Interview: Professor Fekete on QE and gold

There is a big difference between the gold price and the gold basis

Professor Antal E. Fekete talks about the negative impact of QE on debtors, workers and entrepreneurs

Interview: Professor Fekete on QE and gold

Interview: Professor Fekete on QE and gold

Professor Antal E. Fekete is a professor of mathematics and statistics at Memorial University. He talks exclusively with Chris Menon about gold and the negative impact of Quantitative Easing (money printing).

Chris Menon: Do you think the price of gold is likely to rise significantly against the US dollar over the next 2-3 years?

Professor Fekete: If you want my honest opinion, the price of gold is the most uninteresting economic indicator there is. It can be manipulated, it can depend on many different events – economic and non-economic – it can be influenced directly and indirectly.

A better indicator would be the gold basis, and we are taking pride in our efforts to make that notion more widely known…there is a big difference between the gold price and the gold basis. [The gold basis is defined as the difference between the nearest active future’s gold price and the cash price of gold]

As far as the gold price is concerned, I am willing to ignore it. Nothing can change the fact that gold is an ultimate extinguisher of debt. You can praise the dollar to heaven, you can praise the euro to heaven or the pound to heaven, dance around it and have all kinds of celebrations saying that we have arrived at the new Millennium when the governments can print as much as they like, and there is QE and zero interest rate policy. It will not change the fact that none of these are ‘ultimate extinguishers of debt’. Whether you like it or not, only gold – and in the second place silver – could discharge that function.

Gold has virtually constant marginal utility, using the terminology of Carl Mengler. Whereas, all other assets whether commodities or paper assets, it makes no difference, are subject to the law of declining marginal utility. So if you rank everything in existence, according to their rate of decline of marginal utility, on top it is always gold — which has, if not constant, at least the lowest rate of decline as far as its marginal utility is concerned.

And nothing, no government or combination of governments, no IMF, no banks can change that fact. That is why the price of gold is just throwing dust in your eyes, diverting your attention from the main point. Can it discharge debt and, if so, to what extent?

Chris Menon: I wondered if there is a point beyond which the money printing can’t go on? Where will it stop? Where do you see the extinguishing of debt? How do you see it ending?

Professor Fekete: Fiat money has a 100% mortality rate. Now, that in itself doesn’t prove that somebody cannot come up with fiat money, or with bit coin, or whatever, which perhaps will survive. But the chances are infinitely small. And central banks and governments can keep trying to invent something. So far they couldn’t succeed and they are at a very low level right now as far as their credit rating is concerned.

If they couldn’t do it when their credit rating was high – and the US had a very high credit rating only 35-40 years ago – how do you think they can do it now when their credit is a shambles, an absolute shambles?

Another way of putting it is that all ‘marketable’ goods will go into hiding, starting with gold, that is very, very clear. The gold that China buys is not coming back in some other form, it is going to stay there. Sliver is the same. Name something that is highly ‘marketable’ and you will see.

Therefore, the danger is that the world economy is going back to barter. This doesn’t mean that gold and silver will no longer be available. They will no longer be available against fiat money. But for barter, sure people will continue bartering gold for silver and vice versa, or gold for any marketable good, but fiat is going to be fading out.

Chris Menon: What do you think has been the most significant problem caused by money printing around the world?

Professor Fekete: It is not hyperinflation. It’s deflation.

There are three main problems. Firstly, it is the ‘increase in the liquidation value of debt’. Everybody accepts that if the interest rate goes down the price of the bond goes up. That is not controversial and everyone accepts that. But that is just one side of the coin, looking at the question from the point of view of the creditor.

If you look at the same problem from the point of view of the debtor, people don’t seem to understand.

Now you are the debtor, you issued the bond. So if the price of the bond goes up it means that for you to liquidate that particular debt represented by the bond (to pay it off) will be higher. This is why I say the liquidation value of debt is going up as well.

So if you want to get out of debt it will be harder for you. The burden of the debt has increased.

I would say, 90% of people have difficulty understanding that.

You have to look at the problem not as a creditor. Of course, if you are a creditor and the price of the bond goes up you are happy. But if you are a debtor and the liquidation value of the debt goes up that is not good for you. You are squeezed.

You might have to pay more than the debt you have taken to get out of the debt now.

Secondly, there is labour’s deteriorating terms of trade. Now, labour has a cash flow; the wages, whether weekly or monthly it doesn’t matter.  And you might say that the wealth of labour is its ability to do work. That is why the employer pays him, because he works and his work generates profit.

