The Future of Physical Gold (Part IV - Deflationary Canyons and Caves)

Golden Canyon in Death Valley [Obtained from the NPS Wesbite]

After writing Part III of this series, I received an excellent comment from a reader who enjoyed the articles and summarized many of the Marxian arguments that I had made in a much more accessible form. I understand that the academic structure and technical details of this series has not made it the very easy to digest, and it helps when readers are already familiar with the basic foundations of my argument, which was the case for this specific reader.

I am going to re-post a sizable portion of that insightful reader's comment here, as a means of re-encapsulating the somewhat dry theoretical arguments of Parts I, II and III (Dialectic Foundations, The Evolution of Value and The Final Realization) in a significantly more lay reader-friendly capsule with some clear examples. I will also add a bit of my own commentary within the bold brackets, but just a bit, because the comment is quite good on its own: [Chris Martenson's Forums - The Future of Physical Gold Thread]

darbikrash: "Great series of articles Ashvin!

I think you bring a fresh perspective to the Marx/Keen/Harvey axis in coupling these theories to the discussion of gold. I had posted something congruent with these ideas on the ever popular subject of alternate currencies in another thread. You’re quite right, at the center is the struggle between labor and big business [the material dialectic of Part I], which I define as multi-nationals.

This struggle sets up a natural and quite healthy tension between the two opposing forces. When this healthy tension is displaced [it inevitably must be displaced over time], to either direction of bias [labor vs. capital], bad things happen. The convergence over the last three decades of the neo-liberal agenda, and the capture of the mainstream media by conservative business interests has resulted in the disruption of this tension away from the side of labor.

Propelled by the momentum of the burgeoning success in minimizing organized labor, business and conservative interests teamed together to usher in an ongoing era of deregulation and complimentary legislative climate that promoted favorable tax incentives for big business. These incentives were leveraged to follow with near perfect parallelism along with Marx’s prediction of capital heading to markets with unlimited low cost labor surplus [although Marx may not have envisioned the extent and longevity of economic "globalization"].

It is an irony lost on many that the perfect climate for capitalism's magnum opus was to be under the color of a totalitarian Communist regime- embodied by mainland China [under it's "false flag" of Marxism, so to speak]. This diffuse and disjointed labor base was confronted with several classical Marxist predictions, a profound loss of collective bargaining power as the threat of job outsourcing to China and Mexico stymied any meaningful protests for re-organization.

This resulted in lower wages for those lucky enough to retain jobs, and Marx’s predictions about consolidation of capital are demonstrated in the aggregation of “big box” stores [i.e. Wal-Mart] designed to lower the sustenance costs for low and middle class labor, furthering enriching the capitalist class- as predicted chapter and verse. With the cratering of the credit market [due to endogenous instability as described by Hyman Minsky and Dr. Keen - Part III), the emperor can be seen to have no clothes, and here is where it gets real interesting.

With a collapsed income, the vast majority of Americans can no longer afford the products of consumerism that capital has morphed into [the final "realization problem" - Part III], having exhausted by sheer competitive overhang the more productive and meaningful products and services, the average capitalist is now presiding over a string of yogurt parlors and useless iPod apps, analogous to unwashed children selling Chiclets gum at the Mexico border crossing.

The bourgeoisie has simply engorged itself so completely and so effectively on the middle and lower class, there is no money left for the poor fools to purchase the trinkets and trivia that the bourgeoisie needs to maintain their lifestyle, in effect tuning their gated estates into miniature Easter Islands, replete with carved stone masks and bad artwork. So this leaves us with another problem, what do the wealthy do with all the money?

It used to be a budding capitalist could re-invest and maintain an income stream though investment, real estate purchases, or entering the rentier class to sustain cash flow, all the while ignoring, contrary to free market mythology, risky entrepreneurial ventures and instead focusing precious man-hours on reducing tax liability and preservation of capital strategies... There are not simply enough attractive investment opportunities to go around, a face the music moment in a system that requires perpetual compound growth to function.

