Apr 092018

Keith Haring Retrospect 1989


Longtime and dear friend of the Automatic Earth, professor Steve Keen, wrote an article recently that everyone should read (that goes for everything Steve writes). It’s hard to select highlights, but I’ll give it a try. Steve explains where our housing markets went off the rails, what (short-sighted) interests politicians have in subverting them, and, something rarely addressed, why housing markets are unlike any other markets (the turnover of existing properties is financed with newly created money)

He then suggests some measures that might counter this subversion, with a twang of It’s a Wonderful Life nostalgia thrown in. That nostalgia, which will be seen by many as outdated and a grave mistake in these ‘modern times’, instead makes a lot of sense. We might even say it’s the only way to get back on our feet. It resides in the idea that money-circulating building societies, rather than money-creating banks should be in charge of the housing market.

Because it’s not supply and demand that rule the market today, it’s available debt (credit). And banks can, and will, always create more debt at the stroke of a keyboard. That is, until they can’t, and then house prices must and will of necessity fall off a cliff. In Steve’s words: “..mortgage credit causes house prices to rise, leading to yet more credit being taken on until, as in 2008, the process breaks down. And it has to break down, because the only way to sustain it is for debt to continue rising faster than income.

Still, it left me with a big question. But I’ll ask that at the end; here’s Steve first.


The Housing Crisis – There’s Nothing We Can Do… Or Is There?

[..] the UK data is remarkable, even in the context of a worldwide trend to higher levels of leverage. Between 1880 and 1980, private debt in the UK fluctuated as a percentage of GDP, but it never once reached 75% of GDP. But in 1982, both household and corporate debt took off. In 1982, total private debt was equivalent to 61% of GDP, split equally between households and corporations. 25 years later, as the global financial crisis unfolded, private debt was three times larger at 197% of GDP, again split 50:50 between households and corporations.

The key changes to legislation that occurred in 1982 is the UK let banks muscle into the mortgage market that was previously dominated by building societies. This was sold in terms of improving competition in the mortgage market, to the benefit of house buyers: allegedly, mortgage costs would fall. But its most profound impact was something much more insidious: it enabled the creation of credit money to fuel rising house prices, setting off a feedback loop that only ended in 2008.

Building societies don’t create money when they lend, because they lend from a bank account that stores the accumulated savings of their members. There’s no change in bank deposits, which are by far the largest component of the money supply.

However, banks do create money when they lend, because a bank records a loan as their asset when they make an identical entry in the borrower’s account, which enables the property to be bought. This dramatically inflates the price of housing, since, as the politicians themselves acknowledge – housing supply is inflexible, so prices increase far more than supply.

The supply side of the housing market has two main factors: the turnover of the existing stock of housing, and the net change in the number of houses (thanks to demolition of old properties and construction of new ones). The turnover of existing properties is far larger than the construction rate of new ones, and this alone makes housing different to your ordinary market. The demand side of the housing market has one main factor: new mortgages created by the banks.

Monetary demand for housing is therefore predominantly mortgage credit: the annual increase in mortgage debt. This also makes housing very different to ordinary markets, where most demand comes from the turnover of existing money, rather than from newly created money.

We can convert the credit-financed monetary demand for housing into a physical demand for new houses per year by dividing by the price level. This gives us a relationship between the level of mortgage credit and the level of house prices. There is therefore a relationship between the change in mortgage credit and the change in house prices. This relationship is ignored in mainstream politics and mainstream economics. But it is the major determinant of house prices: house prices rise when mortgage credit rises, and they fall when mortgage credit falls. This relationship is obvious even for the UK, where mortgage debt data isn’t systematically collected, and I am therefore forced to use data on total household debt (including credit cards, car loans etc.).

Even then, the correlation is obvious (for the technically minded, the correlation coefficient is 0.6). The US does publish data on mortgage debt, and there the correlation is an even stronger 0.78—and standard econometric tests establish that the causal process runs from mortgage debt to house prices, and not vice versa (the downturn in house prices began earlier in the USA, and was an obvious pre-cursor to the crisis there).

None of this would have happened – at least not in the UK – had mortgage lending remained the province of money-circulating building societies, rather than letting money-creating banks into the market. It’s too late to unscramble that omelette, but there are still things that politicians could do make it less toxic for the public.

The toxicity arises from the fact that the mortgage credit causes house prices to rise, leading to yet more credit being taken on until, as in 2008, the process breaks down.

And it has to break down, because the only way to sustain it is for debt to continue rising faster than income. Once that stops happening, demand evaporates, house prices collapse, and they take the economy down with them. That is no way to run an economy.

Yet far from learning this lesson, politicians continue to allow lending practices that facilitate this toxic feedback between leverage and house prices. A decade after the UK (and the USA, and Spain, and Ireland) suffered property crashes – and economic crises because of them – it takes just a millisecond of Internet searching to find lenders who will provide 100% mortgage finance based on the price of the property.

This should not be allowed. Instead, the maximum that lenders can provide should be limited to some multiple of a property’s actual or imputed rental income, so that the income-earning potential of a property is the basis of the lending allowed against it.


Two smaller points first: Steve doesn’t mention the role of ultra-low rates. Which is a huge factor leading the process. Second, he says his proposals will “..transition us from a world in which we treat housing as a speculative asset rather than what it really is, a long-lived consumption good”. I wonder if perhaps we should take this a step further.

We don’t see land as a consumption good either, or water sources. They are assets that belong to a given community. Or should. So shouldn’t buildings be too? A building society (or some local equivalent, It’s a Wonderful Life style) in a community can’t, won’t lend out money to build homes that serve the interests of the owner, but hamper those of the community. But now I sound even more commie than Steve for many, I know.


On to my main point: if you return mortgage lending to money-circulating building societies, rather than money-creating banks, who’s going to create the money? Don’t let’s forget that a huge part of our present money supply comes from those banks, and much of that from the mortgage loans they issue. Steve may well have thought about this (was he afraid to ask?), and I’d be curious to see his views.

Inflation/deflation is a function of money supply x money velocity (MxV). There are multiple ways to define this, and discuss it, but in the end this remains valid.

This is what the US money supply (stock) has done over the past 30-odd years



And here is the Case/Shiller home price index for the US over roughly that period. The correlation is painfully clear. Except maybe for that drop in 2008, but the Fed caught that one. Can’t let the money supply fall off a cliff.



And why can’t we afford to let the money supply fall off a cliff? Because money velocity already has:



How dramatic that fall has been is perhaps even clearer on a shorter time-frame.



We can say that MV = GDP, or we can make it a bit more complex with MV=PT, where P is prices and T is transactions (or national output), and people can say that this is just one of many ways to define inflation, but when you have a drop in velocity as steep as that one, and you combine it with the rise in money supply we saw, the danger should be obvious.

We have made our economies fully dependent on banks creating loans out of thin air. Which is a ridiculous model, and as Steve says: “That is no way to run an economy”, but we still have. And if and when home prices start to fall, and fewer people buy homes, the money supply will first stop rising, and then start falling, and we will have the mother of all deflations.

If you take the MV = GDP formulation, GDP will go down right with the money supply, unless velocity (V) soars. Which it can’t, because people are maxed out on those mortgages. They can’t spend. If you go with MV=PT, then if money supply falls, so will prices. Unless transactions (output) is demolished, but that will just kill off velocity even more. Why many people see inflation in our future is hard to gauge.


We could, presumably, get our central banks to pump ginormous amounts of money into our societies, but where are they going to put it? Not into our banks(!), which wouldn’t create all those loans anymore, as It’s a Wonderful Life takes over that role, taking the banks and their present role down with it.

Because it’s starting to get obvious that the present ‘system’ is set to go down big time, since as Steve put it:the only way to sustain it is for debt to continue rising faster than income, and we all know where that goes, we can advocate a version of controlled demolition, but who would lead that?

The banks are the most powerful party at the table right now, and controlled demolition of what we have today, as sensible as it may be for society at large, is not for them. Which makes this not only a financial problem, but a political one too: where does power reside. Down the line, it doesn’t even seem to matter much who gives out the loans, there will be very few takers.

Let’s just say we’re open to suggestions. But they better be good.



Feb 072017
 February 7, 2017  Posted by at 11:08 am Finance Tagged with: , , , , , , , , ,  1 Response »

Russell Lee Sharecropper mother teaching children in home, Transylvania, LA. 1939

Trump To Be Barred From UK Parliament Over ‘Racism and Sexism’ (BBG)
Trump’s Wall Street Deregulation ‘The Last Thing We Need’ – Draghi (Ind.)
Meet The Men Who Could Topple Donald Trump (G.)
California Is Not ‘Out Of Control,’ Leaders Tell Trump (R.)
Our Part In The Darkness (Alameddine)
The New York Times Just Doesn’t Understand This Economics Stuff (Worstall)
The Fed’s Mortage-Bond Whale (BBG)
When The Money Supply Dries Up (IM)
Army Corps Of Engineers May Decide On DAPL By Week’s End (BBG)
New Bill Would Block EPA From Regulating Greenhouse Gases
Too Late For Couples Therapy? (DiEM25)
Varoufakis: Tsipras Should Prepare To Break Deal With Greece’s Creditors (FR)
Rare Split On IMF Board Puts Greek Bailout At Risk (MW)
Greece Won’t Meet Fiscal Surplus Targets Set By Europe, IMF Says (BBG)
Third Quake Over 5-Richter Magnitude Rattles Lesbos (K.)



Really dumb stuff. If only because Trump loves it.

Trump To Be Barred From UK Parliament Over ‘Racism and Sexism’ (BBG)

U.S. President Donald Trump must not be allowed to address the U.K. Parliament during a state visit to Britain, House of Commons Speaker John Bercow said. Prime Minister Theresa May invited Trump to visit the U.K., but there have been calls by lawmakers not to give the president the honor of addressing both houses of Parliament after he introduced a ban on people from some majority-Muslim countries traveling to the U.S. “Before the imposition of the migrant ban I would myself have been strongly opposed to an address by President Trump in Westminster Hall; after the imposition of the migrant ban by President Trump I’m even more strongly opposed,” Bercow told lawmakers on Monday.

He added, “I feel very strongly our opposition to racism and to sexism and our support for equality before the law and an independent judiciary are hugely important considerations in the House of Commons.” Trump’s predecessor, Barack Obama, and world leaders including Nelson Mandela, Angela Merkel and Pope Benedict XVI have all been invited to speak to members of the House of Commons and the House of Lords. [..] The announcement was greeted with cheers and – a rare event in the House of Commons – applause from the opposition benches. A motion arguing that Trump shouldn’t be invited to speak has been signed by 163 out of Parliament’s 650 members.

Bercow said he has a veto over a speech in Westminster Hall, the oldest part of the Houses of Parliament, and would block one. It would also be a breach with tradition if Trump spoke in the Royal Gallery behind the Lords without his name on the invitation, he said. “An address by a foreign leader to both houses of Parliament is not an automatic right, it is an earned honor,” Bercow said. “There are many precedents for state visits to take place to our country that do not include an address to both houses of Parliament.”

Read more …

Meet Mario the kettle.

Trump’s Wall Street Deregulation ‘The Last Thing We Need’ – Draghi (Ind.)

Donald Trump’s roll-back of Wall Street regulation is “very worrisome” and “the last thing we need” the President of the ECB, Mario Draghi, has warned. Giving evidence to the European Parliament’s Committee on Economic and Monetary Affairs on Monday, Mr Draghi was asked about the American President’s assault on the US post-crisis Dodd-Frank legislation, which had curbed the risk-taking of US banks, raised their capital requirements and introduced more safeguards for consumers. “The last thing we need is a relaxation of regulation,” Mr Draghi said. “The fact that we are not seeing….significant financial stability risk is the reward of the action of supervisors…. Nowadays financial intermediaries are strong. The idea of repeating the conditions of before the crisis is very worrisome.”

Mr Draghi added: “If we were to look at historical experience and ask what are the main reasons for the financial crisis starting in 2007 onwards, well, one can disagree [over] whether it was too expansive monetary policy or the dismantling of financial regulation in previous years – but surely we can agree it was a combination”. Last week President Trump signed an executive order to relax Dodd-Frank, prompting warnings that he is preparing the ground for another financial crisis. Phil Angelides, who served as chair of the Financial Crisis Inquiry Commission, branded President Trump’s decision “insane”. “In the wake of the financial crisis, millions of families lost their homes. Millions of people lost their jobs. The economy was wrecked and communities across the country were devastated. Big Wall Street banks admitted wrongdoing and paid tens of billions of dollars in fines. And now, with bankers at his side, President Trump begins to rip apart protections put in place to protect America’s families and our economy,” he said.

Read more …

As I said a few dats ago: “More interesting right now is how strongly this is dividing the White House team. Kelly refused to enact some of Bannon’s demands. Tillerson and Mattis are not sitting comfortable either.”

Meet The Men Who Could Topple Donald Trump (G.)

When Trump began putting together his cabinet, liberals and some in the media expressed concern over the number of retired generals he was appointing to top positions. “Trump hires third general, raising concerns about heavy military influence,” blared a headline in the Washington Post during the presidential transition. “I am concerned that so many of the president-elect’s nominees thus far come from the ranks of recently retired military officers,” the Democratic representative Steny Hoyer told the Washington Examiner in December. The fretting over Trump’s generals was always misplaced, not least because the number of retired generals Trump has appointed to top positions in his administration is hardly unprecedented.

Trump nominated the retired Marine generals James Mattis and John Kelly to lead the Department of Defense and Homeland Security, respectively, and tapped the retired army general Mike Flynn to be his national security adviser. When entering office after winning the 2008 presidential election, Barack Obama also appointed three retired generals to top positions and few batted an eyelid. But those concerned about Trump’s presidency should be thankful that the generals are there, particularly Mattis and Kelly. By all accounts, they are men of great honor and courage with strong backbones. Kelly led men into battle and lost a son fighting in Afghanistan. Mattis may be the most distinguished and respected Marine officer of his generation, revered for his dedication to his troops and his intellect. I had the honor of spending an hour with him one-on-one last May when he was a fellow at the Hoover Institution. Our conversation was off the record, but make no mistake, this is not a man to be trifled with.

Trump may have actually boxed himself in by picking highly respected generals such as Kelly and Mattis to helm top posts in his administration. Even conservatives who publicly stand by the president latch on to the appointments of Mattis and Kelly as their best evidence that Trump’s presidency will not be as problematic as his temperament and actions sometimes suggest, or some of his more troubling White House advisers portend. But if Mattis or Kelly were to resign in protest, that might change everything. There have already been reports that Mattis and Kelly are less than happy with some of what has gone on in the White House. During the transition, Mattis reportedly clashed with the Trump transition team over key appointments to the defense department. Tensions boiled over when Mattis and Kelly weren’t given sufficient consultation over the recent immigration executive order.

The Democratic representative Seth Moulton, a retired Marine who served under Mattis during the Iraq war, says insiders have informed him that after the executive order fiasco, some top appointments like Mattis began thinking about what would make them leave the administration. “What I’ve heard from behind the scenes,’’ Moulton told the Boston Globe: “What will make you resign? What’s your red line?”

Read more …

This is the kind of confrontation the country badly needs. Where everyone has to argue and define their viewpoints.

California Is Not ‘Out Of Control,’ Leaders Tell Trump (R.)

California leaders pushed back on Monday against President Donald Trump’s claim that the state is “out of control,” pointing to its balanced budget and high jobs numbers in the latest dustup between the populist Republican and the progressive state. The state’s top Democrats called Trump cruel and his proposals unconstitutional after the businessman-turned-politician threatened to withhold federal funding from the most populous U.S. state if lawmakers passed a so-called sanctuary bill aimed at protecting undocumented immigrants. “President Trump’s threat to weaponize federal funding is not only unconstitutional but emblematic of the cruelty he seeks to impose on our most vulnerable communities,” state Senate Pro Tem Kevin de Leon, a Democrat from Los Angeles, said in a statement on Monday.

State Assembly Speaker Anthony Rendon, an L.A.-area Democrat, said the state has the most manufacturing jobs in the nation, and produces a quarter of the country’s food. “If this is what Donald Trump thinks is ‘out of control,’ I’d suggest other states should be more like us,” Rendon said. The latest war of words between Trump and Democratic leaders in California, where voters chose his opponent, Hillary Clinton, two-to-one in November’s election, began Sunday, in an interview between Trump and Fox News host Bill O’Reilly. During the interview, O’Reilly asked Trump about a bill in the state legislature, authored by de Leon, to ban law enforcement agencies in the state from cooperating with immigration officials in most circumstances. Cities who have enacted similar bans are known as sanctuary cities, and de Leon’s bill, if passed and signed into law by Democratic Governor Jerry Brown, would effectively extend such rules to the entire state.

