Recently J. P. Koning at his Moneyness blog noticed that so-called “Fedwire” transaction volume is down this past year and a half.
The “Fedwire” is a mechanism that enables banks with Federal Reserve accounts to calculate their net obligations at the end of each day and settle that net difference. So, for example, rather than having Bank A pay Bank B $9 billion from one set of transactions, only to have Bank B pay Bank A back $10 billion owing to a different set of transactions, the obligations would be mutually settled through Fedwire and the only net transaction that would have to take place would be for Bank B to pay Bank A $1 billion at the end of the day.
This might seem like a trivial accounting difference, but it actually has critical implications. In order to settle obligations in the first scenario, the banks need $10 billion in currency, or they would need to resort to short-term overnight credit. In order to settle obligations in the second scenario, only $1 billion in currency is needed.
But who cares how much currency is actually needed? Can’t the Federal Reserve just print more currency if it is needed to circulate the desired amount of value that parties wish to transact?
Well, the Federal Reserve could do this, but increasing the dollar tokens with respect to gold would devaluate the dollar versus gold, and at some gut level the Federal Reserve understands this. After all, if the Federal Reserve had absolute freedom to expand and contract the monetary base as the “demands of commerce” apparently demanded, then there would be no need for settlement mechanisms or short-term credit in the first place. No bank would want to take out an overnight loan if it could just as easily ensure that it got paid in hard cash by calling up the Federal Reserve and letting them know that the “needs of commerce” demanded more liquidity.
So, the settlement mechanism is actually quite important. It allows commercial activity to expand to many multiples of what the dollar monetary base, and the world gold market standing behind that, would allow by themselves. The J. P. Koning article linked to above has some exact figures that will astound you—for example, that the Fedwire in 2015 handled $834 trillion in transactions, even after using the settlement mechanism. (How much more money would have had to have changed hands without the settlement mechanism!) To be sure, most of that trading was probably speculation in financial assets of various sorts, but still….
If you will recall from my previous post on money capital vs. commodity capital, I found to my surprise that, over the last 50 years, annual world GDP as measured in ounces of gold has averaged about 1000 times the annual production of gold bullion on the world market, with unsustainable boom periods marked by world GDP outstripping this average, and periods of crisis marked by world GDP lagging behind this average.
In a hypothetical world where a given ounce of gold, or its dollar-token equivalent, could only be exchanged once per year, where there was no credit offered by anyone, and where settlement mechanisms such as Fedwire did not exist, world gold production would need to have been about 1000 times greater in volume over the last 50 years in order to accommodate the circulation of the value of the commodities being circulated. Capitalism overcomes this “metallic barrier” by:
1. Increasing the velocity of money, so that a given ounce of gold or its dollar-equivalent can be exchanged multiple times over a given year. This is aided by technologies such as, for example, having paper tokens represent gold in circulation rather than circulating gold directly and risking wear-and-tear.
2. Extending credit.
3. Introducing settlement mechanisms to cut down on the actual amount of money that needs to be exchanged (which, in a way, is sort of an intra-day credit that temporarily exists on paper before it is paid back at the end of the day without interest, leaving behind a small net settlement balance that then must be paid with either cash or actual short-term, interest-yielding credit).
Although I have not done the math, it makes sense to me that these three factors could account for the large, but consistent discrepancy between world GDP as measured in gold ounces and the actual number of ounces of gold production in any given year.
But is it not strange that this ratio has not re-adjusted to some new order of magnitude over the last 50 years? Yes, there have been fluctuations, but it appears that the 1000:1 ratio has had a very strong pull.
One would think that new technology, such as debit cards and Fedwire, would allow this ratio to increase even more. Perhaps these new technologies have been counter-balanced by the fact that the U.S. left the Bretton-Woods gold peg in 1971, which (counter-productively from the Federal Reserve’s standpoint) made capitalists more insistent on holding, say, 2-3% of their portfolio wealth in gold on average as opposed to, say, 1-2%, due to the greater risk that the dollar could be at any time depreciated versus gold. These larger immobile gold hoards would cause more gold to be needed to circulate a given value of commodities on the world market. Again, I have not run the numbers on this, but it seems plausible that these factors could have partially canceled each other out.
Does the Fedwire data in J.P. Koning’s post say anything about the current state of the business cycle? Yes. I think it shows, once again, that the boom phase of the current cycle has not even really begun yet and still has plenty of room to grow. If the Fedwire settlement mechanism were being stressed to its max (in addition to the credit markets undergoing the same), then I would say that a crisis would be right around the corner. But as J.P. Koning’s post shows, there is still plenty of slack in the Fedwire system, and we know that interest rates on the credit markets are still rock-bottom. There is still plenty of gold, and dollar-token-equivalent representing that gold, to circulate commodities at their present values on the world market. There is still plenty of room for more credit creation (whether of the intra-day Fedwire kind or the longer-term interest-yielding kind) to inflate the appearance of expansion of the world market for commodities.
As Sam Williams says, paraphrasing Marx, an ounce of gold or its dollar-token equivalent can only be in one place at a time. Velocity can increase, but only up to a certain point with our given level of technology. Sooner or later, the world market runs into a situation where the tower of credit and the chain of payments becomes shakier and shakier, until the same ounce of gold or dollar-equivalent is called upon to settle two different credit obligations at the same time, and as this becomes more widespread, a credit crisis erupts and then a general crisis of overproduction that was building latently (while being papered over by the expansion of credit) finally makes itself apparent.
But we are not there yet. We are nowhere close to that part of the business cycle. There is still plenty of slack in the system, plenty of room for credit to expand. That is why I bought into VT (Vanguard Global Equity ETF) this past week right after the Brexit debacle. I anticipate the share price going up quite a bit over the next three years or so. Only when world GDP as measured in gold ounces begins to appear to be solidly outrunning world gold production (after adjusting for the 1000:1 ratio measured earlier), and only when interest rates have climbed again and Fedwire has started accommodating a greatly-expanded volume—that will be when I sell off my stocks and buy gold (or more likely, gold-related financial assets such as SPDR shares). Shortly thereafter we will see stocks plunge and gold soar, as we did in the 2008 recession.