Non-denial about history (1,400)

First of all I want to apologize to some readers because my thoughts this morning are about gold. Again! I’ve written about it many times recently and it may seem that I’m an obsessive about gold. As a subject, it is far less interesting to me than, say, history, or the modern life sciences, or even quantum physics (in so far as anybody knows what this really means!). But, it seems to me, that gold, although apparently a minor player in the modern money market, contains the key to today’s extreme apprehensions about our economic systems in the West, both now and in the years immediately ahead.

Within my ‘non-obsessive’ interest in gold, however, there is one phenomenon which pretty well does amount to an obsession. What is going to happen to the price of gold? From a price of about $250 an ounce 11 years ago, it has been steadily accelerating ever since. Initially, the price started growing at an annual rate from 2% to 5% and then accelerating year by year, During 2010 the price had grown by over 30%. So far this year the price has risen to well over 40% on an annual basis and, if present trends continue, it is likely to be growing at a rate well over 50% p.a. by the year-end.

If the price rise is plotted on a graph, then the slope, starting out at little more than horizontal at around the year 1999, has become steeper and steeper. It’s what mathematicians call an exponential (or geometric) curve. If you extrapolate this slope into the future then the price rise starts to shoot up so quickly that gold would have an infinite price per ounce! This would occur sometime during mid-2012. Clearly, when all the money in the world wouldn’t be able to buy a single ounce, this becomes an impossible situation. Something must happen to the rising price of gold between now and the summer of 2012.

There are only two alternatives. Between now and mid-2012 the price of gold will crash, or it will start to decelerate. In the latter case, the price rise will slow down and then stabilize at a new constant high level. In theory, the new stabilized price could then crash but it wouldn’t, as will be explained a little later.

But what about a crash between now and mid-2012? Those who pour scorn on gold — most Western bankers, politicians and economists — point to a previous rise and crash in the 1980s which they ascribe to fits of panic. They scarcely ever mention the reasons for these fits. As this took place longer than a normal career-lifetime ago then most politicians and bankers have no idea of the reason. All they’re aware of is that there was a spike and a crash in the past which journalists and financial advisors never tire of repeating.

Most economists know better. The reason for the spike was that the American dollar was inflating so rapidly that investors of all sorts (rich individuals, investments funds, pensions funds, endowments, hedge funds) feared the worst and started turning away from investing in American bonds and shares. They began to buy gold for defensive reasons in order to protect their money with an asset that wasn’t inflating but, rather, increasing in value. From trough to peak, the price of gold rose from $100 an ounce to over $800.

What happened then is that a very brave American central banker, Paul Volcker, raised the Fed’s basic interest rate to over 20%. The price rise of gold immediately stopped and fell somewhat. When it became obvious that the high interest rate was going to be reduced only slowly until the dollar was stabilized again, and over a long period if necessary, the big funds started to sell their gold and began to buy American bonds and shares again. From then on, the price of gold declined until it reached $250 an ounce by about 1999 — which is when the modern story starts.

Today, with an American interest rate at 0.5%, which cannot be raised by even as little as another 0.5% without causing an economic depression, there is no possibility of preventing the price of gold continuing to rise This applies whether we are talking of between now and mid-2012, or at a future post-2012 stabilized price level. The best that Bernard Bernanke can do is to raise interest rates to a normal level of about 3% to 4% in several years’ time when a normal economy and full employment resume — if they ever do within his term of office.

The reason for gold’s price rise since 1999 is that the European central banks had stopped selling gold. They had been under pressure from America to sell their gold ever since the end of World War II. America had forced this policy on Europe this in order to maintain the dollar in its primary position of world trade. Gold had to be eliminated as a competitive trading currency. But at last, in 1999, the worms finally turned, resisted America and some began buying again. Furthermore, other central banks in emergent countries around the world, worried about the badly inflating American dollars in their foreign exchange accounts, also started buying gold.

The purchase of gold by central banks, as with many of their operations, is not usually done publicly, but quietly. But from both hard news and from rumours, and at first in ones and twos, it is now eralized that non-European central banks have started to buy gold again since 1999. There are probably at least a score, perhaps two score, banks doing so now. Mexico was the latest country to admit buying significant quantities of gold. The very latest country in the news, Venezuela, has not only nationalized its own gold mines but is recalling all its gold which had been temporarily stored at various central banks around the world, including the Bank of England. Two of the largest gold producers in the world, China and Russia, are also buying gold.

Just as, say, the exhaust from a motor bike engine could gradually accelerate a spaceship to close to the speed of light, so have the steady purchases of gold by central banks been accelerating the price of gold in the past 11 years. This is not panic buying but a deliberate move towards the day when the American dollar will no longer be able to sustain any sort of stable price. As already described, this will lead to an ‘impossible’ situation of the gold price approaching infinity by about mid-2012, if we are to believe the evidence of the last 11 years or so. But there is also an other ‘impossible’ — or at least hitherto inconceivable — situation occurring in 2012. This is when the total trading area of the emergent economies will overtake that of present-day America, Western Europe and Japan.

It is therefore highly likely that, between now and mid-2012, there will come a point when the emerging world will decide it will be better to rely on the dollar no longer but to institute a new trading currency of its own based on the value of gold. At one particular price of gold, even as it continues to rise, there will be a point when, jointly, it suddenly makes sense. The emergent world market will decide that it can make it on its own if necessary. Of course, this will not be a declaration of war. Trade with America, Western Europe and Japan will still be highly desirable even if, as now, they are no longer growth economies.

