Hyperinflation vs Deflation: Rebutting FOFOA

Discuss this article at the Economics Table of the Diner 

 

One of the first Economic/Monetary threads begun when we openned the Doomstead Diner for Bizness a few months ago was a Hyperinflation vs Deflation thread.  As often as this debate has been engaged in all across the internet, it still remains one of the most vehemently argued topics from both sides, and no clear “Winner” in this has emerged as of yet.

The arguments surrounding HI & DF crossover into arguments about the worth of Precious Metals and their possible value in resolving the monetary crisis we have confronting us now.  Particularly lively arguments come off the keyboard of a Blogger who goes by the Nom de Plume of FOFOA, or “Friend of a Friend of Another”.  Apparently, all Austrian School Gold Bugs are very Friendly people, at least with each other. LOL.

Anyhow, I got into discussing the HI vs DF questions with Ashvin Pandurangi of The Automatic Earth a while after trolling and plugging the new DD Blog and Forum on TAE. Ashvin has now decided to resurrect his analysis of FOFOA’s “Freegold” Theory, and is also soliciting other critiques, so I’ll pitch in my 2 Gold Eagles on this subject now.  I’ve been over the fallacies in the thought process of what conventional economists of both the Austrian and Keynesian variety come up with many times already, but I haven’t really addressed specifically the work of FOFOA.  So I will do that here and now.

Like Ashvin, I will also make my disclaimer.  I don’t profess a complete knowledge of WTF the Freegold advocates are talking about, and frankly I have a whole lot of issues as far as wading through the stilted prose style FOFOA writes.  I am just going to look at some underlying assumptions made in this most recent justification for Freegold and for a likely Hyperinflation of the Dollar in the near term, though FOFOA refuses to make any real timeline predictions.

Let us begin here first with a major fallacy underpinning FOFOA’s entire Worldview as far as Money is concerned:

The answer is the concept of money. This is the ability, unique to humans, to use numbers, mental constructs, to relatively value the goods and services of barter in a way that enables economic activity and commerce. It is the enabler of economic activity and commerce. It is a primeval instinct.

Emphasis there is mine of course.  Primeval?  It seems FOFOA believes that Homo Sapiens dropped down out of the trees with the innate ability to create and use money, and the subtext is that it goes back in ALL cultures into the great myst of Prehistory.  He is cock sure that money in some form is an essential ingredient to the primeval Homo Sapiens mindset, but this is so untrue as to be completely laughable.  It’s pretty clear that money only evolved around the time Agriculture did, and that is only around maybe 10,000 years old.  This does not qualify as “Primeval” by any stretch of the imagination.  There is a good 60,000 years here between the time Toba erupted and the beginnings of Ag and Money, and Homo Sapiens appears to have been quite successful through that whole period.

Moreover, its not some mythical Xanadu or Utopia in which large cultures flourished without the use of money, really only once the Europeans arrived on the West Coast of the Amerikas was any Money introduced to a very large culture of First Nations people who used a Potlatch or “Gift” Economy.  FOFOA sweeps all that stuff under the rug, because it doesn’t fit the construct he wants to make regarding Money, and then more specifically Gold as Money.

Here you get into a real problem with the “Primeval” argument, since metal working, even in Gold and Silver which is a bit easier than Iron working is a VERY late coming technology here overall, and again doesn’t fit the description of “Primeval”.

Now, FOFOA does get some of the early history right in the use of PMs in barter, but he never does cover the Coinage issue here.  Metals in early tech worked very well to form difficult to counterfeit Tokens to represent stored wealth in a Warehouse.  Because of their scarcity, a token could be made with an ascribed VALUE to it representing a certain amount of grain held in a warehouse.  The Coin doesn’t have INTRINSIC value, the value gets Stamped on the coin by Da Goobermint.

