Category Archives: Money

NIRP: A Disease of the Twenty-first Century

Central banks (CB) of the world have begun experimenting with a range of monetary policies never tried before. Although they have a certain academic or theoretical underpinning, they are being implemented without any significant experience to assess their effectiveness.

The latest one to emerge from the labs of the CBs is Negative Interest Rate Policy or NIRP. We will first provide enough background that anyone can make sense of these policies. More importantly, in the case of NIRP, we will show how it will be an economic and social disaster for the person on the street. We will also reveal who stands to gain from the economic destruction that NIRP will create. First, however, we discuss positive interest rates.

Bitcoin or Two Bit Coin?

Bitcoin, the cryptographic “currency” is widely known and widely discussed. This ZeroHedge article The Complete Annotated Price History Of Bitcoin briefly discusses and presents a Goldman Sachs article explaining Bitcoin. We do not follow it and considering its ups and downs, view it as a good medium to destroy one’s real wealth with. For the interested, the link  is above.

A Brief Note on Gold As a Currency

With the refinements our ideas on money in Understanding Money: Part 5 – It’s All Money, we decided to apply them to a topic we have addressed in the past, that of the return to a gold standard.

There is an audience for the idea that the change from a gold standard to a pure fiat paper currency is a root cause for the current financial crisis. In particular, a paper currency allows for the expansion of the monetary base in an undisciplined fashion. We suggest that a pure fiat currency and a gold-backed currency both represent MZMc or the currency component of money with zero maturity whose composition or nature is irrelevant to the money creation process. To understand our thinking, refer to the series of articles on “Understanding Money” at the end of this essay.

More Thoughts on a Gold Standard

The article The Long Wave Versus the Printing Press: Central Banks Go All-In posted on motivated us to test an idea. The author states (the emphasis is ours):

This time around the world’s central banks have a new set of tools. In past cycles money was mostly gold and silver, which is to say it was real and in limited supply. Credit might have been flexible because of fractional reserve banking, but the money at the base of the financial system couldn’t be created out of thin air. Today, in contrast, it can. Since the US broke the final link between national currencies and gold in 1971, everyone has been running fiat currencies that can be created in infinite quantities and depend for their value on the trust we place in the competence and honesty of our leaders.

Indeed, the primary reason proponents urge a return to a gold standard is to contain the money supply and indirectly, the credit market and the economy. The effect on the economy we will put aside, but we do want to consider the relationship between base money and the total money supply and the credit market.

Flash Point: How to Spot Hyperinflation

We maintain that hyperinflation is not just a case of large-scale price inflation but essentially, a loss of confidence in the currency causing holders of currency units to immediately convert them into hard assets. This creates a positive feedback loop that exacerbates the runaway price problem (our use of the term ‘positive feedback’ is the correct usage and counter to how most pundits use the term. See Negative Feedback, theTragedy of the Commons, and Complex Systems).

The economic measure of this is called the “velocity of money” or the number of times it changes hands in the economy. If the velocity grows sharply then we should become concerned that we may be on the edge of hyperinflation. So where does the US stand? Consider the following graph:

Figure 1. Velocity of the M2 money stock. Click to open in a new window.

For the broadest measure of the money supply, M2’s velocity has been decreasing since the late 1990s and is currently at record lows for the period the available data covers. Velocity is a calculated rather than a measured quantity and is the ratio of nominal GDP to M2. The interpretation is that the money supply has been growing faster than GDP since the late 1990s. Or in the interpretation of velocity, the rate of circulation of available money in the economy has been slowing. Should this begin to show a large sharp increase (upturn in the graph) then we would want to look for signs that hyperinflation might be emerging.

Comments on Gold for Currency Purposes

In a private communication with our friend JR we wrote

Again we go back to people with an agenda or bias – they don’t think. The article [] identifies the single advantage fiat currency has over a fixed base currency – the ability to create more on demand. Fiat currencies collapse when the multiplication gets out of control. Until that point they are fine. Gold-backed currencies collapse when the sovereign has a sudden need for more money and the fixed-base doesn’t have the flexibility to allow this. Look at the last hundred or so years of the so-called gold standard. Countries were forced off it when they needed a sudden expansion of the money supply to fight a war. Both the US and Europe have this in their past.

As we have observed before, every PM-based [precious metals] currency has collapsed because the sovereign has always found a way to expand the supply (debase it). This should give the advocates looking for a golden nirvana pause – but it doesn’t. They don’t think. The empirical evidence is that ALL currencies collapse. Some survive longer than others but they all go to that currency graveyard in the sky.

In this post we answer some of his subsequent questions and then move onto some current thoughts on PM-backed currencies.

Understanding Money: Part 5 – It’s All Money

This part has been under pen for more than a year. This has given us time to reflect on and clarify our thoughts on money. The result is unconventional but has brought clarity to many issues for us. These will be explored in later essays on the Fed and quantitative easing (QE).

A Swiss Gold-backed Currency? Don’t Bet Your Bottom (Fiat) Dollar On It

In two posts, Gold: Always a Store of Value but Never a Currency and The Case for a Genuine Gold Dollar by Murray N. Rothbard – Commentary, we argued against the likelihood of gold or gold-backed currencies reemerging. Today, Egon von Greyerz, in a King World News blog article, mentions a Swiss initiative to try and introduce a 20% gold-backed currency. There is a very simple reason why the Swiss cannot do this on their own.

The Case for a Genuine Gold Dollar by Murray N. Rothbard – Commentary

When we recently encountered “The Case for a Genuine Gold Dollar” by Murray Rothbard, we decided it deserved a critical read and commentary, especially in the context of our post: “Gold: Always a Store of Value but Never a Currency“. Since the issue of gold or gold-backed currency will never die, any informed input to the debate is important. Ours follows:

Gold: Always a Store of Value but Never a Currency

We have been reflecting and writing on money lately. Now we turn to the question of can we return to gold or gold-backed currencies?

For a large part of human history, warfare has been motivated by and certainly directed at the acquisition of a neighboring country’s gold which represented a country’s wealth. Gold was the basis of a sovereign’s wealth and power and no sovereign, of today included, has ever had enough wealth. Until recent times, gold has been the predominate metal of currency, supported by silver and copper.

Gold Coinage As Currency

Consider an Archimedean experiment. Suppose all world currencies were in gold coins. Suppose we created a large balance such that all the gold coins in the world were on the left side and all the tangible assets in the world, ex gold, were on the right side. Suppose the balance were constructed so it was initially in equilibrium (balanced) and what the balance is measuring is value.

If we multiplied the face values or denominations of the gold coins by their numbers and added them up, we would have the value of all the money in the world.

Since it takes years (typically 5 at a minimum) and huge amounts of money (typically half to multiple billions of dollars) to explore for, develop and put into production new gold deposits, the increase in the gold supply is at a slow, fairly fixed rate. The total value of money on the left side of the balance grows slowly and cannot be accelerated to any extent.

The quantity of tangible assets or durable goods (we will ignore services for our simple example) on the other hand has expanded much faster through industrialization and the utilization of modern technologies. The output per unit of labour in virtually all industries and agriculture has been increasing steadily for centuries. The total value of assets at a fixed price on the right side grows faster than the value of gold on the left.

The experiment we have created would move away from the initial equilibrium or balance quite quickly. A free market would restore balance naturally, but let’s see what we would have to do if we wanted to maintain the balance ourselves.  We would have to increase value on the left side or decrease value on the right side. Let’s look at the left side first.

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