Throughout the ages mankind has created many different forms of payment for goods and services with the use of both trade and money.
If you look back to the Phoenician tribes in Mesopotamia around 6,000 BC there is clear evidence that goods were traded for many types of different goods with the neighboring cities across the ocean.
In ancient Rome soldiers’ salaries were paid with the highly popular commodity of salt.
During the Middle Ages, Europeans traveled to neighboring markets with animal furs and exotic trinkets to exchange for tropical spices and attractive perfumes.
Colonial Americans traded musket balls, deer skins, and wheat.
This style of a barter economy did a good job of fulfilling the demand of the consumer – It also gave a store of value to the items of the supplier.
Commodity money, in these cases, served multiple purposes – It could be used for trade and it could be consumed by the owner. The more rare the commodity, the higher the intrinsic value that was placed on it.
As economies evolved there became additional needs for a more sophisticated payment type. Transportability and longevity became of the utmost importance to replace the financial system that existed at that time.
This demand for a more advanced financial system is what led to the rise of gold and silver as money. Gold and silver served to be far superior to many other commodities for many reasons…
- Gold and silver are rare…
- Gold and silver are not easily destructible…
- Gold and silver have a long life…
- Gold and silver are easy to carry…
- Gold and silver require no additional maintenance…
- Gold and silver can be divided into smaller denominations…
You can see the multiple benefits. And, it didn’t take long for gold and silver to be mass produced in the form of coins with their relative value stamped on them. This simplification process made payment for goods and services much more efficient.
Unfortunately, human nature devised a way of side-stepping the system by debasing the money through limiting the content of the valuable gold and silver in each coin.
Less valuable metal coins with gold and silver plating.
This resulted in local governments entering the process of creating money and preventing these counterfeiting efforts.
And, within the accumulation of vast sums of gold and silver arose a need for safety of storage. This led to the earliest forms of modern day banking with the creation of the goldsmith banker.
The goldsmith banking system, which became popular in 17th-century England, allowed a person to deposit their gold and silver with a goldsmith in exchange for a paper receipt that depicted the amount of gold and silver that was held in storage.
Paper receipts backed by gold storage could now be used as payment for goods and services.
This new paper monetary system created a certain faith in the system because at any point in time that paper receipt could be taken to the goldsmith and exchanged for the gold and silver in storage.
This is the exact reason for the faith in the United States dollar when the United States dollar is backed by gold and silver.
Eventually traders and merchants began demanding capital to expand their businesses. This created a profitable opportunity for the goldsmith bankers to lend paper receipts now showing that the borrowers had gold in storage.
However, in reality there was never any new gold added to storage.
The goldsmith bankers deemed the only way this system would break down was if everybody came and demanded all of their gold and silver at the same time.
A highly unlikely event.
This process of lending money is exactly how today’s banking system operates – Fractional-reserve banking.
As the banking system evolved there became a need to consolidate and nationalize the currency. Thus, the banks would seek a monopoly and form banking cartels that would be enforced by the governing authorities.
As banking cartels grew the Western government created central banks to regulate the money supply and control interest rates – One ring to rule them all.
However, the demand for paper currency began to far outweigh the amount of gold and silver that existed on hand.
This demand created a major problem. Initially, it was to be solved with strong trade policy and a massive military. Military conquest of other nations in search of gold and silver became the way to maintain a growing empire.
However, the constraints to these methods become severe enough to consider a new solution. It was simple, cut the backing link of the commodity to the paper currency and begin massive amounts of money printing – fiat currency.
Fiat currency can create many negative economic consequences…
- Fiat currency is not backed by any type of rare commodity…
- Fiat currency is only backed by government guarantees…
- Fiat currency has no intrinsic value…
- Fiat currency’s value can only be derived through government law…
- Fiat currency has no finite quantity…
Fiat currency is exactly where the global monetary system sits presently.
Is this a sound monetary system?
Who knows because the future is unpredictable.
But, I will tell you that fiat currency experiments have been tried before – They have all failed.
And, as we all know, history may not necessarily repeat itself, but it does rhyme.
The Definition of Money
Over the years economists have wrestled with this central idea.
What exactly is money?
At the most basic level the answer lies within three basic ideas…
- Money is a medium of exchange…
- Money is a store of value…
- Money is a unit of account…
Let’s look at these ideas individually.
Money is a medium of exchange because it is widely accepted as payment for goods, services, debts, taxes, etc. For example, the U.S. dollar is clearly an acceptable method of payment to conduct commerce anywhere in the U.S. – And even in many countries around the globe. When a merchant accepts your U.S. dollar they know, without a doubt, that they will be able to turn around and use the same U.S. dollar to make a purchase with a different merchant.
