Inflation, Debasement or Both

August 25, 2003 – Debasement is a word often used to describe money, or more precisely, the decline in the value of a currency. According to Webster’s, it means “to lower in status, esteem, [or] quality.” That definition surely applies to the dollar, and many other national currencies for that matter. But debasement also has another meaning.

Again according to Webster’s, it means “to reduce the intrinsic value of [coins] by increasing the base-metal content”. We all know how kings and emperors of old reduced by deceitful deception the precious metal in a coin, using base metal in its place. What few today realize is that this type of debasement is still being practiced. In other words, it’s not only coins that can be debased, but paper money can be debased as well.

To understand how the dollar can be debased, it is necessary to look at the monetary balance sheet of the dollar. Here is the current balance sheet:

As with all balance sheets, there are assets and liabilities. The monetary balance sheet basically reflects in a summary form the aggregate assets and liabilities of the nation’s money cartel, the Federal Reserve and the commercial banks.

I use the word cartel purposefully. Only the Federal Reserve and the banks have been granted by government the special and lucrative privilege of allowing their liabilities to circulate as dollar currency.

The liabilities of General Electric do not circulate as currency. The liabilities of Dell Computer do not circulate as currency, nor do the liabilities of any other American company, except the banks. Only the banking cartel has been granted this extraordinary privilege.

The Federal Reserve creates cash-currency. These “Federal Reserve Notes” are the paper currency in your wallet or purse. The banks create deposit-currency, which are dollars that circulate as currency by check and wire transfer. By aggregating the liabilities of these banks, we get M3, which is the total quantity of dollars in circulation.

Turning to the assets in the balance sheet, we see that there are two. There is the gold asset of the Federal Reserve, which is its claim to the US Gold Reserve of 261.6 million ounces. Marked-to-market at the June 30^th gold price of $347.70, this gold is worth 91.0 billion of the units of account we call dollars.

The other asset is the IOU’s owed to the banks and the Federal Reserve. These are the government bonds owned by the banks as well as the loans extended by banks to their customers. These IOU’s are calculated by subtracting the gold asset from total assets, which is the same value as M3 because balance sheets must always balance.

This juxtaposition of assets and liabilities in this construct I call the ‘monetary balance sheet’ makes clear an important aspect of the dollar. Unlike a coin of precious metal, the dollar itself does not have any inherent value. How could it? The dollar is nothing but liabilities of the banking cartel, and liabilities are obligations, not assets. The dollar only has value because the assets that back it have value, and the most important asset is the gold. It is the only tangible asset being used to impart value to the dollar. The other assets consist entirely of intangible financial assets of varying quality and worth.

Having established this background information, the best way to now illustrate the debasement of the dollar is to look at the monetary balance sheet at two different periods, comparing one to the other. Here is the balance sheet as of December 31^st, 1979.

It’s hard to believe, but in less than 23 years, M3 has grown nearly five-fold. The dollar is being inflated by this excessive growth. During the same period, the gold asset has declined by 35.9%. This decline is attributable to two factors.

First, the total weight of gold declined by 3 million ounces, from 264.6 million ounces. Second, the dollar’s rate of exchange to gold – what is colloquially referred to as the ‘gold price’ – has dropped by $188.80, or 35.2%. As a result of this decline in the value of the gold asset as well as the increase in the quantity of total liabilities, the dollar has been debased.

At December 31^st, 1979, gold imparted 7.85% of the value to the dollar. As of June 30^th, 2003, gold only provided 1.04% of the value of a dollar. Long-time readers of these letters will recognize these calculations. This formula is of course my Fear Index, which explains what debasement is all about.

When confidence in the monetary and banking system is high, the dollar is readily accepted without question. But when the monetary and banking system is called into question and confidence as a result is falling, people naturally move away from this bookkeeping currency called the dollar into the safety of gold. The reason of course is that gold is money that is not anyone’s liability. It is a tangible asset, in complete contrast to the dollar, which is a liability of financial institutions full of loans to companies like Enron and Global Crossing as well as countless other deadbeat debtors.

Just like a coin is debased by reducing its gold content, the dollar can also be debased by reducing its gold content. So we can see that a 1979-dollar is very different from a 2003-dollar because the dollar had a 7.85% gold content in 1979 but only has a 1.04% gold content in 2003. So not only has the dollar been inflated by more-than quadrupling in the total quantity of dollars, it has also been debased over this period by 86.8%. The implications of this debasement are staggering.

Nearly everyone knows about the dollar’s steady decline in purchasing power. Inflation became a buzzword long before 1979. But few people realize how little gold backs the dollar. Considering that the dollar is only a ‘money substitute’ (a liability of the banking cartel) and not money itself (a tangible asset), it seems likely that an adjustment in the gold price is imminent.

In other words, it is not necessary to increase the weight of the US Gold Reserve to restore the gold value of the dollar; all that is necessary is to increase gold’s price. I expect that the dollar is about to be devalued against gold, just like the dollar was devalued in 1934, when it required 35 dollars to buy one ounce compared to 20.67 dollars before the devaluation. That was a 69% devaluation of the dollar (a 1.69-times increase in the price of gold). This time the dollar’s devaluation I expect will be much greater, and it will also be different in one other respect.

The 1934 devaluation was completed by government edict, because the dollar – which was still defined back then as a weight of gold – was simply redefined. This time the dollar’s relationship to gold will be ‘re-defined’ by the free-market. An increasing number of people will continue the trend that began in July 1999, dumping dollars in exchange for gold.

If the gold price rises so that the dollar only goes back to the 7.85% level it reached in December 1979, gold will touch $2,624. But I know what you are thinking. I purposefully chose December 1979 (when gold was on its way to over $800 per ounce) to make this comparison so that I would show an eye-catching increase the gold price. Well, that wasn’t my objective.

In fact, I chose December 1979 because the 7.85% gold content prevailing then happened to precisely equal the average monthly gold content of the dollar since the formation of the Federal Reserve in 1913. If I wanted to really wanted to calculate an eye-catching number for the gold price, I would have chosen the 29.9% peak reached in the Great Depression. That would give a gold price of $9,996 per ounce.

These gold price projections of course assume that the quantity of dollars remains unchanged, which is highly unlikely. The dollar will continue to be inflated. After all, that is its recent history – so the dollar is losing purchasing power because it is being both inflated and debased. The dollar is all about fear, and the flip-side of that coin is the safety and security of gold.