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Questions
…Daily Bell: Thank
you for taking time to share your views with readers of the Daily Bell.
Prof.
Fekete: It is my pleasure.
Daily
Bell: Prof. Fekete, you are not directly aligned with any hard-money
factions thatwe can see, at least not at this time. The Misesians in America
have been having greatsuccess arguing for greater economic and personal
freedom. But you may differ withthem on fractional reserve banking. Do you
think, as they apparently do, that fractionalreserve banking is based on
fraud and so it is involved in criminal activity?
Prof.
Fekete: My difference with the position of the Ludwig von Mises
Institute, first andforemost, centers on Adam Smith’s Real Bills
Doctrine.
When
the wholesale merchant delivers supplies to the retail merchant, heattaches
the bill marked: “terms 90 days net”. The retail merchant
endorses the bill inwriting across its face “I accept” and
returns it to the wholesale merchant, who could nowuse the same bill in paying his own suppliers.
This method of payments is called“discounting real bills” as the
payee discounts the face value by the number of daysremaining to maturity at
the going discount rate. Of course, at maturity, the retailmerchant pays the
face value in full when the bill is presented to him for payment.
According
to the Real Bills Doctrine of Adam Smith (1723-1790) real bills financethe
production and distribution of fast-moving consumer goods without the need toinvade the pool of savings. The doctrine is valid even in an economy where there are nobanks,
whether central or not. The consumer goods must be in most urgent demand inorder to enable the
real bill drawn on it to circulate spontaneously
and thus to gainlimited monetary privileges. Real bills are non-inflationary as they appear
simultaneouslywith the emergence of new merchandise, and disappear as the
underlying merchandiseis removed from the market by the ultimate, gold-paying
consumer, in less than 91 days.
This,
incidentally, is the length of the seasons of the year. With the change of
theseasons the character of consumer goods in the greatest demand will also
change.
When
commercial banks have later appeared on the scene, real bills becametheir most liquid earning assets. Saying
it differently, real bills are self-liquidating as theymature into the gold coin surrendered by the ultimate
consumer.
In so
far as the term “fractional reserve bank” refers to a commercial
bank thatkeeps its reserves in the form of gold coins and real bills, it is
preposterous to suggestthat it is involved in a criminal activity. It just
substitutes its own credit for the commercialcredit that exists independently
in the form of real bills. The credit of the bank is morenegotiable in the
sense that it has higher name-recognition. To discount a real bill youneed to
be knowledgeable about the often intricate production process that has givenrise
to it. The circulation of bank credit does away with this need.
I
have never been able to make my opponents agree to the proposition that wehave
to discuss the spontaneous circulation of real bills first, before we are
ready todiscuss fractional reserve banking. Incidentally, Mises himself
admitted that real bills didcirculate in Manchester spontaneously before the
Bank of England opened its branch inLiverpool.
2Cultists at the Mises Institute would love to attack Adam Smith
directly, but theyrealize that they don’t have the prerequisite
intellectual capital to do it. They are barkingup the wrong tree. They
condemn all fractional banking reserves whether real bills orfake bills. They
simply miss the point what constitutes good commercial banking.
Daily
Bell: Do you have any areas of agreement with free-bankers such as
GeorgeSelgin and others who use the Scottish banking interregnum as evidence
that freebanking– private fractional reserve banking -- can work and
has worked historically?
Prof.
Fekete: Yes, I agree with them that private fractional reserve banking
can workand has worked historically, provided that the earning assets of the
banks are confinedto real bills, to the exclusion of anticipation bills,
accommodation bills, treasury bills, andany other kind of fake bills. Out of
spontaneous real bill circulation sprang both theDiscount House and the
Acceptance House. As far as the origin of commercial bankingis concerned, one
can think of the latter as the predecessor of the “bad”
commercialbank that is ready to monetize any and all accommodation bills,
provided that collateralin excess of face value is posted; and the former as
the predecessor of the “good”commercial bank that monetizes only
solid real bills that need no collateral at all.
Daily
Bell: Is there something about gold and silver that is genetic? Do you
believe thathumanity’s interaction with gold and silver is so ancient
that it constitutes a biologicalimpulse? That it is “in the genes”?
Prof.
Fekete: No. Gold and silver owe their monetary role to their property
that they arethe most marketable goods in existence. In more details, gold is
most marketable in thelarge, and silver is most marketable in the small. The
first property is synonymous with“most liquid”, the second with “most
hoardable”. With advances in metallurgy makingmolar processes more
affordable, the hoardability of gold has caught up with that ofsilver,
justifying the movement to replace bimetallism with gold monometallism.
