The Relevance Of Hayek’s Triangle Today

Most of us are aware of the inflationary pressures in the major economies, that so far are proving somewhat latent in the non-financial sector. But some central banks are on the alert as well, notably the Federal Reserve Board, which has taken the lead in trying to normalise interest rates. Others, such as the European Central Bank, the Bank of Japan and the Bank of England are yet to be convinced that price inflation is a potential problem.

Virtually no one in the central banks, government treasury departments, or independent analysts see the real inflationary danger. There is a lone exception perhaps in Dr Zhang Weiying, the top economist at Beijing University and formally in charge of China’s economic policy, who quoted Hayek’s business cycle theory to point out the dangers of excessive deficits.[i] Whether he is listened to by his colleagues, we shall doubtless find out in due course. Otherwise, a sudden acceleration of price inflation will come as a complete surprise to our financially sophisticated markets.

This article explains why the danger lies in the structure of production, which in the West at least is seriously out of whack. The follies of post-crisis central bank monetary reflation are likely to drive us rapidly into the next credit crisis as a consequence. To understand why this is so requires us to revisit the 1930s writings of an Austrian-born economist, who was tasked by the London School of Economics with explaining to advanced students the disruption to the production process from changes in consumer demand.

Friedrich von Hayek was famously reported as the economic guru of both Margaret Thatcher and Ronald Reagan. This distinction owes its origin to his market-based approach to economics, which was in stark contrast with the statist approach that was predominant in political circles at that time, and still is today. It was simple shorthand for the media writing for a mass audience.

The distinction is nonetheless correct. Instead of spending his professorial career bending with the socialist and Keynesian winds, he continued to develop and defend free-market economic theory. As a war for hearts and minds, apart from his occasional successes, it was one Hayek lost, and the consequences of the triumphs of Keynes and socialism are reflected today in systemic instability. But that is no reason to abandon the Hayekian tradition.

Hayek made a number of important contributions to economics, including an understanding of the business cycle, which he demonstrated was driven by credit expansion, and the subsequent consequences of that earlier expansion. The root of the problem, as it is today, is the way producers of goods and services adapt to changes in demand for final goods. It is a problem seemingly ignored by policy makers. Instead they believe that monetary expansion can replace savings without negative economic consequences. This is simply not true.

Hayek illustrated the mechanism of production and the effects of capital flows in a capitalistic economy in the form of a triangle, which showed the steps in production from its early stages towards the final product in time sequence. Using this simplistic illustration he explained the effects of fluctuations of consumer demand on production. The following illustration is of Hayek’s triangle.

The triangle’s sides represent an inverted vertical axis of time, and a horizontal axis of output, the output being consumer goods. The dotted lines represent the various stages of production, typically from the gathering of raw materials and the processing of products through intermediate stages of processing, until the final products are ready for sale to consumers. The assumptions are ones of equilibrium, that is to say there is no change from technology, the distribution of stages of production are even, the quantity of money in the economy is fixed, and lastly there are no alterations in consumer choice.

This highly artificial construction is intended to isolate the factors that determine the relationship between production and consumption, a vital subject otherwise concealed from us by the noise from all the other extraneous factors.

At this point, we must dismiss the common assumption behind GDP, that it is only output that matters. The error has a long history, and goes back even to Adam Smith, who wrote,

“The value of goods circulated between the different dealers never can exceed the value of those circulated between dealers and consumers; whatever is bought by the dealer being ultimately destined to be sold to the consumers."[ii]

In the sense of the sum of added values, this is obviously true. But what matters in our context is payments, payments in the production chain and payment for the final product. The payments between the various stages of production can be many multiples of the final payment, a fact which is hidden from us by the GDP statistic. Indeed, it is only partly revealed to us by the business-to-business activities that occur in production as captured by the US Bureau of Economic Analysis’s gross output statistic.[iii]

Hayek took his triangle to the next stage, and that was to consider the relationship of money flows between intermediate processes, compared with payment for the final consumption output. The intermediate steps are given payment values. The working assumption is that they increase at an even rate as they progress towards the final product, which is likely to be the case because if the returns on one intermediate process is out of line with the others, capital flows can be expected to correct the disparity.

- Source, James Turk's Goldmoney

A Scheme for Linking Currency to Gold

Comparing the value of bullion held to the narrowest expression of money is likely to prove insufficient upon which to base a future monetary policy. But, given a good base of monetary gold, it is possible to set up arrangements to discourage redemptions of currency for physical gold when a gold exchange standard is fully implemented[vi]. The suggested arrangement that follows is based on the issuance of irredeemable government bonds with a coupon payable in either gold or currency at the owner’s choice (the gold bond). Furthermore, an issue of this sort could be used to improve government finances at the same time.

By issuing the gold bond at a discount to par, early buyers get an enhanced yield. This rewards them for buying a new instrument which has yet to gain its potential market recognition. The market price of the bond will become linked to the yield on physical gold once the conversion rate is set, with an additional margin for issuer risk. And if currency balances invested in such a bond are rewarded with a yield payable in gold, demand for currency redemptions into gold are unlikely to be significant, so long as the public has confidence in the issue and the gold exchange standard. So, a country putting its currency on a gold exchange standard should, with a correctly priced bond, minimise redemptions.

A sinking fund should be established at the same time as the bond is announced to buy physical gold to cover anticipated demand for coupons paid in gold. Some gold from reserves can be allocated for this purpose initially but additional gold should be bought to establish sufficient cover to add conviction to the scheme by winding down existing foreign currency reserves where they are unbacked by gold, immediately.

From here on, we shall assume this scheme to introduce a sound, gold-exchangeable currency is taken up by the Chinese government. Government finances can be expected to improve from the arrangement, to the extent that borrowing costs are reduced. For example, China’s 30-year bond currently yields 4.1% having been as high as 4.4% earlier this year. A gold-linked irredeemable Chinese bond, even allowing for issuer risk would probably yield no more than 3% at the outset, which is slightly less than the current yield on 1-year maturities. If it was issued with, say, a 2.25% coupon, it would be priced at 75.00, giving the attraction of a capital gain to private citizens as the risk premium on Chinese government bonds declines.

This will also lend support to the currency in the foreign exchanges. The gold bond should be listed in Shanghai, Hong Kong, Tokyo, Singapore, Dubai, London and Moscow so that sovereign wealth funds and other conservative long-term investors have ready access to it. New York is not on the list because it is Chinese policy to exclude the American banking system from her monetary affairs as much as possible, and the conflicts that necessarily would arise with the US government. Ultimately, for funds based outside America, the gold bond itself would come to be regarded as a gold substitute for investment purposes, integrating gold into both Chinese-led monetary and investment reforms.

