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oftwominds-Charles Hugh Smith: Why Banks Are Doomed: Technology and Risk

oftwominds-Charles Hugh Smith: Why Banks Are Doomed: Technology and Risk.

It’s not just that banks are no longer needed–they pose a needless and potentially catastrophic risk to the nation. To understand why, we need to understand the key characteristics of risk.

The entire banking sector is based on two illusions:

1. Thanks to modern portfolio management, bank debt is now riskless.

2. Technology only enhances banks’ tools to skim profits; it does not undermine the fundamental role of banks.

The global financial meltdown of 2008-09 definitively proved riskless bank debt is an illusion. If you want to understand why risk cannot eliminated, please read Benoit Mandelbrot’s book The (Mis)Behavior of Markets.

Technology does not just enable high-frequency trading; it enables capital and borrowers to bypass banks entirely. I addressed this yesterday in Banks Are Obsolete: The Entire Parasitic Sector Can Be Eliminated.

Unfortunately for banks, higher education, buggy whip manufacturers, etc., monopoly and propaganda are no match for technology. Just because a system worked in the past in a specific set of technological constraints does not mean it continues to be a practical solution when those technological constraints dissolve.

The current banking system is essentially based on two 19th century legacies. In that bygone era, banks were a repository of accounting expertise (keeping track of multitudes of accounts, interest, etc.) and risk assessment/management expertise (choosing the lowest-risk borrowers).

Both of these functions are now automated. The funny thing about technology is that those threatened by fundamental improvements in technology attempt to harness it to save their industry from extinction. For example, overpriced colleges now charge thousands of dollars for nearly costless massively open online courses (MOOCs) because they retain a monopoly on accreditation (diplomas). Once students are accredited directly–an advancement enabled by technology–colleges’ monopoly disappears and so does their raison d’etre.

The same is true of banks. Now that accounting and risk assessment are automated, and borrowers and owners of capital can exchange funds in transparent digital marketplaces, there is no need for banks. But according to banks, only they have the expertise to create riskless debt.

It’s not just that banks are no longer needed–they pose a needless and potentially catastrophic risk to the nation. To understand why, we need to understand the key characteristics of risk.

Moral hazard is what happens when people who make bad decisions suffer no consequences. Once decision-makers offload consequence onto others, they are free to make increasingly risky bets, knowing that they will personally suffer no losses if the bets go bad.

The current banking system is defined by moral hazard. “Too big to fail” also means “too big to jail:” no matter how criminal or risky the bank managements’ decisions, the decision-makers not only suffered no consequences, they walked away from the smouldering ruins with tens of millions of dollars in personal wealth.
Absent any consequence, the system created perverse incentives to pyramid risky bets and derivatives to increase profits–a substantial share of which flowed directly into the personal accounts of the managers.

The perfection of moral hazard in the current banking system can be illustrated by what happened to the last CEO of Lehman Brother, Richard Fuld: he walked away from the wreckage with $222 million. This is not an outlier; it is the direct result of a system based on moral hazard, too-big-to-jail and perverse incentives to increase systemic risk for personal gain.

And who picked up all the losses? The American taxpayer. Privatize profits, socialize losses: that’s the heart of moral hazard.

Concentrating the ability to leverage stupendous systemic bets in a few hands leads to a concentration of risk. Just before America’s financial sector imploded, banks had pyramided $2.5 trillion in dodgy mortgages into derivatives and exotic financial instruments with a face value of $35 trillion–14 times the underlying collateral and more than double the size of the U.S. economy.

In a web-enabled transparent exchange of borrowers bidding for capital, the risk is intrinsically dispersed over millions of participants. Not only is risk dispersed, but the consequences of bad decisions and bad bets fall solely to those who made the decision and the bet. This is the foundation of a sound, stable, fair financial system.

In a transparent marketplace of millions of participants, a handful of participants will be unable to acquire enough profit to capture the political process. The present banking system is not just a financial threat to the nation, it is a political threat because its outsized profits enable bankers to capture the regulatory and governance machinery.

chart courtesy of Market Daily Briefing

The problem with concentrating leverage and moral hazard is that risk is also concentrated. And when risk is concentrated rather than dispersed, it inevitably breaks out of the “riskless” corral. This is the foundation of my aphorism: Central planning perfects the power of threats to bypass the system’s defenses.

We can understand this dynamic with an analogy to bacteria and antibiotics. By attempting to eliminate the risk of infection by flooding the system with antibiotics, central planning actually perfects the search for bacteria that are immune to the antibiotics. These few bacteria will bypass the system’s defenses and destroy the system from within.

The banking/financial sector claims to be eliminating risk, but what it’s actually doing is perfecting the threats that will destroy the system from within. Another way to understand this is to look at what happened to home mortgages in the runup to the meltdown of 2008: the “safest” part of the financial sector ended up triggering the collapse of the entire pyramid of risk.

Once we concentrate risk and impose perverse incentives and moral hazard as the foundations of our financial/banking system, then we guarantee the risk will explode out of whatever sector is considered “safe.”

Once you eliminate the “risk” of weak bacteria, you perfect the threat that will kill the host.

The banking sector cannot be reformed, for its very nature is to concentrate systemic risk and moral hazard into breeding grounds of systemic collapse. The only way to eliminate the threat posed by banks is to eliminate the banks and replace them with transparent exchanges where borrowers and owners of capital openly bid for yield (interest rates) and capital.

Bankers (and their fellow financial parasites) will claim they are essential and the nation will collapse without them. But this is precisely opposite of reality: the very existence of banks threatens the nation and democracy.

One last happy thought: technology cannot be put back in the bottle. The financial/banking sector wants to use technology to increase its middleman skim, but the technology that is already out of the bottle will dismantle the sector as a function of what technology enables: faster, better, cheaper, with greater transparency, fairness and the proper distribution of risk.