If interest rates come down it means that to generate the same value over time by exerting labour, will create value more slowly. The cash flow will be less efficient, whether it is the coupons of the bond or labour working.

Another way of putting it, is suppose labour is in debt and paying a mortgage. What happens when the interest rate is cut?

His cash flow will create wealth more slowly, so if he wants to use his cash flow to repay the debt that amortizes more slowly. So either he has to postpone the maturity or, if that is not an option, then he will have to make higher payments. So his income, which is the wages he earns, becomes less efficient: it loses its value.

The way I phrase it is: ‘Labour’s terms of trade is undermined’, is deteriorating. That applies indiscriminately to all wage earners.

It especially applies to the marginal wage earner, because the marginal wage earner is the first one who will be fired by the employer.

If the interest rate is low there is a temptation from the employer to fire the marginal worker, and borrow at the low rate and put equipment in. Rather than live labour he just buys a computerised system.

What does this mean for the terms of trade of those who need a cash flow for survival, such as all pensioners and all wage earners?

Well, the price they have to pay for the cash flow is just its present value. Any cut in the rate of interest by the central bank affects them adversely;  their terms of trade deteriorates. For example, if the rate of interest is cut in half, then they have to pay twice as much for the same cash flow as before the cut. In practical terms this means that wage earners have to work roughly twice as hard to continue earning wages at the same level.

As far as pensioners are concerned, their pension fund is devastated. It can no longer support the cash flow they have enjoyed before the cut. Clearly, there is going to be a most serious deterioration in the standard of living for a large segment of society as a result of open market purchases of government bonds. This reveals the most cruel aspect of open market operations: it hits the weakest members of society hardest.

Thirdly you have the ‘fading of depreciation quotas’ which leads to destruction of capital.

Each piece of equipment or factor of production (such as a building, a tool, land in which you can plant crops) are all used up in production. ‘Depreciation quota’ is the amount of money an entrepreneur puts aside as he prepares to replace the factor of production.

He has to have enough money to replace the equipment, so the ‘depreciation quota’ is again a cash flow, which accumulates so that the worn capital good (whatever it is), can be replaced.

So what effect will a cut in interest rates have on the process of renewing capital? Well, the depreciation quota is a cash flow. Because of the lower rate of interest, the rate of replacing the original value is slower, at the lower rate. So the cash flow is creating value more slowly.

As a result the capital is being eroded, or destroyed, because at the end of the period when the asset is used up the money that has been put aside is not going to cover the replacement cost of the new equipment. Why? Because the money keeps accumulating at a lower rate, the lower rate of interest.

So, in other words, this is capital destruction, unless you accumulate new capital. But then it has to come from the shareholders or you have to borrow money.

In other words, if you ignore the fact that depreciation quotas no longer represent the wear and tear in capital, then there is a problem.

So these three examples show that cutting interest rates is not a benefit. Most people believe, and governments, banks, universities all tell them: “It’s wonderful, now you can borrow money at a lower rate of interest, it’s helping business.”

I am the banker, telling my client: “Come on, refinance your debt at a lower rate, it’s good for you!”

But it’s not good for you it is bad for you. The bank is lying to you. The bank is in trouble because it is sitting on losses.

When the interest rate is cut, what affect does it have on the loan portfolio of the bank? Well, the liquidation value of the loan portfolio is increased, so the bank is sitting on losses.

Chris Menon: Why is it sitting on losses if the value of the loans it has put out have increased?

Professor Fekete: Because the bank itself is the debtor. Whether you issue bonds or you make loans is economically the same thing. When you sell a bond or you extend a loan there is no economic difference at a fixed rate. As the interest rate is pushed down then the same cash flow will no longer amortize the debt. You have to either push maturity further out into the future or increase the cash flow.

In either case, you as the debtor are suffering, that’s the answer. It’s not easy to understand.

If you try to convince people they say it is nonsense. They say: “It is good for you now the interest rate is lower.” That may be true for future borrowing, but your past debt at a fixed rate is going to be a greater burden for you to carry.

A majority of people make the mistake that they believe Quantitative Easing is really easing, I call it ‘Quantitative Squeezing’; squeezing the debtor, squeezing the labourer and squeezing the entrepreneur.

The Big Difference Between the Gold Price and the Gold Basis & Equity Release

What Is Equity Release?

Equity release is the use of financial arrangements that provide the owner of a house, or other property, with funds derived from the value of the property while enabling them to continue using it.

How Does Equity Release Work?

Equity release is aimed at homeowners aged 55 and over. It allows you to take some of the value of your home as cash.

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