There can be little doubt that if these measures are taken gold convertibility would rapidly promote the yuan to foreigners in Asia and beyond as an acceptable store of value in exchange for trade. In time, all foreign currency held in China’s monetary reserves not backed by gold would have to be disposed for gold or yuan, as being inconsistent with the new monetary policy. As stated above, China’s gold buying using dollars would start immediately and continue until the price of gold has risen to the point where the gold exchange rate is finally established.

Furthermore, with no final redemption on the gold bond, there would be no need to make any repayment provisions. This model is the one that was adopted by the British government for financing the Napoleonic Wars by issuing Consolidated 3% Annuities at a deep discount, so that investors providing war finance not only got an enhanced yield, but also a substantial capital gain when peacetime returned. The fortunes created on the return to peace played an important part in financing the industrial revolution in the early nineteenth century.[vii]

In this sense, there are good parallels between Britain’s war financing two hundred years ago, and China’s current position. In both cases government expenditure exceeded and exceeds respectively tax income by a significant margin, and neither were and are on a gold standard. Britain had temporarily abandoned her gold standard in the 1790s, before reinstating it a few years after Waterloo.

In China’s case, excess government expenditure is due to planned infrastructure spending, which is likely to be ongoing for at least another ten years and extending well beyond her borders. However, Chinese instigated capital expenditure throughout Asia will increasingly be covered by project financing through the Asian Infrastructure Investment Bank, releasing the Chinese government from much of the financing burden.

The British came out of the Napoleonic Wars with an estimated debt to GDP of about 260%. In cash terms it was considerably less, because the debt figure is the total of nominal debt in issue. This was the beauty of irredeemable Consols, because they never need to be repaid, which meant a more accurate debt to GDP figure was 180%. As an historical footnote, it is interesting they were repaid only recently.

China’s government debt is considerably less at just under 50%, but still rising. China is blessed with a savings rate of close to 50% of GDP as well, so further issues of a gold-linked bond into the domestic market should be heavily subscribed. Once the current expansion of infrastructure spending diminishes, the Chinese government will easily return to a budget surplus, paying down its debt more rapidly than the British did in the 1800s.

I would suggest China undertakes the monetarisation of gold in two stages. The first would be to issue the new gold loan outlined above. Proceeds of the new gold bond would be used to finance government expenditure, to purchase existing bonds in the market for cancellation, and to build a sinking fund to provide cover for future coupon demands in gold. The price relationship between coupons paid in gold and yuan will be fixed at a later date and will be the rate for the gold exchange standard once it is set. It cannot be set at the outset, because it is clear that for gold to be rehabilitated into China’s monetary system, and consequently the likelihood it will be elsewhere, will require a far higher gold price than at present. In price theory, it is the introduction of a new use that will set a higher marginal price. That will be the second step, which is announced in advance when the new gold bond is first issued but at a rate yet to be decided.

- Source, James Turks Goldmoney

Gold’s Monetary Rehabilitation

There is a quiet revolution taking place in the monetary vacuum that’s developing on the back of the erosion of the dollar’s hegemony. It is perhaps too early to call what’s happening to the dollar the beginning of its demise as the world’s reserve currency, but there is certainly a move away from it in Asia. And every time the Americans deploy their control over global trade settlement as a weapon against the regimes they dislike, nations who are neutral observers take note and consider how to protect themselves, “just in case.”

Vide Europe over the Iran issue. And Turkey. These are rifts in NATO. Countries in Africa, and elsewhere are now taking China’s money. And to please the Chinese, Gambia, Burkina Faso, Panama and the Dominican Republic have all recently severed diplomatic relations with Taiwan. Small fry perhaps, but a weathervane showing which way the wind is blowing.

We’ve seen Russia set up an alternative to SWIFT in order to be free from American monetary interference in pan-Asian trade. We’ve seen China take major steps to exclude the dollar from her trade as much as possible and to enhance the role of her own currency. And now we have a schism over Iran between America and the Europe it set up after WW2 through the mechanism of the CIA-controlled American Committee for United Europe in 1948.

It is unprecedented, and today America obviously cares less for her relationship with European allies than she hates Iran. There can be little doubt that America’s undeclared war against the land of Omar Khayyam is intended to undermine its economy and create the conditions for internal revolution. The Iranian rial has continued its collapse, and the theocratic government has played into US hands by shutting down “unauthorised” money-changers, with Grand Ayatollah Nasser Makarem Shirazi calling for the execution of money changers to help end the currency crisis. The black-market rate for rials has rocketed as a result, and according to Professor Steve Hanke whose department at John Hopkins University makes a study of these things, the true rate of price inflation has jumped to 74.8%.

For the ordinary Iranian, gold has always been the ultimate money, while their government’s rials are to be rapidly passed on to someone else. America’s sanctions and the government’s actions merely reinforce that message. Time will tell whether America’s attempt to undermine Iran’s theocracy succeeds, but history suggests it is unlikely. And at a national level, Iran is driven by American actions into accepting anything but dollars in payment for her oil exports. She would like euros, and given the EU is still trying to sell her capital goods, that makes sense. But no commercial bank dares facilitate payment in any currency under the threat of US sanctions and penalties.

That leaves only three possibilities beyond America’s influence: Chinese yuan, Russian roubles, and gold, all independent from the West’s banking system. It is no wonder the new yuan for oil contract in Shanghai, perhaps with a little help from China’s state-owned banks, has got off to a roaring start. We can all understand the desire to lock in oil prices for future delivery, in this case it is in return for yuan issued by the People’s Bank of China. However, in the future Iran will be able to spend the bulk of her yuan on other raw materials, using a range of yuan futures contracts as a bridge to them from her oil.

Essentially, US sanctions are forcing Iran onto a yuan standard for her foreign trade. Furthermore, China is there to pick up the pieces the West abandons because of American sanctions, driving Iran into an increasing dependency on China. The new Silk Road, the Chinese-built 200kph railway between Tehran and the eastern city of Mashad, as well as other Chinese-led rail projects are opening up Iran in a purely Eurasian context, marginalising American power. Iran’s problem with this, if there is one, is international yuan markets are not yet developed enough to make full use of hedging instruments. But Iran’s demand for sophisticated financial tools, as well as from other nations in Asia turning their backs on America, is bound to hasten their development.

I have written several times in the past about the importance of yuan-denominated deliverable gold futures in this context, and the evidence that the two markets offering these contracts, Hong Kong and Dubai, are cooperating in establishing additional vaulting facilities in China, roping in other gold centres in South-east Asia as well. In the case of gold, where physical delivery measured in tonnes is tight, the Chinese are ensuring as far as possible that deliverable liquidity will be there.

