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Full Printable Version of "Strategy 2: Protect Your Wealth From Hyperinflation"

Part 1 - The Journey to a Stable Monetary System

1 - Introduction: What is Inflation & Why is it a Risk to Your Wealth?

"The best way to destroy the capitalist system is to debauch the currency. By a continuing process of inflation governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens." John Maynard Keynes

At the time of writing (July 2009), I have some grave concerns that the massive stimulus measures introduced by governments around the world in response to the financial crisis will lead to an unrecoverable and therefore uncontrollable inflation or hyperinflation in the near future. The winners in such circumstances will be those who have bought physical gold, silver or platinum bullion because anyone holding paper assets such as cash, bonds, treasuries, and anyone relying on a pension or a fixed income stream will see their wealth disappear as the inflation plays out. I am particularly concerned about the outlook for assets denominated in US Dollars and British Pounds.

What is Inflation?

The majority of people believe inflation to be rising prices, say on a general basket of goods. But in doing so they mistake a collateral effect for a cause. I ask you to consider what force is in place before rising prices occur in order to give them that upward momentum?

Inflation is the decrease in the value of money due to the printing of an excess of it. Each new unit which is created reduces the value of all units which preceded it, such that an item purchased after money printing requires a higher number of units (as each one is now lower in value) than were required to purchase the same item before money printing occurred. As a direct result of the money printing, the value of money falls and prices rise.

Why does a loaf of bread now cost many times more than it did twenty years ago? The ingredients used to make the bread are unchanged. Intuitively you might even expect the cost of a loaf to decrease when factoring in all of the advancements in productivity, farm machinery, production techniques and transportation. It doesn’t quite make sense why loaf of bread costs substantially more today. Until, that is, you understand that the value of the money in our pockets has fallen during that time, causing the price of bread to rise by a compensatory amount.

Why is Inflation a Risk to Your Financial Security?

As a result of four decades of excess government money printing and inflation, our real salaries, savings and quality of life have decreased. We need more paper dollars and pounds to buy everyday products than we used to and we have to work harder to earn them. Unfortunately, the current inflation is now entering its final stages and will destroy the wealth of those who do not understand how it works. I have written these “Essentials” in an attempt to explain this complicated concept as simply as possible, so that you may become better informed about likely future events and can begin to consider an appropriate action plan for you and your family.

2 - The Journey to a Stable Monetary System

In early society mankind had three principal needs: food, water and shelter. Utilising each other’s particular talents for the benefit of the group as a whole, those with quickness went hunting, the strong fetched water or built shelter, the mothers and the elders tended to the children, prepared food and made clothing. As society progressed, barter agreements became commonplace. A hunter might swap his meat with a farmer in exchange for butter, milk and vegetables. The farmer might later swap potatoes with a fisherman in exchange for a share in the day’s catch. The fisherman might swap the remaining catch with a cobbler for a pair of shoes.

These exchanges are made voluntarily by each character and each character benefits because he values the items he receives more than the items he gives up. Think of it this way, it makes less sense for each character to fetch water separately, to gather food separately, to build and maintain shelter separately. This simple society is better off and experiences more prosperity if each character focuses on his or her own particular skills, exchanging the fruits of their labour with other members of society for something else they might need.

However, the merits of such a barter society are limited by two important factors. To quote Murray N. Rothbard in his book What Has the Government Done to Our Money?: “The two basic problems are “indivisibility” and “lack of coincidence of wants”. Thus, if Smith has a plough, which he would like to exchange for several different things, say eggs, bread, and a suit of clothes - how can he do so? How can he break up the plough and give part of it to a farmer and another part to a tailor? Even where the goods are divisible, it is generally impossible for two exchangers to find each other at the same time. If A has a supply of eggs for sale, and B has a pair of shoes, how can they get together if A wants a suit?

This leads us to the first major conclusion so far... direct exchange is not efficient as a society grows. Instead we need to develop a system of “Indirect Exchange”.

3 - Introduction of Gold & Silver as Money

Over thousands of years of trial and error it has become clear that indirect exchange better facilitates commerce and the progression of society. Smith would be better off exchanging his plough for something else, which is divisible, say butter, which he can then divide up and sell on in exchange for the particular goods he seeks.

However, while an improvement, this is still a clumsy approach. After exchanging his plough for butter, Smith is in a predicament if nobody wants his butter. Smith also suffers the inconvenience of storing the butter in the meantime, and is exposed to the risk of it going bad before he can exchange it. The butter may be divisible, which solves part of his problem, but Smith retains the risk that there is no market for the butter – a lack of coincidence of wants.

Gold & Silver are Chosen as the General Media of Exchange - “Money”

For society to really leap forward its members require a commodity which is divisible into small units without loss of value, which is durable over long periods of time and is transportable over large distances. Throughout the ages, by trial and error and in competition with all other commodities, one or two commodities began to shine through as the preferred general media of exchange – those commodities are gold and silver – and these became referred to as “money”.

Gold & Silver = Money = A Commodity

Continuing with Rothbard’s explanation for a moment... “A most important truth about money now emerges from our discussion: money is a commodity. Learning this simple lesson is one of the world’s most important tasks. So often have people talked about money as something much more or less than this. Money is not an abstract unit of account, divorceable from a concrete good; it is not a useless token only good for exchanging; it is not a “claim on society”; it is not a guarantee of a fixed price level. It is simply a commodity. It differs from other commodities in being demanded mainly as a medium of exchange. But aside from this, it is a commodity.

4 - Benefits of Gold & Silver as Money

The emergence of gold and silver as media of exchange removed the problems of “indivisibility” and the “lack of coincidence of wants” which plagued the early society. A carpenter could now exchange his plough for a number of ounces of gold, and use that gold to buy eggs, bread, a suit, whatever he desired in any location.

