Gold, Redeemability, Bitcoin, and Backwardation

I recently released a video about the Internet-based currency, Bitcoin. I asked the question: is Bitcoin money? In brief, I said no it’s an irredeemable currency. This generated some controversy in the Bitcoin community. I took it for granted that everyone would agree that money had to be a tangible good, but it turns out that requirement is not obvious.This prompted me to write further about these concepts.

A human being has a physical body with physical needs, and lives in a physical world. He produces that he may eat and clothe and shelter himself. Once civilization develops beyond subsistence, men specialize to increase their production. Each relies on others, who specialize in other fields. Each trades his products for the goods produced by others.

A problem arises, called the coincidence of wants. One man produces food and another produces leather moccasins. When the moccasin producer is hungry, the food grower may not need new shoes. Mr.Moccasin must discover that some goods are more marketable than others. He can trade less-marketable moccasins for more-marketable salt, for example. He may not need the salt (though he can always use it) but he knows it is accepted in trade for food and other goods.



Eventually, a market process finds the most marketable good. It becomes even more marketable due to its increasing use as money (but it does not lose the attributes that made it useful in the first place).

People accept the monetary good in trade because it fills one of three needs. They will exchange it for something else later. They may want it for its own sake. Or they may accumulate a hoard during their working years so that in retirement, they can dishoard to pay their bills.

Modern civilization layers a complex financial system on top of the monetary good. It has bills, bonds, and savings accounts, etc.  Most people do not want to redeem most paper credit instruments, for reasons of convenience and the preference for an income. However, it is important to keep in mind that the possibility of redemption is necessary and essential to a working financial system. Everyone must choose for himself the right balance between holding the monetary commodity directly and various earning assets that promise to be redeemed in a quantity of the monetary commodity in the future.

Only this balancing process can perform one particular and critical function. Hoarding, also known as managing risk, has played a vitally important role throughout human history (and which is almost unappreciated by the economics field). Hoarding and investing are balanced by risk tolerance. In a free market without central banking and bailouts, everyone must think of risk.

To the economist, redemption of paper and hoarding of the monetary good, serve to police and clean the system, force the write-offs of bad credit (as opposed to letting them accumulate), and of course empower the saver to enforce his interest-rate preference. This last, is a point that I have not seen anyone make prior to Professor Antal Fekete,  and which is under-appreciated today.[1]

To the hoarder himself, hoarding looks and feels very different. He is thinking of having something tangible in hand. A coin in his pocket does not have a risk, it can be carried anywhere, and can be accumulated in a safe place. To anyone aware that he is living in the physical world, there is no substitute to having a physical, tangible commodity.

Today, of course, legal tender laws obscure most of the above. The monetary commodity is not allowed to do its job, and we’re lucky that after they removed it from the monetary system they at least once again legalized its ownership for American citizens. Even so, most people regard owning gold as a risky speculation because its dollar price is volatile. It’s madness.

Returning to the question of Bitcoin, we have a conundrum. Bitcoin is not debt. In that sense, it is like gold—there is nothing to redeem because the thing is the final good. Unlike gold, it is not a tangible good. You cannot hold it or stack it in a safe in the floor. Other than the value you hope it has in trade, it has no utility by itself.

Bitcoin in this context is like an attempt to reverse cause and effect. Gold is money because people strongly desired it for its physical properties and then, subsequently, discovered that it was the most marketable good and thus useful as money. Bitcoin bypasses this and attempts to go straight to being money. Should hackers break its cryptography, the Internet go down for a few months, or any number of other scenarios occur, the above logic will reassert itself.

Owning Bitcoin is to be in a partially completed transaction. Until it is exchanged for a tangible good in another trade, the owner of the Bitcoin is in the position of having given up something tangible for nothing in return.

I made the point, in a previous video that redemption is not the same thing as purchasing the monetary commodity.  Prior to 1933, one could go to any branch bank of the Federal Reserve and exchange dollars for gold. This was not “buying” gold, but redeeming the dollars. One accepted the dollar bill in trade, with the sure and certain knowledge of the terms (e.g. gold value) of redemption. Unlike then, today the dollar can be used to buy gold. But there is no way to know the terms—or indeed if one can even make the purchase at all—until one attempts the transaction.


It is the same with Bitcoin.


