the gold standard 33

7/27/2019 The Gold Standard 33

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The Gold Standard The Gold Standard Institute

Issue #33 15 September 2013 1

The Gold StandardThe journal of The Gold Standard Institute

Editor Philip BartonRegular contributors Rudy Fritsch

Keith WeinerSebastian Younan

Occasional contributors Thomas BachheimerRonald StoeferlePubliusJohn ButlerCharles Vollum

The Gold Standard Institute

The purpose of the Institute is to promote anunadulterated Gold Standard

www.goldstandardinstitute.net

President Philip BartonPresidentEurope Thomas BachheimerPresidentUSA Keith WeinerPresidentAustralia Sebastian Younan

Editor-in-Chief Rudy Fritsch

Membership Levels

Annual Member US$100 per year

Lifetime Member US$3,500

Gold Member US$15,000

Gold Knight US$350,000

Annual Corporate Member US$2,000

Contents

Editorial ........................................................................... 1News ................................ ................................ ................. 3Entrepreneurial Magic ............................. ...................... 4Double trouble: honest politicians on the one handand secrecy on the other ........................................ ....... 5

Theory of Interest and Prices in Paper Currency PartVI (The End)................................................. .................. 6The American Corner: Rising Interest Rates Spoilthe Party ............................... ................................. ......... 10

Editorial

It is misleading to believe that Europes problems

are restricted to the peripheral nations; Europe issick to the core.

The birthplace of Bastiat and de Tocqueville, has

degenerated into a western showpiece for the idea

that it is the job of a government to run an

economy. While France is an obvious target, the

continent has no shortage of debt-ridden, down-at-

the-heel candidates.

Governments base the legitimacy of their intrusions

into free markets on the claim that it is to savepeople from the laws of the jungle.

The picture painted is of a vicious free-for-all where,

without the tender touch of governments, the frail

and defenceless would be savaged by heartless price-

gougerswhere communities would be sundered by

inequalities and strife.

Like much else that emanates from governments,

this is poppycock.

History shows no supporting evidence for such a

macabre portrayal. On the contrary, in a genuine

free market people who produce are paid in gold (or

silver); nothing else is acceptable. As has been often

noted, gold can neither be debased nor printed.

What has not been so often noted is that when gold

is in circulation, it is the buyer who holds the upper

hand.

While the 19thcentury was not entirely a free market,

it was as close to it as the world has been. The

important point was that gold and silver circulated.

This led to the price of goods showing an overall

decline for decade after decade.

Arthur Toynbee, the 19th century UK economic

historian and social reformer, estimated that by 1875

the working classes had amassed savings of

130,000,000. In light of the situation that existed

just 100 years before, when most of these people had

never seen a pound let alone owned one, this is an

astonishing figure but only for those who do notcomprehend the blessings of real money.
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in those thirty years (1851-1881) the wage-

earning class had increased in number from

26,000,000 to 30,000,000 or 16 per cent; while the

wages paid to them had increased by nearly 100 per

cent. In fact the income of the working classes in 1881

was about equal to that of the whole nation in 1851,

with largely increased purchasing power, owing to

reduction in prices".

W.H. Mallock, in an extensive analysis of British

wages

The 19thcentury was a time of rising prosperity and

peaceful coexistence. Prosperous and free people do

not want war. The word unemployment had not

yet made it into the dictionaries.

Bearing that in mind, let us now return to 21st

century France under socialist President Hollande.

The economy is collapsing under the weight of

regulatory restrictions. Youth unemployment is

26%, and has been rising every month for over two

years. Wealth creation has ground to a halt and jobs

are disappearing as a consequence of the regulatory

burdens and rising government confiscation.


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Free markets do not produce the law of the jungle

only control of the economy by governments can

degrade society to that degree.

Philip Barton

News

Forbes:Keith Weiners piece in Forbes magazine

Khaosod:Fake gold in Thailand

YouTube:A perspective on Europe from Clarke and

Dawe

WSJ:India desperately seeking foreigners who would

like what their own citizens dont rupees

Business Standard:India officially denies that it has

plans to monetise temple gold

Business Standard: Confirming that nothing is true

until it is officially denied

Reuters:A new approach in India

Business Standard:This story is a painful reminder

of a certain editors stash of gold that was hidden in

a pair of shoes; shoes that were then kindly donated

to the Salvation Army.

Business Standard:Indian government creates flightto gold; precisely what they were trying to avoid.

They know not what they do.