Additionally, last week the London Metal Exchange, owned by the Hong Kong Exchange and Clearing (HKEX), admitted it is considering introducing yuan contracts for base metals as well. We can safely assume that while the HKEX is an independent commercial entity, its strategic objectives are closely aligned with and encouraged by the Chinese government. Not only do the Chinese dominate gold markets in Asia, but last year HKEX successfully introduced regulated precious metal contracts in London. There can be little doubt that HKEX will be an important platform for expanding international markets for the Chinese currency. And at some time in the future, a state like Iran will be able to use not only yuan contracts to sell commodities in order to buy other commodities, but to use them as a stepping-stone to mobilise state-owned gold for payments as well.

Our topic is now moving on to gold being actively used as money instead of fiat currencies. While this point is not yet being considered by Western commentators, we can be sure it is by the forward planners in Asian governments. It’s not for nothing India is trying everything to get hold of its citizens gold. To an extent, gold is already used as money by governments, which is why they are still included in monetary reserves. But they are there as a backstop, the money of last resort, no one’s liability. What we could be seeing with the development of international yuan currency markets is a platform that links the use of gold to trade settlement.

This insight means we must look at both the Chinese and Russian policies on gold in a new light. Assumptions in the markets seem to be that China and Russia only see gold as a dollar hedge, or alternatively their accumulation of gold is either to balance the US’s holding of 8,133 tonnes, or alternatively (if you believe the American’s are lying about their reserves) Chinese and Russian gold is there to be used like a sword of Damocles held over the dollar. It would be wrong to dismiss these theories out of hand, but surely, they miss the point. You don’t carefully plan to become a dominant world power, edging out the Americans and their dollars, without careful forward planning of monetary affairs.

There is irrefutable evidence that China has been planning for a post-dollar world since shortly after her leadership threw in the towel on communism and embraced free markets. The regulations appointing the People’s Bank with sole responsibility for gold and silver date all the way back to 1983, since when we can confidently assume the PBOC has quietly accumulated gold on behalf of the state at prices that varied between $250-500 over a nineteen-year period. We know this, because in 2002 the PBOC then permitted private ownership, setting up the Shanghai Gold Exchange to facilitate physical acquisition. This would only have happened after the state had had a clear run at accumulating sufficient physical gold for its future purposes. And, as the largest gold mining nation for many years by far, with state monopolies in refining domestic production, recycling scrap and refining imported doré, there should be no doubt over her policy towards her accumulation of gold bullion.[ii]

Since 2002, the Chinese government has actively encouraged its nationals to accumulate physical gold and judging by net withdrawals from the Shanghai Gold Exchange vaults, the public possesses roughly 18,000 tonnes from more or less a standing start.[iii] My estimate for state ownership of bullion, based on contemporary prices, an analysis of capital inflows in the 1980s, followed by trade surpluses in the 1990s and before the public were permitted to buy in 2002, is approximately 20,000 tonnes. Even so, that may be not be enough gold bullion owned by the state at current prices to operate a simple gold exchange standard, being the equivalent value of ¥5.22 trillion, compared with currency in circulation of ¥7.15 trillion.[iv] For comparison, when President Roosevelt devalued the dollar to $35 in January 1934, the US Treasury held gold worth $7.44bn at the new price against currency in circulation of $5.72bn. Therefore, if the Chinese government has 20,000 tonnes, and if it is to have the same currency cover as America had on 31 January 1934, at current exchange rates gold would have to be priced at $2,317.

Russia began accumulating gold only more recently and is now aggressively building her official reserves. Whether she has accumulated bullion “off balance sheet” is not known but should not be dismissed. Based on her official reserves at 1,910 tonnes worth RUB5.0 trillion, it does not cover M0 yet (RUB8.44 trillion)[v] but a rise in the gold price to $2,200 will do so, and a gold price of $2,860 would be required to match the Americans in 1934. In fact, for both Russia and China if gold is to have a monetary role it would have to be at a far higher price than it is today.

- Source, James Turk's Gold Money

EU Banks are Insolvent, Disaster is Coming

The disruption of an Italian withdrawal from the euro would be fatal for the EU’s banking system on at least four levels.

The support from the ECB for the Italian banks would be withdrawn, which would have the potential to allow a cascade of bank failures in Italy to develop, either as a result of bad debts crystallising within the system, or due to balance sheet deterioration from falling Italian government bond prices.

Problems for banks will arise when past loans remain denominated in euros, while their balance sheets are transitioned into a new, weakening currency. The Italian banks lack the margins to weather lop-sided balance sheets, whose assets are denominated in a declining currency relative to the currency of their liabilities.

There will be a rush for residents in other Eurozone countries to reduce and eliminate their Italian commitments, amounting to a banking run against the whole country. The only political solution would be to impose draconian capital controls between Italy and the rest of the world, including other EU member states.

Lastly, there is the threat to the ECB and the euro-system itself.

These require little elaboration, expect perhaps for the threat to the ECB and the euro-system. The ECB has been buying large quantities of Italian bonds, effectively financing the Italian government’s excess spending, at yields that are ridiculously low. In effect, the ECB has put itself in an impossible position, and as the Italian situation worsens, the debate over the fate of TARGET2 imbalances is bound to intensify. These are shown in the chart below, which is of balances at end-March.

So long as the euro-system holds together, we are reassured that these imbalances do not matter. However, with the Italian central bank in debt to the system to the tune of a net €447bn, how these imbalances would be dealt with on an Italian exit from the euro without a collapse of the system is an interesting question. And it is worth noting that Spain’s central bank is also in the hole for €390bn, just in case the Spanish electorate, or even the Catalans or Basques get ideas of leaving as well.

The Bundesbank is owed a net €896bn and will be extremely nervous about Italy. The ECB itself also owes a net €235bn to all the national central banks. When the ECB buys Italian government debt, the Banca d’Italia acts on its behalf. The Italian bonds are held at the Banca d’Italia, and the money is owed to it. To the extent the ECB has bought Italian bonds, the overall negative balance at the Banca d’Italia is reduced, so its deficits with the other national banks in the system are actually greater than the €447bn shown, by the amount owed to it by the ECB.

In short, it is hard to see how Italy can leave the euro without the ECB having to formally guarantee all TARGET2 deficits. It is not impossible and the guarantee is already implied, but the ECB won’t want anyone questioning its own solvency, so we can safely assume an exit will not be permitted, for one simple reason: the system and the banks in it are only solvent so long as the system is unchallenged.

