradual difference between a 2% or a 0.5% target, but rather that they are committed to and also have the tools to avert a deflationary vicious circle.

The difference between the gold standard and a Euro with a 0% inflation target is qualitative. The difference between a Euro with a 2% target and a Euro with a 0.5% target is gradual. The former is a huge conceptual difference, the latter a technicality.

The following is one of the flaws in our thinking as of one or two years ago:

Q: Once the transition has happened and the new financial system is up and running, and the dust has settled, what will prevent savers from again saving the currency rather than gold. If the currency, say the Euro, is well managed for a few decades, people might again be tempted to accumulate currency savings. Will this destabilize the system?

A: The answer is not that obvious, isn’t it? If the Euro is well managed, why wouldn’t you hold it for the long run? Because you are still shocked by the transition? Alright, then let’s think about the generation of our grandchildren. They will know the transition only from our fireplace tales and hopefully from their Econ 101 textbooks. But they won’t be personally shocked. So will they keep in mind that they have to save in gold in order not to destabilize the system?

Isn’t it convenient for the missing answer that the ECB has a 2% inflation target, and so if our grandchildren are prudent, they would understand that this is not very nice for their savings in the very long run…. Does the ECB need to impose an inflation target strictly above zero just in order to keep the system stable? Yes or no?

The entire point is, of course, moot. The ECB can choose any reasonable inflation target, say, anything between perhaps -2% and +4%, as long as they act in a predictable fashion and don’t cause uncertainty and unnecessary friction in the economy. Freegold will work in any case, and this is because it separates two things:

1) International adjustments by market driven changes in the real price of gold

2) Domestic targeting of some reasonable value metric for your business currency. It is quite obvious that it is a good idea to manage your currency in such a way that there are only small changes to the general price level and to wages.

It is the separation of (1) from (2) that makes the new financial system viable. Conversely, both the gold exchange standard and the dollar system with a paper price of gold link (1) and (2) in a way that prevents you from accomplishing both international balance and purchasing power stability at the same time and in the long run.

Freegold already solves this because it sets gold free and allows it to function: (1). The precise inflation rate or “management style” that you choose for your fiat currency is a separate consideration.

Will the ECB cause some serious bloodshed by not letting the Euro inflate beyond 2% and thereby not relieving the pressure from debtors and savers? FOFOA (from memory) “If you think austerity riots are bad, wait until you see hyperinflation riots.”

I said the way the European debt crisis is being handled today is a grand lesson on how the future financial system will look like. Blondie said that if you want to understand how the ECB views the future financial system you need a point of view from which their actions are consistent. He is absolutely right. Just watch. They are demonstrating it to all of us.

Is the ECB causing a bloodshed in Greece, one that they would have avoided had they printed without limit? Answer: No. Greece enforced some 50% haircut on their bondholders in spring 2012. It is not that the debtors are treated like slaves. No, the creditors share the burden and take a haircut, too. Is this money really too hard? The past haircuts (Greek government debt, Cyprus’ bank deposits, some second tier Spanish bank debt) won’t be the only ones. More will follow. Eventually the investors will bear the majority of the losses. The losses won’t be socialized via inflation, but rather will the investors be “encouraged” to take responsibility and to think about what they are going to do with their savings.

This is as in the new financial system.

Three further Snippets

(21 April 2013)

The following are taken from the NeuralNetwriter Forum and only modified slightly:

One aspect that keeps impressing me is that the entire Eurosystem has been set up in such a way that it can operate under the new financial system without any single change of statutes or change of law. Politicians are not needed for the transition.

This is in contrast to the U.S. (or Japan, UK) where plenty of legal and procedural changes are required. Just think about the U.S. gold reserve and the certificates written against it at $42.22/oz that are on the Fed books. Think of their monetary policy goal of full employment, etc.

Now take a look at the following detail about the Eurosystem. The Treaty on the European Union says their primary goal is price stability:

Then the ECB Governing Council clarified this and specified that they are targeting consumer price inflation below, but close to 2% annually:

Oops. That would be easy to adjust down to 0.5% or even 0.0%, wouldn’t it? The numerical value is not in the Treaty, but it is rather a decision by the governors.

Why would they consider adjusting the inflation target down? Wrong question. The right question is, after the transition to the new financial system, where would they get 2% inflation from?

That would be far from easy. In the absence of any serious turbulences, velocity is approximately constant. Then there is basically one way you can get inflation. The total volume of fungible “money” that is available to purchase goods and services, has to increase. At present, this happens, for example, when commercial banks create credit and when this credit is used to purchase goods and services. It happens when a commercial bank borrows liquidity (=reserves) from the ECB and pledges government bonds as collateral. (This is because, in aggregate, this allows the governments to write additional bonds without exerting any pressure on the interest market and, in turn, makes new base money available) Thirdly, it happens when the ECB buys assets (e.g. government bonds) directly and pays with reserves (=Euro base money).

Now after the transition, do you think that
a) consumer loans will keep growing faster than GDP?
b) loans to governments will keep growing faster than GDP?
c) the ECB will keep printing money and hand it over to the governments?

No? You don’t think so, do you? Then where do you get 2% inflation from?

The answer is, you won’t.

If the Eurosystem can easily go for a 0.5% or even 0.0% inflation target, why haven’t they implemented it right in 1999 when the Euro started? Why only post-transition?

At this point, we need to recall the main pillar of the dollar system. If you are a third party and you need to buy oil, you face the difficulty that oil is sold only for dollars. Therefore, you first need a trade surplus of goods and services into the U.S. (or into some other countries who pay with dollars) in order to earn dollars. Then, you can use these dollars to purchase oil. Furthermore, the U.S. Saudi axis sometimes increase the dollar price of oil, and in this case, you would be in trouble unless you had a considerable reserve of dollars at hand. This is what keeps the dollar alive.

Now in which way has the Eurosystem escaped this dollar system?

They set up the Euro zone in such a way that it had a balanced trade and a balanced capital account in 1999. But the Euro zone is not a closed economy, it is rather the major trade hub of the planet. They import energy and resources while they export machinery and finished goods. The Euro zone will be independent of the dollar system as long as they receive for their exports the same currency that they need for their imports, and as long as their trade account is balanced, i.e. their balance of trade is small compared to their remaining dollar reserve.

But since oil is still sold only for dollars, the Euro zone needs to keep up its exports into dollar countries in order to keep their trade account balanced, or they fall back into the dependencies of the dollar-oil system. For this, the Euro should not appreciate too much compared with the dollar. Well, we have seen that the Euro can easily appreciate by 3% to 5% per year with respect to the dollar without compromising the balanced trade account of the Euro zone. But is shouldn’t increase substantially faster than that before the dollar-oil link breaks.

So how did the founders of the Euro arrive at their 2% inflation target? Perhaps they just estimated which inflation rate was necessary in order for the Euro to slowly decline together with the dollar such as not to destabilize their balance of trade. For example, with a 0% inflation target rather than 2%, taking purchasing power as the yardstick for the currencies, the Euro would now be at $1.70 rather than $1.30. That probably would make a difference for the Euro zone trade account.

You see that as long as the dollar-oil link is intact, the U.S. can basically force the entire world to inflate. Even the Euro zone is vulnerable to this forced inflation to some extent.

How would the Europeans prefer the dollar to end? The above thoughts tell me that they must prefer a resolution in which the link with oil breaks first because this would give them the scope to freely choose their policy. If, however, the dollar collapsed first in the foreign exchange markets, but oil merely adjusted the dollar price per barrel but otherwise remained dollar faithful, the Europeans would be in trouble and would have to start spending their dollar reserve or try to use their gold before the transition. This, in turn, might suggest that should the dollar decline substantially, the Europeans would actively break the dollar gold market, in order to force oil to move, too.

I think that most who have criticized Blondie’s idea (including FOFOA), have so far largely missed the point of that idea.

Blondie’s main point is not that Euros would be a better option for your savings than gold, that you should sell your gold and buy Euros instead, far from it.

What Blondie’s idea explains is the following. The real price of gold needs to fluctuate for gold to function internationally. For gold to function, all international balances need to be settled in gold. This includes capital balances, not merely trade balances.

This implies that when foreigners buy Euros (perhaps because of a dollar panic), the ECB has to sterilize this inflow of money (technically a capital export because Euros are purchased by foreigners) by purchasing gold and creating Euro reserves. This, in turn, told me that both parties of international trade can enforce settlement in gold.

If China (just an example) exports into the Euro zone, the Chinese exporters will at first receive Euros from the European importers. Now the Chinese, either the private sector, or if they don’t, the PBoC, can sell Euros and buy gold.

But even if the Chinese tried to “manipulate the currency” and kept accumulating the Euros in order to retain their competitive advantage, the ECB can just buy gold and create Euros (for the Chinese to hold). I.e. the ECB can act “on behalf of the Chinese” and enforce the international adjustment process that the Chinese forgot to enforce.

Furthermore, it tells you what the incentives are. If the Euro zone is a net importer (in aggregate, not just in trade with China), the ECB’s action would raise the gold price in Euros, and so the Chinese will be better off if they settle in gold right away rather than keep the Euros. Only if the Euro zone was a net exporter in aggregate while only with China they were an importer, would it be profitable for the Chinese to keep the Euros rather than settle in gold. In this case, the ECB would have an incentive to settle in gold on behalf of the Chinese rather quickly, because if they didn’t, some other trade partner might do it and the ECB would record a loss on their gold operations.

This was the first time that I understood that the new financial system is truly stable and that it can be enforced by either one of any two trade partners. Before Blondie’s argument, we always had to invoke something along the lines of “after the change, nobody will trust the currency as a store of value any longer, and so they will all purchase gold immediately”. That was a lot weaker than what we understand now.

It is finally a corollary that, once the new system is in effect, the ECB will have the option to target any consumer price inflation rate they like. There is no particular argument in favour of 2% as opposed to 0%.

This means, precisely as Blondie told us, that the currency can be managed in such a way that it is a store of value, too. Once gold functions (and fluctuates in real terms), the currency can indeed play all three of roles of money: medium of exchange, unit of account, and store of value.

If you are a wealthy family or even an OPEC country, this wouldn’t mean that you no longer converted a large part of your profits into gold right away. Recall that if you export into a currency area that is a net importer, it is the most profitable strategy to go for gold immediately. But it does mean that the OPEC country would have to accept fluctuations in the real price of gold (which includes the gold/oil ratio by the way). They would happily stomach it by the way.

But for an international company, for example, the fact that the Euro (and any other well-managed fiat currency) will be purchasing power stable, does make a big difference. They might prefer not to have exposure to the gold price which will fluctuate considerably in real terms.

Finally, for the near future in which you might be worried about an end of the dollar system, even if I was in the Euro zone, I would prefer gold over Euros, at least for the portion of my savings to which I don’t need access for a couple of years. With gold, you would be able to capture the revaluation windfall, but with Euros, you wouldn’t. On the other hand, I can well imagine that holding Euros will be possible and the ECB will not deviate from their 2% and perhaps later even 0% inflation target.

If in the Euro zone, you should also take into consideration that the only base money that you as a private person can hold, is tangible cash. Foreign CBs and commercial banks can also hold reserves (Euro base money) at the ECB, but you cannot. Everything other than tangible cash that you can hold, is credit money and does involve counterparty risk as people in Cyprus and Spain just had to learn – and plenty of others soon will.

This, finally, is the next advantage of Blondie’s point of view. It allows us to view the present actions in the Euro zone in the light of the future financial system in which the Euro is purchasing power stable and in which gold fluctuates. Let us see which point of view explains the European actions better.

Yet Another Snippet (YAS)

(29 April 2013, originally written here)

The issue with the terminology “store of value” arose because of the three functions of money: MoE, SoV, UoA.

We said that the dollar will ultimately fail to play the role of a store of value, i.e. fail to preserve its real value relative to goods and services inside the U.S., firstly because of its overextended international position and secondly because of the anticipated political reaction to a loss of confidence in dollar debt. I suppose we all agree on this part.

This raises the question of whether every fiat currency will fail as a store of value during the transition and, secondly, whether fiat currencies AG will still be doomed to failure as a store of value.

In my opinion, the answer to both questions is ‘no’, not only for theoretical reasons (there is no argument that would prevent a fiat currency from being well managed) but I also think this will most likely be demonstrated in practice, right from the start and right through the transition: by the Euro.

In other words, the dollar will fail (as a store of value) not because it is fiat, but rather because of the past abuse of its role as a reserve currency and because of the alignment of the current political interests that have a clear incentive to exploit the benefits of the international reserve role up to the very last minute, thereby destroy the old system and then to completely abandon the old dollar the next second.

As Blondie explained, AG a fiat currency can (!) be managed in such a way that it fulfils all three role of money including SoV. The ‘can‘ is a conceptual insight – that’s the main point here. Why ‘can’ it? Because there is a reserve (gold) that can absorb (‘store’) all surplus equity (I like Blondie’s termininology here) and balance trade and capital flows. For the reserve to function, its real value must fluctuate and cannot be expected to be constant. So, according to the standard definition of the three roles of money, gold is not a store of value. (I am saying this, knowing that, for example, resource exporters as well as individual people who “save” for their retirement, will most likely purchase gold – in order to store their surplus “equity”).

Once you are there, you can ask, given that a fiat currency can be managed to preserve purchasing power, whether there are incentives that it will be managed in this way. I answered with yes and then was “educated” by some FOFOA followers who kept explaining the benefits of inflation to me, even if AG the major source of systemic inflation will obviously be absent. This argument is a waste of time. Once systemic inflation is absent from the system, nobody will fall over himself to create any.

The only question that makes for an interesting debate is the question of when the ECB will adjust their inflation target of 2.0% down. They might do this first in practice, tacitly, and only officially announce it much later. Why not?

I don’t know why people don’t like this idea. Perhaps they fear, deep down in their heart, that gold’s purchasing power will vary considerably, making it somewhat difficult to handle in the short run AG. If the CB would then artificially make gold superior simply by making the fiat a poor store of value, it would relieve them from this burden of dealing with the reality of gold. I still think it ain’t gonna happen, dude, and this idea of short-term stable gold is ultimately yet another hard money fallacy.