China, Russia, some Middle East oil countries, Brazil, India and several more emergent countries have been calling for a dependable world trading currency for several years now. America has turned down such discussions repeatedly. Western Europe responded by trying to create a trading currency of its own, the euro, in 1999. Both the dollar and the euro, printed in such vast amounts such that governmental debts will never be repayable, are already in deep trouble. The Federal American dollar, not yet of 100 years’ vintage, and the euro of slightly more than 10 years’ vintage, will once again give way to a currency which has had a currency vintage of about 2,500 years and high value for at least a couple of thousand years before that. The central bankers of the emergent world are no mugs. They are as aware as anybody of the history of gold and trade. The only difference between them and the central bankers of America, Europe and Japan is that the former are no longer in denial about it. This acknowledgement to history is, in my opinion, likely to occur between now and mid-2012.

On an encouraging note (1,350)

It’s frequently said that governments are quite unlike businesses in that they can’t go broke. After all, governments can always print more money, which businesses can’t. And, if the extra money doesn’t solve its problems, then the people can be taxed more. But then the proposition usually peters out lamely, as if already proved. What’s not mentioned is that if a country is still not efficient enough to produce enough exportable goods or services to produce an income (from which, taxes), then some or all of its people find their standard of living going down. And when this happens, the price of food as a proportion of the average wage packet goes up. And if these prices go high enough for long enough then some people start starving to death because, by now, its government won’t even be able to afford sufficient subsistence welfare benefits. If this continues long enough then the population of a country either disappears completely or, at some stage, another country invades it for its unused resources and absorbs the remaining population in one way or another, or simply slaughters it.

Is this an extravagant picture? Not at all. It’s happened countless times throughout history. It just seems remote to us, accustomed as we are to high standards of living in an advanced country and with a welfare system for unfortunates to fall back on. But, at various levels, the above process is actually going on right now in many less advanced countries around the world. Even in the case of advanced countries and as recently as the last century or two in Europe, there have been more than a few genocides of various sizes and more than a few chops and changes of territorial boundaries, including a few total disappearances of nations.

There is, therefore, no essential difference in the workings of a government and the management of a business except in time scales. While a business may fail quickly over a period of a few years, a country might take generations or even centuries to disappear as a recognizable entity. In order to continue to survive, both governments and businesses need good financial housekeeping as a minimum, but also enough outstanding skills so that products desired by others can be sold and exchanged. And, out of these exchanges, profits are made. In the case of governments, profits take the form of positive balances of trade. In the case of businesses, profits take the form of dividends paid to shareholders.

On the face of it, this profit-making is a dilemma. In both cases, if half the entities (countries or businesses) are producing profits then the other half will have losses. And this surely, is unsustainable — that is, if we want a long term future for most people. We need balances of trade (between countries) and profits (between businesses) to balance out at zero for all or, ideally, to zigzag forward in only relatively small steps. Businesses achieve this by competing so hard that profit levels are driven downwards and, sooner or later, the most inefficient go bankrupt. This happens constantly, with the result that, today, the average lifetime of a business before going bankrupt or being absorbed by another more efficient business is no more than about 10 to 15 years. The new more efficient businesses carry the baton further before they, too, are overtaken by innovative efficiencies in production and marketing.

While this mode of balancing is acceptable in the case of businesses it’s no longer acceptable in the case of governments because the weapons of war that are now available, such as nuclear bombs or, even more so, sophisticated computer-hacking, are becoming far too dangerous, at least when used between the major powers. They can bring down such an immediate response that the initiator can quickly suffer as much destruction as the original recipient. Thankfully, although we presently have massive imbalances of trade around the world, warfare hasn’t been resorted to yet.

So if this type of equilibrium is not the answer for governments, what is? It is that every country, with its own natural and geological advantages should maximise them by specializing the education of its children accordingly. Economists call this “comparative advantage”. It can then sell its most efficiently made products. Unfortunately state education got off on a bad foot. The first state schools were started in the 19th century for the benefit of army officers’ children in Germany. These schools then quickly spread to all children in order to produce obedient young men for factory life (and for mass armies if necessary) in Germany and England. State imposed education for the masses then spread quickly to all West European countries and America, and thence to the rest of the world.

In doing so, state education over the past 150 years has generalized somewhat by moving away from producing biddable people for factory or army life. But, supervised by bureaucrats who generally know little of the daily life of business, state education has never been able to teach the really appropriate skills that are needed at any particular time in the life of an economy. Those have been taught at a very small minority of private schools which then supply something like 90% of all the important decision-takers in both government and business, and even about 50% of a country’s research scientists.

America, for all its faults, is still the most experimental country in the world. It scoops well over half of the Nobel Prizes in the sciences. It already has the best meritocratic system for college and university entrance with scholarships for the poor. This is fine for teenagers who have already been well educated at (usually private) school but, until recent years, the SAT exam couldn’t compensate for bad or inadequate parenting in early childhood or for poor aspirational levels of education in many, if not most, state schools. These deficiencies are now being attempted to be overcome by parent- and local community-initiated charter schools which are not under the authority of governmental bureaucracy or trade union regulations. There is already sufficient evidence that at least some of them can lead to far higher skill attainments (particularly in the most deprived local communities) and this is why England and some Nordic countries are now starting fee schools.

These new non-state schools are already giving evidence of levels of personal creativity in children that have hitherto characterized the fee-paid private schools. If advanced governments keep faith with this new democratic initiative in the coming years then this will be the best, if not the only, strategy for at least Western Europe and America which, at present, face seemingly overwhelming economic pressure from countries such as China, Japan and South Korea. In the longer term, the latter countries are going down the wrong avenue. Although a proportion of their children win hands down in international tests they all suffer from intensive rote-learning methods of teaching in their schools. The result?