Capital abides no limits. It must expand its markets to prevent the destruction of demand. It must seek larger and larger labor markets, with lower and lower labor costs, as the coercive laws of competition wreak their havoc [continuous re-investment/realization of surplus value and debt issuance/rollover in markets]. Capital consolidates, aggregating smaller, less powerful firms unable to achieve the international reach necessary to grow into offshore markets, purchased for pennies on the dollar as the multi-nationals observe and track strangling mid-level businesses with a predator’s gaze as they asphyxiate on a contracting domestic market - leaving consumers with even fewer choices."

Obtained from Zero Hedge ["Attention Marxists: Labor's Share of National Income Drops to Lowest in History"]

Obtained from Zero Hedge ["20 Facts about US Inequality That Everyone Should Know"]

Obtained from Zero Hedge ["20 Facts about US Inequality That Everyone Should Know"]

Thank you for a very poignant summary, darbikrash, with an even more poignant ending. Indeed, capital "cannot abide a limit" and so it will transform the limit into a barrier that must be temporarily overcome (by repressing labor's share of wealth/power, as depicted in the above graphs). It creates increasingly larger and stronger barriers in the process, though, since the old ones never really disappear. It is now, at this unique point in time, forced to face these insurmountable barriers and witness the inefficacy of kicking the proverbial can, as it nears the end of a shadowy and winding road in history.

With that systematic foundation established, we can discuss what this internal predicament of capitalism implies for the future roles and values of physical gold in human society. Towards the end of Part III, it was stated that a global system of Freegold was very unlikely to ever take hold. The Freegold system is essentially a modified global financial system with fiat currencies floating against the reserve asset of physical gold, which trades independently of the credit system and solely as a "store of value" for savers, rather than a medium of exchange.

Freegold's argument for gold as a limitless "store of value" in the capitalist system is based on the "marginal utility theory of value", which was discussed and debunked in Part II - The Evolution of Value. Practically, an objective approach to complex economic evolution means that Freegold is unlikely to occur because the concentration and centralization of capital is a process that irreversibly undermines economic growth in the financial capitalist system, and it cannot simply be overcome through either "easy money printing" or re-capitalization with "hard money".

Central banks can monetize all of the assets they want, both debt-based and "debt-free" (gold), but that does absolutely nothing to alleviate systemic issues of severe wealth inequality, insufficient demand and structural unemployment. Even the relatively short-lived trends towards increasing wages in China has already started to threaten the growth of its productive economy, as explained in this recent article from MarketWatch:

"How much should China worry? Actually, the worrying is already over for some enterprises: They’ve closed shop.

An executive in the city of Jiaxing at Zhejiang Youbang Integrated Ceiling Co. said his firm is among the 90% of more than 500 local integrated-ceiling enterprises that have managed to survive since wages started climbing last year. Others, though, have not.

“Since last year, there have been reports of enterprises collapsing, one after another,” the executive said. “About 10% went out of business.”[China's Factories Face Big, Labor-Driven Challenges]

Of course, much of that pressure on productive factories stems from the ongoing collapse of financial capitalism, and the pressure generated from labor and input costs is merely a pronounced effect at this stage of the system's evolution, as there are very few places left for it to expand to. The following example helps reveal the broader inadequacy of gold-based re-capitalization in the context of a specific gold revaluation process that was outlined by FOFOA, a popular Freegold advocate. He has suggested that Congress should force the U.S. Treasury (UST) to revalue their physical gold holdings to the market value (MTM), which has recently trended upwards.

Once the revaluation is complete, he suggests that the UST monetize the additional value by pledging it as collateral to the Fed in return for printed dollars. That actually sounds like a great thing to do in the ideal, and a much better idea than continuing the issuance of Treasury bonds to be monetized by the Fed, but it is practically just as useless and/or destructive when considering the systemic reality we are a part of in the global capitalist economy (this complex reality was discussed at length in Part I) (emphasis mine):

FOFOA: "That's right, it [the available value of the Treasury's gold] jumped again. From $336 billion in October, to $355 billion in January, to $370 billion in April. And guess what it is today. $390 billion! That's the amount of untapped equity the US Treasury has in its gold today. And that equity can be monetized without selling the gold, by the simple act of Congress ordering the revaluation of the gold.

