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Alasdair Macleod: Currency Crisis Dead Ahead

Introducing the 'Fiat Money Quantity' measure
Saturday, October 19, 2013, 9:23 PM

This week's podcast interview introduces a new monetary measurement developed by Alasdair Macleod: the 'Fiat Quantity of Money', or FMQ.

Alasdair explains how FMQ is derived, as well as what it can tell us about the true levels of fiat money supply. In the case of the dollar, it reveals that levels are far above what is commonly appreciated – so far, in fact, that a currency crisis could arrive sooner than even many dollar bears expect.

What 'Fiat Money Quantity' (FMQ) Is Signaling

I started off with the desire to put together a metric of money which allows me to compare sound money with fiat money. My approach to this was to look at what happens in how fiat money was created.

It originally involved the money substitute. In other words, you and I or our great-grandfathers or our great-great-grandfathers would deposit gold in the bank for safekeeping. The bank would give them either notes, which they could then cash anywhere where it was accepted where that bank's credit was valuable, or alternatively, it would give them an account – a deposit account – which would show that yes, the bank holds the gold on your behalf. That was the starting point. So that was how deposits and cash were originally created as money substitutes.

Then the next thing happened: Central banks were invented. What happened was that they took over the note-issuing monopoly. They were given, by the government, essentially a monopoly. In return for that, all of the banks within the central bank's system would take the gold that was originally deposited and move it into the central bank in return for – guess what? – deposit accounts and nice new bank notes.

So really what I wanted to do was to quantify that process [by creating the FQM]. It involved taking cash, all of these instant-access deposits, or deposits which are readily accessible, plus the deposits that the banks have at the central bank, because that is money just the same as your deposit account is in your bank; it is exactly the same in that sense. If you look at that, you get some very interesting statistics.

Going from 1960 to the month before the Lehman crisis in 2008, the average exponential growth rate was around about 5.9%, year in/year out. It followed that track very closely. Then of course we had TARP and all of the rest of it. And then we had QE. And guess what? The level of fiat-money quantity is now over 60% above that long-term trend line. Now, if we stand back unemotionally and look at that chart, we would say that this is monetary hyperinflation.

Here we have this situation now where the Central Bank, the Fed, is having to produce money to finance the government deficit. It’s having to produce money to keep interest rates down so that the banks don't have balance-sheet problems. And if it slows down in that production of money, and even if it doesn't increase the rate of the production of that money, then our world is going to come to a rather nasty halt.

It looks like not only are we in a debt trap, but we are in a hyperinflationary trap, potentially. We need someone who is really quite strong and understands these things to be able to stand on the system and say, no more!

So my question to you, Chris, is, can anyone do that? Do you think Janet Yellen will do that?

One of the things that's interesting in this, which I think is a dynamic that is going to play out over the next few months, is, here we are expanding a quantity of money hugely. But at the same time, what we're not seeing is the prices of raw materials, of things like that really reflecting that expansion of money. Now, there is always a time lag between the two effects. But actually we are seeing this effect on certain things, and in a way in which one would expect. That is that asset prices, particularly things like property, are beginning to rise.

What FMQ Indicates for Gold

The one thing which I think is being triggered is gold. We had a good rise today. We had about a $40 rise. Now I think that this is something quite significant, really, for a number of reasons, but if I go back to my FMQ (fiat money quantity), if I adjust the price of gold from just before Lehman Brothers went under, I think I'm right in saying that in July 2008, the price of gold at the close of that month was $918/ounce.

Now, if you adjust that price by the extra fiat money quantity that is now in circulation, gold has actually gone down, in real terms if you like, by about 30%. Put another way, if the price of gold was to match in real terms that $918 level, it would today be about $1,860. So we have this extraordinary thing where gold, for whatever reason, has become extremely undervalued compared to where it was before Lehman Brothers went under. Now this is important, because before Lehman Brothers went under, not many people actually understood systemic risk. So the price of gold did not really include the weighting for systemic risk.

The other thing I would say is that since then, with our FMQ having taken off, there is a substantial hyperinflation risk that is going to affect prices somewhere down the line. And yet, gold is trading at a discount of 30% to where it was before all of this happened, so it is horribly mispriced.

Click the play button below to listen to Chris Martenson's interview with Alasdair Macleod 45m:56s):

Transcript: 

Chris Martenson: Welcome to this Peak Prosperity podcast. Today I am very pleased to have Alasdair Macleod with me. Alasdair, it's so good to have you.

Alasdair Macleod: It's very nice to be on, Chris.

Chris Martenson: It's very nice to speak to you again. Well, listen, there's so much going on. Of course over here, the big drama, the sturm und drang in the United States is, it looks like they've passed a continuing resolution to allow the government to operate for just a little bit longer. Of course, there's massive relief everywhere in the equity markets. Not just a U.S. phenomenon; I believe the German DAX is hitting all time new highs, despite the fact that industrial production in the eurozone is down even from the peak in 2008.

So it looks to me like we've got just a can-kicking exercise, and the intention here is, we're just going push this along a little further. It looks very political. It looks very partisan. It looks like a lot of things, but what it doesn’t look to me is very substantial or in any way addressing anything structural. How do you see it from over there?

Alasdair Macleod: Well, I think rather like as you've described. There is another aspect that I would push into it. That is, that as the reserve currency, the currency that is used, I think I'm right in saying, in 87% of all of the world's trade transactions outside of the U.S., the brand of the U.S. dollar, the brand image, has taken a very nasty hit.

What is interesting is that you went through a list of all the markets that have risen today. You didn't mention the dollar has really fallen very sharply and gold has taken off. That probably says it all. The overseas bit, the overseas view, is that this is something which is basically not good. It doesn't do well for the future. I can understand, on the other hand, why foreign equity markets have done better, because we all dance to the dollar’s tune. If the dollar’s in trouble, we're in trouble. If the dollar’s sort of smelling of roses, we all cheer loudly. So the relief extends internationally. It's really as simple as that, Chris.

Chris Martenson: Well, Alasdair, the relief seems to have been relief that there was a rumor that this was all going to be solved. Relief, then, that there was another rumor, and another relief rally on the back of the idea that it would all be solved. Here we are at all-time new highs. That would seem to be predicated on the idea I'm trying to –

Okay, here's my problem. I can't find anything substantial; anything fundamental in this story following along with the narrative I'm supposed to follow along with, which is that there is something here that makes sense as to why we would want to be absolutely giddy, where bad news is good news, and good news is good news. There's no fundamental thing in this story I can find.

In fact, I have to be completely honest. I've seen this story before. I heard the same sorts of noises back when the housing prices were appreciating really strongly and back when the equity markets were doing this. I've been here before, Alasdair. This is bubble territory. I know what it looks like. Bad is good. Good is good. It doesn’t matter. Nothing matters until it does. So you're over there close to – I've been reading a lot about The London Property Market. There's nothing fundamentally right about that, is there?

Alasdair Macleod: Well, you're right to draw attention to that. The answer to the conundrum you just set is one thing, and that is the rapid expansion of the quantity of money. What's happening is not so much that asset prices are rising, but in terms of the available money for those asset classes, the purchasing power of that money is going down. I think the bubble is in money. It's not in the individual asset classes.

Now of course, if they were going to do something about this rapid expansion of money and stop it, then prices of property, stock-market shares, and all of that would quite obviously collapse. I can't see that that is going to happen, and I think the bet that everybody is now making is, now the can is being kicked down the road for another 11 weeks, actually we're not going to get any tapering whatsoever. You can forget that. All we have got is the prospect in the continuing production of money to keep interest rates at 0%. It's the money you've got to look at, rather than the asset classes themselves.

Chris Martenson: Ah! The money! It's always the money. This is a piece I've been arguing for a long time. I will confess right here to everybody, I am very surprised that a) it's gone on this long, b) that the quantities produced have been produced c) without some sort of massive flight away from this chimerical world into stuff that's more real. In fact, commodities are down quite a bit, except for oil. Commodities are down quite a bit. That would be the grains, the softs, gold and silver, and all sorts of things, which is really surprising to me, because when you look at the valuations that have been placed on financial assets, it's extraordinary. All of this can be explained through money. I read a very interesting article that you had written recently through GoldMoney, and it was talking about just comparing things to the total amount of fiat money out there. Can you explain that?

Alasdair Macleod: Yes. Absolutely! I'm trying to get a bit of a campaign on this one, so any airing of it, I'm very grateful for. Basically, I started off with this task, and that is to put together a metric of money which allows me to compare sound money with fiat money. My approach to this was to look at what happened in how fiat money was created.

