Friday, December 8, 2023

Gold and Flying Money By Alasdair Macleod

Flying money was the Chinese term for paper credits between merchants in the Tang dynasty, adopted by Emperor Hien-Tsung as the first example of a government paper currency. Today, economists confuse flying money with real money, which is physical gold.

Having broken above the $2000 barrier, nearly everyone thinks that it is gold rising, when in fact it is the dollar falling. Yet we can be sure that as gold appears to be in a bull market, there will be growing interest in it from the financial establishment and private investors alike.

Mainstream media and the economics profession are equally clueless about the distinction between money and credit, so there is important work to be done informing investors seeking wealth preservation in these increasingly uncertain times.

Accordingly, this article reaffirms the true distinction between money and credit, emphasising that fiat currency is credit, not money. The majority of economists deny this fact, being brain washed by the US Treasury’s anti-gold propaganda programme following the Bretton Woods failure.

The consequences of this error are that a collapsing dollar taking other currencies with it will impoverish all those who fail to grasp a proper understanding of the relationship between currencies, their dependent credit, and true money. Regard this as a vital primer for financial survival.

There’s very little understanding behind the rise in gold

It is a time of misinformation and bad analysis. An example last weekend was a claim that the collapsing US reverse repo market was going to implode the entire banking system. This is an example picked up on my X feed[i], which described why the end is nigh:

“Once the reverse repo is drained, the G-SIB banks have no more assets, and the Federal Reserve no longer has a liability side (which is the credit) that values the mortgage-backed securities on the Federal Reserve balance sheet which is the collateral. If the G-SIB banks have no more assets (the reverse repo i.e. bank reserves), to hedge against their collapsing liabilities (U.S. Treasury bond unwind), the G-SIB banks blow up. The Fed is forbidden from going into QE, so there will be no more credit (Fed liability/reverse repo) with which to value the collateral (mortgage-backed securities) on the Feds balance sheet.”

Clearly, there is a high level of nervousness abroad. By the way, that posting is factually incorrect on several points, which invalidates its conclusion. The reason the reverse repo facility is “being drained” is that money funds are buying T-bills instead. It wasn’t the G-SIBs pushing cash into the Fed by reverse repos originally, but money funds refused deposit facilities with the banks, due to the haircut on Available Stable Funding imposed on large deposits by Basel 3.

Undoubtedly, there are huge risks in the financial system, and they are in plain sight without venturing into half-baked theories.

Equally, the vast majority of gold bulls can only resort to technical analysis, which is valid as a trading tool but is not an explanation for what is actually driving the relationship between gold and fiat currencies. Unlike other markets, there is an additional difficulty with gold because those that accumulate bullion don’t shout about it and generally don’t want the world to know. It is therefore a market ripe for conspiracy theories.

Much of the confusion arises from the traders’ premise that interest rates are the cost of money, by which they mean currency, while the lease rates for bullion are very low and static. Therefore, they claim, rising interest rates are bad for gold. It should be noted that the establishment represented by banks is nearly always on the short side through derivatives and unallocated gold deposit at bullion banks, so they have a vested interest in pushing this line in defiance of the facts.

In the past I have drawn attention to the experience of the 1970s, which started with gold valued at $35 to the ounce and the Fed Funds Rate standing at about 6%. At the end of the decade, these two measures were $850 and 19.5% respectively. But we have a current example. In September 2022 gold was valued at $1680 and the Fed Funds Rate was 2.5%. Despite nearly everyone telling us that interest rates and gold cannot rise at the same time, today we see gold valued at over $2,000 and the Fed Funds Rate having more than doubled.

Then there is the belief that gold is no longer money because no one uses it to buy and sell things. Therefore, they say, the dollar is money. I even find economists who favour free markets taking this line, dismissing Gresham’s Law, which explained why only clipped coins circulated. To be consistent, these economists would have to deem unclipped coins as no longer money, because they did not circulate as such.

