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Humans eat or humans die and with the Peak Oil specter looming, this issue is becoming very
pressing for about 923,000,000 people. The Internet is an amazing series of tubes. A
friend told me that Nate Hagens, MBA, former Managing Director at Salomon Brothers,
Lehman Brothers and editor of The Oil Drum, used my liquidity pyramid near the end of his
presentation at the June 2009 Oil Drum/ASPO Conference in Alcatraz, Italy. The presentation was extremely
interesting. Continuing the theme, on 8 July 2009 he authored an article: CFTC – Futures Position Limits On
Energy?
INFORMATION AGE
Mr. Hagens has some key insights.
Let’s return to a central theme: that finite
resources are being quantified by infinite money. … Unfortunately, this
’speculation’ issue is one of many red herrings that ignores the
widening fundamental disconnect between financial and real assets. … As
long as energy and resources were cheap, more long term gearing/profits were
to be had from the vanilla ‘derivatives’: stocks and bonds (these
are derivatives of our real capital: natural,
built, social and human that underpins
them), than from the commodities themselves.
One of the reasons Brazil and Russia have such positive prospects is because of their
tremendous endowment of real assets. The Industrial Age allowed for
obfuscation of information and inefficiencies of epic proportions. Ironically,
during the Information Age there will be a return to all things real. This is
because the Internet pulls back the curtain and exposes with bright
luminescence everything formally hidden in the darkness at the speed of
light.
Additionally, stocks are in a long-term secular bear
market while commodities are in a long-term secular bull market. Like the
seasons on Jupiter; these take a couple decades to completely cycle through.
As commodities represent the antithesis of financial assets this is likewise
a vote of no confidence in the political structures of the earth. And why not
when Bloomberg reports that Neil Barfosky, special inspector
general for the TARP, says ‘US taxpayers may be on the hook for as much
as $23,700,000,000,000 to bolster the ecnomy and bail out financial
companies’. The European banking system is worse condition.
PRICING
Mr. Hagens continues:
As we are mired in a deepening recession, the roots
of which lie in the generation long replacement of tangible things with paper
and digits, the logical human reaction to oil moving back from $40 to $70 is
to blame someone, in order that it retreat some and not act as economic
headwind. … So what does this mean? Energy, particularly liquid fuel,
is the hemoglobin of modern civilization. Price signals based on the marginal
unit create long term distortions for utilities and energy policymakers.
I agree that the world has a very serious problem.
Because it has used a fiat currency with no definition for nearly 100 years
and because oil production was constantly increasing during that time the
effects of unwise capital investment were masked. Energy Return On Energy
Invested (EROEI) calculations were not performed and because of the central bank gold price
suppression scheme it was probably
impossible to accurately do so. But the damage to the economy has already
been done and is a sunk cost. What can be done going forward?
UNTENABLE SOLUTION
Mr. Hagens wrote, “Like M. King Hubbert, I am
in favor of an energy based currency and no futures trading at all other than
for producers and those taking delivery.” After some digging around I
think I found Mr. Hubbert’s plan, which involved ‘energy certificates‘.
On this basis our distribution then becomes
foolproof and incredibly simple. We
keep our records of the physical costs of production in terms of the amount
of extraneous energy degraded. We
set industrial production arbitrarily at a rate equal to the saturation of
the physical capacity of our
public to consume. We
distribute purchasing power in the form of energy certificates to the public,
the amount issued to each being equivalent to his pro rata share of the
energy-cost of the consumer goods and services to be produced during the
balanced-load period for which the certificates are issued. These certificates
bear the identification
of the person to whom issued and are non
negotiable. They resemble a bank check in that they bear no
face denomination, this being entered at the time of spending. They are
surrendered upon the purchase of goods or services at any center of distribution
and are permanently canceled, becoming entries in a uniform accounting
system. Being nonnegotiable they cannot be lost, stolen, gambled, or given
away because they are invalid in the hands of any person other than the one
to whom issued. [emphasis added]
This solution is not practical because it is immoral
and inefficient at allocating resources.
First, I am not sure who Mr. Hubbert intends the ‘we’ and
‘our’ pronouns to refer to. There are only individuals endowed
with certain unalienable rights such as the right to live and by extension
the right to eat their food.
Second, the use of energy certificates in this manner would amount to a
price control or form of rationing. It is basic Austrian economics that price controls cause shortages with Zimbabwe being the latest tragic example. How
would ‘we’ implement these ‘energy certificates’
based upon ‘identification’ that are
‘non-negotiable’? With a barrel of a gun?
Even Vladimir
Putin understands what happens:
The only problem: your results were poor and this
will always be the case because the work you do is unfair and immoral. In the
long run immoral policies always lose.
The issuance of energy certificates whose use is
enforced with the barrel of a gun is immoral and will always fail. Also,
because it relies on force to implement along with identification, price
controls and currency
controls it is an
inefficient solution to allocate energy resources. What would be a tenable
solution?
TENABLE SOLUTION
A fiat currency attempts to sustain the unsustainable
while a commodity-based currency employs the strict laws of reality to ensure
the unsustainable is not encourage. At one of the Cambridge House investment
conferences while talking with a CEO of a mining company I asked some
questions on this topic. He succinctly responded, “Mining is converting
energy into metals.”
The storage and spoilage costs of the metals is far
lower than wheat, cattle, oil, lumber or other commodities. Consequently,
using metals as currency in ordinary daily transactions seems like the most
efficient option.