Business Standard: Indian gold demand increases

despite all. Finance Minister P. Chidambaram

regards gold as a non-essential. Obviously the

people know better.
http://www.forbes.com/sites/realspin/2013/08/21/solving-a-serious-mystery-why-dont-gold-and-silver-coins-circulate/http://www.forbes.com/sites/realspin/2013/08/21/solving-a-serious-mystery-why-dont-gold-and-silver-coins-circulate/http://www.khaosod.co.th/en/view_newsonline.php?newsid=TVRNM056YzFOekE0TlE9PQ==http://www.khaosod.co.th/en/view_newsonline.php?newsid=TVRNM056YzFOekE0TlE9PQ==http://www.youtube.com/watch?v=S8iPH1OILHI&feature=player_embedded#t=0http://www.youtube.com/watch?v=S8iPH1OILHI&feature=player_embedded#t=0http://online.wsj.com/article/SB10001424127887324432404579052411247658956.htmlhttp://online.wsj.com/article/SB10001424127887324432404579052411247658956.htmlhttp://www.business-standard.com/article/economy-policy/no-proposal-to-monetize-temple-gold-rbi-113083100443_1.htmlhttp://www.business-standard.com/article/economy-policy/no-proposal-to-monetize-temple-gold-rbi-113083100443_1.htmlhttp://www.business-standard.com/article/news-ians/rbi-asks-kerala-temple-boards-about-gold-stocks-113090500771_1.htmlhttp://www.business-standard.com/article/news-ians/rbi-asks-kerala-temple-boards-about-gold-stocks-113090500771_1.htmlhttp://www.reuters.com/article/2013/08/29/us-india-economy-gold-idUSBRE97S0IW20130829http://www.reuters.com/article/2013/08/29/us-india-economy-gold-idUSBRE97S0IW20130829http://www.business-standard.com/article/pti-stories/ancient-gold-jewelry-coins-found-in-byzantine-garbage-pit-113081800318_1.htmlhttp://www.business-standard.com/article/pti-stories/ancient-gold-jewelry-coins-found-in-byzantine-garbage-pit-113081800318_1.htmlhttp://www.business-standard.com/article/pti-stories/sensex-rupee-plunge-amid-capital-control-fears-gold-surges-113081600789_1.htmlhttp://www.business-standard.com/article/pti-stories/sensex-rupee-plunge-amid-capital-control-fears-gold-surges-113081600789_1.htmlhttp://www.business-standard.com/article/reuters/india-s-gold-guzzling-still-high-spurs-neighbours-to-act-113081200825_1.htmlhttp://www.business-standard.com/article/reuters/india-s-gold-guzzling-still-high-spurs-neighbours-to-act-113081200825_1.htmlhttp://www.business-standard.com/article/reuters/india-s-gold-guzzling-still-high-spurs-neighbours-to-act-113081200825_1.htmlhttp://www.business-standard.com/article/pti-stories/sensex-rupee-plunge-amid-capital-control-fears-gold-surges-113081600789_1.htmlhttp://www.business-standard.com/article/pti-stories/ancient-gold-jewelry-coins-found-in-byzantine-garbage-pit-113081800318_1.htmlhttp://www.reuters.com/article/2013/08/29/us-india-economy-gold-idUSBRE97S0IW20130829http://www.business-standard.com/article/news-ians/rbi-asks-kerala-temple-boards-about-gold-stocks-113090500771_1.htmlhttp://www.business-standard.com/article/economy-policy/no-proposal-to-monetize-temple-gold-rbi-113083100443_1.htmlhttp://online.wsj.com/article/SB10001424127887324432404579052411247658956.htmlhttp://www.youtube.com/watch?v=S8iPH1OILHI&feature=player_embedded#t=0http://www.khaosod.co.th/en/view_newsonline.php?newsid=TVRNM056YzFOekE0TlE9PQ==http://www.forbes.com/sites/realspin/2013/08/21/solving-a-serious-mystery-why-dont-gold-and-silver-coins-circulate/


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Entrepreneurial Magic

If you have read my last few articles, you may be

starting to understand the full value of HonestMoney to society and to you and ME but we have

barely scratched the surface. The well hidden magic

of Gold money emerges only once Gold is in free

circulation.

To understand this magic and its effects on society,

we need to look at a bit of history. Under the

classical Gold standard, during Peaceable Times,

major war was impossible. Not only that, but there

was no such thing as structural unemployment.

Remember, the mandate of the Central Bank of theUSA (the Fed) is to fight inflation and to fight

unemployment but both inflation and

unemployment do NOT exist under a Gold

standard. The nineteenth century had neither

inflation nor structural unemployment.

Both inflation (monetary debasement) and structural

unemployment first have to be created and then

be seen as being fought by our Heroic Bankster.

Gradually dropping prices and full employment were

the reality experienced under Gold. Inflation is thedirect result of monetary debasement and

unemployment is the direct result of the destruction

of the Gold Standard and its accompanying credit

systems.

The Big Lie operating here is well entrenched in the

collective; it takes money to make money. This

statement is one that Mr. Gmanand his corporate

supporters want you to believe. After all, if it were

true, then no one without any money could ever

hope to make money or could ever hope tocompete with existing corporate players.

