The FreeFiat Fracas

("FreeFiat" - Controversies Post 1)

A tweet from 'DP' prompted me to read the most recent argument about a concept dubbed "FreeFiat" that was unfolding on page two of the comment thread of FOFOA's latest post. Victor The Cleaner was re-presenting the FreeFiat concept and a few members of Team FreeGold were trying to clean his clock.

My first exposure to this concept was back in November 2013 when an old chum sent me a message asking if I had "converted to FreeFiat". Here's a link to the post where the FreeFiat argument first erupted (again on page two of the comment thread). The fact that I had to ask my old chum to explain it to me should give you, dear reader, a strong hint about my answer to his question.

Uncle costata also got a mention in the latest exchanges as being a disciple of the FreeFiat school (h/t to The Motley Fool for raising the red flag on that). 'TMF' also observed that the posts I committed to doing here at STFU have been arriving at a "glacial pace". Sadly true, a series of unforeseen events forced blogging way down in my list of priorities. I'm going to try to make amends with more regular posts from now on.

The FreeFiat Concept
As I understand it one of the main arguments is about whether people will hold their savings in gold or some type of debt instrument (such as bank deposit accounts) after the transition to a new gold-based international financial and monetary system (IMFS). So this fracas is predicated on gold replacing the US dollar in the IMFS. The FreeFiat camp say people will primarily save in currency and their opponents say it will be in gold alone or gold will have primacy in the competition for savings. (I should note here that FOFOA draws a clear distinction in his writings between savers, investors, speculators and so on.)

This FreeFiat concept strikes at the heart of two of the foundational theories of FOFOA's writings. At the risk of over-simplification, one of these theories states that there is a fundamental conflict between debtors and savers which is resolved by savers ceasing to save in debt instruments and making gold the receptacle for their savings. There is also a perceived conflict here with a second foundational theory advanced by FOFOA about gold taking over the store of value (SoV) role in the monetary system leaving currency solely/primarily with the role of medium of exchange (MoE) and unit of account (UoA) in a new gold-based IMFS.  

Victor the Cleaner (VtC) and his allies argue that the Euro is designed to flourish in this new gold IMFS. They argue that the Euro will be as good as gold over periods measured in years and most Europeans will happily hold their short and medium term savings in Euro. VtC argues that storing large amounts of wealth in gold will be more applicable to very wealthy people who are trying to manage inter-generational wealth transfers. Presumably he's talking about people for whom limited government deposit guarantees are insignificant compared to their liquid assets. Of course there is more to this argument than my brief summary can convey but I'm trying to adhere to my commitment to brevity.

(Frankly this aspect of the FreeFiat concept doesn't particularly interest me BUT there is another part of the argument that does interest me greatly. The FreeFiat camp also argue that the ECB's interpretation of its stability mandate will at some point shift from a positive inflation rate target to a zero rate or even to welcoming gradually falling prices (defined by most analysts today as mild "deflation"). I'm going to do one or more separate posts on this aspect of the FreeFiat argument because it opens up a gigantic can of fascinating worms for an old economics junkie like Uncle costata.)

Saving In Gold
In my opinion the average person won't need to personally hold any gold in order to benefit from the stabilizing effect of gold on the major currencies in a new gold-based IMFS. They will be able to ride on the coattails of other key players such as central banks, Treasuries, extremely wealthy people with an affinity for gold and large populations with a cultural preference for gold. Provided there is an international, liquid, free market in gold then gold will be able to price currencies and discipline currency issuers.

The fact that gold is widely distributed across currency zones will be helpful in other ways but this isn't a necessary condition for gold to price all currencies. As long as there is, say, a Euro gold price it would transmit a local currency gold price to other currencies. In order to manage their currency the issuers will also have to deal with the fact that in normal times over 90 per cent of the circulating money is bank credit money loaned into existence by banks in the form of bank deposits. So currency issuers will need to manage the bank created component of the money supply as well. I'll be doing some posts on this issue as well in order to share the results of my reading and research into this topic over the past couple of years.

Dual Currency Systems
I think we can obtain a sneak preview of how gold will discipline currency issuers in a future IMFS by taking a look at countries who, today, operate under dual currency regimes. Historically citizens of countries with a weak or untrustworthy domestic currency have tended to adopt a secondary "hard" currency as well. (In recent decades it was generally the US dollar.) In some instances the local currency functions as the 'petty cash' component of the money stock. Ecuador and Panama, for example, issues coins in the local currency and use the US dollar as legal tender. Domestic demand limits the local issuers ability to debase the currency.

Citizens can also force the adoption of a de facto dual currency system by demanding payment for hard assets such as real estate in a hard currency or gold (as reported in Vietnam). Wealthy people with funds outside their currency zone can transact domestically in local currency and make secret adjustment payments offshore at a different rate to the official exchange rate. So the secondary hard currency can operate in a separate hard asset "circuit" along with the domestic currency in its own daily consumption "circuit".

Countries can be forced to formally adopt a secondary currency by their international trade partners. The forces at work here would also be applicable to the system of currency swaps that China has been developing with gold functioning as the international hard currency unit. So this inquiry is relevant on several levels. International trade partners can (and do) force countries to hold reserves of US dollars in order to facilitate trade settlement. So this $IMFS is a de facto dual currency system.

This international trade requirement can discipline currency issuers in other ways. Sometimes governments (e.g. Argentina, Venezuela recently) attempt to over-ride the market and impose an artificially low exchange rate on their currency against the secondary hard currency that their trade partners demand. If the government's "official" (imposed) rate is above the "black" (free) market rate the government will bleed foreign exchange (FX) reserves attempting to defend their currency peg. As those FX reserves reach dangerously low levels the government will usually capitulate and converge to the market rate or they risk a currency collapse.

Store Of Value
The argument about the SoV role seems straightforward to me. In your local economy the currency must have the quality of SoV for some period of time or it's a dead currency. So at minimum, over short periods of time, your domestic currency will have SoV properties. In my opinion the situation from an international perspective will be even more clear cut. In a gold-based IMFS it will be gold (not currency, SDRs or sovereign bonds) that will have primacy as the store of value. In a gold-based IMFS gold will have the greatest liquidity, universal convertibility and it will exploit all of the network effects that the US dollar has benefited from.


anand srivastava said...

