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Gold, Redeemability, Bitcoin, and Backwardation
I recently released a video about the Internet-based currency, Bitcoin. I asked the question: is Bitcoin money? In brief, I said no it’s an irredeemable currency. This generated some controversy in the Bitcoin community. I took it for granted that everyone would agree that money had to be a tangible good, but it turns out that requirement is not obvious. This prompted me to write further about these concepts.
A human being has a physical body with physical needs, and lives in a physical world. He produces that he may eat and clothe and shelter himself. Once civilization develops beyond subsistence, men specialize to increase their production. Each relies on others, who specialize in other fields. Each trades his products for the goods produced by others.
A problem arises, called the coincidence of wants. One man produces food and another produces leather moccasins. When the moccasin producer is hungry, the food grower may not need new shoes. Mr. Moccasin must discover that some goods are more marketable than others. He can trade less-marketable moccasins for more-marketable salt, for example. He may not need the salt (though he can always use it) but he knows it is accepted in trade for food and other goods.
Eventually, a market process finds the most marketable good. It becomes even more marketable due to its increasing use as money (but it does not lose the attributes that made it useful in the first place).
People accept the monetary good in trade because it fills one of three needs. They will exchange it for something else later. They may want it for its own sake. Or they may accumulate a hoard during their working years so that in retirement, they can dishoard to pay their bills.
Modern civilization layers a complex financial system on top of the monetary good. It has bills, bonds, and savings accounts, etc. Most people do not want to redeem most paper credit instruments, for reasons of convenience and the preference for an income. However, it is important to keep in mind that the possibility of redemption is necessary and essential to a working financial system. Everyone must choose for himself the right balance between holding the monetary commodity directly and various earning assets that promise to be redeemed in a quantity of the monetary commodity in the future.
Only this balancing process can perform one particular and critical function. Hoarding, also known as managing risk, has played a vitally important role throughout human history (and which is almost unappreciated by the economics field). Hoarding and investing are balanced by risk tolerance. In a free market without central banking and bailouts, everyone must think of risk.
To the economist, redemption of paper and hoarding of the monetary good, serve to police and clean the system, force the write-offs of bad credit (as opposed to letting them accumulate), and of course empower the saver to enforce his interest-rate preference. This last, is a point that I have not seen anyone make prior to Professor Antal Fekete, and which is under-appreciated today.1
To the hoarder himself, hoarding looks and feels very different. He is thinking of having something tangible in hand. A coin in his pocket does not have a risk, it can be carried anywhere, and can be accumulated in a safe place. To anyone aware that he is living in the physical world, there is no substitute to having a physical, tangible commodity.
Today, of course, legal tender laws obscure most of the above. The monetary commodity is not allowed to do its job, and we’re lucky that after they removed it from the monetary system they at least once again legalized its ownership for American citizens. Even so, most people regard owning gold as a risky speculation because its dollar price is volatile. It’s madness.
Returning to the question of Bitcoin, we have a conundrum. Bitcoin is not debt. In that sense, it is like gold—there is nothing to redeem because the thing is the final good. Unlike gold, it is not a tangible good. You cannot hold it or stack it in a safe in the floor. Other than the value you hope it has in trade, it has no utility by itself.
Bitcoin in this context is like an attempt to reverse cause and effect. Gold is money because people strongly desired it for its physical properties and then, subsequently, discovered that it was the most marketable good and thus useful as money. Bitcoin bypasses this and attempts to go straight to being money. Should hackers break its cryptography, the Internet go down for a few months, or any number of other scenarios occur, the above logic will reassert itself.
Owning Bitcoin is to be in a partially completed transaction. Until it is exchanged for a tangible good in another trade, the owner of the Bitcoin is in the position of having given up something tangible for nothing in return.
I made the point, in a previous video that redemption is not the same thing as purchasing the monetary commodity. Prior to 1933, one could go to any branch bank of the Federal Reserve and exchange dollars for gold. This was not “buying” gold, but redeeming the dollars. One accepted the dollar bill in trade, with the sure and certain knowledge of the terms (e.g. gold value) of redemption. Unlike then, today the dollar can be used to buy gold. But there is no way to know the terms—or indeed if one can even make the purchase at all—until one attempts the transaction.
It is the same with Bitcoin.