Using Gold and Silver worked OK for a while, but suffered problems all along the way.  First off, Hoarding is a problem, Savers will hoard the metals and take them out of circulation.  This runs you into Money Supply problems for commerce purposes.  Worse still, in periods of famine either nature caused or induced by Human Greed, the actual amount of Food or other necessities can decrease, and then when saved Gold comes back out to buy now scarce items, there isn’t enough of the stuff to go round  to redeem with the Gold.  So the Gold value isn’t really Steady, its only relatively steady during periods of surplus.

The next problem is Increasing Population size.  If the amount of Gold is relatively fixed, but the Population is growing rapidly, in each generation there is less Gold to go round per capita than the last generation.  Today, with 7B people on the Earth, there is less than 1 ounce of the stuff for each person walking the Earth at any given time.  If Gold is the ONLY money around, then as the population grows larger the Gold becomes increasingly more scarce and valuable, so its value is NOT steady.  Its ALWAYS going to increase in value in this situation.  Increased productivity can keep prices more or less stable, but at the point at which real productivity does not match the population increase, a fixed quantity money supply will skyrocket upward in value.  It doesn’t work the same way as fiat, but it is still not truly a stable form of currency when you have a fixed supply working against a population that is growing rapidly.

We still have not worked our way into the biggest problem with PMs though, which is that of consolidation over millenia.  FOFOA himself describes the “Big Players”, long term consolidators of the Gold resource who have sequestered away MOST of the Gold ever mined up here.

Modern bullion banking is a carryover from this past. When Nixon abruptly took the dollar off the gold standard in 1971, the billions of ounces in private ownership didn’t just disappear. They weren’t cast into the streets in disgust. And these giants with 100,000 ounces or more didn’t take those tonnes home to the basement. No, they stayed right there in the bank vaults and literally JUMPED in value.

FOFOA goes on to register his complaints with the Gold ETF market (“Paper Gold”), and the fact that there is fractional lending of this through the Bullion banks just as there is Fractional Lending of Fiat (and no doubt a good deal of Rehypothecation going on with that asset as well!)

MANY claimants to this Gold now, but who REALLY gts to claim it in the end?  Generally speaking it is whoever owns the Keys to the Bank Vault.  The LAST person in the line responsible for making exchanges keeps the Asset, like MF Global whisking away depositors accounts into their own account, which then gets shifted to JP Morgan accounts.  How does Gold as a currency backer stop this from happening?  It doesn’t, and in fact probably makes it easier to accomplish.

Anyhow, with so much of what is admittedly already a pretty limited supply of Gold for 7B people on the Earth already sequestered, its pretty clear that only a very small subset of that population has sufficiently high claim and control to actually take possession of it at some point.  The amount leftover from this for people to actually do some commerce with is exceedingly small, far less than the sub 1 oz in theory available to each person based on what has been mined throughout history.  How do you De-consolidate Gold already Owned and Sequestered away by powerful people and families and then use it once again as a currency medium?  You can’t do it, and so you are left with the creation of Notes or Digibits created to represent Gold, but not Gold which ever is really available for most people to redeem.

In reality, the best arguments for how money works come from the world of Thermodynamics and Heat Flow across gradients.  In order for any Work to be done Heat has to flow from a Hot reserve to a Cold one.

PMs in their Consolidation phase measured the amount of work being done as the PMs were mined and collected up.  The energy was used to reverse the Entropy process of dispersal and consolidate the piles of metal.  During this time, the metals flowed through the economy and could be used as money.  They represented the work being done.  However, all along the way there was a lot of waste Heat expended, and you are not going to get the same amount of work done by taking the piles of Gold and sending them back the other way.

This brings us to FOFOA’s arguments regarding what “Capital” is.

I’m not going to go into great detail on the concept of capital, other than to give you a mental exercise. Because the term “capital” can be quite confusing in our modern paper/electronic world, I want you to imagine a much simpler human civilization. Imagine an ancient Greek city. All the buildings made of stone and mud, the horse carts and agricultural tools, the linens and skins worn as clothing, the knowledge base passed down through generations; all these creations of man’s intellect were the capital of the time.