...Again, I realize this doesn't solve any of the big problems, but it does buy some time... You can use it without selling it for gosh sake! And just like the old gold certificates, the new ones will NOT be redeemable by the Fed or any other banks in physical gold. They will simply be an accounting entry on the Fed balance sheet. In the future, that gold can be mobilized, if necessary, in defense of the US dollar. But only with the approval of Congress. The physical gold remains the property of the United States." [Open Letter to Ron Paul]

Assuming those calculations to be accurate (based on the UST owning 250+ million oz. of gold), there are still many flaws contained in the process. For starters, the monetization of any surplus generated from the MTM revaluation would give the Fed (private banks) a claim on the gold as collateral. It would be just like a "home equity loan" that is secured by the price appreciation of the property since it was purchased. Once that claim is established, it should be obvious that the gold is practically no longer "property of the United States" (the citizens) any more than the home equity would be (unless the asset value manages to completely offset liabilities forever).

Congress may technically have to give "approval" for the Fed to foreclose on our gold, but that would not be difficult to get, considering the fact that the politicians in Congress are realistically owned by major players in the financial industry, especially during these trying times. They are currently "foreclosing" on our retirement accounts as a means of avoiding a technical UST "default" [], so why should we expect anything different for our gold? The MTM revaluation would indeed "buy some time", but that time would only be used by financiers to extract more wealth through the all-American pyramid scheme before it implodes.

Obtained from Wall Street Journal Blog

Secondly, the revaluation would do very little to solve any of the fundamental systemic problems that Marx envisioned (as FOFOA implies), and therefore the ponzi implosion will still occur as expected. Most of the value monetized by the Treasury will not find its away to the productive economy or struggling debtors, and if, heaven forbid, the price of gold takes a large hit during a deflationary process, then the taxpayers will end up losing their gold too. Lastly, it is almost certain that this revaluation will not occur anyway, because it is simply not worth it for the elites, at least not right now.

A gold revaluation doesn't provide nearly as much benefit to them as financing deficits via Treasury bonds and letting most other asset prices naturally decline to subsequently buy them for pennies on the dollar (including gold). The only "solution" to the problem of insufficient demand has become to keep the global ponzi system of capitalism running for as long as possible. Fiscal and monetary policies of influential regions (the West, Japan, China, Russia, Brazil, etc.) will not trend towards some gold-based equilibrium through revaluation and/or dollar HI, but will merely reflect the drawn-out deterioration in financial and productive markets over time.

There is a distinct possibility that the Federal Reserve, for example, holds off on further monetization of federal or agency debt for some time, allowing asset prices (equities, commodities, real estate) to collapse further before once again re-asserting itself directly into the Treasury market to help maintain low rates (it will most likely continuously provide this support indirectly via selling insurance on bonds). By "allow", what I really mean is that the Fed will not make its final "printing" stand against the natural forces of debt deflation for some significant period of time, which could be the result of both voluntary and involuntary forces.

It is starting to become quite clear that foreign investors (private and public institutions) are now very hesitant to hold U.S. Treasuries yielding 3% over 10 years, as public deficits continue to mount, speculative price inflation has raged and the domestic economy (housing/labor market) continues to rapidly weaken. A liquidity crisis, naturally resulting from debt deflation, would conveniently scare that capital back into the Treasury market and the dollar, as the system's elite are forced to sacrifice even the appearance of economic health to hold those markets together a bit longer.

[Bailing Out the Thimble With the Titanic]: "When global equity and commodity markets begin their downward cascade in response to the ongoing debt deflation and a temporary end to quantitative easing, margin calls will indeed be coming in fast enough to make your portfolio spin. The demand by institutional investors for a "safe haven" will emerge as quickly as the daylight descends into pitch black, and it will then become clear that the intent was never to bail out the Titanic with a thimble, but the other way around.

