Saturday, November 14, 2009

Say Goodbye to Wall Street

Fofoa, King of bloggers.

Say Goodbye to Wall Street


So many faces in and out of my life
Some will last
Some will just be now and then
Life is a series of hellos and goodbyes
I'm afraid it's time for goodbye again
Say goodbye to Wall Street
Say goodbye, my baby
Say goodbye to Wall Street
Say goodbye, my baby

Equity versus Credit

This is the difference between gold and dollars. One is limited and the other is unlimited. Gold and equity are limited. Dollars and credit are unlimited. The two cannot be mixed without a negative outcome for society.

Imagine two neighbors. Both are unemployed, yet neither are worried about it at the moment. One neighbor has a stash of gold coins. The other has a FICO score of 800. One has equity, the other has credit. For the time being they can each live on what they have. Eventually both will have to get a job, but hopefully you can see the difference.

Gold Credit?

In my post, The End of a Currency, I wrote about a perfect gold standard in which there was no monetary inflation and no monetary interest on loans. Someone asked, "why would anyone make a loan in this perfect system?" The simple answer is that they would not.

The more complicated answer is that savers would not loan their gold in the way we think of loans today, with only a piece of paper obliging the borrower to return the gold plus some interest. And certainly not with a mere piece of paper requiring the return of only the principle. Even if it would be worth more when it was returned, the same positive result could be had by burying one's gold, eliminating risk.

No, the way that gold would "go to work" in this perfect gold standard is only through equity investment. One man might provide the gold while another would provide the labor and knowledge and together they would share in the profit or loss of the joint venture.

(On a side note, all major religions originally promoted only this kind of economic activity. Loans for a specific nominal return that included interest were forbidden. Christianity called it usury. Judaism called it neshekh, meaning "a bite". And Islam called it riba, meaning "excess or addition".[1][2])

Which Came First, the Chicken or the Egg?

Which came first? The greed of the banksters to make usurious loans to the people? Or the demand of the people to borrow frivolous capital for whatever economic activity they chose without sharing profits?

Adam Smith (1723-1790) taught us that economies emerge as bottom-up spontaneous self-organized order that naturally arises from social interactions, not from top-down bureaucratic design. This is also true of banks.

Banks emerge in economies because man has the innate desire for a credit-based system in which he can engage his own economic folly at someone else's risk. Given pure equity, the individual man will not lend, but still demands to borrow. And as a society, we (rightly or wrongly) end up demanding that the risk of loss is spread far and wide. We say, "don't mind borrowing it, but damned if I'm gonna lose it!" (See: FDIC)

And with the recent bailout of the banks, it is repelling to think that we are responsible. It is true. We are all, as a society, responsible for the actions taken. It was a foregone conclusion a long time ago. That if losses ever loomed large enough to bring down the system, society at large would end up covering the losses. This is the very nature of the system we have built as a society. A system that sprung up from man's desire to borrow, not from man's desire to lend or steal. That came later.

I do not make these statements in support of the bankers or the bailouts. I find them just as revolting as the next guy. But as a pragmatist, I am looking for a realistic explanation of what is happening.


As a credit-based system emerges along side an equity-based monetary system, all kinds of problems arise for society, not the least of which is inflation. The interest portion of all loans requires growth in the money supply over time. And on a large economic scale, this growth can be quite substantial.

As the lenders' credit-paper notes are "seasoned" over time they begin to circulate as near-money at a discount to the original equity they represented. And as the "money supply" grows, so does the disparity of value between credit and equity. At first, governments always keep the two tied at par through legal tender laws, but this only drives real equity into hiding and credit must expand even faster to cover the loss of equity from the monetary system. But sooner or later the credit portion must be devalued against the equity portion and ultimately, the link between the two is severed.

Society as a whole decides what society's official money is. And once the link between credit and equity is stretched to the breaking point, credit alone is declared to be official money. Thus begins the ultimate unrestrained inflation.

Political Risk

Money, whatever it is declared to be, is constantly at risk from the body politic. The infantile will of the collective is the risk faced by all monetary systems. If gold is a part of that system, then it is the people's gold, their savings, that is at risk from the collective's grabbing hands. The collective is most often described as the government, but governments cannot take bold actions without at least the implicit support of the majority.

In our current crisis, it is the dollar that is at risk. The collective has given implicit support to unlimited government printing in hopes that it will slow the fall from the collapse of credit derivatives. We now also have the central bank of central banks suggesting printing support to guarantee the sum total of bank credit derivatives numbering five to ten times larger than the entire value of all equity on the planet earth.
Central Banks Must Agree Global Clearing Supervision, BIS Says
Sept. 14 (Bloomberg) -- Central banks must coordinate global supervision of derivatives clearinghouses and consider offering them access to emergency funds to limit systemic risk, according to the Bank for International Settlements.