Now that I have used Bitcoin as the foil to establish several points, let’s look at the dollar and its ability to buy gold. Consider the following points that I discussed at greater length in this video:


1.      irredeemable debt-based currency provides no way to extinguish a debt

2.      the dollar itself is a debt instrument

3.      payment in dollars merely transfers the debt

4.      all debt is borrowed at interest

5.      eventually, the interest cannot be paid out of income

6.      the only way to pay the interest in aggregate is further borrowing

7.      total debt in the system grows exponentially until it cannot


The system is designed to drive all participants to bankruptcy! “This is,” as they say in technology industries, “a feature, not a bug”.

In this light, the problem is not the rising quantity of dollars per se (though endless issuance by the Fed is certainly not good) but its falling quality. It is all headed to default when the debtors cannot borrow any more. This point was reached in Greece, but it is years away in the United States.

One might be tempted to ask why the banks and financial institutions don’t recognize this and refuse to do business in dollars. The answer is that they are regulated, they ultimately answer to investors who believe in dollars, and they are given perverse incentives to continue to play the game. For example, they can borrow short at near zero from the Fed, and lend long at near 2% to the Treasury. This transaction creates no wealth, but the banks engaging in it earn “profits”. They are fat, dumb, and happy to make this spread and many others like it.

So who understands it? The lowly gold hoarder does. His challenge is that he is sometimes distracted by the mainstream message that gold is a risky commodity that cannot be used to buy bread. He is often distracted by the gold bug message that the rising gold price is a “profit” (and the falling price is a conspiracy). If he can see through these two mirages, then he can see that all the credit in the system must inevitably and inexorably crash to earth like too many rocks impossibly kept aloft for a while by a juggler who exceeds his limited skill.

“Money is gold and nothing else,” as JP Morgan famously said in testimony before Congress. When bad credit eventually is repudiated, gold will still endure.

This is the context to my argument: permanent gold backwardation is a late symptom of the terminal monetary disease. Like jaundice in a cancer patient, signaling to the doctor that the patient is in immediate risk of death by liver failure, permanent backwardation signals to the economist that the monetary system is in immediate risk of death by gold withdrawal.

The dollar is not strictly redeemable, but it can still be used to buy gold. This provides an “escape valve”. Those who wish to convert their irredeemable paper into the monetary commodity, to complete the transaction of trading their product for dollars and dollars for the monetary commodity, can still do so.

Backwardation is when the price of a commodity in the futures market is lower than the price in the spot market. Anyone who has the commodity can make a profit by simultaneously selling the commodity in the spot market and buying a future to recover his position. This trade has no price risk, credit risk, or even spread risk. The only risk is default. Permanent backwardation is when all futures contracts fall below the spot price, and the gap keeps widening no matter how much the price rises.

The existence of now-chronic temporary backwardation, is proof that gold owners are starting to become reluctant to trust the dollar system, and the lure of profit is insufficient. If they do not trust the delivery of a future, then they have to question if they will be able to buy gold on any terms. In an environment of collapsing credit and bankruptcies, this lack of trust will be quite well founded.

The final stage is brought on by the complete withdrawal of offers to sell gold for dollars (i.e. the gold bid on the dollar). Collapse will come swiftly because of asymmetry.  While no gold holder will then want dollars, some dollar holders will desperately want gold. They will buy any goods that have a gold bid. The trade of dollarsàcommoditiesàgold will drive the prices of commodities up to any arbitrary level in dollar terms, and down nearly to zero in gold terms. Oil could become $1,000,000 per barrel and 0.0001 gold grams per barrel at the same time. This process will continue until sellers of commodities will no longer accept dollars.

The dollar is fiat, which means imposed by force. It is debt-based, which means its value derives from the efforts of the debtors to continue to pay. And it is irredeemable which means there is no way for debtors, in aggregate, to get out of debt, and no way for creditors to know the terms by which they can get gold. The government uses force to impose the contradiction of a debt-based currency that cannot extinguish debt. People would not accept it otherwise!

The final resolution of such a contradiction is total collapse.

For those interested in tracking the backwardation occurring in both gold and silver right now, Monetary Metals publishes The Last Contango Gold Basis Report (free registration required).


