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Is the current U.S. fiat economy sustainable? Debt backed by debt backed by debt......

#1 User is offline   Winstonm 

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Posted 2006-May-27, 12:32

Last year when I filled my car with gasoline the cost was twenty U.S. dollars. This past week the cost had soared to over thirty U.S. dollars. The oddity is I cannot determine if the basis for this additional cost is a rise in the price of gasoline or a decline in the value of the U.S. dollar.

The U.S. dollar is fiat money, paper money with no inherent value other than as a trading medium. Let us suppose for a moment that the U.S. dollar were backed by a standard such as gold, that is one U.S. dollar could be redeemed for one gold coin. In such a case, when I had to pay an extra dollar for my gasoline I would know that the scarcity or demand for gasoline had risen - supply and demand at work to establish prices. I would know this because the value of gold did not change drastically - my dollar bill would still "buy" one gold coin.

However, when I am using fiat money, there is no way to determine whether the demand/scarcity of gasoline has changed or whether the value of the I.O.U. "dollar" I am using as an exchange medium has changed.

Suppose I am OPEC with one barrel of oil to sell. Last year I could sell the U.S. that barrel for fifty U.S. dollars and turn around and use those fifity U.S. dollars to buy a vcr from Japan; however, this year, the Japan vcr makers want seventy U.S. dollars for the same vcr - not because of demand/scarcity of vcrs, but because on the world market the trust of the value of the U.S. dollar has declined. So as OPEC, I simply raise my price to accomodate the decline in the dollar. So this year I charge seventy U.S. dollars for that barrel of oil.

This free-floating market value of the dollar could not occur with a commodity-backed currency. The value of the currency is determined by the value of the commodity.

So my question is this: can a fiat economy be sustained indefinately or is there a point at which it must collapse?
If something cannot go on forever, it will stop. - Herb Stein
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#2 User is offline   mike777 

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Posted 2006-May-27, 12:47

"However, when I am using fiat money, there is no way to determine whether the demand/scarcity of gasoline has changed or whether the value of the I.O.U. "dollar" I am using as an exchange medium has changed."

There are alot of ways to measure this. In fact these items are measured everyday, nothing new here. Fiat economies collapse all the time, nothing new.

Yes the "dollar" acts as claim against the assets of the country. What those assets are and how much they are worth and will the claim be honored is a judgement made by the markets every minute of every day.


A currency board or fixed peg has its plus and minus. For many small countries using a currency board attached to the usa dollar or euro makes sense(google Hanke), for large countries such as China...no.

I happen to be one of those who do think Gold is a leading indicator of inflation, esp. when it doubles in price in a shortish period of time, many disagree.

I also view inflation as too many dollars chasing too few goods. I still think Friedman, father of famous bbo poster.....has the right view of just using the fed's open market operations to stop inflation.
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#3 User is offline   hrothgar 

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Posted 2006-May-27, 12:51

Comment 1: The primary reason that gasloine is costing so much more is a simple consequence of supply and demand. There have been a series of supply shocks which are primarily related to political instability in oil producing regions like Iraq, Nigeria, and Saudi Arabia. Coupled with this, the Chinese an Indian economies are developing causing a demand shift. The end result is a very predictable increase in the cost of gasoline.

Comment 2: The whole gold standard discussion is a red herring. Historically, countries were able to manage their currency by pegging its price to something else. Precious metals like gold and silver were a popular choice for a long. More recently, many countries attempted to peg their currency to another currency. For example, the Iraqi dinar and the Chinese Yuan are both pegged against the dollar. In general, trying to maintain a currency peg is infeasible against market pressures is infeasible. This worked in the past because the financial markets were much less developed. Now-a-days folks like Soros are completely capable of taking down a government (look what happened to Thailand etc. a few years back)

Comment 3: It's much easier to maintain a fiat monetary regime than a fixed peg. (Thats why we use them). This doesn't mean that you won't see periods of inflation, hyper-inflation, or even deflation. Many people would argue that there is a real danger that the value of the dollar will take a severe hit. The value of the dollar is artifically high because many other countries use dollars as a reserve currency. Personally, I suspect that many countries that are hevaily leveraged in dollars would like to find a way to diversify their holdings.
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#4 User is offline   luke warm 

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Posted 2006-May-28, 20:34

i don't particularly agree with richard that the 'gold standard' debate (if one exists) is a red herring... i do think that here in america we have grown accustomed to having our cake and eating it too

whether a country is on a gold standard (and i mean totally, not fractionally) or not, in the final analysys it is the trustworthiness of that country's gov't that determines the stability of its policies... i don't personally think our gov't is very trustworthy, so it seems intuitively better to link the value of the dollar to an ounce of gold... at least that way there would be more accountability (and maybe electoral fear) from our elected officials... that also means that unless the price of gold went up to 2 or even 3 thousand bucks an ounce, nothing would change

i think it could work, i don't think we have the political or social will to do it
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#5 User is offline   mike777 

