Wednesday, May 12, 2010

Please comment on Froude, Maine and/or Carlyle

at the original Froude Society post, where comments are now open. Please do not comment unless you've read at least one of the three canons.

If you've read all three, please be patient! Further quests are coming soon.

Saturday, May 8, 2010 106 Comments

Strange rumblings in Dollarstan

I disappear into the garage for a while, and what happens? Wall Street types rm -rf *, Europe melts down, and Harvard kicks off the midget race war.

And now, we hear, JP Morgan is being investigated for evil deeds in the precious-metals markets - more or less confirming, or at least rendering plausible, the longstanding charges of GATA, Ted Butler, etc. Frankly, this doesn't surprise me. But the converse would not have surprised me, either. These markets are extremely opaque.

When I first hypothesized the spontaneous remonetization of gold, way back in 2006, I remember clearly how wacky an idea it was. While not exactly conventional, these days it is not at all hard to find, not even in the official press. (I have no joke - I just like saying "the safest of all investments, gold." I have been telling my mother this for quite some time, but I am still surprised to see it in the Times.) And the basic idea of remonetization was not at all unusual in those days, at least in the goldbug media. Completely unfiltered, this stream contains all good ideas about gold, and all bad ones too.

Remonetization is pretty simple: you have two neighboring countries, Goldenstein and Dollarstan. If Dollarstan systematically dilutes its currency, its savers will move their savings to Goldenstein, whose currency will therefore deflate. If Dollarstan is relatively large relative to Goldenstein, Goldenstein's currency will deflate relatively a lot.

There is no Goldenstein today, but that doesn't mean people can't use gold as money - ie, buy it now for the purpose of selling it later. (If there was a Goldenstein, and capital flight to gold meant capital flight to Goldenstein, all Goldenstein's industries would disappear and its citizens would just be rich for a living, like Kuwaitis. But fortunately, there is no Goldenstein.)

So people move their savings to Goldenstein because gold is going up. And gold goes up because people are moving their savings to Goldenstein. At the end of this cycle, gold is the standard medium of saving and dollars are a kind of soft, hot-potato currency - a North American Peso.

But while this effect - perhaps best simply described as capital flight to gold, or CFG - now appears to be occurring to some extent, it is occurring much less than my evil theory would predict! And it has not yet devoured the entire financial universe. Although that's certainly one of the things that could happen on Monday. But all this talk of gotterdammerungs does leave one a bit blase - does it not, Maurice?

The problem with my evil theory, as of 2006, is that it predicted that either (a) the dollarsphere had already exploded, or (b) would explode, spontaneously, as soon as the theory was properly stated. (a) was inherently false; (b) did not happen.

Therefore, there was some unknown variable in my evil equations. Ha ha! I would have to try again. Egg again, on Dr. Lizardo's face. But surely, any day now, the universe will end! (And it will come, to Dr. Lizardo it will come, and ask him to rule. Laugh while you can, monkey-boy.)

In fact it turns out that whatever JPM was alleged to be doing, it has a considerable resemblance to one good candidate for the missing variable. That is: the gold price is (or was) being managed by the production of artificial gold.

Since the price of all goods is set by supply and demand, the price of any good can be managed down by the creation of arbitrary supply. Who would buy artificial gold? Simple - someone who wanted to make a dollar when the price of gold went up a dollar. Who would sell it? Simple - anyone willing to lose a dollar when the price of gold went up a dollar.

In other words: to a gold investor, ie, someone betting on the gold market, artificial gold is just as good as regular gold. Actually, this is not quite true. But at a crude level, it is true. And to all conventional financial analyses, it is true. Thus, you can expect there to be a fair amount of artificial gold ("paper gold") around.

Even (perhaps especially) among the goldbugs, there is a considerable confusion between two kinds of artificial gold. Let's call them virtual gold and synthetic gold. Moreover, the (now highly suspect) London gold market itself does not distinguish between these types of claim, considering both unallocated.

Virtual gold (VG) is artificial gold that's backed, on the balance sheet of the issuer, by some kind of future gold receivable - eg, a gold forward. This is typically maturity-transformed, a stupid and dangerous practice, but one that is conventional in both bullion and regular banking. So, for instance, Buns & Buns of London might have written a promise to deliver gold in 3 months, backed by a Barrick promise to deliver gold in 36 months.

Again, if this seems dangerous, that's because it is dangerous. In a gold maturity crisis, as all holders of artificial gold demand allocated gold, gold interest rates spike - gold now is much more desirable than gold later.

But gold interest rates are tied by arbitrage to dollar interest rates. So what happens when this irresistible force meets that immovable object? Come on. In nature, what happens when an irresistible force meets an immovable object? What happens is a giant sucking financial death-vortex singularity, that's what. Don't ask these kind of things if you don't want the answer.

