‘Heading for a Fall’

March 1, 2004 – An article in the February 26th issue of The Economist addresses the issue head-on. Even its title is provocative, “Heading for a fall, by fiat?”, and its subtitle appears even more confrontational, “The trouble with paper money”. The entire article is posted at the following link: www.economist.com.

Long-time readers of these letters know that I often disagree with The Economist, and from time to time I hold their feet to the fire when they pontificate their anti-gold views. I did this most recently in Letter No. 331 this past September, advising you to ignore an article that had just appeared in their magazine in which they tried – as is usual for them – to disparage gold. The timing of their article appeared when gold had just ratcheted upward into the $370’s in a trend that eventually took it over $400. My article was entitled “Parting You From Your Money”, which I think is apt because it describes what would have happened had you listened toThe Economist.

So whenever I read The Economist I do it with a jaundiced eye, understanding as I do that as apologists for the Bank of England, their foremost objective is to preserve the status quo in the international monetary arena and to preserve at all costs the privileged position the banking elite has carved out for itself.

So while I recommend that you use the above link to read the entire article, please keep in mind that while The Economist doesn’t go as far as I would like (no surprise there), I do find it pleasantly surprising to see that it has gone as far as it has. Their editorial staff no doubt recognizes the ‘writing on the wall’, namely, that the monetary system they have defended for so long is crumbling around them.

In order to help you get through some of the propaganda and pitfalls of their article, I quote below in italics some parts of it, and thereafter include in brackets my comments. The quoted sections appear in order as the article was written, with three periods (…) noting skipped material.

Is the problem with the dollar only that it is falling?… America needs a weaker dollar to correct its current-account deficit. [Here they state some conventional wisdom, but is it true? I recently noted that imported oil is rising in price to offset the (GoldMoney.com) falling dollar, which suggests a weak dollar is not going to correct the US trade imbalance. What is the cause of a weak dollar? It’s credit expansion – it expands dollar supply. Too many dollars lower the value of any one dollar, so its exchange value against other currencies declines. Of course a magazine that defends the banking system would never admit that too much credit could possibly be the problem for anything, lest anyone suggest that credit be restrained, which would thereby negatively affect bank profits.] But given the dollar’s role as a currency of last resort [A novel description. I think they mean to say that it is the world’s reserve currency, because I am uncertain about what it is the ‘last resort’ for, or why The Economist would use this amateurish description.], some wonder if its decline heralds not just an economic adjustment by the United States, but a crisis of sorts in the value of paper money itself. [Notice how they begin to frame their argument, pointing the blame to some faceless “paper money”, when it would be more correct to point to the cause of those problems and to the issuers of that paper, i.e., banks and governments. Paper money does not spontaneously self-procreate out of nothing. Bankers and governments created it and promote it because they benefit from it. They don’t do it for you and me.]

Money in its present form is a relatively new invention. For most of human history money meant either gold or silver [Money still means gold or silver to thinking people who understand the essential nature of money, but The Economist never misses an opportunity to talk up its loony monetary theories and to malign gold.], either directly, or indirectly by means of the “gold standard” which meant, at least in theory, that all paper money was backed by gold. [Note the “in theory” disclosure. Paper money was never fully backed by gold because of credit expansion by the banks, which debased the currency by maintaining only ‘fractional reserves’, the instability of which caused bank runs, panics and economic disruption.] Enthusiasm for the gold standard evaporated in the 1930s, when it made dreadful conditions worse. [Wrong, bank credit expansion of the 1920’s caused the inevitable bust in the 1930’s, which was made worse by government intervention and mismanagement. Note the statist tone of The Economist – governments can do no wrong, so they need a scapegoat. It was easy to make the gold standard the scapegoat because few people question then or now government pronouncements, even in the gold mining industry whose economic interests are at stake.] But it was adopted in a watered-down version after the second world war, when only the dollar was backed by gold. This arrangement made some sense, since America held three-quarters of the world’s gold stock. [A non-sequitor. The US held 3/4ths of the world’s gold stock because after the devastation of WW II, it held 3/4ths of the world’s wealth.] But it came to an end in 1971, when inflationary pressures in America caused the country’s manufacturers to become uncompetitive and forced the country off the gold standard. [Nonsense of course. The dollar had become debased by credit expansion, not uncompetitive manufactured products. Because one ounce of gold was worth more than $35 because of dollar debasement, a monetary panic developed. Rather than devalue the dollar as Franklin Roosevelt did under similar circumstances, Nixon broke the dollar’s formal link to gold.] Since then the world has relied on “fiat money”, so-called because it is created by government fiat and is backed only by the promises of central bankers to protect the value of their currencies. It is the value of those promises that some are now questioning. [Only now? Just some? Countless sound money advocates have been questioning those promises for years, but their voice is drowned out by government anti-gold propaganda, which all too readily appears in publications like The Economist.]

