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March
7, 2007
By:
Antal E. Fekete
Gold
Standard University
aefekete@hotmail.com
Introduction
The
Inaugural Session of Gold Standard University
was successfully completed at the Martineum
Academy in Szombathely, Hungary, in February,
2007. By unanimous request the original
program Gold and Interest was extended
to include Basis as well. As those who follow
my writings on the Internet well know, basis
is the difference between the nearest futures
price and the spot price. The gold basis
is one of the most sensitive economic indicators
with a seismographic predictive power. In
particular, if taken in conjunction with
other indicators such as the silver basis,
volume, open interest, and the lease rates
for the monetary metals, it is capable of
predicting the beginning of the disintegration
of the world's payments system. No other
scientific method of early warning can come
close. Moreover, basis could also be used
as the guiding star of bimetallic arbitrage
between the gold and silver market. If you
have a program to accumulate monetary metals,
then the basis will tell you which account
you should increase at any particular moment
in time, in order to maximize the efficiency
of accumulation. You always go after the
metal with the wider basis.
It
is nothing short of amazing that all the
websites which concern themselves with the
analysis of gold and silver, with the remarkable
exception of www.silveraxis.com,
ignore the basis in spite of my repeated
prodding to start tracking and reporting
it. I have now proof that this is not due
to lack of demand. Accordingly, I have made
the announcement that at the next session
of Gold Standard University scheduled at
the Martineum for August 15-31, 2007, we
will present a blue-ribbon panel discussion
with the title Last Contango: First Sign
of Disintegration of the World's Payments
System. The present essay is a primer
for prospective participants.
The
Janus-face of marketability
Gold,
interest, and basis are strongly inter-related.
At the Inaugural Session we have covered
the concept of marketability. Gold
and silver have become money through an
evolution as the most marketable goods.
In more details, gold is most marketable
in the large. This can also be expressed
by saying that gold is more saleable
than any other commodity. Silver is most
marketable in the small. This can
also be expressed by saying that silver,
along with gold, is more hoardable
than any other commodity. The Janus-face
of marketability can be observed if we contemplate
that gold is the preferred agent when one
has to transfer value over space.
The preferred agent in transferring value
over time is silver followed by gold.
We may clearly recognize the dual nature
of money throughout history. In the ancient
world money was cattle and salt. Cattle
was most marketable in the large, while
salt was most marketable in the small. Later
two other commodities, far more similar
to one another, took over these functions,
but the dual nature of money has been maintained
to this day, in spite of the silver and
gold demonetization farce. This is no accident.
Duality has to do with the paramount fact
that space and time are absolute categories
of human thought.
A
new theory of interest
Hoardability
leads directly to the concept of interest,
which arises out of the desideratum to optimize
conversion of income into wealth and wealth
into income. In choosing the conversion
problem as our point of departure to develop
a new theory of interest we have deliberately
discarded the old-line theory based on the
exchange of present for future goods that
assumes, wrongly, that without exception
a present good is valued more highly than
an equivalent quantity and quality of future
good. A more careful analysis shows that
this is true only if the delivery of the
various factors to the site of production
or consumption is dove-tailed. Early delivery
may result in a loss.
The
solution to our optimization problem answers
two of the greatest of human needs: providing
for one's old age, and planning for the
education of one's offspring. If the conversion
of income into wealth is done through hoarding,
and the reverse conversion through dishoarding
- a process also known as direct conversion
- then optimum is achieved by choosing the
most hoardable commodity as agent of conversion.
However, direct conversion can be further
improved upon, by passing to indirect
conversion, through the agency of exchange.
Typically, a younger man will give up part
of his income in exchange for part of the
wealth of an older, as the former is anxious
to go into business for himself for which
the latter puts up the capital. Then interest
appears as the value of improvement in efficiency
through the exchange over direct conversion.
In particular, direct conversion means zero
interest. By contrast, interest becomes
positive if social arrangements admit indirect
conversion.
The
following point is important. The nexus
between gold and interest is established
by the fact that if indirect conversion
is hampered by secular or canonical proscriptions
(e.g., usury laws), the economizing individual
is not helpless. He can still achieve his
goals by falling back on direct conversion
through hoarding or dishoarding gold. He
will do that even in the absence of proscription.
In case interest is suppressed by the banks
or the government, he will hoard gold in
protest, and dishoard it as the rate of
interest is subsequently allowed to rise.
