A very apt metaphor for
what is currently happening
to the U.S. monetary system
what is currently happening
to the U.S. monetary system
Introduction
One of the most commonly cited truisms of psychology is that the best predictor of future behavior is past behavior. I’m sure that you have much evidence that bears this out from your own life and also from those you know well. I can tell you for sure that it is strongly aligned with my general experience, both personally and as a psychotherapist.
Sigmund Freud aptly referred to one variant of this principle as the “repetition compulsion.” The ancient Greeks recognized a similar predictable pattern that they called “hamartia,” the fatal flaw in character that leads predictably to the downfall of the protagonist in a tragedy, who is said to “walk in blindness.”
Sigmund Freud aptly referred to one variant of this principle as the “repetition compulsion.” The ancient Greeks recognized a similar predictable pattern that they called “hamartia,” the fatal flaw in character that leads predictably to the downfall of the protagonist in a tragedy, who is said to “walk in blindness.”
With regard to humans repeatedly making the same dumb mistakes over and over again, it sadly seems to hold true across the broad spectrum from individuals to nation states. The 18th century British statesman and philosopher, Edmund Burke, summed up this seemingly lawful principle in his often quoted aphorism: “Those who don’t know history are destined to repeat it.”
The consequences of this unfortunate human proclivity have historically entailed tremendous suffering for humankind. Accordingly, I want to focus here on the history of a particularly dramatic instance of it that has unfolded repeatedly and lawfully in the economies of nation states over the past 2500 years or more.
Within the context of government finances, this recurring pattern can be summarized most simply as follows: The accumulation of excessive debt through the creation of fiat currencies that are not backed by gold, silver, or other precious metals. This leads lawfully and progressively to hyperinflation and then to the eventual economic collapse of the nation states that choose to follow this reckless course.
Some History and Definition of Terms
In order to convey adequately how this repetitive self-defeating pattern unfolds, it will be helpful to define some key basic terms and provide some historical background. First of all, it’s important to understand the difference between “money” and “currency.” Although these two terms are commonly used interchangeably, they actually have distinctively different technical meanings. Money is intrinsically valuable; that is, it stores value in and of itself, quite apart from being used as a means of exchange. Currency, by contrast, has NO intrinsic value and is used ONLY as a means of exchange.
Down through the history of humanity, a wide variety of items have been used as money, or more specifically, “commodity money”. They have included such things as red ochre, sea shells, ivory, whale’s teeth, as well as various commodities (e.g., salt and spices). Interestingly, when a commodity becomes socially defined as money, its value may be increased above its intrinsic worth or usefulness; also, its value commonly fluctuates over time accordingly to the demand for it and/or its prevalence.
In order for a commodity to become conventionally defined as money, it must be fairly easy to transport, durable so that it can be stored for prolonged periods of time without deteriorating, and sufficiently rare to hold its value. Given these criteria, it is not surprising that gold and silver have commonly served as money for thousands of years and, over the past twenty-five centuries, have become its most prevalent form, spreading from Asia Minor across the entire world.
Very remarkably, Gold has steadily held its
value for the past 2,600 years
value for the past 2,600 years
This conventional practice was facilitated by the discovery of the “touchstone” around the 6th century B.C. This made it possible to do a quick assay of gold and silver to determine their degree of purity.
Since gold and silver are relatively soft metals, they are subject to becoming significantly worn or deformed through daily use. In order to increase their durability, therefore, they are commonly alloyed with less expensive metals, such as copper. Common examples of such alloys are sterling silver or 22 carat (92%) gold.
Over time, commodity money gradually evolved into “representative money” as a result of bankers issuing paper receipts or other representative tokens to their depositors. These receipts or “notes” indicated that they were redeemable for whatever goods were being stored (usually gold or silver). This soon led into these notes being traded as money with the understanding that they were “as good as gold;” that is, their bearers could redeem them at any time for the amount of silver or gold that they represented. They were, in other words, gold-backed or silver-backed notes.
It was through this practice, for example, that the paper currency called the “British Pound” evolved. Since it was backed by a pound of sterling silver, it came to be called the Pound Sterling. This general practice was widely emulated by many other nations that elected to back their various currencies with gold throughout much of the nineteenth and twentieth centuries. This became generally known as the “gold standard.”
