Gold Reminds Governments That They're Still Not In Control

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Gold is a barbarous relic, so spoke Lord Keynes. Actually, what he said was that the gold standard no longer fit the times. In his 1923 work, A Tract on Monetary Reform, Keynes savaged the notion then gaining steam that the world should go back to one. All the major powers had effectively left classical gold at the outset of World War I. In its devastating aftermath and with one massive depression in between, the stakes were enormous.

What Keynes would argue then and after the outbreak of the Great Depression was gold’s lack of movement. Hoarding, as it later came to be known. In the eruption of uncertainty, banks, the main holders of money, stop circulating it. There can be no elasticity in currency for the lack of flow of money. The cause of depression itself, many had come to believe, wasn’t in a business cycle it was in the brutal lack of flexibility when needed the most.

Today they call it procyclicality.

In 1923, he asked:

“If we restore the gold standard, are we to return also to the pre-war conceptions of bank-rate, allowing the tides of gold to play what tricks they like with the internal price-level, and abandoning the attempt to moderate the disastrous influence of the credit-cycle on the stability of prices and employment?”

That last part is what Keynes has become known for, a practically religious following that hugely distrusts markets in favor of “enlightened” government intervention often through monetary means. The supposed barbarism of the gold standard was in how it deprived authorities of their authority to act.

To Keynes and those who follow him, market-based money causes depression, therefore the solution was and is detached, dispassionate observers with the power to step in. But since no government can “print” gold, the old way had to be demonized, and demonetized, before it could be reset.

Hatred for gold is a longstanding tradition. Even during its heyday of the latter nineteenth century there was as much controversy as not. William Jennings Bryan stood before the Democratic National Convention in 1896 and railed against the cross of gold in favor of bimetallism because he like Keynes wanted more plasticity in money supply.

As far back as 1873, John Austin Stevens had written for the New York Times that, “gold is a relic of barbarism to be tabooed by all civilized nations.” It should be noted that the backdrop for Mr. Stevens was the same as it would be for Lord Keynes, and the very thing that would so passionately motivate Mr. Bryan two decades thereafter.

The United States in the aftermath of the money printing during the Civil War for years had contemplated getting back on a metallic standard – one that excluded silver in favor of gold alone. The Grant Administration’s Coinage Act of 1873 would come to be called by many the Crime of 1873 for its manipulating of the monetary system in favor of that ancient barbarism.

Getting back to the second decade of the twentieth century, it was perhaps Thomas Edison who elucidated the argument best. Famous as an inventor, it wasn’t much to realize Edison was also quite naturally a thinker. In 1921, gold, he said, “is a relic of Julius Caesar and interest is an invention of Satan.”

Decrying how it was so much less useful than other metals, maybe every other metal, Edison didn’t invent the epithet “you can’t eat gold” but was among its more pioneering fellow travelers. Because it had no other utility, the answer for its long-lasting behavior was simply one of power.

“The probable reason why it is retained as the basis of money is that it is easy to control. And it is the control of money that constitutes the money questions. It is the control of money that is the root of all evils.”

The backdrop for his little sermon was a trip to Alabama in the company of none other than Henry Ford. Visiting the Muscle Shoals nitrate and water power projects located near Florence, Ford in particular was hot for it and he wanted the government involved in the financing for what would be a public-private partnership which would benefit everyone for miles and miles around. The greater good, if you will.

The problem was bonds. In order for the thing to go through, the federal government would have to raise $30 million – a huge sum in those days especially for a single project.

Edison was incredulous, particularly when counting up all the proposed interest that would have to be paid over the life of the debt instruments. It would amount to $36 million in interest alone in order to borrow $30 million in money. To Edison, it was nothing more than a swindle.

“It is absurd to say that our country can issue $30,000,000 in bonds and not $30,000,000 in currency. Both are promises to pay: but one promise fattens the usurer, and the other helps the people.”

The chartalist argument perhaps still closer to its infancy, these same ideas are more and more recognizable today under the re-labeled fabrication of MMT; or, modern monetary theory which is much less modern and monetary than it is made out to be. A gold-based monetary standard required the government to pay something to borrow that which it didn’t own. A serious limit to its reach.

