ECB’s Record Balance Sheet Tops the US Federal Reserve

From the Bloomberg,

The European Central Bank’s balance sheet surged to a record 3.02 trillion euros ($3.96 trillion) last week, 31 percent bigger than the German economy, after a second tranche of three-year loans.

Lending to euro-area banks jumped 310.7 billion euros to 1.13 trillion euros in the week ended March 2, the Frankfurt- based ECB said in a statement today. The balance sheet gained 330.6 billion euros in the week. It is now more than a third bigger than the U.S. Federal Reserve’s $2.9 trillion and eclipses the 2.3 trillion-euro gross domestic product of Germany (EUANDE), the world’s fourth largest economy.

The ECB last week awarded banks 529.5 billion euros for three years in the biggest single refinancing operation in its history, adding to the 489 billion euros it lent in December. The flood of money, which aims to combat Europe’s sovereign debt crisis by unlocking credit for companies and households, has increased the risk exposure of the 17 euro-area central banks that together with the ECB comprise the Eurosystem.

Here are the accompanying charts also from Bloomberg

ECB’s € 3.0 (US $ 3.96) Trillion

US $2.9 Trillion

In seeing the above, we understand that underneath today’s veneer of tranquility, there has been a lingering disorder that has yet to be manifested on the marketplace and on the real economy. These can be analogized to rapidly spreading cancer cells at the earlier stages.

Yet the above does not include the balance sheets of the Bank of England, Bank of Japan and the Swiss National Bank whom have all been undertaking similar actions.

Despite occasional publicized opposition, these policy palliatives will be sustained by political authorities in the hope of rehabilitation and the preservation of the incorrigibly degenerate political system.

Policymakers of developed economies will likely push this or exploit the use of central banks to the limits until a blowback in the economy and the monetary system becomes apparent.

Because the public is hardly aware of the operations of central banks, central bankers have assumed the role of hatch men for politicians and their privileged cronies the banking class.

Yet to desist from the current actions will translate to a collapse of too big to fail banking institutions that should drag along the welfare-warfare state, a development which current political agents have fervently been trying to defer, thus the unprecedented experiment.

There is no way for any person who understands the fundamentals of money to be bearish on prices of precious metals given the prospective extension of these policies.

The recent surge in global stock markets has been symptomatic or signifies as the initial outcome of the the second wave of central banking money therapy that is being applied. I expect that equity markets particularly those from emerging markets to mainly benefit from these remedial measures for the time being. This will hardly be an issue of earnings or valuations, but of the evolving state of money.

Lastly with the Euro balance sheet surpassing that of the US Federal Reserve, it’s time to be temporarily bearish the Euro. I say temporary because I expect the US Federal Reserve to eventually ramp up on their balance sheet through another QE (or a variant of it) for many earlier stated reasons.

However, I wouldn’t short the Euro though, the political management of fiat currencies have already been evincing of their innate tendencies of returning to their intrinsic value—zero. I’d buy precious metals instead

We have to be reminded that the relative valuations of currencies is determined by the relative demand and supply of currency units.

As the great Ludwig von Mises wrote,

These observers do not understand that the valuation of a monetary unit depends not on the wealth of a country, but rather on the relationship between the quantity of, and demand for, money. Thus, even the richest country can have a bad currency and the poorest country a good one.

US to Deal with North Korea’s Dollar $100 bill Counterfeiting

A counterfeiter meets another counterfeiter: North Koreans printing unauthorized US $100 dollar bills

From Business.time.com (hat tip lew rockwell blog)

U.S. negotiators are heading into a second day of what have been dubbed “serious and substantial” talks with North Korean officials. Yet amidst all the discussion of how the U.S. will attempt to work with Kim Jong Un, there has been little (open) speculation as to whether Dear Leader Junior might crank up production of $100 and $50 bills. No, not North Korean 100- or 50-won banknotes, worth about as much as old tissues. I’m talking about fake greenbacks — or, as the U.S. Secret Service has dubbed them, “superdollars.”

These ultra-counterfeits are light years beyond the weak facsimiles produced by most forgers, who use desktop printers. As an anti-counterfeiting investigator with Europol once put it: “Superdollars are just U.S. dollars not made by the U.S. government.” With few exceptions, only Federal Reserve banks equipped with the fanciest detection gear can identify these fakes…

Forging $100 bills obviously gels with the regime’s febrile anti-Americanism and its aim to undercut U.S. global power, in this case by sowing doubts about our currency. State level counterfeiting is a kind of slow-motion violence committed against an enemy, and it has been tried many times before. During the Revolutionary War, the British printed fake “Continentals” to undermine the fragile colonial currency. Napoleon counterfeited Russian notes during the Napoleonic Wars, and during World War II the Germans forced a handful of artists and printing experts in Block 19 of the Sachsenhausen concentration camp to produce fake U.S. dollars and British pounds sterling. (Their story is the basis for the 2007 film “The Counterfeiters,” winner of the 2007 Oscar for Best Foreign Language Film.)