It originally involved as, you know, the money substitute. In other words, you and I or our great-grandfathers or our great-great-grandfathers would take gold to the bank. We would deposit gold in the bank for safekeeping. The bank would give us either notes, which we could then cash anywhere where it was accepted where that bank's credit was valuable, or alternatively it would give us an account, a deposit account, which would show that yes, the bank holds the gold on behalf of Mr. Martenson. That was the starting point. So that was how deposits and cash were originally created as money substitutes.

Then the next thing happened: Central banks were invented. What happened was that they took over the note-issuing monopoly. They were given, by the government, essentially a monopoly. In return for that, all of the banks within the central bank's system would take the gold that was originally deposited and move it into the central bank in return for – guess what – deposit accounts and nice new bank notes.

So really what I wanted to do was to reverse that process or quantify that process. It involved taking cash, all of these instant-access deposits, or deposits which are readily accessible, plus the deposits that the banks have at the central bank, because that is money just the same as your deposit account is in your bank; it is exactly the same in that sense. And everybody includes this, but if you look at that, you get some very interesting statistics.

Going from 1960 to the month before the Lehman crisis in 2008, the average exponential growth rate was at 5.9%, or around about 5.9%, year in/year out. It followed that track very closely. Then of course we had TARP and all of the rest of it. And then we had QE. And guess what? The level of fiat-money quantity is now over 60% above that long-term trend line. Now, if we stand back unemotionally and look at that chart, we would say that this is monetary hyperinflation.

Here we have this situation now where the Central Bank, the Fed, is having to produce money to finance the government deficit. It’s having to produce money to keep interest rates down so that the banks don't have balance-sheet problems. And if it slows down in that production of money, and even if it doesn't increase the rate of the production of that money, then our world is going to come to a rather nasty halt.

It looks like not only are we in a debt trap, but we are in a hyperinflationary trap, potentially. We need someone who is really quite strong and understands these things to be able to stand on the system and say, no more!

So my question to you, Chris, is, can anyone do that? Do you think Janet Yellen will do that? I suspect I may be wrong, sir.

Chris Martenson: Let me think. I probably have to go into movie characters to figure out somebody who could do that. And I understand your point. I understand it well, this idea that we're 60% above even what I would consider. So 5.9%. Anything growing 5.9% per year, which, you mentioned, was the long-term or recent trend for monetary accumulation, that's an exponential function. I'm going to do some math in my head and call it 6% and make it easy on myself. That means every 13 to 14 years, it’s going to be doubling, fully doubling.

And of course, now when we look at the average income, the real wage of an average person, we can go back much more than 13 or 14 years and find out that hasn't doubled. In fact, it's dead flat. So what you're talking about is this idea that what we're doing is, we're doubling the monetary base at what was once a 5.9% rate, and now we're 60% above that. I have to ask, is that a lot? But that means that we now have much faster doubling times.

And the Fed is doing all of this, I would submit, because it's the monetary system that requires it. You don't require it. I don’t require it. The people who are trying to live their lives and abide by the rules, they don't require it. Nobody requires it, but institutions do. The banks do. The Federal Reserve does. The politicians do. This is the Unholy Triumvirate that we're in. I think that's what got peeled back and exposed a little bit in this whole debacle in Washington, D.C. – which, by the way, is probably the same debacle playing out in Italy and Spain and Greece and Ireland and soon coming to a theater near you.

That is that we had this long-running idea that we could perpetually exponentially expand our money at a rate that was faster than underlying economic growth and that everything would somehow pencil out at the end, that's been exposed: a) as broken; lots of people are figuring that out now, but b) the level of dysfunction in our elected officials who have only known how to distribute ever larger pieces of a growing pie, are clueless, lost and lambs in the dark when it comes to what do we have to do when we have to prioritize and we can't promise everybody everything? That's really what I think got exposed here a little bit. And so what I love about what you're illustrating here is, listen, we can just take an objective measure of the monetary supply and look at that.

That tells us a couple of things. First, what should price levels of things be? Guess what? Those price levels, if history is any guide, will catch up to the monetary supply at some point; not the other way around! The second thing is that you can look at all of those many years, decades, of that monetary expansion, and understand that the people who are currently in power, that's all they know. It's like they grew up on the Moon, and you bring them to Earth, and gravity is just befuddling them. How do you see it?

Alasdair Macleod: I completely agree with what you're saying. One of the things that's interesting in this, which I think is a dynamic that is going to play out over the next few months, is, here we are expanding a quantity of money hugely. But at the same time, what we're not seeing is the prices of raw materials, of things like that really reflecting that expansion of money. Now, there is always a time lag between the two effects. But actually we are seeing this effect on certain things, and in a way in which one would expect. That is that asset prices, particularly things like property, are beginning to rise. I'd also draw your attention to the fact that prices in the financial centers for everything are considerably higher than they are elsewhere.

Now this is a reflection of the fact that bankers and lawyers and all of the rest of it are making an awful lot of money out of this policy from the central banks, and they're spending it, lately. They're spending it in the restaurants. They're spending it on improving their homes. They're spending it on buying new country homes. And all of the rest of it. So they drive up prices around them. And you can see this in New York. I just came back from London today, and my goodness, I see it in spirit in London. So this effect, which is called the Cantillon Effect, where prices rise where the new money goes in; we're beginning to see that, and it's spreading.

And I think it's spreading in two ways, in the U.K. anyway. I'd be interested to get your comment on the U.S. House prices are now beginning to move quite rapidly. They are moving very rapidly. London, and anywhere within commuting distance of London, that is now spreading away from London, so that houses that were difficult to shift are now beginning to shift in the market and deep in the country. The second thing I see is that the man in the street can see that new cars can be bought on zero credit. Now, this is a turnaround from how cars used to be sold. Car manufacturers over here used to make more money on the credit than they did after selling the car. Now what they're doing in order to shift stock is, they've cut cost of finance down to virtually zero and effectively incorporated the discount in the price of the car.

So what people are doing is they're saying to themselves, I can buy a brand new Volkswagen, or whatever it is, and the cost of finance from Volkswagen is going to be zero. Now if I take out a five-year loan, that can look very clever because interest rates are going to be higher in five years, so I think I should take the opportunity and buy a new motorcar. And that's what's happening. This is another way in which the whole of this production of money. All of this fiat money is beginning to leak into the economy. It will also, by the way, drive up GDP because all GDP is, is a money total. I think this is why people are getting a little more confident that we've got economic recovery. But on that, there's a secondary effect, which they're not taking into account.

It's going to make it very difficult for the managers in the central banks, and that is, as prices stop rising, what actually is happening to the people, the savers, the people of low-fixed salaries, what's happening is there's a wealth transfer from them into the lucky few who are close to the money spigot. Now that means that those people end up spending less, temporarily, at least. It also means that the businesses that service them, like some of the discount stores and so on and so forth, find their sales are hit, so they start laying off people.

The initial result of this, the wealth transfer effect, is that you end up with certainly a maintained level of high employment, and possibly even an increasing level of unemployment. So if you're the new chairman of the Fed, and you're following the unemployment statistics rather than the inflation statistics, you're probably going to be misled into thinking that the economy is not performing as it should, and you need more stimulus not less, whereas, if you understand the effect, then actually you should be really quite worried about the inflationary effect that is coming down the line. I think it is going to be a very interesting thing to see how it actually plays out. But that is an effect that I think we must bear in mind.

Chris Martenson: Those are great points. Not only did I expect the inflationary effect before now, I was hoping for it. The reason I was hoping for it is that what you're describing to me is stored energy. It's potential energy. Rather than releasing the earthquake early or the cornice on the mountaintop early, we're just storing it up, and there's just a vast quantity of energy stored up.

I know what the Fed thinks they're doing. They think they're in a tug of war between inflation and deflation, because they look at the CPI, which is also the same measure used in the U.K. now. But whatever your inflation measure is across the developed economies, people are looking at that. Japan, everywhere, they're going, Oh gosh! It looks like we're not really experiencing inflation! But this is because they don't put everything in that measure. They miss a lot of stuff.

To me, asset-price inflation is inflation. There is no way you can possibly convince me that a house is worth 20% more this year than last year because that's what it is worth. A house is a house. It's actually a depreciating asset. It's not an appreciating asset. It requires maintenance. It's something you will have to rebuild again. In business terms, you would capitalize it, you would write it off, and it would have a useful life, and it would go to zero. That's what real property actually is, capital property.

