Caution versus Confidence

Sometimes caution is a virtue. When things are going from bad to worse, one does not want to embark on boondoggles. Resources need to be conserved for redeployment in better times.

One of the functions of money historically is its use as a store of value. When prices are low enough that the desire for a good deal overcomes the fear of loss, money is pulled out of hoarding. In 1933, US President Roosevelt signed an Executive Order "forbidding the Hoarding of Gold Coin, Gold Bullion, and Gold Certificates." Evidently, Mr. Roosevelt decided that by forcing money out of hoarding, the same happy result would occur as if the money had come out of hoarding voluntarily.

We believe this was a critical error of judgment, and a factor which prevented the cure of some critical failings in the US (and indeed world) economic systems which caused the 1929-1939 Depression. We agree with the Austrian school of economics theory that excessive credit expansions are the primary cause of depressions. The excesses of these expansions are worked out primarily by a dissolving of the banking system and a subsequent reboot, so to speak. The policies of the Hoover, Roosevelt, Bush II, and now Obama administrations (and their international counterparts) did not allow the liquidation of the banking system. On the contrary, the popular solution to the depressionary stress is rescue of the failed banking system and further expansion of credit.

Classically, metallic money has acted as a brake upon credit expansion. In the Great Depression of 1929-1939 this brake became an inconvenience and was discarded. Since then, the world economy has been riding a runaway train of credit expansion. Sooner or later (and we vote for sooner), it will come off the tracks when spurious 'investments' do not produce intended yields.

Is the 2007 Depression then 'the big one'? It will be if world leaders decide to void the world's paper money supply of what little store-of-value-ness it has left. Zero percent interest rates and debt monetisation (both in progress) are a good start in that direction. Seeing their money become nothing other than something to spend, the world's citizens will dutifully spend away and the greatest crack-up boom ever will ensue, followed by the inevitable hyperinflationary catastrophe.

We would like to hope some other scenario is possible, but it seems less likely by the day.

Signs of Nonfunctional Markets

Free markets are supposed to be very efficient. The general law of supply and demand states that if people want something, the market will provide at the proper cost. This 'cost' includes, at the very least: the cost of the raw materials required; the cost of manufacturing; the cost of delivery to market. Profit usually sneaks in there somewhere, but profit itself is a type of cost. It should suffice to say that the cost of a desired item is typically reflective of the cost to make another, similar/identical item.

When the cost of an item goes below its replacement cost, any number of things may be happening: the market for the item may be saturated, and people don't want to buy anymore; the item might have been so utterly hideous that no one would pay money for it. Most pertinent to our article, though, is when people line up to buy the item, but there is none to be had at the market's price.

A good example of this is in the silver and gold markets. Presently, physical bullion commands a fairly respectable premium over the official market price. Those premiums represent a disconnect, and a rather serious one at that. Healthy demand exists for physical bullion -- perhaps even more than ever -- but that is a demand that cannot be filled based on the official market price. In essence, two markets have developed: the official and the real-world. This is a sign of a serious market break-down, one which will likely have some serious, lasting repercussions.

More than just the bullion markets have been effected, though. One can see a similar situation developing in the oil and natural gas market. The Federal Reserve's zero interest rate policy (ZIRP) is another good example of breakdown. No normal human being can borrow money even remotely close to the Fed's target rate of zero... but yet there it is. This is a disconnect of credit: the official market says no interest, the real-world market has other ideas. Further government intervention and manipulation in markets will result in similar breakdowns, especially as the 2007 Depression progresses.

"Say it ain't so, champ!"

A friend tells us this line comes from The Champ (1931), when the young Jackie Cooper finds that his hero isn't as heroic and upstanding as one would have hoped. So, too, are the best and brightest of Wall Street losing their stature. Today, for example, saw the discovery of what is probably the second biggest Ponzi scheme in financial history (bested only by the original, Charles Ponzi).

The mastermind? Bernard Madoff, former chairman of the NASDAQ. The grand total? Clocking in at around $50 billion or so. This tops the other Ponzi scheme recently ended, a measly $3.5 billion swindle orchestrated by Tom Petters, a Minnesota 'entrepreneur'-cum-felon. Both these men ran schemes which ripped off the gullible for fun and profit; both these men are criminals. Both these men were respected investors; the news of their unscrupulousness is "inconceivable" to their cohorts.

Hahahaha. As Bugs Bunny says, "aw, go on."

These two swindles are telling, however, for a trend of the 2007 Depression. A Ponzi scheme -- indeed, any confidence scam -- is inherently unstable, even in the best of times. The 2007 Depression is going to squeeze these sorts of swindles into non-functionality, and some may blow up spectacularly. There are, however, more swindles out there than just the average Ponzi scheme, and many of them come in forms one wouldn't necessarily expect.

