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Aristotelean Logic

May 22, 2004

This article has been written specifically for those people who are grappling with the conundrum regarding whether we are facing an era of inflation, deflation or stagflation.

The short answer is "all of the above, but in sequence". First we will have an outbreak of inflation - leading to a rise in the gold price, followed by stagflation - accompanied by a churning of the gold price, followed by deflation - accompanied by a gold price which declines from its previous peak.

The basic premise of any logical argument is the effective foundation on which it is constructed. If the foundation is flawed, then the entire argument (no matter how elegantly it is constructed) can lead to nothing other than a flawed conclusion.

As an aside, the article entitled "Uses and Misuses of Logic" (ref: provides a valuable background to the subject of logic, and it is well worth the ten minutes or so that is required to scan this article.

What is the basic premise on which the gold-philes are building their argument that gold is the most appropriate international currency?

  1. Gold has been the reference point to all value since time immemorial
  2. Gold therefore holds (should hold) its value relative to other products/services/commodities until "hell freezes over"
  3. Gold is therefore an "objective" medium of exchange which, in and of itself , places an exogenous discipline on the behaviour of Central Governments and Central Banks
  4. Gold is therefore the most appropriate currency of last resort.

What is the basic premise of the Central Bankers who argue that fiat currency is the most appropriate yardstick of value?

  1. A "medium of exchange" is what ultimately provides grease to the wheels of commerce and industry; and a universally accepted medium of exchange will facilitate commerce and trade on a global scale.
  2. A globalised world will have discrete social sub-entities that are economically interdependent.
  3. It is this economic interdependence that will ultimately dictate the need for fiscal discipline within and between the discrete economic regions vis a vis the global economic system of which they are sub-sets. If any discrete entity behaves in an undisciplined manner it will impoverish itself relative to its peer group.
  4. In a world of exogenously applied systemic economic discipline, fiat currency is superior to any other currency - be it sea shells, gold or porcupine quills - for the simple reason that it is available in unlimited supply.
  5. Because of its unlimited supply (and because of the behavioural constraints imposed by "natural" disciplinary forces) fiat currency is the most appropriate international currency.

It follows from the above that the proponents of fiat currency are against the idea of gold as the currency of last resort because of its limited availability. Their logic tells them that in a world of a finite supply of currency, "depressions" are both unavoidable and inevitable. Markets for old technology products will inevitably become saturated, and the "debt" that was built up in the preceding economic boom will need to be repaid against the background of an (eventual) stagnant economic environment which is not conducive to wealth creation; and this will inevitably lead to an economic bust as the debt mountain implodes.

Proponents of gold are against the concept of fiat currency because they are sceptical of man's ability to act with integrity. Ie They question the premise that there will "naturally" be an exogenously applied systemic discipline because political leaders and others in positions of economic power will have too much of an incentive to "buck the system" for their own personal gain.

Unfortunately, using Aristotelean logic, NEITHER of these arguments is correct, because the base assumptions of BOTH camps are flawed.

Ultimately, the reason they are flawed flows from the existence of a phenomenon called "debt". The act of borrowing is what ultimately gives rise to an artificial increase (inflation) in the money supply which, in turn, gives rise to inflation in prices.

Those who borrow enrich themselves at the expense of those who do not. By borrowing, they are able to "leverage" the process of asset accumulation, and assets tend to hold their value relative to currency. However, given the existence of debt, the following scenarios will manifest, regardless of which "ultimate" currency is used:

A) If gold is the ultimate currency

In an environment of a finite amount of available currency (gold) but a growing nominal money supply (because of debt), the prices of all commodities, products, and services will rise when expressed in terms of ounces of gold. Ultimately when markets saturate, and the debt balloon deflates, the money supply will shrink back to its "nominal" level as defined by the stocks of gold, and as borrowers either repay or default on their debts - leading to a reduction of the money supply and deflation in prices relative to gold. When prices are rising consumers will need more ounces of gold to buy a shirt (as an example) and when prices are falling, consumers will need fewer ounces of gold to buy the same shirt. Because of debt, the "standard" of living will improve for some (the borrowers) relative to others (the non borrowers) on the way up and will deteriorate for some (the borrowers) relative to others (the non borrowers) on the way down.

B) If fiat currency is the ultimate medium of exchange

In an environment of "infinite" money supply, there will be no medium of exchange related constraints to debt creation. Prices will rise faster than under a gold regime as money supply is inflated by the printing presses which, in turn, will facilitate an acceleration of borrowing. But instead of more "ounces of gold" required to buy the shirt, it will require more fiat currency to buy the same shirt. Debt could theoretically pile up to infinity provided the level of "confidence" is maintained and, because debt is likely to be available to everyone, and because incomes will be generally rising when expressed in inflating currency, it will "appear" that the standards of living are improving across the board. The problem here is that humanity cannot divorce its thought processes from "reality" forever. A point will eventually be reached when money supply will need to be increased for the primary purpose of supporting the debt mountain. At the point of recognition that this is what is actually occurring, confidence in the future will wane, and further debt accumulation will either accelerate exponentially (and finally collapse) or it will slow down. In either event, economic activity will inevitably wane, and the "mirage" of debt as a driver of economic activity will evaporate. The "pain" of deflation under this scenario will be significantly greater than that which would have prevailed under a gold scenario - because the debt levels will be higher.

It follows from all of the above that the ultimate cause of depression is not the medium of exchange (currency) that is selected to facilitate economic activity, it is the existence of a behavioural predisposition of any economic entity (private organizational or institutional) to spend more than it earns and to plug the gap with "borrowings".

The ultimate cause of economic "depression" is debt implosion, because "deflation" is the inevitable consequence of debt implosion.

With all of the above in mind, it is critically important to recognise that gold does have one significant advantage over fiat currencies: Because the volumes of its availability cannot be artificially tampered with, in times of depression it will hold its value better than fiat currency. This is self evident because "faith" in fiat currency is likely, eventually, to be lost as confidence in the "creators of the fiat currencies" - the financial authorities who were "supposed" to protect us against depression - will be lost. When confidence in fiat currencies wanes, confidence in gold waxes.

But life carries on. In times of crisis, new leaders emerge and society places its trust in these new leaders. The alternative is anarchy and, ultimately, it is the dysfunctional nature of anarchy that precludes the idea of a gold price "rising to the stars".

Ultimately, this argument is based on faith in human nature. Those who are predisposed to assume that the whole of mankind is generally stupid will be arguing for a stratospheric rise in the gold price. Conversely, those who believe that mankind is generally an intelligent species will argue that gold will likely rise relative to fiat currencies for a relatively short period, until a point is reached where a new breed of (honest) leaders emerges to lead the way.

Personally, I fall into the latter camp. To me, the glass is half full. That Humanity is generally possessed of a sufficient level of innate intelligence to ensure its long term survival is the base assumption on which my entire existence is predicated. It is this premise which forms the foundation of all my arguments. From my perspective, if this premise was false there would be no logical basis for my continuing existence.

It follows that those who believe that the gold price is going to rise into the stratosphere do not accept this basic premise.

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