All of the central banks led by Greenspan back in the mid-1990s came to this idea that asset inflation – they called it a ‘wealth effect’ – they always talked about it in positive terms: When the stock market is going up, we're all getting wealthier, and when houses go up, we're all getting wealthier. Not true if you're a starting a family and you're trying to figure out how to afford that house. Not true if you live in a place like London, as you were just describing, where most people based on median income have no shot at buying in any economically useful or survivable terms the average house over there.

And so our central bankers have their blinkers on, and they say, Ah! This is great! Look at all of this incredible wealth creation we have! But it's not wealth creation. You said the exact right term. It is a wealth transfer. That is the process that's happening. That's the thing that we're seeing right now, and I submit there are two stages to the wealth transfer. There is the first stage where you have the Cantillon Effect, or seigniorage, however you want to describe it, but that effect, which says, those who are closest to the money printer, do the best. They get to siphon it off. First, they have first access to it. Second of all, they have different terms; more favorable terms. They get it at 0%. Third of all, they get to use it before prices begin to rise. So it's great for them.

But this is a really important point. If you could print real purchasing power out of thin air, it would have been discovered a long time ago. Nobody’s figured out how to do it because you can't do it. You can't print purchasing power out of thin air. But it looks like you do during the first stage. So the first stage, they print. Real purchasing power is created. It's handed out to people, but it's not really real, because it's been taken from people. Most people can't see where it's been taken from them, because the mechanism is a little slippery. It's a little hard to understand.

The second stage of this when the wealth transfer accelerates and becomes more complete. This is when the great impoverishment happens to most people, to the unwary, to the people who are not privy to the system. I think we're getting there. It probably still has a little longer to run. This isn't your granddaddy's bubble. This is the biggest bubble in the whole world. This isn’t constrained to railroads in Manitoa; this isn't constrained to Florida swampland. This isn't just housing in the U.S., or Spain, or parts of Ireland. This is global. This is for all of the chips.

Boy -is there an investment in belief systems? I believe most of the people I talk to would fall into this camp – they are not going to be willing to let go of that dream, because when it does, it's going to be pretty interesting what happens next, and that's where I think we get back to your total fiat money supply. I think it's as simple as that. Just add up how much money there is out there.

By money, I might also broaden that. I know you have a very complete, but I'm going to call it a fairly narrow, description, because those claims that you've identified on real stuff is just identifiable money, but people consider other things to be money, too, like sovereign bonds. They trade like money. They feel like money. There are certain banks who consider the derivative holding they have to be money. Anyway, there are all these tertiary claims on wealth, real wealth, houses, land, production factories, gold, silver, and you-name-it. The claims are accelerating. I think we've gone post-exponential – I'll have to find a new term –hyper-exponential.

It's amazing, and that's the world we live in, and that's the world where I think it's going to unfold over time. But for the people who can see it coming: It's happened before. There has to be a reckoning. There has to be a balance. All of the central banks, all of the politicians are hoping that the reckoning comes with really robust economic growth, and it hasn't happened. That much I hope we can all agree on. It hasn't happened!

Alasdair Macleod: That's right. You have described something which, at least, is two-dimensional chess, probably even three-dimensional chess. Let's throw in another dimension, and that is that central bankers do not actually understand prices. The reason I say this is that if you look at the currencies, they actually – as you and I will agree – are based entirely on confidence in the issuer of the currency. It is not like gold, where people will have an idea of value of the currency irrespective of where they live in the world. With currency, it only has currency within the jurisdiction for which it is issued, and I'll put aside the reserve currency and things for the sake of this argument.

So what this means is that you have got two groups of people who could take a rather sudden and different view on its purchasing power. You’ve got the foreign exchanges, and you’ve got the actual users, domestic users. Now the foreign exchanges illustrated this point when Iceland got into difficulties at the time of the Lehman crisis. In fact, it was virtually at the same time, I think it was the Fall of 2008, and between one Friday night and mid-morning the following Monday, the króna halved, literally. It just halved! Now as far as we're aware, no krónas were issued. Or, no Icelandic krónas were issued in order to achieve that halving. It was a fact that came out of the foreign exchanges.

So we have a banking crisis potentially around our necks at the moment. We ought to bear that in mind. That is a currency effect when the foreign exchanges decide that there is risk in a currency. Now that really overrides any idea of the Quantity Theory of money.

Now this is something which I do not think that the central bankers really understand. So what we could have is a sudden collapse in the purchasing power of the currency. That's the way in which you should look at all of these things. It's not a question of prices of goods going up; it's a question of the currency's purchasing power going down. That's the thing that we've got to watch out for.

And if we see that beginning to happen, particularly on the domestic front, the first warning will probably come in the foreign exchanges, which are why I think the move in the dollar today is interesting, and certainly more than that at this stage. But what I'm looking for eventually is that, at some stage, people, like ordinary Americans, are going to start thinking that it's not prices going up, it's their money going down. Now, as that psychology gets hold, then there is actually no hope for the currency. So that is something we have to look out for, Chris.

Chris Martenson: I totally agree. I was reading an interview with a major hedge-fund kind of guy recently, and he noted that of all of the clients he was aware of, 0% of them were in any way hedged or prepared for inflation. So, inflation being the catch-all term, but again, as you said, inflation; not rising prices. But his clients were not yet positioned for the idea of falling value of their money. But the pressures are there. When you look at real economic growth, and you look at what's really happening, and where we really are; you look at, honestly, where we are with industrial production; where we are with all of that. And then you compare that to the claims that are being manufactured, it's extraordinary to build up. Huge! And it just it boggles my mind that people who – politicians, fine. The Federal Reserve? I don’t know the composition necessarily with the ECB or the Bank of Japan as clearly as I do.

But in the Federal Reserve, they're all academics or government types; none of them, as far as I'm aware, have ever actually truly run a business, or operated in a market, trading on a daily basis. So they have a fairly, I'm going to call it, isolated view of the world, but when we look at where the rest of the world is going to be, I'm really shocked by pension-fund managers, hedge-fund mangers, people who have big money and family funds who are looking at all of this, going, Yes, I'll just keep playing this game with 100% of my assets like I'm fully invested. You've got, you know, fancy sophisticated strategies. You're in stock. You're in bonds. You've got derivatives. You're hedged. You're across markets. You do all of that, but if 100% of your wealth is tied up in claims on what I'm going to call ‘real wealth,’ then you're still 100% invested in this whole system.

So it feels to me like we're in a really massive game of Musical Chairs. And everybody is pretty convinced that they'll be able to grab a seat when they need one. I'm not as certain of that. I'm wondering where even a light amount of fiduciary duty doesn't even seem to have crept in. When I look at the prospectuses of fairly large funds I can view, many of them have 0% dedicated to hard assets. They think they're in commodities because they own so few shares of ADM (Archers Daniels Midland) or some Monsanto or something like that. But when I look at the companies who actually own hard assets, it's zero.

Alasdair Macleod: Yes. That's an interesting point. I think that the investment management community does have a problem, because, I mean, you pointed out that no one in the central bank seems to have any trading experience at the top. I think that's very true. I think the last governor of the Bank of England who had any trading experience was Eddie George. He just basically came up through the gold market, and he knew how to trade. He knew how to manage a market. We don't really have that nowadays.

The other thing that has changed really, over here, over the last 20 years, is that anyone in the markets now has degrees. They've got all sorts of degrees, and they've been taught by universities things which they would not have learned at their own trading board, and neither do they understand anything about trading.

So it's really at both ends. When it comes to investment management, the whole investment management community is now dancing to regulators tune. What really matters to them more than anything else is keeping the regulators sweet, and the customer and the clients come second. So much so that if we're talking about hard assets, they won't invest in physical gold for the simple reason that, believe it or not, over here in Europe, physical gold is not a regulated investment, and they are employed to manage regulated investments, so they won't do it.

So you can see that there's a sort of myopia in all of this, which actually – it's degenerate. It deserves to fail. It deserves to collapse. I'm sure it will in time. It's probably not going to take very long.

Chris Martenson: S, what are you looking out for at this point in time? And given what just happened in Washington, D.C., does this really change anything in your personal sense that maybe there are a few more snowflakes on that cornice, or does everything sort trundle along until some unknowable point when things just give way? I would say that's an unpredictable point. How do you view this?

Alasdair Macleod: Well, I think events such as the one we had last night trigger things off. The one thing which I think is being triggered is gold. We had a good rise today. We had about a $40 rise. Now I think that this is something quite significant, really, for a number of reasons, but if I go back to my fiat-money quantity, if I adjust the price of gold from just before Lehman Brothers went under, I think I'm right in saying that in July 2008, the price of gold at the close of that month was $918/ounce.

