"At times, when all the world's asleep, the questions run so deep, for
such a simple man..."
We have had some discussion about international macroeconomics under a future
Freegold system in the last two threads. And
yesterday JR reposted an old comment of mine on the subject. As a companion piece to that comment, and
also to add a new dimension to the discussion, I'd like to introduce a couple
of new concepts. Let's call the first one "usable versus useless
wealth" and the second concept we'll call "organic versus inorganic
Usable versus Useless Wealth
For "usable" and "useless" wealth I'm calling everything
in the physical plane except gold "usable wealth."
"Useless wealth" would therefore be gold and paper/electronic
savings. So obviously I am referring to the economic or living standard
utility of something in the present. Gold would be the physical plane
representation of "useless wealth" and paper/electronic savings
would be monetary plane "useless wealth" because they both have
little or no economic or standard of living utility to the saver. All they do
is store purchasing power (more or less) with the promise of potential future
Let's look at an example. Costata wrote: "In
other words I can't find an example of a country becoming rich via the
monetary plane and then becoming wealthy in the physical plane."
In terms of "becoming wealthy" in the physical plane, I think we
should distinguish between "usable" wealth (goods and services) and
"useless" physical wealth (gold). One is usable right now for
either production or consumption and the other is not.
It seems that the US became wealthy in "usable" wealth via the
monetary plane exorbitant privilege granted by the ROW in 1922. It did have a
period in the middle where it acquired a bunch of "useless" wealth
(gold) while it provided the world with "usable" wealth in return,
but lately that trend has reversed. And by lately, I mean the past half
So then the question would be how do you define "becoming wealthy"?
Do you define it by having the most usable (in the present) wealth, or by foregoing usable wealth now in order to
store useless (in the present) wealth for the future.
Here's one more example which JR sent me. It was published during the Great
Depression on July 11, 1931 in the Magazine of Wall Street:
Gold Does Not Make Prosperity To men, as to nations, the possession of
gold is a symbol of prosperity. Let's see. The United States has more gold
than it ever had-and less prosperity. The banks are bursting with gold and
barely meeting their dividends. Our great corporations have immense reserves
of gold and their business is dwindling. All the nations are sending gold to
us and our business with them is fading away. The truth is that large
accumulations of gold are an inverse measure of prosperity.
Probably four-fifths of the gold in the Federal Reserve banks is idle - and
nobody ever contended that idleness makes for prosperity. The fact is that
except as it is used as the basis of bank credit, gold has no relation to
prosperity. But when there is no business, there is no credit and gold is
useless. In other words, business gives gold a utility value. Gold is dead
until vitalized by commerce.
The piling up of gold in any country does not
signify that it is prosperous; it merely shows that the country is giving
other countries more goods than it receives; that it is parting with more
usable wealth than it is getting back.
Today the United States is receiving gold and going without goods it would
like to have. And because it is receiving gold it is selling less than it
would like to. When we are prosperous, which means that credit is being
freely extended, we need gold because it is the one commodity that mankind
has agreed to accept on balance in place of the goods it would rather have.
It is merely a balancing item in the offsetting of credits against debits. It
might be epigrammatically said that prosperity "makes" gold and
"unmakes" it instead of gold making or unmaking prosperity.
Okay, so that's the "usable versus useless" concept. You can
disagree with my semantics if you want because I'm only trying to get the
Organic versus Inorganic Savings
What I'd like to call "organic savings" is when economic actors
net-produce (produce more than they consume). "Inorganic savings"
is when the monetary authority in a currency zone increases its reserves. And
here reserves mean gold or foreign currency reserves. Assets denominated in a
CB's own currency are not reserves. (I wrote more about the distinction of
reserves in this post.)
For this concept I would like to draw your attention to a statement I've made
many times that any gold inside a currency zone, public or private, is a
viable reserve. That is, any gold inside a zone is "savings". But
now I'd like to distinguish public and private gold and we'll call the
private gold "organic savings" and the public gold (held by the CB
or the government) "inorganic savings".
This concept works for paper savings as well as for gold savings, but we'll
be looking at the future Freegold BOP machinations
from a physical perspective which will exclude paper savings. So
"organic physical savings" would be gold in private hands which is
the product of an economic actor producing more than she consumes and
purchasing "useless physical wealth" (gold) with the excess
currency left over from "underconsuming".
