GM Jenkins' 2014 Predictions

Happy New Year, friends! 

First, a retrospective. Screwtape was forged out of the fullest heat and fire of the gold and silver mania of 2010-2011. I call it a mania now, though I didn't at the time. And that, to me, was the most important lesson of 2013. See, back in the day, it seemed more reasonable (to me, anyway) to interpret the then-ballooning prices of all hard assets as fundamentals-based.  2013 disproved that interpretation. Don't get me wrong: in all likelihood, the unrelenting, world-historical forces of Sociopathy and Folly that drove the world economy to the brink in 2008 simply took a breather in 2013, licking their chops and gathering strength for another foray at the global hippopotamus this year (or this decade, or next decade). Still, the fact that such a pause and major reversal could occur tells us that the price action of 2010-2011 was primarily speculative mania.

With that important lesson in mind, I believe price charts have become more important than any fundamentals-based arguments (e.g. of the "1001 reasons the dollar is doomed" variety you see on Zero Hedge once a week). My goal being to make money in 2014, my resolution is to avoid letting the bone-crushing stupidity of the American population, the knee-weakening asininity of the mind-bogglingly corrupt politicians, and the eye-watering chutzpah the Wall Street scumbags influence my investment decisions (especially short- and intermediate- term decisions).

A final point about 2013. For those wondering if or when the gold market will resume its long term bull trajectory, I say that the action of Q4 has been as ominous as the bloodbath that began Q1. I say this, because regarding the April crash, a violent washout and capitulation was certainly due after 12 years of price increases, and probably even healthy. So we saw the historical drop in April, and then the other shoe fell in June, giving the charts at least the potential to form a text book reversal (I've been arguing against that interpretation, but it was certainly a possibility). See the inset in the chart below to get an idea of what that might've looked like: I simply reversed the price action of the past 3 months. However, the actual grind downwards has no appearance of forming a bottom. None of the long "hammer" candlesticks, for example, that signify a capitulation. Not even a lot of volatility. And of course, a new daily (and weekly, and monthly) closing low.

And so in short, 

though gold may have a relief rally, I believe it will break below its hugely important, never-been-broken, weekly-closing-price trend lines on the linear and log weekly charts [green and blue, respectively, on charts below], and that's a bad sign.

Linear, weekly closing prices
Log, weekly prices

Given that even the most optimistic interpreters of the past few years' price action must concede that gold is undergoing a major correction, it makes much more sense to me that the 50% Fib line of the entire post-2000 bull market will be hit before a capitulation occurs. Looking at the log weekly chart above, and the monthly chart below (as well as the daily chart, not shown), that level appears to be the $1050 level, so I expect a bottom in the monthly, weekly, and daily closing prices somewhere between $1000 and $1075, for another 10-20% drop.

Calling my bet with Turd [UPDATED]

Hullo, Screwtape types. It's been a long time. Did you miss me?

So, those of you with long memories will recall my post at the end of 2012, setting out the case for gold being about to enter a serious bear market. At the time, gold was at $1672/oz (woah - remember those days..?) and had put in rather a stinker of a year.

I pointed out the simple, almost trite, fact that anyone - ANYONE - who had advised you to buy gold during 2012 had been wrong. Not maliciously wrong, perhaps, but wrong anyway. And I thought that this fact should arm the future readers of the silverogosphere in 2013 when considering their next steps.

The All-Important Chart for Gold & Silver Post-Fed Meeting [UPDATED]

Sorry I stole the title from King World News.

 If this line is broken on a weekly close, I say gold won't recover for several months, maybe several years.

There's still Friday, though, for the optimists among you. And King World News ...

The Earliest Known GLD Bar Lists

This article will only be of interest to fanatic bullion bar list historians - I am pleased to announce that with the help of some great individuals, we now have copies of some of the earliest known bar lists for the GLD ETF.

I am grateful to the collective efforts of FOFOA and Ro' on this one - they knew I had an interest and applied a better approach to researching the topic than I did. Prior to this discovery our earliest bar list was from October 2009. As a quick reminder : we're interested in the GLD bar list because it is the biggest and best data source for public weight lists - it constitutes 80% of the bullion bar information we have in the database (currently over 54 million rows of data).

Kid Dynamite: Sell Gold, Crash JP Morgan

Kid Dynamite launched a new campaign today to turn the tables on the evil manipulators. If you ever wondered which side of the coin he is on, then look no further than his great satirical article. Whatever happened to the original 'Buy Silver, Crash JP Morgan' campaign anyway? Did anyone ever do any proper mathematics to figure out whether it would work? Did Max ever declare it a failure? What I mean is, the campaign idea itself worked really well - it got a huge amount of social media traction and many (myself included) bought ounces of silver, and across the world millions of ounces of silver were bought during that time period. Yet JP Morgan seems to be unscathed ...

JP Morgan appears to be losing itself several billions of dollars anyway - through various fines of misconduct and illegal whatever, but I suspect the driver is more about cash-starved governments than it is about justice, and in any case the bank just shrugs off those massive fines and goes about its business. No, if you want to take out JP Morgan you gotta do it properly - Wynter Benton style with the $36/oz silver bomb kneecapping exercise. Damn those guys were smart. Funny though, we haven't heard a word from them ever since they publicly failed to move the price of silver ...