Trump disparaged the bill as ridiculous, saying that sanctuary cities “breed crime.” “We’ll have to, well, de-fund,” Trump said. “We give tremendous amounts of money to California.” Trump went on to say he viewed funding as a weapon. “California in many ways is out of control,” Trump said to O’Reilly. “Obviously the voters agree or otherwise they wouldn’t have voted for me.” Last week, Trump threatened to withhold federal funding from the University of California at Berkeley, where violent protests led to the cancellation of a speech by an editor for the right-wing Breitbart News. But experts said it would be difficult for the President to withhold funds from either the university or the state. Court rulings have limited the power of the president to punish states by withholding funds, and most appropriations come from the Congress and not the executive branch.

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Really excellent. Don’t miss.

Our Part In The Darkness (Alameddine)

Right after the election, my Twitter feed exploded with shock and moans. It seemed that everyone’s favorite phrase was “We are better than this.” I considered the statement so obviously wrong. I understood the convoluted logic of it, the jolt and hurt that would lead someone to type this, but it was not true. We are not better than this. We are this. The man was elected President. Ipso facto, America is this, we are this. I say this not to suggest that we must be blamed, or that someone who did not vote for Donald Trump is just as culpable as one who did. What I keep trying to point out, to friends, to anyone who will listen, is that too few of us are willing to acknowledge responsibility—not necessarily to accept blame, but to stand up and say, “This thing of darkness, I acknowledge mine.”

I remember when the photographs of torture at Abu Ghraib came to light. The response was similar. This is not us. Those soldiers were rotten. It began at the top, with George W. Bush, and it filtered down. But we would never do such a thing. Of course, we did do those things, and we kept on doing them over and over, and doing worse. Some objected, but most of us simply moved on, chose to forget. “No snowflake in an avalanche ever feels responsible,” the Polish poet Stanislaw Jerzy Lec once wrote. Trump bans Muslims and we claim that this is un-American, that we are not this. I don’t have to talk up “ancient” history to show that we are. I won’t bring up settler colonialism, genocide, and land theft, or harp on slavery, or internment camps for Japanese-Americans.

I won’t refer to the Page Act banning those deemed “undesirable,” the Chinese Exclusion Act, the Asiatic Barred Zone Act, or the Emergency Quota Act. I don’t have to mention the hundreds of thousands of Mexicans deported in the nineteen-thirties, or the thousands of Jews escaping Nazi violence who were turned away. It was F.D.R., not Trump, who claimed that Jewish immigrants could threaten national security. I won’t mention any of this, because this happened so long ago. We can always delude ourselves by saying that America was this but now we are better. Let me just say that in 2010 and 2011, state legislatures passed a hundred and sixty-four anti-immigration laws.

Many were upset when Trump campaigned on a Muslim registry, but I was surprised to find out how few knew that we’d already had one: the National Security Entry-Exit Registration System, or nseers, implemented on September 11, 2002. From the Atlantic: “It consisted of two ‘special registration’ programs: one that required foreign nationals from certain countries to check in with the government before entering and leaving the country, and another that obliged some foreigners living in the United States to report regularly to immigration officials.” Obama did not suspend the program until 2011. He dismantled it right before he left office.

[..] I was in Lesbos a year ago, helping Syrian refugees. At Moria, the biggest camp on the island, thousands of refugees were being processed every day. The crisis had been ongoing for more than six months. I’d heard that every big N.G.O. had taken a turn at leading the camp, but each one failed because of mismanagement, backstabbing, interagency bickering, governmental interference, what have you. But, as horrid as the situation was in the camp, I thought that it was being well managed, as well as it could be with so many people in and out. I met this unassuming man, a retired Mormon from Utah, who had been volunteering at the camp since the first boats arrived. He spoke no Arabic or Farsi, had no medical training of any kind, none of the identifiable skills, yet both volunteers and refugees sought him out with every conceivable question about what to do. It seems that he had arrived to offer whatever help he could. He slowly began to fill in wherever he was needed. As the N.G.O.s began to wash their hands of the camp, he was needed more and more. When I was there, he was running the damn place. We are this. We can be better.

Read more …

“That is just a howling error, to talk about the number of jobs and wages as if they are different things.”

The New York Times Just Doesn’t Understand This Economics Stuff (Worstall)

The Editorial Board of the New York Times tells us all that repealing parts of or all of Dodd Frank will damage the economic recovery. It’s possible to see the glimmerings of a point there, no one does think that if half the banks fall over again then all will be toodle dandy. However, they do manage to betray a terrible ignorance of the basics of economics and wages in the same editorial. Really, this is such a basic point that even Karl Marx was able to understand it: Mr. Trump may believe that ending Dodd-Frank will lead to more jobs by making it easier for businesses to get loans. But even if looser credit would help hiring — a very big if — the main problem in the job market today is not too few jobs, but wages that have been too low for too long. A rollback of Dodd Frank will not help that, and will hurt by forfeiting the stability that has helped the economy come this far.

That is just a howling error, to talk about the number of jobs and wages as if they are different things. They are the same thing–it is full employment which lifts the workers’ wages, nothing more and nothing less. As I say this is such a fundamental concept that even Karl Marx was able to get it right. If we have unemployment, that reserve army of the unemployed, then a capitalist can increase his labour force just by hiring some more of those unemployed. He doesn’t have to tempt anyone in with higher wages, he doesn’t need to pay his own workforce more as profits rise. For anyone gets bolshie he can just hire more of those unemployed people. However, the moment that reserve army is exhausted, the moment that there are no unemployed to hire it all changes. Suddenly, to gain access to more labour temptation must be employed.

It is necessary to tempt labour away from the jobs they are already doing. The capitalists, therefore, are in competition with each other for the profits that can be made by employment. At which point of course wages have to rise. To tempt labour into factory B away from factory A then B must pay more than A (in some form, could be shorter hours, better scheduling, more pay, whatever).And factory B had better raise its own wages for the extant workforce to stop A tempting it away. This is how wages rise over time. The capitalists compete for the profits that can be made by employing labour. And in the absence of unemployment they can only do this by raising wages as productivity rises. This process has been going on some 200 years by now, ever since productivity rises became a general feature of the economy.

And there’s no reason to think that it has stopped nor that it will. That is, contrary to the editorial board f the New York Times, it’s not that wages and jobs are different issues. It’s that wages haven’t risen because there haven’t been enough jobs. And seriously, if your understanding of capitalist and market economics is behind even that of Karl Marx are we sure that you should be writing newspaper articles on the subject of economics?

Read more …

If you create an artificial recovery, there will be a price to be eventually.

The Fed’s Mortage-Bond Whale (BBG)

Almost a decade after it all began, the Federal Reserve is finally talking about unwinding its grand experiment in monetary policy. And when it happens, the knock-on effects in the bond market could pose a threat to the U.S. housing recovery. Just how big is hard to quantify. But over the past month, a number of Fed officials have openly discussed the need for the central bank to reduce its bond holdings, which it amassed as part of its unprecedented quantitative easing during and after the financial crisis. The talk has prompted some on Wall Street to suggest the Fed will start its drawdown as soon as this year, which has refocused attention on its $1.75 trillion stash of mortgage-backed securities.

While the Fed also owns Treasuries as part of its $4.45 trillion of assets, its MBS holdings have long been a contentious issue, with some lawmakers criticizing the investments as beyond what’s needed to achieve the central bank’s mandate. Yet because the Fed is now the biggest source of demand for U.S. government-backed mortgage debt and owns a third of the market, any move is likely to boost costs for home buyers. In the past year alone, the Fed bought $387 billion of mortgage bonds just to maintain its holdings. Getting out of the bond-buying business as the economy strengthens could help lift 30-year mortgage rates past 6% within three years, according to Moody’s. Unwinding QE “will be a massive and long-lasting hit” for the mortgage market, said Michael Cloherty at RBC Capital Markets. He expects the Fed to start paring its investments in the fourth quarter and ultimately dispose of all its MBS holdings.

Unlike Treasuries, the Fed rarely owned mortgage-backed securities before the financial crisis. Over the years, its purchases have been key in getting the housing market back on its feet. Along with near-zero interest rates, the demand from the Fed reduced the cost of mortgage debt relative to Treasuries and encouraged banks to extend more loans to consumers. In a roughly two-year span that ended in 2014, the Fed increased its MBS holdings by about $1 trillion, which it has maintained by reinvesting its maturing debt. Since then, 30-year bonds composed of Fannie Mae-backed mortgages have only been about a percentage point higher than the average yield for five- and 10-year Treasuries, data compiled by Bloomberg show. That’s less than the spread during housing boom in 2005 and 2006.

Read more …

Don’t know if it’s money supply drying up or debts becoming overwhelming. Not the same thing. But the last paragraphs of the piece are interesting:

When The Money Supply Dries Up (IM)

Whenever the ability to enforce draconian legislation goes into decline, the people of a nation suddenly realise that they’ve been living in fear of a paper tiger. It doesn’t take long before some people choose to defy the system. When they’re seen to succeed, others follow in droves. So, what does this say of the US and its power? Well, as Doug Casey has been known to say, “Countries fall from grace with remarkable speed.” Quite so. On an international level, this means that international leaders will be watching the economic decline of the US closely. Countries such as China and Russia have been loading up on precious metals in preparation for a collapse in fiat currency. In addition, they’ve created their own version of the World Bank, the Asian Infrastructure Investment Bank, and have been hard at work inking deals with other nations for international settlement in currencies other than the dollar.

Most people in the world today cannot remember a time before Bretton Woods, yet they may soon witness the Bretton Woods agreement becoming a dead duck. But, if we extend this premise, we also should be questioning the other constructs of the postwar period that have become dinosaurs. What of the United Nations? This organisation was once meant to be a body for arbitration and world planning, but has in latter decades become a quagmire of bickering and gainsaying—with its decisions rarely being adopted by the nations in question. And yet the US alone pays some $8 billion annually to keep the UN afloat. Surely, when the world at large ceases its willingness to carry further US debt, the US government will jettison the expense for the UN before it cuts either its military spending or its entitlement programmes.

Similarly, NATO, which requires $2.8 billion annually (with only five of its 28 members currently meeting the recommended payments) would experience a similar fate. With the above entities heading south, the Wolfowitz Doctrine, which has since 1992 been the basis of US aggression policy, would become unachievable. In addition to the decline or cessation of the above international adventurism, enforcement of revenue pursuit in the guise of FATCA and OECD schemes would equally suffer from a loss of funding. It would not be a question of whether the empire still wished to squeeze the lemon more than ever before—it would. But once the funds to do so dried up, the US and EU would find themselves in the situation that we currently observe in Venezuela: The money to pay for the enforcement is simply not there anymore.

The decline would begin with bounced cheques, followed by massive layoffs in the enforcement departments, followed by a decline in receipts, necessitating further layoffs, and continuing in a downward spiral. At present, countless people live in fear of the present empires and their ever-increasing efforts at usurpation. However, as history shows, once debt has reached its nadir and begins its rapid fall, so does the empire’s ability to enforce draconian confiscations.

Read more …

Army vs veterans?!

Army Corps Of Engineers May Decide On DAPL By Week’s End (BBG)

The U.S. Army may decide by week’s end whether to approve construction of the Dakota Access Pipeline across North Dakota’s Lake Oahe and lands claimed sacred by Sioux Indian tribes. Justice Department lawyer Matthew Marinelli outlined the planned timeline for the Army’s decision to a federal judge in Washington hearing a three-way dispute over the planned path of the Energy Transfer Partners LP-led project. Marinelli didn’t say which way the decision might go. President Donald Trump last month issued a memorandum urging the Army Corps of Engineers to expedite its review of the conduit’s path after the federal agency put the brakes on ETP’s nearly complete $3.8 billion, 1,172-mile conduit for shunting crude from northwestern North Dakota to a Patoka, Illinois, distribution center last year amid protests raised by environmental groups and the Sioux.

[..] While U.S. District Judge James Boasberg, and then a federal appeals court, declined to grant the tribes’ request for an order halting the project, the corps stopped construction anyway, stating it was reconsidering whether to issue easements required for tunneling under the lake bed. Jan Hasselman, lead lawyer for the suing Sioux tribes, told the judge that because the Army Corps had already committed to an environmental impact review of the lake crossing, any easement granted before that analysis is complete “would be unlawful.” The Corps turned the decision to the U.S. Army. The tribes will likely file a second bid to halt the project, citing environmental impact concerns, if the pipeline project gets a U.S. government go-ahead, Hasselman said.

Read more …

Now use that to get a deal that actually achieves something.

New Bill Would Block EPA From Regulating Greenhouse Gases (EW)

Republican lawmakers have proposed a bill to curtail the U.S. Environmental Protection Agency’s (EPA) ability to address climate change. The “Stopping EPA Overreach Act of 2017” (HR637) would amend the Clean Air Act so that: “The term ‘air pollutant’ does not include carbon dioxide, water vapor, methane, nitrous oxide, hydrofluorocarbons, perfluorocarbons, or sulfur hexafluoride.” The bill was introduced by Rep. Gary Palmer (R-Ala.) and has already racked up 114 Republican co-sponsors. Palmer is a climate denier who once said that temperature data used to measure global climate change have been “falsified” and manipulated.

Palmer’s latest proposal would nullify the EPA’s regulation of carbon pollution, stating that “no federal agency has the authority to regulate greenhouse gases under current law” and “no attempt to regulate greenhouse gases should be undertaken without further Congressional action.” Liz Perera, climate policy director at the Sierra Club, told Huffington Post that the resolution would make it nearly impossible for the federal government to fight climate change. “This is the legislative equivalent of trying to ban fire trucks while your house is burning,” she said, adding its sponsors “should be embarrassed for so blatantly ignoring reality and ashamed of themselves for so recklessly endangering our communities.”

[..] Fortunately, the bill does not seem to have any legs. David Doniger, a senior attorney for Natural Resources Defense Council’s climate and clean air program told The Guardian that HR637 does not have much of a chance breaking through a Senate filibuster as Democrats would have near-universal opposition to it and even some moderate Republican Senators would vote against it as well.

Read more …

Yes. Annul the wedding. Before someone gets hurt.

Too Late For Couples Therapy? (DiEM25)

For the past seven years, Greece has been stuck in an abusive marriage with its European partners. Of course, she has not been the perfect partner, but who has? No one deserves violence. No one deserves abuse. Everyone deserves hope, and not the delusional “you will be done by 2060, if you can maintain the hilariously unsustainable 3.5% primary budget surplus” kind of hope offered by Mr Schäuble. The hypocrisy and pseudo-morality of European lenders and the IMF is painful. Germany’s “no debt-reduction” stance is particularly exasperating, when that very same country has experienced both the economic, social and political disaster that vindictive, self-righteous hardheadedness can lead to after the Treaty of Versailles in 1919, as well as the miraculous quality of debt-reduction when its own debt was cut by half (!) at the London Debt Agreement of 1953.

The more years pass, the closer Greece and the rest of Europe edge from a post-modern 1919 to a post-modern 1933. And now, with news of Greece’s three-week window to resolve its next instalment before economically imploding – a piece of news which some media outlets appeared surprised about, bless them – many of us cannot help but wonder: when will we get serious about resolving this? The obvious answer is: when there is political will for a resolution. The only place where this seems to be the case is the nation-patient itself. Two summers ago, under remarkable socio-economic pressure, amid capital-controls and an overwhelmingly pro-EU media landscape, 62% of Greeks came out and refused the terms of a third bailout. Anyone with half-an-understanding of economics and finance seems to agree that the current approach to Greek debt is unsustainable economically, socially and politically: all in all, a disaster.

Even the master chef of the entire travesty, the IMF, has come out and admitted that neo-liberalism and austerity simply do not work. So what are we waiting for? Why are millions of Europeans still suffering under utterly misguided political and economic dogmas? Quite simply because to admit defeat at this point would mark the end of a number of powerful careers. Having poisoned European voters against the lazy PIIGS, it would be nothing short of political suicide to turn around and give in to Greek demands. When would be the next electoral victory in Europe for austerity’s architects if it was revealed that the years of financial and social suffering was a pointless self-inflicted wound with only negative economic results?

So it is becoming increasingly obvious that Greece has to work its own way out of this mess. At this stage, that means an immediate halt of repayments to lenders; a stance that will either force its partners to a vital debt-reduction, or will lead the country to an exit from the Euro. With Germany (in clear breach of EU rules) stubbornly maintaining its 9% budget surplus and refusing to increase imports, Europe is at an impasse, and no one is hurt more by this than Greece. Although the former outcome would be preferred – avoiding to rock the European boat at a time of major global instability is a major plus – the latter is still preferable to the status quo.

Read more …

Translation of Greek article by Varoufakis I posted about earlier.

Varoufakis: Tsipras Should Prepare To Break Deal With Greece’s Creditors (FR)

Through a recent article at the Efimerida ton Syntakton (Newspaper of Editors), the former Minister of Finance of Greece, Yanis Varoufakis, referred to Tsipras retreat against Greece’s creditors and called him to prepare seriously this time, to break the destructive continuous agreements. As Varoufakis wrote among other things: The night of the Greek referendum, I tried hard to explain to the Greek PM that the submission of Greece to the third memorandum was Schäuble’s real plan (not Grexit). In reality, there was no hope that the 3rd toxic “program” for Greece would be rationalized progressively through the support of the European Commission to Athens. Meaning, there was no hope that IMF’s austerity and anti-social measures could be softened.

