Barbara Rezende

- Feb 13, 2021

Silver and Narrative Economics

In July 2011, US Congressman Ron Paul, during one of his famous instigations to US chairman of the Federal Reserve, Ben Bernanke, asked why the Fed and many other central banks in the world hold gold as reserve and not diamonds. Mr. Bernanke gave the most simple and reliable answer: "Well it's tradition - long term tradition."

However, gold has not always been the king, before 1873 the US had been under the bimetallism, using also silver to back up the currency.

Bimetallism status quo worked well in the US until 1849, with the equivalent silver ratio of 16:1 to gold in ounces. This dynamic was altered in the aforementioned year, with the flood of gold to the market following the Gold Rush. At the time, people could sell their silver privately and to foreign markets at a lower ratio, making more money. In 1860 silver was discovered in Nevada, but the government, in a populist measure, kept the ratio at 16:1. As expected, this measure led to higher circulation of money, more purchase power to farmers and the poor, who could easily pay off debts or make purchases. The moment was not so bright to Wall Street, which was not making profit from the farmer's loans.

However, by 1873, the flood of silver into government coffers created an economic crisis. Congress responded by passing the Coinage Act of 1873, which effectively ended bimetallism by eliminating the silver dollar and by making gold the only metallic standard (though the U.S. did not accept the Gold Standard de jure until 1900). Western miners and farmers termed it the “Crime of 1873.” Their “Free Silver” movement became a core constituency of the Democratic Party, represented by William Jennings Bryan.

When Willian J Bryan delivers his "Cross of Gold" speech at the Democratic National Convention in 1896, it was a strong criticism of the gold standard and the established system: "Having behind us the producing masses of this nation and the world, supported by the commercial interests, the laboring interests, and the toilers everywhere, we will answer their demand for a gold standard by saying to them: You shall not press down upon the brow of labor this crown of thorns.” Bryan raked his fingers down his temples. "You shall not crucify mankind upon a cross of gold.” Well done, he got the nomination for presidency right after the clamorous speech, but the Republican candidate, McKinley, won the race.

The US abandoned the gold standard in 1971 under President Nixon, with the switch to a floating dollar. The fiat model was being largely defended by eminent economists such as J. M. Keynes as a necessary measure to fight the higher unemployment and the devaluation of the currency.

It is easy to see that Mr. Bernanke was correct, gold as the main central bank reserve follows a long tradition, but more than that, it is part of a powerful popular story, which influences collective and individual economic behavior. This phenomenon is brightly badged by the Nobel Prize Robert Shiller as Narrative Economic.

No doubt, silver is the most popular of the metals and during the last week of January/first week of February, the metal was the focus of the markets, which was actively following the metals squeeze. The graph, from Bloomberg, shows the call option implied volatility of the COMEX Silver Futures jumping from 20's% to 60% as result of the retail surge on February 2nd. The rumors around the silver quote movement points to a desire to hurt big banks with ample short positions in silver, following the GameStop strategy. However, different from stocks, commodities short positions is a promise to deliver the physical underlying commodity at some agreed date. While some shorts are speculative and require covering before expiring, most are driven by industrial producers hedging their forward earnings. Redditors and WallStreetBets already said they were not behind the retail coordinated surge.

Cross of Gold speech is more than a century behind, but when mixed with ongoing movements, produces a clear view of how recurring narratives can fascinate and affect confidence in others, creating the desire to engage in conspicuous consumption and beliefs about monetary institutions.

MMT and dichotomy

On December 26th, 2020, I finished “The Deficit Myth”, by Stephanie Kelton. Professor Kelton describes in her book the pillars of Modern Monetary Theory, “MMT”. After closing the book, I checked the Bitcoin price, it had hit $27K for the first time, thus far a record high.

Modern Monetary Theory is gaining a lot of attention recently, not surprising in a world in which government debt is rapidly rising. However, according to MMT, there is nothing to worry, the government does not operate under a budget constraint, and it can create as much (sovereign) money it wants to buy as much debt it wishes in order to spend and invest to generate jobs for everyone. First condition: the government must have debt only in the currency that it has control, its own currency (the history is over for emerging economies, like my home country Brazil).

Being honest with the MMT and avoiding the simplicity to condemn the theory at first glance, MMT supporters believe that the main goal of the government should be to address unemployment. The government must spend as much as needed to achieve full employment because, according to the theory, the financing directed to accomplish that goal is not a constraint. Who pays for it? The government creates money (the owner of the printing press). In this scenario, taxes are not the answer to finance the spending, taxes in the MMT serve other purposes such as redistribution of income and wealth and to create an obligation to people to use the currency issued by the government. You must own the currency to pay taxes that are payable only in that specific currency.

Supporters don’t believe this practice will create inflation, even if the history tells them opposite.

In the U.S., the annual inflation rate is calculated using 12-month selections of the Consumer Price Index, which is published monthly by the Labor Department’s Bureau of Labor Statistics (“BLS”). The annual inflation rate for the United States is 1.2% for the 12 months ended November 2020, published on December 10, 2020 by the BLS. 1.2% is a very low number, well below the actual target of 2%. However, it is not the feeling in the most populated urban centers. According to The Chapwood Index, the true cost-of living in spiking up in America. For the first half of 2020 cities like Los Angeles and New York experienced increases above 12% yoy. It is hard to believe that it is not correlated with the total public debt as percentage of GDP, ski rocking ~130% (USA-Q32020)

But let’s do a short exercise, even if the government doesn’t face budget constraints and inflation is absent, it will be the government decision to spend where it wants and how it wants and I would be happy to believe that the politician’s main purpose is not to stay in power.