Try walking into a store and making a purchase with a handful of rocks, unless they are rare gems of course, you will most likely be met with weird looks. Rocks are not widely accepted as a payment method for goods and services. Thus, this definition of money as a medium of exchange serves a very useful purpose.
Money is a store of value because it must be able to be tucked away for use at some future date. This is the exact reason that pineapples do not serve well as money – Pineapples have a short life and lose their value over time. A U.S. dollar can be held in person for a very long time or deposited at a bank. When you go to redeem your $20 dollar bill after a period of storage, although it may not have the same purchasing power due to inflation, it will still hold the same value of $20. Money as a store of value is highly important.
Money is a unit of account because it must be able to be accounted for as a universally accepted unit. The price of goods and services would be very difficult to determine without a universally accepted unit of account.
How would a merchant be able to price goods and services if one customer wanted to pay in rocks and another customer wanted to pay in pineapples? It would be virtually impossible – Instead the customer can pay with a universal monetary system that serves as a unit of account.
How Does Fiat Currency Derive its Value?
At its core, fiat money derives no intrinsic value – When you examine a U.S. dollar it’s just a funny piece of paper with a bunch of confusing symbols and words printed on it.
The actual value and printing costs are far less than what it will be able to buy in the open market.
Today, the U.S. dollar is not backed by any type of rare commodity.
When you view the U.S. dollar in this fashion it becomes technically worthless – And governments and central banks know this fact.
To overcome these obstacles the U.S. government has required acceptance of the U.S. dollar in all domestic transactions through the passage of legal tender laws.
Americans have essentially been forced to accept the U.S. dollar as money and believe it has value – An interesting twist by Uncle Sam.
This faith and belief in the U.S. dollar’s value despite having no intrinsic value is a common trait shared by all fiat currencies.
Without this faith and belief the house of cards would inevitably crumble.
U.S. legal tender laws have created a required national demand for the dollar – Consumers must acquire dollars to pay for goods and services.
And this required demand illusion is exactly how the U.S. dollar derives its value. It is only by maintaining a perpetual faith in the U.S. dollar that our current monetary system can continue operating.
Many have pondered why governments cannot simply print enough fiat currency to do away with hot topics such as poverty, famine, and other social needs.
The truth is that economics is much more complex than printing fiat currency – There are many moving parts.
Money printing experiments very similar to the U.S. dollar have been attempted in the past.
Unfortunately, every empire that has abused this power has led to a financial breakdown.
The Fall of the Roman Empire
History has cemented the track record concerning the rise and fall of fiat currency. Every fiat currency monetary system that has been devised has failed with an accuracy rate of 100%
The demise by overproduction.
The illusion of the growing wealth of nations by increasing the money supply is a subtle foe.
The simple fact is that economic prosperity cannot be printed into existence.
Inflation arises when more fiat currency in the system is chasing fewer goods and services causing prices to rise.
Hyperinflation occurs when prices rise at a more rapid pace to out of control increases.
Stagflation happens with inflation, hyperinflation, and a slow jobs market with high unemployment.
These scenarios can spell trouble for an economy.
In Ancient Rome the massive costs of building the empire through government overspending and expanding the territory with military overextension eventually lead to the need for higher taxes. Many citizens simply began to evade this tax burden by not paying their taxes. Less tax revenue coming into the treasury while more spending for social and military going out led to a constant budget deficit.
In 64 A.D. a great fire required the Emperor Nero to rebuild the city and extract higher taxes from Rome’s provinces. In addition, Nero was forced to begin debasement of the Roman denarius, a coin made of 100% pure silver. Gold and silver coins were melted down and replaced with partially iron or copper.
With the debasement of the Roman denarius government leaders could raise vast sums of capital to finance projects.
Few citizens even noticed the new hybrid coins.
As Rome’s financial needs grew, more of these diluted coins were produced which had the effect of expanding the money supply and leading to higher prices. Towards the end of the Roman Empire the denarius coin was a mere .02 percent silver and 99.98 percent iron.
Merchants and borrowers began to lose faith in this currency.
The multiple failed economic policies and widespread currency debasement eventually lead to massive hyperinflation and the fall of the Roman Empire
This is only one example of a failed empire due to massive money printing – History is scattered with many more.
The U.S. Dollar Becomes the Global Reserve Currency
In July 1944, during World War II, the Bretton Woods Conference was held at Mount Washington hotel in Bretton Woods, New Hampshire for the purpose of discussing the economic future of the many nations that had been torn apart from the war.
Great Britain’s currency, the British Pound, was to be replaced with a more stable currency.