The important thing is whether Europeans will have a social security system. If they have then they don't need to save for the long term. The govt is doing it for them. I guess FreeFiat guys will be happy with it. Otherwise, the people must save their long term money in Gold.

I don't think it makes sense for EU to go with Social Security system, its horribly inefficient, and it is kind of a ponzi scheme.

If we don't have a Social Security people need to save in gold.

Nickelsaver said...

What's up Uncle?

I think the main difference between FG and FF is that; FG says that a free (physical) market only for gold will foster a natural spur/brake effect on the different major currencies relative to each other, such that currency managers will need to tighten or loosen their own ropes in order to (for lack of a better term) match phase with gold settlement so that their currency is stable. And that currencies will naturally have a small amount of inflation, while gold will naturally deflate over time.

FF says that the Euro will be managed such that it will have close to no inflation and that gold will fluctuate wildly, making it undesirable as a savings item other than over the long term.

VtC has presented 2 basic reasons why the Euro will be managed this tightly. 1) that historically the bundesbank has sought after an inflation rate of below 2% and ideally towards 1/2%, and that this is current policy of the ECB - hence it will continue to be policy after the transition. And 2) that the Euro won't have the same spur/brake on it that other currencies have because other currencies will be using it as reserves, and so it wont have the same natural inflation aspects as other currencies.

So, FG maintains that Savers will hold currency for the short term, and gold for the medium and long term.

FF maintains that Savers will hold the currency (short and medium term), and gold only for the very long term. Also, that because gold will only be held in the long term, that will make it an investment, not savings.

Nickelsaver said...

I should add, what makes fiat (savings) in FF is its stability, and gold an (investment) its volatility.

So gold won't really be all that different than it is right now, for the common man. Currency will be really sweet though.

This is FF.

Nickelsaver said...

Sorry, I'm not intending to dominated the comversation here. But while we are waiting for some of the real thinkers to chime in, I'd like to add some more..

It seems to me that FF has a major hurdle. Another/FOA/FOFOA often talk about the difference between the western and eastern mindset with regard to money and to gold.

If you think about the fact that the eastern mindset has essentially been to play the other side of this game of international monetary chess by maintaining its traditional view of gold as primary SoV. And that this alone forces the western mindset to capitulate on its continued use.

FF has the hurdle then of changing that eastern mindset, such that it would view gold as an investment.

How does that happen?

Isn't it more likely that the massive transfer of wealth from the west to the east causes the eastern mindset to be vindicated, the western mindset to reevaluate everything?

Is the world going to be looking to currency at that point, or to gold - for stability. And how do you get all those easterners to NOW see gold as a risk investment?

costata said...

Hi anand,

My personal preference is that retirement is privately funded. But I have also read papers arguing that provided social security systems are funded out of recurring revenue then this is a choice that a society is entitled to make about how to redistribute it's collective resources.

However you approach this goal the monetary and fiscal policy framework dictates whether the system is viable. People can save for their own retirement but it's pointless if the taxation system pushes their returns below the true rate of monetary inflation.

costata said...

Hi Nickelsaver,

Thanks for dropping in to comment. I decided to do a post on this FreeFiat concept in order to express my thoughts on it rather than let the assumptions that some people are making go unchallenged. You raise an important point. With all due respect to VtC I don't think he has made the case that the price of gold would be volatile in a gold-based IMFS. I expect that gold will stable/neutral. Currencies may bounce around if they are being mismanaged but it depends on your perspective. Is the price of gold changing or is the exchange rate of a currency with gold fluctuating?

I think the spur and brake function of gold will mainly be expressed through exchange rates in a system of floating exchange rates rather than the movement of gold. Having said that the structures are in place to settle balances in gold via, say, the BIS so that option is open as well.

I have to log off now for a few hours but I'll respond to your other points later.


Nickelsaver said...


Ty for the reply. Yes. Price, value, and purchasing power are different things. I look fwd to hearing more from you and others.

victorthecleaner said...


I don't think he has made the case that the price of gold would be volatile in a gold-based IMFS.

That's not that difficult, isn't it? If, say, China is a net exporter of goods and services into the U.S., what is going to happen? At first, the Chinese exporters will end up with a surplus of dollars. Then what?

During the period of dollar support (roughly 2001 to 2012), the PBoC monetized these surplus dollars, keeping the CNYUSD exchange rate constant. I.e. the PBoC purchased the dollars and printed local currency. Apart from granting the dollar its exorbitant privilege, this had the following effects:
1. The Yuan exchange rate was kept artificially low
2. The inflation from dollar credit expansion that would have happened in the U.S., was shifted to China. The U.S. had unusually low inflation while China had a lot
3. There was no incentive for the U.S. to become more competitive (not anything that made China less competitive) and the U.S. continued bleeding manufacturing industry while the kept importing real goods for free (i.e. paying only with paper).

In a gold based international monetary system, the trade balance will be settled in gold, either by the Chinese exporters themselves or, if their clearing is for some reason incomplete, by the PBoC itself.

In any case, somebody in China will sell dollars and purchase gold. This will result in an exchange rate adjustment. The dollar will decline both versus gold and versus the Yuan.

How would that make the U.S. more competitive and China less so?

Because U.S. made products will now be cheaper in China (U.S. made means the costs are basically wages or U.S. sourced supplies and thus paid in dollars, but the dollar gets cheaper in Yuan). Conversely, Chinese made products will get more expensive in the U.S.

So the Yuan appreciating with respect to the dollar sends a price signal to importers and exporters in both countries. This price signal needs to be strong enough and persistent enough for them to adjust their sales or purchase strategy. Only after the trade flow has adapted will the upwards pressure on the Yuan cease and a new equilibrium be reached.


victorthecleaner said...


If you think about it, since settlement is in gold, what actually matters is how the price in gold of a U.S. made product compares to the price in gold of a Chinese made product. This is the comparison that will be relevant to the importers and exporters when they make their decisions.

This is precisely golds function as a spur and brake as described by Jacques Rueff. (Btw Nickel is having this pretty much confused in his contribution above).

But what happens to the purchasing power of gold in the two countries? If the U.S. is regaining their competitiveness in my example above, then U.S. made goods will get cheaper in gold. But this means that the real price of gold in the U.S. increases, i.e. the gold price measured relative to the prices of goods and services in the U.S.

This price signal must be strong enough and persistent enough for the U.S. and Chinese importers and exporters to adjust their trade flows.