Also, as exchanges were made in gold or silver money, members of society could compare the market worth of each good or service to every other good or service. If an egg exchanged for one ounce of gold, and a plough exchanged for sixty ounces of gold, then everyone could see that one plough was “worth” sixty eggs sets on the market. “These exchange-ratios are prices, and the money-commodity serves as a common denominator for all prices.”

Silver, being historically more abundant than gold has been found useful for small exchanges, while gold is more useful for larger transactions. At the time of writing (July 2009) it is still clear from the in the gold price of $950/oz or £570/oz, and the silver price of $13.50/oz or £8.50/oz that this relationship still holds.

Do Not Underestimate the Importance of Gold & Silver as Money

Gold and silver have been used as money for thousands of years and their influence is not lost today. The words gold and silver are synonymous with word money in 51 countries. The dollar began as the name of an ounce of silver coined by the Count of Schlick. The Count lived in Jaochimsthal. The Count’s coins earned a great reputation for their uniformity and fineness, and they were widely called “Joachim’s thalers,” “thaler,” and finally, “dollar.” The name of the U.K. monetary unit "pound" reflects the fact that it originally represented the value of one troy pound of sterling silver. In Spanish (plata) and French (argent) the words for “money” and “silver” can be interchanged. In Hebrew, the word kesepph means both silver and money. Many Africans and Asians refer to both silver and money as “argent”.

Gold, Silver & The U.S. Constitution

Interestingly, The United States Constitution contains guidance for future generations with respect to the use of gold and silver as money. The American War of Independence, which ended in 1783, was financed in large part simply by printing excess paper money. As a result the new country started its history with hyperinflation. The Founding Fathers understood the implications of excess money printing and were so appalled by the effects of the hyperinflation that the United States Constitution, written in 1787, explicitly forbade the issuance of fiat currency, stating (underline added for emphasis):

No State shall enter into any Treaty, Alliance, or Confederation; grant Letters of Marque and Reprisal; coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts; pass any Bill of Attainder, ex post facto Law, or Law impairing the Obligation of Contracts, or grant any Title of Nobility”.

It is something that current generations have forgotten under a flood of new paper money, but gold and silver are money - that is it, chosen above all other commodities over thousands of years of trial and error. After reading these Essentials you may still decide to call pieces of paper that the government prints “money”, but you will be forevermore be subject to the will of government to expropriate your wealth by printing more of those pieces of paper. It may take some time for this to sink in, but this is one of the core premises of this website.

"Government is the only institution that can take a valuable commodity like paper, and make it worthless by applying ink." Ludwig Von Mises, Economist

5 - Gold & Silver Units & the True Money Supply

As a commodity, the unit of account for money is the weight of gold and silver. For the purposes of this discussion I will use ounces. It should make no difference to us what shape the gold and silver comes in, all that matters is its weight. Usually the metals are forged into coins for smaller, day-to-day transactions, and into larger bars for bigger transactions.

The True Money Supply

The supply of money is therefore the total weight of gold and silver existing in society.

Does an increase in the supply of money make us richer?

What would happen if, overnight, some good fairy slipped into pockets, purses, and bank vaults, and doubled our supply of money. In our example, she magically doubled our supply of gold. Would we be twice as rich? Obviously not. What makes us rich is an abundance of goods, and what limits that abundance is a scarcity of resources: namely land, labour, and capital. Multiplying coin will not whisk these resources into being. We may feel twice as rich for the moment, but clearly all we are doing is diluting the money supply. As the public rushes out to spend its new-found wealth, prices will, very roughly, double.

It seems intuitive that the price of commodities depends on the proportions of money and commodities in existence. Any considerable alteration of either of them has the same effect – either a heightening or lowering the prices. Increase the quantity of commodities and they become cheaper in their abundance; increase the supply of money, diluting its value, and commodity prices will rise.

So, over the long run, changes in the money supply have no impact on the wealth of the public.

Does the Money Supply Need to be Regulated by Government?

We can also deduce from the above that it makes no difference what the money supply is, since a rise in the money supply reduces the purchasing power of each gold or silver ounce, while a fall in the money supply increases the purchasing power of each ounce. The free market will simply adjust by changing the purchasing power, removing the need to tamper with the money supply. There is no need for the supply of money to be regulated.

6 - The Introduction of Money Substitutes

It is usually impractical to carry significant quantities of metal around should we wish to make an array of purchases. The greater quantity of gold and silver money we own, the more inconvenient and the greater trouble to both to keep and transport it.

Similarly, in the field of commerce, it is too cumbersome to deal with stocks of metal moving in and out of a business in return for providing a particular service.

Instead, we could deposit our gold and silver at a bank and receive a receipt of our holding in return – let’s call this a bank note. The bank note states that we have a particular holding of gold and silver money on deposit at the bank.

Since all members of society eventually come to use the services of such banks, bank notes begin to circulate in place of the physical gold and silver deposits. The bank notes pass between parties during economic transactions, shifting the entitlement to the gold and silver money without the need to move the physical metal.

In this way, receipts for money come more and more to function as money substitutes. Fewer and fewer transactions move the actual gold; in more and more cases paper titles to the gold are used instead.

The Money Supply Including Money Substitutes

Let us assume for the moment that the total amount of gold stock is 1000 ounces, split between several different banks. Furthermore, let us assume that 600 bank notes have been issued, each equivalent to 1 ounce of gold and convertible on demand into gold.

