"Give me control of a nation's money, and I care not who makes her laws." - Rothschild, Meyer, merchant banker, 1836
OAKLAND (The Emerging Trends Report) -- Paranoids, conspiracy theorists, the lunatic fringe, traitors. Such are the delightful labels assigned to people who have tried to raise the public's awareness of two of the most contentious issues of our time, both of which involve gold: inflation and the sales or leasing of central bank gold.
Frankly, we would prefer not to address these controversies for fear of getting embroiled in the mudslinging and character assassination all too prevalent today; however, to either skirt or downplay these issues would be doing readers a serious disservice in that both issues constitute major long-term influences on the price of gold and the performance of gold-oriented investments. Considering gold has more than doubled since 2001 and has just completed a dramatic run to well over $530 an ounce, it is reasonable to ask, why now?
Every kind of money in use today is a form of fiat currency, paper money made legal tender by order of a government. It is a medium of exchange not based on, or convertible to, anything. As such, a fiat currency is based solely on the government's promise to pay. Managed by a central bank, the stated goal is to strengthen or weaken the currency as deemed necessary to provide monetary stability and to control inflation.
These goals are accomplished primarily by adjusting interest rates and lending requirements, thereby creating or destroying money and credit, which makes a fiat currency very flexible. Fiat currencies are favored by those governments with large social welfare programs and central planning mechanisms. For example, in recent years it has not been unusual for central banks, notably those in eastern Asia, to weaken their currencies, especially against the U.S. dollar, in order to promote employment and export-lead growth, essentially manipulating their currencies to effect economic policy.
The U.S. dollar has been a fiat currency domestically since 1933 and internationally since 1971, but before that the U.S. dollar was primarily on the gold standard. The gold standard is also paper money made legal tender by order of a government but differs from a fiat currency in that it is based on and convertible to gold. Because the currency is convertible to a fixed amount of gold, the creation of monetary instruments, including debt, is limited to the amount of gold in its vaults, which places clear monetary restraints on government spending.
This fixed relationship between the amount of gold on deposit and the issuance of monetary instruments makes the system very stable but also quite rigid; consequently, there is no need for central bank mechanisms to manage monetary policy. The gold standard tends to be the preference of those who favor laissez faire.
As can be imagined, the differences between these two types of currency have lead to considerable friction between camps. The crux of the argument involves the issues of monetary inflation and history, and which side of the argument you come to side with goes a long way in determining your thinking on a number of other issues, including gold and its instruments as an investment.
However, Americans by and large do not appear to entirely understand inflation. So let us be clear: Inflation is "a steady rise in the level of prices related to an increased volume of money and credit and resulting in a loss of value of the currency." Simply put, introducing new dollars to a monetary system, either by printing money or creating debt, decreases the purchasing power of the existing dollars by diluting their value.
Those in the fiat camp tend to believe that a little inflation is unavoidable, perhaps even desirable in a dynamic economy, and an acceptable quality of such a flexible system. They view the gold standard as antiquated, "a barbaric relic" that would be an impediment to economic progress today because it lacks the flexibility to adjust to ever-changing conditions. This camp argues a gold standard would lead to the elimination of myriad social programs and seriously undermine decades of progress. Alan Greenspan goes so far as to say the failure of the fiat dollar would force us to "go back to seashells or oxen as our medium of exchange."
Further, they claim gold is simply another commodity, and to assign any more significance, let alone value, to gold than to say copper or steel, is to subscribe to a "collective hallucination" akin to the rampant speculation of the dot.com mania. Gold can not even collect any interest: it just sits there.
The pro-gold standard camp wonders what constitutes 'a little inflation' and produces charts such as the following, which shows the purchasing power of the U.S. dollar both in periods when it was a fiat currency (dotted lines) and in periods when it was on the gold standard (solid lines).
Purchasing Power of US Dollar 1800-2005
If the American central bank's goals are to provide monetary stability and to control inflation, gold standard advocates submit they are not doing a very good job. According to this chart, the U.S. dollar has lost about 93% of its purchasing power since going off the gold standard in 1933. To put that in perspective, when the U.S. was on the gold standard, a $100 basket of goods purchased in 1800 could be purchased in 1900 for $102, amounting to a 2% inflation rate over the course of a century; today that same basket of goods would cost more than $4,000. On the gold standard, they claim inflation is next to impossible simply because without increasing the gold in its vaults, a government cannot create more money.
