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The Regression Theorem Understood And Applied

by Trace Mayer, J.D. on December 23, 2010 · 14 comments

Reading time: 10 – 16 minutes

Regarding the regression theorem, can the grandson also be the great-grand father? Ideas can only be overcome by other ideas and words proffer the instruments to meaning. The ability to wield words concisely, accurately and orderly is essential for communication and persuasion. Much of discourse, particularly from court economists, has devolved into sophistry and incomprehensible babbling.

Can The Grandson Also Be The Great Grand Father?

FOFOA’S QUESTION

In an extremely verbose and conflated article the pseudo-anonymous FOFOA asks, “Does anyone have any evidence that silver is still money today?”

I find a few of FOFOA’s assertions fairly odd, especially for a voice in the gold niche. For example,

Money is debt, by its very nature, whether it is gold, paper, sea shells, tally sticks or lines drawn in the sand. (Another shocking statement?) Yes, even gold used as money represents debt. More on this in a moment. …

First, money. Money is always an overvalued something. Usually a commodity of some sort. But it can be as simple as an overvalued line in the sand, or a digital entry in a computer database. But the key is, it is always overvalued relative to its industrial uses! That’s what makes it money! …

Did you hear him at 6:35? “Only one metal in the world that fits the bill for money, and that’s gold!” That’s right Joe! Good job from the “Silverfuturist”. There can be only one!

Mish has chimed in on many of FOFOA’s fallacies.

There is a reason Chapter One of my book The Great Credit Contraction is titled Word Games. In that chapter, I present the two competing theories of money, market versus Chartalism, along with an example of the regression theorem and then distinguish money, money substitutes and illusions which can all function as either currency or legal tender or both. What is so odd about FOFOA’s fallacious assertions is that they contradict basic principles of monetary science.

SCALPEL PLEASE – DISTINGUISHING TERMS

The conflation of the terms money, money substitutes, illusions, currency and legal tender is one of the greatest problems in understanding monetary science. Let’s examine each.

Legal tender by government decree must be accepted if offered in payment of a debt. Currency can be examined either broadly or narrowly and in its narrow examination it is the medium of exchange most commonly used in ordinary daily transactions.

Illusions are figments of people’s imagination and for our discussion we will consider them negotiable instruments that promise nothing. Staying within this same discussion, money substitutes are negotiable instruments that promise the payment of money.

Therefore, it follows that gold cannot be debt and is obviously a form of currency that is no-one’s liability.

THE REGRESSION THEOREM

This exchange between Dr. Ron Paul and Dr. Alan Greenspan centered the issue on the definition of money.

Congressman Ron Paul: So it is hard to manage something you cannot define.

Dr. Greenspan: It is not possible to manage something you cannot define.

First, it should be noted that Greenspan implicitly admits the faulty argument behind Chartalism. Second, a fairly basic theory of monetary science is the regression theorem, one of many contributions by Ludwig von Mises, and answers the question why do illusions, money substitutes or money have purchasing power? For those unfamiliar with the regression theorem, before continuing, you may want to read Bob Murphy’s short article.

What is Mish’s response? “Like FOFOA I believe gold is money. However, unlike FOFOA I think money is whatever the free market says it is. The problem is, we do not have a free market we only have government decree mandating the use of dollars, Pounds, Yen, Renmimbi, Euros, and Francs as money.”

This answer from Mish regarding the competing theories of money is the only reasonable and rational response.

But I disagree with Mish’s assertion that a free market does not exist. Individuals are sovereign and ‘endowed by their Creator’ with rights. The free market existed first and then the State was created. This is the same reason Chartalism is philosophically flawed.

Sure, the Statetrix is extremely strong today but most individuals still have freedom of movement which allows people to vote with their feet. Until the free will of mankind is completely violated worldwide through the establishment of a new world order or one world government then a free market will exist. A new world order is not likely because of the failed fiat currency fractional reserve banking conspiracy. The Great Credit Contraction has begun and there is no stopping it.

Despite what most people think or feel; the State is dead, intellectually, morally, spiritually, financially and economically. Sure, some individuals in certain geographic areas, like North Korea or the United States of America, will face threats of collateral damage as the gigantic rotting corpses tumble to the ground causing great destruction.

But for a sovereign individual in a free market  the management of political risk is just like managing any other risk; weather, contract, counter-party, performance, etc. I devote Chapter Six to Personal Practical Implementation like the five flag theory for managing political risk, geographic diversification and even second passports.

MISH’S MASSIVE MISAPPLICATION

But the regression theorem answers the question on how a medium of exchange can come into existence; it explains the origin of money.

