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Gold Is Not Money

-- Posted Sunday, 7 November 2010 | | Source:

These three functions:
  1. store of value
  2. medium of exchange
  3. unit of account

collectively form the abstract concept we refer to as "money".

All three functions are separate mental processes to which we ascribe different mediums, depending upon circumstance. Money is not one or another of these things, nor anything else. Money is the sum total of these three functions. Period.

This is the definition which I will apply to the term “money” hereafter. Please keep this in mind.

Past Circumstance
There was a time when gold and silver coins filled all three roles, and at that time it would have been accurate to describe gold as money. Human nature put an end to that. (Technology would have inevitably intervened at some stage too, but human nature got there first.)

Human nature demands money it can borrow. I differentiate between money you can spend before (borrowed) or after (earned) you exchange some form of value for it as either easy money, or hard money, respectively.


“In a gold money system with gold lending (which is always demanded by the collective will) fractional reserve banking is the inevitable result. And from there, bank failures are the inevitable result at the first sign of panic (loss of confidence). And from there, some of the savers lose their money.

In a fiat system, the fiat is lent and the savers hold the notes, one way or another. This lending and note holding always increases the money supply just like gold lending and gold-denominated notes expand the gold money supply. You lend something and then you can claim it in the form of a note while the borrower claims it in the form of the currency. Even the notes circulate as they become marketable.

So lending always expands the money supply, whether it is gold or fiat. And when the savers save in the same thing being lent, collapse ultimately comes (or at least threatens), whether gold money or paper. And then the system must undergo a fundamental change one way or another.”
Access to easy money has traditionally resulted in more coupons entering circulation than there is value backing them.

If the coupons are for gold (eg. gold backed dollars pre 1933), not everyone can receive the gold owed them. If the coupons are fiat (modern dollars), everyone can get their cash (it’s printable, after all), but its buying power shrinks.

When there was not enough gold to meet dollar-bearer demand in 1933, it was decided that to boost supply gold held by private US citizens would be confiscated, to reduce demand dollars held by private citizens would no longer be redeemable for gold, and to extend the newly consolidated reserves gold would be revalued, higher.

The exact same symptom resurfaced on an international scale less than 40 years later, and as a solution the redemption of dollars for gold was ceased altogether in 1971.

Another 40 years on, and the same situation requires a remedy once again. This time, though, it is orders of magnitude larger, compounded by the fact that no-one was forced to take their losses in 1971, as the problem was technically just papered over. Today the majority of dollars and their multitude derivatives are held digitally, and with the dollar no longer officially redeemable by the bearer for anything tangible, the solution will be different in appearance, but not in practice. This time, everyone requiring payment has agreed by their participation that they no longer need gold: they will accept cash. And this time, they will get all that is owed them. Of course, when they do, there will be so much of it that it won’t be worth anything. The result is the same as previously: savers pay with their savings. Value is lost

So you can see that in just the last century we have tried using gold simultaneously as both the medium of transaction and store of value, and then the same with fiat, with the same result. It was the lending of the money that forced the departure from a gold money system, when it was deemed more expedient to socialize the losses than to let the banks collapse.

Left to its own devices, the market will naturally remedy the inflationary loss of the real value of money with deflation, as demonstrated by this chart

The chart above shows clearly that the market has not corrected this loss of real monetary value for the last 80 years. This chart is presented for conceptual purposes only, as the official data used has been manipulated over the last 30 or so years to deliberately understate inflation: in real terms, there would quite likely be even more blue on the right hand end.

Present Circumstance
Deflation increases the real value of money, when measured against the real goods and services it can be exchanged for. We are now at a point where real deflation will prevail, because aggregate credit is contracting, and the global deleveraging process is destroying debt-based fiat faster than it can be created.

I refer to this deflation as real deflation because there are no longer any reliable (unmanipulated) traditionally used metrics with which to measure it (the marking to market of credit, for example, has been suspended. This does not mean that it still has value, it just means we are unable to know the degree to which it has lost value), but this does not mean deflation is not really occurring anyway, whether visible or not.

Historically, the medium of exchange deflates against the store of value to reinstate real value to money, as seen in the first 3/4 of the chart above. In a gold money system, this meant that either the physical gold rose in value, or the excess paper coupons in circulation to represent it must be destroyed, to return to a monetary value equilibrium. This process is the bank failures and loss of saver’s money FOFOA spoke of in the quote above.

This "monetary value equilibrium" can be found as a balance in the ratio of value between the store of value and the medium of exchange monetary functions.

Today though, the debt-based dollar is used in all three monetary functions, meaning that the store of value has a counterparty. The counterparty holds dollars (and derivatives thereof) as collateral assets.

How can the dollar deflate against itself?

“Deflation is impossible in today's dollar terms because policy will allow the printing of cash, if necessary, to cover every last bit of debt...”
If the debt this present monetary system utilizes for all three monetary functions is allowed to default, which would be the natural course of events, it will quickly cascade into default on the sovereign nation level and complete systemic collapse. The only way to counter this, as FOA pointed out, is the printing of more (and more...) money by the Fed to buy all this debt, until ultimately it buys it all. When debt-based fiat is used concurrently for all three monetary functions, these are the only two options when the debt load finally becomes too large.

