1912 Gold Clause Sustained!

In the early part of the last century, it was common for people to make contracts based upon payment in gold or its equivalent. At the time, the dollar was standardized as a certain weight of gold: $20.67 equaled one ounce of the yellow metal.

The US went off the gold standard during the 20th century, even going so far as to outlaw the possession of the gold coins that used to circulate. Today, it is legal to hold gold and coins, but it is highly unusual to find a gold clause in any contract.

However, there are exceptions it seems. One such exception is a still-valid 1912 lease for a building in Cleveland.


[thanks to matcmadison.edu for the image.]

The rent was the equivalent of $35,000 in 1912. Believe it or not, the lessee was still paying only $35,000 today, pursuant to his interpretation of the lease. Inflation clauses were unknown in those days.

Now you and I know that $35,000 in 1912 is quite a different sum of buying power than $35,000 today. This interpretation of the lease was highly detrimental to the landlord.

But the landlord, dumb like a fox, found a clause in the lease that said that the rent was payable in gold or gold equivalent, which back then was--let's see, $35,000 would have been 1,693.28 ounces of gold (1 oz = $20.67).

According to this article at Yahoo Finance (thanks to GATA and Walker Todd for bringing it to my attention), the landlord is right. Any such gold clause is still enforceable. The lessee is now obligated to pay 1,693.28 ounces of gold (or its equivalent in dollars), instead of the $35,000 annual rent they had been paying. That's around $1,440,000 a year, "only" 41 times more than they were paying up to now. Ouch.

This sounds like a nightmare for the lessee, a windfall for the lessor (or justice, depending on your experience with landlords), and an amusing anecdote for the casual newspaper reader. But in fact, this court decision is very important.

If it is possible today to use gold as payment in contracts, I can see no reason, other than government fiat, why a court couldn't declare the government's monopoly on legal tender to be unconstitutional and allow gold to reclaim a more prominent role in our monetary affairs.

I won't go into the details about "legal tender" here, because (1) I haven't fully researched it myself, and (2) any discussion would likely contain a lot of legaleze and boring details.

Suffice it to say that this gives me hope for the future. If enough people of the world still retain gold as their personal monetary standard--and I'm convinced they do (remember my mantra), in spite of the fact that their government has forsaken it--they will need a way to assert their right to a stable currency. This might be an avenue for activists to pursue.

On the other hand, this decision is at the level of the 6th Circuit Court of Appeals. There are a few more steps the lessee can take to appeal this decision; and it may go all the way to the Supreme Court, if that court will take it on.

Now this one would be the hearing of the monetary century.

Oh, to remind you of my mantra: You can take gold out of the standard, but you can't take the standard out of gold.

First Silver, Now Gold Is Being Rationed

I noted an article about a shortage of silver at this previous post.

Today, we have this article at Bloomberg about a shortage of gold coins.


[Thanks to Newworldeconomics.com for the photo.]

This is getting tiresome, but I have to repeat:

You can take gold out of the standard, but you can't take the standard out of gold.

And the world knows it, even if much of the West has forgotten this axiom.

Who placed that huge order from a Swiss bank for Krugerrands? Wouldn't you like to know. Probably some Russian with lots of $100 bills to unload. Or maybe Iran. Or maybe an American! Why not.

Reminds me of the old days, back in the 1960s when my father Edward C. Harwood was investigating ways for investment advisers to suggest to Americans how to hold an interest in gold, when American law forbid direct possession. Yes, my friends, it used to be illegal to hold gold.

He found a way or two, and those investment advisers whose customers took advantage of them were able to preserve the value of their hard-earned savings.

Governments may some day again try to outlaw the holding of gold, under some pretence like "It constitutes hoarding and it's doing harm to our monetary system." The truth is that a panic that causes people to hoard gold is a sign that the monetary authorities (with the complicity of the bankers who should know better, I might add) have mismanaged the monetary system.

Unfortunately, any such immoral effort to outlaw gold would, of course, appease the envy and wrath of those voters who don't understand what their legislators have done to deprive them of their standard of living. (For a better understanding of how this works, please go back to my first posts and read forward.)

