Submitted by Thad Beversdorf, Chief Economist – ABX / Bullion Capital
So last week a very savvy investor asked me my view (h/t Simon Popple) on – When and what will break the chains on gold by those seemingly omnipotent forces that so assuredly keep its price in check? In essence, the belief is (and I expect for most honest and impartial analysts this is true) that because there is potentially significant downside risk to a global monetary system built upon a currency to which gold represents the proverbial kryptonite (we’ll discuss why), there are checks in place within the system, to ensure that kryptonite doesn’t become too potent. The architects of the existing system would have been foolish not to implement checks on gold.
And due to traditional physical gold transactions being cumbersome in a world of click, point and trade, checks on gold come surprisingly simple (paper market). However, there now exists a broadening network of architects (think China’s Silk Road Fund, gold ATM’s in Dubai and electronic exchanges like Allocated Bullion Exchange) creating a modernized electronic infrastructure where physical gold transacts as efficiently as all other financial markets but while maintaining the inherent intrinsic and enduring value. Modern logistics for a monetary system with 5000 years of staying power will make it incredibly difficult to rebuild checks on gold subsequent to the death of the Fed.
Below I will provide the Hypothesis, Groundwork, Empirical Evidence and Conclusion that will speak to the title of this essay. With that, grab a coffee and enjoy!
The monetary system enacted in 1913 (and all fiat monetary systems), issuing currency backed by interest bearing indenture, was fatally flawed due to a requirement for its very survival to create an ever-increasing stock of money, without also providing the means for perfect investment, resulting in a system where debt ultimately consumes all profits and labour over time. A system only a banker could love. Because such a system is predicated on devaluation (by its requirement for perpetual growth in money stock) and because that sealed its fate, the system’s end was perfectly predictable upon its inception.
The system’s fatal flaw is inherent in that its very survival necessitates that each dollar supplied requires more than a dollar returned. With that the economy necessarily became a mechanism for ever increasing trade (cash) flow (a banking objective and function), conflicting with its natural mechanism as a means to a rising standard of living (a societal objective and function). The result being an unsustainable build up of debt by way of artificial money creation, which would force economic inefficiencies such that capital allocators would necessarily forsake labour for profits – an unnatural behaviour given labour (i.e. consumer) is the subsistence of profits in the same way profit (i.e. employer) is the subsistence of labour.
With that natural bond broken, the economy would become an impediment rather than a mechanism for growth. Ultimately the amassing inefficiencies overwhelm the monetary system’s ability to make adequate adjustments, transitioning it to the final stage of mass contraction (economic cannibalism – we have now entered this stage) and then death. This will result, as it always does upon the breakdown of intrinsically valueless currency systems, in gold’s chains being broken. Once again establishing gold as the basis for both transactional currency and storage of wealth (as we saw during the 1930’s banking crisis and then more recently with gold’s meteoric price rise post 2008 banking crisis).
This may sound like quite a grand hypothesis and I can see the monetarist disciples rolling their eyes already (as a Booth grad I know how you think!); and so to give the non believers a glimpse at the validity of the hypothesis, allow me to provide a quick observable microcosm lending significant credence to the subject hypothesis before we get started. Think about the 2008 credit crisis. The entire debacle began when policymakers decided to artificially create value out of nothing. That is, they wanted to create housing wealth to those that had not earned it as evidenced in the following excerpt from “The National Homeownership Strategy: Partners in the American Dream”, which was the Clinton Administration official proposal to the banking sector that kicked off the entire housing disaster.
“For many potential homebuyers, the lack of cash available to accumulate the required downpayment and closing costs is the major impediment to purchasing a home. Other households do not have sufficient available income to make the monthly payments on mortgages financed at market interest rates for standard loan terms. Financing strategies, fueled by the creativity and resources of the private and public sectors, should address both of these financial barriers to homeownership.”
And so false value was created but to each dollar of false value created was attached a very real obligation that required repayment of that dollar plus interest. And so despite an increase in trade flow (housing by way of mortgage, and consumer expenditures via inflated housing equity) the system predictably failed to achieve the only (impossible) premise for which the system relied on for its survival, namely perpetually increasing property values. And so the system collapsed as was entirely predictable.
As we know, the false value or the illusion of wealth creation ended with total wealth for 90% of the US falling by 40% (a staggering statistic that remains unimproved even 6 years on). The thing to understand is that this was entirely predicable and was predicted by Ron Paul in a 2001 speech to Congress (and Peter Schiff, and many others subsequently). The point being the system was fatally flawed from its very birth and so its death was, in fact, absolute and predictable. There was no uncertainty as to its fate, as the system design necessitated its own end. I will show that inherent within our monetary system exists a similar fatal flaw and predictable end.
The (Required) Groundwork
Now to truly grasp the when and what it is imperative to understand the how and why underlying the monetary system and it’s inherent fatal flaw. To do so requires laying some groundwork. And so let’s begin….
I believe a useful way to understand gold and its interrelatedness to the financial, economic and markets universe is as a physicist understands gravity in the physical universe. Relative to other forces it appears mostly passive and almost tepid. Something we pay little mind to despite being cognisant it is always there in the background. That said, gravity is ubiquitous and despite generally remaining on the “no danger” end of its continuum, given the right physical scenario (e.g. supernova), it becomes perhaps the only force in the universe that can literally tear a whole in the fabric of the space-time temporal, creating a point called the event horizon beyond which its attraction simply overwhelms all other forces.
Generally gold has a similar character in that it is the one monetary force that has stood the existence of human trade and there is no corner of the financial economic universe in which gold is rejected. Further, given the right financial economic scenario its attraction becomes stronger than all other assets and we’ve seen this proven time and time again, for literally thousands of years. The architects of the fiat banking system themselves are among the worlds largest hoarders of physical gold. That very fact alone should resonate to the non believers as one simply cannot explain it away. Bernanke once stated to a Congressional Finance Committee that he believed the only reason banks bought physical gold was tradition. And he should have either been prosecuted or fired, as he was either lying or grossly ignorant about his own organisation’s activity. Continue reading