The War Between Credit and Resources

The Federal Reserve is probably not ready to take the aggressive plunge into Nominal GDP Targeting, but it likely will.

Such a policy, which received wider attention during Ben Bernanke's Congressional questioning last year and was also highlighted this year in a paper delivered at the Jackson Hole conference (Woodford, opens to PDF), has not caught any visible traction with Washington policy makers possibly because it’s seen as either too radical, or simply too new.

However, after four years of broad reflationary policy (and another year to come) failing to meaningfully spur U.S. employment growth, the Fed may be willing to try such measures by late next year, 2013.

Indeed, given the Fed’s recent announcement of open-ended quantitative easing (QE), one can already anticipate the incremental move towards Nominal Gross Domestic Product (NGDP) Targeting, which has as its central belief that an aggressive and open-ended promise to pursue growth at the expense of inflation is the booster required to push a structurally broken economy back to normal trend. Moreover, in contrast to Bernanke’s swift rejection last year of NGDP on a conceptual basis, Bernanke discussed the idea in friendlier terms during his post-Federal Open Market Committee (FOMC) news conference.

What’s 'exciting' about the emergence of NGDP Targeting into mainstream economic thinking is that, once implemented, it will provide a real-world test of reflationary policy’s final effort to combat the forces that have led to the end of strong, economic growth. The appearance of the Woodford paper (link above) further highlights the reality that endless amounts of cheap capital will be provided to restart economies, now that we are in energy transition, with the world having lost its cheap oil. The battle between credit and natural resources will be renewed.

What will be the effect on global natural resource extraction in an era of NGDP Targeting?

Simple.  All of the remaining fossil-fuel BTUs will be extracted on an accelerated basis, and governments will race to provide the capital to do so.

The Post-Abundance Era

It makes sense that just as the era of abundance is coming to an end – an era which dominated developed world economies over the past 250 years – an enthusiastic, vestigial embrace of Abundance would pour forth from culture. Books such as Abundance: The Future is Better Than You Think and also The Coming Prosperity have appeared in a flourish, all in the past year.

Is it not telling that this outpouring has occurred just as it has become crystal clear that prices of resources were not – even in the post-2008 era – returning to levels of the prior decade?

It is either lurid or tragic that assertions of abundance would flower after energy prices endured a price revolution, agriculture prices did the same, and purchasing power and incomes in the developed world entered decline. The repricing of the planet is a super-trend that has endured for more than 10 years now, and it has wreaked havoc on just about every asset class from stocks to housing. While observers currently cheer stabilization in such prices, it's worth noting that the S&P 500 first reached current levels more than 12 years ago. Therefore, each unit of the stock market buys less of everything. So much for abundance.

It is additionally rather galling to be harangued by Abundance Theorists at a time when OECD economies have essentially failed, both in their financial systems and their ability to produce jobs, and are instead now producers of poverty. As purchasing power declines in the West against energy and food, what can Abundance Theorists possibly be thinking? It is not as if the industrial revolution in the Non-OECD is producing higher quality lives either, as countries like China convert themselves into waste dumps of coal-fired and chemical pollution, and India sees pluralities of its population continue to go without electricity or a reliable water supply.

Abundance would mean that globally, energy is so plentiful that it would be too cheap to meter. On the contrary, global energy prices – and in particular, food prices (which are strongly linked to energy prices) – have completely broken out of long-term trend lines to the upside.

There is no better measure of the aggregate loss of purchasing power against resources than the advance that poverty has made in the past 10 years, especially in the United States. While it’s true that various policy choices have exacerbated income inequality in the West for over thirty years, such explanations were more satisfying from 1975-2000, during a long period of efficiency gains in the economy. As it happens, the U.S. Census Bureau has just released fresh data on U.S. poverty, and while not a surprise, it does not make for pleasant reading. U.S. poverty is at its highest levels since 1993, but the current level -- 15% -- is very near the highs of the last 40 years:

Number in Poverty and Poverty Rate: 1959-2011

(Source - The U.S. Census Bureau)

Some observers have commented that the U.S. poverty rate is actually “not as bad as it seems” because of food stamps, various state and federal assistance programs, unemployment insurance, and other financial aid that the government now provides to the poor. These are collectively known as "transfer payments." However, the income bracket requirements to be placed in the poverty category have such a low ceiling that it seems likely that U.S. poverty remains undercounted. From recent news coverage of the poverty figures at the San Jose Mercury News:

Although the poverty rate didn't rise, the median household income for all Americans declined 1.5 percent to $50,100 in 2011. That was an 8.1 percent decline from 2007, before the recession began, and 8.9 percent lower than the 1999 peak. To be classified as poor in 2011, a family of two adults and two children would have had to make less than $22,811. Some economists had predicted Wednesday's annual report would show the poverty rate hitting its highest level since 1965, when President Lyndon Johnson announced his war on poverty. The fact that the numbers instead leveled off after three consecutive years of increase was a relief to some. Still, the persistent poverty is troubling: the 15 percent poverty rate ties with 2010 as the highest since 1993 and one of the highest since the government began measuring poverty.


There is a certain unreality to a measurement that deems a family of four with an income above $22,811 to not be in poverty. How, exactly, could one live as a family of four in these United States with an income of $24,000 or even $26,000 and not be in poverty? For such a household, energy and food prices alone would dictate either a very poor diet, or the need for government assistance in utility and transport costs, or both. Indeed, a new unreality in our accounting now marks many areas of economic life in the U.S. in the post-Abundance era.

Unreality in Energy Costs: The Ethanol Example

Analysts have pointed out for years that a significant portion of the military budget is devoted to the safety of global oil supply, and thus each barrel of oil has “external” costs that the user does not pay at the pump, but instead pays as a taxpayer. This is undoubtedly true.

