The Gold Standard The Gold Standard Institute

Issue #18 15 June 2012 1

The Gold Standard
The journal of The Gold Standard Institute

Editor Philip Barton
Regular contributors Louis Boulanger
Rudy Fritsch
Keith Weiner
Occasional contributors Sandeep Jaitly
Jason Keys

The Gold Standard Institute

The purpose of the Institute is to promote an
unadulterated Gold Standard

www.goldstandardinstitute.net

Patron Professor Antal E. Fekete
President Philip Barton
President Europe Thomas Bachheimer
President USA Keith Weiner
Editor-in-Chief Rudy Fritsch
Senior Research Fellow Sandeep Jaitly

Membership Levels

Annual Member US$100 per year
Lifetime Member US$3,500
Gold Member US$15,000
Gold Knight US$350,000
Annual Corporate Member US$2,000

Contents
Editorial ........................................................................... 1
News ................................................................................. 2
As Cashless Society Looms, Does Fiat Paper Money
Help Golds Cause? ........................................................ 2
The Criticality of Gold .................................................. 4
Crusoe Economics ......................................................... 5
The Role of the Commercial Bank .............................. 7
Duration Mismatch Will Always Fail .......................... 8
The American Corner .................................................. 11

Editorial
This is written from Vienna where the sun is shining,
the beer and ice-cream is great (with a suitable gap
for digestion between) and the coffee is, as always,
barely tolerable considering that Italy is so close.
The Opera house and museums are still busy.
Vienna is a city that grows on you the longer you
stay. One of its great virtues is the easy access to
other cities. Prague, Budapest, Warsaw, Munich
(dont forget to book for the seminar in September)
and Venice are just a few hours away on the fabulous
European train system. Europe still looks great, but
not too far from the surface the number of marginal
businesses is growing, as are the for lease signs.
Stadtpark (opposite the Vienna Mint) is still full of
families enjoying the sunshine, space and beauty; it is
also now home to those who have nowhere else to
sleep. I dread to think how they coped during the
brutal European winter.

I am over here to check out the gold insurance
scheme that is going live this month more details
in the Julys issue of The Gold Standard courtesy of
Thomas Bachheimer (we ran out of time to include
it this month). These are exciting times for those
who have pushed the return of gold. Gold insurance,
like gold bonds, is one of the first and most
important steps on the road back to sound money.
Those who wish to avoid a future in their local
equivalent of Stadtpark should consider gold
insurance.
Governments in Europe are dragging their heels in
discussing the return of gold some opposition
parties are not. The return of gold to polite
conversation is not restricted to Europe.
Okayama Metal and Machinery, a Japanese pension
fund, has allotted 1.5% of its fund to gold in a sign
The Gold Standard The Gold Standard Institute
Issue #18 15 June 2012 2
of the growing suspicion of paper money.
Yoshisuke Kiguchi, the chief investment officer, said
he was diversifying into gold to escape sovereign
risk. Whilst 1.5% is modest, it is a start.
Philip Barton
News
Mineweb: Gold as the tier one asset (thanks Jacq)

Telegraph UK: Europes debtors must pawn their
gold for Eurobond Redemption [Germany wants the
gold.] Southern Europes debtor states must pledge
their gold reserves and national treasure as collateral
under a 2.3 trillion stabilisation plan gaining
momentum in Germany. Germany would have a
lockhold over the fund, able to enforce discipline.
Each state would have to pledge 20% of their debt
as collateral. "The assets could be taken from the countrys
currency and gold reserves ... Everything being done at a
European level is in the interests of Germany and France, to
save their banks. It is not in the interest of Italy We
should use our gold to take care of our own debt,
collateralizing bonds above 100pc of GDP. That would be a
far more targeted approach," he said.

Jamie Dimon, CEO of JP Morgan Chase: "We bought
some triple-A securities that we think are as good as gold."

24hgold: Filipino legal tender coins are disappearing
as their metallic worth exceeds their stated worth.

24hgold: Beware the pitfalls of swapping gold for
real estate too soon. This scenario will play out
around the world. Owners of real estate will be the
final milk cows available to governments.