There may well be a place for credit unions and community banks in the spectrum of exchanges, but these localized, decentralized enterprises would be unable to amass dangerous concentrations of risk and political influence in a truly transparent and decentralized system of exchanges.

Of related interest:

Certainty, Complex Systems, and Unintended Consequences (February 14, 2014)

Our Middleman-Skimming Economy (February 11, 2014)

James Turk: We’re Living Within A Money Bubble of Epic Proportion | Peak Prosperity

James Turk: We’re Living Within A Money Bubble of Epic Proportion | Peak Prosperity.

James Turk believes the time we live in now will be studied by future historians for generations to come. Just as we today marvel at the collective madness that resulted in the South Sea and Dutch Tulip manias, our age will be known as the era when society lost sight of what money really is.

And as result, the wrong kinds of wealth – today, that’s mostly financial assets – are valued and pursued. And just like those bubbles from centuries ago, when the current asset boom goes bust, the value of paper wealth will vaporize.

In contrast, those holding tangible productive assets or real money will fare much better on a relative basis.

James and co-author John Rubino (of DollarCollapse.com) have recently published a new book covering the details of this prediction called The Money Bubble: What to Do Before It Pops. Within it, they delve into the reasons for why the world is destined for what Ludwig von Mises termed a “crack-up boom“:

Wealth comes in two forms.  It comes in financial assets, bonds, and T-Bills, and things of that nature, and it also comes in tangible assets: real estate, oil wells, timberland, farmland, houses and things that are tangible. And when you’re in a financial bust – and we’ve been in a financial bust since the dot-com bubble collapsed back in 2000 – what you want to do is you want to be involved with tangible assets and you want to avoid, as much as possible, your involvement in any financial assets.  So, consequently, what people should still be focusing on, even though we’re 14 years into this bust, is continuing the accumulation of tangible assets.

Because when this bust is over, promises are going to be broken left and right.  And that means financial assets where you have counterparty risk where you own an asset, the value of which is based on someone’s promise – a lot of those financial assets are going to be diminished in value.  Now, there’s a special kind of financial asset called a stock in a company.  It’s almost like a tangible asset in the sense that if you own stock in EXXON, you’re basically owning a tangible asset, because it’s involved in oil and it owns tangible assets all over the world.

But then, there are financial stocks, credit-card companies and banks, that are financial wealth rather than tangible wealth.  So, you don’t want to own stocks in those companies.  So, basically, own tangible assets or stocks in companies that are involved with tangible assets – those stocks, I call near-tangible – I think that’s the thing that everybody should be focusing on.

And when it comes to money and liquidity, the money, of course, would be physical gold or physical silver or a combination thereof because they will re-emerge in the historical and traditional role as money.

Keep in mind, gold’s been money for 5,000 years.  It was made money by the market.  Money comes from the market.  It doesn’t come from the government.  Over the past century, government’s certainly usurped that authority to control money.  And over the last 40 years, they’ve gone even further afield by completely divorcing fiat currency from the gold that used to back money.  And because of the time element that’s involved, we’ve lost sight of what money really is, and that’s what’s created the money bubble, Chris.

And it’s this money bubble where people have to come back to reality as to what money really is.  It’s liquid, tangible assets being used in the economy in exchange for real goods and services.  And it’s ultimately where we’re going.  And I think it’s going to be very, very disruptive because if you look at an individual country like Weimar, Germany or Zimbabwe more recently, or what Venezuela or Argentina are going through now.  You can see the disruption to the economy when the money is no good.

We’re talking here about fiat currencies throughout the world because nobody’s tied to gold anymore.  No country’s currency is tied to gold anymore.  So this is going to be the bubble, I think, that generations from now, hundreds of years from now people are going to be talking about just like we talk today about the South Sea Bubble or the Mississippi Bubble, from those episodes in history a couple hundred years ago.

Click the play button below to listen to Chris’ interview with James Turk (35m:26s):

TRANSCRIPT

Chris Martenson: Welcome to this Peak Prosperity Podcast. I am your host, Chris Martenson, and today we have the distinct privilege of speaking with James Turk, founder of GoldMoney and whose experience in markets and precious metals spans more than four decades. He is also Director of The GoldMoney Foundation, a not-for-profit, educational organization dedicated to providing information on sound money.

James is one of the foremost authorities on precious metals and has long offered market forecast and commentary, including co-authoring The Collapse of the Dollar and How to Profit from It, with our good friend, John Rubino of DollarCollapse.Com.

John and James, they have a new book out called, The Money Bubble, which has some interesting insights, which we’re going to discuss today.

I’m delighted to have you back, James.

James Turk: Thanks, Chris. It’s always great to speak with you.

Chris Martenson: I have a tall stack of questions prepared. Are you ready to dive in?

James Turk: I sure am.

Chris Martenson: All right. Well, great. Let’s start here. It’s been a while since “The Coming Collapse of the Dollar” was written. Obviously, a lot has changed. And some things haven’t changed. The landscape has some familiar features that you wrote about back then. Some of the things you wrote about came to pass.

Obviously, there have been some heroic measures, if we can call them that, on the part of central banks to continue things as they are.

What sort of a grade would you give them?

James Turk: Well, whenever you’re going to intervene in free markets, I always have to give them an “F.” In terms of what they should be doing, they should be allowing individuals to buy out early, interact with one another without all of this intervention and trying to control individual lives by trying to control all economic activity.

But in terms of being able to kick the can down the road, which is I think what you’re getting at, I’d probably give them an A+ because they’ve managed to keep this system together longer than John and I originally suspected when we put “The Coming Collapse of the Dollar” together back in 2004.

In that book, Chris, were a couple of major themes that John and I made. One was that you should be buying gold, and secondly, you should be betting against the housing bubble, and do that in a variety of different ways including shorting financial stocks.