The fact that Moscovici, Juncker, Sapin and others made such promises, is no excuse because the Greek government knew since May 2015 that these people know how to tell lies, or, they are unable to keep their promises when they don’t lie. Suddenly, the Schäuble-IMF-ECB attacked on Greece, demanding exhausting measures, while Merkel-Hollande-Commission didn’t do anything. Tsipras then retreated for one more time in order to “save” Greece. This was Schäuble’s plan. With his stance, Tsipras sank Podemos, made an approach with the collapsing (ethically and politically) Social Democracy, disappointed the progressive Europeans. And all these happened at the same time where nationalism triumphs everywhere.

Tsipras promises, one more time, that he will not retreat (this time!) by legislating new austerity even after 2018. If he means it, I remind him what we had agreed that is necessary and which – even today – is the only thing that may prevent the worst things to come. Prepare for unilateral restructuring of Greek bonds held by the ECB, which must be repaid in July (and after). Prepare the electronic system of transactions through Taxisnet which I had designed, I had started building it and even announced it to the new Minister of Finance, Euclid Tsakalotos, when I delivered the Ministry. Therefore, if indeed the Greek PM means it this time that he will not retreat, he should prepare for breaking the deal with the creditors, so that to prevent it. The design of a parallel system for payments is ready since 2014, as he knows.

Read more …

Make it stop!

Rare Split On IMF Board Puts Greek Bailout At Risk (MW)

Some members of the IMF are growing concerned with the terms of Greece’s bailout program, fueling fears the fund might pull out of the much-needed rescue plan for the country. The IMF’s annual review of the Greek economy published on Tuesday revealed a rare split among its board members, showing they are in disagreement over the austerity measures imposed on Athens and over the country’s huge debt burden. The report said that “most” of the 24 IMF executive directors agreed Greece is on track to reach a fiscal surplus of 1.5% of GDP. It said Athens does “not require further fiscal consolidation at this time, given the impressive adjustment to date.” However, some of the board members argued that Greece still needs to bring the surplus up to 3.5%, as agreed in the last bailout in 2015.

“Most Executive Directors agreed with the thrust of the staff appraisal, while some Directors had different views on the fiscal path and debt sustainability,” the IMF said in the assessment. The IMF usually keeps its deliberations confidential, so any differences on the board are rarely exposed to the public. The yield on 10-year Greek government debt surged 26 basis points after the report on Tuesday to 7.925%, according to electronic trading platform Tradeweb. Economists consider borrowing costs above 7% unsustainable in the long term.

Read more …

This is getting sadistic.

Greece Won’t Meet Fiscal Surplus Targets Set By Europe, IMF Says (BBG)

Greece is on track to fall short of budget-surplus targets set under a bailout by the nation’s euro-zone creditors, the IMF said. Greece’s primary budget surplus will rise to 1.5% over the long run from about 1% last year, amid a modest recovery, the IMF said Monday after executive directors met to discuss the fund’s annual assessment of the nation’s economy. Still, the projected surplus falls short of the 3.1% forecast by the country’s European creditors. The fund reiterated its view that Greece’s debt is unsustainable. Most of the executive directors don’t believe the economy needs more fiscal consolidation, the IMF said. The IMF has said it would consider giving Greece a new loan to supplement the 86 billion euros ($92 billion) it’s receiving from euro-area countries, but only if the nation’s debt-reduction plans are credible.

Greece’s European creditors also want the IMF to sign off before disbursing the next tranche of the euro-zone bailout. Greece’s government debt will reach 275% of its gross domestic product by 2060, when its financing needs will represent 62% of GDP, the IMF said in a draft staff report obtained by Bloomberg last month. Public debt will reach 181% of GDP this year, the IMF projected Monday. Greece’s economy is expected to grow 2.7% this year, up from 0.4% in 2016, the fund said. However, long-run growth is expected to slip to about 1%, the IMF predicts. The IMF’s assumptions aren’t based in reality and don’t take into account the reform of Greece’s public finances, according to a European Union official who spoke on condition of anonymity because the discussions are sensitive.

Read more …

Yeah, sure, add some more crap. For some reason this makes me think of George Clinton: “Do Fries Come With That Shake?”

Third Quake Over 5-Richter Magnitude Rattles Lesbos (K.)

Seismologists in Greece are keeping a close eye on activity in the eastern Aegean, as a third quake in 24 hours measuring above 5 Richter rattled the area in the early hours of Tuesday. The tremor hit at 4.24 a.m. and measured 5.3 on the Richter scale, according to the Geodynamic Institute in Athens, with the epicenter located 15 kilometers north of Lesvos. With a depth of just 10 kilometers, the quake was felt quite strongly on the Greek islands of Lesvos and Chios. Seismologist Efthimios Lekkas on Monday said two tremors – with a magnitude of 5.1 and 5.3 respectively – were not linked to the North Anatolian Fault Line, the source of powerful quakes in the past.

Read more …

Jul 022016

Jack Delano “Lower Manhattan seen from the S.S. Coamo leaving New York.” 1941

Brexit is nowhere near the biggest challenge to western economies. And not just because it has devolved into a two-bit theater piece. Though we should not forget the value of that development: it lays bare the real Albion and the power hunger of its supposed leaders. From xenophobia and racism on the streets, to back-stabbing in dimly lit smoky backrooms, there’s not a states(wo)man in sight, and none will be forthcoming. Only sell-outs need apply.

The only person with an ounce of integrity left is Jeremy Corbyn, but his Labour party is dead, which is why he must fight off an entire horde of zombies. Unless Corbyn leaves labour and starts Podemos UK, he’s gone too. The current infighting on both the left and right means there is a unique window for something new, but Brits love what they think are their traditions, plus Corbyn has been Labour all his life, and he just won’t see it.

The main threat inside the EU isn’t Brexit either. It’s Italy. Whose banks sit on over 30% of all eurozone non-performing loans, while its GDP is about 10% of EU GDP. How they would defend it I don’t know, they’re probably counting on not having to, but Juncker and Tusk’s European Commission has apparently approved a scheme worth €150 billion that will allow these banks to issue quasi-sovereign bonds when they come under attack. An attack that is now even more guaranteed to occcur than before.


Still, none of Europe’s internal affairs have anything on what’s coming in from the east. Reading between the lines of Japan’s Tankan survey numbers there is only one possible conclusion: the ongoing and ever more costly utter failure of Abenomics continues unabated.

It’s developing in pretty much the exact way I said it would when Shinzo Abe first announced the policies in late 2012. Not that it was such a brilliant insight, all you had to know is that Abe and his central bank head Kuroda don’t understand what their mastodont problem, deflation, actually is, and that means they are powerless to solve it.

That Abe said somewhere along the way that all that was needed was his people’s confidence to make Abenomics work, says more than enough. The multiple flip-flops over a sales-tax increase say the rest. People don’t become more confident just because someone tells them to; that has the opposite effect. Deflation results from reduced spending, which in turn comes from not only decreasing confidence as well as a decrease in money people have available to spend.

That modern economics sees everything not spent as ‘savings’ adds significantly to the failure -on the part of Abe, Kuroda and just about everyone else- to understand what happened in Japan over the past 2-3 decades. To repeat once again, inflation/deflation is the velocity of money multiplied by money- and credit supply. The latter factor has in general gone through the roof, but that means zilch if the former -velocity- tanks.

That this velocity is -still- tanking, in Japan as well as in the western world, is due to, more than anything else, an unparalleled surge in debt. At some point, that will catch up with any economy and society. Even if they are growing, which our economies are not. Growth has been replaced with credit, and credit is debt. It’s safe to say that money velocity cannot possibly ‘recover’ until large swaths of debt have been cancelled, one way or another.

For Japan we saw this week that “..household spending fell for the third straight month in May and core consumer prices suffered their biggest annual drop since 2013..” (Reuters) while “..The Topix index dropped about 9% in June, plunging on June 24 with the Brexit vote, the most since the aftermath of the 2011 earthquake. The yen strengthened about 8% against the dollar in June.. (Bloomberg).

Japan has an upper-house election in a little over a week, and it seems like Abe can still feel comfortable about his position. A remarkable thing. The country needs to stop digging, it’s in a more than 400% debt-to-GDP hole, but Abe won’t listen. The rising yen is suffocating what is left of the economy, as are the negative interest rates, but all the talk is about ‘further easing’.


Still, Japan is outta here, and this has been obvious for a long time to the more observant observer. In the case of China, it is a more recent phenomenon, and it will even be disputed for a while to come. It’s also one that will have a much more devastating effect on the west. We’ve seen problems in various markets in Singapore, Macau and Hong Kong, but the real issues on the mainland are still to be sprung on us.

Mainland stock exchanges are as good a place as any to begin with. The combined tally for Shanghai and Shenzhen looks like this -data till June 23-; yes, that’s a loss of over 40% in the past year.

Beijing has been trying very hard to paper over these numbers, even quit supporting it all for a while through 2014, only to do a 180º when they didn’t like what they saw (foreign reserves drawdown), and now PBoC injections have gone bonkers: $316 billion in one month would mean $4 trillion on a yearly basis in what is really nothing but monopoly money.

Meanwhile, corporate bonds are, perhaps partly because of volatility, becoming an endangered species. Maybe the PBoC can do something there as well, the way Draghi does in Europe (must be high on the agenda), but there’s already so much bad debt we hardly dare watch.

China must and will try to keep boosting exports by devaluing the yuan. It’s just waiting for an opportunity to do it without being accused of currency manipulation. Perhaps it can create that opportunity?! Create a crisis and then use it?! Regardless, this Reuters headline yesterday sounded very tongue in cheek:

China To ‘Tolerate’ Weaker Yuan

China’s central bank would tolerate a fall in the yuan to as low as 6.8 per dollar in 2016 to support the economy, which would mean the currency matching last year’s record decline of 4.5%, policy sources said. The yuan is already trading at its lowest level in more than five years, so the central bank would ensure any decline is gradual for fear of triggering capital outflows and criticism from trading partners such as the United States, said government economists and advisers involved in regular policy discussions. Presumptive U.S. Republican Presidential nominee Donald Trump already has China in his sights, saying on Wednesday he would label China a currency manipulator if elected in November.

Note: remember Japan above? The yen rose 8% against the USD just in June, as the yuan fell by just 4.5% in all of 2015 (6.8% over the past 2 years). Now you go figure what’s happening to Japan-China trade. And the yuan is still hugely overvalued. But the desire to be part of the IMF basket of currencies comes with obligations. Trump doesn’t help either.

I said in the beginning of this year that a 30% devaluation was something of a minimum, and that certainly continues to stand. So yeah, creating a crisis may be the only way out. An accident in the South China Sea perhaps. Combined with a ‘tolerance’ for a 50% weaker yuan….

All of the above leads us to the title of this essay: deflation is coming in from the east. China’s economy’s already in deflation, even though it will take some time yet to be acknowledged. A very ‘nice’ report from Crescat Capital provides a bunch of clues.

China QE Dwarfs Japan and EU

In July of 2014, we wrote about the huge imbalance with respect to China’s M2 money supply and nominal GDP relative to the US. At the time, China’s M2 money supply was 71% higher than the US but its economy was 56% smaller, which we said was an indication of the overvaluation of the Chinese currency. Since that time, the yuan has fallen by only 6.8% relative to the dollar. We haven’t seen anything yet.

Today, the circumstances have significantly worsened. Money supply has continued to grow faster than GDP. With over $30 trillion of assets in its banking system and an underappreciated non-performing loan problem, we are convinced that China is headed for a twin banking and currency crisis. Money velocity has reached historically low levels which reflects China’s extreme credit imbalance and its crimping impact on its ability to generate future real GDP growth.

Just as worrying as the immense amount of credit built up, China has been reporting major downward revisions in its balance of payments (BoP) accounts. For more than a decade, China had been reporting an impossible twin surplus in its BoP accounts. When we wrote about this issue in 2014, we emphasized the likelihood of massive illicit capital outflows that not been accounted for. At that time, according to the State Administration of Foreign Exchange of China (SAFE), China had accumulated a BoP imbalance that was close to $9.4 trillion surplus since 2000 which we believed represented capital outflows that should have been recorded in the capital account.

The same accumulated BoP number today, revised by SAFE several times since, is now a deficit of about $2.8 trillion. Essentially, with its revisions, the SAFE has acknowledged even more capital outflows over the last 16 years than we had initially identified. On the capital account side, there was a downward revision of $10.1 trillion – from a $4.2 trillion surplus to a $5.9 trillion deficit. On the current account side, the revisions show that Chinese exports have not been as strong as initially reported over the last decade and a half. China’s current account surplus has been reduced by $2.1 trillion– going from $5.1 trillion to $2.9 trillion over the last 16 years. What we initially considered to be a $9.4 trillion imbalance has been more than proven by a $12.2 trillion revision.

Those are some pretty damning numbers, if you sit on them for a bit. There was another graph that came with that report that takes us head first into deflationary territory. China’s velocity of money:

That is utterly devastating. It’s what we see in the US, EU and Japan too, but ‘we’ have thus far been able to export our deflation -to an extent- to … China. No more. China has started exporting its own deflation to the west. Beijing MUST devalue its currency anywhere in the range of 30-50% or its export sector will collapse. It is not difficult.

That it will have to achieve this despite the objections of Donald Trump and the IMF is just a minor pain; Xi Jinping has more pressing matters on his mind. Like pitchforks.

The ‘normal’ response in economics would be: in order to fight deflation, increase consumer spending (aka raise money velocity)! But as we’ve seen with Japan, that’s much easier said than done. Because there are reasons people are not spending. And the only way to overcome that is to guarantee them a good income for a solid time into the future, in an economy that induces confidence.

That is not happening in Japan, or the US or EU, and it’s now gone in China too. Beijing has another additional issue that (formerly) rich countries don’t have. This is from a recent Marketwatch article on Andy Xie:

China Is Headed For A 1929-Style Depression

[..] Xie said China’s trajectory instead resembles the one that led to the Great Depression, when the expansion of credit, loose monetary policy and a widespread belief that asset prices would never fall contributed to rampant speculation that ended with a crippling market crash. China in 2016 looks much the same, according to Xie, with half of the country’s debt propping up real-estate prices and heavy leverage in the stock market – indicating that conditions are ripe for a correction. “The government is allowing speculation by providing cheap financing .. China “is riding a tiger and is terrified of a crash. So it keeps pumping cash into the economy. It is difficult to see how China can avoid a crisis.”

And then check this out:

China’s GDP grew 6.9% in 2015, its slowest pace in a quarter-century. For 2016, Beijing has set a GDP target of 6.5% to 7%; The latest spate of global uncertainties prompted Bank of America Merrill Lynch and Deutsche Bank to trim their forecasts to 6.4% and 6.6%, respectively. The export sector, long a driver of Chinese growth, is sputtering due to global saturation and household consumption is barely 30% of China’s GDP, Xie said. In the U.S., household consumption accounted for more than 68% of GDP in 2014, according to the World Bank.

Yeah, China is supposed to be going from an export driven- to a consumer driven economy. Problem with that seems to be that those consumers would need money to spend, and to earn that money they would need to work in export industries (since there is not nearly enough domestic demand). Bit of a Catch 22. And definitely not one you would want to find yourself in when the global economy is tanking.

The more monopoly money Beijing prints, the more pressure there will be on the yuan. And if they themselves don’t devalue the yuan, the markets will do it for them.

Kyle Bass says China’s $3 trillion corporate bond market is “freezing up” (see the third graph above), which threatens to undermine the $3.5 trillion market for the wealth management products Chinese mom and pops invest in. He expects a whopping $3 trillion in bank losses, an amount equal to the entire corporate bond market (!) “to trigger a bailout, with the central bank slashing reserve requirements, cutting the deposit rate to zero and expanding its balance sheet – all of which will weigh on the yuan.”

With the yuan down by as much as it would seem to be on course for, wages and prices in the west will plummet. This wave of deflation is set to hit western economies already in deflation and already drowning in private debt, and therefore equipped with severely weakened defenses.

Leonard Cohen once wrote a song called “Democracy Is Coming To The USA”. Maybe someone can do a version that says deflation is coming too. Not sure that’s good for democracy, though.

Have a great Holiday Weekend.

Sep 112015
 September 11, 2015  Posted by at 1:33 pm Finance Tagged with: , , , , , , ,  18 Responses »

Lewis Wickes Hine Game of craps. Cincinnati, Ohio 1908

The following is a veritable tour de force by Nicole Foss on the value of gold in a crashing economy, for different people in different circumstances.