So what policy has the U.S. pursued in an era when military costs and the price of oil are even more onerous? The policy of mandated ethanol.

Mandated ethanol in the U.S. has done nothing to lower gasoline prices (which are, of course, driven entirely by oil prices) regardless of ethanol content. Moreover, the energy content of all organic material, in this case corn, is so low that by the time the process of converting corn to a liquid is complete, so many other energy inputs have been required that the net energy pick-up is incredibly small. In order to escape the reality of structurally higher oil prices, the U.S. has diverted enormous capital and other resources to a program that is largely symbolic. But billions in tax credits have been devoted to grow and support an industry that could simply not make it without such support, primarily for two reasons: one, because the low energy content of corn does not provide enough profit to pay all entities in the production chain; and two, because ethanol makers are essentially refiners and do not ultimately control the cost of their feedstock (corn).

Ethanol policy has been underway since 2006, when the price of oil had started its price revolution. And aggressive reflationary policy in the US has actually been underway for 12 years, not just the past four years, when the near-zero interest rate policy was first employed (1.00% interest rates). These two policies are an example of how institutions and economies will grapple with both the loss of cheap energy and the tremors such a loss sends out through an economy. Trying to battle, hold back, and generally thwart secular changes in prices and carrying capacity with patchwork solutions not only is destined to fail, but brings with it myriad other consequences.

For example, because the economy was already experiencing energy limits in the early part of last decade, instead of spurring organic growth, reflationary policy simply distributed into the fixed assets of housing. That was confirmation that other barriers to growth were already becoming embedded.

Reflationary policy produced a greater quantity of resources, nor cheaper resources.

Similarly, in ethanol policy, instead of reconfiguring transportation systems or investing in rail, the U.S. foolishly wasted billions trying to produce more liquids when the real problem was the quickly escalating cost of oil supply. As we now understand, agricultural production is not free, but instead tied very much to fossil fuel costs. So the dream of escaping from high oil prices by running large-scale food-to-fuel programs is destined to fail.

No Carbon or Green Solutions at Sufficient Scale Coming

But if you think these measures are desperate, we have only just begun to push energy and financial systems beyond their capability.

The launch of QE3 (and similar measures by the European central bank (ECB) in Europe) is like the crack! of a starting-gun to human psychology that carries the following, urgent message: Hey, humans go get those resources quickly, before someone else does! Indeed, the most powerful lever for monetary policy remains our capacity for social competition. The open-ended promise to pursue a faster rate of growth at the expense of inflation, mal-investment, bubbles, and the environment places a new and fast pressure on human economies to perform.

Those who are concerned about the environment and climate change should also read the onset of QE3 and the inevitability of NGDP Targeting as the start of the next big leg of resource extraction. And, accordingly, of CO2 production.

While the dream of a green energy transition persists, however, no such transition from fossil fuels to renewable energy is taking place at sufficient scale or speed to effectively shift human economies to new energy architectures. We already have sufficient and clear data in our possession to know with some degree of certainty how energy transition is currently proceeding. In short, while wind and solar resources are growing at near-exponential rates, they remain such a small portion of the global energy mix that even in the best case scenario just 15% of the global powergrid will be free of fossil fuels roughly 20 years from now.

Displacing that much of the powergrid with renewables will indeed be an achievement, but unfortunately, the recoverable reserves of natural gas and especially coal are sufficient to fund incremental growth for at least another 20 years. Even if we project a mostly flat global economy for the next two decades, the energy-funding requirements to run a flat global economy will still necessitate that we extract enormous volumes of fossil fuels each year. And that is precisely what will happen as long as aggressive reflationary policy is pursued.

Accordingly, any global effort to place carbon taxes on economies or to agree to other climate treaties will largely be token and symbolic. In Part II: What Happens Once We've Burned All the Resources?, we take a look at the remaining reserves of natural gas and coal, and roughly model the composition of energy inputs to the global powergrid as economies transition increasingly away from oil. Also, now that it’s clear that this reflationary policy will carry on for years and years to come, we explore at a rough calendar as new programs roll out in Japan, the EU, and the U.S. Those who predicted Infinite QE have now been proven correct.

Click here to read Part II of this report (free executive summary; paid enrollment required for full access).

This is a companion discussion topic for the original entry at

Thanks Gregor for an insightful presentation.
Implicit in your analysis is the risk of excessive and perhaps hyper inflation which you did not address. Are you simply assuming that somehow the Central Bankks manage to dodge it, is it even within the control of CB's to manage such a complex issue as confidence in currenciy values is lost? By inflation, I'm referring to price inflation.

Thanks Gregor.
The Limits to Growth, Standard run puts everything in context.

The model-making Left Hemisphere of the economists are applying their toy solutions to Reality. They are applying an artificial construct, money, to a real problem. How can a imaginary construct have any control over Reality? Try to be kind to Ben, he means well.

My model is the diabetic one. The sugar hit no longer works.

Even a perfect energy source will not be a panacea. We have got to get off the planet. To the deniers I say "Oh yes we will. One way or the other." They might not enjoy "the other."

I would be grateful to anyone who destroys my model.


Once a virus reduces our population by 95% we will not need to leave the planet.

Elaisa Kasan,
I am unable to get the population beyond AD2550 on the Limits to Growth model. What does us in every time is loss of arable land. There is a period of stability after AD2100 with a life expectancy of  30 but food production fails around AD2500.

Food production falls below sustanence levels at the end of this century but then picks up again in the beginning half of next century.

Believe me, these are the Good old Days.