Superdollars can be viewed as an act of economic warfare, but Pyongyang’s motive is probably more mundane: The regime is broke. The 2009 attempt to raise funds by devaluing its already pathetic currency revealed not only the country’s fiscal desperation, but also the abuse Dear Leader was willing to inflict on his people. The won was devalued 100-fold, which meant 1,000 won suddenly had the purchasing power of 10 won. (Imagine waking up to a learn that a slice of pizza costs $250.) Officials set a tight limit on how much old money could be exchanged for new, so whatever value existed within people’s paltry savings evaporated overnight. Compared to devaluation, generating quick cash by counterfeiting some other country’s more stable currency looks downright humanitarian.

So part of the reason why the North Korean government counterfeits the US 100 Benjamin Franklin bills has been to put up a façade or a veneer on its rampant inflationism.

But counterfeiting is a twofold process. According to the great Murray N. Rothbard such process involves first, an increase of the total supply of money, thereby driving up the prices of goods and services and driving down the purchasing power of the money-unit; and second, the changing of the distribution of income and wealth, by putting disproportionately more money into the hands of the counterfeiters.

In short, counterfeiting is the finagling of the public’s wealth into the pockets of politicians or the counterfeiters who run the printing press. This essentially makes the US government, via the fiat money standard running on central banking operations, no different than typical counterfeiters except that US central bank operations are reckoned as legitimated.

And besides, North Koreans need not “undercut U.S. global power” because the US has already been working on path towards self inflicted perdition, through US dollar debasement policies.

Yet the US government disdains competition and will likely act to curtail them.

Again Professor Rothbard,

Whereas the government may take a benign view of all other torts and crimes, including mugging, robbery, and murder, and it may worry about the "deprived youth" of the criminal and treat him tenderly, there is one group of criminals whom no government ever coddles: the counterfeiters. The counterfeiter is hunted down seriously and efficiently, and he is salted away for a very long time; for he is committing a crime that the government takes very seriously: he is interfering with the government's revenue: specifically, the monopoly power to print money enjoyed by the Federal Reserve.

So will the counter-counterfeiting of the North Korean government serve as justification for war hungry US politicians to open a new front in the imperial theater of war?

Paper Money’s Usefulness

In Zimbabwe, the former Zimbabwe dollar was used as toilet paper or for mural décor.

Hungary’s Central Bank discovers a new use.

From the Telegraph (hat tip Professor Robert Murphy)

Hungary's central bank is burning old monetary notes to help the needy in Europe's deadly cold snap.

The bank is pulping wads of old notes into briquettes to help heat humanitarian organisations.

"It's a very useful charitable act, a vital aid for our foundation because we can save part of our heating costs," said Krisztina Haraszti, the head of a centre for autistic children in the impoverished northeastern town of Miskolc.

It helped the centre, which also provides aid to autistic adults, save between 50,000 and 60,000 forints (£200) a month, which is a "considerable sum in this time of crisis," she told AFP.

Since the briquettes have a high calorific value, "one only needs to add a few bits of wood and the rooms are really warm," said Haraszti.

As Voltaire once said "Paper money returns to its intrinsic value—zero."

Video: Fiat Money Basics: The Root of the World's Imbalances

Here is a concise explanation of the mechanics of the legal tender based paper money system, a system that rewards the political and the banking class at the expense of everyone else.

Greece’s Welfare State at Death Throes, Germany Prepares to Rescue Banks

The global financial markets have been pricing the imminence of a Greece default as the Eurozone appears lost over trying to contain the contagion.

The Greece government is having a difficult time selling to her populace the EU imposed ‘austerity’ package required for continued bailouts.

From Bloomberg, (bold emphasis mine)

Prime Minister George Papandreou will seek today to counter mounting domestic opposition to budget cuts and growing doubts that Greece can avoid default as a three-year recession worsens.

With the country’s bond yields at records and European officials increasing pressure on the premier for more cuts before they dole out a sixth tranche of bailout loans, Papandreou will deliver a nationally televised address on the economy from the northern city of Thessaloniki at 8 p.m.

A total of 4,500 police officers are being deployed in the city to keep order as unions rally, students march against education reforms, and taxi drivers across Greece strike to oppose new licensing rules. Finance Minister Evangelos Venizelos said on Sept. 6 the government will accelerate austerity measures pledged in return for emergency loans…

Fears have deepened since a scheduled quarterly review of Greece’s progress by the European Union and the International Monetary Fund was unexpectedly suspended for 10 days last week. Greek sovereign debt jumped 212 basis points yesterday to a record 3,238, according to CMA. The five-year contracts signal there’s a 92 percent probability the country won’t meet its debt commitments.

Venizelos expects the economy to shrink by about 5 percent this year, worse than the June estimate of 3.8 percent from the EU and IMF, and a deeper contraction than in the past two years. The forecast damps hopes that Greece will lower its deficit to 7.5 percent of gross domestic product in 2011, with the government blaming the slump for a budget deficit that widened 25 percent in the first seven months of the year.