Nicole Foss: In light of the rapidly-propagating loss of confidence, and consequent shift to deflation, with falling prices across the board as a result, it is appropriate to review our stance on gold. The yellow metal is often perceived as a panacea – a safe haven guarding against all manner of potential financial disruption. It has long been our stance at the Automatic Earth that this is far too simplistic a position to take. We live in a complex world for which there are no simple one-dimensional solutions. It is important to distinguish between the markets for paper gold and for physical gold, and to understand the risks inherent in gold ownership in order to manage them. As we wrote back in 2009:

Firstly, the goldbugs are right that physical gold is real money (unlike paper gold, which is just another Ponzi scheme). It has held its value for thousands of years and will continue to do so over the long term. However, that does not mean that gold prices cannot fall or that purchasing gold now is the right way for everyone to preserve capital….People’s circumstances are different. Those circumstances determine their freedom of action, both now and in the future.

Bubble Dynamics

It is our view that (paper) gold has been in a bubble which peaked in 2011, along with the rest of the commodity complex. It has been subjected to the same dynamic as other commodities, which have collectively lost touch with their own fundamentals as they have become increasingly over-financialized. Financialization moves the dynamics into the virtual world, while simultaneously subjecting them to perverse incentives. Substantial price movements having at best a tenuous connection with actual supply and demand are the result.

Commodity tops are fear-driven, generally on fear of scarcity. This causes market participants to anticipate ever greater demand and tighter supply, to the point where price is bid up in advance of what the fundamentals would justify. In addition, in bubble times momentum chasing becomes a major factor, with speculators assuming that which rises will continue to do so. Once ever-increasing prices become received wisdom, it no longer matters what one has to pay to buy, because there is a false perception that someone else will always pay more. This is true for a while, until it abruptly is not – until the Greatest Fool has been found. At that point a sharp reversal is on the cards.

Our view of market dynamics as swings of positive feedback in a fractal structure is grounded in human psychology.  There are no efficient markets, no rational utility maximization, no equilibrium, no negative feedback, no perfect competition and no perfect information – in short the mainstream model for the functioning of markets bears no resemblance to reality. Prices do not reflect the fundamentals, but the collective state of confidence of market participants engaging in subconscious herding behaviour. 

We agree with George Soros that markets are reflexive:

Soros rejected the prevailing idea that “market prices are … passive reflections of the underlying fundamentals”, a dogma he dismissed as market fundamentalism, or that there were stabilizing forces which would automatically drive prices back towards equilibrium. Instead, Soros propounded a theory of “reflexivity”, in which fundamentals shape perceptions and prices, but prices and perceptions also shape fundamentals. Instead of a one-way, linear relationship in which causality flows from fundamentals to prices and perceptions, Soros developed the theory of a loop in which prices, fundamentals and perceptions all act on one another. “I contend that financial markets are always wrong in the sense that they operate with a prevailing bias, but that the bias can actually validate itself by influencing not only market prices but also the fundamentals that market prices are supposed to reflect”. 

Later he writes more bluntly: “[The efficient market hypothesis and theory of rational expectations] claims that the markets are always right; my proposition is that markets are almost always wrong but often they can validate themselves”. Beyond a certain point, self-reinforcing feedback loops become unsustainable. But in the meantime positive feedback causes bubbles to inflate further and for longer than anyone could have foreseen at the outset. “Typically, a self-reinforcing process undergoes orderly corrections in the early stages, and, if it survives them, the bias tends to be reinforced, and is less easily shaken. When the process is advanced, corrections become scarcer and the danger of a climactic reversal greater”….

….Crucially, the successful speculator responds to bubbles not by shorting them and waiting for stabilizing forces to drive the market quickly back to some fundamental value, but by identifying them early and riding the wave, hoping to get out before the whole edifice finally comes crashing down. Reading people (other investors, narratives) is as important — if not more important — as understanding the fundamentals of an asset itself. Identifying the next “new new thing” earlier than the rest of the crowd and getting aboard, and then being willing to liquidate before the deluge, is at the heart of the speculator’s success….

….Using the Soros idea of a bubble as a process, rather than simply a frothy end-state, gold has already been a bubble for some time as an ever larger group of investors has climbed aboard, propelling prices higher.

This is of course a perfect description of the Ponzi dynamics upon which bubbles are based, where the winners are those who get in early and out early, leaving everyone else holding an empty bag. This has been a consistent theme at The Automatic Earth. Bubbles are very much a process, one of collectively developing a commitment to a view which transitions from being merely self-reinforcing to becoming firmly entrenched to being publicly indisputable, unless one wishes to be dismissed as insane. Unfortunately, contrarians are typically viewed as insane just at the point where their perspective is the most crucial.

Apart from the fundamental model, we also agree with Soros’ 2010 opinion that gold was forming the “ultimate bubble”:

Soros: In this world, gold is the ultimate bubble because apart from the cost of actually digging it out of the ground it has almost no real fundamentals other than price itself. Investors have been buying it precisely because the price has been going up and is expected to carry on rising. Rising prices have created their own demand. It is the ultimately reflexive investment.

In August 2011, gold had reached the blow-off euphoria stage, with everyone having already bet on further prices rises, and therefore no one left to place the further bets required to take the price higher. In our view this constituted a major top:

August 2011: Of all the commodity bubbles, it is the end of the explosive rise in gold that is set to surprise the largest number of people. Very few expect it to follow silver’s lead, but that is exactly what we are suggesting. Gold has been increasingly considered to be the ultimate safe haven. The certainty has been so great that prices rose by hundreds of dollars an ounce in a blow-off top over a mere two months. The speculative reversal currently underway should be rapid and devastating for the True Believers in gold’s ability to defy gravity eternally.

Sentiment is the crucial contrarian indicator:

Ultimately, one has to recognize that the metals are not driven by inflation nor are they driven by deflation. We have clear periods of time in our history where they have acted in the exact opposite manner in which each of the prominent camps would have believed. So, maybe there is another driver of metals which can be relied upon at all times? My answer to that question is that market sentiment is what can be relied upon at all times to point you in the correct direction for the precious metals….One must analyze the market before them irrespective of what other markets may or may not be doing. The main reason is because sentiment is what drives each market, and it varies by market.

The behaviour of central banks is highly indicative of major turning points, given that their actions are lagging indicators of persistent trends, as we have pointed out before:

The Automatic Earth, August 2011: Central banks are buying gold, which some consider to be a major vote of confidence, and therefore bullish for gold prices. However, it is instructive to look at the previous behaviour of central banks in relation to gold prices. When gold hit its low point eleven years ago, after a long and drawn out decline, central bankers were selling, in an atmosphere where gold was dismissed as a mere industrial metal of little interest, or even as a ‘barbarous relic’. 

Selling by central banks, which are always one of the last parties to act on developing received wisdom, was actually a very strong contrarian signal that gold was bottoming. They would not have been selling if they had anticipated a major price run up, but central banks are reactive rather than proactive, and often suffer from considerable inertia. As a result they tend to be overtaken by events. Regarding them as omnipotent directors and acting accordingly is therefore very dangerous. 

Now we are seeing the opposite scenario. After eleven years of increasingly sharp rises, central banks are finally buying, and they are doing so at a time when the received wisdom is that gold will continue to reach for the sky. Once again, central banks are issuing a strong contrarian signal, this time in the opposite direction. While commentators opine that central banks will hold their gold even if they develop an urgent need for cash, this is highly unlikely. In a deflationary environment, it is cash that is scarce, and cash that everyone, including central bankers, will be chasing.

An urgent need for cash does indeed appear to be precipitating selling, and this rationale is going to become far more powerful in the relatively near future:

Gold is now sitting on a 5-year low after China dumped 5 tonnes of gold into the Shanghai markets on Monday during the first minutes of trading, with a slow, but steady sell-off continuing through the week. IVN has reported on China’s financial crisis since February, and this was not a wholly unexpected move to liquidity.

The psychology has once again shifted. Instead of a barbarous relic, gold is now being referred to as a “pet rock” of questionable value:

Gold is supposed to be a haven amid hard times and soft money. So why, even as Greece has defaulted, the euro has sunk against the dollar, and the Chinese stock market has stumbled, has gold been sitting there like a pet rock? Trading this week below $1,150 an ounce, the yellow metal has fallen more than 39% since it peaked at nearly $1,900 in August 2011. Since June 2014, investors have yanked $3 billion out of funds investing in precious metals, estimates Morningstar, the financial-research firm; total assets at precious-metal funds have shrunk 20% in 12 months. “A lot of investors have become disillusioned with gold,” says Suki Cooper, head of metals research at Barclays in New York. “Safe-haven demand hasn’t been strong enough to lift prices, but has only been strong enough to keep them from falling.”

Many people may have bought gold for the wrong reasons: because of its glittering 18.7% average annual return between 2002 and 2011, because of its purportedly magical inflation-fighting properties, because it is supposed to shine in the darkest of days. But gold’s long-term returns are muted, it isn’t a panacea for inflation, and it does well in response to unexpected crises—but not long-simmering troubles like the Greek situation.

It is not inflation we are facing, and therefore not an inflation hedge that is currently required:

Inflation continues to undershoot the Fed’s goals despite extremely low interest rates and years of massive bond purchases. In fact, the recent collapse in the commodities complex is only lowering inflation and inflation expectations. Everything from coffee, sugar, beans to crude oil is heading south. Industrial metals like copper and aluminum have renewed their tumble in recent days as soft global economic growth hurts demand and supply gluts deepen. All of that is creating an anti-inflationary environment that sucks the air out of the gold market.

Much darker days are coming as we move into a highly deflationary era, driven by an inevitable credit implosion. Such an event will be relatively rapid, as it always has been in the past, given that credit expansion creates virtual wealth in the form of copious ‘financial assets’ with little or no connection to any form of tangible underlying wealth:

Laurens Swinkels, a senior researcher at Norges Bank Investment Management in Oslo, reckons that the total market value of the world’s financial assets at the end of 2014 was about $102.7 trillion. The World Gold Council estimates that the world’s total quantity of gold held for investment was about $1.4 trillion as of late 2014. So, if you held the same proportion of gold as the world’s investors as a whole, you would allocate 1.3% of your investment portfolio to it.

Of course there are many forms of tangible real wealth besides gold, but even if one included all forms of collateral, there remains an extreme crisis of under-collateralization, or an extreme quantity of excess claims to underlying real wealth. That which has no substance can disappear very quickly back into the thin air from where it originated:

In the days of a gold – or more correctly – a gold exchange standard, the collapse of excessive bank credit was always sudden, and vicious in proportion to the previous expansion. Since credit was expanded out of thin air by banks without underlying stocks of gold to cover it, inevitably slumping prices became associated with bank failures, and central banks were set up to insulate commercial banks from this brutal reality. Saving over-extended banks always requires the artificial lowering of interest rates and the expansion of the money quantity to restrain the currency’s purchasing power from rising against declining commodities. Gold therefore remains a store of value for savers because it cannot be devalued in this way by a central bank.

It is not is not, however, always possible to save over-extended banks. It depends on the degree to which they are over-extended and the existence, or lack thereof, of a lender of last resort with sufficiently deep pockets. 2008 was an extremely expensive attempt to disguise an intractable financial predicament while simultaneously making it worse by propping up the credit Ponzi scheme – doubling down on a losing bet. During the bursting of particularly large financial bubbles, the system breakdown is likely to be sufficiently extreme to preclude attempts to expand the money supply for many years, meaning that neither the banking system nor the value of financial assets can be saved. Deflation and economic depression are mutually reinforcing and this will be the dominant dynamic for a prolonged period. Gold, and other forms of tangible assets, will remain stores of value during this period.

Paper Gold Versus Physical Gold

Gold has not yet retraced it’s steps to an extent which would indicate a full correction of the preceding advance. In paper terms, it has much further to fall, especially as the world moves further into the deflationary spiral which is only just beginning. Gold has already fallen to its cost of production, with up to half of primary producers losing money at the current price, but in a deflationary spiral we can expect a major undershoot in a race to the cost of the lowest price producer. The implication is that prices can fall many hundreds of dollars an ounce more, which is exactly what we expect.

As we said in 2011::

Expect to hear all about the enormous Ponzi scheme in paper gold, and a lot more about plated tungsten masquerading as gold. It doesn’t even matter whether or not that rumour is true. What matters is whether or not people believe it, and how it could feed into a spiral of fear as prices fall….Typically a speculative bubble is followed by the reversal of speculation causing prices to fall, and then by falling demand, which undermines prices further. As the bubble unwinds, people begin to jump on a new bandwagon in the opposite direction, chasing momentum as always. The need to access cash by selling whatever can be sold (rather than what one might like to sell), and the on-going collapse of the effective money supply as credit tightens mercilessly, will also factor into the developing vicious circle.


This is the scenario that is now unfolding, particularly in relation to the realization of excess claims to underlying real wealth in the gold market. The paper Ponzi scheme in gold is extreme, with over vastly more paper gold claims than actual gold in existence, and this leverage ratio has greatly increased in recent times, particularly in the last month:

This means that what was already a record dilution factor, with over 200 ounces of paper gold claims for every ounce of deliverable gold, just soared even more, and following today’s [September 9th] 8% drop, there is now a unprecedented 228 ounces of paper claims for every ounce of deliverable “registered” gold.

In fact, this may represent a significant underestimate of the real smoke-and-mirrors problem:

The numerical reports from which fancy graphs and and dry detailed data presentations are created originate from the Too Big To Fail Banks. I’ve said for quite some time that IF the bullion banks who control the Comex and the LBMA are submitting honest data reports for the Comex and LBMA, it would be the only business line in which they do not hide the truth and report fraudulent numbers. What is the probability of that?…

….The obvious conclusion is that the supply deficits in gold and silver are being remedied by hypothecating gold and silver bars from allocated accounts held at bullion banks, including the accounts held in behalf of the gold/silver ETFs, like GLD and SLV. This is why ABN Amro and Rabobank stopped allowing their physical gold account investors to take physical delivery of the gold they thought they have invested in – the gold was not there to deliver. This also occurred in 2013.

Where there is pure paper with nothing to back it up, there is considerable potential for large price movements independent of physical supply and demand:

For investors the present marketplace for gold and silver and other precious metals, has lost any real connection to the regular forces of supply and demand. The issuance of paper gold and silver has allowed a separation from market forces. It has divorced the true monetary values from the quantities of precious metals that are actually in existence. This has vastly inflated the supposed supply, thus putting a downward pressure on price.

The reality is that there is far less physical gold and silver than the supply of the paper equivalence. This situation is allowed to exist because there are many players and speculators in the market that do not actually take possession of their holdings. What they have instead, is pieces of paper that gives an impression of ownership. As long as only a small and manageable number of participants in the futures markets for both gold and silver actually demand delivery of their investment, spot prices can move independently of the real fundamentals.

There is considerable debate as to whether this constitutes active manipulation. Some would argue (in an analogous commodity situation), that dynamics in over-financialized markets move prices as an emergent property, without necessarily having malignant motives or prior outcomes in mind:

The huge drop in oil prices came from the action of traders who had bid up the price of crude in the futures market by momentum trading based on unrealistic assumptions about demand growth. When the price started heading in the opposite direction, traders couldn’t catch a bid on their positions, and the whole market went drastically net short, bidding down the price of the commodity….We can see from this that without the slightest bit of skullduggery, the futures market can greatly affect commodity prices in ways that have nothing to do with supply and demand.

Others suggest that movements in the paper market constitute deliberate manipulation:

An enormous amount of paper gold contracts were dumped into the Comex’s globex electronic trading system during one of the slowest trading periods at any point in time during the trading week (July 19th). A bona fide seller trying to sell a big position at the best possible execution prices would never have dumped a position like this. The only explanation is that someone wanted to drive the price the price of gold lower and make a point of doing so. This particular occurrence in the gold market has been a recurring event over the life of the gold bull market. However, the frequency of the above trading pattern has significantly increased since 2011….There is a definitive correlation between the big spike in gold OTC derivatives and the downward pressure on the price of gold.

Gaming the paper gold market by further inflating the Ponzi scheme can engineer considerable collateral advantages, even as it increases the extent of leverage, and therefore of under-collateralization:

Precious metal prices are determined in the futures market, where paper contracts representing bullion are settled in cash, not in markets where the actual metals are bought and sold. As the Comex is predominantly a cash settlement market, there is little risk in uncovered contracts (an uncovered contract is a promise to deliver gold that the seller of the contract does not possess). This means that it is easy to increase the supply of gold in the futures market where price is established simply by printing uncovered (naked) contracts. Selling naked shorts is a way to artificially increase the supply of bullion in the futures market where price is determined. The supply of paper contracts representing gold increases, but not the supply of physical bullion.

As we have documented on a number of occasions, the prices of bullion are being systematically driven down by the sudden appearance and sale during thinly traded times of day and night of uncovered future contracts representing massive amounts of bullion. In the space of a few minutes or less massive amounts of gold and silver shorts are dumped into the Comex market, dramatically increasing the supply of paper claims to bullion. If purchasers of these shorts stood for delivery, the Comex would fail. Comex bullion futures are used for speculation and by hedge funds to manage the risk/return characteristics of metrics like the Sharpe Ratio. The hedge funds are concerned with indexing the price of gold and silver and not with the rate of return performance of their bullion contracts.