Arthur, you are far to pessimistic. Don't you know we will live in a virtual reality, a singularity, where we will just push a button and presto, steak dinner (think star trek)! Technology don't you know.
'Soliant Green' (a movie from back in the day), have you ever seen this movie? Just think, the Elite will indeed eat us for breakfast. isn't this a wonderful thought. A self fulfilling prophecy.

Oh!, you would make a fine President and with the way we just have thrown the laws of the land right out the window I think we could get you elected rather easily. Promise me though, free Internet for all and please ban all lobbyist to a planetary body processing star dust, and NO furloughs.

Goooo Tigers


Really?  I think he is far too optimistic.  He apparently thinks that we will be able to transplant our lives, culture and biota to another planet or somewhere beyond our earth and probably solar system.  I don't think we will ever be able to move more than a token number of humans anywhere beyond the moon.  If that's the goal, its not worth pursuing.  I would much rather focus on keeping out current world survivable.  That's gonna be hard enough.

Arthur, you must know that speculating on how many people there will be on the planet or how much food they will have 88 years in the future, let alone 500 years, is a flight of fancy given the near infinite variables.


Doug, Arthur is genius in my opinion, and I cannot match his left brain, right brain electrical circuits so I try and have an exchange that includes some humor in a very stressful environment at times. Arthur is the Man and I like him very much. As I'm sure you do. Arthur has a way of chilling me out.
The future will be whatever it is, and my guess is that Mother Earth will have to due a re balance at some point. No point in worrying about that though. Just be good stewards ourselves.

Respectfully Given


Happy Pessimist. Embraceing my inner doomster. I'm Just along for the ride.
If humanity is to continue to be sleek and well fed then he will have to leave the planet. 

Just 55 thousand years ago a small window opened that allowed us to escape Africa. Since then we have survived by conquoring new territory and exploiting it's resources. Every time we got stuck in one place we ended up short-lived and hungry. Why should this time be any different? 

Because this time another short window has opened. We have found oil. This has allowed specialisation. In the old days people like Professor Hagelstein would have been pulling up turnips in the mud instead of figurinig out about the coupling of nuclear and phonon energies. Proffesor Meulenberg might have died of a sore tummy instead of flying around the world explaining how to get a space elevator built.

There is no no acceptable alternative to implementing Dr Gerard K O'Neil's plan. 

This discussion has been held many times around campfires between those who want to stay where they are and those others who wonder what is just over the horizon.

“Space is big. You just won't believe how vastly, hugely, mind-bogglingly big it is. I mean, you may think it's a long way down the road to the chemist's, but that's just peanuts to space.” 
― Douglas AdamsThe Hitchhiker's Guide to the Galaxy

I know you are directing your remarks to others but I have to say that movie got so much right, as horrid as it was at the time-overpopulation, pollution, water shortages, and extreme stratification into a comfortable microcosm for the elite and the masses who suffered.

Edgar G Robinson's final film performance as the jewish intellectual who figures it all out, a fine performance. I will never look at strawberry jam the same way…

A real horror film, standing joke from the 70's, eerily prescient…it all started with the death of the plankton in the seas.

Thank you for listening :slight_smile:


My take-away from the movie was that so many accepted Soylent Green from the government without question, save one (Charlton Heston). Today we still accept without question, the news, GMO foods, new laws and policies it’s as if the majority of society has willingly taken the blue pill.
If you haven’t seen the movie Solyent Green it is worth watching for the content.
AK GrannyWGrit

Denise, some things just stick don't they. Every time I have strawberry anything I think of that movie! I thought I was the only one.
We all must realize that some form of rebalancing must occur, will most likely occur because our world has been around for so long, and has always corrected as the stresses of the day mandated it should. I politely stay away from specifics  because it's just horrid. What happens is you start looking around at family, friends, and neighbors, even yourself and well it isn't a pleasant thought so why even spend any time there.  

Now, with Arthur (who I dig), I get this. He truly gives me a perspective that allows me to negate my logic of doom with a sense of adventure. Intended or not.

Arthur's views are critical for me as I see this very bright man as allowing me to turn off from these negative thoughts lingering for too long. I am a realist and a reactionary but my dreams and hopes are my happy place, I like it there. 

I look forward to the future of which sadly 2/3 of my life has probably passed. I will be positive, optimistic, and hope for the best. The numbers are clear…Unsustainable is everything, and major shifts will occur in my last 1/3.

Frankly and selfishly, I do all that I do now to leave this beautiful place adding more to it than I take. I share my excesses freely, like tomatoes in the garden for instance. So less is more are my goals.

It is in the last sentence that I see many like me evolving in the not to distant future. That means low demand so less growth, and a serious destruction of debt before we can ever move forward, and forward is to mean just the necessities of life. These will be expensive enough to maintain especially when wages are stagnant and safe investments are now being forced out into the risky HFT world where money enters the Black Hole, and never escapes. 

I would like to ask you or anyone here at PP, are any of you looking to purchase any big ticket items any time soon? Do you avoid using your car at all costs? Are you squeezing every penny as though it is your last? I do, and most everyone I know do except when it comes to the enjoyment of money like taking my Lady for a special dinner or ball game, and these are rare because I want them to be special. So my season tickets have been let go in favor of a ten game package.

Geez, I am longer winded these days, full of energy, and is a result of Adam's family honey, no question about that. Not 'THE' Adam's family, Adam's family. Oh never mind!


Goooo Tigers

2 up 1 to go


"Soylent Green", thanks folks. I spell by visuals and obviously I had a block going on. So I went with spell check.

Go Tigers


…just a bit.
What doesn't ever bug me is here at PP we are not married to the idea that we are exclusively right about anything. We prepare for all eventualities, and as our goal is to be more self sufficient and THAT is a proper and well stated goal. When you prepare out into the future it free's the mind to focus on the importance that today brings. Anyways, I am in the camp of Deflation and Inflation, "YES!".

