" Thus came a collapse in manufacturing and commerce, just as it had come previously in France: just as it came at various periods in Austria, Russia, America, and in all countries where men have tried to build up prosperity on irredeemable paper (worthless money.)" from: Fiat Money Inflation In France.
In the late eighteenth century, the French Revolution lead to deteriorating socio-economic conditions throughout the nation. The money supply climbed to staggering levels, resulting in a financial crisis of epic proportions. In fact, excess fiat currency exacerbated tenuous living conditions, which in turn catapulted living costs to unimaginable heights. Similarly, rising energy, commodities and precious metals prices indicates the return of domestic inflation. This article compares excerpts from the classic financial text: Fiat Money Inflation In France, with the current domestic economy in order to demonstrate conclusively that gold and silver backed money remains the only suitable remedy for national inflation.
BACK TO THE FIAT
" To cure a disease temporary in its character, a corrosive poison was administered (Printing Fiat Money), which ate out the vitals of French prosperity." from: Fiat Money Inflation In France.
The nation of France experienced two monetary travesties in the 18th century. The first national experiment with fiat money is remembered as, John Law's, Mississippi Scheme. John Law's infamous machinations promoted the distribution of paper money in 1719, approximately 70 years before the French Revolution. Until that point, the nation relied exclusively upon gold and silver coinage. Law's experiment with paper money mirrored the result of all fiat currencies throughout history: complete economic collapse and financial ruin.
Thus, by the year 1789, the French populace was acquainted with the perils of fiat money. Fiat Money Inflation in France probes the latter experiment with unbacked paper money during the Great French Revolution. The government of the newly emancipated masses exceeded available treasury funds. As a result, politicians printed mountains of unbacked money, which flooded the nation like the spent carcasses of the 17 year cicada. The second monetary debacle was as detrimental to national welfare as the first:
" New issues of paper were then clamored for as more drams are demanded by a drunkard...The great majority of Frenchmen now became desperate optimists, declaring that inflation is prosperity. Throughout France there came temporary good feeling. The nation was becoming inebriated with paper money. The good feeling was that of a drunkard just after his draught; and it is to be noted as a simple historical fact, corresponding to a physiological fact, that, as draughts of paper money came faster the successive periods of good feeling grew shorter... " from: Fiat Money Inflation In France.
Thus, by 1790, the ensuing monetary disaster lead to morose living conditions and social upheaval. In fact, merely five years elapsed between the onset of inflation and the inevitable economic calamity. During that brief period, many essential goods increased in price by more than one hundred fold. For instance, a bushel of flour cost approximately 40 cents in 1790. By 1795, the same quantity of flour rose by ten fold to $45. Similarly, a small cartload of lumber rocketed higher from $4 to $500, an astronomical increase in excess of 1,000%.
" Prices of the necessities of life increased: merchants were obliged to increase them, not only to cover depreciation of their merchandise, but also to cover their risk of loss from fluctuation; and, while the prices of products thus rose, wages, which had at first gone up, under the general stimulus, lagged behind. Under the universal doubt and discouragement, commerce and manufactures were checked or destroyed..." from: Fiat Money Inflation In France.
Consequently, inflation statistics from the 18th century indicate difficult times ahead for the domestic economy. For instance, a typical sandwich costs $3, at present inflation levels. Yet, as inflation rates approach the hyper-inflation figure of that period, price increases by 1000%. Few domestic families could afford such prices. In fact, $20 per gallon of gasoline, $15 per loaf bread, $35 per gallon of milk and a $200 meal for a family of 5 is possible. If the previous statistics seem implausible, hyper-inflation figures from the past show that they are not only possible but relatively conservative.
IRRATIONAL EXPANSION
" Early in the year 1789 the French nation found itself in deep financial embarrassment: there was a heavy debt and a serious deficit." from: Fiat Money Inflation In France.
For decades, careless Federal Reserve monetary expansion has over-stimulated the economy. As a result, mountains of unbacked paper money, excessive debt and incalculable deficits jeopardize national solvency. Protective Federal Reserve policies secured economic growth at the expense of inflation. Records indicate that economic collapse is the inevitable result of such currency manipulations.
