ValueWalk is pleased to present our interview with John Butler, the author of a new book titled, The Golden Revolution. John Butler has 18 years’ experience in the global financial industry, having worked for European and US investment banks in London, New York and Germany. John was kind enough to sit down and talk about his book, which focuses on the gold standard and Austrian economics. His full bio can be found at the bottom of this article.
Can you tell us a little bit about your background?
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I worked as an interest rate, currency and commodity strategist for some 15 years prior to founding my own independent investment and advisory firm. At Deutsche Bank, Lehman Brothers and Dresdner Bank I managed teams of analysts responsible for producing regular research, as well as producing my own. As the years went by, I began to focus my efforts more on what I would call ‘alternative’ research, that is, focusing on crises, on abnormal or unusual financial developments in history and the lessons they provide for us today. This sort of work enabled me to predict, for example, why the US housing market bubble would pop and how it would take the financial system down with it. I continue to apply this sort of analysis in my investing and advisory business today. It also informs my new book and my regular investment newsletter, The Amphora Report.
Why do you think the return to the gold standard is a good idea, didn’t we have depressions, including the great depression while pegging gold to the dollar?
I think it is a good idea for a number of reasons, the most important of which is that a gold standard restrains money and credit growth. While that is seen as inconvenient following a crisis, a gold standard generally prevents large crises from arising in the first place, absent major wars or revolutions.
The Great Depression is widely misunderstood in this regard. It is best understood as a long-term consequence of the economically devastating (and highly inflationary) WWI combined with counterproductive activism in economic policy. US economic policy was highly laissez faire in the early 1920s but by 1927 that had changed. The Federal Reserve, for example, eased monetary policy notwithstanding a booming economy. Why? Well the US was trying to do the UK a favor. The UK was stuck in a deep recession and asked the US to stimulate domestic demand to help UK exports. The US obliged. What was already the Roaring 20s entered a crescendo and finally came crashing down in 1929-31. More interventions followed. President Hoover prided himself of being an interventionist president, bragging, for example, in 1931, that thanks to his policies, US workers had the highest wages in the world. Now think about that for a moment: Your economy is falling apart and unemployment is soaring. Then the president comes out and says, in effect, “our labor costs are the highest in the world”. You would have thought he was pointing out the problem—which he was, inadvertently—rather than claiming credit for something.
As for today, when you get to the point where that trust and confidence in economic and monetary policy has eroded to the point where healthy, sustainable economic growth has become all but impossible, you need to start over. Gold provides a kind of ‘reset’ mechanism for the world, as it prevents economic policy makers from doing additional damage.
You talk a lot about bretton woods, if we went back to 1971, what would you do?
In August 1971 President Nixon called a crisis meeting at Camp David to decide what actions should be taken to arrest a rapidly accelerating drain on the US gold reserve. Most of his advisers supported the view that the US should simply suspend gold convertibility indefinitely and allow the dollar to float versus other currencies, implying a substantial devaluation. This was resisted by, among others, Fed
Chairman Arthur Burns, who pleaded with the president not to ‘close the gold window’ but rather to shore up US government finances and raise interest rates, thereby rebuilding confidence in the dollar and in the US economy generally. If it had been up to me at the time, I would have done as Burns had suggested. Indeed, following nearly a decade of economic stagnation and ‘stagflation’, Burns’ suggestions were more or less implemented by Paul Volcker in 1979-82, although the US stopped short of re-instituting the gold standard.
You talk about the ‘option’ of central banking under a future gold standard, can you elaborate?
We take central banking for granted. But central banking is a comparatively modern invention when compared to banking generally. Gold and silver coinage has been the norm, not the exception throughout history. So it should be obvious that, with gold and silver coinage, or on a gold standard backed by gold and silver, central banking is optional rather than required. If on a fiat currency standard, with legal tender laws mandating its use, then it becomes necessary that there is a single, central authority controlling the money supply, which implies some control of interest rates and control over the banking system generally.
