The Gold Standard Journal 18

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The Gold Standard The Gold Standard Institute Issue #18 15 June 2012 1

The Gold Standard The journal of The Gold Standard Institute

Editor Philip Barton Regular contributors Louis Boulanger

Rudy FritschKeith Weiner

Occasional contributors Sandeep Jaitly Jason Keys

The Gold Standard Institute

The purpose of the Institute is to promote anunadulterated Gold Standard

www.goldstandardinstitute.net

Patron Professor Antal E. Fekete President Philip BartonPresident Europe Thomas BachheimerPresident USA Keith Weiner

Editor-in-Chief Rudy FritschSenior Research Fellow Sandeep Jaitly

Membership Levels

Annual Member US$100 per yearLifetime Member US$3,500Gold Member US$15,000Gold Knight US$350,000

Annual Corporate Member US$2,000

Contents

Editorial ........................................................................... 1 News ................................................................................. 2

As Cashless Society Looms, Does Fiat Paper MoneyHelp Golds Cause? ........................................................ 2

The Criticality of Gold .................................................. 4 Crusoe Economics ......................................................... 5

The Role of the Commercial Bank .............................. 7 Duration Mismatch Will Always Fail .......................... 8

The American Corner .................................................. 11

Editorial

This is written from Vienna where the sun is shining,the beer and ice-cream is great (with a suitable gap

for digestion between) and the coffee is, as always,barely tolerable considering that Italy is so close.

The Opera house and museums are still busy. Vienna is a city that grows on you the longer youstay. One of its great virtues is the easy access toother cities. Prague, Budapest, Warsaw, Munich(dont forget to book for the seminar in September)and Venice are just a few hours away on the fabulousEuropean train system. Europe still looks great, butnot too far from the surface the number of marginal

businesses is growing, as are the for lease signs.

Stadtpark (opposite the Vienna Mint) is still full offamilies enjoying the sunshine, space and beauty; it isalso now home to those who have nowhere else tosleep. I dread to think how they coped during thebrutal European winter.

I am over here to check out the gold insurancescheme that is going live this month more detailsin the Julys issue of The Gold Standard courtesy of

Thomas Bachheimer (we ran out of time to includeit this month). These are exciting times for those

who have pushed the return of gold. Gold insurance,like gold bonds, is one of the first and mostimportant steps on the road back to sound money.

Those who wish to avoid a future in their localequivalent of Stadtpark should consider goldinsurance.

Governments in Europe are dragging their heels indiscussing the return of gold some oppositionparties are not. The return of gold to polite

conversation is not restricted to Europe.Okayama Metal and Machinery, a Japanese pensionfund, has allotted 1.5% of its fund to gold in a sign
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The Gold Standard The Gold Standard Institute Issue #18 15 June 2012 2 of the growing suspicion of paper money.

Yoshisuke Kiguchi, the chief investment officer, saidhe was diversifying into gold to escape sovereignrisk. Whilst 1.5% is modest, it is a start.

Philip Barton

News

Mineweb: Gold as the tier one asset (thanks Jacq)

Telegraph UK : Europes debtors must pawn theirgold for Eurobond Redemption [Germany wants thegold.] Southern Europe s debtor states must pledge

their gold reserves and national treasure as collateralunder a 2.3 trillion stabilisation plan gainingmomentum in Germany. Germany would have alockhold over the fund, able to enforce discipline.Each state would have to pledge 20% of their debtas collateral. "The assets could be taken from the countryscurrency and gold reserves ... Everything being done at a

European level is in the interests of Germany and France, tosave their banks. It is not in the interest of Italy Weshould use our gold to take care of our own debt,

collateralizing bonds above 100pc of GDP. That would be a far more targeted approach," he said.

Jamie Dimon, CEO of JP Morgan Chase: "We boughtsome triple-A securities that we think are as good as gold."

24hgold: Filipino legal tender coins are disappearingas their metallic worth exceeds their stated worth.

24hgold: Beware the pitfalls of swapping gold forreal estate too soon. This scenario will play outaround the world. Owners of real estate will be thefinal milk cows available to governments.

King World News : This highlights the risks ofholding gold in the banking system. Logic dictatesthat it will become worse. It should be pointed outthat a similar story out of Australia this week turnedout to be of dubious authenticity.

As Cashless Society Looms, Does FiatPaper Money Help Golds Cause?

Paper Federal Reserve Notes are looked upon with

contempt by gold advocates as the tangible symbolof banks economic c ontrol. But may they actuallybe subtly helping promote the idea of hard money?

We have been drifting toward a fully electronicmonetary system for some time. Governmentsopposed to individual rights must by definitionalways crave ever greater power. Controls breedmore controls, as a wise writer once said. And whatmore important economic and political crossroads isthere to dominate than citizens daily transactions?

The underground economy, consisting of a mixtureof gangsters and ordinary citizens trying to earnmoney un-taxed and un-regulated, is based largely oncash transactions. Governments hate this back-doorfor the dodging of their revenue collectors andcompliance staff.

Slowly, the authorities are closing that door. Starting with the widespread acceptance of credit cards, thendebit cards, and finally online and cell phonepayments systems, the average persons use of cashhas been steadily declining for decades.