Here Mish makes a critical misapplication of monetary theory. “While theoretically possible, in today’s world silver has one huge drawback that gold does not have: Silver is used up. Gold is not. Silver is widely use in industrial applications”

This is the exact opposite of why the market has chosen gold and silver as money. The theory is already being applied. The reason gold is money and currency, a medium of exchange, is because people first valued gold for its commodity uses because they attached increased value to gold based on its expected purchasing power and the reason they were willing to hold cash balances in gold.

Under the theory of market determined money astute traders in a barter environment settle on a particular commodity or commodities that are currently trading in the marketplace as money because of their increased degree of saleableness, saleability, liquidity or marketability.

SILVER PRICE IMPLICATIONS

But silver is also valued for its industrial applications. The market searches for a cash balance medium with the lowest transaction and storage costs. As the silver price discovery occurs there are two large demand drivers: (1) industrial and (2) monetary.

In this case, silver is widely used in industrial applications. Many of these are essential for the current standard of living for humanity such as medical, automation, high tech and etc. while small amounts of silver are actually used in each application so this results in the inelasticity of demand being fairly low.

Additionally, silver is valued for these reasons and is fungible, divisible, scarce, non-corrosive, portable and definable. A problem is the high ratio of about 50 ounces of silver per ounce of gold which along with the lower density results in higher storage costs for silver relative to a substitute good, gold.

Taken in totality these properties make silver extremely efficient economically to be used as a medium of exchange.

As The Great Credit Contraction continues holders of capital will continue seeking safety and liquidity. As the monetary demand for silver increases then industrial and consumer prices will likewise have to increase or firms will face bankruptcy because they cannot sell for less than their costs and remain profitable. This can be particularly helpful in figuring out the implications between inflation or deflation.

But these individual preferences expressed through human action and being revealed through the current silver price does not constitute evidence of silver being overvalued as FOFOA asserts. That assertion rests on there being a proper valuation for silver. A proper valuation set by whom, the State? Chartalist! Plus, I would love for FOFOA to explain what types of industrial applications a digital entry in a computer database has.

Applying monetary science to Internet technology is not a simple task.

CURRENCY EVOLUTIONS

Being able to predict future market innovations from entrepreneurs is the work of often wrong science fiction authors. Could anyone predict a Ferrari in 1880? No, they thought about ‘horseless carriages’. Could anyone have predicted the Internet fifty years ago? Fifteen years ago Google did not exist. YouTube and Facebook are barely over five years old.

The fiat currency fractional reserve banking system that has evolved out of a five hundred year old money substitute system is fundamentally unstable and everyone knows it. The lifeblood of the State is dead and decaying through failing quantitative easing. The 2008 financial crisis shook the financial community and worldwide population to the core. The search for a viable replacement is on like Donkey Kong.

Applying monetary science to Internet technology is not a simple task. The first ‘horseless carriages’, like GoldMoney, have begun to develop. Remember, what the telegraph company and IBM told Alexander Graham Bell and Bill Gates. GoldMoney allows gold, silver, platinum and palladium to circulate as currency in ordinary daily transactions while immunizing the holder of capital from both counter-party risk and illusion risk, the risk that the illusion currency unit will become worthless because of loss of confidence by market participants (hyperinflation).

CONCLUSION

Just like it is logically inconsistent for the grandson to also be the great grandfather so likewise it is logically consistent for the FRN$ to be currency with purchasing power only because gold or silver are money with industrial demand. When you apply the regression theorem it reveals that silver and gold were valued as commodities in the state of barter as a result of sovereign individuals making choices based on human action.

Therefore, it follows that gold cannot be debt and is obviously a form of currency that is no-one’s liability. Sure, a money substitute like a gold certificate is debt but a money substitute is not money anymore than the GLD ETF is gold just like a FRN$ is not a US$ and a dollar is defined as 371.25 grains of fine silver. Silver and gold already possess currency market share though far inferior to the FRN$, Yen or Euro.

Evolutions in currency like the FRN$, credit cards, GoldMoney, frequent flyer points, gift cards, Yen, bitcoin, etc. will continue and hasten as we further transition to the Information Age. To stimulate innovation and increase the standard of living through a more efficient currency market we should support Dr. Ron Paul’s H.R. 4248 – Free Competititon In Currency Act of 2009.

The Internet is a relentless process of decentralization and like a rising sun the inefficiencies in the worldwide free market are being dispelled with the collapse of massive currencies like the broken Euro or FRN$ and their issuers which speaks to the currency market opportunity for entrepreneurs and resulting transition to a new world. There will no more be one currency to settle them all than there will be one world government to rule them all.

DISCLOSURES: Long physical gold, silver and platinum.