GLD Added 6½ Tonnes in October 2013

Late reporting on this ... Last month (October), there was a substantial addition to the GLD inventory (523 bars), the size of which stood out because it was the first 'add' after a sequence of 'removes' but compared by amount to other 'adds' for this year, it only ranked 6th largest.

Quick comparison charting all currently known 2013 GLD additions.

An avid reader of "Harvey Organ's Daily Gold & Silver Report" (who shall remain unnamed) brought to my attention an interesting Harvey Organ footnote (my bold emphasis):

Sunday pre-game, 11/24/2013

Hello friends,

No new conclusions, but an update is due.

Gold and silver continue to look awful, as I predicted. The weekly three-line break charts that I've been using to gauge bull vs. bear cycles in gold ($INDU:GDXJ) and silver (GLD:GDXJ) continue to add weekly bars, also as expected.

I had a thought the other day that gold and silver may continue to fall even as the present bearishness increases, because most of the PM-bearishness that pervades the finance world seems to be of the short term variety. Everyone and his mother seems to be expecting (or at least not ruling out) a blast off in the long term. Perhaps the bull market won't recover until the long term bulls (like me, for example) start to change their tune. It'll take much lower prices, though, (and protractedly lower prices, I should add) for me to lose my confidence in gold's fundamentals. I liked costata's comment from my last post:

If the sovereign bond fails, a "forty story building" of derivatives collapses. Stick gold at much higher prices under it and the building holds up.
Seems like gold at new highs is the long term path of least resistance for the financial elite to maintain their position at the top of the food chain. Not an ideal path for them (or the central banks would already be manipulating prices higher), so it will be drawn out, maybe on the order of a decade, but will we end up with some kind of financial "reset", with gold playing some kind of vital role? I still think so.

On the topic of sovereign bonds, weeks ago I noted the breakout from the bullish pennant in the 10-year yield vs. silver ratio. It's been up over 10% from my last post and looks to keep rising ...

... and rising, perhaps until the ratio hits the green dotted wedge, which has uncannily coincided with lows in gold:

Sunday pre-game, 11/10/13

Nothing has really changed from last week, but I figured I'd post updated versions of charts. Gold needs to recover quickly or it's looking to me like $1000 will be tested soon.

Sunday pre-game, 11/3/13

So it's looking my interpretation from 3 weeks ago was correct: we merely had a short bull cycle in gold (~3 months) within a major 2 years (and counting) downtrend ... and that bull cycle is over. I suspected last week's action was a bull trap, and it looks like my suspicions were well-founded. Like clockwork, the 144-day MA was touched immediately on Monday, but it was all downhill from there.  

Because I'm looking for a sign that the major post-August-2011 downtrend is over, at this point I much prefer weekly closing charts to daily candlesticks. Baked into the weekly closing cake is some clue about what the biggest players are willing to hold going into a weekend. Perhaps as a consequence, with the exception of the post-QE-3 rally last autumn (also ~3 months), the 20-30 week MA ribbon (green, below) has been stout resistance. Note that gold finished the week right below it:

So, it seems to me the downtrend will continue ... although more or less sideways action here is also possible (surely fundamentals must matter somewhat??). Perhaps gold will remain stagnant till the spring, making a double bottom on a monthly closing basis where the blue trend line crosses the 38% Fib line? Of course, even if that scenario holds true, there could still be a lot of intra-month volatility.

Friday Metals recap, 10/25/2013

Quick update. I still have no position in gold or silver. Gold is up over 5% since my bearish post 2 weeks ago, when I thought the charts looked awful. They've improved (the weekly head and shoulders in gold turned out to be a false alarm). But ... I'm still watching the 144-day MA (purple, at $1360). If that's cleared on a daily close I'll move in, looking to sell half at the important dotted blue line ($1400) and more at the 200-day MA (red, at $1432), where I expect at least some very strong short term resistance. But that's assuming the 144-day MA is cleared, which I give at best a 50/50 chance.

Alternately, the (similar) 20-30 week MA "ribbon", which ranges from $1323 to $1361:
I consider that $40 interval a no man's land. Let's see if it can be cleared on a weekly close, which would be a good first step for those of us who think gold can still break $2000 in the next year or two.

Friday metals recap, 10/11/2013

My proprietary weekly three-line break charts based on ratios with GDXJ (which indicate when to go long gold and silver, respectively) have reversed, as I predicted a few weeks ago. So, the short gold and silver bull cycle in the intermediate bear cycle would appear to be over. 

I still expect the top of the expanding wedge below (green, dotted) to be hit on my world-famous "yields in silver" chart before gold bottoms. Clearly, there's a ways to go (for example, at the current 10-year yield of 2.7, silver would have to fall to a 15-handle). 

Also, please note the obvious bull flag on the two year version of the ratio.  

Now, take a look at the 20-30 week MA-ribbon below (similar to my old stand-by 144-day MA). I've been emphasizing it for the past several weeks: gold never cracked it, and now we see an obvious (so obvious, could it possibly have been painted??) head and shoulders pattern, with the right shoulder smack at the lower bound of the ribbon.

One Currency Zone - Two Circuits

(New Gold Supra-Theory Salon des Refusés – Post 4)

We are delving into the workings of the Eurosystem’s TARGET2 system (T2) using circuit theory to separate it into discrete circuits in order to try to identify whether gold could improve this system. The Euro gets the job done in the household consumption circuit (discussed here).