Finally, once that fiat is reasonably purchasing power stable, and it doesn’t matter whether this means 2% or 0% consumer price inflation, there is a second function of gold besides its international one: If fiat denominated credit gives you a high real interest rate in the future, it makes sense to hold a bit less gold (its velocity will increase) whereas when fiat credit gives you only little real interest, people will tend to hold more reserve (=gold). This is exactly the effect that caused Gibson’s paradox.

What’s nice AG is that in periods of low future real interest rates, when people tend to hold gold rather than let it circulate, this does not drain any reserves from the credit system and does not threaten any bank failures. Gibson’s paradox (the price level during the gold standard is high when actual future real interest rates are high and vice versa) will be replaced by gold’s second function: the real price of gold is low when future real interest rates are high.

Why do I want to talk about Gibson’s paradox? Well, we could have a single world currency, no? At least theoretically. No, no, this is no New World Order talk, I am just trying to understand monetary policy.

Alternatively, you can ask how the Euro zone will function internally. I still think it is a major strength of the Euro that there is no federal government of Europe with a single government and a single treasury department. This makes sure that the Euro is “merely” a currency rather than a political instrument – the Euro has severed the link to the nation state. So it is only natural that different economies in the Euro zone are in different phases of the business and in different phases of the fiat credit cycle. If you think about a potential one-world-currency, you would expect this even more so.

How can gold balance trade inside the Euro zone if there is no spur and brake function in the foreign exchange market that would accomplish this for you? It is easy to guess that “gold must flow” from the consumer to the producer – and it might depend on the business and credit cycles which one is which. Why would it? Because of the effect that caused Gibson’s paradox. If future real interest rates are high in some region, but not in another, then gold starts to flow. This way, gold will flow from the consumer (high interest rate because of consumption of capital) to the producer (low interest rate because of a surplus of investment capital), exerting restructuring pressure on the consumer in a way similar to the situation in which trade is cross-border and cross-currency area.

I have to repeat that I feel conceptually a lot better AB (=after Blondie), and given the different expectations about the time AG, it may even be worth some real bucks or quid or, expecting that these two will get in trouble, how do you call Euros?

Update: 8 August 2013

and a snippet from Screwtape Files:

Something has changed. It started around the end of 2012:

* the GLD Puke indicator stopped working
* GLD inventory started to decline and kept declining even during periods of rising London gold price
* the London gold price no longer increased during the last few days preceding a Eurosystem gold price snapshot at the end of a quarter
* on an end-of-quarter basis, gold in Euros started to decline
* the Bundesbank released a list of all gold transactions from which you can see that they used to have unallocated, swaps and gold on lease, but that they have their gold fully allocated as of today
* from this list, you can see that they allocated about 750 tonnes loco London in 1997, the year in which LBMA clearing volume was first made public, Big Trader and Another appeared at the Kitco and USA Gold forums, a year which had a number of sharp down-spikes in GOFO and in which ultimately some 2500 tonnes of gold left the UK
* from this list, you can also see that they moved about 950 tonnes from London to Frankfurt around 2001 without telling anyone for more than a decade – nevertheless towards the end of 2012, they just made a big fuss about relocating a comparably small quantity of 50 tonnes per year from New York to Frankfurt and kept dragging this into the press again and again
* the Europeans started talking of bail-ins and haircuts
* the Europeans started treating bank deposits as loans (which they are) and recognized that these are subject to credit risk and potential loss (Cyprus)
* when Mario Draghi was asked why he wouldn’t do more for Spain given that inflation was well below target around 1.5% per year, he simply replied “I am sorry” and “You should be happy because with low inflation, you can buy more stuff”
* the Brent minus WTI crude oil spread disappeared
* European anti-trust authorities raided the offices of Platts and a couple of UK banks and started investigating manipulation of the oil price
* Lawrence Summers is being put into position for succeeding Ben, a move which everyone is scratching their heads about
* Jean-Claude Trichet gave a speech in which he mentions the phrase “exorbitant privilege” again and again and in which he repeated at least ten times that the dollar no longer enjoys any such exorbitant privilege – Euroean central bankers had not used this terminology for decades
* the gold price is slowly creeping below production costs (at least including capital expenditures)
* according to the US Treasury’s TIC data on Major Foreign Holders of US Treasury debt, the rest of the world switched from accumulating US$ to the tune of $40bn to $50bn per month to selling US$ at a rate of $20bn to $30bn per month (changed in April 2012) – note that these data keep being revised in a rather obscure fashion though
* although the economy and employment were improving towards the end of 2012, the Fed started QE3 and upped their bond purchases from $45bn per month to $85bn per month

I claim that you have found the right point of view once you realize that these are all different symptoms of the same development, a huge tectonic shift in the global monetary system

Tweets on August 17


100 Responses to Snippets on Euro, Gold, Dollar and International Trade

  1. Milamber says:


    “We watch this new gold market together, yes?”


  2. Kid Dynamite says:

    i logged on to find you had copied me on like 25 tweets! but I’ve never discussed gold’s role in the monetary future to the extent that you have…

    definitely too much for twitter – would rather read you write 4 paragraphs about your point (note: FOUR paragraphs – NOT a FOFOA 15,000 word tome…)

    • Kid Dynamite says:

      Victor – is the gist of your point basically this:

      the ratio of

      (USD outstanding) / (US Gold reserves) is much higher than the ratio of:

      (EUR outstanding) / (EUR gold reserves)

      and thus the EUR will win The Future?

      or is your point something else?

      • The point is a totally different one. The quantity of gold someone owns (both official and private) is actually not the key. The key is that gold is used in order to settle international balances (it doesn’t even matter that it is precisely gold as long as it is not debt, i.e. it matters that it is instant payment [“payment in full”, “final settlement”] as opposed to a promise to pay later).

        The present imbalances (U.S. and UK importing some 3-5% GDP every year with accumulation of debt on the other side, and this for more than forty years) are possible only because both
        1) exporters accept IOUs as payment AND
        2) importers choose to let the exporters accumulate their IOUs.

        This is not stable. If it goes on for a decade, the economy of the debtor changes. They lose industry, get inefficient, etc. Once the exporters stop exporting for IOUs (either because their economy changes and they now export less [Japan], they now want full payment [Euro zone after 1999 stopped accumulating dollars], whatever else…), the economy of the importer takes a huge hit because without debt funded imports, some inputs are missing or become expensive (oil, resources, machinery and equipment) and demand for local products (consumption, services) drops because of the lack of available funding and the lack of demand for domestic credit. Sure, with a lower currency, they can start rebuilding an export industry, but that takes time. Textbook macroeconomics has instant equilibrium and cannot describe time lags.

        The Euro architecture is the blueprint for a new international monetary system in which physical gold is used to settle international accounts. This works if
        1) exporters choose to demand final settlement in gold (either their private sector companies or their central bank if some private sector entities keep accumulating IOUs for whatever reason) OR
        2) when the exporter keeps accumulating IOUs of the importer (any credit denominated in the importer’s currency), the importer’s CB can create currency reserves by monetizing gold purchased in the market. This takes away the gold that the exporter ought to have purchased and creates the currency that the exporter keeps holding.

        This system is way more stable because it avoids the accumulation of imbalances, and this strategy (1) and (2) is a Nash equilibrium. No party can get an advantage from fudging their currency exchange rates because the other side can always sterilize the effect.


        • burningfiat says:

          Great points you have there. I agree, both sides can enforce settlement with the ECB solution. Either 1=exporter settlement or 2=importer settlement.
          However I haven’t seen the light (yet?) that option 1 and 2 are both equally good equilibriums. If exporter always goes for option 2, it means they will be hoarding paper claims (importers currency) forever, won’t it? How can that be sustainable? Won’t it rock the boat systemically at one point (counterparty risk must naturally increase (at least) linearly with the number of counterparty claims you hold)?
          Here’s how I think it will go (option 1 and 2 in conjuction will be the basis for a real equilibrium): Exporter tries to accumulate importers currency, importer CB decides to teach exporter a lesson and keep its own circulating money supply stable, and now prints and buys gold with the fresh currency, If exporter is not a total moron at this stage it now realizes that the gold bounty that was the reward for its surplus exporting is now claimed by importers CB instead. Exporter then reverts to the natural option 1, right?


          • If the exporter wants to conserve the surplus for the very long run, they would naturally go for gold rather than Euros. For the short and medium run, Euros are no problem. Do you remember the Noyer speech I was commenting on here?

            The exporter would not hold bonds or credit money, but rather directly an ECB reserve, i.e. base money. So there is no credit risk involved, and nobody in the Eurozone would need to go into debt for this option. Recall the the ECB would create the reserve by buying gold in the market. The exporter merely has the option to accept the risk that the gold price in Euros fluctuates, or he would be invited to offload this risk to the ECB. Depending on the anticipated time frame and on what they are planning to do with their surplus, the exporter would make a choice.

            Here are two examples of such a decision. If you are an exporter of resources and you decide to produce more even though you will not need the proceeds from your increased sales for another generation, you would store most of your surplus in gold. If you are an industrial exporter and have a trade surplus today, but you anticipate that you need some of your surplus for imports next year, you would keep your surplus in Euros. If you merely leave these decisions to your private sector, you may already get a reasonable allocation. Your CB would then only watch whether there is some other country whose administration tries to manipulate the market and would then take countermeasures. But you wouldn’t even need regular CB interventions once the procedure has been established.


            • burningfiat says:

              Yes I remember the Noyer speech and the idea of currency in itself as store of value… I agree the system he describes sounds a lot better than the one we have now. BUT, isn’t there still counter-party risk? If you save in sovereign debt, you have politicians and their willingness to enforce austerity as a counterparty. In this Noyer system, you have central bankers and their performance (and the stability of their democratic mandate) as a counterparty. Gold still trumphs that when you save for an unknown future IMHO.

              I like your examples. I agree with you and Noyer on the “save in currency” concept, although I would like to set the point on the timescale where you go for gold rather than currency closer to the short run end than the “short/medium run -> currency” you advocate. Why? Gold is more stable than central banks (even the new ECB type).

              Let’s watch 🙂

              • I agree that when you keep Euros for a longer period, you still have the decisions of the ECB as your “counterparty exposure”. On the other hand, if you are running a multinational company with sales and salary expenditures in various countries, you might hate the rapid short-term swings in the price of gold and you might prefer Euros for your business all the time. On a time scale of 5 to 10 years, gold would be stable (if history pre WW1 is any guide), and this issue would be absent.

              • burningfiat says:

                I have another thought, regarding the idea that gold’s regional price has to fluctuate once it is being used in the spur-break function (and international settlement).

                Yes, we agree the gold price will need to fluctuate between surplus and deficit zones, but by how much? If gold has a super high price (in terms of goods and services), it will need to fluctuate by a very little percentage to make the necessary physical gold flow from deficit to surplus zone. Arbitraguers could easily make a business out of buying and selling gold across zones with as little 0.5% gold price difference. Meanwhile ECB promises less than 2% inflation/year.
                I see this as an argument to backup my feeling that gold will be the best savings medium for everything else than the short term (< 1 year for instance).

                Freegold could become a system with a really tight (free market based) proportional control system (with high proportional gain) with the price of gold as input and gold flow as output, all due to arbitrage. If that is the case deficits will be punished immediately with gold outflows. I don't think the free market will let the gold price fluctate by +/- 10% before acting.

                • I got the +/-10% figure from some historical price data pre WW1 that were shown somewhere in the Financial Times. The link is somewhere in Blondie’s summary. Before WW1, the international gold standard worked as advertized. So I just took this figure as a first guess of what to expect. It is a guess.

          • Michael H says:


            What is important is that option 1 now exists, which means that the exporter cannot reliably control option 2.

            Look at China. An exporter can accumulate claims on another country to serve its ends — in this case, to build up its domestic industry at the expense of that of its trading partner.

            Victor is saying that China will not be able to do this with Europe once gold fills its international settlement role. That is because the ECB would have bought gold on the open market to keep the Euro’s value stable and preventing underpriced Chinese imports from flooding its domestic market.

            • burningfiat says:

              Michael H,

              I completely agree!
              I basically tried to say the same with:

              Here’s how I think it will go (option 1 and 2 in conjuction will be the basis for a real equilibrium): Exporter tries to accumulate importers currency, importer CB decides to teach exporter a lesson and keep its own circulating money supply stable, and now prints and buys gold with the fresh currency, If exporter is not a total moron at this stage it now realizes that the gold bounty that was the reward for its surplus exporting is now claimed by importers CB instead. Exporter then reverts to the natural option 1, right?

              From reading Victor’s latest, I think he is maybe also in agreement? When I first commented, it seemed to me that Victor thought option 1 and 2 were equally good nash equilibriums in a stand-alone way. So that is what I targeted with my comment…

        • Kid Dynamite says:

          ok thanks for the clarification… so can you elaborate on how the “The Euro architecture is the blueprint for a new international monetary system in which physical gold is used to settle international accounts” ?

          • Just very brief: You don’t like financial crises such as the one we have been in since 2007. How did we get there? Blaming the banks, lax regulation, fair-weather risk measures such as VAR, skewed incentives through bankers’ bonuses, corrupt politicians, … whatever – this has all contributed to it. But one key cause of the crisis has not yet been spelled out. It is kind of a taboo in the Anglo Saxon countries, and the Europeans use a euphemism for it: “international imbalances”.

            It is the role of the U.S. dollar as an international reserve that allows the U.S. to keep importing real goods and services (some 2-5% GDP every year since the mid 1970s) and to export “capital”. The U.S. create credit or write government bonds and pay with financial rather than real assets. This is the exorbitant privilege, and the demand for U.S. financial capital has allowed the U.S. to lever up in a way that would not have been possible without. All this is quite obviously not sustainable but will be unwound at some point.

