I boarded the non-stop flight from Basle, Switzerland to Chicago. It was destined to be an exciting flight due to the persons sitting around me and the topics of their discussions. Given that life is short, let’s start with dessert (conclusion) first. As Chairman Volcker pointed out twenty-two years ago (see his speech in next week’s post), I believe we are headed for a time that will be known as the triumph of central banking.

To my left was sitting Moses. He kept insisting that I need to read over and over again Leviticus 25, which describes the Year of Jubilee, when debts are abolished and the economic system gets a new start. “But that’s about 4500 years ago”, I said, “and to the best of my understanding the Jubilee was never implemented”.

To my right was Prime Minister William Gladstone (as you may recall, in 1892 he was inaugurated for the fourth time as Britain’s prime minister at the age of 82). He did not want to talk about anything else but deficits. Deficits he said ultimately destroy the country’s currency, and that’s the reason he opposed unfunded liabilities and wars.

Across from me and to my left was Solon, the famous Greek lawmaker. He insisted that his jubilee legislation a.k.a. seisachteia of almost 2500 years ago was actually enforced, and liberated the people from the enslavement of debt.

Next to Solon was sitting William Jennings Bryan. What surprised me was the fact that he was not defensive at all (maybe Kazin’s biography has already done its job in remaking his legacy). As the leader of the Democratic Party in the US (and three times presidential candidate in 1896, 1900 and 1908), not only did he remake that party, but he also shaped policy in restraining the power of big banks and corporations, while his speech “Cross of Gold” in the Democratic convention of 1896 planted the seeds of the fight against the gold standard, believing that it was the cause of America’s economic troubles. He reminded me that he was known as the “godly hero”. At that point PM Gladstone intervened and congratulated him for resigning as Secretary of State – during the Woodrow Wilson administration – in protest to the administration’s drift toward entering World War I.

The conversation then shifted to the current economic environment and what we could be facing within ten years unless action is taken over the course of the next two-three years. They painted a pretty accurate picture of all the ills around the world, but they all wanted to emphasize the following:

  • A sea of unsustainable deficits
  • An ocean of national debts that cannot be paid back
  • A gulf of trillions of central bank reserves – in just a short four-year period- that demand an exit
  • International trade and financial imbalances that threaten the foundation of growth
  • Unbearable future liabilities, especially for state pensions and health care
  • Insolvent nations and regions
  • Aged assets and lack of an asset-basis for collateralization and credit extension
  • Co-dependency of nations
  • Tail-risks related to currency instability that could wreck the whole monetary structure
  • Admission that the system needs a new start that will have a solid anchor

They all agreed that all these ills constitute a watershed moment for global finance. The whole fiat money system could collapse unless drastic measures are taken that address these fundamental problems which undermine global growth, stability, and security.

PM Gladstone seemed distracted for a moment, since he thought that he saw PM Disraeli – his famous rival – on the plane, but after careful inspection that proved to be wrong. Then he started lecturing that any such drastic measures have a prerequisite known as fiscal discipline. He said that once the fiscal side of the house is in order then a major threat to stability is – at least partially – under control. Bryan was a bit reserved about dramatic cuts – especially in entitlement programs – but Gladstone had gained him over with his gestures.

Bryan added that exchange rate stability was also fundamental, but he was most concerned about big banks and the over-extension of credit they profligate. “Somehow the power of the banks needs to be restrained”, he said, to add that they need to be better capitalized with some hard assets while their money creation abilities – through the fractional reserve system – needs to be curtailed.

“Don’t forget the need for international collaboration and consultation” Solon added. He seems to have learned from Moses’ Jubilee idea, and the fact that this cooperation produced good results for the Athenian economy. Moses seemed to be surprised by Bryan’s comment about recapitalizing banks with hard assets, so he felt that the time was right to offer another idea: “Let’s treat gold as cash and let gold count as part of banks’ Tier I capital” he said. To add “if needed, I have some gold left over from the golden calf I destroyed about 4500 years ago”.

