Predictable Money Means More Than Politicians' Promises
Late on the night of July 16, 1897, a reporter for the Post-Intelligencer in Seattle boarded a tug and set out into the Strait of Juan de Fuca to intercept an inbound steamer from Alaska. The Portland had sailed from St. Michael carrying several Washington residents and their wild stories. Beriah Brown Jr., the P-I reporter, had heard the whispers of successful gold hunters making their triumphal return and he wanted to get the scoop before anyone else. At around 3 in the morning on Saturday the 16th, the Sea Lion and Portland met up and Brown began to hastily interview anyone he could find.
Satisfied that he had not just a story, but the story, Brown reboarded his tug and raced back to Seattle to publish it. He wired the paper describing a ton of gold that the Portland was carrying, struck from the Yukon region of upper Canada. By the time the steamer arrived in port, a large crowd had already gathered ready to witness the spectacle. The streets were purportedly so crowded in the downtown section that by 9:30 am, just a few hours after Beriah Brown had reported his story, streetcar service had to be suspended. It was a genuine phenomenon.
Thus began perhaps the greatest gold rush in history. Nuggets had been found almost a full year before, in August 1896, but because the area was so remote it had taken that long for word to reach the civilized world. It is thought that 100,000 people ultimately set off for the tiny city of Dawson, the nearest humanity to Rabbit Creek, an embarkation that transformed the whole of the Pacific Northwest in the US and the Western regions of Canada. Seattle would become the largest city in that part of the country, while for a time even Dawson had been transformed into the most populous Western metropolis above San Francisco.
Of the multitude that dared venture north, however, less than half actually reached their destination. The trip was a gauntlet of hardships, starting right from the beginning (trying to secure passage to Canada from Seattle was quickly big and often unscrupulous business). It got no better once reaching Canada, especially given the unforgiving terrain, the length of the journey to surpass it, and then the weather that was more dangerous than anything humans would conjure.
Most of all, however, it was all a long shot. Sure, the stories made it sound like all you had to do was show up and leisurely pluck up the gold lying visible on the surface of the ground. But a year after Rabbit Creek had become Bonanza Creek, the locals had long before staked out all the best claims. It is estimated that though the modern equivalent of $1 billion had been removed during the frenzy, very few directly benefited from any of it. Historian Pierre Berton would later write:
“Some thirty or forty thousand reached Dawson. Only about one half of this number bothered to look for gold, and of these only four thousand found any. Of the four thousand, a few hundred found gold in quantities large enough to call themselves rich. And out of these fortunate men only the merest handful managed to keep their wealth.”
Why did they do it? People from as far away as New York were heading to Seattle by the thousands, with little more than dreams of striking it rich. There is, of course, something innate within us to see the grass as always greener, and there were contemporary factors of Gilded Age life that surely drove these seemingly irrational desires; after all, working all day in a late 19th century factory may not have been as different from trekking headlong into the Canadian wilderness as it may seem today.
At root in the Klondike gold rush, as any gold rush in history, were the basic principles of finance: risk vs. reward. To achieve great reward requires great adversity. It may not seem like it in review, but I doubt many of these dreamers thought it was easy, they simply saw the other side of it for what it could be. WD Wood, Seattle’s mayor the day the Portland arrived, who was away in San Francisco when the hysteria started, upon hearing the news he immediately telegraphed his resignation and headed for Alaska without ever stopping back in Seattle.
Wood eventually returned defeated, like so many others. For him, it was worth the danger because of what was possible. There were Klondike Kings, as those early locals who did strike it rich came to be called; and there were several people on the Portland who upon arriving in Seattle had to immediately hire several laborers so as to unload and transport all their gold. The financial axiom survived more than anything else.
It is the reason gold was at the center of monetary systems throughout history. It was the natural preservation of predictable order. Because it was hard to find and harder still to obtain, the pairing of such gigantic remoteness with the apex possibility of achievement made it an honest method for construing the vital roles that money plays; from honest money flows uncorrupted economy. By maintaining risk vs. reward, it instilled necessary discipline that created a robust and internally consistent system.
Economists view all this as a dangerous comedy. John Maynard Keynes, for example, made his point by recommending that in a depression it would be better for idle labor to be put to use burying, and then digging up, bottles full of banknotes stuffed down abandoned coalmines. From the 21st century view of credit cards and ApplePay, it may seem sillier still. The argument advanced by the chartalists of the 1910’s and 1920’s has won out; that money can be anything. The Great Depression of the 1930’s, however, showed a little more care was necessary than such flippant disregard for the comprehensive basics of tradition.
The entirety of the post-Great Depression central bank regime has been purposed to try to accomplish what gold did without the need for it. Substituting economists for prospectors, the Bretton Woods arrangement was this half-measure. Gold was still central but only central bankers could legally access it. It was supposed to mean the stability of gold with limits on currency imposed by rules only the authorities could achieve in their official capacities. Risk would no longer be defined monetarily by remote gold strikes but instead by the trusted actions of officials.
