BLUF (bottom line up from for the squirrels): I look at how I believe the mistake of “sound money” may be pegging cash to gold. I believe gold is real money and should be pegged/fixed to energy. I believe cash as currency then should float against the energy reflecting the amount of “stuff” or labor needed to extract that energy. I see two possible currency schemes unfolding: a nation-state currency which is 1:1 BACKED by commodities/gold and a localized “BRICS” currency which is used essentially for commerce amongst nations that may have a “gold-based” collateralized fractional reserve currency to establish local currencies as “good currencies” – to be used with private commerce. With a nation-state 1:1 model, no nation can usurp the power of a global reserve currency, and with a 1:1 backing, there is full trust in the purchasing power of this at the nation-state level.
I only got into this stuff deep late in 2019, so there’s a world outside of precious metals I’m familiar with, but don’t understand deep in the weeds. I’m hoping this post has more questions than answers to engage those in the weeds, but primarily I’d like to examine my own form of monetary religion with the “gold-backed” dollar and how I’m shifting some of my philosophy to a “gold-based” dollar. I still believe in sound money, but feel how we have gone about it may have been flawed.
To me, a gold “peg” to a dollar makes sense on paper, but has serious flaws in modern-day society. Especially in today’s debt-driven world. Meaning, it’s sort of like driving up to a horrible car accident and offering to sell insurance to the mangled driver who can’t speak or open his eyes through the blood. Meaning – the crash of the car already happened, and the driver isn’t even cognizant enough about his own surroundings to understand the concept of insurance this late in the game. Meaning, trying to make the square peg fit in the round hole AFTER the system unleashed $2 quadrillion in derivatives and hundreds of trillions in debt seems…not likely to happen. The damage has been done.
There’s two options essentially that exist – wait for some sort of reset, write off all debt, and start all over against with a gold-backed system or retrofit where we are to a “gold-based” system.
The concept with “gold backing” is have the 1:1 gold to dollars to PREVENT the debt from occurring and spending only what you have. The flaws in my reasoning then see the $31T in debt, along with the $9T in Fed balance sheet, along with the $150T in unfunded liabilities – you get the idea. Additionally, how would businesses expand? Save up for a decade to build a factory, or finance it for cheap credit with a monthly payment and build the damn thing? In this case, responsible leverage with collateral seems tenable.
However, if you were going to do a “gold peg” how do you even begin to account for the price of gold with all of that debt out there? When I first started this, the thinking was, “there is $40T in cash printed, so take that and divide by the oz the US has”. It started to get really convoluted when considering all currencies in addition to the US currencies as well as all of the oz owned by all of the central banks, all the countries in vaults – then consider all of the home/vault bullion storage, the consider all of the jewelry. There’s something like 200,000 tons ever mined. So it gives you a good idea of the total pile.
What happens quickly is you can then start to see obscene numbers. Like hundreds of thousands to millions per OZ. I mean, if you own gold, that sounds amazing. But no one has a million laying around to pay you for that oz of gold, so that number is silly other than on a chalk board. It’s money that was already spent in debt. So it then makes sense to base the value of the gold on the cash in existence, right? You start to see estimates of $40-$80T in existence worldwide.
Trying to then PEG the dollar to this number really then becomes throwing darts. You would have to somewhat accurately guess how many dollars out there with how many oz. For argument’s sake, I had previously come up with like $200,000 per ounce as EXTREMELY reasonable. Let’s say, to round up, we currently have a $2,000 gold price. That means, in essence, gold in notional terms is worth about 1% of global money. So there is $100 out there in money for every $1 in gold. Clearly, we are well past the ability to ever go 1:1 and revalue gold to $200,000 per ounce.
I would consider that perhaps 150 years ago, this number was much closer to 1:1. Perhaps with fiat, banking, and borrowing then it was 2:1? 3:1? Don’t know – I’ll let this up to the monetary historians out there. At 100:1, that ship has sort of sailed.
So what to do? Let’s look at little at the fractional reserve concept.