Greece is aiming at an additional 6.4 billion euros ($9 billion) in savings through the end of the year to meet the 2011 deficit target, part of a 78 billion-euro package of state-asset sales and budget measures that threatened to topple Papandreou in June.

Venizelos this week pledged to immediately transfer state assets to a fund for sale and place civil servants in a “reserve” system to retrain them and cut expenses, as well as merge and shut down dozens of agencies.

As I have been saying, the concurrent bailout packages have been a sham. This has not been about restraining the welfare state but about rescuing the banking system.

What has been happening instead is the political process where massive amount of resources are being transferred from the welfare state to the banking sector.

Global political leaders are hopeful that by rescuing the politically privileged interconnected banks, they can bring 'normalcy' back to the 20th century designed politically entwined institutions of the welfare state-banking system-central banking system.

And since the makeshift measures applied by the EU have been less aggressive than that of the US, which have been exacerbated by fierce regional and local political impediments, as the above, economic reality has been swiftly catching up with politics. The latter has made many to mistakenly generalize that a political or fiscal union is the solution,it is not.

And in realization of the looming default, Germany prepares to support her national banks.

Again from another Bloomberg article,

Chancellor Angela Merkel’s government is preparing plans to shore up German banks in the event that Greece fails to meet the terms of its aid package and defaults, three coalition officials said.

The emergency plan involves measures to help banks and insurers that face a possible 50 percent loss on their Greek bonds if the next tranche of Greece’s bailout is withheld, said the people, who spoke on condition of anonymity because the deliberations are being held in private. The successor to the German government’s bank-rescue fund introduced in 2008 might be enrolled to help recapitalize the banks, one of the people said.

The existence of a “Plan B” underscores German concerns that Greece’s failure to stick to budget-cutting targets threatens European efforts to tame the debt crisis rattling the euro. German lawmakers stepped up their criticism of Greece this week, threatening to withhold aid unless it meets the terms of its austerity package, after an international mission to Athens suspended its report on the country’s progress.

Greece is “on a knife’s edge,” German Finance Minister Wolfgang Schaeuble told lawmakers at a closed-door meeting in Berlin on Sept. 7, a report in parliament’s bulletin showed yesterday. If the government can’t meet the aid terms, “it’s up to Greece to figure out how to get financing without the euro zone’s help,” he later said in a speech to parliament.

A Greece default would likely lead the ECB and the US Federal Reserve to make massive transfusions of digital ‘bailout’ money to ECB and US banks.

Also Greece could be ‘convinced’ to leave the Euro.

This should be very bullish for gold.

Yet, realize that the temporary ‘Band aid’ patches being applied by political authorities won’t survive an unsustainable system based on a political economy of zero sum redistributions.

The welfare state-banking sector-central banking architecture operating on a fiat money platform is bound for collapse.

Greece seems as paving the way.

Confiscatory Deflation and Gold Prices

This is a reply to an objection

Gold’s rise represents:

1. fear of bank failure.

My reply

With all the money being sunk into the banking system of major economies, such observation omits the current evidences that abounds (from ECB’s $1 Trilion QE, Fed’s explicit guarantee and rollover of principal payments, SNB’s and Japan’s currency interventions and bans on short sales by 4 European nations plus Turkey and South Korea)

This of course doesn’t even include the money spent for the bailouts during the 2008 crisis where the Federal Reserve audit revealed $16 trillion issued to foreign banks and or previous estimates of $23.7 trillion exposure of US taxpayer money to save the systemically important or ‘too big to fail’ banks and other politically privileged companies.

As one would note, people stuck with an ideology will tend to dismiss evidences even if these have been blatantly “staring at their faces’.

2. concerns of the "Pesofication" of hard currency accounts

My reply

Assumptions that government’s may confiscate deposits or prevent withdrawals like the Argentina crisis (1999-2002) does not translate to an increase of demand for gold, for the simple reason that such government policies promote deflation.

Austrian Economist Joseph Salerno calls this ‘Confiscatory Deflation’

Mr. Salerno explains (bold emphasis mine)

As a result, Argentina's money supply (M1) increased at an average rate of 60 percent per year from 1991 through 1994. After declining to less than 5 percent for 1995, the growth rate of the money supply shot up to over 15 percent in 1996 and nearly 20 percent in 1997. In 1998, with the peso overvalued as a result of inflated domestic product prices and foreign investors rapidly losing confidence that the peso would not be devalued, the influx of dollars ceased and the inflationary boom came to a screeching halt as the money supply increased by about 1 percent and the economy went into recession. Money growth turned slightly negative in 1999, while in 2000, the money supply contracted by almost 20 percent.

The money supply continued to contract at a double-digit annual rate through June 2001. In 2001, domestic depositors began to lose confidence in the banking system, and a bank credit deflation began in earnest as the system lost 17 percent, or $14.5 billion worth, of deposits.

