Niall Fergusson, John Bonython Lecture 2010

Speaking to the Center for Independent Studies in Australia, Niall Fergusson predicts the rapid demise of American hegemony in the world.  He explains that many empires did not ebb away but rapidly fell–however, in many cases, it wasn’t really military weakness that did them in, but debt, particularly debt to foreigners.  He says America is on the same path.  He makes the observation that China, which is rising in power, is quietly reducing its holdings of US debt.

Ferguson is asked during the question period whether he owns gold.  He says that one should only have 10% of holdings in gold, for he believes that there will be deflation.  Funny, in my reading of his book, The Ascent of Money, and my listening to media appearances, I’ve drawn the opposite conclusion from the evidence that he presents: that there will be inflation.  Ferguson, however, makes the point that he is not himself an economist (like that would necessarily help) but an historian.  In any case, I hope the leadership and people of the US are listening to his warning.  It is perhaps not too late to turn the tide.  Ferguson recommends the newly elected Senator Rand Paul as being the only one who has a reasonable plan to help the US to avoid this fall.  Please click on the screen snip below to connect to the video at the Australian Broadcasting Corporation website (hat tip The Business Insider).

War, Gold and Larry Norman

While in Grand Cayman over the Christmas holiday, I finished Justinian’s Flea by William Rosen–a little light historical reading.  In the sixth century AD, when armies would besiege, cities could pay a ransom and avoid violence that could result in a massacre or a selling into slavery of the population.  But in no case did the besiegers accept fiat currency–their preference was for gold and silver.  Imagine the Emperor at Constantinople asking the invading hoards if they would accept a promissory note or nice pieces of papyrus with his picture on it?  Thus, history teaches us that war helps people to sort out their values.  The enemy wants what is mine, and the main thing I have besides my very life is gold and silver; otherwise, I am unable to ransom myself.  It is better to relinquish precious metals than to die or to become a slave for the rest of my life.

Larry Norman wrote in his 1969 song, “I’d wish we’d all been ready”:

Children died, the days grew cold.

A piece of bread could buy a bag of gold.

I wish we’d all been ready.

It is a beautiful song marred by the flawed dispensational theology of the Rapture.  Yet these lines have always haunted me.  What has value in a time of war when everyone is desperately seeking merely to survive with life and limb and to protect their loved ones?  Norman’s song evokes an image of a time so desperate that gold would have no value–only bread.  Could this fit the mantra of some that gold has no intrinsic value?  I would argue that in such a scenario it is not that gold has lost value: it’s that bread has become so scarce so as to increase in market value, and this is what actually happens in war.

Some of my African colleagues testified that during one of the many wars that Bangui experienced, the seminary community remained on campus fearing for their lives as shooting and shelling raged in the city’s streets.  Some brave bread vendors dared to distribute despite the danger.  But instead of asking the pre-war price of 50 CFA per mini-baguette (=$0.125US), they wanted 200 CFA.  Those who were too afraid to step out into the open paid the premium or they went without.  Scarcity led to higher prices.  Economics 101.  Even graduates of Father Guido Sarducci’s 5-minute University should be able to apprehend this basic concept.

The increased price of commodities during times of war notwithstanding, it is clear to me that history teaches us that in the most severe economic crises, gold and silver retain their value while currencies do not–particularly the debt instruments of the war’s vanquished.  As a child growing up in America, I read several tales of people who had found millions of dollars only to learn that they were worthless Confederate notes.  Bank notes are debt.  Debt which the issuer cannot repay is worthless.  Gold, however, does not suffer from such issues.  So in the end, the victor walks away with the gold and the loser sits upon a pile of worthless paper.  In times of war, it can be difficult to pay for supplies and soldiers with the promissory notes that we call currency.  So for example, Niall Ferguson writes in his The Ascent of Money (81-85) about how the British, facing the refusal of their promissory notes, successfully received gold, thanks to the shipments arranged by the Rothchilds, and were able to win a decisive victory against the French at the Battle of Waterloo in 1815.

“Printing money” is a worn out metaphor: reflections on what is real

Our current economic system confronts us with a metaphysical dilemma.  Niall Ferguson writes in The Ascent of Money (30-31; emphasis mine):

Today, despite the fact that the purchasing power of the dollar has declined appreciably over the past fifty years, we remain more or less content with paper money … Even more amazingly, we are happy with money we cannot even see.  Today’s electronic money can be moved from our employer, to our bank account, to our favourite retail outlets without ever physically materializing.  It is this ‘virtual’ money that now dominates what economists call the money supply. … Anything can serve as money, from the cowrie shells of the Maldives to the huge stone discs used on the Pacific islands of Yap.  And now, it seems, in this electronic age nothing can serve as money too.

Gary Shilling has maintained that the electronic money that the Federal Reserve has been creating has remained on the bank books as excess reserves because the banks are too afraid to lend it out.  On the other hand, Gonzalo Lira has argued that all the virtual money that the Federal Reserve created and used to buy up toxic assets was in turn lent to the Federal Government by the banks.  Then, the Federal government spent that virtual money on government employees, welfare recipients, medicare, social security, food stamps etc.  Thus, Shilling misses a big point that the bank’s toxic assets and debts of the government have been monetized by this arrangement–and the virtually inflated money is now already in circulation, forcing up the prices of commodities.  Lira calls this phenomena “stealth monetization”: in Weimar Germany, people needed wheel barrels to carry their money.  Today, all that virtual money can be carried in a credit card or a food stamp debit card.  I would estimate that over 95% of my transactions are done with virtual money.  The scary thing is that now central banks are able to create stealth inflation, while lying about the inflation rate which they erroneously confuse with their manipulated Consumer Price Index, because most of the money that exists today is not real–it is not even printed on paper presenting the people with a tangible, visible clue as to how fast it is expanding.  At least in Zimbabwe today, three zeros are added at each new print run–this is inflation that you can see. The US Federal Reserve, the Bank of Canada and the other central banks today create virtual money which gives us nothing tangible with which to see the inflation which is taking place.  The Federal Reserve, until a few weeks ago, was keeping its books a tightly guarded state secret, and so no one except the members of the cabal knew how much virtual money Bernanke was creating or who benefited from it (see Monty Pelerin and My Budget 360).

Now I think of my virtual trading account in which I create virtual wealth through electronic trades on a virtual trading floor, where after three days virtual money and virtual shares change hands.  Then it is recorded in a virtual trading e-confirmation and I’m provided a monthly e-statement with my virtual holdings.  I have healthy net worth, but only as long as others are willing to accept my virtual money, or I can liquidate my virtual assets which are in the form of stock shares that my brokerage account holds for me electronically.  I feel that my investment life is trapped in the Matrix, and I wonder when someone will offer me a choice between the red or the blue pill.  “Welcome to the real world”.

There are today investors insisting upon physical delivery of precious metals.  Banks have perhaps taken massive short positions, selling virtual gold and silver without having much or any of the real stuff.  The word on the street, e.g., is that J. P. Morgan has a massive short position in silver (see Eric Fry); Mish argues that J. P. Morgan probably has a hedged position, but he is admittedly speculating:

If JPM is hurting as the silver bulls claim, pray tell why does it not show up somewhere? Where is the proof JP Morgan is naked short silver?

To be fair, I do wish JPMorgan would comment on this. Why don’t they?

Why don’t they indeed?

Is it possible to create virtual inflation?  What would it look like? I know this: the metaphor of saying that the central banks are “printing money” is worn out and does not adequately reflect the vast quantity of virtual wealth that has been create ex nihilo.  So I suggest we call it instead “virtual money”–or the like, so that we the people can began to get our heads around what the banks are doing to our assets.