Page 2 of 4 SPEAKING
FREELY Gold 101: The basics of
basis By Antal E Fekete
slavery. In the absence of the
safeguards of a gold standard debt slavery is
inevitable for those who fail to use the only
prophylactic available: gold.
Paper
boat on uncharted waters Let us turn from
the nexus between gold and interest to the nexus
between interest and basis. Mainstream economics
made a fatal
mistake when it failed to
study the consequences of the emergence of the
futures markets in monetary metals. It was not a
spontaneous failure. It was inspired by the banks
and the governments that have taken upon
themselves the "burden" of financing research.
They have a hidden agenda: to keep the public in
deep ignorance and stupor.
Recall that
there are no futures markets in monetary metals
under a gold standard for lack of volatility,
without which speculation cannot be profitable.
But no sooner had volatility appeared than futures
markets in silver and gold sprang up. As they did,
a whole new field of tantalizing research opened
up for investigation. Unfortunately, what it shows
is an appalling and scary prospect for the Brave
New World of global irredeemable currency. It
shows dissipation and destruction of capital on a
large scale through falling interest rates, and
the drying up of new savings through rising
interest rates.
This is the first time
ever in history that irredeemable currency has
been foisted upon the entire world, causing the
rate of interest to gyrate. Humanity was herded
aboard a paper boat named "Dollar" and tossed on
to a stormy sea with no anchor on hand. No wonder
that the powers that be are anxious to put
research under taboo. It is in their interest that
the public stay in blissful ignorance about the
fact that the captain of their paper boat has no
navigational instruments while sailing on
uncharted waters. Gold Standard University is the
first to defy that taboo.
Primer on
basis The condition that obtains when the
futures price is above the spot, or the more
distant futures price is above the nearby, is
called contango and, the opposite, backwardation.
Thus the basis is positive or negative accordingly
as the spot market is in contango or in
backwardation. The prevalence of contango is a
necessary condition for the warehousing business.
Unless there is an expectation for contango to
return after sporadic and temporary backwardation,
warehousemen would go out of business and supplies
for future delivery would be all but unavailable.
The question of what determines the basis
arises. On the upside it is limited by carrying
charges including freight, storage, insurance, and
interest. In the case of gold and silver, the
lion's share is interest. On the downside there is
no limit: theoretically the basis can go negative
and keep falling indefinitely. It indicates that a
tightening supply is facing increasing demand.
Ever larger number of sellers withdraw their offer
to sell. This is the basis risk: the risk of
hedging inventory in the futures market. The cash
price may start going up faster than futures
prices, forcing hedgers to take an opportunity
loss on inventory. A contemporary example is
Barrick Gold Co, with a phony hedge plan losing
tons of shareholder money.
Note that price
risk behaves the other way around. It is limited
in the downside (as the price cannot fall below
zero) but is unlimited in the upside (as there is
no theoretical limit above which the price may not
rise).
Interest and marginal
utility The monetary metals are
characterized by great stores above ground. The
stock-to-flows ratio is a large multiple for gold.
Silver analysts deny that the same holds for
silver. They are at a loss to account for the
disappearance of huge stockpiles of US official
silver in any other way but assuming that it has
been dissipated through consumption. There is no
hard evidence that this is indeed the case. We can
account for the disappearance of monetary silver
through a more plausible hypothesis, namely, that
most of it has gone into hiding. It shall
resurface at the right time and right price, as
indeed some of it already has after the silver
price hit a high of $15 per ounce.
The
case is different for non-monetary commodities.
Here the stock-to-flows ratio is a small fraction.
The reason is declining marginal utility in
contrast with monetary metals with near-constant
marginal utility. Mises argues that constant
marginal utility is contradictory because it
implies infinite demand. He is plainly in the
wrong. He ignores the nexus between gold and
interest. In more details, interest acts as
obstruction to gold hoarding. Demand for
non-monetary commodities is limited by declining
marginal utility. By contrast, demand for monetary
commodities can indeed become arbitrarily large,
but only if interest is suppressed by the banks
and the government. Thus interest is an exclusive
characteristic of monetary commodities.
John Maynard Keynes made a colossal
blunder when he kept talking about the "wheat-rate
of interest", "coal-rate of interest", etc.
Interest can only exist in relation to a monetary
metal with constant marginal utility. The marginal
utility of wheat and coal declines very fast
indeed.
'It takes three to
contango' Keynes made another terrible
blunder when he talked about what he called normal
backwardation. To him backwardation was the
natural state of the markets, and contango, the
aberration. He argued that speculators "charge an
insurance premium" for shouldering the price risk
while carrying the commodity for future delivery.
It is this premium that shows up in the futures
price as backwardation. This shallow theorizing
faithfully reflects the Keynesian mindset that is
haunted by visions of overproduction, market
gluts, deflations, depressions, unemployment, in
one word: the "curse of capitalism".
The
fact, however, is that ours is a world of scarce
resources. Man is engaged in a constant struggle
to overcome the niggardliness of nature. In
particular, he has to have foresight to provide
for future needs. If he succeeds, then future
goods will be available to meet future demand in
adequate quantities at the right time. This would
not be possible without the services of the
warehouseman and without contango in the futures
market. We express this by saying that "it takes
three to contango": the producer, the
warehouseman, and the speculator. Keynes got it
all wrong when he blithely ignored the second
member of the troika.
Hoarding is not a
dirty word, least of all gold hoarding, in spite
of dark hints to that effect dropped by Keynes.
The essential services of the warehouseman must be
studied seriously and without prejudice on the
same footing as those of the producer. The
marginal bondholder who decides to sell his bonds
in protest
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