Now that I have used Bitcoin as the foil to establish several points, let’s look at the dollar and its ability to buy gold. Consider the following points that I discussed at greater length in this video:
- irredeemable debt-based currency provides no way to extinguish a debt
- the dollar itself is a debt instrument
- payment in dollars merely transfers the debt
- all debt is borrowed at interest
- eventually, the interest cannot be paid out of income
- the only way to pay the interest in aggregate is further borrowing
- total debt in the system grows exponentially until it cannot
The system is designed to drive all participants to bankruptcy! “This is,” as they say in technology industries, “a feature, not a bug”.
In this light, the problem is not the rising quantity of dollars per se (though endless issuance by the Fed is certainly not good) but its falling quality. It is all headed to default when the debtors cannot borrow any more. This point was reached in Greece, but it is years away in the United States.
One might be tempted to ask why the banks and financial institutions don’t recognize this and refuse to do business in dollars. The answer is that they are regulated, they ultimately answer to investors who believe in dollars, and they are given perverse incentives to continue to play the game. For example, they can borrow short at near zero from the Fed, and lend long at near 2% to the Treasury. This transaction creates no wealth, but the banks engaging in it earn “profits”. They are fat, dumb, and happy to make this spread and many others like it.
So who understands it? The lowly gold hoarder does. His challenge is that he is sometimes distracted by the mainstream message that gold is a risky commodity that cannot be used to buy bread. He is often distracted by the goldbug message that the rising gold price is a “profit” (and the falling price is a conspiracy). If he can see through these two mirages, then he can see that all the credit in the system must inevitably and inexorably crash to earth like too many rocks impossibly kept aloft for a while by a juggler who exceeds his limited skill.
“Money is gold and nothing else,” as JP Morgan famously said in testimony before Congress. When bad credit eventually is repudiated, gold will still endure.
This is the context to my argument: permanent gold backwardation is a late symptom of the terminal monetary disease. Like jaundice in a cancer patient, signaling to the doctor that the patient is in immediate risk of death by liver failure, permanent backwardation signals to the economist that the monetary system is in immediate risk of death by gold withdrawal.
The dollar is not strictly redeemable, but it can still be used to buy gold. This provides an “escape valve”. Those who wish to convert their irredeemable paper into the monetary commodity, to complete the transaction of trading their product for dollars and dollars for the monetary commodity, can still do so.
Backwardation is when the price of a commodity in the futures market is lower than the price in the spot market. Anyone who has the commodity can make a profit by simultaneously selling the commodity in the spot market and buying a future to recover his position. This trade has no price risk, credit risk, or even spread risk. The only risk is default. Permanent backwardation is when all futures contracts fall below the spot price, and the gap keeps widening no matter how much the price rises.
The existence of now-chronic temporary backwardation, is proof that gold owners are starting to become reluctant to trust the dollar system, and the lure of profit is insufficient. If they do not trust the delivery of a future, then they have to question if they will be able to buy gold on any terms. In an environment of collapsing credit and bankruptcies, this lack of trust will be quite well founded.
The final stage is brought on by the complete withdrawal of offers to sell gold for dollars (i.e. the gold bid on the dollar). Collapse will come swiftly because of asymmetry. While no gold holder will then want dollars, some dollar holders will desperately want gold. They will buy any goods that have a gold bid. The trade of dollarsàcommoditiesàgold will drive the prices of commodities up to any arbitrary level in dollar terms, and down nearly to zero in gold terms. Oil could become $1,000,000 per barrel and 0.0001 gold grams per barrel at the same time. This process will continue until sellers of commodities will no longer accept dollars.
The dollar is fiat, which means imposed by force. It is debt-based, which means its value derives from the efforts of the debtors to continue to pay. And it is irredeemable which means there is no way for debtors, in aggregate, to get out of debt, and no way for creditors to know the terms by which they can get gold. The government uses force to impose the contradiction of a debt-based currency that cannot extinguish debt. People would not accept it otherwise!
The final resolution of such a contradiction is total collapse.
For those interested in tracking the backwardation occurring in both gold and silver right now, Monetary Metals publishes The Last Contango Gold Basis Report (free registration required).
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"government cannot force me to accept their debt" - no, but it can force you to pay taxes - with government tax tokens - which in the US are by law Federal Reserve Notes or their digital equivalent
Bitcoin is defined as an internet crypto-currency. The name says it all.
It is not money. But it is far superior to money in some forms of trade.
I don't understand the argument over it being money or not.