During this time the U.S. was sitting on a rather sizable amount of gold reserves – Thus, it only made sense that the U.S. dollar would be the most viable currency to serve as the global reserve currency for international transaction settlements.
The nations involved in the Bretton Woods Conference agreed that the U.S. dollar was to be linked to a fixed rate of exchange of $35 per ounce of gold. In addition, the foreign currencies of these nations would be linked to the U.S. dollar.
There was a faith that was created around the U.S. dollar because at any point in time any nation involved could convert their foreign currency to U.S. dollars which could then be converted to physical gold.
If a particular nation no longer felt comfortable holding the U.S. dollar they could easily trade their U.S. dollars for the more conservative holding of gold.
And if more nations wanted more U.S. dollars a larger supply of dollars would be needed.
As we already know, printing more currency leads to higher prices and a perceived economic prosperity. When asset prices such stocks, bonds, real estate, etc. are moving higher people feel more confident and are inclined to spend more.
It’s a never-ending vicious cycle, thus, creating more and more demand for U.S. dollars.
In 1965 President Lynden B. Johnson launched massive welfare and warfare programs which included the The Vietnam War and The Great Society which included the adoption of Social Security and Medicare.
With not enough gold in the U.S. treasury these massive government spending packages were to be financed through deficit spending – Borrowing money to make up the difference.
By the late 1960’s many nations that had entrusted their currency to be tied directly to the U.S. dollar began to lose faith in the United State’s willingness to properly manage this debt. These debt levels had grown to enormous amounts relative to the amount of gold on hand at the U.S. treasury.
Foreign central banks began cashing in their U.S. dollars for the safety of physical gold. The U.S. gold reserves began a rapid decline as dollars flooded back into the U.S. economy.
By 1971 the U.S. was literally bleeding gold and the U.S. had realized that the gig was up.
President Nixon Breaks the Link
Through the years of 1961 – 1971 the Federal Reserve had nearly doubled the supply of U.S. dollars with excessive money printing. The Nobel laureate Robert Mundell noted, “monetary expansion was more rapid than in any comparable period in a quarter century.”
Shockingly, foreign central banks and governments soon realized they held over $64 billion worth of claims against only $10 billion of gold held in the U.S. gold reserves.
In July 1971 Switzerland converted nearly $50 million back into gold, France demanded $200 million, and Great Britain requested nearly $3 billion shortly after.
In August 1971 President Richard Nixon gathered a small group at Camp David to devise a plan to avoid the imminent wipeout of U.S. gold reserves.
On the evening of August 15th, 1971 President Nixon effectively broke the U.S. dollar’s link to gold. Foreign governments could no longer exchange U.S. dollars for the physical bullion held within the U.S. treasury.
This was essentially the end of the gold-backed Bretton Woods system created in 1944 and the beginning of the U.S. dollar becoming a purely floating fiat currency.
In addition, the rest of the world’s currencies that were pegged to the U.S. dollar also become purely floating currencies.
This undoing meant that the U.S. now reigned free to essentially print as much fiat currency as it wished without having to worry about the constraints of gold held on reserve.
At the same time this also meant demand for the U.S. dollar would begin to decline – After all, the only reason foreign central banks and governments held the U.S. dollar was because of its convertibility into gold.
The global demand for U.S. dollars was exactly what fueled the nation to grow from a small economy to a vast empire. And the U.S. certainly did not want to discontinue its perpetual state of welfare and warfare.
Washington quickly realized that this was not going to happen and took swift action to ensure global demand for U.S. dollars would not run dry.
This was when the petrodollar system was created.
If you are interested in learning more about the Petrodollar System Click Here
As I mentioned, history doesn’t necessarily repeat itself, but it does tend to rhyme.
Excessive money printing, budget deficit spending, radical welfare policy, and a perpetual warfare state have led the United States to become the largest debtor nation in history.
The current debt of the U.S. government now reads over $29 trillion with $75 trillion+ in unfunded future liabilities such as social security and medicare.
There are 750 American bases in more than 80 countries and territories around the globe with a current budget requirement that tops $100 billion each year.
As with Rome, we have seen this path before and it doesn’t end well.
The simple truth is that financial turbulence lies ahead as more and more begin to realize the extent of the fragility of our fiat monetary system.
I would strongly argue that it only makes sense to protect some of your wealth with physical storage of gold and silver outside of the banking system.
There is no downside to hedging your savings with gold and silver at an off-shore facility located within a stable jurisdiction.
If you are interested in learning How to Buy Gold and Silver Bullion in the Safest Place in the World Click Here
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To your passive income lifestyle,
Justin Ash, Founder/ Member