However, their children grow up to be far less innovative than is now necessary in today’s world. Technologically, their business are still copycats of Western. Even Japan, which has been the longest in the industrial and state educational field, still hasn’t produced any new scientific or technological sector. Also, there is no sign so far that South Korea or China are going to be any more innovative. Their governments know this well and wring their hands wretchedly but they can do little about it in the shorter term because cultures takes generations to change and all three are steeped in it.

The West, however, which has now largely lost any discernible, overall culture left over from the agricultural era, manages to supply almost all the new ideas for more efficient economies. We now have a chance of taking up the latest manifestation of social innovation wholeheartedly. When the local school down the road can supply the sort of young people who are as fully socially confident and speciality-skilfull as those in the most expensive private schools then they will have a chance of sharing the most interesting and useful jobs as well as producing the appropriate efficiencies that we need to gain for a sustainable world.

Ending on an encouraging note . . . for a change!

Keith

Eurozone in catastrophic steps or otherwise? (450)

Surely the break-up of the Eurozone cannot be far away now. The European Central Bank is now trampling over the spirit of its own constitution by buying the debts of Greece, Portugal, Spain, Ireland and Italy. (Technically and legally, it is not permitted to do so directly. It is getting round its own rules by buying bonds indirectly via commercial banks.) Germany has said No to the further idea of “Eurobonds” — comprehensive debt buying — and, in any case, it would have to be ratified by 17 individual parliaments (and there’s no hope of that).

The German President, Christian Wulff, questions the legality of what the ECB is already doing, never mind the new Eurobonds that France and the ECB are proposing. Chancellor Angela Merkel is against the proposal. So is former Chancellor Helmut Kohl — originally a prime mover of the Euro and the Eurozone. For all his previous faults as a massive inflator of the American dollar, the now-retired Alan Greenspan is as objective an observer of Europe as anybody. He is quoted as saying a day or two ago: “The Euro is collapsing”. On top of all that, and where money speaks louder than words, European banks are having to pay unprecedented insurance premiums (Credit Control Swaps) of over 3% on the bonds of Greece, Portugal, Spain and Italy.

The point now is not so much when the Eurozone is going to collapse, but how. Is it going to be in partial catastrophic (albeit sensible) steps by means of Greece, Portugal, Spain, Ireland and Italy withdrawing one by one at, let us say, six-monthly intervals? Or by a larger catastrophic step (almost as sensible) if Germany, Austria, Finland, Netherlands and Flanders (northern Belgium) wrench themselves away bodily as a new Deutschezone, leaving France as the Great Panjandrum over the remainder? Or by total mayhem?

If the last case, then, via their banks, the UK and America will also collapse even further and faster into the Great Recession. And China will also be affected very badly. Its only recourse then (if its government can hold down social unrest for long enough) is to set about creating a new currency zone comprising Russia (for its energy resources), the Deutschezone (for its engineering expertise) and the other emergent countries (for their consumer markets). If that’s the case, and if the new Emergent Zone wants to ensure that it can continue make economic progress while America and Europe repair themselves over the next generation or two, then it will have to do what America has being doing for the last 70 years or so. This is to offer inducements by way of salaries, habitational environments and research facilities to the best scientific brains of the world — of which America now contains the cream. And, of course, they’ll be as footloose as European scientists have been before them when going to America, ever since Einstein in 1933.

To the greatest prophet of modern times (700)

Let’s all buy an airplane? Most of us would like to fly, wouldn’t we? After all, a good engineer, such as our own brilliant James Dyson, could soon start turning out first-class, reliable, beautiful machines for, say £75,000 or $100,000. In real money terms this is no more than the very first family photographic albums, or bicycles, or radios, or televisions, or cars cost when they first started to change from being hand-made items to the very earliest stages of mass production. In due course, with full-scale mass production, an airplane need cost little more than a mid-range car. The family airplane is just about the car’s most natural and obvious successor.

And, just as all the former consumer products did, family airplanes would create such a steady momentum of demand all the way down the social strata (for consecutive status reasons) that it would stimulate saving, investment and thus economic growth. Western Europe, America and Japan would be back on track again. While China was still catching up with mass car ownership in the next 30 years or so, we in the West would be able to forge ahead and export airplanes to their richest people in order to balance up our increasingly deficient balances of trade.

Why not?

Because we’re already locked into a densely populated urban way of life. There’d be insufficient air space for mass commuting. And this would apply even if, instead of airplanes, we were to have individual rocket packs or suchlike (which even the richest in the world are not yet commissioning nor, probably, ever will do). In short, we have arrived at a characteristic way of life which is as unique and as permanent as was the countryside-estate aristocrat-peasant way of life that held sway in all the agriculturally-advanced cultures of Europe and Asia (however different they were in cosmetic ways) before the industrial revolution.

We cannot possibly change our present locked-in way of life until populations of advanced countries are reduced to a fraction of the size they are now. The environmental constraints (in the spatial sense) are too great. Only the very richest among us will be able to possess beautiful homes in beautiful settings. Proportionately, there are too few of these desirable products. Prof Fred Hirsch, the brilliant economist of Warwick University, who tragically died in his 30s some 30 years ago, was the first (as far as I’m aware) to point this out in his seminal work, Social Limits to Growth (1976).

Like it or not, whether the Great Recession — the double dip — occurs imminently or not, the advanced world is already entering a steady-state economy. Whether the rest of the world manage to industrialize to the same extent as we have done is doubtful for all sorts of other reasons. But this is relatively unimportant. They, like us, are also becoming locked-into dense urban conglomerations. The countryside needs to be vacated for modern agricultural methods.