On Friday, November 30, alone, between $700 million and $2 billion of deposits--reports vary--were withdrawn from Argentine banks. Even before that Friday bank run, the central bank possessed only $5.5 billion of reserves ultimately backing $70 billion worth of dollar and convertible peso deposits. President Fernando de la Rua and his economy minister, Domingo Cavallo, responded to this situation on Saturday, December 1, announcing a policy that amounted to confiscatory deflation to protect the financial system and maintain the fixed peg to the dollar.

Specifically, cash withdrawals from banks were to be limited to $250 per depositor per week for the next ninety days, and all overseas cash transfers exceeding $1,000 were to be strictly regulated. Anyone attempting to carry cash out of the country by ship or by plane was to be interdicted.

Finally, banks were no longer permitted to issue loans in pesos, only in dollars, which were exceedingly scarce. Depositors were still able to access their bank deposits by check or debit card in order to make payments. Still, this policy was a crushing blow to poorer Argentines, who do not possess debit or credit cards and who mainly hold bank deposits not accessible by check.

Predictably, Cavallo's cruel and malign confiscatory deflation dealt a severe blow to cash businesses and, according to one report, "brought retail trade to a standstill." This worsened the recession, and riots and looting soon broke out that ultimately cost 27 lives and millions of dollars in damage to private businesses. These events caused a state of siege to be declared and eventually forced President de la Rua to resign from his position two years early.

By January 6, the Argentine government, now under President Eduardo Duhalde and Economy Minister Jorge Remes Lenicov, conceded that it could no longer keep the inflated and overvalued peso pegged to the dollar at the rate of 1 to 1, and it devalued the peso by 30 percent, to a rate of 1.40 pesos per dollar. Even at this official rate of exchange, however, it appeared the peso was still overvalued because pesos were trading for dollars on the black market at far higher rates.

The Argentine government recognized this, and instead of permitting the exchange rate to depreciate to a realistic level reflecting the past inflation and current lack of confidence in the peso, it intensified the confiscatory deflation imposed on the economy earlier. It froze all savings accounts above $3,000 for a year, a measure that affected at least one-third of the $67 billion of deposits remaining in the banking system, $43.5 billion in dollars and the remainder in pesos.

Depositors who held dollar accounts not exceeding $5,000 would be able to withdraw their cash in twelve monthly installments starting one year from now, while those maintaining larger deposits would not be able to begin cashing out until September 2003, and then only in installments spread over two years. Peso deposits, which had already lost one-third of their dollar value since the first freeze had been mandated and faced possible further devaluation, would be treated more liberally. They would be paid out to their owners starting in two months, but this repayment would also proceed in installments. In the meantime, as one observer put it, "bank transactions as simple as cashing a paycheck or paying a credit card bill remained out of reach of ordinary Argentines."

Mr. Lenicov openly admitted that this latest round of confiscatory deflation was a device for protecting the inherently bankrupt fractional reserve system, declaring, "If the banks go bust nobody gets their deposits back. The money on hand is not enough to pay back all depositors." Unlike the bank credit deflation that Lenicov is so eager to prevent, which permits monetary exchange to proceed with a smaller number of more valuable pesos, confiscatory deflation tends to abolish monetary exchange and propel the economy back to grossly inefficient and primitive conditions of barter and self-sufficient production that undermine the social division of labor…

Unfortunately, things were to get even worse for hapless Argentine bank depositors. After solemnly pledging when he took office on January 1 that banks would be obliged to honor their contractual commitments to pay out dollars to those who held dollar-denominated deposits, President Duhalde announced in late January that the banks would be permitted to redeem all deposits in pesos. Since the peso had already depreciated by 40 percent against the dollar on the free market in the interim, this meant that about $16 billion of purchasing power had already been transferred from dollar depositors to the banks.

Prices of gold vis-à-vis the Argentinean Peso only surged after the Argentine government allowed the Peso to be devalued.

Chart from Nowandfutures.com

Devaluation had been the outcome of an explosion of money supply

Chart from Nowandfutures.com

As the bust cycle of the imploding bubble culminated (explained above by Dr. Salerno above) inflation fell (see red ellipse below).

Chart from tradingeconomics.com

More of the Argentine Crisis from Wikipedia,(bold emphasis mine)

After much deliberation, Duhalde abandoned in January 2002 the fixed 1-to-1 peso–dollar parity that had been in place for ten years. In a matter of days, the peso lost a large part of its value in the unregulated market. A provisional "official" exchange rate was set at 1.4 pesos per dollar.

In addition to the corralito, the Ministry of Economy dictated the pesificación ("peso-ification"), by which all bank accounts denominated in dollars would be converted to pesos at official rate. This measure angered most savings holders and appeals were made by many citizens to declare it unconstitutional.

After a few months, the exchange rate was left to float more or less freely. The peso suffered a huge depreciation, which in turn prompted inflation (since Argentina depended heavily on imports, and had no means to replace them locally at the time).