What impact do these bank notes have on the money supply? Since 600 bank notes have been issued and are held in public hands, does it mean that the effective money supply in the economy has increased even though the stock of gold has remained the same? No! The money substitutes are simply receipts for actually-deposited gold. The 600 notes can be used as money, but only as a convenient stand-in for the gold, not as an increment. The gold in the vault is then no longer a part of the effective money supply, but is held as a reserve for its receipt, to be claimed whenever desired by its owner. An increase or decrease in the use of substitutes, then, exerts no change on the money supply. Only the form of the supply is changed, not the total.

7 - Gold & Silver on a Global Scale

Placing silver at the back of our minds for a moment, the description above in “Money Substitutes” is basically a simple form of a “gold standard”. The money substitutes are backed by gold and are convertible “on demand” back into the money metal. For centuries many countries previously existed under some form of gold standard. The limited supply of gold conveyed disciplinary benefits, ensuring that the economy of a particular country did not overheat and that the country’s economic relationship with other countries remained stable. For example...

Country A holds large gold reserves, allowing credit to be created easily by its banks. Individuals and companies borrow freely, facilitating investment and economic expansion.The banking system of Country B contains little gold. Credit creation and borrowing are therefore difficult and the economy contracts.
The economy of country A prospers, corporate profits increase, jobs are created and the consumer appetite grows, leading to the purchase of more products.The inability to borrow forces Country B's companies to operate as efficiently as possible. The prices of its goods and services are therefore low, making them attractive to Country A.
Country A purchases more from Country B than it sells to it. Gold flows out of the country and its gold supplies contract.Country B finds itself seeling more to Country A than it buys from it. Gold flows into the country and its gold supplies increase.
As Country A's gold reserves decrease the amount of credit banks can create also decreases, thus reducing the amount of money they can lend.The banks in Country B find themselves holding larger reserves of gold, increasing the level of credit they can create and the amount they can lend.
The reduction in borrowing power forces a cut in investment, job losses and a reduction in spending as the economy contracts.The increase in borrowing power facilitates private and corporate investment and economic expansion.
As the contraction continues, more jobs are lost and corporate profits suffer further. Country A eventually buys furhter products from Country B than it sells to it and the outflow of gold reverses.As Country B prospers its profits increase, jobs are created and the appetite of consumers grows, leading to the purchase of even more products. Gold starts to flow back out of the country.
As Country A's gold reserves become replenished, its banks can again begin to create credit and to lend more, which leads to an increase in borrowing, investment and expansion.The banks in Country B find themselves holding decreasing reserves of gold, reducing the amount of credit they can create and therefore the amount of money they can lend.
The appetites of consumers and companies begins to grow once more. Purchases of goods and services increase, leading to a new phase of expansion and repetition of the cycle.This reduction leads to a new phase of contraction in which investment is cut back causing job losses and a decrease of purchases from Country A. A new cycle begins.

Both countries exist in economic equilibrium. Balance is maintained by the flow of a limited amount of gold between them, resulting in a cyclical pattern of expansion and contraction depending on whether gold was flowing into or out of the country. It is this balance which helped to prevent economic excess and economic overheating.

8 - Price Setting Under A Gold Standard

We have seen that the money supply has no bearing on our wealth and that one money supply will do as well as any other money supply. We have also seen that if the supply of money does change for some reason, perhaps if some good fairy places an additional gold coin into our pocket, that the free market will simply adjust prices by changing the purchasing power, or effectiveness of the gold-unit. If the fairy doubles the amount of gold in circulation, then prices will also approximately double, but with a small delay in the adjustment.

So the next question to ask is “what stops us raising prices to whatever level we wish”? If the purchasing power can be altered, what is to stop a shop owner raising the price of his goods at his discretion?

Intuitively we might expect that prices of things are set by the people who sell them, or perhaps that prices are set jointly by the people who sell and the people who buy. Since all sales involve only two parties, buyers and sellers, who by mutual agreement fix the price which is acceptable to both of them, it would appear that between them they have absolute power to set prices as high or as low as they please.

However, this notion is largely false. The genuine feeling of each buyer and seller that he is free to do as he wishes when he agrees on a price, and therefore could do something else if he wishes, is largely an illusion. “Buyers and sellers of any one kind of thing, such as food or medical care, do have some freedom to increase the prices of that one kind of thing; but every dollar more that a buyer spends for food or medical care is a dollar less that he can spend for something else, and every increased price of one thing must come out of a decreased price of something else.” As a result, buyers and sellers have some freedom to set prices, but this freedom is limited by external forces.

Therefore, in a system where money substitutes are backed by a limited store of value, such as gold, prices generally remain stable.

9 - Summary of Part 1 omitted

Part 2 - Government, Spending & Inflation

10 - Government, Spending & Inflation

In order to survive, an individual must create value. This might be the production of food and shelter through his own toil, or it might be through the creation of something which is of value to others, which can be exchanged for the items he needs in order to live. Through his labour efforts an individual is in control of the wealth he amasses.

In contrast, a government does not create value. It has no products to sell or exchange and must therefore expropriate the assets of individuals in some way in order to exist. In barter economies, governments expropriate resources by seizing goods in kind. In a monetary economy they seize monetary assets and then use the money to acquire goods and services for government. Such seizure is called taxation.

The taxation the government levies takes on numerous forms: payroll tax, corporation tax, real estate tax, sales tax, and so on. These forms of tax are all known to the public and are visible, and irrespective of the form the taxation takes they are always unpopular. A big problem arises for a government when it wants to spend more money than it has available. If the existing taxes do not bring in enough receipts to fund the government’s needs, then the government must impose additional taxes.

Inflation – A Hidden Tax

New or increased taxes are difficult to apply due to the unfavourable response of the public. Instead the government must find a way of taxing the public without its knowledge - it does so through “Inflation”.