Earlier we referred to the other components of T2 as the 'non-consumption circuit' to differentiate it from the circuit we were exploring. Now we are trying to determine if gold has any potential role in correcting TARGET2 imbalances through some other circuit involving goods that aren't consumed.

Monetary circuit theory is a way of looking at endogenous money creation by a banking system. Individual banks generally borrow first and then lend. So it’s difficult to detect this endogenous money circuit by looking at the books of a single bank. Banking systems lend money into existence in the form of deposits. The money created by one bank’s lending surfaces as a deposit on the books of another bank.

A key point to remember as we look at this T2 system is that by trying to separate it into two circuits we are creating a simplified conceptual model in order to try to understand a few specific issues. The reasons for the current TARGET2 imbalances and to determine if gold could have helped to prevent them or correct the imbalances if it played a different role in the system today aside from being the primary ECB reserve asset.

Before we press on here’s a recap on the household consumption circuit theory. The fathers of the Euro used a modified version of the price>specie>flow mechanism in the design of the Eurosystem. I’ll style this here as prices+>Euro>flow. The phrase ‘prices+’ is used to indicate that there are more factors involved than prices alone. Under a free trade regime the money flows in this mechanism automatically correct imbalances in the availability and diversity of the most-demanded consumption goods and services across the Eurozone.
In this post I’m going to draw on one of the BIS Working Papers (No. 393) titled “Interpreting TARGET2 balances”. (Hat tip to Piripi Peterson for the original link to it.) Even if you don’t have time to read the whole paper take a look at the graph on Page 1 titled “The TARGET2 claims of the Deutsche Bundesbank”. The range of fluctuations in the DB's T2 balance was reasonably consistent from 2000 to 2007. Then it took off between 2007 and 2012. I think we can summarise the conclusions of the authors of this BIS paper as follows:

1. The German banks were pulling loans and repatriating funds from the Club Med countries.

2. Money from international banks was positioning itself in Germany for a breakup of the Euro single currency zone. Hedging “redenomination risk” (or speculating on it) with the aim of being redenominated into a new Deutsche Mark if the breakup happened.

3. The Eurozone inter-bank credit market seized up.

Issues 1 and 2 offer the best explanation for the bulk of the T2 imbalance but I think item three is the one that we should focus on. Under normal circumstances the existence of the Eurozone inter-bank lending market can’t be detected by looking at T2 because clearing occurs between banks before any net balances flow through the TARGET2 payments system. (In that BIS paper the authors explain this using simplified balance sheet entries.)

I think we can also see an inter-bank credit circuit exposed by the T2 imbalances that complements our household consumption circuit. A circuit that mainly funds transactions involving assets as opposed to household consumption goods and services. Exploring the Eurozone monetary system with this perspective could be an interesting exercise but our focus here is on the question of whether gold has a role to play in this circuit and in correcting T2 imbalances.

When the Eurozone inter-bank market froze this circuit became visible on the central bank balance sheets because a central bank is the lender of last resort. It’s only in times of crisis that the lending which normally occurs in the inter-bank market moves onto the balance sheets of central banks. If the cause of a banking system crisis is merely a lack of liquidity the solution is to supply Euro - not gold. If the problem is insolvency the solutions are an orderly bankruptcy, merger with a stronger bank or recapitalisation of the insolvent Eurozone bank with Euro.

One of the major challenges for a central bank is that a liquidity crisis and a solvency crisis are identical in appearance. (Being able to view these net inter-bank flows via T2 doesn’t tell the ECB Eurosystem what is on a commercial bank’s books.) In a crisis the CB must act and carry out a forensic investigation later. In my opinion the right solution to this problem is the banking union and making the ECB the chief regulator of Eurozone banks (with a mandate to deal with the underlying causes of crises pre-emptively).

Highly-rated sovereign debt forms part of this inter-bank credit circuit because it is classified as a risk-free asset for banks under BIS rules. That BIS paper identifes sovereign debt as one of the underlying factors in the current T2 imbalances. Normally the sovereign debt held by banks is imbedded in the inter-bank credit circuit. In an ongoing crisis like the present one it erupts onto central bank balance sheets as collateral for emergency funding.

It doesn't seem likely that gold could address any of the problems in this inter-bank credit circuit of the Eurozone monetary system. To identify gold’s role in this new international monetary and financial system I think we need to turn our attention to currencies and the concept of a risk-free asset. Then we can restart the discussion about gold and international trade settlement (after we deal with a couple of the issues that hindered the first attempt).

New Note Circulation Tuesday 8th October

On Tuesday, the new redesigned $100 note will start circulating, at least according to the press release from last April, which I presume is not affected by the shutdown.


The ECB Targets 1752 (Part 3)

(New Gold Supra-Theory Salon des Refusés – Post 3)
In the discussion thread of this post I think we clarified some important issues around the theory about the adjustment mechanism for household consumption-driven imbalances in the Eurozone. In the course of the discussion it became obvious that gold had no role to play in the operation of this mechanism in the Euro currency zone. The Euro can and does get the job done.

This isn't the end of the story. My view hasn’t changed that the probability of gold being a key part of a new international monetary and financial system has such a high probability that it approaches inevitability. Determining the limits of the role of gold in this new system is a valid line of enquiry too. If gold is making a comeback let’s not be right for the wrong reasons.