Thus gold is the agent to validate one's
time preference. This aspect of gold
is almost always ignored by authors, including
Ludwig von Mises to whom gold hoarding is
a "deus ex machina". He
failed to see that time preference would
hardly amount to more than a pious wish
if gold hoarding did not give it teeth.
Moreover, this is true whether on
a gold standard or off. When on,
gold hoarding means withdrawal of bank reserves
whereby the individual forces the banks
to adjust their lending rate to the rate
of marginal time preference. The main excellence
of the gold standard is that it makes the
adjustment crisis-free. When off, hoarding
makes the gold price soar, leading to a
monetary crisis. The upshot is the same:
higher interest rates. The difference is
that adjustment is made in a crisis-prone
environment. Moreover, it generates a swinging
interest rate structure that is most damaging
to savers and producers.
Gold
hoarding provides an escape for the individual
from the harsh consequences of the predatory
monetary and credit policies of the banks
and the government as they plunge society
into debt slavery. In the absence of the
safeguards of a gold standard debt slavery
is inevitable for those who fail to use
the only prophylactic available: gold.
Paper
boat on uncharted waters
Let
us turn from the nexus between gold and
interest to the nexus between interest and
basis. Mainstream economics made a fatal
mistake when it failed to study the consequences
of the emergence of the futures markets
in monetary metals. It was not a spontaneous
failure. It was inspired by the banks and
the government that have taken upon themselves
the "burden" of financing research.
They have a hidden agenda: to keep the public
in deep ignorance and stupor.
Recall
that there are no futures markets in monetary
metals under a gold standard for lack of
volatility, without which speculation cannot
be profitable. But no sooner had volatility
appeared than futures markets in silver
and gold sprang up. As they did, a whole
new field of tantalizing research opened
up for investigation. Unfortunately, what
it shows is an appalling and scary prospect
for the Brave New World of global irredeemable
currency. It shows dissipation and destruction
of capital on a large scale through falling
interest rates, and the drying up of new
savings through rising interest rates.
This is the first time ever in history that
irredeemable currency has been foisted upon
the entire world, causing the rate
of interest to gyrate. Humanity was herded
aboard a paper boat named "Dollar"
and tossed onto a stormy sea with no anchor
on hand. No wonder that the powers that
be are anxious to put research under taboo.
It is in their interest that the public
stay in blissful ignorance about the fact
that the captain of their paper boat has
no navigational instruments while sailing
on uncharted waters. Gold Standard University
is the first to defy that taboo.
Primer
on basis
The
condition that obtains when the futures
price is above the spot, or the more distant
futures price is above the nearby, is called
contango and, the opposite, backwardation.
Thus the basis is positive or negative according
as the spot market is in contango or in
backwardation. The prevalence of contango
is a necessary condition for the warehousing
business. Unless there is an expectation
for contango to return after sporadic and
temporary backwardation, warehousemen would
go out of business and supplies for future
delivery would be all but unavailable.
The
question arises what determines the basis.
On the upside it is limited by carrying
charges including freight, storage, insurance,
and interest. In the case of gold and silver
the lion's share is interest. On the downside
there is no limit: theoretically
the basis can go negative and keep falling
indefinitely. It indicates that a tightening
supply is facing increasing demand. Ever
larger number of sellers withdraw their
offer to sell. This is the basis risk:
the risk of hedging inventory in the futures
market. The cash price may start going up
faster than futures prices forcing hedgers
to take an opportunity loss on inventory.
A contemporary example is Barrick Gold
Company with a phony hedge plan losing
tons of shareholder money. Note that price
risk behaves the other way round. It
is limited in the downside (as the price
cannot fall below zero) but is unlimited
in the upside (as there is no theoretical
limit above which the price may not rise).
Interest
and marginal utility
The
monetary metals are characterized by great
stores above ground. The stock-to-flows
ratio is a large multiple for gold. Silver
analysts deny that the same holds for silver.
They are at a loss to account for the disappearance
of huge stockpiles of U.S. official silver
in any other way but assuming that it has
been dissipated through consumption. There
is no hard evidence that this is indeed
the case. We can account for the disappearance
of monetary silver through a more plausible
hypothesis, namely, that most of it has
gone into hiding. It shall resurface at
the right time and right price, as indeed
some of it already has after the silver
price hit a high of 15 dollars per ounce.