What in your opinion was the main cause of the economic crisis?
The proximate cause was a seizing up of interbank lending. But why were banks suddenly unwilling to lend to each other? Because they were too exposed to securitized mortgages and other forms of collateral that were suddenly going bad, eroding trust in their creditworthiness. What was the reason for this excessive risk taking? In my book I argue that it was a combination of artificially low interest rates and excessive money and credit growth on the one hand, and various forms of subsidies for risky lending activities on the other. In addition, there was a widely perceived implied bail-out of large firms that got into trouble. As we know, Lehman is the exception that proves the rule.
Is letting all firms fail the solution to future crises? Didn’t some firms in 2003-2007 take on risks and cause their own downfall, which caused a huge economic crisis?
Allowing financial firms to fail, in particular the largest ones, is the single most effective way to prevent excessive risk taking. Under a gold standard system, ‘too big to fail’ becomes instead ‘too big to bail’. If the biggest firms facilitating the flow of credit know that they can fail, they will be very careful in how they extend credit. Risk will be taken more by marginal players rather than those at the center of the system. When you think about it, this is how most industries operate.
It is widely acknowledged that smart people run major financial firms. If so, they are more than able to take care of themselves and manage risks appropriately, even if they make occasional mistakes. But if they sense that there is an implied bail out—and recent history gives them every reason to believe that this is the case—they will continue to take excessive risks. The largest financial firms are even larger now than they were in 2008. And yet the global economy has grown only by a little in the meantime. That is clearly unsustainable. Another crisis lurks in the near future.
Why is a return to the gold standard inevitable? Why? And what date do you expect this by?
This is arguably the most controversial claim in my book. Many advocate a gold standard. Few argue that a return to one is simply inevitable at this point. But it is. The reason has to do with the US’s loss of hegemonic economic and monetary power during the past few decades. When you look at history, you see just how extraordinary the Bretton Woods system was. It clearly favored the US at the expense of other countries. The only explanation for that is the US’s hegemonic position following WWII and the subsequent couple of decades. But already when Nixon closed the gold window, the US was losing hegemonic status. In 1944, the US comprised some 50% of the entire global economy. By 1971 that share had slipped to around 30%. Today, the US is slipping below 20%. Economic power has become increasingly multipolar. Look at the EU. Look at the rise of the BRICs. Look at the lingering importance of OPEC.
Now combine this growing multipolarity with US monetary policy that may suit US interests but not necessarily those of the world at large. Because the dollar remains the pre-eminent reserve currency, US monetary policy has a hugely disproportionate influence on the global economy. One by one, however, countries are taking action to reduce their use of dollar reserves and the implied dependence on US monetary policy. A Nash-equilibrium, game-theory analysis demonstrates just how unstable global monetary arrangements have become. Some of these countries are small, some large. But even if only the small ones begin to use the dollar less, others are required to use the dollar even more or the dollar will decline in importance. But they are not doing so. Even large countries are increasingly using each other’s currencies in trade and as reserves.
There is, however, no currency that can replace the dollar as a global reserve. These bilateral arrangements thus lead away from the dollar but not toward another fiat currency replacing it as the preferred global reserve. It is thus no coincidence that central banks around the world are accumulating gold at the fastest pace in many decades: Absent a reliable fiat currency reserve, gold provides the historically tried and tested alternative. It is only a matter of time before this move back toward gold, already underway, becomes officially acknowledged by a country, or group of countries, choosing to peg explicitly to gold. I think this could happen as early as 2013.
Do you really think a President Obama or Romney would go back to the gold standard?
Probably not. Neither of them appears to appreciate just how precarious the dollar’s reserve position has become. But then I think it unlikely that the US leads the way back to gold. More likely is that a country or group of countries with large accumulated dollar reserves, but also some gold reserves, and a trade surplus implying economic competitiveness, chooses to move back to gold as a way of protecting itself from escalating global monetary instability.
You talk a lot about the BRICs in your book, what role would they play in the future?