Furthermore, if it were true, then someone with no

money but a desire to make money would be obliged

to borrow to the loud cheers of Mr. Bankster. If

we choose to NOT believe this Big Lie, then we

can easily see examples of people who make

money without money to start with.

Seemingly magically, it takes NO money to make

money. Does this sound too good to be true? Soundlike another Ponzi scheme? Well, no in fact, using

trust based commercial credit, it is laughably simple

to make money with no money small

entrepreneurs in poorly regulated i.e. uncontrolled,

free and voluntary markets do so even today.

To bring this home, suppose you lose your job as theeconomy crashes, but you are ambitious and instead

of begging for handouts, either on street corner or

from the Gman welfare, you want to start a

business and make a living without having a

traditional job. If you believe the Big Lie It

Takes Money to Make Money you will never even

start. If you see through the lie, you can start a small

business and succeed.

During the last session of the New Austrian School

of Economics in Madrid, Spain, I was eye witness to

just such entrepreneurial magic. With the financial

crisis at hand, the streets of Madrid had many

beggars clinking their cups for handouts, many

homeless people sleeping on the streets, and many

other signs of poverty. However, primal

entrepreneurship also showed up.

Rain started to fall, and in a matter of seconds there

were street vendors crying out, shouting umbrellas

for sale to an appreciative clientele.Now wheredid these entrepreneurs come from, and where did

the umbrellas come from? Street vendors do not

have money to buy and hold a stock of umbrellas;

nor are they employees of conventional retail outlets;

they are simply entrepreneurs, who disdain the

dole and who are eager to earn a profit.

How do they get inventory, if they have no money

and are not store employees? Simple; through credit

based in trust. The umbrellas are on consignment

from the wholesaler; the street merchant will sellwhat he can, return the unsold units and pay for

what he sold. He will make a profit on umbrellas he

sells. After all, his overhead and his costs are zero

except perhaps for some wear on his shoe soles!

Who benefits? Of course, the street vendor benefits;

if he manages to sell umbrellas, and make a profit.

Also the wholesaler benefits; he could not have

made these sales without giving his umbrellas out on

consignment without giving his trust to the

vendors. Finally, customers benefit; caught in asudden rainfall, many people are glad to buy an


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umbrella just when they need one without having

to hunt for a retail store in the rain.

But what about our Gman and Bankster? Do they

benefit? Mr. Gman does not; the vendor is notlicensed or authorized to sell umbrellas and thus

pays no protection fees. Mr. Bankster does not; the

vendor never borrows money, so pays no interest.

If selling umbrellas was not such a fringe activity,

Mr. Gman would undoubtedly have set up the

framework for regulating the sale of umbrellas

and tapping into the value created by the vendors

like the true parasites they are.

Can you not taste the propaganda? Studies releasedby mainstream media showing that umbrellas are

dangerous; hundreds of people get hurt by an

umbrella every year Studies showing that

umbrellas are unsound hundreds of umbrellas

collapse in the wind every year. Safety standards,

testing laboratories, bureaucracy, umbrella police

just like in virtually all non fringe economic activity

today.

Compliance costs would drive the vendors out of

business and perhaps force them to join the other

beggars, clinking their cups for a handout.

Consumers could run around trying to find an over-

priced regulated, authorized umbrella in the

pouring rain. And who would foot the bill for

supporting the newly created beggars?

The idea that credit can be based on trust seems

incredible to us. But trust based credit is potentially

enormous; before WWI, all consumer trade was

funded by exactly such a trust based system of credit.No loans, no interest payments, no collateral just

free credit that benefits all commerce, all consumers,

all entrepreneurs.

As the World economy falters, in the rest of the

world like in Spain, Greece, Ireland, and on and on,

we will all make a choice. Will we choose to be

beggars, holding out our cups in the hope that

someone puts a dime in it orwill we choose to

be entrepreneurs, who see opportunity to provide

value to the markets and proceed to do so? Thefuture of the world economy depends on us making

the right choice; trust based credit, vs. endless debt.

It was the destruction of the trust based credit

system and its replacement by bank loans, by debt

with interest payments to Mr. Bankster that led to

structural unemployment and to the dole. We will

not solve our debt problems or our unemployment

problems until we recognize this truth and act on

it. Just as the world needs Gold money, it needs

Gold based credit Gold is synonymous with

Trust.

Rudy J. Fritsch

Editor in Chief

Double trouble: honest politicians on

the one hand and secrecy on the other

A couple of months ago I reported on the new

honesty Europeans have experienced of late: the case

in point having being Cyprus, the perfect laboratory

setting for an ordered expropriation of bank

customers and savers. (Clever gold investors, of

course, did not suffer any losses).

