Fiat Money Systems                                           March 6, 2004

The main reason that the masses ignore the inevitable failure of fiat money systems, such as that which is employed by the US and virtually the rest of the world today, is because just prior to their demise, they have more recently been remembered for generating a widespread period of prosperity that has enriched its supporters, if not the masses as well.

The fundamental flaw in a fiat money system can be summed up as human nature. When the going gets rough, the rough start printing. Governments can not be trusted, to not print too much money when it is not linked to a scarce commodity such as gold. How much is too much money? There are many debates about that but the unqualified answer is when the system is brought down. It should be obvious to even the casual observer that we have reached a point in time where even the slightest economic disappointment is met with a deluge of additional paper. One should be able to take a step back, peruse the scene with a calm head, and be able to judge that there is a lot more money being printed than there is economic activity to offset this increase. The writings of the noted economist, Dr. Kurt Richenbacher, put numbers to this unsustainable trend. In his monthly report, “The Richenbacher Letter”, he has shown that over the past several years, it has taken increasingly higher levels of debt to generate each additional dollar of GDP growth. First, it was $3 of debt for every dollar of GDP growth, then $4 of debt, then $5, then $7, and on and on. This policy is highly inflationary and the whole system depends on maintaining confidence in the dollar. Confidence has been aided by Government statistics that have been massaged and manipulated to the point of being ridiculous. If this recovery had any substance wouldn’t we have added jobs by now? Could it be that much of the recovery is a product of one time cost cutting? The masses are blinded by the recent successes of this system and its ability to, so far, avoid an unpleasant event on the economic front, but at what cost?

It is most difficult to judge exactly when this system will implode; but is most certain that it will. There is a limit to how far this type of system can be pushed. Robert Prechter, in his February issue of “The Elliott Wave Theorist”, gives the example of lowering the price of a Jaguar car to stimulate purchases, with deeper and deeper discounts, until you could not pay someone to take a Jaguar; everyone has all they need. It is the same with money and credit and the Fed. They lower rates and lower rates; stores provide financing with no money down and no payments until January 2006; car companies provide money back, etc. etc. God help us when January 2006 arrives, these retailers will not be paid in anything resembling the prior value of the dollars they charged for an item, if at all. There has been an unprecedented amount of debt and credit extended, far in excess of anything we have seen in prior fiat money systems, and the eventual result will be defaults, deflation, and depression. There will also be an accelerating redistribution of wealth, most surely to result in social unrest. The extremes reached under this fiat money system has been perpetuated much longer and deeper than any I have studied, and I believe this is due to the fact that it is consumption-based, and Joe Six-pack whom represents the masses, has been sucked in by the lure of easy, unearned consumption. He is totally uneducated in economic matters, trusts his government, and is dangerously over-exposed financially as is the entire nation.

The Federal Reserve is not a part of the US Government, which seems to be little known. It is owned by a collection of the world’s biggest banks. Alan Greenspan is a pawn of the banks and the politicians, and has certainly earned his place as the greatest abuser of fiat money of all-time by many multiples. He has pulled out all the stops to maintain the illusions of fiat money credibility, and while the system is doomed, there is still time for individuals to save themselves, but they need to act quickly. We have already seen a scary decline in monetary aggregates since last September, despite massive money creation, asset bubbles, and promises to keep the cost of credit at below market rates for extended periods of time. This just leads to further misallocations of capital. Analysts, investors, and in particular, the media, hang on Alan Greenspan’s every word when he speaks publicly. Investors then run out to leverage up on the carry trade, borrowing short to buy long treasuries. Their trust in this mouthpiece is comical regarding professionals, and sad, regarding Joe Six-pack, who has little chance of understanding the dangerous situation he is in. Protection of this fiat money system has reached a dangerous crossroads. Global derivatives have climbed from $130 Trillion to $170 Trillion in the past year alone, which is a one year increase of four times the entire GDP of the US economy. Politicians and bankers may stop at nothing to keep the charade going a little bit longer. Barring that, the best way to protect your assets, is through ownership of Gold and Silver. Judge for yourself by history what actions you should now take.

Examples of Prior Attempts at Fiat Money Systems

20 BC - Roman Empire - After a highly successful period of empire building, Augustus, ordered mines in Spain and France to be mined 24 hours a day to support his tremendous infrastructure costs. Money was increased faster than production, however, creating inflation. He cut back on coinage, but later his stepson put coinage into government coffers which was eventually abused by emperors that followed him including: Caligula, Claudius, and Nero. Their lavish spending on consumption, (sound familiar?) wiped out most of Rome’s riches when Nero got the idea to debase the currency in 64 AD by putting less silver into coins. This allowed the emperor to continue his lavish spending, building increasingly large trade deficits with Rome’s colonies, and causing the wealthy to either hide their wealth or flee from the confiscating government. This did not have a happy ending as we now know.