Take banking: one puts one's money in an account, and then pretends it's still in the bank. Unfortunately, one's money does not simply sit in the bank's vault; it goes into, say... synthetic CDOs; or stock of Fannie Mae and Freddic Mac; or sub-prime loans. The point is, one's money is not in the bank anymore. In fact, we'd argue it probably isn't anywhere anymore. Yes, if one wanted to take out one's money, one can simply walk into a bank and withdraw it. But what if every depositor of the bank wanted their money? The bank never holds enough physical cash to cover its deposits; it can't afford to. The bank, like Mr. Madoff's and Mr. Petters' Ponzi schemes, would implode, and depositors would be left holding the bag, hoping that government insurance pays out.

But the biggest swindle, in our opinion, is money itself. We use it every day: these green pieces of paper get us our food, heat, and shiny, shiny gold. They're legal tender, all right -- every bill tells us so -- but who guarantees this? The Federal Reserve, we presume, since they're the ones who own them... but the Fed is just a bank. We ask: what happens when everyone metaphorically cashes in their dollar bills to hold something tangible? "Say it ain't so, champ!" will be the general cry.

What is Productive Capacity?

Arising from yesterday's post is the question of what wealth really is. Well, this is frankly very difficult to answer. Perceptual wealth is the name of the game right now, it seems: houses in and of themselves are worth 'something;' credit cards are seen as money; various corporations and banks are 'too big to fail.' These are all things which are teetering on the brink of major market revaluations (downwards), all the while desperate attempts are made to prop up their present, unsustainable valuations.

In ye oldie days, economies were predominately run from a mercantilist perspective. Mercantilism generally held that wealth was embodied in money (i.e. gold and silver). Prosperity and productivity flowed from the active hoarding of money, which thereby enriched the nation.

Anyone who has ever owned physical gold or silver should know this is hogwash. We have placed a bar of silver upon a table, and stared at it for quite a while, but as it sat it generated no wealth. Sure it was pretty, but it was only a store of value, not a productive investment. It could never produce wealth by our passive holding of it. To this we add the ideas that stocks, bonds, or houses are wealth: they are mercantilist delusions of the 20th and 21st Centuries, for their hoarding will never create wealth.

Towards the end of the 18th Century, mercantilists were superceded the physiocrats. Physiocrats held that wealth did not come from hoarding money (i.e. bullion), but came from productive capacity. At the time, the physiocrats equated 'productive capacity' with 'farming,' but we will broaden the definition, thanks to UNCTAD:

"...the productive resources, entrepreneurial capabilities and production linkages which together determine the capacity of a country to produce goods and services."[source]

Note that nowhere is 'money,' 'the stock market,' 'real estate,' or any other such silliness mentioned. Productive capacity is what makes the stuff that people need or want, and the services that people need or want. It is what Marx called labour, although that is a bit oversimplified because productive capacity does include machinery and other such complex systems.

Creativity; optimisation; ingenuity; making do; these are all part of productive capacity. However, productive capacity cannot be reduced to any of these things: it is a complex system which must be regarded as a cohesive whole, and guided by human thought. As long as you, dear Reader, are a creative person and know how to do things, you have productive capacity. Nurture this ability; it will certainly come in handy in the Depression.

Rethinking Luxury

First off, we're pleased to announce the launch of another, sister blog: the Silver Money Report. This blog will deal exclusively with topics pertaining to silver, notably in its investment and monetary functions. We have other blogs in the works, which will be rolled out for public consumption in the future.

For today's post, we would like to look at the idea of 'luxury.' We're sure that, to most, 'luxury' is probably brings to mind the lifestyle of a movie star or pop singer, rather than the middle-class living standard of yesteryear. Luxuries typically embody a large amount of wealth, whether financial or otherwise. In the past, one could demonstrate one's wealth by, say, gold-trimmed plates and solid silver silverware. The American rich of the late 19th and early 20th Centuries bought automobiles to show off their wealth.

Westerners in general (and Americans in particular) have forgotten just how much of their lifestyle is actually a luxury. Eating meat is a luxury; indoor plumbing is a luxury; a private room is a luxury; more than twenty square feet of living space per person is a luxury. We're sure these things sound more like necessities to you, Reader, but rest assured they definitely are not. Rather, these are the 'victory' of the 20th and 21st Centuries: making the luxuries of the 19th Century the necessities to the masses.