King World News: This highlights the risks of
holding gold in the banking system. Logic dictates
that it will become worse. It should be pointed out
that a similar story out of Australia this week turned
out to be of dubious authenticity.
As Cashless Society Looms, Does Fiat
Paper Money Help Golds Cause?
Paper Federal Reserve Notes are looked upon with
contempt by gold advocates as the tangible symbol
of banks economic control. But may they actually
be subtly helping promote the idea of hard money?
We have been drifting toward a fully electronic
monetary system for some time. Governments
opposed to individual rights must by definition
always crave ever greater power. Controls breed
more controls, as a wise writer once said. And what
more important economic and political crossroads is
there to dominate than citizens daily transactions?
The underground economy, consisting of a mixture
of gangsters and ordinary citizens trying to earn
money un-taxed and un-regulated, is based largely on
cash transactions. Governments hate this back-door
for the dodging of their revenue collectors and
compliance staff.
Slowly, the authorities are closing that door. Starting
with the widespread acceptance of credit cards, then
debit cards, and finally online and cell phone
payments systems, the average persons use of cash
has been steadily declining for decades.
Inflation lends a hand, acting as the hammer against
the anvil of cashs decreasing functionality. Bank
machines dispensing $50 bills are becoming rarer, yet
prices continually rise. This makes it harder to use
cash in everyday transactions. Fewer merchants
accept large-denominations bills, and stores low
cash floats unofficially discourage use of $50s or
$100s. Dealing with a wad of low denomination
bills, or being told there is insufficient change
available for your tendered payment, makes cash less
appealing.
There is probably an upward trend in the proportion
of merchants who require a customers credit card,
directly or indirectly, before he can complete a
transaction. I hear that Britain is even close to
eliminating checks. Fortunately, the popularity of
paper checks in America is still strong.
What benefits does paper money confer? It upholds
the idea of unrecorded, untraceable transactions and
the implied, inherent right to privacy a free society
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Issue #18 15 June 2012 3
requires. It makes the effects of inflation less
abstract and more easily detectable by the average
citizen in a way that mere numbers on a credit card
statement do not convey. It reminds people money
is a tangible thing, not an electronic, untouchable,
mysterious creation of the banking system or
government. It prevents a bank from taking an extra
service charge out of a transaction. It even
encourages thrift, the true basis of economic growth,
as studies have repeatedly shown people believe they
are spending less when using a credit card for a given
transaction instead of cash.
On a level perhaps more subliminal, paper money
maintains the illusion of extinguishing debt with a
cash payment. Now, it is an illusion, because we
know that todays paper money is itself merely debt
and can only transfer liability. But in this case the
illusion ought to be the reality, and the mere fact that
that illusion is still being maintained by the enemy
helps our cause. As long as banks or mints issue any
tangible money, it supports our claim to the moral
high ground that money ought to be a tangible
thing. Although as peoples mailboxes overflow
with offers for debt-consolidation and credit card
balance transfers, the citizenry is certainly being
prepared for the concept of perpetual servitude.
Todays Federal Reserve Notes are bad, but they are
still one step removed from rock-bottom: a bank-
issued card required for all transactions of any sort.
Paper money today may be fighting a rearguard
action against global tyranny.
Reading Orwells 1984, one is shown the grim face
of a future, technologically advanced traditional
dictatorship. Huxleys Brave New World predicted an
easier way for the rulers to maintain power.
Jackbooted thugs and concentration camps are not
needed when the people are happy to be slaves in
exchange for rewards of sex, drugs and
entertainment. Yet a world without cash might be
even simpler for the elite to dominate. How much
dissent could remain if would-be political activists
can have their ability to transact terminated by a
bureaucrats keystroke in a far off seat of power?
Communication surveillance, video monitoring,
location tracking, all these may become unnecessary
as a dictators systematic policy. The ease with
which the ultimate punishment can be inflicted could
compensate for much sloppiness or inefficiency in
detecting political trouble-makers.
Losing the ability to buy ones next meal, abandoned
by friends and associates anxious to avoid any guilt
by association, instantly forced into either a life of
begging or of crime to continue living who would
risk such a fate without even the ability to confront
ones tormentors? A 3:00 am knock at the door by
the states enforcers is arguably a threat preferred by
a resistor, as it leaves him more options than being
exiled from the economy.
Fortunately for us, paper money is not yet extinct.
In fact, demand for it may grow sharply soon as
banks begin to fail again. Paper currency may even
play an important part in a last-minute transition
back to gold and silver money. It will have the
distinction of being physically in circulation, just like
gold and silver coins and bars, outside of a
permanently frozen banking system.
I am not the only one to have said it before, but it
bears repeating. The monetary end-game, when it
comes, may contain rules and elements we never
predicted or even suspected. And the path to
surviving it, both politically as a free people, and
with ones personal net worth intact, may demand
more than one type of skill.
Publius


The Gold Standard The Gold Standard Institute
Issue #18 15 June 2012 4
The Criticality of Gold
Every day the prophets ask themselves whether currency
convertibility is to occur soon or in the distant future.
Everyone knows that this expression currency convertibility
is a pleasant euphemism to translate those three little words a
return to gold, these last having been banished from the
language of the Anglo-Saxons as being in supremely bad taste,
as they remind one much too vividly of the unseemly conduct of
the yellow metal during the crisis of 1931.
Source: The Triumph of Gold, by Charles Rist, translated
from the French, p220, 1954