And even if it wasn't, that's probably still what I'd predict! But that's virtual gold - artificial gold backed by future gold production. Dangerous - but not lethal. At least, not especially lethal.

Now we turn to synthetic gold. This is also described as a speculative or naked short. A writer of synthetic gold is willing to lose a dollar for every dollar that gold goes down, and has collateral to back it up. Unlike the writer of virtual gold, who gets that dollar back when future gold rises (assuming gold interest rates do not decouple from dollar interest rates), the synthetic alchemist by definition has no gold to back his Mephistophelean paper.

The creation of synthetic commodities and/or securities is a normal aspect of a modern financial market. There is nothing inherently unhealthy about it. However, derivatives are not as safe as conventional theory would make them.

First, it is a fallacy to assume that collateralization can render any loan, however short-term, risk-free. There is no such thing as a risk-free loan. The possibility that the price of the collateral will fall faster than it can be sold, resulting in negative equity, always exists. This is especially the case when the collateral protects, or purports to protect, the lender against systemic risk. Collateral cures systemic risk like a good hot shower cures AIDS.

(The same is true of "clearinghouses." The modern term "clearinghouse" is actually derived from the Old German klarenhaus, a bit of Hamburg wharf argot meaning "too big to fail.")

Suppose you buy a CDS that pays you 1 euro if Greece defaults. Greece defaults. What do you have? A euro? No - a piece of paper, saying someone is supposed to pay you a euro. Who wrote this piece of paper? Who does it obligate? Do they even still exist? You didn't used to have to worry about this stuff. You didn't used to have to worry about Greece! Idiot. Or at least: if you mark this piece of paper at 1 euro on your balance sheet, you're fooling either yourself or someone else. Its expected value may not be much less than 1 euro; it is certainly less.

The government, of course, could pay off on private credit-default swaps. Typically this is the implicit solution - better mathematical finance, through fiat currency! And it has been done before. But not so much again, I think. What saved the world, or purportedly saved the world, in 2008 was a lot of one-off tricks - emergency authorities that could not possibly become routine. This time, things will have to get worse. The old emergency powers are dissipating rapidly, as emergency powers do.

And more practically, if you are one of the people who bet on the collapse of Greece, the people who are going to pay off on that bet are under the thumbs of the people you bet against! No one in Brussels wants to print a bunch of euros, just to pay off speculators and Jews like you.

But this is a minor quibble, compared to the real problem with synthetic gold.

The real problem with synthetic gold is: gold is not wheat. Demand for gold is monetary demand, ie, reservation demand. It is not consumption demand, as in wheat. Therefore, the creation of synthetic wheat by wheat traders should not have a substantial and predictable effect on wheat prices. This is not the case for gold.

Assuming for simplicity that all gold is held as monetary gold, the gold-dollar exchange ratio is set by the size of the gold stockpile and the marginal desire of gold and dollar holders to exchange their loot. If you expand the gold stockpile, you dilute the demand for gold. If you create synthetic gold, you lower the price for gold - just as if you were minting it in a nuclear reactor in your basement. Since your synthetic gold is (almost) just as good as physical gold, it passes perfectly well for the stuff.

A more sophisticated game can be played by minting arbitrary amounts of synthetic gold to move the physical market around, then buying it back to manage the size of the short position. As far as I can tell, this is what is alleged in the case of JPM. This is probably not profitable unless there is some external way to profit by manipulating the price. But here, great opacity descends.

The short takeaway is that in principle, synthetic gold can manipulate the gold market down, so long as the creator of the synthetic gold either (a) profits asymmetrically from success, or (b) is willing to accumulate a large naked short position. Whether (a) or (b), is the case in the case of JPM (or even whether this announcement is real) we cannot say at this time.

What remains puzzling, however, is the existence of any synthetic gold at all, in a world in which gold prices have been rising more or less steadily for a decade. Over this time, everyone who has issued these derivatives has been, on average, losing money. So why do they still do it? How can they still do it? It is not clear to me that quantitative finance can make money flow upstream. But then again, there is the government to consider.

In any case, if JPM has large naked short positions in gold and silver, and now is forced to close them, there will probably be trucks of chanting, machete-waving militia driving through your neighborhood by Wednesday or so. Short, dark men - speaking something that isn't Spanish. Arabic? Mayan? Kenyan? Have the Bilderbergers have been breeding them, in camps in the Sierras? Is this the New World Order, as Rush foretold? Alas, the television is already off. Arm yourself. Go to the window. Soon, the midget race war will begin.