One has to admit that these measures were taken in

a speedy, cautious and very clever manner. Thepublic outcry one would have expected did not

materialise. There was no significant resistance by

the suffering party. Only with the benefit of

hindsight can one appreciate how well this

experiment was executed. The European population

has been prepared for the moment of truth in a

rather smart way just like the frog sitting in a

slowly heating glass of water.

In Europe the day of reckoning is approaching fast.

On September 22, Germany, at once the leadingeconomy and sugar daddy, underwriter and payer-of-

last-resort, holds a general election. (As an Austrian

native I have to add a less significant event: Austria

holds general elections one week after Germany.

Austria, too, is a net contributor to the European

Union, albeit on a smaller scale. However, Austrian

citizens also feel the pain.) Commentators agree that

the German election will mark a watershed for

Europe. Afterwards will be payday. The warnings

from the system have been unequivocal and

unambiguous.
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The new honesty of politicians and mainstream

media has been augmented by the new omert on

the currency crisis. Indeed, the finance minister is

constantly reminding the electorate that new

guarantees and payments to bankrupt Mediterranean

countries have to be reckoned with, but the ailing

top-down currency euro is not mentioned at all. The

propaganda manifests itself in silence. Not one

journalist neither from large, mostly state-

controlled print media, nor private and state TV

stations asks during one of the all-too-frequent

election programmes about the poor health of the

euro. As mentioned earlier, this collective silence is

part of the honesty. Better to remain silent rather

than lie is the new motto.

Honesty and silence about the euro are not the only

actors in this bizarre theatre play on Europes day of

reckoning. There is another completely new

phenomenon. The formerly always eager-to-rule

German socialists have cast the unpopular, past his

sell-by date former finance minister Peer Steinbrck

as their challenger to the incumbent chancellor

Angela Merkel. Thus, they clearly show their lack of

interest in ruling the country: at least during the next

election period. They have given up the fight before

it even started. But even there the oddities do not

end. The stability-seeking and foreign popularity-

craving chancellor has let it be known that she wants

to remain in office for only two more years. Here at

last, not only professional sceptics get suspicious.

One cannot help but ask some hard questions such

as:

What was the purpose of the Cyprusexperiment?

Why are the Social Democrats not seriouslyseeking power?

Why the warnings about guarantees andpayments and, at the same time, the de-factoban on talking about the sick euro?

Why does the chancellor wish to remain inoffice for only two more years?

Without resorting to conspiracy theories I am

content to say that a currency event of unparalleled

dimensions is in the offing. Will it be accompanied

by the loss of civil rights and expropriations? Will itdwarf all past upheavals? Will the incumbent

chancellor have to flee as a consequence so that the

opposition can stage a plausible new beginning?

Without any doubt, in Europe a sea change will take

place in September after the elections. We will have ahot autumn not only with regard to property and

investments, but also as concerns the political set-up

of the next few decades. Very soon we will know

whether Europe will deteriorate into a pseudo-

democracy with dictatorial tendencies, or whether we

will live in a civilised society characterised by

solidarity: of the stronger with the weaker both

within one country as well as across the continent.

As we all know, hope dies last.

Thomas Bachheimer

PresidentThe Gold Standard Institute Europe

Theory of Interest and Prices in Paper

Currency Part VI (The End)

InPart I,we looked at the concepts of nonlinearity,

dynamics, multivariate, state, and contiguity. We

showed that whatever the relationship may be

between prices and the money supply in

irredeemable paper currency, it is not a simple matterof rising money supplyrising prices.

In Part II, we discussed the mechanics of the

formation of the bid price and ask price, the

concepts of stocks and flows, and the central

concept of arbitrage. We showed how arbitrage is

the key to the money supply in the gold standard;

miners add to the aboveground stocks of gold when

the cost of producing an ounce of gold is less than

the value of one ounce.

In Part III, we looked at how credit comes into

existence via arbitrage with legitimate entrepreneur

borrowers. We also looked at the counterfeit credit

of the central banks, which is not arbitrage. We

introduced the concept of speculation in markets for

government promises, compared to legitimate

trading of commodities. We also discussed the

prerequisite concepts of Marginal time preference and

marginal productivity, and resonance.