Kudos (in alphabetical order) to DP, Piripi Peterson and Victor The Cleaner for engaging in the discussion and presenting their perspectives. We clarified some issues about the composition of the HICP Eurostat inflation index that I want to share with you here in the Salon des Refusés. This is where theories that don’t make the cut for the New Gold Supra-Theory will reside. We also discussed a circuit theory approach to understanding the TARGET2 balances that has identified one of the potential roles for gold in the Eurosystem.

Let’s briefly recap on the theory about the consumption circuit and incorporate some of the input from the discussion about the first two parts of this post. I presented the theory that the fathers of the Euro incorporated a modified version of the classical economists “price>specie>flow” mechanism into the design of the Eurosystem. I style this mechanism as prices+>money>flow for a currency zone but it should be rendered as prices+>Euro>flow in the EMU single currency zone.

The adjustment mechanism in the consumption circuit allows the ECB to target it’s two (2) per cent average annual inflation rate with feedback from the Eurostat HICP consumer price index (CPI). On their web pages discussing the HICP the ECB says here: “Key priorities for the coming years are the treatment of owner-occupied housing (currently excluded)....”

If they are including new housing consumption in their index and excluding land already then we will argue that they should Stop right there! The HICP is already capturing the only useful data on owner-occupied housing (OOH) that a consumption index can utilize. If Eurostat isn’t including any part of the consumption associated with new OOH then we propose an approach that will solve three statistical analysis problems associated with OOH that bedevil other CPIs around the world. These problems are: volatile land prices, resales of existing homes and rent (housing services).

If data on house prices that separates land prices is gathered in your region it should be clear that the replacement cost of a house closely tracks increases in the general price level.  Armed with this data it also becomes obvious that it’s the land component of housing that experiences these boom-bust cycles. (One bonus in excluding land from your CPI is that you reduce the volatility in your index.) It is self-evident that houses deteriorate over time unless they are maintained. This is the consumption component of OOH. (There are question marks over the correct treatment of depreciation, repairs and maintenance so I’m going to put these issues aside for now. It's not a deal breaker however you treat them!)

You can also record the purchase of a new house (minus the land component) as a single consumption event in the year in which it occurs. Here’s why: let’s say this new house has a life of 40 years. The first owner has purchased 40 years of house consumption. Even if the house is sold every 10 years each of the 4 owners only “consumes” one quarter of that initial consumption item over the ‘working’ life of that house. So you can exclude resales from your CPI as well.

In the comment thread here Victor The Cleaner offered the analogy of a new car purchase to explain this principal: “If you purchase a new car and then sell it after a year, the value added that you have consumed is only the difference of the prices. Same for the next owner in line after you, and so on, until the car is eventually scrapped. So in effect, the purchase price of a single new car needs to be counted once.” This analogy also deals neatly with the depreciation issue.

You solve the rent/housing services problem by not treating OOH as a form of quasi-income. Occupying a house may be a cost saving if it’s owned outright but an avoided cost isn’t income. If you want to test this out wander past a Ferrari showroom and decide not to buy one and then check your bank balance to see if you are any wealthier. If one of our 4 owner-occupiers in the example above is replaced by a tenant for 10 of those 40 years it’s still part of the consumption life cycle of the house that began with the original purchase.

Rent on a house can be equated to an interest-only private loan. The landlord has invested in an asset. The tenants have an overhead that reduces their disposable income – the income available for consumption. The rent paid by the tenant could result in an increase in the disposable income and consumption of the landlord's household which would be detected by the HICP anyway. This is a transfer of purchasing power rather than a type consumption.

Kudos to Eurostat for not using a “typical household” approach to gauge consumption spending and thereby resolving the classical economists reservations about indexes. They seek to gather statistics on actual household consumption spending across the Eurozone. It appears that Eurostat have finally created an accurate inflation indicator based on prices.

The TARGET2 system also discussed in this series provides a very low friction ‘plumbing’ system allowing the prices+>Euro>flow mechanism to correct imbalances across the Eurozone. In the process optimizing the benefits of free trade and a single currency zone as the classical economists Hume, Ricardo et al said it would.

Next we’ll explore a circuit theory approach to understanding the TARGET2 balances in order to determine if gold has a role to play in correcting imbalances in this part of the Eurosystem.

Dread Pirate Roberts to be keel hauled

Silk Road hit the news wires again but this time it's because the authorities caught
up with the Dread Pirate. I was talking with a friend of mine today and mentioned
this to him and he was completely lost as to what I was talking about.
He didn't know the "Silk Road" was a place where you could order illicit drugs and all manner of illicit other stuff and have it delivered to your door. He hadn't heard of the "Dread Pirate Roberts" and didn't get the movie reference.  For those who prefer the convenience of mail order Cocaine this is going to be a problem.  For those who used the service it's going to be a huge problem.

What is interesting is the DEA, FBI etc have been trying to crack this case for years now and suddenly they got lucky because apparently the Dread Pirate was foolish enough to order nine fake ID's on his own website. Somehow these ID's were intercepted (it could be the fake ID's were part of larger sting ).
They interviewed him and decided to watch him. They also obtained his Comcast account ISP records.
Using Underwear Gnome sleuthing techniques they gum shoed their way to the Silk Road server and commandeered it.
Hmmm, there appears to be large holes in the narrative but the narrative isn't complete yet.
Keep in mind though one of the things Snowden revealed in his leaks is the documents show that the NSA goes to considerable effort to reveal data gathered through its advanced capabilities only when it is possible to come up with a more innocent possible source (a “parallel construction”).