The economic situation became steadily worse with regards to inflation and unemployment during 2002. By that time the original 1-to-1 rate had skyrocketed to nearly 4 pesos per dollar, while the accumulated inflation since the devaluation was about 80%; these figures were considerably lower than those foretold by most orthodox economists at the time. The quality of life of the average Argentine was lowered proportionally; many businesses closed or went bankrupt, many imported products became virtually inaccessible, and salaries were left as they were before the crisis.

Since the volume of pesos did not fit the demand for cash (even after the devaluation) huge quantities of a wide spectrum of complementary currency kept circulating alongside them. Fears of hyperinflation as a consequence of devaluation quickly eroded the attractiveness of their associated revenue, originally stated in convertible pesos. Their acceptability now ultimately depended on the State's willingness to take them as payment of taxes and other charges, consequently becoming very irregular. Very often they were taken at less than their nominal value—while the Patacón was frequently accepted at the same value as peso, Entre Ríos's Federal was among the worst-faring, at an average 30% as the provincial government that had issued them was reluctant to take them back. There were also frequent rumors that the Government would simply banish complementary currency overnight (instead of redeeming them, even at disadvantageous rates), leaving their holders with useless printed paper.

Bottom line:

The above experience from Argentina’s crisis shows that when government adapts policies to confiscate private property through the banking system, demand for gold does NOT increase or gold prices don’t rise.

It is when the Argentine government decided to devalue and inflate the system where gold prices skyrocketed.

Both confiscatory deflation and the succeeding inflation lowered the standard of living of the Argentines. The antecedent to the above events had been a prior boom.

In short, policies that promote boom-bust or bubble cycles represent as net negative to a society and even promotes more interventionist policies that worsens the prevailing social predicaments.

Lastly record gold prices today points to inflationism NOT confiscatory deflation.

Iranians Go for Gold

It’s not just the Greeks, but latest reports say that Iranians too have been stampeding into gold.

From the Reuters, (bold emphasis mine)

Amid global economic uncertainty, the price of gold on world markets rose steadily in the first half of 2011 and Iranian coins appreciated in line with that. Rather than cashing in their coins for a profit, Iranians continued to buy them in ever larger numbers.

"Usually, as the price of an item increases, demand will decrease. But in the case of gold, it seems that higher prices are creating more demand," said a gold retailer in Tehran who asked not to be identified.

The Iranian gold rush was mainly driven by fears about the domestic economy, particularly the risk of soaring inflation and a wobbly currency, he said.

In addition to concerns about a global double-dip recession, the economy has been hit by sanctions as the United States leads global pressure on Tehran over a nuclear program many states say is aimed at building atomic weapons, a charge Iran denies.

Here’s a glimpse of the Iranian rial-US dollar performance

Below is a chart of Iran’s inflation rate

US-Rial, and Iran inflation rate from Wikipedia.org

The Iranina rial-euro over the past 5 years (yahoo finance)

More from the same Reuters article, (bold emphasis added)

Saving rials is also less attractive than a few months ago after the government reduced the level of interest banks could pay on savings. Returns were slashed in April from a range of 26-28 percent to 14-17 percent, below what many Iranians believe to be the actual inflation rate.

Worries about the declining buying power of the rial and doubts over the currency's stability are the main drivers behind the flight to gold.

While the International Monetary Fund has praised Iran for reducing inflation to 12.4 percent for 2010-11 from 25.4 percent two years earlier, the rate has been creeping back up over the last year to 14.2 percent in May. Prices have risen much faster for key items such as fuel, water and food as heavy government subsidies are phased out.

At the end of last year, President Mahmoud Ahmadinejad started winding down some $100 billion of subsidies and giving direct cash payments to families to reduce the impact of price rises. The switch, praised by the IMF, was done despite the predictions that surges in the prices of fuel, food and water could stoke wider inflation.

As well as hoarding gold, many Iranians sought to change their rials into hard currency, increasing demand for dollars so much that the Central Bank devalued the rial by almost 11 percent last month.

That sudden decision did nothing to assuage Iranians' fears about the safety of their savings.

Many economists believe the rial, which is loosely pegged to major world currencies under a "managed floating exchange rate," has not been allowed to devalue in line with inflation and is overvalued by between 30 and 50 percent.

As international trade in rials is very limited, the change in its value has no real impact on global markets.

It sank to 12,500 to the dollar last month, compared to 10,500 earlier in the year.

Same problems haunt paper money system, whether the US dollar, Belarus ruble, Greek drachma or Vietnam Dong or Iranian rial.

Fundamentally, the pathology stems from an overspending welfare state, which has been financed by government’s inflationism and artificially low interest rates, where the crescendoing ramifications of such accrued imbalances have been vented on a devaluing domestic currency and on rising prices of domestic consumer goods and services.

Uncertainty over the preservation of hard earned savings has prompted many of their citizens to swap government legal tender paper currencies for man’s historical default store of value—gold or precious metals. (flight to real value)

These signs of intensifying cumulative efforts worldwide to hoard gold seems to portend the return of gold as money.

