By
Pater
Tenebrarum
:
The current financial crisis may progress to a phase where
people demand and hoard dollar bills but take electronic deposit
credits only at a discount which increases until electronic deposit
credits are repudiated entirely. The Federal Reserve would be
powerless to solve the problem, because while they can create
unlimited electronic deposit credits they can't create unlimited
paper dollar bills, "money you can fold" as Professor Antal Fekete
calls it. There would be a glut of electronic deposits, but a
shortage of dollar bills.
Before the financial crisis metastasized in 2008, Fekete wrote a
paper that I think is underappreciated and under-discussed. "
Can We Have Inflation and Deflation at the Same
Time?
" In his paper, he discussed the "tectonic rift" between paper
Federal Reserve Notes (i.e. dollar bills) and electronic deposits.
By statute, the Federal Reserve cannot print dollar bills without
collateral (e.g. Treasury bonds). Also, they have limited printing
press capacity that is insufficient to keep up with a catastrophic
crisis.
He discussed the inverted pyramid of John Exter. Gold is the
triangle at the bottom, and then above is silver, dollar bills, and
then the various kinds of electronic deposits, stocks, real estate,
etc. In a crisis, people want to move from the top to the bottom of
the pyramid, but of course there isn't enough of the stuff at the
bottom.
In a scenario in which desperate, panicky people are trying to
cope with the enormity of a collapse that they don't and can't
understand, I think this split between "physical" dollars and
"electronic" dollars is very plausible.
Just as there is nothing to be accomplished by selling an
underlying security as it becomes worthless, only to buy a
derivative of it, selling Treasury bonds and buying dollars is
equally nonsensical. The dollar is the Federal Reserve's liability,
backed by the Treasury bond as the asset. If you believe the
Treasury bond is worthless, then you ascribe no value to the dollar
either. This is why gold will go into permanent backwardation.
Holders of dollars will provide an unlimited bid for gold that will
not be reciprocated by offers from holders of gold. The latter own
the only safe asset, and the only monetary asset that is not
ultimately backed by the Treasury bond or the dollar, and they will
have no desire to give it up.
The concept of backwardation is simple. It is when people accept
a future promise to deliver only at a discount to physical stuff
handed over right now. This could be when there is a shortage, such
as wheat before the harvest. Or in the case of gold, backwardation
signifies a collapse in trust. But isn't this the same phenomenon
of a tectonic rift between paper dollars and electronic
deposits?
In a certain sense, the "money you can fold" behaves like a
physical commodity, a present good (I realize I am stretching the
concept here more than a bit). The electronic deposit credit is
most definitely a future promise. In my gold backwardation thesis,
the action begins with the offer on the futures contract falling
below the bid on spot gold. The bid-ask spread on spot gold widens,
as the offer is relentlessly advancing, pulling the bid behind it.
The bid-ask spread on the futures contract also widens, as the
offer remains stubbornly high, but the bid withdraws and retreats
as gold buyers don't trust futures and buy physical gold instead.
Eventually, there are no more sellers of physical gold and that is
that (except for the dollar-commodities-gold arbitrage, a backdoor
way for dollar holders to get a little gold before the end of the
game).
If this split occurs in the dollar, I think it will play out the
same way. At first, sellers of real goods may accept electronic
credit money, but demand a higher price. The spread on the
electronic dollar widens, with the bid from real goods falling. At
the same time, virtually unlimited demand for the "real" paper you
can fold causes the bid on the paper dollar to rise.
Who knows how long it could last? People could go on accepting
paper dollars out of long habit. Obviously, this is an unstable
situation that must necessarily collapse. Unlike gold, the paper
dollar has no value other than the broken promises that back
it.
I dub this "dollar backwardation".
See also
10 Verifiable Reasons Why Antares Is An Excellent
Investment
on seekingalpha.com