            That the dollar will be in serious trouble is basically unavoidable, but what matters for the rest of the world is how they will get along and how they would set up the financial system after the dollar. Quite obviously, some people have thought about it.


            • Kid Dynamite says:

              ok thanks – but how/why is the Euro special in this regard? what is unique about the way it’s set up?

              • Well, that’s the story explained in the tweets above ;D You might also like the observation that the Euro can operate perfectly well in the new regime, without any new law or change of statutes. It is all in place. The U.S., in contrast, cannot use their gold as long as they have the old dollar, simply because they need an international treaty that would revise the Smithsonian Agreement, or every foreign holder of dollars is going to have a claim at $42.22/oz. This is an extraordinary offer, isn’t it. I don’t think anyone will pass. The problem is just that the U.S. need some 5 million tonnes.

                So you are saying, let them send their armies and collect the gold. That’s true, it is not going to happen. But it is not the rest of the world who will have to say ‘please’. The U.S. needs to permanently import some 3%-5% worth of GDP, and much of this is energy. That does change the negotiating position somewhat, doesn’t it?


                • Lord Sidcup says:

                  Okay; the US won’t confiscate, but might the UK be forced to?

                  If the dollar fails, USG could barter treasury gold in exchange for basic supplies through a transition. The UK has very little official gold, so, during a currency crisis. might not be able to swap gold for oil etc for long. Is it feasible that they would have no choice, but to confiscate gold in this scenario (regardless of whether it’s a bad idea or not)?

                  The UK situation seems so awful that they may be forced to destructive extremes.
                  With few friends and little influence in Europe, they might double-down and grab foreign gold stored in London. Is staring into FOA’s “wall of [sterling]” as threatening to Britain?

                  Domestically, they could sell a media story about greedy, tax-avoiding foreign scoundrels (especially if Arab/Russian). Cyprus shows how easily it can be done.

                  I would imagine this is more likely during the transition, before the full FG picture narrative has been clarified. Especially if London trading suddenly stops without a massive run-up in price.

                  *I’m with KD; the twitter format is awful for long sentences/paragraphs.

                  • I agree that the UK in in a shape worse than the U.S. Can they afford to cheat? They are now a net importer not only of oil, but also of natural gas. The relevant pipeline to the Netherlands was reversed some four or five years ago, and these days that get LNG by tank ship from the Gulf. Better play according to the rules.


                • Kid Dynamite says:

                  how do you embed those tweets like that, by the way?

                  back to the issue: I do not understand. you say that the Euro is paper backed by CBs with 2% inflation target. so is the USD.

                  why does it matter if the US’s gold is on the books at 42.22? who cares? they can change that at any time, and what difference would it make?

                  this gets back to my first comment again, which I thought was your point: that the Euro has more gold relative to its currency base… but I appear to still not understand you

    • I apologize – the other one had copied you, and I just kept pressing ‘reply’ on this mobile thing. Next time, I’ll leave you in peace.

  3. A says:

    Hi Victor,
    Quick question, initially how do we get a sufficient amount of Euros enough for world trade and to replace the dollars? doesn’t that require the ECB to print excessively or hyperinflate?

    • The Euro zone has always had a balances trade account and also a balances capital account. This means that there is no structural reason that could case an excessive amount of Euros held abroad. If for some reason, foreigners buy a lot of Euros and cause an inflow of capital into the Euro zone, the Europeans would probably not want to upset their balanced trade account. So they would need to sterilize the inflow of capital by monetizing something, i.e. the ECB buys some asset and pays by expanding its balance sheet, creating additional base money. Which asset is it that they ought to buy?

      If they don’t want the inflow of capital to distort their economic structures, they need to buy an international reserve asset, quite obviously gold. This avoids Triffin’s dilemma and still allows foreigners to hold a substantial balance of Euros. On the other hand, as I explained above, it provides an incentive to foreigners to settle in gold right away.


  4. waxx says:

    Re: “Further Discussion” Paragraph 4

    IN the same way that beef producers don’t want their customers thinking about and actually linking mentally where their steaks and burgers really come from.. i.e… the bodies of dead cows

    So bankers et al don’t want the word “gold” in anyone’s vocabulary or mentioned in the same sentence as them. Even the word “gold” is quite anathema to that group of folks.

    No surprise there really.

    • waxx says:

      … except when they’re accumulating “it”.

    • I don’t share that sentiment. I am in fact waiting for the Europeans to change their public rhetoric and to start promoting gold in some way. It may have started when the Bundesbank published their gold transactions, but that one was primarily for an official audience and for professionals who bother to read Bundesbank publications. The Europeans have always wanted to put gold back to the centre of the financial system – they have just been waiting, most recently probably for China.


      • JS says:

        Victor, I think the Cyprus bail-in has been such a change in public rhetoric. I mean, our media were all over the Cyprus debacle. Of course we had to hear that “bank accounts in our country are still safe”, with bankers receiving airtime claiming that: “it is also safe above €100.000.” I suppose the more they say this, the less they are believed.

        From where I am sitting, I found all this media attention brilliant, at times even hilarious. They had to explain how this bail-in worked and thereby it was also explained how money in the Cypriot banks was already lost (Cypriot bankers had doubled down on Greek debt (..oops!!)). In other words, basic insolvency law was explained.

        What better way to start informing the general public what to do with their ‘money’? After Cyprus, 300 million+ Europeans have gotten an education that was clearly pointing out that money in the bank is NOT saved but invested, and investing implies risks, possibly haircuts: a bail-in. I think the following example explains the European approach/message. Let’s replace “money in the bank” with any car, let’s say your car. Europe is saying: “It is your car, you decide where you park it, and if we find your car like this:

        or this:

        then whose problem really is it?

        Europeans are finally confronted with the “bonus question”: what to do with any amount of money in the bank. Where do you park it? How do you insure yourself for financial mishaps? An obvious first: diversify. If not across multiple banks under 100k with negative real interest rates, then what? Stocks? Hmmm, overpriced. Bonds? That is plain stupid. Real estate? Poor choice considering chronically falling asset prices. Commodities and start trading futures? LOL, you’d better go to a casino instead. Bitcoin? I think that after events of last night Bitcoin will receive some more attention: much too volatile. There isn’t much else, so I think once you start explaining actual financial risks, people will figure out their “golden opportunity” eventually. With this in mind, I have not a shred of doubt that the Cyprus bail-in was a way to push Europe’s “dumb” money to do something smarter.

        Last but not least, explaining how freegold will enforce a definitive BOP solution? You nailed it. As I told you before: text book material.


      • waxx says:

        My understanding is that the Europeans want nothing less than what the Americans want.

        That is complete control over the printing of money and the power that engenders.

        A concept which is obviously at direct odds with any form of previous gold standard.

        Why would the banking elite give up the abiity to print money when they have worked for so many decades to bring this ability to full fruition around the world?

        Gold has no place in a fiat currency based world. They are mutually exclusive concepts. Regardless of your argument to the contrary.

        They are in the process of trying to prove that now as they manipulate equity markets world wide and endeavor to squeeze gold even as they inflate currencies and equities trying (successfully) to force capital into them.

        Gold higher means a loss of confidence in fiat currencies and an equivalent loss of confidence in world wide financial markets more than anything else.

        Gold is a powder keg the financial elite refuse to give an inch to, until they have no other choice.

      • Somebody asked

        VtC – Could the use of $520m (at mkt) of gold in the Cyprus deal be another move in this direction? When I looked at that transaction, if I came down from Mars, I saw $9B in loans (presumably at very low interest rates) go from the Eurozone Bailout fund to Cyprus, & 10 tons of gold going from Cyprus to the ECB.

        I understand it was not worded that way, but when you account for the fact that the difference b/t cash & a low interest rate loan is de minimus, can’t one make a strong case that Cyprus effectively sold 10 tons of gold to the ECB for $9B, or ~$28,000/oz?

        I find it interesting that shortly after the gold provision of the Cyprus bail-in hit the tape, paper gold prices were immediately hit very hard…



        I don’t think they would use it to offset some government debt. This is not the United States where the gold belongs to the Treasury Department. The gold on the balance sheet of the Eurosystem is a monetary reserve. It is not some random government asset that is there to be pushed around. Let’s see what happens: As of last Friday,

        Cyprus’ gold was still on the balance sheet.


        PS: I do think the gold will eventually be used. But it will happen openly once the dollar is out of business, and it will be used to settle the remaining balances of the target2 accounts, i.e. in order to settle honest international balances.

  5. Indenture says:

    Victor: I have also wondered when the ECB or some other European Official would openly say something about ‘saving in gold’. Cyprus was a clear message that banks are not a safe place to save your money but the nudge or push that the public requires towards gold will be a clear sign the timeline has accelerated. I would imagine once gold is mentioned the genie can not be placed back in the bottle.

  6. Mortymer says:

    VtC *-> Concerning the German lending disclosure
    I would add also we should read once again carefully this one:

    “…The Banque de France has always adopted a very prudent and rather conservative approach, acknowledging the fact that the issue of gold lending is a matter of common interest to the major holders….”
    “…Furthermore, lending is even more delicate for a big holder: what is the use of lending if, at the same time, you are depreciating the value of your holdings?…”

    It was there for eyes to see but nobody noticed?

    For JC and waxx – one can derive and walk very very far in the deep thought about IMS if one begins just here in the difference in the handling of the reserves. The differences between USD and Euro on the background of its reserve holdings. Victor´s doing a great job in explaining it. At my blog you can find many related official articles and historical files describing process of the evolution of the IMS.

  7. Mortymer says:

    2 waxx: “Gold has no place in a fiat currency based world.”
    simply wrong

    See the French manifesto from 2000

    I ask you now, this is 1974 or 2000, how much did change since that? How much those major holders sold? (I mean US, France, Germany, exclude UK – I wrote about it lenghtly on my 2nd blog). Do you see the point now? There are piles of docs like this, just look around yourself.

    Your statement: “They are mutually exclusive concepts” is strange as you try to put them one against the other, either-or, which view we do not share.

    “Gold higher means a loss of confidence in fiat currencies and an equivalent loss of confidence in world wide financial markets more than anything else.”
    Well, we are quite a higher percentagewise since the bottom around millenia and I do not see financial markets very down. I suppose it depends on the speed and form? One can not change the IMF within a week but it takes time. If you follow the negotiations in past you can see what is happening behind the scenes. Could we redefine your statement in a way that we observe a slight change in the function of the assets?

    • Lord Sidcup says:



      Mr. Enders: Revaluing their gold—in the individual transaction between the central banks. That’s been in the newspaper.

      A key assumption of freegold seem to be the merging of the CB gold market and the private gold market into one. What if this is incorrect?

      Like most quotes discussing gold as a wealth reserve for international settlement, those below could be interpreted to mean that the flow of gold is ONLY required between CBs/Oil states etc etc.

      FOFOA argues that the US will need to sell gold in to provide gold to citizens/businesses in order to escape historical claims from the BIS/ROW. I see how this mechanism could be required in the US, but does freegold in the the rest of the world really require gold widely dispersed in private hands?

      Blondie, VtC and others discuss elsewhere the use of the Euro as a store of vale (at ~0% inflation), perhaps this reduces the scale of a gold revaluation.
      As the EZ is pushed toward fiscal discipline I’m suggesting that we may arrive at a different model; citizens/businesses transact and save in a stable Euro while the CBs use the gold/Euro to settle imbalances.

      VtC uses the phrase “local adjustment”, do you mean a CB dealing with the currency within their own currency zone. Does this mechanism require gold to be widely distributed within the currency zone? If not, and the Euro was widely accepted, perhaps the CBs could keep settling in gold at either a unknown or market price.

      Freegold looks a more democratic monetary system, but having a private, secret inter-Central Bank gold market could have benefits that are not easily ceded.

      • A key assumption of freegold seem to be the merging of the CB gold market and the private gold market into one. What if this is incorrect?

        The main point is that international balances are settled in gold and that the resulting changes in the real price of gold act as a counterweight to any trade surpluses or deficits. For this to work, the cross border flow of gold needs to affect the import and export prices for goods and services. This in turn needs to involve the private sector.

        In fact, there is no need for the central bank of country X to hold any official gold at all, unless foreigners hold a net investment position in $X denominated financial assets.


  8. I have a question. If people start saving in Euro, then they are basically taking out Euros from circulation. This will require ECB to print more money to keep the currency stable. For printing more money the ECB could buy gold from the market. Eventually the ‘saved’ Euros will enter the economy at some point in time. At this time ECB will have to contend with too many Euros in the market, this would require selling bonds or gold. What would be the correct option?

    • Gold. A capital flow into or out of your currency area creates an international balance, and so it ought to be settled in gold. If the ECB would buy or sell anything else, they would influence asset prices, credit volume etc. and this is what they need to avoid.

  9. Mortymer says:

    Lord Sidcup – Looking at history the idea was to create a new system based on SDR, others agreed about de-monetization of gold. SDR option forward failed while small weak hands were shaken. So we still live in status quo, stuck in the middle, leaving the old system and not reaching into a new one. There are adjustments on the go but no major progress. So no end solution in sight. How does it look in international meetings we could just extrapolate. We do not know what is discussed we just assume.
    btw: 2tier Gold market is IMO long term unstable.
    Does the present arrangement offer value for value to oil producers?
    Does this system not cause huge disequilibrium? (see deficits and huge reserves)

  10. Mortymer says:

    So VtC, does Mundell state here the same in:
    WGC – Gold and the International Monetary System in a New Era
    Proceedings of the Conference held in Paris
    19th November1999

    “…I turn now to the role of gold as an anchor of stability and the criticism of it. We could have three currencies – the euro, the dollar and gold. They are not going to be fixed relative to one another. Which would be the best to hold as a reserve asset will depend on the stability of each one. If one of them is much less stable than the others – if gold was very unstable in terms of the other currencies and the other currencies were stable in terms of commodities, then that would be an argument against holding gold and people would accordingly want to hold a smaller amount of gold and the value of gold would correspondingly be lower. But the price of gold will always go down or up according to the worth of that as a commodity – as a commodity reserve, in this case.