Economists not understanding the difference between money and credit with a counterparty is an evil borne out of Keynes’s description of the gold standard as a barbarous relic, and more importantly fifty-two years of intense anti-gold propaganda led by the US Treasury after President Nixon suspended the Bretton Woods Agreement. Huge damage has been done to our understanding of these matters, not that they were well understood in the first place. Our starting point has to be to correct it before we can even talk about why the value of gold expressed in fiat currencies is rising.

But asking about the prospects for gold is asking the wrong question. Questioners should be asking about the dollar’s future and that of all the fiat currencies referring to it instead of gold. This is because it is not the gold price rising, but the purchasing power of the fiat dollar is declining.

Gold has always been money

In previous articles I have recorded the history of gold as money in Roman Law. The origin of Roman Law was the Twelve Tables (or tablets), ratified in 449 BC and venerated by Romans as their primary legal source. They were superseded by later changes in Roman law, but never abolished. And according to Gaius, of whom more follows, it was at this time that the first Roman coin, the aes made of bronze, was introduced. In its early form it was more a standardised weight of metal than a coin as we know it today, said to weigh a little under one third of a kilo.

Credit certainly existed before then, though not on a formal basis. Trade has always required credit, because time elapses between the acquisition of materials and their delivery to market. The Phoenicians were trading throughout the Mediterranean a thousand years before Rome’s Twelve Tables and in addition to bartering would certainly have required credit to do so, because they had no coinage before Roman times. Clearly, the need to fix the value of credit led to demand for its expression in a superior form of credit without counterparty risk — hence the emergence of real, tangible money.

The Twelve Tables was also at a time of intellectual development, being contemporary with the great Greek philosophers — Socrates, Plato, and Aristotle among others. Coincidentally, Confucius was advancing Chinese philosophy only fifty years before. There is reason to believe that the flowering of philosophy is stimulated by improved economic conditions, always associated with developments in money and credit.[ii]

Roman law took its next evolutionary step when Gaius wrote his Institutiones as well as a commentary on the Twelve Tables in about 161 AD. It provided a template for Justinian’s Institutes (or Pandects) with some of Gaius’s passages even copied verbatim. Gaius’s original manuscript was lost until it was rediscovered as a palimpsest in Verona in 1816 by a German scholar.

With respect to credit and banking, fifty years later the judgements of Ulpian and Paulus superseded and improved on Gaius’s by ruling that credit could be transferred for value without the agreement of both originating parties. This meant that debt could be freely sold on for value without the consent or knowledge of the debtor. It was probably on Ulpian’s advice that the emperor Alexander Severus in 224 CE published his Constitution formalising this freedom.

This vital step meant that credit could be incorporated as personal wealth, which we can define simply as comprised of anything which can be valued in a medium of exchange. By the time of Justinian’s Pandects in 553 CE, the legal principal of the transferability of credit was well established and incorporated in them, and also confirmed in the Basilica of the Eastern Empire which followed 339 years later.

Between the Pandects and the Basilica, the principal that tangible money was the highest form of credit from which lesser forms took their value became firmly established in the two Roman Empires and in their successor nations throughout Europe. The great waves of discovery and colonisation by these nations in more recent centuries spread not only their Christianity, but their laws founded on Roman origins.

For a time, English common law was in a confused position, common law having inherited its precedents from Gaius, which were current when the Romans left Britain in 410 CE, and before Justinian’s Pandects over a century later. Severus’s Constitution appears to have not been fully adopted.

However, with respect to the transferability of credit and therefore the inclusion of debt obligations as personal wealth, the situation was regularised when conflicts between common law and the Court of Chancery, which dealt with matters of equity, were abolished in 1875 after enabling legislation was passed in 1873. And in pre-constitution US law, Blackstone’s Commentaries on English common law was the standard legal treatise in American law, adopting Roman law thereby. 

The entire world outside Asia had and still has at its basis gold as legal money. The great Asian civilisations had their own interpretations, which have the same conclusion. Furthermore, for millennia people independently came to the same conclusion: that money is metallic, and gold, silver, and copper became preferred. Roman law was an expression of this reality. Whatever regulations may say, and whether governments confiscate or try to persuade their citizens otherwise, the legal position remains.