Now, if you adjust that price by the extra fiat money quantity that is now in circulation, gold has actually gone down, in real terms if you like, by about 30%. Put another way, if the price of gold was to match in real terms that $918 level, it would today be about $1,860. So we have this extraordinary thing where gold, for whatever reason, has become extremely undervalued compared to where it was before Lehman Brothers went under. Now this is important because before Lehman Brothers went under, not many people actually understood systemic risk. So the price of gold did not really include the weighting for systemic risk.

The other thing I would say is that since then, with our FMQ (fiat-money quantity) having taken off, there is a substantial hyperinflation risk that is going to affect prices somewhere down the line. And yet, gold is trading at a discount of 30% to where it was before all of this happened, so it is horribly mispriced. You would have to admit that, even if you thought that it was overpriced in July 2008. So, really what I'm looking at is a trigger which is likely to correct that mispricing. It could well be that the events that we've had this last week are the beginning of that correction.

I would also look at it another way. They've got the price of gold down. I'm not going to talk about manipulation and so on and so forth, but one way or the other, Western capital markets got the price of gold down to around about $1,180 on, I think it was, the 26th of June last. It then recovered somewhat. It then started drifting off. There have been so many barriers to talk, you could almost say there's a conspiracy to try and get the price of gold down to somewhere between $1,000 and $1,100. And indeed that was the target, believe it or not, that Goldman Sachs issued in a research note.

Now, there is such a bearish view in Western capital markets about gold, which is really based on the thought that gold is in a bear market; therefore when it rallies, we sell it. In other words, there's not thought going into this at all. Meanwhile, if you want evidence of gold being underpriced, then just look at the quantity of gold that is traveling from the mines and from the West into the Far East.

The thing that is interesting is that we can get firm figures out of China. This has not been replicated at all by the World Gold Council and others. But you can actually go to the Shanghai Gold Exchange, and you can see what is being delivered. You can go to Hong Kong, and you can see the import and export statistics, which are very detailed. I can tell you that the annualized rate of gold accumulation in the private sector in China and Hong Kong in 2013 is running about 2,600 pounds. Now, if we look at world gold-mine production, it is around about 2,700 pounds. Of that, China now mines about 440 tonnes. That leaves 2,260 tonnes available for the rest of the world and anyone who is not the Chinese Government, because none of the Chinese production seems to leave China. We know this because you don't see any Chinese-originated ingot on the market. So the Chinese Government exalts that.

So we are looking at a situation where in China and Hong Kong alone, the demand is 2,600 tonnes. The annual mine production is 2,260 tonnes other than China's.

And then we've got the places like Thailand. Whoever mentioned Thailand? But did you know Thailand's demand is running this year at around about 410 pounds/annum. Then there is India. Now we know that there's been a bit of dislocation in the gold market in England, but I can tell you one thing that's for absolutely certain: If you want to get gold in India, no problem; you've just got to know who to bribe. And that's the way it works. So all they're doing is, they're driving gold out of the official statistics; onto the black market. It doesn't even say the demand is going down.

So every way at which you look at this, there are huge flows of gold going from the Western capital markets, which are underpricing it, into the Far East; in fact, over the whole of Asia, who have a greater appreciation for it. So that, I think, is the other evidence that gold is horribly mispriced at the current level. Now you just need a trigger to change that, and it could be that we're beginning to see it.

Chris Martenson: You know that fundamental argument of gold flowing from West to East is one of the more powerful arguments that I've seen in a while. I mean, it's just extraordinary. It's a huge shift in events. I can't even imagine, for the life of me, gold falling under the circumstances that you've just described, from the monetary pressing in from one side and the demand statistics from the other. And you mentioned you didn't want to go into manipulation. I'm reminded of – I think it was Monty Python it was Life of Brian. Remember they've got the people’s front of Judea, and they're arguing with the Judean people’s front about whether the Romans have got to go, and that's great! I think it’s Cleese who is saying, Well, what have The Romans ever done for us? Well, besides the roads. Oh, I mean, and medicine. Oh, sanitation. And they just keep going through this whole list of extraordinary things.

There's absolutely no way we could possibly rationally think that gold would be manipulated, because I mean, after all ,well, there's Liber; oh, the aluminum markets; oh, the foreign currencies, yes; oh, the oil markets; wait, interest rates... Like, the whole list of things you can go through that we know have been manipulated for gain.

Listen, can somebody manipulate gold for gain? Yes. If they could, and they could do it for gain, would they do it? Yes. Do I happen to believe that the officials who are involved in the regulatory bodies at the Federal Reserve would look the other way, but perhaps with benign neglect and a half-closed eye for as long as possible, as long as gold was being manipulated for gain but it was making the price go down? Of course!

I truly believe those things, and I know for a fact, based on what I've seen watching the tape trade, that there is something going on that's very fishy in those markets. I love the fact that the CFTC came out after a big 100,000 hours of testimony – or pages, I can't remember what the 100,000 referred to, but some quantity of discovery – they'd done in the silver markets, and they're like, Yes, we couldn't find anything wrong. I was like, Dude. Give me a spreadsheet and three hours.

All you need to do is break open the seal and tell me who is placing the trades, and I'll tell you if it's manipulative or not. It's not hard. And somehow they never did that. They got all of those endless hours of testimony of people sitting on the standing going well, wah, wah, wah. I don't think it's being manipulated. It's just like, no, just give us the data. Show us who did those trades at 12:31 that March 8th, and I want to know, were all of those contracts dumped by a single firm or set of related firms? And if they were, that was a price manipulative event because it was designed to drive the price down. That, by definition, is manipulation.

Whether they drive the price up or down, it doesn't matter. If they're doing it to move a price outside of normal market boundaries with the intention of making money off of unsuspecting honest traders, then allegedly that's illegal. That's the world we live in, but we see it every day. We know that this is a corrupt system. It's out there. How can I think that the corruption doesn't extend to gold, silver, oil, corn, wheat, cotton, equities? It's everywhere. So on that front, I guess I'll leave it at that.

Alasdair Macleod: I managed to establish that something like 1,300 pounds had gone from the Bank of England custody in one quarter. This was between the year-end and the 28th of February this year, and some time in the middle of June. That was interesting. I mean, the Bank of England were caught in the hoppers. It was their own statistics. So I was quite pleased to be able to do that.

But here is the thought. If someone told me that the Italians or the French had leased their gold to a respective Italian or French bank in order to help pay some bills and make things look a bit better and raise taxes, I would believe it. Now the point about it is that France has got something like 2.5 tonnes of gold officially. Italy has got 2.5 thousand pounds of gold officially. Spain has got something like 600 pounds officially. Now I've got absolutely no evidence that they have done anything underhanded, or anything like lease the gold and the gold being sold into the market and ending up in the Far East. But if someone said to me I have got evidence that this is the case, I would not be surprised. Let me put it no higher than that.

Chris Martenson: All right. Well, no higher than that. And remember, what have the Romans done for us lately?

Alasdair Macleod: Yes, I know. We keeping on quoting Diocletion and all the rest of it. There is a story. We actually had an inflation in this country in, I think it was, about 1132 AD. I'm going back a long time. I think Henry II was on the throne. And in those days, basically, the people of repute were given the legal job of casting gold and silver into coins, and they were called moniers. Anyway, these people, they weren't paid for doing this. It's not like being what we call a Justice of the Peace. Someone with standing was given this job because they were respected in the community and trusted and all of that.

Well, of course, the system broke down, because what the moniers did was, they adulterated the coins. That was that the coins in circulation increased in quantity, and prices of grains and corn and various sorts of other things, people started rising, the problem was made worse because there was a harvest failure. They had a very bad drought, and prices of wheat went so high the people were literally starving.

So what King Henry II did was, he called all the moniers to a meeting in Winchester, where they were tried. If they were found guilty – and this is straight out of the Anglo-Saxon Chronicles – if they were found guilty, their right hand was chopped off and the testicle removed beneath. Now, I think that sort of penalty against our central bankers might be something we ought to examine.

Chris Martenson: Well that sounds like true accountability. Something sadly missing these days, especially is the monetary master classes. I am not sure Alasdair that we have to roll all the way back to the 1130 on the first go. There does has to be some recognition to the fact that central banks are playing with lives, playing with fire here. They are enriching a few at the expense of many. And history suggests that it works until it doesn’t. And when that brakes - lets just say that is usually best to have the bags packed and the jets engines spooled up because a hasty retreat to a safe haven is what is usually called for there.

But for me one of the main crimes here is that by their actions the central banks are preventing an open and honest discussion about where we are in this story and what actually needs to be done. We are potentially at one of the most critical junctures in human history and whether we get the transition right or badly wrong, is a function of recognizing which things we need to stop doing, which things we need to keep doing, and which things we need to start doing.