That's what it is. The spur and brake function according to Jacques Rueff is a fluctuation in the real price of gold measured in any one country.

How big will these fluctuations be? Enough in order to provide an incentive to importers and exporters in order to adjust their strategies. How big will this be in numbers? I don't know.

But I have an idea where we can get a first impression of the magnitude. Before WW1, the world had a functioning international gold standard. Just take a look at the variation in the real price of gold inside the relevant countries (i.e. Britain, U.S., Germany, say). I see periods of 2 to 5 years in which consumer prices, measured in gold, adjust by 5% to 15% in either direction.


Nickelsaver said...

Yes, Nickel is very confused. But only half as much as the ROW will be when TSHTF. And Nickel will only save in as much gold as he understands.

victorthecleaner said...

I also have a comment on the role of consumer price inflation. This is what's usually presented in a rather distorted way by FOFOA's pit bull terriers.

In the previous comment, I described gold's function as a spur and brake according to Jacques Rueff. The key insight into what some people call "freefiat" was that this function as a spur and brake means that the real price of gold needs to fluctuate and to transmit price signals.

So if gold's real price transmits price signals, then it is not constant. Therefore gold is not a "store of value" in the sense of the three functions of money. In fact, its purchasing power needs to be unstable for the international monetary system to function. (This observation does not contradict the idea that gold is nevertheless a very good reserve to hold for the very long run, say, for inter-generational savings - one of the many straw men that orthodox FOFOAns customarily gun down).

On the other hand, once gold functions, how would you as a CB manage your fiat currency? The ECB goes quite far and says that they fix their Euro relative to consumer prices. For a moment, it doesn't matter whether this refers to the Eurpean treaty with its single mandate of price stability or whether it refers to their target of less than 2% inflation annually (1999 to 2003) or to the target of below but close to 2% annually (since 2003).

This mandate of "price stability" is new !! The Euro is the first currency centered around this principle. (The dollar, in contrast, used to be fixed to a weight of gold, and once that link was gone (domestically 1933, internationally 1968, among CBs 1971), they somehow tried to keep up appearances and have always been afraid of a rising gold price. The Euro was the first currency that said "f*ck gold and target purchasing power instead".

That makes a lot of sense, simply because all credit, all wages, and all prices are denominated in fiat currency, and your life is a lot easier if all these are rather stable and predictable. Any credible and small inflation target that the CB can reliably meet will do for this purpose, be it 2% per year or 0% per year.

At this point, we reach a second conclusion: We know that gold is not a "store of value" (in the sense of the three functions of money). But a well managed fiat currency now is !!! Even with a 2% inflation target, the Euro implements all three functions of money: Medium of Exchange, Store of Value and Unit of Account. (The 2% inflation won't make it a perfect store of value, but, hey, we have lived with higher inflation rates for most of the time since WW2 and people have successfully used currency for a lot of their savings, so do shut up.)

Summary: Gold is not a "store of value" (although many giants, including both wealthy families and central banks will use it to store value for the long run), but the Euro now is a "store of value" (although I wouldn't recommend to use it exclusively for this purpose on time frames longer than, say, a one or two decades).


Nickelsaver said...

What Nickel does understand is that the purchasing power of billions of individuals is a different thing than an equated portion of them, whether it be a currency block, or as a nation, or a state within a nation, or a county, or a city within a county, or a co-op, or a church, or a union, or a breakfast club, or as a Guberment.

victorthecleaner said...


How is this "freefiat" different from orthodox FOFOA lore (except for the new, interesting, use of the term "store of value")?

There have been claims by FOFOAns that, (1) during the transition, the Euro would lose a lot of its purchasing power, and only the use of gold by the ECB would arrest an impending Euro hyperinflation. There have also been claims that (2) after the transition, the gold price would always increase with respect to all fiat currencies. And claims that (3) the ECB would intentionally keep inflating the Euro in order to provide an incentive for people to save gold rather than the Euro. Or, it was implied that (4) if there wouldn't be persistent 2% of inflation, then people would one day return to saving fiat money again and thereby render freegold unstable in the long run. I call bullshit on these claims (1) to (4). Nobody has ever explained the mechanism to me nor has anyone explained why the main actors would have an incentive to act like this.

Finally, what inflation rates would you expect in the Euro area after the transition?

Do you expect (a) the volume of consumer loans to keep growing faster than GDP forever? Do you expect (b) the ECB to begin printing base money and keep handing this new money to the governments or to other consumers for spending in order to generate inflation, something they have not done at any instance in history? If you think that Too Big To Fail banks are a feature of the dollar system and will eventually disappear, then you will most likely think that (a) and (b) are both rather implausible.

Then, please tell me, where do you get persistent consumer price inflation at a rate of, say, 2% per year from? I simply don't know. I do not know any other mechanism that would deliver that kind of persistent inflation. If your credit volume grows in line with GDP and if you don't print base money faster than GDP, I don't see where you would get that inflation from.

Well, if your banks would keep writing credit a lot faster than GDP for, say, a decade, you would get your 2% inflation rate during that decade. But your banks would eventually run into a credit crisis like 2007 (U.S.) to 2011 (southern Europe). Then, as a CB, you could just bail out everyone and render that past inflation permanent rather than allowing it to be reversed by a period of deflation when all that bad credit collapses.

Right. But what have you kept hearing from Europe on the topic of TBTF, bail-ins, separating the banks from the sovereigns....

Not even mentioning that this kind of TBTF induced credit cycle would be plain stupid to artificially maintain for eternity.


victorthecleaner said...


Good. So now you know why I am saying that the ECB will one day adjust their inflation target to something very close to, or at least something that allows 0% inflation in the medium term, simply because this is the natural state of an economy in the absence of blowing bubbles or continuous printing base money.

Finally, once your fiat currency has close to 0% inflation in the medium term, then you can safely use it as a "store of value", can't you? (even better so than with a inflation rate of 2%). No??

Orthodox FOFOAns (here Nickel) write things like this about Blondie's and my ideas: "FF maintains that Savers will hold the currency." This intentionally misrepresents the logic. The logic is that once gold functions, i.e. final settlement is enforced, the natural state of the financial system will be one in which fiat currency will naturally experience rather low inflation rates. That sounds quite different, doesn't it?

Nickel also writes

VtC has presented 2 basic reasons why the Euro will be managed this tightly. 1) that historically the bundesbank has sought after an inflation rate of below 2% and ideally towards 1/2%, and that this is current policy of the ECB - hence it will continue to be policy after the transition.