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Posted 2006-May-28, 20:45

"i think it could work, i don't think we have the political or social will to do it"

Certain unnamed Southerners seem to think the citizens of a country get the government they deserve and as a result reap the consequences of an election or lack of will....whatever. :)

What state is that Jefferson guy from who gets elected year after year without anyone running against him? And is it just me but does 90 grand just sound too cheap to buy influence?
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#6 User is offline   luke warm 

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Posted 2006-May-28, 21:07

hey, you won't find an argument from me... that's part of the having your cake and eating it too that i was speaking of

we have the best gov't money can buy... fiat money, that is :)
"Paul Krugman is a stupid person's idea of what a smart person sounds like." Newt Gingrich (paraphrased)
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#7 User is offline   helene_t 

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Posted 2006-May-29, 01:57

All countries (AFAIK) have a paper-based currency. This works as long as financial markets trust that governments (or central banks) will try to keep their currencies stable.

For central banks and governemts, it has the advantage that the currency becomes a financial instrument. Of course, this is a disadvantage for those who distrust the govenment to keep the currency stable (or at least predictable).

I wonder how the system continues to work in the current money markets dominated by electronic money. The central bank can control inflation by controling the production of bank notes, but it must be much more complicated to control the production of electronic money.
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#8 User is offline   Al_U_Card 

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Posted 2006-May-29, 07:23

The inherent source and cause of monetary or fiscal inequities.

"Value for money."

No matter what the basis of the economy, those that do well produce goods or services efficiently at a relatively lower cost than their competitors. Whenever you provide value for money, as long as you are profitable, you will prosper. More and more we see bloated business infrastructures, wasteful government bureaucracies and downright profiteering (the oil companies/banks etc and their record-breaking profits) which steal away the value that we receive for the money that we spend.
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#9 User is offline   FrancesHinden 

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Posted 2006-May-29, 08:49

hrothgar, on May 27 2006, 07:51 PM, said:

Comment 1: The primary reason that gasloine is costing so much more is a simple consequence of supply and demand. There have been a series of supply shocks which are primarily related to political instability in oil producing regions like Iraq, Nigeria, and Saudi Arabia. Coupled with this, the Chinese an Indian economies are developing causing a demand shift. The end result is a very predictable increase in the cost of gasoline.

Additional comment: the price of gasoline in the US has gone up more, and appeared to go up even more than in Europe for various reasons.

i) The tax/duty on gas in the US is much lower than in Europe, so an additional dollar on the cost/gallon is a much higher percentage increase than an additional dollar in Europe.

ii) The hurricanes last summer caused a number of refineries to close temporarily, which reduced the supply of gas in the US.

iii) There has been an additional supply/demand squeeze in the US that we haven't seen in Europe due to a recent change in motor gasoline specifications. Many US refineries needed to be upgraded to cope with the revised specifications so while that was being done there has been a shortage of refinery capacity driving product prices up even above the global increases in crude prices. At various times the last couple of years it has become economic to ship refined products from Europe to the US.

Quote

In such a case, when I had to pay an extra dollar for my gasoline I would know that the scarcity or demand for gasoline had risen - supply and demand at work to establish prices. I would know this because the value of gold did not change drastically - my dollar bill would still "buy" one gold coin.


Of course, the value of gold can and does change drastically: it's a very volatile commodity. Now, if the US went back to the Gold Standard it's possible (likely?) that the volatility of gold prices in non-USD would decrease dramatically but it wouldn't answer your problem.
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#10 User is offline   DrTodd13 

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Posted 2006-May-29, 11:03

Fiat currencies are immoral. Governments love them because it allows them to print money whenever they like. Printing money is nothing more than theft...stealing from everyone who has money at the time of the printing. The fractional reserve system has the same effect. I don't care what the effect of having real money would be. I think it is a moral issue. I won't listen to anyone who wants to make the argument that we have to have a system that systematically steals from everyone "for their own good."
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#11 User is offline   whereagles 

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Posted 2006-May-29, 11:31

There are some geological hints that world light sweet crude oil production might be peaking.

What does this mean? Simple: extracting oil is pretty much like squeezing a sponge. While it's soaped with some liquid, the sponge drips by itself. As the liquid becomes scarcier, you have to start applying pressure to keep the liquid flowing. The less liquid is there to extract, the less comes out, even if you apply lots of pressure. The result is that extraction over time looks like a bell-shaped curve, with decline after reaching a peak production, the so-called 'peak oil'.

The peak oil theory was presented by geologist King Hubbert in 1956 and was verified experimentally with US domestic production in 1971, when the peak/decline curve was clearly seen in practice. Now history repeats itself, this the whole world close to the point of peaking (if not past already).