My father was a most interesting fellow. I knew this already; but I am presently archiving his papers with a view to doing some kind of book on him. (You'll find information about him in my earlier posts as well.) He was an economist and founder of the American Institute for Economic Research; but he was also one of an endangered species: A true patriot, i.e. someone who is willing to put his life and livelihood on the line for his fellow countrymen and women.

More on him as time progresses. Meantime, don't sell your gold yet. The dollar may be seeming to make a comeback; but it's only relative to other currencies. The reality is that those currencies are doing even less well than the dollar. What's left? You guessed it.

The Underlying Credit Crisis's Recent Effect on Market Prices

Once again, Doug Noland at Prudent Bear has come up with an answer I was looking for.

In this post from August 8, he offers one explanation for our current strange market conjuncture.

Commodity prices for things like food, petroleum, and oil ran up to record levels up until about mid-July for reasons that are unclear, but that economists have described as resulting from a mixture of:

1. Increased worldwide demand along with supply problems; and/or

2. Speculation that the US dollar would collapse.

In mid-July, along came the Freddie and Fannie problems (see this post for an explanation of the origin of their predicament, and this one for the latest dire news).

Then Treasury Secretary Henry Paulson issued this press release regarding the Treasury's intention to bail out Freddie and Fannie should problems arise.

We also learned of the Treasury's intention to bail out the FDIC (the government entity that guarantees some of your deposits at the bank) in case of need. (See this TickerForum.org entry explaining the FDIC situation, which forum, by the way, proves that ordinary citizens are not as dumb as some would think.)

These two government announcements blow both hot and cold. On the one hand, they reassure Freddie and Fannie bond holders and FDIC insureds that their investments will not disappear. This should be good news for the economy and for the market, and therefore for future demand for commodities.

On the other hand, they scream to market players that the US Government officials are really worried about Freddie, Fannie, and the banks. So what should be good news for market players and for future demand for commodities turns into a bad omen for the economy and thus for those same commodity prices.

Meanwhile, the signs of a recession are already evident. (See this American Institute for Economic Research post for the stats.)

So it would make sense that commodity prices would start to reverse big-time, which in fact they did in mid-July.

But--and here's the odd part--the stock market took a simultaneous leap upward, as did the dollar, counterintuitive movements under the circumstances.

Does this mean that the coming recession is somehow calming stock market nerves and inflation hawk fears? Perhaps so, because it might cause "inflation" (read "CPI price increase") to disappear just as the Fed predicted; and it will therefore allow the Fed not to raise rates to curtail such "inflation" (read "CPI price increases"). Low Fed rates mean, in the minds of some market players, that money will be available and things will improve.

BUT: I can't believe that such recessionary momentum will avert real inflation as that term is used in academic economics (read "excess money and credit"--see this post for an explanation of this word's definition problem), even though it may put a brake on CPI price levels.

I believe that real inflation will increase because:

The Fed and Treasury are taking unprecedented measures to avoid catastrophe, i.e. they have once again succumbed to the temptation to use the printing press to pay the monetary system's way out of trouble. They will use Treasury funds to bail out Freddie, Fannie, the FDIC, and--through the Fed's newly seized lending powers--any major failing commercial banks and other financial institutions. And these operations will be carried out on an unprecedented scale.

Remember, real inflation means more dollars running around than is necessary in a balanced monetary system. It means that you will be paying too many dollars for a particular thing, no matter whether the actual price of that thing rises, or whether the price just stays the same when it should in fact be falling in a deflationary market.

This also means that gold prices expressed in dollars (and perhaps other commodity prices as well) will not tend to decrease in the long run, because gold is a hedge against real inflation.

Doug Noland puts my theory into more appropriate financialese in his article. He offers a plausible explanation of how the speculative community has functioned under these unusual circumstances.

I particularly liked these two ideas:

"[I]t is not the nature of dislocated markets to let fundamentals get in the way of price movement. Markets, after all, live on fear and greed."

He is referring here to speculative markets, the ones he credits with causing both the run-up in commodity prices and the recent crashing of same.