Inflation lends a hand, acting as the hammer againstthe anvil of cashs decreasing functionality. Bankmachines dispensing $50 bills are becoming rarer, yetprices continually rise. This makes it harder to usecash in everyday transactions. Fewer merchantsaccept large-denominations bills, and stores lowcash floats unofficially discourage use of $50s or$100s. Dealing with a wad of low denominationbills, or being told there is insufficient changeavailable for your tendered payment, makes cash lessappealing.

There is probably an upward trend in the proportionof merchants who require a customers credit card,directly or indirectly, before he can complete atransaction. I hear that Britain is even close toeliminating checks. Fortunately, the popularity ofpaper checks in America is still strong.

What benefits does paper money confer? It upholdsthe idea of unrecorded, untraceable transactions andthe implied, inherent right to privacy a free society
http://www.mineweb.com/mineweb/view/mineweb/en/page103855?oid=152291&sn=Detail&pid=102055http://www.mineweb.com/mineweb/view/mineweb/en/page103855?oid=152291&sn=Detail&pid=102055http://www.telegraph.co.uk/finance/financialcrisis/9298180/Europes-debtors-must-pawn-their-gold-for-Eurobond-Redemption.htmlhttp://www.telegraph.co.uk/finance/financialcrisis/9298180/Europes-debtors-must-pawn-their-gold-for-Eurobond-Redemption.htmlhttp://www.24hgold.com/english/news-gold-silver-coin-hoarding-soon-a-crime--maybe-so-in-the-phillipines.aspx?article=3915958570G10020&redirect=false&contributor=Charleston+Voicehttp://www.24hgold.com/english/news-gold-silver-coin-hoarding-soon-a-crime--maybe-so-in-the-phillipines.aspx?article=3915958570G10020&redirect=false&contributor=Charleston+Voicehttp://www.24hgold.com/english/news-gold-silver-anecdotes-from-italy-via-canada-taxed-out-of-house-and-home.aspx?article=3921063012G10020&redirect=false&contributor=Mishhttp://www.24hgold.com/english/news-gold-silver-anecdotes-from-italy-via-canada-taxed-out-of-house-and-home.aspx?article=3921063012G10020&redirect=false&contributor=Mishhttp://kingworldnews.com/kingworldnews/KWN_DailyWeb/Entries/2012/5/21_Greyerz_-_Customer_Shocked_Allocated_Gold_Not_in_Swiss_Bank.htmlhttp://kingworldnews.com/kingworldnews/KWN_DailyWeb/Entries/2012/5/21_Greyerz_-_Customer_Shocked_Allocated_Gold_Not_in_Swiss_Bank.htmlhttp://kingworldnews.com/kingworldnews/KWN_DailyWeb/Entries/2012/5/21_Greyerz_-_Customer_Shocked_Allocated_Gold_Not_in_Swiss_Bank.htmlhttp://www.24hgold.com/english/news-gold-silver-anecdotes-from-italy-via-canada-taxed-out-of-house-and-home.aspx?article=3921063012G10020&redirect=false&contributor=Mishhttp://www.24hgold.com/english/news-gold-silver-coin-hoarding-soon-a-crime--maybe-so-in-the-phillipines.aspx?article=3915958570G10020&redirect=false&contributor=Charleston+Voicehttp://www.telegraph.co.uk/finance/financialcrisis/9298180/Europes-debtors-must-pawn-their-gold-for-Eurobond-Redemption.htmlhttp://www.mineweb.com/mineweb/view/mineweb/en/page103855?oid=152291&sn=Detail&pid=102055


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The Gold Standard The Gold Standard Institute Issue #18 15 June 2012 3 requires. It makes the effects of inflation lessabstract and more easily detectable by the averagecitizen in a way that mere numbers on a credit cardstatement do not convey. It reminds people moneyis a tangible thing, not an electronic, untouchable,mysterious creation of the banking system orgovernment. It prevents a bank from taking an extraservice charge out of a transaction. It evenencourages thrift, the true basis of economic growth,as studies have repeatedly shown people believe theyare spending less when using a credit card for a giventransaction instead of cash.

On a level perhaps more subliminal, paper moneymaintains the illusion of extinguishing debt with a

cash payment. Now, it is an illusion, because weknow that todays paper money is itself merely debtand can only transfer liability. But in this case theillusion ought to be the reality, and the mere fact thatthat illusion is still being maintained by the enemyhelps our cause. As long as banks or mints issue anytangible money, it supports our claim to the moralhigh ground that money ought to be a tangiblething. Although as peoples mai lboxes overflow

with offers for debt-consolidation and credit cardbalance transfers, the citizenry is certainly beingprepared for the concept of perpetual servitude.

Todays Federal Reserve Notes are bad, but they arestill one step removed from rock-bottom: a bank-issued card required for all transactions of any sort.Paper money today may be fighting a rearguardaction against global tyranny.

Reading Orwells 1984, one is shown the grim faceof a future, technologically advanced traditionaldictatorship. Huxleys Brave New World predicted aneasier way for the rulers to maintain power.

Jackbooted thugs and concentration camps are notneeded when the people are happy to be slaves inexchange for rewards of sex, drugs andentertainment. Yet a world without cash might beeven simpler for the elite to dominate. How muchdissent could remain if would-be political activistscan have their ability to transact terminated by abureaucrats keystroke in a far off seat of power?

Communication surveillance, video monitoring,location tracking, all these may become unnecessaryas a dictators systematic policy. The ease with

which the ultimate punishment can be inflicted could

compensate for much sloppiness or inefficiency indetecting political trouble-makers.