No
biological impulse is needed to explain all this, unless you refer to the
factthat man is mortal, and he knows it, and he needs savings (hoarded metal parexcellence) that he can draw down in
his twilight years to make up for the deficit in hisearning power, and to
provide for his excess needs due to fragile health.
Daily
Bell: Where do you stand on the issue of a free-market gold and silver
standard?Our reading of history is that absent official interference,
sophisticated societies revertautomatically to a market-based standard that
includes both metals. Gold is usuallyutilized for industrial and banking
purposes, while silver is the people’s money. The ratiobetween the two
metals helps people detect manipulation as well.
Prof.
Fekete: I don’t know what you mean by “free market”
gold and silver standard. Isthere any other? I submit that both gold and
silver money were born spontaneously,without any assistance from the
government as a midwife, through a process of “snowballing”marketability,
as so admirably explained by Carl Menger. It is another story thatkings later
hijacked the process of monetizing these metals for their own purposes, andfostered
the childish belief that the value of gold and silver coins was due to thesovereign’s
effigy struck upon them, rather than the superb marketability of the monetarymetals:
gold and silver.
3You are reading history correctly: our sophisticated economy, if
it remainsreasonably free, will embrace the monetary metals once more, as the
regime ofirredeemable currency is increasingly in an advanced state of decay.
If I
may make a slight correction, gold is less of an industrial metal than silver
butmore of a metal of which jewelry is made.
You
may be right when you assume that the bimetallic ratio helps people detectmanipulation
of the price of the monetary metals by the government. In modern timesthe
success of this manipulation tends to coincide with the rising, and failure with thefalling of the Au/Ag price ratio.
Daily
Bell: Economists are fond of speaking of fiat money, but some believe
that theworld remains on an unofficial gold standard observed privately by
the monetary elite nomatter what the public pronouncements are. Is there any
truth to this?
Prof.
Fekete: There is no unofficial gold standard, just as there is no woman
who is “alittle bit pregnant”. It is another question whether the
“monetary elite”, and somegovernments such as those of China and
Israel, may be big clandestine hoarders inanticipation of a greater monetary
role for gold in the future, or in setting up an insurancefund in case the
threat of a monetary catastrophe becomes an established fact, notingthat such
a threat has returned for the second time in less than a generation. One canonly
speculate but, at least in the case of China, the cat has been let out of the
bag. Wenow know that China is the biggest hoarder of silver in all history,
and is determined tobecome a substantial hoarder of gold. As Chairman Mao has
said, power grows out ofthe barrel of a gun — we may add that the bullets
must be made of gold in order to beeffective. Pity the Americans who may have
the gun but believe in paper bullets.
Daily
Bell: Where do you stand on the issue of monetary metals and market
supply? Ifgold and silver become scarce in a free-market economy, would the
scarcity disappearas hoarders release progressively more of their stores as
the price rises? Or would thescarcity be alleviated by mines reopening in
response to higher prices – or both?
Prof.
Fekete: The monetary metals are by no means scarce. On the contrary,
theycommand the highest stocks-to-flows ratio of all the commodities. This is
what makesthem monetary metals. Gold’s ratio is estimated to be 50,
meaning that it would take 50years to reproduce the existing stocks at
present rate of production. By comparison, thesame ratio for copper is
estimated to be ⅓,
meaning that marketable stockpilescorrespond to 4 months’ production.
Any
impression of scarcity of monetary metals is an optical illusion. Perceivedscarcity
only demonstrates the decay of the monetary system. Gold appears scarce forone
reason only: the wild monetary experimentation of the leading countries withirredeemable
currency. It is futile to expect that hoarders will release more of their
storesas the price advances, or that the mines will increase their output of
gold. On thecontrary, they will hang on and release less and less of their
stores. The mines will savetheir best ore reserves for better times as they
see that a monetary catastrophe isimminent. Note that such a catastrophe will
be unprecedented in history.
Irredeemablecurrency has never been a global phenomenon. It was always a
local phenomenon, thehope of weak governments that they can continue living
forever in financial backwatercomfortably. When their hope turned out to be a
pipe-dream, there were always4countries
around that stayed the course of monetary rectitude, remained on the goldstandard,
and were able to extend a helping hand. No such luck this time.