Supporters of the gold standard suggest that the inflation created by a government operating a fiat currency amounts to a secret, or hidden, tax its citizens neither recognize nor understand. By unilaterally printing money whenever it wants to, without either explanation or public debate, the government is in fact defrauding its constituents by diluting the purchasing power of their money. And this ability to increase the amount of monetary instruments in circulation is the fatal flaw of all fiat currencies, for there has never been a successful fiat currency.
The failure of every fiat currency in history has been due to miscreant politicians, aided and abetted by clever bankers, creating so much money and credit to finance their various agendas, including enriching themselves and their cronies, that the money in circulation eventually becomes worthless and collapses under its own weight. This idea is best summed up by the phrase "confiscation by inflation": the deft transference of naive citizens' savings to slick operators who understand how to manipulate the financial system.
Whereas in more than 800 years of fiat currency use there has never once been a successful fiat currency, during that same time there has never been a currency based on the gold standard that failed-until it was either corrupted or taken off the gold standard. In fact, fiat currency crises resulting in either outright collapse of severe devaluation are so common the public hardly notices anymore.
In the last generation, Mexico, Thailand, South Korea, Indonesia, and Russia, to name but a few, have experienced currency crises that adversely effected the economic well being of their citizens. And do not be lulled into dismissing such events as phenomena that only occur in third world countries: the British pound's most recent crisis was in 1967; the U.S. dollar-gold convertibility crisis of 1971 resulted in the dollar devaluation of 1973, which led to the inflation prevalent for the rest of the 1970's and was followed by the dollar exchange crisis in the mid-1980's. Fiat currencies over time simply do not work.
Interestingly, the life of a fiat currency can be chronicled in rough stages based on patterns of behavior that have been repeated ad infinitum over the centuries. Reduced to its simplest terms, the sequence goes something like this:
A government prints a little extra money (or issues a little extra debt) to finance this emergency measure or that budgetary shortfall, and the effects on the value of the currency go largely unnoticed.
Members of the government, usually via financial advisors, recognize that if new money (or debt) is added in small but regular increments, the passage of time minimizes the appreciable results of the inflation, thereby presenting opportunities to profit.
Restraint regarding money creation also dwindles in time, specious agendas get furthered and fortunes get made, but eventually inflation is noticed in the increased prices of goods and services, especially in real assets.
The worse inflation becomes, the more unstable the government becomes as it resorts to ever more extreme measures to mislead the public regarding the effects of the money it has created and to deflect the public's attention to other matters, thereby allowing the practice to continue. Astute individuals start protecting themselves by trading the fiat currency for real assets to preserve their wealth.
As government credibility diminishes, more citizens realize their currency is unraveling and actively pursue stores of wealth that have historically retained their value during economic crises; wealth preservation develops a speculative aspect as well.
The practice of monetary inflation requires the addition of ever larger amounts of new money and credit instruments to keep the scheme going, but at some point the general public realizes they are holding empty promises and race to exchange the paper for anything of value; thus the fiat currency enters a brief hyper-inflationary period before collapsing under its own weight.
There have been variations of, but no exceptions to, this pattern.
We do not believe it is different this time, but indeed only a matter of time. We have no pretense of being able to foretell even an approximate date of the coming crisis other than to state our belief the U.S. dollar is either late in the fourth or early in the fifth stage of this pattern now.
The sustained, and indeed accelerating, increase in the price of gold, as well as silver, fine art, and gem stones, against all fiat currencies attests to the growing awareness of the problem and reflects attempts to preserve wealth from the gathering inflationary storm. Many also interpret gold's appreciation against all fiat currencies as an indication the second leg in the gold bull market is underway. We therefore recommend taking advantage of upcoming opportunities either to establish a position or to increase your position in gold.
The consequences of growing monetary inflation, waning credibility and a growing uncertainty extant in the U.S. will be far-reaching and calamitous someday. However, we do not believe that day is at hand, for one thing appears certain: the rising tide of liquidity is morphing into a veritable tsunami, which will continue to lift all asset classes near to intermediate term. But if true to form, other asset bubbles will be inflated, for whereas the Fed can unleash stupefying liquidity, as it is presently, it cannot control where that liquidity is directed.
We are convinced that at some point, quite probably at the point marking the beginning of the endgame of competitive currency devaluation, gold will inflate beyond all reason and precedent as the general public demonstrates its loathing of all fiat currencies by piling into gold-an historic, incorruptible store of wealth.
(c) The Emerging Trends Report 2006
To request a free copy of the entire 24-page Emerging Trends Report, "The Gold Treatment," including rudimentary discussions of distorted government figures, its waning credibility, investment recommendations, and our Sources/Further Reading suggestions, please visit our website at http://www.emergingtrendsreport.com.
 Random House Dictionary: page 690, 1992.