Impressive summary of the gold perspective

It would be good if some of the property bulls could do something similar. I must confess to being less than convinced with property analysis including comments such as "moon shot" , etc.

Looking forward to being persuaded otherwise.

Deflation

There is a claim that if the world enters a deflationary phase, in which money gains in purchasing power, that the price of gold will fall along with everything else.
The problem everyone has in trying to predict is that the world has never before been on a pure fiat currency system before. So examples from history are not always available.
The arguments on this point are too detailed to go into in any detail now, but I do think this is a genuine matter.
In short, I think that if the world went into a serious deflationary period, the result would be total financial collapse, and none of the fiat currencies would survive.

October 4, 2006 (LBO) - John Exter is the father of the Central Bank of Sri Lanka, then known as the Central Bank of Ceylon. This article is reproduced on LBO with the kind permission of Franklin Sanders.

Think about this great business idea for a minute. Let's borrow some surplus stuff and sell it for whatever we can get. We'll buy a futures contract to get it back at some certain future date, so we're covered. Meanwhile, we'll earn an interest spread plus commissions. While we're at it, let's sell puts and calls against the stuff even if we don't have it on hand. Our mathematical models will guarantee that our position is always neutral, and we'll clean up on commissions, interest and other fees on the options too.

The foregoing approximates the rationale of the present day, little-known gold derivatives pyramid. John Exter, a famous gold analyst almost two generations ago, was the first to suggest that gold related to paper assets in the form of a pyramid. He described the relationship of gold to paper assets as an inverse pyramid balanced on trust. Currency at one time was a gold derivative. Government issue was backed by physical gold held by central banks. Because currency was a claim on gold, it was in effect a short position against a physical asset that was relatively easy to calculate. Governments hated the idea because they could never seem to stop issuing new paper. Even the pretense of a link has been long abandoned. Since currencies no longer have gold backing, and the world still appears to function, nouveau central bankers assert that gold is superfluous..

The old currency gold/pyramid has been replaced by a little understood labyrinth of paper claims against gold. Responsible senior officials of mining companies, central banks, and bullion banks cannot begin to understand the internal mechanics in order to make appropriate judgements of risk. There are few published figures, no reserve requirements, no supervision or regulation, and no accountability. It is the private domain of bullion dealers, central banks, and mining companies. The credit worthiness of the old currency/gold pyramid was quantifiable. The credit worthiness of the new pyramid can only be an educated guess. Our guess is that it is bankrupt.

“The Fed is locked into an expansionism it dares not stop, a prisoner of its own expansionism.” The words of John Exter are as timely today as when he wrote them in 1988. For those unfamiliar with the man, John Exter served six years as Vice President of the Federal Reserve Bank of New York in charge of gold, silver and international operations. In November 1988, he presented a paper from which the following comments are taken.

Quote:

“Most people today think the Fed, despite its running the printing presses at higher and higher speeds over the last three decades, has been doing a good job. I see it on the road to a far worse disaster than in the thirties.”

“The entire world’s monetary system is in serious disequilibrium. Since money runs like water, both within each currency and among them, market forces work every minute of every day trying to restore equilibrium, while central banks worldwide, especially our own Fed, intervene every minute of every day to prevent it. So uncertainty abounds. Markets do not like uncertainty.”

“Eventually markets will win, as they always have, so you should bet on markets. The problem is timing. Confidence erodes, but very slowly.”

“The safest and most liquid asset will be gold. It will be [by] far the biggest run out of paper money into gold money in history. I cannot say when, but it is now months, not years away.”