And when 2008 came along, we thought that the final piece of the puzzle would fall at the place where the dollar would collapse. Generally, as currency, gold would soar. And maybe central bankers and central pawners would get the idea that they’re on the wrong road and we have to go back to basics. But what they’ve managed to do is, an unprecedented amount of money printing has just built yet a bigger bubble. And this is the theme of the new book; the bubble itself is now money.

Chris Martenson: Money. And by money, quick definition – what do you mean when you say, “money”?

James Turk: Let me explain it this way. If you’re a shopkeeper, Chris, and I want to buy a loaf of bread from you, I go in and I’ll say, Well, I’ll pay you in a week’s time, but give me the loaf of bread now. You, as a shopkeeper, haven’t been paid. You’ve accepted credit. If I go into your shop and use “fiat” currency, it’s the same thing. You’ve accepted credit, and you’ve got payment risk associated with that. But if I go into your shop and buy a loaf of bread with a silver coin or a gold coin, the assets are exchanged for assets. There’s no lingering payment risk. The exchange is extinguished at that particular moment of time.

And that’s what really money is. Money is the most liquid, tangible asset in the economy, and that happens to be gold and, to a certain extent, silver as well. But we’ve lost sight of that. What we’re using today is not money. We’re using a money substitute in place of money, and that’s what’s created the illusion that that everybody’s acting upon, and it’s this illusion that’s really created the money bubble.

I think we have to go back to basics when this final, biggest bubble finally pops. The basics, of course, are that money is the most tangible asset and the most liquid tangible asset in the economy, which, of course, is gold.

Chris Martenson: I needed to check what you meant by “money” because there’s been this big debate between the deflationists/inflationists, and the proper definition of money has to include certain debt instruments and credit. And as you note in your book, and something that I’ve noted as well – since about 1980, we’ve been expanding our total credit markets by roughly twice the rate of the underlying economies underneath them. And that’s across most of the developed world.

So with this, when you’re borrowing like crazy – it gives you the sense of prosperity, that illusion, the idea is that you have to pay it back at some point. I think the debate, as I understand it right now, is between those who believe that fundamentally that catches up with you. You have to pay it back. You pay it back in the form of defaults or inflation or hyperinflation. But one way or the other, those claims get diminished or destroyed.

And on the other side, I think we have people who believe that you can just kick this can down the road indefinitely. And is that a fair way to summarize the state of the spectrum of thinking on this right now?

James Turk: Yes. I think that’s really a very good description of it. But clearly, I’m in the former camp that you can only take so much debt on in the economy because debt has to be serviced. You have to generate wealth to pay back the interest expense on the debt that you’re accumulating.

And ultimately that determines how far you can go. And we’re long past the stage where the amount of debt has been put on the – the burden on the economy where the service interest can be properly serviced. And what they’re trying to do is to perpetuate the system by debasing the currency. But as you debase the currency, you’re ultimately destroying capital.

Look at the middle class and savers and generally how badly they’re being hurt by this policy of zero interest rates. You’re basically destroying capital with this policy of zero interest rates. You’re destroying purchasing power. But it’s being done simply to make it appear that the U.S. Government can continue to fulfill all of these promises that it has made and that it can continue to service this debt burden – but it can’t.

Let’s put some numbers on it. There’s $17-trillion of debt now, and that’s just the direct obligations of the U.S. Government. If interest rates were at one percent, that’s $170 billion. That’s about five percent of government revenues. If they went to a more normal level, you’re talking about an additional trillion dollars of expenses. And what that does is it puts you on this vicious downward cycle where the higher the interest expense becomes, the more money has to be printed to keep the system going. But that just leads to higher interest expense and ultimately hyperinflation of the currency.

And my guess is that’s the way we’re headed.

Chris Martenson: Well, let’s take a petri dish sort of an example around this. Japan – and Japan cuts both ways in this story. One, some people hold it out and say, Well, look, obviously you can hold interest rates at one percent pretty much indefinitely. Japan’s got a couple of decades of financial repression under their belt. And so that’s held up as an idea that that can carry on forever.

I just saw a tweet this morning from a Robert Ward, very interesting. In 2010, the population of Japan was 128 million. Best-case trend is that in 2100 they’ll have 65 million. Worst case, they’ll have 38 million people.

The question that was asked on that: Who pays back all the public debt again? So, here’s Japan piling up their public debt faster and faster and faster into a declining population, which I think just lays bare, in a fairly large petri-dish example, just how ridiculous this glide path that they happen to be on really is.

And is that a fair way to look at it? And if it is, is Europe or the United States on any different of a path?

James Turk: No. They’re really not. And ultimately, if you really look at the total level of debt, not just the direct debt but all of the promises that it made, the only rational conclusion that one could come up with is that a lot of promises are going to be broken.

What those broken promises will be, will be determined in the future by politicians. But we’re generally – given the fact that they only have a limited capacity to fulfill all of these promises, you as an individual investor has to basically decide, do you want to participate in any kind of government promise, be it the T-Bill or T-Bond, Social Security payment or whatever, hoping that you’re going to choose correctly and that they’ll continue to make good on the promise that they’ve given you?

Or, do you just want to avoid the sector completely, which is what I recommend, and go to something that’s safe, which is basically tangible assets and avoid debt instruments.

Chris Martenson: Let’s get to the theory of how this all comes to an end. Obviously, interest rates are one form of the Achilles’ heel, but you have in your book a notion of something called the “crack-up boom.” What is a crack-up boom?

James Turk: Yes. The term comes from Ludwig von Mises, the Austrian School of Economics. And basically, it’s just a shorthand way of saying that governments will destroy the currency to relieve the burden of all of the promises that they made when you reach that point in time that you can’t fulfill all of the promises.

So yes, crack-up boom is basically a flight from the currency, because people want to exit the currency, because they know it’s going to continue losing purchasing power, because of government and central bank actions that debase the currency.