The USD is not money either, anyway.
money describes the function of the thing - if I can buy something with it to the point that I calculate everything with it, than for me it's money, be it salt, sheep or young women
when the Romans invaded Gaul, they were doing something like in the Opium War: opening markets for their delicious wine
one amphor of wine = one young female slave
note: both functioning as money
Gaulish tribe elders were just trying to stop their young warriors from selling their sisters for their drug, hence the war
I'm not familiar with Gaulish women. But here in Britain, the going rate for a young, horse-fed, pure estate queen is about 1000btc.
If you have any you'd like to rid yourself of, I'll send you my BTC address. I'll take 30% up front, and the rest on delivery.
Was I wrong, or did I read this guy to say that the monetary commodity had to be good for something, which I agree bitcoin is not.
How then does he explain that the actual "usefulness" of gold would trade it at a few hundred dollars an ounce compared to petroleum or wheat, perhaps 1/3 of what it actually trades for?
A load of baloney.
Money is a promise. 10 people move into virgin country and build the first person a house. He owes each somewhat more than one tenth of a house. Money has been created out of thin air. It is fiat money. It is good while the ten men are honest and reputable. It does not need a physical commodity. With a skerrick of honesty the bond between the men is of much, much more value than any scrape of shiny yellow junk.
exactly - coincidence of want as an econ. 101 genesis story is a fiction. societies did not evolve this way - anthropologists have not found any society that started this way - systems of debt preceded coin - coin has a huge push in the 6th-5th centuries BC as social order breaks down (e.g. fiat no longer trusted) and gold comes to the fore. barter really only takes place on a large scale when things falll apart--e.g. when people used to having a money no longer do. so lead, silver, & gold stackers are, historically, the next phase after the fiat falls apart.
a.k.a. "Debt: The First 5000 Years" by David Graeber.
Actually, Ghordius stole my thunder. I will only add that I will will gladly trade you 100 sherricks of honesty for one ounce of your gold. Gold forces honesty to some extent. Sure, if governments and banks were universally and without exception "honest" enterprises, we would not have fractional reserve banking and promises would trade like Dutch tulips at the height of their popularity. The social security "trust/honesty" funds would be overflowing with highly-valued IOUs. Karl Marx would make a lot more sense. We'd also live in a place called Utopia.
as J.P. Morgan tried to explain, a man I can trust (in your case with 100 sherriks of honesty), a man of character, is worth my credit
otherwise nothing will lead me to lend him even one ounce of gold
of course that was 1907 - no federal taxation and no federal banking system
meanwhile NY and London are busy explaining us eurozoners that we need federal taxation and a federal banking system - I wonder why? ;-)
that's a good approach. since I feel a bit punctilious today, what you are describing is credit, and it's twin brother debt
in your example one person has a debt of 9 10ths of a house (and a house) and the others have each a credit of 1 10th of a house from him
this is how credit and debt is created - the very moment this is written down or carried on a Tally stick, you have debt instruments
particularly if they are allowed to be sold to third parties - as tally sticks were already over 7'000 years ago
meanwhile, if they are parceled in small amounts (let's say in notes for one hour of work), you have debt instruments that can be used as money
but since in your virgin country there is probably some staple crop or animal, it's more likely that those notes are promises for let's say sheep, or salt, or wheat
add a clearing house like a temple or a church and you have debt-based money that is also commodity-based money
add a few soldiers and merchants from far away who accept only gold and you might have a translation to metal - money as we used to know
this confuses most people: credit and debt are way older than money - but they are based on trust
meanwhile "monetary metals" are not based on trust - and so suitable for commerce among strangers
modern fiat is way younger than the above, and it's based on tax systems - fiats like USD and EUR are tax-tokens-usable-as-money
Bravo..........
Using the springboard of Feketes' valid critique of Misean "errors of omission," the author of this piece has attempted an Olympian-class dive to the depths of the ocean of controversy as to what constitutes 'money'...
unfortunately, there seems to have been a mix up as to which end of the pool Mr MM was diving into...ouch!
No matter how fondly one might regard the utility of 'real bills doctrine' to explain and cover for the intrinsic weakness of the Austrian analysis, that fatal flaw remains as unresolved in Fekete's argument as much as in any other of the schools proponents; money is not capital...capital is land, and the labor which harnesses the resources of which to produce ...goods for trade...there is no system alternative to this economic truism except primitive sustenance economies and the debt-based illusions of the usurers - which parasitize, and ultimately destroy all real capital...by leveraging exchange with debt.
