"There is no means of avoiding a final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency system involved."
- Ludwig von Mises

Thursday, April 14, 2011

Jim Grant: US Fiscal Crisis To Be Resolved With US Dollar - Gold Convertibility

I have speculated many times in the past that the current debt based system that was created in 1971 with the end of Bretton Woods would ultimately end with the restoration of a gold standard.  Mind you, governments will be extremely reluctant to do this.  But in the face of a breakdown in the global financial system, there is nowhere else to go when your system is merely based on easily keystroked electronic digits.

When a virtual system, like the system we have today, expires, only a tangible system can replace it.  And by tangible, I mean real, something you can hold in your hands.  Something that has no nationality.  Something that Central Banks around the world have been increasingly hoarding and accumulating.  That something is gold.

Eric King of King World News recently interviewed Jim Grant.  Here are snippets from his blog. The audio portion of the interview will be posted shortly.
When asked about the Great Recession and how it has left its mark Grant replied, “It is notable. Not so many months passed from the depths of our sorrows in 2008 and 2009 before people seemed to be reverting to much the same kind of financial conduct that was much in evidence in 2005, 2006, 2007. The cycles are getting shorter. Then again the government is now in the business of, so it declares, of restoring financial prosperity through main force. 
So, after the Great Depression there was nothing like the policy that Ben Bernanke and company have been implementing now. I don’t think that human beings are much different than they were way back when, but certainly the government’s response to crises is vastly different.” 
When asked about gold specifically Grant stated, “To me the gold price takes the form of a very uncomplicated formula, and all you have to do is divide one by ‘n.’ And ‘n’, I’m glad you ask, ‘n’ is the world’s trust in the institution of paper money and in the capacity of people like Ben Bernanke to manage it. So the smaller ‘n’, the bigger the price. One divided by a receding number is the definition of a bull market.

You’ll notice that this had nothing to do with security analysis. This is conceptualizing, brainstorming, nothing to do with price/earnings ratios, other valuation methods like cash flows. It is a proposition or a hypothesis on what is driving the gold market. So the gold market is necessarily a speculative piece of business. It’s not to be confused with the kind of investment that Ben Graham wrote about. Anyway, I happen to be bullish on it, but not for reasons that I can readily defend before a member of the fraternity of chartered financial analysts.”

When asked how the United States will resolve its debt and deficit problems, Grant remarked, “Well, in my mind it will resolve them necessarily by undertaking the step of restoring the dollar to convertibility into gold.”
Jim Grant has become legendary for having one of the top financial publications in the world. This comment from the Financial Times points out one of the many reasons for Grant’s success, “If Grant could see what was happening this clearly,” wrote John Authors of the staff of the FT, “and warn of it in a well-circulated publication, how did the world’s financial regulators fail to avert the crisis before it became deadly, and how did the rest of us continue to make the irrational investing decisions that make Mr. Market behave the way he does?”


The question that comes to mind when I think of a gold standard restoration is: At What Price? I believe that the longer the current system is artificially propped up, the higher the ultimate price.


boatman said...

ultimately, the planet will demand it......but they have to get over voting for someone on a campaign slogan o change or the color of his/her skin.

i can only barely imagine the coming convulsion that will lead the average joe to a backed-currency......he thinks his credit card is money presently.

Jim Slip said...

I think you gold-people are in too much of a rush. Imo, a restoration of a gold-standard would only happen if, say, Chinese exporters refused to accept fiat dollars in payment, or something like that. I don't see such a scenario happening anytime soon.

"The planet will demand it."

Hey, c'mon, you think the average guy really has any sort of idea about the difference between fixed-rate monetary systems and free-floating fiat systems? It took me a long time to get my head around that stuff, and I'm actually sitting down and reading a ton of articles a day. The average people know nothing. Nothing.

Demand a gold-standard, why? People that are now 40, weren't even alive before 1971, that is when a gold-standard was actually in place. So why would they demand something they don't know what it represents, and can't compare with the current system?

And to me this talk about Ben Bernanke this and Ben Bernanke that is hugely misleading. If the lesson of the Great Depression was to restore credit, then it wasn't a good lesson learned. Right now all that has happened is that there's a trillion of bank reserves, and interest-rates close to zero. And credit still hasn't been restored (and why should it when the previous credit cycle almost drove everything to collapse).