Addendum, by PT:

Bitcoin has recently gone bonkers. This is to say, even more so than previously.  Last time we wrote about it, it was at $70; evidently, it was still a buy at that level. See for yourself:




Bitcoin continues to go parabolic – via bitcoinchart. And there we thought that last year's rally was spectacular, but it was really nothing compared to what has happened in 2013 so far – click for better resolution.



As trading sardines go, this has to be one of the best trades of the past few years, but certainly it is a bit eerie that mere code is becoming such a bubble (even if the amounts traded are relatively small).



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9 Responses to “Gold, Redeemability, Bitcoin, and Backwardation”

  • mc:

    This brings up a thought that will scare the rest of the top-down interventionist mindset world:
    If BTC is a real currency, then capital controls must become internet controls must become controls of transactions of all sorts, because titles (claims on assets) and BTC are both information – and they will be exchanged over the internet just like banking claims. The idea of limiting transfers of Euros in/out of Cyprus it that it would prevent claims on assets in Cyprus from rapidly devaluing as the putative owners try to sell as all of their other money was taken. With the controls, no one can get money to buy, and no one can withdraw money if they sell, and this allows the banks to maintain a fiction that the assets are now not much less valuable after the “bailout”.
    Enter BTC and the rest of the world, who are willing to hold titles to assets in Cyprus (for the right price), and very rapidly “capital will flow out of Cyprus”. What is really happening is that the assets in Cyprus never moved, just revalued to a much lower level and ownership transferred on the account of financial oppression foisted on them and now-dismal future business climate.
    If I sell my house in Nicosia to a couple in Frankfurt for 1000 BTC, and then deposit it into a Swiss bank in CHF, will Cyprus refuse to enforce that title of a fellow EU citizen?
    Will the Swiss bank deny my receipt of francs from another Swiss citizen?
    Would the countries involved comb the internet for the transaction and attempt to reverse it? (return the BTC to the german citizen, euros to the frankfurt couple, house to me, and francs to the swiss citizen)
    Would the EU and Cyprus agree to cut off all internet communication, by any means, indefinitely?
    If the answer to all of these is no, then the dreaded capital controls are just a sham. Nothing happened from an accounting standpoint that differed from money moving freely from Cyprus to Germany to Switzerland and the appropriate transfers of title that these controls would supposedly block.

    • worldend666:

      I think you might find that any purchase over 5000 euro must be carried out through the bank or it is invalid. That’s an easy one for the bureaucrats.

      I am not sure if it’s a problem not having access to the internet. I never used bitcoin but I am pretty sure you could read someone the numbers over the phone and they would then be able to get new coins issued to them using these numbers so long as the other person had internet access.

  • worldend666:

    Hi Keith

    Bitcoin does have some disadvantages (its tangibility and risk of a tech breakdown/hack), but gold also has some:

    – It can be confiscated
    – It can be forged (gold plated tungsten)
    – It can be easily stolen with virtually no chance of retrieval
    – It must be delivered physically (delivery cost, theft in transport)
    – Large purchases must be reported (admittedly the same for Bitcoin recently but much harder to trace)
    – You can only carry so much (say 12kg). Much less undetected.

    Bitcoin on the other hand:

    – can be easily hidden form confiscation. It can even be stored on paper as a string of 1s and zeroes.
    – cannot be forged (until it is hacked)
    – Is very hard to find if hidden properly and therefore hard to steal.
    – can be transmitted in any form (even smoke signals if you wish)
    – Can be traded for goods outside the monetary system and therefore is difficult for authorities to trace
    – can be carried in unlimited amounts and is completely undetectable

    In addition in a country going into hyperinflation local supplies of gold are likely to be severely restricted, but Bitcoin is easily purchasable over the internet and is simple to store outside the clutches of government.

    Perhaps Bitcoin is not money. Maybe it is better :)

    • mc:

      I think the BitCoin vs Gold debate is a great one. But “better” is very relative. Looking at the two issues you mentioned, verifiability and portability, the real conflict is ideal vs un-ideal conditions.
      A) Ideal B) Fleeing the country via airport due to confiscation (Cyprus scenario) C) Fleeing your home in a car (Syria scenario) D) Dystopic post monetary system breakdown