John Exter's Inverted Financial Triangle Built on Gold

In an interview with a favorite stock broker of ours, namely Ron Gilchrist earlier this year, he told us of the inverted financial triangle concept devised by John Exter. John tutored Ron Gilchrist early in Ron's stock brokering career. John Exter is one very rare creature. He is a former central banker that believes we should build our monetary system on gold. What makes this even stranger is that John was a member of the Council of Foreign Relations, which is an anti-gold, pro collectivist, pro-fiat currency organization that is in your editor's view at the very heart of what ails America. But that's an issue for another day. What made me think of John Exter was a reference to his inverted financial triangle concept last week by Richard Russell. Richard pointed out how gold is the only asset that cannot default. As such it is at the bottom of the inverted triangle while assets of the highest risk are at the top of the inverted triangle. Financial assets at the top are the first to self-destruct.

So at the top of the inverted triangle are the equity markets, which have to a great extent already begun a process of significant self-destruction. Some $8.4 trillion of wealth has already been lost from equities. Next to fall are the debt markets and we have begun to see lower quality issues now defaulting at levels not seen since the 1930's. According to Ned Davis who spoke on CNBC last week, an amazing 40% of junk bonds are now in default. Davis noted on Ron Insana's show that a normal default rate is 2%. A 12% rate was about as bad as junk bonds had gotten in the past. So the 40% default rate represents major, major problems in lower quality debt instruments. Next to decline will be higher grade paper followed by government debt itself. Finally, Treasury Bills and bank deposits will begin to evaporate and all that will be left standing will be gold. That is why gold gains value even faster than paper in a deflationary environment.

So, even though paper money itself may gain purchasing power in a deflation, the system upon which it was manufactured comes tumbling down as the debt load can no longer be serviced. This in fact has begun to take place in Japan. Investors are not sure their deposits will be available to them when they go to take their money out of their accounts, so they continue to exchange their yen for gold, which is one reason gold has performed well this year.

The theory goes that, in a deleveraging, people scramble to get down into the cone of the pyramid. Sort of like Leonardo diCaprio and Kate Winslett trying to get up to the tip of the Titanic as it sinks under them.

The surge in the USD represents people getting out of derivatives and leverage and into Treasury Bonds. This is already a goodly distance down into the tip of the pyramid.

Only cash and gold remain.

And during an asset deflation, capital flows down the pyramid. In deflation "Cash is King", a point I made in On "Hyperinflation". But the question is what is really the "cash" that statement is referring to? What is really the bottom of that inverse pyramid that capital is striving for? Is it government paper? Or is it still the old foundation, gold?
...
But the actual electronic money credits that can be spent, cannot be destroyed, unless a bank fails and actual M1 deposits are not replaced by the government (FDIC). The only credit which is destroyed is money that has been stored in assets (asset deflation) and the ability of people to draw money into the present from their future productivity (credit cards, financing, etc...). The destruction of those do not reduce the money supply. They create "asset deflation", but not monetary deflation more commonly known as "price deflation".
...
FOFOA: Here, let me help you out with this picture. During a credit expansion like we have had for the last 27 years or so, capital flows UP the inverse pyramid. And as the private sector leverages up and creates credit money in many multiples of real money, it creates new products to buy. New places to store this "wealth". John Exter created his inverse pyramid in the 1970's, so let's add some new, monstrous levels for the 21st century. The arrows show how capital flows during a credit expansion:

That's right, it's flowing down the inverse pyramid as those upper levels shrivel and dry up. There is much loss of perceived value in this downward flow. In fact, that's what's causing it. But as we bail out entities like AIG so they can pay off the winning tickets held by Goldman Sachs and others, we are feeding more good money into this downward cascade. What should have been a loss of perceived wealth is actually being converted into REAL, SPENDABLE wealth at the taxpayer's expense. "Whew!", says Goldman Sachs as he collects on his winning ticket. Do you think that fresh digital money he just collected is going to go back UP the inverse pyramid? Not a chance! It will go down to safety along with everything else.

FOFOA: In the inverse pyramid, each level you go up is essentially a derivative of the lower levels. And during expansionary times those derivatives yield a little more than the lower levels. That is why capital climbs during the good times. But when PRINCIPLE is destroyed, this dwarfs the meager benefits of a yield and the capital scurries down the ladder to safety.