What might actually help, that is fiscal policy, has either been too little, or not been there at all.

Misthos said...


We reached a point where 1) as a whole, the west is in a balance sheet recession, so credit growth is difficult and 2) each additional dollar of credit created or government spending is having a diminishing effect on gdp growth.

The system is over. Either we have a deflationary collapse, or a monetary/global financial breakdown from competitive devaluations.

The US, as the host of the world's reserve currency, is in a trap. It can not maintain massive deficits at the current pace, not due to funding issues (MMT), but due to dollar stability issues. However, the world's economy still mostly functions on US Dollars. So the US can't really "balance the budget" without creating a worldwide recession. At the same time, it can't maintain deficits as far as the eye can see either. It's a trap.

You and I know the current trading patterns that exist are unsustainable. Where we may disagree is that I believe that fiat money fuels such imbalances much more and much faster than any other monetary system can.

The bigger the pyramid, the bigger the collapse.

As for boatman's comment. His is more political than economic, but it is also a viable view. That is, malinvestments occur more so under a fiat regime than a commodity backed standard. Could Wall Street have been bailed out under a commodity backed system? Could the credit bubble and global imbalances have grown so large under a commodity backed system?

There is a growing trend towards sound money in the US. Is the trend followed by a majority of the people? No. But if you think back ten years, and see the view on gold today, there is a monumental leap in awareness.

Gold will experience a parabolic rise as the system breaks down. That's when the people that have no idea about gold will suddenly understand it. For many of them, it will be too late.

Misthos said...

One more thing, a correction to what I wrote above.

We are actually in breakdown mode right now. It is a gradual process, but fragile nonetheless.

An EU member default, a serious Oil crisis, etc... could accelerate the breakdown.

boatman said...

its not that joe will demand a gold standard, jim....its that in the next biggest badda bust they hopefully will demand a viable answer.

unless someone can come up w/something else, gold is the answer out of abdication.

but i doubt we will get a viable answer, demanding one or not.

and one of the pol. parties here is only better than the other one by the slimest of margins.

Misthos said...

Gold hitting new highs in many currencies.

This is not just an inflation trade.

What we are watching is basically the cost of an insurance premium rising. More people are understanding the risks the current global monetary system faces.

Gold is the final resort if/when the system breaks down.

Jim Slip said...

Misthos, you are making it too easy for yourself. You are making statements, but not explaining them adequately.

Why does each additional dollar of credit have negative GDP growth? I would imagine it has to do with debt service within the private sector, but please explain.

Why does additional government spending have negative GDP growth? I don't believe that. I also read that somewhere, I think it was in Reinhart's and Rogoff's "This Time it's Different", but I believe it to be false.

Why is the system over? Why is there gonna be a deflanationary collapse or a financial breakdown, other than for political reasons?

I want to hear your insight, but instead you start with conclusions, which you don't explain adequately.

Misthos said...

I occasionally make statements that are not thorough because I have covered these topics before in the past six months. I make an assumption of shared knowledge, I guess. You're right, I should be more thorough.

One thing I need to make absolutely clear: I never said negative growth, I said diminishing growth. There is a difference.

Total debt to gdp figures for most western nations is rising. The money multiplier is not working as it used to, in my opinion. Look at any total debt to gdp chart of any (or most) western nations, and you will see a rising trend over the past 30 years. Debt growth is growing faster than corresponding gdp growth.

So what does that tell me? More debt creation is needed for every additional dollar of gdp.

MMT aside, these numbers still matter. It's how nations judge each other's currencies. It's how the markets decide how to trade a currency.

Here's an interesting take on government spending and subsequent gdp growth:


The political reasons of a financial breakdown are based on unsustainable economics. How long can the Chinese - US trade relationship last as is? How long can the imbalances between EU member states last?

You and I know that the numbers for Greece don't add up. And yes, the MMT'ers are right, austerity is not the solution. But really, is there a solution that involves a smooth transition from an unsustainable economic model to a sustainable one?

boatman said...

the stretching,papering over, print and borrow by politicians eager to keep their jobs n get reelected guarrantees there is not a solution with an easy transition.

we're not going to be living in bunkers trading gold for can goods, but its not going to be pretty.

