Thursday, January 28, 2010 38 Comments

On sovereign financial reconciliation

When Necker published his Compte rendu in 1781, many have credited him with causing the French Revolution. Before the Compte rendu, no one in France had understood anything about Bourbon finance - possibly not even the Bourbons. As La Wik puts it, in charming Wikipedese:
Before, the people had never considered governmental income and expenditure to be their concern, but now armed with the Compte rendu, they became more proactive.
Indeed. Of course, in the subsequent decades, many thought twice about becoming more proactive! But governmental income and expenditure had indeed become the people's concern - then and forever. Alas, it remains our own.

According to modern historians, Necker's accounts were not entirely honest. I will go with the modern historians on this one - sight unseen. I have not personally inspected the Compte rendu, but my guess would be that Bourbon finance included a lot of strange French holes in which strange amphibians things could hide. The Bourbon administration, while great at many times and in many ways, is seldom celebrated for either simplicity or transparency.

One of the most fundamental patterns of history is that good government is responsible government. A corollary is easily deduced: good government is financially responsible government. Since good government is indeed our concern, we should become concerned indeed when our government does not appear to be financially responsible.

An easy way to be financially irresponsible is to be financially opaque. If an institution is responsible, it must be responsible to someone; to observe it, that someone must be able to form a clear picture of its financial operations. There are many ways to be financially opaque, while superficially appearing transparent. Suffice it to say that I am not sure anyone has a really sound understanding of America's sovereign balance sheet.

But regardless of the cause, if an institution is not financially responsible, it must be reconciled. Reconciliation is simply a polite word for bankruptcy. What are we reconciling with? Reality!

As Carlyle writes:
Great is Bankruptcy: the great bottomless gulf into which all Falsehoods, public and private, do sink, disappearing; whither, from the first origin of them, they were all doomed. For Nature is true and not a lie. No lie you can speak or act but it will come, after longer or shorter circulation, like a Bill drawn on Nature's Reality, and be presented there for payment, - with the answer, No effects.

Pity only that it often had so long a circulation: that the original forger were so seldom he who bore the final smart of it! Lies, and the burden of evil they bring, are passed on; shifted from back to back, and from rank to rank; and so land ultimately on the dumb lowest rank, who with spade and mattock, with sore heart and empty wallet, daily come in contact with reality, and can pass the cheat no further.
But with a Fortunatus' Purse in his pocket, through what length of time might not almost any Falsehood last! Your Society, your Household, practical or spiritual Arrangement, is untrue, unjust, offensive to the eye of God and man. Nevertheless its hearth is warm, its larder well replenished: the innumerable Swiss of Heaven, with a kind of Natural loyalty, gather round it; will prove, by pamphleteering, musketeering, that it is a truth; or if not an unmixed (unearthly, impossible) Truth, then better, a wholesomely attempered one, (as wind is to the shorn lamb), and works well.

Changed outlook, however, when purse and larder grow empty! Was your Arrangement so true, so accordant to Nature's ways, then how, in the name of wonder, has Nature, with her infinite bounty, come to leave it famishing there? To all men, to all women and all children, it is now indubitable that your Arrangement was false. Honour to Bankruptcy; ever righteous on the great scale, though in detail it is so cruel! Under all Falsehoods it works, unweariedly mining. No Falsehood, did it rise heaven-high and cover the world, but Bankruptcy, one day, will sweep it down, and make us free of it.
There are many ways to define a sovereign bankruptcy, most of which convert one falsehood into another. A true sovereign reconciliation produces a financially sound and transparent sovereign balance sheet in one step, fair to all creditors. If your plan matches this definition, whatever it is, it cannot possibly be wrong.

As I see it, any sovereign bankruptcy which is "true and not a lie" must recognize three facts:

First, any real bankruptcy demands a change of management. What follows is certainly not a plan that can be executed by the present management. What restructuring plan is? But this is outside our scope today.

Second, precious metals are the only currencies to which a sovereign can be accountable. Therefore, reconciliation must produce a sovereign whose books are done in direct gold. A direct gold standard is 100% blue agave. A basket of gold and gold loans is not gold. (Ie, the 19th-century Bank of England "gold standard" was not a PGS.) The exact technical term is allocated gold.

Third, fiat currency is sovereign equity. Let me repeat that: fiat currency is sovereign equity. Perhaps I could say it a little louder: FIAT CURRENCY IS SOVEREIGN EQUITY. If the right twelve people ever understand this, the world as we know it will come to an end.

Fiat currency has to be equity. It is (a) a financial security, and (b) not a debt. Ie, it is not a promise of anything. If it was a promise of anything - regardless of the quality of that promise - it would not be fiat currency! D'oh.

Therefore, we know exactly what a dollar is: a share of stock in USG. It is just one class of stock, of course, conveying no voting rights. The dollar has never paid any dividends, though perhaps this will change. In sufficient quantity it does convey one very important benefit: the right not to be arrested by the IRS. It also conveys an important right: the right to be treated equitably with all other dollars. My dollar is worth just as much as your dollar or China's dollar.

If you disagree with these facts, you can stop reading this essay now. We are going to reason as if they were true. If they are not true, all that follows is nonsense.

First, we see instantly why we cannot get a clear picture of the financial condition of USG. It calculates its accounts in its own stock! Can you imagine a company which paid all its vendors in its own corporate shares?

Any corporation can, of course, issue new shares to itself any time it likes. (This is called dilution.) But how on earth can anyone assess whether this company is profitable? How do you value a share? Actual companies which do crazy things like this are generally not profitable, because otherwise they would not need to do crazy things like this.

And that's not all. Not only does USG calculate its own accounts in terms of its own shares - it compels its citizens to do likewise. It operates an entire economy in which the medium of exchange is this scrip. Of course, we all know this and think of it as normal, so it takes some effort to see how insane it is from an accounting perspective.

One metaphorical crutch that can help us with this is the new invention of virtual worlds. Virtual worlds tend to have virtual currencies, whose economics differ not at all from the economics of real currencies - except, of course, that they are virtual. But virtual worlds are operated by real companies, which exist in the real world and do their books in it.