What I am saying is there is no way in hell a guy running a Billion dollar illegal business, who understands crypto currencies, encryption and encryption gotchas (if you don't know what you are doing) is going to use his home computer and his own internet connection to administer a website like Silk Road. He was smart enough to be able to hide the Millions of Dollars he made on the site in the form of bitcoins offline presumably. He was able to convert some of those coins to dollars to pay his rent. He obviously wasn't smart enough to get out of the USA though.

To get an idea of just how big the operation was:

The criminal complaint revealed that the site had collected revenues of some 9.5 million bitcoin since 2011, the equivalent today of $1.2 billion in sales and $80 million in commissions for Ross Ulbricht, who allegedly ran the site under the moniker “Dread Pirate Roberts.”
There are only about 11.75 million bitcoin in circulation. There were even fewer when Silk Road first began—the supply of bitcoin will steadily increase until there are 21 million in existence.
If you want to know more about the Silk Road then load up TOR or downlod something like TAILS and start searching around or just go here for this brilliant analysis

The ECB Targets 1752 (Part 2)

(New Gold Supra-Theory Salon des Refusés - Post 2)


Let’s take a look at the ECB’s TARGET2 system. Here’s a very brief outline of the similarities between the ECB and the Federal Reserve system from the blogger ‘DP’.

Now let’s play spot-the-difference between them. The ‘Fed’ was created to deal with the kind of liquidity crisis that almost brought down the financial system in America in 1907. It’s brief wasn’t to “create a payments system”. According to the ECB (here) TARGET2 was developed in close cooperation with its future users. One of those users’ main requests was that the new system would offer a harmonised, state of the art payment service.”

So the ECB wears at least two hats. It’s a central bank for the Eurosystem central banks and it operates the payment system in the EU. Now I have to digress here. One area where the “fathers” of the Euro differ markedly from the classical economists and Professor Viner is in their attitude to price indexes and statistics. Alexandre Lamfalussy, one of the “fathers of the Euro”, stated: “Nothing is more important for monetary policy than good statistics.”

The classical economists rejected the notion of indexes being used as a proxy for the real world. Jacob Viner also lamented the difficulty in providing conclusive evidence of the benefits of free trade using statistical analysis. So Viner also had deep reservations about its value (back in 1937). Obviously this was a long time before super-computers and the arrival of this highly, digitally-integrated world we now live in. Perhaps today we can put aside these reservations and rely on prices and statistics to give us an accurate insight into the state of an economy.

Now let’s take a closer look at the Eurostat "Harmonized Index of Consumer Prices" (HICP). The HICP only uses final consumption prices in the index. In their words, “household final monetary consumption expenditure" The focus of this index is not “intermediate goods”. Goods that are in the process of being combined with other goods to produce final consumption goods for households. Cars are in the HICP but components in the process of becoming a car aren’t the focus of the HICP.

The HICP also excludes owner-occupied housing (OOH).  That is extremely unusual in a consumer price index (CPI). Housing costs are estimated in different ways around the world but an estimate is usually included in a CPI. I think it isn’t included in the HICP because the treatment of OOH in other CPIs can’t be used in a system designed around Hume’s mechanism. As Viner points out: "It is not purchases, or transactions, in general which are significant for the mechanism of adjustment, but only purchases of certain kinds." (You can search the PDF I linked in Part 1 if you want to check the accuracy of any quotes.)

Jacob Viner actually uses houses as a specific example of the kind of things that need to be excluded when you are trying to identify the operation of the mechanism: “If, for instance, a particular house has changed ownership as between dealers through purchase and sale three times in one year, and not at all in the next year, neither the transactions in one year nor their absence in the next year have any direct significance for the international mechanism." (Simply replace “international mechanism” with “Eurozone mechanism”.)

In order to zero in on the adjustment mechanism we need know three things. Firstly we need to know the size of the portion of the overall money supply that is being used to facilitate final consumption expenditure. Secondly we need to know the velocity of the money used for this purpose and lastly we need to know the prices of household consumption goods. (It’s also worth noting that HICP isn’t based on a “typical household” approach. It aims to capture the actual consumption expenditure of all Eurozone households.)

I don’t think it is a mere coincidence that Jacob Viner’s preferred measure of velocity is the “final purchases velocity of money”. He describes this as the ratio of final purchases per unit of time to the amount of specie in the country”. We can replace specie with Euro here. We would expect velocity to be stable most of the time. In most households the consumption patterns are fairly consistent for long stretches of time.

As mentioned above only part of the money pool is involved in these final consumption expenditures. There is no need to get bogged down in discussions about how much consumption is funded with credit. We’ll divide the money supply into two pools and then I’ll justify that assertion about the credit component. The pools are a consumption goods money pool and a non-consumption goods money pool.

If we had access to the range of data that the ECB has access to, we could obtain a reasonable estimate of the size of the consumption goods money pool through trial and error. One indicator of the size of this pool would be the total value of all of the simultaneous consumption expenditure transactions taking place across the Eurozone at a point in time. We could then test our estimate against observations of consumers actual behaviour and through the huge data feed the ECB has access to. Then over time we could refine the estimate. Now let’s assume these ‘tools’ work and examine how they might have been used in a situation that actually occurred.
When the SHTF in Ireland a few years back the ECB was pouring billions of Euro into the Irish banking system. Try to put yourself into the mindset of a central banker with “good statistics”. The Irish are pulling Euro out of their banks like there’s no tomorrow. However, final purchase velocity is stable and so are the prices of consumption goods. TARGET2 is wired into the FX market as well so you know that most Irish people aren’t exchanging Euro for another currency.