"Since those dim beginnings in the forests of the Stone Age, governments have been perpetually rediscovering first the splendors and later the woes of inflation. Each new government discoverer of the splendors seems to believe that no one has ever beheld such splendors before. Each new discoverer of the woes professes not to understand any connection with the earlier splendors. In the thousands of years of inflation's history, there has been nothing really new about inflation, and there still is not.

Put simply, it is far easier for the government to print more money to pay for its needs than to raise taxes or balance its fiscal responsibilities. During election campaigns a politician will usually promise the world. So often, following their election into office, is the supply of money substitutes increased to pay for the earlier promises.

Inflation is the disease which follows that money printing. Each new unit of money which is printed to fund government spending reduces the value of all preceding units, causing the value of money to fall.

The expansion of the money in circulation, always led the way in the inflation. When it abated temporarily, the inflation abated temporarily. When it stopped permanently, the inflation stopped permanently. Nevertheless, the inflation is officially blamed on everything under the sun but the government's spending, its deficits, and its money issues.

Example: A New healthcare Bill

For example, the government wishes to pass a new health care bill which provides free healthcare to all of its citizens. If it cannot cover the cost of healthcare through existing taxes and the public will not accept a tax increase, the government can decide to pay for the bill through inflation. It will simply print the money out of thin air in order to cover the costs of healthcare. In this case the government gets what it wants - additional money to pay for healthcare. But money can never really be created out of thin air, it can merely be transferred from one place to another – from you to them. From the perspective of the public, it may appear that they now have free healthcare, provided by the government, but in fact the country’s citizens pay for their own healthcare, albeit indirectly, through a reduction in their wealth.

If this concept is not yet clear, try to think of it in the following way: assume that the money supply of this particular country is $1 trillion but the government plans to print another $1 trillion to pay for healthcare. We have already learned that an increase in the supply of money reduces the value of each money unit, albeit with a small delay in adjustment, so the doubling of the money supply halves the value of each unit and prices appear to double. Before the government starts spending the newly printed $1 trillion assume that the combined savings of the public will buy 600 billion loaves of bread. From the instant the government spending commences the additional money enters the economy and begins to filter its way to every corner of the country. As the new money feeds out into the economy the price of goods will begin to rise and will continue to do so until they have roughly doubled, fully reflecting the doubling of the money supply. The public will not realise until it is too late that their savings will only buy them 300 billion loaves of bread - their wealth has halved as the price of bread doubled.

Under a gold standard such government inflation is difficult to instigate. The money printing would quickly become apparent as the excess money substitutes in circulation would cause the price of gold to rise, signalling to the public that government spending was out of control. Realising these limitations, governments take a number of steps to ensure they have full control over money and thus full control of the inflation tax.

11 - From Gold & Silver Money to Worthless Paper

The one who discovered that if he could decree what was money, he himself could issue the money and gain real wealth in exchange for it.

Before a government can successfully embark on the path to inflation, there are a number of obstacles it must first overcome...

Seize a Monopoly of the Minting Business

The first step is to take control of the minting business and to outlaw the production of private coinage.

Next a government must slice through the notion that gold and silver are money. Remember that money is a commodity and its unit of measure is quoted as its weight in gold or silver. This limits a government’s ability to inflate the currency since the government cannot create more gold or silver than it has title to.

In order to commence an inflation the government must move away from quoting money in terms of weight, instead choosing to create a “national name” for the currency: dollars, marks, francs, and the like.

Declare What is Legal Tender

To ensure that no other coins circulate in competition with those of the State, a Government must decree what is “Legal Tender”. The cementing of its own national currency in law is accompanied by the abolition of coins minted by rival governments. Usually a “Central Bank” is created and this institution is granted monopoly of the note issue by the government.

Move Away from Gold & Silver Backing

The most important thing about money is to maintain its stability….You have to choose between trusting the natural stability of gold and the honesty and intelligence of members of the government. With due respect for these gentlemen, I advise you, as long as the capitalist system lasts, to vote for gold." George Bernard Shaw

Despite the name changes and the abolition of rival coins, a government is still shackled to the disciplines of gold and silver money through its trade with other nations. Before it can have unlimited power over the money of a nation it must unshackle itself from these constraints. Unfortunately for us, governments’ ability to do so became significantly easier in the twentieth century with the proliferation of money substitutes and electronic banking.

Once a government has full control over its money and has removed any precious metal backing it is free to do as it wishes. It can spend as much money as it wishes because it can print as much money as it wishes and it can expropriate as much public wealth as it wishes because it is in full control of that money printing process.

12 - A Repeating Pattern of Government Inflations

There is evidence of inflation for four thousand years of recorded history. Babylon and Ancient China had inflations. The Athenian lawgiver Solon introduced devaluation of the drachma. The Roman Empire was plagued by inflation and, more rarely, deflation. Henry the Eighth of England was a proficient inflationist, as were the kings of France. The entire world underwent a severe inflation in the sixteenth and seventeenth centuries. "Continentals" in the American Revolution and the assignats in the French Revolution were precursors of the wild paper inflations of the twentieth century. Steadily rising prices have been the general rule and not the exception throughout man's history.

The twentieth century brought inflations like no other. The proliferation of money substitutes, credit, electronic banking, the refinement of highly organised economic systems and increasing central bank power ensured that there has been nowhere to hide from inflation. Two major inflations have been experienced over the last 100 years...

i) The German Inflation (1914-1923)

The German inflation ran for nine years - eight years of gestation and one final year of precipitous collapse. This inflation had its roots in World War I, after which the German money printing machine went into overdrive.

