Havenstein's choice

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The Money Changer
From the Archives : Originally published December 04th, 2001
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FOLLOW : Deflation
Category : History of Gold

"The whole extraordinary depreciation of the mark has naturally created a rapidly increasing demand for additional currency, which the Reichsbank has not always been fully able to satisfy. But these enormous sums [printed] are barely adequate to cover the vastly increased demand for the means of payment, which has just recently attained an absolutely fantastic [nominal] level *** "

-- Dr. Rudolf Havenstein, Reichsbank President, August, 1923, quoted in When Money Dies by Adam Ferguson, p. 173; London: Wm. Kimber & Co., Ltd, 1975.


·         “Inflation” is an increase in the money supply that eventually causes prices to rise because it cheapens the purchasing power of each and every monetary unit.  Inflation is the cause, rising prices the effect.

·         “Deflation” is a decrease in the money supply that eventually causes prices to fall because it enhances the purchasing power of each and every monetary unit.  In a deflation money becomes more, not less, valuable.  Deflation is the cause, falling prices the effect.

·         Every monetary inflation causes and masks a real deflation and economic contraction.  While nominal prices rise, real prices fall as paper (fiat) money loses value relative to all other assets.

·         Inflation makes money appear cheap because it suppresses the interest rate.  The lower price of money fools businessmen into making investments that look profitable at the inflation-lowered interest rate.  Consumers are not really forcing down interest rates by saving more now to spend more later, so the lower rate sends a false signal about future demand.  When the future arrives, those who were fooled go bust.  Inflation induces malinvestment that at some point will be liquidated (written off).

·         Inflation always brings on lower commodity prices eventually because it initially induces overproduction.  Overproduction will always call out lower prices.

·         When will inflation not be able to raise prices?  When the fiat money is debt-based (borrowed into circulation) and the debt is being revalued (written down and off) around the world, i.e., a deflation of debt is underway.  New money is not borrowed into circulation because no matter how much money is offered (by increasing reserves), or how low its price (interest rate), borrowers are afraid to borrower and lenders to lend, so the monetary authorities are “pushing on a string.”

·         Government cannot cure economic deflation by outright printing and spending money into circulation because the recipients will save and not spend it (the velocity of money drops because demand for cash and safety increases).

·         Hence when the snapping turtle of deflation locks on to the economy’s leg, he won’t let go until he hears the thunder of (1) the last bankrupt’s rubble being cleared off the economy’s foundation, or (2) the guns of war. 

·         Economic deflations (depressions) last for years and do not respond to government spending or central bank monetary tricks.

·         Gold and silver are money by nature while fiat national currencies are only money substitutes.  Formerly gold and silver along with other money substitutes formed one single monetary system, but today they form two parallel and competing systems.

·         If a monetary unit’s purchasing power declines, the most likely explanation is a money supply inflation.  If a monetary unit’s purchasing power rises, deflation is the most likely explanation.

·         Generally falling commodity prices usually mean a deflation is in progress; rising prices point to an inflation.

·         Falling paper money prices for gold and silver cannot foretell a deflation, because gold and silver are not mere commodities among all others.  They are money; they are the numeraire; they are the denominator, unlike any other commodity.  If their prices are falling in paper money, the fall can only mean (1) the supply of fiat money is falling, or (2) the supply of gold and silver is rising (being inflated).

Above our axioms the puzzling quotation reveals an arresting paradox about inflations:  increasing the money supply actually shrinks its purchasing power.  Throughout the German hyperinflation of 1920-1923 Havenstein contended that his job was to print money as fast as possible. Why?  Because the country was suffering a shortage of money.  But how was this possible?  Wasn’t the country already choking on the tidal wave of paper money pouring from Havenstein’s presses?

Havenstein had a choice:  print more money to ease the shortage of purchasing power caused by inflation, or stop printing and bring on a deflationary collapse.  Either way, Havenstein’s Choice is only Havenstein’s Trap.  The faster you print money, the faster its value evaporates; stop printing money and the economy collapses into a deflationary depression.  It can only end in the death of the monetary unit.