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14 comments

ABOUT THE AUTHOR: Trace Mayer, J.D., author of The Great Credit Contraction holds a degree in Accounting, a law degree from California Western School of Law and studies the Austrian school of economics. He works as an entrepreneur, investor, journalist and monetary scientist. He is a strong advocate of the freedom of speech, a member of the Society of Professional Journalists and the San Diego County Bar Association. He has appeared on ABC, NBC, BNN, radio shows and presented at many investment conferences throughout the world. This is merely one article of 240 by .
Free Free Great Credit Contraction Sample

{ 12 comments… read them below or add one }

1 Carl Leweke December 23, 2010 at 9:11 am

Not a light and fluffy posting…thanks for the Christmas present Trace!

Any thoughts on the Bitcoin’s usefulness or lack thereof?

2 john anderson December 26, 2010 at 11:08 pm

Having just read the article by FOFOA and then coming across Mr. Mayers response was perfect for me. As a newbie to macroeconomics and money with no formal education I sometimes get a little lost trying to understand the complexities. After reading FOFOAs article I came away somewhat confused and was lucky to have Trace sort it out for me.
Common sense and truth have a way of ringing true when it is heard. In my search for truths I’m glad I came across Trace Mayer and favorited his site.
I second Leweke, nice present. Thanks Trace

3 mel Lindley December 27, 2010 at 4:57 am

With gold being the only metal occurring naturally in its elemental form, all others needing to be extracted from their ore, man’s ancestors would have been attracted to gold like jackdaws to jewellery.

Somewhere along the evolutionary road to becoming homo sapiens, pre-man would have learned how to work the metal thus further enhancing its attraction and we can see clearly how it would have quickly become a barter item, evolving eventually into money as we define it, where it served loyally through all of human history until President Nixon broke the spell by reneging on America’s commitment to redeem $35 for 1oz of gold.

As gold occurs across the globe the search for it could well have been a major cause of early mans Diaspora, whilst the development of a universally accepted measure of value would surely have been a major factor in the development of trade.

As painful as it is to admit that the ‘barbaric relic’ tag was misplaced and that modern man is less wise than the ancients, this certainly appears to the case – witness the present financial turmoil and the difficulty of visualising a solution that does not involve a return to the roots of money.

During my National Service – served with the B.A.O.R. (British Army on the Rhine)- we were paid in BAFS (British Armed Forces currency) – a monopoly-like money but which on camp was, to all intents and purposes, real money accepted for all your requirements – cigarettes, beer, cinema tickets, coffee, jam doughnuts, toiletries, repaying debts to comrades etc etc. Were you planning to leave camp for a night on the town then you had to pre-order the necessary Deutsche Marks, which were duly received at the next pay-parade.

The system worked perfectly, which begs the question as to whether a similar setup would work on a larger scale, that is for national currencies to be used within a country’s borders with gold reserved for international trade. Clearly the price of gold would have to be the free-floating market price, not one dictated by bureaucrats and probably used (for added liquidity) in conjunction with Bills of Exchange (redeemable in gold), as espoused by Professor Antal E. Fekete

4 Trace Mayer, J.D. December 28, 2010 at 6:00 am

Thanks John. Glad to help. While I occasionally get very complex on RTG; often I have found that complexity is a veneer for lack of understanding or nefarious motives.

5 Robert Happek December 30, 2010 at 6:54 am

The statement that fiat money (or even gold) represents debt is a common fallacy which has its origin in logical inaccuracies and syntactical errors. If someone takes out a mortgage in order to buy a house, the money she paid to the seller of the house is not debt – it is in fact the opposite of debt, it is the most desirable of all real assets, namely cash. The debt obligation is strictly limited to the party taking out the mortgage. To see the truth of that statement, imagine for a moment that the party taking out the mortgage defaults on its monthly payment obligation. The bank will then foreclose and ultimately write down the loan balance on its books. The debt was erased or paid for by the bank. However, the cash spent by the buyer of the house will never be recalled from the economy. That is proof that this cash is not debt. It was created by issuing a debt obligation, but that does not mean that it is debt.

The corollary to this observation is that a significant amount of cash circulating in the economy is not related to any debt because that cash represents the sum of all past bankruptcies which have been paid for or written down by the banking system a long time ago. To counteract this “leakage” of cash from the control of the banking system, we need inflation, that is, a constant increase of the total amount of cash in circulation in order to keep the percentage of cash not backed up by debt relatively small.