CHS does have his thinking cap on today as he does with everything he prints in my opinion. Just as GM does with his essays.

A Triffin parodox?

I have no clue what has led me to absolutely fall in LOVE with all things financial, political, and Oil but I thank the you know who above for giving me all of this to pass my days away. Lord knows I love it.

Goooo Tigers




What Will Benefit from Global Recession? The U.S. Dollar
 October 9, 2012

Understanding the euro's failure and Triffin's Paradox helps us understand why the dollar will rise significantly in the years ahead.

Many times what "should" happen does not happen. For example, global stock markets "should" decline as the global economy free-falls into recession, as global recession is not exactly an ideal scenario for rising corporate sales and profits or demand for commodities.
Yet global markets are by and large rising significantly.

Sometimes what "should" happen is simply being delayed. In other cases, some other dynamic is at work. Stock market bulls, for example, say the "other dynamic" is global money-printing by central banks, and this "easing" will power stocks higher even as sales and profits sag.
Analysts who believe fundamentals eventually over-ride monetary manipulation believe the stock market decline has only been delayed, not banished.
A similar tug-of-war is playing out between those who feel the U.S. dollar "should" decline in the years ahead and those who see the dollar strengthening significantly.
Those who feel the dollar should decline look at the Federal Reserve's money-creation operations (buying $85 billion a month of mortgages and Treasury bonds) and see money expansion that devalues the existing base of dollars. Thus they feel the dollar "should" decline, and any rise in the dollar versus other currencies, oil and gold are temporary.
Those on the other side are dollar bulls, of which I am one; I have consistently been presenting the case for a stronger dollar since early 2011. We see other dynamics in play that "should" push the dollar much, much higher.
The technical case is encapsulated in this chart, courtesy of our Chartist Friend from Pittsburgh:

This is not to say that we don't believe expansion of base money is not dollar-negative; clearly, expanding money while the real economy of goods and services remains stagnant will gradually devalue the currency.
But there are other forces at work that complicate the simple case for a dollar decline based on Fed money-creation. For example, money is constantly being destroyed as paid-in capital vanishes in writedowns and write-offs. Many readers insist money is not being destroyed, but it has to work both ways: money can't just be created, it can also be destroyed.
To cite my previous example: if J.Q. Citizen bought a house in 2007 with $50,000 down payment in cash, and the house was sold in 2010 for less than its outstanding mortgage, that $50,000 is gone. It was real money, and it's gone. The fact that the purchase money went to the previous owner and mortgage-holder in 2007 does not mean the money is still floating around: a decline in asset valuations destroys money. Any loss booked by the bank is also real money, as the loss comes off the bank's cash reserve.
So if the Fed prints $1 trillion and $2 trillion in losses are booked in the same time period, base money has actually declined. In effect, the Fed is creating money to offset the deflationary effects of deleveraging.
There is another structural dynamic in play known as the Triffin dilemma or paradox. The basic idea is that when one nation's fiat currency is used as the world's reserve currency, the needs of the global trading community are different from the needs of domestic policy makers.
Prior to 1971, the dollar was backed by gold, which acted as a supra-national anchor to the dollar's reserve status. The gold standard inhibited both massive trade deficits and money creation, so it was jettisoned.

The Triffin paradox is a theory that when a national currency also serves as an international reserve currency, there could be conflicts of interest between short-term domestic and long-term international economic objectives. This dilemma was first identified by Belgian-American economist Robert Triffin in the 1960s, who pointed out that the country whose currency foreign nations wish to hold (the global reserve currency) must be willing to supply the world with an extra supply of its currency to fulfill world demand for this 'reserve' currency (foreign exchange reserves) and thus cause a trade deficit. (emphasis added)
 The use of a national currency (i.e. the U.S. dollar) as global reserve currency leads to a tension between national monetary policy and global monetary policy. This is reflected in fundamental imbalances in the balance of payments, specifically the current account: some goals require an overall flow of dollars out of the United States, while others require an overall flow of dollars in to the United States. Net currency inflows and outflows cannot both happen at once.
Here is an informed exploration of the relationship between Gold And Triffin's Dilemma (Zero Hedge).
A lively debate is taking place about how to "fix" the global currency so the U.S. doesn't have to run huge current-account deficits to provide liquidity and reserves for global trade. Some feel a return to the gold standard is the best solution, others favor a "basket of currencies" approach, while the International Monetary Fund (IMF) and other globalists unsurprisingly favor a supra-national new currency called the "bancor" overseen by (you guessed it) a global central bank.
In my view, the euro currency is a regional experiment in the "bancor" model, where a supra-national currency supposedly eliminates Triffin's paradox. It has failed, partly (in my view) because supra-national currencies don't resolve Triffin's dilemma, they simply obfuscate it with sovereign credit imbalances that eventually moot the currency's ability to function as intended.
What happens instead is the currency's central bank–in the case of the E.U., the European Central Bank (ECB)–attempts to square the circle by shifting surpluses from some nations (Germany) to those with structural imbalances via credit (debt). Correcting imbalances is the proper function of currencies, and the attempt to eliminate imbalances with a single currency has failed, for the simple reason you cannot eliminate imbalances between nation-states by brute force.
Now the ECB is attempting to paper over the imbalances with bank-issued credit. But the problem with credit is that it accrues interest, which must be paid in cash by somebody. Issuing credit does not resolve imbalances, it simply transfers the imbalance from the currency ledger to the credit/debt ledger. Eventually the imbalances destabilize the system. That is what Europe is experiencing but refusing to admit.
So where does the global recession leave the U.S. dollar? We know what happens in global recession: global trade declines as sales drop and "trade wars" arise to protect domestic economies from the ravages of global contraction.
The global demand for U.S. trade deficits to create dollar reserves will thus also decline. Domestically focused observers think that the Fed is the only creator of dollars, but in effect the U.S. creates dollars–and must create dollars–when it buys more from other nations (imports) than it exports. To expand their own credit base, trading nations need more reserve currency. This is the heart of Triffin's insight.
Another way of stating this is that the dollar will strengthen, buying more imports with fewer units of currency.