The question over Italy’s euro membership may not arise anyway, because the new coalition does not yet know what it wants. The Italians must also be dissuaded from their desire for debt forgiveness, for the same reasons the Greeks were similarly deterred. And as the Greeks found, trying to negotiate with the EU and the ECB was like talking to a brick wall. The Italians will experience the same difficulties. We can dismiss any idea that because Italy is a far bigger problem, they have negotiating clout. A brick wall remains a brick wall.

So far as Brussels and Frankfurt (the home of the ECB) are concerned, they are always in the right. The European project and the euro are more important than the individual member nations, and their electorates have no say in the matter. We often take this to be arrogance, which is a mistake. It is worse: like Marxists, the eurocrats have unarguable conviction on their side. Across the table will sit the Italians, with no political beliefs worth mentioning, and all too readily frightened by the consequences of their own actions.

This is the way the EU works. Inevitably, in a faceless statist system such as this there are always problems at the national level to deal with. Then there are localised difficulties, such as Deutsche Bank, whose share price tells us it is failing. But in that event, it will doubtless be rescued because of its enormous derivative exposure, the containment of eurozone systemic risk, and German pride. The ECB has shown great skill at bluffing its way through these ands other problems and is likely to continue to succeed in doing so, except for one particular circumstance, which is the crisis stage of the credit cycle.

- Source, James Turk Goldmoney

The Gently Rotting Debt Ridden EU

The EU as a political construction is in a state of terminal decay. We know this for one reason and one reason alone: its core principle is the state is superior to its people. A system of government can only work over the longer term if it recognises that it is the servant of the people, not its master. It matters not what electoral system is in place, so long as this principle is adhered to.

The EU executive in Brussels does not accept electoral primacy. It shares with Marxist communism a belief in statist primacy instead. The only difference between the two creeds is Marx planned to rule the world, while Brussels is on the way to ruling Europe.

The methods of satisfying their objectives differ. Marx advocated civil war on a global scale to destroy capitalism and the bourgeoisie, while Brussels has progressively taken on powers that marginalise national parliaments. Both creeds share a belief in an all-powerful executive. The comparison with Marxism does not flatter the EU, and suggests it has a limited life and that we may be on the verge of seeing the EU beginning to disintegrate. Despite economic evolution in the rest of the world, like Marxian communists Brussels is stuck with a failing economic and political creed.

It has no mechanism for compromise or adaptation. A rebellion from Greece was put down, the British voted for Brexit, which is proving impossible to negotiate, and now Italy thinks it can partially escape from this statist version of Hotel California. The Italians are making huge mistakes. The rebel parties forming a coalition government want to stay in the EU but are looking to exit from the euro. Putting aside the impossibility of change for a moment, they have it the wrong way around. If they are to achieve anything, they should be exiting the EU and staying in the euro. Let me explain, starting with the politics, before considering the economics.

As stated above, the EU is quasi-Marxist, placing the state above the people. The Italian government has collaborated with Brussels to enslave its own people as vassals of the EU super-state. If there is a revolt in Italy, this is what the electorate is rebelling against. Faceless eurocrats tell the Italian people what to do and what to think. The people are discontent with both the super-state and their own weak governments.

The two parties forming the latest coalition are too frightened to blame the EU, and instead propose to beg for debt forgiveness and say they are considering leaving the euro. But without a clear vision, and understanding why the Italian electorate is discontent, this coalition will turn out, in one of Boris Johnson’s memorable phrases, to be comprised of little more than supine protoplasmic invertebrate jellies. Greece is the precedent. This makes it easy for the EU to deal with the Italians. They will get nothing.

The economic argument, that Italy would be better with her own currency, is insane. With a history of weak irresponsible governments, it is far better for the currency to be beyond Italy’s control. However, Keynesian commentators are sympathetic to the weak currency argument, believing that the euro was constructed for the benefit of Germany. Italy, along with the other Mediterranean members, is said to be paying the price. This, they allege, is the fatal flaw in the one-size-fits-all euro. This interpretation of the monetary situation is baloney. It ignores the fact that Italy’s debt rocketed after the formation of the euro, because the cost of borrowing for Italy fell towards Germany’s borrowing rates, thanks to the guarantee of eventual unification. The difference was Germany borrowed to invest in production, while the Italian government borrowed to spend. The problem today is the profligacy of the past has caught up with Italy, and its government must stop borrowing.

Setting up a lira alternative, or the mooted mini-BOTs, is an ill thought out concept that only makes matters worse. The mini-BOT proposal appears to be for an issue of certificates backed by future tax revenues to be used to pay the government’s creditors. They would then circulate like bills drawn on the state, but at a discount to reflect both their time value and the fact they are not euros. It seems to not occur to the promoters of schemes like this that the state’s creditors will insist on payment in euros.

Promoters of schemes like mini-BOTs are monetary cranks, incentivised by a desire to avoid reality. The Italian government has been using this sort of hocus-pocus for years, mostly with securitisation of future income streams, such as the national lottery. Mini-BOTs appear to be a proposal for just one more throw of the dice.

It’s hardly surprising that the Italian people are fed up with their establishment and feel they can only collectively undermine it by voting against it at election time. But it is too late, because the state, and therefore the banks, are already irretrievably bust, a fact barely concealed by the ECB’s funding of the Italian government at near-zero interest rates through the purchase of government bonds. Not only is the ECB in denial over Italy’s financial situation, but also Italy is firmly imprisoned.

- Source, James Turks Goldmoney

It’s not stagflation, but inflationary impoverishment

It is a matter of personal interest that it was my uncle, Iain Macleod, who invented the term stagflation shortly before he was appointed shadow chancellor in 1965i. It is no longer used in its original context. From Hansard (the official record of parliamentary debates) 17 November that year:

We now have the worst of both worlds —not just inflation on the one side or stagnation on the other, but both of them together. We have a sort of "stagflation" situation and history in modern terms is indeed being made.ii

The inflation that Iain was referring to was of wages, which were averaging an increase of 6.2%, and rising, and stagnation in production, which had declined from an index of 134 to 131. It was this divergence that gave him the opportunity to invent this portmanteau word. It has now passed into more common use to describe an economy that fails to respond to the stimulus of monetary inflation.

Its use in this context is therefore different from the original. The idea that stagflation exists as an economic phenomenon is only really true for neo-Keynesians, who view inflation as economically stimulative, and its failure to stimulate perplexing. In this sense it is frequently applied to conditions today, where massive monetary stimulus does not appear, so far at least, to have brought about the economic growth that might have been expected from it.

The explanation why monetary stimulus has not worked as intended is not difficult to understand, but for neo-Keynesians it is unpalatable. This article takes its cue from the misapplication of the stagflation term to explain why Keynesian stimulation of the economy is bound to fail, and symptoms commonly but incorrectly referred to today as stagflationary are simply a reflection of the costs of monetary policy imposed on ordinary people.