The fractional reserve
The main issue you can see with “pegging” a currency to a dollar is it limits spending in emergencies or growth. The Austrian folks would be like, “that’s a FEATURE!”. And, to an extent, I’d agree. But there are times of severe emergencies that might require to borrow more than you have. Think about how many years ago we were a nation of savers, now we are a nation of debtors – perhaps you had $20,000 in savings and something horrible happened where your kid needed $50,000 in cancer surgery. Perhaps a fire took your house out and you lost everything. Perhaps you lost your job during a depression. Perhaps you were older and got sick. Then, consider new businesses that would go to a bank and try to lend money to start up. Borrowing money to buy a house. You need to borrow money to grow the economy.
Risk usually is what takes care of the collateral. Perhaps with a business loan you might need 40% down and have 8% rates due to the 90% failure rate within 5 years. You put the 40% cash in, and if you fail to pay, the bank seizes the property, equipment, and anything else – perhaps they write down the loan 30%. Out of 1,000 loans, perhaps you expect a certain failure rate. With a house, if someone puts 20% down, and you borrow 80% of the value, and you default – the bank in theory can get its money back. Unless the housing market crashes. Your credit score helps assess the amount you need down as well as your interest rate.
But when we create money out of thin air and borrow it into existence – that risk might not be accurately captured. Sure, we have gold in Ft. Knox, supposedly, but how is that tied to anything? It’s literally just sitting there. We read about central banks buying gold, but the Fed does not own any.
In western societies, some form of backstopping of social services came to be in the 1930s. Many want to call FDR a socialist, and it’s hard to argue that these Keynsian programs did not add a lot of socialism to this country. But this was intended for basic human survival. Money was borrowed to get us out of the depression and the productivity of making war “stuff” helped really pull us out of it. From what I understand, war bonds and later high inflation helped us get out of this debt in the 1940s.
But one then has to look at when the Fed came to be, that the path moving away from the 1:1 gold standard began to take form. You could see the backing being less and less until Nixon did what he did in 1971. During this time, you have to look at the great advancements in society with all of this. I am a huge fan of the game “Civilization” and in it was a “banking technology”. I forget the exact term, but it was something like “financial engineering”.
Many today want to scoff at the MMT people, and I’m one of them, but this kinda sorta started with Keynes back in the 1930s. Meaning – it’s been in our system now almost 90 years to some degree, but only the last 40 did we see the debt spiral out of control. This also correlates with lower interest rates for 40 straight years. Instead of being responsible with this lower interest rates to pay down debt – what they did was then borrow more and more. One can also observe how irresponsible leverage was back in the 1920s which then perhaps was a key ingredient to the “roaring 20s” which led to the Great Depression in the 1930s, and one can then also see a parallel with this amount of debt incurred which has led to amazing market gains the past 12 years or so. So while history doesn’t repeat, it rhymes – we could also look at the 4th turning stuff to see perhaps being drunk on so much leverage the past 13 years is sort of the same trap that happened with the roaring 20s. And this is why many see perhaps a deflationary bomb coming at some point. For all we know, all of this QT that started 11 months ago may have begun a deflationary bomb.
I didn’t understand fractional reserve banking well. Back in the day, I thought if I put money in my savings account, and they paid me 5% interest, that they are lending out my deposits to people buying homes at 8% rates, then pocketing that spread as profit. Little did I know that the deposits during the GFC might have been levered up 30x+. In the Great Depression – they saw runs on the banks, and the banks didn’t have the money. Today, good luck trying to show up at the bank and taking all of your cash out and closing your account. They now have capital controls to prevent such runs.
As a result of the GFC, I was led to believe that banks were required to de-lever a lot and thus have a 10:1 ratio. However, I also understood that entities outside of the US didn’t do that so much. Then, during COVID, I heard they removed the 10:1 ratio on US banks. This 10:1 ratio was, in a sense, a responsible means of preventing massive amounts of borrowing and inflating money supplies. Perhaps I’m reading this wrong, but ideally, a 10:1 ratio was a means of trying to remain SOMEWHAT responsible with leverage.