    The real issue, though, is if we were talking about going back to a gold standard again – not talking about gold as a fluctuating commodity used as a reserve, but if countries were to adapt and hold on to gold again – would this be a good currency to hang on to, or is it unstable? My argument right now against countries – let’s say small countries – adjusting to gold is that gold at the present time is not stable enough…”


  11. Anon says:

    What do you see as the merits of a BTU unit of account (energy unit) rather than say freegold (on the merits). The US has made a lot of noise (IEA) about the oil potential in the US even going the distance and saying it displaces Saudi (& Russia on gas). Of course the shale gas revolution (or bust) is still up for debate?

  12. Anon says:

    Would the German Weidmann loosening up and hinting at the acceptability of rate cuts be consistent with the EUR thesis? To the point you made above the Germans once again reiterated that any bailout (In) would have to start with the Depositors(whose logical end has to be returning banks to a utility model insofar as the bread and butter confidence is shattered & presumably gold becomes a defacto alternative).

    Cheapening the EUR to USD parity has interesting implications if indeed some form of reset is in order…

  13. Rob says:

    Victor, first I want to thank you for your blog. I’ve been a PM bug for years but recently tumbled on the freegold theory and have been reading up ever since. I have a few questions that I hope you can answer.

    1. When/if freegold happens as I understand it gold will be re-valued in a very short order of time (days , weeks?). What I can’t understand is who will actually be buying gold right after the re-evaluation? My thinking is it should take a very long time before the price actually settles in peoples minds? Years?

    2. So there is a lot of focus on the euro because as I understand it, it doesn’t have a fixed price on gold in its balance sheet. What will happen with other currencies in the Euro area? SEK, NOK, CHF, Pound? I ask bcause I’m Swedish and I’m trying to figure out how this will affect my currency?

    Thanks once again for your work!

    • If only I knew…

      1. Who would purchase gold at a price much higher than today’s? That depends on the circumstances, doesn’t it? Assume the dollar collapses in the foreign exchange market and, at the same time, the London gold market runs out of reserves and a few major clients are left in the cold, the ETFs are wound down, the London gold fixing is suspended. Who would want physical gold in this situation? Everyone, wouldn’t they? Who will actually get some? Coins and retail size bars will be sold out, the mints will shut down when the major Western resource exporters (Canada, Australia,…) enact capital controls.

      In this situation, central banks and major exporters (OPEC) will fight for the gold that is still for sale. At what price? The People’s Bank of China have some $2000bn. Foreigners as a whole have another $7000bn. What do you plan to do with all this money? Buy Starbucks’ coffee? Buy GM cars? … dream on. If you were one of them, how much would you pay per ounce?

      Who will eventually purchase gold at the new, higher, price? Pension funds? Insurance companies? Private investors? Banks? Private sector exporters? Everyone who is scared about the alternatives?

      2. Norway has the oil. They can always stabilize their currency by forward-selling oil. Their issue will be to get along with a world price of oil of perhaps Euro 30..40/bbl. They will manage to. Britain has the same double deficits as the U.S., just worse. My guess is that they will eventually (be forced to) join the Euro. The question is how long it will take them to realize that this is their only way out. Switzerland has effectively been a member of the Euro zone since August 2011. Right now, however, the CHF is overvalued relative to the EUR in terms of purchasing power. This will eventually adjust. In any case, the Euro zone is their major trade partner, and so some sort of pegging to the Euro is the obvious strategy. Sweden? I don’t know enough about their foreign trade. It is probably a good guess that they will go with their largest trade partners, too. This is maybe the Euro zone, but I haven’t checked the figures.


      • Rob says:

        Wow thank you for that excellent and fast reply. I’m a bit embarassed about my first question since it’s pretty obvious that the price will support itself in a free market. I guess I’m just having a really hard time grasping how people will react to the price when we wake up one morning and it’s multiples higher. I would assume a lot of average Joe’s would go on a selling frenzy selling whatever gold they still have after all the “we buy gold” stores gobbled it up. But of course the bigger fish would be waiting with their mouths open since they understood what was going on.

        Concerning the second question. I think you are right about that most countries will probably be forced to join the Euro. I guess what I’m wonderring is what happens prior to that. The answer is probably that those currencies will be pushed down in relation to the Euro. Which will mean that people like me will have less purchasing power hence being in gold is even more important compared to if I was a German for example.

        What really caught my attention in Your reply was when you say a barrel of oil will be in €30-€40 range. I haven’t read enough about freegold and how the oil price fits in but how does a falling EROI with increasing production costs fit in to a price which is so low? Like you say countries like Norway will have a problem with that and well, probably just wont be able to produce oil at a profit. Which will result in a lower production and non functioning market.what is your take on this?

        • IMO the increase in the price of oil since 2002 has several origins:
          1) No incentive for any OPEC producer nor any close-to-nationalized producer (Russian companies) to produce at full capacity because oil in the ground is worth more than dollars in the bank. Why would you produce and sell if you cannot store the dollars that you receive, for the long run?
          2) After 2001, there has been a high coincidence of political and military events that took a lot of oil supply off the market: Iraq, Libya, Iran come to mind – there are others.
          3) The price of oil and the price of gold have been increasing largely in parallel. Here is the gold/oil ratio since 1944

          Gold/oil ratio in barrels per ounce since 1944

          and this is the recent chart of the gold/Brent oil ratio which has been suspiciously close to 15 since the financial crisis

          Gold/Brent oil ratio in barrels per ounce since 2002

          If you follow Another, there have been agreements on the gold/oil ratio in the past. This may be ongoing as an (inofficial) international agreement. It may also be the consequence of (1), perhaps with someone “help” by (2).

          FOFOA speculated that it was the Europeans who supported the London price of gold between 2002 and 2012. Then, the rising oil price has been a consequence of the rising gold price. On the other hand, what is the position of the U.S.? Do they like or not like the high oil price. They must be in a situation similar to the 1970s during which they desperately wanted a higher oil price. Firstly, in order to develop their own domestic resources and reduce their dependence on energy imports (from producers who might not always accept their paper payment). Secondly, every country still needs dollar in order to purchase oil, and so the oil trade creates a substantial demand for dollars. From whatever angle you view this, the gold and oil price rising together have provided a lot of support for the dollar. Well, there are some costs as well, for example, the drag on the economy from a high dollar oil price, and in particular the fact that the oil price can hardly rise another 50% without seriously damaging the economy.

          In any case, if you follow Another, there is a lot of oil in the Middle East that is comparably easy to produce. It is just that many of these resources are under or even undeveloped because of political events, and that those who keep producing did not have much incentive to produce fully because of the currency situation. Once that changes, oil ought to be substantially cheaper, and this easily for several decades.


          • Rob says:

            Very interesting Victor.

            Concerning (1) I’m not sure I buy this argument. Oil prices are at historically high prices in dollar terms and although smart money may understand that dollars are not the place to be in the long run why couldn’t producers just sell their dollars and buy assets like gold or other currencies like euro’s now when they get a lot of these assets on a dollar basis?

            Concerning (2) this is somewhat true although a oil producer like Lybia is only about 1% of the total global oil supply. Iraq is bigger however but still these political events aren’t actually anything out of the ordinary if one looks back to the last 40 years or so (Iranian revolution, first Iraq war etc.).

            Also you say that Oil producers in the Middle East can actually crank their production up quite a bit but this is something I highly question. If you look at this image of Saudi Arabias production during the last 45 years you can see that production at the moment is at an all time high.

            It’s not a situation as in the 80s where their production output had a serious dip. Also today a lot of the Saudi production fields are using enhanced oil recovery techniques which wasn’t the case in the 70-80s. Unless we have some kind of significant break through in this field promoting an even larger recovery on a percentage basis I really have a hard time seeing how production output will increase. Wasn’t this one of Another’s points about the 80s, that there were technological advances that allowed things to keep rolling for a while longer? I could have got that wrong but that’s what I thought I read somewhere?

            Also you just can’t ignore the falling EROI (Energy Return On Investment) where typical oil fields have gone from over 100 to an average of slightly above 10 during the last 100 years or so.

            Very interesting idea that the US actually would want a higher oil price in order to spark it’s own oil supply. The problem is that the current oil price is barely enough for oil shales to be profitable and when you look at the natural gas price, shale gas plays are actually not even profitable at today’s prices. But perhaps they have an incentive to see even higher prices since an energy independence would be a pretty darn big achievement in today’s world?

            My thoughts on the current economical situation is that it’s all because of a falling EROI. Energy is what makes the global engine run. Currencies and money flow is the oil lubricant in the engine. With a falling EROI the engine gets less and less fuel to run on and at the same time the economic system is built on a basis of a steady increase in motor rpms in order to see constant steady growth. So the motor actually fails in sustaining a higher rpm based on an energy input so governments desperately start fooling around with the motor oil, making it less viscous in order to get less motor friction and slightly higher rpms. Or in real terms they start debasing their currencies together with higher debt burdens in order to see artificial economic growth. I’m trying to figure out how I think freegold fits in this picture.

  14. Mortymer says:

    @Rob – check this one out:
    Published on Apr 30, 2013

    The CSIS Energy and National Security Program hosted His Excellency Ali al-Naimi to hear his views on the dynamic changes taking place on the global energy scene.

  15. Hi VtC,

    I’m intrigued by that speech by Christian Noyer that einanderer posted the link to. I want to run something past you on the topic of preventing “fragmentation” of ECB monetary policy across the EMU. I think this passage holds the key:

    Noyer: “Indeed, we have learned a great deal from the past five years and have made progress at an unprecedented pace. EMU is now firmly on the road to a banking union. To a large extent, this is the very institutional mechanism that was lacking in the first place. Our OMTs have limited the scale of financial fragmentation and have greatly reduced the risk that increasing spreads might end in sovereign defaults. But the euro area needs an institutional framework capable of preventing the recurrence of such crises, essentially by decoupling financial risk from sovereign risk.

    The banking union thus consists of three major pillars: a Single Supervisory Mechanism, a supranational resolution mechanism, and a unified system of deposit insurance. For now, the first pillar of the banking union is the most advanced, but the other two are also in the pipeline and need to be pursued.”

    If the problem in a banking sector of one of the EMU member countries is liquidity that can be resolved through the Target 2 channel and conventional CB programmes. The ECB can pour Euro into the local banking system. If the banks are insolvent it’s not a liquidity issue. It’s a capital issue which the ECB cannot resolve without exceeding its mandate and involving itself in fiscal policy.

    As we have discussed previously defaulted and/or non-performing loans create an unbacked deposit in a banking system. Obviously loans that are repaid reduce the money stock by an equal amount. Defaulted debt does not reduce the deposit component of the money stock.

    A country in the EMU that is going through an internal devaluation has a high potential for inflation. Supply destruction (due to, say, companies going broke) could lead to a mismatch in the money stock and the availability of goods and services to spend it on. Over-priced assets which are collapsing in price and/or illiquid cannot absorb excess money either.

    The only way to prevent deposits from over-inflating the money stock (in an EMU member country with price stability (“inflation” and/or “deflation” issues)) is to destroy part of the deposits in the banking system along with other creditors’ holdings.

    The thesis that I want to test with you is that in order to pursue its mandate the ECB must force the EMU banking union to explicitly recognise bank deposits as a credit instrument and include them automatically in the resolution mechanism for a failed bank and regional banks and the European-wide banking system.

    It looks to me that some of the Austrians are going to get part of their FRB wish list. Formal recognition that deposits are a debt of the banks and depositors are creditors of said banks. Therefore there would only be one way for an EU citizen to avoid this counter-party risk – hold a supranational “currency” – as their savings/deposit vehicle. So the choices are Euro cash, another currency held in cash, the most liquid sovereign debt or gold. Euro is guarranteed to devalue by around 2 per cent per year. With foreign currency there is, of course, exchange rate risk.

    As per Noyer and Weidmann’s recent statements it appears that sovereign risk is going to be formally recognised in upcoming EU agreements. So that leaves gold as the only risk free asset reserve and savings vehicle. The deposit insurance scheme is a “fig leaf” in that it will only work if it is only required to assist one or two insolvent banks. It can’t be large enough to resolve a systemic crisis in a banking system as a whole.

  16. Mortymer says:

    HI costata, VtC
    “The thesis that I want to test with you is that in order to pursue its mandate the ECB must force the EMU banking union to explicitly recognise bank deposits as a credit instrument and include them automatically in the resolution mechanism for a failed bank and regional banks and the European-wide banking system.”

    On this topic – Czech CBer in a speach from about 1/2y ago – He discussed the banking union from perspectivity of inter country deposit guarantees; in an open question exactly he pointed out country differences, in regulations, in laws, ect and what it means if one country depositors would guarantee deposists in other countries… Just more technical and political details of this issues.

    For now (I think it is flat but not 100% sure) there is a 100 000 Euro deposit guarantee harmonized in place for already few years.
    You can read here also some proposals.

  17. Hi mortymer and VtC,

    The problem with the bank deposit guarantee scheme is that it can only work as an insurance fund because the governments who guarantee it don’t have their own printing presses.

    In other words, it will work for individual cases of bank insolvency and perhaps even where more than one bank is hopelessly insolvent but it cannot backstop an insolvent banking system.

    It’s not possible to collect contributions from banks to an insurance fund that are large enough to make it deposit guarantees a systemic safety net (even with a limit of Euro 100k).


    I think I have a metric we can use to calculate the Euro Freegold-RPG sponsor’s price target in Euro for gold post-transition based on some “new old” currency management metrics used in earlier systems where gold and/or a reserve currency was systemically important.

    Simply price gold to a level where the ECB’s gold reserves have a 110% coverage of the total Euro base money. In other words a price at which the ECB could buy back every Euro of the base money supply plus a 10% buffer. This will be a rough guide and would need to be refined by deducting any FX reserves held by the ECB that are likely retain value after the transition.