The virtual world Second Life, operated by Linden Lab, is one such. Linden Lab is not a publicly traded company, and perhaps it will never be. Suppose it was. We'll call its stock ticker LLX.

Second Life has a currency called the Linden dollar. The Linden dollar is an irredeemable fiat currency, though LL keeps it roughly pegged. But suppose it was backed and redeemable - making it debt, not equity. What should it be backed by? US dollars? Gold? Or...

Let's suppose Bernie Madoff, or some other unscrupulous person, were appointed the CEO of Linden Lab. As CEO, he is responsible to his board. His board will love him - everyone will love him - if he can only get the price of LLX up. Hm...

I know! Bernie will back Linden dollars with LLX shares. That way, when you buy Linden dollars to play Second Life, you are actually investing in Linden Lab. Share prices are set by supply and demand, of course - to issue a new wodge of L$, LL goes to Nasdaq to buy an LLX share. Naturally, this drives the stock price up. Which is what Bernie wants! Problem solved.

What Bernie has done is to redirect the monetary demand of Second Life residents into the market for LLX shares. Since as long as Second Life exists and thrives, this monetary demand will remain high and stable, what goes up need never come down. By using his own shares as a fiat currency, Bernie has performed a rare successful act of market manipulation.

The result is that LLX, as a stock on the Nasdaq, will not be priced like other Nasdaq stocks as a function of its theoretical earnings. LLX may have no earnings whatsoever, ever. A Linden dollar now certainly conveys no rights to any distribution. The shares of an ordinary company would be worthless under this condition, but not LLX. Were it not that Linden Lab's churlish, ungrateful vendors demand payment in US dollars rather than Linden dollars, Linden could operate forever under these conditions, however inefficient its operations.

Needless to say, Linden Lab's financial operations under this system would be entirely impenetrable - probably even to Linden Lab itself, but certainly to any external examination. But this is exactly the model under which USG operates: it directs the monetary demand of its own subjects into its own equity, in which it also does its own books. Small wonder no genuine Compte can be Rendu. There is nothing in the books but madness. Madness!

So let's reconcile this madness. Let us not only render accounts - but pay them. The ends of any design: (a) create a sound and viable financial structure; (b) treat all creditors fairly. These goals are just as appropriate and essential at the sovereign level as in any private bankruptcy.

No sovereign balance sheet can be reconciled without admitting and employing the full set of sovereign powers. Frankly, the days when it made sense to talk about property rights in the United States are over. Any such talk is babble - like talk of restoring the Bourbons. God may once have granted France to the Bourbon family, but he appears to have changed his mind.

If property rights must be preserved, USG's balance sheet cannot be reconciled. You either do this thing or you don't. We are all creditors of USG, and none of us has any special rights. After the reconciliation, of course, property rights can and should be as rigorous as anything. During the reconciliation, they are all just pieces of paper - signed by USG. USG is bankrupt. The pieces of paper remain important; the bankruptcy process will treat them fairly.

During the reconciliation, the essential criterion is fairness. A bankruptcy process creates no winners and no losers. At least, it creates no winners and losers among those in the building. If you got out before the bankruptcy, there is no way you will not be thanking yourself. Since USG is sovereign, to a limited extent it can perform such clawbacks, but a sovereign must be careful not to test the physical limits of its sovereignty.

What I'm trying to say here is that in any scenario in which any sovereign undergoes this process, and converts its balance sheet back to gold, there will be one set of big winners. These will be people who sold the sovereign shares, or assets denominated in those shares, for gold - before the bankruptcy. A sovereign, to a limited extent, can and should tax these moguls - just as it taxes people who bought Google at the IPO price. If it taxes them too much, however, it must either create a large gap between the price of natural gold and the price of monetary gold, or apply a tax rate which creates a black market in old gold. Either is dangerous.

There are always rich people. A marginal dollar in the hands of the rich is much less likely to be competing in any market with your dollar, than a marginal dollar in the hands of the poor. In other words: it is less "inflationary." Therefore, enriching the goldbugs is not a serious concern for policymakers. They were right; therefore, they should profit. In a word, that's capitalism.

The brutal truth about USG's shares is that, due to the above (and other) manipulations, they are overvalued in gold. If a dollar is a USG share, and USG shares are repriced in gold, a dollar cannot be worth anywhere near 30mg. It might be worth 1, or 2, or 3. For the dollar holder, the main pain is still to be felt. If 2008 and 2009 felt financially stormy, your barometer is overcalibrated. The market has barely come under pressure.

Because even its currency is tied up in the strange machinations of its bizarre 18th-century government, USG, America must experience bankruptcy as a whole. USG was never designed to be a total state, but it is one now. If you would like it not to be a total state, the only way to start is by acknowledging that it is a total state. Capisce? Is this for some reason difficult?

The task of the new financial managers of this total state is to set a new price level across the entire American economy. That price level must be one at which the economy is (a) stable and (b) can generally pay its debts. At present, the economy is artificially depressed by deflation; thus, the new price level should be set at a low, stimulative point.

Devaluation is always and everywhere an economic stimulus. It rewards the poor at the expense of the rich. This is bad policy on a continuing basis, but excellent policy as part of any one-time event. Any reconciliation should include a strong dose of stimulative inflation. Because the endpoint is a direct gold standard, this stimulus will not last; in the long run, the economy must rearrange itself to a profitable equilibrium with no fiscal, trade or monetary deficit. However, through devaluation the transition can be made almost arbitrarily gentle.

This transition plan has six steps. First, we identify all of USG's liabilities - simple or contingent, formal or informal - and securitize them, converting them to debt in dollars. Second, we nationalize all financial assets at the present market price, converting them all to dollars. Third, we cut each dollar in half: the left half is a share in USG without its gold reserve, the right half an allocated claim to that gold reserve. Fourth, we run a Dutch auction to set the price of left dollars in right dollars - an IPO for USG, now highly profitable, owning the entire country, and debt-free. Fifth, we convert all payment and accounting systems to right-dollars, treating left-dollars as ordinary portfolio securities, and normalizing right-dollars into units of weight - ie, grams Au. Sixth, we privatize all the nationalized assets

The first and second steps are the hard ones. The fifth is a lot of work, but it's a small matter of programming. The first and second actually require thinking. Let's do that thinking.

