The history of printed money

Addison Wiggin - Wed 06 Dec, 2006

...History has shown that money - not counterfeit, but official money printed by the government - has been known to lose value and become virtually worthless...

 
 
History has shown that money - not counterfeit, but
official money printed by the government - has been
known to lose value and become virtually worthless.
Examples include Russian rubles from pre-Revolution
days, 50-million marks from 1920s Germany, and Cuban
pesos from pre-Castro days. In all of these cases,
jarring political and economic change destroyed currency
values - suddenly, completely, and permanently.

What kinds of events could do the same thing to the US
dollar, and what can you do today to position yourself
strategically? The potential fall of the dollar is good
news if you know what steps to take today. We're not as
insulated as many Americans believe. In the 1930s, 20
percent of all US banks went broke and 15 percent of
life savings went up in smoke. After the emergency
measures put into effect by President Franklin D.
Roosevelt through the Emergency Banking Relief Act of
1933, confidence was restored with another piece of
legislation: the 1933 Glass-Steagall Act. This bill
created the Federal Deposit Insurance Corporation
(FDIC), insuring all US bank deposits against loss.

The severity of the growing situation had been seen well
in advance. The financial newspaper Barron's,
established in 1921, editorialized in 1933
that: "Since early December, Washington had known that a
major banking and financial crisis was probably
inevitable. It was merely a question of where the first
break would come and the manner of its coming."

Two weeks earlier, the same column cautioned its readers
that when the dollar begins to lose value, this leads to
a series of "flights" - from property into bank
deposits, then from deposits into currency, and finally
from currency into gold.

We can apply these astute observations from 1933 to
today's currency situation. The government, anticipating
a flight from currency into gold, had already made
hoarding gold or even owning it illegal. The second step
- insuring accounts in federal banks - helped to calm
down the mood. By preventing the panic, currency
stabilized. But in those times, we were still on the
gold standard. The currency in circulation was, in fact,
backed by something. Remember, that riverboat gambler
who keeps asking for ever-higher markers will eventually
run out of credit. At some point the casino boss
realizes that his ability to repay is questionable.
Maybe those markers are just a heap of IOUs that can
never be cashed in.

In the 1930s, the causes of the Great Depression were
complex but related to a series of obvious abuses in
monetary, financial, and banking policies. History has
simplified the issue by blaming the Depression on the
stock market crash (which takes us back to the
explanation that "wet sidewalks cause rain"). The stock
market crash, one of many symptoms of policies run amok,
has lessons for modern times. The unbridled printing of
money - expansion of the "IOU economy" - is good news
for those who recognize the potential for gold.

We hear experts on TV and in the print media shrugging
off the deficit problems. "Our economy is strong and
getting stronger" is the mantra of those with a vested
interest in keeping dollars flowing: Wall Street brokers
and analysts, for example. But we cannot ignore the
facts. The federal deficit is growing by more than $40
billion per month. It is not realistic to point to this
economy and say it's doing just fine.

Gold is the beneficiary of reckless monetary policies
and the War on Terror. Check the average value of an
ounce of gold over the past decade.
It has been rising steadily since the end of 2001. The
cause of this change in gold's price may be attributed
at least partly to the attack on the World Trade Center.
But it reflects equally on the Fed's monetary policies
and spiraling debt-based economic recovery. During the
same period that gold prices have begun to rise, we
should also take a look at the trend in money in
circulation.

This is troubling for the dollar but - again - great
news for gold. Remember what the world economic and
political situation was like in the early 1970s: a
weakening dollar, easy money, and international unrest.
Sound familiar? We're back in the same combination of
circumstances that were present when gold prices went
from $35 to over $800 per ounce.

The numbers prove that gold is going to be the
investment of the future. World mining in gold averages
80 million ounces per year, but demand has been running
at 110 million ounces. So if central banks want to hold
the value of gold steady, at least 30 million ounces per
year must be sold into the market. This creates a
squeeze. As the dollar weakens, central banks will want
to increase their holdings in gold bullion, not sell it
off.

This is why gold's price has started to rise and must
continue to rise into the future. As long as that demand
grows - and it will rise as the dollar's value continues
falling - the price of gold simply has to reflect the
forces of supply and demand.

But, you might ask, why do central banks want to hold
down the value of gold? We have to recognize how this
whole money game works. Most world currencies are off
the gold standard, following the US example. So as
gold's value rises, it competes with each country's
currency. Of course, the trend toward weakening
currencies and the continuing demand for gold mean that
the growth in gold's value could continue strongly for
many years to come.

When the United States removed its currency from the
gold standard, it seemed to make economic sense at the
time. President Nixon saw this as the solution to a
range of economic problems and, combined with wage and
price freezes, printing as much money as desired looked
like a good idea. Unfortunately, most of the world's
currencies followed suit. The world economy now runs
primarily on a fiat money system.

Fiat money is so-called because it is not backed by any
tangible asset such as gold, silver, or even seashells.
The issuing government has decreed by fiat that "this
money is a legal exchange medium, and it is worth what
we say." So lacking a gold backing or backing of some
other precious metal, what gives the currency value? Is
there a special reserve somewhere? No. Some economists
have tried to explain away the problems of fiat money by
pointing to the vast wealth of the United States in
terms of productivity, natural resources, and land. But
even if those assets are counted, they're not liquid.
They're not part of the system of exchange.

We have to deal with the fact that fiat money holds its
value only as long as the people using that money
continue to believe it has value - and as long as they
continue to find people who will accept the currency in
exchange for goods and services. The value of fiat money
relies on confidence and expectation. So as we continue
to increase twin deficit bubbles and as long as consumer
debt keeps rising, our fiat money will eventually lose
value. Gold, in comparison, has tangible value based on
real market forces of supply and demand.

The short-term effect of converting from the gold
standard to fiat money has been widespread prosperity.
So the overall impression is that US monetary policy has
created and sustained this prosperity.

Why abandon the dollar when times are so good? This is
where the great monetary trap is found. If we study the
many economic bubbles in effect today, we know we
eventually have to face up to the excesses, and that a
big correction will occur. That means the dollar will
fall and gold's value will rise as a direct result.

The sad lesson of economic history will be that when the
gold standard is abandoned, and when governments can
print too much money, they will. That tendency is a
disaster for any economic system, because excess money
in circulation (too much debt, in other words) only
encourages consumer behavior mirroring that policy.

Thus, we find ourselves in record-high levels of credit
card debt, refinanced mortgages, and personal
bankruptcies - all connected to that supposed prosperity
based on printing far too much currency: the fiat
system.

We can see where this overprinting will lead. As debt
grows relative to gross domestic product (GDP), we would
expect to see positive signs elsewhere, such as a growth
in new jobs. But like a Tiananmen Square Rolex watch
deal, the value simply isn't there. Job growth is slow
but, in reality, there is a decline in earnings. High
paying manufacturing jobs have been replaced and
exceeded by low-paying retail and health care sector
jobs, so even if more people are at work, real earnings
are down.

Instead of simply measuring the number of jobs, an
honest tracking system would also compare average wages
and salaries in those jobs. Then we would be able to see
what is really going on - more low-paying jobs being
created, replacing high-paying jobs being lost.


Regards,

Addison Wiggin
The Daily Reckoning