Technological 'revolutions' may have created the illusion of a capital base free of labor inputs, but that is all it is...an illusion...intense mechanisation of production always requires expanding markets...which robots cannot be...consumers are necessary for these markets...and creating 'consumers' out of 'people' has been merely the ponzi scheme which is soon due to run it's course...exposing the shell game of debt based economics for what it is...
a neo-feudal system of enslavement of the many at the hands of the few...no matter how finely dressed up it may be in this i-world of gadgetry and gigabytes...Fekete's attempt to distinguish between 'debt' and 'value-added' real bills founders on the fact that all debt allows some people to risk other people's capital...without their permission...once that is permissible, the road to real serfdom via the heavy hand of the STATE opens and is paved with the good intentions of all the economic theorists who protest it's intrusion into the affairs of men! Talk about unintended consequences!
Ability to see through to this point clearly, past the fog of usury\interest based banking, has been lost due to the insularity and supposed 'superiority' of the western mindset...which balks at any study of how, in the past, trading peoples have put their minds to the question of just exchange and harmonious society, and treatised upon the same questions...without banging their noggins against the floor of the pool!
Gold, silver, foodstuffs, and other commodities can all be traded as 'money' and debt can be contracted between private individuals as promise to pay...but not used as an item to be traded outside the bound of those who have made that contract.
and, Let the peoples of East & West trade in peace, and profit each from the other, instead of being forced into phony wars which only serve to further enrich the usurers, at the expense of the rest of us. Peace and prosperity instead of useless economic contention!So gold is physical, bitcoin can be physical ( https://www.casascius.com/ ), gold has to be confirmed to be real via a test and with a physical bitcoin you need to check that it's still valid.
Only differences I see is that Bitcoin was never jewelry and gold has been used for a few thousand years.
Check out the features already built into the Bitcoin Protocol.
http://www.youtube.com/watch?v=mD4L7xDNCmA&feature=youtu.be&a
No wonder Western Union may adopt it.
http://mashable.com/2013/04/02/western-union-bitcoin/
You can even pay certain local governments now with it.
http://siliconangle.com/blog/2013/04/01/local-governments-can-now-accept-bitcoin-with-e-gov-link/
The price could drop no doubt, but the tech is very cool.
DotGov has been trying to get CASH out of consumer hands for years, to close the tax-loophole. Bitcoin represents a trackable way of doing that, similar to credit and debit settlement systems. In this respect, all Bitcoin is, is another "fight the system" fad that plays right into the hands of the system it claims to be fighting against.
You are not "being subversive". You are not "fighting the system". You are getting set up to be bagholders.
Bitcoin is intangible. It is electronic fiat paper and nothing more. It's not even worth as much as paper, which can be written on, drawn on, used as kindling, or folded into airplanes & origami animals to keep the kiddies amused. Hell, you can even wipe your ass with paper.
It's not even worth as much as shit. You can at least use shit to fertilize a garden. I can trade shit to the farmer down the road from me for fresh eggs.
Bitcoin is not Gold, and won't ever be. There may be a "Max Keiser acolyte" willing to pay you for your 'Satoshis', but that'll change.
A little science experiment for you Bitcoin boys and girls: Put on a Gold ring, and go into your local Kwikee-Mart and ask the Indian or Pakistani working behind the counter if you can pay for your energy drink, or pack of smokes in Bitcoin. Chances are pretty good that he or she will give you a WTF? look when you try to explain what a Bitcoin is. Then ask if you can trade him the ring your wearing instead. That same person will probably smile when you offer the ring.
how is it electronic fiat? do you know what fiat is?
the lies here are epic
@ dark pools: Apparently, I missed taking that out in the revision.....
I've been here a long time.. i am not one to lash out in general but people are really missing what is going on with bitcoins
please do yourself a favor and read up a few days on it, take the trouble to make a wallet or two, search for vendors accepting bitcoin already, and learn the ways to buy a few
extra credit, learn the history on the miners
@ Dark pools:
I know you've been here a while, buddy. I have done some reading on BTC. and actually did create an account on Mt.Gox...but it doesn't change what I see with my own eyes.
I don't view BTC as "a new and exciting form of money". I understand that it's appealling as hell to young tech-types, but it has absolutely none for me.
I've posted numerous times in different threads about "all that could go wrong with BTC"........from how it could be manipulated, to regulations/taxes (because we all know governments want their pound of flesh), to EMP, etc.
I'm old-school, and while I adapt fairly well with the times, there is no reason for me to buy BTC, when I have so many other options, that are much more widely accepted.
Here is a picture of silver's parabolic rise up to Apr 2011 and Bitcoin's currently:
http://monetary-metals.com/wp-content/uploads/2013/04/Bitcoin-and-Silver...