Maggie's Farm

There is a difference between crony capital as you say "has always existed" and the way it exists today.

Today, firms can create a variety of means of leverage (derivatives) that, if extended beyond a certain level, will lose value because they just extended too far. This is why margin requirements exist. As those margin requirements were increased, the risks related to the leverage in question increased.

Most of this leveraged debt was spent on 'things' - vacations, homes, cars (if it was spent personally) or businesses, buildings, shopping malls, etc. (if spent by investors). When the economy tanked, all this outstanding debt was backed by goods that were declining in value. How can so much leverage be recouped?

Two ways:
1. debt destruction (banks and other lenders swallow the losses) which can lead to bank failures and other financial unrest. We saw a bit of this happening with the Lehman failure.
2. Inflation. By forcing prices to rise, the goods being held become 'worth' more, matching the debt values which are still outstanding. It's the old "pay back with dollars that are worth less than you paid with" scenario.

The Fed has chosen inflation. It has purchased most of the toxic debt, which is sitting in the Fed's vaults, and handed the banks newly printed dollars (in electron form) to shore up their reserves. The Fed has the luxury of being able to sit on this stuff indefinitely until someone can purchase it back, when (and if) it's ever worth something. In the meantime, they are hoping the banks will lend out the reserves. This will make the situation worse, of course, so the banks are being very careful about who and how they lend, leading to massive reserves just sitting in bank vaults.
This is why politicians continue to scream "why won't the banks lend?" Well, one reason is - it's bad policy that led to this current situation, so how will bad policy make it better?

With regard to gold - no, gold is not worthless if quatoos are worthless. This is because gold has intrinsic transfer value. This value may vary from person to person or place to place, but would you say that you'd be willing to accept a paper quattoo as opposed to a gold quattoo? I think not. I (and most businesses) would be willing to accept the gold because someone, somewhere, will want it. Nobody will want the paper.
This reminds me of a gun runner during the Civil War who ran in and out of Charleston. He refused Confederate currency, and insisted on gold payments. He is one of the few gun runners on the Confederate side who had money after the war. I wonder, if Confederate quattoos were worthless, and he was accepting gold Confederate quattoos, why this is so?
Basically, gold is one thing paper is not - it is a store of value AND a medium of exchange. Paper is not a store of value UNLESS the government says it is. But if the government undermines the value of its currency, then it ceases to be a store of value. Think about it. Is your paper dollar from 1960 that you stuffed in a mattress still worth the same amount today? How about 1/32 of an ounce of gold (worth $1 in 1960)?

Who lends countries money? That's an "it depends" answer. Right now, Greece would say nobody. Of course, soon it will be Germany. As long as Germany has the right to veto Greece's budget. We'll see how long that lasts.

In the US, the US is loaned money by the Fed. The Fed is not allowed to bid on US Treasuries. So they let banks bid. Then, a week or so later, the Fed uses newly purchased dollars from the Treasury to purchase US Treasuries back from the banks. The banks make a profit, the Treasury makes a small profit. The Fed technically loses money overall. Over time, the Fed hopes to 'make money' via inflation. So far, it's worked pretty well. But there are eventual limits to this program because of the very issues laid out in a post I made a few months ago, which told the story of the Mississippi Bubble.

You see, currency carries value only if it is 'sound'. That means it has to be backed by something of value. If an empty shopping mall in Deadwing, Nevada has value, then newly minted fiat currency can have value because the debt is backed by productive capital.
When that productive capital lies idle and unwanted, newly minted fiat currency is inflationary, not productive.

It's called a debt trap in economics. You can lower rates to zero, but you can't make people borrow or banks lend when either sees a loss on the horizon. But to get rates to zero, you have to print lots of new money....so it creates inflation since more money is chasing fewer (or the same amount) of goods.

The 'best' solution is to kill debt. Raise rates, promote savings. It's terribly painful, but in the long run it's beneficial. A revisit to Volcker's years would do us all some good, because we are having massive inflation now. It's just hidden in the official statistics. If you visit Shadow Stats, you'll see the real rate of inflation in things like food, clothes, and energy.

