My last few articles talked about the Golden Triangle, the ‘Nirvana’ of Economics; about what is needed to achieve an honest, stable foundation for the world’s economy. A stable economic foundation comprises Gold (and Silver) money, credit sharply differentiated from money, and credit in turn sharply differentiated between borrowing as represented by the bond market and clearing as represented by the Real Bills market. Money, Borrowing, and Clearing are the three legs necessary and sufficient to ensure a stable economic foundation.
This foundation is ready and able to support any level of legitimate economic activity. It is time to start building on the foundation; to see how the vital economic functions of the economy relate to the foundation. Most importantly, to build the economic superstructure without compromising the stability of the foundation; compromise by introducing fraudulent, dangerous practices such as borrowing short to lend long… or compromise by issuing legal tender notes against irredeemable promises backed by ‘faith and credit’.
Bond markets represent long term borrowing used to finance fixed capital. Equities in turn represent the ownership of fixed capital. Money borrowed through bond markets and money acquired through equity markets is closely related; the relationship between bonds and equities is one major link between foundation and the superstructure. I will talk more about this link in an upcoming article.
Another vital link between foundation and superstructure is the relationship between commodity markets and the Real Bills market. Just as bond and equity markets support the financing and ownership of fixed capital, bill and commodity markets support the financing and ownership of flowing capital. Real Bills finance the movement of vitally needed goods on their way to the consumers. Commodity markets represent the ownership of many of these goods; foods (grains and meat products) as well as fuels (crude oil, natural gas, gasoline) and other essentials.
To fully understand the importance of commodity markets, we need to take a look at their history. Commodity markets, more precisely commodity futures markets, grew out of the need for producers of commodities, like farmers and ranchers, to reduce the risk of their inherently risky enterprises. A farmer is much at the mercy of weather, crop disease, locusts, and other naturally occurring conditions not under his control; he certainly does not want to add price risk to this already heavy risk burden.
There is no way to reduce natural risks… only to ameliorate their effects. Fortunately for the farmer, it is possible to remedy price risk. Price risk is avoided through the technique of forward sales. In a forward sale, the producer and the user of the product sit down and negotiate a sales price for crops about to be planted, crops to be harvested months in the future. The crop is sold ‘forward’ in a temporal sense, well before harvest. Future sales are voluntary; the buyer and seller must both benefit, or else no transaction would take place.
The benefit to the buyer is the very same as the benefit to the seller; the elimination of risk. A poor crop could lead to shortages, soaring prices; the buyer would be hurt. A bumper crop could lead to a glut, collapsing prices; the farmer would be hurt. By agreeing on a mutually agreeable price well before the harvest, both participants avoid the destructive effects of adverse price swings. Of course, they also give up the opportunity to benefit from beneficial price swings; the farmer will not profit if prices soar, and the buyer will not profit if prices collapse. So be it; neither farmer nor end user are willing to risk possible excess profits against possible major losses; major losses could easily lead to bankruptcy.
But there are problems with forward sales; each farmer is obliged to find a buyer for his full crop, and each buyer wants all his product needs satisfied. It is unlikely that one buyer and one farmer will offer or need the same quantity of product; more than one farmer and/or more than one buyer would need to participate in most forward sales. Such deals are hard to negotiate, costly, and risky; what if a buyer or a farmer defaults? This is a form of direct barter, difficult under any circumstances… and more difficult in the temporal sense; far more difficult than an immediate barter of ‘fish for eggs’ in a farmers market. Not only spatial, but temporal obstacles must be overcome in order to negotiate a deal.
An opportunity thus arises for a ‘clearing house’, an entity that accommodates the needs of both sellers and buyers of corn, or wheat, or cattle. The clearing house issues standardized contracts for these and other important agricultural commodities, and guarantees acceptance and delivery of the commodity to both buyers and sellers. This makes the farmers life much easier; no more need to find an appropriate counterparty and negotiate a deal, simply call the commodities clearing house and sell contracts. No risk of counterparty failure to worry about… or to insure against. The clearing house takes care of all this.
Same for the buyer; to ensure receipt of the right product at the right time for a known price, a flour mill buys wheat futures and waits for delivery… at a locked in price. A slaughter house does the same; buys appropriate cattle futures, and later takes delivery. The only remaining problem is one of market liquidity; what if a bunch of farmers decide to sell wheat contracts all at the same time, and there are not enough buyers present… or vice versa? Prices would become unnecessarily volatile, and the clearing house could not assure timely transaction of all contracts… without the services of the third protagonist in commodity futures markets; the often reviled speculator.
