Currencies in ‘FIAT Folly' - face Abyss of destruction Investment Indicators from Peter George March 12, 2004 PART ONE Scripture […] Summary This is a story about the folly of government intervention in free markets. The trail we expose has its source high in the mountains of central bank control and manipulation, driven by a joint determination to protect their ill-fated FIAT money system. The word ‘FIAT’ comes from the Latin word ‘fieri’ and means ‘Let it be done’ or ‘Let there be made’. When combined with the word ‘money’, as in ‘FIAT Money’, it is used to describe: ‘an inconvertible paper currency which is made legal tender by a fiat of government’. The phrase ‘fiat of government’ refers to ‘an authoritative pronouncement’ by government, to the effect that citizens accept printed paper currency, as if it were ‘real money’. The word ‘money’ also comes from Latin, in this case ‘moneta’ meaning ‘to mint’. It follows that for ‘money’ to be ‘real’ – in contrast to FIAT - it needs to consist of coins produced in a ‘mint’, as opposed to paper printed in a press. The metal will then have intrinsic value. This was certainly the case when coins were made from gold and silver. The modern day story of FIAT money begins with a brief history of government efforts to suppress the price of gold, focusing on America’s actions since the founding of the Federal Reserve in 1913. We explain why suppression of gold was pivotal in promoting the US Treasury’s “strong dollar policy” of the past decade. We show why, with the ‘dollar bubble’ recently having burst, central bank gold strategies are increasingly falling into disarray. Suppression of the dollar price of gold is no longer possible. New techniques of intervention must be found to slow the dollar’s slide and protect the US bond market. Failure will allow free market forces to vent their wrath on 22 years of stock market excess and property price exuberance. Then expect the following chain of events. The dollar slide becomes a rout. This in turn precipitates the panic sale of foreign-held US government bonds. The resulting crash in bond prices automatically implies a sharp rise in long term interest rates. In dollar terms bond values will fall more than 50%. The hard currency equivalent could be closer to 80%. As with the Dow, the bubble in bonds has been building for all of 22 years. In May 1981, 30-year bond rates peaked at over 15%. By May 2003 – 22 years later – they had plunged to a multi-year low of 4,2%. In the June bond sell-off one month later, rates bounced back to 5,4%. If one looks at an arithmetic chart - more sensitive than log -there was a hint of trouble as long ago as May 1999. At that point rates broke up out of a long-term falling wedge formation. Although they subsequently went on to make new lows, they never pulled back into the old formation. They stayed above the down trend, and the original break still stands. Given the 30 year bond’s current yield of 5,0%, even a 1% rise to 6% would puncture the white-hot US housing bubble by ratcheting up mortgage rates. Down pressure on house prices would kick away the last remaining prop to consumption by killing off the ‘refi’ market. Homeowners would be prevented from repeatedly increasing their bonds to draw out endless gobs of cash. Once started, the decline in prices would feed on itself, finally shattering the biggest debt bubble of all time. The fallout could lead to a Russian-style hyperinflationary depression as government responds to the crisis by printing to stave off a total economic collapse. If this sounds too extreme, consider the following. It is an extract from a recent issue of The Privateer, a newsletter published in Australia: “The Federal Reserve puts out a Flow of Funds Report …known as Z-1….it states that over the past year total US credit market debt increased by $2.784 trillion, or 9%.When that increase is placed side by side with annual US Gross Domestic Product – a slightly optimistic $11 trillion – it shows that last year the US economy BORROWED 25,3% of its latest annual GDP!...If that borrowing had NOT taken place THEN THE US ECONOMY WOULD HAVE CONTRACTED BY THAT SAME 25,3%!..The US economy is a bankruptcy waiting to happen.” In other words, a resumed slide in the dollar can trigger a domino effect. As foreigners dump US bonds to avoid exchange losses, it could precipitate a crack in government bond prices, and therefore a sharp rise in rates. This will immediately feed through to the corporate and mortgage markets, fast curbing the highly-geared American appetite for debt. Halting the spiral would at once wipe out 25% of the following year’s GDP, tipping the US economy into depression. If consumers actually begin to SAVE, the scale of economic shrinkage in the first twelve months could massively exceed anything experienced in the aftermath of the ’29 crash. In the period 1930 to 1933 annual GDP declines averaged 8% per annum. This one would be three times that figure in the first year alone. Yet THAT is what is necessary, if Americans are to learn to live within their means, pay back debts, and retain the remotest chance of preserving the long term integrity of their currency. The purpose of this letter is to study the alternatives available for coping with the deflationary consequences of eliminating the US trade deficit and restoring the liquidity of American households. To date the only solution being put forward is one of postponing the evil day of reckoning by keeping the wheels turning. This requires taking on more debt for the US as a nation, more debt for US corporations, and more debt for US consumers. Central banks fearful of a dollar fall and its consequences for their own economies have shied away from addressing the issue of exploding US deficits. To the contrary, those of them anxious to protect their nations’ exports have sought short term relief by supporting the dollar through intervention in the currency markets. In