It involves the reinstatement of Say’s law to its rightful place, not as Keynes misleadingly described it, that supply creates its own demand. It requires an understanding of why inflation destroys wealth, the opposite of the creation of wealth that a stimulus implies. And it necessitates an appreciation that GDP is no more than a misleading accounting identity covering only a minor part of the economy. I shall explain the relevance of these topics in turn, and why stagflation is an inappropriate description of some sort of intermediate condition between inflation and deflation...

- Source, James Turks Gold Money, Read More Here

Economics 101: Who Sets Prices?

Since the advent of nineteenth century socialism, politicians and economists in the centre ground have argued for a balanced approach, where vital services are provided by the state, and capitalism is left to provide the rest. Vital services in a modern economy are taken to include pensions, unemployment and disability benefits, healthcare and education. Most states also provide communications, such as rail and road infrastructure, electrical grids and perhaps telecommunications. They often own and operate on behalf of the people utilities, such as the railways, ports, electricity and water.

The rest they regulate. There is hardly a product or service in the private sector unregulated by government. So far as the public is concerned, they see the benefit of a state acting in its behalf, protecting it from the uncertainties in life, and from unscrupulous profit-seeking businessmen. People do not stop to consider that the state and its necessary bureaucracy is less efficient at protecting individuals than the individuals protecting themselves. Nor do they understand the enormous burden on them of having the state act in an economic role.

The central question, why the state is less efficient than free markets, is answered by understanding prices. Should they be set by the state, or by the consumer? The consumer exercises choice. The state intervenes to restrict choice. This article seeks to demonstrate why government services always come at a higher cost than the same services provided by free markets.

The position of Austrian economists

Last week, the Mises Institute published an article by Robert Murphy, explaining why Ludwig von Mises described the consumer as sovereign, and why Murray Rothbard contradicted Mises, and urged his followers to “reject the notion of consumer sovereignty as an inaccurate political metaphor”.[i]

Rothbard’s criticism appears to be semantic, based on a purist argument that the phrase confuses a political statement for an economic one. What von Mises actually meant is that in a capitalist economy all production of goods and services is aimed at satisfying consumer demand, and it is the consumer who ultimately decides what is bought and at what price. And we are not just talking of the retail sector. Retailers through their demand for supplies from wholesalers, importers and manufacturers pass the signals from consumers back up the chain, imparting valuations to the productive process and to the pricing of raw materials.

Rothbard agreed with this entirely. Rothbard’s criticism of consumer sovereignty appears to be a very minor poke at his mentor, but it also betrays a different approach to explaining price theory in his Man, Economy, and State from von Mises’s Human Action. We should bear in mind Rothbard addressed a predominantly neo-Keynesian audience, when the first edition of his book was published in 1962. In the first part of his book, Rothbard deploys charts and examples to show relationships between price and quantity of goods and enters into a discussion of supply and demand schedules. No charts can be found in von Mises’s earlier Human Action, though taken as a whole, the message is the same.

It is easy to confuse Rothbard’s approach to prices with the mathematical one taught by the economic establishment. But the mathematical economists take us in the direction of a static market devoid of evolution and shorn of the dynamics of time. This is where Rothbard differs from today’s mainstream.

The mainstream assumption is equational maths, illustrated by charts, is the way to go. If so, a computer replicating the calculus behind supply and demand curves could accurately model prices, something that is yet to be achieved, even allowing for developments in artificial intelligence. Those who think consumer demand can be replicated by algorithms fail to distinguish between a static economic model and the dynamic world which is ever-changing. This point is fully acknowledged by Rothbard in his approach. Furthermore, he understands, as von Mises did, that the British classical school with its theory, that prices are determined by costs of production, did not accord with reality.

A different approach is found in European subjective value theory, originally developed by the scholastics in the Middle Ages, and taken up by the likes of Cantillon, Turgot and Say. It was Carl Menger, the founder of the Austrian school, who linked the two approaches by explaining that it was marginal supply, satisfying the least important use for a consumer, that sets the price of a good. Therefore, a greater level of supply, by satisfying less important uses leads to a fall in price, while a reduction in supply only satisfies more important uses, leading to a higher price.[ii]

If it is use-value that sets prices, then clearly it is the needs and wants of consumers that decide them. Hence von Mises’s metaphor, that the customer is sovereign.

We are dealing with non-financial assets here. The buying and selling of financial assets should be regarded as a separate subject, where the roles of participants in an exchange are not so neatly delineated. But there is a crossover which must be mentioned: since Rothbard wrote his Man, Economy, and State the prices of commodities have become increasingly distorted by derivatives, which are no longer simply used to iron out seasonality in agricultural production. They represent an extra source of paper supply that is never consumed, but because little or no distinction is made between physical commodities and financial derivatives, an increase in the supply of the latter suppresses relatively prices of the real thing.

Even putting derivatives to one side, it is clear that the question of who takes the lead in determining prices has become a broader subject than it was when the concept of marginal utility was established by Menger in 1871.[iii] The subject, is of course, almost limitless. This article will be confined to some brief comments designed to put consumer subjectivity into a modern context.

The importance of price subjectivity

It is assumed for the purpose of this article that all price changes in consumer transactions come from the product, and not from changes in the purchasing power of money. In other words, in individual exchanges the exchange value of money is regarded as fully objective, and the value of goods and services as fully subjective. For money to function as money, this must be true, notwithstanding the changes in purchasing power for money that always occur all the time, as evidenced in the foreign exchanges and the continual fluctuations in the price of gold.

This means that all subjectivity in value must be confined to the goods and services involved in individual purchases. Within the objective/subjective framework, the seller desires money more than the goods or services being sold, whether he is purely a trader for profit, or a retailer. And if the buyer agrees to buy, at that moment he desires the product more than the money exchanged at the price.

There continues to this day to be confusion over what criteria sets a price. Is it the cost of exploited labour, as Marx proclaimed and is still accepted by modern socialists to this day, or is it the cost of production, as Adam Smith and the classical British school averred? Keynes ducked the issue. As stated above, Menger demonstrated it was neither. Monopolies aside (which I’ll come to in a moment) prices are set by what a buyer will pay, and that will depend on the value to him he puts on a product. 

The reason this is so is the buyer can always refuse to pay a price he believes is too expensive, while a producer must sell his product or face going out of business. And as a reality check, note that manufacturers usually think in terms of price points: a motor manufacturer will aim for a price that in its judgement the market will pay for a motor car of particular specifications, in the context of competitive offerings. Costs will then be adjusted to ensure the proposition is profitable instead of being price determined on a cost-plus-margin basis...