The statistics are telling you that this money is going into “mattresses”. The confidence crisis is people-banks not people-Euro so you can supply a huge amount of Euro without worrying about prices getting out of control. The prices+>money>flow mechanism will automatically correct the imbalances after people calm down. A central banker would have been monumentally stupid to restrict the supply of Euro under these circumstances.

The beauty of a system like TARGET2 is that it allows the prices+>money>flow mechanism to function smoothly. This mechanism is usually an auto-correcting monetary policy tool that only requires intervention infrequently. It does not resolve problems in fiscal policy, taxation policy and other areas of government policy. If you expect it to do that your expectations are unrealistic.

I think that by using this two-tiered approach and disaggregating credit* (described here and here) it could help to explain a “two-speed” economy. One where the prices of consumption goods aren’t indicating high inflation but the prices of some asset classes are looking bubbly. A banking union in the Eurozone is a natural progression toward giving the ECB “good statistics” on the non-consumption money pool and what people are doing with it.

PS - Here’s a link to an interesting discussion about “disaggregated credit” and gold with ‘Victor The Cleaner’. A big hat tip to DP and VtC for the feedback in the comments here that helped to crystallize this post. But don’t blame them if you think it’s rubbish. If it is, it’s down to me alone.

The ECB Targets 1752 (Part 1)

(New Gold Supra-Theory Salon des Refusés - Post 1)

The year 1752, that is. In 1752 David Hume published his paper “On the balance of trade” presenting his theory about international trade known as the ‘price>specie>flow mechanism’. I have a theory to share with you about the ECB Eurosystem.

My theory is that Hume’s mechanism and the insights of the classical economists guided the Euro founding fathers’ in the design of two of the ECB’s most important currency management systems.
The two systems I’m referring to are the index called HICP and TARGET2. The ECB uses HICP to assess its performance in maintaining an average annual inflation rate of two (2) per cent. TARGET2 is the system that facilitates the flow of money around the Eurozone. Hume’s mechanism is usually discussed in terms of international trade but it is equally applicable to regional trade. This post is about trade and other flows within the Eurozone.

Confining the discussion to one currency zone while we explore this mechanism enables us to ignore some of the complications that need to be addressed in looking at international trade between currency zones. So when I rework part two of the series on gold and international trade settlement I’ll concentrate on trade settlement between currency zones and let this post try to explain the mechanism itself.

The main source I am drawing on for this post is a very dense, scholarly book published in 1937 called “Studies in the Theory of International Trade”. The writer was a Professor of Economics at the University of Chicago named Jacob Viner (Here’s a link to his bio.) In this book he discusses the work of the classical economists on international free trade theory as well as the many debates they were involved in.

Here is some background information for readers who are unfamiliar with this mechanism. I style this mechanism as prices+>money>flow. The expression ‘prices+’ is meant to convey that there are more factors involved than prices alone. Jacob Viner discusses factors such as real costs, relative demand, velocity, comparative advantage and so on. I replaced ‘specie’ with ‘money’ because this mechanism works with other types of money – not just gold “specie” coins.

For this mechanism to deliver its benefits you simply need to have the right conditions which are: (a) The countries trading with each other must share a common currency; and (b) Minimal friction in the flow of goods and money. In other words free trade and no capital controls or trade barriers to interfere with the flows. The common currency could be like the Euro – a currency union - but there are other ways to achieve the right conditions. If two trading partners both accept gold specie as money (as they did in Hume’s proof) then they are in one currency zone.

Now I need to emphasise a couple of important factoids about this mechanism. It comes from thinkers who viewed trade as a human welfare issue. To them trade was intrinsically a goods-for-goods and exports-for-imports exercise not a goods-for-money exercise. (Wherever I use the word ‘goods’ please read that as ‘goods and services’.) So we’ll leave the exploration of the goods-for-money perspective for the trade settlement series as well.

Hume’s mechanism didn’t increase overall trade between countries and regions. It enabled the mix of the most-demanded-goods available in each country to change. A flow of money was followed by a flow of exports from Country A into its trading partner Country B. This temporarily increased the money supply in Country B but the increased diversity of goods available to the citizens of Country B would endure.

In David Ricardo’s words (as quoted by Viner) this resulted in an increase in the “mass of commodities” and an increase in the “sum of enjoyments.” Ricardo also noted that people could increase their monetary savings instead if they didn’t want to avail themselves of, say, cheaper goods by increasing their consumption. Over time the prices+>money>flow mechanism rebalances the volume of money in each country until the next trade disruption.

A closely related theory of the classical economists about free trade was that it would tend to equalize the prices of the goods that were traded. Arbitrage and competition would reduce price differentials to weed out profit premiums and prices would more closely reflect actual cost differences for transport, relative demand and so on.

In the second, final part of this post (with Professor Viner’s help) we’ll try to connect the dots between TARGET2, HICP and the prices+>money>flow mechanism.

Solar Power in Australia

Since discovering Eric Sprott's social media agency I've been unimpressed by any (or all) precious metals 'news'; I have recently been turning some of my research efforts to the energy sector. I have a few observations that I wanted to share with anyone who will listen (apologies to anyone awaiting the next GLD article installment - it's coming soon ... in the meantime please do check out Costata's new gold series). This is not a research article specifically, it's more of a personal checkpoint, and if I can attract at least a few oil lobby shills denigrating the solar industry then I have achieved my secondary goal.