 Those who believe the Fed's expansion of its balance sheet will weaken the dollar are forgetting that from the point of view of the outside world, the Fed's actions are not so much expanding the supply of dollars as offsetting the contraction caused by deleveraging.
Put another way, the global trading community and the domestic economy's interests align in a strengthening dollar. While many observers believe the Status Quo seeks a weaker dollar to boost exports, this overlooks the premium gained by the "exorbitant privileges" of the global reserve currency and petro-dollars. This premium is worth far more than marginal increases in exports.
I have long held that the demand for oil will plummet on the margins as the global economy contracts. As the dollar strengthens, the U.S. will pay less for imported energy and earn more for exported energy. This decline in energy costs will ripple through the real economy, offsetting any decline in exports. A strengthening dollar lowers the cost basis of all goods and services originating in the U.S.
A strengthening dollar also benefits trading nations, as the increasing value of their dollar reserves enlarges the base for their own credit. This is the irony of China's dumping of its dollar reserves: China only amassed such massive dollar reserves because it was running equally massive trade surpluses with the U.S. As the trade surplus shrinks, so too must China's dollar reserves contract.
From the point of view of the currency markets ($2-$3 trillion traded daily) and global trading nations, the Fed's expansion of base money is marginal: after all, the U.S. has some $60 trillion in household assets, a $15 trillion economy, an expanding base of energy production, a dynamic private sector, a dominant military, the petro-dollar and the global reserve currency.
As destructive as the Fed's policies are to the domestic U.S. economy, from this point of view the Fed's actions are stabilizing actions on the margin. The real action is in the global expansion/contraction of dollars from trade and in reserves. It boils down to supply and demand: the demand for dollars as reserves will remain high, while the supply will actually decline as global trade contracts. The dollar will rise in value for this reason alone.
There is also the question of alternatives: what other currency could act as a reserve currency and trade in size without disrupting markets? The renminbi? It's not even convertible/liquid yet, and recall Triffin's primary point: countries like China and Japan that run trade surpluses cannot host reserve currencies, as that requires running large structural trade deficits.
The euro? Good luck with a bet on papering over currency/trade imbalances with credit designed to drain the stronger economies of cash. The Swiss franc? It's now a proxy for the euro and it's simply too small to trade in size. Ditto all the other small currencies. Japan? With its history of trade surpluses and its demographic/fiscal cliff looming?
Not only are there no real-world alternatives to the dollar, its strengthening will benefit everyone holding dollars everywhere in the world. That is a positive development."

Guest Post: Gold And Triffin's Dilemma
Submitted by Tyler Durden on 10/05/2012 19:34 -0400

Central BanksChinaExcess ReservesFederal ReservefixedForeign Central BanksGlobal EconomyGuest PostHyperinflationInternational Monetary FundMonetary BaseNational DebtReserve CurrencySovereignsTrade Deficit

Submitted by Joe Yasinksi and Dan Flynn of GBI,

Have you seen Robert Triffin?

"It was the outcome of an unbelievable collective mistake, which, when people become aware of it, will be viewed by history as an object of astonishment and scandal"
-Jaques Reuff 1972

The obscure Belgian economist Robert Triffin is not only very dead he also isn't exactly a household name, yet. Triffin, who died in 1993 studied at Harvard, taught at Yale, worked at the Federal Reserve, the IMF, and was a key contributor to the formation of the European monetary system. Triffin exposed serious flaws in the Bretton Woods monetary system and perfectly predicted it's inevitable demise yet his work remains largely ignored and unstudied by today's mainstream economists. This "flaw" became known as the Triffin dilemma, and many believe Triffin's dilemma has as serious implications today as it did 50 years ago. In short, Triffin proposed that when one nations currency also becomes the worlds reserve asset, eventually domestic and international monetary objectives diverge. Have you ever wondered how it's possible that the USA has run a trade deficit for 37 consecutive years? Have you ever considered the consequences on the value of your Dollar denominated assets if it eventually becomes an unacceptable form of payment to our trading partners? Thankfully for those of us trying to navigate the current financial morass, Robert Triffin did.

Prior to the 1944 Bretton Woods agreement, central banks used gold as the asset to back their currencies. By the end of World War II, the United States had established itself as the world's creditor and largest holders of gold. Under the 1944 Bretton Woods agreement, the US Dollar was fully backed by gold at a fixed value of 1/35th an ounce per dollar, and foreign Central Banks could use US Dollar assets as reserves backing their currency, in lieu of gold. This agreement avoided the inevitable deflationary pressure a return to pre-war gold/currency ratios would have forced just as Europe was beginning to rebuild, and allowed US debt held abroad to be used as an asset by central banks against their local currencies.

In the 1960's Triffin observed that there existed an excess of dollars offshore relative to the gold available to tender at the set $35 price. He hypothesized that given foreign central bank demand for dollars as reserves, the trend of a growing and continuing glut of dollars was going to continue unabated. It would continue until the excess reserves would so clearly be many multiples of the gold available to satisfy them that enough countries would start tendering dollars for gold and eventually the entire scheme would collapse. Triffin went as far as congress in 1960 to testify that the system as currently devised could not possibly maintain both liquidity and a stable value in the dollar and eventually, the agreement would prove unsustainable. As Triffin predicted, on August 15, 1971 the United States closed the gold window as Richard Nixon came on national television and defaulted on US gold obligations while national gold reserves drained from over 20,000 tons to 8,133 tons. Up until Nixons actions, foreign sovereigns tendered their dollars for gold at an increasing pace. On that day, nations that were holding US dollars because they were "as good as gold" were left with paper promises and nothing more.