Losing the ability to buy ones next meal, abandonedby friends and associates anxious to avoid any guiltby association, instantly forced into either a life ofbegging or of crime to continue living who wouldrisk such a fate without even the ability to confrontones tormentors? A 3:00 am knock at the door bythe states enforcers is arguably a threat preferred bya resistor, as it leaves him more options than beingexiled from the economy.

Fortunately for us, paper money is not yet extinct.In fact, demand for it may grow sharply soon asbanks begin to fail again. Paper currency may evenplay an important part in a last-minute transitionback to gold and silver money. It will have thedistinction of being physically in circulation, just likegold and silver coins and bars, outside of apermanently frozen banking system.

I am not the only one to have said it before, but itbears repeating. The monetary end-game, when itcomes, may contain rules and elements we neverpredicted or even suspected. And the path to

surviving it, both politically as a free people, and with ones personal net worth intact, may demandmore than one type of skill.

Publius


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The Criticality of Gold

Every day the prophets ask themselves whether currencyconvertibility is to occur soon or in the distant future.

Everyone knows that this expression currency convertibilityis a pleasant euphemism to translate those three little words areturn to gold, these last having been banished from the

language of the Anglo-Saxons as being in supremely bad taste,as they remind one much too vividly of the unseemly conduct of

the yellow metal during the crisis of 1931.

Source: The Triumph of Gold, by Charles Rist, translated from the French, p220, 1954

Time is a funny thing. We say that what goes aroundcomes around. Yet, we still think of time in linearterms. Cant we make up our mind: is time linear orcircular? Well... it would appear to be both! Ormaybe its just too complex to fit one shape oranother. Does it matter?

It matters if we want to better understand what isgoing on now with our failing global monetarysystem. You see, weve been here before 1; but still

too few of us recognise this. As a result, all our warnings have been like whistling in the wind.However, it seems as if all these past murmurs fromfriends of the gold standard about the role of goldare now finally starting to have an effect.

Indeed, something seems to have changed recently.People are suddenly starting to be more open to theidea (as if it was only an idea...) that maybe, justmaybe, gold does matter. What comes to mind hereis the concept of critical threshold in complexity

theory. What also comes to mind is thatphenomenon called murmuration, as in a large flockof starlings that all turn at the same instant. Thebirds all turn in the sky at the same instant withoutany apparent communication!

We don't know how they do that. It seems to besome kind of collective cognitive processing beyondour understanding. James Dines, the original gold

1 Fiat money has died before. In fact, in all of recorded human

history, not once has fiat money survived. This time however,all currencies in the world are fiat money. So weve pushed theexperiment to its limit. But the end result will inevitably be thesame. The triumph of gold over fiat abuse is only a question oftime.

bug, suggested earlier this year that a great humanmurmuration was now underway, vibrating like abass chord through bodies politic all over the

world... Hey, maybe thats what Bob Dylan wastrying to tell us when he wrote the answer my fri end isblowin in the wind ...

What does it all mean? It means we are approachinga critical threshold for gold awareness. JamesRickards explains in his book, Currency Wars(pp212-216), how complexity theory works and howa small loss of faith in something fundamental to thesurvival of the existing system, for whatever reason,can potentially lead to a complete collapse ofconfidence. He uses faith in the US dollar as an

example.Each individual will have a different tipping point, heexplains, or critical threshold on how many otherpeople will need to have already lost confidence inthe dollar before he or she also decides to loseconfidence. Rickards likens this critical thresholdphenomenon to asking how many people must runfrom a crowded theatre before the next persondecides to run. Some will run out at the first sign oftrouble; others will not move until many have started

to run; and so on, until the last.

Of course, he may just as well have taken the Fed orthe Euro to make the same point. In fact, I thinkthat it does not matter what one uses, the existingsystem left to its own is already beyond saving. But,rather than letting it come to its inevitable collapse,maybe the avalanche of capital destruction can beprevented with the arrival of an idea whose time hascome again: the gold standard.

The key then, based on complexity theory, is for usto lower certain other peoples critical threshold forthe repudiation of fraudulent money. In other

words, we need to bridge the gap between the verysmall minority of individuals who believe that areturn to the gold standard is a good idea and the

wider community. But, as was elegantly explained inRickards book, it does not mean we need toconvince a whole lot of people; maybe even only onegroup of people!

Heres how it works. Suppose the worldspopulation can be divided based on peoplesindividual critical thresholds, called T. Here T would


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The Gold Standard The Gold Standard Institute Issue #18 15 June 2012 5 represent the number of other people who must loseconfidence in fiat money before that individual alsoloses confidence. In other words, T is the tippingpoint when one runs to gold, based on how manyothers already have. Everyone has a different point,but these can be grouped to show the potentialinfluence one group can have on the next .

Lets say there are 1,000 people in the world with thelowest critical threshold for the repudiation of fiatmoney and that threshold for them is 100 people or

T=100. Since there are at least 100 readers of this Journal that must have already repudiated fiatmoney, clearly then all of those 1,000 people in the

world in the first group would then also have

rejected fiat money in favour of a return to soundmoney or the gold standard. But what is the criticalthreshold of the nextgroup?

Thats the great unknown, of course. But lets notget too discouraged yet. Let us suppose that thenext group is made up of 1,000,000 people that sharea T of 100,000. In other words, once 100,000 peoplein the world will have repudiated fiat money, there

would then be one million of us wanting a return tosound money or the gold standard. But how do we

go from, say, just 100 now to 100,000 people whoget it? Thats quite a bridge of ignorance to gap...