InPart IV,we discussed the rising cycle. The central

planners push the rate of interest down, below the

marginal time preference and unleash a storm whose
http://keithweinereconomics.com/2013/04/22/theory-of-interest-and-prices-in-paper-currency-part-i-linearity/http://keithweinereconomics.com/2013/04/22/theory-of-interest-and-prices-in-paper-currency-part-i-linearity/http://keithweinereconomics.com/2013/04/22/theory-of-interest-and-prices-in-paper-currency-part-i-linearity/http://keithweinereconomics.com/2013/05/15/theory-of-interest-and-prices-in-paper-currency-part-ii-mechanics/http://keithweinereconomics.com/2013/05/15/theory-of-interest-and-prices-in-paper-currency-part-ii-mechanics/http://keithweinereconomics.com/2013/06/16/theory-of-interest-and-prices-in-paper-currency-part-iii-credit/http://keithweinereconomics.com/2013/06/16/theory-of-interest-and-prices-in-paper-currency-part-iii-credit/http://keithweinereconomics.com/2013/07/16/theory-of-interest-and-prices-in-paper-currency-part-iv-rising-cycle/http://keithweinereconomics.com/2013/07/16/theory-of-interest-and-prices-in-paper-currency-part-iv-rising-cycle/http://keithweinereconomics.com/2013/07/16/theory-of-interest-and-prices-in-paper-currency-part-iv-rising-cycle/http://keithweinereconomics.com/2013/07/16/theory-of-interest-and-prices-in-paper-currency-part-iv-rising-cycle/http://keithweinereconomics.com/2013/06/16/theory-of-interest-and-prices-in-paper-currency-part-iii-credit/http://keithweinereconomics.com/2013/05/15/theory-of-interest-and-prices-in-paper-currency-part-ii-mechanics/http://keithweinereconomics.com/2013/04/22/theory-of-interest-and-prices-in-paper-currency-part-i-linearity/


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ferocious dynamics are more than they bargained

for. The hapless subjects of the regime have little

recourse but they do have one seeming way out.

They can buy commodities. The cycle is a positive

feedback loop of rising prices and rising interest

rates. Ironically, their clumsy attempt to get lower

interest results in rising interest. Alas, the cycle

eventually ends. The interest rate and inventory

hoards have reached the point where no one can

issue more bonds or increase their hoards.

InPart V,we discussed the end of the rising cycle.

There was a conflict between commodity speculation

and leverage. Leverage won. Liquidations impaired

bank balance sheets, and the result was a spike in theinterest rate. It finally rose over marginal time

preference. Unfortunately, it rose over marginal

productivity as well. Slowly at first, the bond market

entered a new bull phase. It becomes ferocious, as it

pushes down the interest rate which bleeds

borrowers of their capital. Companies find it harder

to make money and easier to borrow. They are

obliged to borrow to get a decent return on equity.

In short, they become brittle.

In this Part VI, we look at The End. At thebeginning of Part I, I noted in passing that we now

have a positive feedback loop that is causing us to

spiral into the black hole of zero interest. In

astrophysics, the theory says that a black hole is a

singularity with infinite gravity at the center. There is

a radius called the event horizon, and everything

including light that gets inside this radius is doomed

to crash into the singularity.

Black Hole

For years, I have been thinking that this is a perfect

analogy to the falling rate of interest. At zero interest

on long-term debt, the net present value is infinite.

There is a positive feedback loop that tends to pull

the rate ever downward, and the closer we get to

zero the stronger the pull. But an analogy is not a

mechanism for causality.

In the fall of 2012, I attended the Cato Institute

Monetary Conference. Many of the presenters were

central bankers past or present, or academics who

specialize in monetary policy. It was fascinating to

hear speaker after speaker discuss the rate of interest.

They all share the same playbook, they all follow the

Taylor Rule (and indeed John Taylor himselfpresented), and they were all puzzled or disappointed

by Fed Chairman Bernanke not raising interest rates.

Their playbook called for this to begin quite a while

ago now, based on GDP and unemployment and the

other variables that are the focus of the Monetarists.

Then it clicked for me.

The Chairman is like the Wizard of Oz. He creates a

grand illusion that he is all-powerful. When he

bellows, markets jump. But when the curtain ispulled back, it turns out that he has no magical

powers.

At that conference, after hearing so many speakers,

including some of Bernankes subordinates, discuss

when and why and how much the rate should be

higher, I became certain that it is not under his

control. It is falling, falling.1

One cannot go from analogy to theory. It has to be

the other way around. And yet, the black holeanalogy corresponds to the falling rate in several

ways. First, zero interest is like a singularity. I have

repeatedly emphasized the fact that debt cannot be

paid off; it cannot go out of existence. It is only

shifted around. Therefore, regardless of whatever

nominal duration is attributed to any bond or loan, it

is in effect perpetual. At zero interest, a perpetual

debt has an infinite net present value.

1To briefly address the 80% increase in the 10-year interest rateover the past few months: it is a correction, nothing more. Therate will resume its ferocious descent soon enough.
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The next part of the analogy is the strong

gravitational pull from a very far distance. The rate

of interest has indeed been falling since the high of

16% in 1981, and it was pulled in to a perigee of

1.6% before making an apogee (so far) of 2.9%. The

analogy still holds, objects spiral around and into

black holes; they do not fall in directly.