Time is a funny thing. We say that what goes around
comes around. Yet, we still think of time in linear
terms. Cant we make up our mind: is time linear or
circular? Well... it would appear to be both! Or
maybe its just too complex to fit one shape or
another. Does it matter?
It matters if we want to better understand what is
going on now with our failing global monetary
system. You see, weve been here before
1
; but still
too few of us recognise this. As a result, all our
warnings have been like whistling in the wind.
However, it seems as if all these past murmurs from
friends of the gold standard about the role of gold
are now finally starting to have an effect.
Indeed, something seems to have changed recently.
People are suddenly starting to be more open to the
idea (as if it was only an idea...) that maybe, just
maybe, gold does matter. What comes to mind here
is the concept of critical threshold in complexity
theory. What also comes to mind is that
phenomenon called murmuration, as in a large flock
of starlings that all turn at the same instant. The
birds all turn in the sky at the same instant without
any apparent communication!
We don't know how they do that. It seems to be
some kind of collective cognitive processing beyond
our understanding. James Dines, the original gold

1
Fiat money has died before. In fact, in all of recorded human
history, not once has fiat money survived. This time however,
all currencies in the world are fiat money. So weve pushed the
experiment to its limit. But the end result will inevitably be the
same. The triumph of gold over fiat abuse is only a question of
time.
bug, suggested earlier this year that a great human
murmuration was now underway, vibrating like a
bass chord through bodies politic all over the
world... Hey, maybe thats what Bob Dylan was
trying to tell us when he wrote the answer my friend is
blowin in the wind...
What does it all mean? It means we are approaching
a critical threshold for gold awareness. James
Rickards explains in his book, Currency Wars
(pp212-216), how complexity theory works and how
a small loss of faith in something fundamental to the
survival of the existing system, for whatever reason,
can potentially lead to a complete collapse of
confidence. He uses faith in the US dollar as an
example.
Each individual will have a different tipping point, he
explains, or critical threshold on how many other
people will need to have already lost confidence in
the dollar before he or she also decides to lose
confidence. Rickards likens this critical threshold
phenomenon to asking how many people must run
from a crowded theatre before the next person
decides to run. Some will run out at the first sign of
trouble; others will not move until many have started
to run; and so on, until the last.
Of course, he may just as well have taken the Fed or
the Euro to make the same point. In fact, I think
that it does not matter what one uses, the existing
system left to its own is already beyond saving. But,
rather than letting it come to its inevitable collapse,
maybe the avalanche of capital destruction can be
prevented with the arrival of an idea whose time has
come again: the gold standard.
The key then, based on complexity theory, is for us
to lower certain other peoples critical threshold for
the repudiation of fraudulent money. In other
words, we need to bridge the gap between the very
small minority of individuals who believe that a
return to the gold standard is a good idea and the
wider community. But, as was elegantly explained in
Rickards book, it does not mean we need to
convince a whole lot of people; maybe even only one
group of people!
Heres how it works. Suppose the worlds
population can be divided based on peoples
individual critical thresholds, called T. Here T would
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Issue #18 15 June 2012 5
represent the number of other people who must lose
confidence in fiat money before that individual also
loses confidence. In other words, T is the tipping
point when one runs to gold, based on how many
others already have. Everyone has a different point,
but these can be grouped to show the potential
influence one group can have on the next.
Lets say there are 1,000 people in the world with the
lowest critical threshold for the repudiation of fiat
money and that threshold for them is 100 people or
T=100. Since there are at least 100 readers of this
Journal that must have already repudiated fiat
money, clearly then all of those 1,000 people in the
world in the first group would then also have
rejected fiat money in favour of a return to sound
money or the gold standard. But what is the critical
threshold of the next group?
Thats the great unknown, of course. But lets not
get too discouraged yet. Let us suppose that the
next group is made up of 1,000,000 people that share
a T of 100,000. In other words, once 100,000 people
in the world will have repudiated fiat money, there
would then be one million of us wanting a return to
sound money or the gold standard. But how do we
go from, say, just 100 now to 100,000 people who
get it? Thats quite a bridge of ignorance to gap...
For the sake of simplicity, we could argue that the
rest of the world has even much higher critical
thresholds than these first two groups, such that it
could be classified into two further groups where the
next 1,000,000,000 (one billion) would have a T of
100 million people and the rest of the world (the
other six billion or so) a T of 1,000,000,000. Now,
heres where this criticality thing gets really
interesting. Pay attention!
We are, it seems, at the edge of chaos. According to
science, this is where the degree of complexity is
maximal. But this is also a point of emergence,
when whole new behaviours can emerge. So, as I
see it, it is our duty to educate relentlessly until the
T of the next group after us drops from 100,000 to
just 10,000 or less. Hey, thats less than 0.1% of the
population to work on, so lets get busy!
The whole world will then suddenly get it and itll
be like 1931 all over again, except that this time... itll
be a run on the dollar, not the pound. But, in
essence, itll once again simply be a run to gold!
Louis Boulanger
Louis holds a B.Sc. from Laval University in Canada; is a Fellow
of the Canadian Institute of Actuaries and the New Zealand
Society of Actuaries; and is a Chartered Financial Analyst.
Prior to coming to New Zealand in 1986, Louis worked for nine
years with a global consulting firm based in Montreal, Canada.
In New Zealand, Louis worked for another global consulting
firm for 18 years, including as Chief Executive of New Zealand
operations for five years. In 2006, he launched his private
practice.
Louis is also Founder & Director of LB Now Ltd, which
provides independent investment advice to private and
institutional clients, facilitates the purchase of bullion for private
and institutional clients as an authorized dealer for BMG
BullionBars and also helps firms comply with GIPS.
For more information of LB Now's services or to subscribed to
Louis' e-letter Prosper! see the contact details below.