Indeed, the Monetarists at the helm of the Federal Reserve insist that increased liquidity is required to rejuvenate national conditions. Although economic stability is the intent of such monetary policies, excessive infusions create deleterious side effects. The insurmountable surplus of fiat money has caused disequilibrium within the economy. The unending flow of dollars has forced the economy toward a precipice. The dollar is held hostage to monetary decision makers, as was the French currency of the late 1890s:
" La Rochefoucauld proposed to issue an address to the people showing the goodness of the currency and the absurdity of preferring coin. The address was unanimously voted. As well might they have attempted to show that a beverage made by mixing a quart of wine and two quarts of water would possess all the exhilarating quality of the original, undiluted liquid." from: Fiat Money Inflation In France.
Eventually the dollar bubble will burst as excessive monetary liquidity further threatens economic solvency. In order to better illustrate the danger of unregulated liquidity one can compare the economy to an expanding rubber balloon. For instance, each time the balloon (economy) sags, more air (money creation) is introduced. The balloon remains intact until it expands beyond the bursting point. Following decades of monetary stimulus, the economy cannot sustain its present, over-inflated state.
Indeed, until 2005, monetary growth climbed sharply following the September 11th, 2001 terrorist attack, a fateful episode in American history. The Federal Reserve cushioned the economy from a stock and bond market crash and decrease the likelihood of panic by increasing liquidity. Although the short-term affect was market stabilization, the long-run result is damaging inflation and currency collapse. Thus, Irrational expansion is eroding confidence in the dollar as the global reserve currency.
Thus, declining dollar value in 2003-2004, relative to global currencies, temporarily boosted sales and enhanced the competitiveness of many U.S. manufacturers. Yet, dollar erosion leads to hyper-inflation. At first, runaway inflation appears to offer an economic advantage to manufacturers. Price hikes for manufactured goods are implemented without a proportionate increase in wages paid. However, the scenario changes abruptly as domestic consumers curtail purchases for manufactured items due to lower wages earned. For instance, during the 1970's, food, gas, clothing and energy prices advanced faster than real wages. During inflationary periods, wages tend to lag far behind price hikes. Higher prices without an incremental rise in personal income places considerable pressure upon fixed income as well as lower to middle income families:
" Strange as it might seem to those who have not watched the same causes at work at a previous period in France and at various times in other countries, while every issue of paper money really made matters worse, a superstition gained ground among the people at large that, if only paper money were issued and were more cunningly handled the poor would be made rich. Henceforth, all opposition was futile."
From: Fiat Money Inflation In France.
Consequently, scoffers insist that a domestic inflationary disaster is unrealistic. Pundits tout fiat money's important qualities: its lightweight, easily stored and transported. Yet gold and silver backed paper money has the identical qualities. The unfolding monetary dilemma stems from the intangible aspects of paper money, not the tangible. Paper bills are not problematic, when each bill is properly backed. However, the dollar has no gold or silver support and thus the entire monetary system is in jeopardy:
"Various bad signs began to appear. Immediately after each new issue (money growth) came a marked depreciation; curious it is to note the general reluctance to assign the right reason...New issues only increased the evil; capitalists were all the more reluctant to embark their money on such a sea of doubt... The decline in the purchasing power of paper money was in obedience to the simplest laws in economics...(Supply and Demand.)" from: Fiat Money Inflation In France.
Moreover, U.S. dollar gold backing was abolished in 1971. The dollars decoupling from gold and silver ushered in the Great American Bubble. Since that point, paper assets have flourished beyond the dreams of avarice. The resulting inflationary boom diverted hyper-inflated dollars into alternative routes. Firstly, funds flowed into precious metals beginning in 1971, which culminated in 1980 with an incredible peak in gold and silver prices. Next, the stock market expanded from 1980 until 1999, an astounding 20 year period of growth. The final inflation peak culminated in the U.S. real-estate and bond market bubbles and a the current bull market in gold and silver assets.
Clearly, the chart above illustrates the degree that Federal Reserve policies affected the 1990's stock market boom. The 1980's yielded similarly impressive stock market results. Expansionary policies distorted the equilibrium within the national supply and demand for money. Consequently, the stock and bond market, real estate and dollar bubbles resulted. A euphoric domestic economy roared forward for two decades, fueled by loose monetary restraints.
However, Isaac Newton's third law of motion holds true in monetary concerns as well: for every action there is an equal and opposite reaction. The temptation to continually print dollars for 2 decades has become a self perpetuating inflationary cycle. The peak of the artificial economic boom has given way to an inflationary disaster. Clearly, unsustainable money growth is steering the nation toward, a Fiat Money Inflation in France style, economic disaster:
"...doubling the quantity of money or substitutes for money in a nation simply increases prices, disturbs values, alarms capital, diminishes legitimate enterprise, and so decreases the demand both for products and for labor." from: Fiat Money Inflation In France.
