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Guest Post: Dollar Backwardation
Submitted and © by Keith Weiner of the New Austrian School of Economics
Dollar Backwardation
The current financial crisis, may progress to a phase where people demand and hoard dollar bills but take electronic deposit credits only at a discount which increases until electronic deposit credits are repudiated entirely. The Federal Reserve would be powerless to solve the problem, because while they can create unlimited electronic deposit credits they can’t create unlimited paper dollar bills, “money you can fold” as Professor Antal Fekete calls it. There would be a glut of electronic deposits, but a shortage of dollar bills.
Before the financial crisis metastasized in 2008, Fekete wrote a paper that I think is underappreciated and under-discussed. “Can We Have Inflation and Deflation at the Same Time?” (http://www.safehaven.com/article/8507/can-we-have-inflation-and-deflatio...) In his paper, he discussed the “tectonic rift” between paper Federal Reserve Notes (i.e. dollar bills) and electronic deposits. By statute, the Federal Reserve cannot print dollar bills without collateral (e.g. Treasury bonds). Also, they have limited printing press capacity that is insufficient to keep up with a catastrophic crisis.
He discussed the inverted pyramid of John Exter. Gold is the triangle at the bottom, and then above is silver, dollar bills, and then the various kinds of electronic deposits, stocks, real estate, etc. In a crisis, people want to move from top to bottom of the pyramid, but of course there isn’t enough of the stuff at the bottom.

In a scenario in which desperate, panicky people are trying to cope with the enormity of a collapse that they don’t and can’t understand, I think this split between “physical” dollars and “electronic” dollars is very plausible.
Just as there is nothing to be accomplished by selling an underlying security as it becomes worthless, only to buy a derivative of it, selling Treasury bonds and buying dollars is equally nonsensical. The dollar is the Federal Reserve’s liability, backed by the Treasury bond as the asset. If you believe the Treasury bond is worthless, then you ascribe no value to the dollar either. This is why gold will go into permanent backwardation. Holders of dollars will provide an unlimited bid for gold that will not be reciprocated by holders of gold. The latter own the only safe asset, and the only monetary asset that is not ultimately backed by the Treasury bond or the dollar, and they will have no desire to give it up.
The concept of backwardation is simple. It is when people accept a future promise to deliver only at a discount to physical stuff handed over right now. This could be when there is a shortage, such as wheat before the harvest. Or in the case of gold, backwardation signifies a collapse in trust. But isn’t this the same phenomenon of a tectonic rift between paper dollars and electronic deposits?
In a certain sense, the “money you can fold” behaves like a physical commodity, a present good (I realize I am stretching the concept here more than a bit). The electronic deposit credit is most definitely a future promise. In my gold backwardation thesis, the action begins with the offer on the futures contract falling below the bid on spot gold. The bid-ask spread on spot gold widens, as the offer is relentlessly advancing, pulling the bid behind it. The bid-ask spread on the futures contract also widens, as the offer remains stubbornly high, but the bid withdraws and retreats as gold buyers don’t trust futures and buy physical gold instead. Eventually, there are no more sellers of physical gold and that is that (except for the dollar-commodities-gold arbitrage, a backdoor way for dollar holders to get a little gold before the end of the game).
If this split occurs in the dollar, I think it will play out the same way. At first, sellers of real goods may accept electronic credit money, but demand a higher price. The spread on the electronic dollar widens, with the bid from real goods falling. At the same time, virtually unlimited demand for the “real” paper you can fold causes the bid on the paper dollar to rise.
Who knows how long it could last? People could go on accepting paper dollars out of long habit. Obviously, this is an unstable situation that must necessarily collapse. Unlike gold, the paper dollar has no value other than the broken promises that back it.
I dub this “dollar backwardation”.
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this is the logic of those who think you win by turning the other logical cheek to the Oligarchs. Wake up, they can swindle you down to the very apex of your green pointed inverted pyramid. As their logic is as perverse as their construction, right upto the very end.
Aside from the obvious of holding physical metals...
The added side effect of holding and hoarding some physical paper currency is that one also removes some of the precious base money from the fractional money expansion system.
2 weeks ago I stopped at a familiar gas station only to realize it had changed hands. Not concerned I put my credit card into the pump only to receive the message $0.35 fee for credit card. Annoyed I hit OK, only to be presented with another message: debit cards and cash only.
I didn't have the cash, so I left and went to a different gas station. I had read Fekete's article when it came out, so i was thinking what this all meant. It is possible that the station hadn't changed hands, but affiliations form Chevron to Arco. This might have been due to lousy credit, which might explain why the credit card company wouldn't grant them credit.
Or perhaps they are a stressed merchant rejecting fees to finacial institutions for the use of credit money. Cash bears no such fees or payment delays. Could just be the beginning.
I don't get this crew... I thought there were financial pros on this site?!
Cash in the mattress was during the time cash could be exchanged by gold or silver. There is as much reason to stuff our cash under our mattress as there is to stuff grocery store coupons under our mattress.
I think this pyramid idea is okay but too flawed, knowing what we know about the differences between currency and money. I think we can reduce this pyramid but grouping everything between gold and real estate into one level. It's all based on fiat currency. The other items on the pyramid have real economic value.
In response to HAHyperion, gold & silver are money... dollars, euros, etc are fiat currencies because they are not pegged to gold or silver. They are manipulated by governments for the same reasons that kings would debase their coins with lead.