One has to then see the quality of life we have now versus 100+ years ago and look at all of the great advances that perhaps came from having money in this system to invest in technology, research, and startup companies. Without this form of leverage, you could speculate, perhaps correctly, that we wouldn’t live much differently than our US Amish live today. I’m not talking about horses and buggies literally, but without all of the excess cash, communities would have to rely on each other for productivity. You could not afford a pool. These bigger houses could never be built. You could then figure that industry would have never had the liquidity available to expand and we might still be more agrarian. Meaning – there have been merits with leverage, but the question is, how much is too much leverage in the system??
No one can know what life would be like if we were still 1:1 with gold and never levered up the system, but I can tell you that it doesn’t take long going down that rabbit hole to really solidly understand we are where we are today because of financial engineering.
Which then brings up the question we asked above….how much is too much?
In 2018 or so, I was walking through a best buy and saw a pink computer and next to it, $300 headphones. Anyone could apply for Best Buy credit and get rubber stamp approval. I had disgust in my heart, at that moment, and said, “this needs to stop”. It’s not hard to look up the average CEO to worker salary ratio is like 400:1. It’s not hard to see the financial guys on Wall St that make 7 or 8 figures shuffling paper and trades around. Furthermore, you can see how we have zero problems sending $100b to Ukraine to help them fight a war against Russia – but our schools are a joke. We have a spending problem.
With this spending problem, the hope I had was that gold would rein in this spending. If we just did a 1:1 gold backing, all would be solved. But it won’t be, because we cannot stop spending more than we take in, by a LOT now. No one can win in either party now without buying votes in some way, shape, or form for their party’s interests. I am what I considered to be a “fiscal conservative”, but these don’t exist anymore. It’s either the left promising UBI and free everything, or the right offering virtually no taxes – in both camps, you create massive deficits. Spending is the root of all evil.
But we also saw how this spending had improved our lives over the last 100 years. The main issue I see now is this…
- With the financial engineering, those at the top of the money “food pyramids” are taking far more of the pie than we feel comfortable with. Excessive leverage may be being soaked up by them by means of asset inflation.
- those in power are playing the stock markets with insider information and getting stupid rich, and no one seems to want to stop this
- elections are costing more and more, requiring more special interests to essentially buy votes. I looked into running, and essentially was laughed at by a dozen people when I told them I didn’t want to deal with any special interests. You are simply not a serious candidate unless you pimp yourself out there for millions and do nothing but fund raise. This system is broken and those who can change it won’t, because it makes them all rich.
- The amount of debt needed to “keep up” increases faster than wages, which has led to a hollowing out of a middle class in the US.
- 10:1 leverage SEEMED reasonable. But the gloves came back off and we are accelerating a debt spiral.
So is 10:1 ok? What is the collateral? Cash?
Russia and gold and oil
Where I think the flaw in the monetary system is, is pegging a dollar to an asset. We can talk about 1:1 gold to currency all day long, but you run into the same issues time and time again with the Amish lifestyle. If you then talk about a 10:1 cash to gold ratio, it seems more reasonable than 1% now. But isn’t that also kind of arbitrary? If gold only comes into the system at 1.25% per year, then would it not stand to reason that inflation could not occur to any degree much different than the gold supply? It seems with $31T in debt, the government needs higher levels of inflation to then inflate their way out of debt. IF you have a peg to a dollar – it limits the ability to create inflation. Which, perhaps, is what Austrian fundamentalists want?
Even at 10:1, you might then be dealing with crooks. I think the issue is conflating CURRENCY with MONEY. And, when the gold peg of sorts left the dollar in 1971, the US dollar ceased being money and thus became a fiat currency, backed by nothing. So if there is no peg, in essence, how do you value dollars to gold? You would think in that scenario that a gold price might go vertical? Well, it kind of did, but the main issue then appears to be anti-gold policies “verbally” by central banks, while then going out and buying it. Except the US. We are rumored to have 8100 tons, and some say audits never happened. Some say audits are infrequent and not perfect. Others say they happen routinely. Yet others say we leased out all of that gold 40 years ago and we have none. China just admitted to adding 300 tons of gold.
