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"In effect, there is nothing inherently
wrong with fiat money,
provided
we get perfect authority and god-like intelligence for kings."
-- Aristotle
Today, Monday, August 15, 2011, marks the 40th
anniversary of the US default on the dollar’s convertibility into gold.
It was the world’s de facto reserve currency and thus began an
experiment with a reserve fiat currency that was doomed to failure before it
began, because there has never been a successful fiat currency in all of history.
August 15, 1971 was just like any other day for most people, and President
Nixon’s unprecedented decision to cut the US dollar’s gold
international convertibility was largely ignored by the public. The majority
of citizens didn’t understand the implications for their financial
future. Contrast that to today, where a historic downgrade of US debt and a
very public $2-trillion increase of the debt ceiling dominated headlines and
the television news.
Forty years later, it is a tale of contrasts
between US dollars and gold. The US dollar is the world’s reserve
currency despite the fact that it is being issued by the world’s
largest debtor nation. Investors around the world flee to it during times of crisis, despite it continually loses value through debasement.
Gold meanwhile is dismissed as a viable asset, ignored by most pensions,
institutions and asset managers despite increasing from $35 in 1971 to over
$1800 last week.
It is important to note that on this historic
day 40 years ago, the dollar quietly ceased to be money and instantly became
a currency. Money and currency are often considered as one and the same;
however, there are meaningful and significant differences between the two.
While fiat currencies function well as a medium of exchange and a unit of
account, they fail miserably as a store of value.
The US dollar has lost over 80 percent of its
purchasing power compared to gold in the last decade alone. Gold, however,
has endured as money for over 3,000 years, and maintained its purchasing
power throughout that time, because it meets all of the criteria for money.
To satisfy the functions of money, an item must be a unit of account, a
medium of exchange and a store of value. Gold is all of these things; it is
durable, portable, divisible, consistent, intrinsically
valuable and, of crucial relevance today, it cannot be created by central
banks.
Gold is a tangible asset, something that is
real and in limited supply, as opposed to fiat currency, which is merely
worthless paper that governments can produce at will. It is only the promise
written on the paper enforced by a government decree that gives it any value.
The more governments produce, the less value it has.
In light of this, it makes sense to earn
currency and then protect its value through precious metals ownership of
gold, silver and platinum.
The current monetary system, which, in its
current form, began in 1971, has two critical features that have profound
implications for our financial future:
- Fiat currency is created out of debt via the banking
system and the Federal Reserve.
- The amount of currency created must continually
expand.
 
In May 2006, we wrote August 15,
1971 Inflation Unleashed, and I
direct you to key statistics of just five years ago.
There are limits to debt expansion, and it is
my guess that we are now entering the phase where the compounding of the debt
and the loss of our purchasing power is not only more noticeable, but also
about to become exponential. In three years time,
it is quite possible that these numbers could be double what they are today.
Chris Martenson
quotes Dr. Bartlett, an emeritus Professor of Physics at the University of
Colorado, who said, “The greatest shortcoming of the human race is the
inability to understand the exponential function.” I encourage you to
spend eight minutes viewing the following presentation on exponential growth
and compounding from Chris Martenson’s
"Crash Course."
Exponential Growth,
Length 06:20
Compounding is the
Problem, Length 03:06
It puts into context why the only logical
conclusion that can be drawn from the ever-expanding debt and money supply
problems that the US and other countries are facing is hyperinflation. See
John Williams “Hyperinflation Report” (www.shadowstats.com/article/hyperinflation-special-report-2011)
Until governments around the world stop
spending beyond their means, running huge deficits, incurring massive debts
and creating endless amounts of fiat currency, precious metals will continue
to rise and fiat currency values will continue to erode. The best way to
protect portfolios and preserve wealth from this impending crisis is to own
precious metals.
When we consider that total global financial
assets are estimated at over $200 trillion, but total global aboveground gold
bullion is a modest $3 trillion, and only growing by approximately $100
billion a year, we can see that once a shift towards gold occurs, there will
be too much paper currency chasing too little gold. Of the $3 trillion of
aboveground gold bullion, about half is owned by central banks and half is
privately held. The central banks have been net buyers since 2009, and most
of the privately held gold is not for sale at any price. If only five percent
of the $200 trillion in financial assets were to allocate to gold, there
would be about $10 trillion trying to buy the $1.5 trillion of privately held
gold bullion. Under that scenario the price of gold will trade substantially
higher than the levels today.
There have been suggestions in the media that
holding gold is too risky. It has been called a useless, overvalued relic
that pays no interest and is in a bubble. We heard this same rhetoric when
gold was $300, then $500, $800, $1,000 and last week at $1,800This advice has
been costly to those who listened. In truth, gold is not rising; fiat
currencies are falling and will continue to do so until governments around
the world begin to act responsibly. There is nothing on the horizon to
indicate this will happen any time soon.
It is difficult to predict how the financial mess
the major economies of the world are in will unravel. Some economists believe
the increase in money supply will have an inflationary effect, while others
believe the lack of demand and lack of growth will result in deflation.
Federal Reserve Chairman Ben Bernanke made it quite clear in his famous
“helicopter” speech that there will be no monetary deflation on
his watch. Other historical examples indicate we will end up in a
hyperinflation followed by a deflationary collapse. Recent examples of this
have occurred all over the world. See http://en.wikipedia.org/wiki/Hyperinflation.
The best defense in either eventuality,
however, is to hold precious metals. The lack of understanding in the difference
between money and currencies is so pervasive that even Warren Buffett, who
has received many accolades for his investment track record, has criticized
gold in the past. In a speech to the 1998 Harvard graduating class he said:
“Gold, It gets dug out of the ground in
Africa, or someplace. Then we melt it down, dig another hole, bury it again
and pay people to stand around guarding it. It has no utility. Anyone
watching from Mars would be scratching their head.”
In contrast to this view of gold, fiat currency
is nothing more than a medium of exchange that is susceptible to abuse by the
governments that produce it. Trees are cut down, turned into paper, a number
is written on it and by force it is declared legal tender. It is created out
of thin air, backed by debt, printed without limit and its value decreases as
the amount of printing increases. There has never been a successful paper
currency in history; the longest-standing currencies, the British pound and
the US dollar, have both lost 99.5 percent of their purchasing power.
Currency completely fails as a store of value. Anyone watching from Mars
would be scratching their head at this, as well.
Perhaps the former chairman of the Federal
Reserve, Alan Greenspan, explained the importance of the gold best when, in
1966, he said, “In the absence of the gold standard there is no way to
protect savings from confiscation through inflation. There is no safe store
of value.” Forty years after President Nixon ended the dollar’s
convertibility to gold; it seems that Mr. Greenspan was correct.
*All dollar amounts expressed in US currency
unless otherwise indicated.
Nick Barisheff
Bullion Management
Group
Nick Barisheff is the
co-founder and President of Bullion Marketing Services Inc., which was
established to create and manage The Millennium BullionFund.
The fund is Canada’s first and only RRSP eligible open-end Mutual Fund
Trust that holds physical Gold, Silver and Platinum bullion www.bmsinc.ca
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