At that time, the world was at a crossroads. Would foreign governments and trade partners continue to accept fully fiat US Dollars? The alternative was a deflationary return to a hard (pre-Bretton Woods) gold standard. It can be argued that structural support was granted to the dollar given the fact that with cheap oil, the US economy was expanding at a pace far more rapid than the growth in US government debt. They rationalized that US dollar was still a claim on future growth and production and the rest of the world was lifting it's standard of living as well. Going backwards to the last failed monetary regime was politically unappealing.

And so the US dollar hegemony continues to this day. The dollar is fully entrenched as the settlement currency for international trade. As of today if any nation wants to buy oil, the lifeblood of the global economy, they pay in dollars. This alone, along with demand for foreign reserves create an unnatural demand for US assets, specifically treasury debt. Robert Triffin opined that the collapse of Bretton woods did not solve his dilemma because the country that supplies the world with it's reserve asset in the form of their currency and debt will still be forced to supply an excess of this reserve to satisfy world demand and thus, run a trade deficit in perpetuity. Such a dynamic can not exist under the natural laws of economics, it can only survive only with active and unanimous political support and intervention.

The issue facing the modern United States is that since the rest of the world uses the US dollar as a reserve behind their own currencies, that demand has allowed the United States to run a deficit in perpetuity and the mechanics of this trade has allowed the US to export price inflation abroad. Quite simply, the US imports real goods in excess of the real goods it exports. The deficit balance minus service exports is made up with printed US dollars. Our trade partners ship/recycle the same dollars back to the United States in exchange for US Treasury Debt. The US Treasuries are held as reserves on the balance sheet of their central bank, and local currency printed against those new reserves. This process, although inflationary for our trade partner, allows them to keep their currency weak vs the US Dollar and prices cheap for US consumers.

Every nation on earth other than the United States has a limit to their potential trade deficit confined by their existing reserves plus their borrowing capacity. Not only does the US have the capacity to run a perpetual and growing trade deficit but the rest of the world actually demands us to run a balance of payment deficit or else their reserves will have to shrink, along with their credit, currency and economy. Good deal for us, no? This situation means that for 40 years our trade partners have not only tolerated, but dysfunctionally enabled our perpetual deficits. The United States has had the "exorbitant privilege" of being the issuer of the worlds' reserve currency. We've all enjoyed the benefits, now comes the pain.

Sure enough as Triffin foretold the US trade surplus began shrinking immediately after the collapse of Bretton Woods and transitioned to a permanent trade deficit by 1975, never to return to a surplus to date, 37 years later. The previously stable national debt (with a permanent ceiling of $400 billion dollars) has ballooned to over $16 trillion dollars, a multiple of 40 times what it was during the previous monetary regime. Given this 4-decade perpetual trade deficit with the rest of the world and "hyperinflation" of US dollar credits and claims, many have wondered how the US has avoided massive price inflation at home.

Triffin's dilemma continues to play an important role in the ongoing financial crisis the world has found itself in since 2008. The governor of the Peoples Bank of China specifically referenced Triffin's Dilemma as the root cause of the current financial disorder and suggested an immediate effort to transition away from the US dollar to avoid more catastrophic consequences.

The US Council on Foreign Relations aptly describes why Triffin's dilemma becomes unsustainable:

"To supply the world's risk-free asset, the center country must run a current account deficit and in doing so become ever more indebted to foreigners, until the risk-free asset that it issues ceases to be risk free. Precisely because the world is happy to have a dependable asset to hold as a store of value, it will buy so much of that asset that its issuer will become unsustainably burdened."

Have we reached the day when the United States has become unsustainably burdened? Can US debt honestly be considered to still be risk free? S&P certainly doesn't think so, neither does our second largest creditor, China (after our own Federal Reserve) who has been a net seller of US government debt for some time now. And where will the world go to find another dependable asset to hold as a store of value?

Triffin's endgame is simple. A rapid diversification of reserves out of the dollar by foreign central banks. This diversification out of the dollar is only possible given a viable alternative. More and more nations are agreeing to unilateral trade agreements settled in their individual currencies. With each new agreement, global demand for the dollar wanes. It is no coincidence that QE1 coincided with China and the rest of the world backing off demand for US treasury debt. The amounts of QE2 and QE3 match perfectly (or close enough for government work) with US trade deficits from 2009 to today. Given the US Government's seemingly permanent addiction to "free" foreign goods, the trade deficit appears to be irreversible. The extreme danger for those of us in the United States, holding assets denominated in US dollars, is that the Fed is actively creating base money to feed the addiction. As the monetary base grows, the value of existing US dollar denominated assets and credit is devalued. One way to protect against this debasement of your savings is to do as the central banks do – acquire and hold physical gold bullion.

The blueprint for this alternative has been in plain sight since the late 1990's, and if you watch what central banks do – not what they say – you can benefit.

For the first time in FOUR DECADES, global central banks have become net buyers of gold. This central bank demand has been driven by countries that previously had an insatiable appetite for US treasury debt – most notably China. After 40 years, the political and structural support for US dollar holdings abroad is slipping away. Foreign central banks know that the only way to protect their reserves (and defend the value of their home currency), is by holding gold. Their preparations are well under way.

