What Colour is Your Parachute?

We have grown up, conditioned to believe that Currency = Money = Wealth and to accept the idea that our financial worth is best measured in terms of our national currency units: Pounds Sterling, Dollars and so on. But currency, money and wealth are not the same thing. Let me be pedantic for a moment and offer some working definitions:

• Currency – the unit of accounting for transactions (usually paper, or fiat). It flows, like the current of a river, and represents, or symbolises, the movement of value from one place to another.
• Money – items of actual value, very widely accepted as a medium of exchange in trading. For most of history, this has meant gold and silver coins or bullion which has inherent value. Only in the last century or two has currency largely taken over this role (at least, while a country’s currency system operates normally).
• Wealth – accumulated store of money (not currency) - real assets of long-term value. Usually traded very infrequently.

What is fiat paper money? Fiat is Latin for “let it be done” and is used to describe currency which has been issued “by decree”. Fiat currency is first created by a central bank and then issued to a government as a National Debt which is nominally repayable, with interest. The government then distributes the currency to its citizens via the banking system, and decrees that it is legal tender: it can be used to pay government taxes, and must always be accepted in settlement of trade debts. Governments normally create some form of taxation system, ostensibly to repay the interest on the National Debt.

But this currency is not money; it does get used in place of money, and if all goes well, it may even fulfil many of the functions of money better than money itself. Money has inherent value, whereas currency does not. Currency represents a unit of exchange, but is not the value itself; money has value itself. We are not used to thinking like this.

The most direct route is to riches is to use currency to acquire real wealth assets, then to hold them. However, the confusion between currency and wealth arises because all currency it is founded on DEBT. On the simplest level, personal debt is the opposite of personal wealth: Debt is an obligation to give back value to another party, whereas Wealth is real assets which flow towards you and belong to you. Paper currency simply cannot be the basis for storing Wealth as it is made of the wrong stuff, although it is often used as a snapshot measure of the current value of somebody’s Wealth.

What causes Inflation?

But governments can issue more currency at any time, in paper and electronic form. When they do, they get to spend it at face value before anyone else, but then it flows into the normal money system, increasing the number of banknotes and bank deposits in circulation without increasing the amount of real, valuable assets that exist. This effectively dilutes the value of all the existing “money” (currency), as more notes are chasing the same amount of goods. This is the definition of inflation – an increase in the “money” (currency) supply. Because prices don’t rise when the government first spends their brand new currency, often taking 6-18 months to manifest at the corner shop, banks can then point to the symptoms of inflation (rising prices) and cleverly deflect the blame for the cause of it onto grasping, selfish suppliers whose greed hurts everybody.

Bullion Markets

The markets in physical precious metals (PMs), especially in investment-grade gold and silver bullion, are becoming very interesting places. There are two main types of players:

• “Long” – parties who have contracted to take possession of physical PMs.
• “Short” – parties who have contracted to deliver physical PMs.

There are also markets in many bullion derivative products, such as futures, forwards, call and put options, spreads (simultaneous call and put options), ETFs (electronic Traded Funds) etc. I’m not talking about any of these, as they are not real PMs which you can hold in your hand or visit in a vault – they are claims over the right to take delivery of PMs and all of them involve some degree of risk that the counter-party will not come up with the goods, or will manipulate the market price and force you to close out a worthless speculative option position.

There is a lot of circumstantial evidence that the major Short players do not possess enough physical PMs to cover their delivery obligations. I am talking here about very big players like J P Morgan, who currently have enough muscle to control PM prices downwards, especially in silver, so that they can buy their physical metal, as required for onward delivery, as cheaply as possible. If they are overwhelmed by delivery contracts and “squeezed” to honour their obligations, they will be forced to buy physical PMs from whomsoever will sell to them at any price – and once the word is out, the price will take off.

Stress Tests

The major European banks are about to go through “stress tests”, to see how they might fare under certain types of financial pressure. Many people feel that this exercise is a bit of a pantomime, but one very likely outcome is that there will be general agreement among banks that they are under-capitalised. One painless solution to this problem which has been suggested, that would avoid the need for banks both to rein in their lending and to call on shareholders for more capital, would be to agree on a once-only upward revaluation of gold, which would increase the value of bank gold reserves to a more comfortable level.

Long Multiplication

• As more currency is issued and its unit value decreases, and the value of PMs remains the same, their currency price goes up.
• As more ordinary people start to buy PMs for the first time, the rise in demand will cause an increase in value, and their currency price goes up.
• As the large “short” positions (obligations to deliver physical precious metals) held by bullion bankers get squeezed, their immediate demand for large amounts of physical precious metals will markedly increase their value, and their currency price will go up a lot.
• If the banks agree to revalue gold, the currency price of gold will go up a lot, instantly and stay high indefinitely.

All of these things can happen at around the same time, and their effects will multiply. If you already have a “long” position in gold or silver bullion (i.e. you have what is called allocated, physical ownership in a vault, or you have ingots or coins in a safe at home) and these events start to unfold, you will be so glad.