And this one:

"The unwind[ing] of bearish speculations and hedges would be a most problematic market development, unleashing a final bout of speculative excess and disorder that would set the stage for a major market crisis."

He is talking about the credit maladjustments that are taking place behind the scenes and that most of us never hear about. See this post for a description of these.

This should all play out by the end of this year. Hold onto your hats.

Freddie & Fannie: Off With Their Heads

Cato usually gets it right, and William Poole has done it again.

He tells the story of Freddie and Fannie like it is in this latest article appearing recently in the New York Times. His recommendation: Get rid of 'em.


[Thanks to VictorianWeb.org for the image.]

He's right: Freddie and Fannie have been government entities from the start, even though they were "privatized." The federal guarantee simply went underground for those years.

Just the other day, private investors of Freddie and Fannie "convinced" Congress to admit that the guarantee was valid and made them sign on the dotted line--with your and my "pen" (read "money"), of course.

So this is the denouement of my recent blog post. Therein, I described an example, among many, of government intervention run amuck, where good intentions have dire consequences--a frequent occurrence where government is involved.

In this case, Freddie and Fannie have, in essence, been nationalized.

Who said the US was not a socialist country?

Here's another viewpoint by Gerald P. O'Driscoll, Jr., also of Cato.

Fisher Gets My Vote for Fed Chairman

Just as expected, the Fed left the rates alone while making reference to inflation and the poor economic outlook--once again, trying to be all things to all people.

Today's Wall Street Journal tells us who the lone dissenter was.


[Thanks to Dallas Fed for the picture.]

This guy has got a lot of guts, as did Jeffrey Lacker in the past, always voting to raise rates to counter inflationary tendencies. (See my cartoon with Lacker at the back of the boat.)

Here's a little bio information on this inflation hawk.

What a strange mixture he is of government service and private entrepreneurship.

Can't hold his Carter service against him, I guess. More power to him.

We can conclude that the Fed is putting inflation worries on a back burner. We may all have to pay for their decision down the road.

The Central Banker Credibility War

Every weekend I turn to three sources of bearish information, having been fed to the gills all week long with bullish Wall Street candy.

My three favorite permabears are:

PrudentBear.com
SirChartsAlot.com
The-Privateer.com

This week, it's this July 8 article by Gary Dorsch at SirChartsAlot.com that got my attention.

He points out that stagflation is here, just as we all expected it would be.

He also notes that today's global game is one of central bank credibility, a game that the US, the UK, and a few others are losing.

Back in the early 1980's, Paul Volcker, the then Fed Chairman, took the stagflation bear by the paws and wrestled it down to the ground in spite of the bitter deflationary medicine it required the US economy to take.

Today, "Mr. Volcker warned US Treasury chief Henry Paulson, and Fed chief Ben Bernanke against letting inflationary expectations become embedded once again." Unfortunately, neither "Strong-Dollar (Ha-Ha)" Paulson nor Helicopter Ben is listening.

Another inflation hawk, the Bank of International Settlements chief Malcolm Knight, said on June 24 that “'[t]here must be a forceful response to confront the danger that inflation expectations could rise appreciably, with all the attendant problems that would bring.... With inflation a clear and present threat, and with real policy rates in most countries low by historical standards, a global bias towards monetary tightening would seem appropriate, even though economic growth is likely to be hit harder than most observers expect....'"

He too is talking to himself.

Dorsch continues:

"So far, the Fed and US Treasury have ignored Volcker’s [and Knight's] advice, and instead, are pegging the fed funds rate at -2.25% below the inflation rate, while inflating the MZM Money supply at a +16.5% annualized rate, a prescription for hyper-inflation. [Meanwhile,] the Fed’s aggressive rate cuts have failed to stop the bleeding...."

Why are they ignoring such good advice? Well, here's one explanation: Apparently some of our Fed governors just don't get it:

"San Francisco Fed chief Janet Yellen told her audience ... 'I see inflation expectations as reasonably well anchored. There is little monetary policy can do about rising commodities prices. If rising commodity prices reflect supply and demand fundamentals, then the situation is not likely to turn around any time soon.'”