P.O. Box 25 676, St Heliers, Auckland 1740, New Zealand
Ph: +64 9 528 3586 Mob: +64 275 665 095
Email: louis@lbnow.co.nz www.lbnow.co.nz

Crusoe Economics
Einstein said it best; for a model of reality to be
useful, it must be as simple as possible but no
simpler. The very simplest possible model of
economics comprises one person because one
human actor is the smallest and simplest possible
means of looking at economic reality.
Chopping the person into parts to simplify the
model further wont work, and adding more people
to the mix makes the model more complex than
needed to study the fundamentals the gist of
economics. Of course, mainstream economists scoff
at this idea; our modern economy is much too
complex to worry about Crusoe economics
snicker.
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Issue #18 15 June 2012 6
This is about as intelligent as the design engineers
responsible for the Boing 747-800 snickering at
Newtons apple; our modern engineering is much
too complex to worry about Newtons law of
gravity! Any engineer guilty of this type of insane
thinking would be summarily dismissed if not, the
747 would never get off the ground or if it did, the
wings would likely depart at the most inopportune
time.
Robinson Crusoe on his deserted island has no need
or use- for money, or credit, or barter; but the three
fundamental laws of economics show up with stark
clarity, un-muddied by any extraneous complications.
The very first law is; production must precede
consumption.
If Crusoe does not first catch fish, he will not eat
fish nor he will not eat apples unless he first picks
apples, nor have a fire unless he first gathers wood,
kindling, etc. Nevertheless, we hear every day in our
new economy that demand drives production
and if we stimulate demand, all will be fine with the
economy. This is strike one; claiming that demand
precedes production.
The second law is; saving must precede investment.
Crusoe cannot invest in financial products, only in
real capital; that is, tools and such items that help
him live better, more productively. For example he
may decide to weave a basket, so he no longer has to
carry the berries he gathers in his bare hands; but to
do so, he will have to first save the vines, and he will
have to put time into this work; he must not
consume everything he gathers, but must put some
aside ie save so that he can invest in his new
tool.
Or, he may decide to make a fish net, to catch fish a
lot easier than by tickling them same thing, he
needs to put aside string, and food to sustain him
while he attends to this tedious but important chore.
Nevertheless, the arrogant and ignorant sociopaths
of the Washington economics establishment claim
that there is a glut of saving, particularly in the
East; and they claim that this is the problem with the
world economy never mind that the East is
prospering, while Washington is sinking quickly.
This is strike two; claiming that consumption
precedes saving.
The third law is not only fundamental to humankind,
but is even obvious in the animal kingdom; hoarding
is essential for survival. Even squirrels have enough
brains or perhaps enough instinct to save nuts
during summer, to tide them over the coming winter.
According to geniuses like Mr. Munger, hoarding is
for uncivilized people. Bah; if Crusoe does not
hoard the essentials of life, like food or water or fuel,
he will not survive the next dry spell, or the next
winter.
Of course, in a more advanced economy it is not
necessary for every person to hoard everything; it is
only necessary to hoard money; honest money will
serve to buy all the essentials of life. Just as money
allows indirect exchange to take the place of barter,
so money allows indirect hoarding to take the place
of hoarding many necessities. Specialization is far
more efficient in hoarding like grain elevators,
cold storage, etc just as specialization through the
division of labor is far more efficient than autarky.
But what does all this have to do with Bills and
Bonds? In a sophisticated economy, one that has
outgrown the Crusoe stage, and outgrown the tribal
barter stage, and has progressed to a monetary
system with developed markets, Real Bills are the
very best means of funding production and
production comes before consumption. The very act
of consumption is what brings Real Bills into
existence; and the implicit value of the Real Bill is
what enables production to be funded. In a modern
economy with much division of labor, consumer
goods go through many stages of production before
reaching the ultimate consumer and each stage has
to be funded somehow.
Think of something simple, like bread; we start with
wheat from the farmers, the wheat goes to the mill
to be ground into flour, then to the bakery where the
bread is made, then it is sold to the customer. If Real
Bills do not circulate, then money (Gold) must be
used to fund each transaction; the economy must
work on a COD basis this means Gold must
change hands many times. By comparison, if Real
Bills are in circulation, NO Gold changes hands until
the ultimate purchase is made; no money is invested
in the production cycle the credit inherent in the
Real Bills Doctrine funds the production process
most efficiently and naturally.
The Gold Standard The Gold Standard Institute
Issue #18 15 June 2012 7
Bills follow and support the first law, the law that
production precedes consumption. In the very same
fashion, Bonds follow and support the second law;
saving precedes investment. Any fixed capital in the
economy is financed through the bond markets; the
farm used to grow wheat, the mill used to grind
flour, and the ovens used to bake bread are all
examples of fixed capital and they are all financed
through the bond market from savings. No
savings means no (real) capital available for
investment purposes.
Finally, we come to the third law; hoarding is
essential for human survival. The recipient of a
salary or of wages faces three choices; hoard the
Gold coin, spend the Gold coin, or invest the Gold
coin there is no other choice possible. Some coin
simply must be spent, else the wage earner will starve
or freeze in the cold; thus the bill market has a hard
floor, it can never go to zero.
Some coin may be saved, or invested; this is not a
must but depends on risk and returns. If the return
being offered is too low, then hoarding is a natural
choice; the only reason one would invest is to obtain
a reasonable gain for giving up the use of ones
Gold for whatever length of time. This return is
called interest and the desire to earn interest is
called time preference. Zero interest rates mean that
there is NO capital available for investment; all
money earned will be spent or hoarded.
Today we have a zero interest rate policy strike
three, we are out. The economy is dying, like the 747
with the wings departing. The so called Global
Financial Crisis is in reality a monetary crisis. The
world needs real money; the world needs Gold. The
world also needs the clearing system that is the
indispensable companion of God money, the
circulation of Real Bills. Once this reality is accepted
and acted upon, the GFC can be resolved not
before.
Rudy J. Fritsch
Editor in Chief


