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Who Are the Guinea Pigs This Time?


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( March 11, 2016) 

Boy, this was a rough task, coming back after two years and trying to write some worthy commentary about money and gold. Gold’s price action is the easy question, and here’s the short answer about gold prices versus the US dollar: after trending downward from its all time peak dollar price of $1895 in September 2011, and bottoming at $1049.40 about three months ago, gold prices have gained some $200 so far in calendar year 2016.

But we don’t hear all that much about gold so far this year, despite its being the best performing asset class since 2016 began. Instead, the loudest noises you hear today come from the Presidential campaign now going on, and the possible results of that circus in November cannot be ignored. Take your pick - the revolutionary socialist, the reality-show demagogue, the ‘fiercely friendless’  Texan, and the unindicted baggage queen –  one of them almost certainly will be elected president of the United States come November. A logical and timely question is: The election of which of those candidates would likely cause gold prices to go down? Answer: none of the above.

Not to mention the extraordinary events abroad: disruptions and chaos in Syria and the Middle East, the continued threat from ISIS, the rise of Putin’s Russia, China’s expanding influence and island-claiming in the South China Sea,  Europe’s troubles holding the EU together in light of the migrant crisis, and the threat of Great Britain exiting the European Union.

But in terms of relevance to gold itself, it seems to me that the most striking aspect of our situation in March of 2016 is the continued practices of the Fed and Treasury to experiment with money, monetary policy, and interest rates, despite the failure of any such interventions to actually revive our unenergetic economy over the past seven years. The underlying danger in such actions is that our faith-based currency, the fiat US dollar, is a modern experiment itself, begun in 1971 with the abandonment of the dollar’s ties to gold. In a sense, we are all lab rats, or guinea pigs, in this economy based on a modern concept of money that is far, far distant from money’s traditional meaning over the past millennia.

The following is the short, short history of money from its inception. Feel free to skip the next few paragraphs if you already understand the concept that precious metals, in standard weights and fineness, historically are money itself.

It’s like this: Money was invented in the form of gold and silver coins around 600 BC, and the concept was an immediate hit. Local transactions were made vastly easier by the use of precious metals coinage instead of barter. But more importantly, the use of coins of intrinsic value made world trade possible.
Of course, it wasn’t too long before the idea of printing paper money, at first backed by gold and silver, came into being when a government (China in this case) decided that representations of money could be printed on paper, rather than struck of scarce gold or silver, and made to circulate by official decree:

“Paper bills were first used by the Chinese, who started carrying folding money during the Tang Dynasty (A.D. 618-907) — mostly in the form of privately issued bills of credit or exchange notes — and used it for more than 500 years before the practice began to catch on in Europe in the 17th century. While it took another century or two for paper money to spread to the rest of the world, China was already going through a fairly advanced financial crisis: the production of paper notes had grown until their value plummeted, prompting inflation to soar. As a result, China eliminated paper money entirely in 1455 and wouldn't adopt it again for several hundred years.” –, “10 Things You Didn’t Know About Money.”

Over time, other paper currencies issued as a substitute for gold and silver likewise failed utterly. The 13 British colonies of America ‘printed’ money that spectacularly failed, as finally did the “Continental Currency” paper issued by the United States during the War of Independence. France in the 1790s did the same, with John Law’s ‘assignats’ printed as a substitute for gold and silver, eventually destroying billions in wealth in a few scant years. During the US civil war, the Union and the Confederacy raced to print money to finance the war. Confederate paper fell to zero value when the South lost, and Union legal tender notes traded at a steep discount to gold coins for 15 years after the war. Other total paper money failures included Germany in the 1920s, France again, Argentina, Brazil, Mexico, and pretty much every country that ever tried to issue paper that could not be converted to gold at a fixed price. If un-backed currencies didn’t collapse entirely, they inflated wildly, losing value so fast that they were suitable only for spending, as ‘saving’ such monies simply guaranteed a loss of wealth over time.

By the end of World War II, the United States dollar, convertible internationally to gold at a fixed price of $35/ounce, was the last major gold currency standing. The Bretton Woods agreement of 1944 tied 44 major countries to a system based on each country ‘pegging’ their currency to the US dollar, with the US providing the stability by making a market in gold, buying and selling at the $35/ounce price.
But in August of 1971, the United States, with its gold reserve draining out at a rapid rate as countries turned in paper dollars for gold, terminated the agreement, making the dollar a free-floating fiat currency.
In short, traditional money came to an end in 1971, and we started our modern experiment: money issued by the government, not convertible to gold, with its supply and price under unrestricted government control. 
Today, the first lesson we learn from this experiment in fiat money is inflation. Gold began the year 1971 at $35 per ounce, and in 2011 traded at $1895 per ounce. So far, this is pretty much exactly what can be expected from fiat money. Yet, we still use dollars, and inflation has been under control now for most of the 21st century. As a matter of fact, today the Fed targets an inflation rate of about 2%, and is struggling to get it there. And so, more experiments are coming.