Part of a tweet I had yesterday was sort of a white flag with the 1:1 gold to USD. It’s not that I don’t want sound money, it’s that the realization that can never occur, ever, dawned on me with the stupid levels of debt out there and all of our elected politicians that want to protect the status quo. Change to 1:1 can never come from within.
Enter Putin and gold to oil.
I did a LOT of work 18-21 months ago about “gold being the center of the financial universe”. Everything you do, you can see essentially that gold is the peg to other things – not necessarily currency. For example, the idea that an ounce of gold is equal to a fine suit goes back hundreds of years. We can measure a gold to silver ratio going back perhaps 3,000 years. No matter what the nominal currency value was, gold was always related to other things.
And now oil.
When I did a lot of this work, you can see an oscillation from gold to oil. Peaks and valleys. They also have a relationship. You need money to explore and drill for oil, and you need oil to extract gold. We can now substitute “currency” to extract oil, and you need oil to mine for gold. Meaning – you can take dollars (currency) and buy things to extract that oil. But without some sort of collateral to de-risk the currency, it seems a country can just print money out of thin air and add debt to their central bank’s books to infinity to get energy. AND – that is the root issue here we are finding with un-collateralized currency.
Meaning, to me, the price of gold essentially is dependent on the energy needed to extract it, and not vice versa. Now what is interesting – is measuring fiat dollars to ENERGY, not gold.
My first real look at this came with Luke Gromen earlier in 2022, and I really did a deep dive on this. The chart is mine, but the model is based off of how I interpreted Gromen to put it. Putin didn’t really back the ruble with gold. But there was a relationship established. Even a hint of this relationship sent the value of the ruble against other currencies to the moon.
I think this is what the model is evolving to:
When I REALLY started to look at this, it appeared that….
- Gold is “base money” that can be collateral to show a currency has value in a fractional reserve system. Other things can be pledged as collateral, but gold is a dense financial energy store that can be relatively easily stored and transferred as well as titled to SN.
- Oil is energy and is required to get base money out of the ground
- Currency varies against the effort to produce energy. This needs to float against oil.
- Therefore, a currency can have a floating relationship with energy, but the energy would have the “peg” to gold.
- The currency at the top of this can be digital currency. The question then is, will proper currency controls ever work against a pool of collateral?
It then really dawned on me that this was sort of the beauty of the PetroDollar – where you saw the link to currency to oil. But what was missing to keep the system from getting in over its skis, was to have a stronger relationship with gold to oil. To me, this would not really be a permanent peg, but a market with relatively tight spreads. So you might say 1.2g of gold today, but if everyone went out and mined gold, this could then be raised to 1.5 g of gold, etc. If everyone went out and drilled oil, perhaps this is lowered to 1g of gold. This would be not an EXACT peg, but a tight spread which is range bound. This is a PEG-relationship and not a DIRECT peg. Meaning, this “fix” could change once a month or quarter to adjust for market conditions.
In Putin’s system earlier this year, the government was offering 5,000 rubles for 1g of gold. They never said they would REDEEM rubles for gold, which is when all of the gold guys got on me and others talking about this. At the same time, it was said you could buy oil from the Russians, in gold. This is where the 1g of gold per barrel of oil came from. If you look at the charts over years, you pretty much see that a barrel of oil was usually costing about 1.2 g of gold, with a 25% or so swing in oscillation. But that relationship is there over the last 70 years or so.
While fiat currencies devalue – THAT relationship remains.
Death of Petro Dollar
I have written about this kind of extensively, but the “value” of the USD is that if all of the energy in the world is bought in USD, that creates a demand for it. But China is visiting Saudi Arabia this coming week, again, and with this – rumors of the Saudis selling oil in Yuan heating up. Zoltan wrote an article suggesting that Russia may sell oil at 2 barrels per gram. Russia having offered to sell oil in gold.
You can clearly see that central banks are now buying gold, en masse. Why?
If, one day, you could buy oil in gold or your local currencies, why would you need to then buy the dollar with your currency? If the main driver for owning the USD is to buy oil, and those who supply the oil no longer require the USD to buy oil, that lessens the relationship of the USD to oil. It’s not a cliff drop, but you can clearly see a glide path where the USD demand lessens as gold is increased as a reserve currency for settlement.