During the Industrial Age the middle class survived
and thrived but taxation exploded and concepts like economies of scope and
scale led to bloated Welfare State governments. As Mr. Hagens wrote,
“We have a monumental problem – a system whose claims on the
future are higher than its real assets.”
Governments around the world will massively
default on their promises; Social Security, Medicare, Medicaid, the Pension
Guaranty Benefit Corporation and the equivalents in Europe, Australia, etc.
What is needed is not larger organizations and institutions but smaller ones.
Individuals are like the plankton of the investment world; they will likely consider how to buy gold or silver to protect themselves from the insidious inflation
tax which is a surreptitious form of confiscation without due process of law
and is a prime reason to Raze The Fed. Plus, the Federal
Reserve’s quantitative easing is failing.
Digital commodity currencies, like GoldMoney, which allow gold, silver and platinum to circulate as currency in ordinary daily
transactions are tremendous monetary evolutions made possible by technology in
the Information Age. Like Facebook, Twitter, Google (GOOG), etc. they will explode into world commerce. They are tremendously
more efficient than the fiat paper franchises.
For example, from 2001-2007 the cost of storing
$1,000,000 of capital in gold versus T-Bills was approximately $1,254 per
month lower. Second, the use of these private currencies is voluntary and
does not rely on the barrel of a gun via legal tender laws or capital gains
taxes to remain competitive. Third, as a result the market would choose, voluntarily,
commodities as currency and civil liberties would be protected. There is a
great book on this topic by Jörg Guido Hülsmann called The Ethics Of
Money Production.
PRECIOUS METAL
AND OIL VALUATIONS
As of 20 July 2009 there is slight gold
backwardation, again. When I
chronicled the chronic nine week silver
backwardtion we watched the
spot price rise from FRN$11 per ounce to almost FRN$15 per ounce or a 36%
rise. Usually the summer is very weak for gold but it appears to be trading
primarily as a currency right now so the backwardation situation is
intriguing.
Additionally, as I recently recommended buying silver around FRN$12.50 and buying
platinum around $1,115;
those who followed the advice may need a snorkel to breath because of the
~10% gains in less than a month. The speculator may want to take some gains
and wait for the last pullback before this fall.
While the gold to oil
ratio does matter perhaps it will
not return to previous patterns but instead normalize to a higher price in
gold. But even with perpetually higher average energy costs this autumn and
winter will likely see a tremendous fall in the price of the DOW in gold
because of the relationship between unemployment, gross revenues, net
incomes, P/E ratios, etc. In September the first batch of unemployment
benefits expires out for about 500,000 people. Then each succeeding month the
numbers will continue piling up just like the job losses which began 18
months ago.
Perhaps because we are 70 years removed from the
Great Depression we think of it as an
event; but in reality it took place over a couple decades and the
first few years of it were marked by increased unemployment which caused
people to burn through their savings before they became destitute.
A great book is Wealth War and Wisdom by Barton Biggs. Mr. Biggs, former chief global strategist for Morgan
Stanely (MS), advises
you want your sanctuary to be remote enough to be
inaccessible to the dispossessed hordes. Assume a breakdown of the civilized
infrastructure. Your safe-haven must be self-sufficient and capable of
growing food. It should be well-stocked with seed, canned food, wine,
medicine, and clothes. There should be a stash of automatic weapons that you
know how to use in case roving bands of hungry barbarian brigands show up.
(p. 347-8)
CONCLUSION
The world has a very serious problem regarding
energy and food production. The Information Age will continue to reveal the
inefficiences and flaws in the current monetary structure with barbarous
relics known as central banks. As I assert in my book, The Great Credit Contraction, capital is moving down the liquidity pyramid
seeking safety and liquidity and it has only begun. There will likely be less
capital available for metal or oil investment.
But there are digital
commodity currencies that function in
ordinary daily transactions. Each ounce of silver will likely buy a nice
steak dinner. A couple ounces of gold will usually pay rent on a nice abode
while 50-70 ounces of platinum will purchase a nice house. Based on
historical averages, the gold to oil ratio should decline. In the meantime
you may want to prepare for survivalism
in the suburbs.
The role of the monetary metals, particularly gold,
is to perform mental calculations of value; pricing. The sooner you begin to
calculate value in terms of real things the sooner you will be able to
understand the relationship between gold, oil and your stomach.
How will this all play out? I do not think anyone
really knows. The collapse of the gold rig will not be a garden variety
exchange rate adjustment but the collapse of a worldwide monetary system. The
decline of supply of cheap and abundant energy, the ‘hemoglobin of the
world economy’, will have tremendous implications for every cell in the
food chain. It would be nice if humanity acted morally. But have you ever
watched a pack of hungry wolves on the Nature channel? Keep in mind that
governments need less hungry mouths and lower unemployment.
Disclosures: Long physical gold, silver and
platinum.
Trace Mayer
RuntoGold.com
Trace Mayer, J.D., holds a degree in Accounting from Brigham Young
University, a law degree from California Western School of Law and studies
the Austrian school of economics. He works as an entrepreneur, investor,
journalist and monetary scientist. He is a strong advocate of the freedom of
speech, a member of the Society of Professional Journalists and the San Diego
County Bar Association. He has appeared on ABC, NBC, BNN, many radio shows
and presented at many investment conferences throughout the world.
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