I
deplore that Switzerland, caving in to the indecent pressure from the U.S.
government,
railroaded through a change of the Swiss Constitution dropping themandatory
backing of the liabilities of the Swiss National Bank with gold. This remindsme
of the tale of Aesop about the wolf that has lost his tail in an unfortunate
encounterwith a trap. He wanted to persuade his fellow wolves that they
should also get rid of this“barbarous relic”, and have that
useless appendage, their tail, cut off. Sorry to say, theSwiss government
exhibited far less common sense than the assembly of wolves inAesop’s
tale. It pointed out to the tailless wolf that his case would have been morepersuasive
if it had been made before his loss.
Daily
Bell: Is there any evidence that hoarders of gold and silver behave as
yousuggest, and not as common sense would dictate? After all, it is a
universal feature ofthe commodity markets that the longs take profits
periodically as prices keep rising.
Prof.
Fekete: Yes, indeed, there is: the behavior of the gold basis. Basis is
thedifference between the nearby futures price and the spot price. Contango
is the name forthe condition whereby the basis is positive; while
backwardation indicates a negativebasis: higher spot price and lower futures
price. Whenever supplies are adequate,contango obtains and the basis
indicates what the carrying charges are such as interest,cost of storage and
insurance. Backwardation always and everywhere indicates ashortage of the
physical metal. Therefore, normally, gold should never be inbackwardation,
i.e., the futures price should always be higher than the spot price. Thebasis
may be substituted by a spread, i.e., the difference between the price of a
distantand a nearby futures contract.
Right
now, the gold basis is at a critical inflection point, suggesting that gold
mayplunge from permanent contango to permanent backwardation for the first time ever. OnApril
21 Dan Norcini published charts showing the dramatic collapse of the April
09/June09 and of the April 09/Dec 09 gold spreads at the Comex. The former
went from $6.50 atone point to $0.60 now. The charts indicates that gold is
on its way to backwardationlater this year. Backwardation in gold is an
extremely rare phenomenon with the mostserious implications. It shows that
supplies of physical gold are drying up as hoardersand the mines are
increasingly withdrawing their offer to sell. It is like a chain reaction, atthe
end of which gold is not for sale at any price.
The
basis is an extremely sensitive market indicator, far more important andaccurate
than the price itself which comes through a “very noisy channel”.
What is more,the basis, unlike the price, cannot be manipulated. Unlike the
price, the basis never lies.
The
gold market behaves differently from other commodity markets because goldis a
monetary metal. Unlike other commodities, gold hoarding is not inhibited bydeclining
marginal utility. When market participants expect an imminent collapse of themonetary
system, their preference is to hoard the monetary commodities, gold andsilver.
This explains backwardation.
Daily
Bell: Is deflation an economic good in the sense that it can rectify
monetarymaladjustments?
Prof.
Fekete: Certainly, you can say that deflation is nature’s cure for
man-madeinflationary excesses, if only policy-makers would allow the cure to
do its benevolent and5beneficial
work. Instead, they try to prevent it by hook or crook, and pour gasoline on
thefire by madly increasing the money supply and total debt. Compounding
abuses withmore abuses never works, and the longer the needed adjustment is
delayed, the morepain it would eventually cause.
Daily
Bell: Can the current paper money system stand, or is it on its last
legs?
Prof.
Fekete: Since the eruption of the financial and economic crisis in 2007
we maytake it for granted that the regime of irredeemable paper money is on
its last legs.
However,
it may take several more years of agony, because of the colossal ignorance ofpeople
concerning money. For example, most people with a better than average graspof
the theory of money expect that the dollar will succumb to hyperinflation.
They will bedisappointed. The dollar will put up a tough fight and in the end
it will self-destruct, notthrough inflation but through deflation.
Daily
Bell: Can you expand on this issue? What makes you suggest that
hyper-inflationis not in the cards?
Prof.
Fekete: Producers will, of course, try to raise prices as the dollar is
weakeningfurther. However, people are not in the mood to spend. If they come
into possession ofmoney, they will use it to repay their debts. They have no
savings to fall back on in casethey lose their jobs. In the absence of buying
price increases will have to be rescinded(as they have been in the case of
crude oil, for example) causing many a producer to gobankrupt.
There
is a new factor that plays an important role, not present in previousepisodes:
the parallel existence of electronic dollars and Federal Reserve notes. Only
asmall portion, less than ten percent, is in the form of the latter; the rest
is electronicmoney. People at home and abroad hoard only dollars that they can fold. It is physicallyimpossible
to print them fast enough to replace electronic dollars that the people,
firms,institutions and foreign governments may decide to reject. The velocity
of circulation ofpaper dollars is falling to zero while that of electronic
dollars is rising beyond any limit.
This
splitting of the money supply into two components of divergent velocities
spellsdeflation. The component with increasing velocity will have to be
written off. The Fed ishelpless as the hoarding of its notes assumes unheard
of proportions.