It is the non-arrival of the family airplane (or some equally magnificent consumer item) which is the real reason why, since about the 1980s, the normal currency inflation of previous years turned into a gallop with a huge rise of credit-making innovations from the mass personal credit card and so on. Western governments and their close buddies in the financial sector were so desperate to keep economic growth going by one means or another that they broke all the normal sensible rules about money. It is the artificiality of this credit expansion which caused the crunch of 2008/9. This is far from being fully played out yet. A great many home foreclosures, business bankruptcies, cancellations of property development and government defaults have yet to occur before the main body politic and economic will finally start to realize that the most insightful economist of the last century had better be paid attention to.

I described Fred Hirsch’s book as “seminal”. Unfortunately, it’s only considered so by a very small number of economists at the present time. Social Limits to Growth won’t really become seminal until Hirsch’s ideas become lodged in minds as open, fresh and young as his own was. So we’ll probably have a generation of distress and social mayhem until some constructive ideas of progress can take root in this or that city, region or country.

Xenophon and the price of gold today (750)

If Xenophon (430-354BC), the historian and pupil of Socrates, were alive today he would scarcely have raised an eyebrow at yesterday’s astonishing rise in the gold price (and perhaps also today’s for all I know, as I begin to write this piece). As the first author of the ‘hidden hand’ of the market place (with apologies to Adam Smith!) he’d have understood the coming restoration of a gold standard currency. “After all,” he would have said, as one of his slaves poured him another horn of wine on his patio in Athens and offered him more grapes, “we’ve seen it all before”.

In fact, Xenophon could almost physically see the place of origin of the first gold coin. It was already known by a predecessor historian, Herodotus, that it was first invented in Lydia, little more than 200 years previously. As he looked out across the Aegean Sea to the coast of Lydia just over the horizon (about 150 miles away), and by way of being an economist as well as an historian, Xenophon would probably have guessed that it was a Lydian sea merchant who had the first brainwave. In the years following, Lydian, Thracian, Macedonian, Thessalonian, Laconian and, above all, Athenian merchants, would have found gold coins indispensable as they settled up balances between them in the port cafes of their own fully ‘globalized’ world (the Mediterranean Sea).

Gold coins would never have been used for ordinary purposes, of course. Gold was much too rare and valuable for that. There were all sorts of other tokens for daily use in the city market places where common folk bought their food and trinkets. Even comfortably-off middle-class folk in Ephesus or Athens probably never saw a gold coin from one year’s end to another. Xenophon, being an aristocrat, probably had a few safely tucked away under a marble slab in his house. Yet gold was still the basic, background currency even though it was seldom used. Even in 19th century, gold-standard England, when a lot more gold had been mined in the world, particularly from the Californian gold rush of 1849, and when most of it ended up as the ultimate reserve (for most of Europe and America) in the Bank of England, most ordinary folk never saw a gold coin in the whole of their lives.

But back to Xenophon. Yes, he knew the power of the market. He knew all the basics as taught in A-level Economics in school today. For example, he also knew about the ‘division of labour’ because Athenian-made sandals were bought throughout the Mediterranean as being the cheapest as well as the best. All other sandals around the Mediterranean were made by hundreds of individual sandal makers here and there. However, Athenian sandals were made by specialists — those who tanned and cut out the upper straps, those who cut the soles, those who made the buckles, those who stitched them all together. No doubt these methods were kept as secret as possible for as long as possible by its entrepreneurial factory owner as he proceeded to mop up.

During the course of writing this piece this morning, gold has risen $30 an ounce, an acceleration of yesterday’s acceleration. This is a rise that would have been normal in any month of the last 11 years when European central banks stopped selling gold (against America’s ‘diplomatic’ instructions) and started buying it. The price might check later his morning, or it might proceed further as more central banks, more recently of emergent countries, continue to buy. The stock markets of London and New York and many others might slide today as they did yesterday. Movements of both may become panics.

One thing is for sure, the price of gold won’t come down as it did in 1980 when it last had a try for acceptance. But then we have no central banker today who would dare raise interest rates for money to over 20% as Paul Volcker did then in order to restore confidence in the badly inflating dollar. All central bankers today are in a state of paralysis. They have no ammunition with which to fight the free market of gold. Bernard Bernanke, the central banker of America, might already be ruing the day about two months ago when he told a Congressional finance committee [I paraphrase], “I don’t know much about the history of gold”. I’ve suggested once before that Bernanke ought to read Macaulay to find out about how central banks were first started. It would better if he read Xenophon and understood the power of gold in the market place.

Going With the Wind? (450)

A few days after the second big German air raid on Coventry in 1942 when large parts of the city centre were obliterated and the smoke had cleared, I went down town with my mother to buy whale meat. (Because so few people bought whale meat, it was off-ration, but it made a wonderful Lancashire hot pot — tasting just like beef, which was then almost unobtainable.) Most of Corporation Street had been bombed out, including the Rex Cinema. However, its front facade was still standing and, hanging by one end from it, and touching the pavement at the other, was a long placard. It read Gone With the Wind.

As I was only seven and, like all the boys I knew (or at least, those in our street who hadn’t been bombed), I thought that the war was a wonderfully exciting occasion. So I laughed when I saw this displaced placard, which had certainly gone with the wind. I was quickly reprimanded. And quite rightly, too. Strangely enough, however, I’ve never read Gone With The Wind since then, although I’ve read more than enough ‘Great American Novels’.