"Inorganic physical savings" on the other hand would be gold
purchased by the CB by printing currency. "Inorganic paper savings"
would be like the PBoC purchasing US Treasuries by
printing yuan. "But wait" you say,
"the PBoC purchases Treasuries with US dollars
it received through trade." This is true, but it also printed yuan in exchange for those dollars regardless of your
perspective on the mechanism driving that transaction. You see, if the
Chinese exporter had bought those Treasuries for his own savings, no yuan would have been printed. That would have been
"organic paper saving". But by exchanging printed yuan for the dollars the PBoC
is making those savings "inorganic" and at the same time it is
managing the exchange rate of its currency. This equates to the PBoC printing yuan to buy gold
as a currency management tool in Freegold.
The reason I am making this distinction is that I plan to show you that, in Freegold, the CB's inorganic "saving" and
"dishoarding" actions will generally be the opposite of (or
countercyclical to) the net-actions of organic savers in its currency zone
when it manages its currency. Freegold will be much
more smooth and balanced (than the $IMFS) even without CB interference, but
we all know that in the real world CBs gotta do
something to justify their existence, right? So I hope to show that their
natural response will actually smooth cycles out even more than they would be
without the CBs. And that's with everyone acting in their own self-interest.
The monetary plane is merely a reflection of the unsettled portion of the
physical plane. It is simply remembered debt; it reflects uncompleted
physical-plane trade. It, the "m-plane", reflects open transactions,
those not yet extinguished. And the BOP, or Balance of Payments is the
m-plane account for showing what has transpired and explaining what is
presently happening from a macro perspective. It is often said that the
Balance of Payments must balance. This is a tautology. It is like saying a
sphere must be spherical. What it means is that if the BOP doesn't balance,
you've made an error in your calculations, not that something needs to be
done to bring it into balance.
The BOP never balances perfectly because they use aggregated,
government-collected data which is inherently imperfect. It is only a tool
that helps us understand what's happening out there in the real world by
compiling macro data. It is a lens for seeing, not an active participant.
In a previous thread costata called current BOP
accounting methods an anachronism. That may well be true, but I think he was
trying to imply that it has some negative effect on reality. I don't think it
does. And whether or not they change BOP accounting in Freegold,
I think we can still use the current methodology to explain what will be
happening in Freegold from a macro perspective.
Again, that's all the BOP is—a lens that helps us understand what's
I have done the "Freegold BOP" exercise a
number of different ways and it seems to be hopelessly confusing trying to
conceptually traverse a paradigm shift of this magnitude from a monetary
plane perspective. What I have found is that the aggregated marginal actions
of the various players in Freegold are
counterintuitive given our immersion in the current paradigm. So I think we
need to begin with the physical plane in order to understand how the macro
m-plane will look in Freegold.
First of all, "useless" gold will flow in the opposite direction of
usable goods and services at the margin. It's just like Another said, "gold and oil will never flow in the same direction." The same is true of the net-flow of "usable wealth" (goods
and services) versus "useless wealth" (gold) in Freegold.
"Usable wealth" and "useless wealth" will flow in
opposite directions at the margin (deficit/surplus region). 
But physical gold exists in a (nearly) fixed amount (by weight), so we can
imagine it "sloshing" back and forth (by weight) like the ocean moves
back and forth expressed in the tides. What will prevent all gold from
flowing uncontrollably into one country is the price of gold in that country.
And it is important to understand that savers alone determine the trade
surplus. Non-savers trade goods for goods, but savers are the ones who "underconsume" thereby creating a trade surplus. We
also need to distinguish between organic savers (you and I) and inorganic
savers (CBs like the People's Bank of China). In Freegold
these two types of savers will act in opposing ways which will have a damping
effect which will smooth out the cycles, similar to the way opposing waves
cancel each other out.
When you provide more usable wealth to the external world than you enjoy for
yourself (consume), you will record the difference by buying gold. So when we
see someone accumulating a lot of gold, we should think, good lord he's
providing a lot of usable wealth in exchange for "useless" yellow
metal. But on an aggregate (national or regional) scale, something like this
could not go on forever or else all the gold would flow into that region.