But then again, gold as part of a reformed monetary architecture would mean a vastly reduced welfare state, a privilege which incumbent politicians everywhere would unlikely yield...until market forces prevail on them.

Interesting times indeed.

Paper Money System: Origin And Destiny

321gold’s Darryl Robert Schoon on the origin of paper currency (he quotes Ralph T. Foster’s book, Fiat Paper Money, The History and Evolution of Our Currency)

By 1661, China finally learned its lesson and the new Qing dynasty officially outlawed paper money. Regarding China’s 600 year experiment, Foster writes:

“Over the course of 600 years, five dynasties had implemented paper money and all five made frequent use of the printing press to solve problems. Economic catastrophe and political chaos inevitably followed. Time and again, officials looked to paper money for instant liquidity and the immediate transfer of wealth. But its ostensible virtues could not withstand its tragic legacy: those who held it as a store of value found that in time all they held were worthless pieces of paper. (page 29) [emphasis mine]

As the above excerpt shows, the paper money system has been an age old predicament for political leaders who always try to circumvent the fundamental laws of economics, but always ended up a failure.

Today, paper money has been repackaged and sold to the public as a product of modernity anchored upon central banking—operating on the platform of technology aided complex and sophisticated math or quant models.

And where lessons seem to have never been assimilated or learned, the same outcome should be expected as in the past. As Voltaire once said, “Paper money eventually returns to its intrinsic value…zero.”

Is Mainstream Banking Bringing Gold Back as Money?

At the Huffington Post, structured securities expert Janet Tavakoli notes that US mainstream banking has began accepting gold as a collateral, she writes,

J.P. Morgan Chase & Co. announced on February 7, 2011 that it will accept physical gold as collateral for investors that want to make short-term borrowings of cash or securities.

Presenting gold to satisfy demands for performance bond collateral has been allowed on the London CME in a limited way since October 2009. As of November 22, 2010, the Intercontinental Exchange Inc. (ICE) has accepted gold bullion as collateral on all credit default swaps and energy transactions.

I don't recall the G-20 declaring gold a new currency. Yet JPMorgan Chase and a couple of financial market exchanges have effectively declared that gold is an alternative currency.

In other words, gold is money.

The market appears to be driving gold back to reassume its lost function—a role stripped away by ideological statists to advance their political agenda which has led to the grandest experiment of nearly 40 years: paper money via the US dollar standard.

And perhaps, such illusion—turning stones into bread—maybe coming home to roost.

As Professor Ludwig von Mises once wrote,

The return to gold does not depend on the fulfillment of some material condition. It is an ideological problem. It presupposes only one thing: the abandonment of the illusion that increasing the quantity of money creates prosperity.

Is Sound Money Incompatible With Democracy?

One of the recent feedbacks I received is the attribution that sound money can’t be compatible with democracy. The implication is that inflationism is an indispensable instrument for democratic survival.

Of course, this assertion accounts no less than an arrant bunk (nonsense) for the following reasons:

One, this serves as an example of argumentum ad populum (appeal to popularity), where the belief of the many holds that the argument is true.

Just because many seek to live off at the expense of the others this doesn’t mean that their demands are necessarily justifiable or valid and should be provided for.

This is similar to the unwisdom of the crowds which we have recently critiqued. Moreover, these proponents seem oblivious to the fact that populist policies tend to self-destruct overtime. What is unsustainable won’t last.

Second, the alleged incompatibility is also misleading because this operates on the premises of the 'tyranny of the majority' or the rule of the mob.

Say for example, 10 persons get stuck in a remote island where only one of them is a woman. Yet 6 of the male elected to force themselves on her. Is the majority’s action justified? The answer is obviously NO. The means to an end isn’t justified by mere numbers.

What is needed is the rule of law, of which inflationism chafes at.

As Friedrich A. von Hayek wrote in the Decline of the Rule of Law, Part 1

The main point is that, in the use of its coercive powers, the discretion of the authorities should be so strictly bound by laws laid down beforehand that the individual can foresee with fair certainty how these powers will be used in particular instances; and that the laws themselves are truly general and create no privileges for class or person because they are made in view of their long-run effects and therefore in necessary ignorance of who will be the particular individuals who will be benefited or harmed by them. That the law should be an instrument to be used by the individuals for their ends and not an instrument used upon the people by the legislators is the ultimate meaning of the Rule of Law.

Three, the collectivist charade is to sell popular wisdom to the economic ignoramus. The collectivists forget to tell everyone that inflationism is a redistribution scheme which benefits the minority at the expense of society.