Indeed, declining dollar value in 2003-2004, relative to global currencies, temporarily boosted sales and enhanced the competitiveness of many U.S. manufacturers. Yet, dollar erosion leads to hyper-inflation. At first, runaway inflation appears to offer an economic advantage to manufacturers. Price hikes for manufactured goods are implemented without a proportionate increase in wages paid. However, the scenario changes abruptly as domestic consumers curtail purchases for manufactured items due to lower wages earned. For instance, during the 1970's food, gas, clothing and energy prices advanced faster than real wages. During inflationary periods, wages tend to lag far behind price hikes. Higher prices without an incremental rise in personal income places considerable pressure upon fixed income as well as lower to middle income families.
"PONZI" DOLLARS
" Still another troublesome fact began now to appear. Though paper money had increased in amount, prosperity had steadily diminished. In spite of all the paper issues, commercial activity grew more and more spasmodic. Enterprise was chilled and business became more and more stagnant. Whenever a great quantity of paper money is suddenly issued we invariably see a rapid increase of trade." from: Fiat Money Inflation In France.
Unrestricted monetary expansion has resulted in the worlds greatest Ponzi scheme. Ponzi schemes guarantee exorbitant returns to each subsequent investor. However, the profits used to reward the original participants are merely the entry fees of the final group of unwitting investors. As a Ponzi scheme progresses, it becomes apparent that the last group of investors will receive zero profits as well as lose their initial investment.
Similarly, the dollar Ponzi scheme was financed by well meaning investors worldwide. Considered as safe as gold, U.S. bonds were exported to satiate global demand for secure interest payments. However, the surplus U.S. bonds has diluted investor demand. The Federal Reserve must now raise interest rates to combat inflation, which in turn decreases demand for government bonds.
Yet, bond values are inversely related with interest rates. In fact, merely the threat of higher rates worries bond investors. Climbing interest rates reduces the value of existing bonds. Thus, in order to decrease exposure to "Ponzi" dollars, investors will lower portfolio exposure to U.S. bond holdings and add a competing asset class: gold and silver related investments.
TREASURY BONDS: FIAT IOU
As the government increases debt to fund domestic projects, the national debt continues to reach lofty peaks. For decades, much of U.S. debt has been shipped abroad, away from North America. Thus inflation has remained relatively tame. Yet, as global bond holders collectively liquidate debt positions, dollars will flood back into the U.S. creating an instantaneous hyper-inflationary scenario. Several economic events could trigger investors to sell U.S. debt instruments:
1) Renewed dollar deflation.
2) Economic weakness/recession.
3) Climbing interest rates.
4) Unregulated, interest rate sensitive derivatives.
1) Renewed dollar deflation: In recent years, most dollars denominated assets have lost considerable value. Although the dollar exhibited considerable strength in 2005, the multi-year downward trend against world currencies is likely to resume. As the dollar continues to wane, U.S. bonds will become less attractive. Eventually, demand for U.S. debt will diminish and market liquidity will evaporate. The deluge of dollars returning to domestic shores will threaten economic stability.
2) Economic weakness/recession: Ironically, following decades of U.S. manufacturing dominance, the nation now consumes more than it produces. In fact, the ravenous appetite for globally manufactured goods encourages demand for U.S. bonds. Yet a significant recession or depression would drastically decrease the spending habits of the American public. The resulting loss of demand for imported goods would decrease foreign demand for new bond issues. If American demand for globally manufactured goods declines, U.S. debt will lose its luster and an economic tailspin will commence.
3) Climbing interest rates: Following decades of decline, interest rates reached the lowest level in forty years. Low rates were fomented, in part, by the loose monetary policies of central banks. As inflation becomes apparent to the general public, the Federal Reserve will be forced to raise interest rates to far higher levels. In fact, the Federal Reserve has increased rates at several consecutive meetings. Bonds eventually lose value in an environment of escalating rates. Thus, U.S. bond sales will force a staggering supply of dollars back into the American economy - leading to hyper-inflation.
4) Rate Sensitive Derivatives: Derivatives are sophisticated financial instruments used to offset market risk, based upon one or more market conditions such as interest rates. Climbing rates negatively impact interest rate sensitive derivatives. Unregulated derivatives mask hidden and oftentimes unlimited risks.
(Part II next week)