I agree with you that food, shelter, etc are vital. I just don't agree with the idea that we're headed for a dystopian future. As the 1000 year map video in another link here in ZH demonstrated quite clearly, we will always have the basic elements of civilization to rely on.
True enough, but this is also the first and only time the entire world has been forced onto a purely fiat system in which they really are not competing currencies. Even PMs are fixed to fiat manipulation and aren't truly acting as real PMs should.
I'd hold some dollars not only as dry powder for more PMs down the line but also as Jim Rogers would play his currency game investments. Since the entire world is forced onto the rigged fiat system, I do see relative dollar strength in the near term. I also see a phase in which people would first reject electronic dollars for physical dollars before fiat collapses. But you're right that I would not hold dollars in the mattress for the long term.
I'm no financial expert, btw.
Sheeple grease forwardation!
So where is the silver on the pyramid? Is it with gold or is it in with commodities?
No question about it.
Physical gold; check
Physical silver; check
Physical dollars; check
Everclear; check
PMs, toilet paper, and food. Nice.
for me it is plain simple
electronic deposit can be shut down by government on individual basis (you get wiped the rest continues to go on)
paper bills can only be shut down on nation wide basis (bills become no legal tender or get devalued by government changing exchange rate)
gold can not be shut down at all
When the ATMs are all "empty," folks will really understand the difference between physical and digi-fiat.
Time check: 400 eastern time
Damn, I was pretty close on my call further up thread...Amazing!
FOFOA has been discussing this issue for 3 years.
" there isn’t enough of the stuff at the bottom" There is always enough gold to go around. If you save 100k in 65 ounces or in 10 doesn´t matter to a saver. Trust is a factor but between Govt, bankers and gold i choose gold.
I may have all kinds of "ZH-incompatible" reservations about the popular PM mania (not disagreeing with the fundamentals - just not as sure about them playing out as people popularily assume).....
...and yet, i will never understand this braindead argument of "there is not enough of this stuff to go around".... uh, hell? The only way a "currency" can not have enough to go around, is if it is not devisible enough. Absent lack of divisibility, the price just goes up to reflect the balance of demand and "divisible quantity".
And lets not forget, that for a "modern" currency, divisibility isn't even that important, because contrary to ZH opinion, a good amount of them will be indirectly exchanged via what is basically ETFs (just hopefully, with the "claims vs. physical backing"-question being much more transparent and PUBLICALLY verified).... at which point the divisibility of the backing good only matters anymore for "hard coin money" as well as "hard savings".
TL/DR: A few things about how ZHers imagine a gold backed currency may perhaps not play out exactly like that..... but the appeal to "there is not enough of it to go around" is an outright KINDERGARDEN ARGUMENT. IT MAKES NO FUCKING SENSE TO ANYONE BUT THOSE WITHOUT ANY CLUE.
i used to state with considerable regularity that gold was in permanent and severe backwardation regardless of what the paper markets state....antal fekete is always valuable read....
This is a BRILLIANT post.
lots of good information for people that think and plan.
lots of fog for the rest of you........
Section 31 U.S.C. 5103, defines legal tender as "United States coins and currency (including Federal reserve notes and circulating notes of Federal reserve banks and national banks) are legal tender for all debts, public charges, taxes, and dues."
From FRB: Credit dollars are a debt generated currency that is denominated by a unit of account. Unlike money (by a strict definition), credit itself cannot act as a unit of account. However, many forms of credit can readily act as a medium of exchange. As such, various forms of credit are frequently referred to as money and are included in estimates of the money supply.
Google "U.S. money in circulation", one of the first responses you'll get is by the FRB stating $1.1 trillion. Seems the FRB knows the difference between money and credit, even if most people don't.
Credit currency has no legal standing as money but all debts incurred through its use are legally binding.
Our economy is totally dependent upon the continuing flow of digits, which necessitates the continued expansion of public/private debt as well as the continued expansion of assets and asset values, for its survival.
The FRN doesn't belong to the USG, it's the property of the Federal Reserve. There are about $1,040 Billion FRNs in circulation, world wide. FRNs represent a first lean against all assets of the Federal Reserve. The USG has its own printed currency, United States Notes of which, there are about $240 million in circulation. The USG also circulates about $40 billion in coin.
Every Treasury bond, as well as all other securities held by the Fed have already been monetized and can't be monetized again, they represent debt owed to the Fed.
The Fed has no legal obligation to cover the credit generated by banks, or issued through the Fed, with FRNs.
One slight problem. Banks also create dollars, so the limitation of the government to print is not as influential as the author thinks.
Banks don't "create dollars", they create credit denominated in dollars. The author is talking about the collapse of credit as a medium of exchange as people revert to using an extraordinarily limited supply of FRNs.
I don't fully understand this. Can't limited printing press capacity be "solved" simply by printing extra zeros at the end of the denomination? And isn't the government happy to borrow ever-more... and ever-as-much as Bernanke says he "needs" to print?
If I was the government and had just been through a hyperinflation I would knock add two zeros to the coins and use pennies as dollars.
Minting coins is more difficult than printing dollars.
At this point, is ANY electronic currency soverign?
It's all just numbers attached to three capital letters; none of them actually have any value.
And the last time I checked, drug dealers don't take credit cards.