Misthos said...

boatman - I agree, shotgun shells and gold for food is far out there. But like you said, it's not going to be pretty.

But I don't rule out wars, or even temporary martial law in some western countries if rioting gets really bad, or another electronic bank run takes place as it did in 2008.

Some believe we were just that close to the precipice in 2008. I know many people don't believe it and think it was the elites exaggerating the consequences if they were not bailed out.

Personally, I don't think it was exaggeration. Did the elites probably use the situation to keep the bonus machine running for them? Sure. But I share the view that in 2008, the financial world was really close to falling off a cliff.


Jim Slip said...

Misthos, is it accurate to say that your view is that a bigger part of the output goes to servicing the debt, which leaves less space for consumption, and thus has a diminishing effect on GDP? If that's the case, then that may be a problem for the private sector, but not for the government.

Is there a solution for trade imbalances? Yes there is, but it would require central planning on a global scale, which is unlikely to happen due to lack of co-operation, and it would be completely against the whole notion of a free-market. It would be against the notion of Darwinism, as you put it. However, if as a race, after 3.000 years of civilization, we see fit to return to Darwinism (that is survival of the fittest) on a social and economical level, then we aren't very different to animals.

I prefer the entropy of a nanny-state to a jungle. A jungle is a wild, dangerous thing. If that goes against nature, then so be it.

Misthos said...


I'm going to address your two points above in separate posts.

I'll be giving my opinion on why total debt to gdp has been growing in some countries, and the possibility of global cooperation.

This past Friday, the G20 has announced an agreement regarding global trade and debt/surplus imbalances. This is the root of the financial crisis in my opinion.

The world has gotten extremely complex thru globalization, and capital flows, aided by modern technology, can and do affect different parts of the world at lightening speed.

I look forward to your critique and comments.

boatman said...

the US, in effect, bought the TBTF banks....n instead of taking them apart RTC style, we saved their butt so they can do it again, along with now currency problems produced by the bailout....we're still bailing them out as we speak--qe2- backdoor bailout.

its gonna take a very large collapse, make 2008 look like a party(yes,we were close-but we extended n pretended.....coming soon.

Jim Slip said...

I completely agree that the root of the current financial-crisis is the trade-imbalances, and the various capital flows which were allowed to take place in the "globalized" economy. In fact, without the latter, globalization would not exist.

Say, when 20-30 years ago Greece "opened" it's economy, foreign players entered the Greek market and obtained market-share from the local players. The difference? The local players kept their production and profits inside the Greek economy. The foreign players didn't (don't) and so capital flows became a necessity for this process to be completed.

Now, this whole talk about private-debt versus sovereign-debt is largely irrelevant imho. It's two sides of the same coin. In the end both serve to finance the account deficit. But the Eurozone treats the two in a different manner. Go figure.

boatman said...

roubini on china:


Dave Narby said...


First, I hope everything is OK with you and yours over there.

I have been reading about some pretty violent clashes with police over in Greece, and that the police actually pulled out of one city. This doesn't seem to be getting much airplay over here. Could you give us an update?

Seems like what happens on the periphery could easily spread...

Misthos said...


Thanks for your concerns. Where I live, everything is OK. The situation here in Greece is pretty dire, but it is not that relevant to most that live outside of Athens - at least not yet. There are signs of debt deflation everywhere though - a near cessation of construction, closed storefronts, rising unemployment, etc...

But Athens and nearby towns will always be the center where political expression, for lack of a better word, will be exercised. Athens is also where the most unemployment, poverty, etc... can be found.

The police here show tremendous restraint, and there is an historical basis for that. In the late 1960s and early 70s, Greece was ruled by a military dictatorship. It's eventual overthrow was messy, and involved mass student demonstrations and significant deaths. Since then, no government wants to strong arm the population, least they be seen as a reminder of the junta. Thus, they show a lot more restraint than you would see in the US.

Friends of mine that live in Athens will be visiting this week. Greek Orthodox Easter is this Sunday, and it is the most important holiday of the year - rivaling Christmas. So I have been visiting many relatives and have not had much time to post.