A rational speculator faced with strong demand for bullion and constrained supply would not short the market. Moreover, no rational actor who wished to unwind a large gold position would dump the entirety of his position on the market all at once. What then explains the massive naked shorts that are hurled into the market during thinly traded times? The bullion banks are the primary market-makers in bullion futures. They are also clearing members of the Comex, which gives them access to data such as the positions of the hedge funds and the prices at which stop-loss orders are triggered. They time their sales of uncovered shorts to trigger stop-loss sales and then cover their short sales by purchasing contracts at the price that they have forced down, pocketing the profits from the manipulation.

As always, this is at the expense of smaller investors:

According to the Zero Hedge piece, the equivalent of 17 tons of gold was sold on the New York Comex in two bursts in one morning. Think how crazy that is. A seller trying to optimize profits would not make huge sales like this in a short period of time. The size of the sale itself causes the price to drop. Someone (person or entity) owning that much gold would know such things. So, one has to wonder why someone would work against its own interests like that.

The only answer I can come up with is that the sellers had already accumulated huge short positions in derivatives that they wanted to push into the money. The bottom line effect was that someone who wanted a lot of real gold got it, and the seller probably made a bundle on the other side of trade by shorting in the paper market. Two deep-pocketed entities came out happy. Rank and file gold investors were left licking their wounds.

Some regard gold’s rather more ambivalent recent image as evidence that powerful parties are attempting to undermine gold’s monetary legitimacy, presumably in order to drive the price down and purchase it in quantity at a much lower price:

The bullion banks’ attack on gold is being augmented with a spate of stories in the financial media denying any usefulness of gold. On July 17 the Wall Street Journal declared that honesty about gold requires recognition that gold is nothing but a pet rock. Other commentators declare gold to be in a bear market despite the strong demand for physical metal and supply constraints, and some influential party is determined that gold not be regarded as money.

Why a sudden spate of claims that gold is not money? Gold is considered a part of the United States’ official monetary reserves, which is also the case for central banks and the IMF. The IMF accepts gold as repayment for credit extended. The US Treasury’s Office of the Comptroller of the Currency classifies gold as a currency, as can be seen in the OCC’s latest quarterly report on bank derivatives activities in which the OCC places gold futures in the foreign exchange derivatives classification.

The manipulation of the gold price by injecting large quantities of freshly printed uncovered contracts into the Comex market is an empirical fact. The sudden debunking of gold in the financial press is circumstantial evidence that a full-scale attack on gold’s function as a systemic warning signal is underway.

While it is possible that gold’s recent bad press could be an attempt to talk the price down for nefarious purposes, it is not necessary to invoke conspiracy. Just as gold sentiment was extremely bearish at it’s price nadir in 2000, and then rose to fever pitch as the price increased to nearly $1900/ounce, one would expect sentiment to have gone off the boil with prices down substantially over the last four years. Price and sentiment move in tandem in a self-reinforcing feedback loop. Considering the huge extent of excess claims to underlying physical gold, and therefore the approaching destruction of virtual wealth as the paper gold pyramid implodes, both price and sentiment would appear to have much further to go to the downside. At the point where gold sentiment is the diametric opposite of its peak in 2011, price will be bottoming, but a great deal of upheaval will be unfolding at that point, and paper gold will likely be essentially worthless:

If the owners of this paper gold begin to want a conversion to physical gold, panic will ensue and the entire market in precious metals will collapse. The ratio between paper gold and physical gold is now at a record low of 0.08%. This situation has now become a Ponzi scheme, where the majority of investors will be wiped out, when the next crisis unfolds. It is no longer a matter of if, but when this happens.

Apart from the machinations in the paper gold, and silver, markets, physical precious metals are increasingly in demand, and for a considerable premium over the spot price as supplies tighten. The divergence between paper prices and physical prices will continue to widen, with a major discontinuity expected in the future at the point where extent of the paper Ponzi scheme is finally recognized:

Public demand for physical bars and coins of gold and silver are soaring, since the middle of June. At the same time demand for paper gold and silver has leveled off and is actually falling during this period. As a result, government and private mints are struggling to maintain sufficient supplies of precious metals, for the orders they receive. Some have even been forced to temporarily halt sales. Interest in buying physical gold and especially silver, is at the highest level since the financial meltdown of 2008.

Premiums are already being given, above the spot price for both raw gold and silver, at a number of private mints. Some major national depots in the United States are running empty and more investors than ever, are seeking physical delivery of their investment from Comex (Commodity Exchange) warehouses, which are rapidly becoming depleted as well….

…For the first time, knowledge of the thin inventory of gold and silver held in exchange vaults that back the enormous volumes of paper being traded on a daily basis, is beginning to seep out. For those who are shorting these metals, they are counting on being able to settle accounts in cash or to make a withdrawal from a vault. If too many investors start wanting delivery of gold and silver, the whole present corrupt system will rapidly unravel….

….The United States Mint in July ran out of silver the same day the price of the metal dropped to the lowest level in 2015. The same month the US Mint had sold 170,000 ounces of gold. This was the highest rate since April of 2013 and the fifth highest rate on record. Yet, it was occurring as gold was dipping to the lowest price in five years. The Perth Mint in Australia is also struggling to keep up with demand, as interest surges with new customers in Asia, Europe and the United States. The problem for the mint is the amount of unrefined gold delivered, is not meeting the present physical demand.

In Europe numerous dealers had their inventories emptied, as investors decided given the financial crisis in Greece, that owning gold and silver would be a hedge against any further instability. The UK (United Kingdom) Royal Mint for example, saw demand from Greek customers alone, double earlier this summer. In the United States the amount of Comex registered gold dropped to 359,519 ounces or just over 10 tons, by the beginning of this month. It has never been lower. Meanwhile, the paper gold demand for these remaining stocks, is at a whopping 43.5 million ounces.

Gold’s physical movements are somewhat obscure, but it appears that significant parties are already seeking physical delivery:

Back in April, the publication said that JPMorgan Chase, which has the largest private gold vault in the world, showed a 20% drop in “eligible” gold in its vault in one day. That day was April 5, just five days before the two-day $210 plunge in gold prices. (Eligible gold is gold stored that is not registered to a specific owner, but is available to be either registered or traded.)…Comex-registered gold remained relatively flat in the following days. JPMorgan’s vault is one of the Comex vaults, so the data suggest that the gold was not reclassified from “eligible” to “registered” but actually left the building.

Where did it go? China? India? Russia? We will probably never know. We do know that while the price of paper gold (ETFs, funds, stocks, futures) plunged, demand for the actual metal soared, with buyers paying significant premiums to the spot price.

It is no surprise to see ‘cashing out’ of a Ponzi scheme before a crash that is obviously coming, and this this case ‘cashing out’ means claiming physical possession before a flood of claims collapses the paper gold market. It will, however, be interesting to see what transpires when that crash occurs. Physical gold must be stored somewhere, and the security of storage is also suspect, especially in times of upheaval were storage companies involved in many different aspects of the financial system may fail. As account holders at MF Global discovered in 2011, holders of financial derivatives enjoy super-priority in bankruptcy. Customer segregated accounts had been fraudulently pledged as collateral for derivative bets in Europe that went against the company. Despite the fraud involved, the customer accounts, including those holding physical gold, were removed by the owners of the derivative rights. 

Thus even those who take physical possession early may lose later to paper claims by those higher up the ‘financial food chain’ if they store their wealth within the system and are therefore dependent on the solvency of middle-men. Warehouse receipts for gold will be worthless if the warehouse has been emptied, and possession will be nine tenths of the law. This is already happening:

By the time auditors and lawyers got access to Bullion Direct’s 14th-floor offices six weeks ago, there were only a handful of gold and silver coins in an office safe. A second vault it had recently rented held only slightly more. An estimated $30 million in cash, metal bullion and valuable coins, meanwhile, had vanished. The cumulative weight of the unaccounted for metal is the equivalent of dozens of standard-sized gold bullion bars and hundreds of silver ones. Also missing are an estimated 1,400 ounces of platinum and palladium.

What is clear is that the news has devastated those who believed the company was safekeeping the futures they’d bet on the rounds and bricks of gold and silver. Some lost hundreds of thousands of dollars’ worth of the precious metal with little apparent prospect of regaining it. Jesse Moore, an attorney representing several creditors, predicted that investors can hope to recover 2 or 3 percent of their money, at best….Philosophically, the disappearance of their precious metal has left many Bullion Direct customers, who turned to gold as a safe port in a turbulent financial world, with a crisis of confidence. Attracted to an investment specifically because of its detachment from a government and financial system they didn’t believe in, now that their treasure has disappeared they find themselves wondering what, really, is permanent.

Similarly, safety deposit boxes may well not be secure. They would not be accessible in a systemic banking crisis, and are too obvious a location for the storage of valuables. Following a bank holiday, or a raid by authorities looking for what they believe are ill-gotten gains, as they did in 2008, there may be nothing left to recover:

More than 300 officers and staff were involved in simultaneous raids at three depots in London’s Park Lane, Hampstead and Edgware. Officers have secured the concrete and steel vaults and will take several weeks to remove each box, using angle grinders, to a secret location where they will be prized open with diamond-tipped drills. It is believed that a top tier of criminal masterminds may have rented out “the majority” of the boxes. The safe-keeping company – Safe Deposit Centres Ltd – has been operating for more than 20 years.

Metropolitan Police Assistant Commissioner John Yates said: “Each box will be treated as a crime scene in its own right.” Members of the public who have innocently and legally stored their valuables were “inevitably” going to get swept up in the disruption, it was predicted.

In short, if you do not own metals in physical form, you do not own them at all, and ownership is only as secure as the storage method chosen:

To those who have some gold ETF certificates in a brokerage account, which by law are the possession by DTCC’s Cede & Co. – a bank owned institution – we wish the best of luck to anyone hoping to preserve or even recover any of the invested wealth in such instruments.


In times of extreme financial crisis, states are highly likely to seek to control the money supply. As previously noted, gold has been considered money for thousands of years, whether or not a gold standard is in force. Financial crisis will involve the loss of monetary equivalence for credit instruments representing promises which will obviously not be kept, leaving relatively few forms of wealth still accepted as having value. Cash, particularly US dollars and a few other favoured currencies, will hold value for the period of deleveraging, but only precious metals will likely retain value in the longer term. The desire to control the supply is going to be powerful, as it was in the United States during the Great Depression of the 1930s, when gold was subject to confiscation.

The Emergency Banking Act of 1933 amended the Trading With the Enemy act of 1917, which had granted the President power to investigate, regulate, or prohibit any transactions in foreign exchange, export or earmarkings of gold or silver coin or bullion or currency by any person within the United States, and to prevent the hoarding of gold by Americans. The provisions of the earlier Act, referring to wars and enemies were extended in 1933 in order to encompass “any other period of national emergency declared by the President”, specifically the protection of a currency on a gold standard at the time.

Emergencies allow for legislation to be rushed through with little scrutiny:

A key piece of legislation in this story is the Emergency Banking Act of 1933, which Congress passed on March 9 without having read it and after only the most trivial debate. House Minority Leader Bertrand H. Snell (R-NY) generously conceded that it was “entirely out of the ordinary” to pass legislation that “is not even in print at the time it is offered.” He urged his colleagues to pass it all the same: “The house is burning down, and the President of the United States says this is the way to put out the fire. And to me at this time there is only one answer to this question, and that is to give the President what he demands and says is necessary to meet the situation.”

Executive Order 6102 under the 1933 Act criminalized the possession of monetary gold by any individual, partnership, association or corporation, requiring that gold be exchanged for paper currency. In accordance with the eminent domain clause of the 5th Amendment, market value compensation was paid at $20.67 per ounce.

Only a month was given for compliance, and the penalty for non-compliance was $10,000 and up to ten years imprisonment. Only jewellery and a few rare collectable coins were exempted. Since currency had previously be convertible into gold on demand, those who surrendered their gold would not initially have thought the surrender permanent, but this reality dawned shortly, especially after the Gold Reserve Act of 1934 altered the conversion price by fiat to $35 per ounce, engineering a devaluation of the gold-based dollar. The Act also made gold clauses in private contracts unenforceable, forcing payment in paper currency instead, without reference to an equivalent value of gold, despite the fact that such contracts had been deliberately constructed to guard against the risk of a currency devaluation:

On June 5, 1933, at the behest of the president, Congress took the next step, passing a joint resolution making it illegal to “require payment in gold or a particular kind of coin or currency, or in an amount in money of the United States measured thereby.” Any provision in a private or public contract promising payment in gold was thereby nullified. Payment could be made in whatever the government declared to be legal tender, and gold could not be used even as a yardstick for determining how much paper money would be owed.

After 1934, only foreign governments and central banks were allowed to convert dollars into gold, and only until 1971. Gold ownership remained off-limits to ordinary people until 1975, but the restriction could be circumvented by those with the means to do so through off-shoring:

Many Americans dutifully turned in their meager holdings. But not everyone. Many simply ignored the order, assumed the risks and stashed them away knowing that gold was more valuable than the paper given in exchange. Keeping it literally meant the difference between living or dying for some. There are not significant historical legal records of US citizens being fined or imprisoned for failing to comply. This was the bottom of the depression and average citizens did not have large quantities of gold. Many were jobless, bankrupt and barely surviving; selling pencils and apples on the street corners as so often depicted in the old black and white newsreels from that era. 

But wealthy businessmen, bankers and society elites did own considerable gold. They obviously did not turn in their gold. How do we know? Most of the US mint made gold coins that were in circulation at the time ($2.50, $5.00, $10.00 and $20.00 denominations, but mostly the 10 and 20 dollar coins) were simply shipped off in bags by the thousands to European banks (primarily in Switzerland and Great Britain) for anonymous safekeeping, far away from the reach of US authorities. They simply sat there in darkness and dust buried at the bottom of bank vaults. When gold ownership was again legalized for US citizens in 1975, tons of the coins appeared back on the US market.

In the depths of the Depression, President Roosevelt was attempting to decrease unemployment, raise wages and increase the money supply, but these goals were complicated by the country’s adherence to the gold standard. Gold confiscation allowed for greater concentration of wealth in the hands of the government in order to fund the programmes of the New Deal:

The forced call-in was done not as a punitive measure against gold owners but as a way to enrich the government at the expense of the entire US population, whose purchasing power would be reduced in the future by both inflation and the subsequent devaluation. The government’s new-found wealth supported New Deal programs such as Social Security (1937)….The motivation of the government for a call-in must be to gain some value, not to merely to deprive, discourage or punish investors. In 1933 the purpose was to enable the government to expand the money supply to overcome deflation and to fund the vast social programs of the New Deal, something impossible to do when the country was on the gold standard and the public held significant quantities of gold.

Ironically, the devaluation created an incentive for foreigners to export their gold to the United States, even as many wealthy Americans were preserving their holdings by sending them in the other direction. In combination with domestic confiscation, foreign inflows resulted in a substantial increase in the supply of gold in the hands of the US Treasury:

Even in 1900 the U.S. only held 602 tonnes of gold in reserve. This was 61 tonnes less than Russia and only 57 tonnes more than France. Over the next 20 years countries’ reserves grew as the amount of gold in the market increased and as normal trading occurred. However, in the 1930s there was a sudden shift up in reserves in the U.S. From 1930 to 1940, treasury holdings had tripled, mostly due to foreign investing….The Bank of France also saw over 200 tonnes of gold get transferred to New York following the raising of prices in America.

This in turn allowed for a major expansion of the money supply during the Depression:

The Gold Reserve Act, an act of monetary policy, drastically increased the growth rate of the Gross National Product (GNP) from 1933 to 1941. Between 1933 and 1937 the GNP in the United States grew at an average rate of over 8 percent. This growth in real output is due primarily to a growth in the money supply M1, which grew at an average rate of 10 percent per year between 1933 and 1937. Previously held beliefs about the recovery from the Great Depression held that the growth was due to fiscal policy and the United States’ participation in World War II. “Friedman and Schwartz stated that the ‘rapid rate [of growth of the money stock] in three successive years from June 1933 to June 1936… was a consequence of the gold inflow produced by the revaluation of gold plus the flight of capital to the United States’”. Treasury holdings of gold in the US tripled from 6,358 in 1930 to 8,998 in 1935 (after the Act) then to 19,543 metric tonnes of fine gold by 1940.

The largest inflow of gold during this period was in direct response to the revaluation of gold. An increase in M1, which is a result of an inflow of gold, would also lower real interest rates, thus stimulating the purchases of durable consumer goods by reducing the opportunity cost of spending. If the Gold Reserve Act had not been enacted, and money supply would have followed its historical trend, then real GNP would have been approximately 25 percent lower in 1937 and 50 percent lower in 1942.