That was, of course, the whole undoing of Bretton Woods. Given the ability to act on discretion, governments did so immediately. In truth, the post-war gold exchange system lasted barely a decade and a half. By 1960, the London Gold Pool had been formed which was by then an outright cheat. Throughout the decade of the sixties, central bank circumvention of Bretton Woods had become so common (swaps and eurodollars) as to actually be a primary cause of its downfall. The end of it in August 1971 was merely recognizing what long ago had transpired; gold was replaced by the intellectual rigor of economists, a truly distasteful proposition to everyone but economists.
But what of risk vs. reward and the predictability of money under this new design? These intrinsic monetary ideals, the real intrinsic value of gold, not its price, remain as central as ever. Though we may not recognize them as personally as those departing Seattle in 1897, no monetary regime can survive without them. Even economists will admit as much, as Ben Bernanke did in December 2006 using then China and its monetary policies.
“The People's Bank of China (PBOC), the nation's central bank, is capable and well-respected around the world. However, monetary policy can work well only to the extent that financial markets are sufficiently developed to allow the monetary authorities' interest-rate decisions to affect economic activity in a reasonably predictable way. The development of a reliable ‘monetary transmission mechanism’ is thus another reason to reform and strengthen China's banks and financial markets.”
Ten years ago, it made sense to highlight these principles relating to a modernizing giant chock full of contradictions, a Communist government rising on a mercantilist code. A decade forward, Bernanke’s contention cuts a little too close to home, raising the question about whose contradictions might actually be more contentious.
Where once gold was a dependable base for all honest trade, central banks have tried to become that for the modern system. At least that was the argument for the Great “Moderation”, that monetary policy had reliably and predictably acted so as to maintain good order and did so to achieve only the best results. There was a heavy element of self-fulfilling prophecy, one that policymakers both recognized as well as sought to exploit; if people believed a central bank was omniscient or near enough so they would act as if that was the case. Thus, the true task of a central bank was merely to get people to believe everything that was good was good because of its policies.
Nagging questions like asset bubbles would have to be obscured under a fog of complexity. The Federal Reserve has taken the stance at various times that there are no such things, and if there are there isn’t anything the Federal Reserve can or should do about them. But what is the defining characteristic of all asset bubbles? It is the rationalization of risk, meaning that people come to define none financially as if an entirely new paradigm has been reached detached from all historical experience (new plateau of prosperity).
This is very different from the gold rush irrationality, though it may not seem that way. For those heading to the Klondike, despite all the stories they knew very well the risks and went anyway believing the reward was well worth taking on hardship, danger, even death. Dot-com investors and the house flippers who followed them, by contrast, simply convinced themselves there was no risk at all.
But it wasn’t just these speculators who made these bubbles. They were the face of them, for sure, though in reality the dot-com bubble wasn’t truly distinct from the housing bubble. They were both different symptoms of the same cause, which is where the absence of discipline was most dangerous. If day traders saw no risk in buying however briefly tech stocks that did little or too often no business, the global banking system saw no risk in providing the monetary resources (money dealing) that underwrote all of it.
Ironically, one of the chief reasons for this destructive skew was that self-fulfilling prophecy about monetary policy. To many people Alan Greenspan really was the “maestro”, but on Wall Street and more so Lombard Street he was more than that. No matter what money dealers could come up with, they all believed deep down that if they all got into trouble at the end of the day the Federal Reserve would get them out of it (and do so quite easily). I have borrowed and repurposed Charles Dickens’ description of insurance companies to illustrate this imbalance:
“One bank that holds no dollars gets another bank that holds no dollars to guarantee everyone has dollars.”
From that assumption, along with a great many other mistakes about the capabilities of statistics to define as well as predict the incomprehensibly complex, dealers created monetary capacities that both astound and terrify with absolutely none of the discipline required for a truly robust and sustainable system. It was all reward, determined exclusively by volume, no less, without any sense of risk. There was such a deep chasm of understanding on both sides, private money system as well as the monetary officials everyone believed were overseeing them, because nobody thought there was any reason to actually investigate. That is what the unhealthy skew of risk vs. reward does; like not bothering to test a new airplane design before ramping up mass production of it, all based on faith in some very narrowly construed regression calculations.
While a gold-based system acted predictably, the central bank one of the Great “Moderation” quickly faded and disappeared. It is no small wonder, either, given all these inconsistencies. Starting in early 2007, the system which had in theory depended on the Fed’s liquidity and money management prowess as the last resort backstop began to see both the central bank’s limitations as well as its unhealthy, unearned arrogance (subprime is contained). It was a dangerous mix that shook the global monetary system to its very core, largely because there was no longer any dependable basis for anything.