What stops this from happening is that gold's price will rise, rewarding the
earlier savers while "punishing" the ongoing (newest) savers (underconsumers) with less gold by weight.
At some point the early savers will see enough reward (high priced gold)
while the ongoing (new) savers will sense a "top" in gold and the
flow will reverse. Savers in aggregate will start net-dishoarding. So how
does this translate into the m-plane in Freegold?
Let's view this as the organic hoard-dishoard cycle within a
The upleg, when organic savers are accumulating
gold and gold is flowing in, while the price of gold is rising and the
country is exporting more "usable wealth" than it is importing,
we'll call Leg A of the cycle. Then Leg B will be the dishoard leg of the
cycle, when the zone is importing more usable wealth and exporting gold as
the savers net-dishoard. (This is counterintuitive right now because we're
thinking in terms of China and the US under the $IMFS. Seems like gold should
be rising (dollar falling) in the US right now, but under Freegold
it would be the opposite --> counterintuitive! --> because the trade
deficit (more goods flowing in) would mean that savers are dishoarding (gold
Freegold Currency Management
In Freegold, a currency manager will influence
exchange rates by buying or selling gold. If a currency is trading higher
than he wants, he'll purchase gold on the open market (doesn't matter where
thanks to arbitrage) with freshly printed currency to weaken his currency.
This will exert pressure for gold to flow into his zone and usable wealth to
flow out. Normally he'll do this in a countercyclical way to what's happening
with the "organic" savers. So our currency manager would most
likely be inflating the currency (printing) and using that new currency to
buy gold (weaken the currency while increasing reserves) during Leg B of the
cycle described above (where the savers are strengthening the currency (to a
point above where it "should" be given some measure of Purchasing
Power Parity with its trading partners) by dishoarding gold).
If a currency is showing unwelcome weakness, he can sell his gold reserves on
the open market. This will exert pressure for gold to flow out of his zone
(or at least counteract the ongoing inflow driven by organic saving) and for
usable wealth to flow in (or at least slow down the ongoing outflow (trade
surplus)). He would do this during Leg A of the cycle described above, so as
to be countercyclical to the organic savers. (Again, this is counterintuitive
given our present immersion in the $IMFS. Who'd expect the PBOC to be selling
official gold right now to reduce the trade surplus.
Yet that's what they'd be doing in Freegold.)
So obviously a currency manager has nearly unlimited ability to weaken his
currency (to counteract Leg B of the savers' hoard/dishoard cycle) but he is
constrained by his accumulated reserves as to how much he can strengthen
(defend) it (during Leg A). This actually makes sense because Leg B is when
savers in the zone have stopped buying gold in aggregate (so that gold is no
longer flowing in) and the printer can get them to start again by debasing
their currency while simultaneously driving up the price of gold. In extremis
the printer can stop the outflow of gold from dishoarding savers (and stop
the inflow of goods and services) by buying every ounce sold by domestic
(organic) savers with freshly printed currency.
I don't know if I would call that "pegging" a currency since gold
is not the currency of a specific trading partner. But if you want to know
how it would look on the FOREX, just imagine a steady gold price in the
trading partner's currency and a rising gold price in your currency. The
obvious arbitrage would lower your currency on the FOREX relative to the
trading partner's currency with a stable gold price. Arbs
would buy gold in the trading partner's zone and sell it in your zone
delivering you an inflow of gold and the requisite outflow of "usable
I hope it is obvious to you that a zone which is experiencing an inflow of
gold (in Freegold) is also experiencing an outflow
of usable wealth. Gold is the symbolic token that implies you are providing
more usable wealth to externals than you are using for yourself. Counterintuitively, the transactional currency of a zone
experiencing this (in Freegold) is likely lower
than it deserves to be on the FOREX. That's why its exports seem cheap to
foreigners. So foreigners are buying more usable stuff from this country than
they are selling to it. The currency manager would resist this by selling his
own gold locally to stop the inflow of ("useless") gold which
reflects the outflow of usable wealth. He is strengthening his currency by
doing this and slowing exports of real goods (while also slowing imports of
A currency manager can induce exports of real usable wealth and imports of
("useless") gold by inflating his currency to buy gold. This
weakens the currency inducing the inflow of gold and the outflow of exports
of real usable wealth. I realize this is counterintuitive (it seems obvious
that a strong currency should buy more gold), but the easiest way to
picture it is to imagine a currency manager doing this in isolation. He's
printing and buying gold to weaken his overvalued currency. This is going to
first cause gold to flow in but then the price of gold will rise. The
currency manager could continue buying, say $10B in
gold every day forever. And we could say that $10B in gold would flow into
his reserves every day forever. But the reality is that the flow of gold by
weight would slow and stop very quickly because the price of gold
would rise so rapidly. At some point your $10B/day inflow of gold would be a
fraction of an ounce.