- Read the Full Article on James Turk's Gold Money Here

Artificial intelligence, or can machines think?

Artificial intelligence (AI) is seen as both a boon and a threat. It uses our personal data to influence our lives without us realising it. It is used by social media to draw our attention to things we are interested in buying, and by our tablets and computers to predict what we want to type (good). It facilitates targeting of voters to influence elections (bad, particularly if your side loses).

Perhaps the truth or otherwise of allegations such as electoral interference should be regarded in the light of the interests of their promotors. Politicians are always ready to accuse an opponent of being unscrupulous in his methods, including the use of AI to promote fake news, or influencing targeted voters in other ways. A cynic might argue that the political class wishes to retain control over propaganda by manipulating the traditional media he understands and is frightened AI will introduce black arts to his disadvantage. Whatever the influences behind the debate, there is no doubt that AI is propelling us into a new world, and we must learn to embrace it whether we like it or not.

To discuss it rationally, we should first define AI. Here is one definition sourced through a Google search (itself the result of AI):

“The theory and development of computer systems able to perform tasks normally requiring human intelligence, such as visual perception, speech recognition, decision-making, and translation between languages.”

This description is laced only with the potential benefits to us as individuals, giving us facilities we surely all desire. It offers us more efficient use of our time, increasing productivity. But another definition, which might ring alarm bells, is Merriam-Webster’s: “A branch of computer science dealing with the simulation of intelligent behaviour in computers. The capability of a machine to imitate intelligent human behaviour.”

Now we are imitating humans, particularly when we add in the ability of machines to learn and adapt themselves to new stimuli. Surely, this means machines are taking over jobs and even our ability to command. These are sensitive aspects of the debate over AI, and even the House of Lords has set up a select committee to report on it, which it did last week.[i] Other serious issues were also raised, such as who do we hold accountable for the development of algorithms, and the quality of the data being input.

This article is an attempt to put AI in perspective. It starts with a brief history, examines its capabilities and potential, and finally addresses the ultimate danger of AI according to its critics: the ability of AI and machine learning to replicate the human brain and thereby control us.

AI basics

AI has always been an integral part of computer development. As long ago as 1950, Alan Turing published a paper, Computing Machinery and Intelligence, which posed the question, “Can machines think?”.[i] It was the concept of a “Turing Test” that determined whether a machine has achieved true AI, and the term AI itself originated from this period. The following decade saw the establishment of major academic centres for AI in the US at MIT, Carnegie Mellon University, Stanford, and Edinburgh University in the UK.

The 1980s saw governments become involved, with Japan’s Fifth Generation project, followed by the UK Government launching the Alvey Programme to improve the competitiveness of UK information technology. This effort failed in its central objective, and the sheer complexity of programming for ever-increasing rule complexity led to a loss of government enthusiasm for funding AI development. In the US, the Defence Advanced Research Projects Agency also cut its spending on AI by one third.

However, in the late-1980s, the private sector began to develop AI for applications in stock market forecasting, data mining, and visual processing systems such as number plate recognition in traffic cameras. The neural method of filtering inputs through layers of processing nodes was developed to look for statistical and other patterns.

It was only since the turn of the century that the general public has become increasingly familiar with the term AI, following developments in deep learning using neural networks. More recently, deep learning, for example used for speech and image recognition, has been boosted by a combination of the growing availability of data to train systems, increasing processing power, and the development of more sophisticated algorithms. Cloud platforms now allow users to deploy AI without investing in extra hardware. And open-source development platforms have further lowered barriers to entry.

While the progress of AI since Turing’s original paper has been somewhat uneven, these new factors appear to promise an accelerating development of AI capabilities and applications in future. The implications for automation, the way we work, and the replacement of many human functions have raised concerns that appear to offset the benefits. There are also consequences for governments who fail to grasp the importance of this revolution and through public policy seek to restrict its potential. Then there is the question of data use and data ownership. I shall briefly address these issues before tackling the philosophical question as to whether AI and machine learning can ultimately pass the Turing test in the general sense.

- Source, Gold Money

The Worst Man In Modern History

It seems extraordinary that in defiance of all factual history and philosophical knowledge anyone should celebrate the bicentenary of the birth of Karl Marx. More than anyone, through wrong-headed ideas, he bears responsibility, indirectly admittedly, for the deaths of an estimated one hundred million people in the last century, and the severe suppression though economic and social servitude of fully one third of the world’s population. And if you also include those who have suffered under the yoke of Marxist-inspired modern socialism, the philosophy that says the state is more important than the individual, you could argue nearly the whole world is influenced by Marxian philosophy today.

That might seem an extreme statement, but you only have to ask almost anyone anywhere, which do they consider is more important, the individual or the state, to see if this supposition is correct. The only explanation for the continued adoration of the man is that with such universal influence, there are bound to be legions of supporters remaining, ignorant of and blind to the reality. However, during his lifetime – he died in 1883 – he was hardly known. It wasn’t until the Russian revolution thirty-four years later that Marx began to be taken seriously.

How did Marx achieve this powerful posthumous position? It was not through his economics, though they are often quoted and form the core principles of his Communist Manifesto, but through his philosophy, old ideas from forgotten men such as Hegel (1770-1831), which he rehashed into a socialist philosophy that is still accepted by many today, despite the accumulated evidence against it. The difference with Hegel is Hegel strove to establish that historical evolution would lead to increasing individual freedom, while Marx strove to prove the individual played no role in historical evolution.

Hegel argued that all reality is capable of being expressed in rational categories and can be reduced to a synthetic unity by dialectic reasoning within a system of absolute idealism.[i] In plain English, he concluded we all take our cue from our social and cultural surroundings and circumstances, and that they in turn are set by historical events. This became the basis for Marx’s extreme philosophy of class structure, which, in common with Hegel, denied any role to the independence of human thought.

His philosophical stance was comprehensively set out in his book, A Contribution to the Critique of Political Economy, published in 1859. The fundamental principle behind Marxism is stated early in the preface, where he defines his deduction from the Hegelian dialectic: “It is not the consciousness of men that determines their existence, but their social existence that determines their consciousness.” In other words, social organisation takes precedence over the individual, and it therefore follows that the individual is subordinate to the social organisation.

It follows from this logic, Marx argued, that the classes that formed on the back of material interests forces members of those classes to think and act in their narrow class interests and not independently in their personal interest, there being no such thing. For Marx, ideologies evolved on class lines, where the interests of the minority, the bourgeoisie, dominated. And as the bourgeoisie profits from the labour of the proletariat, it is in their interest to keep the proletariat suppressed. The accumulation of wealth in the hands of the bourgeoisie was entirely due to the exploitation of the proletariat.

