Duration and Perpetual Debt

7/31/2019 Duration and Perpetual Debt

1/7

DURATION

and

PERPETUAL DEBT

Sandeep Jaitly, Director of Economic Research

Gold Standard Institute, Vienna

14th September 2010

THE roots of our Great Financial Crisis have not had any true light shed upon them by

the wider economic community partly because they are objective-value in stance, but

principally because they have little grasp of physics. The avaricious nature of the western

consumer; the resultant huge distortions between creditor and debtor nations and the

stratospheric leverage of the financial system to name but a few of the reason proffered.

These are grave problems for sure; however they overcomplicate the issue unnecessarily

and are symptoms of a malign financial system rather than its cause.

Why does this paper exist? The aim of this paper is to show...

The essential problem of the current monetary regime is the mismatch of durations of financial

assets and liabilities. The shorter mismatch of durations presents perennial problems for the

monetary system. Combined with perpetual debt the problem is exponentially amplified. This

outcome is a direct consequence of abandoning that physical substance, which has the propensity forits utility at the margin to decline the least, as the monetary unit of account.

To get to the route of our problem it is important to start from first principles.

In the beginning silver was money. The recursive procedure by which the people

themselves determined the most marketable item produced silver countless millennia ago.

The acquisition of silver as the most marketable good presents problems of a physical

nature. What does the successful merchant do with their accumulated stockpile of silver

beyond that needed for daily expenses? What does the prudent and thrifty individual do

with their large stockpile of silver? For that matter what does anyone who has a surplus

stockpile of silver do with it to ensure its safety and security?

The concept of the safe storehouse is born. Individuals worried about the theft of their

silver holdings kept domestically can entrust them to a respected individual with safe

storehouse facilities. Just think of the necessary traits and character of the person to

whomyouwould entrust the storage and safekeeping of your silver. Not any old pleb with

a secure warehouse and key would do, but a person of utmost ethics and standing.

Temples were the first institutions that had the privilege of safeguarding the peoples

money.


2/7

The priests of the remote past who had sacrificed personal material gain were deemed

superior to warring kings or acquisitive merchants in the safeguarding of the monetary

balance.

The entirety of ones silver holdings is not usually needed on demand. Demand means

physically keeping the silver coin at home or keeping with receipt at the storehouse. The

amount of silver that would be needed on demand, say, might cover day to day living

expenses: clothing; food; transportation etc. Youdeem, say, that only 10% of your silver

holdings are needed on demand for such purposes, the remainder is not. It is an entirely

subjective decision. It is the remainder of ones silver holdings not immediately required that

is effectively put to use to create the principle of the silver bond and the associated

counterpoint of the time deposit. This is the time preference element of the creation of the interest

rate bid-offer spread in action.

The initiation of a loan for productive enterprise could be fashioned from one individual,

say. It would naturally be fashioned from silver that is not required on demand. The

dispersalof loan proceeds by the borrower for the productive enterprise createsa subsetof

individuals whose aggregate increase in physical silver coin is a sum no greater than the

amount initially lent.


3/7

Each one of those individuals is then at the very least, and certainly at the margin, in the

same position as the person who fashioned the loan in the first place: they will have a

[marginal increase] in their silver balance which can subjectively split into what is required

on demand and what is not. It is very important to understand this concept. Multiplier is

an insufficient and inaccurate description of the process: recursive would be moresuitable as would iterative, or self-similar. It is also worth remembering that ones own pecuniary

position is the result of this process as well. By the beneficence of others with regards to their preference

for demand versus non-demand ones own personal silver balance is greater (or not.)

The result of the dispersal of silver coin through the spending of loan proceeds creates a

system comprised of demand deposits and time deposits of varying maturities. The

storehouse which was initially there to keep silver on demand, could now branch out into

lending silver which is in excess of any individuals demand requirements. The determination

of the proportion of any individuals silver that is required on demand is a purely subjective process. It iscertainly not the prerogative of the storehouse owner. The subjective determination of silver

required on demand coupled with the recursive procedure detailed above gives rise to a

system of financial assets and liabilities that match perfectly in duration by subjective

definition.