Not that we're going to run out of oil anytime soon (there's lots still to be squeezed out), but past-peak production will decline, resulting in less and less gasoline and consequently higher and higher prices.

The peak theory, being geophysical, applies only to light sweet crude, whose world reserves are estimated to be something like 2-3 trillion barrels. There are many more barrels in non-conventional oil sources (2-3 trillion tar sands, 1.5 trillion oil shale), but their extraction is much, much harder than that of light sweet crude and their rate of flow might never be enough to make up for what we need (85 million barrels/day).

More info on:

Oil drum
Peak oil site
Association for study of peak oil

Be warned the talk there is rather pessimistic, though. But it does have the virtue of alerting to the problem.
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#12 User is offline   mike777 

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Posted 2006-May-29, 11:37

"The peak theory, being geophysical, applies only to light sweet crude, whose world reserves are estimated to be something like 2-3 trillion barrels. There are many more barrels in non-conventional oil sources (2-3 trillion tar sands, 1.5 trillion oil shale), but their extraction is much, much harder than that of light sweet crude and their rate of flow might never be enough to make up for what we need (85 million barrels/day)."

Ya peak theory is another silly theory that ignores economics. Your last sentences hit the nail on the head. Tar sands, Oil shale and price drive the solution to this fake crises. I note oil is up a buck from last year and still the USA drives more this weekend than last year...so much for the gas price crises...we Americans whine and whine and then drive even more.......
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#13 User is offline   hrothgar 

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Posted 2006-May-29, 12:20

DrTodd13, on May 29 2006, 08:03 PM, said:

Fiat currencies are immoral. Governments love them because it allows them to print money whenever they like. Printing money is nothing more than theft...stealing from everyone who has money at the time of the printing. The fractional reserve system has the same effect. I don't care what the effect of having real money would be. I think it is a moral issue. I won't listen to anyone who wants to make the argument that we have to have a system that systematically steals from everyone "for their own good."

I'm interested in understanding the depth of your psychosis.

There is a school of economists known as monetarists who argue that in favor fixing the rate at which the money supply grows. A typical argument is that the expected long term growth rate for the economy is .75% per annum. Accordingly, the central government should increase the size of M1 by .75% per annum. The government would apply the same growth rate regardless of whether the economy was experiencing a recession or an economic boom. Is this still immoral? If this is immoral, why does morality require deflation?

A more complex question involves the notion of “Rational Expectations”. Rational Expectations is a fancy way of stating that the economy is able to adapt to events that are known to happen in the future. Case in point: Assume that the government credibly committed to increasing the money supply by 15% on August 18th, 2038. Rational expectations states that consumers and producers will design their long term contracts such that the impact of the future increase in the money supply is built into the system, thereby negating much “real” impact on the economy. Some individuals go so far as to argue that the government is only able to impact the economy when it takes an unexpected course of action. Do any of these types of issues impact your dogma? Do you differentiate between expected and unexpected events?
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#14 User is offline   whereagles 

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Posted 2006-May-29, 12:37

mike777, on May 29 2006, 05:37 PM, said:

1.
Ya peak theory is another silly theory that ignores economics.

2.
Your last sentences hit the nail on the head.  Tar sands, Oil shale and price drive the solution to this fake crises.

3.
I note oil is up a buck from last year and still the USA drives more this weekend than last year...so much for the gas price crises...we Americans whine and whine and then drive even more.......

1. It's not a theory, it's a fact :) Light sweet oil will peak sooner or later. It's just a matter of time. Can take a while though.. about 20 years if conventional oil reserves turn up to be in the 3 trillion range. We might be able to weather the storm, but our children might not. Please note that 'peak oil' refers to light sweet crude only. Shale and tar sands have different geologies.

Economics isn't a concern for peak oil theory because the theory is just physics. It isn't the same as Apocalypse Now; it's just a statement of how conventional oil production will behave in the course of time.

Of course economics might change the law if new tech such as CO2 and nitrogen injection increase the percentage of oil that is recoverable, but it can't change the trivial fact that you can't take 2 litres out of a 1 litre bottle.


2. Tar sands and oil shale have technical problems, but money isn't an issue. Physics is, though. It might be unfeasible to extract for, say, 20 million barrels a day. That I don't know.. the tech is still at an early stage of development. Still, there will be a crisis at some stage, after all the light sweet, shale and tar is used up. Could take 100+ years, though.


3. Well, that's economics :P Everything goes up in price but in the end it's all business as usual. Money is just paper. Geology isn't, though.
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#15 User is offline   luke warm 

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Posted 2006-May-29, 12:54

hrothgar, on May 29 2006, 01:20 PM, said:

DrTodd13, on May 29 2006, 08:03 PM, said:

Fiat currencies are immoral.  Governments love them because it allows them to print money whenever they like.  Printing money is nothing more than theft...stealing from everyone who has money at the time of the printing.  The fractional reserve system has the same effect.  I don't care what the effect of having real money would be.  I think it is a moral issue.  I won't listen to anyone who wants to make the argument that we have to have a system that systematically steals from everyone "for their own good."