Marx’s world was a black and white one of haves and have-nots, the exploiters and the exploited. As Emmanuel Kant (1724-1804) had said, “If one man has more than necessary, another man has less”[ii]. The only way this apparent wrong could be righted would be through the collapse of the capitalist system, which led to these imbalances in the first place. The final solution was a classless society of the proletariat, handing them the means of production administered on their behalf by a revolutionary government.

If proof was needed, it came for Marx in the increasingly disruptive economic slumps over the course of his lifetime. Slumps hit the proletariat hardest, leading to unemployment and starvation. Initially, Marx was convinced that with the slumps getting progressively worse, a communist revolution would eventually be triggered, and the socialists (i.e. Marx himself) would take command from capitalist governments on behalf of the proletariat. Unfortunately for Marx, this never happened, and he increasingly turned in favour of a violent revolution to hasten the ultimate solution, reflecting his growing impatience and desperation.

Above all, Marx despised, even hated other socialists with an irrationality that can only have been fuelled by fear of competition. This hatred remains with us today, with communists loathing all forms of national socialism. Marx’s line of reasoning also freed him from criticism, because dissenters were always labelled bourgeoise, and were therefore dismissed as arguing on class lines. They were unmasked as bourgeoise, whatever their dissenting view, and therefore not qualified to comment on matters that affected the wider proletariat. The only answer was for the bourgeoisie to join the proletariat or to be made to do so, then their interests would be forcibly aligned.

We cannot gloss over the inconsistencies here, where on the one hand the bourgeoisie can only pursue a rigid class interest, yet its members are capable of the independent interest required to migrate to another class. And we must also mention that Marx himself, along with his supporter Engels, was a member of his so-called bourgeoisie, so according to his own strict doctrine, was unable or unqualified to align himself to the proletarian interest.

Marxian dogma was riddled with such inconsistences. Partly, this was due to the state of human knowledge at that time, and which formed the basis of any dialectical debate. Darwin contemporaneously proposed his evolutionary theory, pronouncing that humans evolved from the apes, and therefore were merely a higher form of animal, not a species apart favoured by God. This played neatly into Marxian philosophy.

It was also before the development of psychology by Sigmund Freud and Josef Breuer. It was believed that all human brains were the same, just as we have other internal organs with specific functions within the corpus. The concept, that humans differed in their intelligence, their acuity, was unknown. Even mental illness was believed to be a disorder emanating from the body. To Marx the philosopher, drawing on Hegel’s dialectical approach, it could have seemed logical that we are all the same, and that the obvious social differences are down to our upbringing in one or the other class.

He never defined class, which is too slippery a concept to pin down. Instead, he separated humanity into the exploited majority, the proletariat, and the minority that controls the proletariat, the bourgeoisie. He expected the proletariat to eventually rebel, forcing the bourgeoisie into the lower class, to be ruled over by a socialist administration. He believed that this would happen, because under capitalism, the impoverishment of the workers was inevitable, leading to a workers’ revolution. Yet, at the same time, he believed in the iron law of wages, most associated with David Ricardo. According to this law, wages were set by the availability of labour and the payments required to subsist. Higher wages than this basic level would lead to an increase in the availability of labour over time, while lower wages would reduce the labour pool. In this way, the cost of labour was expected to rebalance at a subsistence level. Labour was regarded as a simple commodity, whose supply was regulated by its demand. However, Marx’s belief in the iron law of wages is at odds with his supposition that the proletariat would be gradually impoverished. You cannot subscribe to both.

Subsequent improvements in economic knowledge have disproved both theories anyway. Marx’s approach was to arrogantly assume workers are unthinking work-slaves, which they are not. They are individuals with individual aspirations, and as Freud and Breuer showed later, they have brains separate from the corpus, with individual mental abilities that govern the corpus. Marx even despised the trade unions of the day, arguing that striking for higher wages was colluding with members of the bourgeoisie by negotiating with them, when instead they should be seeking their destruction. His thinking had evolved from the proposition that the destruction of the bourgeoise class would occur naturally in time, to encouraging a violent class revolution to bring it about. Workers going on strike compromised both alternatives.

Marx also cooked up a theory of dialectical materialism, a concept based on Hegelian dialectics and the materialist philosophy of Ludwig von Feuerbach (1804-72), whereby the material productive forces were meant to propel society through the class struggle towards socialism. Materialism, in this sense, is the doctrine that all changes are brought about by material entities, processes and events, and that all human ideas, choices and value-judgements can be reduced to material causes, which one day will be explained by the natural sciences.

Marx, the man, and Engels, his financial backer, came from the bourgeoisie, and had nothing in common with the proletariat. Their motivation was fundamentally dishonest. After expecting the destruction of the bourgeoisie through an evolution out of capitalism, they actively sought a violent revolution, and there can be little doubt that they impatiently expected to emerge as the leaders of the new order. They despised other socialists, who were seen as rivals. Far more famous in Marx’s time was Ferdinand Lassalle (1824-64), who shared the basic Hegelian philosophy, but helped Bismarck defeat the liberals in Prussia. To Marx, this cooperation with a government was anathema, just as national socialism was to Marxists in the next century.

To Marx, world communism could only have one leader and other socialists must be denounced. As von Mises wryly put it, the worst thing for a socialist is to be ruled by a socialist who is not your friend.

Marx and Engels despised both nationalism and national socialism, because they sought a global revolution so there was no place for national characteristics or cooperation with governments. It was, in effect, their bid for world domination, cooked up in the reading room of the British Library. A decade after the Communist manifesto was published, Marx stopped advocating peaceful revolution, in favour of civil war in all countries to destroy the bourgeoise class. Marx and Engels sought to provoke and benefit from it. The plotting with Engels increasingly took that direction and Engels studied military science in preparation for his role as commander-in-chief.[iii]

Despite Marx’s theories and subsequent plotting with Engels, Marxism was exposed by events, even from the outset, as a failure. In the years following the publication of the Communist Manifesto until his death in 1883, despite the boom and bust cycles following the middle of that century, the lot of the proletariat improved immeasurably. Something was going horribly wrong with Marxist predictions, and the chief architect had passed away into obscurity. He had, however, set the template for Lenin, who took up the Marxist banner with the Russian revolution thirty-four years later.