Chris Martenson: This is an interesting point, then, because all fiat currencies owe a large portion of their value, as it were, to faith. We have to have faith, particularly on an international setting. Within a border, a government can dictate that your currency has value because a) you have to pay taxes, and b) they can arrest you and do other things in circumstances if you don’t trust their currency appropriately.

But given that trust is a component of this, that’s really what in my mind shifts you from an inflation to a hyperinflation. Hyperinflation is just a state of mind more than an actual mathematical place to be. It’s when people have lost confidence in the paper currency and they want to be in anything else.

So let’s talk about – you talked in your book, again, about distorted signals and lost trust. What are you talking about when you say “lost trust”? Because I’ve lost plenty of trust; I’m wondering how you characterize that?

James Turk: Yes. People don’t trust institutions anymore. They don’t trust the government anymore. The approval rating of Congress is something like 8%. And ultimately, people start to question what’s going on. They realize they’re not being treated fairly by what government is doing. The banking system is favored over individuals. Eighty percent of the American population was against the bailout in 2008, the bailout of the banks. But the banks got bailed out anyway.

And all of these things lead to, ultimately, a breakdown in trust. And the economy depends upon everybody being able to work with everybody else on a level playing field. That’s what governments are supposed to do. They’re supposed to maintain a level playing field by maintaining a standard rule of law that everybody abides by regardless of whether you’re a big bank or a little shopkeeper on Main Street or a husband and wife trying to get by in a very difficult situation.

But the playing field has been tilted now. It’s been tilted by various vested interests to serve themselves, rather than to serve the general public. And that ultimately leads to a major breakdown in trust and a flight from the currency in the Crack-Up Boom.

Chris Martenson: You talked about shrinking trust horizons. You had a list of things that might be indicators of that. This reads like my personal indicator list, by the way, where people might begin buying local food instead of national brands because they no longer trust the institutions that are producing the food. Community banks over money center banks. I have most of my wealth stored in community or local banks. Homeschooling over public schools – started that about eight, 10 years ago, tuning out national politics, etc. and so forth.

There’s a whole list there saying that people have lost a bit of faith. We detect that in the Congressional approval ratings.

There’s another one I’d like to talk about here for a minute, which is sort of my own proxy. And I’m looking at a chart here of CNBC viewership. So, CNBC being one of the primary mouthpieces for Wall Street, Here’s how you invest in the markets. Buy stocks. Here’s how you participate in the equity markets.

And what’s interesting in this chart is that their viewership rose all the way through the 1990s right up through 2000. So, the viewership rose with a rising market. And then it fell again down into a depth at around 2003 or 2004, and then it rose again with the markets up to 2007; fell and has continued falling; there’s been no recovery in their viewership with the so-called return of prosperity as evidenced by all-time new highs in global stock markets in many cases.

Why do you – is this – is it fair? I mean, when I’m looking at this, I’m thinking that the reason their viewership is falling off is the same reason I’m not watching, which is, I don’t think there’s any useful information on that program for a person like me.

James Turk: Yes. I think you’re right. There’s a bigger-picture issue here. You sort of touched on it in what you were just saying, that during periods of rising prosperity, the viewership rose, but during periods of declining prosperity, it didn’t.

So, despite what you hear in the media about the economy supposedly getting better, it’s not. There’s no rising prosperity in pretty much most of the world today, because the economy is getting worse and worse, because fewer and fewer people are working today. There are less people working now in America than there were back in 2005.

And the only way an economy is going to improve is if you have people interacting with one another, and that comes with a greater number of people working.

So, it brings up another point, Chris. Not only is there a decline in trust, but we have to look at the other side of the coin. It’s that the less people trust institutions or governments, the more governments respond by exercising financial repression.

What they do is, they try to maintain the system by imposing more and controls. And it’s these controls that ultimately are the final last-gasp effort by government to maintain a system that is no longer sustainable.

And you’re seeing these controls now being imposed regularly, not only in the United States but in many countries around the world. Increasing government intervention is not the solution to the problems that are faced today. The solution to the problem is less government, less taxes, less burden on working individuals and a sound money so that people can interact regardless where they are in the world, on a level playing field, because these interactions create commerce and it’s commerce which raises everybody’s standards of living.

And that’s ultimately what government should be doing – withdrawing all of this financial repression, withdrawing all the taxes and the overheads and the burdens, and let individuals get on with their lives.

Chris Martenson: Well, James, one man’s repression is another man’s gold mine. The financial repression has certainly been hitting savers of all stripes, people living on fixed incomes, pensions, endowments, you name it. But there have been absolutely enormous beneficiaries of that, not the least of which is seeing the rising wealth gaps that occurs everywhere – which, by the way, is just a mathematical function of what happens when you print money. Those closest to it certainly do very, very well. And those further from it do less well, even negatively well.

And so what I’m seeing in this data is, first of all, it’s fully predictable that when the Fed, et al., meaning all the other central banks, do what they do, there’s going to be a certain class of speculators that are going to reap the majority of those gains.

What do you think – I mean, just to speculate for a second – the Fed’s now got five going on six years of information about how their policies are working by many, many of the statistics that we’ve talked about here: unemployment, the true nature of the unemployment when you dig into the statistics a little between part-time/full-time jobs, the amount of capital expenditure spending by corporations. There’s a lot of things to say the seeds for good, organic growth are simply not there.

They’ve created a speculative arena, which they should have known was what they were going to create, because there’s lots of papers written about that well-known phenomenon. What do you think they’re thinking now going on into the sixth year of this?

James Turk: I don’t know. It’s hard to put myself in the shoes of a central banker. But I mean, if they looked at themselves honestly, here we are supposedly five, six years into an economic recovery, and they’re still printing money hand over fist? I mean, how can that possibly be? If they’re supposedly having good economic activity, why do they continue to print money?