      Verifying Gold in A) is easy, using a battery powered specialized meter, while an internet connection anywhere in the world suffices for BitCoin and thus a slight edge. It is mostly easy to transport and store gold anywhere in the world, but more convenient for BitCoin.
      In B) you would have a good certainty that gold you obtained in Cyprus was real, and the small loss one would take to melt it (losing the goldsmith imprints) would satisfy any doubt. However, you could seamlessly transfer your Euros to BTC and redeem them elsewhere in Europe, where conversion to gold in Cyprus still requires the transport out of the country. I would expect that you could get no more than 10-100oz of gold thru security without suspicion.
      Case C), the local demand for gold is high and people fleeing have very high time preference. Verification is harder, jewelry and non-coins with lower karat contents are used, people get cheated or at the very least much less than their gold is worth. However, with internet access is spotty and banking a huge challenge, one would need to exchange goods or money locally for BTC. The downside being your person is much less secure and anything could be taken from you, so funds to save for later or needed over a border crossing could be sent via BTC more securely. No internet access means no access to the funds, so gold is more useful in this scenario for immediate use and possibly survival at this level.
      Case D), if it comes to war, trade/guns/words/internet espionage/otherwise, a worldwide internet may or may not even exist, so whatever extent it does BTC may be a significant player or be the enemy of failed monetary states. Verification and use of BTC is much more tenuous in this case, as is personal access and use of the technology required. For some people, this could be a huge reduction in the marketability of BTC if they cant get internet access or have government opposition to overcome. Gold remains easily verifiable in all cases, which is its primary downside in the monetary confiscation endgame. It will be seen as the most undeniably marketable money, but also a sudden windfall of wealth. If you owned a farm as a hard asset that employed and fed people, you might be stable in a post-monetary collapse depression, but a suddenly wealthy gold-hoarder is likely (for political reasons) to be confiscated and gold prohibited. Because it is information, is hard to outlaw the possession of BTC, but they can make it hard on users by going after the clearinghouses like MtGox, and it will be much harder to know who actually owns any BTC. Since internet lock down is more likely than house-to-house searches and bank confiscations (but both are >0), gold will outperform in times of crisis.

  • worldend666:

    Did anyone notice this story on the front page of Marketwatch yesterday?

    A decoupling of paper and physical no less. I have never seen that in mainstream media before.

  • Keith Weiner:

    georgew: Thanks for your comments. A can give a few quick responses:

    Why gold is money is a whole in itself, but I will say two things. First, the market demands money–the most marketable good. This is because money enables indirect trade which is vastly more efficient than direct barter. Second, gold’s physical properties make it better suited, objectively, to being money and this is why the market selected it.

    Re point #2, I agree that one never wants to advocate a policy simply to compensate for another bad policy. That was not my point regarding debt, extinguishment thereof, and marking off bad debt. With banknotes, the question is what aspect of reputation of the bank is it that depositors are concerned with? Its reputation for redeeming its gold obligations when due. I also think it’s useful and important to understand how the rate of interest is really set in a free market with gold as money.

  • Whose coin, what coin? The decree on the dollar is its value, to satisfy debt contracts. When that becomes impossible, as it was temporarily in 2008, odd things occur. A credit crunch is on the horizon right now, regardless of Bennie.

  • SavvyGuy:

    A bubble in Bitcoin already…who’d have thought?

  • georgew:

    I always enjoy your articles Keith. I have some questions:
    1. When von Mises asked the question, why Gold?, the only answer needed is “because the market chooses it”. One could observe that the gold stock is quite large compared to yearly production, and that may be useful to consider, the salient point is that the market chooses it, not trying to theorize (even if probably correctly), why.
    2. “To the economist, redemption of paper and hoarding of the monetary good, serve to police and clean the system, force the write-offs of bad credit (as opposed to letting them accumulate), and of course empower the saver to enforce his interest-rate preference.”
    It doesn’t seem to me, though certainly I may be mistaken, that this is relevant to the free market. For example, if I have a bad debt, I can choose to recognize that whenever I want, but the capitalized loss has already occurred. If I am, or to the degree that I am correct, I’d say advocating something to partially mitigate the nefarious and insidious practices legalized by our Govt is in fact advocating those policies.
    3. I am not sure (haven’t thought about it enough or seen all arguments) if I agree or not with your opinion on bit coin. My initial impression is that it is like bank notes, and the market will value them to the degree the reputation of the provider is trusted. If we ignore the current problems of the monetary system, which impacts everything but hard assets, it would seem it is identical to bank notes. Perhaps it is the current monetary system which clouds the issue.

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