Inflationists presuppose – in the teeth of all history and logic – that they can increase wealth by increasing the money supply.  True, if there were more money there would be more wealth, but only if the money itself is wealth.  Money created out of thin air – fiat money, whether bank credit created by bookkeeping magic or by crude printing – has no value in itself.  It is not wealth, only an alleged representative of wealth.

On the other hand, gold and silver inflations do contribute new wealth, and hence do boost prosperity long term (after initial dislocations). After 1492 new gold and silver pouring into Europe from the Americas laid the foundation for growth lasting centuries.  Huge discoveries of gold and silver in the mid-1800s – in the Carolinas, California, Australia, Nevada, and South Africa  -- all contributed to the world’s wealth and later prosperity.  However, all this new money was itself valuable.  Every new ounce mined contributed to the sum total of wealth.  Conversely, every new unit of fiat money divides the sum total of wealth, impoverishing many to benefit a few.


This paradox abides for every inflation.  More money ought to makes us all rich, but it never does.  It seems contradictory,[i][1] still holds true.  Never mind the enormous volume of paper money thrown into circulation, the actual purchasing power in circulation decreases with every new emission.  The faster the money is issued, the faster the total purchasing power declines.  Two parallel hyperbolas grapple for supremacy, one graphing the amount of money circulating, the other depicting its rate of depreciation.  Depreciation always wins.

You can easily see the depreciation by turning upside down the graph of any price index under an inflationary regime.  Viewed right side up, the graph shows prices increasing.  However, to understand what it truly means, you have to turn the graph upside down:  the monetary unit’s purchasing power is decreasing.  More and more money buys less and less.  Nominally increasing fiat money prices mask a real fall in the value of all goods against real money, gold and silver.

Check this out for yourself.  Look at the price of anything in 1964, the last year that the United States minted silver money and while the dollar was still tied to gold at a rate of $35 to the ounce.  As a rule of thumb, you will find that fiat prices have increased by a factor of about ten times.  In 1964, a package of cigarettes cost about a quarter.  Today, it costs $3.00.  (Gasoline is about the only exception to this rule of thumb.  It has actually decreased in price, 20¢ a gallon in 1964, about a dollar today.  However, less than a year ago, gas prices were over $2.00.)

Until recent years prices in gold and silver had uniformly dropped.  Now that no longer holds true.  At $4.07 silver that 1964 25¢ pack of smokes now costs 73¢. In gold, it cost 0.0071 ounce in 1964, but today at $280 gold costs 0.0107 ounce. 

“Aha!”  you shout, “That proves your theory wrong!

“Oho!”  I shout back, “In a pig’s eye!  That proves my theory right:  they’re suppressing the gold and silver prices.” [2]


In 1964 the government fixed gold and silver at $35 and $1.2929, a ratio of about 27:1.  Today the ratio stands at 68:1.  The change in ratio can only mean either (1) silver has become much more plentiful than gold, or (2) the market has been deceived into believing silver ought to be much cheaper than gold.

Alternative No. 1 we can reject out of hand, because it is demonstrably false.  In the past 35 years mankind has continued to consume (use up) silver in ever increasing amounts and vast silver stockpiles have disappeared while most of the gold ever mined is still in existence.  Compared to silver, only miniscule amounts of gold are consumed yearly, like the gold necklace your sister wore on a date and lost.

Contrary to the worshippers of the free market mechanism, Alternative No. 2 certainly is possible without conscious and concerted manipulation.  Fashion – the change in social mood - rules the investment world as strictly as it rules hemlines. Fashion (social mood) makes bull and bear markets. No matter how attractive some investment’s fundamentals may be (silver, for example, after ten years of supply deficits), if it is out of fashion, most investors just won’t see it.

On the other hand, something more sinister than mere social mood may be at work.  Somebody may be actively manipulating the market.  Since we can prove from history [3] and from statute [4]  that the U.S. government and the Federal Reserve, as well as foreign central banks, all manipulate markets, the manipulation hypothesis cannot be rejected as frivolous or without factual foundation.  Indeed, on its face it offers the most logically preferable explanation because it is the most obvious, the simplest, and explains the most things. Occam’s Razor, you know.


I keep hearing analysts citing the falling gold price as a sign that Gigantic Deflation is coming.  In fact, history teaches us that can’t possibly be true.  Look at Roy Jastram’s figures below to prove it to yourself once and for all.