The Pound Sterling and other British money
As these notes became widely trusted and utilized as a medium of exchange, bankers (or goldsmiths) observed that it was very rare for people to redeem all of their notes at the same time. This led them to the avaricious realization that they could invest a portion of these gold reserves into interest-bearing loans and thereby generate additional income. This left them, however, on a slippery slope with more notes on issue than reserves with which to pay them. It also set in motion an evolutionary process whereby goldsmiths were transformed from being passive guardians of gold and silver bullion, who charged fees for safe storage, into the wealthy interest-paying and interest-earning bankers of today.
Moreover, it ushered in the highly lucrative modern practice of fractional-reserve banking. This refers to the fraction of its total reserve assets that a bank can legally use in issuing loans to its customers. This fraction is most commonly fixed at 10%, but can be as low as 1%. In practice, this means that if the clients of a particular bank have deposited, say, a total of one million dollars, that bank can immediately use at least 90%, or $900,000, of these deposits in issuing interest-bearing loans.
Even more amazingly, they now commonly issue these loans not only on the actual deposits that they have received, but also on the basis of mortgage agreements where there is merely a promise on the part of the mortgagee to pay a certain sum to the bank over a fixed period of time. So, for example, suppose that you get a mortgage of $100,000 from a bank to buy a house. On the basis of this purely paper transaction, the bank credits itself with $100,000, 90% of which it can then legally issue in the form of additional interest-bearing loans to other clients. Critics of this astonishing process commonly call it “creating money out of thin air.”
Fiat Currency--The Fatal Financial Mutation
How "toilet paper money" is created
This background puts us in position to understand the potentially fatal flaw of fiat currency and how it has historically led to hyperinflation and the collapse of a vast number of national economies.
The Latin word, “fiat,” literally means “let it be done” or “by decree”. “Fiat money,” then, is actually a form of currency that has no intrinsic value and also is not backed by anything of value; rather it is simply decreed by governmental fiat to be “legal tender.” For this reason, it is sometimes referred to disparagingly as “toilet paper money.”
Just as is true of individual humans, national governments have a strong and unfortunate propensity to spend beyond their means. This is especially true when they go to war—which, tragically, they do quite repetitively. As a result of this over-spending, they commonly incur huge amounts of debt. Then, in order to avoid bankruptcy, they create fiat currency—or what is often called “making money out of thin air.” If an individual citizen of a country were to do this, it would simply be called “counterfeiting.”
When governments create fiat currency more rapidly than what is produced through their economic growth, some inevitable and unfortunate consequences occur. Most immediately, it lowers the value of each monetary unit. As this happens, progressively more of these units are thus required to purchase consumer goods. This is called inflation. As the supply of fiat currency is inflated, prices are inflated accordingly. This excess “money” progressively dilutes the value of ALL money in the system.
Gradually—or sometimes very suddenly—this can (and does) lead to hyper or runaway inflation. When this occurs, ordinary citizens are unable to afford even the most essential goods, because of their exorbitant prices. Moreover, the financial assets of the vast majority of citizens suddenly plummet in value and may literally be wiped out overnight. It takes relatively little imagination, then, to understand how this tragic and progressive scenario can (and does) lead to the complete collapse of a nation’s economy.
This insidious scenario has played itself out repeatedly in hundreds--or even thousands-- of nation states over the past 2500 years. The following brief summary, which is much like singing the same song with different verses, shows how it has led to economic collapse in a sampling of nine different countries during the past century:
German children stack nearly worthless
fiat currency in the Weimar Republic
fiat currency in the Weimar Republic
1. The Weimar Republic in Germany – 1922-23: Unable to pay war reparations as stipulated in the Treaty of Versailles at the end of WW I, the German government printed fiat currency in order to pay benefits to workers, as well as its delinquent international debt. As a result, the excessive currency that was circulated quickly became worthless. The largest denomination of the Papiermark increased from 50,000 in 1922 to 100 trillion a year later. By November, 1923, the estimated inflation rate was 325,000,000%!
2. Hungary – 1945-46: In compliance with the Treaty of Versailles, The Austrian Pengo replaced the Austrian-Hungarian Korona in 1926. Following the devastating effects of WW II, the highest denomination of the Pengo was a 1,000 note. It increased to 10,000,000 over the next year and was 100,000,000,000,000,000 by mid-1946. The Pengo was then replaced by the Forint in the ratio of 400 octillion to one. At that time, it was estimated that the value of ALL Hungarian currency in circulation was worth less than 1/1000 of one U.S. dollar! Today, $1 USD is worth approximately 195.2 Forints.
