Tuesday, April 9, 2013

Laser Guided Policy and the 80th Anniversary of EO 6102


To gold bugs, and more recently, American libertarians U.S. President FDR's executive order 6102 looms in their imaginations as one of the key examples of their government turning on the citizenry and illegally seizing their property.

Back in 1933, citizens were compensated for their forfeited gold at a fixed price of about $20/oz. The fine for  not turning it over to the state was the equivalent to about $175,000 today, in addition to the threat of 10 years imprisonment. Of course many Americans did not turn over their gold, and there are few if any reported cases of anyone actually going to prison over it.

Anonymous comment contributors to skeptic financial blogs (or fringe blogs, depending on your view) seem to think that the U.S. and certain European countries are preparing for a similar move. It's not unreasonable to hypothesize that personal gold confiscation could happen again. While it is unlikely that we will return to a gold backed currency in the west anytime soon, if ever. But if the Euro, the GBP, CAD or USD were suddenly devalued to pay off liabilities - at face value a scenario of gold confiscation through forcible "repurchasing" is not as paranoid as it might seem...
While Keynesian economists view gold as a "barbarous relic," obsolete as a viable currency, there is a good reason it has been said that, "gold is the money of monarchs." Between nations, institutions, and armies - those who are in power, or external to it - gold has always been and will continue to be an acceptable method of payment. Citizens and subjects bound by regional laws may be forbidden to transact in gold, but so long as there is a market external to a given state, there will always be some demand for gold. Its physical and economic qualities have demonstrated it is a viable candidate for a permanent currency. The only arguable element of that is the question of 'currency to whom?'

If the law were that subjects are forbidden from transacting business in gold, then from the perspective of someone aligned to the law, a gold ingot is indeed useless lump of metal. In that view, the value of a currency is entirely social. Paper is valuable precisely because it is backed by sovereign promises and social power. In the case of paper, when all value is social, non-social (or anti-social) value necessarily means less value.  This explains both Paul Krugman and Ben Bernanke's skeptical views about the value of gold, since gold has (or requires) no intrinsic social value; where paper currency exclusively represents social value. To them, all other means of exchange - ones that do not represent intrinsic social value or backing - are essentially barter. Anti-social currency does not require a society or any kind of collective alignment to function beyond an exchange between two individuals.  That view would likely purport that even animals can barter, but only human societies can engage in currency based trade.
 
So in the year 2013, with the USD as the global reserve currency, and with the GBP and JPY as close seconds as convertible paper currencies, why would the 'murican gub'mint, or any other democracy  bother with an executive order similar to FDR's 1933 edict that confiscated all gold held by private individuals?

If they or any European governments did, it might be for surprisingly similar reasons as FDR.

As governments run short on funds to pay their liabilities, and need more assets to put up as collateral on new debt to fund their deficits, they have two main options to raise the cash. The first is to "print" the money to pay the liabilities. This can mean anything from literally printing dollar bills and using them to the pay pensions, bond holders, employees, fund social programs they promised - to "borrowing" the money from central banks and other institutions it already controls; the odd equivalent to forcing employees take out lines of credit to loan their bosses money.  The second option is to raise the tax haul by demanding more money from people who will not, or cannot, vote the government out of office.

Japan has just embarked on the first case, where it has signaled that it will "double its monetary base" and devalue its currency by half over the next few years.  Without a bit of a background in economics, it can be hard to appreciate the relationship between nominal vs. real prices fully. This means that any savings held in yen will in a few years be worth only half what they are now. The short version is, instead of the government just confiscating half of savers' balances, they will double the supply of money and flood it into the market. The prices in yen for everything bought and sold in Japan will effectively double over a few years, but the price of these things when bought by foreigners with strong currencies will be cut in half. It's a firesale on Japanese assets, with Japanese cash savers taking the loss on the discounts, and the government will reap the nominal economic "profits" to pay their debts.  It could be said that this is like a bar choosing between serving half pints when people paid for full ones, or just watering down the beer. 

Printing money has additional problem that, the more you print, the less acceptable it becomes as collateral for loans that fund spending, the more you need to print, the less acceptable it becomes and the interest rate to pay back debts becomes unmanageable. You see where this goes. There are numerous mainstream economic examples of debasement in recent history, and extreme comparisons to Zimbabwe and Wiemar Germany are both unnecessary and misleading.

