Gold Vs. Fiat Currency

Editor’s Note: Today’s article comes from guest columnist and friend of Gold World, Peter Schiff. You may know Peter as the president of Euro Pacific Capital, Inc. and from his bestselling book, Crash Proof: How to Profit From the Coming Economic Collapse. Peter was also an economic adviser for Ron Paul’s campaign in the 2008 Republican Party primaries, and back in November CNBC dubbed him “The Man Who Called The Collapse." Today he writes on the importance of owning gold right now. Enjoy.

Luke Burgess
Editor, Gold World

Since early last year, when the financial crisis began to bloom in earnest around the world, one refrain that we have heard repeated often is: "history has consistently shown that stoking aggregate demand through robust monetary expansion is the only proven means to quell a slowing economy." Informed by this central precept of Keynesian economics (first described less than 100 years ago), governments from Washington to Tokyo are now relying on deficit spending, credit expansion, and monetary stimulus to prevent their economies from falling into what they argue would otherwise be an inescapable downward spiral of demand destruction, falling prices, economic contraction, and corporate and personal bankruptcies.

The miracle tool that permits all of these aggressive government responses, and which many consider to be the crucial advancement in modern economics, is known in academic circles as an "elastic money supply." The expansion of the money supply (through money printing, debt monetization, or increased lending) is credited with limiting the severity of the free market boom and bust cycle and keeping the global economy on an even keel since the Second World War. Advocates of the tool argue that it has ended the economic miseries supposedly common in unchecked free market capitalism (think Dickens).

However, in order to provide this apparent benefit, governments had to discard what they perceived as a burdensome relic of the past: inelastic gold-based money. When civilization first began 5,000 or so years ago, societies almost universally developed mediums of exchange to replace the gross inefficiencies of barter-based economies. Many things were tried (shells, beads, cooking oil, salt, etc.), but eventually nearly all civilizations settled on precious metals -gold, in particular – as the best form of money based on its durability, uniformity, scarcity, and divisibility.

For 99% of recorded history, emperors, kings, and parliaments "struggled" with the limitations of gold. If Henry VIII, for instance, wanted to spend money to stimulate the English economy, he had a few choices as to where to get the gold: tax his citizenry, borrow from the bankers in Holland, dig for gold in his own realm, or seek to plunder gold from foreign sources through war or blackmail. All of these options involved significant costs and pitfalls. Henry’s easiest means to expand his money supply was to debase his gold by secretly mixing in base-metal alloys. However, such a ruse was easily detected by sophisticated market participants, who would subsequently shun Henry’s coinage. The result was that the governments of the world could only spend what they had.

Despite these "limitations", the global economy expanded significantly over the centuries. The march from ancient, to medieval, to renaissance, and ultimately to industrial economies occurred without the ability to easily or rapidly expand money supplies. This is because the key to economic growth is not to push up aggregate demand, as the Keynesians would argue, but to increase the efficiency and amount of goods produced. As a result, despite wars, pestilence, natural disasters, and famines, the general march of economics had always been upward. During that time, money generally increased in value as greater efficiency expanded the number of goods that a given weight of gold could buy.

But modern economists tend to ignore the period of history before the Great Depression – which is, in fact, most of history – and instead focus solely on the period since the supply of non-gold "fiat" money has been expanded at will. Although the drift began before the Second World War (with the devaluations of the Roosevelt Administration), the end did not come until 1971, when President Nixon officially dissolved the linkage between the U.S. dollar (the world’s reserve currency) and gold. Since that time, the supply of U.S. dollars has expanded exponentially and has resulted in the currency losing more than 80% of its value.

The Keynesians argue that this controlled devaluation has created consistent growth, in excess of inflation, and has greatly minimized the depths of economic contractions for all global recessions since the Second World War. To them, the nearly uninterrupted expansion over that time is absolute proof that the active management of fiat money is the economic equivalent of penicillin.

Such a view completely ignores economic fundamentals and the many other coincidental factors that have contributed to strong growth in the second half of the 20th Century.

Not insignificantly, the absence of warfare on a global scale has allowed an unprecedented level of international economic cooperation and has not resulted in the wasteful destruction of capacity that was seen in the first half of the century. Automation, computerization, plastics, transportation, and digitization all helped to significantly expand productive capacity. Western countries counteracted growing government burdens through social changes, such as bringing women into the workforce. In the last 30 years, the latent industrialization of the emerging economies and the ultimate dissolution of communism around the world brought about the largest influx of production that the world has ever seen.

I would argue that these forces have been so powerful that they have largely outweighed the harm done by currency debasement. We can only imagine the global prosperity that may have resulted if the world’s reserve currency had increased in value. Instead, Keynesian economists largely ignore these factors and pin the successes of the past 60 years on the back of wise monetary policy.

This is a dangerously selective and myopic view of history. What is closer to the truth is that the world has embarked on what will likely be a relatively short-lived experiment in trading worthless currency. Yes the post-War recessions have been mild by historical standards, but these benefits have been allowed only by the creation of a much more devastating correction that is just now beginning. Fiat money has simply allowed problems to be swept under the rug. But there is a limit to how much dirt any rug can hide.

There are precedents for money debasement as a sustained policy, but they have been much smaller in scale and they always end badly (French Revolutionary Assignats, Weimar Germany, present day Zimbabwe). The current experiment will go the same way. When it will end is hard to say, but end it will.

When the dust settles the world will once again understand that money must have a value that is not arbitrary or subject to the expansive will of central bankers. When that day comes, gold will re-emerge as the single most reliable form of money. (This is not to say that we will abandon electronic transactions in favor of the scale and the change purse. It simply means that the underlying value of the electronic pulses will be tangible.)

Wise investors will see this change coming. They will stock up on gold now, while the price is still deceivingly low relative to the collapsing U.S. dollar. Protect your wealth and preserve your purchasing power before it’s too late. Discover the best way to buy gold at www.goldyoucanfold.com.

Peter Schiff
President, Euro Pacific Capital

From the desk of Luge Burgess: Uncle Sam’s massive construction of debt virtually guarantees inflationary pressures and the continuing devalutaion of the U.S. dollar. And now that the greenback has had some short-term strength over the past few months, there’s never been a better time to go short on the U.S. dollar. Fortunately for us as informed investors, there are several brand new investment vehicles that double — and even TRIPLE — short U.S. dollar and treasury positions. To learn more about these investment vehicles, just keep reading here.