The dollar cannot deflate against itself. It can collapse in total default, or collapse in hyperinflation. Under the current arrangement with the dollar as the "only money”, these are the only two options to restore the monetary value equilibrium.

Future Circumstance
What if, in a break with tradition, the current monetary function arrangement were altered?
With the debt-based dollar performing all three monetary functions, we face a choice between two unpalatable options, both of which culminate in collapse.

Circumstances dictate a different medium be assigned the store of value function, to give the dollar something to deflate against.

Voila! A third option, one which does not result in collapse.

The only feasible store of value the market can select is the same one the market had always used, because it is the only medium meeting all the criteria that the store of value requires, with the top of the long list being... no counterparty, and the inability to create more at will. Physical Gold.

There is a hidden (in plain sight) escape hatch from the losses this switch in store of value medium would otherwise cause: existing holders of physical gold will be automatically recapitalized when the exchange rate between gold as the monetary store of value and paper currency as the monetary medium of exchange is left free to float. Central Banks will still hold valuable reserves, for the value lost from their foreign currency (FX) holdings would be offset by the value gained by their gold.

When Adam Smith wrote “Wealth Of Nations” in 1776, he spoke of an “invisible hand”, a concept which remains a fundamental economic principle, in which the cumulative effect of individuals' actions of self interest move the market as an unseen, self-regulating force. It is this self interest which will force the change of monetary function, as the only viable option. The very biggest and most influential market participants already hold gold reserves for just this eventuality, for their own recapitalization in this event. Some of the Central Banks, such as the ECB, India and Russia, already mark their gold reserves to market. For them, this recapitalizing is already underway, as the value of their gold reserves grow in response to the diminishing value of their FX reserves.
Another conceptual example:

This process of reinstating gold as the monetary store of value is a mental process, one already underway. As the market gradually becomes aware of the inevitable choice it faces, the trickle of value into physical gold will become a flood, and the invisible hand will uplift debt-based paper from its role as the monetary store of value, and install physical gold as replacement. Recapitalization is automatic, but only for holders of physical gold.

While paper currencies may have turned in a miserable performance as a store of value, they have excelled in their role as medium of exchange, in more ways than one. In digital format it has introduced new efficiency to international trade, and to its usage and management daily by billions of people. While its quantity is easily adjusted by its issuer, indiscriminate issuance of paper can be kept in check by a rising price of gold in said currency, through an international floating exchange rate with physical gold.

This new arrangement leaves us with a self-regulating monetary value equilibrium: physical gold becomes the perfect hedge against inflation. Capital now has a safe harbour, where it can be stored without loss of value while awaiting a sound investment opportunity, not being rushed into misallocation in an attempt to outperform inflation.

“I was personally shocked when I discovered that we absolutely NEEDED paper currency in order to set Gold free.”
And what of the monetary unit of account function? Which medium will it utilize? Both. Whether one uses gold or paper currency in this role will depend entirely upon what one's intentions are for the monetary value in your possession. If this value is to be used for current expenses, paper currency will be most adequate. On the other hand, if this value is surplus to your immediate requirements, it would fall into that category usually regarded as "savings", and for this gold would be the best vehicle.

All three of the monetary functions that constitute money are purely mental, and a change of medium in any of them is a collective mental decision. This is a decision our elected leaders are wise to let us make for ourselves.

"Do you know the value of gold?
From the day of our birth we are taught to value all things using the one factor alone, currency! Can one contemplate the value of all possessions in other terms? Do you not have to think first as to "how many dollars is that worth", then "how many dollars is this worth" to compare two items? If it is deep within our mind, that we can know value only in terms of paper, to this I ask, can one know value at all?
The Western mind does focus on "what I buy today for the lowest price". Yet, in this modern world economy, the lowest price is always the function of "the currency exchange rate"? The Yen, it is compared to the dollar today, and used to purchase goods. One year later and Japan offers these goods for much less, as the Yen has fallen to the US$. The currency value of this purchase, was it "true" today, or a year ago? Understand, all value judgments today are as subject to "exchange rate competition"! It is in "this exchange rate valuations" that the private citizen does denominate all net worth! A safe way to hold the wealth for your future, yes? You should ask a Korean or an Indonesian?
One should grasp that "today, your wealth, is not what your currency say it is"!
In this world, paper currency is for trade, only! It is for the buying, selling, earning and paying, not for knowing the value of your family holdings! Know this, "the printers of paper do never tell the owner that the money has less value, that judgment is reserved for the person you offer that currency to"! Again, I ask, how can we know a true value for our assets, when they are known only in currency that finds it's worth, as in the exchange rate for another currency?
Many will "think long and hard on this", but will find little reason for this position. For it is in your history to know only "things valued in paper terms". Some say, "I hold investments of great increase these past years, and am much ahead of the inflation, if it should come". I say, "your investments, worldwide, have moved little, as it has been the currencies that denominate your assets, that fall a great deal". The price inflation that comes, it is larger than your vision can see! Your past, holds little of knowing value outside of currencies, this does block the good view!"

To paraphrase Aristotle:

The flow of value- Create value to earn currency, buy what you need, save in gold, enjoy what life has to offer.

Ender: “... he who holds gold has already been paid.”

FOFOFOA: Gold is not money.
Gold is the master proxy of value.
Money is the means by which we collectively manage value.


-- Posted Sunday, 7 November 2010 | Digg This Article | Source:


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