6 Joshua Nielsen January 2, 2011 at 10:54 am

Oddly enough, this last comment stirs mixed feelings in me: the first paragraph I agree with completely, and the second I disagree with completely. I understand that paper as money is an “asset” made by creating an equal liability, an “asset” that has no real intrinsic value and is backed by someone’s promise to pay (debt), which means that, by definition, though not debt itself, the paper money is a debt-backed currency. However, the second part of the comment suggests that inflation is a good thing which keeps “leakage” of money which is no longer debt-backed. I’d like to ask, precisely how does the money lose its debt backing? Even if the mortgage is defaulted, the bank only accepts the liability itself, rather than claiming an “asset” from the debtor’s liability. The money never loses its debt backing, the debt obligation is merely transferred to a different party. If it were to truly lose its debt backing, what would be the value of it?

Perhaps this is a place to introduce a simple mathematical exercise I discovered recently. It may reveal the simplest concept of inflation as a way of understanding it. Basically, it uses official figures and official definitions: inflation, here, is the increase in prices (resulting, of course, from increase in supply); and inflation can be assumed to average 4%, the average annual core CPI rate in the US. Using these official numbers, holding other factors constant, and assuming you are not going to receive any of the newly created money, we can project $10,000 of savings over fifty years. Formula: 10,000 * 0.98 ^ 50 = 3641.7. That means, in fifty years, your $10,000 savings retains the purchasing power of $3641.7 in current dollar values. So even the seemingly harmless official statistics are scary, and when factoring in increases of food, fuel, and property prices, plus money shipped overseas, the results are unreal. It’s the power of cumulative interest, does no one I talk to understand this power? Even my economics professor, who discussed cumulative interest and the power of fractions of a percent over a long term, failed to apply the same to inflation.

So while I realize this exercise is not strictly realistic, neither are the models adopted by my economics professor as teaching tools. And Trace, maybe you know a way to make the model more real?

7 Trace Mayer, J.D. January 2, 2011 at 7:21 pm

Hi Joshua,

Nice comment. Addressing the second part and your question about ‘a way to make the model more real’ I have to ask whether you have watched the video I made: Confiscating Certificates Of Confiscation? I am not sure how much more plain I could make it.

The first part of your comment gets a little more complex but you are still conflating the terms money and currency which I think is causing most of your problem in understanding. I do not really have time right now to go into further depth.

8 Joshua Nielsen January 2, 2011 at 11:22 pm

Actually I should have used quotes around “money” as well as “assets,” so thanks for that correction. I was trying to reference the sort of zero-sum game where banks basically add to both sides of an equation and then start swapping parts of their equation to other people.

And having just read the article to which you refer from FOFOA, all I can say is ouch. Sound to me as if his definition of money makes debt, by definition, an IOU debt (or IOU an IOU). And oddly enough, not one person commenting on it ever mentioned that rather blaring economic error.

I do read quite a bit of you, Peter Schiff, and Richard Maybury, and I am trying to understand, so any aid in that journey is definitely appreciated.

9 Trace Mayer, J.D. January 3, 2011 at 7:52 pm

Hi Joshua,

Thanks for the comment. It is important to remember that I am fairly unique in trying to define and distinguish money, money substitutes, illusions, currency and legal tender. For me it works well for practical use and is a reason I wrote in response to FOFOA’s article whose writing style appears neither concise nor logical. As you point out, the words stand on their own.

10 Invest It Wisely January 4, 2011 at 1:51 pm

I’m not sure that the paradigm of the state is “dead”; certainly not amongst the common man. I do think that there is more criticism of the government and bankers than there has been at any time in recent history, and that’s not such a bad thing, but like babies, we are still prey to the candy dropped on us from the sky, regardless of if they are illusionary or not.

11 Robert Happek January 21, 2011 at 8:19 pm

The value of cash is not that the underlying medium (currency) is made of a scarce and valuable commodity (gold or silver coin), No, the value of cash is in the fact that it is accepted everywhere and at any time as payment for all real goods and services produced in the economy. In the case of fiat money, this acceptance is the result of government laws (legal tender laws). So in some sense, the value of cash is the monopoly value assigned to it by the legal system. The true value of cash or more generally money, is immaterial and consists in the myriad of rules and laws governing the monetary system.

12 Robert Happek January 21, 2011 at 8:32 pm

Take a gold coin. Although very valuable to the knowledgeable person, the fact is, that most people and most shops will not accept it as payment for a bag of groceries. In that sense, gold coins are not money. They are not money because they are not accepted universally. A gold coin needs to be sold to a gold dealer, that is, converted into cash at the going market rate first in order to pay with it for groceries.

The same remark applies to any other currency. The Euro is money in Europe, but it is not money in the US simply because it is impossible to buy much in the US with Euros. Similarly, Dollars can not be used to buy anything in Europe. That is, the Dollar is not money in Europe. Modern money has geographic boundaries simply because national laws are not valid outside the boundaries of that nation.

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