First: boys and girls, let's play a fun game - "find the liabilities!" USG has many conventional debts; it also has many strange liabilities of an unconventional form. We need to find and liquidate all of them, converting them into dollar securities.

In the second step, we convert all these liabilities to present dollars. We already did this in the first step for financial securities: if you held T-bills or Agency bonds, USG bought them at the present market price. However, many of USG's liabilities are (a) contingent; (b) actuarial; or (c) informal. All of these must be discovered and replaced with mere dollars.

First, USG has contingent liabilities. These are promises USG has made which may force it to be liable for a debt. A good example is a loan guarantee. USG has made a lot of loan guarantees. Most of them were made to institutions acquired in the first step, and obviously a guarantee to oneself is void. But in case any are still floating around, they need to be cleaned up.

To clean up a loan guarantee, assume the loan and pay it off. If A has loaned $X to B and USG has guaranteed this loan, USG pays $X to A and is owed $X by B. Poof! Reality is revealed. A loan guarantee is in reality a government loan. Better living through bankruptcy.

Next, USG has actuarial liabilities. For instance, suppose you have been paying into Social Security. You have therefore earned Social Security benefits. The payout will vary depending on your age. The present actuarial value at present interest rates of your benefits, however, is easily calculated. This sum is deposited into your Fed account. Social Security can be entirely closed out in this way.

So can all entitlement programs, even those paid in benefits rather than cash. For instance, what are your Medicare benefits worth? What would it cost you, in present dollars, to buy your Medicare benefits from a profit-making insurance company? That sum is deposited into your Fed account. In fact - why not give everyone Medicare coverage while we're at it? If the people want national health care, this is a perfect way to give them exactly that.

Essentially, we are cutting the strings of dependency that bind voters to Washington, not by eliminating their benefits but by cashing them out. Once said voters understand this model, it strikes me as unlikely that they will oppose it. If there is some problem with this, just increase the allocations by 20 or 30 percent. The yelps will rapidly subside.

These political buyouts should already be calculated in a generous and giving spirit. Since the old management spent 75 years buying political power with USG's printing press, surely the new management cannot be excused for doing so on a one-time basis.

(Progressives are attracted to national health care because of the enormous number of strings it will attach. Voters are attracted to national health care because they want national health care. If you have a plan that provides national health care without any strings attached, do not expect it to attract progressives.)

All recurring payments made by Washington should be investigated for conversion to debt. They probably are debts - just informal debts. For instance, welfare payments proper obviously cannot be monetized and transferred to the recipients. This budgetary stream, however, can be monetized and converted into an endowment, which endows a charity that looks after the recipients. Washington, which is a very caring place, can get all its caring good works out of its hair and off its books in this way. Even national defense can be endowed - a proposition that would certainly tend to minimize unmotivated adventurism.

Even the most basic expenses can in fact conceal debts. For instance: consider a government employee who cannot be fired. Well, new management is what it is! It turns out: he can be fired. (In fact, I would be quite surprised if new management keeps many of the old employees.)

But the old employees have a right: the right not to be fired. This is an entitlement. Being sovereign, the new management cannot be compelled to employ them. Being fair, and anxious to prove its fairness, it is compelled to respect this entitlement, as it respects others. Thus it should compensate fired government employees with a mammoth dollar severance, which repays them for their loss of tenure.

So there is a simple explanation for the first step. Formalizing and securitizing entitlements is always and in every case a Pareto optimization - except in one case, the case in which the entitlement is a mechanism of dependency through which the provider asserts paternal guidance.

USG is particularly noted for the high quality of its paternal guidance. Not. Moreover, since this objective (debatable in the first case) cannot be observed in polite company, it cannot be the actual motivation for these policies. Otherwise, you would be making the same argument for welfare that George Fitzhugh made for slavery. I'm sure you wouldn't want to do that.

Second: nationalize all financial assets, at their present market price.

This is not hard to define. But why? What is the rationale for this unprecedented act? The word "nationalize" is needlessly provocative. Rather, we are consolidating the sovereign balance sheet. This is both righteous and essential for more reasons than I can count. But let me just enumerate a few.

The basic moral reason is that since the dollar financial markets are so fundamentally and thoroughly manipulated, the prices of financial assets cannot in any way be regarded as market prices. The new management will create free markets. The old management ran the book at a rigged casino. The new management is closing that book - with its present entries. If you have a balance at the casino, you get the balance back in cash. (Ideally at a premium, for your trouble.)

Perhaps you doubt that all securities prices are set by the government. Actually, this can be trivially deduced from basic investment theory. The price of a loan is set by the interest rate of that loan, the probability of default, and the risk-free market interest rate. If the USG fixes or manipulates the last - as of course it does - in what sense is this price a market price? Duh.

We can still compute the probability of default from the price of the loan; this market information is still visible. We can compare relative prices of securities. The number that appears next to the loan in the owner's portfolio window, however, is entirely determined by USG. The absolute price, in dollars, is an administrative decision of the government.

For instance, if the Fed ceased to lend or buy loans tomorrow, interest rates might well go to 87%. I pick this number arbitrarily. It might also be 187%. Or 287%. Question: if interest rates go to 87%, what is a 30-year zero-coupon T-bill paying 5% worth? Can you even sell it? Or do you just recycle it? You do the math.

Moreover, this principle extends not just to financial instruments, but also to financed assets. Consider a house. The house's owner is in the quaint habit of talking about what her dwelling was "worth," as though this was some objective quality of the physical object, like being brown. Between 2000 and 2006, her house "went up" - before it was "worth" $300K, after it was "worth" 550K. The house, in fact, deteriorated. It did not spontaneously remodel its kitchen. Perhaps its neighborhood became more attractive - or perhaps the dollar market was being pumped full of government loans.