But what a big IF that is, my dear. There is a distinct possibility that people like Anna Schwartz and Milton Friedman are right, and that "inflation [rising prices] is always and everywhere a monetary phenomenon."

After all, why would food and energy prices suddenly and violently increase if they were caused only by supply and demand?

The increase in global demand for food and energy and the resultant tightening of supply are two forces that have been on the increase over more than a decade now, and that have been squarely in the sights of suppliers worldwide for at least that long. Why the sudden upward move over the last year?

The only credible answer is that the market is finally waking up to the fact that, Yes Dorothy, inflation IS, always and everywhere, a monetary phenomenon, and Yes, Dear, it's coming back with a vengeance.

Unfortunately, what our US and a few other central bankers seem to be losing is the only thing they ever had to bank on--lacking as they do any scientific foundation--and this is their credibility; and this loss is being hedged against by at least two who seem to have the guts our bankers lack: the central bankers of China and Europe.

China's bankers warned the stock market public that they intended to act no matter what; and they did.

Likewise in Europe, "on Dec 19th, 2007, Trichet was asked on German television channel N-TV if the bigger danger to the Euro zone economy was the banking crisis or inflation? 'The response is very clear. We have a mandate. The primary goal is to preserve price stability. We are alert, and everybody must know that we will do whatever is needed, to deliver price stability in the medium term, and be credible in that delivery. The single needle in our compass is price stability,' Trichet said."

Fortunately for him, the European Central Bank mandate is straightforward price stability, unlike our dual mandate of price stability and steady employment in the US. (For further discussion on this point, see this article of mine, Page 1, Page 2, and Page 3 at the Los Angeles Business Journal.)

On the other hand, "the ECB’s anti-inflation crusade is thwarted by the other G-7 central banks [Japan, UK, US, Canada], which are afraid to raise their interest rates to combat speculators in commodities. Legions of 'yen carry' traders have migrated over from the global stock markets to the crude oil markets, since the rescue of Bear Stearns in mid-March [and since Dorsch's article was written, they seem to be moving elsewhere]. A continuation of the 'Commodity Super Cycle' to new high ground could trigger another ECB rate hike to 4.50% in the months ahead, putting enormous pressure on Bernanke to lift the fed funds rate to defend the dollar, or surrender the last ounce of the Fed’s credibility."

The question is becoming, Does Bernanke have the economic argumentation, the political mandate, and/or the plain-old cojones to begin raising rates?

We'll see Tuesday.

My bet is, they'll forgo it "this time"; and they'll jawbone about the lurking dangers of inflation just in case anyone's listening. But market ears are becoming deaf ears; and soon, without action by the Fed, inflation will take over in earnest. Then, someone in that Naked Emperors' Court will be obligated to do something.

(Until then, don't sell your gold.)

Anna Schwartz, Still Feisty

I noted the bowed gray head across the library at the American Institute for Economic Research. She was to give a talk to visiting students and fellows on the evolving role of the Federal Reserve.


[Thanks to NBER.org for the image.]

Siding up to her chair, I put a soft hand on her shoulder and she lifted her attention from the Financial Times. I had to repeat my introduction--her hearing isn't what it once was. But as soon as she got the words, a bright smile lit up her face.

I didn't want to tire her before her upcoming effort, so I left her to her collected thoughts. She seemed too tiny to stand up to the demands of improvised talking and questioning, and someone warned me that she would probably simply read a recent paper. So I prepared myself to be a little uncomfortable listening to something I had already read.

Twenty minutes later, I was listening to the booming clear thunder of her voice as she laid on thick her criticism of the Fed's lack of moral backbone (my words--she is much more diplomatic).

Walker Todd, co-writer with Dr. Schwartz of an upcoming article about the legal and economic significance of the Fed's recent actions, would ask a leading question of her, and this uncanny out-of-body voice just took over.

This woman's mind is still as sharp as it ever was. She updates her stats and info daily and--better yet--retains them, analyzes them, and puts them to good use. She is 93 years old.

Even at this advanced age, she'd make a great Fed chairman.

She got her Masters in economics at Columbia, age 19. What a phenomenon.

See this article for her position.

As soon as her new co-authored paper is available, I'll link to it.