Note that the concept of time deposit and bond is not dependent upon the existence

of a literal storehouse. They can be pure concepts of the mind and just noted mentally.

Of course, it is much harder to look for a secondary market price for a bond that exists

only in the mind as opposed to a bond that exists in legally documented and notarised

form. The successive entrance of storehouses into the lending game was effectively a

form of market making. They reduced the bid-offer spread between those that wished to

borrow silver and those that wished to lend it.


4/7

Demand deposits are automatically (strictly by definition) covered 100% by physical

silver coin. It should be evident that the extent of time deposits and the associated bonds

has no limit in aggregate attached to it it is certainly not dependent on the amount of physical

silver in the system. Consequentially, there is no physical limit (up to reluctance at the

margin to lend) to the ratio of time deposits to physical silver.

It is not difficult to see how this perfectly stable and subjective mechanism could be

usurped by unscrupulous characters. The most obvious fraud would be for the

storehouse owner to lend demand deposits for any length of time. In this case, cash silver

balances would not match one to one with deposits on demand. Should a person require

access to their demand deposit and there is insufficient cash silver because of this, then

whatever the cash silver was invested in by the storehouse owner will have to be

liquidated in a secondary market. Alternatively, the silver required could be taken from

the storehouse owners equity capital. Either way this is nefarious and fraudulent.

Although not fraudulent, the lending of silver for non-productive enterprise, or to put it

bluntly, lending for dubious activities where there is no guarantee the principle debt can

be amortised will cause problems at some point. What would be the consequence of

lending to such characters in the case of a default? It would be the wide scale destruction of

the relevant time deposits (beyond the equity capital if any of the financial system.)

Default would be characterised by the bond in question not being paid back at all, or the

secondary market price of the bond being well below par expectations.

The wide scale destruction of time deposits would lead to assets (financial and real) beingsold on their relevant secondary market should there be a bid. This is done in order to

cover any loss potential or real to the time deposit system. It is quite clear that the

resultant environment would be one of falling prices. However, this has nothing to do with reduction in

consumer demand but is a result of the aforementioned process of deposit destruction.

Clearly, manipulative methods to increase consumer demand do not understand the true

cause of a declining price environment and would be lacking by their very nature.

To summarize at this stage: the lending of demand deposits is fraudulent, and lending for

non-productive enterprise could cause catastrophic problems to the deposit mechanism.

HOW has the current state of the financial system evolved from the ideal? The current

financial system is not characterised by either fraudulent lending of demand deposits or

lending to non-productive enterprise, but both.

The first step on the road to our financial Armageddon was made when the storehouse

owner, having graduated to a licensed commercial bank many centuries later, was allowed

by the authorities to only keep a fraction of the physical silver coin behind demand

deposits.


5/7

Anyone that went to a commercial bank seeking demand deposit facilities would be

shocked to learn that only 10%, say, of their demand deposit is kept in physical silver

coin as supposed to the 100% required. The 90% of the demand deposit that was

fraudulently lent out would naturally be in secure, liquid investments like government

bonds (!) which have a deep secondary market. What if the secondary market has a dearthof bids and there is a high demand for cash? The newly created central bank would be

there to repo any eligible assets against a cash advance. The ratio of physical cash silver

to total deposits (both demand and time) is distorted beyond the natural determination by

subjective preference. Duration mismatch is born. This is also known as borrowing short to lend long.

The second step on the road was made when lending to the government became the

main preoccupation of the banks. These loans never tended to be amortised at expiry,

but merely rolled on. Combine that with the recent practice of lending to anyone and

everyone regardless of their credibility and there is a disaster waiting to happen (whichdid in 2008.) Government debt of any duration rolled into perpetuity is effectively a

perpetuity, but without the funding base of a perpetuity. Lending to characters of

dubious credit will eventually show up in the form of defaulted bonds which tend not

have much value. The financial systems asset base is mainly composed of quasi-perpetuity government

bonds (without perpetuity funding) and sour paper collateralised by illiquid assets.

- It must be appreciated that funding any loan with a funding source that is not ofequal (or greater) duration is in effect equivalent to lending out demand deposits.