The economic planner thus faces a dilemma. Any return to free-market economics will have an extremely chaotic, and generally negative, effect on the price of financed assets. This is because any return to free-market economics is likely to result in higher interest rates, since there will be no government lending or loan guarantees.

This is why no realistic reconciliation plan can maintain property rights - at least, not in the market for securities and securitized assets. It is essential to fall back on the less rigorous, but more important, standard of fairness. What is fair in dealing with this problem? What's fair is that whatever you own, be it stocks or bonds or houses, you bought in dollars; if it "went up," you earned those dollars too; when it "went down," you suffered with it; whatever you are "worth" is yours. All results of the financial ancien-regime are permanent.

The present prices are not free-market prices. But they are market prices. They represent genuine results of real life. A fair system would maintain these results. Therefore, the only way to revert to market pricing, while preserving fairness, is for USG to buy these assets at their present price, which USG itself has set; and sell them again at market prices. Which will generally be lower, since any liquidation is bound to be deflationary.

What is the difference? Who takes the loss? The "loss" is a liability that USG assumed, when it decided to manipulate the freakin' market. It cannot just cancel this debt. Rather, the debt must be paid. But the debt cannot even be calculated without returning the asset to the market. Thus, temporary nationalization is essential.

Nationalization can be quite involuntary. Financial assets are not, in general, of sentimental value. Houses are an exception. There is no sense in kicking people out of their houses. However, there is such a thing as a long-term lease. If the government nationalizes your house, you will obviously get a long-term lease.

Therefore, we have our plan for the asset side of USG's balance sheet. Since USG is sovereign, it is the final and ultimate owner of everything. It exercises that right. It buys all market-traded securities at the market price. It grants all holders of all financed assets, right down to cars, the right to sell the collateral to USG at the present market or assessed price, whichever is higher. Cars and houses are leased back to their owners. For financed assets, this is an option and you don't have to take it - but if you don't take it, USG is not responsible for any pain you may taste.

Where does USG get the money for this? Remember, no one has any money. Fiat currency is sovereign equity. Instead, we have shares of USG. The correct question is: where does USG get the dollars? The answer is: it issues them. Any financial reconciliation will see the creation of enormous numbers of shares. That's why they call it a debt-to-equity conversion.

As for gold, USG demands that all citizens turn in half their gold. It's called a "tax," doofus. The new management is hardly about to abandon their right to tax! And the tax includes jewelry - to keep it, pay the gold tax. More than this, and people will cheat. Less, and USG would get more by asking for more. 50% should be somewhere near the top of the Laffer curve.

Moreover, no such tax is a rational reason for present gold holders to oppose this plan. Again, they will profit massively by it - as they should.

What have we done to USG's balance sheet? On the liability side, we have added 10 or 20 trillion dollars - at least. Almost all American debts are now owed to USG; almost all American assets are now owned by USG. This is the nation-state as giant totalitarian corporation. It is not a sustainable state of affairs, but we do not intend to sustain it. On the asset side, we have added a large number of valuable assets - debts, homes, corporations, etc.

We also must consider personal balance sheets. As a result of this operation, your net worth in dollars is unchanged. Your net worth, however, consists entirely of dollars. If you had $200K in home equity, you now have $200K in dollars. If you were in debt, you are still in debt. (Except that underwater nonrecourse mortgages are wiped out.) All that changes is that you now send your checks to Washington, instead of "The Lakes, Nevada."

Moreover, since the Fed has acquired all banks, you don't have $200K "in the bank." You have your own account at the Fed, a privilege previously reserved for actual banks. This layer of indirection is entirely artificial and unnecessary - in short, a historical legacy. In a world of electronic dollars, the Fed's state is simply a big spreadsheet in which each row is a pair: your SSN, and the number of dollars you own. Your number indicates how many brownie points Uncle Sam has assigned you, so to speak. And if you prefer your brownie points on paper, all ATMs now have a new logo: the Fed's.

Liquidation is the conversion of debt into equity. But when we find all the spending that is actually debt, and convert it into actual debt, we don't just liquidate the debt.

What we are doing here is destroying USG's chronic deficit. All of its regular expenditures which are not related to the production of revenue - revenue in gold - are in fact debts of the old regime. Since the old regime was bankrupt, all its debts are converted into equity - ie, present dollars. The result is a gazillion dollars - but all those dollars are shares in USG. Which is now massively profitable. Bankruptcy in a nutshell!

Financially, the continent has been converted into one immense gold farm. It costs very little to administer, the Americans being docile, and produces enormous returns. In short, it is more profitable than Jesus. This profits must be split, however, across a gazillion shares - or dollars.

The new America has the simplest possible balance sheet. On the liability side, it has no debt and a single class of equity. On the asset side, it has everything. An enormous stream of gold, from both taxes and debts, pours into Washington's coffers. Naturally, it must be distributed to the shareholders - and thus the shares have value. Gold value.

But what, exactly, is their price? USG's profits are not yet an enormous stream of gold. They are only an enormous stream of dollars. An entity cannot be financially responsible if it pays dividends in its own shares. This would just be bizarre.

We now face our third problem: dividing the dollar. This is our automatic dollar-gold devaluation figure.

Again, all dollars are cut in half. Quite literally - if you hold dollars as cash, you take a pair of scissors and cut them right down the middle. Electronically, of course, no scissors are required. Electronically, all dollars are in your Fed account. This will simply change from one number to two. If yesterday you held 50K dollars, today you hold 50K left-dollars and 50K right-dollars. These will not exchange at 1:1 exactly - probably nowhere near. But their sum is no more, and no less, than what you had before.

Left dollars are shares in USG's vast pile of assets, seized in the nationalization, and of course in the future revenues of USG itself. Which are themselves vast. Right-dollars are claims to USG's gold reserve, fully allocated and redeemable. Essentially, a left dollar is a share in the American Treuhand; a right dollar is a zilligram in BullionVault.