Just before the First World War in 1913, the German mark, the British shilling, the French franc, and the Italian lira were all worth about the same, and four or five of any were worth about a dollar. At the end of 1923, it would have been possible to exchange a shilling, a franc or a lira for up to 1,000,000,000,000 marks, although in practice by then no one was willing to take marks in return for anything. The mark was dead, one million-millionth of its former self. It had taken almost ten years to die.

The German people suffered a period of hardship and real starvation as well as a permanent obliteration of their life savings. When the debacle was finally stopped, the old mark, which had once been worth a solid 23 U.S. cents, was written off at one trillion old marks to one new one of the same par value. The most spectacular part of that loss was lost in the mark's final dizzy skid; all the marks that existed in the world in the summer of 1922 (190 billion of them) were not worth enough, by November of 1923, to buy a single newspaper or a tram ticket. That was the spectacular part of the collapse.

The German inflation paved the way for the rise of Adolf Hitler and World War II.

ii) The Great American Inflation (1973-ongoing)

Potentially the most spectacular inflation of them all, and still ongoing, is the Great American Inflation. This is the inflation which will impact you and your family, and it is the inflation I am now going to explain...

13 - The Story of The Great American Inflation

Historically, the most stable periods of economic activity have existed under some form of “Gold Standard” in which money was backed by a store of value such as gold. We already know that gold and silver have underpinned the world's monetary system in one way or another for thousands of years.

Adoption of a Gold Standard in the U.S. and U.K.

Britain first moved to a gold standard in 1717 when the value of the pound was translated into gold at 3 pounds, 17 shillings, 10.5 pence per ounce of gold. This standard persisted for more than 200 years, interrupted only by wars and one or two other major crises. The U.S. first moved to a gold standard in the 1870s.

More recently, towards the end of the Second World War, the Bretton Woods Agreement was signed in which 44 major industrial nations, including the US and the UK, agreed to fix their currencies at a certain price against a certain quantity of gold.

However, in America in the 1960's and 70’s, significant overseas investment by U.S. corporations and the expanding expenditure on the Vietnam War resulted in millions of dollars leaving the United States. Its trading partners found themselves holding increasing amounts of paper U.S. dollars and as they exchanged their dollar holdings for gold with the U.S. Federal Reserve, a torrent of gold began to leave the U.S.

The U.S. Ends The Bretton Woods Gold Standard

Unhappy with the rate of outflows, in 1971 the U.S. suspended the convertibility of dollars into gold and by 1973 the major industrial countries had agreed to end the gold-based Bretton Woods agreement and to let their currencies float freely against one another.

From this point the major currencies were no longer backed by gold, or any other store of value. There was no longer a correction mechanism in place to prevent economic excess, no control in place to prevent inflation and a far greater likelihood that private citizens would see their savings obliterated.

14 - The Exponential Increase of Unbacked Money

As the requirement to peg their currencies to gold was lifted, countries began creating un-backed paper money substitutes at an unprecedented rate. Rather than pay for their purchases in gold, governments issued paper debt instruments such as treasuries and gilts as payment.

Our Definition of Money Supply Now Changes

Our perception of money supply needs to change at this point. Since the precious metal backing has been removed, we can no longer think of the money supply as the weight of gold and silver in existence. Money supply is now simply the amount of paper money substitutes in circulation. And since there is no limit to the production of paper money, since the early 1970’s the supply of money substitutes has increased at an exponential rate.

US Money SupplyUK M4 Money Supply

To put this statement into perspective, consider that it took the entire history of the dollar up to 1974 to create the first $1 trillion of money supply (M3), and only one single year (March 2008 – April 2009) to create the latest trillion! The UK took all previous history of the pound up to the end of 2002 to create the first £1 trillion of money supply (termed M4 in the UK) and only 6.5 years to 2009 to double it. These growth rates are truly staggering and acutely frightening.

Recent Government Bailouts are Increasing the Money Supply Even faster

Recent government stimulus packages would not have been possible under the previous gold standard agreements. So much gold would have left these countries that credit would have evaporated, throwing them into a deep depression. Yet the current governments of these countries believe that the cure for our economic woes is to further increase our debt and to print even more paper money to bail out the financial system. In effect they are trying to “buy another boom”.

Everyone loves an early inflation. The effects at the beginning of an inflation are all good. There is steepened money expansion, rising government spending, increased government budget deficits, booming stock markets, and spectacular general prosperity, all in the midst of temporarily stable prices. Everyone benefits, and no one pays. That is the early part of the cycle. In the later inflation, on the other hand, the effects are all bad. The government may steadily increase the money inflation in order to stave off the later effects, but the later effects patiently wait. In the terminal inflation, there is faltering prosperity, tightness of money, falling stock markets, rising taxes, still larger government deficits, and still roaring money expansion, now accompanied by soaring prices and ineffectiveness of all traditional remedies. Everyone pays and no one benefits. That is the full cycle of every inflation.

Future Prosperity will be Hollow

Please note that, from this point onwards, any prosperity the government attempts to generate will be hollow, while the wealth destruction of those with cash, savings, treasuries and so on will accelerate. Hugo Stinnes, a successful industrialist during the time of Germanys inflation, declared in much-noted speech that it was madness to think that a defeated Germany with all its huge burdens could spend more, have more, work less, carry an ascending prosperity, and do it all with mirrors. But Germany seemed quite willing to try. Sound familiar?

Writing in February 1921, in the midst of the German hyperinflation, Dr Walther Rathenau who was appointed Minister of Reconstruction wrote "The majority of statesmen and financiers think in terms of paper. They sit in their offices and look at papers which are lying in front of them, and on those papers are written figures which again represent papers … They write down noughts, and nine noughts mean a milliard. A milliard comes easily and trippingly to the tongue, but no one can imagine a milliard. What is a milliard? Does a wood contain a milliard leaves? Are there a milliard blades of grass in a meadow?"

