by Keith Weiner, Sprott Money:
There is a popular notion, at least among American libertarians and gold bugs. The idea is that people will one day “get woke”, and suddenly realize that the dollar is bad / unbacked / fiat / unsound / Ponzi / other countries don’t like it. When they do, they will repudiate it. That is, sell all their dollars to buy consumer goods (i.e. hyperinflation), gold, and/or whatever other currency.
Redemptions Balanced With Deposits
No national currency is gold-backed today. In a gold backed currency, each currency unit begins life with someone who chooses to deposit his gold coin in exchange for the paper currency. And it ends life with someone redeeming the paper to get back the gold coin. A good analogy is bone in the human body. One process is constantly removing bone material. And another process is growing more. What seems to be a static bone, with fixed length and mass, is constantly being torn down and rebuilt. The seemingly stable bone is actually in equilibrium between two opposing forces.
So it is with the gold standard. Some people are redeeming paper to get the gold coin. Others are depositing gold coins to get paper. The seemingly stable gold standard is actually in equilibrium between two opposing processes.
We often hear that governments hate the gold standard because they cannot print gold. This is true, but there is another reason. When people don’t like the interest rate or the soundness of the banks, they withdraw their gold coin. What had seemed to be stable, is no longer. This has nothing to do with quantity of currency or gold. It has everything to do with honesty.
Thus our definition of inflation is not based on increase in quantity (or its assumed consequence, rising prices). Inflation is monetary counterfeiting. It is borrowing without means or intent to repay.
For some odd reason, people tend to want to pull their gold coins out of a bank that engages in this practice. It’s a real head-scratcher. Someone should write about this mystery…
Anyways, in the gold standard (i.e. in a free market for money and credit), people have a choice. They can deposit or redeem their deposits. It is never safe for the banks and the government to presume how people will choose.
In making once-redeemable currencies irredeemable, governments have disenfranchised the people. If you don’t like a bank deposit, perhaps because its interest rate is too low, you can withdraw irredeemable central bank notes. However, those notes pay zero. So you are out of the frying pan, and into the fire. Also, the central bank lends to the government and the banks. So its paper has the same risks.
Declaring Currency to be Gold Backed
Many people think that a government could make its irredeemable currency gold-backed once again. But this is like trying to make a dead bone, live again. The currency no longer has either process: deposits or redemptions. The government would be starting—in the best case—with a great gold hoard. It also has a vast quantity of paper currency, some of it productive and much of it counterfeit. And there’s no way for the people to differentiate.
Who would deposit gold into such a system?
Aside from that slight little problem, neither the government nor the banks quality to borrow gold today. They do not have a gold income, nor do business enterprises.
To declare a “gold standard” today, can only mean a gold price-fixing scheme. With no deposits—no willing depositors, and no productive purpose for a gold deposit and hence no interest on gold —it will be a one-sided process. There will be demand for gold by people who hold paper, but no corresponding demand for paper by people who own gold.
And this demand is not really redemption, as it does not extinguish a debt. All of the debt—from student loans and credit cards, to car and home mortgages, to business loans to bonds to accumulated welfare-state deficits—is denominated in the old irredeemable paper. None of these parties are suddenly paying their debts in gold (if you think lobbying in Washington or Brussels is bad now, just imagine if every debtor was going to be forced to pay their debts in gold!)
So this alleged gold standard has: no interest on gold, no deposits coming in, and is not using gold to extinguish any debts. It has only people trading their currency for gold. I.e. buying gold.
If the government sets a low price, then the people will buy all of its gold and it will run out. If it sets a price too high, then there will be no buying. And, of course, there is not a fixed “right” price of gold or anything else. The market clearing price moves for many reasons, not least of which is the endless dilution of the currency that represents good credit with more and more units of counterfeit currency.
Like all other central bank price-fixing schemes, such a “gold backed currency” would fail.
And this brings us back to the Swiss franc, which was the subject of a price-fixing scheme, to keep the value down to €0.83. This scheme failed spectacularly in January 2015. And it was doubly interesting, because if currency is printed as most people suppose, then there is no reason why the Swiss National Bank could not have continued printing.
The Mechanics of Currency Collapse
We said then, and again in our recent series of articles, that the franc will collapse.
Just as people won’t suddenly get woke to the dollar and repudiate it, they won’t with the franc either. That is not how it works. So last week, we promised to discuss how the franc could collapse. The currency is fraught with potential mechanisms.
One is the negative deposit rate. Currently, retail depositors do not pay. They get a rate of zero, and so they experience no reason to withdraw paper currency in preference to a bank deposit.
And arguably, corporations and institutions are far less equipped to hold paper cash. For one thing, the quantities are much larger. And corporate financial controls are usually not designed to deal with hundreds of millions or billions worth of paper.
So far so good, right? Not quite. There are two problems even so. Banks are losing on every retail deposit. 0 interest is far too high in a negative rates world. How much this is costing? Whether this, by itself, will cause a crisis is for someone else to analyze. We can only say that perpetual losses are not sustainable.
And the problem gets worse. Because, rates will resume their falling trend. So even if banks can afford a 75bps subsidy to retail depositors today, they cannot afford a 100bps or 150bps subsidy tomorrow. There is a line, somewhere, and it will be reached sooner or later.