Paper money eventually returns to its intrinsic value – zero. So said Voltaire and his words begin this exposition on the coming financial crisis and failure of the paper dollar - a fiat currency that will fail, as all eventually do. Trends in key financial indicators are pointing to fiscal disaster. Per capita debt compared to per capita gross domestic product grew at the same rate until about 1980; now debt is growing much faster and has reached $600,000 per family of four. The dollar has fallen to record lows, gold is pushing record highs. Economic misconceptions are reasons why economists and politicians don’t see the danger – like: Debt doesn’t matter; governments can be trusted to manage a country’s money; the U.S. economy operates independently of the foreign exchange markets; and gold has no constructive role in our economy. Economists and politicians overlook foreign governments and investors that now own enough dollars that they could do massive damage to the U.S. economy – e.g., China.
The framers of the Constitution designed the union to prevent it from becoming a country where borrowing is a way of life, yet the U.S. has become the world’s greatest debtor nation. How have we been able to move from the last two decades of the 20th century with surpluses beginning to accumulate and emerging countries like China linking its currency to ours to a country borrowing billions each year to pay debt? We are running up unsustainable debt. The U.S. is printing money. This will lead to a fiat (government controlled) currency that will become less valuable and gold will reclaim its place as the center of our financial world.
Fiat currencies always collapse because governments are unable to maintain the value of their currencies. Taxpayers and those receiving government help make this a self-fulfilling prophesy. A politician that alienates either of these groups will be looking for a job. So, he/she must find ways to continue supporting those receiving government help without raising taxes. The only option this leaves is borrowing without raising taxes then creating enough new currency to cover the borrowing. The result is a gradual decline in the value of the currency – inflation. Historical examples of this process are legend: Rome when a pound of gold started at 50,000 denari and rose to 2 billion and the arrival of the Visigoths; France when by 1794 there were 7 billion paper livres in circulation which doubled in 18 months and rose to 40 billion soon after; and the Weimar Republic when hyperinflation resulted in folks having to shop using wheel barrows to carry their paper currency.
Is the U.S. doing the same? Is all of this really an issue? What exactly is money? It’s a standard of value, a store of value, and a medium of exchange. When the unit of the money is unchanging it is considered “sound.” That is, it effectively measures wealth over time. Sound money is the same yesterday, today, and tomorrow in measuring an amount of wealth. The U.S. dollar does not fit this definition. For example, from 1947 through about 1973 a barrel of crude oil was worth about 3 U.S. dollars – making it “sound.” However, today a barrel of oil may be worth on the order of 80 U.S. dollars. The dollar isn’t tied directly to any single tangible thing of intrinsic value.
What of gold? The average price of a barrel of oil has fluctuated around approximately 2.2 gold grams since 1947. 2.2 gold grams would buy a barrel of oil 60 years ago and it still does today (on average). Gold is “sound” money when compared to the dollar or any other fiat currency. Why? Gold is sound money because it exists in limited supply and is, by definition, not subject to government manipulation. Gold is a tangible asset. Fiat currencies are controlled by governments…their value changes, typically only decreasing.
George Bernard Shaw said if he had to choose between trusting in the value of gold and trusting the honesty and intelligence of members of government, he would vote for gold. As the dollar collapses gold coin/bullion will be used to preserve wealth. Now, digital gold is available to make it convenient to own and manage gold. Other precious metals will likely profit from the collapse of the dollar: silver, platinum, and palladium. Gold mining stocks will be used to profit from gold’s revival because they tend to appreciate as gold becomes more valuable in the fiat currency.
There is the confiscation threat. The U.S. did once and, although eventually it didn’t work. It could happen again. Divesify. Own gold but spread it among several nations and own it in several forms. Be careful about how much of your wealth is in easy-to-freeze accounts like IRAs and 401(k)s.
Authors: James Turk managed the Abu Dhabi Investment Authority of Chase Manhattan Bank and is founder of GoldMoney.com. John Rubino, previously a Wall Street financial analyst, writes for Fidelity Magazine, Kiplinger’s Personal Finance, and CFA Magazine. He is author of How to Profit from the Coming Real Estate Bust (Rodale, 2003) and Main Street, Not Wall Street (Morrow, 1998).