The
case is different for non-monetary commodities.
Here the stock-to-flows ratio is a small
fraction. The reason is declining marginal
utility in contrast with monetary metals
with near-constant marginal utility. Mises
argues that constant marginal utility is
contradictory because it implies infinite
demand. He is plainly in the wrong. He ignores
the nexus between gold and interest. In
more details, interest acts as obstruction
to gold hoarding. Demand for non-monetary
commodities is limited by declining marginal
utility. By contrast, demand for monetary
commodities can indeed become arbitrarily
large, but only if interest is suppressed
by the banks and the government. Thus interest
is an exclusive characteristic of monetary
commodities. John Maynard Keynes made a
colossal blunder when he kept talking about
the "wheat-rate of interest",
"coal-rate of interest", etc.
Interest can only exist in relation to a
monetary metal with constant marginal utility.
The marginal utility of wheat and coal declines
very fast indeed.
"It
takes three to contango"
Keynes
made another terrible blunder when he talked
about what he called normal backwardation.
To him backwardation was the natural state
of the markets, and contango, the aberration.
He argued that speculators "charge
an insurance premium" for shouldering
the price risk while carrying the commodity
for future delivery. It is this premium
that shows up in the futures price as backwardation.
This shallow theorizing faithfully reflects
the Keynesian mindset that is haunted by
visions of overproduction, market gluts,
deflations, depressions, unemployment, in
one word: the "curse of capitalism".
The fact, however, is that ours is a world
of scarce resources. Man is engaged in a
constant struggle to overcome the niggardliness
of nature. In particular, he has to have
foresight to provide for future needs. If
he succeeds, then future goods will be available
to meet future demand in adequate quantities
at the right time. This would not be possible
without the services of the warehouseman
and without contango in the futures market.
We express this by saying that "it
takes three to contango": the producer,
the warehouseman, and the speculator. Keynes
got it all wrong when he blithely ignored
the second member of the troika.
Hoarding
is not a dirty word, least of all gold hoarding,
in spite of dark hints to that effect dropped
by Keynes. The essential services of the
warehouseman must be studied seriously and
without prejudice on the same footing as
those of the producer. The marginal bondholder
who decides to sell his bonds in protest
against low interest rates, and to invest
the proceeds in gold, must not be depicted
as Scrooge. He is a legitimate warehouseman
who carries the hard core of social savings
at a time when banks behave like drunken
sailors on leave at the waterfront, and
governments engage in compulsive overspending
as if there was no tomorrow. The resulting
capital destruction is appalling. After
Armageddon no one but the warehouseman,
alias gold investor, will be in the
position to supply capital for reconstruction.
Thank heaven for goldbugs. Without them
we would have to go back and start from
scratch as cavemen.
Backwardation
can certainly occur, in particular, when
supplies are drawn down just before the
new crop of agricultural goods is ready
to be brought in. However, backwardation
for monetary metals is a gross anomaly,
a red alert indicating potential breakdown
of the payments system in the not-too-distant
future. Gold Standard University has championed
the cause of researching this vital topic.
It proposes to study the basis in conjunction
with other market indicators such as lease
rates and the yield curve with its various
types of inversion. This research should
help people escape the worst when catastrophe
strikes. Forewarned is forearmed.
Lysenkoism
- American style
The
reason why mainstream economics is silent
on the subject of gold, interest, and basis
is that the interplay of these reveals the
incredible mismanagement of the economy
in the twentieth century, as well as the
corruption of the monetary and credit system
by the banks and by the government in the
twenty-first. Universities no longer serve
the cause of search for and dissemination
of truth. Instead, they provide refuge for
a reactionary conspiracy trying to cover
up mismanagement and corruption reinforced
by seventy years of Keynesian and thirty-five
years of Friedmanite brainwashing. No university
in the entire world, save Gold Standard
University, is prepared to study in a detached
manner the subject of gold, interest, basis,
and the theory of warehousing as it applies
to the hoarding of monetary metals. Universities
betrayed people anxious to secure their
economic survival in the face of untold
dangers, as indicated by the Babeldom of
runaway debt and exploding derivatives markets.
Rather, they are serving the interest of
their paymasters.
History
will not be kind to mainstream economists.
Keynes, Friedman, and their followers will
be lumped together with Soviet biologist
Lysenko, stooge and sycophant of Stalin.