I feel I ought to read it now. I came across mention of it on the Internet this morning. One character in the book, Rhett Butler, apparently says that the biggest fortunes can only be made during the building up of an empire or the breaking down of an empire. Well . . . that’s certainly true today as America continues to sink under its massive government debt. And, of course, since the 2008/9 crisis, quite a few bankers, particularly investment bankers, have made a fortune out of it. And the same applies in Western Europe.

If we proceed further into a double-dip — on the edge of which, like the aforesaid placard, we are now dangling — then more fortunes will be made, no doubt. It’s likely, however, that it will not be the bankers who will make fortunes this time but much cleverer people who are now buying agricultural land or buying gold against the day when food will be a great deal more expensive than now and gold will perforce become the background world currency.

Governments will not be able to bail-out the foolish bankers in the same lavish fashion as before. If they fear for their very survival, governments will need all the money they can print simply to keep large proportions of their electorates on survival welfare for a few years. Meanwhile, politicians will be promising — perhaps sincerely this time — that they will sort out their currencies once and for all, and forthwith stop the continuing inflation of currencies which has plagued the world for most of the past century.

Yes, I must read the book, if only to discover the insightful comment for myself.

Reculer pour mieux sauter (600)

The personal computer has already had its day. It has never been an iconic consumer product in the same way as family photographs, bicycles, radios, phones, fridges, washing machines, televisions or cars were. That is, they were all extremely expensive to start with and took weeks, months or years of hard saving to buy as they gradually filtered downwards from the very rich to the ordinarily poor. These are the sorts of things that have powered the industrial-consumer revolution for the last 200 or 300 years. These iconic products have stayed with us, too, largely unchanged. They are permanent features of our typical way of life.

The personal computer has never been one of those. Within a lifetime, it has proceeded from being a toy for boys, to being a status symbol for the educated elite, to being a revolutionary catalyst in industrial and commercial organization and a sub-assembly in many products. It will soon be as small as, as cheap as, and as easy-to-use as a mobile phone. The personal computer has never been unique in the same way as all the other iconic products were. It was always an amalgam — albeit a very brilliant one — of the library, or the personal letter, of board games, or pornography, of journals and newspapers, or schools and universities, of the concert hall and cinema, and many other things besides. Versatile though it has always been, it will soon disappear, particularly when very powerful and very advanced voice recognition software is available from a cloud on the Internet.

But where are the new, unique, iconic consumer products? Where are the things to power economic growth in the coming years? They don’t exist. They petered out, roughly with television and cars, at around the 1980s. Unconsciously, manufacturers and retailers realized that they had no more consumer products for which people would save hard. This is why, since then, there has had to be a string of financial innovations in the credit industry from hire-purchase through to credit cards through to the most fanciful derivatives used by the banks.

It is this, at bottom, which may well be the reason why Western Europe, Japan and America are now poised, dithering, on the edge of what will prove to be a long-term economic recession (in the terms that economists presently use). Consumers, investors, manufacturers and retailers are all losing confidence in the future, according to all the polls. Maybe there’s still hope for the emergent countries such as China, India, Brazil and several more. Together, their consumer market, as yet unfulfilled, is already almost as large as the consumer market of the West. If they get their act together with a stable common trading currency then they could survive and catch us up.

In the West, this is a classic Emperor’s New Clothes dilemma. Very few economists, and almost no politicians dare whisper the possibility that we might now have reached a sort of ‘locked-in’ way of life. In truth, a steady-state economy might have already arrived. If economists and politicians were imaginative enough to admit this possibility then they could perhaps begin to see that this needn’t be the end of the world. We’re still innovative. We can still become more efficient. We can still increase the satisfactions of daily life and vastly increase our educational methods and health care. In material goods for everyday life we have simply reached a pause point. It may be a case of reculer pour mieux sauter, as the French say.

Let’s listen to Zoellick and Rogers (550)

The shooting of an unarmed young man who was taunting the police from the doorway of his home and which then set off scores of riots and shop burnings and lootings in London and a dozen other cities of England is relatively unimportant in the larger scheme of things. The two most powerful individuals in England, Prime Minister Cameron and Chancellor Osborne, face a much more serious problem.

They face the possible bankruptcy of many scores, if not hundreds, of financial industries and services which occupy only a square mile or two of London. For the last 15 years or so, these have been by far and away the predominant profit-making sustainers of the whole of the economy of England, not to mention the dependent economies of its satrapies, Scotland, Wales and Northern Ireland.

London is not alone, however. Hundreds, if not thousands, of financial industries and services in New York, Shanghai, Tokyo, Singapore, Sao Paulo, several West European capitals, and many other financial cities also face disaster. Eminent and highly qualified spokespeople in all these places have been giving opinions which agree with those of our own Chancellor two days ago when he said: “This is the most dangerous time for the global economy since 2008”.

Whereas the London burnings were the product of a complex mixture of policy mistakes and trends of the last 50 years or so, the really important crisis of the world originated with one simple decision taken in the first few weeks of World War I, 1914. When the Treasury in London realized that the war was going to last longer than a few weeks and that its armaments would require far more banknotes than the gold-backed banknotes then in existence, it instructed the Bank of England to start printing them (against government bonds as collateral) in massively larger quantities. All the other European countries and America followed tout de suite.

And it has continued ever since, the arch-destroyer of real money now being America with its ever depreciating dollars. The dollar today (and each and every other currency) is now worth only about 2% of what it was in 1914. There is a minority of economists who now say that the only (and inevitable) ultimate solution is to go back onto gold-back currency. This is the so-called Austrian school of economists. Unfortunately, their books are so impenetrably pedantic that we must turn somewhere else for clear vision.