For the following forty years, the US government was able to build enormous gold reserves:

Not only did the government remove the incentive for ordinary citizens to hold gold by establishing price and criminal controls over possession, it also changed the rules in the middle of the game allowing it to build up a massive gold hoard of over 8000 tons today which is maintained at Fort Knox, and is, to the best of our knowledge, unauditable by any mere mortal. Critically, it made the US government the sole source and monopoly agent of gold purchases, using reserve fiat currency it could print with impunity, beginning in 1933 and continuing through 1974 when the limitation on gold ownership was repealed after President Gerald Ford signed a bill legalizing private ownership of gold coins, bars and certificates by an act of Congress codified in Pub.L. 93-373, which went into effect December 31, 1974. In summary, the US government, which is now the largest official holder of physical gold in the world, had 40 years of uncontested zero cost gold accumulation.

The gold confiscation of the Depression years has been described as “grabbing private wealth, and using it to try and reboot the system”. At the time, this was motivated by a combination of the gold standard and the holding of gold reserves by a significant fraction of the population:

It is important to realize that the motivation for confiscating gold which existed for FDR in 1933 has largely disappeared. Back then the U.S. was still on the gold standard (the U.K. had been forced off 18 months earlier). So seizing private gold and then devaluing the currency was in fact a 1930s version of quantitative easing. Saving our banks from their stupidity still means swelling the money supply, and hurting cautious savers by devaluing their wealth.

While gold is still hoarded by governments (and increasingly by fast-growing emerging economies), it is only tenuously tied to our currency system as the “foundation” of sovereign reserves. Gold also makes a disappointing asset to grab, especially in the rich but troubled West. Because few people own it compared for instance to real estate (a sitting duck for local government levies and the new talk of “wealth taxes”) or readily-captured financial assets such as pension pots (already so enticing to distressed governments in Argentina, Hungary and Portugal).

The risk of such a confiscation occurring again in modern times is complicated. The rationale for doing so has changed, since the gold standard is no longer operative. So some regard the risk as remote:

To assess the likelihood of confiscation today, we need to look at what the government could gain by calling in privately held gold. My view is that the Federal government has little to gain by calling in gold today and that therefore the likelihood of confiscation is remote. Because the size and cost of the federal government has expanded so much since the 1930’s, and because the quantities of gold currently held by Americans are too small to fund the huge federal budget for more than a few weeks, the government has little to gain by a call-in today. Furthermore, doing so would send the dollar tumbling toward worthlessness, which would be a disaster when so many dollar-denominated bonds are held as central bank reserves by creditor nations like China. So, while confiscation is certainly possible, we consider it unlikely….Investors who are concerned about confiscation today are often assiduous about keeping their purchases from any one dealer small and their holdings secret. Some avoid keeping their gold in a bank safe-deposit box, and some keep their gold in a non-bank vault outside the country.

Others point out that the mechanisms for a modern confiscation still exist:

On March 9, 1933, the statute was amended to declare (as it remains today) that “during time of war or during any other period of national emergency declared by the President,” the President may regulate or prohibit (under such rules and regulations as the President may prescribe) the hoarding of gold bullion.

Other jurisdictions besides the USA also have confiscation mechanisms on the books, albeit presently in suspension. These could quickly be revived if it were thought expedient:

In Australia, part IV of the Banking Act 1959 allows the Commonwealth government to seize private citizens’ gold in return for paper money where the Governor-General “is satisfied that it is expedient so to do, for the protection of the currency or of the public credit of the Commonwealth.” On January 30, 1976, this part’s operation was “suspended”.

Targeting other more prevalent forms of private wealth may well be a more significant risk at this point. Indeed it is already happening in our current era, for instance with the hijacking of pension funds. Expect significant attacks on real estate holdings as well, since this form of wealth is a ‘sitting duck’ to which punitive property taxation can be applied. Unlike the 1930s, however, confiscation of private wealth by the government will not be able to fund a recovery along the lines of the New Deal. The ocean of bad debt is simply too large this time for any amount of confiscated wealth to fill the gap.

Storing gold outside of one’s home country, in order to avoid whatever confiscation risk may exist today, is a consistent theme, exactly as it was in the 1930s:

People can also own gold in ways which make it inaccessible to government decree. In our opinion, a good way to own gold is directly (i.e. not through a trust), in allocated physical form, and offshore, in a place with a strong tradition for protecting international investors’ property.  This makes it a tough target for confiscation by your government, and one that would upset other countries for little reward.  BullionVault stores gold in four separate jurisdictions, all of which have a reasonable (if imperfect) tradition of defending private property rights: London, New York, Zurich and Singapore. There are clear potential benefits to diversifying physical property across international jurisdictions.

Even with the reduced focus on the monetary role of gold in recent times, it is not at all difficult to imagine desperate governments seeking to concentrate ownership in their own hands. This would not be a simple matter, but it would be extremely naive to presume that the attempt would not be made. Ultimately, consolidation of central control over money is the goal, and that requires preventing capital preservation by the public:

Since gold acts as a stand-alone asset that is not another’s liability, it functioned as an effective store of value prior to 1933 for those who either converted a portion of their capital to gold bullion or withdrew their savings from the banking system in the form of gold coins before the crisis struck. Those who did not have gold as part of their savings plan found themselves at the mercy of events when the stock market crashed and the banks closed their doors (many of which had already been bankrupted)….

….That, by the way, is the primary reason governments tend to restrict gold ownership when confronted with widespread bank runs and failing financial markets. Governments seize gold not because they need the money; they seize it to cut off the escape route and force capital flows back into banks and financial markets. As an aside, that is precisely the reason why governments have an interest in controlling the price of gold. Former Fed chairman Paul Volcker, it has been copiously reported, once said, “Gold is my enemy. I’m always watching what it is doing.”…Gold, in the end, is not just competition for the dollar; it is competition for bank deposits, stocks and bonds most particularly during times of economic stress — and that is the source of enduring interest among policy-makers.

As Alan Greenspan wrote in 1966, gold represents economic freedom. It is economic independence – the ability to opt out of the system – which is inimical to the Ponzi dynamics upon which the system is based. Ponzi schemes require continued buy-in, therefore buy-in becomes less and less optional over time, as the potential lack of it becomes an ever greater threat to an increasingly tenuous credit expansion. Credit expansion actively requires that there be no safe store of value, and therefore no true independence:

In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold. If everyone decided, for example, to convert all his bank deposits to silver or copper or any other good, and thereafter declined to accept checks as payment for goods, bank deposits would lose their purchasing power and government-created bank credit would be worthless as a claim on goods. The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights.

Greenspan’s focus is on government spending and the welfare state, but this is far too narrow a focus. Public spending and debt is much less of an issue than private credit expansion and debt. The bulk of the Ponzi scheme requiring continued buy-in is based in the private sector, in derivatives and shadow banking. This is the heart of the credit expansion that governments are required by their Big Capital paymasters to protect. Regulations preventing independence and opting-out result from pervasive regulatory capture. The system creates artificial scarcity and rationing on price, forcing the population to obtain the essentials of its own existence through ever greater amounts of borrowing, and in doing so pay its dues to the system as it keeps the credit expansion going. The end comes when the debt overhang is so large that it can no longer be serviced, even by all the income streams of the productive economy which credit expansion has so thoroughly parasitized. The supply of willing borrowers and lenders dries up, and the game is over.

It is not simply deficit spending which amounts to a confiscation of wealth, but the global credit Ponzi scheme which has generated a vast excess of claims to underlying real wealth. As we have pointed out many times before at the Automatic Earth, those excess claims will be invalidated in the coming financial crisis. People will be trying to protect and fulfil their claims, but larger entities will be trying to prevent them from doing so. Under such circumstances, an attempt at gold confiscation, even in the absence of a gold standard, seems to be a very real threat.

Putting Gold Ownership in Perspective

Gold ownership is not a panacea, nor a guarantee of security. It could even represent a threat to personal security. Confiscation is a distinct possibility during a substantial economic contraction. At least gold, unlike real estate, is, for the time being, capable of being transferred to another jurisdiction for remote storage. The risk, of course, is whether or not it might be possible to reclaim it from another location at some point in the future, given that the degree of upheaval is likely to be larger this time than in the 1930s, and that possession is nine tenths of the law.

If stored remotely, its usefulness in the meantime would be very limited. If concealed locally under a confiscation scenario, rather than held in a foreign ‘secure facility’, it may still be extremely difficult and dangerous to exchange for anything of more immediate value, such as cash, or essential supplies. Even with the best forethought, gold ownership is no guarantee of wealth preservation in a major depression. Depressions are not times when much of anything can be guaranteed. 

Gold represents an extremely concentrated source of value, and it is not always advisable to own that which others are very highly motivated to obtain for themselves. Being too close to a highly concentrated source of value is comparable to being too close to the centre of power. If everyone wants what you have, having it creates substantial risks in its own right, and creates a need to manage those additional risks. Where risk management would become too complex or expensive, taking the risk in the first place may not be the best course of action. Other lower risk strategies, with better risk management potential, may be preferable.

The advisability of owning gold would depend very much on one’s own personal circumstances. There are many things one would wish to secure first, before pondering gold as an option. Cash will temporarily be king in a deflationary scenario, where a systemic banking crisis is increasingly likely. As we have seen in Cyprus, for instance, a country can be forced to revert to a cash-only economy very rapidly, meaning that access to cash would be critical for obtaining supplies not already in storage. Supplies cannot normally be purchased directly with gold, and if cash is exceptionally scarce, the cash price for distressed gold sales would not be high. 

While all fiat currencies are destined to die eventually, and competitive devaluation currency wars have indeed already begun, cash will nevertheless be necessary during the period of deleveraging, and is likely to see its purchasing power rise substantially in relation to goods and services domestically. The falling prices characteristic of deflationary times, as prices follow a contracting money supply to the downside, amount to  bull market in cash, for those lucky enough to have some. However, as the vast majority of the money supply is credit rather than physical cash, and ephemeral credit is going to disappear under such circumstances, little cash will remain, and relatively few will have any unless they have secured it in advance.

Following the destruction of much of the money supply with the evaporation of credit, those with very scarce cash would be less an less likely to want to part with it as the value of access to liquidity rises. What little actual cash remains is likely to be hoarded, so that very little cash circulates.

In other words, the velocity of money is going to fall much further than it already has. Obtaining cash will become very difficult, even as the need for it becomes acute. Supplies could be exchanged for gold, but under a scenario where such a thing might be necessary, distressed gold exchange would not result in as many supplies as one might think. Cash on hand will be more important in the initial stages of a financial crisis than gold, as it is cash that confers freedom of action, including the freedom to seize opportunities presented. 

The argument relating to cash does have caveats however, in that where currency re-issue is a substantial risk in the short term, holding much of such a currency makes much less sense. This is clearly the case in the European Union, where the single currency is already under threat and national currencies are arguably likely to be revived within the foreseeable future. 

Another higher priority than gold ownership would be the elimination of debt. Debt repayments create a structural dependence on cash flow at a time when cash will likely be very difficult to come by. Eliminating debt will remove this requirement for cash and secure important assets, such as homes, from the potential for foreclosure. A debt servicing requirement at a time when debt servicing is becoming increasingly difficult (due to high unemployment, falling salaries, rising taxation and pay-as-you-go services), would be a factor in forcing distressed gold sales at much lower prices than one would get today. In addition, the burden of debt will rise as the increasing perception of risk creates a move towards much higher interest rates. This will compound the potential for distressed gold sales.

Obtaining critical supplies and control over the essentials of one’s own existence would also be a higher priority than gold ownership. Securing access to food, water, energy and other essentials would confer relative peace of mind, and also reduce the need for cash going forward. Ultimately, one cannot eat gold. Also, while prices fall in a deflation, volatile currency inter-relationships are going to affect the price of imported goods, meaning that not all prices will necessarily fall, where imported goods are denominated in weak currencies. Imports could rise in price, or cease to be available at all as the evaporation of credit undermines international trade, hence certain imported goods should be obtained as a matter of priority.

In addition, a good strategy could be the establishment of a business dealing in essential goods and services, with local supply chains and local distribution networks. Returns will typically be low in comparison to the returns one might be used to from financial speculation, but the risks will also be much lower, and will be far more manageable with a certain amount of forethought. Deploying a certain amount of capital in the real economy today in order to set up such ventures could secure a vital source of income in the future, as well as providing a means of maintaining essential social stability in uncertain times. This would be a far better use of resources than purchasing a hoard of gold. Business risks during a liquidity crunch would be very large, so a substantial operating cushion would probably be required, however.

For ordinary people, having cash on hand, getting out of debt and securing access to essential supplies is likely to push them to, or beyond, their financial limits. They may need to pool resources with family or friends in order to be able to accomplish these goals, or make hard choices between them. Gold ownership makes little sense unless these hurdles have already been crossed. It represents an insurance policy for those who can afford to own it, but such insurance is a luxury that will not be available to all.

Those who can afford the luxury of insurance are likely to be those who have all higher priority issues already addressed and who can afford to sit on their gold for perhaps twenty years without relying on the value it represents in the meantime. In other words, the benefit of gold ownership would accrue to those who would not need to make distressed sales over the next few years when gold prices would be very depressed – those who are wealthy enough not to have to make hard choices between competing basic priorities. 

For those who can afford to hold gold for the long term, and who are lucky enough to have found a secure and trustworthy storage mechanism in the meantime, gold will hold its value in terms of goods. One can buy approximately the same number of loaves of bread for an ounce of gold as one could have done during the Roman Empire. At that time an ounce of gold would have bought a good toga, and now it would buy a good suit.

It represents a long term store of value for those who are both wealthy enough to own it, and lucky enough to keep it, but this will be a very small minority. For most people, wealth will be measured not in terms of gold, but in terms of far more prosaic, but far more essential commodities and skills. For most people, wealth will not be measured in terms of having something inert to bury in a hole in the ground, or to send abroad for someone else to bury in an armoured hole in the ground.

The real value of gold will always be difficult to establish, as that relative value will always depend on prevailing circumstances, and so many of those circumstances will be subject to rapid change in the coming era of extreme volatility:

And you will put lightning in a bottle before you figure out what gold is really worth. With greenhorns in gold starting to figure all this out, the price has gotten tarnished. It is time to call owning gold what it is: an act of faith….Own gold if you feel you must, but admit honestly that you are relying on hope and imagination. Because gold, unlike stocks, bonds, real estate and other financial assets, generates no income, valuing it is all but impossible. It’s intrinsically worthless or intrinsically priceless. You can build a financial model to value it, but every input is going to be your imagination.

Jan 172014
 January 17, 2014  Posted by at 4:40 pm Finance Tagged with: , ,  16 Responses »

National Photo Co. Federal Clothing Store, Washington, D.C 1925

The time has come. The Automatic Earth has been talking about the inevitability of deflation for years, but the concept only now goes mainstream. Which is a shame, because a lot could have been done to try and mitigate the damage it’s going to do.

Although it’s as inevitable as the laws of thermodynamics, the notion that record debts will always lead to record debt deflation is hardly discussed; you have Steve Keen, Mike Shedlock, and Nicole and yours truly here at The Automatic Earth, and that’s about it (I’m sure I miss one or two, apologies, but I can’t think of any). And although put together we have a reasonable readers base, blogs and websites are still no more than fringe sources compared to the main media where everyone lacks either the intelligence or the courage or both to even think about the notion, no matter how close its certainty may be to that of thermodynamics. They won’t have their world view disturbed by reality.

Well, reality is here. And we can have our 15 minutes of fun watching them try to explain away their expert blinders. Sure, Japan was recognized as being in deflation, but that’s far away, and moreover, no sooner does PM Abe play double or nothing all on red with another huge chuck of public debt, or everyone’s ready to claim he beat the deflation beast. Yeah, we’ll see about that. The next region the pundit choir, all in unison in case they need to claim everyone else was wrong too, declares to be “under the threat” is Europe. Nary a word yet about the US.

And moreover, the only way they think they can now see deflation is in consumer prices, which are nothing but a consequence of what deflation really is: a drop in the combination of money and credit supply, multiplied by the velocity of money. Or, if you will, you can broaden this to include GDP, and thereby arrive at the quantity theory of money: Inflation x Real GDP = Money x Velocity.

For money supply in the US, it’s best to look at John Williams’ Shadowstats, because as we know M3, the “really broad” money supply, is no longer published by the Fed. Here’s John’s latest update:

And since there is no reason to assume M3 velocity is shockingly higher than M2 velocity, it seems pretty safe to use a FRED graph for the latter:

What we see if we take the period since the start of Williams’ data, 2003, is that both M2 and M3 money supply have actually fallen a little, while M2 velocity has plunged by 25% or so. Yes, that means, admittedly painted in broad strokes, that the average American spends 25% less than they did in the late 90’s! If you insert that knowledge into the quantity theory of money, Inflation x Real GDP = Money x Velocity, it becomes clear that either GDP or inflation, and probably both, must have gone down quite a bit.

By the way, looking at Europe, it’s clear they, unlike the US, certainly tried to boost one side of the equation, as the other one crumbled. It’s almost funny.