The BRICs may play the key role in moving the world back toward gold-backed currencies. They have large reserves of dollars and gold and they are collectively large net exporters. Their monetary interests are increasingly aligned and they are working closely with other countries to explore alternative global monetary arrangements, including the creation of their own ‘IMF’ or ‘World Bank’. The BRICs also
oppose certain US foreign policies, such as those regarding both Syria and Iran. That could also provide an impetus to reduce their dollar dependency.
I am sure you are familiar with Ron Paul; do you like his economic ideas? Is there anyone in the UK with similar views and the same stature?
Ron Paul supports a return to the gold standard. He was co-author of the Minority Report of Reagan’s Gold Commission (1982), which was tasked with studying whether or not the US should, and if so, how it could place itself back onto the gold standard. As mentioned above, I don’t think that the US should have left the gold standard in the first place, even if the specifics of the Bretton Woods arrangements were themselves flawed in certain respects. As for his other economic ideas, I think these generally have some merit. Most important, however, is simply that Ron Paul seems to understand just how unsustainable US economic and monetary policies have become. Few other politicians seem aware of the danger. And for those that do talk such talk, few if any seem as credible as Ron Paul, who has been highly consistent in his criticisms of US policies for years.
There are a handful of ‘sound money’ or pro-gold politicians here in the UK, including Conservative MP Steven Baker and Lord Rees-Mogg, although none with anywhere near the stature that Ron Paul now has in the US. That could change in time, although the UK lacks the political traditions of mistrust of government, self-reliance and a libertarian-leaning frontier that are all central to what makes US political culture what it is today.
You are bullish on gold? And discuss ways of actually valuing the asset can you explain?
I’m bullish gold ((SPDR Gold Trust (NYSE:GLD)) primarily because I’m bearish unbacked fiat currencies. It is not as if gold is some magical substance that creates wealth. No, it merely protects it because it cannot be printed and diluted by government or central bank diktat, as it the case today with paper currencies.
Warren Buffet recently criticized gold as an unproductive investment. But gold is not an investment. His entire criticism was a huge straw man. Of course companies are productive. That is what they do, they produce. Gold produces nothing. It merely protects. It is like an insurance policy. How ironic that Buffet’s empire is centered around an insurance company, yet he doesn’t seem to understand this basic point.
Like any other economic good, insurance has a cost, or a price. You don’t buy it as an investment. But you buy it anyway when something is uncertain or if trust is an issue. Why buy fire insurance if your house is fire-proof? But if you don’t trust the fire proofing to be 100% effective, you probably want to buy some insurance.
As trust in general declines and/or uncertainty in general rises, you spend proportionately more on insurance, leaving less for everything else. The price of insurance rises in relative terms. This is what is happening today with gold. It is really that simple.
So how far is this process going to go? At what point will investors have sufficient ‘insurance’ against currency devaluation or sovereign debt default? One way to estimate this is to look at history and see roughly what portion of the money supply was backed by gold while under a gold standard.
The US, for example, maintained around a 40% backing of narrow money. If that were the case today, the gold price would be around $5,000. However, as we know, the modern financial system is comprised largely of bank deposits, money market funds and other forms of ‘broad money’, with physical cash being used less and less all the time. So to focus exclusively on narrow money is probably not realistic today. If the US were to back broad money (M2) 40% by gold today, that would imply a gold price of around $13,000. That may seem just outrageous to some, that the gold price could soar to over $10,000. But what is outrageous really is that money and credit growth have been growing exponentially for years now, with the economic and policy mainstream not remotely concerned until 2008. And now the money supply has just exploded. The rise in the gold price has been rather tame by comparison, perhaps because many investors still believe that somehow the current system can be fixed without resort to some combination of currency devaluation or debt default. I don’t believe that is possible.
I assume you are expecting high inflation in the future?