Daily
Bell: Can the Fed really sterilize the monetary system as Ben Bernanke
andothers contend?
Prof.
Fekete: If by “sterilization” you mean isolating the
exploding money supply fromexploding prices, my answer is that Bernanke does
not want to do that. In fact he isdesperately but unsuccessfully trying to
induce a rise in the price level, even at the riskof a price explosion. But
to no avail: all the new electronic money he is creating goes intodebt
liquidation and speculation on the long side of the bond market. None of it
goes tobid up commodity prices, or the prices of industrial shares, or the
price of real estate.
There
is a vicious spiral: the more money Bernanke creates, the more rampantbond
speculation becomes, the higher bond prices go, the lower interest rates
fall, thelower price-level falls, prompting more money-creation by Bernanke,
etc.
Why
do falling interest rates necessarily induce lower prices? Now here is therub:
because falling interest rates destroy capital through increasing the
liquidation value6of
debt. I have a whole new theory on that: the revisionist theory of
depressions. Mymain thesis is that a falling interest-rate structure
increases the burden of debt (just theopposite that you would intuitively
expect!) thereby causing producers to go bankrupt indroves. You can find the
details on my website.
Daily
Bell: Does the current crop of central bankers fully understand the
interactionbetween paper money and the failure of civil society? Could it be
that they understand ityet they ignore it and knowingly support a destructive
system anyway?
Prof.
Fekete: Probably they do, but the only thing they care about is
protecting their turf.
The
politicians have given them unlimited power that they exercise by creating
unlimitedamounts of currency. They have used this power to wreck the world
economy. Now theywant to retain that power to do “damage
control”. They are not going to give up unlimitedpower voluntarily.
They fully exploit the weakness of the political system that is entirely inthrall
to their “expertise”. Why should they admit that Keynesian and
Friedmanite fiscaland monetary policy has been a dismal failure? Rather, they
pretend that, as a result ofcontinental drift, the fault-line gives way,
producing an earthquake ten point strong onthe Richter scale. Who is better
qualified than they are to handle the disaster?Daily
Bell:
Is the International Monetary Fund destined to manage a global
currency? Oris it being used as a stalking horse to provide pressure for
other possible solutions, suchas regional monetary systems (a euro region, an
amero region, a yen region)?
Prof.
Fekete: Whatever ambitions the IMF may have, it is irrelevant. Yes, they
probablywant to rearrange the deck chairs aboard the Titanic, but it makes no difference.
Theship is on a collision course with the iceberg. The incompetence of
bureaucrats at theIMF is appalling. What they are worried about most is the
problem how to get rid of thelife boats and life savers (read: the IMF gold
reserve) that may come handy for thesurvivors after the Titanic has sunk.
Daily
Bell: Is the Internet having an effect on the elite’s ability to
maintain a papermoney standard?
Prof.
Fekete: Most certainly it is, in the negative sense of the word. The
elite thoughtthat it would suffice to discard the gold standard in the United
States, never mind theConstitution. They thought that through their control
of money they could also control thepress and the media. There was no need to
tamper with the right to free speech and thefreedom of the press, which would
have alarmed people far more than thedemonetization of gold. And guess what?
The elite had a most docile press and mediathat made them feel cozy and
comfortable.
How
wrong they were! Here comes the Internet through which you can air themost
devastating condemnation of the activities of the elite, without putting up
one dollarin capital to do so! The endless lies about irredeemable currency
can now be refuted.
Truth
will out. The Internet will ultimately neutralize and even bankrupt the
servile press.
Daily
Bell: What will the world look like in ten years – from an
economic standpoint?
Prof.
Fekete: It is not possible to say. The elite could put the economic
program of Hitlerinto effect if it belatedly decides to suspend civil rights,
including free access to the7Internet.
But it is also possible that even such a coup will remain ineffective in adecentralized society with
individualistic traditions going all the way back to itsfoundations, such as
we have in the United States. Make no mistake about it: the fightover
gun-control laws is not about curbing violence — criminals will always be able toget guns whatever the
laws may say. It is about curbing the right of
the people to reject agovernment that tries to
govern by trampling on the Constitution.
If
“we, the people” come out on top in this tug-of-war with a
totalitariangovernment, then the future of the world should be very bright.
All you have to do is toforce the U.S. government abide by the Constitution.
And I mean both the letter and thespirit of the Constitution.
Daily
Bell: Can you expand on the issue of monetary consolidation? Fiat
money needsconstant consolidation and enlargement to maintain pretence of
solvency in our opinion.