Central bankers only have one solution to everything. They just print money and print money. But what they don’t understand is they’re ultimately destroying the currency and destroying the economy as a consequence.

Yes, Bernanke today could be very much compared to Doctor Havenstein, who ran the Reichsbank in Germany, which was its central bank during the Weimar Republic in the early 1920s. He felt that he had to continue buying government debt and turning it into currency because if he didn’t, that there would be an economic collapse and unemployment would rise.

Well, Bernanke’s turning U.S. government debt into currency for the same thing. It didn’t work out well in Germany. Obviously, central bankers should be reading the history books to see what happens as a consequence of money printing. This is one of the key themes that John and I are putting in this book, that we’re on a path that’s unsustainable, and we have to turn around and basically go back in the right direction. And each individual themselves has to take those steps to make sure that they themselves – they and their family – are protected come what may. And what we do is offer a variety of different ideas as to how to do that. And of course, precious metals are a key element of that strategy.

Chris Martenson: Let’s get to precious metals in a minute. One of the more enduring debates is whether or not precious metals are being manipulated in any way, shape, or form. So, before we talk about the potential for various market participants, I’ll call them, to manipulate the price of gold or silver – let’s review a couple of the other market riggings and overt frauds that we know about.

The LIBOR Scandal, if you followed that, that’s the very definition of a huge, gigantic conspiracy involving lots and lots of players that persisted for years and years. And yet, it was, they are fiddling around with rates that literally impact hundreds of trillions of dollars of derivatives and related investments.

So, when you look at the LIBOR Scandal, what – do you see anything other than big banks behaving badly?

James Turk: Absolutely not. I think that is a good example, and it’s just one of many. I mean, look at the number of things that various banks have become involved with in terms of scandals, and lying to authorities, lying to regulators, lying to customers. Why are precious metals any different from any of the other things that central banks have tried to do?

And it all comes down to the interest rates. Gold is money. It has its own interest rate. The market is basically for interest rates controlled by governments, so they have to control the gold price in order to control gold interest rates. It’s very simple and very straightforward.

But there’s a bigger picture here, Chris. What governments are doing now is no different than what they’ve been doing for over 100 years. It used to be under the classical gold standard, but what governments did is they managed domestic currency in order to maintain the constant purchasing power of gold.

About 100 years ago, they flipped that around. They started managing gold in order to maintain the ever-diminishing purchasing power of the domestic currency, and they do that by trying to control the gold price. I mean, we saw a good example of it in the 1960s, particularly with the collapse of the central Banking Cartel called the London Gold Pool. When eventually they couldn’t sustain the financial depression anymore, the gold pool collapsed and the gold price rose.

We have a similar set of circumstances today. We’re getting, I think, very close to the stage where the managing of the gold price or manipulation or the intervention in the market, however you want to describe it, is approaching its end. And that ultimately means a much higher gold price in the months and years ahead.

Chris Martenson: I just want to tick down this list I’ve got because it’s really instructive. So, my view is this: Anything that banks or central banks can do in order to achieve a profit or a policy aim, they will do. And banks, in particular, have proven extraordinarily aggressive at all manner of frauds, many of them just rather dramatic.

So we mentioned LIBOR. They’ve also been implicated now in Forex and currency manipulations, particularly banging the close on those markets. There’s the gold price fix. Certainly, in London they had an investigation there. I think Germany’s now in on that. Bafin’s checking out Deutsche Bank.

Others, on the CDL markets there were material withholdings from clients. The energy markets in California and other states were heavily manipulated by banks that got tagged in that. Mortgages, obviously, the Platt’s oil prices for global oil prices, those benchmarks had been – it’s been alleged and is under investigation. Active rigging there.

The ISDA fix that sets the benchmark for a $380-trillion stock market also been tagged with banks just quietly backpedaling away, saying, We’re leaving. Don’t investigate us. And obviously, the daily high-frequency trading, quote-stuffing shenanigans, overt price manipulation – this is the world we live in now.

If it turns out that – when I look at that constellation, I say, Oh, you really just can’t trust that the bank’s self-interest and your interest align even remotely. They don’t.

So, what does a person who’s more of an average investor supposed to do when they see that’s the world that we live in and that regulators seem to be rather uninterested in untangling that mess. And what a mess it is. Where do they go? What do they do?

James Turk: Wealth comes in two forms. It comes in financial assets, bonds, and T-Bills, and things of that nature, and it also comes in tangible assets: real estate, oil wells, timberland, farmland, houses and things that are tangible. And when you’re in a financial bust – and we’ve been in a financial bust since the dot-com bubble collapsed back in 2000 – what you want to do is you want to be involved with tangible assets and you want to avoid, as much as possible, your involvement in any financial assets. So, consequently, what people should still be focusing on, even though we’re 14 years into this bust, is continuing the accumulation of tangible assets.

Because when this bust is over, promises are going to be broken left and right. And that means financial assets where you have counterparty risk where you own an asset, the value of which is based on someone’s promise – a lot of those financial assets are going to be diminished in value. Now, there’s a special kind of financial asset called a stock in a company. It’s almost like a tangible asset in the sense that if you own stock in EXXON, you’re basically owning a tangible asset, because it’s involved in oil and it owns tangible assets all over the world.

But then, there are financial stocks, credit-card companies and banks, that are financial wealth rather than tangible wealth. So, you don’t want to own stocks in those companies. So, basically, own tangible assets or stocks in companies that are involved with tangible assets – those stocks, I call near-tangible – I think that’s the thing that everybody should be focusing on.

And when it comes to money and liquidity, the money, of course, would be physical gold or physical silver or a combination thereof because they will re-emerge in the historical and traditional role as money.