Perhaps it may be one of the students of the London School Economics who attended a debate a few days ago between eminent proponents of Keynes (his early ideas) and Hayek. A straw poll of these students revealed the surprising result that half of them were inclined to the views of Hayek — who, of course, was an expositor of a gold-backed currency. (Keynes became a Hayekian in his last years.) There’s also a group of brilliant economists at George Mason University in America who are saying the same. However, for now, until a fresh young intellectual mind appears on the scene — hopefully a genius equivalent to Keynes or Hayek — we’ll have to make do with Jim Rogers, one of the original partners of George Soros. He ought to know a thing or two about the real workings of finance. Or perhaps Robert Zoellick, the President of the World Bank, who wrote a very careful article on the matter in the Financial Times last November.

Consequences of our second-strongest instinct (850)

As the stock markets of the world seem on the point of collapse and likely long-term economic depression looms, let me dwell on a couple of fundamentals.

The strongest instinct of all is individual survival. In extremis we have even been known to eat one another. Thus food and water are the ultimate backing for any currency. A billionaire marooned in a tent in the middle of the Sahara would spend his last penny if he were to be offered food and water and taken to safety. He might even spend his last penny on one cupful of water without any further guarantees.

We don’t need any of the biological sciences to tell us the above. However, for the vast majority of mankind, as yet uneducated in any of the biological sciences (even in the Western world), we need such stuff as anthropology or evolutionary biology to tell us what is the second-most important instinct which we share with 3,000 other mammalian species.

This is procreation, disguised in practical form as status. The male of the species needs to have as high a status as possible in order to have as much sex as possible, in particular with young, healthy, desirable females. This, of course, can’t happen for more than a small minority of human males, as with other mammals, because of the 50:50 male:female sex ratio. Mao Zedong, the all-powerful dictator of China for many years was a recent example of an exception (now that his true life story is being told!). By the age of about 30 years, when our frontal lobes have largely ceased developing, and potential skills are largely revealed, most males have settled into an acceptable status role or themselves. It is not that any male (to my knowledge anyway) will turn down an opportunity to increase his status, but he won’t necessarily strive hard for it. Only relatively few will continue to be energetic in mid- and older-life in pursuing higher status intensively in the arts, or sciences, or politics, or business, or sport (of the gentler sort!) or even in some obscure hobby or activity.

The general instinctive strategy of the young pubescent female is to choose as her life partner a male of as high a status as possible within her domain as her intelligence, health and beauty allows. This is our human version of the quality control instinct of all mammalian species in making sure that the more inept males are left childless so that their less fortunate genes are not passed on. In oppressive cultures, parents will do this for her, often having to entice such a male with a dowry offering.

And, talking of dowries, this immediately brings us back to money because currency and status are highly correlated in most spheres of human activity. Even individuals with the finest intellectual minds who don’t usually bother overmuch with conventional status objects strive for gongs such as Nobel Prizes — and usually also find themselves (accidentally?) in higher-paid jobs than the humdrum mental plodder.

Food and water are not convenient items to carry around in exchange for items which have to do with our second-strongest instinct, so man has made do with small items which are valuable because of their rarity. Gold and precious stones are good examples. In fact, as an economic survival-of-the-fittest phenomenon, gold coins became by far the best currency to carry around. By the 17th century it was the universal currency except in a few small isolated islands.

Gold had to be assisted, however, with a cloud of many other vicarious currencies during the course of the industrial revolution, because of the sheer volume of money that was being transacted. Principally (as regards most people most of the time) these surrogates were banknotes, though they could be exchanged, if absolutely necessary, with gold. This regime was thrown over completely, however, in 1914, when major countries started printing hitherto unimagineable quantities of banknotes to pay for wartime armements. After WWI was over, they decided that it was in their interests to outlaw gold as the currency with which their electorates had to pay their taxes — that is, the legal currency. By printing banknotes, at first modestly and then exuberantly, they could devalue the cost of their debts.

But, as we are seeing in the past few weeks and months, this trick never quite came off. The principal paper currencies — the dollar, the euro and the renminbi — have all been devaluing and are now close to panic mode. Gold, which had never quite lost its currency status, either in the minds of many ordinary people nor in the vaults of the central banks, is now re-establishing its basic value in mirror-like fashion. Central banks of the world, particularly those of the fast emerging countries, have been buying gold steadily since the last pseudo currency, the Euro, was instituted in 1999.

If we do, in fact, descend into world-wide economic depression in the next few days then one thing is for certain. Treasury economists, central bankers and top politicians will be re-reading their history books to determine more precisely just what went wrong in the last century. Then we might have some hope that a dependable stable world trading currency will ensue.

Goodbye warfare: Welcome gold (750)

The future of gold as currency actually rests on one foundation — the absence of wars. By this I mean major wars between major nations when their economies gear up to the maximum extent to produce heavy artillery and when a high proportion of their young men are conscripted into armies in order to kill other young men. Actually, both of these are relatively recent innovations from the 18th century, so we have had only three major wars as I define them — the Napoleonic wars, WWI and WWII.

The last of these major wars finished in 1945 when America and its Allies defeated Germany and Japan. Since then, during periods when tensions between the major powers rose to almost fever pitch, we might have had three other major wars. America versus Russia. China versus Russia. America versus China. That these didn’t happen was fortunate because all concerned were only just recovering economically from WWII. If any of these had taken place we would probably be in a much worse economic state today than we are now because, almost certainly, the initial third party in any of them would have joined one side or the other in order to protect its own interests, and thus we would all have been involved.