Nowadays we are talking about trillions of Dollars and Pounds being created but it is hard to imagine how much money that is. Here is an illustration taken from Chris Martenson's website...

> A million is a one with 6 zeroes behind it. We can all appreciate what a million dollars or pounds will buy.
> A billion then is a thousand times bigger than a million, and it’s a one followed by 9 zeros.
> And a trillion is a thousand times bigger than that, and it’s a one followed by 12 zeros.
> So a trillion is a thousand billions, which means it is a million millions.
> If you had a stack of $1000 bills which was 4 inches in height you would be a millionaire.
> If your stack was 358 feet high you would have a billion dollars.
> A trillion dollars is a stack 67.9 miles high!

If you spent $1,000,000 per day, every day since the birth of Jesus Christ, you would only have spent about 0.75 of a trillion. You would have to keep spending a million a day until the year 2739 before you reached a trillion dollars.

15 - Where Does All the Paper Money Go?

The new money which is created disseminates throughout the economy in two ways: through national product transactions and through capital transactions.

National Product Transactions

This is money spent on current goods and services, such as buying food, a car, or perhaps the services of a carpenter or lawyer. If all of the new money were to feed into national product transactions we would see the price of consumer goods and services rise dramatically. Meanwhile there would be little impact on the values of capital markets.

Capital Transactions

These consist of spending on such things as savings, stocks, bonds, property, land, plant and equipment. You might call this category “Investments”. If all of the new money were to flow into the capital markets, we would see rising asset prices, while experiencing little change in the price of goods and services.

Matching Theory to Experience

From your own experience you will know that we have seen rising prices in both pools over the last few decades. However, the majority of the new money has fed into capital transactions, fostering all manner of asset bubbles.

Consider your own circumstances for a moment: you go to work and earn a salary and with the money you earn you purchase your essentials for the month, plus perhaps some luxuries. If you have any money left over you have two principal options. The first is to purchase additional consumer items. But if you don’t need more food or more shoes (sorry ladies!) it is more likely that you will opt for the second option, which is to save or invest the residual money.

In this way, little of the excess money flows into national product transactions and the goods and services in that pool do not experience price increases which are out-of-the-ordinary. The excess money therefore feeds into the capital markets with the effect of inflating prices there beyond reason and expectation.

Taking recent history as an example, the dawn of this century saw the bubble inflate and burst. Between 1990 and 2000 the S&P500 rose from 350 to 1550 (a rise of 340%) before falling 48% back to 800 in 2003. Over the same period the NASDAQ rose by a staggering 900% before falling 77% from its highs. Next came the turn of the real estate bubble. The ongoing flood of money into banks generated a lending boom which pushed property prices to stratospheric, unjustified heights. The collapse of real estate prices since 2007 has been accompanied by yet another devastating stock market crash and a precipitous fall in the value of commodities.

The Public Reinforce These Bubbles

While the flooding of the capital market reservoirs with freshly printed money substitutes seeds the early stages of asset bubbles, the public reinforces them. Firstly, since the inflation causes a real decrease in the public’s quality of life as their savings and incomes are continuously eroded, people are pushed towards speculation in order to supplement their incomes. This was also a clear observation during the German inflation...

Speculation alone, while adding nothing to Germany's wealth, became one of its largest activities. The fever to join in turning a quick mark infected nearly all classes, and the effort expended in simply buying and selling the paper titles to wealth was enormous. Everyone from the elevator operator up was playing the market.

"As regards dealing in shares, all classes of the population have for months been speculating with a fine disregard for common-sense. Shares have been freely bought in totally unknown concerns, in some cases with the object of exchanging valueless paper money for what was considered a good security, but generally in the hope of profiting by a rise in the stocks. Shares in respectable concerns which had paid a 20 per cent dividend, say, were pushed higher and higher till the final holders could not expect a return of even 1 per cent, with the result that the improvement of the mark has brought not satisfaction but the very reverse."

Secondly, the inflation strips people of their sense of value - when money is so easy to come by, we seem to take less care to obtain real value for it. The profits generated during the asset bubbles are for the most part fictitious. No real value or wealth is created, it is simply that the increase in paper money that has pushed up assets prices in general. If the money printing averages a rate of 7% per annum, it is a fact that we would see the stock market and house prices increase by 7% per annum, albeit with some small delay in adjustment. Yet little investigatory work is performed by the public to estimate the appropriate value for the assets they are purchasing. The absence of logical checks on value help the asset bubbles to increase out of all proportion.

16 - Capital Markets: A Store of Future Inflation

The significance of all this is that the funnelling of money into the capital markets acts as a temporary holding container for the inflation and the frequent asset bubbles which emerge are the manifestation of all that excess paper money which has been pumped into the economy.

It is important to note that the distribution of money between the two pools is not fixed and there is no dam between the markets other than the habits of the people. The public may choose to move their personal money supply from the stock market to automobiles and back again.

Consequently the two markets must comply with the law of prices not only separately but also as an aggregate. As money moves from one market to the other, prices must go down in the first and up in the second and vice versa.

Excess Money Has Not Yet Spilled into National Product Transactions

It is fortunate for us that we may not have yet experienced dramatic increases in the cost of the essential items we need to survive, namely food, fuel and water. But if something were to cause the money sloshing around in the capital markets to feed into the national product pool, we would see almighty price rises and a dangerous scramble for life’s essential items. This is what happened during the initial acceleration of the German inflation, leading to a catastrophic collapse of the currency and the nation.