The Role of the Commercial Bank
Bankers and their ilk are often vilified in the press.
But their true role is essentially forgotten and is
necessary for the efficient functioning of social
activity. Under a true gold standard, the unit of
account and exchange is a defined weight of fine
gold. In the United Kingdom this was/is the Pound
Sterling defined as 7.2g of fine gold.
Social activity in all areas, naturally, involved gold.
Contracts for the export and import of various
wares, receipts from retailer to wholesaler, tailor and
shirtmaker bills - all were denominated in terms of
gold. These gold contracts were an expression of the
ingenuity and enhanced coordination that results
from unfettered social interaction. Of course, the
contracts had nothing to do with gold per se. Gold
merely acted as the measure.
Gold contracts existed in various forms and
frequencies. By form we mean the nature by which
the contract was extinguished by payment of gold
and by frequency the time by which the money
would be received. Naturally, both aspects have an
element of risk to them as a contract holder.
The contracts themselves were as varied as
unrestricted social interaction is, as the former was
merely a crystallisation of the latter. The
contracts had a wide variety of integrity as one - who
is not utterly naive - might expect.
Those contracts representing the most identifiable
and necessary goods with quick liquidation were in
demand by the public looking for a return on their
idle money holdings. These 'bills,' which matured in
less than a season's worth of days, could be
exchanged for current gold in lieu of a discount on
the face value of the contract.
The best quality bills could be discounted at discount
houses; a euphemism for the commercial/clearing
bank. The discount house would pay for bills in
exchange for gold coin or their own (standardized)
note issue which matured into gold. The discount
house acted as a guarantor for the bills via their
equity reserve. The managers of the discount houses
were expected to be knowledgeable about all sorts of
businesses that could be conducted across
borders. An example of banks that issued their own
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Issue #18 15 June 2012 8
notes in their role as a commercial bank was the
Chartered Bank of India, Australia and China, now
Standard Chartered Bank plc. This tradition - merely
as a curio - is still retained in Hong Kong by
Standard Chartered Bank.
The name of a good discount house behind a
bill/banknote promoted its circulation in public as a
money substitute - the nearest security to gold
possible. The threat of a failed exchange was
nullified by the discount house acting as the
underwriter of a bill. The depositor at the discount
house would not suffer - merely the equity holders
of the discount house in a failed exchange.
The commercial banks could only offer term
deposits to the public for maturities less than or
equal to the bills that they held. Three month deposit
rates were thus the longest maturity that could be
obtained from a commercial bank solely.
The commercial banker brought order and
coordination to the bill market; that market which
would exist with or without them. 'Spreads' are made
narrower by the commercial banker's very existence
and their will to do this activity. In a similar manner,
the investment banker brings order to the bond
market. I am sure at this stage we would all be
familiar with the differences between an investment
and commercial bank.
Do not vilify the role of the banker! They are just as
essential as that of the doctor or teacher to the
maintenance and progression of society. I hope this
short essay has demonstrated why.