As Jörg Guido Hülsmann wrote in Deflation and Liberty (emphasis added)

``Inflation is an unjustifiable redistribution of income in favor of those who receive the new money and money titles first, and to the detriment of those who receive them last. In practice the redistribution always works out in favor of the fiat-money producers themselves (whom we misleadingly call central banks) and of their partners in the banking sector and at the stock exchange. And of course inflation works out to the advantage of governments and their closest allies in the business world. Inflation is the vehicle through which these individuals and groups enrich themselves, unjustifiably, at the expense of the citizenry at large. If there is any truth to the socialist caricature of capitalism—an economic system that exploits the poor to the benefit of the rich—then this caricature holds true for a capitalist system strangulated by inflation. The relentless influx of paper money makes the wealthy and powerful richer and more powerful than they would be if they depended exclusively on the voluntary support of their fellow citizens. And because it shields the political and economic establishment of the country from the competition emanating from the rest of society, inflation puts a brake on social mobility. The rich stay rich (longer) and the poor stay poor (longer) than they would in a free society.”

Fourth, what collectivists see as essential is actually the opposite. History reveals that democracy and sound money has had and can have a symbiotic relationship.

In The Gold Standard, Indirect Exchange section of the epic Human Action, Ludwig von Mises wrote, (bold emphasis mine)

``The gold standard was the world standard of the age of capitalism, increasing welfare, liberty, and democracy, both political and economic. In the eyes of the free traders its main eminence was precisely the fact that it was an international standard as required by international trade and the transactions of the international money and capital market. It was the medium of exchange by means of which Western industrialism and Western capital had borne Western civilization into the remotest parts of the earth's surface, everywhere destroying the fetters of age-old prejudices and superstitions, sowing the seeds of new life and new well-being, freeing minds and souls, and creating riches unheard of before. It accompanied the triumphal unprecedented progress of Western liberalism ready to unite all nations into a community of free nations peacefully cooperating with one another.”

Finally, the hucksters of false promises of inflationism are no less than blinded by economic dogma whose foundations seem to operate outside the realm of the law of scarcity—yes fantasyland.

As Ron Paul wrote on Why Governments Hate Gold, (bold emphasis mine)

``Time and again it has been proven that the Keynesian system of big government and fiat paper money are abject failures in the long run. However, the nature of government is to ignore reality when there is an avenue that allows growth in power and control. Thus, most politicians and economists will ignore the long-term damage of Keynesianism in the early stage of a bubble when there is the illusion of prosperity, suggesting that the basic laws of economics had been repealed.”

Hardly does any of these fanatics have ever explained why throughout the centuries, experiments with paper money has ALWAYS failed.

Of course if one believes redistribution is a way or a path to prosperity, then apparently they are merely deluding themselves.

As Henry Hazlitt once wrote,

Any attempt to equalize wealth or income by forced redistribution must only tend to destroy wealth and income. Historically the best the would-be equalizers have ever succeeded in doing is to equalize downward. This has even been caustically described as their intention.

The collectivists amuse us with their logical fallacies, incoherent theories, misleading definitions, short term nostrums, and misinterpretation and deliberate twisting of facts.

For them it’s not about being right, but about blind faith.

Beware of false prophets.

Gold Unlikely A Deflation Hedge

This article says Gold is a hedge against deflation

According to mineweb,

``Gold is also an excellent hedge in periods of deflation. What is happening in times of pronounced deflation? Public budgets are strained, the financial sector is faced with systemic problems, currencies are depreciated in order to reflate the system, and the money supply is continuously rising. The creditworthiness of companies and countries is queried, the confidence in paper currencies falls, and gold is subjected to remonetisation."

The article uses historical performance, based on gold and gold mining share prices, to make such claim...

I don't think this is valid.

All one has to do is look at how the US dollar has performed during the years prior to central banking and the years after central banking existed.

In the period of 1814-1897 the US dollar fundamentally retained purchasing power relative to Gold. Post 1914 or the birth of the US Federal Reserve, the US dollar begun its steady decline.

chart from American Institute For Economic Research

And it has not been confined to the US dollar...

chart from Uncommon wisdom

Whether it is the Canadian dollar, Swiss franc or the British Pound, once released from gold as the anchor, paper currencies has steadily lost purchasing power.

Ergo, the fundamental difference is that GOLD and SILVER had then been money, because of the Gold Standard. Today we have fiat money, where gold has been reduced to "reserve assets" for central banks. Therefore we can't apply gold's exalted past with today.

Where the deflation represents the rise of the real purchasing power of money, until gold is accepted by the public as money, will then it serve its purported role as deflation hedge.

What Gold’s Latest Record Prices Mean

``The struggle against gold which is one of the main concerns of all contemporary governments must not be looked upon as an isolated phenomenon. It is but one item in the gigantic process of destruction which is the mark of our time. People fight the gold standard because they want to substitute national autarky for free trade, war for peace, totalitarian government omnipotence for liberty.” Ludwig von Mises

A major trait of bullmarket is, whatever assets we sell today will climb higher tomorrow. This implies that the most regrettable course of action in a bullmarket is to sell.

And one great example would be the gold market. Gold just set a new record in terms of nominal high (see figure 1).

Figure 1: Netdania.com[1]: Gold’s Stairway To Heaven

The monthly chart reveals that gold prices have been in a bullmarket since 2000. While true enough, there have long periods of consolidation, the general trend over the last decade has been up.