Price inflation follows monetary. I am rather fond of this view: Price inflation is inflation past; money and credit growth are inflation present; fiscal deficits and debts are inflation future. By focusing on price inflation, central banks are looking through the rear-view mirror while driving the car. This is at best ineffective and more likely outright dangerous. The word ‘reckless’ comes to mind. But the point is that governments that spend more than they collect in revenue build up debts over time that become costly to service and, at some point, even a highly independent central banks finds it must either accommodate these deficits with easy monetary policy or, alternatively, crash the financial system, something all central banks are tasked with preventing. So it becomes a ‘Catch-22’ and I would say that this is no accident but rather it is by design. So the central bank eases policy to facilitate debt service. The government can then use easy money to help de-leverage through a currency devaluation and inflation (otherwise known as ‘financial repression’), or it can incur even more debt instead to facilitate growth. That is what the US government is doing today and to a lesser extent what other countries are doing. They are adding debt to debt amid low rates, as if this somehow solves the problem. It doesn’t.
History is very clear regarding where this is going: It is leading to another crisis far larger than that we experienced in 2008. Will it be inflationary? That depends on the choices policy makers make at that time. But based on what has happened so far, I would say yes, there lies much price inflation in future.
How would you increase the prosperity of America and Britain today? Is total laisse a faire the best solution?
Not all problems have solutions, at least not palatable ones. If there is one thing in economics on which we can all agree on in principle, it is that there is no free lunch. Yet the modern economic mainstream seems comprised primarily of people who claim that, if you will just do exactly what they say, even if you don’t understand it, well then they will somehow work magic and provide a free lunch. The truth is harsher. Once you have borrowed from the future to spend in the present, that income is gone. Yet the debt incurred must nevertheless be serviced out of future income or it will be defaulted on.
Now I am a fan of laissez faire for a variety of reasons, several of which are discussed at length in my book, but I would not purport to claim that somehow it is a ‘solution’ for the mess we are in. The ‘solution’, if I must call it that, is to acknowledge the mess and start cleaning it up by de-leveraging the financial system and reducing government spending. This is going to take years and it implies a lower standard of living during that period of time. There is just no other way to sort it out. That is the economics of it. So the question then becomes political: Who is going to suffer the most? Right now, it appears that this will be primarily the middle class. That is what inflationary policy does: It transfers wealth from those who are ‘diluted’ (savers) to those who stand first in line to receive the printed money, namely financial institutions, leveraged investors and the government itself. Inflation and the relative growth of finance and government go hand in hand through history. This is no coincidence.
Who would benefit the most from this book? Investors? Keynesians? Politicans?
My book is written primarily with investors and financial professionals in mind. I doubt that Keynesians will have much patience for it as they will disagree with too many of my assumptions, as I disagree with theirs. But I would be delighted if they would give it a go. The same goes for politicians. Much of what I say is just politically unpalatable but it is instructive, and perhaps some politicians will be drawn to that.
For the main audience, however, my book explains how we got into this mess and, most probably, how we are going to get out. Keynesians and politicians may not be convinced but that is hardly a problem. If only investors and financial professionals begin to act in a certain way—just taking prudent actions to protect themselves really—they will force the issue. In an age in which governments have grown so much in size and central banks have taken to micromanaging the economy, it might seem as if these guys are in control. But they’re not. Control is an illusion. A large government with failing finances has substantially less control over the future than a more minimal government with sound finances. And central banks only have control to the extent that financial markets trust them. Lose that trust and the bond market will send interest rates soaring. And if central banks intervene to stop that, the currency collapses. And if you impose capital controls to defend the currency, well then your currency cannot function as a reserve and will be dumped in short order by foreigners. Checkmate.
Back in the 1980s and 1990s there was occasional talk about how the ‘bond market vigilantes’ forced governments to keep their houses in order. Now that governments have shut down the bond vigilantes with various forms of QE, the game has changed. The time is rapidly approaching when the ‘golden vigilantes’, as I refer to them in my book, are going to force countries back onto gold via the global financial markets. It is my hope that people who read my book join these forces and, thereby, join The The Golden Revolution.
Thank you John.