And from a slightly different and more recent angle:

Whether we talk about Europe or the US or Japan (where wages have been falling even faster than prices – the true sting of deflation -, for many years): when people buy less stuff, there is less need for workers to produce it and sales(wo)men to sell it to them. So they will be out of work and have less money to buy stuff, which creates even less need for workers and sales(wo)men, and so on. Deflation really is, sorry but there is no better word, a bitch. And as Japan can tell you, one that’s very hard to get rid off. Deflation is a bitch that really makes herself at home. And Japan has had the luck until 5 years ago that they were suffering deflation in a world where there was still demand for their products. Europe and the US obviously won’t be so lucky.

But if people have less money to spend, they can borrow, right? After all, isn’t that what we’ve all done all the time? And hey, to be fair, it’s not for lack of trying by the head honchos. Over the past 5 years, governments, certainly in the US and UK, have tried very hard to get people to buy homes again (with debt). But that doesn’t fight deflationary forces, since it doesn’t really raise the velocity of money, it may even bring it down: In essence, it puts more debt on people’s shoulders (which will instead conveniently be labeled ‘assets’ as long as prices keep rising), and more debt means less spending elsewhere. Cristmas sales were, overall, gloomy again. And that when people can still buy with plastic.

Another example: QE doesn’t enter in to the real economy, so it doesn’t increase the velocity of money. A large part of QE creates reserves that banks hold at the Fed, with the emphasis on hold, while, as Professor Steve Keen recently suggested in private – dinner – conversation, the part that reaches the shadow banking system is pumped into the stock markets, because shadow banks don’t have accounts with the Fed and they need to put it somewhere. Still, that has little effect on the velocity of money, though one might argue resulting – temporary – higher valuations tempt more people to buy stocks.

But it’s not about stocks, either, the velocity of money is something that takes place in the street, it’s not something that is controlled by 300 Wall Street bankers, but by 300 million Americans, the ones that make up 70% of GDP. Even if those bankers spend 100 times more on food and clothing than Joe No Blow, the effect will be negligible. It’s not about banks or bankers, it’s about what those 90 million Americans who are no longer part of the labor force spend on a daily basis on food and clothing and heat, and the 40-odd million on foodstamps, and the fast growing segment of the population that depends on incomes at the level of burger flippers and WalMart greeters. The lives all these people find themselves in, and let’s not forget the record low labor participation rate, drag down the velocity of money ever more.

It’s perhaps this complete lack of control the financial system has over the velocity of money that had former Fed Governor Laurence Meyer make the following utterly incredible remarks last July at CNBC. You really should hear this specimen. I guess it’s accepted “policy” that anything you don’t have control over, you just pretend doesn’t exist. As per Meyer: “The word ‘velocity’ doesn’t appear in my vocabulary; the issue is the amount of lending by banks”.

He also asserts that velocity is not a useful concept because it is “too variable”. What on earth is that supposed to mean? That we’re only supposed to take note of things that are constant? For some reason this reminds me of Homer Simpson’s stern declaration that “In this house, we obey the laws of thermodynamics”. Equally convincing at first bite, equally absurd two seconds on. It also reminds me of Steve Keen’s debate with Paul Krugman, in which the latter sought to entirely deny the role of banks in money creation. Sure, just pretend it doesn’t exist, that’s all you need.

Former Fed Governor Meyer: Velocity of Money Means Nothing

Former Federal Reserve Gov. Laurence Meyer told CNBC Tuesday [July 9, 2013] that velocity of money – the rate at which capital is transacted in an economy – shouldn’t concern markets, and he dismissed the metric as a guide in setting central bank policy. The concept is not very useful, Meyer said. “Monetary policy is about affecting rates, which affect financial conditions and affect aggregate demand.”

Velocity of money refers to the rate at which money in circulation is spent on goods and services, and economists use it to determine the expected rate of inflation. An economy with a higher velocity of money can expect a higher rate of inflation.

But Meyer, who now works with Macroeconomic Advisors, said that velocity is “just a definition” that doesn’t help predict much of anything. “Monetary policy is determined by basically a strategy that is embedded in policy rules. I can’t tell you what the money supply is or how fast it’s growing – I don’t care.” he said. “The word ‘money’ is never said in our office [and] probably not by the staff at the Fed,” he added. “Money doesn’t appear in any modern macro model. We have got to get over that, OK? We’re beyond that now.”

It’s not all that easy to silence me, but Larry Meyer managed to do it there for a minute or two. If this is how economic policy in America is decided, it’s no wonder there are 42 million people on foodstamps in what was once the richest nation on earth. Play that 6 minute video! Ben Bernanke is/was a little less absurd in this regard, but only a little, because as scared as he said he was of deflation, he’s always maintained he had it all under control. Sadly, there are debt levels at which debt deflation becomes like thermodynamics, events that can’t be stopped.

And pumping money into banks through QE does nothing to raise the money supply, only the monetary base (something I suspect Ben knows very well, which would mean he’s lied throughout his tenure about stimulating the economy), and Ben and Timothy and Jack Lew’s refusal to restructure bank debt hasn’t exactly helped either, to put it mildly. Bernanke’s claim, when seen in this light, that he had the deflation threat under control, is like saying he had the power to stop the waves from hitting the shore. And I think he’s known that, too, all along. The Buddha of banking my a**. I find it hard to believe he gets to leave as some sort of hero. The man should be under investigation.

But yeah, the press has en masse started to talk about deflation in the EU these days (good luck trying to spot a European politician who agrees, though). Try “deflation” as a search term in Google news, and you’re inundated with articles that include the term. Most still with pundits claiming “they” won’t let it happen, but it has certainly become a very popular word, almost overnight.

I don’t want to bother you with a long string of such pieces, but let me lift out some that I think are interesting. This morning, Royal Dutch Shell issued a strong profit warning, and cited “weaker refining conditions caused by industry overcapacity and weak demand”. The introduction of a new CEO is of course the ideal moment to announce bad news: he can’t be held responsible, he’s cleaning the slate. But I still smell deflation in this. Overcapacity, weak demand, money’s not rolling.

Shell issues shock profit warning as results plummet

Royal Dutch Shell’s new boss Ben van Beurden has admitted the oil firm’s performance was not what he expected from the group in 2013 as he issued a shock profit warning just two weeks after taking over at the helm. Van Beurden – who succeeded Peter Voser as chief executive on 1 January – said the firm’s fourth-quarter figures were expected to be “significantly lower than recent levels of profitability”.

Its fourth quarter underlying earnings are now expected to almost halve to around $2.9 billion. This is set to leave full-year results 23% lower at $19.5 billion. Shell blamed lower oil and gas prices and “weak industry conditions” in downstream oil, as well as higher exploration expenses and lower upstream volumes. Its recent third-quarter figures were badly hit by a 49% drop in downstream profits as a result of weaker refining conditions caused by industry overcapacity and weak demand.

On Wednesday, the incomparable Ambrose Evans-Pritchard took it upon his genius mind to link oil to deflation as well, in his own equally incomparable style (when he starts venting his opinion, you know it’s time to go walk the dog. Ambrose makes a lot of sense here:

Coming ‘oil glut’ may push global economy into deflation

One piece of the jigsaw puzzle is missing to complete the deflation landscape across the West: a slide in oil prices. This is becoming more likely each month. Turmoil across the Middle East and parts of Africa has choked supply over the past two years, keeping Brent crude near $110 a barrel despite a broader commodity slump. Cotton and corn prices have halved, as has the UBS index of industrial metals. Such anomalies rarely last. “We estimate that crude oil is now the mostly richly priced commodity in the world,” says Deutsche Bank in a fresh report.

Michael Lewis, the bank’s commodity strategist, said markets face an “new oil supply glut” as three forces combine. US shale will add 1 million barrels a day (b/d) to global supply for the third year running; Libya will crank up shipments after a near collapse in 2013; and Iran will come out of hibernation. “This will push OPEC spare capacity to levels last seen in the depths of the financial crisis in 2009,” he said.

America is on track to overtake Saudi Arabia as the top global producer of oil by 2016. It will account for more than half of non-OPEC world supply this year. The US Energy Department says US oil imports will drop to 5.5 million b/d by next year, half the level a decade ago. This turns the world’s 89 million b/d market upside-down.

Deutsche Bank said Saudi Arabia may have to slash its output by a quarter to 7.5 million b/d this year to stop the bottom falling out of the market. The Saudis no longer have such money to spare. They are propping up an elephantine welfare nexus to keep a lid on explosive tensions in the Eastern Province, home to Saudi oil and its aggrieved Shia minority. A cut of this size would push the budget into deep deficit.

This comes as Iran makes its peace with the West. Its 30-year vendetta with the US – Iran’s natural ally in many ways – no longer makes sense. President Hassan Rohani is no doubt pushing his luck by describing the nuclear deal as a “surrender” to Iran by the great powers, but let him have his flourish to save face. “It does not matter what they say, it matters what they do,” retorted the White House. [..]

Meanwhile, Libya is picking itself up from the floor after separatist militia forces reduced the country to anarchy last year, blockading key export terminals. The oil minister said this week that crude output has tripled since the summer to more than 600,000 b/d as the El Sharara field comes back on stream. Libya may add 1 million b/d to global supply this year.

Bank of America says a simultaneous return of Iran and Libya could add up to 3 million b/d. Just a third of this “positive supply shock” could shave $20 off the world oil price, unless OPEC’s fractious cartel can slash output quickly enough to offset it. We should expect hot words at OPEC summits, and plenty of cheating. [..]

Oil bulls says global economic recovery is strong enough to soak up any rise in supply. Perhaps, but Simon Ward at Henderson Global Investors says the world money supply rolled over in November and is now flashing amber warnings.

His key gauge – real six-month M1 – for the G7 rich states and E7 emerging market economies has slowed to 2.3% from 3.7% last May. It acts as an early warning indicator, six months ahead. This suggest that global growth may soon fade. “Global risks are rising. The cycle already looks mature by historical standards,” he said. The growth of broad M3 money in the US has slowed to 4.6% even before Fed tapering cuts off stimulus. In the eurozone it is has been near zero for the past six months.

The latest data from China are very weak, with M2 growth falling to 13.6% in December from 14.2% in November as the authorities tighten. It is the change in pace that matters. China looks eerily like the US in 2007 when broad money buckled. The sheer scale of money creation in China has worldwide implications. Zhang Monan from the China Foundation says the money supply is 200% of GDP, and 1.5 times larger than the US money supply in absolute terms. She said debt deflation is now setting in as the central bank tries to rein in credit.

As readers know, my view is that China is riding a $24 trillion credit tiger that it cannot control. Fresh data show that fixed investment surged to $5 trillion last year, more than in the US and Europe combined. This implies yet more excess capacity, transmitting a deflationary impulse worldwide.

A sudden slide in oil prices against this background may not be entirely benign. [..] The risk is that it will “unhinge” inflation expectations as the headline rate keeps dropping. Half of Europe already has one foot in deflation, with prices falling over the past five months once austerity taxes are stripped out. Any shock at this point could start to frighten the horses. [..]

To avoid confusion, let me be clear that the dangers of dwindling oil supplies in the long-run have not gone away. Easy reserves of crude are being depleted. New fields are more costly. Peak oil may have the last laugh. Yet this should not be confused with the short-term risks of deflationary shock.

I recently attended a Transatlantic Dialogue on Energy Security with senior military officers in London and Washington. The message was that shale will come and go – with US tight gas peaking by 2017 – creating a false sense of security as the deeper strategic threat continues to build. That is broadly my view as well. Much drama can intrude along the way.

Sorry for the long quote (the original is quite a bit longer still), but I think Ambrose had something in just about every word I quoted. He even made sure to include that shale oil is no more than a short-term fad, albeit with the potential (and this is because of speculation) to disrupt an entire industry (re: Shell’s losses announced today and its $2.1 billion write-down of shale “assets” last year).

And it’s good for people to ponder the notion that lower gas prices are not – only – a good thing. With the potential to drag down even CPI (consumer inflation) numbers below zero, they can create panic, a huge loss of trust in both political and economic systems, and a severe slide in markets. Shell accounts for close to 19% of the Amsterdam Stock Exchange (AEX), to name an example. In general, seeing deflation as beneficiary is not a very smart thing to do.

Albert Edwards had a noteworthy take on deflation as well, as quoted by Business Insider.

We’re On The Cliff Of Deflation And Markets Don’t Seem To Care

Societe Generale’s Albert Edwards has warned for some time that we are on the precipice of deflation. But in his new note to clients, he seems utterly bemused. Markets just don’t seem to care. “Markets remain stoic about the risks of outright deflation in the US and eurozone for one very simple reason,” he writes.

“They simply do not believe a recession that would trigger outright deflation is on the horizon. Quite the reverse – they believe with all their heart that we are at the start of a self-sustained recovery. That is despite the fact that the US recovery is already noticeably longer than average, and that the classic signs of old age, such as rapidly slowing productivity growth and stagnant corporate profits, can clearly be seen.”

Market expectations of inflation — via the 10-year bond market — have “remained entrenched” above 2% for more than a year, Edwards writes. “A chasm is growing between reality, both on a core and headline basis, and expectations,” he says. “If investors begin to doubt the economy recovery then they will no longer be able to ignore the lurking deflationary threat. Rapid market moves would ensue.”

There’s only one reason for stocks to be as high as they are at present, and it’s obviously not to be found in the real economy it allegedly reflects, but in stimulus from governments and central banks (Greek stocks were up 19% in Q4?!). Take away QE et al and all stock prices will be reflecting is unemployment numbers and foodstamps. I’m quite amused by people who say that since QE has had little effect on the real economy, tapering can’t possibly do much damage. You think? I say: take it away, Janet!

In the end, central banks are powerless when it comes to fighting deflation. Certainly when they have become so politicized and bought up by industry, as the Fed has, that they refuse to restructure debt. When that’s accepted policy, it’s merely a matter of time before the debt drags everything down that’s not bolted fast. The only sensible thing to do when there’s too much debt is to restructure it. But yes, I know, that would sink a too big bank or two, and a bunch of properties in Connecticut and St. Barth’s. And if you got the power to sink an entire nation instead and save your friends, hey …

Of course the reason the Fed does no restructuring and defaulting is to provide more time for private debt to be transferred to the public. If one thing defines Ben Bernanke’s tenure, it’s that. And when that process is deemed to be no longer sufficiently beneficial, we all better make sure we found ourselves adequate shelter from the storm.

I’ll close with a piece Zero Hedge posted from Phoenix Capital Research, where they don’t belive in mincing their words:

Three Points That Refute All Talk of Recovery

For well over five years now we’ve been told that the US was in recovery and that as most the biggest risk was a potential double dip or worse a slow down to the recovery. The reality however was that the US never experienced a real recovery (unless you work at one of the “chosen” firms on Wall Street). Housing has re-entered a bubble driven by liquidity, not first time homebuyers entering the market.

The key relationship for housing is home prices relative to income, NOT nominal prices. Stocks are valued relative to earnings. Homes have to be priced relative to incomes. Today, the median US income is $51K. The median home price is $328K. So homes are priced at 6.4X incomes. To put this into perspective, in 2007, the housing bubble was only marginally higher than this with homes priced at 6.8X incomes. So housing, which is alleged to be in a recovery, is not much more affordable today than it was in 2007… at a time when home prices were more overpriced than at any point in the last 100 YEARs.

Speaking of incomes, they remain WELL below their 2007 peaks… which were in fact below the 2000 peaks. In fact, the median income in the US today is effectively the same as back in 1987.

Again, NO recovery to be seen here. Indeed, the number of people of working age who actually HAVE jobs is back to levels not seen since the 70s. Gotta love that recovery… when the percentage of people working is the same as it was back when the US was in a recession four decades ago!

At the end of the day, the entire economic landscape is very simple to understand. The economy grows when people make more money and spend that money on things including homes. Lower incomes= lower spending= lower economic activity. Sure, you can reflate a credit bubble in which spending rises briefly due to people having easy access to credit… But at the end of the day, all this does is set the stage for another economic collapse when people once again default on their credit card payments/ mortgage payments.

That day of reckoning is coming… It’s just a matter of time.

Amen. Deflation is here to stay, and it’s going to hurt you much more than you care to think.

This article addresses just one of the many issues discussed in Nicole Foss’ new video presentation, Facing the Future, co-presented with Laurence Boomert and available from the Automatic Earth Store. Get your copy now, be much better prepared for 2014, and support The Automatic Earth in the process!

Dec 262013
 December 26, 2013  Posted by at 2:12 pm Finance Tagged with: , , ,  19 Responses »

Lewis Wickes Hine Indianapolis Market 1908

Despite the media talking up optimism and recovery, people are not seeing the supposed good news playing out in their own lives. As we have discussed here many times before, the squeeze continues on Main Street, while QE has generated asset bubbles at the top of the financial food chain. Complacency reigns, but this is the endgame. Increasingly delusional collective optimism, based on illusory wealth for the few, has ben the driving force for 2013, even as the smart money has been selling everything not nailed down for most of the year – cheerfully handing the empty bag to a public that demands it. It’s been a five year long party, where, demonstrably, no lessons were learned from the excesses preceding the previous peak, and the consequences that followed from it.