In due time, there being no dam between the markets, a leakage of excess money demand back from capital markets into national product will occur. There will always be that spoilsport in the capital casino who will take his winnings and buy national product with them. There will always be that footslogger selling national product who senses that there is surplus money demand over yonder among the capitalists and demand some of it by raising prices. It is inevitable. Excess money which starts out in the capital markets winds up back in national product. If luck is good, the excess money will merely redistribute itself proportionately between the two markets.” “If luck is bad and people lose faith in all kinds of capital investments, there may be a general exodus of money from capital markets which will make the price inflation in national product much worse than the money inflation would seem to justify.

17 - Summary of Part 2 omitted

Part 3 - The Collapse

18 - The Inflationary Collapse

The economics of disaster are as simple as the inflationary economics were complex. The government was the managing proprietor of the inflationary economics, but the economics of disaster are conducted by persons other than the government and are largely beyond the government's control. Inflationary economics required motive power supplied by the government, but the economics of disaster are self-propelled. It is the government that decides when and how fast the inflationary reservoirs shall be filled, but it is something else that decides when the dam shall burst.

Unsound Economics

The U.S. and U.K. economies are not built on sound fundamentals of production and savings. Instead they are built on debt fuelled government and consumer spending. It is impossible to perpetuate such a situation because we would have to borrow more and more and more in order to keep buying things. But the countries we are buying from, notably China, will eventually want to be paid back and when these nations realise that we cannot meet our debt obligations they will refuse to keep us afloat and the economy will collapse. Adding fuel to the fire, the U.S. and U.K. government response to the global financial crisis has been a massive injection of money into the financial system.

The problem is that the U.S. and U.K. are basically insolvent but their governments have now taken us so far down the inflationary path they chose to follow when the gold-backed money system ended, that the plain fact is that any future prosperity or boom will not be possible without more money printing and inflation. If the U.S. or U.K. attempt to stop the money and credit growth the resulting credit squeeze will strangle any signs of recovery, causing businesses and consumers to scream. Thus at every hint of trouble in the economy governments’ easy money policies will resume, the debt and money printing will accelerate and will never stop until the bitter end.

The Limit to Money Printing is the Credibility of the Currency Involved

The only limit to perpetual money printing is the credibility of the currency involved. As long as the government can sell its debt, or print more money to pay for its spending, or as long as foreigners are content to continue buying paper substitutes denominated in US Dollars or British Pounds, the inflation can continue.

But if trust in money is lost, citizens and foreigners will begin to dump dollars and pounds after decades of continuous theft from them. They will flee dollar and pound assets by selling stocks, bonds and by converting their dollar and pound cash holdings into real tangible assets. At this point the existing money which has been employed in capital markets will leave them for the national product market, dramatically inflating the price of food, fuel and other necessities of life.

China has the largest holding of US dollars, currently around $2 trillion, and is becoming increasingly vocal about its concern over U.S. money printing. Recently Cheng Siwei, a top member of the Communist hierarchy, stated that "The US spends tomorrow's money today”. "If they keep printing money to buy bonds it will lead to inflation, and after a year or two the dollar will fall hard. Most of our foreign reserves are in US bonds and this is very difficult to change, so we will diversify incremental reserves into euros, yen, and other currencies". "Gold is definitely an alternative, but when we buy, the price goes up. We have to do it carefully so as not to stimulate the markets".

I think we are getting close to that point where all trust is lost and the dollar and pound are dumped.

19 - The Loss of Trust

The economics of disaster commence when the holders of money wealth revolt, getting rid of their money and declining to hold it any longer than necessary to get rid of it. Taking example from the German hyperinflation...

The desertion of money holders has many of the aspects of a panic, like any desertion in the thick of a struggle. A filling of inflationary reservoirs in the capital markets which may have taken years may be emptied in a day.

[Money] velocity started to rise with moderate vigour in the summer of 1921, when Germans began to smell a governmental rat, and that signalled the gradual emergence of the latent price inflation. Velocity took an almost right-angle turn upward in the summer of 1922, and that signalled the beginning of the end. An explosive rise in velocity thus accurately marks the point of obliteration of an inflated currency, but it does not cause itself. People cause velocity, and they only cause hypervelocity after prolonged abuse of their trust. The German mark had been undergoing massive dilution for over two years, and the people only at last realized it when they turned on the velocity.

The final convulsion when it began was at first bizarre and at last became sheer nightmare. Beginning in July 1922, prices rose tenfold in four months, two hundredfold in eleven months. Near the end in 1923, prices were at least quadrupling each week.” “The worker had to compute his pay in the trillions, carry it in bales, and spent it instantly lest he lose it. The forlorn buyers' strikes of earlier days against the mildly higher prices were no more; in their place the buyers were vying with one another to buy up any kind of goods at any price before their little money could evaporate...Legally "fair" interest rates reached as much as 22 percent per day. The price of a schnitzel dinner might rise 20 percent between giving the order and paying the check.

At the end in 1923, the velocity of German money began to approach infinity, because paper bills could easily change hands hourly or faster and practically did.”19 “Finally, the government finds itself deprived of its inflationary tax while its regular taxes yield little, and it resorts to still more money inflation as a means of finance. In so doing, the pathetic government trails far in the dust of the fleeing citizenry.”20 “In October 1923 it was noted in the British Embassy in Berlin that the number of marks to the pound equalled the number of yards to the sun. Dr Schacht, Germany's National Currency Commissioner, explained that at the end of the Great War one could in theory have bought 500,000,000,000 eggs for the same price as that for which, five years later, only a single egg was procurable.

The unwinding of the inflation will leave a tremendous destruction in its wake and the damage which is done will be permanent for the currencies involved. But those who have read and understood all of the above have power to protect themselves from such a disaster.