Edison was exactly right about the nature of gold as money. Everything boils down to who gets to control it. If you believe as Edison and Ford the government can be and most often is a force for good, then monetary restraint is a barbarous evil. But what if the government is populated, always, by bumbling incompetents masquerading themselves as technocratic geniuses?

Lord Keynes never did get around to answering that question, not directly anyway. Nor has any of his intellectual descendants; almost certainly because they are the bumbling idiots in question.

And because this is so, it has left us with what seems to be the great paradox of our age. Freed from having to borrow actual money, governments have become profligate spenders. Deficits, the great bane of civilized society, are now routinely of incomprehensible size.

From the outside, it seems as though the government is rewarded for its reckless behavior – bond vigilantes an extinct species. Before we ever get to entitlements like Social Security and the day when payroll taxes no longer cover the outlays, the US is so far in the hole and yet the cost of borrowing would only please Thomas Edison. The government doesn’t need to pay a huge premium to a skeptic for his gold, it found a way to print it all the same.

Not on purpose, mind you, quite by accident. And we aren’t talking about printing money in the same way as what Edison had in mind for Ford’s Muscle Shoals. This isn’t physical currency, not a deluge of Federal Reserve Notes flooding their way out into the economy and back into the hands of the US Treasury.

It is the debt itself which has become gold. It’s a hard concept to grasp, I know, but that’s what’s behind what otherwise appears to be a hard and irreconcilable contradiction.

The Great Depression was a serious crisis no government let go to waste. Removing gold from the public’s hands, and relegating it to gold exchange in their hands, the process was set in motion. Keynes had won the argument in the official realm; there would be governments through central banks who would control money - but only when they reasoned it was perfectly necessary.

The market would be the market with the enlightened few over top to watch over everything. Elasticity at last.

What neither Keynes nor his followers had anticipated was what the freedom would do in the private realm. In fact, Bretton Woods was carefully constructed so as to assure the world that gold exchange still functioned as an effective check on government irresponsibility. The very idea of private, bank-centric money never made it into their thoughts.

The great irony here, of course, was that it was the banking system which had irked Stevens, Bryan, Edison, and Keynes in the first place. The banks were the primary holders of gold, and so had acted the barbarians in their eyes. Whereas today many people curse Wall Street, in those days they cursed “Eastern bankers.” Taking away gold was supposed to have subjugated the banking system to enlightened centralized authority.

Instead, it opened the door for innovation and expansion. They hadn’t just freed the government from hard money, they freed the global banking system from it, too. Without its constraint, the system we all know of deposits and vaults was wholly circumvented by wholesale and interbank – and offshore.

A dollar which used to mean ownership over a quantity of gold in American hands would come to mean nothing more than a stripped-down unit of account without any borders.

Though repurchase agreements had been in practice since the time of Keynes and Edison, it was only later that what we now call repo would take its primary monetary form. At its center is a form of liquid gold, highly-prized collateral that is bandied about as if it was money itself. To put it simply, a bank’s liabilities can best be managed by its stock of collateral. Elasticity has today almost nothing to do with currency as it was once known.

While this may be news to many people, it is nothing new. In fact, the first great eruption of repo was half a century ago. By the early 1990’s, it was already done deal. One of the oldest Wall Street names around, the very firm most associated with the Big Eighties, nearly met its demise not because of early forms of subprime mortgages but because it sought total control over repo collateral; US Treasuries, in particular.

I purposefully recalled the story back in July 2015 (during Euro$ #3):

“What Solly had pioneered, in the end, was not just expanding the envelope of financial processes and engineering, but how this wholesale system could obliterate that envelope altogether. In other words, the prior restraints that acted upon banking were no longer restraints, and that what lay ahead, if you could get there, was an entirely new framework of money and currency that was to be written as they went.”

In 1990 and 1991, Salomon Brothers had resorted to cooking its own books and flagrantly circumventing government rules not because it was trying to hide losses, as you might suspect, rather it was because the “bank” wanted to hoard as many US Treasuries at auction – the best collateral around – by any means. Nobody at the time could figure out why this giant would risk everything for what one national newspaper account called an “inept little scam.”

