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Following my decision
last November to quit writing these reports, I was inundated with a flood of
emails requesting me to continue writing. The emails are still arriving some
six months later. The power of communication via the Internet web sites is
truly astonishing and I had no idea of the huge readership that I had
developed.
The publication of this
commentary does not mean that I plan to resume writing. The decision to stop
writing remains unchanged. The main purpose of this communication is to thank
everyone who wrote such wonderful emails to me. I read them all, but replying
individually would have been a physical impossibility.
I will, however, take this
opportunity to review the current economic and financial situation, dust off
a centuries old law that has a modern corollary and finally suggest a
possible way in which this debacle may end.
There is little doubt in my mind
that the current crisis arose because of unsound money and a flawed
international monetary system. This point of view was discussed in several
previous articles, but most notably “Chaos
Chronicled”, which was published in April 2008.
Virtually everyone born after
the early 1950’s has lived their entire adult and working lives under a
fiat monetary system, i.e. a system where the money is something which the
Government declares is money. Since August 1971, when President Nixon cut the
link between the US dollar and gold, Governments have had the right and the
ability to create virtually any amount of new local fiat money at will. The
majority of economically active people today only know fiat currency as
“money”.
Sadly the history of money and
monetary systems is not taught in universities and other institutions that
train economists and financial analysts. This is the reason why so many
people do not understand what has been happening over the past four decades
and why younger analysts and stockbrokers have no idea of the monetary
properties of gold. I got tired of trying to tell people about gold and the
problems in the monetary systems, national and international. Their eyes
would just glaze over and the subject would be changed. No doubt others will
have had similar experiences. That is why I started writing these reports, to
try to educate people.
The fact is that anyone with an
understanding of monetary history could have predicted the inevitability of
the current financial crisis. Only the timing of the onset of the crisis and
the trigger that started it were areas of uncertainty. I first publicly
predicted the current crisis at the Gold Rush 21 Conference in August 2005. I
was a delegate, not a featured speaker. The talk was impromptu and off the
cuff.
Someone has kindly placed a
video copy of that talk on the internet and it can be accessed at:
http://video.google.com/videoplay?docid=-737911643773862674
That talk referred to the fact
that all the problems then emerging in the US economy started with the letter “D”. It is
appropriate to review the progress of these various problem sections of the
economy. They now include a couple of new ones:
- Debt: This was
discussed in detail in the “Crisis
Cogitations” article. Deleveraging is taking place with debt
totals declining. The nominal value of GDP needs to be increased to help
sustain the debt levels. Government debt will replace and then exceed
the private debt that is currently being eliminated.
- Deficits: These cover
both the US Government Budget deficit and the external trade deficit.
The trade deficit is declining but the Budget deficit is about to go
exponential. This is where the rubber hits the road. Cash required for
all of the other D’s will eventually filter into the budget
deficit.
- Dollar: The US Dollar
is a major problem as other countries recognise that the US dollar
cannot continue as the world’s Reserve Currency.
- Deflation: Caused by the
debt and credit collapse – and may even lead to the other D-word,
Depression. The worse the economic downturn becomes, the greater will be
the efforts to turn the economy around, all requiring increasing Federal
Budget deficits. This applies to all countries around the world.
- Demographics: The Baby
Boomers have entered their retirement phase, which means that there will
be increasing claims for pensions, social security and medical
entitlements for which the Government has no resources. These unfunded
claims could amount to a total of more than $40 trillion, all of which
will swell the budget deficit for years to come.
- Derivatives: This is the
“biggie”, running into many hundreds of $ trillions at
notional values. Huge losses are already emerging from this area, which
have nearly sunk AIG and the banking system. Nobody knows where the
losses will settle, but it seems a foregone conclusion that they will be
massive, eventually finding their way into increasing US budget deficits and debt.
- Dwellings: The slump in
real estate is far from over and attempts to assist in this area will
also swell the US budget deficits.
- Destruction: Wars in Iraq and Afghanistan continue to cost vast amounts of money, all
funded by additional budget deficits.
- Deceit: This is a new
one. The first casualty of war is truth. Lies, deceptions and
misinformation abound in a war situation. Whether we like it or not, we
are all involved in a war between government fiat currency and sound
money. Governments will not willingly give up their right to create new
fiat money. We must expect Governments to fight the introduction of
sound money with whatever tools they have, which will include propaganda
and misinformation.
Realistically we must
assume that the world economy will continue to wind down. Deleveraging is
continuing apace and people are scared. In such circumstances one cannot
expect people to borrow and spend with gay abandon. That will not happen.
People have become conservative and will save or repay debt to improve
personal balance sheets. It is probable that unemployment numbers will
continue to escalate, possibly sharply. Unemployment in the USA has reached 8.1% and will almost certainly go higher.
We cannot exclude the possibility of a 20% unemployment rate.