910 AD – China experiments with paper money - It takes several hundred years but the system is abandoned due to unacceptable levels of inflation as money printing exceeded production.

1500's - Spain gathered gold from Mexico and the new world, becoming the richest nation in the world. Instead of developing their own economy they sent gold to trade partners in a consumption orgy not dissimilar to the US today. Then they went on a military rampage to extinguish pirates, (terrorists?) in an imperialistic march into other lands, dropping any distinction between terrorists, (I mean pirates) and the countries that harbor them. Their excessive consumption ran through their gold hoard, so they turned to financing the war with debt, bankrupting them.

1716 - John Law convinced France to use paper money and declared all taxes must be paid with it to gain acceptance. The idea snowballed and paper money became more desired than coin. It led to excessive printing, additional money-making schemes and fraud. Exaggerated values coinciding with money printing eventually blew up the system.

1791 - The French Government again tries its hand with a paper currency. The Government confiscated land from aristocrats and issued “assignats” which paid interest against the properties. Land was auctioned off in exchange for these notes, inflation rose to 13,000% by 1795. Napoleon ended the revolution and replaced the “assignats” with the gold franc, which set off over a century of prosperity for France. In the 1930’s Socialists came to power and brought the Bank of France fully into the Government. They quickly removed gold backing of the currency and made the franc a managed fiat currency. In only 12 years the currency lost 99% of its value.

1853 - Argentina went on a gold standard and thrived for close to 100 years. A central bank was created in 1932, beginning a long downfall. Juan Peron took charge in a 1943 coup and depleted reserves causing trade to fall. Argentina continued on this path of paper money, falling from the eighth largest economy to a mere shadow of its former self, which it has not recovered from as of today.

1862 - Abraham Lincoln passed the Legal Tender Act allowing the Government to issue paper money, backed by nothing but government promises. A huge inflation transpired that caused the practice to fall out of favor until the Federal Reserve System was put in place in 1913.

1923 - Weimar Republic - After World War I, Germany, crippled from its loss in the war, was held accountable for its war reparations. The country was destitute so found no other choice but to simply print the money in massive quantities to pay the reparations. The result was the plundering of the entire middle class, wiping out all value of savings, and paving the way for Hitler in front of an angry public.

The US dollar went off the gold standard in stages:

1934 - President Roosevelt revalued gold from its official price of $20.67 to $35 an ounce in an attempt to print more money, with the hope that this would lift us out of the depression.

1944 - The Bretton Woods Agreement was made to treat the dollar as a substitute for gold, since a dollar was defined as 1/35th of an ounce of gold, which was pegged at $35 per ounce. The door was opened worldwide to print money; foreign nations could print if they had gold or US dollars.

1971 - President Nixon closed the gold window, ending convertibility of dollars to gold. This came about because the US was printing too many dollars and living beyond its means. Foreign nations led by France, recognized this and began demanding payment in gold, breaking the system as the US experienced a major gold drain.

Look how long a fiat currency can thrive. Between 1948-1969 world money reserves increased only 55%, since that time they have shot up more than 2000%. See any connection? Also note that after Nixon’s move, gold went up over 25 times in less than ten years. Was it discounting the unprecedented money printing that was about to unfold? A brief perusal of history will show that when a nation went on a gold standard it was the beginning of a very long period of that nation thriving. When a country went to a fiat currency there was a period, as long or longer than 30 years, in which it thrived even more. However, during that period of prosperity on a fiat currency, excesses began to build. Once they have built up to extreme levels, it is a very dangerous time. When levels of debt become too excessive, an increasing amount of the rewards of production; profits, must go to servicing debt. When the servicing of debt consumes all of the profits of production, it finally consumes production itself. This is the real culprit for the loss of jobs domestically. As more of the economy shifts from real production of goods, to the pushing of various forms of paper, citizens lose jobs and live in more dangerous times. We have reached that time.

Gold has held its value over very long periods of time, unlike any former or present fiat currency. Gold and gold stocks can be more volatile than any asset class; particularly at a time when fiat currencies are on their last legs. Gold is the enemy of fiat currencies because it eventually reveals the truth, the fraud behind the fiat currency. As it emerges in a primary bull market, gold will have to weather the attack of the proponents of the fiat currency, as they cling to its withering life. If you look at history, you will understand which will win, and you should move to protect yourself as the mountains of credit and paper money, gravitate to their true value.

Richard J. Greene CFA