A crucial question is whether Fort Knox accepts bail-ins - ie, you can deliver a right dollar's worth of natural gold to Fort Knox, and get a right dollar for it. If so, the monetary system is a direct gold standard. If not, the price of monetary gold may float above the price of natural gold. There is no technical problem with this, but it is probably imprudent. A hybrid gold standard with restricted bail-in is an interesting design, but perhaps too experimental. After 75-plus years of New Deal economics, the people will demand only the simplest and most classical of financial designs. Floating super-gold is not in this class.

To divide the dollar, we need to (fourth) establish an exchange rate between left and right dollars; and (fifth) convert the standard of payment to right dollars. (a) is the same problem as the problem of valuing the East German Treuhand, except in gold - of assigning a stable gold value to all financial assets. Basically, a left dollar becomes an investment dollar; a right dollar a spending dollar.

In particular, all debts are converted to right-dollar debts, at the initial left-right rate. If the market does not set a good exchange rate, debtors may be unfairly penalized or rewarded. However, we cannot do better than this market.

In a single gigantic Dutch auction, a left-dollar price is set; all those who prefer left to right dollars below this price receive left for their right, and vice versa. The result is the Rate - best expressed as the price of a dollar in milligrams of gold. (My guess is: somewhere around 2.) The old dollar is split into left dollars and right dollars; the left is an investment, ie, a stream of future returns; the right is money.

To create a new capital market, we must value our investments in terms of money. We must value the dollar in gold. We do this, in one step, by getting all the investments into one pool, and valuing that pool in gold. We can then By centralizing this decision, we ensure that its consequences are fair to everyone.

And, again, fifth: payments can then be switched to right dollars. Or rather, grams of gold. Since right dollars are no more than claims to gold, going all the way to a weight-based standard is trivial. And probably advisable. But the difference is not substantive. Once we have valued left dollars in right dollars, we can value dollars in right dollars. Or rather, grams of gold.

Let's say we go directly to milligrams. On the flag day, therefore, all prices become milligrams Au, all payments gold payments. To set the gram price from the dollar price, multiply by the Rate. To rewrite old contracts written in dollars, multiply by the Rate. This change, like any redenomination of the currency, is mechanical.

Of course, these prices may fluctuate; all prices do. However, we have been extremely careful throughout this entire exercise to preserve relative purchasing power. Asset prices will have no choice but to change, because the entire financial market has been rebooted. Consumer prices and labor prices should remain roughly the same, because purchasing power (relative to the Rate) has remained roughly the same.

Or, for a slight stimulus, become slightly greater. At the expense, of course, of stealing from the rich and giving to the poor, the economy can be arbitrarily stimulated on a one-time basis in the course of this procedure. In the long run it will have to become more productive or more austere, hopefully the former. In the short run, the transitional management can print as many dollars as it wants. And probably should - to grease the wheels. Inflation is not a concern.

Not continuing inflation, anyway. Because, again, the result is a direct gold standard. A thing never before seen in history, at least not for the last three centuries. It will run stably and indefinitely without serious market fluctuations. It will certainly not exhibit persistent inflation, unless someone figures out how to extract gold from seawater. (There actually isn't that much gold in seawater.)

Finally, in the sixth step, USG spins off the nationalized assets and becomes a lean, mean 21st-century corporate government - extremely small and highly profitable. When it sells (reprivatizes) the private assets it acquired in the second step, it sells them of course for gold.

It will sell them into a market that can establish true, stable market prices for them. This market will price them by measuring their expected yield in direct, 100%-reserve gold, and setting a yield curve that reflects the balance between present and future direct gold.

And this is the end state: a stable private economy on the gold standard. Moreover, unlike most plans for returning to gold, this plan does not cause a reduction in aggregate consumer demand by reducing aggregate purchasing power. Implemented properly, it should perform a one-time inflation in which the purchasing power of the rich is redistributed to the poor - stimulating demand, not contracting it. But this inflation cannot be chronic, as it is one-time. It thus cannot produce the perverse incentive structure we see under chronically-inflating economies.

So can we do it? Nah, we can't. No way. Nothing like this will ever happen. I guarantee you.


Blogger Aneesh Mulye said...

I'm a bit wary of including jewellery in the gold tax. This could hit a certain class of investors disproportionately hard, namely, American citizens of Indian, and, to a lesser extent, Chinese origin. You'd have an instant black-market on your hands if *any* tax, not just 50%, was to be applied, because the sentimental value of gold jewellery is, in their minds, inextricably linked with its investment potential.

I can offer this perspective because I'm an Indian, in India, and this is how I see people here thinking of it. You can take my response to be representative of how Indians in the US think because most who go there are from a background similar to mine.

(I've read with fascination your blog, along with the similar classification you developed for the US, and in case you have any questions you want to ask an actual Brahmin, feel free to go ahead.)

January 28, 2010 at 5:00 AM  
Blogger G. M. Palmer said...


I understand the notion of sentimentality--however, I think MM might say that this would be a point on which USG might consider testing the limits of said sovereignty.

Moreover, our friends of Indian and Chinese origin tend to be pretty savvy. Perhaps they wouldn't want to give up 50% of their gold as a tax--but if you make it clear that the value of their gold will go up by about 20x they might see the value.

My concern with such a plan would be unsecured credit--cards, signature loans, and student loans. IMO the best plan is to simply jubilee these away.

January 28, 2010 at 5:52 AM  
Anonymous Pals said...

“This is the nation-state as giant totalitarian corporation. It is not a sustainable state of affairs, but we do not intend to sustain it.”

--Yes. After owning everything and having the biggest army in the world, the management of NUSG will quickly unwind the whole thing and settle for a minimalist government. History is full of people willfully giving up massive amounts of power. If by some miracle somehow MM’s “reconciliation” begins, the only possible end result of it is history’s biggest, most criminal, most totalitarian state.

I’m coming more and more to the conclusion that there is only one possible end to this orgy of inflation, big government and economic crises: Mises’ crack-up boom. But I really don’t think it will be all that bad. Currency collapses are never fun, but they are certainly better than the insanity that precedes them. And what follows after them is much, much better. Just look at Zimbabwe today which is regaining normalcy after it ditched its currency. Heck, they even have deflation!