Silver is still assumed to be the unit of account. In this scenario of financial assets

composed of government bonds and other forms of paper collateralised by illiquid assets,

should there be any deterioration in the quality of the assets, or an increase for the liquidation of

demand deposits into physical coin in excess of the banks physical coin balance, then there would be a

massive impact on the secondary markets bid for these assets. An avalanche of offers for paper will

hit a likely dearth of bids. The consequence would be wide scale destruction in the book

value of demand deposits as well as a shortfall on time deposits coming due. People

would find that when they went to their local bank, they would not be able to make a

withdrawal against demand receipts, let alone time receipts with a penalty. The bank was

said to be bankrupt and the liquidation of assets in a weak market the next step in order

to pay back depositors. Fractions of the original sums deposited would be achieved. Such

happenings characterised the banking system frequently over the centuries and this was

all due to the mismatch of duration and thoughtless allocation which are catastrophic

individually let alone together.

The final step was abandoning silver and gold as the monetary unit of account. This

allows one to paper over the fractured realities (mentioned above) with debt rolled into

perpetuitythat would have nevertheless occurred under a silver standard from a combination of duration

mismatch and poor allocation. Deposit write downs werestill at stake under a fiat standard...


6/7

...That is up until 2008, when the wider world realised there might be a problem in high

finance, people were blissfully ignorant to the accumulated problem that will necessarily

arise from breaking natural principles. Not only were the individual banks at risk as is

commonly known but the entire deposit base of the financial system was at risk as well

which is not commonly appreciated. No payments would have been processed.Deposits would have disappeared. The majority of people would have been left

destitute. Prices of all varieties of good and assets would have collapsed as everyone

sought physical notes and coins. Imagine the price of a standard home falling 95%.

Imagine the price of a cup of coffee going back to one shilling. This would have

happened had the governments of the world not stepped in.

The purchasing power of a Federal Reserve note would have regained 95 years of losses. The mismatch of

durations combined with effective perpetual government debt explains the destruction in the purchasing

power of the fiat Dollar over the decades. Not the linear quantity theory of money. A lot of that loss inpurchasing power would have been regained in a few months at the expense of the continuance of western

civilization. The graph of bank reserves would have been similar to the increase in the purchasing power of

Dollar (physical) note and coin were the system allowed to implode upon itself.

However this did not happen. The governments of the world effectively nationalised the

entire deposit system. This is unprecedented. The natural determination of durations has

been so grossly distorted that the only salvation is to nationalise any form of loss. This is

only possible under a fiat standard.

This is how the current situation is arrived at: first an utter degradation in the character

and nature of the individuals charged with banking privileges occurred; then the

introduction of fraudulent practices of lending demand deposits and financing assets of a

much greater duration than the underlying funding. This was accompanied by consistentbanking collapses and panics, as one might expect. The icing on the cake was the removal


7/7

of silver/gold as the unit of account in order to bypass these phenomena. This has not

occurred nor will it ever. The self-regulating and self-correcting mechanism of the silver

based demand and time deposit mechanism has been morphed into a system that is more

likely to experience catastrophic resonance.

WHERE now? The nationalisation of the deposit system will have grave consequences

for assets prices (financial and real) in general going forward. A system which should

have imploded under its own [mismatched] debt burden was not allowed to. Nor will it

ever be from a deposit integrity standpoint.

No longer is Mrs. Smiths 3-month time deposit with Northern Bank at risk. Nor is

anyones anywhere in the world to all intents. An economic expansion nothing more

than the consequence of nationalising the deposit mechanism is likely to ensue. But this

will be no realeconomic expansion merely a nominal one. The stock market shall soar

not because of exponentially increasing productivity, but because the deposit end-game

was never allowed to be concluded nor will it ever be.

Has this paper shown what was intended? Yes

The essential problem of the current monetary regime is the mismatch of durations of financial

assets and liabilities. The shorter mismatch of durations presents perennial problems for the

monetary system. Combined with perpetual debt the problem is exponentially amplified. This

outcome is a direct consequence of abandoning that physical substance, which has the propensity for

its utility at the margin to decline the least, as the monetary unit of account.

Duration and Perpetual Debt

Documents

Transcript of Duration and Perpetual Debt