We now know what happened, though much of it was kept from us until the Berlin Wall was dismantled. Just as Marx strove for a global communist revolution, destroying nation states as well as the bourgeoisie, Lenin had the same Marxian objective. It persisted into the post-war era, with the annexation of Eastern Europe, and persistent attempts to undermine Western Europe. Soviet spies were everywhere. Not only did we have the Cambridge five, and left-wing economics professors promoting socialism in the top universities, but even Harry Dexter-White, a very senior US Treasury official who founded the IMF and the World Bank, was a Soviet spy.[iv]

Marx was a dead-beat plotter, who should have simply sunk into obscurity. But like Keynes in the following century, he made his half-truths sound eminently plausible. His training as a philosopher imparted a respectability to his theories. Even at his graveside, Engels eulogised him thus:

“Just as Darwin discovered the law of development or organic nature, so Marx discovered the law of development of human history: the simple fact, hitherto concealed by an overgrowth of ideology, that mankind must first of all eat, drink, have shelter and clothing, before it can pursue politics, science, art, religion, etc….”

How can you not respect, even adulate a man expressed in these terms? You cannot say that a philosopher, who discovered the law of development of human history, who recognised that man needs food, water, shelter and clothing is wrong, or bad. This is in strict contrast with the title of this short essay, that Marx was the worst man in modern history. If it hadn’t been for developments long after his death, this epitaph would not be worth challenging. There have been far worse perpetrators of human misery in their lifetimes, with a roll call that goes back to the beginning of recorded history.

No, the reason Marx was a thoroughly bad man, even evil, was he plotted not just the domination of one country, but the whole world by advocating the destructive forces of civil violence. He was a poor parody of a Bond villain. And as is the case with all socialists, he wanted total domination. You could take the view that he was a latter-day Don Quixote, delusional and mad, and that Engels was a sort of financial Sancho Panza without the wit. This would be incorrect. Marx was a failure as a philosopher, and instead of rethinking and recanting, he moved from a position of preparing himself for a leading role in what he saw as inevitable, to advocating violent social destruction.

It was Marx’s wrong-headed philosophy that led to the deaths of a hundred million souls, perpetrated by those he inspired, as well as the enslavement of most of the population of the Eurasian land-mass. And if we are to identify his catastrophic error in the simplest terms, it was the brief sentence in the preface to his A Contribution to the Critique of Political Economy, referred to above. If instead he had correctly concluded that,

“It is the consciousness of men that determines their existence, and not their social existence”

the world would be a far better place today, with ordinary people free to have delivered economic progress to their fellow men and women without bearing the burden of Marx’s failed philosophies.

He is my nomination for the worst man in the modern history of humanity, and we should remember this and only this on the bicentenary of his birth.

- Source, James Turk's Gold Money

Crude Oil: The Next Five Years

OPECs 2016 shift back to its former strategy has led to a sharp decline in global inventories and a rally in spot prices. It has also reintroduced the problem that OPEC spare capacity deters global oil companies from investing in future production. This problem is now exacerbated by increased hedging activity from shale oil producers. As a result, non-OPEC output ex-shale will start to decline in about 2-3 years, just when shale oil production begins to struggle offsetting ever increasing decline rates. We believe the next big move in oil will be in longer-dated prices, which will need to go higher in order to secure future supply.

OPEC once again changed strategy...

In 2016 we published a note with the title “OPEC at the crossroads” (June 06, 2016). In that note we described the difficult choice OPEC had to make: Should it continue to let the market play out as it did for the past couple of years, hoping that low prices will push out or at least curtail the shale oil producers over the long run; or, should it return to its former strategy and try to balance the market. While OPEC seemed initially reluctant to do the latter, in late 2016, the OPEC members changed their mind and agreed to curtail output. The new stated strategy sounded much like the old: OPEC would curtail production until global inventories normalized.

...which lead to a dramatic decline in inventories...

As we have explained before, OPEC cannot influence the price of oil directly. It can only manage inventories. What do we mean by that? Longer-dated oil prices are set by the marginal cost of future supply, or in other words, what long-term price is needed in order secure future supply? Spot prices can fluctuate widely around this longer dated price, depending on how much inventory there is1. Hence, by letting inventories decline, OPEC can push the curve into backwardation, which is exactly what happened since the production cuts. Importantly, by the time OPEC decided to curtail output, the market was already balanced and inventories were drawing in line with seasonal patterns. The production cut pushed the market immediately into a deficit. As a result, global inventories have been drawing over 300 million barrels more than normal since mid-2016 and days of supply cover is back to normal levels.

...pushing the crude oil price curve into backwardation and spot prices sharply higher

This led to a USD30/bbl rally in crude oil spot prices. In order to fully understand this price move, it is important to highlight the strong inverse relationship between inventories and time-spreads. A commodity price curve tends to trade in contango when inventories are high and in backwardation2when inventories are low (see Exhibit 2). The reason is that in an environment of low inventories, consumers of a commodity are willing to pay a premium for immediate delivery. For example, an airline is willing to pay a premium for jet fuel delivered today rather than in six months if jet fuel inventories are low. If the airline runs out of jet fuel, the planes will be grounded, which will be much costlier than paying a premium for prompt delivery of fuel. In contrast, when inventories are very high, consumers of a commodity are not worried that they could run out of this input good. Because it costs money to store commodities (storage cost, insurance costs) and there is a time-value attached to money, consumers of a commodity prefer to get delivery only when they really need it. As a result, spot prices will trade below forward prices in such an environment.

The sharp decline in oil inventories over the past two years lead to a massive shift in time-spreads. In early 2016, the Brent curve was in steep contango. Prompt month prices traded USD15 below the 5-year forward. As of today, it is trading USD15/bbl above the 5-year forward (see Exhibit 3). 

Longer dated price remained practically unchanged for the past two years. Hence, the entire move in the spot price was due to the shift in the curve, which was driven by the inventory decline. Importantly, the change in the spot prices does not imply that the market somehow changed its view on how much it costs to produce oil. Longer-dated prices, which are set by the marginal cost of future supply, are still below USD60/bbl. 

This means that the market still believes that USD55-60/bbl gives enough incentive to producers to make the necessary investments to meet future demand. The spot price rally thus was simply due to the decline in inventories.

- Source, James Turk's Gold Money

Gold and Silver Solutions to Monetary Madness

Over the past several months it has become quiet clear that we had best be seeking solutions for this ongoing monetary madness that will safe guard our our individual needs and future wealth preservation. This is not a great mystery nor is it some "theory" dreamt up by basement dwelling lunatic. All one needs to do is read the headlines around the world and the picture is as clear as bright sunny day.

- Source, The Daily Coin

James Turk: You don't invest in gold, gold is money

James Turk, globally recognized expert on precious metals, joins Kuzman Iliev and Vladimir Sirkarov in the Boom and Bust show on Bloomberg TV Bulgaria to discuss a wide range of investment topics - monetary policy, the new reality of negative nominal yields, investment strategies for wealth preservation, what to consider when investing in gold and how to prepare for turbulent times.

- Source