Now imagine the destruction of capital. Imagine an earthquake or volcano that destroys the fruits of many generations. Or a plague or war, perhaps, that destroys the knowledge base. That’s the loss of real wealth you are imagining. And it is this cycle of capital creation and destruction that tells the story of mankind throughout many civilizations.

The modern analogy to FOFOA’s Stone and Mud Huts and Horse Carts in the Ancient World are today’s McMansions and Carz.  In his version of Capital destruction it takes an Earthquake or Volcano to destroy this “Capital”, but he doesn’t address the fact that Capital of this kind can become worthless even if it is still standing.  The McMansions and the Carz are losing Value because the Energy is no longer there to use them.  The “Capital” that was expended to build said infrastructure was the Oil burned, which now exists only as molecules of CO2 in the atmosphere.  What “Capital Destruction” has been going on for the Age of Oil came in the form of the burning of that Oil.  The OIL was the Capital here, not the stuff that was built with it.

Finally, WRT arguments about Hyperinflation and the relative worth of Gold in a monetary system collapse such as the one we are undergoing now is concerned, most of the perceived value of the Industrial Era has been “accounted” for by using the Dollar as a measure of the relative worth of goods and services through the era.  In order to try and keep nominal values from collapsing even though the real value of assets is decreasing, more dollar liquidity is being pushed into the center of the system at the TBTF Bank level.  However, said liquidity is not escaping into the real economy as of yet, and until there are some signficant Policy shifts, it is not likely to escape either, except into the pockets of a few well connected thieves.

Shifting onto Gold at this point in the Game would be outrageously Deflationary, which I think the Austrians overall view as a Good Thing as the Credit Cycle gets a Reboot that way, but in practical terms it would pretty much halt all trade since most of the Gold in the world is sequestered in the vaults of only a few people and Sovereign holdings, to which there is also likely Private Claim on.  Such a shift to Gold WOULD of course be Hyperinflationary for the Dollar, so for Gold Bugs that is a self-fulfilling prophesy.  In essence, the constant propaganda being written by Gold Bug websites for people to take their Dollars and convert to Gold is meant to increase the perceived value of Gold and in turn force a hyperinflation of the Dollar.  This is proving a bit harder to accomplish IRL than in the mind of the Gold Bug.

Because the Fiat structure is so large and complex, the value system of all assets including the PMs are being subjected to tidal forces as it implodes on itself, resultant from the fact the Capital underpinnning of Oil is becoming more scarce. Oil however isn’t disappearing overnight, and the overall game is being balanced out some by Demand Destruction.  The Dollar’s preemminence as World Reserve Currency isn’t yet being challenged effectively, despite Chinese claims that Renminby will soon be the World Reserve Currency, or Gold Bugs claims that it will soon be Gold.  This is not to say the Dollar will not eventually collapse in its value, it most certainly will.  However, many more parts of the peripheral economies and other currencies will get hit on here first, and during that period the Dollar is likely to remain perceived as the Safest Haven in a War Zone.

In the deleveraging that must occur by any economic argument, all asset classes are going to come under pressure, that includes Gold and it includes Oil too.  The CBs may work in concert to try and maintain nominal values, but this will simply turn their own balance sheets into TOAST as well. The Market in turn will react to that, and eventually you do get your currency collapse of the Dollar as well.  Whether Gold is turned to as an alternate Currency Medium in this phase remains an Open Question.  I do not think so based on my thermodynamic arguments or in sheer practicality terms, but I wouldn’t rule it out.

Far as FOFOA, FOA and A are concerend, they are all just shills for a very old concept of money, and who all also likely have skin in the game for making their prophesies come true.  Anyone who does hold a lot of Gold in the Basement safe clearly would be ecstatic if it rocketed up in value to $10K/oz or more.  I will be very surprised if that occurs, I think the whole trading system would collapse if PMs took on those kind of valuations, but only time will tell on that one.  In the medium term here though, an HI of the Dollar seems unlikely to begin inside the next couple of years anyhow.  The Euro definitely has to collapse first, and that will take some time yet to play out.

RE