The definition and role of credit

While the argument that gold is no longer money violates the human and legal facts, credit is confused with money, because it is routinely described as money. Nowadays, what governments and economists describe as money supply is entirely made up of credit. The best way to understand the difference is that credit is an agreement between two parties with a matching obligation in the form of a debt. It is classified as an incorporeal asset, having no material existence. Money is not a credit agreement, being corporeal, having a physical form.

The Roman juror Ulpian led the way in defining the difference. A depositum is a person’s property entrusted to the care of another. Thus, a sealed bag of gold coins, given to the custody of a banker, remains the property of the depositor, and the property in it is not transferred to the banker. A modern example is a custodial relationship, whereby a bank or similar institution stores bars of gold on behalf of others, not using the asset for its own purposes, and not including it in its own balance sheet.

But if a person gives gold coins to a banker on the basis that the banker will return the same value in coins on demand or at a future date, that is a mutuum, where the property in the coins deposited is transferred to the banker for him to use as he sees fit. The value of those coins will be included in the banker’s own balance sheet as an asset with a matching liability to the depositor. That is credit, and Ulpian’s definition is the basis of all banking and economic activity today.

Therefore, credit is the transfer of property from one person to another where the latter has a matching obligation, or debt, to return the property to the former. Credit is the entire basis of banking today which was invented by the Romans. They were the first to use cheques and bills of exchange, but these forms of credit did not circulate as mediums of exchange, restricted to obligations between immediate parties. This was the basis of Gaius’s Institutiones, ruling that a credit agreement could only be transferred to another party with the agreement of both creditor and debtor.

Ulpian contradicted Gaius later, ruling that credit was incorporeal wealth. Translated from the Latin, he said, “Under the term Wealth, not only ready Money, but all things both movable and immovable both being corporeal things and Rights are included”.[iii] The point to understand is that wealth is property, both corporeal and incorporeal, whose value can be measured. The value of incorporeal property can only be measured if it can be transferred freely. Gaius’s earlier ruling was an impediment to valuing credit and its matching debt obligation because it required the endorsement of the original parties. 

With respect to credit and banking, fifty years later the rulings of Ulpian and Paulus superseded and improved on Gaius’s by ruling that credit could be transferred for value without the agreement of the originating parties. This meant that debt could be freely sold without the consent or knowledge of the debtor. It was probably on Ulpian’s advice that the emperor Alexander Severus in 224 AD published his Constitution formalising this freedom.

This vital step meant that credit could be incorporated as personal wealth. By the time of Justinian’s Pandects in 553 AD, the legal principal of the transferability of credit was well established and incorporated in them, and also confirmed in the Basilica of the Eastern Empire which followed 339 years later.

Between the Pandects and the Basilica, the principal that money was possession of physical gold, silver, and copper from which credit took its cue became firmly established in the two Roman Empires and in their successor nations throughout Europe. The great waves of discovery and colonisation by these nations in more recent centuries spread not only their Christianity, but their laws founded on Roman origins as well.

Chinese called currency “flying money”

As noted above, the Romans invented banking upon which banking today is based. But paper representations of money, or currency, were invented by the Chinese. In about 807 CE Emperor Hien-Tsung of the Tang dynasty ordered all merchants and rich citizens to bring their gold and silver to the public treasury, and in exchange they were given notes called fei-ch’ien, or “flying money”. It was so named because it enabled the value of money to be transferred over distances without the need to transport specie. It was a credit device invented by Chinese merchants a few years before the emperor deployed the invention of flying money for his exclusive benefit. 

In short order, we saw the first example not only of the invention of a fiat currency, but its deployment by the state. This was long before the invention of modern bookkeeping, but we can see that whether this flying money originated between merchants or was imposed upon citizens by their ruler, that it was credit between parties, notionally valued in physical money. 