I agree with you about "intrinsic" value. If people decided tomorrow that something else would be a store of value and gold would no longer serve that function, the value of gold would decrease and the value of the other thing would likely increase.

Except that your definition of how a store of value is decided upon is exactly what makes it 'intrinsic'.
Gold has intrinsic value because it is an historic and social convention. If nautili (plural for nautilus) were suddenly decided to be a store of value by everyone in the Keys, simply because there was no gold available, then nautili would be very valuable there. It probably would carry less value elsewhere.

In fact, this has happened in the US. http://www.realitysandwich.com/ithaca_hours

Ithaca Hours are an extension of a similar scrip program in upstate New York from the 1970's, instituted when economic activity led to very little currency in the region. Ithaca Hours, however, are backed by productive capacity. Thus they are backed by a value, not unlike gold. Productive capacity can be generated easily, but there are limits to how much can be produced, since a person can only work a certain amount of time during a day. Thus it meets all the requirements of a store of value.
However, outside Ithaca, it's not really worth much because social convention does not value productive capacity in a similar fashion.

So if my town were to institute a local currency like Ithaca, how could we transfer Hours from New Jersey to Ithaca? There is no clear medium of exchange (a huge problem with local currencies). So you need something to benchmark against that (once again) is common enough to use, but rare enough to have value. Gold, as usual, will be that standard.

Local currencies were what started in the US originally. It's probably not a bad idea to go back to them, because (like Ithaca) there is value in productive capacity. So it's a good basis of value. But it's not a solid medium of exchange over a wider network. That's where a currency backed by a valuable product (like gold) comes in.

By the way, Keynes predicted that the Bretton Woods Agreement would eventually fail, and that its replacement would face institutional failure, for one reason. He pointed out that a national currency cannot act as a global currency. The goals of a nation almost never align with those of the world, and at some point would collapse. He proposed the Bancor as the medium of exhcange between national currencies. The Bancor would be backed by gold, giving it a standard value (value as based on market price), that would allow other currencies to float against it. If one nation decided to devalue its currency and print at will, then it would pay the price in more currency for less Bancor.

Sadly, we chose not to listen to him. In retrospect, most central bankers recognize he was correct.

We face the difficult times he predicted now because he said one nation acting as a world currency would, eventually, face issues like we currently face.

Say what you want about Keynes and the General Theory (which I do not adhere to), but when it came to currency, he was brilliant.

Common sense would lead you to believe that, so I agree (theoretically).

However, convention has reasons for 'creating rules' and those rules have been in place a long time. Over that period of time, the rules have been explained many times (money is defined very explicitly by 4 rules, all of which gold adheres to, and very few other things do).
1. it is accepted as a unit of accont (gold acts as that now, and has in the past)
2. it is a medium of exchange (gold still acts as that at an international level, and has at a local level in the past)
3. store of value (given due to its marginal utility)
4. standard of deferred payment (gold is always a preferred standard of deferred payment, even today, though my Civil War story outlines another example of it)

Other items have fulfilled these rules, too. Silver, platinum, etc.
So has salt, rice, shells, etc. But those items lost value as other means of creating or finding them en masse were cultivated or discovered (similar to printing massive amounts of paper and calling it dollars).

During the gold standard years, inflation existed in the manner we are familiar with it today when gold was discovered. New World Gold made Spain incredibly wealthy, but also lead to a massive bubble burst when they exceeded their expectations on how much would be forthcoming...all while prices spiralled out of control (newly found gold = printing new paper).

Gold standards are a benchmark and provide discipline.


On the face of it, your explanation makes sense, but across history it doesn't.

The Physiocrats (French Economists from the 1700's) believed all agriculture was the basis of economic growth. Manufacturing was, to them, just a 'remanifestation' of previous goods into new products. They didn't value effort - the work that goes into manufacture. Part of the reason they came to this conclusion was based on their belief that you can't do much with other 'stuff', if you can't use it.
Basically, they subscribed to your POV and rejected Mercantilism, which was based on using manufacturing processes to increase trade and accumulated gold and silver.

