The Collapse of the Fiat System
All fiat currencies eventually go to zero value, and usually they do it in less than forty years. We now are in year forty-one.
On August 15, 1971, President Nixon decoupled the U.S. dollar from gold in connection with international payments. That action made the U.S. dollar a pure “fiat” currency, with no backing other than the promise of the Federal Reserve to replace one dollar with another dollar. Today, as the Fed continues to devalue the currency and serious investors turn to gold reserves, we are beginning to see the collapse of the fiat system.
Consider the real rate of inflation experienced by Americans during the forty-one years since the end of Bretton Woods. That real inflation rate—1,400 percent in the aggregate, according to ShadowStats—is substantially higher than the “official” rate calculated by the United States Bureau of Labor Statistics. The nominal price of gold, having risen from just below $100 per troy ounce when gold ownership by Americans was relegalized during 1974 to over $1,500 per ounce currently, perfectly mirrors the loss of the U.S. dollar’s purchasing power.
With respect to certain commodities essential to modern life in America, especially gasoline, the nominal price of precious metals (gold and silver) has more than compensated for the loss of the dollar’s purchasing power. This point was illustrated remarkably well in an exchange on the morning of Wednesday, February 29 between Congressman Ron Paul and Federal Reserve chairman Ben Bernanke during the Fed Chairman’s testimony before Congress’s Committee on Financial Services.
During his questioning of Mr. Bernanke, Congressman Paul, a longtime Fed foe and author of End the Fed, extracted a U.S. one-ounce silver eagle from the left pocket of his suit coat. Brandishing that coin, Paul schooled the Fed chairman about how well that one ounce of silver had retained its real worth compared to Mr. Bernanke’s fiat Federal Reserve notes.
Congressman Paul informed Chairman Bernanke that in 2006, when Bernanke took over the reins at the Fed, an ounce of silver bought about four gallons of regular unleaded gasoline. Paul then described that the value of that same ounce of silver can purchase eleven gallons of gasoline today, notwithstanding that the nominal price of gasoline is the highest it ever has been on the last day of any February. “That’s preservation of value,” said Paul, waving the silver eagle. It also is emphatic proof of the loss of value of the U.S. dollar.
It is not only the dollar that is losing substantial purchasing power. Every major central bank on the planet is creating their equivalent of trillions of dollars of new fiat money. The European Central Bank, under the control of “Super Mario” Draghi, is digitally printing euros and engaging in dollar-swap agreements with the U.S. Federal Reserve to fund the bailouts of the failing European states, including but not limited to Greece. China’s central bank, the Peoples Bank of China (PBOC), is printing yuan (aka renmibi) to exchange for the dollars that have flooded into China as a result of the enormous, chronic trade imbalance between the United States and China. Japan’s central bank, the Bank of Japan (BOJ), is printing yen to deflate the value of the Japanese currency so that Japan can continue to export that country’s wares. Even the Swiss have pegged their formerly “hard” currency to the euro, so as the euro declines in aggregate purchasing power, the Swiss franc loses its value as well.
Economists refer to the actions taken by the world’s central banks as “competitive devaluation." This policy, undertaken to reduce the burden of sovereign debt and to “keep exports cheap," means that wealth preserved in bonds and bank accounts (essentially fiat-money equivalents), no matter in which currency, is declining. Stated more plainly, the value of the savings of billions of people is being stolen by the hidden tax of inflation resulting from the endless money printing of the central banks. It is for this very reason that small investors, big investors and, most significantly, the central banks themselves are purchasing and taking delivery of precious metals. For example, according to the FinancialTimes, China increased its gold holdings to 1,054 metric tonnes by acquiring at least 227 tons during the fourth quarter of 2011.
In April of 2011, when gold was selling in the mid-$1400 range, the University of Texas (UT) endowment fund took delivery of $1 billion worth of gold. Generally, institutions do not take delivery of commodities they intend to trade or resell in the short term. They take delivery only when they intend to hold that position for a long time. In the case of UT, its billion dollars of gold was acquired because of the metal’s merits as a wealth preserver over the long term. Kyle Bass, the hedge-fund manager who advised the UT endowment fund to take delivery of the bullion, suggested that UT’s investment was undertaken as a hedge against worldwide currency debasement, represented by the endless, and accelerating, printing of fiat money. Sure, the daily swings in the futures market for gold and silver make the trading of those commodities the exclusive province of experts. Do not attempt it at home. But gold and silver bullion coins (e.g., Canadian maple leafs and U.S. eagles—not the collectibles, sold with huge premiums over the spot price, that so many TV pitchmen are offering) are essential for wealth preservation. This is particularly true when the volume of world fiat money increases at an exponentially increasing rate, as it has since the beginning of the financial crisis, while interest rates on Treasury securities are engineered by the Fed to remain far below the real rate of inflation.
“What we are witnessing today is the end stages of a grand experiment,” Paul said as he addressed Chairman Bernanke. That forty-one year experiment in fiat money is failing. It is no different this time than it ever has been in history. All fiat currencies eventually go to zero value, and usually they do it in less than forty years. We now are in year forty-one. Is Bernanke smarter than history? The University of Texas does not think so.
Jay Zawatsky is the CEO of havePower, LLC (a natural gas infrastructure developer) and a professor of business in the dual degree MBA program of the University of Maryland University College.