Certainly, those promises have only been worth much in recent years. [Here they are trying to put lipstick on a pig, acknowledging the government-caused monetary disasters of the 1970’s, but pretending recent experience was satisfactory. Inflation today continues to hack away at the purchasing power of national currencies, not to even mention the economic disruption and misallocated resources that occur because of volatile exchange rates.] In the early years of fiat money, inflation took off, especially in America, in part because of the two oil shocks of the 1970s. This debased the value of the dollar, and the price of gold climbed from $35 an ounce to $850. [Wet streets do not cause rain. The debased dollar caused the oil shocks. Oil rose in dollar terms to keep up with the dollar’s debasement. That is still the case. In gold terms, oil today is the same price it was in the 1950’s.]

It was only in 1979, in his famous “Saturday night special”, that Paul Volcker, then chairman of the Federal Reserve, raised interest rates sharply to clamp down on inflation. [Raising interest rates to try saving the dollar is not an option today in this over-indebted economy. Higher interest rates would kill the economy, cause bad debts in banks to rise, which in turn would cause a banking crisis – not to even mention the derivatives that hang precariously over the banks.] The gold price subsequently fell sharply and in its place came a bull market in government bonds that has, with a few sharp interruptions, continued to this day. [Bonds peaked a couple of years ago. They’re in a bear market, but their prices appear stable because Asian central banks are buying them with dollars from their currency interventions.] Although central banks around the world still hold about 30,000 tonnes of gold in their reserves [No, they hold only about 18,000 tonnes at most because the rest has been loaned, probably to never be repaid back. Labeling gold on loan as part of their reserves is just one of many common central bank deceptions.], many have been offloading their stocks over the years. They can earn only a nugatory rate of interest on these stocks (by lending them out) compared with what they can earn on government bonds. [This is laughable. Just look at the losses the Bank of England has taken since selling half of its gold.] For most people, gold has been relegated to the status, in the words of Keynes, of a “barbarous relic”; [Wrong, Keynes used this term to describe the ‘gold standard’, not gold. And it was a relic because governments had broken all the voluntary rules that made it work so well from circa 1708 when Sir Issac Newton invented it until its demise in 1914. By breaking the rules that made it function so well, the gold standard no longer worked in an increasingly statist world.] its price has risen only feebly when investors have fretted about inflation. [The work published by www.GATA.org  I think establishes without any doubt that governments have kept gold from rising to its natural level as a way to try downplaying the ongoing dollar debasement.]

Those who doubt the continued worth of paper money as a store of value [i.e., those people out there whose thinking defies conventional wisdom] point to two things. The first is that the price of gold has been rising even though official inflation is low [Note their use of the word official. Everyone knows the unofficial rate of inflation is rising because the so-called ‘official’ inflation numbers are being distorted and massaged by governments to make them look good.] … But the rise in the price of gold in particular has raised questions.

The biggest of these—and the second main reason for concern—is the amount of debt that rich-country governments have been running up. [Finally, they are turning toward the real culprit – credit expansion, but don’t be surprised if they do not mention banks as part of the problem.] America’s official budget deficit has surged in the three years since George Bush became president, to around $520 billion and climbing. But this is just the shortfall this year. The government’s total future liabilities are much larger … European governments are only slightly better at managing their budgets … Japan’s attempts to coax its economy back to life have left it with a gross national debt of some 160% of GDP, the highest of any big country. No country has tried harder to debase its currency. [There you have it. Governments work hard to debase their national currency, and The Economist tries to make it sound like a good thing. Governments make promises to pay benefits in dollars, yen or euros. Those promises get the politicians elected, but are unrealistic to keep. So rather than maintain the value of the currency, they cheapen the currency to lower the real cost of the promises – which get cheapened by the currency debasement.]

In theory, such debts would not be tolerated for long by investors, since the easy way out for central banks is to “monetise” them with inflation [which is what in fact central banks are doing]. Bond prices would fall (and thus yields rise) as investors worried that they would be paid back in a debased currency. But capital markets currently seem oblivious to spiraling debts [No, only The Economist is oblivious. What hubris for it to suggest that its hack writers know more than the body of knowledge encompassed in the prices expressed in the capital markets.] … Perhaps, too, investors have been lulled into a false sense of security by the performance of central banks in recent years [Just like The Economist never misses an opportunity to disparage gold, it never misses a chance on the opposite side of the spectrum to praise the bankers that have created today’s monetary mess.], and the independence that has been granted to many of them by governments. [This independence is a myth. Where it was granted, it was eventually taken back – the Bundesbank is just one obvious example.] But this very aura of inviolability may be storing up problems, since it means that governments can borrow still more at cheap rates. And if governments then find themselves crushed by debt, you can rest assured that this independence will be taken away. And then, once again, the paper in your pocket will only be as good as a politician’s promise. [It’s only as good as that now, and who in their right mind values the promise of any politician.]

Despite my criticisms of The Economist because of their disinformation in this article as well as their biases, it is an interesting article and one worth contemplating. It seems that today’s monetary turmoil has become so great thatThe Economist feels compelled to start pointing its finger at governments and paper money, thereby trying to frame and publicize the arguments to make sure that no fingers get pointed at the banks.