this they have been colluding with a US Administration desperate to maintain economic momentum, as it readies itself for elections in November. Japanese actions over recent months have been a perfect example of this strategy. By printing Yen to purchase dollars, Japanese financial authorities have been able to subscribe for increasing quantities of US Treasuries bills. They have played a key role in sustaining US deficit spending at current levels. Others have not yet decided what to do. The European Community is a case in point. At the latest G7 meeting in Florida, while calling for ‘currency flexibility’, they railed against ‘too much instability’. We are convinced they will be induced to buy dollars, following in the footsteps of Japan. The ultimate consequences of rising central bank intervention could be profound. It may well lead to a co-ordinated explosion of paper, the end result of which could be a ‘FIAT Folly’ of destructive proportions. We are reminded of the quote by the late British economist Lord Robbins. When reviewing the aftermath of the 1929 crash in 1933, he said: “The size of the bust is directly proportional to the size of the preceding boom.” In defiance of the above truism, it was current Fed Chairman Alan Greenspan who boasted, many years before attaining to his present position: […] His wish has been granted. Let us see whether the laws of economics and the principles of sound money will bend to the whims of a man who displays incipient signs of smoking economic pot. Whatever the path chosen, one thing is certain, the buying of gold offers a safe haven second to none, more particularly as the FIAT system begins to crumble. The other certainty is that the days of central banks being able to suppress the price of gold are over. To the contrary, they might be forced to recognize that the neatest way to sidestep major economic collapse could be through the re-introduction of gold as money – but at a price far higher price than most can conceive. The Japanese and Chinese could drive it together. One would combine the massive savings of the former with the growing economic strength of the latter, exchanging US dollars and dollar bonds, both for US gold. If the price chosen were high enough, the exchange would STRENGTHEN the dollar, not weaken it, by helping clear US debts. $2500 an ounce would be a useful STARTING point. 1. Origins and History of US Gold Strategy The purveyors of FIAT money have always treated gold as enemy number one. Over the centuries they have done their best to denigrate the metal’s role as the ultimate store of value. The latest state of play in the currency markets suggests another victory for gold is imminent. To find out why, we need historical perspective. 1.1 From Roman coin-clipping to Chinese bark money Official denigration of gold has been with us for 2000 years, long before the advent of central banks. Roman emperors used to clip their coins, melting down the off-cuts. In the beginning it meant they could mint more coins using less gold. When the precious metal ran out, they would replace it with brass and copper. The new coins cost less to produce and had little intrinsic worth. Their real value depended on the power of the emperor to force their acceptance on an unwilling public through an act of FIAT. A Chinese emperor went further down the road towards a pure paper currency. He wrote his decrees on pieces of bark and declared THEM to have value. 1.2 Formation of the Federal Reserve In 1913 the long-term fate of the gold-backed dollar was sealed with the formation of a privately owned Federal Reserve. A small group of extremely wealthy individuals were given sole right to print notes and control the US money supply via their banks. Enabling legislation was rushed through Congress prior to a Christmas, when everyone was going home. The subsequent printing of paper, in lieu of gold and silver coins, was in blatant contravention of the US Constitution which exclusively specified the former. Moreover, and in contrast to its name, there was nothing ‘federal’ about the ‘Fed’, nor does it keep anything like enough ‘in reserve’. It remains private to this day. We are indebted to The Privateer for the additional facts about the Fed given below. In the preamble to the legislation which gave it birth, was the following statement of intent: “An Act to provide for the establishment of Federal Reserve banks, to furnish an elastic currency…” Compare this to Isaac Newton’s reply when asked why, when Master of the Mint in Britain in 1717, he FIXED the British currency to a known and given weight of gold. “Gentlemen, in order to calculate, you MUST DEFINE YOUR UNIT.” Small wonder the buying power of the Fed’s elastic currency has collapsed over the passage of time. 1.3 Gold confiscation profits used to establish ESF In 1933, in cahoots with then President Roosevelt, the money powers confiscated all gold coin and bullion. Two years later the US Treasury was instructed to raise the price of gold from $20 an oz. to $35. All profits from this heinous transaction accrued to a little known branch of the US Treasury, called the Exchange Stabilization Fund. (ESF) It was to operate independently of Congress, on express instructions from the President and the Treasury Secretary. It would use the pool of assets acquired through its profits on the confiscation of citizens’ gold holdings, to manipulate both currencies and the price of gold in the future. It would grant loans in defiance of the wishes of Congress. This occurred in 1995 when, despite a Congressional veto, the ESF rescued Mexico with a $40billion loan. Thereafter the ESF became the main vehicle through which US financial authorities, having ostensibly dumped the official gold standard, would unofficially pay homage to gold’s continuing role by manipulating and suppressing its price. Their main purpose was to protect, by default, the dollar and US bonds. Gold is the world’s financial thermometer. By massaging its readings markets would be lulled into a false sense of security. 