Which brings us to our two modern money experiments, born of academic group-think, both of which completely ignore what average people expect money to be and do. Could there be any ideas dumber than negative interest rates, and the War on Cash?
Negative interest rates now prevail in Japan and the European Central Bank, the idea being that discouraging the parking of money, and encouraging the lending and spending of money, will stimulate the economy and bring on needed inflation.

Paul Davies and Richard Barley wrote an article entitled “Positives Are Elusive in Negative Rates Move” in the Wall Street Journal March 9, and led off with:

“Banks and insurers don’t like it, borrowers are seeing little benefit from it and savers and pensioners fear their money is being eaten away by it: the policy of negative interest rates is an unpopular as it is mysterious. The European Central Bank looks likely to cut rates further into negative territory this week and yet no one really knows exactly how it is supposed to help.”

Even our own Janet Yellen at the Fed is said to be ‘considering’ negative interest rates, not content with today’s already tiny positive rates. “I wouldn’t take them off the table but we would have work to do to make sure they would be workable,” she said February 11th at a meeting of the Senate Banking Committee. The low rates/no rates/negative rates experiment has essentially eliminated the centuries-old practice of actually earning money when one lends out one’s cash. For those who’ve saved up money to live off the proceeds in retirement, this is a disaster.

Of course, the first rational reaction to negative interest rates is to cash out one’s bank accounts. But, not so fast. The War on Cash aims to make that much harder to do.
Recently we have seen lots of discussion, chatter, and noise about the coming death of cash and the subsequent triumph of electronic payments instead. Cash, particularly large bills such as the 500euro and USD $50 and $100 notes, have been described as tools for aiding and abetting terrorists, criminals, money launderers, tax evaders, human traffickers, and drug dealers (not to mention ordinary folks who, logically, don’t want to experience negative interest rates). The elimination of cash would, of course, mean that our transactions would all be handled by intermediaries taking their cut: Paypal, American Express, Square, Visa, Apple, Mastercard – each would have their hand out on all exchanges. 

The contrary view, that cash is convenient, useful, and one of mankind’s greatest economic inventions, is seldom heard. But there was this last week from Carl-Ludwig Thiele, the board member most involved with cash issues at Germany’s central bank, Bundesbank:

“I have my doubts that introducing a cash limit or getting rid of bigger denominations can really prevent terrorists or criminals from engaging in illegal activities. We also should ask ourselves: what sort of an understanding of government forms the basis of these proposals? Citizens should not be put under general suspicion.”

A world without cash would mean, of course, that all our monetary transactions would be handled by intermediaries. So taking their cut of every purchase would be private entities such as Paypal, American Express, Square, Visa, Apple, Mastercard, and probably more.

Today we find that the great Fiat Dollar Experiment, born circa 1971, seems to have taken off into the 4th dimension - negative interest rates are on the horizon, quantitative easing is now the world monetary standard forever, and support grows among  the elites for a War on Cash, for the good of everybody, of course.
Yet don’t these trends threaten the viability of our dollar? If money shrinks in the bank, rather than growing; if central banks the world over are now convinced that no matter how much money they print, inflation will always remain elusive; if we strive to demonize and /or eliminate cash – don’t these efforts seem designed to lessen the attractiveness of holding dollars and other currencies? Shouldn’t the Fed and Treasury act more conservatively here, rather than subjecting our money to radical experiments which have shown few positive results? Isn’t there the risk that our fiat dollar, now 45 years old, can only take so much abuse, and may prove to be more fragile than the Federal Reserve and Treasury Department imagine?

Gold as an investment yields no income, fluctuates in value, and is too risky for ordinary investors, or so goes the standard recitation of why gold should play no part in anyone’s portfolio.

However, gold will still be valuable long after the world’s present currencies have faded into nothingness. So, under what circumstances would gold be a good and prudent purchase? If today’s wacky and off-the-mark experiments in official monetary manipulation don’t immediately suggest gold as a viable asset class, then you have to ask yourself, what would? And do you think a bell will ring when that time comes?

-Richard Smith, March 11, 2016


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