In the end, both the Physiocrats and Mercantilists were found to be wrong....but for vastly different reasons. If anything, Mercantilists wound up being slightly more 'correct' because they believed in trade, markets (though not necessarily free or fair markets) and having a standard by which to gauge trade (gold/silver).

I don't believe that fiat currencies MUST fail. They all have, but there are reasons why they have. Usually those reasons are politically motivated.

In fact, I have no problem with a well-managed fiat currency system that has a value-based means of backing. In other words, if economic growth determines there needs to be 5% more currency, then 5% more currency will not be inflationary, it will map organic growth.

Sadly, that's not how our system operates. There are many who believe it's OK to just print money, buy debt, use the printed money to cover bad debt (toxic assets), let the bad debt sit in reserve until such time it has value and can be sold off, or until it is essentially 'paid off' and can be retired.

There is a time value to money. If the Fed can manage that time value effectively, then the printing doesn't have to be inflationary. That much I agree on....and any economist really would.
Where it fails is on these points: What is the proper amount that needs to be printed? At what point do interest rates need to be raised to tamp down inflation as opposed to driving up unemployment? What is the impact of massive reserves at banks and the increased moral hazard associated with those reserves and their need to earn a return somehow? How can this be controlled using proper margin requirements?

There are many other questions, all equally unanswerable and all interconnected, which make the Fed's policy outlandish, and the belief in the current fiat system misguided.

Does this mean we're doomed? Not necessarily.
But it does mean the people controlling the system think they are a hell of a lot smarter than the market in general. And you know, when you think you're THAT smart, you're in for a world of hurt.

You can't walk into Kroger's and pay with gold. Yet. But if you remember when other nations currencies have failed (China was a classic example, as Mao took over), the rush for gold to replace currency was standard behavior.

This will happen again. Even now, China and India are buying gold. As financial crises erupt, those with the gold make the rules. Why did the US make the rules in the Post WWII environment? Most of the gold was in the US.

Other tokens, as you suggest, can operate as 'currency'. Silver and other rare metals will operate as well as gold. But silver actually has manufacturing uses (unlike gold, generally) and is more plentiful. For a store of value to work well, it has to have relatively few uses in an economy (so it doesn't disappear, like oil does). It has to be rare enough that marginal value increases with each increment, but plentiful enough that it is readily available. It has to be portable. It cannot be just picked up off the land easily at every turn.

As such, a nautilus could work, to a degree. In fact, other items like this have worked before (the stones of Yap, for example).
But in most of the world, over time, regardless of culture (save premodern cultures like Mayan or Aztec), gold has been recognized for its intrinsic value.

Gold is increasing in value because the Fed is printing money like it's going out of style. If the bubble collapses eventually, the dollar value of gold will fall to zero. The actual value, however, will be whatever social convention allows it to be. My guess is it will go hyperbolic - it will be in greater demand as people seek some form of stability.

Sorry. In my very LONG response, I spent time explaining how the Fed finances debt and creates leverage.

This is crony capitalism that is 'new'. It's really never been done this way before. So, in order to maintain a facade of 'health', politicians created Too Big To Fail. It's a new form of crony capitalism that uses massive debt to create the appearance of stability.

This is very different than the Defense Dept. paying $400 for a hammer.

This is different not because similar things haven't happened before. It's the scale. It's not just a single company in a particular contract. It's many companies in many different industries. For the first time in history, the US government is the primary shareholder in not only a major bank, but several manufacturing firms.

This marks a massive break from the past.

Not to mention that, even with that...the government has basically said the entire system is going to be backed up by newly printed money. This has never been done before either.

Finally, the government has assured all the major firms that their contracts with major employees are intact, and fully backed by government cash. In essence, the government has said taxpayers are OK with massive moral hazard, backed up by huge paychecks and bonuses.

Each of these points are very new, and their scale very different to prior events. We have, in essence, affirmed that we are a fascist nation to some large degree. While it's been true on much smaller scales in the past, it was also never openly assured.

This is true.
I didn't allude to this at all because while I'm aware of the things you mention, I haven't seen them firsthand so I can't really comment.