Sandeep Jaitly
Sandeep is a fund manager at First International Group plc. in
London. He manages a global equity fund as well as a gold and
silver fund, the operations of which are based on ideas
developed by Professor Fekete. For more information about
First International Group plc., please visit www.figplc.com.
Sandeep founded Fekete Research in 2011 to preserve,
disseminate and expand upon the works of Professor Fekete.
For more information please visit www.feketeresearch.com.
Duration Mismatch Will Always Fail
I have written a number of pieces on fractional
reserve banking and duration mismatch. I have
argued that the former is perfectly fine, both morally
and economically, but the latter is not fine. I have
dissected the arguments made against fractional
reserve banking, and pointed out that it is nothing
more than a bank lending out some of the money it
takes in deposits.
I have debunked the most common errors made by
opponents of fractional reserve:
1. Banks print money
2. They lend more than they take in deposits
3. They inflate the money supply
4. Money is the same as credit
5. Fractional reserves banking is the same
thing as central banking
6. It is the same thing as duration mismatch
Duration mismatch is when a bank (or anyone else)
borrows short to lend long. Unlike fractional
reserve, duration mismatch is bad. It is fraud, it is
unfair to depositors (much less shareholders) and it
is certain to collapse sooner or later. This is not a
matter for statistics and probability, i.e. risk. It is a
matter of causality, which is certain as I explain
below.
This discussion is of paramount importance if we are
to move to a monetary system that actually works.
Few serious observers believe that the current
worldwide regime of irredeemable paper money will
endure much longer. Now is the time when various
schools of thought are competing to define what
should come next.
I have written previously on why a 100% reserve
system (so-called) does not work. Banks are the
market makers in loans, and loans are an exchange of
wealth and income (see here). Without banks playing
this vital role, the economy would collapse back to
its level the previous time that the government made
it almost impossible to lend (and certainly to make a
market in lending). The medieval village had an
economy based on subsistence agriculture, with a
few tradesmen such as the blacksmith.
But I have not directly addressed the issue of why
duration mismatch necessarily must fail, leading to
The Gold Standard The Gold Standard Institute
Issue #18 15 June 2012 9
the collapse of the banks that engage in it. The
purpose of this paper is to present my case.
In our paper monetary system, the dollar is in a
closed loop. Dollars circulate endlessly.
Ownership of the money can change hands, but the
money itself cannot leave the banking system.
Contrast with gold, where money is an open loop.
Not only can people sell a bond to get gold coins,
they can take those gold coins out of the monetary
system entirely, and stuff them under the mattress.
This is a necessary and critical mechanismit is how
the floor under the rate of interest is set.
This bears directly on banks. In a paper system, they
know that even if some depositors withdraw the
money, they do not withdraw it to remove it
altogether (except perhaps in dollar backwardation,
at the end: see here). They withdraw it to spend it.
When someone withdraws money in order to spend
it, the seller of the goods who receives the money
will deposit it again. From the banks perspective
nothing has changed other than the name attached
to the deposit.
The assumption that if some depositors withdraw
their money, they will be replaced with others who
deposit money may seem to make sense. But this is
only in the current context of irredeemable paper
money. It is most emphatically not true under gold!
There are so many ills in our present paper system,
that a forensic exploration would require a very long
book (at least) to dissect it. It is easier and simpler to
look at how things work in a free market under gold
and without a central bank.
Lets say that Joe has 17 ounces of gold that he will
need in probably around a month. He deposits the
gold on demand at a bank, and the bank promptly
buys a 30-year mortgage bond with the money.
They assume that there are other depositors who will
come in with new deposits when Joe withdraws his
gold, such as Mary. Mary has 12 ounces of gold that
she will need for her daughters wedding next week,
but she deposits the gold today. And Bill has 5
ounces of gold that he must set aside to pay his
doctor for life-saving surgery. He will need to
withdraw it as soon as the doctor can schedule the
operation.
In this instance, the bank finds that their scheme
seems to have worked. The wedding hall and the
doctor both deposit their new gold into the bank.
Its not a problem until its a problem, they tell
themselves. And they pocket the difference between
the rate they must pay demand depositors (near
zero) and the yield on a 30-year bond (for example,
5%).
So the bank repeats this trick many times over. They
come to think they can get away with it forever.
Until one day, it blows up. There is a net flow of
gold out of the bank; withdrawals exceed deposits.
The bank goes to the market to sell the mortgage
bond. But there is no bid in the mortgage market
(recall that if you need to sell, you must take the bid).
This is not because of the borrowers declining credit
quality, but because the other banks are in the same
position. Blood is in the water. The other potential
bond buyers smell it, and they see no rush to buy
while bond prices are falling.
The banks, desperate to stay liquid (not to mention
solvent!) sell bonds to raise cash (gold) to meet the
obligations to their depositors. But the weakest
banks fail. Shareholders are wiped out. Holders of
that banks bonds are wiped out. With these
cushions that protect depositors gone, depositors
now begin to take losses. A bank run feeds on itself.
Even if other banks have no exposure to the failing
bank, there is panic in the markets (impacting the
value of the other banks portfolios) and depositors
are withdrawing gold now, and asking questions
later.
And why shouldnt they? The rule with runs on the
bank is that there is no penalty for being very early,
but one could suffer massive losses if one is a minute
late (this is contagion).
What happened to start the process of the bank run?
In reality, the depositors all knew for how long they
could do without their money. But the bank
presumed that it could lend it for far longer, and get
away with it. The bank did not know, and did not
want to know, how long the depositors were willing
to forego the use of their money before demanding
it be returned. Reality (and the depositors) took a
while, but they got their revenge. Today, it is
fashionable to call this a black swan event. But if
The Gold Standard The Gold Standard Institute
Issue #18 15 June 2012 10
that term is to have any meaning, it cant mean the
inevitable effect caused by acting under delusions.
Without addressing the moral and the legal aspects
of this, in a monetary system the bank has a job: to
be the market maker in lending. Its job is not to
presume to say when the individual depositors would
need their money, and lend it out according to the
banks judgment rather than the depositors.
Presumption of this sort will always result in losses,
if not immediately. The bank is issuing counterfeit
credit (see here). In this case, the saver is not willing
(or even knowing) to lend for the long duration that
the bank offers to the borrower.
Do depositors need a reason to withdraw at any time