Wars will continue, of course. It’s very much part of our human nature to fight. We might very well have future wars of major nations against medium or small nations, such as America versus Korea or Vietnam, China against Cambodia, or Russia against Chechnya in the past. Or we might have wars between medium or small countries, such as seems probable in the Middle East sometime or in South America or Africa unless the big powers jointly put a stop to them. Also, we could all put a major bet on about 30 minor wars taking place internally every year in various parts of the world, as they have for decades past.

There’ll be no more major wars because, quite simply, all the major nations are, in fact, already bankrupt in one way or another and, besides, young men and their mobile phones and their growing contempt for politicians are moving on culturally. They would probably refuse to be enthusiastic cannon fodder on a large scale as they were before. If there are to be any major wars between the great powers, or even by small and medium nations against big ones, then it will be cybernetic warfare which hardly costs anything at all. Even an individual hacker with an ordinary PC can bring down major defence or corporate computer systems. This why governments are becoming hysterical about them. Scores of these hackers are being expensively bought-off every year in order for our present financial and governmental systems to continue at all.

More specifically, major nations can no longer go throw the gold standard over and go into massive money printing as they did during the Napoleonic wars and WWI and WWII.

But, you might say, we no longer have a gold standard financial system to throw over! Oh, but we have. Advanced country governments have never entirely thrown gold out with the bathwater, despite what official spokesmen and politicians have manipulated the masses into believing. Despite saying that gold is useless as a currency, and despite America forcing the (mostly) European countries to sell a great deal of their gold, the central banks never entirely got rid of their bullion. And America has certainly hung onto its own gold! And, since the Eurozone, with its new Euro, challenged the supremacy of the American Dollar in 1999, central banks have been buying gold again. It was slow and tentative at first but, today, increasing numbers of those countries which aspire to economic growth, are now buying gold.

Gold is quietly restoring itself. When its price is high enough and when the value of the Dollar, Euro and Renminbi become low enough, the gold standard will return. It will recapitulate its several thousand year-old history. About five thousand years as it graduated from being a precious status item to becoming a reliable currency for trading (Greek merchants in the Mediterranean at about 500BC). About two thousand years as it was adopted throughout the world as currency and then as it evolved to became the fulcrum of the most sophisticated financial system yet known to man in pre-1914 England.

That is, when we had absolutely no currency inflation for a century beforehand. One day — and probably very soon — governments will be forced back to that desirable state of affairs.

Why (and how) gold will make a comeback (1,900)

Gold started to became useless as currency 300 or 400 years ago. At least, useless as coinage. By then, as the industrial revolution machine began getting into gear, and as trade began to expand vastly, there were plainly insufficient numbers of gold coins to cope on a daily basis, particularly within a country.

Banknotes had to be invented. Invoices with 30-day and 60-day due payments began to be accepted as interim money (that is, between banks and merchants who had a sufficient degree of trust in each other). Promissory notes (later, personal cheques) were also satisfactory substitute money. (If they were repeatedly countersigned they could last for weeks or months, enabling many successive transactions to take place without ever going near a bank and having to be exchanged for gold.) Also, governments’ IOUs (bills and bonds) became acceptable as good as gold. Today, particularly since the 1980s, derivatives of all sorts have become effective money.

Gold coins could always be asked for if a banknote was presented to a bank and someone wanted a birthday present to give to his granddaughter. But, gradually, coins became increasingly invisible in daily life as they disappeared into bank vaults. If a bank prospered and needed more banknotes for its customers then it would exchange its gold coins with the Bank of England (the first central bank in the world). Subsequently, the vaults of the Bank of England filled up with gold coins, apparently uselessly.

Useless? Not really. When the Duke of Wellington wanted to pay his mercenary soldiers of all sorts of nationalities fighting Napoleon on the Continent, they would only accept gold coins. When countries such as Argentina wanted to build a railway or the Suez Canal was built large quantities of gold bullion had to be sent abroad to pay the labourers (probably reaching down no further than the gang foremen!). Large foreign importers needed to be paid in gold, not in English banknotes. Foreign governments would borrow money but only in gold. When financial panics ensued (and there were several of those in England during the rapidly expanding industrial revolution) both gold and banknotes had to be lavishly dispersed in order to prevent runs and to settle everybody down.

Thus, although gold was gathering dust in the vaults of central banks for most of the time, and although, physically, it was only a small proportion of the total amount of substitute money flying hither and thither in daily transactions, it was the ultimate capstone of a vast financial pyramid. If absolutely necessary, and from different levels directly and indirectly, everything else in the pyramid could be exchanged into gold.

That is, until America tried to de-gild the world in 1944. It tried to decapitate the financial pyramids of all the significant countries of the world (except itself!). At Bretton Woods Hotel, New Hampshire, America, the US representative, Harry Dexter White, more or less crushed John Maynard Keynes’s argument for a world currency. By then, Keynes was terminally unwell and hadn’t the stamina he once had. Once he was overcome then the other 42 represenetatives of other nations were easily strong-armed. Thenceforth, the value of their currencies could only be expressed in terms of the dollar. Only the dollar was to remain exchangeable with gold. All the other central banks, except America’s (the Fed) were to sell their gold and drive down the price of gold as low as possible. (America had the whip hand over Europe because it was effectively protecting Europe from a possible Russian attack in the 1950s to 1970s.) Gold was no longer to be of any value as currency. Officially it was to be disparaged. Weary with the devastation of world War II, all the European nations (except Switzerland at the time), together with 30 more countries which were dependent on America, could only agree.