For the sake of simplicity, we could argue that therest of the world has even much higher criticalthresholds than these first two groups, such that itcould be classified into two further groups where thenext 1,000,000,000 (one billion) would have a T of100 million people and the rest of the world (theother six billion or so) a T of 1,000,000,000. Now,heres where this criticality thing gets reallyinteresting. Pay attention!

We are, it seems, at the edge of chaos. According toscience, this is where the degree of complexity ismaximal. But this is also a point of emergence,

when whole new behaviours can emerge. So, as Isee it, it is our duty to educate relentlessly until theT of the next group after us drops from 100,000 tojust 10,000 or less. Hey, thats less than 0.1% of thepopulation to work on, so lets get busy!

The whole world will then suddenly get it and itllbe like 1931 all over again, except that this time... itll

be a run on the dollar, not the pound. But, inessence, itll once again simply be a run to gold!

Louis Boulanger

Louis holds a B.Sc. from Laval University in Canada; is a Fellowof the Canadian Institute of Actuaries and the New ZealandSociety of Actuaries; and is a Chartered Financial Analyst.

Prior to coming to New Zealand in 1986, Louis worked for nineyears with a global consulting firm based in Montreal, Canada.

In New Zealand, Louis worked for another global consultingfirm for 18 years, including as Chief Executive of New Zealandoperations for five years. In 2006, he launched his privatepractice.

Louis is also Founder & Director of LB Now Ltd, whichprovides independent investment advice to private andinstitutional clients, facilitates the purchase of bullion for privateand institutional clients as an authorized dealer for BMGBullionBars and also helps firms comply with GIPS.

For more information of LB Now's services or to subscribed toLouis' e-letter Prosper! see the contact details below.

P.O. Box 25 676, St Heliers, Auckland 1740, New ZealandPh: +64 9 528 3586 Mob: +64 275 665 095Email: [email protected] www.lbnow.co.nz

Crusoe Economics

Einstein said it best; for a model of reality to be

useful, it must be as simple as possible but nosimpler. The very simplest possible model ofeconomics comprises one person because onehuman actor is the smallest and simplest possiblemeans of looking at economic reality.

Chopping the person into parts to simplify themodel further wont work, and adding more peopleto the mix makes the model more complex thanneeded to study the fundamentals the gist ofeconomics. Of course, mainstream economists scoff

at this idea; our modern economy is much toocomplex to worry about Crusoe economicssnicker.
mailto:[email protected]:[email protected]:[email protected]://www.lbnow.co.nz/http://www.lbnow.co.nz/mailto:[email protected]


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This is about as intelligent as the design engineersresponsible for the Boing 747-800 snickering atNewtons apple; our modern engineering is muchtoo complex to worry about Newtons law ofgravity! Any engineer guilty of this type of insanethinking would be summarily dismissed if not, the747 would never get off the ground or if it did, the

wings would likely depart at the most inopportunetime.

Robinson Crusoe on his deserted island has no need or use- for money, or credit, or barter; but the threefundamental laws of economics show up with starkclarity, un-muddied by any extraneous complications.

The very first law is; production must precede

consumption. If Crusoe does not first catch fish, he will not eatfish nor he will not eat apples unless he first picksapples, nor have a fire unless he first gathers wood,kindling, etc. Nevertheless, we hear every day in ournew economy that demand drives productionand if we stimulate demand, all will be f ine with theeconomy. This is strike one; claiming that demandprecedes production.

The second law is; saving must precede investment.Crusoe cannot invest in financial products, only inreal capital; that is, tools and such items that helphim live better, more productively. For example hemay decide to weave a basket, so he no longer has tocarry the berries he gathers in his bare hands; but todo so, he will have to first save the vines, and he willhave to put time into this work; he must notconsume everything he gathers, but must put someaside ie save so that he can invest in his newtool.

Or, he may decide to make a fish net, to catch fish alot easier than by tickling them same thing, heneeds to put aside string, and food to sustain him

while he attends to this tedious but important chore.Nevertheless, the arrogant and ignorant sociopathsof the Washington economics establishment claimthat there is a glut of saving, particularly in theEast; and they claim that this is the problem with the

world economy never mind that the East isprospering, while Washington is sinking quickly.

This is strike two; claiming that consumptionprecedes saving.

The third law is not only fundamental to humankind,but is even obvious in the animal kingdom; hoardingis essential for survival. Even squirrels have enoughbrains or perhaps enough instinct to save nutsduring summer, to tide them over the coming winter.

According to geniuses like Mr. Munger, hoarding isfor uncivilized people. Bah; if Crusoe d oes nothoard the essentials of life, like food or water or fuel,he will not survive the next dry spell, or the next

winter.

Of course, in a more advanced economy it is notnecessary for every person to hoard everything; it isonly necessary to hoard money; honest money willserve to buy all the essentials of life. Just as money

allows indirect exchange to take the place of barter,so money allows indirect hoarding to take the placeof hoarding many necessities. Specialization is farmore efficient in hoarding like grain elevators,cold storage, etc just as specialization through thedivision of labor is far more efficient than autarky.

But what does all this have to do with Bills andBonds? In a sophisticated economy, one that hasoutgrown the Crusoe stage, and outgrown the tribalbarter stage, and has progressed to a monetary

system with developed markets, Real Bills are the very best means of funding production andproduction comes before consumption. The very actof consumption is what brings Real Bills intoexistence; and the implicit value of the Real Bill is

what enables production to be funded. In a moderneconomy with much division of labor, consumergoods go through many stages of production beforereaching the ultimate consumer and each stage hasto be funded somehow.