20 - The Winners & Losers in Inflation

The precise moment when the inflation turned upward toward the vertical climb was undoubtedly timed by no event but by the dawning psychological awareness of the German and foreign investor that Germany was not going to back its money. With that, the rush to get out of the mark was on. Like a dam bursting, the seas of marks flooded into the markets and drove prices beyond all bounds.

“The seas of marks which had been stored up by Germans and especially by trusting foreigners flooded forth and fought to buy into other investments, foreign currencies, tangible goods, almost anything but marks.”

The Losers in Inflation

The biggest losers in the inflation are the savers, the pensioners, those who are reliant on fixed income, those who have cash, bonds, treasuries or gilts. When the paper money that they have carefully accumulated, saved or invested is revealed to be worthless, this class of people is left with the most staggering permanent loss.

This class paid the piper for all of Germany. Great numbers of pensioners were left totally impoverished and forced back into the work gang to end their days there. The encouragement to thrift, an old German weakness, turned out to have been a complete swindle. Instead of a levy on all the Germans to pay for Germany's indulgences, a levy which might have been heavy but could have been fair, Germany left the levy to fall on those who were too innocent to evade it, and from them it took everything they owned. In any case, it was not the piper who went unpaid.

The Winners in Inflation

When the desertion of paper money becomes widespread the prices of desirable things rise. Government debt will quickly be deserted and the enormous quantities of money which previously occupied that pool will flood out into real, tangible assets such as precious metals, food, fuel, land, etc. Even the money which was previously occupied in buying goods and services, many of them now revealed to be useless, leaves them in favour of real assets.

For those in search of protection from the final ravages of inflation and steeply rising prices I recommend gold, silver and platinum. We have learnt that precious metals are money and that they achieved this position following thousands of years of trial and error and in competition with all other commodities. It is intuitive therefore that gold, silver and platinum will benefit the most from the collapse of paper money assets.

During the German hyperinflation precious metals were so highly prized that there is an account of a family who found a silver coin, and as they jockeyed amongst each other for a glimpse of it the coin dropped and rolled along the floor into a crack in the doorframe. A heated discussion followed in which the family tried to decide whether they would tear down the wall, or rip up the floor in order to retrieve the silver coin. There is another account of a german family supported by selling every day or so a single tiny link from a long gold crucifix chain.

Why were the gold and silver so highly prized? With them families could buy food and pay for their essentials. Without it they had only depreciating pieces of paper money which could buy them nothing.

So rather than buy up stocks of food or fuel supplies now, which have a use-by-date or are difficult to store, you might instead wish to buy gold, silver and platinum which you can exchange at a later date for the goods and services you require. At the time of writing a 1 ounce gold bar is worth around $1,018 or £614, and is 42mm long, 24mm wide and 2mm thick. So you can store a great deal of wealth in a very small amount of space and can transport it easily, unlike other tangible assets (for the same price you could buy 14 barrels of oil).

21 - The Conclusion

The decision whether or not to buy gold, silver or platinum rests with you. The years ahead will be extremely challenging and quite frankly, frightening. Until the early 70’s our currencies were backed by a store of value – gold. In 1971 the U.S. suspended the convertibility of dollars into gold and by 1973 all of the major trading countries had agreed to follow suit, letting their currencies float freely against one another. From that point onwards the world’s major currencies have not been backed by gold, or any other store of value for that matter. The correction mechanism put in place to prevent economic excess and inflation disappeared.

So, nowadays money is just a piece of paper. Its value depends on how many of those pieces of paper are in circulation. Oh dear! The world’s governments and central banks own printing presses and for the last 30 years these have been running at full speed, causing the global money supply to increase exponentially.

Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost.” Fed Chairman Ben Bernanke.

Government Response to the Global Financial Crisis

Money printing has become even more prevalent in response to the global credit crisis. The monetary powers are completely focused on bailing out the financial system and have now taken us so far down the inflationary path that any future prosperity or boom will not be possible without more inflation. Government will print more money in an attempt to “buy another boom”. I liken current events to the monetary powers focusing on diffusing a candle in one corner of a room, while a time-bomb situated on the other side of the room ticks down towards zero.

The alternatives to additional inflation are extremely unattractive for government. They could raise taxes to pay for the bailouts – but consumers and businesses would scream. They could cut government spending – but this means no more bailouts, so they would have to let banks fail, house prices crash and so on. Any attempt to contain future inflation and to stop the money and credit growth will be unsuccessful since the resulting credit squeeze will strangle any signs of recovery. Thus, at every hint of trouble in the economy the easy money policies will resume, the debt and money printing will accelerate and will never stop until the bitter end.

Since the only limit to perpetual money printing is the credibility of the currencies involved it is difficult to gauge when the inflation might accelerate out of control, but you can be sure that it is coming. I believe that the credibility of US Dollars and British Pounds is already evaporating and that the risk of hyperinflation - a complete loss of trust in our currencies - grows stronger by the day.

Your Action Plan

By taking appropriate actions now, individuals can mitigate the impact of the inflation on their wealth. Now that you know that the value of paper money decreases year after year, do you still want to hold cash, savings, treasuries, bonds? Knowing that the depreciation of these currencies is likely to accelerate uncontrollably in the years ahead, do you feel comfortable holding your current investments?

As a result of the coming inflation I see the prices of gold, silver and platinum increasing due to their safe haven status, their ability to store wealth and to hedge against inflation. The precious metals may suffer from market volatility over the short term, but longer-term their destiny has already been set out by the actions of government today.

In light of all of the above you need to develop an action plan to protect yourself ahead of the coming financial storm. There is a more in depth discussion of the various ways you can buy precious metals in the "How to Buy” section.