FOFOA: Got it! Thanks. But wasn't that more of a long-winded explanation of the difference between "money" and "assets" (or let's say between "wealth" and "perceived wealth")? Credit is essentially the ability to pull future capital into the present. Digital money credits are different, they are actually money, just like printed paper money. And wealth held in shitty assets is neither credit nor money. Right? It is simply an asset, or a derivative of an asset that gives you the perception of holding wealth, until "all that paper starts to burn".

During the credit expansion, new monetary units are created constantly. None of these units have disappeared. The credit expansion has stopped, but all the previous monetary units remain. And all the assets that were inflated during the expansion are now collapsing because the flow of new credits which fed the new assets has stopped. But money is not disappearing.

So now money is flowing downward into much smaller vessels. All the previous monetary units remain, and new ones are still being created by the Fed right now. But they are not flowing into those higher asset levels. They are and will continue to flow into lower ones which are much smaller.

So first of all, it is a mistake to think of the value of any assets as part of the money supply. And secondly, it is a mistake to think that just because the costs of higher levels of the pyramid are falling, that the cost of the entire pyramid will fall.

We could add an infinite number of pancakes into that pyramid. We could put in a level for gasoline. We could put in a level for bread. Anything that money can flow through, can have a level in the pyramid. And as capital abandons the dangerous heights for the safety of the foundation, the size or value of that foundation will swell.

You said, "gold is also an asset I believe (just for the record)."

That is because you believe they successfully removed the foundation of the pyramid and stuck it up amongst the investment categories. But consider this. Those same central banks that tell you gold is merely an asset still consider it a monetary reserve. Even the US Fed counts its gold as a reserve, albeit at a low valuation. So what do all the central bankers know that they aren't telling us? Why are the central banks net buyers of gold right now? Are they just building "assets"? Or is something else going on?

I think he put commodities up in the top as an "investment class". Notice the groupings are gold, then money, then usury, then investments.

You say, "of the entire list commodoties and gold have the most in common"

This is the point. Gold is money, not a commodity. But the CB's have tried to shove gold up with the commodities, to convince the sheeple it is a mere commodity, a mere investment.

Understanding inflation and deflation is critical to making the right investment decisions. Strictly speaking, inflation is simply an increase in the supply of money and deflation is a decrease in the money supply. Most financial advisors are now calling for inflation to resume
and even hyper-inflation to run rampant in the United States, because of the Federal Reserve’s current effort to circumvent deflation by excessive money printing. We are of the opposite, and certainly the minority, view. We believe that central banks will be unable to forestall
deflation and that when it arrives, it will be unprecedented in magnitude. This conclusion is based upon three factors:

• Once the debt bubble is unwound, it is deflationary in nature because it is painful and results in bankruptcies on both side of the ledger. Actually, it takes money out of the system and during our Kondratieff winter, trillions of dollars of debt will be expunged. Total debt in the United States is now approximately $58 trillion. If we exclude government debt, which is approximately $15 trillion, this leaves $43 trillion of consumer, corporate and fnancial debt underpinning the U.S. economy. How much of that is destroyed is any-
one’s guess, but it is likely to total at least $22 trillion. This money is effectively destroyed.

• Under these circumstances, banks won’t lend money. Those banks that survive bankruptcies, and most won’t, will conserve it. Consumers and corporations won’t be able to borrow money, even if they so desire.

• The velocity of money will essentially come to a standstill, since there will be none to spend. Money will be hoarded, either under the mattress, or in banks that consumers believe will survive the debt deflationary onslaught. During inflation, as in the 1970s, the
velocity of money increases as people spend today, rather than pay higher prices tomorrow. In deflation, as in the 1930s, those few people with money curtail their spending in the knowledge that prices will be lower tomorrow, next month and next year. As the early 19th Century saying goes ‘money like manure, does no good till it is spread’.