Think of something simple, like bread; we start with wheat from the farmers, the wheat goes to the millto be ground into flour, then to the bakery where thebread is made, then it is sold to the customer. If RealBills do not circulate, then money (Gold) must beused to fund each transaction; the economy must

work on a COD basis this means Gold mustchange hands many times. By comparison, if RealBills are in circulation, NO Gold changes hands untilthe ultimate purchase is made; no money is invested

in the production cycle the credit inherent in theReal Bills Doctrine funds the production processmost efficiently and naturally.


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The Gold Standard The Gold Standard Institute Issue #18 15 June 2012 7 Bills follow and support the first law, the law thatproduction precedes consumption. In the very samefashion, Bonds follow and support the second law;saving precedes investment. Any fixed capital in theeconomy is financed through the bond markets; thefarm used to grow wheat, the mill used to grindflour, and the ovens used to bake bread are allexamples of fixed capital and they are all financedthrough the bond market from savings. Nosavings means no (real) capital available forinvestment purposes.

Finally, we come to the third law; hoarding isessential for human survival. The recipient of asalary or of wages faces three choices; hoard the

Gold coin, spend the Gold coin, or invest the Goldcoin there is no other choice possible. Some coinsimply must be spent, else the wage earner will starveor freeze in the cold; thus the bill market has a hardfloor, it can never go to zero.

Some coin may be saved, or invested; this is not amust but depends on risk and returns. If the returnbeing offered is too low, then hoarding is a naturalchoice; the only reason one would invest is to obtaina reasonable gain for giving up the use of ones

Gold for whatever length of time. This return iscalled interest and the desire to earn interest iscalled time preference. Zero interest rates mean thatthere is NO capital available for investment; allmoney earned will be spent or hoarded.

Today we have a zero interest rate policy strikethree, we are out. The economy is dying, like the 747

with the wings departing. The so called GlobalFinancial Crisis is in reality a monetary crisis. The

world needs real money; the world needs Gold. The world also needs the clearing system that is theindispensable companion of God money, thecirculation of Real Bills. Once this reality is acceptedand acted upon, the GFC can be resolved notbefore.

Rudy J. FritschEditor in Chief

The Role of the Commercial Bank

Bankers and their ilk are often vilified in the press.But their true role is essentially forgotten and is

necessary for the efficient functioning of socialactivity. Under a true gold standard, the unit ofaccount and exchange is a defined weight of finegold. In the United Kingdom this was/is the PoundSterling defined as 7.2g of fine gold.

Social activity in all areas, naturally, involved gold.Contracts for the export and import of various

wares, receipts from retailer to wholesaler, tailor andshirtmaker bills - all were denominated in terms ofgold. These gold contracts were an expression of the

ingenuity and enhanced coordination that resultsfrom unfettered social interaction. Of course, thecontracts had nothing to do with gold per se. Goldmerely acted as the measure.

Gold contracts existed in various forms andfrequencies. By form we mean the nature by whichthe contract was extinguished by payment of goldand by frequency the time by which the money

would be received. Naturally, both aspects have anelement of risk to them as a contract holder.

The contracts themselves were as varied asunrestricted social interaction is, as the former wasmerely a crystallisation of the latter. Thecontracts had a wide variety of integrity as one - whois not utterly naive - might expect.

Those contracts representing the most identifiableand necessary goods with quick liquidation were indemand by the public looking for a return on theiridle money holdings. These 'bills,' which matured inless than a season's worth of days, could beexchanged for current gold in lieu of a discount onthe face value of the contract.

The best quality bills could be discounted at discounthouses; a euphemism for the commercial/clearingbank. The discount house would pay for bills inexchange for gold coin or their own (standardized)note issue which matured into gold. The discounthouse acted as a guarantor for the bills via theirequity reserve. The managers of the discount houses

were expected to be knowledgeable about all sorts ofbusinesses that could be conducted acrossborders. An example of banks that issued their own


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The Gold Standard The Gold Standard Institute Issue #18 15 June 2012 8 notes in their role as a commercial bank was theChartered Bank of India, Australia and China, nowStandard Chartered Bank plc. This tradition - merelyas a curio - is still retained in Hong Kong byStandard Chartered Bank.

The name of a good discount house behind abill/banknote promoted its circulation in public as amoney substitute - the nearest security to goldpossible. The threat of a failed exchange wasnullified by the discount house acting as theunderwriter of a bill. The depositor at the discounthouse would not suffer - merely the equity holdersof the discount house in a failed exchange.

The commercial banks could only offer termdeposits to the public for maturities less than orequal to the bills that they held. Three month depositrates were thus the longest maturity that could beobtained from a commercial bank solely.

The commercial banker brought order andcoordination to the bill market; that market which

would exist with or without them. 'Spreads' are madenarrower by the commercial banker's very existenceand their will to do this activity. In a similar manner,

the investment banker brings order to the bondmarket. I am sure at this stage we would all befamiliar with the differences between an investmentand commercial bank.

Do not vilify the role of the banker! They are just asessential as that of the doctor or teacher to themaintenance and progression of society. I hope thisshort essay has demonstrated why.