When the economy tanks and
unemployment rises, two things happen to the US Government budget.
Expenditures increase due to higher unemployment claims while Government
revenues decline as tax receipts plummet. The result is that Government
budget deficits mushroom rapidly. These deficits are then aggravated by
spending on stimulus packages, money thrown at supporting the banking system
and the “too big to fail” corporations.
Bloomberg has estimated that all
the various packages thus far propagated by the US government total more than $12 trillion. Where will
this huge amount of money come from? It comes from the US budget, to be found in ballooning deficit numbers.
How does the US government raise the money to fund these deficits?
Increasing taxes would have a detrimental impact on the economy, so that will
not happen. Can the money be borrowed? Not in the quantities that will be
needed, and $12 trillion may only be the first pass at a much, much higher
final number. Money to fund the deficits can only come from selling Treasury
Bonds to the Fed in exchange for newly created fiat US dollars. That is
already happening and is a trend that will rapidly escalate .
As mentioned above, this is
where the rubber hits the road, not only for the USA but in countries around the world. Escalating national
budget deficits will be financed by newly created local fiat money. The
frightening thing is that whereas this situation has occurred in individual
countries from time to time throughout history, this is the first time that
it is happening world wide in virtually every country at the same time.
Where does this lead to? It is
time to dust off the centuries old “Gresham’s Law”.
Gresham’s
Law
Sir Thomas Gresham was an
English financier who lived nearly 500 years ago. His Law states that
“bad money drives out good money” What he meant was that people
will hoard “good” money while spending the “bad”
money.
Gresham lived in an era of
metallic money and the “bad” money he referred to related to
coins that had been clipped or had been debased by having some of the
precious metal content supplanted by base metals. The “good”
coins were hoarded and disappeared from circulation. People got rid of the
“bad” money while they could still find someone to accept it.
There is a corollary to Gresham’s law that applies to the modern situation when a
country rapidly increases the fiat currency in circulation. Initially people
exchange the local “bad” currency for foreign “good”
currency (or gold) and hoard the good money. Gradually the locals introduce
the use of foreign currency into every day trade and eventually the local
fiat currency is spurned. At some point Gresham’s Law is reversed. The
“good” money drives the “bad” out of circulation.
This is exactly what happened in
Zimbabwe recently. Initially South African Rand and US
Dollars were hoarded by Zimbabweans. Subsequently these currencies emerged in
every day trade until the Government had to accept the de facto
situation that they could no longer spend Zimbabwe dollars in Zimbabwe. The people would not accept them. The Government
eventually announced that trade in Zimbabwe could be conducted in any foreign currency.
“Good” money had replaced the “bad”.
History is littered with similar
examples. Virtually all South American countries went through a similar
process 30 years ago where the bad money was eventually driven out by the
good money, which at the time was the US dollar.
The downfall of the Roman Empire included a similar set of circumstances. Roman government
spending reached a point where it exceeded the income raised in taxes and
tributes. The Emperor raised taxes to cover the deficit, but citizens voted
with their feet and departed from Rome to avoid the higher taxes. Tax collections declined.
The Emperor refused to cut
expenditures and finally resorted to debasing the silver currency to cover
the deficit. Initially this worked while the population remained unaware of
the minor reductions in the silver content of the coins. This could not be
hidden when the reductions in silver content became more obvious. Eventually
the silver content was reduced by 95% in just a few years. The Roman Legions
rejected the debased currency. Without an army, the Roman Empire collapsed
I recently visited Vietnam for the first time. It was basically a tourist
visit, but I was interested in monetary developments in that country. The
local currency, the Dong, is not an internationally exchangeable currency and
has showed signs of moving in the direction of the Zimbabwe dollar.
The first thing that made an
impression was a question on the Vietnamese arrival form. Immediately
following the normal question: “Are you carrying more than $10,000 in
cash or convertible currencies?” was another question: “Are you
carrying more than 300 grams of gold? If so, list the gold that you are
carrying.”
This is an interesting
development. Be prepared for this question to soon be inserted on arrival
forms near you.
Virtually all trade in Vietnam can be conducted in either Dong or in US Dollars.
Every Vietnamese can instantly quote the price in either currency. The locals
spend Dong while US Dollars are hoarded. Gresham’s Law is alive and well in Vietnam. The Vietnamese are also well versed in the
benefits of holding gold as “good” money. This article suggests that the
Vietnamese people hold a total of 700 tonnes of gold, a huge amount for such
a small country:
It will be interesting to follow
developments in Vietnam.
How will the current crisis end?
How will the current crisis end?
As mentioned, this is a war between fiat money and sound money. It is
extremely unlikely that Governments will voluntarily give up their freedom to
create fiat money at will. They will have to reach a point where there is no
alternative to introducing sound money because citizens finally refuse to
accept the fiat currencies. This journey will probably be decidedly
unpleasant.