A number of western countries are looking at raising money through devaluing their currencies by increasing their monetary base. It's already happening as part of a informally declared "currency war" by countries like Brazil, Argentina, Japan and China, among others. They do this to make their exports cheaper than rival countries due to more favourable exchange rates. Debasement can be a  precursor to hyperinflation, but that is more of a nuclear option a government can use when it can no longer fund itself and must continue to pay the popular coalition that keeps it in power, usually at the expense of people with savings and wealth. Hyperinflation is an extreme outcome from debasement and it usually ends in strife and civil unrest. These are just the cost of business in politics, and so in this sense, currency debasement "works."

The second way to raise money is to impose taxes, either by raising existing ones, or finding new things to levy taxes on, known euphemistically as "broadening the tax base." Usually the imposition of taxes is some combination of the two. The cardinal rule of taxation is that the source of tax must come from people  who cannot organize to vote the government out of office, and they should be on assets that cannot easily be spirited out of reach.

The U.S. has already embarked on a tentative combination of money printing and tax imposition, most recently by proposals for increased income taxes on the "rich" (incomes greater than $250,000 a year) and changing rules that allowed savers to withdraw their retirement savings above $200,000 at a low to negligible tax rate. The targets of these taxes form such a small portion of the electorate, that they are unlikely to be able to form a coalition to resist that could unseat the Democratic Party from power.

Advances in personal information and marketing databases technology mean that the population can be sliced and diced according to criteria so specific, that a Democratic (or Republican) policymaker could find out fairly precisely not only how many people a tax on retirees who withdrew more than $200,000 in a given year would affect - but where most of them live, how many of them live in electoral districts that voted Democrat, how close the vote was in that district, what effect a given group of retirees would have on the electoral college votes in the region, and in how many years they were likely to make the bulk of their withdrawal.

The ability to broaden the tax base with this kind of laser focused policy makes it surprisingly plausible that a constituency of upper middle-class individuals - who vote non-Democrat, who already identify as disenfranchised and have little faith in government, who are politically isolated from public institutions or political organizations (other than the NRA), and who are holding significant stores of wealth outside the mainstream financial system - would become a target for tax base broadening.

From a policy perspective, such a group is almost too good to be true. What's more is that the nominal increase in the price of gold in the last 5 years means that this group has had its capital appreciate by a significant multiple. At the time of this writing, the price of gold is hovering around a volatile $1600 USD, up from less then $500 a decade ago. Commentators who include professional bankers, successful investors and hedge fund managers, and even some mainstream politicians have made predictions based on arguably rigorous analysis that the gold price could reach $2500, $5000 or even $10,000 USD per oz in the foreseeable future.

Whether they are correct or not, before the end of the next administration (less than 8 years) the individuals who own physical gold will be sitting on an undeclared capital gains exposure of anywhere between %150 and %1000 or more. Even if it were technically legal today to sit on the gold and not pay taxes each year on it, gold bugs are a sitting on stockpiles of what could be presented as "anti-social" hoards of wealth. Any reprise of FDR's EO 6102 would be more subtle. But if the gold price hits a high enough threshold, it is plausible and even likely that the government would force the declaration of individual gold holdings for the purposes (or with the pretext) of collecting capital gains taxes.

Given that financial transactions greater than $10,000 are routinely and automatically reported to financial authorities in most western countries, social media and web tracking profiles can identify whole classes of individuals based on shared habits, communications patterns, and browsing histories, and the relative political isolation of gold bugs from mainstream politics, the technical details of how to identify gold owners and collect contraband metal from them is as simple as sending them targeted election messages.

If the financial crisis deepens, both in Europe and America, a preoccupation with government seizures of physical gold from individuals may not turn out to be an artifact of right-wing paranoia after all. Perhaps ironically, presuming that physical gold will protect individuals from the debasement of social currencies and deposit confiscations, may be the truly irrational belief.  Perhaps in their skepticism about the value of gold as a hedge against debasement and inflation, there is something Messrs. Krugman and Bernanke are not telling us. 

 It is not a matter of if a repeat of EO 6102 is possible, but rather why and how such a reprise could occur. Political risk from a government targeting upper-middle-class gold bugs with punitive capital gains demands to "broaden the tax base" is a scenario more  commentators and advocates should price in to any gold based strategy. 


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