Unlike the farmer and miller who are looking to avoid risk, so they can concentrate their capital in their respective business, the speculator risks his capital… hoping to capture the profits the producer and buyer choose not to seek. He neither grows crops, nor makes use of them; he simply studies the markets, and decides to buy if prices seem low, and to sell if prices seem high… thus accepting risk in return for an opportunity to profit. In effect, when he buys when the farmer wishes to sell, he seeks the excess profit the farmer chose not to seek, and in return takes on the farmer’s risk. He does the same for the buyer; by selling when the user wishes to buy, he seeks the excess profit the buyer chose not to seek… and in return takes on the buyer’s risk.
Clearly buying at low prices tends to support prices, and selling at high prices tends to cap prices; the ‘nefarious’ speculator is doing society a favor. Collapsing prices hurt the farmer, perhaps pushing him into bankruptcy; bankruptcy of farmers is not to the benefit of any society. Skyrocketing commodity prices hurt all commodity users. The speculator’s work, his risk taking, tends to level prices to the benefit of all.
Indeed, the so called ‘speculator’ may better be called an arbitrageur; an arbitrageur who works in the vertical –time- dimension rather than the horizontal –space- dimension. An arbitrageur by definition works, and profits, by reducing price unbalances, or the ‘spread’. Temporal arbitrage tends to reduce extreme price swings over time, just as horizontal arbitrage tends to reduce extreme price swings between geographic areas.
So, what does all this have to do with ‘economic Nirvana’? Very much indeed. Speculation as a means of ameliorating naturally occurring risk is one thing… speculation on man-made risk is another thing; it is called gambling. Risking one’s own money to speculate is one thing; using other people’s money to gamble with is another thing altogether… especially if the rightful owner of the money has no say in the gambling being undertaken with his money… and double especially if gambling losses are charged to the rightful owners of the money, while gambling profits end up in the pockets of the gambler. This can no longer even be called gambling; it is called stealing.
This of course is what is going on today, so much so that this particular type of theft even has a name; it is called ‘socializing’ losses. Heads I win, tails you lose… this is what happens to you if you have any of your money ‘deposited’ in our fiat based banking ‘system’. The legitimate owners of deposited money have their property rights invaded; the money deposited in the bank is no longer considered the depositor’s under the law; the depositor has no say in the ongoing swindle.
As if this legalized theft were not bad enough, it gets worse. The biggest casinos today are not the commodity futures markets, but the ‘enhanced’ futures markets. It is today possible to speculate on future interest rates. It is today possible to speculate on foreign exchange, the relative value of fiat currencies. Since both these factors are under human control… namely under the control of central banks and treasuries… it is not correct to call betting on future interest rates or on foreign exchange values speculation; it needs to be called gambling.
The so called ‘carry trade’ is the illicit bastard son of futures speculation; it combines interest rate gambling with forex gambling… a double whammy. Just think about it, billions of Dollars are put to risk in this type of gambling. Gains… we should not call them profits, as legitimate profits are hard earned… are enormous, and are risk free to the participants, the ‘too big to fail’ banks and financial houses. These gains come at the loss of the real economy. Of course, losses that are ‘socialized’ also come at the loss of the real economy. The tax payer is forced to foot the bill for both gains and –inevitable- losses.
Not only monetary capital but human capital is devalued by this gambling, instead of being put to good use solving the world’s endless problems; poverty, war, desertification, hunger, disease, pollution, on and on. The ‘best and brightest’ minds are busy inventing ever newer, ever riskier derivatives to ‘game’ the system… instead of putting their talents to good use.
The problem seems insoluble, and so it is; under fiat. The real solution is not ever more regulation, not ever more infringement of property rights, not ever more ‘oversight’… not more ‘hacking at the branches of evil’. The solution is very simple; destroy the root.
The way to destroy the root of interest rate speculation, and forex speculation, and carry trade speculation, is to destroy the profitability of the casino. Put the world economy onto the stable three legged foundation of the Unadulterated Gold Standard… and the casino is out of business.
The Unadulterated Gold Standard stabilizes interest rates, making bond speculation unprofitable. Once it is clear that there are no profits to be made, the speculative edifice collapses, with no regulation required… without any new bureaucracy or new government ‘oversight’… without a shot being fired.
The Unadulterated Gold Standard eliminates forex gambling… after all, Gold money is money anywhere, unlike Dollars and Yen, or Euro and Yuan… and if there is no forex, then how can there be speculation on forex? With interest rates stabilized, and no forex to ‘fluctuate’, then the carry trade also disappears without a trace. No more destructive ‘hot’ money flows; there is no more ‘hot money’. If there is no ‘hot money,’ how can there be ‘hot money’ flows?
With all the obscene gambling demolished, badly needed capital -both monetary and human- will look to where real profits can be made; in the real economy. Speculation will be reserved for natural risk amelioration, where it belongs. As Professor Fekete so aptly puts it, fire insurance is prudent and worthwhile; unless arsonists run the insurance company!
Rudy J. Fritsch
Editor in Chief
The Gold Standard Institute
January 4 2012