So gold starts flowing out of a zone (and "usable wealth" starts
flowing in) when the price of gold peaks and starts falling. The currency
manager can counter this (for stability) by inflating the currency and buying
some of that gold that the savers are dishoarding, slowing the export of gold
and thereby slowing the import of "usable wealth".
So… When savers are hoarding gold, the CB is dishoarding. When savers
are dishoarding, the CB is buying their gold with fresh currency. Over time this
will minimize the flow of gold between currency zones and because the flow of
gold is a reflection of the flow of "usable wealth" we can deduce
that trade will be balanced and disruptive cycles and corrections will be
Will there be some paper debt involved across zones? Yes, because there is a
time lag involved. But as long as savers and CBs aren't using that debt as
their long term reserves/savings, it won't build up and it will reverse sides
regularly. I think that this short term debt (call it the buffer) will still
be reflected in the "Capital Account" of the Freegold
BOP and the cross-border flow of gold will be reflected as a normal trade
good. I don't think Freegold requires
a revised BOP methodology.
As a parting thought, just remember that this BOP discussion is looking at Freegold from a macro (aggregated) perspective which is
different from the personally subjective (micro) perspective in which it is
usually discussed here. Things appear very different from the mountain top on
the other side of a singularity. ;)
 A relatively tiny amount of gold will flow as a "usable" good
along with the rest of the "usable wealth". There are a few
electronic uses for which gold is irreplaceable. At the current price there
are about 300 tonnes consumed every year in
electronics. But, even at today's price, substitutes are being created for
the less important ones. My brother is a materials engineer working for a
major medical equipment manufacturer. He personally administers the physical
application of gold to these vital electronics.
They coat vital electronics with gold not because gold is a good conductor
(silver and copper are much better) but because a very thin layer of gold
prevents the lesser metals from corroding. Corrosion inhibits conductivity. In one product he makes there is
10-cents-worth of gold at today's price. That product costs $2,500 to
manufacture and sells to medical professionals for $10,000… and it
contains 10 cents of gold. Even with a 40X revaluation the gold component
will only be $4.
On these high-end medical applications they use sophisticated techniques for
applying the gold. Much more sophisticated than the gold plating used on cell
phones and thumb drives. My brother uses evaporation and sputtering
which deposits a layer only a few atoms thick. Gold electroplating from a
liquid onto cheap electronics deposits a much thicker layer, and those lesser
electronic uses will likely be substituted with something like this.
It's kind of funny that a $50 cell phone today contains 50-cents-worth of
gold while the gold-plated piezoelectric capacitor in a $10,000 piece of
medical equipment only contains 10 cents. That's right,
an ounce of gold is required for every 16,000 of these devices. And that
particular capacitor requires a lot of gold, about 10 sq
cm of surface area to be coated. For comparison, an integrated circuit chip
requires anywhere from 0.1 to 2 sq cm of surface
area to be coated in gold. An ounce of gold covers about 160,000 sq cm using these high-end techniques at a thickness of
1000 angstroms (0.1 micron, 0.00001 cm).
My point is that I foresee the amount of gold being used in electronic
applications dropping significantly to maybe 100 tonnes
per year in Freegold. That's out of the 170,000 tonnes of gold in storage. A 1,700 year
supply overhang perhaps? Somehow I don't think Freegold
will interfere with any vital industrial uses for gold.
PS. I'd like to take the opportunity of a postscript in a fresh post to
highlight Victor the Cleaner's explanation of what Mario Draghi
meant when he said "whatever it takes". Reposted from Screwtape Files:
It seems that most people don't understand the ECB.
If Draghi says "within their mandate", he
is referring to their inflation target "below but close to 2%
annually" in the medium term (i.e. 2-3 year average).