And where I think we need to have an honest discussion about the earth’s finite limits the Fed has prevented us from even having a reasonable discussion about fiscal limits by monetizing the majority of US fiscal debt. That enabling function of the Fed is just not helping, in the way removing a bathroom scales from a morbidly obese person’s house does not help. Its not the measuring devices at fault, but the practices involved.

And with that cheery image left behind, as always I have really enjoyed this conversation with you Alasdair and I want to thank you very much for your time.

Alasdair Macleod: It's been very much my pleasure, Chris, and I thoroughly enjoyed it.

About the guest

Alasdair Macleod

Alasdair started his career as a stockbroker in 1970 on the London Stock Exchange. In those days, trainees learned everything: from making the tea, to corporate finance, to evaluating and dealing in equities and bonds. They learned rapidly through experience about things as diverse as mining shares and general economics. It was excellent training, and within nine years Alasdair had risen to become senior partner of his firm.

Subsequently, Alasdair held positions at director level in investment management, and worked as a mutual fund manager. He also worked at a bank in Guernsey as an executive director.

For most of his 40 years in the finance industry, Alasdair has been de-mystifying macro-economic events for his investing clients. The accumulation of this experience has convinced him that unsound monetary policies are the most destructive weapon governments use against the common man. Accordingly, his mission is to educate and inform the public in layman’s terms what governments do with money and how to protect themselves from the consequences.

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27 Comments

Arthur Robey's picture
Arthur Robey
Status: Diamond Member (Offline)
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Posts: 3936
Zimbabwe.

"Zimbabwe" The word just keeps popping into my mind. I can't keep it out. Is this schizophrenia?

Who cares if some minute country in the middle of Africa just prints its way to oblivion? It is a different kettle of fish when the whole world follows suit.

Sigh! And to think that I had such high hopes for people with the same skin colour as me. How disappointing.

Just for fun lets roll back the film and see what could have been done differently.

In the 1930's someone makes the astounding observation that oil is a one-off finite resource and it must be consumed wisely.

It is also observed that if the population curves were extrapolated that we would be in serious trouble. Therefore strict population targets were to be enforced. Anyone who breeds without a license to do so would be banished to Australia and never allowed back out. If you reject the rules you are quarantined. Bon Voyage.

Further, someone discovers that we live on the surface of a planet. The corollary of that is the fact that we are each a sub-set of the Living Planet. Anyone who propagates the myth of the lonesome cowboy or "I did it My Way" is prescribed 5 doses of the ego dissolving Ayahuasca. This is no time for niceties. 

Wars have to be paid for by the people who think it is a good idea up-front. And when their money is finished they have to pull more out of their own pockets. Further, they have to offer their own offspring up for recruitment. Why should everyone have to pay for someone else's follies?

Any law that is passed that gives any advantage to any section of society over any other section is recognised as discriminatory and is automatically illegal.

Company means the company one keeps. Therefore companies are recognised as people and the board of directors is held to be the embodiment of the body corporate. So any legal penalties attracted by the company are applied to the board of directors. For example:- the penalty for premeditated murder is whatever it is, and is applied to the board. The company is considered to be the company of the board of directors, so when they die the company dies with them or is passed on to their heirs and successors who would form a new "company of people".

thc0655's picture
thc0655
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What have the Romans ever done for us?!

Ok, aside from the Libor scandal, rigging the energy markets, foreign currency markets, interest rates, and the MF Global theft, what have the Banksters ever done that is underhanded and fraudulent?

You have to laugh to keep from crying!

And also from The Life of Brian, here's CONgress trying to decide how to rein in the excesses of the Banksters...

Wendy S. Delmater's picture
Wendy S. Delmater
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Posts: 1951
thank you

What a lovely interview. Sadly, right on the money, too.

climber99's picture
climber99
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Let all have a guess what will happen

Let all have a guess what will happen. Here are my guesses.

5 year moving average for world GDP will go negative and stay there. QE will stop because it fails to produce growth in GDP. Equity markets will crash to very low levels.  Bond yields will go to near zero and stay there.  Interest rates will stay at near zero.  Debt will never be fully repaid or paid back very slowly and will eventually be forgiven.  Inflation for short time (to burn off the QE money) followed by permanent deflation as wages fail to grow and energy and food prices increase in post peak NET energy world.  Japan showed us the way and we're following their script.

 

westcoastjan's picture
westcoastjan
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some thoughts

And if we see that beginning to happen, particularly on the domestic front, the first warning will probably come in the foreign exchanges, which are why I think the move in the dollar today is interesting, and certainly more than that at this stage. But what I'm looking for eventually is that, at some stage, people, like ordinary Americans, are going to start thinking that it's not prices going up, it's their money going down. Now, as that psychology gets hold, then there is actually no hope for the currency. So that is something we have to look out for, Chris.

Chris Martenson: I totally agree. I was reading an interview with a major hedge-fund kind of guy recently, and he noted that of all of the clients he was aware of, 0% of them were in any way hedged or prepared for inflation. So, inflation being the catch-all term, but again, as you said, inflation; not rising prices. But his clients were not yet positioned for the idea of falling value of their money.

So we have this extraordinary thing where gold, for whatever reason, has become extremely undervalued compared to where it was before Lehman Brothers went under. Now this is important because before Lehman Brothers went under, not many people actually understood systemic risk. So the price of gold did not really include the weighting for systemic risk.

Bolded sections my emphasis.

There was a recent article on PP that said something to the effect of 25% of Americans did not know what QE was. I personally suspect that number is a lot higher.  So with reference to the first paragraph above, to think the masses will understand prices are not rising but rather the dollar is falling is a pipe dream.

Furthermore, with regard to the second and third paragraphs, to deal with a hedge fund requires $$$. If these folks, and fund managers are zero invested in hard assets, and if they do not know or recognize systemic risk, then they are high on something too, to put it politely.

We are potentially at one of the most critical junctures in human history and whether we get the transition right or badly wrong, is a function of recognizing which things we need to stop doing, which things we need to keep doing, and which things we need to start doing.

There are but a miniscule number of us on a global scale who recognize what we need to stop doing. Most of us here on this site are doing what we needs to be done, and stopping that which must be stopped. But the multitude's who are oblivious are dragging us all down. We as individuals cannot do anything about a currency collapse, save for our personal preparations. My fear is that regardless of mitigation strategies, we are going to have to tough it out alongside the party til' you puke crowd. In many ways, that knowledge makes me sick.

Jan

gillbilly's picture
gillbilly
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Posts: 423
Further comments and questions

Interesting discussion! Wrapping my mind around currency markets and exchange rates always makes my head spin, but as I try to contemplate all you are saying some comments and questions come to mind.

I would be hesitant to say the central bankers don’t understand the risk of currency, unless I’m misunderstanding you. Ever since going off the gold standard there has been the on-going battle between the pros and cons of fixed vs. floating exchange rates.  Central banks often target three important factors – the instability of exchange rates, the tendency for inflation and/or recession, and the inadequacies of the international capital market. In addition, the main causes of major exchange rate fluctuations seem to be divergences in monetary and fiscal policies between trading partners. And many problems seem to stem from governments not wanting to subordinate their domestic motives to exchange rate stability.

Is moving to a fixed exchange rate world realistic? Is it realistic to think countries would want to return to a fixed exchange pegged to gold or even a basket of commodities (which has been suggested in the past) since they have been given monetary policy freedom? Do you think most countries would give it up? Monetary policy freedom inevitably leads to fluctuating exchange rates.  Wouldn’t it also constrain international capital markets, including their choice of reserve assets?  Am I missing something? I don’t understand this as well you, so, just asking.

How do SDRs fit into this equation? I guess if exchange rates get too unstable, a fixed exchange rate with some centralized international bank is possible, and because trade and finance is global and basically instantaneous it would need to be an international bank. SDRs would definitely fit into this type of scenario, but would like to hear other opinions.

Having a centralized international bank is scary, but isn’t this kind of what we’re seeing on a global scale right now, a type of global monetary integration?

Also, your comments about central bankers not having trading experience is a little unsettling for me. I agree it would benefit the decision making to have some traders, but I wouldn’t want a room full of nothing but traders making the decisions, as traders don't necessarily impress me either. It reminds me of comments from those who say the government should be run like a business, and therefore, we need people who have run businesses to run the government. Macro and micro are two very different things, and governments absolutely should not be run like a business. Sometimes yes, but often times no.  Governments do need some business minds, but they also need a lot of other types of minds to have a balanced perspective (which seems to be missing at the moment, as we have a glut of finance/legal types now). I have a relative who was a past CEO and the guy has no clue about macro economics.  It’s rather embarrassing.

