by Keith Weiner, Sprott Money:
Last week, we made a very controversial statement. We are happy to write the truth, and let the chips fall where they may (e.g. our thoughtful disagreement with Ted Butler about price manipulation). We can accept the flak that we get for this, so long as our position is understood. Some criticized our approach as mere technical analysis , and therefore insufficient to the task of explaining the dynamics of the gold and silver markets. But whether we quibble with this characterization of our work or not, we believe that the points we made and the unique data we published stand. No one, including Mr. Butler, responded substantively to our data or logic. People can read and choose sides, and we’re OK with that.
But last week , we said something that we feel was not well understood. And it is one of the most important ideas in monetary economics, and the key to understanding banking.
The Federal Reserve, of course, is a key participant in this monetary inflation scheme. Does the Fed have a printing press? Does the Fed print?
Like any bank, the Fed borrows to fund its purchases of interest-paying assets. It earns a spread between what it pays (currently about 1.25%) and what its asset portfolio pays (over 2%)… Unlike any commercial bank, there is a law that obligates us to treat the Fed’s liabilities as if they were money .
Borrowing is pretty close to the opposite of printing. So how is it possible that there is so much contention on this issue? Perhaps it would be more accurate to say that, in Austrian circles, there is little contention: Monetary Metals are just heretics!
If the Fed printed, then hyperinflation would have come, and this is what many Austrians predicted. For example, one famous personality predicted at FreedomFest in July 2009, that we would have hyperinflation by the end of that year.
Printing would create a flood of worthless paper. Apart from the sheer quantity of it (trillions), would be the absurdity, the meaninglessness of it. Though many call the dollar “worthless paper”, it is not worthless. It is still quite worthful—a dollar can buy over 24 milligrams of gold, not to mention food, fuel, housing, artwork, and laptops on which we can pontificate about matters monetary.
But suppose an organized crime ring printed up $3,500,000,000,000, and went on a shopping spree. These forgers begin buy everything from cases of Cristal to paintings by Cézanne, from Maybach cars to Malibu homes. What would happen?
They would push up the prices of everything. Relentless buying by price-insensitive purchasers lifts all offers and keeps moving them up. Of course, if you have a printing press then it does not matter to you if Cristal is $200 or $20,000. You can easily print more. Price only matters to those who have to earn before they spend (or liquidate the family estate ).
So the net result of printing would be relentlessly but probably steadily rising prices. At first. Until people begin to see the game and look forward to its inevitable denouement. Then something happens. Economist Ludwig von Mises described the “Crack Up Boom”:
But then finally the masses wake up. They become suddenly aware of the fact that inflation is a deliberate policy and will go on endlessly. A breakdown occurs. The crack-up boom appears. Everybody is anxious to swap his money against “real” goods, no matter whether he needs them or not, no matter how much money he has to pay for them. Within a very short time, within a few weeks or even days, the things which were used as money are no longer used as media of exchange. They become scrap paper. Nobody wants to give away anything against them.
We must reckon with the fact that this did not happen. Here is a graph showing the prices of crude oil and wheat from the start of the first “quantitative easing” to the end of “zero interest rate policy”.
Both commodities go up, though wheat went down first. They end lower than they start. Notably, wheat (and other commodities) began to fall by late 2012. Oil was last to join the party (due, we believe, to geopolitical risks rather than monetary effects) in mid-2014.
We don’t want to quibble here. The question is not: “did oil go up proportionally to the increase in the quantity of dollars?” Oil went up about 133% from start to peak in April 2011, while M1 measure of money supply went up 20% during the same period. Then as M1 increased by an additional 63%, oil went sideways before declining 69% from its peak.
The question is: “what did the Fed do?” Obviously, it did not print and buy wheat or oil (nor give the dollars to someone else who did).
The Fed exchanged dollars for bonds (Treasury and mortgage). This leads to two questions. One, what is the nature of a dollar and of a bond? Two, what does it mean for the Fed to make such an exchange?
There is much confusion today because we call the dollar “money”. In the classical gold standard, the paper dollar was redeemable. That is, anyone could bring dollar bills to a bank and exchange them for gold coins. The bill, or note, is a credit instrument. It is paper evidencing an obligation to pay money on demand. The gold is the money.
Now that the dollar is irredeemable, there is a temptation to use shorthand and say that the dollar itself ismoney, to define money as just a medium of exchange. But if the dollar is money, what is the difference between the dollar and the bond? Both are forms of credit.
The difference is duration.
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