He said he would save the Euro "whatever it takes". He didn't say
he would save government debt whatever it takes. Some people seem not to get
it that these two are completely different goals.
If you take the 2% inflation target seriously (and every single step by the
ECB is consistent with the assumption that they do), you conclude that:
1) The ECB will print money in order to create inflation as soon as the
medium-term inflation rate gets substantially below 2%.
2) In order to create this inflation, the ECB will have to purchase consumer
debt with new base money (this is how you create price inflation). So their
standard choice will be to buy government debt - government expenditures are
largely consumption, either directly or through salaries, pensions, benefits.
3) In the inflation rate drops substantially below 2% in some countries, but
not in others ("policy transmission distorted"), the ECB will buy
government debt of these countries, but not of others - most governments
spend mainly in their own economy which allows the ECB to target where they
want to create inflation
4) The ECB has no mandate to create more inflation than the mentioned 2%
annually. So they will make sure this doesn't happen either.
5) How will they do it? Well, that's easy. A lot of debt is being written off
(Spanish home owners defaulting on their mortgages etc.), and several
governments had to sharply cut down on their deficit spending. Both are
deflationary. So the ECB could simply leave the market alone, and the Euro
zone would get some price deflation. So the ECB has enough tools to limit the
inflation rate at 2% annually.
6) What is the main mechanism that might cause an inflation rate higher than
2% in the medium run? This would happen if the commercial banking system or
the ECB monetize the running budget deficit of their governments or if they
monetize other consumer debt beyond about 2-3% of GDP annually.
7) How can this be prevented? Well, some governments have gotten into serious
difficulties raising funding, and Ireland, Portugal, Greece, Spain are forced
to cut down on public spending. How precisely? The interest rates they would
have to pay for additional debt are going up.
See? Some idiots claim "Draghi wants to print
and buy all government debt in order to lower the interest rates" and
then "ECB is too stupid to really lower interest rates"?
How about this: ECB has purchased some government debt in order to create
inflation in those countries in which inflation was dropping too much below
2%, but ECB never intended to lower interest rates?
Much easier explanation, isn't it?
8) So what do we conclude if we assume that the ECB is doing nothing other
than their job, i.e. to maintain their 2% inflation target?
8.1) They will buy government debt if the inflation rate drops too much below
2% annually. In particular, if this happens in some countries, the ECB will
buy the government debt of these specific countries (SMP).
8.2) Although the ECB may buy government bonds for this reason, they will
make sure they do not artificially suppress the interest rates (in contrast
to the Fed or the BoE).
8.3) As long as the inflation rate stays around 2%, the ECB will not monetize
government debt, simply because this would create more inflation. In
particular, this indicates a limit of the annual budget deficits that will
end up on the balance sheet of the combined banking sector (commercial banks
and ECB): no more than around 2-3% of GDP which would cause about 1.4-2.1%
consumer price inflation in the steady state (assuming roughly 70% of
government expenditures is consumption - you can adjust these figures if you
have better data, the ECB certainly do have better data).
8.4) So while some debt will be bought by the ECB in order to maintain 2% inflation, some other debt will most likely be defaulted
on. How much? I guess this will still be a lot.
8.5) If some politicians try to give the ESFS or ESM a banking license or to
use government run banks in order to monetize their own debt, the ECB will
have to obstruct these attempts, for example, by changing the requirements on
the collateral they accept from these banks. Also, the northern countries
will not like this and presumably already be influential enough to stop it.
When I was young, it seemed that life was so wonderful,
a miracle, oh it was beautiful, magical.
And all the birds in the trees, well they'd be singing so happily,
joyfully, playfully watching me.
But then they send me away to teach me how to be sensible,
logical, responsible, practical.
And they showed me a world where I could be so dependable,
clinical, intellectual, cynical.
There are times when all the world's asleep,
the questions run too deep
for such a simple man.
Won't you please, please tell me what we've learned
I know it sounds absurd
but please tell me who I am.
Now watch what you say or they'll be calling you a radical,
liberal, fanatical, criminal.
Won't you sign up your name, we'd like to feel you're
acceptable, respecable, presentable, a vegtable!
At night, when all the world's asleep,
the questions run so deep
for such a simple man.
Won't you please, please tell me what we've learned
I know it sounds absurd
but please tell me who I am.