Thought provoking podcast! Thank you.

sand_puppy's picture
sand_puppy
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Posts: 1582
FMQ ponderings

As a person without a background in finance, I find that I must ponder, summarize and create a Cliff Notes version .....  

(This graph is from Alasdair Macleod's article at GoldMoney.)  The FMQ metric he created approximates the amount of fiat money in circulation.

I really appreciate this interview as it discusses the exponential pace of money creation that has accelerated to "hyper-exponential" in the last 5 years, and yet the paradox of the lack of obvious price inflation on the streets.  It explains how those closest to the printing press get the benefit of the new money, while those at the periphery of society are left to founder as the buying power of their puny Social Security checks withers.

Going from 1960 to ... 2008, the average exponential growth rate was at 5.9%....  Now, if we stand back unemotionally and look at that chart, we would say that this is monetary hyperinflation....

But .... we're not seeing is the prices of raw materials...reflecting that expansion of money. [T]hings like property, [around the financial centers of London and New York] are beginning to rise. [P]rices in the financial centers for everything are considerably higher than they are elsewhere.... [B]ankers and lawyers and all of the rest of it are making an awful lot of money out of this policy from the central banks, and they're spending it, lately. They're spending it in the restaurants. They're spending it on improving their homes. They're spending it on buying new country homes. .... So they drive up prices around them. And you can see this in New York. I just came back from London today, and my goodness, I see it in spirit in London. So this effect, which is called the Cantillon Effect, where prices rise where the new money goes in [closest to the printing press].

On the other hand, we see the wealth depleting effect on people, far from the printing presses, who live on low-fixed incomes:  Social Security, retired people on pensions, the poor on Food Stamps, Medicaid and Medicare payments.  So this is why Wall-Mart sales are faltering and the American poor are hungry, while prices around the global financial centers bloom.

Thanks for helping tie this all together.

I'm going to start making regular donation to our local food bank.  The number of poor who will be needing help will be growing.

 

davefairtex's picture
davefairtex
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FMQ - utility of money supply analysis

So if you just look at money supply, you are only seeing one part of the picture.  Its why the Fed missed the housing bubble - they weren't looking at growth in mortgage credit as inflationary.

Here's a chart that illustrates this.  Black line is home mortgages/GDP, red line is M2 Money Supply/GDP.  Which do you think better correlates with the housing bubble?  My answer: Mortgages.  They inflate at the same time housing does, and they also deflate when housing bubble is over.  The magnitude of the growth in the mortgages is also larger than in M2.  M2 on the other hand just slowly rises all during the period.

My contention: any attempt to predict either inflation OR hyperinflation with just money supply is doomed to provide an incomplete picture that is ultimately not that useful.

We also have to believe that all those excess reserves eventually have to come out of hiding and start moving around at high velocity for them to contribute materially to this long-awaited hyperinflation.

climber99's picture
climber99
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Posts: 169
Advice

Bad news will eventually be seen as bad news. QE money is not ending up being loaned into the economy by Joe Public. Anyone with any sense is deleveraging and/or buying physical assets. The bursting of the equity bubble will be something to behold.

Question. If you have savings, do you pay back some of your mortgage on a rental property or buy physical gold when it gets manipulated down to $900 ?

gillbilly's picture
gillbilly
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Oops, clarification

I reread my post this morning and the sentence about not being impressed with traders was poorly written. I was tired when I wrote it.  What I meant to say was I would be equally not impressed with a room full of traders as I would be with a room full of academics. It takes all kinds to make the world go round.

Didn't want traders to think I don't appreciate their perspective! For example, especially DaveF's perspective...I had the same thoughts about M2, money pooling does not apply inflationary pressure.

Thanks!

ferralhen's picture
ferralhen
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good article..scary in fact.

good article..scary in fact. and jan, i highlight the same two paragraphs, they jumped out at me too.

it does boil down to value of money will someday devalue and i'll add so will the value of human labor. , perhaps soon, perhaps not...but the trigger is cocked so the trigger event is much more likely given it will take less of a pull.

i put a large share of my assets into hard assest , mostly on this homestead, not only providing food, shelter, water etc for my self, but into having the land set up to produce income should i need to use it . it's all bought outright. the value doesn't matter, it's mine.(til the army wants it then it;s theirs)

i've concensed down to:

money has way less value, buying power.

availability of "stuff" is questionable

affordability of "stuff" ,whatever you call it, my labor buys less, so my economic status drops from any starting point.and as i age and can do less.use my assets now to have a way to produce income completely independent of the markets...any of them.

unreliable electric grid

very expensive oil products.so less usage of them, less relying on them.

to not rely on feeling secure by my savings, excess

the psychological part the hardest, so i've given it the most time ,effort and thought.

and finally to be able to live independent from the masses. i need to be able to stay away

from people for long periods of time.

 

so i have focused on providing  what i need, not what is going to happen i can drive myself crazy with the futility on that ..

i had to have things in place now  because i cannot build a fence when i'm 70, probably for all of the above reasons, so i built it 4 years ago.while stuff available , affordable, gas available, and my energy available, and the internet for education on how available. my model works well for no collapse and just aging.

since i feel in place, i no longer have to watch the news so closely and was able to completely ignor the govt shutdown bs.i didn't have that weighing on me one bit.my time and life are my own now. i've tried to set up so i can protect as much freedom and choice as i can.

all in all, i think living among wild and distressed humans will be the biggest challenge for most of us. and that has already begun

my take away from this article...money worth less as we go forward..

 

ferralhen's picture
ferralhen
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i should correct my 2nd line,

i should correct my 2nd line, it does boil down to value of money will someday devalue and i'll add so will the value of human labor to mean:   value has been lessening rapidly for some time and will continue to trend that way til it collapses .

davefairtex's picture
davefairtex
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money pooling, M2/FMQ, potential energy, Dominicans

gillbilly-

Ha thanks for clearing up that trader comment!  But I kind of knew what you were saying anyway.  I feel the Fed should stick to its knitting, and not be involved with trading at all.  Just be a lender of last resort to the banking system, and stay out of the rest of the economy.  For that, they likely just need people with some practical banking experience, not traders.

Regarding FMQ, if historical prices are a guide, the simple existance of a pool of money doesn't in and of itself drive inflation.  This is just common sense: a trillion in cash sitting in the cellar isn't inflationary, as they say.

I view M2/FMQ as potential energy.  If the money comes out of hiding and the money multiplier (rate of circulation) increases, then yes it would seem that the larger the pool, the greater the damage it does when it decides it wants to be spent.

Some analyses I've read suggests that different pools mean different things.  Savings accounts represent a "slower" pool of money than demand deposits, and those are slower than currency.  So - theoretically at least - a trend of money moving from savings to checking, or from checking to currency, implies (possibly) an early detection of an increasing velocity of money.

Here is the order I have read, from slow to fast:

* Time Deposits

* Savings accounts, money market funds

* Demand Deposits accounts

* Currency

So it would seem that if we watch movements between different pools we might be able to detect a velocity increase prior to it showing up in CPI, or in the quarterly M2V series.  I haven't done the legwork on that, but it might be interesting.  Maybe I'll go take a look...seems like it might have some promise.

At the core, however, both FMQ and M2 are both asking the question, "what happens if every dollar sitting in an account somewhere decided it wanted to buy gold - and only gold - where would the price of gold go to?"  As goldbugs and/or sound money advocates (and I include myself in that group) its an interesting question to ask, but in terms of practical effect on the US economy and/or informing trading decisions, its a bit like a medieval Domincan discussing whether there is excrement in heaven, or whether two angels can exist in the same spot at once.  In other words, it's a Dr. John question, not a Fat Tony question.

That is because so few members of the public in the west care about gold.  We Domincans are few, and the peasants (for whom angels, the existence of heavenly excrement, and the ultimate answer to our particular question are unimportant to their daily lives) are many.  And its the peasants who would be the ones driving any actual move to exchange dollars for gold.  What's more, as a percentage of GDP, M2 (and FMQ) are not crazy-high vs historical values.  If we are to consider that the USD is now practically backed by "the stuff you can buy with USD in America" - in some more practical sense money no longer needs to be underpinned by convertibility to gold, but rather its convertibility to property, goods, and services.  China buying the Chase Manhattan building in downtown NYC is an example of them converting USD into a big building, rather than gold.  Which likely explains why the peasants don't care.

[A USD confidence vulnerability: if we start disallowing foreign buying of US assets.  Then USD get sold for sure.  Its the moral equivalent of slamming the gold window.]