I'm interested in understanding the depth of your psychosis.

There is a school of economists known as monetarists who argue that in favor fixing the rate at which the money supply grows. A typical argument is that the expected long term growth rate for the economy is .75% per annum. Accordingly, the central government should increase the size of M1 by .75% per annum. The government would apply the same growth rate regardless of whether the economy was experiencing a recession or an economic boom. Is this still immoral? If this is immoral, why does morality require deflation?

A more complex question involves the notion of “Rational Expectations”. Rational Expectations is a fancy way of stating that the economy is able to adapt to events that are known to happen in the future. Case in point: Assume that the government credibly committed to increasing the money supply by 15% on August 18th, 2038. Rational expectations states that consumers and producers will design their long term contracts such that the impact of the future increase in the money supply is built into the system, thereby negating much “real” impact on the economy. Some individuals go so far as to argue that the government is only able to impact the economy when it takes an unexpected course of action. Do any of these types of issues impact your dogma? Do you differentiate between expected and unexpected events?

i don't think it's fair to label his opinion as some sort of psychosis... imagine for a moment that the usa had been on the gold standard prior to the iraqi attack... would it have occurred? (true, we did "temporarily" go off gold to finance wwI, but that's my point)... however, if a war has to be financed, a gov't can't merely finance one by stealing, as the usa has done for decades.. at least it can't in a moral sense

if one holds the view that governments can, or should, only represent the will of the governed, it seems that its (the gov't's) ability to print money (at whim - read up on the billions of newly printed money shipped to iraq) must be curbed in some way... presently there is no such curb nor is there any electoral accountability

the global economy issue, imo, is the real red herring here... trade balances among nations would seem to be more equitable given a gold standard.. i'm not an economist, but matt is... i don't know his views on fiat vs. gold standard, but i'm sure whatever they are they'd be worth hearing
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#16 User is offline   mike777 

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Posted 2006-May-29, 14:01

peak theory says oil has peaked in fact years ago..not sometime in the distant future...peak theory does not only apply to sweet crude...that is your theory :P.

Again price as a rationing device until price forces new tech to be price viable...that is pretty simple though many seem to find it impossible.

Look many said whale oil peaked and we are running out of whale oil and how will run the world when whale oil runs out...samething...

I just think price will act as the rationing device and I think tech will evolve faster than many think.......but that is another thread.....

I also note that oil is often thought of as a nonrenewable resource....Heck if we can clone people I bet down the road we can clone oil or some source of energy.....Just a matter of price..oops that word again.
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#17 User is offline   whereagles 

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Posted 2006-May-29, 14:20

mike777, on May 29 2006, 08:01 PM, said:

1.
peak theory says oil has peaked in fact years ago..not sometime in the distant future...

2.
peak theory does not only apply to sweet crude...that is your theory :).

3.
Again price as a rationing device until price forces new tech to be price viable...that is pretty simple though many seem to find it impossible.

4.
Look many said whale oil peaked and we are running out of whale oil and how will run the world when whale oil runs out...samething...

5.
I also note that oil is often thought of as a nonrenewable resource....Heck if we can clone people I bet down the road we can clone oil or some source of energy.....Just a matter of price..oops that word again.

1. No.. peak oil says US oil peaked many years ago. Which is true.

2. It applies to the output of a conventional oil well. The reason other sources are brought into the picture is because decline in easily-extractable oil makes it scarcer. Unless you can make up with non-conventional sources (not yet clear if you can), scarity will force some changes in the way we use energy. So, in theory, peak oil applies to conventional oil, but since it's used with political intentions, the frontier gets blurred.

3. Well, that's very simple to me.. certainly not impossible.

4. Whale oil is renewable, as long as you don't exterminate the whales :P

5. Crude oil is not, though. It does regenerate naturally, but at too slow a pace. We can syntethize it, of course, but not at a rate of 85 million barrels a day.
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#18 User is offline   bid_em_up 

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Posted 2006-May-30, 14:30

There is one company that is claiming to have (supposedly) made some major inroads made into tar sands extraction technology, at a fraction of the costs of todays current technologies that will make it a more viable option in the near future.

Whether or not the company's claims are true, I do not know. At least on the surface without drilling too deep (pun intended), they appear to be.
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#19 User is offline   whereagles 

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Posted 2006-May-31, 03:52

Hum.. does that company feature in the NYSE? :rolleyes:
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#20 User is offline   bid_em_up 

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Posted 2006-May-31, 07:19

whereagles, on May 31 2006, 04:52 AM, said:

Hum.. does that company feature in the NYSE? :rolleyes:

No, its on the NASDAQ.
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