Sandeep Jaitly

Sandeep is a fund manager at First International Group plc. inLondon. He manages a global equity fund as well as a gold andsilver fund, the operations of which are based on ideasdeveloped by Professor Fekete. For more information aboutFirst International Group plc., please visit www.figplc.com.

Sandeep founded Fekete Research in 2011 to preserve,disseminate and expand upon the works of Professor Fekete.For more information please visit www.feketeresearch.com.

Duration Mismatch Will Always Fail

I have written a number of pieces on fractionalreserve banking and duration mismatch. I have

argued that the former is perfectly fine, both morallyand economically, but the latter is not fine. I havedissected the arguments made against fractionalreserve banking, and pointed out that it is nothingmore than a bank lending out some of the money ittakes in deposits.

I have debunked the most common errors made byopponents of fractional reserve:

1. Banks print money2. They lend more than they take in deposits3. They inflate the money supply4. Money is the same as credit5. Fractional reserves banking is the same

thing as central banking6. It is the same thing as duration mismatch

Duration mismatch is when a bank (or anyone else)borrows short to lend long. Unlike fractionalreserve, duration mismatch is bad. It is fraud, it isunfair to depositors (much less shareholders) and itis certain to collapse sooner or later. This is not a

matter for statistics and probability, i.e. risk. It is amatter of causality, which is certain as I explainbelow.

This discussion is of paramount importance if we areto move to a monetary system that actually works.Few serious observers believe that the current

worldwide regime of irredeemable paper money willendure much longer. Now is the time when variousschools of thought are competing to define whatshould come next.

I have written previously on why a 100% reservesystem (so-called) does not work. Banks are themarket makers in loans, and loans are an exchange of

wealth and income ( see here ). Without banks playingthis vital role, the economy would collapse back toits level the previous time that the government madeit almost impossible to lend (and certainly to make amarket in lending). The medieval village had aneconomy based on subsistence agriculture, with afew tradesmen such as the blacksmith.

But I have not directly addressed the issue of whyduration mismatch necessarily must fail, leading to
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The Gold Standard The Gold Standard Institute Issue #18 15 June 2012 9 the collapse of the banks that engage in it. Thepurpose of this paper is to present my case.

In our paper monetary system, the dollar is in aclosed loop. Dollars circulate endlessly.Ownership of the money can change hands, but themoney itself cannot leave the banking system.Contrast with gold, where money is an open loop.Not only can people sell a bond to get gold coins,they can take those gold coins out of the monetarysystem entirely, and stuff them under the mattress.

This is a necessary and critical mechanism it is howthe floor under the rate of interest is set.

This bears directly on banks. In a paper system, theyknow that even if some depositors withdraw themoney, they do not withdraw it to remove italtogether (except perhaps in dollar backwardation,at the end: see here ). They withdraw it to spend it.

When someone withdraws money in order to spendit, the seller of the goods who receives the money

will deposit it again. From the banks perspectivenothing has changed other than the name attachedto the deposit.

The assumption that if some depositors withdraw

their money, they will be replaced with others whodeposit money may seem to make sense. But this isonly in the current context of irredeemable papermoney. It is most emphatically not true under gold!

There are so many ills in our present paper system,that a forensic exploration would require a very longbook (at least) to dissect it. It is easier and simpler tolook at how things work in a free market under goldand without a central bank.

Lets say that Joe has 17 ounces of gold that he willneed in probably around a month. He deposits thegold on demand at a bank, and the bank promptlybuys a 30-year mortgage bond with the money.

They assume that there are other depositors who willcome in with new deposits when Joe withdraws hisgold, such as Mary. Mary has 12 ounces of gold thatshe will need for her daughters wedding next week,but she deposits the gold today. And Bill has 5ounces of gold that he must set aside to pay hisdoctor for life-saving surgery. He will need to

withdraw it as soon as the doctor can schedule theoperation.

In this instance, the bank finds that their schemeseems to have worked. The wedding hall and thedoctor both deposit their new gold into the bank.Its not a problem until its a problem, they tellthemselves. And they pocket the difference betweenthe rate they must pay demand depositors (nearzero) and the yield on a 30-year bond (for example,5%).

So the bank repeats this trick many times over. Theycome to think they can get away with it forever.Until one day, it blows up. There is a net flow ofgold out of the bank; withdrawals exceed deposits.

The bank goes to the market to sell the mortgagebond. But there is no bid in the mortgage market

(recall that if you need to sell, you must take the bid). This is not because of the borrowers declining creditquality, but because the other banks are in the sameposition. Blood is in the water. The other potentialbond buyers smell it, and they see no rush to buy

while bond prices are falling.

The banks, desperate to stay liquid (not to mentionsolvent!) sell bonds to raise cash (gold) to meet theobligations to their depositors. But the weakestbanks fail. Shareholders are wiped out. Holders of

that banks bonds are wiped out. With thesecushions that protect depositors gone, depositorsnow begin to take losses. A bank run feeds on itself.Even if other banks have no exposure to the failingbank, there is panic in the markets (impacting the

value of the other banks portfolios) and depositorsare withdrawing gold now, and asking questionslater.

And why shouldnt they? The rule with runs on thebank is that there is no penalty for being very early,but one could suffer massive losses if one is a minutelate ( this is contagion ).