If you have read up to this point, you'll know that neither have I said this nor does this make much sense.

Further, Nickel writes that

And 2) that the Euro won't have the same spur/brake on it that other currencies have because other currencies will be using it as reserves, and so it wont have the same natural inflation aspects as other currencies.

Again, you'll see that I have neither claimed this nor does this make any sense. Of course, the real price of gold in Euros is going to vary in the same fashion, depending on trade and capital flows, as it does in any other currency area.

Nickel, your are not going to win an argument by misrepresenting the arguments of the other side. So stop it.


Nickelsaver said...

Sorry VtC,

My descriptions of FF may not be to your liking. Your descriptions of FG are equally puzzling to me.

I could simply go back into comments and direct quote you on what the implications of FF are. I might still do that...

anand srivastava said...


What you are saying is that the Spur and Brake will always be wild. That is why it will cause volatile gold price swings.

IMO, a currency zone which has such wild spur and brake must be undergoing a major political or economic upheaval. Yes Spur and Brake will force the political system to correct the system, but the mechanism will only be very prominent in currency zones that are in a problem. ie badly mismanaged currency zones.

In other words Gold price will be very stable in well managed currency zones, eg Euro. EU is already getting very stable deficit wise, and this is IMF$ we are talking about.

You do agree that people will want to save their excess wealth in Gold for the long term. If that happens then people will only keep a couple of years worth of money in banks. Depending on the persons they may speculate in the markets. Not all people are speculators or investors (I think both are the same). The savers will quickly have more money than the 100,000Euro limit of saving in banks. And then they have to save in gold. EU will make it easier to save in gold, by having very low or non-existent taxes on gold.

In the long run gold must be better than storing physical Euros in sock drawers, even if Euros are well managed in time frame of several decades. This is pretty obvious if you think that the price of gold directly derives from the efficiency in production due to technological advancement. If we expect that humans will keep on innovating, they will keep on improving the efficiency of production, allowing people to make ever more money, than the amount they must consume. If long term saving for a majority happens in gold, the price of gold will rise with the improving wealth of the people (which will happen if the population is becoming richer).

So I don't see why you think that Gold will be very volatile in Euros and that it will not rise in value over Euros. I don't see why you have to force generalizations on FreeGolders when we hate generalizations. No we don't think that Gold will be stable in all currencies. We are only concerned about well managed currencies. So lets keep the dialogue restricted to Euros, which will be among the best managed currencies.

costata said...

Hi VtC,

You have given me quite a lot to respond to. In order for others to follow this discussion I'm going to give a heading for each topic and a brief summary of how I interpret what you are saying followed by my response.

1. Jacque Reuff's Gold Spur and Break

I haven't read any of his books or papers but I have read a lot of works on the gold standard and so on. I'm fairly confident that Reuff's presentation of gold's role is the same as the classical economists and the economists who built on their legacy.

Under certain conditions* gold is a proxy for the real exchange value of (tradeable) goods and services in any one country. And it shows the price differences between countries who trade. These differences send price signals to exporters and importers to adjust their business affairs to rebalance trade when it has moved into deficit or surplus.

*As I highlighted above this is how gold functions under "certain conditions" which generally existed for most of the gold standard period. The conditions include:

(i) The trading partners need to be in the same currency zone.
(ii) There has to be a free trade regime in place.
(iii) The market can't be subject to intervention by governments that create distortions or confuse the price signals.

If this is how you envisage trade in a gold-based IMFS then IMO we are talking about gold being an international reserve and trade settlement currency, everyone being in a (de facto) single currency zone and domestic currencies being for local use only.

That's the only way I can see that gold could act as the kind of "brake and spur" you described. If so, I'm anticipating something different which has gold more in the background and currencies in the foreground of the IMFS and international trade. I will try to explain in my subsequent comments.


costata said...

Hi again Nickelsaver,

I want to pick up on two of the same points you made that VtC commented on but first I want to deal with this notion that there will be some barrier to an Eastern mindset toward gold crossing to the West. It won't matter who holds the gold in a country under this new gold-based IMFS - public or private sector.

IMO even if the general public in a Western country doesn't cotton on to the new/old way of thinking their central bank, Treasury and government will be able to adjust and fall into line with the new system. Everyone doesn't have to understand and endorse the law of gravity in order for it to work.

Two points you wrote about that VtC picked up on, the Bundesbank as the template for the stability target rate approach and the notion of the Euro as a reserve currency for other countries. I think the Bundesbank was the model for the ECB Eurosystem but the ECB isn't a straight copy. I think the architects grasped the opportunity to improve on the Bundesbank model by placing more restrictions on the ECB Eurosystem's freedom of action and they strengthened the institution's defenses against political interference.

The Eurozone doesn't run sufficiently large or consistent trade deficits to allow it to provide a reserve currency like the US dollar IMFS. This is one of the factors that will push central banks and like minded parties toward gold as the primary, and most liquid, reserve asset.

I'll pick up on this discussion about inflation targets etc in a follow up comment to VtC. My response will be limited for now because I think it needs a post-length treatment.


DP said...

What is preventing price inflation in the dollar zone today?

Hoarding of dollars, and the resultant falling Velocity.

Without hoarding of the currency, velocity will increase and one unit will do the work of many.

costata said...


2. Gold As The Enforcer

Let's assume for the sake of argument that we have two countries who are trading partners with a trade imbalance in goods and services operating under this new gold-based IMFS. We'll call them Surplus-Land (S-L) and Deficit-Land (D-L). They entered into a currency swap 1 year ago to facilitate trade in their own currencies and now their representatives are sitting down to settle up.

As you described earlier the S-L has a surplus of D-L's currency as a result of their central bank providing local currency to exporters in exchange for their trade partners currency. Again for the sake of argument neither country attempted to deal with this imbalance over the course of the year because they preferred to resolve it at the end of the year.

What are their settlement options?

In no particular order (and without suggesting there aren't others):

1. A transfer of gold.

2. Set up a jointly controlled investment fund to invest the surplus D-L currency inside D-L.

3. Issue D-L government bonds to S-L to hold in their FX reserves.

4. Invite S-L to make direct investments into D-L of their own choosing by removing any foreign investment restrictions.

Let's now assume that D-L and S-L can't agree. What are S-L's options:

1. Buy gold and put downward pressure on the exchange rate of D-L's currency in other currencies and gold.

2. Dump D-L's currency onto the FX market and put downward pressure on the exchange rate of D-L's currency in other currencies and gold.