gold they deposited on demand? From the banks
perspective, the answer is no and the problem is
simple.
From the perspective of the economist, what
happened is more complex. People do not withdraw
their gold from the banking system for no reason.
The banking system offers compelling reasons to
deposit gold, including safety, ease of making
payments, and typically, interest.
Perhaps depositors fear that a bank has become
dangerously illiquid, or they dont like the low
interest rate, or they see opportunities offshore or in
the bill market. For whatever reason, depositors are
exercising their right and what they expressly
indicated to the bank: this money is to be
withdrawn on demand at any time.
The problem is that the capital structure, once
erected, is not flexible. The money went into
durable consumer goods such as houses, or it went
into partially building higher-order factors of
production. Imagine if a company today began to
build a giant plant to desalinate the Atlantic Ocean.
It begins borrowing every penny it can get its hands
on, and it spends each cash infusion on part of this
enormous project. It would obviously run out of
money long before the plant was complete. Then,
when it could no longer continue, the partially-
completed plant would either be disassembled and
some of the materials liquidated at auction, or it
would sit there and begin to rot. Either way, it
would finally be revealed for the malinvestment that
it was all along.
By taking demand deposits and buying long bonds,
the banks distort the cost of money. They send a
false signal to entrepreneurs that higher-order
projects are viable, while in reality they are not. The
capital is not really there to complete the project,
though it is temporarily there to begin it.
Capital is not fungible; one cannot repurpose a
partially completed desalination plant that isnt
needed into a car manufacturing plant that is. The
bond on the plant cannot be repaid. The plant
construction project was aborted prior to the plant
producing anything of value. The bond will be
defaulted. Real wealth was destroyed, and this is
experienced by those who malinvested their gold as
total losses.
Note that this is not a matter of probability. Non-
viable ventures will default, as unsupported buildings
will collapse.
People do not behave as particles of an ideal gas,
as studied by undergraduate students in physics.
They act with purpose, and they try to protect
themselves from losses by selling securities as soon
as they understand the truth. Men are unlike a
container full of N2 molecules, wherein the motion
of some to the left forces others to the right. With
men, as some try to sell out of a failing bond, others
try to sell out also. And they are driven by the same
essential cause. The project is non-viable; it is
malinvestment. They want to cut their losses.
Unfortunately, someone must take the losses as real
capital is consumed and destroyed. A bust of credit
contraction, business contraction, layoffs, and losses
inevitably follows the false boom. People who are
employed in wealth-destroying enterprises must be
laid off and the enterprises shut down.
Busts inflict real pain on people, and this is tragic as
there is no need for busts. They are not intrinsic to
free markets. They are caused by governments
attempts at central planning, and also by duration
mismatch.
Keith Weiner
President of the Gold Standard Institute USA
The Gold Standard The Gold Standard Institute
Issue #18 15 June 2012 11
The American Corner
As I intimated last month, my goal in this column is
to discuss developments in the USA that are relevant
to advocates of a gold standard. Shortly after I sent
my copy in to be laid out and published in The Gold
Standard last month, Ralph Benko (a longtime gold
standard advocate in the US) published an article at
Forbes. His article discusses a new bill sponsored in
the US Senate to change the charter of the Federal
Reserve to focus on price stability (vs. its current
dual mandate of prices and employment).
I should state for the sake of clarity that I do not see
any room for a central bank (or any central planner)
in a free market, and so I do not want to debate its
charter. I dont think that the Fed has direct control
of the prices of goods nor of gold, anyway. Prices
are set by a complex, non-linear, dis-contiguous,
dynamic process, and the Feds control over interest
rates is wholly insufficient to control prices.
I also do not believe that there should be a gold
price fixed by law. I think it would cause the ultimate
partisan war, between debtors who want a high gold
price and creditors who argue that the gold price
should be low. The former can get out of debt for a
small amount of gold at a high dollar price per
ounce. The latter get more gold at a low dollar price.
This partisan war will have vast interest groups lined
up on both sides. To the victor will go untold spoils,
and to the loser will go either catastrophic losses or a
long time of indentured servitude. In any case, the
government does not know what the right price of
gold is and of course all prices change constantly in
the market.
My purpose in writing this article is not to address
the contents of that bill, per se. The reason why I
think the bill (and the article in Forbes, which is a
mainstream publication) is important and a Good
Thing is that it shows that the cultural trend is
changing. We have passed an inflection point. 10
years ago, or even 4 years ago, it would not have
been possible to introduce a gold bill in the US
Legislature or to be taken seriously discussing a gold
standard.
Today, gold has entered the mainstream debate.
Even if it is only right wing politicians and
conservative
2
magazines discussing gold, the taboo
on saying the four-letter word gold in polite
company has been broken.
Lets go back through some American history.
When Ronald Reagan was elected president, he
convened a committee to look at gold. That was a
time when the price of everything was rising at a
terrifying rate, as were interest rates.
The gold committee effort went basically nowhere.
Meanwhile Paul Volcker at the Fed engineered a
spike in the rate of interest and then set a process in
motion to cause the rate to go into a long slide
(which continues through today, 31 years later). The
crisis created by Richard Nixon with his gold default
seemed to have been resolved. And all serious
policy experts, and public opinion, abandoned
thought of gold.
In fact, nothing was resolved, merely postponed. In
1987, then in 2001, then finally in 2008, a crisis
erupted out of the banking system and into the
public awareness. Today, everyone who is financially
literate knows that unemployment remains much
higher than it ever has this far into a recovery, that
there is a huge debt problem, and that the European
crisis will come to the US and Japan sooner or later.
In the fall of 2008, George Bush said he had to
abandon free market principles to save the free
market. The US government provided bailouts and
stimulus. Most people accepted that it was
necessary, even if grudgingly. But over the following
years (and as more and more information is coming
out regarding the beneficiaries of these trillions of
dollars of largesse), the goodwill and feeling that if
we all work together, we can fix anything is long
gone. Attitudes have changed.
Then, most people thought how can we save the
system. Now they are starting to demand can the
system be saved and how can we change the
system. I think this presents a once-in-a-century
opportunity to promote not only gold, but a proper
gold standard! Color me optimistic.
Keith Weiner