Just as central banks are increasing their gold purchases, private citizens also are exercising their right to diversify their own private reserves. But given the still infinitesimal rates of gold ownership (1% tops most estimates) there is a long way to go. Why shouldn't the average person do what the big boys are doing? Diversifying out of the dollar, out of paper currencies and making sure their assets aren't someone else's liability seem prudent for everyone in times like there. Here at GBI, we see ourselves as a way for every investor to have the choice on how to save their stored labor. We want to make it as easy to buy and sell gold as it is to move money from your savings account to your checking account. We can all walk in the footsteps of the giants, as a Friend and mentor is apt to say.

As a bonus, if gold was to become the worlds foremost reserve asset, would that not finally solve good old Triffins dilemma? Wouldn't gold serving as the preferred global saving vehicle and fiat continuing to serve as the worlds spending vehicle finally break the natural tension Triffin has so aptly illuminated for us? Perhaps, but given golds stable supply and other unique features (see our next essay titled "Forget Supply and Demand, it's all Stock to Flow."), it would by necessity be at a much higher price to function in that reserve role. Some estimates put that potential price into the many tens of thousands of dollars, and given a monetary and fiscal path that seems to be following Triffin's fateful trajectory, how could any price be ruled out?

Thank you for posting that Bob.
Triffin’s dilemma is something that I have studied before and it seems both intellectually sound and verified by events. Unfortunately it conflicts badly with the desire to keep printing money to spend on things at a faster pace than actual economic growth and so it has not garnered much serious attention at the higher official levels.

Sometimes it helps to return to the basics. Here they are:

  1. Money is nothing more than a marker, something to use at a future time to obtain something real that has actual immediate human utility.
  2. Money then is a claim on future economic output.
  3. Debt is a claim on money, so it is merely a derivative of money.
  4. If total economic output is growing faster than money + debt then your claims (money) and its derivative (debt) are becoming more valuable over time.
  5. If total economic growth is less than the rate of growth in money + debt, then both money and its derivative are becoming worth less over time.
It’s really that simple. If the economy is growing at 4% but debt and money are growing at 5% then both money and debt are becoming worth less over time.

That’s simple inflation in a nutshell. More claims being manufactured in a given period of time than goods and services. More money than GDP.

Many complications muddy the clean lines of this story including time itself as money is a free variable as it can be redeemed at any point in the future including one second from now, while debt has a fixed component that stretches out in a defined way into the future, with the muddying feature that it too can be renegotiated or restructured giving it a slight bit of flexibility.

But that’s the essential story right there. Money and debt are simply claims on future resources and human activity and the entire edifice of modern debt and money owes a good bit of its value to the expectation that future economic growth will persistently outpace the rate of interest on the outstanding debt plus the rate of new debt creation plus the rate of base money growth.

The critical question is what happens when (not if but when) the realities of living on a finite planet catch up with this rather poorly thought out system of money and political incentives?

Perhaps the whole thing winds itself down like a really old-school debt jubilee with fewer and new loans being made until the economic realities and monetary additions finally match again. This scenario looks like a very long process of incremental austerity with associated micro-bursts of failing debt popping here and there as necessary.

A different outcome involves the complete denial that anything’s out of whack and a complete, head-long, high-speed run into a brick wall with pieces and wreckage scattered everywhere. After that we get to start anew with hopefully some of our skills and technology intact and a collective memory of ‘what went wrong’ that can last two or three generations.

A third alternative, is to change via insight rather than pain, and on our terms, beginning right now, we fashion a new narrative that comports with all the known data.

We know that fossil fuels cannot last forever.

We know that all non-renewable resources run out at some point, either for economic reasons or because they are simply all gone.

We know that nutrient cycles on farm land are open loops that have to be closed.

We know that eventually human population has to level off at some sustainable number. We know that starved or deprived people or nations are desperate things and that we’d like to avoid intentionally creating either whenever possible.

We know that we already have the ability and technology to use substantially less energy and resources while spending less and requiring almost no changes to our habits or comforts.

We know all of these things and many more besides, and yet something prevents us from collectively acting on them.

As ever, I am keenly focused on how we change on our own terms, while time and resources remain, and avoid changing on other more painful terms later on. I still think this rests with ‘getting the story right’ and this means figuring out how to change our cultural narrative.

No simple task. My mind is continually drawn back to the book Ishmael, which rather brilliantly lays out the idea of our cultural narrative, what it is and how it is that mother culture whispers to us all so comprehensively and yet seductively that we cannot even hear her.

Each of us here is involved in this task and it involves so much more than finding the right words. It involves changing our own habits, showing the way with actions, and leading by example. It is in how we hold our thoughts and intentions in alignment with the world. It is in what we say and in what we don’t say.

There is no manual, no guidebook, no example from history that we can turn to and say, ‘oh, so that’s how it’s done.’ Each period of time is unique and requires something like a surfer’s attention to the wave being ridden even as past waves provide the grounding for the precise symphony of subtle balancing moves and anticipation required to remain joyously upright.

Given what we know (see above) and given what mother culture asks us to do is out of alignment with what we know, our salvation individually lies with bringing our actions into alignment with what we know to be true.  The gap between what we know and what we do is filled with anxiety, it is the place where fear dwells and grows.

So we protect our money and grow food and insualte our homes and test out conversations with loved ones and strangers to see where we might help orient a few more souls to the idea that we're collectively pointed and stumbling towards a future that we might rationally seek to avoid.