Sunday pre-game, 9/22/2013

So, the Fed was forced to show its hand last week and it wasn't pretty. Of course, gold and silver always fall precipitously whenever a Fed shill farts out some noisome propaganda about imminent tapering, so it stood to reason that gold and silver would be up BIG this week. Except both gold and silver were down this week. 
That's why it's probably best just to use the charts. For example, I've mentioned many times here that on days when gold is flat but miners are getting killed, I always short gold. To my recollection, this trade has yet to fail.

And it didn't on Thursday/Friday:

Gold and International Trade Settlement (Part 2)

(A New Gold Supra-Theory – Post 2.)

Please Note: As a result of feedback on this post it became clear to me that I had to separate the explanation of Hume's mechanism from the discussion of international trade settlement. So I have created a post in two parts called "The ECB Targets 1752" that looks at the mechanism in the Eurozone.

I'm going to rework this post and discuss trade between currency zones here in order to keep to a 3 part limit. The original text will be archived and accessible. Warren James is helping me to put this together. My apologies if my learning curve is annoying anyone.

I'm determined that the build-out of this theory isn't going to become multi-layered. I don't want people to have to drill down through 5 layers of old posts to understand each component. Likewise if I commit to a maximum of 3 parts (as I have with this topic) I don't want it to become 4, 5 or 6 in the future. If updates are required then the existing parts may become longer posts but they will be reposted as "updates" to replace the original. The original text will continue to be accessible.


The challenge for the New Gold Supra-Theory is to predict how a new gold-based international monetary and financial system (IMFS) will operate. In part one I mentioned the ‘price-specie-flow mechanism’ originated by David Hume (1711-1776). An insight into international free trade that was further developed by classical economists such as David Ricardo. This mechanism may have influenced the design of the ECB Eurosystem’s Target 2 system.

The source I am drawing on for this post is a very dense, scholarly book published in 1937 called “Studies in the Theory of International Trade”. The writer was a Professor of Economics at the University of Chicago named Jacob Viner (Here’s a link to his bio.) It discusses the work of the classical economists on international free trade theory in great detail as well as the many debates they were involved in.

If anyone expects gold to correct international trade imbalances on its own via some mechanism like this the news isn’t good unless gold becomes a circulating currency again. However, if (as I do) you expect gold to tightly discipline currency issuers and to discover currency prices through international arbitrage then it’s no big deal. Currency exchange rates will get the job done that a flow of specie would have accomplished in the distant past. The description of this mechanism is usually presented (inadequately) like this short Wikipedia entry.

As I said in Part 1 this mechanism doesn’t require a gold standard to operate. It can and did operate under a mixed currency system. Classical economists were also able to observe the effect on this mechanism during periods when gold exchange was suspended by the Bank of England. Jacob Viner discusses a number of other factors, aside from prices, that influenced the operation of this mechanism including real costs, relative demand, velocities (that’s plural) and so on. I’m only referring to prices here for the sake of brevity. Here’s my summary of the features and limitations of this mechanism:

1. It requires the trading partners to be in the same currency "zone" i.e. using the same money (e.g. gold, silver, Pounds etc) So the Eurozone is readymade to benefit from this mechanism if the Euro is managed well. We should be able to see its influence at work in the numbers emerging from the Eurozone over time as it tends to equalize the prices of internationally traded goods to reflect one price plus transport and distribution costs and relative demand.

2. This mechanism worked both internationally and between regions within countries through deflation and inflation of the currency supply. This in turn influences prices and other factors that encouraged a constant flow of money. As prices etc adjust the flow responds until the amount of money in each country or region returns to its starting position. I imagine tidal forces when I try to picture this mechanism in operation.

3. This mechanism increased the diversity and volume of goods available in each region/country. There is an extract from Viner quoting Ricardo on this topic below.

4. It apparently exercised no influence over the amount of bank-created money. This was a regulatory and policy issue that was the subject of a long running controversy between the “currency school” and the “banking school”. Viner also reviews these debates in great detail.

5. The classical economists and Jacob Viner dismiss the possibility of any index being able to simulate the effect of this mechanism. This mechanism works but it’s impossible to prove it with statistics. In an interventionist world like ours today if something can’t be indexed or measured in some way it doesn’t matter or doesn’t exist for policy makers. That’s a huge impediment for the supporters of free trade even though the logic appears to be impeccable.

P. 342 Jacob Viner (my emphasis):
Free trade, therefore, always makes more commodities available, and, unless it results in an impairment of the distribution of real income substantial enough to offset the increase in quantity of goods available, free trade always operates, therefore, to increase the national real income. That the available gain is ordinarily substantial there is abundant reason to believe, but the extent of the gain cannot in practice be measured in any concrete way.

(From Page 339-40 of “Studies in the Theory of International Trade”)
... Ricardo went on to say that “it will very powerfully contribute to increase the mass of commodities, and therefore, the sum of enjoyments.” What was intended by Ricardo as the main proposition was, at least for our present purposes, of no importance. The incidental comment, on the other hand, was of great importance. It suggests two income tests of the existence, and perhaps also two income measures of the extent, of gain from trade, namely, an increase in the “mass of commodities” and an increase in the “sum of enjoyments.”

