How Currencies Die and Gold Prospers — Part I

January 30, 2012 06:27

Matters approach a critical state around the world. Most of the advanced economies, including the U.S., are insolvent (see here and here). It is mathematically impossible for these countries to avoid defaults on financial and social obligations. Spending cuts and tax hikes are also inevitable. The tipping point for such actions was passed years ago.


From Monty Pelerin’s World


The Dollar is doomed. So too are most other fiat currencies. It is the nature of fiat currencies and the nature of governments throughout history.

All countries have abused their citizenry and investors via the printing press. Since the formation of the Federal Reserve in 1913, the dollar has lost 96% of its value. Most of that loss has occurred since 1970. It was 1971 when the U.S. officially defaulted on its promise to redeem dollars for gold. That marked the point where, for the first time in modern history, gold was completely removed from any role in the world monetary system. Then, there was no hard constraint to prevent any country from inflating its currency. All did!

With the dollar as the reserve currency of the world, the U.S. has had (and used) advantages not available to, but coveted by other countries. At times, our monetary policy has forced (at least in the opinion of foreign policy makers) inflation onto other countries. Behind the scenes there has been resentment building toward U.S. dollar hegemony for decades. Part of this resentment results from US abuses, part results from other countries wanting a similar ability to plunder. The current financial crisis, arguably begun in the U.S., has exacerbated both of these sentiments.

We were at an impasse with Europe over proper monetary and fiscal policy. In The Keynesian Dead End the conflict was described:

Now the political and fiscal bills are coming due even as the U.S. and European economies are merely muddling along. The Europeans have had enough and want to swear off the sauce, while the Obama Administration wants to keep running a bar tab.

Even the progenitor of Keynesian economics, England, was abandoning the model by implementing spending cuts and tax increases, despite the major recession. The U.S.was and still is unwilling to bite this bullet, despite signs that other governments have lost faith in the U.S. and its dollar reserve system. The US continues to stimulate, primarily via the creation of credit.

Recently, as the economic crisis worsened in Europe, politicians backed away from their “austerity” moves. Their central bank began creating money to flood the ailing banking system so as to avoid individual or multiple banking system failure. When the Greek panic struck, the dollar benefited. However, it benefited primarily relative to the Euro. Did the dollar strengthen or did the Euro merely weaken? Certainly the dollar strengthened relative to the Euro, but both deteriorated against gold, now near all-time highs in both currencies. In other words, both currencies weakened, but the Euro did so faster than the dollar.

Were there any alternative to the dollar, the U.S. would already have lose its monetary hegemony. That does not mean that other countries are not feverishly working behind the scenes to create one. Several meetings have taken place, without the U.S., to develop a substitute. Only the vagaries of history enable the dollar to continue, at least for a time, as the world currency. This important perquisite may be near its demise.

Financial Sense Online provides evidence of declining faith in the dollar:

In another ominous sign for the dollar, the Financial Times reported Wednesday that after two decades as net sellers of gold, foreign central banks have now become net buyers. What’s more, more than half of central bank officials surveyed by UBS didn’t think the dollar would be the world’s reserve in 2035. Among the predicted replacements were Asian currencies and the euro, but – by far – the favorite was gold. This is supported by Monday’s revelation by the Saudi central bank that it had covertly doubled its gold reserves, just about a year after China made a similar admission. There is no reason to assume these are isolated incidents, or that the covert trade of dollars for gold doesn’t continue. To the contrary, this is compelling evidence that foreign governments are outwardly supporting the status quo while quietly preparing for the dollar’s almost-inevitable devaluation.

Sophisticated investors are moving money into gold. That and rising gold prices are signs that something is happening. The value of all fiat currencies are moving toward Voltaire’s definition of their “intrinsic value” — zero.

Matters approach a critical state around the world. Most of the advanced economies, including the U.S., are insolvent (see here and here). It is mathematically impossible for these countries to avoid defaults on financial and social obligations. Spending cuts and tax hikes are also inevitable. The tipping point for such actions was passed years ago.

Europe’s situation is unique because one central bank serves different countries. Their announced austerity programs are too little too late. As the politicians experience the social unrest and potential risk of civil war(s), these efforts will be abandoned. They, like the US, will avoid the hard decisions to cut back programs and spending and turn to more monetary stimulus and bailouts. Instead of fixing the problems, politicians will sacrifice their currencies. So is the way of politics — never impose pain. Instead the game will be kept going via inflationary expansion of money and credit until fiat currencies collapse.

If the U.S. continues to stimulate, the devaluation of the dollar will harm “responsible” countries, as they will become less competitive in terms of exchange rates. Whether intended or not, this strategy is identical to the “beggar thy neighbor” policy that was employed during the 1930s. History shows that such behavior leads to competitive devaluations or even war. No country can gain at the expense of another under this policy, except for a short period. The policy is nothing more than a race to the bottom. All countries end up conforming to the policies of the least responsible one. All currencies are destroyed in such a competition.

It is not practicable to forecast the process or rate at which world currency debasement plays out. There are too many market and political variables. It will continue, because it is the only political alternative to default on real and promised obligations. Currency purchasing power is headed down. They will not all head down in relative terms,(measured against one another in terms of exchange ratesw); that is mathematically impossible. But they all will head down in terms of purchasing power or when measured against gold and other scarce commodities. Against gold all currencies have been in consistent decline for more than a decade. Although an imperfect measure of loss of purchasing power, it took $250 to purchase an ounce of gold a decade ago. Today, it takes over $1700!

Got Gold?

(Part II will follow later this week)


“Monty Pelerin” is a pseudonym derived from The Mont Pelerin Society. I retired to Asheville, NC from primarily a corporate but also an academic background. The corporate experience was primarily in the corporate financial field in several CFO positions. My academic background includes AB, MBA and PhD degrees from Duke University, the University of Chicago and Syracuse University in finance and economics. College and graduate level teaching lasted about 10 years.

Monty Pelerin’s World is at

Used by permission. All rights reserved.

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