And importantly, contrary to those who allege that gold functions as safehaven during recessions or during the “deflation-symptom” crisis similar to the Bear Stearns-Lehman episode of 2008, evidence has shown otherwise—gold fell during the previous two recessions of 2001 and 2008 (see black channel lines)!

Alternatively, the most recent record run only implies that the fresh milestone high, established last week, DOES NOT presage of any forthcoming market crashes or “double dip” recessions. And if gold serves as a lead indicator as previously discussed[2], then the likelihood is to see reanimated activities in global risk markets.

At the start of the year, we were told that gold wouldn’t generate investor appetite as the menace of “deflation” continues to lurk around the corner. We even read predictions stating that gold would fall back to the $800 levels[3] way until last month[4].

However, as we have always been saying--in a world of central banking, deflation is no more than a bogeyman to rationalize more inflationism, which central bankers are likely to accommodate. After all, inflation is ALL about politics. And central bankers, in spite of their supposed “independent” role, have been the main conduits in financing government expenditures. Thus all talks of “independence” are mostly demagoguery. Fact is, global banking regulations, as the Basel Accords, have all been skewed to accommodate government expenditures[5].

Of course, one major bullish factor about gold is that mainstream STILL doesn’t get it; gold isn’t just an inflation hedge, nor is it about alternative assets[6]. It’s also been starkly misguided to impute ‘conventional’ financial valuation metrics to gold when this doesn’t apply. It’s even myopic to calculate or value gold prices premised on commodity usage. And it is also faulty to appraise gold based on global mining output. Since gold isn’t being consumed, incremental additions to the above ground supplies by existing mines hardly determine the pricing model (see previous discussion[7]).

In a decadent world of fiat money, where money printing to fulfil specific political agenda have been the most convenient route resorted to by political leaders everywhere-for the simple reason that the ignorant masses hardly understands how such surreptitious redistributive activities influences their lives- gold seems to be re-establishing its role as ‘money’.

Therefore, gold’s ascendant trend in ALL currencies have simply been manifestations that demand for gold has been transforming from mere “commodity” (jewelry and industrial usage) to “money”.

Gold is being held as reserve asset not just by the central bank, but importantly by the general public. Gold’s increased function as “reservation demand” is what usually the mainstream sees as “speculation” or “speculative hoarding” or “investment demand”.

Otherwise said, money’s “store of value” is increasingly being factored into gold prices (unit of account). Hence, relative to gold pricing, this implies that reservation dynamics or the reservation model (and not consumption model) determines gold valuations or that the exchange ratio or monetary valuations relative to fiat currency applies-- where valuations are determined by the expected changes in relationship between the relative quantity of, and the demand for, gold as money vis-a-vis paper currencies.

And possibly one day, such transformation would include the deepening of “exchange demand” or gold as ‘medium of exchange’ (see previous discussion[8]). Proof of this has been the emergence of Gold ATMs in Germany[9] and in Abu Dhabi[10].

All these, of course, are ultimately dependent on the stimulus-response and action-reaction of global political leaders on the swiftly evolving political, economic and financial sphere.

And thus, periods of weaknesses, whether from recessions or from consolidations (in technical or chart lingo the “energy fields”), has served as buying windows rather than selling opportunities.

Yet for those whom have remained sceptical and or earnestly drudge to market “timing” gold’s prices, they usually end up chasing gold prices higher-- buy high and sell low.

And this is especially brutal to those in constant denial of gold’s ascendancy; they have entirely missed out the rally for ideological reasons, and vent their frustrations by continually disparaging such developments. The odd thing is that this has already been a 10-year market process.

Yet since gold rise has been threefold, all errant attempts to “time” the market has resulted to lost or missed profit opportunities.

As the legendary trader Jesse Livermore expressed by Edwin Lefevre in the classic must read for any serious investors, “Reminiscences of a Stock Operator”,

``Disregarding the big swing and trying to jump in and out was fatal to me. Nobody can catch all the fluctuations. In a bull market your game is to buy and hold until you believe that the bull market is near its end. To do this you must study general conditions and not tips or special factors affecting individual stocks.[11]”

In short, the best returns emanate from long term investments.

---

[1] Netdania.com, Forex charts

[2] See Why The Current Market Volatility Does Not Imply A Repeat Of 2008

[3] Yahoo. Finance, Gold Is "Fairly Expensive," Could Fall to $800 If Fed Moves, Midas Fund Manager Says, January 22, 2010

[4] CNN.Money, The coming gold bust

[5] See The Myth Of Risk Free Government Bonds

[6] Reuters.com, US gold sets record, ends strong as alternate asset

[7] See Gold As Our Seasonal Barometer

[8] See Financialization of Commodities: Boon Or Bane?

[9] See Creative Destruction: Electronic Payments Over Cash And Checks

[10] Financial Times Blog, Abu Dhabi’s gold ATM machine a sign of more opulence to come, May 13 2010

[11] Lefevre, Edwin, Reminiscences of a Stock Operator p.76 John Wiley and Sons