Keep in mind, gold’s been money for 5,000 years. It was made money by the market. Money comes from the market. It doesn’t come from the government. Over the past century, government’s certainly usurped that authority to control money. And over the last 40 years, they’ve gone even further afield by completely divorcing fiat currency from the gold that used to back money. And because of the time element that’s involved, we’ve lost sight of what money really is, and that’s what’s created the money bubble, Chris.

And it’s this money bubble where people have to come back to reality as to what money really is. It’s liquid, tangible assets being used in the economy in exchange for real goods and services. And it’s ultimately where we’re going. And I think it’s going to be very, very disruptive because if you look at an individual country like Weimar, Germany or Zimbabwe more recently, or what Venezuela or Argentina are going through now. You can see the disruption to the economy when the money is no good.

We’re talking here about fiat currencies throughout the world because nobody’s tied to gold anymore. No country’s currency is tied to gold anymore. So this is going to be the bubble, I think, that generations from now, hundreds of years from now people are going to be talking about just like we talk today about the South Sea Bubble or the Mississippi Bubble, from those episodes in history a couple hundred years ago.

Chris Martenson: If a country was going to behave more rationally and responsibly, how would we detect that? Looking at, say, Europe to the U.S., some are saying Europe is not printing nearly to the same degree as the United States.

Do you find any merit in that sort of, let’s say, jurisdictional analysis where you’re lumping, all fiat currencies are headed for the same cliff?

James Turk: Yes. All fiat currencies are headed for the same cliff. And the way you’re going to turn away from the cliff is, you have to look at what the central bank has in terms of gold reserves. If the central bank still has a credible amount of gold reserves relative to the amount of promises that the government has issued and the amount of paper that the central bank has issued, they have the ability to go back to some kind of a gold standard.

I mean, if the U.S. Gold Reserves are still there, they could probably do it at a gold price of $10 or $12 thousand an ounce or maybe a little bit higher. And you’d still have a lot of promises be broken, though, by the U.S. Government.

But if the gold’s not there in the central bank, then there’s no hope. And that’s really the worrying thing, because we don’t really know where all of the physical gold is these days. All we do know is that a lot of physical gold is moving from West to East, is being accumulated by people in Asia who understand gold and its historical role as money that is being taken away from people in the West, who view gold as an investment and something to speculate on, rather than something that’s fundamental to economic activity.

Chris Martenson: Well, it’s interesting. I’ve seen several studies that have done this same thing and asked the question, If you wanted to have a permanent portfolio…? meaning it would survive every war and it would perform well on every single up and down cycle as you go forward, the perfect weighting has 20% gold in it and then different weightings in stocks and bonds.

So, it had a role. And the thing that’s interesting to me is that you can, with just simple risk-adjusted returns put gold in a portfolio. Dial it up and down. Ask what’s going on. A very high weighting delivers the best efficient frontier on an idealized portfolio, back-tested through the last 100 years of history, and what I detect in my country from the United States is the slandering of gold at every opportunity in the mainstream press.

Do you see the same thing? And if so, what’s the motivation?

James Turk: Yes. Because it’s a type of financial repression. Propaganda is repression. They can’t let the truth get out that gold really is money, because if they do, then you’re going to have people fleeing fiat currency and going into gold. And that’s the worst fear of central bankers.

So governments and central bankers have this unholy alliance that governments borrow money and central banks facilitate that process by making sure that governments have all the money they want to spend. And the mainstream media basically facilitates it by providing anti-gold propaganda and telling everybody the economy is good, when in fact, all you have to do is talk to some of your neighbors and you’ll find out that the economy is not as good as the media tends to portray.

And we’re on this path where trust in institutions and things is rapidly declining.

Chris Martenson: And maybe for good reason, if you pay attention.

As we get towards the end here, here is a common question I get, and I think this is a tricky one. It’s around the idea of debt. And if you have to break the subject of debt down, that’s fine, because not all debts are created equal.

You have a chapter in here entitled, “Pay Off Debt and Internationalize,” but on the debt side of this, why would you advise getting out of debt at this point in history?

James Turk: Yes. There is this beguiling belief that if you have a lot of debt and the currency gets destroyed, your obligation will get destroyed with it. It may not work out that way. We live in an economy today where governments are heavily influenced by the banking system. If the currency collapses, there’s no reason to believe that the bank’s obligations are going to be minimized. They may impose on the government a rule that the debt has to be repaid in the new currency at fair economic value, not in a depreciated currency.

And I like to use the example of what happened to Thomas Jefferson – other than the Declaration of Independence and third president of the United States – he ended up dying a pauper because he ended up paying the debt on his father-in-law’s estate twice. He paid it once during the War of Independence and put the money with the Virginia Government, but the currency was destroyed by the end of the war. And he was then obligated to repay the debt again in pound sterling, which of course, was on a gold standard. And that basically bankrupted him and he ended up dying a pauper years later.

So, don’t assume that you’re going to benefit from having debt. It could very well be that the debt is going to be re-denominated in the new currency after the fiat currency collapses. The safe way to play it is to own tangible assets without any debt obligations.

Chris Martenson: I agree, and I have one other wrinkle on that, which is, there’s also this enduring idea, maybe a fantasy that as the currency debases, your income will be going up. But if it turns out labor markets have no power and your income stays low in nominal terms and is below the rate of inflation, you get a 3% percent raise but inflation goes to 10%, then you’re going to find that your disposable income is just shrinking and shrinking and shrinking. Your debt payments are fixed, and all of your other non-discretionary payments are fixed, and so things just get tighter and tighter.

Hey, that’s just the ‘70s. It’s stagflation again, in some way, but this time without the rising wages that we had back then. So I think it could be quite damaging to be holding debt.

James Turk: That’s a very good point and one of the things that John and I talk about in the book is that it’s becoming more and more difficult to actually measure wealth. What you really need to do is you need to measure the wealth by determining purchasing power, and we use, in this regard, ounces of gold. That’s a great way to measure whether your wealth is actually increasing or decreasing as an indication measure of purchasing power, rather than using dollars or Swiss francs or euros or any other currency.