Effectively, once the whole thing blows up, the end result won’t be too different from what MM ascribes here. A hard money will emerge and the economy will be stable and sane. The main difference is that when the crack-up boom happens, there will be massive redistribution of wealth and swings of value and none of MM’s laughably meticulous fairness in redistribution—which couldn’t possible work anyway. There will be countless inflationary forces (the government printing money, people selling their treasuries, people dumping the dollar) and countless deflationary forces (Exter’s triangle unfurling, fractional reserve banking being destroyed, a million bubbles bursting, etc…) It’ll be a total crap shoot as how that all sorts itself works out and what is worth how much. But it will work itself out. And it will pass.

And the most important thing: it will be over without anyone getting to play God with the fate of humanity.

January 28, 2010 at 6:00 AM  
Anonymous Pals said...


What do you kids think of the recent grumblings of Volckerism from the Obama Administration? Though pathetic, the idea of contemplating a drop in spending seems to suggest that the geniuses in the Administration are not as completely batshit Keynesian as the Krugmans of the world. Could this be the beginning of a monetary and fiscal retrenchment alike Volcker's term as Fed chair?

I remember MM mentioning that he thinks goldbugs should worry if they hear of Volcker being brought back. Does he still think that?

January 28, 2010 at 6:06 AM  
Anonymous Anonymous said...

An easy way to be financially irresponsible is to be financially opaque. If an institution is responsible, it must be responsible to someone; to observe it, that someone must be able to form a clear picture of its financial operations.

The USG is plenty irresponsible even in its transparent transactions. We know that it is energetically outspending revenue even if you take opaque transactions off the table.

Thus it should compensate fired government employees with a mammoth dollar severance, which repays them for their loss of tenure.

These greedy parasites should go to the wall, not be compensated for their loss of tenure.

no realistic reconciliation plan can maintain property rights

Just because your house dropped to pre-bubble prices, doesn't mean your "property rights" weren't maintained!

If the government nationalizes your house, you will obviously get a long-term lease.

Gosh, I can't think of any idea more certain to generate a massive armed revolt than nationalizing people's houses. Great idea, genius!

Remind me again how "property rights are maintained" if the government nationalizes my fucking house?

As for gold, USG demands that all citizens turn in half their gold.

Yeah, let's punish people with thrift and foresight! Another great idea!

no such tax is a rational reason for present gold holders to oppose this plan. Again, they will profit massively by it - as they should.

They would profit even more massively if this "plan" were enacted without the huge tax on gold, ergo, they are rational to oppose this tax.

January 28, 2010 at 6:16 AM  
Blogger G. M. Palmer said...


A couple things:

The fate of the population of USG is hardly "humanity."

MM says property rights can't be maintained in a sovereign bankruptcy.

MM also says it's not going to happen but that his prescription--if followed--would be the most painless way to fix the problem of what he originally called formalism.

January 28, 2010 at 7:16 AM  
Blogger gwern said...

French finances were incredibly bizarre. I like this paper:
'The French government currently honors a very unusual debt contract: an annuity that was issued in 1738 and currently yields €1.20 per year. I tell the story of this unique debt, which serves as an anecdotal but symbolic summary of French public finances since the 18th century.'

January 28, 2010 at 7:32 AM  
Blogger gwern said...

Pals: and it's not *that* bizarre. There are many cases of people giving up substantial amounts of power, or never going for it.

George Monck single-handedly controlled England before abandoning his power in the Glorious Revolution; Belisarius could have conquered the Byzantine Empire easily but was too loyal to Justinian (who didn't deserve it); Cincinnatus is proverbial.

January 28, 2010 at 7:59 AM  
Anonymous Michael S. said...

Louis XIV had at least some understanding of his finances. W.H. Lewis, in his book "The Splendid Century," notes that when Mme de Maintenon suggested to him that the royal charities should be increased, he responded that to do so would only burden the people of France with higher costs in taxation for the maintenance of the state. If only Mr Obama and most members of Congress had as much understanding as the Sun King!

January 28, 2010 at 9:26 AM  
Anonymous Michael S. said...

I just took a brief look at M. Velde's paper. The concept of rente viagere, which Velde translates as "life annuity," exists also in Scots law and is idiomatically translated as liferent. I have never heard of one that has lasted since the eighteenth century.

The British government has issued "Consols" since 1752, which are essentially perpetual bonds or annuities. They are still outstanding and pay a 2-1/2 per cent coupon. Theoretically the government may call them at par by an act of Parliament, but it has not done so to date.

January 28, 2010 at 10:42 AM  
Blogger Zimri said...

gwern, the key with Monck and the classical dictators, ending with Sulla, is that they took power to do an unpopular job.

Whereas the classical tyrants came into power with popular support.

Caesar claimed to be a dictator - to be legal - but, in fact, was a popular tyrant.

The people who clean up America's finances know they're not going to be feted with roses and dancing girls when they do their work. They don't want to sit below that dangling sword any longer than they have to. By contrast, some celebrity who proclaims himself to be saving the American people WILL be serenaded. (And the sword? THERE IS NO SWORD! IT IS TREASON TO MENTION THE SWORD!)

January 28, 2010 at 12:13 PM  
Anonymous zanon said...

Fiat currency is actually negative govt equity.

Yes, in fiat world, the Govt must have a negative equity position where its liabilities are greater than its assets, and the balance sheet is reconciled with negative equity entry.

For a blog that prides itself on being reactionary, on the issue of currency, Moldbug is a Republican to the Academic Democrats.

Everybody, academic, Democrat, republican, economist, austrian blah blah blah thinks that accounting is only something that little people do and then go off on nonsense yarns about finance. All progressive religious nuts shunning good engineering for a variety of christian mystery plays. bah!

January 28, 2010 at 3:26 PM  
Blogger Aaron Davies said...

@gwern: your link now seems to be broken

January 29, 2010 at 8:41 AM  
Blogger G. M. Palmer said...

Crypto-locked weapons anyone?