It would then stand to reason that a lot of these countries are perhaps buying gold with their local currencies to bolster their own national interests – exactly like what Ghana is doing. You could probably see Canadians are not far behind. All of the talk of nationalization – I have said many times I don’t see that happening because the government is not a miner. All they have to do is put some sort of royalty on miners, or in the Ghana case, require a miner to sell them gold in local currencies and let the miner pay their people in the local currencies or have the miners do the currency conversion.
Think about what I said above – how it would not make sense for us to have any kind of real 1:1 “gold backing” with all of the debt we have? But if we did not have that level of debt, wouldn’t it make sense to have gold as a “base money” and then have currency printed at about a 10:1 clip using the US treasury gold as collateral? Not a peg, but a collateral. Since a lot of the US treasury debt is short term, you could use the gold there to then lever up 10:1 on new debt. If you have $500B in gold, today, and you have a cap of 10:1, and $30T in debt, this would then stand to reason the price of gold, in USD would have to raise about 6x over the next 1-5 years to account for the new debt created that is rolled over. Perhaps they choose a 20:1 at the start (5% collateral) and with this, gold only needs to go up 3-5x. This would significantly lower the value of the USD. But it’s about the only way you can see a way to the US getting to where it needs to be. Other than perhaps then buying gold from US miners. Again – we have spending problems. So either you stop spending, or gold goes up 3-10x. Your choice if you want to keep using the USD in the new system that appears to be getting spun up.
Why did I choose those numbers? Look below.
I stole this chart off of the internet, and I didn’t do 5 hours of research to verify this, but many of the charts I reviewed told the same story. That countries on the left side of this with massive amounts of debt want MMT and to bury the idea of gold. But countries on the right have far less debt per capita and could perhaps pivot to a system with gold as collateral.
You can also see a flavor of this chart above here – take note the BRICS countries seem on the low end. The MMT countries on the high end.
Imagine a reality that could happen in the next 12-24 months:
- Russia reads Zoltan (and here for non-premium ZH readers) and then decides to offer 2 barrels of oil for a g of gold. This re-values gold overnight to about $3600 or so per oz. This also would revalue silver to perhaps $45 per oz, but let’s keep silver out of this as the manufacturing requirements for this might lead a different path than gold here. This has a net effect of doubling the value of Russia and China’s gold hoards. Hemke pointed out yesterday in his podcast this could take China’s potential $2T in gold reserves to $4T. This also potentially allows them to dump more US treasuries onto the market.
- China and others start to buy oil from the Saudis/Russians in their local currency because the sellers know the buyers have an ass load of gold /commodities they could convert that currency to, if they needed to. I believe the convertibility here is what provides the upsides to these currencies and reduces risk. YES – you can do that with the USD, today. But let’s go further down the rabbit hole. Of most issue is the gold is SEPARATE from the printed currency, so this lack of link would need to be addressed.
- All of these countries that have been buying gold for the last 10 years now see the value of this pile double in value. Some of this gold may then be sold off to reduce debt loads further – or to create more currency to improve their standards of living. So while gold could be revalued to $3,000-$5,000 in USD terms, you would see gold hit the market and lower it a bunch.
- Rather than sell their currency to buy USD, countries bypass this and settle in gold or local currencies for oil.
- IF there is less demand for USD, you could see the USD plummet. If gold “doubles” in value in a near term, you would also potentially see a smash down of the USD. This would in theory make asset prices go up, as you would need more currency units to buy them. Gold is a highly liquid asset that has correlation with money, historically.
The new system
Many have told me not to worry about a gold-based system because we have 8100 tons and that should satisfy that discussion. I’m an inquisitive person by nature. But at these rates, I think I calculated we have like $500b in gold. However, we have perhaps $40T in USD cash out there, let alone what the hell these $80T in swaps are. What you may find is that with all of these countries accumulating more gold, with their much lower debt per capita, it is possible that their gold may exist at a 10:1 backing to their currency as COLLATERAL. If we indeed have $40T out there in cash and gold doubles in value, we are still at 40:1. But that’s just cash, not debt.