China’s flying money tradition continued. Marco Polo told us of Kubla Khan’s paper made out of mulberry leaves as credit issued to merchants, who were forced to submit their gold and silver to him. But the most interesting comment came from Sir John Mandeville who travelled to China some eighty years after Polo. In his Travels Mandeville wrote, translated from Chaucerian English, that:

“The emperor may dispense as much as he will without estimation. For he depends not, he makes no money but of leather imprinted, or of paper… And that money goes through all his provinces. For there and beyond they make no money of gold and silver. And therefore, he may dispense it at will, and outrageously.”[iv]

Outrageously was the key word. Much of what Mandeville wrote about China was fanciful, but this description of the Chinese state practicing the same monetary skulduggery we see today rings true.

Over a thousand years later and echoing Chinese flying money, one of the debates between the German historic school of economists and the Austrian school was over the right to determine the medium of exchange. Led by Georg Knapp who published Staatliche Theorie des Geldes in 1905 and translated into English as The State Theory of Money in 1926, the German school argued that money was a matter for the state, while the Austrians argued that it was the business of economic actors using money as the medium of exchange.

In arguing that the medium of exchange is a matter for its users, the Austrians’ basic premise is that it is not the function of the state to use its legislative powers to determine the basis of the medium of exchange. Proof of this line of reasoning is found in the abuse of the power to issue bank notes and other debt liabilities as money substitutes without possession of the money itself. The repeated collapse of unbacked “flying money” from 807 CE to this day is testament to this fraud perpetrated upon its people by the state. Despite this, it is an uncompromising argument taken to its logical conclusion which can be ridden into the buffers. We must regard the entire subject of money and credit from a practical standpoint.

The hair shirts in the Austrian School argue that the state should have no role in determining the value of circulating credit, and as noted above history is on their side. But modern conditions have seen credit evolve into a highly sophisticated system, allowing transactions to be settled seamlessly without its users giving the topic any thought. To regress to a situation where the state is not involved in providing a monetary standard for credit would be a regressive step. How would we cope without dollars, pounds, euros, or yen? Could we really carry out our daily transactions in units of gold by weight, or fractions of bitcoin?

It is not impossible, but the invention and use of currency units has succeeded as money substitutes in recent centuries because they fulfil a demanded purpose. It is the systemic abuse of a monetary system based on credit which is the problem. And there is no better example of this abuse that the gradual detachment of state-issued money substitutes that commenced with the Federal Reserve under the chairmanship of Benjamin Strong, following the First World War. 

This abuse led to the run on gold reserves culminating in the failure of the London gold pool in the late 1960s, and the suspension of the Bretton Woods Agreement in 1971. To cover up the latest in a long line of statist frauds, the US Treasury embarked on a propaganda campaign to persuade us all that its dollar has replaced gold as money. It is a deliberate falsehood.

Anyone looking at the facts can only surmise that the Fed’s bank notes and its obligations to commercial banks are credit, for which the Fed is fully liable. This debt to the public is clearly recorded as a liability on the Fed’s balance sheet. Without the obligation to pay gold in exchange for notes and bank reserves submitted, it might be tempting to think that while the obligation exists on paper in practice it does not.

It is this reasoning which persuades economists, including many successors to the Austrian School who should know better, that today is somehow different. But all they show is a despairing lack of understanding behind the clear distinction between corporeal money and incorporeal credit, with modern currencies firmly in the latter category. 

Anchoring credit’s value

There is a fundamental difference in value terms between a national currency and gold. A national currency has its value expressed as a medium of exchange for goods and services in its jurisdiction, while the value of gold and its credible substitutes is international.

In its propaganda mission to replace gold with the dollar, the US Treasury played upon its universal acceptance for pricing commodities and settling international trade. In favour of its campaign was that everyone using the dollar did so without giving any thought about its value, so were ill-equipped to understand the implications of the abandonment of gold as the value standard for credit. To think that the dollar, or any other currency for that matter replaces gold as the yardstick against which all other credit is measured is only true for a domestic audience and depends entirely upon its user’s faith.