January 29, 2010 at 10:28 AM  
Blogger Alrenous said...

Which is harder to do in your basement, construct a quality auto-fire weapon, or counterfeit bank notes?

January 29, 2010 at 8:13 PM  
Anonymous Johnny Abacus said...

Completely unrelated to this post,

This company just demoed a .22 pistol that only fires when within some distance from a paired watch, which requires bio-metric authentication.

It costs 7000 euros and probably isn't nearly as reliable (or effective) as a Glock, but it did demo at the latest SHOT show.

Some fuel for the fire.

January 30, 2010 at 7:54 AM  
Blogger G. M. Palmer said...

Johnny Abacus

Pardon me but please actually look at links that are posted. I believe I ninja'd you by a good 20 hours.

January 30, 2010 at 12:02 PM  
Anonymous Anonymous said...

Off-topic but unintentionally hilarious:

"It's like a French Revolution in reverse in which the workers come pouring down the street screaming more power to the aristocracy."

January 30, 2010 at 2:22 PM  
Anonymous Anonymous said...

Alrenous: your question is as it stands something of an imponderable, because you have not stated how good the counterfeit bank notes to be, nor how good the firearm in question is to be.

I would say, though, that making counterfeit bank notes traditionally required the services of a person with an extremely rare and specialized set of skills to perform the near-microscopically-fine hand-engraving of the printing plates, though the 21st Century has apparently seen at least a few people doing surprisingly passable work in this area with high-resolution color laser printers. Or so rumor has it.

Firearms have not historically required anywhere near that level of sophistication, being mostly at the village-blacksmith level of difficulty to manufacture. The Dutch Resistance made Sten SMGs in clandestine basement shops with hand tools, and they worked. The Pathan gunsmiths of Pakistan boast that they can make anything you want, as long as you bring them an example to copy. The Pathans almost universally operate at the village-blacksmith level, making copies of late-model Soviet assault rifles and belt-fed machine guns with hand tools, copying the originals right down to the serial numbers and proof marks.

And given the number of surprisingly cheap surplus CNC mills floating around out there, I'd have to speculate that it's a lot easier to make machine guns than passable phony hundred-dollar bills, even without such recent additions as tiny plastic strips with the denomination printed on them running through the paper, magnetic ink, etc.

This is only speculative and for entertainment purposes only, of course.

January 30, 2010 at 5:46 PM  
Blogger Father Boethius said...

To My Wayward Children G.M., Alrenous, Jimmy, and 5:46,

You don't need cryptographically locked or grey-market built weapons if you have the strength of Family and The Shadow Kingdom.

Fides Et Conscienta,
Father Boethius

January 30, 2010 at 8:30 PM  
Anonymous CrisisMaven said...

I have just added a Reference List to my economics blog with economic data series, history, bibliographies etc. for students & researchers.

January 31, 2010 at 3:24 AM  
Anonymous Anonymous said...

Second, precious metals are the only currencies to which a sovereign can be accountable. Therefore, reconciliation must produce a sovereign whose books are done in direct gold.

Why gold? Why not rarer metals like rhodium, ruthenium, rhenium,or tellurium? Better still, gemstones (less easily debased, easier to store and transport). Might someone please explain the distinct importance of gold versus any other stable reservoir of value (including revenue producing physical assets --manmade or otherwise-- and partial/paper claims thereupon??)

Me honestly don't get it.

February 1, 2010 at 4:50 AM  
Anonymous Anonymous said...

I'd add that as far as 'stable' goes, gold's value (denominated in other assets) is significantly less stable than any major currency pair. Long term historical volatility of gold vs silver is over 2x that of USD/EUR; gold vs oil over 4x higher.

February 1, 2010 at 5:19 AM  
Blogger G. M. Palmer said...

But didn't the processes involved to extract silver get easier over time?

And isn't the price oil wholly influenced by and subject to political whims?

February 1, 2010 at 7:12 AM  
Anonymous Anonymous said...


Isn't the price of anything is subject to political whims? if anything gold is more subject to those whims as its supply is less diversified geographically and politically. Gold's value is also more variable versus the CPI. I'd also imagine that mass abundance (fixed geologically) is a more reliable determinant of long term value than extraction cost (highly variable as with any mineral), and gold doesn't look great on either terms. Though only 20 times more rare than silver, it costs 60 times as much. contrast with tellurium : 4 times rarer than gold, but costs less than silver!

And ALL of these (generally useless) metals have negative carrying costs. Rather than rights to a lump of metal, wouldn't you prefer fractional ownership of state assets (all natural monopolies, the highway system, nuclear plants, hydroelectric dams etc) that along with their native inflation-resistance, also kick off an income stream?

February 1, 2010 at 8:27 AM  
Blogger G. M. Palmer said...

I wasn't stating a preference.

I'd prefer to have a nice plot of land and the ability to defend it.

February 1, 2010 at 8:48 AM  
Blogger Alrenous said...

Then that's not really the point of crypto-locking. Sure, a rebel army could equip themselves, fine.
The point is not gun control, but rather military control.

So let me ask a follow-up question. In America, the military has most of the guns. (And definitely most of the heavy armor.)

Is this also the case in, say, Pakistan? Or the African hellholes?

February 1, 2010 at 10:39 AM  
Blogger TGGP said...

Completely off-topic: A while back Mencius listed Anthropogenic Global Warming, Human Neurological Uniformity and Keynes-Fisher Macroeconomics as examples of pseudoscience. In his narrative, Mises and the Austrians had been doing real economics before the field was perverted by the New Deal's universities. Perhaps Mises thought that way about Keynes (Frank Knight certainly did), but Jerry O'Driscoll recently noted that both Mises and Hayek evinced a lot of respect for Fisher in their writings. Fisher was kooky in a number of ways (to the extent that it got his own daughter killed), but as far as they were concerned he was a decent economist.

February 1, 2010 at 4:54 PM  
Anonymous Dregs of the Ancients said...