    I’ll explain the reasoning in a more detailed comment. Suffice to say for now that none of the other estimates of monetary aggregates come into this calculation.

  18. VtC,

    I want to bring this Vox EU post to your attention. IMHO the authors have produced a good analysis of the EMU/ECB’s options for dealing with the inevitable default on some of the European sovereign debt in a conventional way (sans gold). The paper is here:

    One of the elements of the paper that got my attention was the stress which the authors put on the stock vs flow implications of the ECB burying some of the sovereign debt on its balance sheet. The author’s proposed solution treats the problem differently than a normal debt monetization. They point out that this would be a case of moving the existing debt stock around not an excercise in funding the flow of new debt. Hence it could be done in a way that was not inflationary.

    The author’s speculations about how the ECB could unwind a debt swap with the over-indebted sovereigns don’t factor in a Freegold-RPG revaluation. They suggest a Euro cash repayment. If you factor in the impact of a revaluation of the debtor nations Treasury holdings of gold then unwinding the deal later becomes quite easy and painless for the debtor nations.

    Provided all of the sovereign debt swappers have a positive primary balance and ironclad agreements that wont allow them to go straight back into excessive debt it looks like an ideal solution to the unsustainable debt problem. And a lasting solution at that if balanced budget constitutional amendments are adopted by all of the EMU members.


    • Thanks, costata.

      Yes, I agree that the ECB can buy a lot of existing debt if that goes bad. As long as some scared investor who was planning to hold the debt for the long run, sells this debt to the ECB and receives a risk-free CB reserve in turn, but does not spend this CB reserve either, all this will not be inflationary. Debt buying by the ECB is inflationary only if it allows some governments or other consumers a permanently elevated spending level.

      How about the gold? Remember, the gold of the Eurosystem is a currency reserve, but not a government slush fund. So I don’t expect the governments to sell gold (after the revaluation) in order to pay off excessive debt. But there is a monetary way as well in which the gold can be used. If the ECB buys a substantial amount of distressed government bonds during the crisis, the Eurosystem will end up with huge TARGET2 balances. These are the cumulative intra-Eurosystem balances of payments. They are perhaps eventually settled in revalued gold. This would provide the TARGET2 creditors, i.e. those CBs of the Eurosystem whose government’s bonds have not been bought, to sell gold in order to cancel the excessive amount of base money that will be issued during the crisis.

      The defaulting countries would end up with credit deflation without consumer price deflation (internal devaluation) whereas the creditor countries would get away without significant consumer price inflation once the crisi is over. In effect, the bad bonds would have been retired and some (other) investors been paid off in revalued gold.


      • VtC,

        “As long as some scared investor who was planning to hold the debt for the long run, sells this debt to the ECB and receives a risk-free CB reserve in turn, but does not spend this CB reserve either, all this will not be inflationary.”

        I don’t think the ECB would have to go to the secondary market. They could pick up a lot of the existing sovereign debt stock from rollovers. Provided the total was capped so that there was no net increase in sovereign debt it would not be monetization of the flow. Also let’s not forget that banks are holding a substantial amount of this ‘risk free’ sovereign debt.

        “If the ECB buys a substantial amount of distressed government bonds during the crisis, the Eurosystem will end up with huge TARGET2 balances.”

        Two birds with one stone, perhaps. Very astute observations in your next two paragraphs.

        “The defaulting countries would end up with credit deflation without consumer price deflation (internal devaluation) whereas the creditor countries would get away without significant consumer price inflation once the crisi is over.”

        So by excluding the secondary market from participation in the bond swaps this problem:

        “In effect, the bad bonds would have been retired and some (other) investors been paid loff in revalued gold.”

        Unless I’m misunderstanding the interaction between our scenarios the non-bank, private investors would be paid off in Euro (no rollover of the bonds they were holding) and only the ECB Eurosystem members could exchange revalued gold to cancel the excess Euro. Gold would be shifted around to balance out Target 2 imbalances but there would be no leakage of gold out of the EMU.

        Any excess Euro created by paying out the bond investors who aren’t permitted to buy a new series of bonds at rollovers could be drained from the system in the conventional way – creating excess reserves for the banks in the system. If this is a correct view then it also underlines the importance of the EMU-wide banking union that is emerging. All of the plumbing and control mechanisms would be in place to facilitate orderly defaults without damaging the currency or creating inflation.

        Is that how you read it?

        • First, there would be no gold leakage out of the EMU. Yes, this is perfectly in line with the fact that the EMU has a roughly balanced trade account (right now in 2013 a small surplus even).

          I do think that some Euro CBs will eventually sell some revalued gold in order to cancel excessive amount of base money. This means some gold will flow from the CBs to the private sector in the Euro zone. I find this plausible because the CBs still own an excessive amount of gold well beyond what will be required AG [note: AG=”after gold”, i.e. after gold has been restored as the prime international reserve]. The huge amount of gold at the CBs is the consequence of two perverse historical coincidences: (1) The US were the major exporter during and after WW1 and as such received a huge amount of gold between 1914 and 1922 when Europe was at war or under reconstruction and had to import huge amounts of goods; (2) The US recalled all the gold from their private sector, banks and Federal Reserve system in 1933 (1934 Gold Standard Act), and so this excessive amount of gold ended up at the US Treasury department. Later, under the Bretton-Woods System about two thirds of this gold was sent to Europe for the European trade surpluses with the US. Under Bretton-Woods, it ended up with the European CBs rather than in the private sector.

          On the banking union. The following is just a guess. I had the impression that the European bureaucrats tried to write a number of bailout provisions into the new banking regulation that the ECB would eventually not accept. Just as in the case with Cyprus, it was Germany who took the blame and derailed that agreement, postponing the date from which the banking union will be effective. My guess is that Germany did that to prevent the bailout provisions from being implemented, and that the crisis will occur well before the banking union is in effect, but that the rules of the banking union (without massive bailouts) will be followed “in spirit” although it will not yet be in effect at that point.


  19. Much food for thought here VtC. Cheers

  20. Hi again VtC,

    I would llike to run a few thoughts past you that touch on the ECB’s efforts to take control of the currency emission channels in the EMU. First I want to draw a distinction between the EMU and other jurusdictions. In the USA, for example, there are three currency issuing channels (or circuits):

    1. Government issuing debt that is monetized by the CB.
    2. Central bank transactions with the banking system.
    3. Banks lending deposits into existence.

    Provided the ECB holds to its mandate the EMU is a different animal in that it has only two channels – the CB issuance of base money and the banking system lending deposits into existence. EMU member government bond sales are sold into the market in exchange for money from the existing money stock. As a result of the rehypothecation of sovereign ‘risk free’ bonds the banks can leverage these bond issues but a government cannot expand the money stock directly.

    Provided the ECB has the requisite powers to regulate the banking system no government can push the Euro onto a hyperinflationary track e.g by allowing their banks to run amok. Hence HI of the Euro is not possible under this structure. So the natural tendency of this Euro currency is toward deflation in a somewhat similar way to the Yen prior to the Abenomics policy change. Despite the massive amount of JGB issued the Yen remained a hard currency throughout the past few decades (with an occasional blip on the charts).

    I find it difficult to believe that the European sponsors of the Euro project failed to study the monetary experience of the Japanese. As the borrowers from Japanese banks paid down debt they were cancelling bank credit money lent into existence. Forcing banks to sell real estate at a loss that was collateral for loans also reduced the bank credit money in existence.

    So long term we had two opposing forces impacting on the Yen. Government de facto ‘printing money’ by issuing bonds that were monetized by the banking system and via the private sector who were using the increasing base money to buy JGB as their savings vehicle. (I’m including institutions like the pension funds in the private sector as an indirect channel for private sector savings.)

    The net result was a balance between the inflationary and deflationary forces which was ultimately reflected in prices – some falling and others rising but overall a 0-2% net decline. In this period Japan’s demographics were actually an asset for the currency managers. Rather than having to go through the pain of trying to reduce wages in order to maintain their competitive position Japanese corporations could rely on natural attrition through retirement, reduced pressure for wage rises because prices were stable/falling and ‘offshoring’. As long as their economy had a CAcc surplus this was sustainable (or perhaps containable would be a better description).

    Returning to the EMU with the Japanese experience in mind. Regardless of what any analyst would like to believe the Euro cannot experience HI under the current structure. There is no potential for contagion from a USD hyperinflation either. The main issue in the EMU is how to engineer the debt cancellation and recapitalization of sovereigns without allowing the politicians to immediately embark on the fiscal profligacy that would lead the EMU countries full circle into another debt crisis in the future.

    A truly far-reaching project by the Euro architects!


    • Nice summary – I fully agree.

      Depending on the sequence of events and at what stage the dollar will get trashed in the foreign exchange markets, the biggest problem the Euro zone may face, might actually be an inflow of capital (all the short-term institutional money getting out of the dollar and into anything else that still has any heart beat left). The Euro zone may even be able to offload a lot of their own questionable debt in that process. You are late trying to get out of the dollar? Well, you can have Euros, but there is a price to pay….


  21. Hi VtC,

    I think any non-EMU domiciled institutions trying to get out of the dollar and into the Euro will find the same problem that countries with a CAcc surplus have – a limited range of options for investment of FX reserves. And I would expect that EU institutions with dollar exposure will be at the head of the queue for conversion anyway.


  22. mike f. says:

    Hi Costata and Vic,

    I really enjoy your discussions and tune in regularly here to read updates. Wish you both well !! cheers, Enough

  23. mortymer001 says:

    Watched the last addition online. Thanks for adding it here :o)

  24. Hi VtC,

    I’m going to reproduce an article in full below from an online publication in Australia called Business Spectator because it requires registration. I think it succinctly captures the inflation versus deflation argument and the reasons why a mild deflation could actually be desirable. From my recent research into the ECB’s system and approach there is no imperative for inflation in the Eurozone except in so far as it is thought to be desirable in mainstreamm economic theory.

    Link to original article:

    What central banks are really up to

    Alan Kohler – 6 Nov, 7:37 AM40

    “It is a great irony of the modern world that central banks are forced to battle the destructive effects of higher productivity. If that statement seems ridiculous, bear with me. Central banks everywhere are currently engaged in a desperate war against deflation, with zero interest rates and money printing.

    In Europe it may be a losing battle – the EU appears to be one downturn away from deflation; in the US inflation is 1.2 per cent and falling; in Australia we have had tradable goods deflation for about two years and the only reason there is not overall deflation is because of non-tradables, like health, education, construction and child care services.

    In fact global prices have been trying to fall for 20 years because of the productivity improvements of the Digital Revolution and the entry of cheap labour into world’s workforce as a result of globalisation.

    The credit crisis of 2007-08 then tipped this trend towards lower inflation into potential outright deflation by crushing global demand. Demand has not fully recovered, especially in Europe but also in the United States. Meanwhile wages are rising in China but technology is continuing to drive up productivity through automation, while new, cheaper, labour forces keep entering the global trading system.

    Central banks are trying to keep inflation within what they regard as the optimum target band of 2-3 per cent. They used to be battling to keep it down to that level; now they’re trying to keep it up to 2 per cent. Why? Because of debt.

    During the second half of the 19th century prices fell consistently – that is, there was deflation – because of the impact on productivity of the Industrial Revolution. Between 1870 and 1900 the purchasing power of the US dollar doubled as prices came down. But in those days there wasn’t much debt. For those with savings and fixed incomes deflation is wonderful, but for those with debt it is catastrophic since the value of the dollar repaid is greater than the dollar borrowed.

    Households, businesses and governments around the world are now deeply in debt after three decades of falling interest rates, asset price bubbles, a desire to consume today rather than put it off, and aggressive banking practices. To preserve economic and social order, and prevent the crippling impact of deflation on an indebted society (like what happened in Japan after 1990) central banks are now working to preserve the world’s debtors.

    That means fighting the impact of the third great technological revolution – the Digital Revolution (the first two were Agricultural and Industrial). When the Industrial Revolution reduced costs, debt wasn’t an issue and prices could be allowed to fall. In fact, society’s most powerful were savers, not borrowers: for them deflation was a good thing so they made sure it happened.

    This time around it’s different: borrowers are ascendant and central banks are working for them, not savers. In fact, savers are being plundered with super low interest in the name of promoting aggregate demand and maintaining inflation.

    The Federal Reserve’s dual mandate requires it to “…promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates.” Leaving aside the fact that that’s three things, not two, the mandate calls for “stable prices”, not “rising prices”. The Fed has determined that this means prices rising by 2 per cent a year, not falling by 2 per cent a year.

    If it weren’t for the high levels of debt, I believe they would not be fighting the tendency of prices to fall because of the Digital Revolution and would see “stable prices” as moderate deflation, not inflation.

    By the way the Reserve Bank’s mandate is to “contribute to: the stability of the currency of Australia; the maintenance of full employment in Australia; and the economic prosperity and welfare of the people of Australia”. It doesn’t even mention “price stability”, let alone a target band of 2-3 per cent inflation.

    In yesterday’s monetary policy statement, the governor, Glenn Stevens wrote that the Australian dollar is still uncomfortably high. Uncomfortable, that is, for the preservation of inflation, which is implicitly needed to “achieve balanced growth in the economy” – that is, the replacement of the resources investment boom with domestic non-mining industrial growth.

    Without inflation, borrowers get crushed and don’t spend, because they are keen to reduce debt. Since most people are borrowers these days, the promotion of domestic demand requires some inflation so that the value of debt reduces naturally over time – and thus a lower currency.

    That’s why “currency wars” became a thing last year, although it’s turned out to be more a low-level cold war than a hot one. The real war is between monetary policy and the Digital Revolution – between the world of finance trying to reduce the value of money and therefore debt, and the world of technology pushing for greater efficiency and productivity, to drive prices lower and the value of money higher.”

    Me again: If you also factor in the demographics of an ageing population it strengthens the case for a deflationary bias in fiscal and monetary policy.