Lysenko sent his fellow biologists to the
Gulag, never to be heard from again, for
opposing his hare-brained theories of genetics.
Lysenko betrayed science as he betrayed
humanity. He was, no less than Stalin, a
monster.
The
Quantity Theory of Money
I
have never subscribed to the Quantity Theory
of Money, nor have I ever believed that
the downfall of the regime of irredeemable
currency must necessarily take the form
of hyperinflation. It could, of course,
in the wake of wars and revolutions destroying
supplies of goods and facilities of production.
But the Quantity Theory of Money is a linear
model that is wholly inapplicable to our
highly non-linear world, now at the peak
of its productive powers. The dénouement
of the present global experiment with irredeemable
currency is not likely to involve hyperinflation
(assuming that the world will not be plunged
into another World War). Unfortunately,
a lot of innocent people will be led astray
and ruined financially by the nearly unanimous
propaganda predicated upon the Quantity
Theory prophesying hyperinflation.
In
order to see what is happening to our money
a more sophisticated theory is needed. The
new theory must assume a thorough understanding
of both monetary metals, warehousing, futures
markets, basis. We must also have a new
theory of interest that takes gold into
full account. We must develop a non-linear
model for the global world economy. This
is what the Gold Standard University has
set out to do. It exposes the central fallacy
of mainstream economics in assuming that
producers will forever put up with the plundering
of capital accounts through falling interest
rates while meekly accepting irredeemable
promises to pay in exchange for real goods
and real services, and that savers will
forever put up with the pilfering of savings
accounts through rising interest rates while
meekly turning over their right pocket when
the banks and the government finished picking
clean the left. Producers and savers will
rise in protest. They will unite in demanding
a stable interest-rate structure. Only a
gold standard can eliminate the plundering
of capital accounts and the pilfering of
savings accounts, thus securing social peace.
In
the same order of ideas, it is a grave mistake
to explain rising gold and silver prices
in terms of the supply/demand equilibrium
model. There is simply no scientific way
to define speculative supply and demand
applicable to the monetary metals. This
being the case, the model is meaningless.
Speculators jump back and forth between
the supply and demand side of the market
on a moment's notice and, when they do,
they are likely to act en bloc. The
only thing that the supply/demand equilibrium
model can predict is the ever increasing
volatility of the price of monetary metals.
Bull
in bear's skin
We
must also exorcise the boogeyman of silver
analysts: the naked short seller of monetary
metals. The inordinate short interest in
the futures markets is better explained
in terms of the activities of a market maker
whom I call "bull in bear's skin".
Typically, he is a super-wealthy individual
who has learned the trick how to derive
an income in gold on gold - even
while retaining physical control over his
holdings. He is not a naked seller by any
stretch of the imagination. He does have
the gold and silver, but keeps them at a
safe distance from the commodity exchange
and its predatory policies favoring the
shorts at the expense of the longs. To his
mind it pays to pose as a short. He hides
his full armour underneath a mask showing
him naked.
The
proposition that it is possible to earn
an income in silver on silver without relinquishing
physical control of the stuff may sound
like gaining something out of nothing, contradicting
the Principle of Conservation of Matter
and Energy. Yet we should not be too hasty
in dismissing this possibility. It is true
that income and risk go hand-in-hand. Income
is the reward for consistently successful
risk-taking. Show me a man who can generate
an income without taking risks, and I show
you one who has invented perpetual motion.
Yet
there is no contradiction here. Paradoxically,
it was mainstream economists themselves
who made this black art possible. They promoted
the regime of irredeemable currency with
the result that the gold price fluctuates.
The upshot of it all was that those intelligent
enough to keep their book in terms of gold
units rather than units representing irredeemable
promises can indeed earn an income in gold
on gold, even without relinquishing the
metal thereby incurring the risk of losing
it. To understand this we only need to refer
to the possibility of harnessing the energy
represented by the flow and ebb of water
in the oceans. Likewise, it is possible
to harness the energy represented by the
fluctuating price of gold and silver. The
best way of doing this is to keep accumulating
both monetary metals while maximizing the
efficiency of hoarding. This means that
one always buys the metal the hoarding of
which is more efficient at the given price.