1.4 Monetary Policy, Gold, and the Great Depression - Bernanke In a recent address to Lee University, Washington, on March 2, Fed Governor Ben Bernanke set out to apportion blame for the policy mistakes of the Great Depression. Drawing on a book written by Milton Friedman more than 40 years ago, he says Friedman ascribed most blame to errors by the Fed which repeatedly led to an ‘undesirable tightening of monetary policy, as reflected in sharp declines in the money supply’. Friedman particularly blamed the Fed for raising rates in the spring of 1928, in face of sharply declining commodity prices. He also laid blame at the foot of the conventional Gold Standard. In the above address Bernanke gratefully latched onto Friedman’s remarks, using it as an opportunity to pillory gold. Naturally Bernanke himself has an agenda. He hates the discipline of gold, loves the illusion of creating wealth via FIAT money, rejects the whole concept of falling prices as something which should never be allowed, and fears the return of gold. He knows full well the dethroning of the dollar will force the US to enter a painful period of adjustment as it learns afresh to live within its means. Bernanke admits that during the ‘classical’ gold standard period, stretching from 1870 to the beginning of World War 1 in 1914, international trade expanded markedly. Central banks experienced few problems. This ensured that currencies retained their value, both against one another and gold. He points out that during the war the standard was suspended because of disruptions to trade, and because countries needed financial flexibility to finance the war. After 1918, when the war ended, he says nations made extensive efforts to reconstitute the gold standard, believing it would be a key element in the return to normal functioning of the international economic system. He says that, contrary to expectations, the gold standard as reconstituted in the 1920’s proved both unstable and destabilizing. He gives reasons which, if carefully studied, show that the gold standard never had a chance of working. Here are the reasons. The war left behind enormous economic destruction, large government debts, banking systems whose solvency had been compromised by periods of HYPERINFLATION during the war. These underlying problems created stresses for the gold standard which had not existed before the war. The system lacked effective international leadership. During the classical period, the Bank of England, in operation since 1694, provided sophisticated management of the entire international system. After the war, with Britain financially depleted and the US in ascendance, leadership passed to the Fed. “Unfortunately, the fledgling Fed, with its decentralized structure and it’s inexperienced and domestically focused leadership, did not prove up to the task of managing an international gold standard.” Finally, and after World War 11, new labour-dominated political parties rose to power which were sceptical of the merits of maintaining a gold standard if it in any way threatened employment. Bernanke concluded that declines in the money supply in the post-World War 1 period, induced by adherence to the gold standard, were a principal reason for economic depression, but that those countries leaving the gold standard were able to avoid the worst effects and begin an earlier process of recovery. As a case in point he mentions that one of Roosevelt’s first actions as President was to float the dollar, resetting its value at a significantly lower level. What Bernanke does not explain is the following: After the disruptions of World War 1, the price of gold should collectively have been raised substantially, with weaker currencies devaluing in relation to their stronger counterparts. Instead Britain went back at the old rate, as did most other countries. No account was taken of the inflationary effects of war. Yet intrinsic currency values had all been undermined. When the US reset the value of its dollar in 1935, it did so in terms of GOLD. The price was raised from $20 an ounce to $35. Foreign central banks were helped to settle outstanding war debts to the US, selling off gold at higher prices. Increasing the price gave a major boost to world liquidity and assisted in the process of effecting a general reduction in debts. As in any cyclical upturn, this was a necessary pre-condition to encouraging post World War II economic recovery. What Bernanke does not tell us is that recovery in the US itself was deliberately sacrificed by the pernicious manner in which Roosevelt went about raising the price of gold. First he confiscated all gold in the hands of the public. Only later did he raise the price. This ensured that all profits accrued to the secret Exchange Stabilization Fund. Imagine the boost to money supply in the US if the benefits had remained in the hands of the public. But you can bet your bottom dollar the private owners of the Fed had their own gold stored offshore and were able to realize the full benefits of the rise in price, as and when it suited them, tax free and offshore. They knew it was coming. 1.5 Bretton Woods displaces the Gold Standard The Bretton Woods Agreements of July 1944 took the limited 1935 demonetization of gold a step further. Instead of merely banning purchases of the metal by US citizens, having been shattered by reckless government spending during World War II, the Gold Standard itself was replaced with a Gold Exchange Standard. Bretton Woods achieved this by declaring the US Dollar to be ‘as good as gold’ – but only for official transactions between foreign governments. They were given the RIGHT to exchange their dollars for gold at will. Few bothered to do so until there was a perceived threat that the exchange was no longer capable of being honoured. Quelle: http://www.lemetropolecafe.com