Either of these two options has the potential of causing a crisis for S-L's export sector. Their products and services may suddenly become uncompetitive after conversion into D-L's weakened currency. This may be a price S-L is willing to pay if D-L is committed to trying to screw S-L. And for D-L they run the risk of a sudden shutdown in their imports and potentially a sudden drop in their citizens' quality of life and political unrest. I think this is a stalemate that both parties would prefer to avoid.

Under the classical brake and spur gold regime the system has high automaticity. Some of the powerful economic actors in this world may not be happy about adopting this approach. So this begs the question who or what could force them to adopt the brake and spur regime?


costata said...


Thanks for raising the issue of velocity. I was doing a lengthy comment in reply which I deleted when a different perspective opened up for me. I have seen graphs showing that the velocity in the broadest US monetary aggregates has been trending downward for decades. Over that time frame this tendency has gradually migrated from the broadest aggregates to the narrower aggregates. It reached the narrowest monetary aggregate recently.

Is this what you would expect to see in your hoarding scenario? Is this hoarding or simply an oversupply of funds with no place to go? If this is hoarding, who is doing the hoarding?

costata said...

I have to log off. I'll be back to review the comments tomorrow.

Goodnight All

DP said...

It's not just the size of your velocity, but what someone chooses to do with it.

WRT your velocity moving down through maturities question, it seems like it would be a manifestation of growing distrust in the future? AKA: OBA's slide towards the here & now.

Meanwhile, in other news…

(3) the ECB would intentionally keep inflating the Euro in order to provide an incentive for people to save gold rather than the Euro.

Who said that? Is there somebody else in here? Pudd'em up! I sez, I sez, pudd'em uuuup!

Nickelsaver said...


A lot of statements and info to process through, so it is difficult to know where to start.

Let me start by saying that when I refer to the eastern mindset, it isn't merely the eastern currency managers or giants. And when I speak of Savers, it isn't entities which are seeking settlement (as if they gave damn about the strength of their local currency relative to other currencies), but rather individuals wishing to forego consumption in a item which they are accustomed to thinking of as having the best SoV properties.

These individuals do not HOLD the currency as SAVINGS, but they do HOLD gold. And these individuals are not concerned about settlement (as if they thought of the currency as being paid in full), but rather the Storage of Value aspect of gold as a physical item, which is not an aspect of the currency. The Store of Value aspect of currency is a bit of a tautology. Value is only ever known when the currency is used to buy something, like say gold, or real estate, or a cup of coffee. And that can change depending on which street corner you are on.

victorthecleaner said...


What you are saying is that the Spur and Brake will always be wild.

Let's try to understand the magnitude of the price changes. Let's again say China is a net exporter into the US. The Chinese exporters sell most of their dollars for Yuan in order to purchase supplies. The surplus is eventually exchanged for gold, either by the exporters, by their owners who receive the profits, or eventually by the PBoC who might decide to settle any net amount that the private sector hasn't already taken care of.

As long as this flow (selling dollars, buying Yuan, buying gold) continues, the gold price in dollars will tend to increase while the gold price in Yuan will tend to decrease. How long for?

Obviously until some of the importers or exporters modify their contracts. What do you think what sort of price difference is required before
1) an importer cancels an existing contract for supplies and starts negotiating with a supplier in a different country?
2) an exporter gets under pressure, can no longer sell profitably into one country and goes out to find new buyers elsewhere?
3) a producer who is planning a new factory in country X goes back to the drawing board and considers to expand in country Y instead?

I find it rather plausible that you need more than 1% or 2% of price differential before the real trade flows are adjusted.

Secondly, you are writing about the real price of gold that

IMO, a currency zone which has such wild spur and brake must be undergoing a major political or economic upheaval.

I actually learnt it from FOFOA that two of gold's major features are that
(1) it is useless (i.e. very few areas of the economy actually need it and would be hurt if the price went berserk)
(2) it's price is arbitrary (i.e. there are very few economic processes that link the price of gold to other prices)

[Note that (2) has been artificially suspended by the gold for oil agreements that link the price of gold to the price of oil]

Isn't this nice? FOFOA has explained to us that there would be rather little economic upheaval if the (real) gold price changed in an unpredictable fashion.



victorthecleaner said...


in your 1. Jacque Reuff's Gold Spur and Break, you are writing (i) The trading partners need to be in the same currency zone.. I don't get this. Is this perhaps a typo? It did work between Britain and the U.S. before WW1.


victorthecleaner said...


What is preventing price inflation in the dollar zone today? Hoarding of dollars, and the resultant falling Velocity.

I don't think this is correct as stated.
(1) What's being hoarded is not dollars, but rather dollar denominated debt, primarily Treasury bonds.
(2) Who is hoarding? Foreigners. That's how the exorbitant privilege is being funded.

Why does this distinction matter?
(1) Nobody can go shopping for groceries with T-bonds. They have to sell the debt for currency first. Only then they can go shopping and drive up inflation.
(2) Even if foreigners sell their T-bonds and hold a Eurodollar balance instead, they can still not go shopping for groceries in the U.S.

(1) Let's first think about the domestic situation inside the U.S. If confidence in Treasury debt is destroyed, people would sell their bonds. If everyone is trying this at the same time, they won't receive much dollars for their bonds in order to go groceries shopping. It is only the commitment by the Fed/government to bail out debt that poses a risk for inflation.

The Euro area can easily make a different choice. In fact, about half of the Greek government debt was defaulted on in March 2012. In early 2013, there were defaults on debt in Cyprus including bank deposits beyond E100000 as well as defaults on subordinate debt by a number of Spanish savings banks. What velocity??

Who is talking about bank bail-ins, separating the banks from the sovereigns, etc?

(2) Most of the excessive debt of the U.S. is not held domestically, but rather by foreign governments and foreign central banks. Even if they sell their bonds and receive the full face amount of dollars through a bail-out, what is the PBoC going to do with all these dollars? (Note that this will probably happen only once they can no longer buy their crude oil with dollars).

As Another said, these dollars have spent all their lives abroad, and they are going to die abroad.