…I love it!!! My Dear Mother always told us to "LET OUR CONSCIOUS BE OUR GUIDE " and if you don't mind I will keep that sage advice until I die. You really don't know what happens in the after life but I know this, in the here and now I can live with myself.
This world is absolutely messed up. It has always been rumor that the Big Boys will get there's, come hook or come crook. On the street we just wanted the crumbs. Now, the crooks want it all and some of these crooks will save their arrrssses by showing conscious and deliver the goods. Here is what is now to be one serious problem in my estimation, and seeing as the "Conspiracy" theme has hit the market place recently (Jack Welsh) lets see if we can get Oil down rather substantially before the election too. Crazy world and I would just let it go, prop nothing up and start all over. Use the original version of the United States Constitution and start removing these scum bags from society. I sent Chris (some time ago) an interview with Chris Cook that seemed to have merit. I never heard back and assumed the interview was not something Chris wanted to discuss so I kept it alive in my back ground stuff. Well, here it is folks!!!, and the interview with Max Kaiser.


Goooo Tigers

BASEBALL!!!, the only HONEST GAME in town.


Hi Arthur: I agree that the willingness of the population to accept and work for financial-marker slips (credit, cash, future promissory notes, claim-checks on future services) is time limited. Until then, however, governments will issue all sorts of scrip and barring a rupture or discontinuity in this system I think it has an excellent chance to continue. By continue, I mean that many real assets will continue to hold their value while all the various paper currencies continue to decline in value. The question is: when does a sufficiently critical mass of OECD paper currency users decide they are willing to opt out of the system? Or more to the point, when does a commercial extractor of natural resources (Copper Miners, Oil and Gas Companies) decide they are losing too much purchasing power by holding their own reserves in cash? It's an open ended question. And given that I have pitted Credit vs Resources, I would suggest we concentrate on the real-world juncture between all forms of goverment money (or scrip) and the willingness of resource providers to accept that scrip. It is a testment to how strong the OECD remains, however, given how much trouble it has had to contend with. The US-EU-Japan zone may not be sustainable, but, its combination of instituions, history, laws, banking, and currency system(s) looks more robust than we might have guessed just 5 years ago. Ultimately, we will want to look for the ways resource scarcity can trigger cultural disturbances. This is all exceptionally difficult to model.That said, I believe the last five years have given us a very good test of these systems, as the world loses access to cheap oil–with all the painful changes that result from that loss. First, life quality in industrial terms has gone into steep decline. (Decline of financial wealth) However, life quaility in simplicty terms may actually be stabilizing or increasing (Decline of complexity). Fertility rates are in decline. However, global growth in energy consumption terms continues to advance. Many assets are in secular decline–like housing. Other assets like commodities, farmland, and precious metals either continue to advance or have held the price changes from the last decade.
Yes, your model is bascially true. Each hit of sugar tastes less sweet. Therefore, each hit of sugar is less persuasive. Let's consider however that in Japan, for example, after 20 years of sugar tablet distribution, collapse in confidence has still not unfolded. Might we see a confidence collapse somewhere in the OECD? Probably. But my guess is that it happens on a smaller scale.
Coda: Just wanted to note, relatedly, that exports of US coal to Europe continue to soar. I'm not going to make a grand case with this one data point–but–I have pointed out that a world getting poorer is a world that will turn to coal. This gets into my current theme which is that long Decline, rather than Collapse, is worth worrying about also, as it will "feel" like collapse to many indviduals.

Chris, I love you (as I would a Brother), no question about that. This review is awesome and well understood. It is difficult though when plugging in numbers and researching everything under the sun that out the other end is useless toilet paper. Then again, toilet paper has value of which I personally favor a great deal.It is the massaging of numbers, and the manipulations of true math that feeds my printer with garbage, and thus garbage is the results. If I have the truth then honestly I would have my "Plan". However, lacking the Truth I could loose it all in the blink of an eye (HFT). It is therefore prudent that I preserve my capital, PM's, cash, and prepare for a future that I have some control over. If I could store food for my lifetime, and energy in sufficient quantities then that is where I would spend all my energies. I have done what I can, and I am compelled to watch very closely as it is just to much fun.
PP is a community that I believe in, it gives me more than anywhere else. Your character is the only reason I stay, you walk it Chris.
I have noticed another Titan has arrived in Gregor, now, if Charles would just show up, and the three of you decided to go all crazy Professors on us, well, that would be a delight. Maybe 'ET' would show up. Got popcorn/root beer.
Gooo Tigers

OK, Gregor, I get all that you are saying. Certainly Chris has given you a "spot on' one thumbs up. Where I get confused, truly and humbly is when Chris states that he see's Japan as his "Black Swan Event" as perhaps delade but coming by 2013. Then you suggest that this sugar high has some resilence, and risk is 'off the table', a collapse is not likely or some such conclusion. Honestly, this is what I am referencing when I say lets just flip a coin.
Based on this I could then look at Charles and state that in the last five years everything he has written is spot on too, and that this would be proved up if Chris is right about a Japan Black Swan Event! Capeesh! I am assuming of course that if Japan blows up then holly cow I would think it would have a ripple effect at least.

I don't still know what is your collapse model as I don't even think 2008 was a collapse. How could it have been when here we are, which I believe is your point, and understood. 

Now, if a Black Swan event occurs or is a strong possibility or is a possibility at all then is a risk of collapse off the table? We have Mark Grant who believes Europe is in for some serious troubles, that our 3rd quarter and 4Th are not going to be pretty. I value all you folks but honestly, lets stop tap dancing. Perhaps Chris or anyone would answer this for me with the same care as Gregor wrote his opinion. It would be very beneficial to making sense of this all.

What I would like to know is if Japan and Europe blow, have a Black Swan Event if these would mean a collapse of our complex system? Please, don't tell me it's hard to model when Lehman took us to S&P 666 and as we know this wasn't a collapse. The markets are near all time highs for gosh sakes three years later, and I know how that happened. Out of thin air.

Respectfully Given 

Gooo Tigers