Search Blog Posts

Sunday, May 5, 2013

Gold Backwardation and the Collapse of the Tacoma Bridge

With Anthony Wile
Dr. Antal Fekete

The Daily Bell is pleased to present this exclusive interview with Antal Fekete.

Introduction: Professor Antal E. Fekete is an author, mathematician, monetary scientist and educator. Born in Budapest, Hungary, in 1932, he graduated from the Eötvös Loránd University of Budapest in mathematics in 1955. 

He immigrated to Canada in 1957 and was appointed Assistant Professor at the Memorial University of Newfoundland in 1958. In 1993, after 35 years of service he retired with the rank of Full Professor. In 1995 he was Resident Fellow at the Foundation for Economic Education in Irvington-on-Hudson, New York and in 1956 he was Visiting Professor at the Francisco Marroquin University in Guatemala. He is the founder and chairman of the board of the New Austrian School of Economics in Hungary. His website is Professor Fekete is a proponent of the gold standard and critic of the current monetary system. His work falls into the school of free-market economic thought led by Carl Menger. He is an advocate of Adam Smith's Real Bills Doctrine.

Daily Bell: Nice to speak with you again. Let's jump right in. Why is the price of gold declining?

Antal FeketeColumbia University professor Michael Woodford, the world's most closely followed monetary theorist said recently that if we are going to scare the horses, might as well scare them properly. He said it in an allegorical sense: loose talk about ending QE and about exit strategies is amateurish. Telling the world that central bank financing of the public debt is here to stay, and that QE is forever, is professional. The allegory can be extended from fiscal policy to monetary policy as well. The demand for dollars is waning spectacularly due to its unprecedented debasement that, to add insult to injury, is done with great fanfare. The price of paper gold was declining in April because Bernanke now thinks it's time to scare the horses properly. They have strayed too far afield to graze. They should get back to the dollar turf.

Daily Bell: Where is the price of gold headed from here?

Antal FeketeThe price of gold is headed for extinction. I for one don't believe that the price of gold is headed for five digits. Long before that might happen, permanent backwardation* would shut down the gold futures markets. Gold could no longer be purchased at any price. Gold would only be available through barter. World trade is facing an avalanche-like transformation flattening out monetary economy into barter economy. Practically all economists, financial writers and market analysts have missed this possible scenario. They don't see the greatest economic contraction ever staring them in the face. They don't see the coming tsunami of unemployment. Very few see deflation as indicated by the progressive disappearance of cash gold. It never occurred to Bernanke that the new Federal Reserve notes he is printing galore could also go to purchase physical gold, causing the gold basis to shrink. Once the gold basis* goes permanently negative, the total U.S. debt, all $16 trillion of it, will not be worth one ounce of gold. That will pull the rug from underneath the international monetary system. Barter is the ultimate in deflation, and that is what the world economy is getting.

Daily Bell: Is gold a commodity?

Antal FeketeGold (and silver) must be distinguished from other metals and other commodities. Gold is a monetary metal due to the fact that its marginal utility declines at a rate lower than that of any commodity. For this reason gold does not obey the Law of Supply and Demand. For example, a higher price of gold need not call out a greater supply; often it causes the supply to shrink further. Also, the threat of a lower or falling price for paper gold, far from "scaring the horses properly," will induce people to dump paper gold and make them flock to cash gold. Keynesian and Friedmanite economics have wiped out the distinction between ordinary commodities and monetary commodities. Today no university offers courses treating the gold basis, the gold cobasis and their interplay, or on the apocalyptic threat of permanent gold backwardation. At the New Austrian School of Economics we do offer those couses.

Daily Bell: How about silver?

Antal Fekete: Silver is not an ordinary commodity either. Like gold, silver is also a monetary metal. Its marginal utility declines at a rate slower than that of any other substance save gold. The silver basis, just like the gold basis, has shown a secular decline from its maximum, the full carrying charge to zero and beyond, proving that the supply of silver available for futures trading is dwindling and disappearing fast. Permanent backwardation of silver is a matter of time, probably not a very long time. It is an intriguing question which event will come first. While there is a strong argument that its greater relative scarcity will trigger permanent backwardation of silver first, it's hard to see how permanent backwardation of gold can lag that of silver, making it probable that the two events might occur simultaneously. Be that as it may, either event will create an unprecedented and uncontrollable turmoil in the financial markets, for which Bernanke is utterly unprepared. Practically nobody realizes that the root cause of all the bubbles, price-shocks, currency crises, as well as the more recent deflation in Japan, Europe and America was the secular decline in the gold basis. The "Big Bang" occurred in 1971, when the U.S. defaulted on its international gold obligations.

Daily Bell: Why do they fix the price of gold in London? Is this how commodities should be priced?

Antal Fekete: Of course, they don't fix the gold price in London. It's more like taking a snapshot and pretend that the landscape was frozen thereby. It is another question that the London gold fix could come handy in trying to manipulate the gold price and to "scare the horses properly".

Daily Bell: Are gold and silver manipulated or is the current shake-out a result of too-high market expectations?

Antal FeketeMy own position is that manipulation in the gold and silver markets, if that's what's been occurring, is far less important than it is made out to be by market observers. Having said that, I also believe that after four decades of neglecting to study the phenomenon of the secular decline in the gold basis, Bernanke woke up and realized the extremely grave danger of permanent gold backwardation. The likely cause of the shake-out in the gold futures markets is not what you call too high expectations; rather, it is Bernanke's belated recognition of the threat of permanent backwardation, and his attempt to "scare the horses properly".