I will be catching up next week, with posts on China, the EU endgame, as well as a series on the debt and global imbalances resolution.

I am very pessimistic. And I mean, when I really think about what lies ahead, I feel a pit in my stomach.

Things are getting out of control. This is not a Greek phenomena, I tell my friends here. It is a global phenomena.

Jim Slip said...

Misthos and everybody,

Violent protests have been happening in Greece since forever. Since I can remember, every week there is at least one protest-march in the center, which always derails to the usual molotov-cocktails and clashes with the police. In all honesty, no big deal. The international media are just jumping on this now because Greece is in the center of international attention.

Misthos said...

Jim, you have to admit, it is getting worse - both in scale and frequency.

Dave Narby said...

Here is why I asked


Can't imagine that's "normal" even for passionate Greeks.

Jim Slip said...

Misthos, in all honesty, I don't think it's getting worse. Yet.

The worst protest I've seen personally was in the late 90's, when Bill Clinton visited during the period when NATO was bombarding Serbia. That one was huge, and when the crowds tried to move towards the American embassy, all hell broke loose. It was so severe, and there were so many arrests, that a lot of my friends ended in jail for a few days.

Zero Hedge exaggerates everything. It thrives in fear mongering. Last year, when protesters attempted to burn a bank, which resulted in a couple of the bank's employees burning alive, again Zero Hedge presented it like it was the start of the French revolution or something. In fact it's a minor miracle than in over two decades there haven't been more casualties with the kind of violence that erupts during these demonstrations.

OKL said...

Been awhile since I last posted here.

I think the reality is that while the MMT'ers is in accounting terms correct in saying that more effective fiscal policies are the answer, the political reality right now simply does not allow it to happen- though that can change in the future.

Bailouts, QE, regulatory capture, absence of law enforcement etc, all served to erode public confidence and trust in govt, which directly undermines the implementation and effectiveness of fiscal policy.

people simply do not trust the govt to spend wisely anymore; they had all the time and resources back then during the good times to do so... and they wasted it on the war, causing regulatory oversight, amongst other things.

unrest in foreign countries is almost inevitable; if the US gets it right and starts to run surpluses to pull out of the recession, then the rest of the world gets the exact opposite because their economies are geared towards export-oriented growth- somebody has to run a deficit for every dollar in surpluses.

many say that global trade needs rebalancing and that might well be the case, but it requires a change of ideology and understanding of issues, all of which requires time and most importantly, patience- which is sorely lacking in today's society. try telling the export-oriented countries that importing more will mean their citizens having a better life, when it is that exact strategy that made them wealthy.

Misthos said...


Good to hear from you. I have been busy lately, hence the infrequent posts. I agree with your MMT observation.

I believe that MMT'ers do have the best grasp of the current monetary system, where I disagree with them is the political implementation of it - or to be more exact - the political realities of the system.

Ron Paul once said about the closing of the gold window in 1971 by Nixon:

“After that day, all money would be political money rather than money of real value. I was astounded.”

This observation, in my view, not only deals with the domestic decisions on money, but also in the international arena re: money and trade.

I find it highly unlikely that there will be global cooperation on rebalancing the world's economies. Thus, as I have always believed, gold by default will rebalance the world economy.

In some ways, it is already occurring - RIGHT NOW! Think about it this way: Many Western debts held by Eastern countries are losing value, at the same time official gold reserves, currently held mostly by western countries, are increasing in value.

This is no accident and no coincidence. The system is re-balancing itself right before our eyes. It is a gradual process. But it could quickly accelerate as well.

Put another way: Does China worry about the value of its gold reserves, or the value of its UST and Agency debt holdings?

Gold by default - happening slowly, in real time, right now... and I see nothing that can stop that process.

Jim Slip said...

Hey Misthos.

I am answering here to your post in Market-Talk regarding what you should write about.

Personally, I found great interest in how exactly the European banking system works.

I believe an understanding of this is also key to understanding the financial crisis.



Misthos said...


I thought that was you at Market-Talk. I too, have been reading up on the banking crisis in Europe lately. The issue however, is difficult due to the different countries involved. It's not as easy to understand as the US banking crisis - it's more complex.

Thanks for the links, I'll look into it and write something soon again, for what its worth.

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