But it’s just an indication of how bad things have become with regard to the monetary unit. One of the basic things as to why things are money is because they use them for economic calculation, to measure the prices of goods and services. And it’s becoming extremely difficult when you’re adjusting the size of the measuring stick.

In the book we use the example of what happened if a meter kept changing; how would you measure records at the Olympics from year to year? And that’s what we’re trying to do with this fiat currency that’s in circulation today.

Chris Martenson: So, from a macro perspective, nothing’s really changed. We’re trying to paper over it – the issues. We’re trying to sustain the unsustainable, as it were. We’re trying to pretend as if the next 30 years can resemble the past 30 years, which were extraordinarily unique in financial history with the run-up in debt relative to income.

So, that’s the macro story. And so you’re saying that even though it’s been a rough couple of years for precious metals investors, that they still remain one of the obvious solutions to the story; one of the obvious resolutions will come through precious metals, at least in part, with precious metals as a representative of tangible assets?

James Turk: Yes. Because, the last year, gold was down, but it was up 12 prior years. You can’t look at just the last year in isolation. You have to look at the big swing of things. And we’ve been in a gold boom market, believe it or not, since 100 years ago, since the Federal Reserve was created.

If you had held gold over that period of time instead of owning dollars, because a 1913 dollar has been so debased compared to what we have as dollars today, it takes only a penny of a 1913 dollar to purchase today what a full dollar today purchases.

So, I mean, it’s sort of like the end of currency in the Roman Empire. In over 100 years, it kept getting debased and debased and debased until it finally collapsed. And the same thing is likely to happen with the dollar. And every individual has to take those steps to protect themselves, come what may.

Chris Martenson: Absolutely. I agree.

Well, the book is, The Money Bubble: What to Do Before It Pops. I’m sure it’s going to be a great read if it’s anything like The Coming Collapse of the Dollar.

James, it’s been a pleasure talking with you. Where would people find your book?

James Turk: It’s available on Amazon, of course, and it’s also available through local bookstores.

Chris Martenson: Well, fantastic. You self-published this, didn’t you?

James Turk: Yes. We did. But it’s so easy to self-publish a book now that you can use the same distribution systems that the big publishing company houses use. What John and I wanted to do is, we self-published this because we didn’t want to go through the editing process that’s required when you’re using big publishing houses. What we wanted to say, we actually say without having to worry about what a publishing house might or might not cut out.

Chris Martenson: Oh, yes. That’s a very important consideration.

Well, thank you so much for your time today. I’m going to look forward to reading more of the book, and it’s going to be a very interesting 2014, I hope. Thank you for everything you’ve been doing to help raise awareness around one of the most important topics of our generation.

Thank you very much, Chris, I’m hopeful that The Money Bubble will be – well, it already is well-received, I hope it gets a lot of attention, because I think that I’m hoping that, as “Coming Collapse of the Dollar” did, it helped a lot of people, I think The Money Bubble will provide a lot of educational material that people will find useful as they try to get a handle on the crazy things that are going on today.

Well, James, thanks again and be well.

Charles Hugh Smith: What If Nations Were Less Dependent on One Another? | Peak Prosperity

Charles Hugh Smith: What If Nations Were Less Dependent on One Another? | Peak Prosperity.

Autarky is more than a ten-dollar word for self-sufficiency, as it implies a number of questions that “self-sufficiency” alone might not.

Autarky vs. Self-Sufficiency

The ability to survive without trade or aid from other nations, for example, is not the same as the ability to reap enormous profits or grow one’s economy without trade with other nations. In other words, ‘self-sufficiency’ in terms of survival does not necessarily imply prosperity, but it does imply freedom of action without dependency on foreign approval, capital, resources, and expertise.

Freedom of action provided by independence/autarky also implies a pivotal reduction in vulnerability to foreign control of the cost and/or availability of essentials such as food and energy, and the resulting power of providers to blackmail or influence national priorities and policies.

Where self-sufficiency might suggest a binary state – you’re either self-sufficient or you’re not – autarky invites an exploration of which parts of one’s economy and political order are self-sufficient and which ones are critically dependent on foreign approval, capital, resources, and expertise.

In terms of military freedom of action, some nations are able to commit military forces and project power without the aid or approval of other nations. These nations have military autarky, though they might be entirely dependent on foreign countries for critical resources, capital, expertise, etc.

In this case, though their military may be self-sufficient in terms of capabilities (power projection, control of airspace, etc.), any dependency in other critical areas introduces an element of political, financial, or resource vulnerability should the key suppliers disapprove of a military action. These vulnerabilities impose often-ambiguous but nonetheless very real limits on freedom of action.

The key take-away from this brief overview is that autarky has two distinct states. One is absolute: i.e., Can a nation grow, process, and distribute enough food to feed its population if trade with other nations ceased?, and the other is relative: Is the we-can-feed-ourselves self-sufficiency of the subsistence-survival variety that requires great sacrifice and a drastic re-ordering of national priorities and capital? Or is it relatively painless in terms of national sacrifices and priorities?

Clearly, relative autarky invokes a series of trade-offs: Is the freedom of action and reduction in vulnerability gained by increasing autarky worth a national re-ordering of values, priorities, and capital, and quite possibly broad-based, long-term sacrifices?

There is an additional issue raised by autarky: Is the self-sufficiency a matter of being blessed with abundant resources, or is it the result of conscious national policy and resolve?