2
Readers outside the US should be aware that left and right,
liberal and conservative have a different connotation in the
US than in Europe.
The Gold Standard The Gold Standard Institute
Issue #18 15 June 2012 12
NEW AUSTRIAN SCHOOL OF ECONOMICS




CRITIQUE OF MAINSTREAM AUSTRIAN ECONOMICS

Marginalism; Marketability; The Real Bills Doctrine vs. the Quantity Theory of Money; Interest versus
Discount; The True Role of the Gold Standard

September 3 - 9, 2012
(10am 12:30 and 4pm 6pm)

Lecturer: Prof. Antal E. Fekete

Guest Lecturers: Sandeep Jaitly (United Kingdom, feketeresearch.com)
Keith Weiner (USA), Rudy Fritsch (USA, beyondmises.com)

Location: Munich, Germany


This course is a seven-day, twenty-lecture session. Its topics are not recycled but new material. Its completion
will earn one credit of the four needed towards a Bachelor of Monetary Science (BMSc) degree handed out by
Prof. Fekete.

It is meant for those, including beginners, who are interested in the theory of money, credit, and banking, with
special emphasis on the current financial and economic crisis. Previous courses are not a prerequisite.


Registration Information:

The participation fee for the full course is 1,100.00 Euro (incl. 19% German VAT). Day tickets can be
purchased: 1-day: 300.00 Euros, 2- days: 500.00 Euros, 3 and more days: 200.00 Euros/day.

This includes tuition, non-alcoholic drinks and snacks during the lectures, printed lecture notes for the course.
Hotels and Restaurants are within walking distance and you will receive a list of suggestions.

There is a EUR 300.00 non-refundable pre-registration fee that will be credited toward the tuition fee.

Students will receive a scholarship reducing the tuition fee to 100.00 Euro for the complete seminar (limited to
10 scholarships in total).

Organizers of the course are Wilhelm Rabenstein and Ludwig Karl.

In order to register for the course you can get in contact with us via mail ( nasoe@kt-solutions.de ) or phone (
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