The firm wasn’t seeking to profit on the price of the UST’s themselves, seemingly picking up at most a penny or two, it was trying to control what had already become a key money component. It was a scam, absolutely, but it was neither inept nor little. And it was a bright flashing sign of how things had changed.

With repo markets at the center of modern money and with sovereign bond collateral at the center of repo markets, there is a money-like utility to these issues. It is entirely separated from the fundamental characteristics of the bond issuer. For collateral purposes, no one cares that the US government is the brokest entity ever conceived by human beings; the only thing that factors on the morning repo desk is the liquidity characteristics of what’s being offered.

As hard for it is for most people to conceptualize, even a sovereign bond with a negative yield has monetary utility – for a bank. It makes no sense as an investment; that’s not how banks conceive of them.

But central banks are supposed to be at the top, or in the center if you are so disposed. Elasticity, we are taught, is meant to be determined by monetary policy just as Keynes had wanted. The media uses words like “accommodation” and “easing” when referring to whatever a central bank does; and it doesn’t matter what it is, so long as a central banker claims it is a monetary positive. The printing press reportedly still resides in its domain.

The Global Financial Crisis in 2008 proved without a shadow of a doubt how that wasn’t true – and it was the repo market which was at the center of the global meltdown. In almost every way, it behaved like a classic bank run – only it wasn’t the public queued up outside of bank branches seeking to turn deposits into cash, it was banks themselves struggling desperately to hold onto whatever collateral would be deemed acceptable in repo.

Where once banks would hoard gold and currency to Keynes’ eternal damnation, not letting the public claim any, in especially October 2008 banks hoarded US Treasuries not letting each other have access to them.

The greater this perception to hoard collateral, the more valuable the utility of ownership becomes. That simply means, as always, when a currency is inelastic its price can rise sharply as demand for it surges. In this case, since the money or currency is UST collateral, the rising price is perversely denoted by falling interest rates.

The low and even negative yields are effectively the expense of this new form of money reflected in the opportunity cost lost by being forced to hold more of the best collateral. In that way, it shares the same driving agency as with modern gold.

No longer a useful form of money, gold has been relegated to a hedge. Most commonly associated with inflation, the metal is actually in demand for other forms of instability, too, chiefly deflationary circumstances. Since gold doesn’t pay an interest rate (apart from gold leasing, but that’s a different if somewhat related story) the opportunity cost of holding gold is effectively the flipside of what it is in the bond market.

As interest rates on UST’s and the like fall, that’s the banking system paying more for these money-like reserves while at the same time it reduces the opportunity cost of hedging via gold. And both for the same reasons; a monetary shortage brings with it all the dangers investors seek to avoid by holding gold.

In a cosmic twist of fate, the whole thing has been run backward from where it was in the twenties and thirties. It used to be governments paying through the nose in order to borrow the banking system’s money, gold, in order to do what they wished. Now it is the banking system which will pay through the nose “to lend to the government” in the hopes of grabbing sufficient reserves of this modern type.

And it is gold which helps confirm the malady. As interest rates around the world collapse to new lows and new negative lows, the price of gold has skyrocketed. It’s not because markets are hedging for a resurgent Fed or ECB - in fact, inflation expectations in both the US and Europe have collapsed of late - rather it’s because as the world (outside of the mainstream financial media) realizes the bond market view it drives up demand for gold (hedge against instability) and down the cost of holding it.

In that way, it may be the gold market which is having the last laugh. Keynes as others wanted to demonetize gold so as to give the government exclusive authority over money. But what gold is showing us today in 2019 is that they aren’t anywhere near being in control.

Keynes wanted, no, required, a central authority to be able to monitor and regulate elasticity in order to make his worldview work. The current price of gold is an important and strong voice right now barbarously savaging the very notion of central authority for the obvious lack of it at a time when the need for elasticity is again dangerously high. 


Jeffrey Snider is the Chief Investment Strategist of Alhambra Investment Partners, a registered investment advisor. 

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