There is also a causal mechanism for the falling

interest rate. As discussed in Part V, the interest rate

is above marginal productivity. So long as it remains

there, the dynamic is given motive power. In Part V,

we discussed the fact that due to the arbitrage

between interest and profit, at a lower interest rate

one will see lower profit margins. This is what putsthe squeeze on the marginal business, which

borrowed previously at a higher rate. The marginal

business is unable to make a profit when competing

against the next competitor who borrowed more

cheaply.

It is worth saying, as an aside, that this process of

each new competitor borrowing money to buy

capital that puts older competitors out of business

who borrowed too expensively is a process of capital

churn. It may look a lot like the beneficial process ofcreative destruction2, but it is quite different. Churn

replaces good capital with new capital, at great cost

and waste.

In falling rates, no one has pricing power, and

generally one must borrow to get a decent return on

equity. The combination of soft consumer demand,

shrinking margins, and rising debt makes businesses

brittle.

Consumer demand is softened by the soft labormarket. The labor market is soft because there is

always a tradeoff between labor and capital invested.

For example, in India Wal-Mart does not use

automation like it does in the US. Labor is preferred

over capital, because it is cheaper. With falling

interest rates, capital equipment upgrades become a

more and more attractive relative to labor. Many

attribute the high unemployment to high minimum

wages and generous welfare schemes. This is part of

2Joseph Schumpeter coined this term in 1942 in his bookCapitalism, Socialism and Democracy(1942)

it, but it does not explain unemployment of skilled

workers and professionals.

As the interest rate falls, the marginal productivity of

labor rises. This may sound good, and people mayread it as productivity rises or average

productivity rises. No, it means that the bar rises.

Each worker must get over a threshold to be

employed; he must produce more than a minimum.

This threshold is rising, and it makes more and more

people sub-marginal.

Unemployed people do not make a robust bid on

consumer goods.

The next-to-final element of the analogy is the eventhorizon. In the case of the black hole, astrophysicists

will give their reasons for why everything inside this

radius, including light, must continue down into the

singularity. What could force the interest rate to

zero, once it falls below an arbitrary threshold?

Through a gradual process (which occurs when the

rate is well above the event horizon), the central

bank evolves. The Fed began as the liquidity

provider of last resort, but incrementally over

decades becomes the only provider of credit of any

resort (see my separate article on Rising Interest

Rates Spoil the Party).

Savers have been totally demoralized, discouraged,

and punished. Borrowers have become more brazen

in borrowing for unproductive purposes. And total

debt continues to rise exponentially. With lower and

lower rates offered, and higher and higher risk, no

one would willingly lend. The Fed is obliged to be

the source of all lending.

A proper system is one in which people produce

more than they consume, and lend the surplus,

which is called savings. The current system is one

in which institutions borrow from the government

or the Fed and lend at a higher rate. Today, one can

even borrow in order to buy bonds. Most in the

financial industry shrug when I jump up and down

and wave my arms about this practice. Other than a

bank borrowing from depositors (with scrupulously

matched duration!) there should not be borrowing tobuy bonds. A free market would not offer a positive

spread to engage in this practice, and rational savers


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would withdraw their savings if they got wind of

such a scheme.

Thus, the system devolves. Sound credit extended by

savers drives a proper system. Now, the Fedbecomes the ultimate issuer of all credit, and this

credit is taken from unwilling savers (those who hold

dollars, thinking it is money) and is increasingly

extended to parties (such as the US government)

who havent got the means or the intent to ever

repay it.

The actual event horizon is when the debt passes the

point where it can no longer be amortized. Debtors,

especially the ultimate debtors that are the sovereign

governments, and most especially the US

government, depend on deficits. They borrow more

than their tax revenues not only to fund welfare

programs, but also to pay the interest on the total

accumulated debt.

That singularity at the center beckons. Every big

player wants lower rates. The government can only

keep the game going so long as it can refinance its

old debts at ever-lower rates. The Fed can only

pretend to be solvent so long as its bond portfolio isat least flat, if not rising. The banks balance sheets

are similarly stuffed with bonds. Businesses, long

since made brittle by three decades of falling rates,

likewise depend on the bond market to roll their old

bonds by selling new ones. No debt is ever repaid,

because there is no mechanism for it. An ever-

greater total debt burden must be refinanced

periodically. Lower rates are the enabler.

Recall from Part IV that the dollar system is a closed

loop. Dollars can circulate at whatever velocity, andthey can circulate to and from any parties. For

interest rates, what matters is whether net credit is

being created to finance net increases of

commodities and inventories, or whether net sales of

commodities are used to finance net purchases of

bonds. The spreads of interest to time preference,

and productivity to interest determine the direction

of this flow.