I can see the Russians and Chinese doing a form of gold/commodity backed currency within the BRICS system like noted above in my chart. I wrote in depth about it last week, so no need to revisit all of it, but you could see a BRICS currency that is used to buy/sell commodities around the world. Meaning, a global reserve currency which is 1:1 with commodities in the system. However, the local currencies would have the gold-based collateral. The 1:1 model is your INTERNATIONAL SETTLEMENT money. However, to be a member state, you might need to have a gold BASE to your paper currency at perhaps 10:1 (which I define as “good currency” on the chart. This would show that the country is stable. has healthy debt loads, has decent currency controls in place, and has sufficient collateral in case of emergencies. That collateral can be borrowed against in times of emergencies rather than just printing to infinity. This is a key difference from MMT. Borrowing against collateral is different than “debt doesn’t matter, we just inflate out of it”.
***** I think there are potentially 2 camps here. A “local currency” to be a member of a BRICS currency basket for commerce would need the 10:1 gold-based collateralized currency. A “global reserve” currency would be the 1:1 I discussed last week, where a commodity-backed currency is used at the nation-state levels. *****
The USD is obviously not backed or based by anything, but at least we supposedly HAVE gold. And oil. And tanks. We just don’t want to show people our vaults, mine gold, or extract oil. THAT is what needs to change in the emerging system that we seem to be fighting. We LOVE the ability to print green slips of paper and give to people for oil. That was yesterday, sorry. I feel when the US seized Russian reserves, the day of us being the MAJORITY reserve currency ended. Other systems will pop up which will create a market alternative to the USD. None of what I said here is probably the exact model, but you can potentially see where the puck is going to skate to it as many nations got scared shitless of us confiscating hundreds of billions of reserves and kicking Russia off of SWIFT. I believe this will be Yellen’s legacy 100 years from now – she singlehandedly killed the USD as the reserve currency of the world as the Treasury secretary. It might be referred to something like, “Yellen’s gaffe” or something like that. While we were moving away from dollar hegemony perhaps over the next 10-20 years, I believe this was the death knell that killed it.
I believe this whole thing globally we are seeing right now is the WEF/West/MMT/progressive force fighting against a BRICS/sound money/trader/regressive force. I believe that the West doesn’t value gold nearly as much as the East, and I believe that GOLD and ENERGY will be linked in the next 100 years.
I believe the flaws with the paper peg to gold is that you peg gold to a currency, rather than peg gold to the energy. You need a CURRENCY to float against the ENERGY based on EFFORT(work) to get the energy (labor, materials, etc which are subject to supply/demand fluctuations). Things can then be bought/sold for CURRENCY to TRADE for ENERGY. GOLD as a BASE MONEY can then be used as COLLATERAL to create CURRENCY to buy ENERGY (this is your POW for the currency to have “value”).
Meaning – I think what the Russians, Chinese, and BRICS are doing will force the gold price up, in some way, shape, or form. I believe these movements, along with the selling of energy in Yuan, rubles, gold, etc undermines the demand for the USD. Countries with better balance sheets, possessing gold, will be first in line to buy energy. In the end, why would you sell energy for “worthless” currency with no collateral? To me, the US has plenty of gold, gold in the ground, and oil/natural gas. They are trying to use the little green slips of paper as long as they can get away with it. Those days are numbered. I believe the US will be fine adapting to the new system down the road, given our resources. I feel Canada will be fine – they have oil and gold in the ground, but not gold in the vaults.
Those who have a static view on the USD are not properly accounting for the world moving in a new direction. How it gets there is not perfect, but you can clearly see currency wars are now fully in effect.
December 8, 2022 at 1:32 pm
Good paper, Nate.
December 13, 2022 at 9:27 pm
The problem with fractional reserve banking and debt-based currencies is that there ends up being more debt than actual money to pay it back with.
“You need to borrow money to grow the economy.” Why’s that? Shouldn’t a government issue their own public money to grow the domestic economy instead of borrowing commercial money from a central bank? Wouldn’t that save the nation and its people huge sums of interest?