Daily Bell: Should gold and silver compete with other money to provide the world with a free-market money standard?

Antal FeketeI don't have much respect for Hayek's position that choosing the monetary standard should be "left to the free market". The market has already spoken. Hayek was not a friend of the gold standard. He didn't really understand Menger's point that market has promoted gold to the status of most marketable good in making its marginal utility decline at a rate slower than that of any other substance. There is no need to put the world through the agony of death throes of irredeemable currencies once again. Gold would beat fiat money hands down, were it not for coercive laws making paper money 'legal tender'.

Daily Bell: Should gold be the only money?

Antal FeketeIt would not be practical. There is need for money for making large payments, for example, purchasing territories such as Louisiana and Alaska; and there is need for money to make small purchases and to pay the wages of day laborers. So there is need for both gold and silver. However, it would be a grave mistake to fix the exchange ratio between the two, as was done in the U.S. when Congress enacted the Coinage Act of 1792. It is significant that this mistake was not made by the Founding Fathers of the Republic. The U.S. Constitution did not mandate bimetallism. It established one monetary standard, that based on the Constitutional silver dollar. It also established the gold eagle (without naming it) but did not make it the standard coin of the realm. The Constitution left it to the market to determine the rate at which the gold eagle would be tariffed in terms of the standard silver dollar. The Coinage Act of 1792, championed by Alexander Hamilton, the Secretary of the Treasury, established an official bimetallic gold/silver ratio at 15 to 1. This was price fixing and as such unconstitutional. That mistake led to a charade of tampering with the monetary standard, to the outrageous demonetization of silver in 1873, and to the even more outrageous demonetization of gold a hundred years later, in 1973. Time will show that these two demonetizations caused the greatest anguish in history second only to the world wars, namely, the collapse of the international monetary system that is still shrouded in the future.

Daily Bell: Should the state fix the price of gold within the context of a neo-gold standard?

Antal Fekete: It is an error to say that the essence of the gold standard is to fix the price of gold, and the way to return to a "neo-gold standard" is to re-peg the gold price. This error was maliciously spread by Milton Friedman in an effort to promote the view that the "natural state of things" for currencies is floating, and it was an inadmissible state intervention in the free market to fix the price of gold thus putting the straitjacket of the gold standard on the economy. In truth it was not the gold price that was fixed in terms of government promises to pay, but the value of promises to pay was fixed in terms of gold. Historically money is not the creature of the state. It is the creature of the market in promoting gold as the most marketable substance on Earth over the millennia.

Daily Bell: Is gold susceptible to private market forces? You indicated recently that it is.

Antal FeketeWhat I said was that one ought to distinguish between the value of gold and the price of gold. The value of gold, like the length of the yard, is not subject to individual preferences or to market forces. The price of gold, insofar as it is the reciprocal of the price of the dollar in terms of gold, is susceptible to individual preferences and to market forces. To say that the price of gold reflects the value of gold is akin to saying that an anamorphic mirror renders the true shape and form of things.

Daily Bell: Is it possible that there is too little gold in a free-market economy? Would you say that in such a case people gradually cease to hoard it and recycle their hoarded gold into the market?

Antal FeketeYou got it. People would dishoard gold if its scarcity pushed up interest rates. In the 19th century there was a saying that the Bank of England could pull in gold from the moon with a bank rate of 5 percent.

Daily Bell: What means too much or too little gold? How does an economy tell?

Antal FeketeUnder the gold standard the amount of gold in circulation tends to be just right. If people think there is too much, they could melt, hoard or export the gold coins of the realm in their possession; if they think there is too little, then they could exercise their Constitutional right to free coinage, take their old jewelry or newly mined gold to the Mint and exchange it for gold coins of the realm. The result of this flow of gold from the Mint to the refinery and back is that the number of gold coins in circulation is always optimal, conforming to the wishes of the people (and not to the wishes of the bank or the government).

Ludwig von Mises dismissed the idea of gold having constant marginal utility. According to him constant marginal utility would imply infinite demand for gold which is contradictory. This is the greatest flaw of the economics of Mises: the rejection of the essential nexus between gold and interest. Mises ridiculed John Fullarton for conjuring up the deus ex machina of gold hoards. This was as unfair as it was untrue. The concept of constant marginal utility is not contradictory, because the rate of interest is obstruction to gold hoarding. If it is sufficiently high, gold hoarding fades out and gives way to dishoarding. Equally important is the fact that if the rate of interest is too low or, more precisely, if the government and the banking system pushes it down to a level lower than the rate of marginal time preference, then gold hoarding kicks in. People present their bank notes to the banks for redemption, or withdraw gold coins against their bank deposits. Bank reserves contract. The banks must call their marginal loans. Gold hoarding is not an aberration: it is one of the main excellence of the gold standard. It is an essential part of the system of checks and balances. It constrains the banks and the government preventing them from expanding credit or running open-ended budget deficits and going into debt without seeing how the debt will be retired. It gives teeth to time preference which would otherwise be just a pious wish. Take gold out of the hand of the people, and you give free rein to the banks for unlimited credit expansion, and to the government for constructing a Babelian Tower of Debt.

Daily Bell: When there appears to be too much gold, do people begin to hoard?...Read more>> The Daily Bell