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If you have not yet read Part I, available free to all readers, please click here to read it first.

Part II – The Transition to a Post-Friction Economy

In Part I, we pursued the idea that much of the US economy is, in essence, unproductive friction that is overcome with vast borrowing — itself a form of friction — and the importing of fossil fuels. We also noted that the Central State/cartel “capitalism” partnership has greatly expanded the unproductive, uncompetitive “friction” segments of the economy and has limited consumer “choice” to purposely-selected menus designed to appear like a “free market” while benefiting State fiefdoms and private-sector cartels.

Entrenched Interests Keep Our Markets From Being Free

Looking at the sources and costs of friction gives us some insight into issues that are often seen as political — for example, the costs and benefits of borrowing trillions of dollars into existence every year and the costs/benefits of State regulation. Once we recognize how rising systemic friction will eventually freeze the system, then we also recognize that the path we’re on is unsustainable, and the political “rightness” or “wrongness” of increasing debt to fund the forces of friction becomes irrelevant.

The same can be said of State regulation. Given that one of the purposes of government is to protect the nation’s “commons” — air, water, public lands, and other shared resources — then some regulation is necessary to limit exploitation and predation of the commons by either private parties or the State itself. 

But we have confused productive regulation with regulation that achieves little beyond diverting funds to unproductive segments of the economy. There are hundreds, if not thousands of examples in every sector from criminal justice to farm subsidies to health care.

How about the enormous expense of the “war on drugs” and the resulting prison complex and criminal justice system? Are the benefits being reaped — marginal, or even counterproductive, in many analyses — worth the expense? Those employed in these systems naturally feel the benefits far exceed the costs. But self-interest is simply not an accurate measure of friction; ultimately, only a free market of free citizens can make that assessment.

If you have not yet read Part I, available free to all readers, please click here to read it first.

Part II – What to Expect for Gold in 2012

As I covered in Part I of this report, Dr. Krugman uses Hotelling rather creatively to explain the strength of gold from an investor’s point of view. I actually think Krugman is also applying a kind of traditional, discounting method of valuation. In essence, he is arguing that because interest rates are so low, the penalty normally associated with holding a non-income-producing asset, like gold or even cash, has evaporated. Indeed, this is the deflationist view, that cash is king because its purchasing power is increasing while the price of goods and services is falling. However, for those of us who prefer gold to cash, we are asking that gold provide additional services by offering protection against instability in the system and maintaining purchasing power more completely over all prices produced by economists and governments, not just price indexes.

But what about gold from the producer’s point of view? Remember, Hotelling says there’s a declining incentive for producers to extract and market their natural resources if the price appreciation taking place in situ (in the ground) is greater than the capital they could earn after having turned those resources into cash. Let’s take a look at more than a century of global gold production, updated with the latest data from the USGS.

If you have not yet read Part I, available free to all readers, please click here to read it first.

Part II – What to Do Before the Next Crash

What a Bank Holiday (Collapse) Means

If the next shock to the system is a sovereign debt default in Europe that spreads throughout the world banking system or perhaps a surprise that comes from China, we might expect a bank holiday. During such an event, the idea is that the banking system has to be shut down for some period of time in order to sort out whatever mess has interrupted its normal operations.

By this I mean that the banks are literally closed to normal commercial and retail traffic, and things like credit and debit cards, ATMs, and even checks are no longer useful for moving money or conducting transactions.

The key risk here is that by and large, the world runs on credit. Without that credit, things don’t ship, and shortages will rapidly develop.

For example, major cities might keep a week’s worth of chlorine on hand to treat municipal water supplies. The next week’s shipment of chlorine requires that the credit system be up and running so that debits and credits can be recorded appropriately. Without chlorine treatment, water is no longer safe for drinking without boiling.

The same need for a functioning system of credit is true for food shipments, medical supply deliveries, and virtually every other item of daily importance. Unless the banking system is there as the middleman in an enormous proportion of these exchanges, many transactions will slow down considerably, if not cease entirely, until things get sorted out.

That’s the risk. However, nobody really knows how big this danger really is, or how long things will take to get resolved, or even what sorts of disruptions may result, and this is why you find politicians bending over backwards in order to avoid finding out the hard way.

Remember Hank Paulson marching into Congress in October of 2008, closing the door, and ranting about martial law and social collapse? On one hand, we might be tempted to think of his act as a heavy-handed scare tactic to assure that his colleagues on Wall Street got a big, fat bailout. On the other hand, we should reserve some space for the idea that he might simply have peered into a banking abyss and gotten scared by what he saw. Perhaps it was a bit of both, but it is the latter idea that should give you pause, because if the Treasury Secretary has no idea how dangerous things are, it means the same uncertainty lurks in the hearts and minds of everybody else on some level, too. When your entire system of money runs on confidence, such doubts are more serious than you might at first appreciate.

A bank holiday, then, simply means that banks close for some period of time, ranging from a day to perhaps several months, limiting or precluding some range of transactions, and affecting only retail customers or impacting everybody. A bank holiday can fall anywhere between a minor inconvenience and a world-changing event.