What happened to start the process of the bank run?In reality, the depositors all knew for how long theycould do without their money. But the bankpresumed that it could lend it for far longer, and getaway with it. The bank did not know, and did not

want to know, how long the depositors were willingto forego the use of their money before demandingit be returned. Reality (and the depositors) took a

while, but they got their revenge. Today, it isfashionable to call this a black swan event. But if
http://keithweiner.posterous.com/dollar-backwardationhttp://keithweiner.posterous.com/dollar-backwardationhttp://keithweiner.posterous.com/dollar-backwardationhttp://dailycapitalist.com/2012/05/30/keithgram-contagion-defined/http://dailycapitalist.com/2012/05/30/keithgram-contagion-defined/http://dailycapitalist.com/2012/05/30/keithgram-contagion-defined/http://dailycapitalist.com/2012/05/30/keithgram-contagion-defined/http://keithweiner.posterous.com/dollar-backwardation


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The Gold Standard The Gold Standard Institute Issue #18 15 June 2012 10 that term is to have any meaning, it cant mean theinevitable effect caused by acting under delusions.

Without addressing the moral and the legal aspectsof this, in a monetary system the bank has a job: tobe the market maker in lending. Its job is not topresume to say when the individual depositors wouldneed their money, and lend it out according to thebanks judgment rather than the depositors.Presumption of this sort will always result in losses,if not immediately. The bank is issuing counterfeitcredit ( see here ). In this case, the saver is not willing(or even knowing) to lend for the long duration thatthe bank offers to the borrower.

Do depositors need a reason to withdraw at any timegold they deposited on demand? From the banksperspective, the answer is no and the problem issimple.

From the perspective of the economist, whathappened is more complex. People do not withdrawtheir gold from the banking system for no reason.

The banking system offers compelling reasons todeposit gold, including safety, ease of makingpayments, and typically, interest.

Perhaps depositors fear that a bank has becomedangerously illiquid, or they dont like the lowinterest rate, or they see opportunities offshore or inthe bill market. For whatever reason, depositors areexercising their right and what they expresslyindicated to the bank: this money is to be

withdrawn on demand at any time.

The problem is that the capital structure, onceerected, is not flexible. The money went into

durable consumer goods such as houses, or it wentinto partially building higher-order factors ofproduction. Imagine if a company today began tobuild a giant plant to desalinate the Atlantic Ocean.It begins borrowing every penny it can get its handson, and it spends each cash infusion on part of thisenormous project. It would obviously run out ofmoney long before the plant was complete. Then,

when it could no longer continue, the partially-completed plant would either be disassembled andsome of the materials liquidated at auction, or it

would sit there and begin to rot. Either way, it would finally be revealed for the malinvestment thatit was all along.

By taking demand deposits and buying long bonds,the banks distort the cost of money. They send afalse signal to entrepreneurs that higher-orderprojects are viable, while in reality they are not. Thecapital is not really there to complete the project,though it is temporarily there to begin it.

Capital is not fungible; one cannot repurpose apartially completed desalination plant that isntneeded into a car manufacturing plant that is. Thebond on the plant cannot be repaid. The plantconstruction project was aborted prior to the plantproducing anything of value. The bond will bedefaulted. Real wealth was destroyed, and this isexperienced by those who malinvested their gold as

total losses.Note that this is not a matter of probability. Non-

viable ventures will default, as unsupported buildings will collapse.

People do not behave as particles of an ideal gas,as studied by undergraduate students in physics.

They act with purpose, and they try to protectthemselves from losses by selling securities as soonas they understand the truth. Men are unlike a

container full of N2 molecules, wherein the motionof some to the left forces others to the right. Withmen, as some try to sell out of a failing bond, otherstry to sell out also. And they are driven by the sameessential cause. The project is non-viable; it ismalinvestment. They want to cut their losses.

Unfortunately, someone must take the losses as realcapital is consumed and destroyed. A bust of creditcontraction, business contraction, layoffs, and lossesinevitably follows the false boom. People who are

employed in wealth-destroying enterprises must belaid off and the enterprises shut down.

Busts inflict real pain on people, and this is tragic asthere is no need for busts. They are not intrinsic tofree markets. They are caused by governmentsattempts at central planning, and also by durationmismatch.

Keith WeinerPresident of the Gold Standard Institute USA
http://keithweiner.posterous.com/inflation-an-expansion-of-counterfeit-credithttp://keithweiner.posterous.com/inflation-an-expansion-of-counterfeit-credithttp://keithweiner.posterous.com/inflation-an-expansion-of-counterfeit-credithttp://keithweiner.posterous.com/inflation-an-expansion-of-counterfeit-credit


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The American Corner

As I intimated last month, my goal in this column isto discuss developments in the USA that are relevant

to advocates of a gold standard. Shortly after I sentmy copy in to be laid out and published in The GoldStandard last month, Ralph Benko (a longtime goldstandard advocate in the US) published an article atForbes. His article discusses a new bill sponsored inthe US Senate to change the charter of the FederalReserve to focus on price stability (vs. its currentdual mandate of prices and employment).

I should state for the sake of clarity that I do not seeany room for a central bank (or any central planner)

in a free market, and so I do not want to debate itscharter. I dont think that the Fed has direct controlof the prices of goods nor of gold, anyway. Pricesare set by a complex, non-linear, dis-contiguous,dynamic process, and the Feds control over interestrates is wholly insufficient to control prices.

I also do not believe that there should be a goldprice fixed by law. I think it would cause the ultimatepartisan war, between debtors who want a high goldprice and creditors who argue that the gold priceshould be low. The former can get out of debt for asmall amount of gold at a high dollar price perounce. The latter get more gold at a low dollar price.