So long as the interest rate is higher than marginal

productivity and marginal time preference, thesystem is latched up. So long as the consumer bid is

soft and getting softer, marginal productivity is

falling. So long as debtors are under a rising burden

of debt, and creditors have the upper hand, then

time preference is falling.

The final element of our analogy to the black hole isthat, according to newer theories that may be

controversial (I dont know, I am not a physicist,

please bear with me even if the science isnt quite

right) if enough matter and energy crash into the

singularity quickly enough, then it can cause an

enormous explosion.

Black Hole Ejecting Matter and Energy

Here is my prediction of the end: permanent gold

backwardation. The lower the rate of interest falls,

the more it destabilizes the system because it makes

the debtors more brittle. The dollar system has, to

borrow a phrase from Ayn Rand, blackmailed people

not by their vices, but by their virtues. People want

to participate in the economy and benefit from the

division of labor. Subsisting on ones own efforts

alone provides a very low quality of life. The

government forces people to choose between using

bogus Fed paper vs. dropping out of the economy.

People naturally choose the lesser of these two evils.

But, as the rate of interest falls, as the nominal

quantity of debt rises, as the burden of each dollar ofdebt rises, and as the debtors incur ever-greater risks,

the marginal saver reaches the point where he
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prefers gold without a yield and with price risk too,

over bonds even with a yield. We are in the early

stages of this process now. A small proportion of the

population of Western countries is buying a little

gold, typically a small proportion of their savings.

What happens when this process accelerates, as it

must inevitably do? What happens when people will

borrow dollars to buy gold, as they had borrowed

dollars to buy commodities in the postwar period?

By then, the bond markets may be so volatile that

this could cause a spike in interest rates. Or it may

not. It will pull all the remaining gold out of the

bullion market and into private hoards. At that point,

gold will begin to plunge deeper and deeper into

backwardation. As I explained in my dissertation, a

persistent and significant backwardation in gold will

pull all liquid commodities into the same degree of

backwardation. Desperate, panicky people will buy

commodities not to hoard them or consume them,

but as a last resort to get through the side window

into gold after the front door is closed. When they

cannot trade dollars for gold, they can trade dollars

for crude oil and then trade crude oil for gold.

Of course, this will very quickly drive prices of all

commodities in dollars to rapidly skyrocket to

arbitrary levels. At that point, there could even be a

short-lived rising cycle where people sell bonds to

buy commodities, or this may not occur (it may be

over and done too quickly).

In any case, this is the final death rattle of the dollar.

People will no longer be able to use the dollar in

trade, even if they are willing (which is quite a

stretch). Then the interest rate in dollars will notmatter to anyone.

My description of this process should notbe taken

as a prediction that this is imminent. I think this

process will play out within weeks once it gets

underway, but that the starting point is still years

away.

The interest rate on the 10-year Japanese

government bond fell to 80 basis points. I think that

the rate on the US Treasury can and will likely gobelow that. We must continue to watch the gold

basis for the earliest possible advance warning.

This completes the series on interest and prices. There is

obviously a lot more to discuss, including the yield curve and

what makes it abruptly flip between normal and inverted, and

of course mini rising cycles within the major falling cycle such

as the one that is occurring as I write this. I would welcome

anyone interested in doing work in this area to contact me at

keith (at) goldstandardinstitute (dot) us.

Dr. Keith Weiner

Dr. Keith Weiner is the president of the Gold Standard Institute USA,

and CEO of Monetary Metals where he write on the basis and related

topics. Keith is a leading authority in the areas of gold, money, and credit

and has made important contributions to the development of trading

techniques founded upon the analysis of bid-ask spreads. Keith is a sought

after speaker and regularly writes on economics. He is an Objectivist, and

has his PhD from the New Austrian School of Economics. He lives with

his wife near Phoenix, Arizona.

The American Corner: Rising Interest

Rates Spoil the Party

The big news in America is that the rate on the 10-

year Treasury bond has risen dramatically from

around 1.6% to over 2.9%. This is 130 basis points

from a starting point of 160, or an increase of more

than 80%!

So naturally, the financial media are discussing the

essential issues. They have commentators

philosophizing about whether the tapering of

Quantitative Easing is priced in (an invalid

question, as I argue in my in the Theory of Interest

and Prices). They credulously entertain the view that

it signals economic recovery. If the economy were

really recovering for four years, there would be no

need for such hype.

On CNBC this week, Larry Kudlows guest was a

sell-side analyst. He worried that either the absolute

level of the rate, or the speed with which it has risen,
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will interrupt the bull market in stocks. Why is he

concerned? Higher rates may discourage companies

from borrowing to buy back their shares and issue

dividends. I have previously written about this

madness.