We're not saying that these things will necessarily once again become luxuries, but we're willing to bet the 2007 Depression will push the average closer to historical norms than Americans (and Westerners) are willing to accept all at once. Average living space in the West may not become ten square feet per person again, but it will probably be closer to 200 than the 1,000 Americans enjoy presently. Indoor plumbing probably won't go away, but the average person almost certainly won't have their own, private bathroom.

Perhaps the biggest luxury that Americans especially are unaware of is being able to live anywhere. Many areas of the United States are not viable economically, either from lack of productive capacity, remoteness, or outright uninhabitability. As energy becomes scarcer, and the 2007 Depression squeezes the economy even more, the 'live where I want to' mentality of Americans will likely end.

We could go on, but we instead will suffice with saying that knowledge of the living standards of the 19th Century is something one might want to be more familiar with. Not to forget, there are 4 billion people in the world who do not have even the quality of living as the average in the 19th Century. They are perfectly willing to fight tooth and nail, and work as hard as humanly possible, to get their indoor plumbing. They will work harder for this than you ever will, or ever have.

An Introduction to the Gold Standard

There is some talk on the fringes of the media about a "Bretton Woods 2" being developed. If it sees the light of day, this system would be similar to the financial treaty established at the end of World War II. Put simply, the original Bretton Woods made the U.S. Dollar backed by Treasury Bills and gold (initially fixed at $35 an ounce), while the member nations pegged their currencies to the U.S. Dollar. This system was effectively gutted by President Nixon, when he effectively took the Dollar off the gold standard.

The United States' gold standard, loosely, was a monetary program where a bank issues paper notes (the certificate notes of yore). These certificates were backed by a preset quantity of physical gold, held by the bank. Due to other banking regulations (which we will discuss in a later post) the banks were not required to hold enough gold to cover all of their issued certificates, merely a certain percentage of them.

One of the reasons the United States went off the gold standard, and indeed one of the primary criticisms of gold-as-money, is that there is not enough gold physically in the world to have a smoothly-circulating monetary system. This is indeed true, both now and in the past. Historically, gold was not a form of money which circulated. Rather, it was more of a store of value, or for exceptionally large purchases (say, an apartment building or two). Gold has always been too scarce to serve as a day-to-day form of money.

To remedy the problem, one can turn to 'lesser' metals, such as copper, nickel, and silver. These metals are more commonly discovered. Discussion of these other metals as money will be for a later post. Let it suffice to say that gold, due to its inherent scarcity, will never, ever work as the day-to-day money of any economy.

Indeed, the idea that it could work is foolish, and is a definite reason the entire world has entered the 2008 Depression (to say nothing of the 1929 Depression). The idea that a paper currency could be 'as good as gold,' and that gold could function as a day-to-day money, are both flawed. We will explore this concept, as well as others, in the near future.

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We've posted more discussion about problems with gold standards on the Silver Money Report.

Ice Cream, Gold, & Consumerism

What would you, Reader, consider yourself? In the media, the individual is most commonly called a 'consumer'. It is an odd label, in our estimation: to be a consumer means one should be spending money on stuff. It isn't important what stuff is bought, simply that money is still flowing. It's just something one does, like breathing, sleeping, and eating.

To us, the concept of 'consumer' brings to mind a cow. A cow grazes, mindlessly eating grass because, well... that's what cows do. They eat grass, because they have no choice in the matter. A consumer, likewise, spends money mindlessly, because they have no choice in the matter. One tends to feel insulted when called a cow.

We do not mean to play with semantics; we only wish to make a point. To consume is to spend money, something one finds is forever in short supply. Money is something one receives in exchange for one's efforts, which one can then do with what one wants. Honestly, we prefer our efforts to deliver things of lasting value (utility, entertainment, or otherwise). It's a difference of mindset: rather than spending like a mindless cow, we study ourselves and ask what we really want.

We must admit, however, our ideals do not always come into play. For example: if presented with $100, we would desire a 1/10th ounce of gold far more than twenty ice cream sundaes. However, when we look back on our life, we remember far more ice cream sundaes than 1/10th ounces of gold. Our preference of ice cream over gold was a reaction, an unexamined urge. In the moment, we might have rationalised that an ice cream sundae costs much, much less than a 1/10th ounce of gold... but we were probably too busy drooling over the chocolate double-fudge. Gold was the furthest thing from our mind as we stuffed our face, but in the final analysis we'd rather the gold.

This is a tongue-in-cheek example, but it goes to show the sort of decision-making one must make. For our part, we've written off a lot of future ice cream in the hopes of saving more money, which we will then turn into our more-desired gold... or something like that.