(3) Finally, it is a common goldbug fallacy that QE necessarily creates consumer price inflation. The question is what people intend to do with their debt that the CB then bails out and replaces by M. If the original debt represents "savings" and people need not consume it and decide to hold on to these "savings", then they might indeed "hoard money". Now, let us assume that suddenly they are even afraid of holding this money and want to get rid of it.

If they still want "savings" as opposed to consumption, they may even purchase real estate, fine art or gold. You won't get hyperinflation from this move either. In extremis, the price of gold (your reserve) can rise arbitarily high and absorb all these "savings". You see, it is the real price of gold that needs to be free to fluctuate. If it is, a free gold market may even prevent hyperinflation resulting from a loss of confidence in debt.

I also said that I find it much more likely that the primary problem for the Euro area will not be a threat of hyperinflation and that they need to use the gold in order to avert the threat, but rather that their main problem will be a sudden inflow of money, similarly to what the SNB experienced in the summer of 2012.


victorthecleaner said...


Under the classical brake and spur gold regime the system has high automaticity. Some of the powerful economic actors in this world may not be happy about adopting this approach. So this begs the question who or what could force them to adopt the brake and spur regime?

I don't think there is any obstacle here. I explained this with the example of China and the U.S.

Common wisdom says that (between 2001 and 2012 at least), China "manipulated" the value of the Yuan such as to retain their competitive advantage over the U.S. China voluntarily abstained from settling their dollar surplus for any real asset (be it direct investment, purchasing gold or what not). Instead, the PBoC purchased all the stray dollars, hoarded them for the long run, and issued Yuan instead, thus artificially fixing the Yuan exchange rate relative to the dollar. The poor U.S. couldn't defend against this rogue currency manipulation (unless they wanted to impose outright trade barriers).

Does this make sense?

No, I am claiming, it doesn't. What is the U.S.' defence when China hoards dollar assets? The U.S. could have purchased gold in the market and printed dollars instead (precisely the dollars for China to hoard), neutralizing the entire Chinese currency manipulation in one step.

[Btw this is exactly what the SNB did when people started hoarding Swiss Francs, except that the SNB purchased Euros rather than gold]

So we conclude that what some have referred to as "Chinese currency manipulation" must have been rather welcome to Washington. Otherwise, they would have acted against it. No surprise here either. Who would complain if some foreigners volunteered to fund your excessive lifestyle aka expriv? Washington, of course, loved it.


costata said...


WRT velocity it appears that we need to approach a discussion of monetary velocity on the basis that velocity is different in various sectors (or circuits?) of the economy. Final consumption goods velocity could be consistent while, say, bank deposit credit velocity in the stock market could be driven high by increasing speculative activity.

This suggests to me that velocity isn't, at least for now, a very useful indicator because they are collecting the wrong data and/or the existing data feed isn't being processed in a way that gives rise to a useful indicator.

Having said that I guess the trend in the broad aggregates migrating to the narrower aggregates could be an endorsement of OBA's theory.

costata said...


Looking at just three Eastern states - Turkey, India, Vietnam - the attitude to gold of the citizens of these countries seems to be informed by distrust of their local currencies and banking system (where they have access to banks). So it's a kind of hard currency for these people where they can store purchasing power.

I would argue that gold today in western countries sits alongside real estate in the class 'hard asset' for a limited cross section of people and it's viewed as either decorative jewellery or part of the high risk speculative markets by the rest of the population.

costata said...


That wasn't a typo. During the gold standard period prior to World War 1 after the free traders overturned mercantilism in the late 1700s the world was operating in a single gold-silver currency zone. I realise there was "paper" in wide use as well in that hybrid system but the anchor was gold-silver ultimately trending toward a mono-metallic gold standard toward the end of that period.

The Mint that was the source of the money wasn't as important as the quality of the money itself. America is a good example of this indifference to the composition of the money supply. Despite it's charter the Bank of England also held both domestic and foreign metal to back its liabilities.

I'll comment on some of your other points separately.

costata said...


You wrote: So we conclude that what some have referred to as "Chinese currency manipulation" must have been rather welcome to Washington. Otherwise, they would have acted against it.

100% agree on this analysis. It would have also been welcomed by the US multi-nationals sourcing product in China and selling in and reporting profits in US dollars. So that cheer squad would have provided further encouragement to the politicians to support the status quo.

costata said...


You wrote: I find it rather plausible that you need more than 1% or 2% of price differential before the real trade flows are adjusted.

I don't think you will need anything like 100 or 200 basis point moves to influence the underlying trends. We are speaking of arbitrage are we not? There are legions of examples of tiny differentials leading to major trends developing over time.

The forward looking structure of these markets (FX and gold) should ensure that they are constantly pricing in the future prices today as opposed to selling based on past purchase prices like a typical retailer.

I think the tenor of this whole "FreeFiat" discussion would change if you discarded this notion of large swings in the price of gold. When gold was money it was pricing all manner of goods. That isn't the gold-based IMFS that either of us is describing. This is, or should be, a gold+currency-based IMFS where the currencies (and, from an FX perspective, quasi-currency gold) continue to float against each other.

If you strip out all of the paper gold messing with the price discovery function of the market then gold can perform the "indicia" function that Federal Reserve Governor Charles Partee argued for against Ron Paul's faux "gold standard" in their debate back in 1983. (

costata said...

Hi VtC,

I decided to read Jacque Rueff's book "The Monetary Sin Of The West". I'm only about a quarter of the way through the book but I want to draw your attention to the extract below and invite you to drop the argument that there would be wild swings, volatility and so on in the price of gold in a Rueff style gold-based IMFS of the "brake and spur" kind that you envisage.

On Page 43 of the e-book of Rueff's book he describes the operation of the gold standard in siphoning off gold from the deficit country. He describes how the process cannot be avoided under a gold exchange standard:

3. However, while maintaining the balance-of-payments deficit in key-currency countries, the gold-exchange standard does not prevent the deficit from making its effects fully felt. It automatically and inexorably siphons off the gold and foreign-exchange reserves of such countries, so that after a certain period of time their governments are faced with the option of having either to institute general import quota restrictions and severe controls on foreign-exchange movements, or to restore balance-of-payments equilibrium.

Until now, the Western countries, having relied on the first of these methods and having promptly experienced its inefficacy, have had no choice but to fall back on the second. But as they could not be content with mere words, they have had no alternative but to reduce domestic purchasing power, as the gold standard would have done.....