It is a strange politically correct world that makes it a

taboo to say the simple truth. Unfortunately,

freedom of speech in America is slippingat least

on controversial topics that matter. It may still be

legal, but there is a very real chilling effect. In a

crony system, ones career is at risk to say the

unpopular. So the gentlemen in the club safely

confine their discussion to the M1 and M2 measures

of the money supply, and the number of angels thatcan dance on the head of one pin.

Lets take a step back from the noise. In the real

world, every change in the interest rates destroys

capital. To avoid this, firms hedge using derivatives.

The good gentlemen in the club do sometimes

acknowledge the derivatives problem, but never the

cause, never why derivatives grow and grow and

grow until they are now estimated to be approaching

one quadrillion dollars. Those who sell these hedges

must, themselves, hedge. They can push risk aroundand around in a circle of the big multinational banks.

They cannot eliminate it.

Historically, the Federal Reserve has exhibited what

Ill callbipolar interest rate disorder. They vacillate

between bingeing and purging. First they try to

encourage the economy to grow by offering a

buffet of too much credit, dirt-cheap. Then with

pangs of regret if not guilt, they try to fight

inflation by raising the price of credit. This leads to

a bogus debate among economists: which evil shouldthe Fed be pursuing at any given moment. Wall

Street, of course, has a strong bias towards more

credit, dirtier and cheaper. So do politicians seeking

reelection.

Today, these two false alternatives are called

stimulus and austerity. Fans of the latter

sometimes fantasize about a mythological place like

Atlantis or El Dorado. It is called the Exit.

Unfortunately, the Fed cannot sell their bonds. If

they reversed from big buyer to even a small seller, it

would reignite the very conflagration they fought in

2008. Leveraged market players would be unable to

sell new bonds to pay their old bonds when due, and

would therefore be forced into default. Talk of a Fed

exit is a smokescreen.

Lets take a further step back. The collapse of theSoviet Union proved that central planning doesnt

work. It cant even deliver simple goods like food.

The Fed is the central planner of something much

bigger and vastly more complex. Money and credit

are the foundation of our economy, and everything

else depends on them.

The issue is not what the Fed should do next!

We should be discussing how to transition from

irredeemable currencies to a free market based ongold without collapsing the financial system. I wrote

a paper proposing how to do this. There may be

others with good ideas. Lets begin the discussion.

Unfortunately, few want to risk their careers. I am

not sure what would be worse: the cowardice of

remaining silent in the face of a Big Lie, or the fact

that saying the truth would indeed jeopardize ones

career in finance or economics.

We should be talking about the evolution of the Fed.

Lets not get distracted by conspiracy theories,

stories about banking families and creatures from

islands with unfortunate names. And no, the Fed is

not a private cartel.

The Fed began in 1913; it was the liquidity provider

of last resort. If a bank needed gold, it could take

Real Bills to the Fed, who would buy them at a

discount. The government should have no role in

the financial system at all, but Fed v1.0 was not the

destroyer of markets as Fed v8.2 is today.

Subsequently, they began to buy government bonds.

Incrementally, over many decades, the Fed evolved

into the central planner it is today. Some of these

steps were by presidential decrees, some were Acts

of Congress, and of course the Fed took new powers

for itself at opportune moments.

Today, there are many distribution channels, but the

Fed is the only provider of credit of any resort.

Should they cease issuing new credit, every bond

market in the world would seize up followed

immediately by the default of every bank, insurer,
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annuity, and pension. Despite the Feds record

pumping of credit effluent, some bond markets are

beginning to collapse anyway, along with the national

currencies backed by those bonds.

We face a bitter dilemma. Without credit, large-scale

production is not possible. The economy would

devolve into medieval villages, with subsistence

production done on family farms and workshops.

On the other hand, continuing a system based on

ever morecounterfeitingwill destroy more and more

capital until the economy collapses.

Markets are being slammed back and forth between

austerity and stimulus, between credit

contraction and credit expansion. The number of

units of the Feds credit paper required to buy an

ounce of gold has long been rising. In other words,

those units of credit were falling in value. But in the

past few years, one has needed fewer of them to

trade for gold. One day, traders are borrowing freely

to speculate in the markets, driving prices up. The

next, they are squeezed in a vice, desperate to roll

over their liabilities, or if they cannot, to sell assets,

especially assets that do not have a yield.

In conclusion, here is what I think the Fed should

do. The Fed should go on buying bonds and doing

what it has to do to keep the system going. No one

wants the system to collapse. We should all be clear

that the Fed is doing nothing more than buying time.

We need to use that time to transition to the gold

standard, to begin the process of gold and silver to

circulate, to develop a market for lending and

borrowing gold. We need to repeal the capital gains,

VAT, GST, and any other taxes that make itimpractical to use gold. We need to repeal laws that

force creditors to accept paper as payment in full.

We need to develop the institutions such as gold

banking and Real Bills.

Dr. Keith Weiner
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