Here is M2 (Money Supply) divided by GDP - the ratio of money in circulation (and in bank accounts, etc) to our actual annual production.  You can see that while it is historically high, it hasn't gone nuts the way debt/GDP did over time.  My interpretation: there is more money than usual out there, but it is not factors of three above normal, the way the debt is right now.  Conclusion - debt: big problem.  Money supply: small problem.

Being a sound money guy, I actually think the issue will matter more than it does currently at some point, since gold is one of those things that works when all other stuff fails.  Most likely, this will be when the world devolves into a bit more chaos than it has at the moment.  For instance, if I take my Chinese reserves of USD and buy a US building, if there is a war - who says I get to keep the building?  Or the gold mine.  Or the oil well.  Nationalization is always a popular thing, we've all seen it.  Whereas if I buy gold, I can most definitely take the gold outside the country and I can keep it regardless of the international relation situation.

However until this independent movable asset store-of-wealth attribute becomes more important than it is now, its unlikely that the FMQ or M2 debate will have much relevance for the rest of the world.

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dmger14
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Interesting

Would stopping QE lead to higher growth than with QE in place?  Seems to me QE does help to keep rates lower than otherwise, and that alone could be reason it won't stop even though it isn't leading to appreciable growth in GDP.  After all, when it comes to decisions at the fed (or congress) these days the option chosen will always be the one that causes the LEAST IMMEDIATE pain.

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gillbilly
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Thanks Dave

Dave, Thanks for the post. I especially like the excrement in heaven, angels, and Fat Tony references. Lol I recently went back to the library stacks and read some papers from economists in the 1980s in regard to the move off of the gold standard and the effects of fluctuating exchange rates. One in particular by William Cooper was interesting (written 1986, can't remember the exact title of the article or the journal now).  He wrote a pretty damn accurate description of what the markets would be like in 2010. He was advocating a one world currency, and using SDRs as reserve and denomination. I don't hold an opinion on this, but rather I'm just trying to entertain many perspectives.

I agree sound money can take the form of any type of commodity backing, or a combination of them, and I also agree that this will probably not happen until things become much more unstable, or a complete crash.The flexibility of monetary policy is too intoxicating for political reasons (to satisfy fiscal goals). I also don't understand why gold bugs get upset over market/price manipulation/intervention/etc. All markets are manipulated and intervened. You're a trader, I'm sure you see it in every market on daily basis. Why would the PMs be any different? One thing that isn't touched on (and I'll be the devil's advocate here) is that "efficient" markets advocated by free marketeers do not always result in fairness, and most often don't, so the manipulation of the FED/Govts is to redirect fairness (wealth distribution, employment, etc). Whether they see it or intervene appropriately is another matter. I know I'll probably get lambasted for that statement, but my caveat is that when the FED or govt intervenes in a market it is taking an active role in that market, and so its intentions also need to be questioned. That's just the way it is, at least for now. Anyway, isn't this what we are doing here at this site, questioning the intentions of intervention and manipulation? 

Thanks again for the posts and charts.

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darbikrash
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The FED intervenes because it has to

 Efficient Market Hypothesis and General Equilibrium Theory have been, for the most part, abject failures when applied to the political economy. Despite the supposed intellectual underpinnings that seek to convince us why no FED intervention should ever be the order of the day, these theories don’t work, never did work, and come to find out, never can work.

Like layers of an onion, the more you peel back and strip away failed and ineffectual theories, the more you get to see the extents of the chicanery and duplicity. Until finally what’s left on the cutting room floor is the rotting scraps of Marginal Utility Theory as the prima facie cause of some really, really, bad science.
 

What we see is the entire basis for Neo-classical economics called into question- and ironically, called into question by among others, traders. Of late there is a wave of quants migrating from the hallowed halls of the financial firms joining ranks with scientists, physicists, and mathematicians who are doing something that should have been done long ago, digging back into the economic textbooks which have been playing fast and loose with neo-classical theory, and specifically,  marginal utility. And what they are finding is pretty shocking, the basis for these theories cannot really be supported, which is a polite way of saying that these concepts, and the assumptions that underlie them, are just plain wrong. Not all of it (marginal utility) is wrong, but huge swaths of it are based on overly simplistic aggregations between micro and macro, half-baked theories of rational consumers, single agent entities representing an entire agency such as consumers or banks, and theories of marginal cost that suggest that as production quantities increase, so do prices, which as anybody that has ever set foot on a factory floor will tell you, is precisely the opposite of what really happens.

 

On top of these faulty assumptions are built towering edifices of economic theory, Keynesianism, Austrian economics, MMT, you name it, cascading blunders firmly anchored in the quagmire of marginal utility. These assumptions were plugged in to allow the dismal science to advance to macro, to evolve into explanations designed explicitly to replace Labor Theory as the dominant economic theory. The trouble is no one ever revisited the placeholder assumptions that were plugged in to the freshman economic texts, although the authors fully expected that someone would do so. No one ever did.

 

We have to interject a historical context, the supplanting of Labor theory with marginal utility was a tectonic event of huge proportion that took place late in the 19th century, largely set into motion by Alfred Marshall. Up until then, so-called Classical Theory governed economics, and Marshall’s theory of marginal utility ushered in the Neo-classical phase. The main difference was in the operating theory, which up until that point was centered on a theory of Value that specified labor as the sole input. This was perhaps most famously advanced by Adam Smith, followed by Ricardo, and brought to its penultimate form by Marx of course, in 1867. But there were problems with Labor Theory (or so it was thought at the time) and we had simultaneously the ascendancy of the Industrial Revolution which was to hit full stride at the end of the 19th century in America.

 

But there was trouble in River City, just as the capitalist mode of production was to hit full stride, we have the dominant economic theory based on, and wholly centered around, you guessed it- Labor.

 

This would never do.

 

Any top to bottom economic theory that uses labor as the centerpiece was going to be nothing but trouble, serving as a constant remainder of who exactly it was that buttered the bread, and giving a key role and high visibility to the rapidly assembling labor coalitions rising in response to the emerging robber/barons of the turn of the century Industrial Revolution.

 

Ostensibly in response to the abandonment of the Labor Theory of Value due to its “inconsistencies”, and it’s unsightly cousin, the Tendency of the Rate of Falling Profit, it became convenient to proffer a new top-to-bottom theory of economics, and the Neo-Classical regime went to the front of the class. Neo-Classical theory advanced none of the tedious shortcomings of its predecessor, instead, completely ignoring any semblance of Value Theory, suggested that prices were determined by consumer preference curves, as the “rational” consumer made choices based not on exchange value but on Pareto superior preference curves. (Apples and bananas were chosen based on utility as a function of comparative price).

From here it is just a hop, skip and a jump to Efficient Markets Hypothesis and General Equilibrium theory- and the notion that the market can fix itself.

 

Before I leave this subject I wanted to point out that marginal (cost) theory has no rigorous means of determining (historic) value, other than the temporal, real time free market exchange price. In contrast, Labor theory offered a highly detailed history of a commodities’ value, the value in a metal part could be traced back to the stamping plant, to the stamping equipment, to the iron ore used to feed the smelting plant, to the bricks used to create the plant, and the labor needed to extract the ore from the ground (and the shovel used to extract it). All of this traceability is gone in marginal utility, replaced by a single commodity price based on whatever someone is willing to pay, achieving near complete obfuscation of the price, labor inputs, and exploitation up until that point.

 

Exactly as intended.

 

Despite the obstacles, there is a growing group of heterodox physicists and scientists, operating as economists, challenging these assumptions using mathematics and dynamic systems analysis to properly characterize a dysfunctional economy. Below is a podcast interview with Professor Grasselli, where he discusses many of these topics.

 

http://fromalpha2omega.podomatic.com/entry/2013-10-12T12_21_15-07_00

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Feral Hen The value of your

Feral Hen

The value of your labor is only falling in our currant situation were there is a glut of labor, cheap energy, intricate supply chains and an industrial capability for producing stunning amounts of complex products at shockingly low "prices".  As we move to a situation were electronic financial transactions are impossible and no one will exchange anything for paper currency and there is little or no "money" (gold and silver coins) labor will be the only thing that has value.  When one looks at what it would take to reproduce a T-shirt and a pair of blue jeans that can currently be had for 4 hours of your time at todays minimum wage from scratch (that is, prepare the soil, plant, cultivate and harvest  the cotton.  Card, spin and weave the fibers into cloth.  Cut and stitch by hand the fabric into the finished garments) the mind boggles. And this presupposes that you already have a hoe, cards, spinning wheel, loom, scissors and needles and don't have to make those things from scratch as you go along. 