3. Chile – 1971 – 1981: In 1971, Socialist President, Salvador Allende, nationalized Chile’s leading industries. Due to bureaucratic mismanagement, the Chilean Central Bank began printing huge quantities of fiat money. As a result, inflation soared to 600% by the end of 1971 and then skyrocketed to 1200% by the end of 1973. Then, following the overthrow of the Allende regime later that year, the Escudo was replaced by the New Peso at the rate of 1000 to 1. By selling off most of the state-owned enterprises, the Chilean economy then recovered, following a slight depression in 1981.
4. Argentina – 1975 – 1992: Following the 1973 oil crisis, the government was headed for a sharp recession. The situation worsened when the government refused to borrow to cover its deficits. From 1975 to 1976, the largest Peso denomination increased from 1,000 to 5,000. Following a violent military coup, it rose by 1979 to a Peso note of 10,000. Then, in 1981, the Argentine Central Bank introduced a 1,000,000 Peso note, and Argentina’s GDP fell by 12%. Through three successive currency reforms in 1983, 1985, and 1992 (sometimes referred to as “The March of Zeros”), the Pre-’83 Peso was progressively devalued. As an end result, in 1992, 1 New Peso was equal to 100,000,000,000 Pre-’83 Pesos!
5. Peru – 1988 – 1991: During the 1980’s, Peru privatized enterprise, increased public spending, and neglected its growing national debt. This resulted in negative economic growth, multiple deficits, and hyperinflation. The Peruvian government reacted to this by replacing the “Old Sol” with the Inti in 1985, at the rate of 1000 to 1. Within 2 years, monthly inflation increased by 132% in Sept., 1988 and to 400% by Sept., 1990. New notes, as high as 10,000,000 Inti, were introduced by 1991. The government then replaced the currency again, this time with the Neuvo Sol at the rate of 1,000,000,000 to 1. Thus, over a six year period, the value of the currency increased one billion times!
6. Angola – 1991 – 1999: A brutal civil war placed a great strain on Angola’s economy, including its currency, the Kwanza, from 1975 – 2002. The largest Kwanza note was 50,000 in 1991. It soared to 500,000 by 1994. In 1995, it was replaced by the Readjusted Kwanza (Kwanza reajustado) at the rate of 1,000 to 1. The New Kwanza was introduced in 1999 at the ratio of 1,000,000 reajustados to 1 New Kwanza. This new currency, then, was equivalent to one billion of the pre-1991 Kwanzas.
7. Yugoslavia – 1992 – 1995: The denomination of the Yugoslavian Dinar note was inflated from 50,000 to 2,000,000 between 1988 and 1989. It was then replaced by the New Dinar in 1992 at the rate of 1 to 10. The highest denomination of this note then soared from 50,000 to 10,000,000,000 by 1993. The government then replaced it with a “Newer” Dinar by simply removing six zeros. It was replaced yet again in the next year at the astonishing rate of 1 to 1,000,000,000! The German Mark was then pressed into service as the country’s fiat currency in 1995. By this time, prices had increased by a quadrillion percent in 2 years. At the height of this hyperinflation in 1994, currency was being devalued at the rate of 100% per day!
8. Belarus – 1994 – 2002: At the end of the cold war, the economy of Belarus was relatively well developed and had one of the highest standards of living in Eastern Europe. The largest Ruble note there in 1993 was 5,000. By 2000, it had increased to 5,000,000. The government then replaced it with a new Ruble at an exchange rate of 1 to 1,000 “old” Rubles. The highest denomination now is the 100,000 note, which is worth 100,000,000 1993 Rubles. Many citizens blame this on Lukashenko, who came into office in 1994. Currently, about 80% of the country’s industries remain nationalized.
9. Zimbabwe – 2000 – 2009: Zimbabwe became an independent African state in 1980. At that time, the value of each Zimbabwe dollar was equal to 1.25 U.S. dollars. Following a series of race-based seizures of land and rampant printing of fiat currency, however, marked inflation ensued. This reached a high of 624% by 2004 and then declined again to less than triple digits before surging again to 1,730% in 2006. Although the currency was then replaced with a New Zimbabwe dollar at the rate of 1 to 1000, inflation continued at a progressively accelerating rate. It reached an annual increase of 11,000% by mid-2007 and then continued to soar. New Zimbabwe Dollars (ZWD) were released in May, 2008 with denominations of 100 Million and 250 Million and then 500 Million after two weeks. This note was worth about $2.50 in U.S. dollars. This escalation continued on a weekly basis as notes worth 5 billion, 25 billion, 50 billion, and 100 billion were sequentially released. In August, 2008, the government simply removed 10 zeros from the currency, making 10 billion ZWD equal to 1 new ZWD. At this point, the estimated annual inflation rate was about 500 quintillion percent, with a month rate of about 13 billion percent.