People who make this “falling gold price presages deflation” argument have adopted the inflationists’ presupposition that gold and silver are mere commodities, and that “money” is whatever government says is money. [5]   They believe that gold and silver, along with all other commodities, will drop under a deflation. 

But gold and silver are not commodities like all other commodities.  They are money by their nature.  However vociferously tyrants and inflationists may scream that gold and silver have been “officially demonetized,” their monetary essence remains.  The question is, how hard will the frauds try to suppress that?  How many people or nations must they impoverish or shoot before they will give up?


In his books The Golden Constant (1976) and Silver the Restless Metal (1980) Roy Jastram defined “`inflation’ and `deflation’ in a sense descriptive of prices’ behavior.  Inflation refers to a period of rapidly rising prices; deflation connotes an interval of swiftly falling prices.”  (p. 84).  This differs, of course, from the definitions I use:  inflation is “an increase in the money supply” and deflation is “a decrease in the money supply.”  Jastram’s usage focuses on the effect of the change, mine focuses on the cause.  However, as we will see, his work supports my conclusions, namely, that gold and silver should gain purchasing power in a deflation.  (See table, “Gold, Silver, & Prices under Inflation or Deflation”).


Now I am left with an apparent contradiction of my own.  How come the prices of gold and silver rose in all the deflations Jastram listed and fell in all inflations, except in inflations since 1933?  What changed?  Why would their purchasing power now rise in an inflation?  Does that also mean their purchasing power will fall in a disinflation, the slower inflation we saw from 1980 – 1995? 

The reason gold and silver’s value now rise in inflations instead of dropping is because the once-unified monetary system that embraced gold, silver, and money substitutes (bank notes, etc.) has been split into two systems sealed off from each other, fiat money versus metallic money.  These separate systems now meet only at their exchange rates.  They no longer belong to one system, but form alternative and competing monetary systems. When confidence in one blooms, the value and price of the other wilt, and vice versa.

Before the days of central banks and government run currencies, money supply consisted of gold and silver coin and bank notes.  Both the metallic monies and money substitutes worked together in one system.  Since central banks have ascended the throne of monetary monopoly, however, both gold (1934) and silver (1873 & 1967) have been pushed out of the system – “demonetized,” as the inflationists claim. 

There now exists a fiat money system based on debt but claiming a theoretical gold backing of 15%: the gold “reserves” which the US government claims to hold against gold certificates issued to the Federal Reserve.  However this only forms a 15% reserve [6] when measured against outstanding Federal Reserve currency (“bank notes’).  When compared to the wider measures of money supply, the vast amount of bank-created deposit currencies, credit card debt, money market funds, and on and on, the percentage of gold “backing” the system becomes minuscule.  (See Tables, “Theoretical Gold Backing,” & “Price of Gold Needed.”)  Even the banks’ so-called “reserves” held in fiat Federal Reserve currency are tiny, a paltry 0.83% of the banking system’s liabilities.

Further, the “gold reserve” does not function as a constraining reserve the public can reach by convertibility, but only as an illusion.  It gold plates the fiat money system to lend it the illusion of redeemability without the tedious restraint of a genuine anchor.


Is that why the prices of gold and silver are falling?  Or is a mysterious, disembodied “deflation” stalking the world, chopping off values like Procrustes chopping off his victims at the ankles? Many otherwise astute analysts think this “deflation” is causing the prices of gold and silver to remain low.  Their prices, these people claim, foretell a worldwide deflation.

But if gold and silver “prices” are falling then it can only be the result of an inflation of the gold and silver money supply, not a deflation in fiat money, or even an economic deflation. [7]  That’s what Jastram’s figures show.  Otherwise you have to adopt the inflationists’ viewpoint that gold and silver are mere commodities and not money at all.

Where can this “gold and silver inflation” be coming from?  Inflation with gold and silver money is not only possible, but also a historical fact. Every year the supply also increases as more gold and silver are mined, but normally that happens so slowly that the amount of metals added to the money stock no more than matches the growth of the economy.  But what if gold and silver supply suddenly surged?  In the past it has only proven beneficial, as I mentioned above.

But today no such source of new physical gold and silver underlies the gold and silver inflation (drop in their prices).  Still, prices dropping point to supply increasing, but where?  If not from the ground, then only from paper gold and silver in the form of derivatives and metal leasing. 