The bond markets of Japan and Europe simply can't make the grade, and, as referenced in Jumping the Treasury Shark, there really isn't enough gold to soak up all of that capital. Instead, the U.S. dollar and Treasury bond, because of their fundamental weakness, will be the refuge of choice and design, and this will also serve to aid the Fed's Mafioso protection scheme [selling Treasury "puts"] for controlling rates."

[Welcome to Slaughterhouse-Finance]: "Stoneleigh at The Automatic Earth has repeatedly pointed out that people in such fearful environments tend to discount the future by an increasing rate, which means they care less and less about what will happen several decades, years or even months from the present time. The discount situation of financial elites is similar because they know how precarious the dollar-based financial markets are, so their concern is over whether they can corral all of the lambs into one or two places over a relatively short time period. So far, most of the evidence says that not only is it possible, but the process is already well under way."

If this process of short-term (within the next 10 years) debt-dollar deflation is likely to occur within developed economies, then one should not be surprised to see both paper and physical gold holdings liquidated along with other investment assets as investors are forced to meet their margin requirements, and average workers are forced to pay their consumer debts, bills and expenses, all of which are denominated in fiat currencies (primarily the U.S. dollar). A gold price collapse in dollars could occur just as it did in 2008, since nothing has fundamentally changed in financial markets since then, except there is more debt and less ability of governments and central banks to intervene.

We could even see several large institutions, such as central banks and governments in Asia, Europe or Japan, flood the markets with (sell) a portion of their gold holdings to temporarily relieve pressure from their dire private and public funding situations. The sheer momentum of financial capitalism will lead them to conduct their "re-capitalization" efforts through established fiat currency and debt mechanisms, rather than through an ongoing revaluation/monetization of gold by central banks such as the ECB (as argued in FOFOA's Reference Point: Gold - Update #1 and Update #2).

Darbikrash provides us with another insightful observation of why such a MTM revaluation and monetization process is practically precluded by the "coercive laws of competition" in a capitalist system, through the example of "competing" currencies, with my emphasis in bold [Chris Martenson's Forums - John Rubino Thread]

Darbikrash: "Beyond these points, competing currencies violate one of the fundamental requirements, that of universality. Note we all currently have access to competing currencies, we can use dollars, yen, francs, German marks etc. if we are so disenfranchised with any particular flavor of fiat. But then we face the onerous task of currency conversion, due to lack of universality. We must convert one currency to another, and suffer devaluation risk as well as a arbitrage fee to operate between currencies.

The notion of free market forces attempting to migrate patrons to a common system based on perceived stability or any other inherent advantages is not practical and subject to the same coercive laws of competition that any other unregulated commodity will precede. This means regulation is needed, and we come full circle back to the eventuality of regulatory capture, centralization and consolidation, and ultimately fewer choices for the consumer and just another, slightly varied distribution of the same wealth."

At this stage in "free market" capitalism, it would be hardly worth it for the financial capitalists to switch to a system of currencies competing relative to the floating value of gold, because liquidity constraints in the productive economy would only be magnified by that transition. It would be perceived as a futile endeavor to generate effective demand in a system that has already pulled demand forward to its maximum threshold. The following is a very loose analogy I discussed with regards to the "choices" of capitalist elites operating in the debt-dollar system earlier this year:

[Jumping the Treasury Shark]: "The choice they face can be analogized to the choice faced by a middle-class entrepreneur with a relatively profitable business operation in his home country. Although the businessman may be getting anxious about the market for his products and his ability to continue generating revenues and profits, he is also very experienced at operating the company in its current environment, with his current clients and his traditional methods of conducting business.

...There is no guarantee that a smaller market in another community would even be able to accommodate the scale at which he is used to operating his business, or that new clients there would be able or willing to entertain his services. Ultimately, the physical, financial and psychological costs of such a dramatic switch do not appear to be worth the trouble for the businessman. He decides to simply continue running his local business and hoping or praying for the best possible outcome.

Are the major financial players, who hold trillions of their net worth in dollar-denominated debt-assets, any different from the hypothetical businessman above? Perhaps they have a degree of more flexibility in their decision-making process and significantly more resources to help them decide, but they are also slaves to tradition and the human tendency of sticking to what they know."