    • Very nice. 100% agree. And add that in the Euro zone, they will be getting rid of that debt not by inflation, but rather by the appropriate amount of write-offs needed to retain stable prices.

      Btw you said that mainstream economics thinks that some inflation is beneficial. These are ideas around the so-called “Phillips Curve”. They are easily debunked once you look at the actual figures. John Hussman has the relevant data for the U.S.

      After the empirical check, what’s left is the original idea about the Phillips Curve (accidentally during the gold standard, similarly to Barsky-Summers): Current employment anti-correlates with future real wages, i.e. unemployment today leads to slower inflation of the real wages, i.e. the wage component of the price level increases more slowly (or decreases more quickly) than the general price level.

      What’s wrong about the mainstream argument is basically everything:
      1) High unemployment today leads to lower real wage inflation in the future, but there is no such mechanism in the opposite direction, allowing us to influence future employment by setting real wages today
      2) What matters in the stated correlation is the ratio of wage inflation to general price inflation. Changes in the general price level that are equally reflected in its wage component, simply don’t matter at all.

      I guess the people on the ECB directorate know this (as know Bernanke and Yellen by the way). It is foolish to base one’s theory on the assumption that everyone else is stupid.


      • Piripi says:

        An additional observation to append to Alan Kohler’s succinct analysis: due to gold being the actual money of the time, the deflation of the mid-late 19thC (and early 20thC) was probably tempered by the massive concurrent rise in gold production – a ‘natural’ quantitative easing, if you will, whereby large quantities of “money” were dug from the ground all around the globe.

        When gold was money, the affect of the changing ratio of goods to money upon the value of the money (gold) made it difficult to isolate any changes in the value of gold which were due to the performance of gold’s (actual, original, underlying and under appreciated) function as a physical reserve instrument, until revealed as corollary to Barsky-Summers.

      • AD says:

        re.1.) what’s about minimum wages? Will be introduced in Germany soon: €8,50.
        re.2.) what’s about taxes on energy? Today in Germany far exceeding 100%, so plenty of room to play around in either direction.
        Greets, AD

        Noyer is a complete moron. Lately he demand that Germany better get their women to work (more). How about having his own folks maybe even to consider start working at all?

        • Yes, if energy imports get cheaper and you desperately want to avoid the resulting deflation, the “best” (as in most reliable) option is the obvious fiscal one: just raise taxes on energy. If your competitors abroad don’t do the same, however, you will probably lose exports.

          Similarly with raising the minimum wage.

          In other words, irrespectively of your CBs monetary policy, your government can always commit some blunder.


    • Hello Costata.

      Thanks for the piece you posted above. It echoed a few things I was chatting to DP about by email recently.

      I wondered why you commented on Twitter that you don’t subscribe to the freefiat view? It seems from your comments that you agree with FF views on inflation, and the ECB’s approach to currency management, so I was curious as to what you see differently? Any thoughts you could share please?


  25. Hi VtC,

    I’m not convinced that the Fed and other CBs see that the Phillips Curve is fallacious when the general price level is the reference used for inflation. In Australia the RBA talks about the “wage-price-spiral” as if it is holy writ. Perhaps it is merely a convenient excuse for doing what they want to do.

    I agree that a formal debt write-down would be a game changer for Europe but only if it extends to private debt. If it only applies to sovereign debt and bank liabilities then it would merely be another way of screwing savers/investors.


    • First on the Phillips Curve. I do think people in the Fed understand it. They just use it as an “explanation” that can be fed to the press and to Wall Street.

      I had the same doubt that I have about the Phillips Curve about another “model”, the so-called “Fed model”, i.e. the future return on stocks would match the future return on bonds plus a constant equity risk premium. This would mean that when interest rates are low, stocks can easily be richly prices without being in a bubble. This can also easily be seen to be nonsense empirically. People at the Fed definitely do now it, yet, Greenspan still used this “argument” in some of his speeches.

      Concerning the debt write-down. As far as I understand, the private sector in the affected peripheral countries (e.g. mortgages in Ireland or Spain) is already in a serious deleveraging mode with substantial credit losses at the banks. The deleveraging of the private sector is way ahead of the government sector.


  26. Hi VtC,

    I want to do some thinking out loud about the USG deficits and the implications for the US dollar and hyperinflation. I’ll address that issue in a later comment. I noticed the question from This2Shall_Pass about FF. I’d like to deal with this first since you are also heavily involved in that discussion.


    Hi This2Shall_Pass,

    You wrote:

    “It seems from your comments that you agree with FF views on inflation, and the ECB’s approach to currency management, so I was curious as to what you see differently? Any thoughts you could share please?”

    Since I sent the tweet distancing myself from the FF camp I came across some additional material from Otmar Issing discussing the ECB mandate that puts it in a very different light to the one most people would anticipate. I shared that piece with VtC and here’s a link to the papers from the conference in 2006 where Issing presented his paper:

    Click to access roleofmoneyen2008en.pdf

    Extract from Page 265:

    “….the Governing Council back in 1998 took the right decision when choosing its stability oriented monetary policy strategy……..the ECB took a high risk not joining the then dominant approach of inflation targeting.”

    I note that this paper was written 3 years after the ECB made its 2% inflation target more explicit. This paper by Otmar Issing nudged me further toward acceptance that the ECB could cope something much closer to zero inflation (or a gentle deflation) under the right circumstances. I differ with some of the proponents of the FF theories on a few issues:

    1. I’m agnostic about this save-in-gold versus save-in-Euro in a post-transition environment argument. The stability of the Euro will be determined by the marginal sales of gold. If the Euro is well-managed and stable then most people won’t need to own gold to get the benefit of a stable store of value – either Euro or gold would do the job. However a deposit account that pays interest could be more attractive than gold to savers.

    2. I think any argument about petro-Dollar versus petro-Euro has been overtaken by events. The bi-lateral currency swap system that China has been promoting makes a single reserve/trade currency unnecessary.

    3. I’m not convinced that there will ever be another global reserve currency. IMHO that is a failed experiment. At the time that Another was writing it seemed self-evident that the world needed a single, global reserve currency. I think that time has passed.

    4. I have major reservations about the emphasis that is being placed on monetary policy’s role in determining economic outcomes. My thinking these days is that fiscal policy is a far more important influence. Having said that I question whether the ECB can actually create inlfation and influence the price of consumption goods under the TARGET2 and HICP system.

    I hope this is answers your questions.


    • Some comments:

      1. I’m agnostic about this save-in-gold versus save-in-Euro in a post-transition environment argument.

      This has never played any major role in Blondie’s or my argument. It is basically a straw man produced by FOFOA. My point has always been that post transition, the ECB not only has the option to target zero inflation, but that this will rather be the natural state of the dollar-free financial system. Once you accept this conclusion you have to admit that the Euro would then fulfil all three functions of money: unit of account, medium of exchange and store of value.

      If someone then tries to purchase an excessive amount of Euros (say, from abroad), the ECB would have to act in order to prevent an imbalance in their capital account. In order to sterilize this action by the foreigners, the ECB could print Euros and purchase gold.

      2. […]The bi-lateral currency swap system that China has been promoting makes a single reserve/trade currency unnecessary.

      One might claim that a multi-polar currency system with floating exchange rates would also solve the problems with the international imbalances – I don’t know whether you are trying to say this, but if you do, I have a remark.

      The floating exchange rates would indeed take care of the adjustment process of the trade account. But they are not sufficient to provide an adjustment process to the capital account at the same time. With floating exchange rates, but without gold, an exporter can implement a mercantilist trade strategy and “manipulate” their currency down by accumulating debt denominated in the importer’s currency. The importer can counteract this only by printing their own currency and purchasing real assets, which ultimately means gold.

      3. I’m not convinced that there will ever be another global reserve currency.

      This will be gold for the reason explained under (2). Somewhere in the discussion above, I have detailed under which conditions foreigners would prefer to hold Euros rather than gold (when their country has a trade surplus with the Euro zone and the Euro zone still a net trade surplus) and in which cases they would prefer gold over Euros (if the Euro zone has a net trade deficit). In any case, if foreigners decide to accumulate Euros, the ECB will have an incentive to print Euros and purchase gold.

      I.e. effectively all foreign exchange reserves will be “backed” by gold somewhere, just not necessarily in the same country in which they are held.

      4. […] I question whether the ECB can actually create inlfation and influence the price of consumption goods

      There are several ways of creating consumer price inflation:
      I) Increase the monetary base and give the new money to a consumer.
      II) Reduce output without reducing credit plus base money.
      III) Create consumer loans in the banking system.

      But you are right, there probably needs to be a helper on the fiscal side. Here are some measures I can imagine that would certainly create consumer price inflation in the Euro zone:
      a) All unemployed are hired and paid salaries at the Attorney General level. This is paid for by an expansion of the monetary base.
      b) The ECB/governments approach one million employees and pay them a 20% higher salary under the condition that they sunbathe all day, being otherwise idle. This is funded by expansion of monetary base.
      c) The ECB/governments purchase one million (Europe made) cars and then pay for scrapping them, again funded by expanding base money.
      d) The ECB/governments ask 20% of all workers to go on strike immediately, but continue to pay their salaries.
      e) The ECB/governments ask the commercial banks to expand the volume of consumer loans much faster than GDP. If the banks are unwilling because that would be too risky, the ECB/government promises that the banks are TBTF and guarantee their solvency.

      (d) is basically what happened in 1922/23 in Weimar Germany. (e) is a good part of how the inflation was created that is still keeping the dollar system “alive”.

      It’s difficult to see how you would get that kind of systemic inflation after the transition, isn’t it?


      • Hi VtC,

        I have to agree that as long as gold is in the new system in the role that we envisage then a currency that is well managed with gold as the reference point will be stable. So of course it would operate as an SoV. From my reading of the exchange with FOFOA he doesn’t appear to disagree with this argument.

        “The floating exchange rates would indeed take care of the adjustment process of the trade account. But they are not sufficient to provide an adjustment process to the capital account at the same time.”

        I agree. The system needs an anchor. At present the “anchor” (US dollar) floats as well. Rather than floating on the FX market alone the US dollar is tossed around on the domestic fiscal policy of the US government and Fed monetary manipulation. Gold’s neutrality makes it the ideal anchor. I don’t have a problem with referring to gold as an international reserve currency. It’s a much easier concept for a lot of people to grasp.

        In regard to this issue of the ECB’s ability to create inflation I think that if they adhere to their mandate the present system would make it very difficult to create inflation. Different story after the banking union is in place perhaps. IMO the inflation engendering tools are in the fiscal policy area. Again IMO this movement toward adopting balanced budget laws in the constitutions of EMU members lends weight to the argument that a neutral approach could emerge to mild inflation or mild deflation.

        Again I also agree that the $IMFS is inherently inflationary for the rest of the world. Replacing the US dollar as the sole global reserve with gold and perhaps a few sound, well-managed international currencies should remove any automatic inflationary bias in the monetary system.


    • Hello Costata.
      Thanks for sharing your thoughts.
      I was reading some of that (very long) 2006 ‘role of money’ conference only today, as it was linked at the bottom of Draghi’s speech given today.

      It seems your views are similar to mine (borne of Blondie and VtC’s insights).

      • Hi This2Shall_Pass,

        You’re welcome. It seems to me that once you drill down into the FF concepts as presented by VtC that it’s not such a radical departure from the Freegold model discussed at FOFOA’s blog. IMO the main point of difference is the notion that savers will abandon bank deposit accounts in favour of physical gold as their savings vehicle. Turkey’s success in persuading its citizens to put gold into banks might be instructive on this topic.

        “Turkey’s official-sector gold reserves have also risen by more than 130 tonnes this year. This does not reflect central bank acquisitions, but is a result of the Turkish authorities’ acceptance of gold on deposit as part of commercial banks’ reserve requirements.”

        Not such a great deal for the Turks once you delve into how these accounts operate if the banks and the government are untrustworthy. If, on the other hand, they can be trusted then this system places private physical gold in the safekeeping of the Central Bank. If a similar project was adopted successfully by Raghuram Rajan the (brilliant and talented) Governor of the Reserve Bank of India then it could offer a neat solution to some of their problems.

        That said, it was only in 2005 that Turkey lopped 6 zeros off their old lira which was repeatedly subject to high inflation and episodes of hyper-inflation over the previous 30 years. In the early part of the last decade the Turkish government also put billions into a bailout of the banking system. Same-old, same-old – people seem to have short memories.

        I can see why the notion of savers sticking with bank deposits would be a contentious issue with FOFOA. Whichever way it plays out I don’t think it will have any material impact on gold’s performance in the new IMFS.


        • I don’t think the question of whether shrimp savers will continue to use bank accounts, is the main issue here. Conceptually, Blondie’s point of view tells you that the Euro will be a Store of Value. This means that SoV and MoE won’t be separate. And it derails the entire “debtors and savers” picture because it implies that after the transition, we will see the complete triumph of the savers over the debtors.

          This is because once zero inflation is the natural state of the economy, this implies that the banks will (again) be accountable for their lending, i.e. the end of Too Big To Fail, and this in turn is the “end of easy money” by which I mean the end of irresponsible lending to consumers.

          (Btw the money for productive enterprises will then be much “easier” since it will no longer be crowded out by speculative uses of money)


          • Piripi says:


            Agreed; the “material impact” of significance is upon a narrative, as Victor notes.

            Employing what I understand to be a Bayesian approach (unless/until I find something better, that is), I have no allegiance to any narrative, including “FF”. Probability, continually reassessed with regard to new (to me) data. That means I expect to regularly find error in my own previous opinions. No problem; adjust and move on. A static or rigid narrative eventually outlives its utility to a dynamic approach, it’s just the nature of the beast.

            I find it highly unlikely that the ECB would renounce their single mandate of euro price stability in favour of gold price stability, but that’s just me.

            • I find it highly unlikely

              That’s me, too. It would be totally foolish because that would effectively mean a flavour of the gold exchange standard (if consumer prices do this or that, the CB needs to buy or sell gold). Since they perfectly understand the failure of the gold exchange standard, I conclude the ECB won’t commit that kind of blunder.