MMT in the end evokes and embraces an activist fiscal policy, financed by a state-controlled central bank. The theory is a virtuous road paved with beautiful promises that the government should create jobs for everyone, and unemployment is brutal and should not exist. Seems like this “macroeconomic” discourse is following the actual debates in our society, mainly about gender and race and creating dangerous dichotomy. Compromise, complexity and even compassion for the counterpoint are impossible in this context, because any issue, by definition, will be defined by a dichotomy between two positions, one virtuous and correct and one sinful and wrong, the latter which often either is, or has been, the prevailing oppressive paradigm.

Is BTC the alternative? Hard to say yes, but it is harder to ignore.

First central bank and stablecoins

If you go to Google and type “what was the first central bank in the world”, the answer will come as Swedish Riskbank, established in 1668. However, according to an increasing number of academics, the first central bank in the world was the Bank of Amsterdam (1609-1820).

The Bank of Amsterdam was owned by the City of Amsterdam and was famously discussed in Adam Smith’s Wealth of Nations, becoming one of the best-known public deposits banks in Europe. As any other public deposits banks during the time, the Bank of Amsterdam started out as a “stablecoin”: it issued deposits backed by silver and gold coins, and settled payments by transfers across deposits (Jon Frost, Hyung Song, Peter Wierts, 2020).

At the beginning, the aforementioned first central bank operated as a passive or rigid stablecoin, which means that new deposits could be created only by holders surrendering gold and silver coins.

According to Schnabel and Shin (2014), Amsterdam pre-eminent financial center was key to Bank of Amsterdam success playing one of the most important roles of modern central banks: settlement liquidity. The Bank played a central role in European and global trade, channeling hundreds of tons of silver coins, mostly from Spanish colonies, to growing economies in Asia. The ability to execute payments promptly and effectively, maintaining the settlement liquidity, is one of most important characteristics of actual established central banks

In 1683 the Bank of Amsterdam found itself performing more and more the lender role, but it began to operate as an “elastic stablecoin”, where the value of its deposits was backed by the general strength of its balance sheet rather than the ability to convert it to gold and silver coins. In summary, the Bank began to resemble modern central banks, as a public institution issuing fiat money.

The Bank had a strong performance over more than a century, passing through times of turbulence, and solidifying itself as an institution. From Adam Smith:

“At Amsterdam, however, no point of faith is better established than that for every guilder, circulated as bank money, there is a correspondent guilder in gold or silver to be found in the treasure of the bank. The city is guarantee that it should be so.”

However, the Bank lacked one key part of modern central banks: it was not fully fiscal backing of the sovereign. The Bank was owned and governed by the City of Amsterdam, but the city authorities did not extend fiscal backing to the Bank to return the Bank to full solvency through fiscal transfers (Jon Frost, Hyung Song, Peter Wierts, 2020).

While it was able to survive bouts of political turmoil, the Bank saw the depleting of its stock of silver and gold coins driven by its lending to the Dutch East India Company (“DEIC”). In the Anglo-Dutch war, the Bank relied in particular on unsecured lending and on open market operations with DEIC, and with the conclusion of the war the Bank had accumulated a large credit exposure which became non-performing.

The City of Amsterdam was not able to play the role of a modern fiscal authority, which means no taxation power that governments have today. The lack of fiscal backing, combined with weak governance and economy ravage by war culminated in the Bank of Amsterdam default, closing the doors in 1820.

In light of Bank of Amsterdam's first years and 100% backed by gold and silver coins, today we have a decent number of private stablecoins initiatives, and the most well-known is Libra, by Facebook.

According to its creators, Libra would be backed by a basket of currencies, starting with US dollars, euro, British pounds, Japanese yen and Singapore dollars. It would be governed by the Diem Association, made up of various private companies who would operate “nodes” in the network, and assets would be held in the Libra Reserve.

Stuart Levey, Diem Association CEO, was not focused on the new currency side during its latest public statement, but rather in the payment system that the Facebook related association is about to launch: “The Diem project will provide a simple platform for fintech innovation to thrive and enable consumers and businesses to conduct instantaneous, low-cost, highly secure transactions. We are committed to doing so in a way that promotes financial inclusion – expanding access to those who need it most, and simultaneously protecting the integrity of the financial system by deterring and detecting illicit conduct."

Libra (LBR) started aiming to be a fiat currency, but Diem Association decided to change the project and now LBR will not be a separate digital asset from the single-currency stablecoins. According to Diem's White Paper, LBR will simply be a digital composite of some of the single-currency stablecoins available on the Libra network. It will be defined in terms of fixed nominal weights, such as the Special Drawing Rights (SDR) maintained by the International Money Fund. The new goal for Diem Association is to have LBR being used as a cross-border settlement coin as well as a neutral, low-volatility option.

Given Central Banks enforts to issue the Central Bank Digital Currency (CBDC), Diem Association new approach for Libra seems to comply with all requisites for a perfect integration, not risking to end-up like Bank of Amsterdam, using fiat currency without the fiscal backing of the government.

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Silver and Narrative Economics

MMT and dichotomy

First central bank and stablecoins