Besides being international, gold’s supply of above-ground stock has grown broadly in line with the global human population, so its supply is neither inflationary nor deflationary. With respect to fiat currencies, they are today’s “flying money” which can only be credit. Money in the form of gold coin rarely circulates, and the entire economy revolves round credit. And today, even silver and copper coin have been debased into metallic junk. To secure their continuing existence, currencies must be freely exchangeable at their issuers’ office for corporeal money, which is gold.

Of course, the reason governments deny the discipline of a gold standard is exactly the same as that of Emperor Hien-Tsung of the Tang dynasty — no change there then. The “outrageous” debasement that Sir John Mandeville recorded over five centuries later is a tax painlessly extracted from the people. Forget self-serving government statistics: just look at the growing budget deficits virtually every government enjoys — that is what really matters because it is currency debasement, a process that continues until people begin to notice that the general level of prices appears to be rising because the currency’s purchasing power is falling.

It affects two groups differently. Foreign traders accounting in their own currencies only hold another currency for trade liquidity purposes and speculation against their own currencies. They are therefore the first to sell a currency if their belief in it diminishes. The second group are its domestic users, who, while they suffer from its debasement are usually late in recognising it.

The dollar’s value on the foreign exchanges is therefore determined by foreign influences in the first instance. The roll of interest rates, properly determined in markets is to compensate foreigners for their perception of the future purchasing power of the currency. It is not to manage expectations in the domestic economy. By their nature, central banks are incapable of managing interest rates, and target the wrong group anyway. When this is understood, the flaw in responding to domestic considerations, always at the forefront of economists’ and policy-makers’ minds becomes apparent.

Without the dollar’s value anchored to gold it becomes unstable. Over a century, foreigners have been duped into accumulating enormous quantities of dollar credit, far greater than they need for trade purposes. To the approximately $33 trillion recorded by the US Treasury as being in foreign ownership, there are foreign exchange dollar commitments in non-US banks totalling a further $85 trillion, and a further $10 trillion in eurobonds. At over $120 trillion overhanging financial markets, that’s more than four times US GDP. 

Clearly, the term “flying money” is set to come back to haunt us. With a combination of unproductive debt, debt traps sprung upon the US and other G7 governments, and a gathering recession leading to yet higher budget deficits, faith in the fiat dollar’s value is sure to be undermined in foreign creditors’ minds. The only way in which this approaching calamity can be avoided is to put the dollar back onto a credible gold standard.

That is unlikely to happen for the following reasons:

  • After fifty-two years of official denial, the mindset for a return to a gold standard is not there. The fact that American and other economists now believe that the dollar is not credit but money having replaced gold as the credit standard is testament to the intellectual mountain to be climbed.
  • Questions about the true level of US gold reserves need to be convincingly addressed.
  • We know from both the evidence and the IMF’s accounting guidance to central banks that gold leases and swaps are being recorded as actual possession, leading to double counting. In 2002, respected analyst Frank Veneroso estimated that at least 10,000—14,000 tonnes of central bank gold reserves were overestimated due to this double-counting. The latter figure was half total official reserves at that time. With increased reserves recorded today at 35,828 tonnes, this is unlikely to have diminished. Furthermore, while the Bank of England has been active leasing gold into the market, it is likely that the New York Fed, which stores foreign gold on an earmarked basis, has been more aggressively so. Its reluctance to return a small portion of Germany’s gold suggests that with or without the knowledge of foreign owners, custodial bullion has been sold into markets in accordance with the US Treasury’s anti-gold policy.
  • We know that first China, and then Russia have added considerably to their holdings and that their officially declared reserves are only a small part of their holdings. Therefore, a move to bring gold backing into the dollar-based global monetary system would tip hegemonic power firmly away from America and into the Asian axis’s hands. On strategic grounds any move in this direction will be strongly resisted.

The most likely outcome is that with the global economy facing a debt-induced slump, a rapid deterioration in the US Government’s credit rating, soaring budget deficits, and increasingly obvious G7 debt traps that the entire dollar-based currency system is found to be facing an existential crisis.