It is the political will of the collective, now facing momentous losses, that is the biggest threat to the dollar. This will is already set in stone. And we have yet to see the full impact of this will as pension funds fail and state and local governments face inevitable insolvency.

The dollar's collapse through the loss of its reserve status has already begun. But it is the political risk, this political will inside the US that ensures that this collapse will be a hyperinflation the likes of which the world has never seen. Never before has a global reserve currency imploded. The stage is now set, the audience seated, the lights dimmed, and a low, rumbling, tympanic drum roll can be heard rising from under the stage.

Evolution of the Dollar

Over the past 65 years, the US dollar has been parlayed into a cost advantage for the United States greater than any other currency scheme throughout all of history. The reason this advantage has been so great was that the true inflation cost of the currency was concealed from the pricing markets.

In the fiat-gold systems of the past, steep price inflations always signaled that the official money was about to be destroyed and redenominated. This fear carried forward into our present purely symbolic currency system, but we soon evolved to accept price inflation as the cost of doing business. As long as it was low enough that we could out-gain it through other investments, the benefits that our fiat trading economy provided were readily accepted.

Over time we have grown numb to the slow, hidden increases of the inflation tax. In moderation, this tax would have been somewhat acceptable, in an immoral sort of way, as society stole the productivity and efficiency gains (from those that could provide such) to pay for itself. But alas, hidden theft is just too good of a process for our collectivist political system not to expand on.

And in the US it is our political system's MO that government does exactly what the majority demands, and then expands the inflation tax to cover it. It has been this way since before we were born!

The Catch

But here's the catch. Since 1971 at least, and probably since 1944, the US dollar has been EXPORTING most of its inflation. And in doing so, it has built up an enormous inflation tax deficit on all dollar based assets. The full amount of this deficit is unknown because it has been masked, hidden, rejigged, absorbed and papered over time and time again. But one thing is for sure. The full price of this tax is way, way above anything we imagine. Most of it hidden over many years in the "dollar reserve function".

As a credit-based currency expands, the market acts as the lever that balances equity values against the expanding currency within its legal tender zone. But in the case of the dollar, a constant outflow lasting decades has been absorbed and held in reserve (think reservoir) outside of the dollar zone.

In addition to this main monumental price deception, the little bit of price inflation that actually did seep into the dollar zone was either suppressed through the gold and oil price manipulation scheme, masked by CPI rigging, or simply papered over with low interest rates and intentional asset bubbles. In other words they handed out free money to pay for what little price inflation actually showed up, in the form of HELOCs on overpriced homes.

So even though prices have risen over the last 40 years, don't assume the inflation tax has been paid. Don't even assume we have made a down payment on it. Just think about the gains we have seen in the US ever since our purely symbolic currency became the global reserve. (Actually, ever since our gold-backed paper fiat currency became the global reserve and then somehow managed to retain that privilege after switching to pure fiat!) Think of the standard of living improvements. Think of the growth. Think of the military expansion. Think of the social program expansion. Think of all the spending we've done over the last 40 years, compared to the producing we've done.

Our spending has gone parabolic while our production has collapsed. And now we are mostly a service industry workforce and a consumer driven economy. The result of decades of decadence. The result of public and private profligacy. And now the tax is due.

Hugo Salinas Price's graph [3] gives us a good visual depiction of some of this unpaid inflation tax.

Payment of this enormous inflation tax deficit will present itself to us as a sudden hyperinflation. It will be perceived and reported by the media as something that was done to us by China. But now, at least you know the truth.


The taxman is at our door. The mother of all taxes is now due. But curiously, there is a refuge. There is a haven in which you can hide. Can you guess what it is?

Of course it is physical gold in your physical possession. But gold will not just protect you from this 65-year inflation tax. As the system collapses from its own weight, gold will first reveal its true value. And then, from there, it will hold its true value as paper burns all around it.

And once we make it through this firestorm to the other side, gold will continue to be THE world class refuge from the future inflation tax that is sure to come.

You see, the Siamese twins, credit and equity, have finally been separated. Gold has been demonetized! It is now a world class wealth asset. A tradable wealth asset. A portable wealth asset. A durable wealth asset. Money, which has been deemed by society to be fiat currency only, no longer needs to carry the heavy burden of ALSO being a store of value. No longer must we raise entire industries that suck in generations of our best and brightest talent for the sole purpose of designing paper wealth derivative products in a vain attempt to make money be a store of value. No longer. Say goodbye to Wall Street.


[1] History of Usury Prohibition
Wayne A.M. Visser and Alastair McIntosh
Centre for Human Ecology

[2] Islamic finance principles to restore policy effectiveness
Willem Buiter, Financial Times

[3] A New Magna Carta for Our Times
Hugo Salinas Price

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