first majestic silver

Fiat Currency

November 2, 2005

"We inflate our paper currency, we repair commerce with unlimited credit, and are presently visited with unlimited bankruptcy."

- R.W. Emerson, The Young American, 1844

According to the Chambers Dictionary of Etymology, the verb "inflate "- means increasing the money supply. "The US currency has been increasing at a rate of 10% above it's GDP growth rate for more than twenty years" According to a book titled "Triumph of the Optimists: 101 Years of Global Investment Returns" there is a continuous spread of inflationary damage done to the world's currencies. Its happening not only to the dollar, but to all paper currencies, which while nobody appears to be watching, all seem to be engaged in a race to the bottom. Continuous Monetary Inflation is uniquely a 20th century problem that continues to the present day.

Prior to Central Bank controlled monetary systems, money consisted of commodity-backed money. Inflation, then, was most often a product of temporary suspensions of the commodity standard, usually occurring during wars or panics. At times, inflation occurred as the supply of gold and silver grew. (the Discovery of America) There were spikes in some countries and regions during certain periods of time when the supply of gold jumped due to discoveries (California during the gold rush, for example). But, by and large, a dollar in 1900 had held its purchasing power with the dollar of 1800. The 20th century American had a vastly different experience. "A dollar bill put under the mattress 101 years ago would today have only 4.2 cents purchasing power. That is, four cents in 1900 had the same purchasing power as $1 in 2000." Put in another way - that's a loss of 95%. Furthermore, the pace of price increases was much greater in the period subsequent to 1970, where, annual prices rose at a 5.1% clip compared to 2.4% for the first seventy years of the century. Makes you think how and why to days FED thinks 2% per year of rising prices it not inflation. What is particularly scary about the dollar is that it has been the third-best-performing currency in the world. Only the Swiss franc and the Dutch guilder have held up better. In the UK, for example, the rate of price increases over the same full 101-year period was 4.2%, compared to the 3.2% in the U.S. - a seemingly small difference. And yet, compounded over time, U.K. prices increased 55-fold, a factor more than 2 times that of the U.S.! Keeping in mind, that the dollar has lost 95% of its purchasing power... it still beats almost all of its rivals, sometimes by very large margins.

The performance of fiat currencies in the past century has been dreadful. But what has changed? If anything, the monetary setting of today is much worse than that of the 20th century, for at least in the earlier part of that century there was still a gold standard. Up until 1971, there was some semblance, however weak, of an international gold standard. The monetary shackles on today's central bankers are, much more lenient. Hence, the threat of inflation is far more lethal. As horrid a performance as the dollar turned in for the 20th century, the 21st might make it look pretty good in comparison. Paper monetary systems have a tendency to blow up, in what is commonly called a hyperinflation. They are really not so rare. looking back at the 20th-century experience, has heard of the famous German hyperinflation of 1922-23, where price inflation was 3,422% in 1922 alone (and where, in January 1923, one could buy a dollar for 20,000 marks - but by early November it took 630 billion marks to buy that same dollar). The numbers are simply staggering and hard to comprehend. Yet, Hungary's hyperinflation of 1945-46 was even more spectacular, with price inflation of 19,800% per month. Phillip Cagan wrote, in the 1950s, what many consider to be a classic study of hyperinflation, in which he set the definition of the term hyperinflation at an arbitrary inflation rate exceeding 50% per month. Even so, Cagan still manages to find seven hyperinflations meeting his definition, the limiting factor being that these seven were the only ones where monthly price data was available. They include the great German hyperinflation, two in Hungary and also hyperinflations in Austria, Greece, Poland and Russia. These all occurred between 1921 and 1946. Witness, then, that the phenomenon was not a rare thing. To update Cagan, the more recent hyperinflations were mostly in emerging markets. According to "The Realities of Modern Hyperinflation") some of the more recent ones occurred in places like Argentina, Bolivia, Brazil, Peru and the Ukraine and that doesn't cover them all. Further searching provided examples of devastating hyperinflations in Zimbabwe, Zaire, Georgia and Nicaragua. Large inflations but not quite Hyperinflations occurred since 1998 in Malaysia and other far east emerging countries as well as Russia and I suspect there are many more but they did not keep records.

The most interesting part of the IMF researchers' essay was their conclusion. They wrote: "The benign inflation environment of recent years may lead some to believe that chronic high inflation and hyperinflation have been eradicated for good. History suggests that such a conclusion is not warranted." Indeed, that is precisely the point. Do not be deceived by only the most recent experience. Structurally, all the pieces are in place to experience very high levels of price inflation or that it was only 2% last year. Don't forget the magic of compounding. Crystal ball gazing on monetary systems is still extraordinarily difficult.. There are lots of things that can happen along the way. It was not that long ago - 1996, to be exact - that economist Steven Hanke wrote a piece titled "Argentina, the 'Germany' of South America." He meant the Germany of the post-WWII era, where the sturdy mark proved to be one of the world's most stable currencies. His case rested mainly on the passage of tougher laws and a currency board-like system. This prediction, of course, proved very far off the mark, since the Argentina of today is trying to recover from its most recent financial meltdown. Far from being the Germany Hanke envisioned, it became more like the Germany of the 1920s. This is not to say hyperinflation is imminent in the U.S., but it does pose the question because the U.S. Dollar is the worlds only reserve currency. However, with the EU now expanded by ten countries to twenty five, the Euro could now more possibly either take the Dollars place or become a dual reserve currency, just as the British lb was for a while in the early 1900's: That in conjunction with the attempted emergence of the GOLD DINAR, all points to the dangers of men with printing presses. And it points to the weakness of the dollar - or any paper currency - as a long-term investment.

To be Fore Warned is to become Fore Armed. In spite of what I think of Greenspan as an economist, he has been one hell of a FED Chairman, prolonging and forestalling, what I had thought to be, the inevitable for more than five years now. But his term ends in Jan. 2006 and will his replacement have the same acumen and world wide trust to carry on successfully. Even if Ben Bernanke the new Chairman is every bit as flamboyant as Greenspan was how long can one central banker go on manipulating and fooling the whole world, let alone us lowly Americans.

Unless every definition and every book ever written on INFLATION is completely wrong, rampant inflation followed by deflation and depression is inevitable. The only question remaining is not IF but When does the big charade begin to unravel?

My guess is that the first signs have already begun to show themselves with the most recent PPI figures of 9% and 5% core rates of inflation and if anything these numbers are understated.

The Greenspan Conundrum is not a conundrum at all. Twelve straight Discount Rate increases in conjunction with massive money supply expansion is his way of forestalling the inevitable until he his safely Retired and out of office; so that the coming tragedy will fall on some else's watch and his legacy is preserved.

To give the devil his due, he is trying to raise interest rates sufficiently to at least bring them into positive territory (1.5% above the inflation rate) so that when the "S hit's the fan" the FED will at least have some wriggle room to sharply cut interest into a rapidly increasing recession. But this time, unlike 2001-2003 there will be no massive Income tax cuts to save the day.

The Bible teaches us that there is a "Time and a Place for everything" and that "every dog has its day". Well I think the Day of the long Suffering Gold Bug is upon us, and now is the "time and the place" for GOLD GOOD LUCK and GOD BLESS.


Aubie Baltin CFA, CTA, CFP, Phd. (retired)

Palm Beach Gardens, FL

[email protected]



2 November 2005

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