If by
some chance the current system does survive, is a single global currencyinevitable?
Prof.Fekete:
The only conceivable single global currency is the international
goldstandard, because it decentralizes power to the utmost. The individual is
empoweredthrough his role of deciding whether to buy or to refuse to buy. He
casts his ballot printedon gold, and not just once in every other year but several times every single day.
Producers
and merchants will have to defer to the individual’s wishes. Under any
othermonetary system producers and merchants will defer to the wishes of the
issuer ofcurrency.
Daily
Bell: What can people do to protect themselves at this time?
Prof.
Fekete: Other than praying and hoping, they could get out of debt and
keepaccumulating gold and silver coins, buying on every weakness in the
price. They couldalso hoard Federal Reserve notes and the notes of the Swiss
National Bank of smalldenominations, in amounts corresponding to their needs
for up to two years. To keepmoney on deposit in a bank is not advisable under
any circumstances. And, let’s notforget, they should cash in on their
life insurance policies.
Daily
Bell: What is the biggest single issue that even the American
Misesians fail tograsp at this time – historically or otherwise?
Prof.
Fekete: It is their insistence on Rothbard’s so-called 100 percent
gold standard, anuntenable theory that leaves the problem of elasticity of
the stock of purchasing mediacompletely out of consideration. In this way the
Mises Institute runs the danger that itsgold standard, if put into effect,
will seize up during the first Christmas shopping season,and Keynesians and
Friedmanites will return triumphantly saying: “We’ve told you
so!”The cause of the Great Depression of the 1930’s, to a large
extent, was thefailure of the victorious powers to reorganize world trade on
the basis of the Real BillsDoctrine after World War I. This bottled up world
trade and made the gold standardutterly inelastic. What we need is a gold
standard that is made elastic through thecirculation of real bills.
Daily
Bell: What endeavors are you involved in that you may want to point
out to our8audience? What’s most important to
you that you would like our audience to be aware ofand support?
Prof.
Fekete: Gold should not be considered as an investment outlet or an item
forspeculation. It should be looked upon the same way as you look at your
fire insurancepolicy: you buy it, lock it up in a safe, and hope that your
house will not burn down.
Above
all we should train ourselves to think in terms of gold units (gram, Troyounce)
when we estimate our net worth, annual income, and future needs — to
theexclusion of dollars or francs. This is not as easy as it sounds.
Instinctively we tend tothink in terms of paper units. It takes
self-discipline to get away from this habit.
If
you have gold, you are a trustee of the world’s future. You have the
only formof capital that can survive a financial Armageddon. You should take
this trusteeshipseriously and prepare yourself for exercising it properly
when time comes.
Daily
Bell: What are the most important – seminal -- works of yours
that you wouldencourage everyone to read? Where can they be found?
Prof.
Fekete: I am going to give a twenty-lecture academic course on Money andBanking
at the San Francisco School of Economics in California, from July 27 to
August7 later this year. The syllabus is posted on my website. I hope that my
book covering thesame ground will come out this year, which will also include
my criticism of Mises.
Daily
Bell: Finally, give us your best estimate of where is gold headed,
pricewise, overthe near and longer term.
Prof.
Fekete: I don’t like that question, because it obscures the fact
that higher goldprices only mean a lower value of irredeemable currencies.
People tend to bemoan thatthe gold price is not rising fast enough to their
taste. They have the wrong perspective.
From
mine, a slowly rising gold price is a blessing in disguise as it gives you
more timeand opportunity for further scale-down purchases of the monetary
metal.
An
explosive rise in the gold price would be very damaging for most people,because
they are quite unprepared. Universal suffering around you would not beconducive
to your desire to lead a peaceful life and to enjoy your newly-found riches.
On
the gold price let me just say this. Gold is still cheap considering itspurchasing
and employing power at the beginning of the Modern Age. There is noreason why
it should not have a comparable purchasing and employing power when thedust
settles.
Daily
Bell: On behalf of all of our readers we thank you for sharing your
views with usand hope to hear from you again soon. And we encourage all
readers to visit YOURSITE and
consider learning more about your work.
Prof.
Fekete: And I thank you for the opportunity to discuss these grave
problems ofour time. In passing I would like to draw your attention to the newly
established GoldStandard Institute and its website www.goldstandardinstitute.com
.
This
interview was conducted by Scott Smith. In addition to writing special
reports, suchas this Swiss Perspective, Scott is also a contributing editor
to the TheDailyBell.com.
Antal
E. Fekete
San Francisco School
of Economics
aefekete@hotmail.com
Read
all the other articles written by Antal E. Fekete
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