("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".
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.