One of the primary reasons the eurodollar system grew as far and as fast as it did was because it was eminently fungible in every way imaginable. It expanded more than quantitatively, more so qualitatively. Everything was negotiable, meaning that any form of bank liability that any far flung bank might create could be used to in a matter f seconds to monetarily satisfy the monetary commitment of another bank on the other side of the world. Central bankers had a sense of what was going on, most especially Alan Greenspan who waxed periodically throughout the 1990’s about the dizzying evolution of money. He did nothing because he actually came to believe he was the “maestro”, a trait he lamentably passed down to his immediate successor, Ben Bernanke, who was only too compatible with it.
That meant the basis for eurodollar expansion was only this skew of risk vs. reward. With the Fed or any other central bank of no help, there was only one possible outcome as a matter of time. By that I don’t mean just the panic in 2008, which was nearly unique in history for being a monetary panic of and by banks alone, but also systemic reset. Having first learned the hard way that there is and always was a great deal of risk to even eurodollar money dealing, and that accepting any bank liability from any bank was inherently risky to a considerable degree, these money dealers then suffered further through the hardships of the QE’s that brought only promises of relief but none in reality; risk and reward have been pushed perhaps way too far in the other direction.
It’s as if the eurodollar money dealers of the past few decades have been at last subjected to the conditions of the Klondike rush, but without any of them finding any gold by the end of it. The world has been scarred monetarily to where there is now all risk and no reward, or at least so little that the deficiency has become a permanent (and dangerous) drag on the global economy (constant liquidity preferences) so long as it continues.
It is a global problem, one that defines “dollars” as well as all the global systems connected to it by necessity (because eurodollars are what replaced Bretton Woods). The PBOC, for example, was an almost perfectly mechanical operation in 2006, which drew in Bernanke’s qualified admiration, but in ten years’ time has evolved not by choice into anything but predictable. The defining characteristic of Chinese banking in RMB terms in 2015 was contraction. The PBOC by weight of exiting “dollars” on the asset side of its balance sheet allowed them to be surrendered and destroyed, preferring instead to use interest rate cuts and unlocking required bank reserves of the private system (through reductions in the statutory requirements, or RRR) to mediate negative “dollar” flow.
The result was some of the worst economic and financial conditions in China for decades, more troubling than its experience during the Great “Recession” both in terms of scale and more so in terms of duration. In the year that followed, 2016, the PBOC scrapped all that and shifted to a fiat operation in order to more directly balance persistent “dollar” declines. Bank reserves are rising again but systemic liquidity is not. Economists and the media have been quick to attribute improved economic conditions around the world in 2017 to Chinese “stimulus”, but in truth there really isn’t anything different about the economy this year versus last year. The global monetary noose only tightens.
These past few years of the “rising dollar” in China have been a microcosm of this larger approach of discipline. The PBOC expected that the private RMB dealers would on their own alleviate an exogenous monetary shock, only to find that Chinese money dealers acted very much like, in their own way, eurodollar dealers after 2007. They are now unusually shy for good reason. Then, like the Fed with QE’s, the PBOC belatedly steps in to salve its own mistakes with its own balance sheet expansion (RMB, anyway) and ends up proving private suspicion instead. Chinese money markets are an increasingly volatile mess and the best that can be said from several trillion RMB is that China’s economy may have stopped decelerating.
There is a collective confirmation bias to always overcome, and more so in the last decade. What I mean by that is we have a tendency to believe nothing bad can ever last so long, and if something does start to drag for an extended period the government will employ the “best and brightest” to step in and fix it. That is the legend of the 21st century central bank, one that is actually a relatively new and until 2007 untested creation.
The global money system, however, is way past Humpty Dumpty; all Bernanke’s horses and all the PBOC’s men can’t make it work no matter what they do, and at the expense already of considerable effort and resources (trillions in idle dollar as well as RMB bank reserves, not to mention euros and half a quadrillion yen). What’s worse is the amount of time squandered for no results other than the self-serving declaration of “jobs saved.” The focus on quantity misplaces the diagnoses of liquidity. What is lacking is not more of the same, but a stable system that can have a serious chance to achieve what Ben Bernanke was talking about in 2006, minus all the bubbles, meaning undisciplined central banks and the money dealers they allowed, through self-imposed ignorance, to run totally amok.
The idea of going back to having hoards of the otherwise unsophisticated traipsing through the last remaining wildernesses on earth to pluck nuggets from the ground might be too distasteful for the 21st century mode of commerce. Besides, mining is strictly a corporate affair now just as it was in every gold rush (by the end, most prospectors simply became mine labor for the early locals who found the best locations). Yet, the ugly, barren nature of the post-Bretton Woods regime should not be lost on its successor.
So long as the eurodollar remains the global currency, and it has survived in a decaying state for just shy of a decade so far, the whole unstable imbalance remains with it – and therefore the economic depression that though slightly better this year continues on. Bernanke was correct to identify monetary transmission as crucial, though the way in which he sought instead to exploit it was the absolute wrong direction to take. Predictable money means so much more than policymakers promising to be good, it means internal discipline that organically arises from the consistent nature of the system itself; getting back to basics.