By then, because of its huge exports of wartime armaments, America had more gold in the Fed’s vaults than all the other central banks in the world put together. It also had a vast wartime governmental debt, mainly owed to its own citizens. However, with less and less reference to the actual amount of ‘capstone’ gold in the Fed, America began to print more and more dollars to bring about inflation and thus, with the devalued money, began paying back its government debt at a fast lick. Also, its exports to the rest of the world were also bringing in more gold, but it was only paying for its imports in dollars. By then, the US Treasury ‘discovered’ that by printing even more dollars it could pay for increasing amounts of armaments and even fight major wars such as Korea and Vietnam with its arms tied behind its back.

This was amounting to a subsidy to America from the rest of the world. But this wonderful period lasted for only 25 years or so. (George Soros’s famous ‘reflexivity law’ kicks in here!) By the late 1960s, Europe was finally getting back on its feet and its revived industries were beginning to export to America and being paid their profits in dollars. American dollars started accumulating in large quantities in Europe (‘Eurodollars’). These Eurodollars couldn’t be used directly within European countries without governments losing their own currency sovereignty, so governments started asking America to exchange their surplus dollars for gold (despite America’s constant pressure to sell it). This ability to buy gold with American dollars was allowed for by the Bretton Woods ‘Agreement’ (though not anticipated!). Germany and France were particularly demanding.

By 1971, American gold was disappearing from the Fed’ vaults at such a fast rate (probably two-thirds of it had gone by then) that President Nixon called a halt. He could have eased into this in various ways over a period of months or years but the way he chose was peremptory and immediate — and illegal (in the terms of the international Bretton Woods Treaty). He cut the gold tie completely. From then onwards, without the restraint of gold, America began printing more dollars than ever. Inflation ensued and the value of the dollar started to decline so precipitously that Volcker, the chairman of the Fed had to raise interest rates in 1980 to the astonishing level of over 20% for a while until the dollar was retaining its value and was only inflating at acceptable levels — acceptable to America, that is, not to the rest of the world.

Inflation has two effects for governments. Firstly, it enables governments to pay off their debts quicker than they would otherwise. Secondly, because of the ‘progressive’ nature of the taxation system, it causes taxation income to bound forwards, sometimes in great leaps. This finds a ready response in politicians and civil servants alike. Governments start absorbing more and more of the total GDP of a country, always able to find a reason to grow in size. Before the Great Depression of the 1930s, America’s government expenditure was 6% of the total GDP. By World War II time it had reached 10%. At the end, it was 15%. By Nixon’s time, it was 20%. By Bush’s time, it was cracking 35%. Today, under Obama, it’s already exceeding 40% — and is now pretty well near where the more socialist countries of Europe are desperately trying to get back to from 50% (when the taxation level pretty well demotivates everybody).

In short, inflation has the perverse effect of actually increasing governmental aspirations and thus of its accumulation of debt. And that is where America is now. Even with the most rigid demands of the Tea Party contingent of the Republican Party, Congress decided yesterday to increase governmental debt. “Just a little more”, it is being said, “before we stabilize.”

Will it ever stabilize? Not in the near future, according to almost every financial commentator or bond investor or credit agency. But it will have to sooner or later if America is to retain any credibility at all. If it does not, it will either continue sinking into the recession it’s been in since 2008 or it will go through another mad phase of quantitative easing (money printing) and have even more inflation — which will then cause a sudden collapse into economic depression. And the rest of the world will be thrown into depression also.

Meanwhile, the value of gold, with an inverse credibility to the American dollar, is shooting upwards at about 25% per annum and accelerating. If it keeps to the same price curve as of the last 11 years, its price will be going up vertically before about mid-2012. This, of course, is ridiculous and will have to start dawdling sometime before then. Otherwise every spare dollar (or any other currency) in the world will start to be spent on gold. It is obvious to anyone with the remotest knowledge of the differential calculus that America will have to stabilize its debt long before stratospheric price levels of gold are reached.

Whether President Obama will see the Damascene light before then, or whether he’ll be forced into it remains to be seen. But this is what he, or his new Treasury Secretary will have to do (Geithner is giving up the job shortly it is rumoured — a failure of nerve?). 1. Announce, and execute, a halt to any further increase in the rate of money printing beyond normal industrial productivity and then wait for the value of the dollar to stabilize against other currencies and commodity prices. There might be violent currency gyrations for a while after this announcement and many more of America’s less efficient industries will continue to go bankrupt. 2. As soon as this settles out roughly and to prevent further loss of confidence (causing rapid inflations or deflations from taking place from then onwards), the existing money supply of dollars is then to be tied to the amount of gold in the Fed at the market price then obtaining.

This will have huge disruptive effects on America and the rest of the world and many countries will go through bad times for a while, but no more than that will inevitably happen if America doesn’t stabilize its government debt pretty soon and thus plunges itself and the rest of us into depression. These bad times needn’t last long. By then, in order to exchange with the dollar, all the other national currencies in the world will also automatically be linked to the market value of gold — which will then be fairly constant (output from gold mines being able to grow only very slowly from year to year). In effect, the whole of the world’s national currencies will comprise a stable world currency, albeit with different names and different unit exchange values. Currency and bond speculation will then cease. Firms can then negotiate contracts without fear of further big currency movements. The present huge currency imbalances that now exist will have vanished. From then onwards, any country with any exportable goods or services at all will be able to start standing on their own feet. Once again, gold will be scarcely visible but it will still be the capstone for all the other practical substitutes.

Strong medicine? Certainly. But no stronger than what will be automatically thrust down our throats if President Obama continues to treat his growing government’s debt lightly (aas he seems to be doing) and allows the dollar to continue to inflate. In 1944 America took over the ownership of the financial barn. It now has to make it rainproof.