In terms of GDP, in terms of financial health or economic health, I have studied enough and experienced enough to realize there are some solutions which will only cause more problems.

Thanks. For what it's worth, I agree with you. I just don't know enough about these countries demographics or culture to make any statements about whether it's true.

I've read plenty about the idiosyncracies of Chinese culture to believe that they do not represent a potential long term threat to us, economically.
You can't build empty cities hoping they will fill up (or assuming you can force people in), or have buildings falling over like dominoes or blowing up regularly and expect to appear like a world leader.

That said, the Chinese have many other things going for them (particularly in economics and business) to assume they will catch up with us at least in some degree of standard of living.

There is a difference between 'stable' prices in the sense that a dollar today is worth a dollar 40 years ago and the concept that prices increase as a matter of policy.

Growth doesn't happen because prices go up, or because there is more money. That flies in the face of not only theory, but fact.

Prices may go up because demand increases for a product or supply diminishes. Under a gold standard, this created 'price instability'. However, over time, the dollar spent in 1920 had, roughly, the same purchase power in 1950 (in reality $1.00 in 1920 was the same as $1.20 in 1950...but you could buy MUCH MORE due to improved productivity).

Consider that a similar 30 year period AFTER the gold standard - 1970 to 2000 - saw $1 be equivalent to $4.40.

No price stability under a gold standard? The funny part was that $4.40 in 2000 couldn't buy MORE than $1.00 in 1970. A $26,000 home in 1970 went for $200,000 in 2000. This, in a nutshell, is the degrading power of fiat currency. Your dollar is worth less, but your purchasing power is also diminished. Keynes was right when he said inflation was a scourge.

http://www.measuringworth.com/ppowerus/index.php

You're right, to an extent, that a fiat currency doesn't HAVE to lead to inflation. In fact, a well managed fiat currency which is linked to productive capacity and stable valuations will act in the same fashion as gold.

However, this has been attempted and it works until POLITICIANS begin to think money is equivalent to wealth and charlatans who propose Chartalism (or Modern Monetary Theory) tell us we can "borrow and print our way to wealth and full employment"

This idea is not only dangerous, but borders on insanity in my view. History is rife with failed fiat currencies, and inflations caused by those who seem to believe you can print as much as you want without punishment.

Gold is a stabilizing factor.

In business, we use benchmarks. These aren't used to determine our limits, they are used to know where we stand and where we can go. In monetary policy, they don't utilize similar benchmarks anymore. They say they do, when called to account. But then they won't let us audit public books to see if they are lying, do they?

That concept is known as "Chartalism" or "Modern Monetary Theory". It has never been tested, let alone used, because the risks are so high. In that theory, the government can tax the 'increase' in the monetary supply, thus limiting the impact of inflation.
That's a very simple explanation, but directionally correct.
At any rate, it's very wrong for several reasons. First, 'money' can be many things. Stocks are used as money (in mergers or acquisitions financed by stock), for example. Secondly, the increase in the money supply depends on how you choose to define it. All money and monetary equivalents is really the only way to measure it - and that has been exploding. Third, there is the issue of reserves and/or 'velocity'. As money supply increases, velocity drops naturally, but then speeds up again as the 'new money' is thought of to be 'more money'. This is known as 'money illusion'.

Chartalism is an odd thing, in my book. While I can't stand Krugman, one would think he'd sign right up for it given his desire to run the deficit to high heaven. In fact, however, (and to his credit) Krugman rejects Chartalism.
A study of the Mississippi Bubble, or the Weimar Republic, or Zimbabwe (which was, in fact if not in spirit, a failed attempt at Chartalism) should be enough to cause anyone to wonder why this concept is legitimate.

The only thing which could act to reduce the impact of inflation is slack demand. However, demand is not slack. Any measure of consumer demand over the last 4 years shows that it's higher now than it was 4 years ago - and all you have to do is study the CPI (at 6% right now) or Shadow Stats (over 10%) to see that printing money leads to inflation is, in fact, the only way to view things.
http://www.shadowstats.com/alternate_data/inflation-charts