On Page 44 he makes this observation about the experience of the brake and spur under a gold standard (my emphasis):

...The first approach—i.e., the one involved in the operation of the gold standard—is followed daily and its application is therefore limited, as regards the size of the changes in the purchasing power which it brings on, to the amount of the net balance of external settlements effected daily. The changes it generates are therefore slow and gradual. Their effects are hardly perceptible from the social point of view.

I think that emphasizing the prospect of volatility in the price of gold based on the unreliable historical record of prices in gold during the gold standard period is getting in the way of a useful discussion of this question:

How free will this free market in currencies and gold in a new gold-based IMFS actually be? Gold standard free, gold exchange standard free or something different again. I lean to the latter but I'm happy to be shown the error in my analysis and reasoning.

Lord Sidcup said...


I appreciate this attempt to unravel this argument – especially as you are obviously an independent thinker and interested in getting at the truth.

I'm agnostic on FF v FG.
Having an opinion either way won't change my behaviour so I'm happy to let time prove all things.

Whether right or wrong, the FF side has described the specific mechanisms of their view in ways that are much easier for me to grasp;

a) They show a model of how fluctuating gold will be used to keep the euro purchasing power stable.

b) They point to current actions/words from the ECB et al to support their view (yes, some of the evidence is tenuous), while some on the FG side argue for what would be the better system (in the abstract), rather than what the ECB is actually going to implement.

Anyway, I'd be grateful if you provide/point me towards a short, simple explanations of the mechanism that keeps gold stable/steadily rising?

Also, I would like to know of any BIS or ECB statements/actions that points away from FF toward FG?

My last point may be stupid, but I'll make it anyway; there are areas of the EZ with virtually no gold storage infrastructure (Ireland for example). It seems that during the transition, FF be implemented immediately in areas with no vaults and deposit boxes, whereas FG would require considerable time, explanation and resources to make this happen.

costata said...

Hi LS,

Thanks for joining the discussion.

WRT lack of gold storage in any part of the Euro currency zone is no impediment to a gold-based IMFS. If I can use the analogy for gold pricing of casting a vote in an election - absentee ballots still count.

Anyway, I'd be grateful if you provide/point me towards a short, simple explanations of the mechanism that keeps gold stable/steadily rising?

The closest thing to a "mechanism" is Jacques Rueff's explanation of how gold functions under a gold standard. In a separate comment I'll try to summarize his explanation of why gold tends to be relatively stable in that system. It's the first time I have seen a really good explanation so I'm grateful to VtC for nudging me into getting around to reading Rueff's "Monetary Sin Of The West"

The key issue we're arguing about in relation to the volatility of the price of gold is whether it's likely to experience big movements as the norm or stability as the norm. IMO you can create conditions where either outcome is likely but the ECB's mandate, again IMO, makes stability the most likely outcome for the Eurozone. That said, you can definitely create instability and volatility in the price of gold in a currency zone by implementing bad fiscal and/or monetary policy. Stability isn't guaranteed by making gold central to the IMFS.

FWIW I'll be discussing the ECB mandate in a follow up post.

victorthecleaner said...


on the flucuations of the real price of gold. You write

We are speaking of arbitrage are we not?

Not in the usual meaning of the word, i.e. entering two different financial contracts at the same time without taking any risk, immediately netting a profit.

In the spur and brake case, one side of the arbitrage is in the "financial plane" (gold price and exchange rates) while the other side is in the "real plane" (adjusting supply contracts, hiring/firing workers, shipping goods to a different country, relocating a factory abroad).

I think the tenor of this whole "FreeFiat" discussion would change if you discarded this notion of large swings in the price of gold.

I don't think you can avoid this part of the discussion. I have three comments:

(1) For the spur and brake argument it is not required that the trading partners are all on a local gold standard. It is sufficient if international balances (the current accounts) are settled in physical gold. Take a look at how I describe this above with two countries and two local fiat currencies.

I don't think Jacques Rueff was advocating a return to the gold standard domestically. But he did advocate settlement in real terms, i.e. ultimately in gold.

(2) If you think this through, you realize that the spur and brake argument works irrespectively of what the local currencies are, whether they are on a gold standard or whether they are fiat.

(3) My argument is that the rules of the game of the international gold standard lead to considerable variations in the real price of gold. If the countries use fiat currencies, of course, their governments and CBs decide how to run these currencies. But if they are on a gold standard, it is not only the real price of gold that is affected by the international flow of goods and services, but rather the general price level.

There is a nice example in FOFOA's Once Upon A Time. After WW1, the U.S. exported a huge volume to Europe as a consequence of their reconstruction efforts after the war and of the fact that the U.S. industry survived the war undamaged. As real goods flowed from the U.S. to Britain, gold flowed in the opposite direction. This caused the real price of gold to drop inside the U.S. But under the local gold standard, this was the same as consumer price inflation.

Under the Harding administration, on 1920-21, this inflation caused so much trouble, that the Fed enacted their first major monetary policy operations, fighting this inflation (and sterilizing the spur and brake function).

The spur and brake was undesired because it caused too much inflation !!! This wasn't any "arbitrage" under 100 base point. It must have been real annoying.


victorthecleaner said...


Btw, here is another interesting aspect of the 1920/21 story.

We learned that the U.S. put their local purchasing power stabilily ahead of the rules of the international gold standard. As a consequence, the U.S. experienced less inflation than they should have according to the rules. In turn, Britain experienced more deflation than necessary. The spur and brake function was suspended. The U.S. remained highly competitive compared with Britain and there was no incentive and no reward for Britain to regain their competitiveness. Apart from the fact that at that time, neither of the two parties fully understood what was happening to them, could Britain theoretically have defended themselves against the American currency manipulation?

The answer is rather illuminating in the light of the freegold idea: With a gold standard, Britain had no defence. They were running out of gold and experienced a reserve crunch. But with a fiat currency in a freegold setting, there would have been an obvious defence. Britain could have printed local fiat money (pound sterling) in order to purchase gold - precisely the same amount of gold that the Federal Reserve purchased in their fight against local dollar inflation.