Bryan in his inner-thoughts contemplated that fiscal discipline will force the price of his arch-enemy (gold) down, since the fear premium will decline significantly. He might have given in in matters related to fiscal discipline, but he was winning in matters related to prices of precious metals. However, he seemed to be missing the point that if banks are allowed to use gold as part of their Tier I capital, then gold prices will go up, since demand for gold will increase. I was surprised that he was not reacting to that idea. I start suspecting that he knew of something that I did not.

Moses said that he had stayed as a shepherd in the Sinai desert for almost forty years before returning to Egypt, and in retrospect he thought that those forty years prepared him well for the other round of forty years that it took them to reach the Promised Land. He wanted to talk about economic life in terms of generational waves that last 30-40 years, pointing out that the Bretton Woods Agreement of 1944 had outlived its purpose and life and thus under fiat currency the financial system needed a new start, which the global economy (under Volcker’s plan of the early 1960s) established in the 1970s and 1980s.

Solon, took the opportunity then to add that the time is approaching for a new system where the burden of debt can be wiped out. If that happens then you have eventually bought another 30-40 years for the fiat currency system, let alone the stability that will be brought will generate growth, incomes, and jobs. “Yes, but besides needing international coordination and collaboration for such a thing, you also need to put in place a new international monetary system”, Gladstone added. I start wondering, how such a system would look like and what would the steps be prior to such implementation.

The four of them asked to be left alone, and I was supposed to return in about an hour. I was able to find a seat and relocate myself. This seemed to be the conversation of a lifetime. About seventy minutes later Solon came and said they were ready to share a plan. He added that they had already called Irving Fisher who was supposed to meet them at the O’Hare airport in Chicago.

Here is the basic outline of the plan and its effects:

  • Financial repression to continue around the world for at least two-three more years. It buys time, lowers interest payments on the debt, motivates a risk-on environment, and keeps overall costs down while allows households and businesses to rebuild their balance sheets.
  • Fiscal discipline is implemented starting in 2013 that makes the market believe that in the medium to long-term things will be OK. I knew that Gladstone’s signature was on it.
  • Gold prices will decline in the short term, equities will enjoy healthy returns, and profit margins will increase given that the fear premium will be reduced. For those who like precious metals that will be an opportunity to buy more of them. It seemed that this had Bryan’s approval.
  • The banks will start treating gold as cash i.e. part of their Tier I capital. The lower gold prices will shake out of the market speculators, and will allow institutional investors to buy the precious metal at lower prices.
  • International consultation starts on a plan that will have three pillars: First, an increase in the required reserve ratio (the portion of every deposit that the banks are required to hold in cash) to at least 50%. The effects would be obvious: Less leverage, less credit extension, lower risks, higher financial stability, less powerful banks, diminished role of financial institutions which will mainly be intermediaries and not market makers or speculators, and more control over economic affairs (Bryan seemed exuberant).

Second, central banks transfer their assets (which are commercial banks’ liabilities) to the Treasury so that such credits will offset governments’ liabilities (bonds). This will eventually wipe out a huge part of the national debts (Moses and Solon I suspected were behind it), will affirm the prominence of fiat money, will allow the governments to meet future liabilities, and will boost confidence and investment spending. The Damocles’ sword hanging over the global economy a.k.a. derivatives will be diminished in terms of size and scope.

Third, the establishment of a new global monetary system of collateralization and credit creation that will be based on real hard assets (they made clear that Bryan abstained in that vote given that gold prices will stabilize at a multiple of their previous low) as well as fiat currencies, and which could eventually establish a managed exchange rate regime where one dollar would be equal (but allowed to fluctuate within a narrow range) to about one euro, one sterling pound, one Canadian dollar, one Swiss Franc, and 4 Chinese renminbi.

As I was trying to gather my thoughts and reaction from such a shock and contemplate issues related to moral hazard, the rule of law, and the possibility of government abuse, the plane landed in Chicago, and the year seemed to be 1934. This was truly destined to be the time of central banks’ triumph.

From all of us at the BlackSummit Financial Group, we wish you a healthy, joyful and blessed New Year.