Fiat money will survive for as
long as people are prepared to accept it in payment for goods and services.
The end will come when the general populace rejects the fiat currency in
favour of sound or “good” money.
The bottom line is that it is
the people who will finally decide when this crisis will end, when
they reject bad money and force the good, sound money into circulation.
How can this happen in the USA? We need to go back to examine the basics of banking.
Centuries ago goldsmiths, the forerunners of modern banks, provided a storage
service for metallic coin money. The receipts they issued were regarded as
being as good as gold and enabled commercial transactions to take place
easily. The goldsmiths’ profit came from storage charges.
Later the goldsmiths started
issuing receipts for their own gold as loans and charging interest on those
loans. Then they started lending fictitious receipts based on the gold they
were holding in storage for clients. That was when they morphed from the
sound business of storage into the murky waters of lending money belonging to
others.
The same two functions are
performed by modern banks – the transaction function and the loan
function. The transaction function is easy, safe, but unexciting business.
The loan function is much more profitable and invites risk taking. This is
where problems normally emerge.
With the development of
electronic money and electronic banking, the transaction function has become
vital to continuing economic activity. This is why Governments are so
determined to save their national banking systems, but this requires them to
absorb all the bad investments and derivatives from the loan side of the
banks.
It seems inevitable that before
this crisis is resolved, that the two functions performed by banks, the
transaction function and the loan function, will need to be separated.
It also seems inevitable that
when government fiat money is rejected by the people, (following unbridled creation
of new fiat money), that gold and silver will have to re-enter the national
and international monetary systems. In our modern economies, with their
electronic money transaction systems, gold and silver will need to be in an
electronic format to be reintroduced as money.
Electronic gold and silver money
already exists. Some people (ahead of their time) have perceived this need
and set up the electronic transaction function of a banking system using gold
and silver. James Turk at Goldmoney.com
is one such person. Their business provides a facility for people to open
electronic gold and silver accounts. Goldmoney.com buys and holds the
precious metals on behalf of clients who can use their holdings to make
electronic payments from their accounts, either in gold or silver or by
converting back to fiat currencies.
Goldmoney.com makes
its profits from minor transaction fees and small margins between the buying
and selling prices of precious metals. They only provide the storage and
transaction functions of a bank. They do not get involved in the loan
function. Thus goldmoney.com
has also achieved the separation of the loan and transaction functions of a
banking system.
I have no connection with goldmoney.com and
only mention their business as an example of how good money may evolve and
eventually drive out the less desirable fiat money from circulation. If you
use goldmoney.com
or any similar business, please be aware that you must do your own due
diligence to satisfy yourself of the security of the operation.
What to do in the interim?
Nobody can be certain how the
various forces will play out in the period ahead, but if events unfold along
the lines described in this article, then there should be a massive transfer
of wealth from fiat money and financial assets into tangible assets.
The top tangible assets will be
the precious metals that should form the basis of the new sound monetary system.
Gold and silver, but particularly gold, will be the main financial life
preservers. The ship has been holed and is sinking. This is not the
time to take off your life jackets. Do not try and trade your precious metal
positions.
Most people are uncomfortable
holding too large a percentage of their assets in precious metals and related
mining company shares. There are many other tangibles that can be considered,
ranging from commodities, base metals, energy assets to real estate, equities
and collectibles such as works of art by renowned artists. It is important to
pick a suitable point in the valuation cycle to purchase tangibles such as
real estate and equities.
A personal note.
My life changed two years ago
with the birth of my first grandchild. There are now four grandchildren with
number five on the way. I guess all grandfathers think that their
grandchildren are the brightest, prettiest, cutest grandchildren ever. I am
no different and find that I am spending increasing amounts of time helping
with the grandchildren. I love watching their development, which always fills
me with amazement. As a consequence I seem to be spending less time following
events in financial markets and economies.
I recognise that if I continued
writing these articles that I would find myself simply repeating much of what
I have written before. There would be no fun in doing that. So it really is
time for me to quit writing. If I have any talent, then it has been a gift
from God that I have been happy to share freely. If on the journey I have
helped a few people to understand what has been happening in a complex world,
then that is sufficient reward.
Alf Field
Read
all the other articles written by Alf Field
Disclosure and
Disclaimer Statement: The author is not a disinterested party in that he has
personal investments gold and silver bullion, gold and silver mining shares
as well as in base metal and uranium mining companies. The author’s
objective in writing this article is to interest potential investors in this
subject to the point where they are encouraged to conduct their own further
diligent research. Neither the information nor the opinions expressed should
be construed as a solicitation to buy or sell any stock, currency or
commodity. Investors are recommended to obtain the advice of a qualified
investment advisor before entering into any transactions. The author has
neither been paid nor received any other inducement to write this article
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