The Fed fought inflation. This prevented U.S. made products from becoming more expensive in Britain. With the Brits printing pound sterling and purchasing gold in a freegold setting, they would have lowered the exchange rate of the pound and made U.S. goods more expensive in Britain anyway, in spite of the Fed fighting inflation. In fact, the Brits would have fought their deflation to the same degree as the Americans did fight their inflation. You see, this even points to two independent local fiat currencies, managed to have stable purchasing power while the real gold price varies and transmits the relevant price signals. If you carefully study the history of the early 1920s (as Jacques Rueff apparently did), one of the main ideas of freegold, namely independent local fiat currencies plus final settlement of international balances in physical gold, is plainly visible.

Btw, when Jacques Rueff writes

The changes it generates are therefore slow and gradual

he obviously praises the classical international gold standard (automatic rebalancing) with the gold exchange standard (accumulating imbalances). He, too, knows the history of consumer prices during the period in question.


costata said...


I would argue that when the net imbalances in international trade are settled in gold then the world is in a de facto single currency (gold) zone and, if we are wise enough not to interfere, we can enjoy the benefits of the brake and spur "mechanism". Under those circumstances it doesn't matter what the local currencies are provided there is full convertibility between all currencies and gold. We would be operating on a form of gold standard. (I'm including the Freegold-RPG model as a form of gold standard.)

It's interesting that you cite the early 1920s in the USA as an example. I have recently read two books that discuss the lead up to WW1, the 1920s and the Great Depression period from a banking system perspective. I'll be doing a post informed by those books at some point and that's probably the best place to revisit the example you cite.

Apologies in advance if I'm erratic in my responses for the next week or two. The financial year in Australia ends on June 30th and I have some housekeeping to attend to.

I will try to fashion a comment about Rueff's explanation of how gold performed it's job in the gold standard as I mentioned in a comment above. I think it could help to clear up some confusion among the goldbug mystics and people who think gold standard advocates are fantasists and dreamers. What like Jacques Rueff describes is so practical and down-to-earth it's hard to imagine why someone would argue against it unless they are speaking out of very narrow self-interest.


anand srivastava said...


I think the Western world didn't lose interest in gold because of a measly 1-2% change in price of gold vis-a-vis CPI. It was because of as much as 50% over 2 decades. This was only possible because the European Central Banks were allowing it to happen.

During Gold Standard days the price swings used to happen upto -10% to +10%. This was because the gold was fixed, and the govt spent a lot of money to maintain the fix.

I don't think we will get more than +-5% swings and the swings will be much shorter because the govt will not care about the price swings (at least in the well managed currency zones).

The example you gave a +5% swing in US and a -5% swing in China would cause a 10% difference between the two. That may not be plenty for a company to move. But it is enough for a country to decide where to open new branches or for new companies to decide where to startup. And for more liquid investments the threshold would be even smaller, as Costata said.

I don't think savers would care about 5% swing over a time frame of a couple of years. But I don't think that the swing will be that strong or that long.

That is my biggest beef with Freefiat. I don't really care too much about ECB having 0% or 2% inflation. I do believe that it will be easier for ECB at 2%. Yes it will need to print some money at that rate. And it could play favorites with that money. But I don't think its that big a problem.

victorthecleaner said...


if we are wise enough not to interfere,

A part of last year's "snippets" dealt with the mechanics of gold settlement and explained that
(1) if a country is on a gold standard, it has to rely on everyone else voluntarily comply with the "rules of the game"
(2) if the country has a local fiat currency, it can always enforce gold settlement even if the other side tries some sort of "currency manipulation".

In other words, the classical international gold standard before WW1 wasn't stable. But freegold is. (Well, then it's rather freefiat). It's a Nash equilibrium.

Why don't we have it today if it is a Nash equilibrium? Because there is a rogue symbiosis of two parties in the system: The U.S. (keeping the oil price high, attacking most other oil exporters that might rival Saudi Arabia) and Saudi Arabia (not enforcing gold settlement, but rather accepting most of the payment in dollars and only a small part in gold, but most likely still receiving a disproportionate amount of gold in the process).

Of course, this symbiosis relies on the paper gold market and the resulting low gold price, and several other parties can throw a wrench into the arrangement at any time. Question is whether and when they would do this or how long the paper gold market will last if left on its own.


Gary said...
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Motley Fool said...


"There have been claims by FOFOAns that, (1) during the transition, the Euro would lose a lot of its purchasing power, and only the use of gold by the ECB would arrest an impending Euro hyperinflation."

Hum. What do you consider the source of the coming dollar inflation? Would it be fair to say that more credit/currency exists than can be redeemed in the physical plane? How is this different in the EZ?

"There have also been claims that (2) after the transition, the gold price would always increase with respect to all fiat currencies."

Nope. Strawman.

"And claims that (3) the ECB would intentionally keep inflating the Euro in order to provide an incentive for people to save gold rather than the Euro."

Intentionally inflating? happens. :P

And no, not for that reason. If one wants to attribute a reason for having inflation it would be social stability rather.

"Or, it was implied that (4) if there wouldn't be persistent 2% of inflation, then people would one day return to saving fiat money again and thereby render freegold unstable in the long run."

I suppose a large circus tent to draw from helps when one is looking for things to criticise. I think whoever implied such did not think things through clearly.

"Well, if your banks would keep writing credit a lot faster than GDP for, say, a decade, you would get your 2% inflation rate during that decade. But your banks would eventually run into a credit crisis like 2007 (U.S.) to 2011 (southern Europe)."

Nope, not when gold is a free-floating indicium of the real value of the stock and unit of currency.

One could have permanent 10% inflation rates with no failure of the credit markets(certainly a lot of failure of credit though) as long as gold is free to change in price.


Ps. Hey costata. ^^ Hope you are well.

Gary said...
This comment has been removed by the author.
costata said...

Hi MF,

I'm well and gradually getting on top of the paper work. I hope to rejoin this discussion tomorrow.


Motley Fool said...


I'm a bit confused. Help me out.

I assume you agree that at some point the US will have a currency crisis, and probably hyperinflation?

Right. So when this is going down do you expect the rest of the world to be unaffected in terms of currency?

Or perhaps the less stronger but even weirder in some regards thought, perhaps you expect most countries to be affected, but the EU will be sitting pretty as if nothing is happening?

I don't get it.


Gary said...
This comment has been removed by the author.
costata said...

I'm parking this here for a future follow up on the posts discussing how Eurostats estimates consumption spending and inflation versus the US BLS:

Lee Adler discusses how the 1983 major change in the way that CPI was calculated. Excellent break down of the strategy, implementation and impact.