The History of Fiat Currency in the United States
Many of the U.S. Founding Fathers were exposed to the damaging effects of fiat money during the American Revolutionary War, which was mainly financed by the worthless Continental Currency issued by the American colonists through the Continental Congress. This painful exposure to fiat currency during the birth of our nation became memorialized in the well known epithet, “not worth a Continental.” As a result of this experience, the Founding Fathers were in strong consensual agreement about the importance of limiting the issuance of money. In this regard, Thomas Jefferson, for example, gave this very strong prophetic warning:
The History of Fiat Currency in the United States
Many of the U.S. Founding Fathers were exposed to the damaging effects of fiat money during the American Revolutionary War, which was mainly financed by the worthless Continental Currency issued by the American colonists through the Continental Congress. This painful exposure to fiat currency during the birth of our nation became memorialized in the well known epithet, “not worth a Continental.” As a result of this experience, the Founding Fathers were in strong consensual agreement about the importance of limiting the issuance of money. In this regard, Thomas Jefferson, for example, gave this very strong prophetic warning:
Thomas Jefferson--how
far we've strayed from
his vision!
far we've strayed from
his vision!
"I believe that banking institutions are more dangerous to our liberties than standing armies. Already they have raised up a money aristocracy that has set the government at defiance. This issuing power should be taken from the banks and restored to the people to whom it properly belongs. If the American people ever allow private banks to control the issue of currency, first by inflation, then by deflation, the banks and corporations that will grow up around them will deprive the people of all property until their children will wake up homeless on the continent their fathers conquered. I hope we shall crush in its birth the aristocracy of the moneyed corporations which already dare to challenge our Government to a trial of strength and bid defiance to the laws of our country"
The Continental Currency was thus replaced by the U.S. Dollar as the unit for national currency by the Continental Congress in 1785. Through the subsequent U.S. Coinage Act of 1792, the U.S. Dollar was defined by statute as a specific weight of gold.
Despite this statute, fiat money was first used by the U.S. government in 1862 in the form of “Greenbacks” in order to finance the huge cost of the Civil War. They were issued as a debt of the U.S. government to be redeemed in gold at an unspecified future date. Gold certificates, also backed by the promise of the government to pay in gold, were circulated at that time. This floating fiat currency continued to be used through 1879.
A Civil War Greenback--
a precursor of things to come
a precursor of things to come
The U.S. then returned to the fixed gold standard for the next 34 years. This era was marked by price stability and virtually no inflation. It ended quickly, however, in 1915 at the advent of WWI. Once again, the U.S. reverted to using floating fiat money over the next 10 years as a means of financing the enormous costs of that war.
Then, in 1926, the gold exchange standard was established whereby participating countries each pegged their currencies to the U.S. dollar and the British pound, both of which were backed by gold. This ended abruptly, however, at the onset of the Great Depression due to a “run” on gold by countries trying to cash in their dollars and pounds for gold.
FDR found the solution
that has now evolved into
a major problem
To counteract this, President Roosevelt declared a bank moratorium in March, 1933. This forbade banks to pay out gold or to export it. Soon thereafter, on April 5th, he ordered all Americans to deliver all gold coin, gold bullion and gold certificates to the Federal Reserve by May 1st. This was followed, on June 5, 1933, with a joint resolution of the U.S. Congress, nullifying the right of creditors to demand payment in gold. Finally, in 1934, the price of gold was increased to $35 per ounce. This increased the gold reserve in the Federal Reserve Bank by 69% and thus allowed it to print more money. that has now evolved into
a major problem
By virtue of the Bretton Woods Accord in 1944, the U.S. dollar continued to be pegged to the price of gold at $35.00 per ounce. This accord also pegged other major currencies to the dollar and stipulated that they could fluctuate no more than 1% on either side of this standard.
This accord—and the U.S. Gold Standard as well--was effectively ended on August 15, 1971 when President Nixon acted unilaterally to sever completely the link between the dollar’s value and gold reserves. In keeping with many historical precedents, this enabled the U.S. to fund the escalating costs of the war in Viet Nam with fiat money. This key and fateful decision initiated the bubble of U.S. debt that has continued to grow progressively up to the present time. Accordingly, from 1971 to 2009, inflation increased in the U.S. by 177% and it has continued to rise until the present time.