The journey back to money

The dollar is so committed to its fiat status that a collapse in its purchasing power appears to be inevitable. Since 1971, it has already lost over 98% of its purchasing power measured in real money, which is gold, and that is despite US Treasury attempts to expunge gold from the global monetary system.

The dollar’s valuation against other currencies is such that while there are likely to be considerable fluctuations in it, the dollar will drag down all other fiat currencies which do not introduce credible gold standards. The methods whereby gold standards can be introduced is a separate topic, but it can be done with a determination to eliminate budget deficits and for the state to withdraw from economic activities as much as possible leaving them to free markets.

The indications are that the return to money will be led by Russia, with her senior economic advisers to President Putin, particularly Sergei Glazyev, pushing in this direction already. Furthermore, Russia tried unsuccessfully to get a gold-backed trade settlement currency on the agenda at the BRICS summit in Johannesburg last August, apparently blocked by India and China. But Russia takes over the BRICS presidency in three weeks’ time and will be setting the agenda.

With debt to GDP about 20%, a strong export position, and a basic income tax of 13%, Russia is in a strong position to put the rouble back onto a gold standard. The major consideration holding her back is the economic consequences for China, which is strongly dependent on the export trade, though her long-term plans are to become less so on exports to America and Europe. But that takes time, which due to US economic mismanagement is becoming a scarce commodity.

Undoubtedly, China is carefully watching developments for the dollar and is prepared to protect herself from the fallout by putting the yuan on a gold standard, but she doesn’t want to be seen triggering a dollar crisis. 

The real sufferers from the dollar standard have been the emerging nations whose currencies lack relative credibility and trade in thin markets. Certainly, their regimes have not helped by injecting large doses of mismanagement and often corruption into their currencies’ values. Furthermore, they have become trapped by earlier loans in dollars through the IMF, which have been malinvested and have to be repaid. And the days when their politicians depended on foreign aid, much of which lined their pockets are over. And it was in Nairobi that the Russian Embassy confirmed that a new gold-backed trade settlement currency would be on the BRICS agenda.

The bitcoin delusion

That currencies are being increasingly debased is so obvious to speculators and small-time investors that they are simply dazzled by the maths behind bitcoin. The easiest thing to understand is that if you invent a form of money which cannot be expanded beyond a certain limit, then its value is bound to rise, measured in a rapidly expanding currency. This has led fans to predict prices of $250,000 and upwards, so who wouldn’t want to believe in it?

Putting aside the controversy as to whether bitcoin has or will ever have the status of money, it is being bulled up by almost everyone involved on the basis that they stand to make enormous profits, in guess what — dollars or their own currency. While everyone says it is taking the monetary initiative away from the state and back to the people where it should belong, they are merely speculating for gain, not intending to hold bitcoin to spend when there is a lawless successor to our dysfunctional world.

Like the economists who fail to distinguish between money and credit, bitcoin hodlers seem to think that money and credit are the same thing. Apparently, this makes bitcoin a better store of value than gold whose quantity increases as it is mined. But in their land of Cockaigne, if the world’s circulating media is limited to 21,000,000 bitcoin whose value is designed to continue rising, the creation of credit will all but cease. The world will return to the feudal conditions that existed before credit became available to finance the industrial revolution.

Bitcoin is not a substitute for or competitor with gold for the status of money. The bitcoin delusionists fail to grasp the importance of price stability, which only comes from credit whose value is firmly anchored to gold, together with the fact that gold is understood to be money everywhere, while bitcoin is assumed to be so only among its profit-seeking enthusiasts. 

Money is and only ever has been metallic gold, silver, and copper. And the only practical monetary standard is the one metal which has almost no other use than as a store of value — gold.

[i] @MacleodFinance

[ii] An example was the Scottish enlightenment, which followed the introduction of cash credits by the Royal Bank of Scotland in the 1720s. It created a commercial revolution which generated wealth, followed by the flowering of Burns, Hume, and Smith.

[iii] See HD Macleod’s The Theory of Credit, Chapter 1, 11.

[iv] Ibid.

Reprinted with permission from Goldmoney.