Does Thomas Friedman read UA? "Beijing concensus" is a euphemistic way of describing an authoritarian centralized govt. And who would argue that China's sovereign decision makers are among its key "shareholders". Shades of neocameralism.

February 1, 2010 at 6:49 PM  
Anonymous Johnny Abacus said...

G.M. Palmer: My apologies.

The NRA estimates there are more than 250 million small arms in private hands in the US

No idea what the official figures are for the military, but enlisted lower ranking than 1sg (or the equivalent) generally aren't issued side arms, which means that there are likely 1.3-1.5 small arms per enlisted soldier (,sailor, marine, etc.). With about 3 million personal in the US military, there are probably a bit less than two orders of magnitude more small arms in civilian rather than military hands.

3rd world countries might have a higher density of privately owned small arms, but I can't imagine the difference in density being particularly meaningful.

February 1, 2010 at 10:54 PM  
Blogger G. M. Palmer said...



But how many of the small arms in US Citizens' hands are automatic? Also, how many jets do we have?
None at my count--certainly statistically none.

February 2, 2010 at 4:28 AM  
Blogger Alrenous said...


Then yes, I have to agree that small-arms locks are only a small part of security.

(Actually the crucial statistics are gun ownership (35% in the US) and gun training {which is, naturally, unavailable.})

The States have never had a proper peasant revolt, and so I can't say how relevant their weaponization is.

The people have a twentyfold advantage in numbers, assuming a massive 50% mobilization.

The army has the advantage in coordination, training, discipline, firepower, espionage, tactics, and strategy - provided they can be kept loyal to the generals.

Such a battle would come down almost entirely to morale. If the army is too republican, they'll break ranks, but it's just a matter of time before the casualties cause the mob to rout.

(Although again, modern combat hasn't seen too many battles where a rout is a real possibility, which means the psychology there is something of an X-factor.)

How much do military coups actually involve the populace? Can the disgruntled faction maintain enough leadership to harvest small arms without being found out?

The locks would help security, but could only be a single brick in a large dike holding back chaos.

February 2, 2010 at 7:04 AM  
Blogger DR said...

"I'd add that as far as 'stable' goes, gold's value (denominated in other assets) is significantly less stable than any major currency pair. Long term historical volatility of gold vs silver is over 2x that of USD/EUR; gold vs oil over 4x higher.'

A little bit of selection bias there...

You're only picking currencies that are held in high regard in this day and age. Almost by definition these currencies will have had stable trajectories over time. How does the vol compare when using the Weimar Republic Deutschmark, the Soviet Rubble, the Icelandic Krona or the Argentinian Peso?

Even the fact that we still have fiat currency today is selection bias, because if currency would have performed at the left tail of its distribution the chance that the world would still be on a fiat system is substantially lower.

Your statement is a little bit like saying playing the lottery is the best investment because the investor with the highest return in the market played the lottery (million to one return).

February 2, 2010 at 10:45 AM  
Blogger DR said...

li"I'd add that as far as 'stable' goes, gold's value (denominated in other assets) is significantly less stable than any major currency pair. Long term historical volatility of gold vs silver is over 2x that of USD/EUR; gold vs oil over 4x higher.'

A little bit of selection bias there...

You're only picking currencies that are held in high regard in this day and age. Almost by definition these currencies will have had stable trajectories over time. How does the vol compare when using the Weimar Republic Deutschmark, the Soviet Rubble, the Icelandic Krona or the Argentinian Peso?

Even the fact that we still have fiat currency today is selection bias, because if currency would have performed at the left tail of its distribution the chance that the world would still be on a fiat system is substantially lower.

Your statement is a little bit like saying playing the lottery is the best investment because the investor with the highest return in the market played the lottery (million to one return).

February 2, 2010 at 10:47 AM  
Anonymous Johnny Abacus said...

G.M. Palmer:

Automatic weapons smaller than an M249 (i.e. lighter than light machine guns) are specialized weapons which are generally only advantageous when breaking contact after an ambush or when breaching - when distance is low and you need extremely high firepower per person (other people may disagree, this is just my experience).

I'd estimate the US military inventory of functional machine guns at about 10% +- 3% of all small arms. The active duty army and marine corps are undoubtedly higher than this number, the navy, air force, reserves and national guard are probably below this.

Your later point is, of course, almost certainly correct. Artillery + helicopter mounted machine guns >> civilians (without major power support).


There are tons of "gun trained" civilians. Gunsite and Blackwater are probably the most notorious training sites, but there are hundreds of high quality institutions which offer training to civilians.

While many (most?) civilians, particularly the urban ones, who own guns are shockingly inept, pretty much anyone who participates in IDPA/USPSA, tri-gun, etc. is going to be better trained individually than the median soldier (SOCOM soldiers shoot > 10x the average infantry soldier in training).

This doesn't mean that I don't think the military wouldn't win - it's just that their big advantages are (much like you indicated) organization, heavy weapons (artillary, tanks, close air support) and logistics (the most important part).

February 3, 2010 at 4:36 AM  
Anonymous Anonymous said...

Almost by definition these currencies will have had stable trajectories over time.

DR, I was not contemplating a gold standard for Iceland, though perhaps that would be a good idea. Among the arguments for returning the USA to a gold standard is that gold is somehow a more stable reservoir of value than the fiat dollar (not the peso or ruble). It seems we agree that this argument holds no water, as anyone can see by examining long term commodity price ratios measured against commodity prices in the dominant fiat currency. The volatility of the first is simply higher than that of the second, whether by definition or by accident.

February 3, 2010 at 7:03 AM  
Blogger Alrenous said...

Yeah, I forgot logistics.

February 3, 2010 at 10:41 AM  
Blogger Faré said...

Why tax 50% of the gold, instead of nationalizing it just like the rest? Just buy it all with dollars, at pre-reboot market price, like any other asset.

Which in practice means let people keep 50% of it which corresponds to the right-dollars they'd otherwise get, and take the other half, leaving left-dollars in exchange. A much fairer deal. I don't see why gold holders should be treated defavorably (or favorably) compared to holders of other assets.

February 5, 2010 at 11:23 AM  

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