              • I think that the fofoabug’s desire for stable, gently rising gold prices is merely a modern iteration of the classic goldbug view. In effect they want gold as money, but just the store of value function of money. Whilst that would be lovely, in a volatile world full of imperfect humans and finite resources, it just isn’t going to happen. Ever.

                Giants will still use gold for investment purposes and inter-generational planning, but will be aware of the risks. As CGV said ‘gold is an equity claim on mankind’s prospects’, and they aren’t guaranteed always to be stable or rosy. Crap eh?

        • Hello Costata,

          For me, the biggest difference between Fofoa’s view and that of CGV/Blondie revolves not around gold versus deposits as savings. (The only thing the two ideas share is the simple view that gold will be revalued in its physical form, and will serve as an international reserve asset. The rest of the FG view is IMO Fofoa’s imagination run wild. Stable, gently rising gold? Simply impossible. I don’t recall Another/FOA commenting on that, just that gold was the best way to get through what is coming).

          For me, the standout difference is the separation of the currency from the nation state, and how this contradicts FOA/Fofoa’s view that losses will always be socialised, because the collective prefers to share the pain, rather than apply them to any one group. To be fair to FOA, he had no way of predicting how the ECB would behave in 2013-16, but those of us watching what is happening right now have no excuses for not seeing the change. Or acknowledging its huge significance once we grasp it as such.

          The ECB set-up is clearly going in the opposite direction, and losses will be inflicted, both on large bank creditors, and sovereign bond creditors. (In fact I believe this is how gold is freed, at the same time the ECB will destroy the unallocated paper market and bid for physical gold to counter deflation).

          At the bank level, bank executives’ knowledge that any bank can fail if it gets itself into trouble will force banks to evolve (finally) into more prudent businesses. Some will still fail, because capitalism always involves risks, but it won’t ever get to the level of systemic threats.

          Also, sadly, Fofoa argues at his blog that savers saving in gold will keep the banks honest, as they have to compete for the capital. Elsewhere on his blog he acknowledges (as we all know) that banks don’t need a penny of savers money to lend, they can and do create money/credit from thin air, and then seek reserves from many sources, notably the CB. It will be the banks’ ‘skin in the game’, and no state bailouts that will change things, gold really doesn’t come into this side of matters, nor do savers. But it is a huge change, I think potentially mankind’s greatest ever evolutionary advance. Thanks to some clever people who designed the Eurosystem, and other folk who helped to get it implemented.

          (Also, it is this capitalist approach to credit creation that will naturally keep inflation under control, as credit is only extended to those with genuine credibility, not to chase short-term profits, and causing bubbles in doing so).

          So, the whole ‘gold savers’ narrative is a fallacy. I always thought it was a ridiculous idea anyway for the Western saver, before I grasped any of this stuff. Now I know it is for sure in the Eurozone.

          I could write more, but have already done so on my twitter feed and at Screwtape Files freegold thread too for any that are interested, so I will stop there. All of the above is originally GCV’s (and Victor’s) thoughts at Neural Net Writer anyway, I claim no credit for any of it.

          It is sad that Fofoa leads his followers on a dead-end trail though.

  27. Hi VtC,

    Before I do a little thinking-out-loud on USG deficits and interest rates I’d like to paint the background scene.

    I have recently been reading articles and papers discussing the reduction (as a percentage of GDP) in the US government’s deficits. Apparently it is currently running at somewhere around 4.5% down from a high in 2009 of 10%. Some analysts are projecting that it could get down to 3.5% by 2015 or even lower. Barring a major plunge back into a broadly-based recession this seems quite likely to me.

    The ISM manufacturing stats seem to be displaying a major recovery in US industry where as the small business sector is in major difficulties. Since small business is the job creation “engine” for the US economy this (plus automation) helps to explain the jobless recovery. There’s a lot of US multi-national corporation US dollars held offshore that could also be repatriated if the USG offered them some incentives. So there’s the tax on a couple of trillion there. Between increased revenue and falling costs as the military adventures are wound back the USG could easily achieve a positive primary budget balance (net of interest) over the next two years.

    The Fed seems to have interest rates under control at present. The overnight repo arrangements that the Fed has been trialling expand its tool kit to the point where it can overcome any liquidity issue in the banking system. Once this repo is available to hundreds of banks, insurers and other financial institutions a classic bank run is virtually impossible. So the Fed appears to be well-placed to buy the USG the time it needs to a achieve a positive primary balance. Once the USG gets to this point it doesn’t need to roll over debt to fund its expenditure.

    The structure of the $IMFS creates demand for US sovereign debt. Bernanke’s purchases of this debt competes with the private sector demand. So the Fed’s buying helps to keep supply and demand tightly matched. Because the Fed remits all of its profits to the US Treasury it’s purchases of USG debt is equivalent to cancellation. Even if you characterize it as substitution of USG debt for Fed Notes it shifts the liability off the US Treasury’s books free of charge.

    So here’s the thinking out loud part of this comment. A lot of people think that the key vulnerability of the US government and the US dollar is interest rates. People calculate the debt servicing burden from an increase in interest rates and simply add it on to the deficit and pronounce the USG broke (in a similar fashion to Japan) as a result of rising interest rates.

    I think people should be looking elsewhere for a few reasons. Firstly, interest is a dollar liability not a physical production liability. There’s no colllateral backing this interest rate contingent liability. Secondly the interest rate exposure cuts both ways. Let’s say that interest rates on USG bonds went from, say, 3% to 15% overnight. The 5x increase in the rate of interest is a 5x decrease in the amount of Fed Notes required to buy back the principal component of the debt. A 5x reduction in the increase in the money supply required to settle the buy-backs. If the supply of USG debt gets tight enough there might even be strong competition for this paper at higher rates.

    So I’m wondering if interest rates aren’t the trigger for a collapse in the US dollar then does that mean that it will come down to inflation? All of this money running into hard assets around the globe can do so without affecting the general price level because it’s basically on a separate circuit from consumption goods. I see this as an indicator that big money is “getting out of Dodge” but that isn’t a trend most people would recognise as inflation. Am I missing something here?

    I’d like to hear your thoughts on this if you have the time.


    PS. Anyone else who wants to chime in please do so.

    • I agree that interest rates is not the main danger to the U.S. financial system. This is for the reason you are stating. Btw AFAIK FOFOA agrees. He phases it in the following way. The dollar system won’t break because of something internal to the “financial plane”. It is most likely to fail when the “financial plane” detaches from the “real plane”, i.e. either when the old relationship between the dollar and goods and services breaks (hyperinflation) or when the old link between the dollar and gold breaks (failure of paper gold). We are seeing serious asset price inflation, although not in the case of gold, but for example in prime real estate, art, jewellery etc. You might say that prime real estate and fine art are kind of gold substitutes for some private sector giants, and so this is a warning sign.

      As far as interest rates are concerned, the Fed controls them, even at the long end, don’t they? The worst that can happen to them is that foreigners dump so many long bonds that they have to extend QE or at least reintroduce some kind of twist and may have some difficulty explaining this to the public. Eventually, I suppose, the public is going to believe anything.


  28. Hi VtC,

    Thanks for reviewing my thoughts here. It’s basically a reality check. I agree there are really only two pathways that lead to the new system. Or perhaps better seen as one pathway (credibility inflation over decades) leading up to our two major inflection points – failure of the paper gold markets and the catastrophic loss of confidence in the US dollar.

    I have been thinking along similar lines with regard to hard assets. High end RE is the preferred safe haven for many of the very biggest players. So this flight into hard assets is IMO like a canary in the coal mine.

    Thank you for sharing your thoughts.

  29. Hi VtC,

    I have been thinking about this issue of stability in the “price” of gold. Perhaps it’s a question of using the wrong terminology. Rather than discussing stability perhaps we should be talking about ‘neutrality’. The notion of gold changing in price by more than the increase in stock each year implies that causation runs from gold to the prices of goods and services.

    If we view gold as a neutral benchmark for the value of the UoA/MoE/SoV then causation runs in the opposite direction. Consumption items and currencies move in price and gold simply reflects that price movement on a cumulative basis. So there’s an internal/domestic aspect to the gold price and an external/trade aspect to the gold price. Arbitrage should ensure that the two influences cannot pull too far in opposite directions.

  30. VtC,

    I put out a couple of tweets to Steve Keen responding to a tweet by Stacy Herbert where she provided a link to a chart showing the Fed’s analysis of M2 velocity. I put up a link to a chart for MZM that showed velocity in a falling trend since around 1982. There is a sequence here that could have some significance. The velocity of M2 goes into a falling trend in the late 1990s and M1 rolled over circa 2008.

    I’m wondering what information, if any, this sequence might have to offer us?


    • IMO this just shows that the M0,M1,… don’t measure the sort of “money supply” that’s relevant for the prices of goods and services. I suppose, they calculate velocity from Fisher’s exchange equation MV=PQ (M=money supply, V=velocity, P=price index, Q=output). Now when you use consumer prices for P, but most of your M circulates in the market for financial or other investment assets, say bonds, stocks, real estate, then you find a declining velocity simply because you have been comparing apples with oranges.

      If you’d like to make Fisher’s equation work, you have to “disaggregate credit”, i.e. use the correct money supply (base plus credit created by the banks) and split it into the part that circulates in the market for goods and services (as opposed to real estate, financial assets). Then everything works as expected. Details in Richard Werner’s book.


      • It does reflect on the composition of the aggregates and disaggregating credit cleans up the data to a large extent. There’s also another angle I have been working on since I posted the comment above i.e. the divergence between final consumption goods production and the “financial innovation” that increases the range of “assets” that money and its equivalents can flow into. This financial innovation also affects the composition of the monetary aggregates over time.

        The velocity of money used to trade in final consumption goods appears to be very stable adjusted for population (and income/employment to a lesser extent) over the long term. The huge growth appears to be in assets which in turn seems to manifest as a declining velocity of money. Several of the people in the debt deflation camp interpret a declining rate of velocity as an indicator of deflation. I’m perceiving it as an indicator of runaway monetary inflation – reflected specifically in asset markets.

        Another issue I am still mulling over is why M2 rolled over before M1. I’m looking at the composition of the two aggregates for a possible answer. I have an outline for a post but I’m still developing it. If it gets to a satisfactory standard I’ll post it at Screwtape Files.


  31. Hi VtC,

    I found the extract below in the IMF paper by Reinhart and Rogoff discussing the likelihood of sovereign default that was the subject of an article from Ambrose Evans-Pritchard. This may be a crucial piece of the Freegold-RPG picture.

    From Page 15 (my emphasis):

    From the U.S. creditor vantage point, the collective default of World War I debt owed by foreign countries amounted to 15–16 percent of U.S. GDP. In this connection, it must be added that the United States had already defaulted on its sovereign debt in April 1933 to domestic and external creditors alike.

    The abrogation of the gold clause in conjunction with a subsequent 40 percent reduction in the gold content of the U.S. dollar (January 1934) also amounted to a debt haircut amounting to about 16 percent of GDP. The magnitude and incidence of post–World War I default worldwide is also understated by not considering in this exercise war debts owed by countries (other than the United States) to the United Kingdom. For the most part, these debts were also defaulted on and never repaid.

    Default on a global basis was around 15-16% of GDP. The implication is that this wasn’t merely a competitive devaluation as part of an ongoing currency war in which the USA “fired” the final shot. The devaluation of the US dollar against gold was merely part of a global devaluation of currencies against gold and a quasi debt jubilee to bring the debts back to a level that would allow the world economy to revive. A system wide reset of the IMFS regime of that period against gold.


  32. Hello again VtC,

    I wanted to comment on something I picked up from Twitter that was posted by one of the FOFOA regulars. This is the link: and this is the comment:

    Capt Goodvibes
    Fri, 13/12/2013 – 10:07

    Obviously, in a monetary system utilising a currency which is managed with the aim of keeping constant its purchasing power in everyday goods and services, the currency is the reference point. If the currency in question is the euro, we could call it Reference Point Euro, or ‘RP€’. Gold is merely a means to such an end, rather than the end itself.

    I think that this is where Blondie “jumps the shark” on this FreeFiat concept. Where price stability is the aim and mandate it is the prices of everyday goods and services that is the reference point not the currency. That’s presumably why the HICP was created.

    Also despite the fact that HICP appears to be focusing on the right prices and the methodology appears to be much better than other consumer price indexes it is still backward looking. It is quite likely that the HICP could show the ECB a deviation from trend early enough for them to change course but it has limited value as a forecasting tool.

    Secondly the international currency regime needs a focal point, a reserve/trade supra-currency, that can price all of the other currencies. This is obviously an area where gold shines. After the transition to the new regime gold will price currencies. Speaking of a “Reference Point Euro” is simply misguided IMHO.

  33. Hi VtC,

    I’m reading a document called “Oil Security 2025” downloaded from here: You can read more about the publisher and the authors of the document in the introduction. Suffice to say the contributors include some super-heavyweight ex-US military names.

    I may have found something in this document that is relevant to Freegold-RPG and the A/FOA insights. If you are already aware of the oil supply metric that I’m about to discuss apologies in advance for wasting your time. I’m calling this the swing producer oil surplus (SPOS) metric. I want to run this past you and some of the folks who are well versed in the A/FOA writings and F-RPG theories in order to cut down on the need for detailed explanation. (Obviously STFU is not the right venue for this discussion at present.)

    Let me present a few extracts that may help to kick off a discussion about how this metric might fit into an analytical framework along with other data series such as the oil:gold ratio.

    P. 16-17 (My emphasis)

    The OPEC Cartel and Spare Capacity

    A simple gauge of the supply-demand balance in the global market at any point in time is the level of spare production capacity in OPEC countries. As a cartel, OPEC maintains individual member production quotas that vary depending on the current global economic climate and geopolitical considerations. Though adherence to individual quotas is not always strong, OPEC production capacity typically exceeds the combined output of its members, with much of the surplus at any given point in time resting with Saudi Arabia. This spare capacity is a kind of market manipulation, but it can also serve incredibly useful purpose—it provides a short-term buffer in the event of unexpected supply disruptions or demand surges.