What you expect to see is not what you do see.  How do you explain the contradiction?  With verifiably rising fiat inflation (increasing paper money supply) you would expect to see silver and gold prices rising as the realisers edge for the escape hatch.  Yet both metals are dropping while the paper dollar strengthens.  How do you explain that?

What do we need to prove a crime?  Motive, means, and opportunity.  Greenspan and the Treasury have the means and the opportunity.  With stocks collapsing, the dollar threatened, and the US economy fainting, they also have a powerful motive.  Can the jury point to the winner?

That makes all the talk of gold “forecasting deflation by declining” just so hogwash.


Because our money is borrowed into circulation our fiat system can cause another kind of deflation:  the great writing down of debt, the revaluation of all values.  Debt builds and builds, and suddenly some creditor runs for the door with the shout, “I want my money!”  That triggers a universal questioning of debt (remember “change of social mood”?). Around the world, the creditworthiness of every debt is scrutinized.  Rotten debt is simply written off – the creditor’s money “goes to money heaven” (to borrow Doug Casey’s happy turn of phrase).  Bankruptcies abound as the malinvestment induced by the previous paper money inflation (“easy money”) are recognized as failures and written off.

But in the very best of times the debt-based fiat money system already lives under a perpetual twofold deflationary threat. New money can only be created by borrowing it into existence. [8] So think about it:

(1)    If all the money is based on debt, then the writing down of debt must reduce the entire money supply, by definition.  A loan written off is bank credit destroyed.

(2)  The money supply must grow by at least the amount of the interest burden, or bankruptcy is guaranteed for some players. [9].  The less the money supply grows, the more numerous the bankruptcies.

What follows from the great debt deflation?  It must reduce economic activity as demand for money increases and money becomes harder to get.  More companies going bankrupt means fewer companies hiring and more companies laying off workers.  Fewer people working means people have less money to spend which means they buy less which means that even for those companies that don’t go bankrupt, it’s tougher to make a profit.  In other words, times get tougher and tougher and the economy sinks into a self-reinforcing depression – for years.


The whole picture of inflation confuses us because it acts differently as it develops.  History, however, does not equivocate about inflation’s end:  it destroys the monetary unit.  Commenting on Havenstein’s Choice in a recent newsletter, James Turk wrote,

“Within a few short years, the Reichsmark was inflated away; it was destroyed as a currency. … What really killed the Reichsmark? … Hyperinflation was only the result; it was not the cause.  The cause was a `flight from the currency’.  No one wanted to hold the currency, and quickly exchanged it for any good or service.  That’s why the Reichsmark was losing purchasing power in the first place; the demand for Reichmarks was declining.

“Interestingly, these same circumstances faced by the Reichsbank are what the Federal Reserve is now facing . . .Unfortunately … the governors of the Federal Reserve have learned nothing from the Reichsbank.  The Fed is pump-priming like a crazy person.  Instead of focussing on building demand for dollars – so that people don’t take flight from it – they instead are pumping more dollars into circulation to overcome what are perceived as deflationary forces in the economy, just like the Reichsbank did.  And the end for the dollar will be just as brutal.” [10]

To most people today, a flight from the US dollar sounds crazy – crazier than the Fed’s pump priming.  But believe me, from a historical or an economic perspective, Greenspan & Co. have put the dollar on the fast track to oblivion.  You may toy with Treasury bills for a while, but the only safety against a depreciating currency is gold and silver.

The faster Greenspan inflates, the tighter the cabal tries to suppress gold and silver, the more the government manipulates markets, the faster they hasten the day when the dollar dies.


 [1] What this contradicts is the inflationists’ false presupposition that inflation can create prosperity.  It confuses us because what holds true for inflation initially doesn’t hold true permanently.  True, at first the inflation increases economic activity, but as time goes on larger and larger doses are needed to give the economy the same jolt.  And since the inflation actually sends money into bad investments --  investments no one would undertake unless the inflation had fooled them -- then in the long term inflation promises only a depression.

 [2]  “They” means, in this case, the U.S. Treasury, the Federal Reserve, and the bullion banks or other agents in cahoots with them.