Perhaps a group of earnest young people will knock on your door and ask if they can help you work your place in exchange for a share of the crop.  Perhaps a potential "enforcer" has already got an eye on you and your place (I know several people, myself included, who are making notes on local resources.  One in particular who is already making plans on how to defend the dairy farm across the road from him ).  You, your knowledge and your preps maybe valuable enough to an emergent warlord to be worth defending.  Perhaps you and your preps will simply overrun and eaten.  Perhaps, perhaps.

Hmmm, I may have to lay in some more axes, saws and hoes.

John G

 

 

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owt about nowt

Aren't you clever. I thought for a moment you were going to say something profound. Sort of fizzled out at the end. In my opinion anyone espousing economic theories that don't incorporate energy production knows nowt, be it Marx, Neo-classical or whatever. Sorry.

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Arthur Robey
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Australia follows suit.

 Finance minister Joe Hockey said that we in Australia need austerity amongst the little people  and the Big End of town needs printed money.

The debt ceiling is to be raised to half a billion, in a country of 23 million.

Woopie doo.

Seeing that I will be picking up the tab, am I going to have the the pleasure of spending it on my yacht?

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Uggggghhhh

This is spoken like a true academic with little to no business world experience.  These are the same types at the fed telling us they have to intervene because without a central bank society would crumble and millions die (sorta like pre 1913 in the US where we just barely made 140 years).  Thank god for the fed, the last 100 years has been incredible for our currency!  I tell you what, make a payroll, run a business, take risk and borrow money to expand your business and then we should talk.  Until then your spouting a lot of nonsense in a sophisticated way to make your argument sound, well, academic.

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darbikrash
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jcat3022 wrote: I tell you
jcat3022 wrote:

 I tell you what, make a payroll, run a business, take risk and borrow money to expand your business and then we should talk.  Until then your spouting a lot of nonsense in a sophisticated way to make your argument sound, well, academic.

So I'm guessing you didn't get to the podcast.....

Sorry to burst your Randian bubble, no academic here, but I've been making payroll every two weeks now for more than 25 years... 

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AKGrannyWGrit
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Jcat3022

You said "thank god for the fed, the last 100 years has been incredible for our currency.". It would have been more appropriate to say "thank god for the fed, the last 100 yeasr as been incredible fot the fed, all their banks and their friends.". For Mr. And Mrs Middle America, well we have gotten, hmmm let me be nice here, the short straw, bamboozled, used, coned, manipulated and screwed. Not being acedemic here. Also, my crystal ball shows a parallel world without the.fed and it's not on the verge of collapse.

AK Granny

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Micro is not Macro

jcat3022, this is exactly what I mentioned in a previous post about those who live in the world of micro and dismiss macro theory as academic, or worse try to apply micro theory to macro. You might listen to podcast. It's quite good, and it describes many of the pitfalls of just that...applying micro/individual to the macro/mass society. Micro and macro are two very different beasts and therefore require different sets of skills and thinking.

Darbikrash gave some very good and needed context to the discussion. Instead of dismissing it, you might go back and do the tedious research of reading where these theories came from and how they evolved over time. Our current predicaments can only be contextualized by having a good understanding of the past, and the only way to do that is to read the past authors on these subjects. My formal training left much of this reading out, which is why in the past couple of years I've returned to many of the original authors. So many of them discuss the same things we are discussing now.

Climber99, where is energy missing from these theories? Built into all these theories is the use of energy, otherwise how do you derive a price/marginal utility/general equilibrium at all. Are these theories flawed? I think so, but it's important to try and understand them, how they came into being, and where they fall short to have a meaningful discussion as to how to transcend them within the context of our predicaments. We need to put ourselves in the shoes of FED members, regulators, and not just blindly dismiss them as evil, that is, if we truly want to have meaningful discussions. If you mean these theories don't include the concept of finite resources in relation to energy, I agree, but you still need to understand these theories because they drive much of the current narratives.

I think it needs to be reiterated that those of us who challenge the ideas in podcasts, articles, interviews, etc. are not attacking Chris, Alasdair, or anyone else. Finding contradictions, discrepancies, and alternative perspectives, helps all of us crystalize our views, but only if we are open to listening.

I find it is in my nature to play devil's advocate for the sake of learning. When I do this, I'm not necessarily expressing my personal beliefs, but I do learn something every time. If all I do is applaud the person and move on, I feel much is lost.

Let's be open to the discussion. Darbikrash gave some wonderful historical context as to why the FED operates the way it does, not necessarily an opinion whether it's right or wrong. DaveF gave some great examples of why debt should be more worrisome than the actual money supply. Hopefully Alasdair reads some of these comments, thinks about them, adjusts some of his views, and writes more. Maybe he doesn't adjust his views at all, but he argues within the context of these challenges next time. Who knows? But in the end we all gain something from the discussion.

Peace!

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ferralhen
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john , tell me what you have

john ,

tell me what you have in place to ride this out and i'll enter a discussion with you.

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jgritter
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Posts: 270
Ferralhen, short of a missile

Ferralhen, short of a missile silo, do any of us have a place to ride this out?

I am in a village of less the a thousand people between Kalamazoo and Lake Michigan.  I have been here for about 15 years and I am a member of the village council and the volunteer fire department. I have, food, water, a garden, bees, books, tools, etc.  I think I may have as good chance as anyone of surviving the next 20 years.

South west Michigan is one of the most agriculturally diverse areas in the United States and we literally have more fresh water then we know what to do with. The area is dotted with fruit, vegetable and grain processing and storage facilities. Unfortunately we are within a tank of gas range of Chicago.

What I don't have is military training or combat experience, with a little luck I won't need it.

I think that the great frustration for all of us is the crushing number of variables.

I'm curious to hear what you have to say as I have enjoyed your past posts,

John G

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Wendy S. Delmater
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feralhen, you said: money

feralhen, you said:

money will someday devalue and I'll add so will the value of human labor.

and jgritter disagreed:

As we move to a situation were electronic financial transactions are impossible and no one will exchange anything for paper currency and there is little or no "money" (gold and silver coins) labor will be the only thing that has value.

I'd have to agree, with one caveat. While it's lovely to look back and think about how we got into this mess (and yes, I'm looking at you, darbikrash) we are here. We need to look forward. Every one of my preps looks toward a world made by hand, where not only my labor but the hand tools of that labor are valued.

"Women's work" has in the past century, to a large extent, been done by appliances fueled by electricity - often electricity provided by fossil fuel use. To the chagrin of some of my more feminist friends, after a crash (if we make it to the other side) Women's Work will perhaps become valued again, and running a household may become full time, honored work as sources of cheap and easy energy fade. For a homemaker, I think an "investment" might be a clothesline and clothespins, a watering can or a basin & pitcher, and of course the tools and seeds of a kitchen garden. You can buy such things, still: everything from hand-looms to flat irons to rug beaters to hand-cranked egg beaters can be found second hand. They still sell cloth diapers. Just getting and making food took the homemaker of a century ago 30 hours a week, not to mention the child-rearing and the cleaning. We don't realize how much time our mechanical servants are saving us, or we won't realize until they are gone. Learn to do things by hand, now, while you still can.  In a hyperinflationary environment in Germany, an uncle of my husband's saw what value women had. If they could prepare food that they grew themselves from storage, irrespective of  the currency crash, they were priceless treasures.

For men, who have 30% more muscle mass, take a hint from the increasingly high cost of even broken farm equipment that can be repaired. Tools matter. Activities like splitting wood and cleaning a chimney, shoeing a horse or plowing with one, hand-shingling a roof or digging a latrine will end up back in your purview, I think.  Keep an eye out for hand saws, hand planes, hand drills. Have several hammers and set aside some nails. Buy a glass cutter and learn to use it, and stock some glass to replace broken windows. The next 20 years will be very different than the last 20. You may not be able to call a repairman. You may BE the repairman. You may not be able to call the police or fire department; along with your neighbors, you'll be them, too.

We can cut out a number of the "crushing variables" by being more self reliant and investing in community, I think.

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DGCanuck
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Posts: 9
Velocity of money

Velocity of money may be a trigger to watch.  All this stimulus has had some effect but not nearly what it should have.  It's like the central banks are trying to paddle down a stream but the tide is coming in so fast they can't make headway.  Wait until the tide goes out, and they may wish they had been paddling the other way.  If the velocity of money takes off, combined with all this fiat supply, maybe that's when we'll get hyper-expo-mega-whopper-(insert favorite hyperbole, it won't be far off) inflation.

Graph of Velocity of M2 Money Stock

http://research.stlouisfed.org/fred2/series/M2V/

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