    As a general rule of thumb, markets are typically comfortable when OPEC spare capacity is the equivalent to four percent of global demand. Averaged for the year 2000, OPEC effective spare capacity stood at almost exactly this level, with three mbd of reserve capacity on 77 mbd of global demand.25 Levels increased in 2001 and 2002, before tightening dramatically in 2003 as a result of a worker strike in Venezuela and the commencement of hostilities in Iraq, both of which lowered output. During the following five years, effective spare capacity in OPEC never exceeded four percent, falling below one percent in parts of 2003 and 2004—precisely the moment that oil prices began climbing to record highs.

    Though the 2007-2009 global economic recession and financial crisis ultimately brought reduced oil demand, lower prices, and high levels of OPEC spare capacity, the reprieve was short-lived. A strong global recovery in 2010—particularly in China, where oil demand surged by 12.7 percent—coupled with a series of supply disruptions associated with the Arab Spring brought the return of sharply higher oil prices in early 2011.27 As a result of the Libyan Civil War, which removed 1.5 mbd of oil supplies from the global market at its peak in Q2 2011, OPEC spare capacity averaged 2.9 percent of global demand in the second half of 2011.28.

    Through 2012 and 2013, ongoing challenges to Libyan oil production and export, international sanctions that removed Iranian oil from the market, growing unrest in Iraq that affected output, and a host of issues that resulted in production outages in Nigeria contributed to an additional, sharp decline in OPEC spare capacity, which averaged just 1.8 percent of global demand in Q3 2013.

    Moreover, the various entities on the supply-side have extremely different motivations and incentives that drive their decision making. In the case of many OPEC members, there is little incentive to over-build spare capacity that sits idle the majority of the time, just as a means to keep markets calm. Admittedly,Saudi Arabia has frequently deployed its spare capacity to assuage volatile oil markets. Yet over the long term even Saudi Arabia considers the anticipated effects of investment levels in other global regions when making decisions about its own capacity.

    As a whole, the oil industries in OPEC members do not function as profit-maximizing firms seeking to expand market share. Instead, investment levels are determined—at least partially—as part of a strategy to achieve specified price targets, which have recently been suggested to be around $100 per barrel. These price targets are today driven by an urgent need to maintain generous domestic spending programs to placate restive populations.

    If OPEC adheres to its historical pattern, its members will view developments such as rising non-OPEC production as a signal to forestall investments in new production capacity, tighten quotas, and keep the global balance tight. Indeed, despite recent record growth in non-OPEC oil production, the International Energy Agency has begun warning of a looming global supply crunch by the end of the decade due to an emerging pattern of under-investment in Middle East oil production capacity.

    I think mortymer and several of the other guys and gals could be interested in this too. Thoughts?

    • So how does the price fixing between Saudi Arabia and the U.S. work? Apparently, Saudi Arabia does not continuously produce at their OPEC quota rate, but rather voluntarily abstain from even filling that quota when the price needs to be supported. Alternatively, some of the Saudi shipments into the U.S. are never sold at spot, but rather taken off market immediately (disappear in the SPR? – I think I remember that Marshall Auerback said that Saudi Arabia is allowed to use the spare capacity of the SPR in order to store oil that is still owned by them, and since it is still owned by Saudi Arabia rather than the U.S. government, it doesn’t appear in the reported SPR inventory – kind of a “dark oil” inventory).

      So if in your article, they use the spare capacity as an indicator for the future oil price, then they take the reported spare capacity. It may be that Saudi Arabia even produce less than that.

      Does that make sense?


  34. Hi VtC,

    So how does the price fixing between Saudi Arabia and the U.S. work? IMO the surplus is one of the elements of a decision making framework that guides US government policy. For example, provided the oil surplus was high enough and US domestic production was climbing then constricting Iran’s oil exports was a relatively painless policy for the US to adopt. I don’t think this swing oil producer surplus (SOPS) is an indicator that you could use to fine tune a price target. As the document makes clear there are too many elements that can influence prices on both the supply side and the demand side. I think this is a kind of “macro” control.

    (This is the first time I have heard about about the SPR being available for the use of the House of Saud. Food for thought, thank you.) In order to influence prices one of the obvious elements you need to be able to influence is supply. I note the discussion in that document about the co-ordinated use of releases from the strategic oil reserves of the USA and its allies to influence the price of oil. Factor in those stories about oil tankers being used to store oil by speculators when the oil price crashed after the GFC commenced and I think a picture begins to come into focus of a macro control (SOPS) and a fine-tuning mechanism (tankers + land-based stockpiles).

    I note the huge difference between the cost of production in the MENA countries ($10-$30 per barrel) versus the oil price needed to fund their budgets (up to $130 in some cases) at a given rate of production. One of the things that I’m gleaning from the discussion about the oil market in that document is that Saudi Arabia’s position among OPEC members is truly unique. To an ext ent the ME members of OPEC share some of their advantages but it appears that only two countries have the theoretical capability of competing with the Saudis to be the swing producer – Iraq and Iran. Aside from excess production capacity in order to occupy this position you need to be able to profitably increase production volume in order to make up for low prices. As this analysis makes clear many of the other producers can’t produce at low prices let alone increase production.

    (FOFOA should find a lot of support in this document for the description of Saudi Arabia’s position in A/FOA’s material. It appears that only one oil producer “matters”.)

    If the gold:oil ratio matters to the MENA oil producers then being able to influence the price of gold is a policy co-ordination imperative too.

  35. Hi again VtC,

    From P. 57-58 of “Oil Security 2025”:

    China is also currently building up a strategic oil reserve expected to hold 500 million barrels by 2020.183 The country’s commercial stockpiles number between 170 and 300 million barrels of crude oil and 400 million barrels of refined products as of 2010.

    Source: U.S. EIA, Country Analysis Briefs, China

    The document also discusses China’s growing equity share of energy resources outside Chinese territory.

    Also from P. 57:

    Investment in overseas oil and gas assets in 2011 topped $18 billion, while overseas equity oil production reached 1.5 mbd. China has also provided resource-backed development loans to many major oil-producing countries, including Russia, Kazakhstan, Venezuela, Brazil, and Angola, with deals totaling about $100 billion since 2008. The oil-for-loan deal between China and Venezuela guaranteed $32 billion in exchange for 430,000 barrels per day of oil. Chinese investment has not been limited to the developing world. Chinese access to Canadian oil sands was assured by the recent $15 billion Chinese takeover of Canadian company Nexen, China’s largest ever foreign takeover, in addition to other smaller investments in Canadian oil resources.

    Source: U.S. EIA, Country Analysis Briefs, China

  36. Another extract from “Oil Security 2025” from a section discussing Iraq as a wildcard for oil supply disruption:

    P. 64 (My emphasis and comments below.)

    Iraq’s oil industry has rebounded to a present-day level of approximately 3.0 mbd, up from a recent low of 1.3 mbd in 2003.195 This sharp increase in oil production has allowed Iraq to displace Iran as the second largest producer in OPEC. With 150 billion barrels of proved reserves (behind only Iran and Saudi Arabia in conventional petroleum reserves), Iraq has the potential for sustained increases in oil production over the medium and long term. The IEA recently projected Iraqi production to reach 6.5 mbd by 2020.

    Iraqi government forecasts are even rosier, projecting 9.5 mbd by 2017. For context, U.S. crude production averaged 7.5 mbd in 2013. Moreover, Iraqi oil production is extremely low-cost, approximately $2 to $3 per barrel.199 A large influx of low-cost OPEC oil has the potential to reduce global oil prices and displace more costly investments in deepwater, oil sands, and biofuels projects in addition to threatening current OPEC dynamics. However, although there are many reasons to be optimistic about Iraq’s prospects, achieving such high production growth is still far from certain and many hurdles remain. The biggest threat to this growth—and to the country’s overall security—lies in the potential for ongoing ethnic, religious, and political disputes to prompt a descent into open military conflict and even civil war.

    This huge gap between production cost and the “fiscal” oil price required to fund government budgets and domestic hydrocarbon fuel subsidies reinforces the theory that:

    “…OPEC members do not function as profit-maximizing firms seeking to expand market share. Instead, investment levels are determined—at least partially—as part of a strategy to achieve specified price targets…”

    I recall a paper I commented on over at FOFOA’s blog a long time ago that highlighted the massive difference in the per capita consumption of oil in Saudi Arabia compared to the USA and Germany. If memory serves me it was around 10x higher on average. Given the size of their sovereign wealth funds clearly the ME oil producing countries have the resources to achieve levels of efficiency in their energy consumption comparable to western developed countries.

    This may put the angst over Iran’s nuclear program into a different light. Perhaps Iran is upsetting an arrangement that maintains a reasonably tight balance between supply and demand in the export oil market. By flooding their domestic oil markets with subsidized fuel the oil producing countries build production capacity that could in theory be freed up for export by a crash program to increase energy efficiency. None of this suggests a potential physical shortage of oil (or any other hydrocarbon fuel) in the near future.

    My interpretation is that oil, like gold, has a geopolitical price not a free market price. In these circumstances oil (priced in gold ounces) could become extremely cheap while oil priced in US dollars could become extremely high. Provided gold reserves are located in the right hands it should be possible to transition to a new international monetary and financial system without starting another world war. It’s down to political will or a “black swan” event that forces everyone’s hand to complete the transition.

    VtC, thanks for providing a venue in which to air my thoughts on this topic. Cheers!

  37. Hi VtC,

    I just realised that I didn’t respond directly to this comment you made:

    So if in your article, they use the spare capacity as an indicator for the future oil price, then they take the reported spare capacity. It may be that Saudi Arabia even produce less than that.

    Does that make sense?

    Depending on the analyst you read Saudi Arabia’s spare capacity is around 2-3 mbd. This report and others I have read suggests it is vastly higher than this. IMO the key to this is to understand that the Saudis suffer less from lower oil prices than other producers because they have much lower production costs. If prices drop they can maintain their revenue by increasing volume and crowding out an equal volume of higher cost production. As a result their increased production doesn’t put additional downward pressure on the price of oil.

    This powerful position of low cost, swing producer also has a disciplinary effect on other members of the OPEC cartel. The Saudis can force the shut-in of production by other producers in extremis. However, given the increase in non-OPEC production the hammer would fall first on other high-cost producers outside OPEC. Can you see the alignment of interests here among the ME members of OPEC? They have an incentive for collective action in managing the price of oil because the negative effects are mainly borne by non-OPEC producers.

    Here’s the fly in the ointment of this arrangement. Two resurgent, powerful oil producers are also affected now – Russia and increasingly the USA through domestic production. This must to some degree lead to the emergence of some common interests between these powerful actors and two key potential Saudi rivals – Iran (foremost) and Iraq.

    I can’t resist posting one last extract from this document discussing the succession problem confronting the Saudi royal family. P. 70 titled “Wildcard 3” (my emphasis):

    Since the death of founding Saudi King Abdulaziz in 1953, all subsequent kings have come from among his 45 sons. The few remaining members of this generation are aging, and both King Abdullah and Crown Prince Salman have health problems that have contributed to lengthy hospitalizations. Prince Muqrin was appointed last year to the post of second deputy prime minister, a traditional springboard for succession. At 68, Muqrin is the youngest remaining male member of the generation that has ruled the Kingdom since his father’s death. His elder brother, Prince Ahmed, remains a possibility as well, in spite of his dismissal as interior Minister in 2012 after a tenure of only five months.

    Although King Abdullah formed the Allegiance Council in 2007 to determine future succession, there remains no clear plan of succession in place that incorporates the vast next generation of the House of Saud. Against this backdrop, discontent about inequality in the Kingdom —despite the vast wealth and land holdings of the royal family and other elites, varied estimates and measures report that 40 percent of the population lives below the poverty line— has resulted in low-level protests, particularly during the Arab Spring in 2011. These protests have occurred despite the restrictive security atmosphere in the Kingdom.

    A powder keg IMVHO.

  38. VtC,

    I came across another line toward the end of that paper which gave me a final jolt. This was a reference to the Texas Railroad Commission and America’s role as swing oil producer up to the end of the 1960s. As American oil production approached “Hubbert’s Peak” in the early 1970s we see the rise of OPEC led by Saudi Arabia, closure of the gold window, Kissinger’s deal with the Shah of Iran to raise the price of oil in order to make the North Sea and Alaska discoveries commercially viable and so on.

    With the benefit of hindsight this shift in the role of swing oil producer from America to Saudi Arabia is obviously implicated as one of the key drivers of the other events. It flips some things around e.g. Nixon closed the gold window because America could no longer supply cheap oil to suppress the price. And in fact the Anglo-American alliance needed more expensive oil in the 1970s in order to reduce it’s dependence on the ME. In retrospect the drain of gold from the USA was a reserve asset conversion not redemption of US dollars for gold. Conversion into a reserve asset that could be reliably expected to be convertible into oil. A role for the USD and USD denominated sovereign debt that appeared to be in doubt in the 1970s.

    I have understood for a long time that oil is central to this A/FOA narrative. Obviously my thinking now is that the key is this role of swing producer – price regulator. In the Saudi’s case when they inherited the role they couldn’t guarantee their own security. Consider how different things might have turned out if the Russians had become the swing producers with Russia as the king pin of an oil cartel. Perhaps a rouble-based IMFS?

    I’m in awe of the cleverness of the deal making that kept the US$ in the role of primary reserve currency. Cheap gold for cheap oil to get the Saudis onside. The cheap oil is a partial payoff to US dollar bloc allies to make them fall in line. Essentially free imported oil and free goods from the US trade deficits (if you look at the national accounting with a mercantilist perspective). The USA provides the security guarantees and the costs, despite the claims in this document I’m discussing, is actually paid for by the rest of the world when they accept dollars and dollar-denominated bonds from the US government.


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