But how to determine the relative efficiency
of warehousing different goods as a function
of price? This is the same dilemma facing
the elevator operator when he buys grain
at harvest time. Should he buy more wheat
or more corn? Should he sell one in order
to make more room for the other? The price
could easily mislead him. The basis would
not. He solves the problem by always buying
the grain with the wider basis. In this
way he maximizes the efficiency of warehousing
operation.
What
to silver analysts appears as naked short
selling is more likely the activities of
bulls in bear's skin. It is the tip of the
iceberg that can be seen. What is not seen,
the bulk of the iceberg, is dynamic hedging
of ever increasing gold and silver hoards,
and covered option writing, where the principal
wants to stay anonymous. Needless to say
the bull in bear's skin is actually very
happy that analysts believe, and spread
the belief, that he is naked short. The
longer he can keep his "cover"
as being "naked", the better it
is for his operations.
It
is futile and puerile to wait for the naked
shorts to cover in a panic, sending the
price through the roof. Cover yes, panic
no. Make no mistake, this does not mean
that the price may not go through the roof,
but if it does, then it is also likely to
go through the floor next time around when
the pendulum swings back. It means that
volatility is increasing. The get-rich-quick
crowd, those who are "insanely bullish
on silver" waiting for the miracle
of the silver price going to four digits
overnight, will be frustrated. Rewards will
go to the patient and industrious observer
taking pains to study the market, and who
has the right strategy that can handle the
ever-increasing swings in the price both
ways. He will not be dislodged from
his long position when the pendulum swings
back. He doesn't subscribe to linear models.
His guiding star is the non-linear model
of the variation of basis.
Gold
Standard University is working out a strategy
following these principles, one applicable
to small and big investors alike. It will
be unveiled during the next session in August,
2007. At this point let's just say that
the strategy is essentially bimetallic arbitrage,
but it uses the basis rather than the bimetallic
ratio for clues.
Conservation
of matter and energy
But
how do we answer the objection that our
proposed scheme contradicts the Principle
of Conservation of Matter and Energy? Simple.
We don't. We might as well admit up front
that the contradiction is real. Chalk it
up as an unintended gift from the managers
of the regime of irredeemable currency.
Helicopter Ben has air-dropped manna to
the enemy camp by mistake. Nor can he help
but keep doing it. His navigation system
is all screwed up.
The
gold standard, when in force, is an instant
reward/penalty system that rules out income
generated without risk. Were our schools
allowed to teach economics properly, the
electorate would know this and it would
demand the immediate scrapping of irredeemable
currency as the most wasteful and iniquitous
monetary system imaginable. It would also
demand the immediate reinstatement of the
gold standard as the only monetary system
serving even-handed economic justice. Under
a gold standard foreign exchange and interest
rates are stable. So is the price of monetary
commodities. There is no profit in gold,
silver, and bond speculation. Interest rate
derivatives and bond futures are unknown.
Debt is reined in by the ability to service
it. Banks cannot lend long while borrowing
short with impunity. When they lend short,
they are limited by their quick assets.
Under the gold standard all economic risks
are created by nature, none by man. Risks
created by nature are clearly separated
from risks created by man as the first are
addressed on the floor of the commodity
exchange and, the second, in the gambling
casino. Under the gold standard Helicopter
Ben belongs to fairy tales, not to banking,
let alone central banking.
The
regime of irredeemable currency builds on
ignorance. As it defies natural law, it
is digging its own grave. This is the true
explanation of the coming crack-up boom,
not the "overissuing" of the currency.
The currency was overissued already a hundred
years ago. What needs to be explained is
the lag.
References
A.E.Fekete,
What
Gold and Silver Analysts Overlook,
www.gold-eagle.com, May 4, 2004
...,
Bull
in Bear's Skin?, www.gold-eagle.com,
May 4, 2006
...,
Ultracrepidarian
Musings, www.gold-eagle.com, May
11, 2006
...,
The
Last Contango in Washington, www.gold-eagle.com,
June 3, 2006
...,
The
Rise and Fall of the Gold Basis,
www.gold-eagle.com, June 23, 2006
...,
Monetary
versus Non-Monetary Commodities,
www.financialsense.com, June 25, 2006
Tom
Szabo, The
Silver Basis, www.silveraxis.com
Further
information on Gold Standard University
can be obtained by writing to: GSUL@t-online.hu
Copyright
© 2007 by A.E.Fekete. All rights reserved.
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