Ricardo did not expand these suggestions, but in his Notes on Malthus he repeated them: if two regions engage in trade with each other “the advantage ... to both places is not [that] they have any increase of value, but with the same amount of value they are both able to consume and enjoy an increased quantity of commodities,” adding, however, that “if they should have no inclination to indulge themselves in the purchase of an additional quantity, they will have an increased means of making savings from their expenditure.”

I would like to leave you with a question to ponder. If all currencies are fully convertible (freely exchangeable [1] with each other) and there is no intervention inhibiting the flow (such as capital controls) then all of the world's currencies would be like one single fungible money supply. Of course there is constant intervention in many currencies. So if you wanted to promote international free trade it would be helpful if you could create an international reserve currency that no one could mess with, would it not? 
In the third and final part of this series I’ll present an issue that I think has brought those of us who anticipate a new gold-based IMFS to an impasse -  a stalemate. I think it needs to be addressed so we can move on.

[1] Another hat tip to DP. I added 'with each other' in order to try to make it clearer that this is purely an exchange of currencies and not a reference to a gold exchange standard.

Gold and International Trade Settlement (Part 1)

(A New Gold Supra-Theory – Post 1.)
I realize that this topic sounds utterly boring. But if you think that gold has a role to play in a new international monetary and financial system (IMFS) this topic should be of the utmost importance to you. There is more than one theory about international trade. If one particular theory is correct then gold better not give up its day job just yet because it’s not going to get the trade settlement gig in a new IMFS.
A concept called “balance of trade” or “national balance of trade” is central to this discussion. This term appears to have been coined around 1615 and it started a food fight among economic thinkers that's still in full swing. There are several competing theories about the drivers of trade and the appropriate objectives of international trade.
Any attempt to examine this topic is complicated by the intervention of monarchs or governments and their bureaucracies down through the years. However, I think we can distil a few key themes from the debates about this subject over the centuries. The classical economists believed that free trade served human welfare and that imbalances are naturally self-correcting. The way this was done was through the prices+-specie-flow mechanism and refraining from intervention in free trade.[1]
(The word “specie” implies gold and/or silver to many people. This view is erroneous. Specie should be read simply as ‘money’ or ‘capital’. With money as a subset of capital provided the money is accepted in exchange for capital goods. [2])
Another perspective (labelled “mercantilism”) holds that the national balance of trade should be viewed as the sum total of all of the merchants cash tills in the country. The false implication this conveys is that the mercantilists sole aim was to obtain a cash surplus (or profit like a merchant) from trade. The actual aim of many of the mercantilists was to obtain a surplus of imports over exports. A money surplus represented a future goods surplus. Some of the mercantilists proposed controlling both exports and imports in order to ensure that there were enough goods available within the borders of their nation to enrich the lives of everyone who lived there.
On at least one issue the classical economists and the mercantilists were on the same page – viewing international trade as an indirect exchange of goods-for-goods mediated by money. Goods that contributed to human welfare and wealth (in its broadest sense). Money (bullion for “the bullionists”) stored the surplus purchasing power. The real issue between these two camps was balanced trade versus creating a deliberate imbalance in your own favour which the classical economists viewed as self-defeating.
In recent times the view has been propounded that a country running a trade deficit is unproductive and countries running surpluses are productive. Surplus producers are lauded and the citizens of countries with trade deficits are derided as net-consumers. The implications are that deficit = lazy and surplus = industrious. But kindly note: Countries who run trade surpluses must export capital and countries with deficits must import capital – "balance sheets must balance" as the Minskyite economist Michael Pettis is fond of saying.

For a long time I viewed this solely as a win-lose deal. Trade deficit countries are “forced to sell off the farm” to the surplus countries. But eventually I realized that there are a few problems with this lazy vs industrious and winner vs loser perspective which I’ll briefly summarize for you. The biggest problem is the existence of a theory that the capital flows occur first and lead to the trade deficits. If you subscribe to this theory you could use it to support the claim that the deficit countries like the USA are in a sense the "victims" of the surplus countries excessive saving and lack of domestic consumption.
Secondly citizens of a country running a trade deficit can be highly productive and industrious but obtain prices for their products which are too low to generate sufficient revenue to pay for their imports. (I suppose the rejoinder might be that these people in deficit-land were stupid in their decisions about what to produce and it serves them right. Personally I think the return of serve on that stroke might be a sizzler.)
Thirdly a country could have a surplus of capital absorbing investment opportunities for which there is insufficient capital available locally. If this was the case then it could make sense to adopt policies that encourage a surplus of capital imports rather than trying to "save" up enough money to finance them domestically. Figuratively speaking that “deficit” country could run an “export” surplus of in-bound foreign direct investments (FDI).
Now we come to an important issue that needs to be addressed by those of us who believe that a gold-based IMFS is in the pipeline. In the capital flow trade model I just outlined there is no need for so much as a single gram of gold to flow in order to settle the trade “imbalance” implied by running a current account deficit (CAD). There is NO imbalance for a flow of gold to balance.

[1] I changed the text from "prices+costs" to this - ‘prices+-specie-flow mechanism’ - to reflect the fact it’s influenced by more factors than prices and costs alone and to give this mechanism my version of its formal title which is the "price-specie-flow mechanism".

[2] Hat tip to 'DP'. The way I expressed it originally implied that money and capital are two different things.