 [3]   E.g., Roosevelt’s manipulation of silver, gold, and the dollar in the 1930s, plus the US government and Federal Reserve’s never-ending manipulation of interest rates, money supply and exchange rates since then.  Add to that various central banks “managing” their currencies’ exchange rates.

 [4] E.g., the Exchange Stabilisation Fund with the stated purpose of manipulating the price of gold and the US dollar, and the secretary of the Treasury’s statutory mandate to “protect” the dollar’s exchange rate.

 [5]   After all is said and done, since Aristotle’s time there have two and only two theories of money.  The first presupposes that money must have value in itself.  This is the so-called “intrinsic value” theory of money.  The second presupposes that money is a social convention or social construct:  it makes no difference what we use as money, or that it has any value in itself, only that everybody agrees (or is forced) to receive it as money.  It ought to be obvious that the first leads to cultural integrity, honesty, prosperity, security, stability, property rights, and independence while the second leads only to cultural crookedness, institutionalised fraud, poverty, theft, insecurity, instability, influence peddling, socialism, and tyranny.

 [6] Nominally 15%, because I think that’s the number they aim at.  That’s the goal the Euro Central Bank set for itself when the Fed’s rate was the same.  Lately their aim has soured, as the chart shows gold reserve against currency amounts to only 12%.

 [7]  It is true that because of the hindrances governments have imposed on the metallic system – difficulty of conversion, tax on acquisition, tax on gains – that in the present short term gold and silver are less spendable than fiat.  Therefore in a debt-busting panic the price of both metals might drop as the crowd rushed for paper dollars to stay liquid.  However, this would be a temporary phenomenon.

 [8]  For example, you go to the bank and “borrow” $10,000.  Five minutes before the bank credited it to your account, that $10,000 didn’t exist.  Your loan called it into existence.  The bank created the $10,000 out of thin air, by double entry bookkeeping magic:  the loan to you an “asset” of the bank, the deposit to your account a “liability” of the bank.  Neat and clean, money is born from nothing.  It makes no difference whether the government borrows from the central bank or the public borrows from a commercial bank, either way the money is borrowed into existence.

 [9] It’s the game of cards explanation.  Five men are on a desert island.  Four one to play cards, the fifth has a deck.  He proposes, “I will loan each of you thirteen  cards for one hour, provided you each agree to pay me back fourteen cards at the end of the hour, and I’ll take your clothes for collateral.” 

Once the four players agree, they have just guaranteed that at the end of the hour one or more of them must go bankrupt and lose his shirt.  There are only 52 cards in existence, so to pay back fourteen cards at the end of an hour, some of the players must lose  cards to the others.  Anyway you cut it, somebody will end up short at the end of the hour and the “banker” will get his clothes. 

Thus in a debt-based fiat money system where money must be borrowed into existence, the money supply must always keep on expanding by at least the amount of the interest burden, or some of the players must go bankrupt.

 [10]  Freemarket Gold & Money Report, Box 5002, North Conway, NH 03860.  20 e-letters per year, 24 gold grams or $220.  www.fgmr.com.  11/5/01, p. 2.  This is one of the newsletters I read very closely.

Franklin Sanders


Reprinted with permission from The Moneychanger. Franklin Sanders lives on a farm in Middle Tennessee by choice, deals in physical gold & silver, and has been writing and publishing The Moneychanger for nearly 26 years. In 1993 he wrote Silver Bonanza for Jim Blanchard. Last year he published "Why Silver Will Outperform Gold 400% and & The Professional Trading Secrets That Will Make the Most of Your Silver & Gold Investments," still available at www.the-moneychanger.com/order/publications.phtml.

You can sign up for Mr. Sanders' free daily e-mail commentary on gold & silver at www.the-moneychanger.com, and download your free portfolio calculator to keep up with your gold and silver investments.

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Franklin Sanders lives on a farm in Middle Tennessee by choice, deals in physical gold & silver, and has been writing and publishing The Moneychanger for nearly 26 years. In 1993 he wrote Silver Bonanza for Jim Blanchard. Last year he published "Why Silver Will Outperform Gold 400% and & The Professional Trading Secrets That Will Make the Most of Your Silver & Gold Investments," still available at www.the-moneychanger.com.
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