Sunday, May 2, 2010 65 Comments

Solzhenitsyn, "As Breathing and Consciousness Return," 1973

In honor of this incident, I thought I'd post an excerpt from Alexander Solzhenitsyn's As Breathing And Consciousness Return, the first essay in his samizdat anthology From Under The Rubble.

It's a pity I don't have time to type more of this piece, but From Under The Rubble can be bought for a penny at many fine online bookstores. Inside the ellipses is Solzhenitsyn's great attack on Andrei Sakharov, for his "socialism with a human face" moderate dissidence.

Solzhenitsyn says: reject all the lies, not just those that contradict "world progressive opinion." The "world progressive opinion" of 1973 being not at all different from the mind of Harvard, 2010. Indeed for the reader of 2010, Solzhenitsyn does not attack Sakharov so much as pass through him - like a bullet through a stick of butter. Remaining lethally relevant, as Sakharov's Brezhnev-lite bromides grow comically dated:
The transition from free speech to enforced silence is no doubt painful. What torment for a living society, used to thinking for itself, to lose from some decreed date the right to express itself in print and in public, to bite back its words year in and year out, in friendly conversation and even under the family roof.

But the way back, which our country will soon face - the return of breathing and consciousness, the transition from silence to free speech - will also prove difficult and slow, and just as painful, because of the gulf of utter incomprehension which will suddenly yawn between fellow-countrymen, even those of the same generation and place of origin, even members of the same close circle.

For decades, while we were silent, our thoughts straggled in all possible and impossible directions, lost touch with another, never learnt to know each other, ceased to check and correct each other. The stereotypes of required thought, or rather of dictated opinion, dinned into us daily from the electrified gullets of radio, endlessly reproduced in thousands of newspapers identical as peas, condensed into weekly surveys for political study groups, have made mental cripples of us and left very few minds undamaged.

Powerful and daring minds are now beginning to struggle upright, to fight their way out from under heaps of antiquated rubbish. But even they still bear all the cruel marks of the branding iron, they are still cramped by the shackles into which they were forced half-grown. And because we are intellectually isolated from each other, they have no one to measure themselves against.

As for the rest of us, we have so shriveled in the decades of falsehood, thirsted so long in vain for the refreshing drops of truth, that as soon as they fall on our faces we tremble with joy. "At last!" we cry, and we forgive the dust-laden whirlwind which has blown up with them, and the radioactive fallout which they conceal. We so rejoice in every little word of truth, so utterly suppressed until recent years, that we forgive those who first voice it for us all their near misses, all their inexactitudes, even a portion of error greater than the portion of truth, simply because "something at least, something at last has been said!"
[...]
The state system which exists in our country is terrible not because it is undemocratic, authoritarian, based on physical constraint - a man can live in such conditions without harm to his spiritual essence.

Our present system is unique in world history, because over and above its physical and economic constraints, it demands of us total surrender of our souls, continuous and active participation in the general, conscious lie. To this putrefaction of the soul, this spiritual enslavement, human beings who wish to be human cannot consent. When Caesar, having exacted what is Caesar's, demands still more insistently that we render him what is God's - that is a sacrifice we dare not make!

The most important part of our freedom, inner freedom, is always subject to our will. If we surrender it to corruption, we do not deserve to be called human.

But let us note that if the absolutely essential task is not political liberation, but the liberation of our souls from participation in the lie forced on us, then it requires no physical, revolutionary, social, organizational measures, no meetings, strikes, trade unions -- things fearful for us even to contemplate and from which we quite naturally allow circumstances to dissuade us.

No! It requires from each individual a moral step within his power - no more than that. And no one who voluntarily runs with the hounds of falsehood, or props it up, will ever be able to justify himself to the living, or to posterity, or to his friends, or to his children.
In this case, the lie is the proposition of human neurological uniformity (HNU). It's not just that HNU is rebutted by a considerable weight of evidence - that's relatively unimportant. It's that it is supported by no evidence at all. Yet your government requires you to believe it. Quite effectively, as we see. 150 years ago, Froude had much the same problem with the Thirty-Nine Articles. Transsubstantiation redivivus.

But as an act of mandatory faith, HNU is no less subject to Chesterton's observation: when people stop believing in God, they don't believe in nothing. They believe in anything. The task of understanding the world we live in, without the assumption of HNU, is gargantuan. It is not just a matter of putting a Confederate flag on your pickup truck. It requires both tremendous mental energy, and tremendous analytic judgment. It is too vast for any individual; too dangerous for any organization.

So? What is the first step? Simply to discard the lie, and to realize that you have proceeded from a state of false knowledge, to one of true ignorance. The frame of your television is broken; you have no television; the illusion of omniscience vanishes. Eyes you have, and a brain. They are small. The world is large. History is even bigger. So what? You are not first, and not alone.