Autarky as Policy

Consider petroleum/fossil fuels as an example. Nations blessed with large reserves of fossil fuels are self-sufficient in terms of their own consumption, but the value of their resources on the international market generally leads to dependence on exports of oil/gas to fund the government, political elites, and general welfare. This dependence on the revenues derived from exporting oil/gas leads to what is known as the resource curse: The rest of the oil-exporting nation’s economy withers as capital and political favoritism concentrate on the revenues of exporting oil, and this distortion of the political order leads to cronyism, corruption, and misallocation of national wealth on a scale so vast that nations suffering from an abundance of marketable resources often decline into poverty and instability.

The other path to autarky is selecting and funding policies designed to directly increase self-sufficiency. One example might be Germany’s pursuit of alternative energy via state policies such as subsidies.

That policy-driven autarky requires trade-offs is apparent in Germany’s relative success in growing alternative energy production; the subsidies that have incentivized alternative energy production are now seen as costing more than the presumed gain in self-sufficiency, as fossil-fueled power generation is still needed as backup for fluctuating alt-energy production.

Though dependence on foreign energy has been lowered, Germany remains entirely dependent on its foreign energy suppliers, and as costs of that energy rise, Germany’s position as a competitive industrial powerhouse is being threatened: Industrial production is moving out of Germany to locales with lower energy costs, including the U.S. (Source)

The increase in domestic energy production was intended to reduce the vulnerability implicit in dependence on foreign energy providers, yet the increase in domestic energy production has not yet reached the critical threshold where vulnerability to price shocks has been significantly reduced.

Assessing the Trade-Offs

This highlights the critical nature of the autarchic thresholds of systemic costs and freedom of action. Above a difficult-to-define threshold, the trade-off required to increase self-sufficiency to the point of being meaningful is too high in sacrifice or cost to the economy or society; the trade-offs required aren’t worth the gain in freedom of action and self-sufficiency.

Put another way: Below a difficult-to-define threshold, an increase in self-sufficiency does not yield either lower or more reliable economic costs, nor does it decrease the nation’s vulnerability to blackmail, price shocks, etc.

In other words, though dependence always has potentially negative consequences, it can also be cheaper, more convenient, and more profitable than autarky.

The diffused benefits of autarky are often overshadowed by the presumed burdens of increasing self-sufficiency. But this trade-off can be illusory. Though the status-quo players benefiting from dependence on foreign markets, trade, and capital will shrilly claim that the nation is doomed should their foreign-derived profits be sacrificed in favor of increasing autarky, a desire for more autarky often pushes the economy and society into a highly positive and productive search for greater efficiencies and more productive uses of capital.

Is the sacrifice needed to reach self-sufficiency as steep as presumed, or is a new order of efficiency enough to meaningfully reduce dependence on foreign resources and capital?

A Thought Experiment in American Autarky

If we look at America’s consumption of fossil fuels and its dependence on oil imports to feed its consumption, autarky forces us to ask: Exactly how difficult would it be to lower consumption enough to eliminate the need for imported oil? Would the economy suffer a death-blow if vehicle, heating, and appliance-efficiency standards were raised, and business travel declined in favor of telecommuting and teleconferencing, etc.?

The answer of those profiting from the status quo is, of course, “Yes, the U.S. will be fatally harmed if energy consumption declines,” but the reality is that such creative destruction of wasteful inefficiencies and consumption is the heart of free enterprise and the rising productivity that creates widespread prosperity.

If the U.S. had listened to the 1970s-era defenders-of-the-status-quo doomsdayers, who claimed that environmental codes and higher energy-efficiency standards would doom the nation, the U.S. economy would in fact be doomed by the absurdly inefficient energy consumption of that era. The U.S. economy has remained vibrant and productive precisely because the defenders-of-the-status-quo doomsdayers lost the political conflict between the forces of improved efficiency and productivity and the defenders of the inefficient, wasteful, and diminishing-returns status quo.

There is one other element in the calculus of dependence, vulnerability, and freedom of action implicit in any discussion of autarky. Despite the rapid increase in production of oil and gas in the U.S., America remains dependent on imports of oil. But not all foreign sources of oil, capital, expertise, etc. are equal; some suppliers may be stable, close allies, and share borders and standards of trade (for example: Canada, Mexico, and the U.S.), while others may be distant, unstable, and unreliable.

In other words, autarky may not be worth the cost if a nation is dependent on stable, close neighbors, but the value of autarky rises very quickly when a nation’s survival is dependent on distant, unstable nations with few ties other than the profitable export of resources.

Though a survey of America’s relative dependence and self-sufficiency would require a book, let’s look at a few charts to get a taste of America’s declining dependence on foreign-supplied oil.

Declines in consumption have the same effect in terms of reducing dependency as do increases in domestic production. Has the U.S. economy imploded as miles driven have declined? Or has the increased efficiency this implies boosted productivity?

U.S. imports of petroleum have declined:

U.S. domestic crude oil production has increased:

U.S. natural gas production has risen:

The U.S. oil/gas rig count is still far lower than the peak in the 1980s:

There are many issues raised by these charts, including the sustainability of increased production, the possibility of further declines in consumption, policies that affect production and consumption, and so on, but similar charts of grain, capital, expertise, goods, etc. would help to fill out the complex set of issues raised by declining consumption and increasing domestic production and productivity.

In finance, dependence can mean dependence on other nations for capital and/or profits. What is the consequence of rising autarky for an economy such as America’s that is heavily dependent on foreign markets and trade for the stupendous profitability of its corporations?

In Part II: The Consequences of American Autarky, we discuss this and other ramifications of America’s rising autarky.

America’s ability to project power and maintain its freedom of action both presume a network of diplomatic, military, and economic alliances and trading relationships which have (not coincidentally) fueled American corporation’s unprecedented profits.

The recent past has created an assumption that the U.S. can only prosper if it imports oil, goods, and services on a vast scale. Could the U.S. shift production from overseas to domestic suppliers, and reduce its consumption of oil and other resources imported from other nations?

Click here to access Part II of this report (free executive summary; enrollment required for full access).

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