Even if we assume that the Freegold transition will be (or is being) initially attempted in some regions, then, as darbikrash pointed out, the system will soon end up coercing economic actors (countries and large institutions) to re-adopt the "easy money" modes of accounting, exchanging and storing whatever limited value they have left. This coercion would be accomplished through both explicit regulations (capital controls, tax structures, etc.) as well as implicit incentives and the butterflies in the bellies of those who are initially hesitant to comply (i.e. the lingering threat of sanctions, asset confiscation or military force).

What this means in the debt deflationary phase of financial capitalism is that demand will spike for those "easy money" currencies which are still the primary means of settling debts and purchasing real goods and services, by natural design and by conscious regulation. What this implies for debt-dollar holders, then, is that they should not sell their dollars for physical gold when they reasonably expect that cash will be needed to satisfy daily/monthly expenses, such as principal and interest on debt. In addition, a smaller excess portion of savings should be held in dollars for more favorable entry points into various hard assets over the next few years, including physical gold.

The substantial monetization of debt-assets (i.e. private and public bonds), however, will also fail to alleviate fundamental economic instabilities, and its continuation will only make them worse at a later time by destroying the currency-based savings of people who have become thoroughly dependent on the debt-dollar system and were placed far away from the money spigot (less time to trade devalued currency for hard assets). That is why the global capitalist economy is in a classic "predicament", because neither deflation nor hyperinflation of debt-based currencies will "cure" the problem of insufficient aggregate demand anytime soon.

The ponzi process of creating additional credit-based claims on wealth to support the previous ones and "manage" a debt deflation will not be sustainable in the medium to long-term (my best estimate is 10-20 years). A self-reinforcing debt deflationary spiral will eventually grind economic activity to a halt somewhere within that range of time (most likely on the shorter end), and leave much of the global population under-employed, unemployed and/or struggling to survive. Local, state and federal tax revenues will dry up and governments at every scale and in most regions will be forced to borrow, print and spend more to maintain a semblance of social and political control.

That is when we can expect the real HI "tipping point" to arrive, as hyper-deflation has naturally set up a complete loss of confidence in the economic and political structures of global society, which will invariably include the global reserve currency. By that time, the destruction of the dollar will simply be the equivalent of blowing out the candles on a moldy cake that nobody dares to look at anymore, let alone eat. It will be a ceremonial burial of the deceased; the act of laying limp corpses to rest after bloody battles have already been waged for years and years on end.

The only legitimate question to ask, then, is when will HI of major fiat currencies happen and what does it imply for the value of gold in specific locations.  Although this article was meant to be the final part of my series on the future of physical gold, I have decided to write an additional fifth part for the sake of constraining length and increasing clarity. Part V will delve into more detail about the prospects of HI in various regions and its implication for the roles and values of physical gold. We will discuss the fact that the "periphery" of a complex and dynamic system tends to completely give out before the center does.

Until then, we should remember that upcoming years will be characterized by debt-dollar deflation, and therefore the dollar price of gold will most likely face significant downward pressure for some time. That does not mean physical gold, however, should not be purchased as either inflation insurance or a long-term monetary store of value right now. Both of those functions are best served by physical gold (and silver to a somewhat lesser extent), and the percentage of excess currency wealth that one should devote to physical gold is entirely dependent on the individual's circumstances (amount of excess wealth, levels of debt, recurring expenses, extent of physical preparations, etc.).

Slaughter Canyon Cave [Obtained from Our Amazing Planet]

Some people will find that they cannot reasonably afford to purchase any gold, while others will find that they are well-prepared for deflation, both financially and physically (control over the "essentials of your own existence"), and now is a great time to allocate some excess wealth towards precious metals. Still others may even find that they happen to live in a specific location in which gold and/or silver could soon potentially thrive as an informal means of exchange. As debt-assets and confidence deflates, the unifying structures of economic, social and political coordination will seize up, and the subtle cracks between local environments will be magnified into canyons and caves.