Now, as a result of throwing caution to the wind again (mostly with other people’s money of course), we face another set of consequences, but this time the hangover will be worse. Timely warnings are rarely credible, as they contradict the prevailing wisdom of the time, but it is exactly at this time that warnings are most needed – when we are collectively irrationally exuberant on a grand scale. We need to understand the situation we are facing, in order to see why this period of global excess will resolve itself as a global credit implosion, what this means for ourselves and our societies, and what we can hope to do about it, both in terms of preparing in advance and mitigating the impact once we are confronted with a new, sobering, reality.

We are facing an acute liquidity crunch, not the warning shot across the bow that was the financial crisis of 2008/2009, but a full-blown implosion of the house of cards that is the global credit pyramid. Not that it’s likely to disappear all at once, but over the next few years, credit will undergo a relentless contraction, punctuated by periods of both rapid collapse and sharp counter-trend rallies, in a period of exceptionally high volatility. The primary impact will stem from the collapse of the money supply, the vast majority of which is credit – a mountain of IOUs constituting the virtual wealth of the world.

This has happened before, albeit not on this scale. Since humanity reached civilizational scale we have lived through cycles of expansion and contraction. We tend to associate these with the rise and fall of empire, but they typically have a monetary component and often involve a credit boom. Bust follows boom as the credit ponzi scheme collapses. Mark Twain commented on one such episode in 1873:

“Beautiful credit! The foundation of modern society. Who shall say that this is not the golden age of mutual trust, of unlimited reliance upon human promises? That is a peculiar condition of society which enables a whole nation to instantly recognize point and meaning in the familiar newspaper anecdote, which puts into the mouth of the speculator in lands and mines this remark: — ”I wasn’t worth a cent two years ago, and now I owe two million dollars.””

Few recognized at the time that the ensuing financial panic of 1873, at the culmination of a period of speculative excess, was going to lead to a long and grinding depression. The signs were there, as they are today, but few connected the dots in advance and understood what was about to unfold and why. Few ever do at comparable points in time.

Unfortunately, humans are not good at remembering, let alone learning from, and applying, the lessons of history. The information is available for those who care to look – far more information than people had access to at previous junctures – but not in the mainstream media. The media’s role is to reflect and amplify the mood of the time, spinning events in accordance with it in a self-reinforcing feedback loop. Real information – the kind we need if we are to face a future more challenging than anything most of us have ever experienced – is found elsewhere, with independent voices contradicting received wisdom when it most needs to be contradicted. That has been our task at The Automatic Earth for the last six years. We cover the events of the day, placing them in the context of the bigger picture we have developed since January 2008.

We aim to make complexity comprehensible, so that people can identify the most immediate and most significant threats and prepare themselves to face them. At the present time, the threat people most need to appreciate is a liquidity crunch, hence this is a major focus of our most recent Video Download release – Facing the Future. It is well underway in some parts of the world already and many more countries will find themselves affected in the not too distant future.

Essentially, a liquidity crunch creates a situation of artificial scarcity. People hold on to what money they have when they are unsure when they might earn any more of it, as makes perfect sense from an individual perspective. However, when a large number of people do so, the amount of money in circulation falls sharply, leaving an insufficient supply to sustain anything like the same amount of economic activity. Not just actual unemployment, but the fear of future unemployment can be enough to cause spending to plummet, drastically reducing money in circulation. When money is not available to change hands in exchange for goods and services, those goods and services are not exchanged. In the Great Depression of the 1930s, observers noted that “they had everything but money”. The people and resources were still there, but were not able to connect.

As an artificial construct, one might think that a loss of money would have little impact if other factors remained, but this is not the case. As we have explained before, finance is the global operating system, and crashing the operating system has severe consequences in terms of disrupting supply chains – with cascading effect – at both local and global levels. Since this is the major risk we face, and the consequences are likely to be severe, we need to take steps to prepare ourselves and our communities.

The more cohesive and close-knit a community, the better it is likely to be able to withstand external shocks, so all manner of community-building initiatives can be extremely valuable. In our new Facing the Future Video Download series, Laurence Boomert describes a wide range of demonstrably effective possibilities in considerable detail, explaining how and why they work. Such efforts address a liquidity crunch indirectly, through increased resilience.

However, there are also means to address the scarcity of money directly, and these are likely to have a very important role to play. Alternative currencies can go some distance towards filling the void left by a lack of money in circulation, albeit at a local level. These have been used in many places faced with an economic seizure at the national level, notably Austria, during the Great Depression of the 1930s, Argentina, following the financial crisis of 2001, and Greece today. They are very likely to arise spontaneously in times of crisis, but have the potential to be more effective more quickly if established in advance. A range of them is covered in our new Facing the Future Video Download material.

Nicole Foss and Laurence Boomert with Peak Moment TV’s Janaia Donaldson (center) in Vancouver, Canada

The best known, and arguably most effective, example of local currency in action is the Austrian town of Wörgl in the early 1930s. In the depths of the depression, with over 30% unemployment, the mayor, Michael Unterguggenberger, did not have the funds to cover projects he wanted to build to put his constituents back to work. Rather than use his reserves of 40,000 schillings, he deposited these in the bank and in 1932 issued local stamp scrip backed by his reserves. The scrip required a stamp each month, at a cost of 1% of its face value (a feature called demurrage), hence there was an incentive to spend the money rather than to hoard it. Although the incentive was small, the psychological effect was disproportionately large, keeping the money in circulation at a substantial rate. Although only a small quantity of scrip was issued, it circulated quickly enough to support a great deal of economic activity in a town previously caught in the grip of an economic seizure:

They not only re-paved the streets and rebuilt the water system and all of the other projects on Mayor Unterguggenberger’s long list, they even built new houses, a ski jump and a bridge with a plaque proudly reminding us that ‘This bridge was built with our own Free Money’. Six villages in the neighborhood copied the system, one of which built the municipal swimming pool with the proceeds. Even the French Prime Minister, Édouard Dalladier, made a special visit to see first hand the “miracle of Wörgl.”

It is essential to understand that the majority of this additional employment was not due directly to the mayor’s projects…..The bulk of the work was provided by the circulation of the stamp scrip after the first people contracted by the mayor spent it. In fact, every one of the schillings in stamp scrip created between 12 and 14 times more employment than the normal schillings circulating in parallel. The anti-hoarding device proved extremely effective as a spontaneous work-generating device.

The use of scrip enabled approximately 100,000 schillings worth of local government spending to occur on projects without the need to deplete reserves of national currency at all. In addition, a multiple of this amount in private spending occurred, even though only some 8000 schillings worth of scrip was ever in circulation. Altogether, it has been estimated that some 2.5 million schillings worth of economic activity was financed in one year.

As the stamp scrip was a creation of local government, people were allowed to pay their taxes using it. As there were substantial tax arrears, this was an effective tool for encouraging the acceptance of the currency. People were, in fact, paying their taxes early in order to avoid the 1% monthly loss due to the stamp fee:

On July 31, 1932 the town administrator purchased the first lot of Bills from the Welfare Committee for a total face value of 1,800 Schillings and used it to pay wages. These first wages paid out were returned to the community on almost the same day as tax payments. By the third day it was thought that the Bills had been counterfeited because the 1000 Schillings issued had already accounted for 5,100 Schillings in unpaid taxes. Michael Unterguggenberger knew better, the velocity of money had increased and his Wörgl money was working.

Mayor Unterguggenberger understood the nature of the crisis he was addressing and how is stamp scrip acted to mitigate it. Each Wörgl note was printed with the following justification:

“To all whom it may concern! Sluggishly circulating money has provoked an unprecedented trade depression and plunged millions into utter misery. Economically considered, the destruction of the world has started. – It is time, through determined and intelligent action, to endeavour to arrest the downward plunge of the trade machine and thereby to save mankind from fratricidal wars, chaos, and dissolution. Human beings live by exchanging their services. Sluggish circulation has largely stopped this exchange and thrown millions of willing workers out of employment. – We must therefore revive this exchange of services and by its means bring the unemployed back to the ranks of the producers. Such is the object of the labour certificate issued by the market town of Wörgl: it softens sufferings dread; it offers work and bread.”

It was not necessary for the stamp scrip to replace the national currency, only to supplement it. Local currency in Wörgl was always exchangeable for Austrian schillings, at a cost of 2%, but the scrip was so well accepted that few sought to covert it. One observer, Claude Bourdet, master engineer from the Zürich Polytechnic, reported on the success of the stamp scrip at the time:

“I visited Wörgl in August 1933, exactly one year after the launch of the experiment. One has to acknowledge that the result borders on the miraculous. The roads, notorious for their dreadful state, match now the Italian Autostrade. The Mayor’s office complex has been beautifully restored as a charming chalet with blossoming gladioli. A new concrete bridge carries the proud plaque: “Built with Free Money in the year 1933.” Everywhere one sees new streetlights, as well as one street named after Silvio Gesell [originator of the concept of Freigeld, or Free Money]. The workers at the many building sites are all zealous supporters of the Free Money system. I was in the stores: the Bills are being accepted everywhere alongside with the official money. Prices have not gone up.”

Local goods and services could be purchased with scrip, allowing scarce national currency to be used for non-local essentials and national taxes. If spread widely enough, this model could potentially have protected both local and national supply chains, at least to some extent. However, the central bank decided to assert its money monopoly, shutting down the Wörgl experiment in late 1933 after 13 months. The town then sank back into economic depression. The deprivation across the country set the stage for an unfortunate choice of ‘solutions’:

Only a central authority saviour can help people who are not allowed to help themselves locally. And as all economists will point out, when there is enough demand, supply always manifests in some way. Even if you have to import it. During the Anschluss of 1938, a large percentage of the population of Austria welcomed Adolf Hitler as their economic and political saviour. The rest is well known history.

The power inherent in a money monopoly is tremendous. As far back as the late eighteenth century, the patriarch of the Rothschild banking family, Mayer Amschel Rothschild, acknowledged the extent of power over money in saying ,”Permit me to issue and control the money of a nation, and I care not who makes its laws!” This was acknowledged in the early days of the United states, when debt enslavement was recognized as the power to conquer. Thomas Jefferson wrote of his concern in 1816:

“And I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around the banks will deprive the people of all property — until their children wake-up homeless on the continent their fathers conquered.”

We have had the inflation, in the form of a money supply expansion, largely based on credit creation, that has proceeded virtually uninterrupted for decades. Now we stand of the verge of the deflation that follows all credit expansions as night follows day.

Given its significance, it is no surprise to find the power of money monopoly defended. The ability to do so depends, however, on being able to project power at a distance through strong central control. As this in turn depends on the extent of chaos, the state of supply lines and the availability of sufficient energy, defence will not always be possible, and a money monopoly is not likely to stand the test of time. We will need to develop alternative trading arrangements, both for the present and for the future, as we will be faced with rebooting our financial operating system.

Given the potential for local currencies to mitigate the coming liquidity crunch, it is very much worth the effort to create one. They exist in many locations already, some with a history measured in decades. Emergency currencies have also been recently created in order to address the liquidity crisis already hitting the European periphery. For instance, the Greek town of Volos holds a market where all goods and serviced are denominated in TEM (Τοπική Εναλλακτική Μονάδα, meaning Alternative Monetary Unit):

In this bustling port city at the foot of Mount Pelion, in the heart of Greece’s most fertile plain, locals have come up with a novel way of dealing with austerity – adopting their own alternative currency, known as the Tem. As the country struggles with its worst crisis in modern times, with Greeks losing up to 40% of their disposable income as a result of policies imposed in exchange for international aid, the system has been a huge success. Organisers say some 1,300 people have signed up to the informal bartering network.

For users such as Ioanitou, the currency – a form of community banking monitored exclusively online – is not only an effective antidote to wage cuts and soaring taxes but the “best kind of shopping therapy”. “One Tem is the equivalent of one euro. My oil and soap came to 70 Tem and with that I bought oranges, pies, napkins, cleaning products and Christmas decorations,” said the mother-of-five. “I’ve got 30 Tem left over. For women, who are worst affected by unemployment, and don’t have kafeneia [coffeehouses] to go to like men, it’s like belonging to a hugely supportive association.”

Greece’s deepening economic crisis has brought new users. With ever more families plunging into poverty and despair, shops, cafes, factories and businesses have also resorted to the system under which goods and services – everything from yoga sessions to healthcare, babysitting to computer support – are traded in lieu of credits. “For many it plays a double role of supplementing lost income and creating a protective web at this particularly difficult moment in their lives,” says Yiannis Grigoriou, a UK-educated sociologist among the network’s founders.

Such networks clearly have significant social value in bringing people together to face hard times. Much can be gained through mitigating the psychological effects of deprivation in isolation, and the resulting relationships of trust can be enduring. Providing the ability to purchase goods and services, including essential staples, without the requirement for scarce euros, is also critical for those without any other means of support:

Back at the market, I’m told the TEM network in Volos is growing quickly. More than 1,000 people have joined or are waiting to join in this city of 150,000. Katarina, who joined a month and half ago, is selling homemade liqueurs, jams and sweets. For her, the network isn’t just about creating an alternative social structure. It’s about survival. She uses her credits to buy staples – vegetables, fruits and eggs – from others in the network. She said she wishes the TEM network were bigger – she wants to be able to buy things like olive oil and meat. Katarina said she’s been unemployed for five months now. When I asked if she’s received any help from the local government, she laughed. “The state is completely absent.”

The Greek government approves of this limited form of monetary creativity and has passed legislation encouraging “entrepreneurship and local development” as a substitute for the welfare state it is no longer able to provide. So far nothing more ambitious that might challenge the money monopoly has been attempted. The TEM system of electronic barter only goes so far, as it does not involve local government and cannot be used as a means to meet tax obligations. Local government has only been able to offer moral support:

The city has been hit hard by the crisis, said Volos Mayor Panos Skotiniotis. When construction fell off, the region’s cement and metal industries suffered. Unemployment is rising, and local funding from the Greek state is down 40 percent over the past three years. Skotiniotis said the municipality can’t support the TEM network in any official way. But he certainly sees its value. “It goes without saying that this currency is not substituting for the official state currency, the euro,” said the mayor. “But it’s a supplement for people who can’t meet their own needs.”

It is probably only a matter of time before a more ambitious form of alternative currency, along the lines of the Wörgl experiment, is tried in some of the regions of the European periphery where suffering is particularly acute. This may occur before or after these countries give up their doomed attempt to stay in the eurozone, but would probably be more successful if tried during a transition away for the euro, as this would amount to less of a direct challenge to the global money monopoly. Experiences gained in such an experiment would be valuable if communicated to other locations, many of which will be facing similar difficulties in their turn.

An alternative currency interchangeable with the national currency and usable for local tax obligations, as in Wörgl, is not necessarily a panacea, nor even a permanent solution, but it can make a significant difference mitigating the effects of a liquidity crunch in the short to medium term. Had the Wörgl experiment been allowed to continue, it is possible it would have run its natural course before the local economy could have become self-sustaining:

The activity would not have been sustainable. Once the taxes in arrears were completely paid and when people had paid enough taxes in advance to feel safe and comfortable (at some point they would stop paying forward), the scrip would lose a key part of its attractiveness. One way a government can ensure the demand for its currency is to mandate that taxes be paid in the government-issued currency. The other way is through monopoly legal tender laws. Wörgl could not legislate or enforce monopoly legal tender, so the demand for the scrip is partially attributable to the need to pay taxes.

Nevertheless, the monetary experiment allowed for many municipal projects to be completed and for local economic activity to be supported for a period of time. This was clearly beneficial. As with the TEM currency in Greece, part of the effect of local initiatives like this is psychological – alleviating a prevailing sense of isolated deprivation and brining a community together. This has value in its own right, independent of the monetary effect. Such a course of action should be tried again, and permitted to run for longer, but it is not clear that this will happen once we find ourselves facing widespread economic depression again. The money monopoly is even more powerful today than it was in the 1930s, and even more likely to defend its powerbase, at least while it remains capable of doing so.

Alternative currency can mitigate a situation of artificial scarcity caused by a liquidity crunch, but there are other limits that are not artificial. We were not facing resource limits, or a skills shortage, in the 1930s, but we are today. For a time, money will be the limiting factor, and local currencies may come into their own if allowed to do so, but beyond that financial crunch we will have to face physical curbs to growth. Energy will probably be the next hurdle we have to address. The future will be challenging and we must face it fully informed.

For those who are interested, I will be teaching, along with Albert Bates, Marisha Auerbach and Christopher Nesbitt, on a Permaculture Design Certificate course in Belize in 2014. The course will be the 9th annual event held at Maya Mountain Research Farm between Feb 10-22nd. Click here for details and registration .

This article addresses just one of the many issues discussed in Nicole Foss’ new video presentation, Facing the Future, co-presented with Laurence Boomert and available from the Automatic Earth Store. Get your copy now, be much better prepared for 2014, and support The Automatic Earth in the process!