The Ominous Handwriting on the Wall
As of early May, 2011, the U.S. economy seems to be following in the footsteps of endless previous national economies that have suffered the horrors of hyperinflation through reckless accumulation of debt and the creation of fiat money.
Treasury Secretary, Timothy Geithner, has recently predicted that the U.S. $14.3 trillion debt limit will be breached as of May 16th. He has issued an urgent warning that failing to raise the debt cap could have a “catastrophic” impact on the economy.
Also, on April 19, 2011, the U.S. government received an unprecedented warning from Standard & Poor’s that it may lose its top investment (triple-A) rating within the next two years unless it finds a way to control the massive federal deficit. Such an action would drive up U.S. borrowing costs, make credit more difficult to obtain, cause higher interest rates, and would thereby inevitably slow the rate of U.S. economic growth.
ShadowStats editor, John Williams estimates that when Social Security, Medicare and other programs are taken into account on a net-present-value (NPV) basis, the total federal debt and obligations is around $75 trillion, which is 15 times the gross domestic product (GDP). These total obligations are increasing by $5 trillion a year. Williams points out that if the U.S. were a corporation with this level of debt and obligations, “it would be headed into bankruptcy rather quickly.” The federal government now has to borrow about 40 cents of every dollar it spends.
Another strong indicator of lowered confidence in the U.S. dollar is the consistent rise in the “spot price” of gold and silver over the past eleven years. (Very interestingly in this regard, gold has consistently maintained its value over a period of 2,600 years.) Over this period, gold has fluctuated from a low of $256 per oz. to more than $1,500 per oz.—nearly 600%; silver has fluctuated from a low of $4.14 per oz. to a recent high of nearly $50 per oz.—a rise of nearly 1200%!
In view of these and many other ominous indicators, the National Inflation Association (NIA) recently issued this statement: “In our estimation, the most likely time frame for a full-fledged outbreak of hyperinflation is between the years 2013 and 2015. Americans who wait until 2013 to prepare, will most likely see the majority of their purchasing power wiped out. It is essential that all Americans begin preparing for hyperinflation immediately.”
How to Prepare for Hyperinflation
Here are some suggested basic guidelines for how to prepare for, and cope with, hyperinflation most effectively:
Start taking protective action immediately. The sooner you do so, the more fully you are likely to be prepared to cope with the enormous challenges that hyperinflation entails.
Beware of reassuring governmental propaganda. Remember that all governments have a strong vested interest in calming their citizens and avoiding panic; for this reason, the true status of any national economy is almost always more negative than how it is portrayed by official governmental sources. Many cynics, in fact, actually interpret positive reports from these sources as “bad news.”
Ben Bernanke--his job requires
telling it like it is. . .NOT
telling it like it is. . .NOT
Be vigilant and proactive in collecting data. Monitor reports from organizations such as the National Inflation Institute, ShadowStats and the Ludwig von Mises Institute regarding the state of the economy. It’s also wise to pay attention to the consensus of knowledgeable financial experts in this regard and to track objective indicators, such as how gold and silver prices are trending.
Protect your financial assets. As Robert Kiyosaki is fond of saying about our fiat money economy, “cash is trash.” He, along with a great many other financial gurus, thus strongly recommend the conversion of at least a portion of one’s fiat currency into precious metals—silver and gold in particular. Also, in order to guard against any future governmental restrictions on owning these metals, it’s wise to have them safely stored outside of the U.S.
Become more self-sufficient. Due to the inevitable societal breakdowns associated with hyperinflation, the more practical self-help skills you acquire. Very importantly, this includes growing and preserving your own food and developing bartering relationships with others.
Stock up in advance on key commodities and basic health care items. Food costs increase astronomically with the onset of hyperinflation and food items also commonly become unavailable. For these reasons, purchasing canned goods, other non-perishable foods, and emergency health care items in advance is recommended.
Prepare for quick evacuation if necessary. Just as is true in being prepared for natural disasters, it’s a good idea to have important personal documents and other key personal items organized in readiness for emergency evacuation if this becomes necessary. Social breakdown and lawlessness are commonly associated with hyperinflation, especially in urban areas, so it’s important to have a plan in place of where to take refuge if necessary. In this regard, having an emergency supply of non-fiat currency (e.g., silver or gold), may be essential.
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