This partisan war will have vast interest groups linedup on both sides. To the victor will go untold spoils,and to the loser will go either catastrophic losses or along time of indentured servitude. In any case, thegovernment does not know what the right price ofgold is and of course all prices change constantly inthe market.

My purpose in writing this article is not to addressthe contents of that bill, per se. The reason why Ithink the bill (and the article in Forbes, which is amainstream publication) is important and a Good

Thing is that it shows that the cultural trend ischanging. We have passed an inflection point. 10years ago, or even 4 years ago, it would not havebeen possible to introduce a gold bill in the USLegislature or to be taken seriously discussing a goldstandard.

Today, gold has entered the mainstream debate.Even if it is only right wing politicians and

conservative 2 magazines discussing gold, the tabooon saying the four- letter word gold in politecompany has been broken.

Lets go back through some America n history. When Ronald Reagan was elected president, heconvened a committee to look at gold. That was atime when the price of everything was rising at aterrifying rate, as were interest rates.

The gold committee effort went basically nowhere.Meanwhile Paul Volcker at the Fed engineered aspike in the rate of interest and then set a process inmotion to cause the rate to go into a long slide(which continues through today, 31 years later). Thecrisis created by Richard Nixon with his gold defaultseemed to have been resolved. And all seriouspolicy experts, and public opinion, abandonedthought of gold.

In fact, nothing was resolved, merely postponed. In1987, then in 2001, then finally in 2008, a crisiserupted out of the banking system and into thepublic awareness. Today, everyone who is financiallyliterate knows that unemployment remains muchhigher than it ever has this far into a recovery, that

there is a huge debt problem, and that the Europeancrisis will come to the US and Japan sooner or later.

In the fall of 2008, George Bush said he had toabandon free market principles to save the freemarket. The US government provided bailouts andstimulus. Most people accepted that it wasnecessary, even if grudgingly. But over the followingyears (and as more and more information is comingout regarding the beneficiaries of these trillions ofdollars of largesse), the goodwill and feeling that if

we all work together, we can fix anything is longgone. Attitudes have changed.

Then, most pe ople thought how can we save thesystem. Now they are starting to demand can thesystem be saved and how can we change thesystem. I think this presents a once -in-a-centuryopportunity to promote not only gold, but a propergold standard! Color me optimistic.

Keith Weiner

2 Readers outside the US should be aware that left and right,liberal and conservative have a different connotation in theUS than in Europe.
http://www.forbes.com/sites/ralphbenko/2012/05/07/sen-mike-lee-and-rep-kevin-brady-attempt-to-bring-back-the-gold-standard/http://www.forbes.com/sites/ralphbenko/2012/05/07/sen-mike-lee-and-rep-kevin-brady-attempt-to-bring-back-the-gold-standard/http://www.forbes.com/sites/ralphbenko/2012/05/07/sen-mike-lee-and-rep-kevin-brady-attempt-to-bring-back-the-gold-standard/


12/12


NEW AUSTRIAN SCHOOL OF ECONOMICS

CRITIQUE OF MAINSTREAM AUSTRIAN ECONOMICS

Marginalism; Marketability; The Real Bills Doctrine vs. the Quantity Theory of Money; Interest versusDiscount; The True Role of the Gold Standard

September 3 - 9, 2012(10am 12:30 and 4pm 6pm)

Lecturer: Prof. Antal E. Fekete

Guest Lecturers: Sandeep Jaitly (United Kingdom, feketeresearch.com)Keith Weiner (USA), Rudy Fritsch (USA, beyondmises.com)

Location: Munich, Germany

This course is a seven-day, twenty-lecture session. Its topics are not recycled but new material. Its completion will earn one credit of the four needed towards a Bachelor of Monetary Science (BMSc) degree handed out by

Prof. Fekete.It is meant for those, including beginners, who are interested in the theory of money, credit, and banking, withspecial emphasis on the current financial and economic crisis. Previous courses are not a prerequisite.

Registration Information:

The participation fee for the full course is 1,100.00 Euro (incl. 19% German VAT). Day tickets can bepurchased: 1-day: 300.00 Euros, 2- days: 500.00 Euros, 3 and more days: 200.00 Euros/day.

This includes tuition, non-alcoholic drinks and snacks during the lectures, printed lecture notes for the course.

Hotels and Restaurants are within walking distance and you will receive a list of suggestions. There is a EUR 300.00 non-refundable pre-registration fee that will be credited toward the tuition fee.

Students will receive a scholarship reducing the tuition fee to 100.00 Euro for the complete seminar (limited to10 scholarships in total).

Organizers of the course are Wilhelm Rabenstein and Ludwig Karl.

In order to register for the course you can get in contact with us via mail ( [email protected] ) or phone (+49 170 380 39 48 , before calling please consider a possible time lag)

You might also want to take a look at the New Austrian School of Economics on Facebook:https://www.facebook.com/newasoe and https://www.facebook.com/events/191504464305951/
mailto:[email protected]:[email protected]:[email protected]://www.facebook.com/newasoehttps://www.facebook.com/newasoehttps://www.facebook.com/events/191504464305951/https://www.facebook.com/events/191504464305951/https://www.facebook.com/events/191504464305951/https://www.facebook.com/events/191504464305951/https://www.facebook.com/newasoemailto:[email protected]

The Gold Standard Journal 18

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